UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D. C. 20549
                                    FORM 10-Q

(Mark One)
 X       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 
---      EXCHANGE ACT OF 1934

For the quarterly period ended       September 30, 1998

                                                        OR

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

For the transition period from                          to

Commission file number      1-7179

                                   SONAT INC.
             (Exact name of registrant as specified in its charter)

           DELAWARE                                             63-0647939
(State or other jurisdiction of                             (I.R.S. Employer
 incorporation or organization)                            Identification No.)

           AMSOUTH-SONAT TOWER
           BIRMINGHAM, ALABAMA                                    35203
(Address of principal executive offices)                       (Zip Code)

Registrant's telephone number:                               (205) 325-3800


                                   NO CHANGE
(Former name, former address and former fiscal year, if changed since last 
report)


         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.

                                   Yes X No _

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

                         COMMON STOCK, $1.00 PAR VALUE:

               110,032,997 SHARES OUTSTANDING ON OCTOBER 31, 1998



<PAGE>


                           SONAT INC. AND SUBSIDIARIES

                                      INDEX
<TABLE>
<CAPTION>

                                                                                                              Page No.

PART I.       Financial Information

              Item 1.      Financial Statements

                           Condensed Consolidated Balance Sheets
                               (Unaudited)--September 30, 1998 and
<S>                                                                                                          <C>
                               December 31, 1997                                                               1

                           Condensed Consolidated Statements of Operations
                               (Unaudited)--Three Months and Nine Months Ended
                               September 30, 1998 and 1997                                                     2

                           Condensed Consolidated Statements of Cash Flows
                               (Unaudited)--Nine Months Ended
                               September 30, 1998 and 1997                                                     3

                           Notes to Condensed Consolidated Financial
                               Statements (Unaudited)                                                          4 - 18

              Item 2.      Management's Discussion and Analysis of Financial
                               Condition and Results of Operations                                            19 - 35

PART II.      Other Information

              Item 6.      Exhibits and Reports on Form 8-K                                                   36 - 37
</TABLE>





<PAGE>
                          PART I. FINANCIAL INFORMATION
Item 1.  Financial Statements
                           SONAT INC. AND SUBSIDIARIES
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                                   (Unaudited)
<TABLE>
<CAPTION>

                                                                               September 30,                December 31,
                                                                                   1998                         1997
                                                                               -------------                ------------
                                                                                                             (Restated)
                                   ASSETS                                                      (In Thousands)
Current Assets:
<S>                                                                                <C>                       <C>       
    Cash and cash equivalents                                                      $   10,620                $   27,278
    Restricted cash (Note 3)                                                            -                       115,956
    Accounts receivable                                                               351,363                   619,581
    Inventories                                                                        71,440                    65,161
    Income taxes                                                                        1,714                     1,985
    Gas imbalance receivables                                                          11,737                    16,644
    Assets from trading activities                                                    125,068                    92,150
    Other                                                                              29,144                    42,052
                                                                                   ----------                ----------
       Total Current Assets                                                           601,086                   980,807
                                                                                   ----------                ----------

Investments in Unconsolidated Affiliates and Other                                    699,552                   553,618
                                                                                   ----------                ----------

Plant, Property and Equipment                                                       8,457,665                 7,830,697
    Less accumulated depreciation, depletion
       and amortization                                                             5,818,460                 4,264,917
                                                                                   ----------                ----------
                                                                                    2,639,205                 3,565,780
                                                                                   ----------                ----------
Deferred Charges and Other:
    Assets from trading activities                                                     28,169                     9,638
    Other                                                                             140,483                   142,271
                                                                                   ----------                ----------
                                                                                      168,652                   151,909
                                                                                   ----------                ----------

Total Assets                                                                       $4,108,495                $5,252,114
                                                                                   ==========                ==========

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
    Long-term debt due within one year                                             $  109,829                $   14,508
    Unsecured notes                                                                   637,276                   446,721
    Accounts payable                                                                  342,414                   615,322
    Accrued income taxes                                                               19,758                    18,274
    Accrued interest                                                                   44,691                    37,242
    Accrued long-term compensation (Note 3)                                             -                        73,799
    Gas imbalance payables                                                             11,434                    14,320
    Liabilities from trading activities                                               120,271                    85,398
    Other                                                                              41,517                    75,299
                                                                                   ----------                ----------
       Total Current Liabilities                                                    1,327,190                 1,380,883
                                                                                   ----------                ----------

Long-Term Debt                                                                      1,100,591                 1,235,984
                                                                                   ----------                ----------

Deferred Credits and Other:
    Deferred income taxes                                                             158,065                   485,950
    Liabilities from trading activities                                                18,015                     5,014
    Other                                                                             161,995                   182,507
                                                                                   ----------                ----------
                                                                                      338,075                   673,471
                                                                                   ----------                ----------
Commitments and Contingencies

Stockholders' Equity:
    Common stock and other capital                                                    179,514                   167,786
    Retained earnings                                                               1,223,990                 1,858,871
                                                                                   ----------                ----------
                                                                                    1,403,504                 2,026,657
    Less treasury stock                                                                60,865                    64,881
                                                                                   ----------                ----------
       Total Stockholders' Equity                                                   1,342,639                 1,961,776
                                                                                   ----------                ----------

Total Liabilities and Stockholders' Equity                                         $4,108,495                $5,252,114
                                                                                   ==========                ==========
</TABLE>

                             See accompanying notes.

<PAGE>


                           SONAT INC. AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (Unaudited)
<TABLE>
<CAPTION>

                                                                        Three Months                      Nine Months
                                                                   Ended September 30,                Ended September 30,
                                                                  ----------------------             --------------------
                                                             1998              1997              1998              1997
                                                             ----              ----              ----              ----
                                                                      (In Thousands, Except Per-Share Amounts)

<S>                                                          <C>              <C>               <C>              <C>       
Revenues                                                     $  874,497       $1,073,715        $2,908,772       $3,053,169
                                                             ----------       ----------        ----------       ----------

Costs and Expenses:
    Natural gas cost                                            512,592          690,315         1,827,809        2,013,706
    Electric power cost                                         133,667           98,993           314,279          174,849
    Operating and maintenance                                    39,098           49,845           118,828          132,666
    General and administrative                                   28,053           29,974            86,705          116,702
    Depreciation, depletion
       and amortization                                          85,991          101,773           278,866          290,156
    Ceiling test charges                                        455,027            -             1,035,178            -
    Restructuring costs                                           -                -                15,017            -
    Taxes, other than income                                      9,391           11,308            36,826           28,210
                                                             ----------       ----------        ----------       ----------
                                                              1,263,819          982,208         3,713,508        2,756,289
                                                             ----------       ----------        ----------       ----------

Operating Income (Loss)                                        (389,322)          91,507          (804,736)         296,880

Other Income, Net:
    Equity in earnings of
       unconsolidated affiliates                                 16,668            8,876            43,848           28,443
    Minority interest                                              (882)            (448)           (2,513)          (1,244)
    Other income, net                                             4,735            1,059             6,699            8,563
                                                             ----------       ----------        ----------       ----------
                                                                 20,521            9,487            48,034           35,762
                                                             ----------       ----------        ----------       ----------

Earnings (Loss) Before Interest
    and Taxes                                                  (368,801)         100,994          (756,702)         332,642

Interest:
    Interest income                                                 938            1,467             4,201            3,662
    Interest expense                                            (34,470)         (26,763)         (101,392)         (78,134)
    Interest capitalized                                          1,220            1,791             4,092            5,658
                                                             ----------       ----------        ----------       ----------
                                                                (32,312)         (23,505)          (93,099)         (68,814)
                                                             ----------       ----------        ----------       ----------

Income (Loss) Before Income Taxes                              (401,113)          77,489          (849,801)         263,828

Income Tax Expense (Benefit)                                   (142,697)          25,141          (304,039)          87,636
                                                             ----------       ----------        ----------       ----------

Net Income (Loss)                                            $ (258,416)      $   52,348        $ (545,762)      $  176,192
                                                             ==========       ==========        ==========       ==========

Basic Earnings (Loss) Per Share
    of Common Stock                                          $    (2.35)      $      .48        $    (4.96)      $     1.60
                                                             ==========       ==========        ==========       ==========

Diluted Earnings (Loss) Per Share
    of Common Stock                                          $    (2.35)      $      .47        $    (4.96)      $     1.58
                                                             ==========       ==========        ==========       ==========

Weighted Average Shares
    Outstanding                                                 110,034          109,926           110,017          110,164
                                                             ==========       ==========        ==========       ==========

Weighted Average Shares Outstanding-
    Assuming Dilution                                           110,034          111,397           110,017          111,716
                                                             ==========       ==========        ==========       ==========

Dividends Paid Per Share                                     $      .27       $      .27        $      .81       $      .81
                                                             ==========       ==========        ==========       ==========
</TABLE>


                             See accompanying notes.

<PAGE>


                           SONAT INC. AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)
<TABLE>
<CAPTION>

                                                                                             Nine Months
                                                                                         Ended September 30,
                                                                                    ----------------------------------
                                                                                     1998                    1997
                                                                                     ----                    ----
                                                                                           (In Thousands)
Cash Flows from Operating Activities:
<S>                                                                                 <C>                     <C>        
    Net income (loss)                                                               $  (545,762)            $   176,192
    Adjustments to reconcile net income (loss) to
       net cash provided by operating activities:
          Depreciation, depletion and amortization,
              including ceiling test charges                                          1,314,044                 290,156
          Deferred income taxes                                                        (315,090)                100,518
          Equity in earnings of unconsolidated
              affiliates, less distributions                                            (36,868)                (23,926)
          Change in:
              Accounts receivable                                                       269,057                  74,823
              Inventories                                                                (6,280)                (11,709)
              Accounts payable                                                         (289,313)                (54,128)
              Accrued interest and income taxes, net                                      9,204                 (41,744)
              Accrued long-term compensation                                            (73,799)                 20,758
              Other current assets and liabilities                                      (18,853)                  5,711
              Net change from trading activities                                         (3,574)                 (2,930)
          Net change in restricted cash                                                 115,956                    -
          Other, net                                                                      7,355                  22,260
                                                                                    -----------             -----------

              Net cash provided by operating activities                                 426,077                 555,981
                                                                                    -----------             -----------

Cash Flows from Investing Activities:
    Plant, property and equipment additions                                            (653,658)               (760,562)
    Net proceeds from disposal of assets                                                259,991                   7,413
    Investments in unconsolidated affiliates and other                                 (109,923)                (21,955)
                                                                                    -----------             -----------

              Net cash used in investing activities                                    (503,590)               (775,104)
                                                                                    -----------             -----------

Cash Flows from Financing Activities:
    Proceeds from issuance of long-term debt                                            500,000               1,497,000
    Payments of long-term debt                                                         (541,935)             (1,172,125)
    Changes in short-term borrowings                                                    190,555                  77,167
                                                                                    -----------             -----------
       Net changes in debt                                                              148,620                 402,042
    Dividends paid                                                                      (89,117)                (69,635)
    Treasury stock purchases                                                             (1,289)                (51,316)
    Other equity                                                                          2,641                   9,629
                                                                                    -----------             -----------

              Net cash provided by financing activities                                  60,855                 290,720
                                                                                    -----------             -----------

Net Increase (Decrease) in Cash and Cash Equivalents                                    (16,658)                 71,597

Cash and Cash Equivalents at Beginning of Period                                         27,278                  48,009
                                                                                    -----------             -----------

Cash and Cash Equivalents at End of Period                                          $    10,620             $   119,606
                                                                                    ===========             ===========

Supplemental Disclosures of Cash Flow Information
Cash Paid for:
    Interest (net of amount capitalized)                                            $    88,215             $    68,821
    Income taxes paid, net                                                                8,724                  22,969
</TABLE>




                             See accompanying notes.


<PAGE>


                           SONAT INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

1.       Basis of Presentation

         The accompanying  condensed  consolidated financial statements of Sonat
Inc. (Sonat) and its subsidiaries (the Company) have been prepared in accordance
with the  instructions  to Form 10-Q and include the  information  and footnotes
required by such  instructions.  In the opinion of management,  all adjustments,
including those of a normal recurring nature,  have been made that are necessary
for a fair presentation of the results for the interim periods presented herein.

         The 1997  periods  have  been  restated  for a change  to the full cost
method of accounting for the Company's oil and gas  operations  (see Note 2) and
to reflect the Company's merger with Zilkha Energy Company (see Note 3). Certain
other amounts in the 1997 condensed  consolidated financial statements and notes
have been reclassified to conform with the 1998 presentation.

         During the first quarter of 1998, the Company  recognized the effect of
a change in salvage values,  including reversal of excess depreciation  expense,
relating to certain fixed assets,  primarily aircraft and vehicles.  The change,
which was to comply with recent  Federal  Energy  Regulatory  Commission  (FERC)
directives,  increased net income for the nine-month  period ended September 30,
1998, by $4.6 million.  The effect of the change on the three-month period ended
September 30, 1998, was not material.

2.       Change in Method of Accounting For Oil and Gas Operations

         In September  1998, the Company  changed its accounting  method for oil
and gas operations as conducted by its subsidiaries,  Sonat Exploration  Company
and Sonat  Exploration  GOM (Sonat  Exploration),  from the  successful  efforts
method to the full cost  method  because  its future  capital  spending  will be
focused  significantly more on exploration  activity than in the past. Full cost
accounting,  which amortizes rather than expenses dry-hole exploration and other
related  costs,  provides a more  appropriate  method of matching  revenues  and
expenses  for the  Company's  exploration  strategy.  Exploration  activity  has
increased  from 6  percent  of 1995  capital  spending,  or $27  million,  to an
estimated 33 percent of 1998 capital spending,  or approximately $175 million. A
significant  percentage of Sonat  Exploration's 1999 capital program is expected
to be spent on exploratory drilling.

         The  adoption of the full cost method is expected to increase  1998 and
1999  normalized  earnings  from  levels  that  would have been  reported  under
successful  efforts  accounting  and,  more  importantly,  will reduce  earnings
volatility from quarter-to-quarter and year-to-year going forward. The Company's
earnings will now be more  comparable to its integrated  pipeline  company peers
that have substantial  exploration and production operations,  most of which use
the full cost method.

         Under the full cost method,  all  productive and  non-productive  costs
incurred in connection with the acquisition,  exploration and development of oil
and gas reserves are capitalized and amortized on the unit-of-production  method
using

<PAGE>


2.       Change in Method of Accounting For Oil and Gas Operations (Cont'd)

proved  reserves.   Certain   unevaluated   properties  are  excluded  from  the
amortization  base until a  determination  has been made as to the  existence of
proved  reserves.  Since the  Company's  operations  are  limited  to the United
States, it utilizes a single cost center for amortization purposes.  Capitalized
costs are subject to a "ceiling  test" which limits such costs to the  aggregate
of the  present  value of  future  net  revenues  plus the lower of cost or fair
market value of unproved  properties.  Any conveyances of properties are treated
as  adjustments  to the  cost  of oil and  gas  properties  with no gain or loss
recognized.

         The Company has restated all prior financial  statements as a result of
the conversion to full cost accounting.  As a part of this process, all previous
charges related to the impairment of Sonat Exploration's assets, including those
taken in 1998, were reversed, which significantly raised the book value of those
properties as well as the Company's  stockholders' equity. The full cost method,
however,  requires  quarterly ceiling tests to ensure that the carrying value of
assets on the balance sheet is not overstated.  Sonat  Exploration has performed
ceiling tests for each of the three 1998 quarters.  At March 31, 1998,  June 30,
1998 and September 30, 1998, it was determined that  capitalized  costs exceeded
the ceiling test limits by $39.7  million,  $540.5  million and $455.0  million,
respectively,  which are  included  as ceiling  test  charges  in the  Condensed
Consolidated Statement of Operations.  The third quarter test was based on NYMEX
prices of $1.67 per  thousand  cubic feet (Mcf) for  natural  gas and $14.98 per
barrel for oil,  and was  adjusted  for hedges,  basis  differentials  and other
pricing  factors.  Future quarterly full cost ceiling tests will be based on the
then-current NYMEX prices for both natural gas and oil, after  adjustments.  The
end  result of the full  cost  conversion  is that both the book  value of Sonat
Exploration's  properties and the Company's  stockholders'  equity are at higher
levels  than  if  it  had  continued  with  the  successful  efforts  method  of
accounting.

         The effect of the accounting change on net income is as follows:
<TABLE>
<CAPTION>

                                                    Nine Months Ended
                                                       September 30,                        Years Ended December 31,
                                                   -------------------                    -------------------------
                                                 1998              1997              1997          1996          1995
                                                 ----              ----              ----          ----          ----
                                                               (In Thousands, Except Per-Share Amounts)
Effect on:
<S>                                              <C>              <C>                <C>           <C>          <C>    
    Net income                                   $(317,544)       $94,858            $130,584      $18,006      $64,289
    Earnings per share of
       common stock                              $   (2.89)       $   .86            $   1.19      $   .16      $   .58
    Earnings per share of
       common stock-
       assuming dilution                         $   (2.89)       $   .85            $   1.17      $   .16      $   .58
</TABLE>



<PAGE>


2.       Change in Method of Accounting For Oil and Gas Operations (Cont'd)

         The balances of retained  earnings  for all periods have been  adjusted
for the effect (net of income taxes) of applying retroactively the new method of
accounting.

         The  effect  of the  accounting  change on  stockholders'  equity is as
follows:

<TABLE>
<CAPTION>
                                                    Nine Months Ended
                                                       September 30,                        Years Ended December 31,
                                                   -------------------                    -------------------------
                                                 1998              1997              1997          1996          1995
                                                 ----              ----              ----          ----          ----
                                                                            (In Thousands)
<S>                                              <C>             <C>                 <C>          <C>          <C>     
Stockholders' Equity                             $39,443         $312,060            $347,786     $228,707     $219,506
</TABLE>

     The effect of the  restatement  on earnings by quarter for 1998 and 1997 is
as follows (per share amounts are on a diluted basis):

<TABLE>
<CAPTION>
                                                         Amount          Per Share            Amount          Per Share
                                                                 1998                                 1997
                                                                 ----                                 ----
                                                                 (In Thousands, Except Per-Share Amounts)

<S>                                                    <C>                <C>                <C>                <C> 
         First                                         $ (10,063)         $ (.09)            $17,672            $.16
         Second                                        $ (57,317)         $ (.52)            $19,454            $.17
         Third                                         $(250,164)         $(2.27)            $57,732            $.52
         Fourth                                               N/A             N/A            $35,726            $.32
</TABLE>

         Under the  successful  efforts  method of accounting  the Company would
have reported net income as follows:

<TABLE>
<CAPTION>
                                                                    Three Months                      Nine Months
                                                                Ended September 30,                Ended September 30,
                                                               ---------------------              --------------------
                                                           1998             1997              1998              1997
                                                           ----             ----              ----              ----
                                                                  (In Thousands, Except Per-Share Amounts)

<S>                                                       <C>               <C>               <C>               <C>    
Net Income (Loss)                                         $(8,252)          $(5,384)          $(228,218)        $81,333
                                                          =======           =======           =========         =======

Earnings (Loss) Per Share of
     Common Stock-Assuming Dilution                       $  (.07)          $  (.05)          $   (2.07)        $   .73
                                                          =======           =======           =========         =======
</TABLE>

     Net  income  under the  successful  efforts  method  for both 1997  periods
included a charge of $34.0 million, or $.31 per share, related to the impairment
of certain oil and gas properties.

         Net income under the successful efforts method for the 1998 three-month
and nine-month  periods included a charge for restructuring and impairment costs
related to the Company's oil and gas  operations of $21.2  million,  or $.19 per
share, and $310.4 million, or $2.82 per share, respectively.



<PAGE>


3.       Changes in Operations

         Business  Combination  - On  January  30,  1998,  following  a  special
shareholders'  meeting,  the Company  completed  the merger  with Zilkha  Energy
Company by exchanging  approximately  24.2 million  common shares for all of the
outstanding  shares  of Zilkha  Energy.  Zilkha  Energy  was a  privately  owned
exploration and production company.  Immediately thereafter Zilkha Energy's name
was changed to Sonat  Exploration GOM Inc. It operates mainly on the continental
shelf of the Gulf of Mexico.

         The merger constituted a tax-free reorganization and has been accounted
for as a pooling of interests under  Accounting  Principles  Board (APB) Opinion
No.  16.  Accordingly,   all  prior  period  condensed   consolidated  financial
statements,  notes and  operational  data have been  restated  to include  Sonat
Exploration GOM in the Company's financial statements for all periods reported.

         There were no  transactions  between  Sonat and Sonat  Exploration  GOM
prior to the combination.

         At December 31, 1997, Sonat  Exploration GOM had accrued $73.8 million,
which   represented   compensation  due  to  certain  employees  under  deferred
compensation  plans.  The liability was estimated based on the fair market value
of Sonat Exploration GOM as of December 31, 1997. The Company's  restricted cash
deposit at December 31, 1997,  reflected on the Condensed  Consolidated  Balance
Sheet was used to  settle  this  liability  and  certain  other  merger  related
expenses.

         Sonat  Exploration  Company  Restructuring  - On April  23,  1998,  the
Company   announced  a  restructuring   of  Sonat   Exploration   Company.   The
restructuring  included  significant  property  sales and certain cost reduction
activities  associated  with a  reduction  in work  force.  Oil and  natural gas
properties  with  a  net  book  value  of  approximately   $605  million  having
approximately  500 billion  cubic feet of natural gas  equivalent  reserves  and
daily net  production  of  approximately  190 million  cubic feet of natural gas
equivalent were sold or are in the process of being sold. Most of the sales have
been completed with proceeds used to pay down debt.

         A pretax  restructuring  charge  of  $15.0  million  for  restructuring
expenses  primarily  associated with a reduction in work force was recognized in
the second quarter of 1998. All work force reductions have been completed.

4.       Trading Activities and Derivative Financial Instruments

         The Company uses derivative  instruments  (commodity futures contracts,
options and price swap  agreements)  to both hedge its  commodity  price risk on
natural gas, crude oil and electricity, and as a market maker (trading activity)
in natural gas.



<PAGE>


4.       Trading Activities and Derivative Financial Instruments (Cont'd)

         Natural gas, crude oil and electricity  futures contracts are traded on
the New York Mercantile  Exchange  (NYMEX).  Natural gas contracts are for fixed
units of 10,000 MMBtu and are available for up to 36 months in the future. Crude
oil contracts are for fixed units of 1,000 barrels and are available for periods
up to 84 months in the future.  Electricity contracts are for 736 megawatt hours
and are available for up to 18 months in the future.

         Price swap  agreements  call for one party to make monthly  payments to
(or receive payments from) another party based upon the  differential  between a
fixed and a variable  price  (fixed-price  swap) or two variable  prices  (basis
swap) for a notional volume specified by the contract.

         Options can be exchange traded on the NYMEX or traded over the counter.
Exchange traded and  over-the-counter  options give the owner the right, but not
the obligation, to a futures contract, or to buy or sell an underlying commodity
at a given price, respectively.

         At September 30, 1998,  the Company had  outstanding  energy  commodity
futures,  swaps and options.  In the table below, buys of swaps represent either
1) payment of fixed price and receipt of NYMEX or index;  or 2) payment of NYMEX
or  index  and  receipt  of  index.  The  notional  volume  and  terms  of these
transactions are as follows:

<TABLE>
<CAPTION>
                                                                       Notional Volume                 Maximum
Commodity                                                            Buy             Sell               Term
---------                                                            ---             ----               ----
<S>                                                               <C>              <C>                <C>      
Natural Gas (Tbtu)                                                1,324.46         1,456.27           60 months
Electricity (Thousands of MWh)                                       16.9             16.9              1 month
Oil (Millions of Barrels)                                             4.4              1.1            60 months
</TABLE>

Derivative Commodity Instruments Held or Issued for Trading Purposes

         The Company maintains active trading positions in natural gas and crude
oil commodity futures,  swap and option contracts and limits its risk to changes
in the  value of its  outstanding  positions  through  the use of  Value-at-Risk
models,   establishment  of  offsetting  positions,  and  limit  and  monitoring
procedures.  The  trading  operation  also enters  into  natural  gas  commodity
purchase and sale commitments.  These activities constitute its trading business
and are  essential  to provide  customers  with market  products at  competitive
prices.  All of these trading  positions are reported at fair value and recorded
under the heading of  Assets/Liabilities  from Trading  Activities  (current and
long-term)  in the Condensed  Consolidated  Balance  Sheets.  The change in fair
value is  recognized  in revenues as it occurs.  Fair value is subject to change
and reflects  management's  best estimate of market prices  considering  various
factors including closing exchange and over-the-counter  quotations,  time value
and  volatility  factors  underlying  the  commitments.  These market prices are
adjusted  to reflect  the  potential  impact of  liquidating  Sonat  Marketing's
position in an orderly  manner over a  reasonable  period of time under  present
market conditions.
<PAGE>

4.       Trading Activities and Derivative Financial Instruments (Cont'd)

         The  amounts   disclosed  in  the   following   table   represent   the
end-of-period fair value and the average fair value of the trading portfolio.

<TABLE>
<CAPTION>
                                                            Fair Value                   Average Fair Value
                                                         (Carrying Amount)               for the Nine Months
                                                           as of 9/30/98                    Ended 9/30/98
                                                                            (In Thousands)

Energy Commodity Trading:
<S>                                                            <C>                             <C>     
    Assets                                                     $153,237                        $113,750
    Liabilities                                                 138,286                         100,227
=======================================================================================================
</TABLE>

     Net trading gains for the three months and nine months ended  September 30,
1998, are $4.3 million and $23.3 million, respectively.

Derivative Commodity Instruments Held or Issued for Purposes Other Than Trading

         In  certain  cases  derivative  positions  are  taken  specifically  to
mitigate market price risk associated with significant physical transactions and
are accounted  for using hedge  accounting  provided they meet hedge  accounting
criteria. Under hedge accounting,  gains and losses from futures are deferred in
the  Condensed  Consolidated  Balance  Sheets in Deferred  Credits and Other and
recognized  in  earnings in  conjunction  with the  revenue  recognition  of the
underlying  physical  transaction.  Each net payment/receipt due or owed under a
swap  agreement  is  recognized  in  earnings  during  the  period  to which the
payment/receipt   relates,   and  there  is  no  recognition  in  the  Condensed
Consolidated  Balance  Sheets for  changes in the swap's  fair  value.  Gains or
losses  resulting  from  settlement of swaps are amortized  over their  original
terms.

         The derivative  instruments used to hedge commodity  transactions  have
historically  had high  correlation  with  commodity  prices and are expected to
continue to do so. In the event that correlation  falls below allowable  levels,
the gains or losses  associated  with the hedging  instruments  are  immediately
recognized to the extent that correlation is lost.



<PAGE>


4.       Trading Activities and Derivative Financial Instruments (Cont'd)

         Sonat  Exploration  hedges a portion of its production by entering into
intercompany  swaps with Sonat  Marketing.  The  exposure  that Sonat  Marketing
assumes  from Sonat  Exploration  is then  hedged by  entering  into  derivative
instruments  with  outside  counterparties.  Sonat  Marketing  and  Sonat  Power
Marketing also hedge third-party  purchases and sales by entering into commodity
futures,  swaps and options.  The information in the following table  represents
the fair value of all outstanding derivative positions as of September 30, 1998.
Not included are the related physical positions that these derivative  positions
hedge.

                                         Fair Value
                                       (In Thousands)
         Natural Gas                      $(32,581)
         Electricity                            13

         Deferred  amounts on open futures  positions  will mature over 1998 and
1999.

Credit Risk from Derivative Activities

         NYMEX  traded  futures  are  guaranteed  by the NYMEX and have  nominal
credit risk. On all other  transactions  described above, the Company is exposed
to credit risk in the event of nonperformance by the counterparties. The Company
has established policies and procedures to evaluate potential counterparties for
creditworthiness   before  entering  into   over-the-counter   swap  and  option
agreements.  The credit risk resulting from in-the-money swaps is monitored on a
regular basis  against  established  collateralization  limits and credit limits
establish by the Company. Due to changes in market conditions,  the market value
of swaps and options and the associated credit exposure with the  counterparties
can change  significantly.  At  September  30,  1998,  the  market  value of the
Company's   in-the-money   swaps  and   options  was  $7.6   million,   and  all
counterparties  were within collateral and credit limits except one counterparty
which was $0.3  million over their  credit  limit.  Reserves for credit risk are
established as necessary.



<PAGE>


5.       Unconsolidated Affiliates

         The following  table  presents the  components of equity in earnings of
unconsolidated affiliates.

<TABLE>
<CAPTION>
                                                                      Three Months                      Nine Months
                                                                  Ended September 30,               Ended September 30,
                                                                  -------------------               -------------------
                                                            1998              1997             1998              1997
                                                            ----              ----             ----              ----
                                                                                 (In Thousands)

Company's Share of Reported Earnings (Losses):

<S>                                                        <C>                <C>             <C>               <C>    
    Exploration and Production                             $    49            $   89          $   370           $   290
                                                           -------            ------          -------           -------

    Natural Gas Transmission:
       Citrus Corp.                                          6,269             5,241           21,262            17,343
       Amortization of Citrus basis
          difference                                           345               345            1,037             1,037
       Bear Creek Storage Company                            2,438             2,558            6,973             7,889
       Destin                                                3,381               188            8,515               307
       Other                                                   255               (30)             322               (83)
                                                           -------            ------          -------           -------
                                                            12,688             8,302           38,109            26,493
                                                           -------            ------          -------           -------

    Energy Services                                          3,594               186            4,375               669
                                                           -------            ------          -------           -------

    Other                                                      337               299              994               991
                                                           -------            ------          -------           -------

                                                           $16,668            $8,876          $43,848           $28,443
                                                           =======            ======          =======           =======
</TABLE>


         Natural Gas  Transmission  Affiliates - Sonat owns 50 percent of Citrus
Corp. (Citrus),  the parent company of Florida Gas Transmission Company (Florida
Gas).  Southern Natural Gas Company owns a one-third interest in Destin Pipeline
Company,  L.L.C.  (Destin)  and a  subsidiary  of  Southern  Natural Gas owns 50
percent of Bear Creek Storage  Company (Bear Creek),  an underground gas storage
company.



<PAGE>


5.       Unconsolidated Affiliates (Cont'd)

         The following is summarized income statement information for Citrus:

<TABLE>
<CAPTION>
                                                                    Three Months                       Nine Months
                                                                Ended September 30,                Ended September 30,
                                                                --------------------               -------------------
                                                           1998             1997              1998              1997
                                                           ----             ----              ----              ----
                                                                                (In Thousands)

<S>                                                       <C>               <C>              <C>               <C>     
Revenues                                                  $151,150          $213,535         $446,712          $572,685
Expenses (Income):
    Natural gas cost                                        72,400           136,326          202,003           323,591
    Operating expenses                                      25,103            23,384           69,990            73,814
    Depreciation and amortization                           13,255            13,181           38,986            47,768
    Interest and other                                      20,360            23,422           66,850            71,904
    Income taxes                                             7,494             6,740           26,359            20,922
                                                          --------          --------         --------          --------

Income Reported                                           $ 12,538          $ 10,482         $ 42,524          $ 34,686
                                                          ========          ========         ========          ========
</TABLE>

         The  following is  summarized  income  statement  information  for Bear
Creek.  No provision for income taxes has been  included  since its income taxes
are paid directly by the joint-venture participants.

<TABLE>
<CAPTION>
                                                                    Three Months                       Nine Months
                                                                Ended September 30,                Ended September 30,
                                                                --------------------               -------------------
                                                           1998             1997              1998              1997
                                                           ----             ----              ----              ----
                                                                                (In Thousands)

<S>                                                         <C>               <C>             <C>               <C>    
Revenues                                                    $8,882            $8,899          $26,732           $27,218
Expenses:
    Operating expenses                                       1,533             1,157            5,286             3,519
    Depreciation                                             1,361             1,358            4,080             4,072
    Other expenses, net                                      1,112             1,269            3,420             3,849
                                                            ------            ------          -------           -------

Income Reported                                             $4,876            $5,115          $13,946           $15,778
                                                            ======            ======          =======           =======
</TABLE>


         In April 1997, units of Shell Oil Company and Amoco Corporation  joined
with   Southern    Natural   Gas   in   the    ownership   of   Destin,    a   1
billion-cubic-feet-per-day  pipeline  designed  to  transport  natural  gas from
deep-water  areas in the eastern  Gulf of Mexico.  Construction  of the pipeline
began in December 1997. Destin was partially  completed and placed in service in
September 1998, and is expected to be fully in service by January 1999. The FERC
has approved two  extensions  of Destin for a total filed cost of an  additional
$56  million.  The total  cost of Destin is now  estimated  to be $446  million.
Destin's  earnings in 1997 and 1998 primarily  relate to the allowance for funds
used during  construction  (AFUDC)  capitalized on its capital  expenditures  to
date.



<PAGE>


6.       Debt and Lines of Credit

         Long-Term Debt and Lines of Credit - Sonat has a bank revolving  credit
agreement  that provides for periodic  borrowings and repayments of up to $500.0
million through June 30, 2001.  Borrowings are supported by unsecured promissory
notes  that,  at the option of the  Company,  will bear  interest  at the banks'
prevailing prime or  international  lending rate, or such rates as the banks may
competitively  bid. At December 31, 1997,  there was an  outstanding  balance of
$130.0 million. During the first nine months of 1998, $70.0 million was borrowed
and $200.0 million was repaid under the revolving credit agreement, resulting in
no amounts outstanding at September 30, 1998.

         In January 1998, Sonat made two public offerings of Notes pursuant to a
shelf registration  statement.  In one offering,  Sonat issued $100 million of 6
5/8 percent Notes due February 1, 2008, at 99.531 percent to yield 6.69 percent.
In the other offering, Sonat issued $100 million of 7 percent Notes due February
1, 2018,  at 99.787  percent to yield 7.02  percent.  The net proceeds  from the
offerings  were  used  for  general   corporate   purposes,   including  capital
expenditures, working capital and repayment of debt.

         In  September  1998,  Southern  Natural  Gas made a public  offering of
$100.0  million of its 6.125  percent  Notes due  September  15, 2008, at 99.531
percent to yield 6.189 percent. The net proceeds from the offering were used for
general corporate purposes, including capital expenditures.

         Unsecured Notes - Loans under all short-term  credit facilities are for
a duration of less than three months.

         In January 1998,  Sonat completed a new 364-day $700 million  revolving
credit  facility with 20 banks. In connection with this new facility the Company
terminated  existing  lines  of  credit  providing  for up to  $200  million  of
borrowings.  At September  30,  1998,  Sonat had  short-term  lines of credit of
$700.0 million  available  through  January 25, 1999.  Southern  Natural Gas had
short-term  lines of credit of $50.0  million  available  through May 31,  1999.
Borrowings  are  available for a period of not more than 364 days and are in the
form of  unsecured  promissory  notes that bear  interest  at rates based on the
banks'  prevailing  prime,  international  or  money-market  lending  rates.  At
September 30, 1998, Sonat had $25.5 million outstanding under its agreement at a
rate of 5.99 percent.  No amounts were  outstanding  under Southern Natural Gas'
agreement.

         Sonat had $611.8 million in commercial paper  outstanding at an average
rate of 5.82 percent at September 30, 1998.



<PAGE>


7.       Rate Matters and Contingencies

         Periodically, Southern Natural Gas and its subsidiaries (Southern) make
general  rate  filings  with the FERC to  provide  for the  recovery  of cost of
service  and a return on equity.  The FERC  normally  allows the filed  rates to
become  effective,  subject to refund,  until it rules on the approved  level of
rates.  Southern provides reserves relating to such amounts collected subject to
refund, as appropriate, and makes refunds upon establishment of the final rates.
At September 30, 1998, Southern's rates are established by a settlement that was
approved  by FERC  orders  issued in 1995 and  1996.  All of its  customers  are
parties to the  settlement,  and all  revenue  is based on the final  settlement
rates and therefore is not being collected subject to refund.

8.       Comprehensive Income

     As  of  January  1,  1998,  the  Company  adopted  Statement  of  Financial
Accounting  Standards (SFAS) No. 130, Reporting  Comprehensive  Income. SFAS No.
130 establishes new rules for the reporting and display of comprehensive  income
and its components; however, the adoption of this Statement had no impact on the
Company's  net income  (loss) or  stockholders'  equity.  SFAS No. 130  requires
unrealized gains or losses on the Company's available-for-sale  securities to be
included in other  comprehensive  income.  Comprehensive  income (loss),  net of
related tax, is as follows:

<TABLE>
<CAPTION>
                                                                Three Months                       Nine Months
                                                            Ended September 30,                Ended September 30,
                                                     1998                1997              1998             1997
                                                                             (In Thousands)

<S>                                                  <C>                 <C>              <C>              <C>     
Net Income (Loss)                                    $(258,416)          $52,348          $(545,762)       $176,192
Unrealized Gains (Loss)
    on Securities                                       (1,730)           (5,288)              (866)         (5,067)
Reclassification adjustment                             (1,181)              (20)            (1,219)         (1,179)
                                                     ---------           -------          ---------        --------
Comprehensive Income (Loss)                          $(261,327)          $47,040          $(547,847)       $169,946
                                                     =========           =======          =========        ========
</TABLE>

         Common Stock and Other  Capital in the Condensed  Consolidated  Balance
Sheets includes $1.1 million at September 30, 1998, and $3.2 million at December
31,  1997,  related  to  other  comprehensive  income,  which  is  comprised  of
unrealized gains on securities.



<PAGE>


9.       Segment Information

         As of January 1, 1998,  the Company  adopted SFAS No. 131,  Disclosures
about  Segments  of  an  Enterprise  and  Related  Information.   SFAS  No.  131
establishes  standards for the way public  enterprises are to report information
about  operating  segments  in annual  financial  statements  and  requires  the
reporting of selected  information about operating segments in interim financial
reports  issued to  stockholders.  SFAS No. 131 also  establishes  standards for
related  disclosures  about  products and services,  geographic  areas and major
customers.  The Company had  previously  modified its  definition of segments to
conform to the approach required by SFAS No. 131.

         The Company's  consolidated  financial statements reflect operations in
three segments:  Exploration and Production, Natural Gas Transmission and Energy
Services.

<TABLE>
<CAPTION>
                                                                Three Months Ended September 30, 1998
                                      ---------------------------------------------------------------------------------
                                      Exploration            Natural
                                          and                  Gas             Energy
                                      Production          Transmission        Services         Other            Total
                                                                       (In Thousands)
Revenues from
<S>                                    <C>                    <C>              <C>            <C>             <C>      
    External Customers                 $  30,427              $82,056          $762,024       $   (10)        $ 874,497

Intersegment Revenues                     90,734               11,293              -           11,801           113,828

Earnings (Loss) Before
    Interest and Taxes                  (428,537)              52,857             4,206         2,673          (368,801)
</TABLE>


<TABLE>
<CAPTION>
                                                                Three Months Ended September 30, 1997
                                      ---------------------------------------------------------------------------------
                                      Exploration            Natural
                                          and                  Gas             Energy
                                      Production          Transmission        Services         Other            Total
                                                                       (In Thousands)
Revenues from
<S>                                      <C>                  <C>              <C>            <C>            <C>       
    External Customers                   $90,358              $70,445          $912,910       $     2        $1,073,715

Intersegment Revenues                     89,897               22,709              -           12,108           124,714

Earnings Before
    Interest and Taxes                    50,413               48,983               710           888           100,994
</TABLE>



<PAGE>


9.       Segment Information (Cont'd)

<TABLE>
<CAPTION>
                                                                Nine Months Ended September 30, 1998
                                      ---------------------------------------------------------------------------------
                                      Exploration            Natural
                                          and                  Gas             Energy
                                      Production          Transmission        Services         Other            Total
                                                                       (In Thousands)
Revenues from
<S>                                    <C>                   <C>              <C>             <C>            <C>       
    External Customers                 $ 152,363             $257,150         $2,499,242      $    17        $2,908,772

Intersegment Revenues                    278,839               37,200              -           34,109           350,148

Earnings (Loss) Before
    Interest and Taxes                  (954,340)             184,919              6,686        6,033          (756,702)
</TABLE>


<TABLE>
<CAPTION>
                                                                Nine Months Ended September 30, 1997
                                      ---------------------------------------------------------------------------------
                                      Exploration            Natural
                                          and                  Gas             Energy
                                      Production          Transmission        Services         Other            Total
                                                                       (In Thousands)
Revenues from
<S>                                     <C>                  <C>              <C>             <C>            <C>       
    External Customers                  $257,733             $226,309         $2,569,114      $    13        $3,053,169

Intersegment Revenues                    279,801               69,393              -           33,465           382,659

Earnings Before
    Interest and Taxes                   160,279              164,139              1,464        6,760           332,642
</TABLE>




<PAGE>


9.       Segment Information (Cont'd)

<TABLE>
<CAPTION>
                                                                Three Months                      Nine Months
                                                            Ended September 30,                Ended September 30,
                                                           ---------------------              --------------------
                                                      1998              1997              1998             1997
                                                      ----              ----              ----             ----
                                                                            (In Thousands)
Total Earnings (Loss) Before
    Interest and Taxes for
<S>                                                  <C>                <C>             <C>                <C>     
    Reportable Segments                              $(368,801)         $100,994        $(756,702)         $332,642
Interest Income                                            938             1,467            4,201             3,662
Interest Expense                                       (34,470)          (26,763)        (101,392)          (78,134)
Interest Capitalized                                     1,220             1,791            4,092             5,658
                                                     ---------          --------        ---------          --------

Income (Loss) Before Income
    Taxes                                            $(401,113)         $ 77,489        $(849,801)         $263,828
                                                     =========          ========        =========          ========
</TABLE>


         Assets for the Company's three segments are as follows:

                                                    September 30, 1998
                                                    ------------------
                                                      (In Thousands)
         Assets by Segment
             Exploration and Production                   $1,643,021
             Natural Gas Transmission                      1,938,847
             Energy Services                                 627,039




<PAGE>


10.      Earnings Per Share

         The  calculation  of diluted  earnings  per share  differs from that of
basic  earnings  per share due to the  denominator  for the diluted  calculation
including common stock equivalents applicable to outstanding stock options.

         The  following  table  presents  the  computation  of basic and diluted
earnings (loss) per share of common stock:

<TABLE>
<CAPTION>
                                                                    Three Months                      Nine Months
                                                                Ended September 30,                Ended September 30,
                                                               ---------------------              --------------------
                                                           1998             1997              1998              1997
                                                           ----             ----              ----              ----
                                                                   (In Thousands, Except Per-Share Amounts)

Numerator:
<S>                                                      <C>                <C>             <C>                <C>     
    Net income (loss)                                    $(258,416)         $ 52,348        $(545,762)         $176,192
                                                         =========          ========        =========          ========

Denominator:

    Denominator for Basic Earnings Per Share:

    Weighted average number of
       shares of common stock
       outstanding                                         110,034           109,926          110,017           110,164

    Effect of Dilutive Securities:

    Common stock equivalents
       applicable to outstanding
       stock options                                            (a)            1,471               (a)            1,552
                                                         ---------          --------        ---------          --------

    Denominator for Diluted Earnings Per Share:

    Adjusted weighted average
       shares using treasury
       stock method for assumed
       conversions                                         110,034           111,397          110,017           111,716
                                                         =========          ========        =========          ========


Basic Earnings (Loss) Per Share
    of Common Stock                                      $   (2.35)         $    .48        $   (4.96)         $   1.60
                                                         =========          ========        =========          ========

Diluted Earnings (Loss) Per Share
    of Common Stock                                      $   (2.35)         $    .47        $   (4.96)         $   1.58
                                                         =========          ========        =========          ========
</TABLE>

(a)      The  addition  of  457,000  dilutive  potential  common  shares for the
         three-month period of 1998 and 882,000 dilutive potential common shares
         for  the  nine-month  period  of  1998  would  be  antidilutive  in the
         computation  of diluted  earnings  per  share,  and are  therefore  not
         included.


<PAGE>



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

RESULTS OF OPERATIONS

Operating Income

         Business segment  operating results for Sonat Inc. and its subsidiaries
(the  Company) are  presented in the table below.  The table also shows  unusual
items that  affect  earnings  before  interest  and taxes  (EBIT) and net income
comparisons. The table is presented because management believes this information
enhances the analysis of results of  operations.  All prior period data has been
restated for the Company's  adoption of the full cost accounting  method for its
oil and gas operations.

<TABLE>
<CAPTION>
                                                                    Three Months                      Nine Months
                                                                Ended September 30,               Ended September 30,
                                                          1998              1997            1998                1997
                                                                    (In Millions, Except Per-Share Amounts)
Earnings (Loss) Before Interest and Taxes:
<S>                                                      <C>                <C>           <C>                  <C>   
    Exploration and production                           $(428.5)           $ 50.4        $  (954.3)           $160.3
    Natural gas transmission                                52.9              48.9            184.9             164.1
    Energy services                                          4.2                .8              6.7               1.5
    Other                                                    2.6                .9              6.0               6.7
                                                         -------            ------        ---------            ------
                                                          (368.8)            101.0           (756.7)            332.6

Adjustment for Unusual Items:
    Exploration and production
       Ceiling test charges                               (455.0)              -           (1,035.2)              -
       Restructuring costs                                   -                 -              (15.0)              -
                                                         -------            ------        ---------            ------
Earnings Before Interest and Taxes
    Excluding Unusual Items                              $  86.2            $101.0        $   293.5            $332.6
                                                         =======            ======        =========            ======

Net Income (Loss) As Reported                            $(258.4)           $ 52.4        $  (545.8)           $176.2
Adjustment for Unusual Items:
    Exploration and production
       Ceiling test charges                               (295.8)              -             (672.9)              -
       Restructuring costs                                   -                 -               (9.7)              -
                                                         -------            ------        ---------            ------
Net Income Excluding Unusual Items                       $  37.4            $ 52.4        $   136.8            $176.2
                                                         =======            ======        =========            ======

Diluted Earnings (Loss) Per Share                        $ (2.35)           $  .47        $   (4.96)           $ 1.58
                                                         =======            ======        =========            ======

Diluted Earnings Per Share
    Excluding Unusual Items                              $   .34            $  .47        $    1.24            $ 1.58
                                                         =======            ======        =========            ======
</TABLE>



<PAGE>


EXPLORATION AND PRODUCTION

         The  Company  is engaged in the  exploration  for and the  acquisition,
development  and  production of oil and natural gas in the United States through
Sonat Exploration. Most of Sonat Exploration's natural gas production is sold to
Sonat  Marketing  Company  L.P.  (Sonat  Marketing),   the  Company's  affiliate
operating in the Energy Services segment.

         On January  30,  1998,  the  Company  completed  its merger with Zilkha
Energy  Company  for  $1.3  billion  (see  Note  3 of  the  Notes  to  Condensed
Consolidated Financial Statements).

         In September 1998, the Company changed its method of accounting for oil
and gas operations from successful efforts to full cost (see Note 2 of the Notes
to Condensed Consolidated Financial Statements).

         So far this year,  the  Company has been  successful  on four of the 13
exploratory  wells that it has  drilled in the Gulf of Mexico.  The  Company has
recently completed the technical and permitting work necessary to drill a number
of important offshore prospects, including its Timbalier Trench and Viosca Knoll
blocks.  With  these  prospects  now ready to drill and  because  of the  recent
decline  in day rates for  offshore  drilling  rigs and  related  services,  the
Company plans to increase  substantially its offshore  exploration activity with
13 wells  planned  for the  fourth  quarter  of 1998 and first  quarter of 1999.
Onshore  exploration  activity is also  expected to increase  sharply due to the
significant number of exploration  prospects that the Company has generated this
year.

         In the  August  Federal  Lease  Sale  171,  Sonat  Exploration  was the
successful bidder on 24 offshore tracts at a total cost of $6.9 million.  Twenty
of these  leases  are in deep water and are a part of the  Company's  efforts to
build a deep-water  exploration program in depth levels greater than 600 feet in
the Gulf of Mexico.




<PAGE>


EXPLORATION AND PRODUCTION OPERATIONS

<TABLE>
<CAPTION>
                                                                   Three Months                        Nine Months
                                                                Ended September 30,                Ended September 30,
                                                               --------------------               --------------------
                                                           1998             1997              1998              1997
                                                           ----             ----              ----              ----
                                                                                 (In Millions)
<S>                                                      <C>                <C>            <C>                 <C>   
Revenues:                                                $ 121.2            $180.2         $  431.2            $537.5
                                                         -------            ------         --------            ------

Costs and Expenses:
    Operating and maintenance                               16.2              21.0             54.8              61.2
    General and administrative                               7.0               9.0             25.3              45.7
    Depreciation, depletion and
       amortization                                         69.4              87.3            238.3             248.3
    Ceiling test charges                                   455.0               -            1,035.2               -
    Restructuring costs                                      -                 -               15.0               -
    Taxes and other                                          3.9              12.6             19.2              24.7
                                                         -------            ------         --------            ------
                                                           551.5             129.9          1,387.8             379.9
                                                         -------            ------         --------            ------
Operating Income (Loss)                                   (430.3)             50.3           (956.6)            157.6
Other Income                                                 1.8                .1              2.3               2.7
                                                         -------            ------         --------            ------

Earnings (Loss) Before Interest
    and Taxes As Reported                                 (428.5)             50.4           (954.3)            160.3
Restructuring Costs and Ceiling
    Test Charges                                           455.0               -            1,050.2               -
                                                         -------            ------         --------            ------
Earnings Before Interest and
    Taxes Excluding Unusual Items                        $  26.5            $ 50.4         $   95.9            $160.3
                                                         =======            ======         ========            ======


Net Sales Volumes:
    Gas (Bcf)                                                 54                68              177               196
    Oil and condensate (MBbls)                             1,622             1,747            5,356             4,453
    Natural gas liquids (MBbls)                              378               496            1,553             1,293
---------------------------------------------------------------------------------------------------------------------

Average Sales Prices:
    Gas ($/Mcf)                                          $  1.85            $ 2.08         $   1.96            $ 2.20
    Oil and condensate ($/Bbl)                             12.34             18.72            13.44             19.89
    Natural gas liquids ($/Bbl)                             8.33             10.94             9.04             11.84
---------------------------------------------------------------------------------------------------------------------
</TABLE>


Third Quarter 1998 to Third Quarter 1997 Analysis

         EBIT decreased $23.9 million after excluding the recognition of ceiling
test charges of $455.0  million in the third  quarter of 1998 (see Note 2 of the
Notes to Condensed Consolidated  Financial  Statements),  primarily due to lower
revenues due to lower energy  prices and  production  volumes,  partly offset by
lower costs and expenses.

         Natural gas and oil and condensate  production decreased 21 percent and
7  percent,  respectively,  from the  third  quarter  of 1997  primarily  due to
property sales that have occurred as part of the previously  announced corporate
restructuring. Average realized natural gas prices decreased 11 percent to $1.85
per thousand  cubic feet (Mcf) from $2.08 per Mcf in the third  quarter of 1997.
Realized oil and condensate  prices decreased 34 percent to an average of $12.34
per  barrel  from  $18.72  per  barrel in the  third  quarter  of 1997.  Oil and
condensate production decreased 7 percent primarily due to property sales.
<PAGE>

         Costs and expenses were $33.4 million lower than the prior period after
excluding the ceiling test charges discussed  earlier.  Depreciation,  depletion
and amortization  expense  decreased by 21 percent due to lower production and a
slightly lower  amortization  rate ($1.06 for the 1998 period  compared to $1.07
for the 1997  period).  Taxes and other  expenses  decreased 69 percent due to a
contract  termination  fee incurred by Sonat  Exploration  GOM (formerly  Zilkha
Energy)  in  1997.  Operating  and  maintenance  expense  decreased  23  percent
primarily due to property sales in 1998.

         Other  income  increased  due to a gain on the  disposal of  marketable
securities in the 1998 period.

Nine Months 1998 to Nine Months 1997 Analysis

         EBIT  decreased  $64.4  million  after  excluding  the  recognition  of
$1,035.2  million for ceiling test  charges,  discussed  earlier,  and the $15.0
million  restructuring  charge recorded in the second quarter of 1998, primarily
due to lower energy prices and production volumes,  partly offset by lower costs
and expenses.

         Natural  gas  production  decreased  to 177 Bcf  from  196 Bcf in 1997.
Average  realized  natural gas prices  decreased 11 percent to $1.96 per Mcf for
the 1998  period  from  $2.20  per Mcf for the  1997  period.  Realized  oil and
condensate  prices  decreased 32 percent to an average of $13.44 per barrel from
$19.89 per barrel in the 1997 period. Oil and condensate production increased 20
percent, slightly offsetting these unfavorable factors.

         Costs and expenses were $42.3 million lower after excluding the charges
for  ceiling  tests  and   restructuring   in  the  1998  period.   General  and
administrative  expense  decreased 45 percent primarily as a result of executive
compensation  expense for Sonat  Exploration GOM, which was included in the 1997
period.  Operating and maintenance expense decreased 11 percent primarily due to
property sales during 1998. Taxes and other expenses decreased 22 percent due to
a contract termination fee incurred by Sonat Exploration GOM in the 1997 period.
Depreciation, depletion and amortization expense decreased slightly due to lower
volumes.

         Other income was slightly lower for the nine-month 1998 period compared
with the  nine-month  1997  period due to gains on the  disposal  of  marketable
securities in 1997, partly offset by a gain on disposal of marketable securities
in the 1998 period.



<PAGE>


Hedging Activities

         Sonat Exploration,  through Sonat Marketing,  uses derivative financial
instruments  to manage  the  risks  associated  with  price  volatility  for its
production,  which it sells in the spot  market.  (See Market Risk and Note 4 of
the  Notes to  Condensed  Consolidated  Financial  Statements.)  Gains or losses
experienced on Sonat  Exploration's  hedging  transactions offset the changes in
revenue  recognized  on the sale of the  commodity.  Natural gas  revenues  were
reduced by $.2  million  and $5.9  million  in the  three-month  and  nine-month
periods  ended  September  30, 1998,  and were reduced by $2.1 million and $24.8
million in the  three-month  and  nine-month  periods ended  September 30, 1997,
respectively,  as a result of  hedging  activities.  There  were no oil  hedging
activities  reflected  in the 1998  period.  Hedging  activities  increased  oil
revenues by $.2 million in the three-month  period ended September 30, 1997, and
reduced oil revenues by $.5 million in the nine-month period ended September 30,
1997.

         A  portion  of Sonat  Exploration's  future  gas  production  is hedged
through the year 2012. At September  30, 1998,  Sonat  Exploration's  hedged gas
production is as follows:

                                                              Weighted
                                                               Average
                                     Volumes                    Price
                                      (Bcf)                   (per Mcf)
Remainder of 1998                     13.8                      $2.14
1999                                  62.5                       2.13
2000                                  42.2                       2.16
2001                                   4.4                       2.30
2002-2012                             41.8                       3.33
---------------------------------------------------------------------
                                     164.7                      $2.45
=====================================================================

NATURAL GAS TRANSMISSION

         The Company is engaged in the natural gas transmission business through
Southern Natural Gas Company and its subsidiaries (Southern) and Citrus Corp. (a
50   percent-owned   company).   Southern  and  Citrus  are  actively   pursuing
opportunities to expand their pipeline systems in their traditional market areas
and to connect new gas supplies.

         In April 1997, units of Shell Oil Company and Amoco Corporation  joined
with   Southern    Natural   Gas   in   the    ownership   of   Destin,    a   1
billion-cubic-feet-per-day  pipeline  designed  to  transport  natural  gas from
deep-water  areas in the  eastern  Gulf of Mexico.  Southern  Natural  Gas has a
one-third interest in this pipeline.  Shell and Amoco have made substantial firm
transportation  commitments  to this  pipeline.  Eight other  shippers have also
dedicated their  production from certain leases in the eastern Gulf of Mexico to
Destin for  transportation  and discussions are under way with other prospective
shippers.  Construction  of the  pipeline  began in  December  1997,  and it was
partially  completed  and in service in  September  1998,  and is expected to be
fully in service by January  1999.  In June  1998,  the FERC  approved  Destin's
application to extend its pipeline  system  approximately  14 miles to transport
additional gas reserves committed to Destin's system. This extension is expected
to be in  service  in late  1998.  In July 1998 the FERC also  approved  another
Destin application to extend its pipeline by approximately 31 miles to transport
additional gas reserves  committed to its system.  This extension is expected to
be in  service  in early  1999.  The  total  capital  expended  by Destin is now
estimated to be $446 million.
<PAGE>

         Southern  Natural Gas is moving forward on three expansions to northern
Alabama,  eastern Tennessee, and central Alabama that have a total filed capital
cost of $126 million.  The North Alabama  expansion,  which originally  received
FERC  approval in May 1997, is now  anticipated  to go in service in the fall of
1999.  Southern  Natural  Gas  received  FERC  approval  in  October  1998 of an
application  that it had filed to change the route of the pipeline as it crosses
the Wheeler National  Wildlife Refuge,  but the new route must still be approved
by the U.S. Fish and Wildlife  Service.  The 122-mile  expansion will provide 76
million-cubic-feet-per-day  capacity to the  participating  customers.  A second
expansion  to serve  customers  primarily  in eastern  Tennessee  received  FERC
approval  in April 1998 and was placed in service  in  November  1998.  Southern
Natural Gas has firm transportation  commitments  totaling 65 million cubic feet
of natural gas per day from customers in eastern Tennessee,  Georgia and Alabama
related to this  expansion.  The  expansion  in central  Alabama  received  FERC
approval  in March 1998 and is also  expected  to go in service in  November  of
1998.  This  expansion  will  provide  34  million  cubic  feet  per day of firm
transportation to Alabama Power Company and two other customers.

         In December  1997,  an  affiliate of AGL  Resources,  Inc. and Southern
Natural Gas formed a new entity,  Etowah LNG Company,  L.L.C.  (Etowah  LNG), to
jointly construct,  own and operate a new liquefied natural gas peaking facility
in Polk County,  Georgia.  Peaking services provide supplemental gas supplies on
days when demand is highest,  typically during the winter.  Under the agreement,
AGL Resources  and Southern  Natural Gas each will own 50 percent of Etowah LNG,
which will be regulated by the FERC.  The proposed  plant will connect  directly
into AGL Resources' principal natural gas distribution  subsidiary,  Atlanta Gas
Light  Company,  and  Southern  Natural Gas'  pipeline.  Etowah LNG will provide
natural gas  storage  and peaking  services to Atlanta Gas Light and the city of
Austell,  Georgia. The new facility will cost approximately $90 million with 300
million  cubic  feet per day of  deliverability  capacity.  Etowah  LNG  filed a
certificate application with the FERC in April 1998. Subject to receiving timely
FERC approval, construction will begin in early 1999 in order to provide peaking
services during the 2001-02 winter heating season.  The agreement for Etowah LNG
to provide services to Atlanta Gas Light includes, however, a provision allowing
Atlanta Gas Light to terminate  the  agreement in the event it does not receive,
with respect to the  agreement,  a  satisfactory  order from the Georgia  Public
Service  Commission  (Georgia  PSC). In September 1998 the Georgia PSC issued an
order approving the agreement, but allowed for further review of it. In light of
this order,  the parties  have  agreed to extend the time  period  during  which
Atlanta Gas Light may  terminate  the agreement to December 15, 1998. If Atlanta
Gas Light  exercises its option to terminate its service  agreement  with Etowah
LNG,  the project  would not go forward and Atlanta Gas Light would be obligated
to reimburse Etowah LNG for all of its costs incurred in the project to date.
<PAGE>

SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES
<TABLE>
<CAPTION>
                                                                    Three Months                       Nine Months
                                                                Ended September 30,                Ended September 30,
                                                                -------------------                -------------------
                                                           1998             1997              1998              1997
                                                           ----             ----              ----              ----
                                                                                 (In Millions)
Revenues:
    Market transportation and
<S>                                                        <C>               <C>             <C>               <C>   
       storage                                             $77.7             $74.9           $239.1            $232.7
    Supply transportation                                   11.1              12.8             34.8              35.7
    Other                                                    4.6               5.4             20.5              27.3
                                                           -----             -----           ------            ------
       Total Revenues                                       93.4              93.1            294.4             295.7
                                                           -----             -----           ------            ------

Costs and Expenses:
    Operating and maintenance                               21.0              20.4             59.6              60.2
    General and administrative                              14.8              15.8             42.5              52.9
    Depreciation and amortization                           13.6              12.0             32.2              35.6
    Taxes, other than income                                 5.4               5.0             16.1              15.0
                                                           -----             -----           ------            ------
                                                            54.8              53.2            150.4             163.7
                                                           -----             -----           ------            ------

Operating Income                                            38.6              39.9            144.0             132.0
Other Income:
    Equity in earnings of
       unconsolidated affiliates                             6.0               2.7             15.7               8.1
    Other                                                    1.9               1.0              3.7               5.9
                                                           -----             -----           ------            ------
                                                             7.9               3.7             19.4              14.0
                                                           -----             -----           ------            ------

Earnings Before Interest and Taxes                         $46.5             $43.6           $163.4            $146.0
                                                           =====             =====           ======            ======

                                                                             (Billion Cubic Feet)
Volumes:
    Market transportation                                    140               133              462               439
    Supply transportation                                     85               109              283               289
                                                           -----             -----           ------            ------
       Total Volumes                                         225               242              745               728
                                                           =====             =====           ======            ======
</TABLE>


CITRUS CORP.
<TABLE>
<CAPTION>
                                                                    Three Months                       Nine Months
                                                                Ended September 30,                Ended September 30,
                                                                -------------------                -------------------
                                                           1998             1997              1998              1997
                                                           ----             ----              ----              ----
                                                                                 (In Millions)
Equity in Earnings of
<S>                                                         <C>              <C>              <C>              <C>   
    Citrus Corp.                                            $ 6.7            $ 5.6            $ 22.4           $ 18.4
                                                            =====            =====            ======           ======

                                                                             (Billion Cubic Feet)
Florida Gas Volumes (100%):
    Market transportation                                     119              124               323              346
    Supply transportation                                      11                5                27               18
                                                            -----            -----            ------           ------
       Total Volumes                                          130              129               350              364
                                                            =====            =====            ======           ======
</TABLE>



<PAGE>


Third Quarter 1998 to Third Quarter 1997 Analysis

         Southern  Natural Gas Company and  Subsidiaries - EBIT for Southern was
$46.5  million in the third  quarter of 1998  compared with $43.6 million in the
third  quarter of 1997.  The  increase  was  primarily  due to higher  equity in
earnings  of Destin and an  expansion  placed in  service,  partially  offset by
higher depreciation expense.

         Market  transportation  revenues  increased  as a result of the  recent
expansion. Supply transportation revenues decreased due to a decrease in volumes
as a result of hurricanes and tropical storms, and natural  production  declines
taking  place in  certain  Gulf of Mexico  fields.  General  and  administrative
expense  decreased   primarily  due  to  lower  employee  benefit  expenses  and
stock-based   compensation   expense.   Depreciation  and  amortization  expense
increased in the 1998 period due to plant  additions and pursuant to a provision
of the customer  settlement allowing a deferral of depreciation on certain plant
categories until March 1, 1998. That deferral is now being amortized.

         Equity in earnings of unconsolidated  affiliates  increased in 1998 due
to earnings of Destin,  primarily  resulting from AFUDC capitalized.  During the
third quarter,  construction of the offshore  portion of the Destin pipeline was
completed,  and it is currently  transporting about 90 million cubic feet (MMcf)
of natural gas per day. As additional  reserves are connected  during the fourth
quarter, daily throughput is expected to exceed 200 MMcf per day by year end.

         Citrus - Equity in earnings of Citrus  increased  $1.1  million to $6.7
million for the three months ended September 30, 1998. The increase is primarily
due to the  recognition  of credits on a gas supply  agreement,  lower  interest
expense and an  adjustment  to a reserve for gas  imbalances,  partly  offset by
higher operating expenses.

Nine Months 1998 to Nine Months 1997 Analysis

         Southern Natural Gas Company and Subsidiaries - EBIT was $163.4 million
for the nine months ending September 30, 1998,  compared with $146.0 million for
the same 1997 period.  The increase was primarily due to an expansion  placed in
service,  lower expenses and increased earnings of Destin.  Partially offsetting
these increases was the net effect of reserve  adjustments  made in the 1997 and
1998 periods, which is discussed below.

         Market  transportation  revenues  improved  primarily  due to a  recent
expansion.  Other  revenues  decreased  due to a favorable  $10 million  reserve
adjustment in 1997 relating to  Southern's  obligation to pay royalty  claims in
connection  with  take-or-pay  settlements  entered  into in the 1980's,  offset
partially by the reversal of the remaining  $4.2 million of royalty  reserves in
1998. Such reversal was made because  management  determined that the likelihood
of the Company making any significant  royalty payments as a result of its prior
take-or-pay   settlements  was  remote.  General  and  administrative   expenses
decreased  primarily due to lower employee  benefit  expenses,  lower  insurance
expenses  and  lower   stock-based   compensation   expense.   Depreciation  and
amortization  expense  decreased  primarily  due to an adjustment of the salvage
value on certain fixed assets (see Note 1 of the Notes to Condensed Consolidated
Financial Statements).  Increases due to plant additions and the amortization of
the deferred  depreciation  pursuant to the customer settlement partially offset
this decrease.
<PAGE>

         Equity in earnings of unconsolidated  affiliates  increased in 1998 due
to earnings of Destin, primarily resulting from AFUDC capitalized on its current
construction costs. Other income was lower primarily due to the recognition of a
gain on the termination of a forward rate agreement in the 1997 period.

         Citrus - Equity in earnings of Citrus  increased  $4.0 million to $22.4
million for the nine months ended  September 30, 1998. The increase is primarily
due to the  recognition of credits on a gas supply  agreement,  lower  operating
expenses and lower  interest  expense,  partly offset by reduced  utilization of
firm  transportation  capacity  held by Citrus  Trading  and lower  revenues  at
Florida Gas due to lower throughput.

Natural Gas Sales and Supply

         As a result of FERC Order No. 636,  Southern  Natural Gas terminated or
renegotiated  to market pricing  substantially  all of its gas supply  contracts
through which it had historically obtained its long-term gas supply. Pending the
termination of the remaining supply  contracts,  Southern Natural Gas' remaining
gas supply is sold on a month-to-month  basis. Gas sales revenue and natural gas
cost are included in other revenue.

         Southern Natural Gas' annual purchase  commitments  total less than $25
million per year for 1998 and subsequent  years.  Based on Southern Natural Gas'
current  expectations  with  respect to natural gas prices in 1998 and the years
following,  only an  insignificant  amount of gas  volumes is  expected to be at
prices above market.

Rate Matters

         Under  terms of a  settlement  approved  by the FERC,  all of  Southern
Natural Gas' previously  pending rate proceedings and proceedings to recover gas
supply realignment and other transition costs associated with the implementation
of FERC Order No.  636 have been  resolved.  The  settlement  requires  Southern
Natural Gas to file a new rate case no later than September 1, 1999.

         In September  1997,  the FERC approved a Rate Case  Settlement  between
Florida Gas and its customers.  The terms of the  settlement  provide for tiered
rates effective  beginning March 1, 1997, which, for a two-year period,  reflect
an increase over the rates in effect prior to the rate filing for transportation
through both the pre expansion and Phase III expansion  systems.  The settlement
resolved all issues related to Phase III construction and the construction  cost
audit. The settlement terms require Florida Gas to file a new rate case no later
than October 1, 2001.



<PAGE>


ENERGY SERVICES

         Sonat Energy Services, through its majority-owned  subsidiaries,  Sonat
Marketing  and Sonat Power  Marketing  L.P.  (Sonat Power  Marketing),  conducts
marketing activities in the natural gas and electric  industries,  respectively.
Sonat Marketing  purchases and resells  substantially all of Sonat Exploration's
natural  gas  production,  as well as  purchasing  and  reselling  gas for other
customers. Sonat Power Marketing has executed electric power purchase, sales and
transmission  agreements with numerous companies and is focused on expanding its
wholesale electric marketing business. Both of these subsidiaries use derivative
instruments in managing  commodity price risk (see Market Risk and Note 4 of the
Notes to Condensed Consolidated Financial Statements).

         In 1998 a  subsidiary  of Sonat Energy  Services  acquired a 50 percent
interest in a natural  gas-fired power plant in Georgia (the  Mid-Georgia  Cogen
plant) for a gross  investment  of  approximately  $28 million.  The power plant
began operations in June 1998. In July 1998, Sonat Energy Services announced its
intention to develop a 680-megawatt  natural  gas-fired peaking power plant near
Columbus,  Georgia.  The Cataula Power Plant, which will have a gross investment
of approximately  $227 million,  is scheduled to begin  commercial  operation in
June 2000.  The plant  will  provide  energy to serve the  growing  Georgia  and
Southeast power markets during peak power demand periods.  Sonat Energy Services
is pursuing additional power plant opportunities.

         Sonat Intrastate-Alabama Inc. (SIA), a wholly owned subsidiary of Sonat
Energy  Services,  owns an  approximately  450-mile  intrastate  pipeline system
extending  from  natural  gas fields and coal seam gas  production  areas in the
Black  Warrior  Basin in  northwest  and  central  Alabama to  connections  with
customers in Alabama,  as well as  interconnections  with three other pipelines,
including Southern. SIA's throughput in the first nine months of 1998 was 31 Bcf
compared with 26 Bcf in the first nine months of 1997.

         Sonat Power Systems Inc., a wholly owned subsidiary of Sonat,  formed a
strategic alliance in 1997 with AlliedSignal Power Systems Inc., an unaffiliated
company,  to market and support its onsite electric power systems in 13 Southern
states from Texas to Virginia, and the District of Columbia.



<PAGE>


ENERGY SERVICES

<TABLE>
<CAPTION>
                                                                    Three Months                       Nine Months
                                                                Ended September 30,                Ended September 30,
                                                                -------------------                -------------------
                                                           1998             1997              1998              1997
                                                           ----             ----              ----              ----
                                                                                 (In Millions)

<S>                                                       <C>               <C>              <C>               <C>     
Revenues                                                  $762.0            $912.9           $2,499.2          $2,569.1
                                                          ======            ======           ========          ========

Operating Margin                                          $ 13.7            $ 11.0           $   41.1          $   31.4
                                                          ======            ======           ========          ========

Operating Income                                          $  1.5            $   .9           $    4.8          $    2.0
                                                          ======            ======           ========          ========

Earnings Before Interest and Taxes                        $  4.2            $   .7           $    6.7          $    1.5
                                                          ======            ======           ========          ========

Physical Volumes:
    Sonat Marketing Gas Sales
       Volumes (100%)
          (Billion Cubic Feet)                               285               339                929               942
                                                          ======            ======           ========          ========

    Sonat Power Marketing Sales
       Volumes (100%)
          (Thousands of Megawatt Hours)                    3,051             3,344              8,950             6,662
                                                          ======            ======           ========          ========

Financial Settlements (Notional):
    (Bcf/d)                                                 11.8               4.5                8.7               3.6
                                                          ======            ======           ========          ========
</TABLE>


Third Quarter 1998 to Third Quarter 1997 Analysis

         Third quarter 1998 financial  results  improved from third quarter 1997
levels,  as EBIT rose to $4.2 million from $.7 million in 1997. The increase was
due  to  better  power  marketing   results  and  the  contribution  of  the  50
percent-owned  Mid-Georgia  Cogen L.P. power plant.  Sonat  Marketing  Company's
third quarter  physical sales volumes were slightly below 1997 levels.  Notional
sales  volumes  from  natural gas  derivative  transactions  more than  doubled,
however,  reflecting an increase in Sonat Marketing's financial  transactions on
behalf of  customers  and an increase in reliance on financial  transactions  to
manage its basis  positions.  While Sonat Power  Marketing's  third quarter 1998
volumes were slightly below 1997 levels,  margins were substantially  better due
to improved market  conditions.  Sonat Power Marketing's  financial results also
benefited from marketing  arrangements,  whereby it  participates  in the spread
between natural gas and electricity prices.

Nine Months 1998 to Nine Months 1997 Analysis

         EBIT for the first nine  months of 1998 rose to $6.7  million  compared
with $1.5  million  for the first  nine  months of 1997.  The  improved  results
reflect  higher  volumes  at Sonat  Power  Marketing,  better  margins,  and the
contribution  of  the  Mid-Georgia  Cogen  L.P.  power  plant.   Although  Sonat
Marketing's physical sales volumes were essentially flat, notional sales volumes
more than doubled.  Sonat Power  Marketing's  sales volumes  reached 9.0 million
megawatt hours, up  significantly  from 6.7 million  megawatt hours in the first
nine months of 1997. The initiation of commercial  operations at the Mid-Georgia
plant in June 1998 and electric  power  marketing  opportunities  created by the
above  normal  temperatures  in the  Southeast  and Midwest  contributed  to the
increase  in EBIT.  Results  for 1998  reflect  start-up  losses for Sonat Power
Systems, which slightly offset these favorable factors.




<PAGE>

Other Income Statement Items

<TABLE>
<CAPTION>
                                                                    Three Months                       Nine Months
                                                                Ended September 30,                Ended September 30,
                                                                -------------------                -------------------
                                                           1998             1997              1998              1997
                                                           ----             ----              ----              ----
                                                                                 (In Millions)

<S>                                                      <C>                <C>             <C>                <C>    
Interest Expense, Net                                    $ (32.3)           $(23.5)         $ (93.1)           $(68.8)
</TABLE>

         Net interest  expense  increased in both the three-month and nine-month
periods of 1998 as  compared to the same  periods of 1997 due to higher  average
debt levels. Partially offsetting was the effect of lower interest rates on debt
in both periods of 1998.  In addition,  the  nine-month  period of 1998 reflects
higher  interest  income  on  restricted  cash and other  investments.  Interest
capitalized  decreased in both periods of 1998 due to lower interest capitalized
at Sonat Exploration.

<TABLE>
<S>                                                      <C>                <C>             <C>                <C>   
Income Tax Expense (Benefit)                             $(142.7)           $ 25.1          $(304.0)           $ 87.6
</TABLE>

         Income tax expense  decreased  in both  periods due to the ceiling test
charges related to the Company's oil and gas  operations.  Absent these charges,
the  effective  tax rate was lower in both  periods of 1998 as  compared to 1997
because tax preference  items had a greater impact on income before income taxes
in the 1998 periods.



<PAGE>


LIQUIDITY AND CAPITAL RESOURCES

Cash Flows
<TABLE>
<CAPTION>
                                                                                                       Nine Months
                                                                                                   Ended September 30,
                                                                                              1998              1997
                                                                                                    (In Millions)

<S>                                                                                         <C>                <C>   
Operating Activities                                                                        $ 426.1            $556.0
</TABLE>

         Cash flow from operations decreased $129.9 million compared to the 1997
period primarily due to lower operating results at Sonat Exploration.  Partially
offsetting the decrease was higher cash flows at Sonat Energy Services.
Operating results were discussed earlier.

         Depreciation,  depletion,  and  amortization  and deferred income taxes
include  a  charge  of  $1,035.2  million  and  a  benefit  of  $362.3  million,
respectively,  for ceiling test charges related to Sonat  Exploration's  oil and
gas properties in 1998. Absent the ceiling test charges,  the change in deferred
income  taxes and accrued  interest  and income  taxes  primarily  reflects  the
capitalization of intangible drilling costs in the current period. The change in
accounts  receivable  and accounts  payable is primarily  attributable  to lower
natural gas prices and volumes. The change in restricted cash, accrued long-term
compensation,  and other current assets and liabilities  primarily represent the
payment of certain  expenses in connection  with the merger  between the Company
and  Zilkha  Energy  in  January  1998  (see  Note 3 of the  Notes to  Condensed
Consolidated Financial Statements).  Lower broker deposits at Sonat Marketing in
the  current  period   slightly   offset  the  decline  in  current  assets  and
liabilities.

     The caption  Other in the 1997 period  includes  $15.4  million of deferred
gains on derivatives designated as hedges at Sonat Marketing.

<TABLE>
<S>                                                                                         <C>               <C>     
Investing Activities                                                                        $(503.6)          $(775.1)
</TABLE>

         Net cash used in investing  activities was $271.5 million lower in 1998
compared to 1997. The decrease was primarily  attributable  to proceeds from the
sale of certain  oil and gas  properties  (see Note 3 of the Notes to  Condensed
Consolidated  Financial  Statements).  The sale of those properties also had the
effect of decreasing  capital  expenditures at Sonat  Exploration in the current
period.  Higher  investments in  unconsolidated  affiliates,  specifically,  the
Destin  and  the  Mid-Georgia  Cogen  joint  ventures   partially  offset  these
decreases.



<PAGE>


<TABLE>
<CAPTION>
                                                                                                       Nine Months
                                                                                                   Ended September 30,
                                                                                              1998              1997
                                                                                                    (In Millions)

         Capital  expenditures for the Company's  business  segments  (excluding
unconsolidated affiliates) were as follows:

<S>                                                                                         <C>               <C>    
         Exploration and Production                                                         $ 481.1           $ 649.1
         Natural Gas Transmission                                                             160.3             100.5
         Energy Marketing                                                                       8.1               8.3
         Other                                                                                  4.2               2.7
                                                                                            -------           -------

         Total                                                                              $ 653.7           $ 760.6
                                                                                            =======           =======
</TABLE>

     The  Company's  share  of  capital   expenditures  by  its   unconsolidated
affiliates was $100.3 million and $18.1 million in the first nine months of 1998
and 1997, respectively.

<TABLE>
<S>                                                                                         <C>               <C>    
Financing Activities                                                                        $  60.9           $ 290.7
</TABLE>

         Net cash provided by financing  activities  was $229.8 million lower in
1998  period  compared  to  1997.  The  proceeds  from  the  sale of oil and gas
properties were used to repay  borrowings under Sonat's floating rate facilities
in the current period.

CAPITAL RESOURCES

         At  September  30,  1998,  the  Company  had bank lines of credit and a
revolving  credit  agreement  with banks with a total capacity of $1.25 billion.
The  Company's  bank and  commercial  paper  borrowings in the aggregate are not
authorized to exceed the maximum amount  available under its lines of credit and
revolving  credit  agreement.  As a result,  after  giving  effect to the $611.8
million of commercial  paper and $25.5 million of borrowings from the short-term
lines of credit, $612.7 million was available to the Company under such lines of
credit and revolving credit agreement at September 30, 1998.

         Sonat and Southern Natural Gas have shelf registration  statements with
the Securities and Exchange  Commission  which provide for the issuance of up to
$500 million in debt securities by both companies.  Southern  Natural Gas issued
$100 million in debt under its  registration  statement in the third  quarter of
1998.

         The Company's capital expenditures and other investing requirements for
1998 are expected to aggregate $910.2 million.  This amount reflects investments
in unconsolidated  affiliates and proposed expenditures for oil and gas property
acquisitions,   exploration  and  development,   pipeline  expansion  and  other
projects.  The Company  completed  the Zilkha Energy merger on January 30, 1998,
issuing  $1.04 billion of common stock to the Zilkha  Energy  shareholders  (see
Note 3 of  the  Notes  to  Condensed  Consolidated  Financial  Statements).  The
Company's  cash  requirements  relating  to the  Zilkha  Energy  merger  totaled
approximately $290 million,  principally for repayment of debt and certain other
liabilities of Zilkha Energy and transaction expenses.
<PAGE>

         The Company has a stock repurchase program in effect through the end of
1998. As of September 30, 1998, the Company had remaining  authority to purchase
approximately  967,000 shares of the Company's  common stock.  Shares  purchased
under the program are expected to be reissued in connection  with employee stock
option and restricted stock programs.

         The Company  believes that cash flow from  operations and borrowings in
either the private or public  market will  provide the Company with the means to
fund operations and currently planned investment and capital expenditures.

MARKET RISK

         Financial  instruments of the Company expose it to both commodity price
risk and interest rate risk.

         Commodity  Price Risk - The Company's  primary  market risk exposure is
the volatility of energy commodity prices, relating to the portfolio position of
its  financial  instruments  and  physical  commitments,  which can  affect  the
operating  results of Sonat  Exploration and Sonat Energy Services.  The Company
uses commodity futures contracts, options and price swap agreements to hedge its
commodity  price risk on crude oil,  natural gas and  electricity.  Sonat Energy
Services performs all hedging activity (non-trading) for both its own operations
and for the operations of Sonat Exploration.  Sonat Energy Services, through its
subsidiary,  Sonat Marketing, also uses derivative instruments as a market maker
(trading  activity)  by  maintaining  active  trading  positions  in natural gas
futures and swap  contracts and limiting its risk to changes in the value of its
outstanding positions through the use of Value-at-Risk models,  establishment of
offsetting positions, and limit and monitoring procedures.

         The  Company's   non-trading   (hedging)  and  trading  activities  are
implemented  under a set of  policies  approved  by the Board of  Directors.  In
addition,  all derivative activities are internally reviewed by a Risk Oversight
Committee  to  ensure  compliance  with  all  policies.  The  Company's  use  of
derivative instruments to reduce the effect of market volatility is described in
Note 4 of the Notes to Condensed  Consolidated  Financial  Statements.  The Risk
Oversight Committee and management monitor the portfolio Value-at-Risk to ensure
compliance with Board limits.

         Interest  Rate Risk - The Company's  entire  portfolio of interest rate
risk instruments is classified as non-trading. The Company's interest income and
expense are  sensitive to changes in the level of short-term  interest  rates in
the  United  States.  In  general,  the  Company  uses  excess  funds to  reduce
short-term debt levels and therefore has minimal cash equivalent investments. To
mitigate the impact of fluctuations in interest rates,  the Company  maintains a
balance among components of its capital structure, providing a mix of maturities
and pricing methods for its debt  obligations.  In the past the Company has used
derivative  instruments to aid in its management of interest rate risk, although
it is not currently doing so.
<PAGE>

YEAR 2000 PROJECT

         The Company is aware of the  potential  impact the Year 2000 could have
on its information  technology and business  infrastructure.  To answer the Year
2000  challenge,  the Sonat Board of Directors  directed  that a  corporate-wide
initiative  be  undertaken.  A  consulting  firm was  engaged  to assist in this
effort.

         The  Company  has  divided  its  Year  2000  project  into  assessment,
implementation,  and testing phases.  During the assessment  phase,  the Company
completed a comprehensive inventory of IT systems, embedded systems,  equipment,
computer  hardware and software  that rely on a computer chip as well as service
providers that could be impacted by the Year 2000 problem.  For vendor  supplied
items,  the Company has contacted its vendors  seeking  written  verification of
Year 2000 readiness.  In addition,  the Company is also  communicating  with its
customers and business  partners to determine the extent to which the Company is
vulnerable  to the failure of those third  parties to remediate  their Year 2000
issue.

         The  Company is  currently  engaged in the  implementation  and testing
phases of the Year 2000 project.  The implementation  phase includes  completing
the replacement of mainframe systems with Year 2000-compliant vendor packages on
new  client/server  platforms  and  performing  any required  modifications  and
upgrades  identified  during the  assessment  phase.  The testing phase involves
testing  systems for Year 2000  readiness.  The Company is scheduled to have all
critical  systems  tested,  remediations  plans defined,  and corrective  action
underway by December  31,  1998.  All  remediation  efforts are  scheduled to be
completed by June 30, 1999.

         The  Company  is  also  currently   developing   contingency  plans  as
practicable for critical  systems,  service  providers,  and business  partners.
These plans involve  developing  contingencies for failures that may result from
the Year 2000 problem. The Company is scheduled to have these plans completed by
June 30, 1999. The Company has not completed  analyzing worst case scenarios and
therefore is not able to estimate potential lost revenue at this time.

         The estimated  cost to the Company of the Year 2000 project for capital
as well as general and administrative  costs is expected to be $5 million to $10
million.  As of September 30, 1998, the Company has incurred  approximately $1.3
million  in Year 2000  project  costs.  The  Company  expects  to fund Year 2000
expenditures from normal operations.

RECENT ACCOUNTING PRONOUNCEMENT

         In June 1998, the Financial  Accounting  Standards  Board (FASB) issued
Statement of  Financial  Accounting  Standards  (SFAS) No. 133,  Accounting  for
Derivative Instruments and Hedging Activities. SFAS No. 133 requires the Company
to recognize all  derivatives  on the balance  sheet at fair value.  Derivatives
that are not hedges  must be adjusted  to fair value  through  income as changes
occur.  If the  derivative  is a hedge,  depending  on the  nature of the hedge,
changes in the fair value of derivatives are either offset against the change in
fair value of assets,  liabilities,  or firm  commitments  through  earnings  or
recognized in other comprehensive  income until the hedged item is recognized in
earnings. The ineffective portion of a derivative's change in fair value will be
immediately  recognized in earnings.  SFAS No. 133 becomes  effective for fiscal
years beginning after June 15, 1999. As a result,  calendar  year-end  companies
have until January 1, 2000, to adopt. Early application is encouraged,  but only
permitted as of the beginning of any fiscal quarter.  Retroactive application to
previous  periods,  even previous  quarters  within the same fiscal year, is not
permitted.  The Company has not yet  determined  what the effect of SFAS No. 133
will be on the earnings and financial position of the Company.
<PAGE>

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

         This  Quarterly  Report  contains  certain  forward-looking  statements
regarding  the  Company's  business  plans  and  prospects,  objectives,  future
drilling plans,  expansion projects,  proposed capital expenditures and expected
performance  or  results.   These   forward-looking   statements  are  based  on
assumptions that the Company believes are reasonable,  but are subject to a wide
range of risks and uncertainties and, as a result, actual results and experience
may  differ  materially  from the  anticipated  results  or  other  expectations
expressed  in such  forward-looking  statements.  Such  statements  are  made in
reliance on the safe harbor  provisions  of the  Private  Securities  Litigation
Reform Act of 1995.

         Important  factors  that could cause actual  results to differ  include
changes  in oil and  gas  prices  and  underlying  demand,  which  would  affect
profitability  and might  cause the  Company to alter its plans;  the timing and
success of the Company's  exploration and development  drilling programs,  which
would  affect  production  levels and  reserves;  the  results of the  Company's
hedging activities;  risks incident to the drilling and operation of oil and gas
wells; future drilling, production and development costs, including drilling rig
rates;  the  success  of  the  Company's  cost  reduction  activities;  and  the
requirements to receive various governmental approvals to proceed with pipeline,
storage and power generation projects, and unanticipated  construction delays in
connection  with such  projects.  Realization  of the Company's  objectives  and
expected  performance can also be adversely affected by the actions of customers
and competitors, changes in governmental regulation of the Company's businesses,
and changes in general  economic  conditions  and the state of domestic  capital
markets.

         Changes in business conditions in the oil and gas industry and at Sonat
Exploration  could  change its  current  plans for  increasing  its  onshore and
offshore  exploration  programs.  Such changes would include material changes in
oil and gas prices and  drilling rig rates.  Finally,  there can be no assurance
that  Destin will be able to timely  connect  new fields or that the  production
from those fields will allow it to meet its planned throughput objectives.




<PAGE>
                           PART II. OTHER INFORMATION

Item 6.  Exhibits and Reports on Form 8-K

(a)      Exhibits1

Exhibit
Number                                      Exhibits


10.1*         Executive Award Plan of Sonat Inc. as Amended and Restated as of 
              July 23, 1998

10.2*         Amendment to the Performance Award Plan of Sonat Inc. dated as of 
              July 23, 1998

10.3*         Amendment to the Performance Award and Cash Bonus Plan of Sonat 
              Inc. dated as of July 23, 1998

10.4*         Amendment to the Cash Bonus Plan of Sonat Inc. dated as of 
              July 23, 1998

10.5*         Executive Severance Agreement dated July 23, 1998, between Sonat 
              Inc. and Ronald L. Kuehn, Jr.

10.6*         Executive  Severance Agreement dated July 23, 1998, between Sonat 
              Inc. and Thomas W. Barker, Jr. and schedule identifying 
              substantially identical Executive Severance Agreements between 
              Sonat Inc. and other parties

12*           Computation of Ratio of Earnings to Fixed Charges

18*           Letter re Change in Accounting Principles

27.1*         Financial Data Schedules for the period ended September 30, 1998, 
              filed electronically only

27.2*         Restated  Financial  Data  Schedules  for the period ended 
              June 30, 1998, filed electronically only

27.3*         Restated  Financial  Data  Schedules for the period ended 
              March 31, 1998, filed electronically only

27.4*         Restated  Financial Data Schedules for the period ended 
              December 31, 1997, filed electronically only

27.5*         Restated Financial Data Schedules for the period ended 
              September 30, 1997, filed electronically only

27.6*         Restated  Financial  Data  Schedules  for the period ended 
              June 30, 1997, filed electronically only

27.7*         Restated  Financial  Data  Schedules for the period ended 
              March 31, 1997, filed electronically only

27.8*         Restated  Financial Data Schedules for the period ended 
              December 31, 1996, filed electronically only

27.9*         Restated  Financial Data Schedules for the period ended 
              December 31, 1995, filed electronically only
------------

*   Filed herewith

(b)      Reports on Form 8-K

         The  Company  filed a Report  on Form 8-K on July 23,  1998,  reporting
certain  information  under Item 5 with respect to the second quarter results of
operations  and  the  completion  of  the  restructuring  of  its  wholly  owned
subsidiary, Sonat Exploration Company.

         The Company filed a Report on Form 8-K on September 17, 1998, reporting
certain information under Item 5 with respect to the Grynberg complaint.

         The Company  filed a Report on Form 8-K on October 22, 1998,  reporting
certain  information  under Item 5 with respect to the  Company's  third quarter
results which  reflected the adoption of the full cost method of accounting  for
its exploration and production business segment.



1    The Company will  furnish to  requesting  security  holders the exhibits on
     this list  upon the  payment  of a fee of $.10 per page up to a maximum  of
     $5.00 per exhibit.  Requests  must be in writing and should be addressed to
     Beverley T. Krannich,  Secretary,  Sonat Inc., P. O. Box 2563,  Birmingham,
     Alabama 35202-2563.

<PAGE>



                           SONAT INC. AND SUBSIDIARIES




                                   SIGNATURES




         Pursuant to the  requirements  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.




                                                  SONAT INC.



Date:      November 12, 1998               By:      /s/ James E. Moylan, Jr.
       --------------------------                 --------------------------
                                                  James E. Moylan, Jr.
                                                  Senior Vice President and
                                                  Chief Financial Officer





Date:      November 12, 1998               By:      /s/ Thomas W. Barker, Jr.
       --------------------------                 ---------------------------
                                                  Thomas W. Barker, Jr.
                                                  Vice President-Finance