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       June 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:

                 110,035,497 SHARES OUTSTANDING ON JULY 31, 1998



<PAGE>


                           SONAT INC. AND SUBSIDIARIES

                                      INDEX
<TABLE>
<CAPTION>

                                                                                                              Page No.

PART I.       Financial Information

              Item 1.      Financial Statements

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

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

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

                           Notes to Condensed Consolidated Financial
                               Statements (Unaudited)                                                          4 - 16

              Item 2.      Management's Discussion and Analysis of Financial
                               Condition and Results of Operations                                            17 - 34

PART II.      Other Information

              Item 5.      Legal Proceedings                                                                  35

              Item 6.      Exhibits and Reports on Form 8-K                                                   35
</TABLE>





<PAGE>


                                                          
                          PART I. FINANCIAL INFORMATION
Item 1.  Financial Statements
                           SONAT INC. AND SUBSIDIARIES
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                                   (Unaudited)
<TABLE>
<CAPTION>
                                                                                 June 30,                   December 31,
                                                                                   1998                         1997
                                                                                           (In Thousands)
                                                        ASSETS
Current Assets:
<S>                                                                                <C>                       <C>       
    Cash and cash equivalents                                                      $   11,139                $   27,278
    Restricted cash (Note 2)                                                            -                       115,956
    Accounts receivable                                                               490,760                   619,581
    Inventories                                                                        63,021                    65,161
    Income taxes                                                                       26,164                     1,985
    Gas imbalance receivables                                                          13,091                    16,644
    Assets from trading activities                                                     96,035                    92,150
    Other                                                                              37,425                    42,052
                                                                                   ----------                ----------
       Total Current Assets                                                           737,635                   980,807
                                                                                   ----------                ----------

Investments in Unconsolidated Affiliates and Other                                    661,758                   553,618
                                                                                   ----------                ----------

Plant, Property and Equipment                                                       6,328,070                 6,079,239
    Less accumulated depreciation, depletion
       and amortization                                                             3,578,615                 3,096,541
                                                                                   ----------                ----------
                                                                                    2,749,455                 2,982,698
                                                                                   ----------                ----------
Deferred Charges and Other:
    Assets from trading activities                                                     28,980                     9,638
    Other                                                                             170,399                   190,298
                                                                                   ----------                ----------
                                                                                      199,379                   199,936
                                                                                   ----------                ----------

Total Assets                                                                       $4,348,227                $4,717,059
                                                                                   ==========                ==========

                                         LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
    Long-term debt due within one year                                             $    9,829                $   14,508
    Unsecured notes                                                                   816,909                   446,721
    Accounts payable                                                                  481,409                   615,322
    Accrued income taxes                                                               12,579                    18,274
    Accrued interest                                                                   41,089                    37,242
    Accrued long-term compensation (Note 2)                                              -                       73,799
    Gas imbalance payables                                                             10,277                    14,320
    Liabilities from trading activities                                                86,848                    85,398
    Other                                                                              41,879                    75,299
                                                                                   ----------                ----------
       Total Current Liabilities                                                    1,500,819                 1,380,883
                                                                                   ----------                ----------

Long-Term Debt                                                                      1,101,691                 1,235,984
                                                                                   ----------                ----------

Deferred Credits and Other:
    Deferred income taxes                                                             196,190                   298,681
    Liabilities from trading activities                                                23,333                     5,014
    Other                                                                             186,387                   182,507
                                                                                   ----------                ----------
                                                                                      405,910                   486,202
                                                                                   ----------                ----------
Commitments and Contingencies

Stockholders' Equity:
    Common stock and other capital                                                    168,872                   167,786
    Retained earnings                                                               1,231,712                 1,511,085
                                                                                   ----------                ----------
                                                                                    1,400,584                 1,678,871
    Less treasury stock                                                                60,777                    64,881
                                                                                   ----------                ----------
       Total Stockholders' Equity                                                   1,339,807                 1,613,990
                                                                                   ----------                ----------

Total Liabilities and Stockholders' Equity                                         $4,348,227                $4,717,059
                                                                                   ==========                ==========
</TABLE>

                             See accompanying notes.

<PAGE>


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

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

<S>                                                          <C>                <C>             <C>              <C>       
Revenues                                                     $  925,222         $856,130        $2,034,407       $1,979,795
                                                             ----------         --------        ----------       ----------

Costs and Expenses:
    Natural gas cost                                            551,734          548,293         1,315,217        1,323,391
    Electric power cost                                         115,421           42,970           180,612           75,856
    Operating and maintenance                                    42,021           44,878            82,501           83,817
    Exploration cost                                             23,015           34,493            47,702           67,050
    General and administrative                                   35,924           59,179            75,158          103,958
    Depreciation, depletion
       and amortization                                          85,142           77,986           172,690          160,565
    Impairment of oil and gas properties                        429,827             -              429,827             -
    Restructuring costs                                          15,017             -               15,017             -
    Taxes, other than income                                     13,830           11,108            27,435           16,902
                                                             ----------         --------        ----------       ----------
                                                              1,311,931          818,907         2,346,159        1,831,539
                                                             ----------         --------        ----------       ----------

Operating Income (Loss)                                        (386,709)          37,223          (311,752)         148,256

Other Income, Net:
    Equity in earnings of
       unconsolidated affiliates                                 17,527            9,445            27,180           19,567
    Minority interest                                            (1,089)              76            (1,631)            (796)
    Other income, net                                             1,252            1,337             1,964            7,504
                                                             ----------         --------        ----------       ----------
                                                                 17,690           10,858            27,513           26,275
                                                             ----------         --------        ----------       ----------

Earnings (Loss) Before Interest
    and Taxes                                                  (369,019)          48,081          (284,239)         174,531
                                                             ----------         --------        ----------       ----------

Interest:
    Interest income                                               1,063            1,013             3,263            2,195
    Interest expense                                            (34,792)         (26,518)          (66,922)         (51,371)
    Interest capitalized                                          1,448            1,824             2,872            3,867
                                                             ----------         --------        ----------       ----------
                                                                (32,281)         (23,681)          (60,787)         (45,309)
                                                             ----------         --------        ----------       ----------

Income (Loss) Before Income Taxes                              (401,300)          24,400          (345,026)         129,222

Income Tax Expense (Benefit)                                   (143,322)           7,549          (125,061)          42,504
                                                             ----------         --------        ----------       ----------

Net Income (Loss)                                            $ (257,978)        $ 16,851        $ (219,965)      $   86,718
                                                             ==========         ========        ==========       ==========

Basic Earnings (Loss) Per Share
    of Common Stock                                          $    (2.34)        $    .15        $    (2.00)      $      .79
                                                             ==========         ========        ==========       ==========

Diluted Earnings (Loss) Per Share
    of Common Stock                                          $    (2.32)        $    .15        $    (1.98)      $      .77
                                                             ==========         ========        ==========       ==========

Weighted Average Shares Outstanding                             110,049          110,185           110,008          110,285
                                                             ==========         ========        ==========       ==========

Weighted Average Shares Outstanding-
    Assuming Dilution                                           111,057          111,883           111,060          111,915
                                                             ==========         ========        ==========       ==========

Dividends Paid Per Share                                     $      .27         $    .27        $      .54       $      .54
                                                             ==========         ========        ==========       ==========
</TABLE>




                             See accompanying notes.

<PAGE>


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

                                                                                             Six Months
                                                                                           Ended June 30,
                                                                                   1998                      1997
                                                                                           (In Thousands)
Cash Flows from Operating Activities:
<S>                                                                                 <C>                       <C>      
    Net income (loss)                                                               $(219,965)                $  86,718
    Adjustments to reconcile net income (loss) to net
       cash provided by operating activities:
          Depreciation, depletion and amortization,
              including impairment                                                    602,517                   160,565
          Exploration cost                                                             47,702                    67,050
          Deferred income taxes                                                      (102,225)                   44,078
          Equity in earnings of unconsolidated
              affiliates, less distributions                                          (20,663)                  (15,056)
          Gas supply realignment costs                                                    563                     4,967
          Change in:
              Accounts receivable                                                     188,074                   160,415
              Inventories                                                               2,140                   (23,067)
              Accounts payable                                                       (133,913)                 (101,397)
              Accrued interest and income taxes, net                                  (26,027)                  (19,017)
              Accrued long-term compensation                                          (73,799)                    1,135
              Other current assets and liabilities                                    (11,235)                   (8,551)
              Net change from trading activities                                       (3,458)                     (127)
          Net change in restricted cash                                               115,956                      -
          Other, net                                                                   (4,820)                    6,430
                                                                                    ---------                 ---------

              Net cash provided by operating activities                               360,847                   364,143
                                                                                    ---------                 ---------

Cash Flows from Investing Activities:
    Plant, property and equipment additions                                          (451,360)                 (416,820)
    Net proceeds from disposal of assets                                               14,479                     3,954
    Exploration cost, excluding lease write-offs                                      (23,758)                  (50,512)
    Investments in unconsolidated affiliates and other                                (88,645)                     (572)
                                                                                    ---------                 ---------

              Net cash used in investing activities                                  (549,284)                 (463,950)
                                                                                    ---------                 ---------

Cash Flows from Financing Activities:
    Proceeds from issuance of long-term debt                                          400,000                   750,000
    Payments of long-term debt                                                       (540,834)                 (700,455)
    Changes in short-term borrowings                                                  370,188                   122,701
                                                                                    ---------                 ---------
       Net changes in debt                                                            229,354                   172,246
    Dividends paid                                                                    (59,408)                  (46,489)
    Treasury stock purchases                                                           (1,289)                  (40,849)
    Other equity                                                                        3,641                     7,628
                                                                                    ---------                 ---------

              Net cash provided by financing activities                               172,298                    92,536
                                                                                    ---------                 ---------

Net Decrease in Cash and Cash Equivalents                                             (16,139)                   (7,271)

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

Cash and Cash Equivalents at End of Period                                          $  11,139                 $  40,738
                                                                                    =========                 =========

Supplemental Disclosures of Cash Flow Information
Cash Paid for:
    Interest (net of amount capitalized)                                            $  58,270                 $  43,502
    Income taxes paid, net                                                              7,395                    21,896
</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 to reflect the  Company's  merger
with Zilkha  Energy  Company  (see Note 2).  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 six-month  period ended June 30, 1998,
by $4.4 million.  The effect of the change on the three-month  period ended June
30, 1998, was not material.

2.       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 in the shallow waters of
the Gulf of Mexico where it has accumulated the industry's largest net leasehold
position in the shallow-water area.

         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 as if it had always been a part of Sonat.

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



<PAGE>


2.       Changes in Operations (Cont'd)

         The  following  are the  revenues  and net  income  for the  previously
separate  companies  and the  combined  amounts  presented  in  these  condensed
consolidated financial statements.
<TABLE>
<CAPTION>

                                  Three Months                        Six Months
                               Ended June 30, 1997                Ended June 30, 1997
                               -------------------                -------------------
                                                  (In Thousands)
Revenues
<S>                                 <C>                                <C>       
    Sonat Inc.                      $815,864                           $1,888,102
    Sonat Exploration GOM             40,266                               91,693
                                    --------                           ----------
       Combined                     $856,130                           $1,979,795
                                    ========                           ==========

Net Income (Loss)
    Sonat Inc.                      $ 36,223                           $  103,069
    Sonat Exploration GOM            (19,372)                             (16,351)
                                    --------                           ----------
       Combined                     $ 16,851                           $   86,718
                                    ========                           ==========
</TABLE>

         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  includes  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 $638.4  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  are being
sold.  The Company  expects the sales will be  completed by the end of the third
quarter of 1998 with  proceeds  used to pay down debt.  Based on an  estimate of
sales proceeds and as the result of other  impairments and charges,  the Company
booked an after-tax charge of $289.1 million in the second quarter of 1998.

         The  restructuring  charge is comprised  primarily  of two items;  $279
million for  impairment of properties  and  approximately  $10 million for other
restructuring  expenses primarily associated with a reduction in work force. The
Company  reviewed  all of its oil and  natural  gas  reserves  during the second
quarter of 1998. Based on that review, Sonat Exploration revised downward proved
reserves by a net 199 Bcfe from year-end 1997 proved  reserves.  The majority of
the work force  reductions were completed by the end of the second quarter.  The
remaining reductions under the plan are expected to be completed concurrent with
the remaining  property  sales expected to close by the end of the third quarter
as discussed above.



<PAGE>


2.       Changes in Operations (Cont'd)

         The asset  impairments are associated  primarily with the properties to
be  disposed  of in the  Company's  divestiture  program.  The  impairment  loss
associated  with these assets to be disposed of,  calculated  as the  difference
between the estimated fair value less costs to sell and the carrying amount,  is
estimated at $160 million,  net of gains on certain  properties  included in the
divestiture  program.  The asset  impairments  also  include the  impairment  of
certain assets to be held and used,  which were composed  primarily of producing
properties,  non-producing  leaseholds  and deferred data costs.  The impairment
loss associated  with these assets was estimated at $119 million.  The Condensed
Consolidated  Statement of Operations for both 1998 periods includes revenues of
$27.0  million  associated  with  these  properties  for the  period of  planned
disposal.  The Company has recorded a reserve of $12.4 million to eliminate from
total  Company   operating   results  the  portion  of  the  operating   results
attributable  to the sales package  properties  which  occurred  after the sales
package effective date.

3.       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.

         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 up to
34 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.



<PAGE>


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

         At June 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)                                                1,070.15         1,199.22           72 months
Electricity (Thousands of MWh)                                       87.2             70.4             2 months
Oil (Millions of Barrels)                                             4.4              -              72 months
</TABLE>

Derivative Commodity Instruments Held or Issued for Trading Purposes

         The Company  maintains  active  trading  positions in energy  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  energy  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.

         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 Six Months
                                                           as of 6/30/98                    Ended 6/30/98
                                                                            (In Thousands)

Energy Commodity Trading:
<S>                                                            <C>                              <C>    
    Assets                                                     $125,015                         $93,246
    Liabilities                                                 101,181                          80,099
=======================================================================================================
</TABLE>

     Net trading  gains for the three months and six months ended June 30, 1998,
are $8.9 million and $18.2 million, respectively.



<PAGE>


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

Derivative Commodity Instruments Held or Issued for Purposes Other Than Trading

         Derivative  positions taken  specifically to mitigate market price risk
associated with significant physical  transactions 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.

         Sonat Exploration's  production is hedged 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 June 30, 1998. Not included are the related physical
positions that these derivative positions hedge.

                                                               Fair Value
                                                             (In Thousands)
         Natural Gas                                            $(54,545)
         Electricity                                              (1,783)

         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. 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 June 30,
1998, the market value of the Company's  in-the-money swaps and options was $5.3
million,  and all  counterparties  were within collateral  limits.  Reserves for
credit risk are established as necessary.
<PAGE>

4.       Unconsolidated Affiliates

         The following  table  presents the  components of equity in earnings of
unconsolidated affiliates.
<TABLE>
<CAPTION>

                                                                     Three Months                        Six Months
                                                                    Ended June 30,                     Ended June 30,
                                                                 -------------------                -----------------
                                                            1998              1997             1998              1997
                                                            ----              ----             ----              ----
                                                                                 (In Thousands)

Company's Share of Reported Earnings (Losses):

<S>                                                        <C>                <C>             <C>               <C>    
    Exploration and Production                             $   177            $   84          $   321           $   201
                                                           -------            ------          -------           -------

    Natural Gas Transmission:
       Citrus Corp.                                         10,482             5,807           14,993            12,102
       Amortization of Citrus basis
          difference                                           346               346              692               692
       Bear Creek Storage                                    2,446             2,623            4,535             5,331
       Destin Pipeline                                       3,074               106            5,134               119
       Other                                                    91               (28)              67               (53)
                                                           -------            ------          -------           -------
                                                            16,439             8,854           25,421            18,191
                                                           -------            ------          -------           -------

    Energy Services                                            556               191              781               483
                                                           -------            ------          -------           -------

    Other                                                      355               316              657               692
                                                           -------            ------          -------           -------

                                                           $17,527            $9,445          $27,180           $19,567
                                                           =======            ======          =======           =======
</TABLE>


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



<PAGE>


4.       Unconsolidated Affiliates (Cont'd)

         The following is summarized income statement information for Citrus:
<TABLE>
<CAPTION>

                                                                    Three Months                        Six Months
                                                                   Ended June 30,                     Ended June 30,
                                                                --------------------               -----------------
                                                           1998             1997              1998              1997
                                                           ----             ----              ----              ----
                                                                                (In Thousands)

<S>                                                       <C>               <C>              <C>               <C>     
Revenues                                                  $161,981          $189,546         $295,562          $359,150
Expenses:
    Natural gas cost                                        70,989           104,988          129,603           187,265
    Operating expenses                                      20,900            27,980           44,887            50,430
    Depreciation and amortization                           13,009            14,382           25,731            34,587
    Interest and other                                      23,070            24,247           46,490            48,482
    Income taxes                                            13,049             6,335           18,865            14,182
                                                          --------          --------         --------          --------

Income Reported                                           $ 20,964          $ 11,614         $ 29,986          $ 24,204
                                                          ========          ========         ========          ========
</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                        Six Months
                                                                   Ended June 30,                     Ended June 30,
                                                                --------------------               -----------------
                                                           1998             1997              1998              1997
                                                           ----             ----              ----              ----
                                                                                (In Thousands)

<S>                                                         <C>               <C>             <C>               <C>    
Revenues                                                    $8,821            $8,973          $17,850           $18,319
Expenses:
    Operating expenses                                       1,452             1,120            3,753             2,361
    Depreciation                                             1,360             1,358            2,719             2,714
    Other expenses, net                                      1,116             1,248            2,308             2,581
                                                            ------            ------          -------           -------

Income Reported                                             $4,893            $5,247          $ 9,070           $10,663
                                                            ======            ======          =======           =======
</TABLE>


         In April 1997, units of Shell Oil Company and Amoco Corporation  joined
with    Southern    in    the    ownership    of    Destin    Pipeline,    a   1
billion-cubic-feet-per-day  pipeline  designed  to  transport  natural  gas from
deep-water  development  in the  eastern  Gulf of  Mexico.  Construction  of the
pipeline began in December  1997,  and it is expected to be partially  completed
and in service in August 1998,  and 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 $416  million.
Destin's  earnings in 1997 and 1998 primarily  relate to the allowance for funds
used during construction capitalized on its expenditures to date.



<PAGE>


5.       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 six 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 June 30, 1998.

         In late 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.

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

         In late  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 June 30, 1998, Sonat had short-term lines of credit of $700.0
million  available  through January 25, 1999.  Southern 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 June 30, 1998, Sonat had
$12.7 million  outstanding  under its  agreement at a rate of 6.56  percent.  No
amounts were outstanding under Southern's agreement.

         Sonat had $804.2 million in commercial paper  outstanding at an average
rate of 5.81 percent at June 30, 1998.

6.       Rate Matters and Contingencies

         Periodically,  Southern and its subsidiaries  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  and its
subsidiaries  provide  reserves  relating to such amounts  collected  subject to
refund, as appropriate,  and make refunds upon establishment of the final rates.
At June 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 not collected subject to refund.
<PAGE>

7.       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, net of related
tax, is as follows:
<TABLE>
<CAPTION>

                                                       Three Months                        Six Months
                                                      Ended June 30,                     Ended June 30,
                                                  ---------------------               -----------------
                                                     1998                1997              1998             1997
                                                     ----                ----              ----             ----
                                                                             (In Thousands)

<S>                                                  <C>                 <C>              <C>               <C>    
Net Income (Loss)                                    $(257,978)          $16,851          $(219,965)        $86,718
Unrealized Gains (Loss)
    on Securities                                         (438)              550                826           1,953
                                                     ---------           -------          ---------         -------
Comprehensive Income                                 $(258,416)          $17,401          $(219,139)        $88,671
                                                     =========           =======          =========         =======
</TABLE>

         Common Stock and Other  Capital in the Condensed  Consolidated  Balance
Sheets  includes $4.0 million at June 30, 1998, and $3.2 million at December 31,
1997, related to other  comprehensive  income,  which is comprised of unrealized
gains on securities.

8.       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.



<PAGE>


8.       Segment Information (Cont'd)

         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 June 30, 1998
                                      Exploration            Natural
                                          and                  Gas             Energy
                                      Production          Transmission        Services         Other            Total
                                                                       (In Thousands)
Revenues from
<S>                                    <C>                    <C>              <C>             <C>            <C>      
    External Customers                 $  42,229              $82,806          $800,164        $   23         $ 925,222

Intersegment Revenues                    106,041               12,694              -            9,935           128,670

Earnings (Loss) Before
    Interest and Taxes                  (435,178)              63,147             1,644         1,368          (369,019)
</TABLE>

<TABLE>
<CAPTION>

                                                                  Three Months Ended June 30, 1997
                                      Exploration            Natural
                                          and                  Gas             Energy
                                      Production          Transmission        Services         Other            Total
                                                                       (In Thousands)
Revenues from
<S>                                    <C>                    <C>              <C>            <C>             <C>      
    External Customers                 $  76,443              $83,257          $696,425       $     5         $ 856,130

Intersegment Revenues                     75,548               20,125              -           12,467           108,140

Earnings (Loss) Before
    Interest and Taxes                   (10,152)              55,052              (170)        3,351            48,081
</TABLE>



<PAGE>


8.       Segment Information (Cont'd)
<TABLE>
<CAPTION>

                                                                  Six Months Ended June 30, 1998
                                      Exploration            Natural
                                          and                  Gas             Energy
                                      Production          Transmission        Services         Other            Total
                                                                       (In Thousands)
Revenues from
<S>                                    <C>                   <C>              <C>             <C>            <C>       
    External Customers                 $ 122,067             $175,094         $1,737,219      $    27        $2,034,407

Intersegment Revenues                    188,106               25,907              -           22,307           236,320

Earnings (Loss) Before
    Interest and Taxes                  (422,141)             132,062              2,480        3,360          (284,239)
</TABLE>

<TABLE>
<CAPTION>

                                                                  Six Months Ended June 30, 1997
                                      Exploration            Natural
                                          and                  Gas             Energy
                                      Production          Transmission        Services         Other            Total
                                                                       (In Thousands)
Revenues from
<S>                                    <C>                   <C>              <C>             <C>            <C>       
    External Customers                 $ 167,716             $155,864         $1,656,204      $    11        $1,979,795

Intersegment Revenues                    189,904               46,684              -           21,357           257,945

Earnings Before
    Interest and Taxes                    52,750              115,156                754        5,871           174,531
</TABLE>




<PAGE>


8.       Segment Information (Cont'd)
<TABLE>
<CAPTION>

                                                                Three Months                       Six Months
                                                               Ended June 30,                    Ended June 30,
                                                           ---------------------              -----------------
                                                      1998              1997              1998             1997
                                                      ----              ----              ----             ----
                                                                            (In Thousands)
Total Earnings (Loss) Before
    Interest and Taxes for
<S>                                                  <C>                <C>             <C>                <C>     
    Reportable Segments                              $(369,019)         $ 48,081        $(284,239)         $174,531
Interest Income                                          1,063             1,013            3,263             2,195
Interest Expense                                       (34,792)          (26,518)         (66,922)          (51,371)
Interest Capitalized                                     1,448             1,824            2,872             3,867
                                                     ---------          --------        ---------          --------

Income (Loss) Before Income
    Taxes                                            $(401,300)         $ 24,400        $(345,026)         $129,222
                                                     =========          ========        =========          ========
</TABLE>


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

                                                   June 30, 1998
                                                  (In Thousands)
         Assets by Segment
             Exploration and Production              $ 1,927,432
             Natural Gas Transmission                  1,804,020
             Energy Services                             704,795




<PAGE>


9.       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                       Six Months
                                                                   Ended June 30,                    Ended June 30,
                                                               ---------------------              -----------------
                                                           1998             1997              1998              1997
                                                           ----             ----              ----              ----
                                                                              (In Thousands, Except
                                                                               Per-Share Amounts)

Numerator:
<S>                                                      <C>                <C>             <C>                <C>     
    Net income (Loss)                                    $(257,978)         $ 16,851        $(219,965)         $ 86,718
                                                         =========          ========        =========          ========

Denominator:

    Denominator for Basic Earnings Per Share:

    Weighted average number of
       shares of common stock
       outstanding                                         110,049           110,185          110,008           110,285

    Effect of Dilutive Securities:

    Common stock equivalents
       applicable to outstanding
       stock options                                         1,008             1,698            1,052             1,630
                                                         ---------          --------        ---------          --------

    Denominator for Diluted Earnings Per Share:

    Adjusted weighted average
       shares using treasury
       stock method for assumed
       conversions                                         111,057           111,883          111,060           111,915
                                                         =========          ========        =========          ========


Basic Earnings (Loss) Per Share
    of Common Stock                                      $   (2.34)         $    .15        $   (2.00)         $    .79
                                                         =========          ========        =========          ========

Diluted Earnings (Loss) Per Share
    of Common Stock                                      $   (2.32)         $    .15        $   (1.98)         $    .77
                                                         =========          ========        =========          ========
</TABLE>






<PAGE>



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

RESULTS OF OPERATIONS

         Business segment  operating results for Sonat Inc. and its subsidiaries
(the Company) are presented in the table below.  The table also shows the effect
of a major  restructuring  program  recorded in the second  quarter of 1998 that
affects  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.
<TABLE>
<CAPTION>

                                                                    Three Months                        Six Months
                                                                   Ended June 30,                     Ended June 30,
                                                                --------------------               -----------------
                                                            1998            1997              1998              1997
                                                            ----            ----              ----              ----
                                                                                 (In Millions)
Earnings (Loss) Before Interest and Taxes:
<S>                                                      <C>                <C>             <C>                <C>   
    Exploration and production                           $(435.1)           $(10.1)         $(422.1)           $ 52.8
    Natural gas transmission                                63.1              55.1            132.0             115.2
    Energy services                                          1.7               (.2)             2.5                .7
    Other                                                    1.3               3.2              3.4               5.8
                                                         -------            ------          -------            ------
                                                          (369.0)             48.0           (284.2)            174.5
Adjustment for Restructuring Program:
    Exploration and Production
       Impairment of oil and gas
          properties                                      (429.8)              -             (429.8)              -
       Restructuring costs                                 (15.0)              -              (15.0)              -
                                                         -------            ------          -------            ----
Earnings Before Interest and Taxes
    Excluding Unusual Item                               $  75.8            $ 48.0          $ 160.6            $174.5
                                                         =======            ======          =======            ======


Net Income (Loss) As Reported                            $(258.0)           $ 16.9          $(220.0)           $ 86.7
Adjustment for Restructuring Program:
    Exploration and Production
       Impairment of oil and gas
          properties                                      (279.4)              -             (279.4)              -
       Restructuring costs                                  (9.7)              -               (9.7)              -
                                                         -------            ------          -------            ------
Net Income Excluding Unusual Item                        $  31.1            $ 16.9          $  69.1            $ 86.7
                                                         =======            ======          =======            ======

Earnings (Loss) Per Share of
    Common Stock                                         $ (2.34)           $  .15          $ (2.00)           $  .79
                                                         =======            ======          =======            ======
Earnings (Loss) Per Share of
    Common Stock-Assuming Dilution                       $ (2.32)           $  .15          $ (1.98)           $  .77
                                                         =======            ======          =======            ======

Earnings Per Share of Common Stock
    Excluding Unusual Item                               $   .28            $  .15          $   .63            $  .79
                                                         =======            ======          =======            ======
Earnings Per Share of Common Stock
    Excluding Unusual Item-
    Assuming Dilution                                    $   .28            $  .15          $   .62            $  .77
                                                         =======            ======          =======            ======
</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 Company. 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 2 of the Notes to  Condensed  Consolidated
Financial Statements).

         Following  the merger  with  Zilkha  Energy,  the  Company  undertook a
comprehensive  review of its exploration and production  business to improve its
overall financial performance.  As a consequence,  a major restructuring program
was announced in April 1998. Steps originally announced included the sale of oil
and gas properties, consolidation of business units and a substantial work force
reduction.

         Oil and gas properties to be sold have proved reserves of approximately
500 billion cubic feet of natural gas equivalent (Bcfe) and daily net production
of  approximately  190 million cubic feet (MMcf) of natural gas equivalent.  The
divestiture  includes  all of the  Company's  Austin  Chalk,  Arkoma  Basin  and
substantially  all onshore Gulf Coast  properties as well as various  properties
from other  business  units.  No significant  properties  from the Zilkha Energy
merger  or in  the  Cotton  Valley  Pinnacle  Reef  Trend  are  included  in the
divestiture  program. The property sales are expected to be completed during the
third quarter of 1998.

         Sonat  Exploration  has  consolidated  its business units from seven to
three. This action, together with related staff reductions,  when complete, will
reduce its workforce by approximately 220 people, or approximately one-fourth of
the Sonat Exploration  workforce,  including those employed by Sonat Exploration
GOM Inc.,  the former Zilkha Energy.  The majority of the work force  reductions
were completed by the end of the second quarter.  The remaining reductions under
the plan are expected to be completed  concurrent  with the  remaining  property
sales expected to close by the end of the third quarter as discussed above.

         In addition to these  previously  announced steps, the Company reviewed
all of its oil and natural gas reserves during the second quarter of 1998. Based
on that review,  Sonat Exploration has revised downward proved reserves by a net
199  Bcfe  from  year-end  1997  proved  reserves  and has  impaired  additional
properties.  A substantial  portion of the additional  impaired properties is in
the Cotton Valley Pinnacle Reef trend following an unsuccessful exploratory well
in the  Opelika  region of the play in June 1998 and poor  well  performance  of
recently  completed wells in the Bear Grass area of the trend. The effect of the
further impairments is substantially  offset by the better than expected results
now anticipated from the property sales effort.

         Therefore,  the after-tax restructuring charge, estimated previously as
being up to $275 million,  is $289.1  million,  which was recorded in the second
quarter of 1998. As a result of the  restructuring and giving effect to the sale
of oil and gas properties,  Sonat  Exploration's  proved reserves as of June 30,
1998, are approximately 1.7 trillion cubic feet of natural gas equivalent.

         Management  believes the steps being taken will  significantly  improve
Sonat  Exploration's  financial  performance.  Going forward,  Sonat expects its
total unit costs, other than interest, to be $1.59 per thousand cubic feet (Mcf)
of natural gas  equivalent,  down sharply  from $1.89 in first  quarter of 1998.
Sonat  Exploration's  total 1998  production,  not  including  volumes  from the
properties being sold after the effective sales dates, is now expected to be 258
Bcfe.




<PAGE>


EXPLORATION AND PRODUCTION OPERATIONS
<TABLE>
<CAPTION>

                                                                    Three Months                        Six Months
                                                                   Ended June 30,                     Ended June 30,
                                                                --------------------               -----------------
                                                          1998              1997             1998               1997
                                                          ----              ----             ----               ----
                                                                                 (In Millions)

<S>                                                      <C>                <C>             <C>                <C>   
Revenues                                                 $ 148.3            $152.0          $ 310.2            $357.6
                                                         -------            ------          -------            ------

Costs and Expenses:
    Operating and maintenance                               19.2              20.8             38.6              40.1
    Exploration cost                                        23.0              34.6             47.7              67.1
    General and administrative                              16.6              36.4             34.8              54.0
    Depreciation, depletion and
       amortization                                         69.3              64.8            148.7             133.1
    Impairment of oil and gas
       properties                                          429.8               -              429.8               -
    Restructuring costs                                     15.0               -               15.0               -
    Taxes and other                                         10.8               6.0             18.1              13.1
                                                         -------            ------          -------            ------
                                                           583.7             162.6            732.7             307.4
                                                         -------            ------          -------            ------
Operating Income (Loss)                                   (435.4)            (10.6)          (422.5)             50.2
Other Income                                                  .3                .5               .4               2.6
                                                         -------            ------          -------            ------

Earnings (Loss) Before Interest
    and Taxes As Reported                                 (435.1)            (10.1)          (422.1)             52.8
Restructuring and Impairment of
    Oil and Gas Properties                                (444.8)              -             (444.8)              -
                                                         -------            ------          -------            ------
Earnings (Loss) Before Interest and
    Taxes Excluding Unusual Item                         $   9.7            $(10.1)         $  22.7            $ 52.8
                                                         =======            ======          =======            ======


Net Sales Volumes:
    Gas (Bcf)                                                 60                62              123               129
    Oil and condensate (MBbls)                             1,784             1,312            3,734             2,706
    Natural gas liquids (MBbls)                              591               414            1,175               796
---------------------------------------------------------------------------------------------------------------------

Average Sales Prices:
    Gas ($/Mcf)                                          $  2.00            $ 1.97          $  2.01            $ 2.26
    Oil and condensate ($/Bbl)                             13.00             19.30            13.92             20.65
    Natural gas liquids ($/Bbl)                             8.81              8.39             9.27             12.41
---------------------------------------------------------------------------------------------------------------------
</TABLE>

<PAGE>

Second Quarter 1998 to Second Quarter 1997 Analysis

         EBIT increased $19.8 million after excluding the recognition of charges
of $448.8 million for  restructuring  and impairment costs in the second quarter
of  1998  (see  Note  2  of  the  Notes  to  Condensed   Consolidated  Financial
Statements),  primarily due to lower costs and expenses,  partly offset by lower
revenues.

         Realized oil and condensate  prices  decreased 33 percent to an average
of $13.00 per  barrel  from  $19.30  per  barrel in the second  quarter of 1997.
Natural gas  production  decreased  slightly to 60 Bcf from 62 Bcf in the second
quarter of 1997. Oil and condensate  production increased 36 percent and average
realized  natural gas prices  increased  slightly to $2.00 per Mcf to  partially
offset these unfavorable factors.

         Costs and expenses were $23.7 million lower after  excluding the charge
for   restructuring  and  impairment  costs  discussed   earlier.   General  and
administrative   expense   decreased  54  percent  primarily  due  to  executive
compensation  expense at Sonat  Exploration GOM (formerly  Zilkha Energy) in the
1997 period. Exploration cost decreased 34 percent as a result of lower dry hole
costs and lower  seismic  expenses.  Depreciation,  depletion  and  amortization
expense  includes a reserve  relating to the  operation of properties to be sold
(see  Note 2 of the  Notes  to  Condensed  Consolidated  Financial  Statements).
Excluding  this  reserve,  depreciation,   depletion  and  amortization  expense
decreased by seven percent due to a lower  amortization  rate ($.77 for the 1998
period compared to $.89 for the 1997 period).

         Other  income  was  slightly  lower  for the  three-month  1998  period
compared  with the  three-month  1997  period  due to gains on the  disposal  of
marketable securities held by Sonat Exploration GOM in the 1997 period.

Six Months 1998 to Six Months 1997 Analysis

         EBIT decreased  $30.1 million after excluding the $444.8 million charge
for  restructuring  and impairment costs,  discussed  earlier,  primarily due to
lower revenues  resulting  from lower natural gas and oil and condensate  prices
and lower natural gas production.  Average realized natural gas prices decreased
11 percent to $2.01 per Mcf for the six-month 1998 period from $2.26 per Mcf for
the  six-month  1997 period.  Realized oil and  condensate  prices  decreased 33
percent to an average  of $13.92 per barrel  from  $20.65 per barrel in the 1997
six-month  period.  Natural  gas  production  declined  five  percent.  Oil  and
condensate   production   increased  38  percent,   slightly   offsetting  these
unfavorable factors.

         Costs and expenses were $19.5 million lower after  excluding the charge
for  restructuring  and impairment  costs.  General and  administrative  expense
decreased 36 percent primarily as a result of executive compensation expense for
Sonat  Exploration GOM which was included in the 1997 period.  Exploration  cost
decreased  29 percent due to lower  seismic  expense  and dry hole costs.  These
favorable factors were partially offset by higher depreciation expense primarily
due to the aforementioned reserve.

         Other income was lower for the six-month 1998 period  compared with the
six-month  1997 period due to gains on the disposal of marketable  securities in
the 1997 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 3 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 $3.1  million  and $1.9  million  in the  three-month  and  six-month
periods ended June 30, 1998,  and were reduced by $1.7 million and $18.9 million
in the three-month and six-month periods ended June 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 June 30, 1997, and reduced oil revenues by $.7 million
in the six-month period ended June 30, 1997.

         A  portion  of Sonat  Exploration's  future  gas  production  is hedged
through the year 2001. Sonat Exploration's hedged gas production is as follows:

                                                                     Weighted
                                                                      Average
                                            Volumes                    Price
                                             (Bcf)                   (per Mcf)
Remainder of 1998                            28.1                      $2.33
1999                                         62.5                      $2.13
2000                                         42.3                      $2.16
2001                                          4.4                      $2.30
----------------------------------------------------------------------------
                                            137.3                      $2.18
============================================================================

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  in  the  ownership  of  Destin  Pipeline  Company,  L.L.C.,  a 1
billion-cubic-feet-per-day  pipeline  designed  to  transport  natural  gas from
deep-water  areas  in the  eastern  Gulf of  Mexico.  Southern  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 is
expected to be partially  completed and in service in August 1998,  and fully in
service by January 1999. In June 1998, the Federal Energy Regulatory  Commission
(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,  which will cost  approximately  $19  million,  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 at a cost of
approximately $37 million to transport  additional gas reserves committed to its
system.  This  extension  is expected to be in service in early 1999.  The total
cost of Destin is now estimated to be $416 million.
<PAGE>

         Southern 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 received FERC approval in May
1997, is now  anticipated to go in service in the fall of 1999,  subject to FERC
approval of an  application  that Southern  filed in February 1998 to change the
route of the pipeline as it crosses the Wheeler National  Wildlife  Refuge.  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 is anticipated to go
in  service in  November  1998.  Southern  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 the fourth quarter 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
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  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's  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.  Affiliates of AGL  Resources  will manage the
construction   of  the   facility   and  operate  it.   Southern   will  provide
administrative  services.  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.



<PAGE>


SOUTHERN NATURAL GAS COMPANY AND SUBSIDIARIES
<TABLE>
<CAPTION>

                                                                    Three Months                        Six Months
                                                                   Ended June 30,                     Ended June 30,
                                                                --------------------               -----------------
                                                           1998             1997              1998              1997
                                                           ----             ----              ----              ----
                                                                                 (In Millions)
Revenues:
    Market transportation and
<S>                                                        <C>              <C>              <C>               <C>   
       storage                                             $77.9            $ 74.6           $161.4            $157.8
    Supply transportation                                   12.1              12.4             23.7              22.9
    Other                                                    5.5              16.5             15.9              21.9
                                                           -----            ------           ------            ------
       Total Revenues                                       95.5             103.5            201.0             202.6
                                                           -----            ------           ------            ------

Costs and Expenses:
    Operating and maintenance                               19.0              22.2             38.6              39.8
    General and administrative                              12.2              19.1             27.7              37.1
    Depreciation and amortization                           13.1              11.9             18.6              23.6
    Taxes, other than income                                 5.4               4.8             10.7              10.0
                                                           -----            ------           ------            ------
                                                            49.7              58.0             95.6             110.5
                                                           -----            ------           ------            ------

Operating Income                                            45.8              45.5            105.4              92.1
                                                           -----            ------           ------            ------
Other Income:
    Equity in Earnings of
       Unconsolidated Affiliates                             5.6               2.7              9.7               5.4
    Other                                                    1.1              .9                1.8               4.9
                                                           -----          ------             ------            ------
                                                             6.7               3.6             11.5              10.3
                                                           -----            ------           ------            ------

Earnings Before Interest and Taxes                         $52.5            $ 49.1           $116.9            $102.4
                                                           =====            ======           ======            ======

                                                                             (Billion Cubic Feet)
Volumes:
    Market transportation                                    137               136              322               306
    Supply transportation                                    103               100              198               180
                                                           -----            ------           ------            ------
       Total Volumes                                         240               236              520               486
                                                           =====            ======           ======            ======

    Transition gas sales                                       3                17                6                35
                                                           =====            ======           ======            ======
</TABLE>




<PAGE>


CITRUS CORP.
<TABLE>
<CAPTION>

                                                                    Three Months                        Six Months
                                                                   Ended June 30,                     Ended June 30,
                                                                --------------------               -----------------
                                                           1998             1997              1998              1997
                                                           ----             ----              ----              ----
                                                                                 (In Millions)
Equity in Earnings of
<S>                                                        <C>              <C>               <C>              <C>   
    Citrus Corp.                                           $ 10.8           $  6.2            $ 15.7           $ 12.8
                                                           ======           ======            ======           ======

                                                                             (Billion Cubic Feet)
Florida Gas Volumes (100%):
    Market transportation                                     109              124               204              222
    Supply transportation                                       9                6                16               13
                                                           ------           ------            ------           ------
       Total Volumes                                          118              130               220              235
                                                           ======           ======            ======           ======
</TABLE>


Second Quarter 1998 to Second Quarter 1997 Analysis

         Southern  Natural Gas Company and  Subsidiaries - EBIT for Southern was
$52.5 million  compared with $49.1  million in the second  quarter of 1997.  The
increase was  primarily  due to lower  expenses of Southern and higher equity in
earnings of the Destin  Pipeline.  Partially  offsetting was the effect of a $10
million reserve  adjustment in the second quarter of 1997 relating to Southern's
obligation to pay royalty  claims in  connection  with  take-or-pay  settlements
entered into in the 1980's.  The adjustment  related to a favorable  state court
ruling.

         Market  transportation   revenues  increased  as  a  result  of  recent
expansions.  Other revenue decreased  primarily due to the reserve adjustment of
$10 million  included in the 1997  period.  Operating  and  maintenance  expense
decreased primarily due to lower fuel costs. General and administrative expenses
decreased  primarily  due to lower  employee  benefit  expenses and  stock-based
compensation. 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.

         Equity in earnings of unconsolidated  affiliates  increased in 1998 due
to earnings of Destin Pipeline, primarily resulting from the allowance for funds
used during construction (AFUDC) capitalized.

         Citrus - Equity in earnings of Citrus  increased  $4.6 million to $10.8
million.  The increase is primarily due to the  recognition  of credits on a gas
supply  agreement  and lower  operating  expenses,  slightly  offset by  reduced
utilization of firm transportation capacity held by Citrus Trading.
<PAGE>

Six Months 1998 to Six Months 1997 Analysis

         Southern Natural Gas Company and Subsidiaries - EBIT was $116.9 million
for the six months ending June 30, 1998,  compared  with $102.4  million for the
1997 period.  The increase was primarily  due to  expansions  placed in service,
lower expenses and earnings of Destin Pipeline. Partially offsetting 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  recent
expansions. Other revenues decreased due to a favorable 1997 reserve adjustment,
discussed  earlier,  offset  partially by the reversal of the remaining  royalty
reserves in 1998. Such reversal has been made because  management has determined
that the likelihood of the Company making any significant  royalty payments as a
result of its prior take-or-pay settlements is remote. Operating and maintenance
expense decreased primarily due to lower fuel costs.  General and administrative
expenses  decreased  primarily due to lower  employee  benefit  expenses,  lower
insurance  expenses  and  lower  stock-based   compensation.   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).

         Equity in earnings of unconsolidated  affiliates  increased in 1998 due
to earnings of Destin Pipeline,  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  $2.9 million to $15.7
million.  The  increase  is the  result of the  recognition  of credits on a gas
supply agreement, lower operating expenses and lower interest expense, partially
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  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's  remaining gas supply is sold on a
month-to-month  basis.  Gas sales  revenue and natural gas cost are  included in
other revenue.

         Southern's annual purchase  commitments total less than $25 million per
year for 1998 and subsequent  years.  Based on Southern's  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's
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 to file
a new rate case no later than September 1, 1999.



<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  business.  Both of these  subsidiaries  utilize  derivative
instruments in managing  commodity price risk (see Market Risk and Note 3 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 a
joint  venture  with  Calpine  Corporation  to  develop a  680-megawatt  natural
gas-fired peaking power plant near Columbus, Georgia. The Cataula Power Plant 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 six months of 1998 was 20 Bcf
compared with 16 Bcf in the first six 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, plus the District of Columbia.



<PAGE>


ENERGY SERVICES
<TABLE>
<CAPTION>

                                                                    Three Months                        Six Months
                                                                   Ended June 30,                     Ended June 30,
                                                                --------------------               -----------------
                                                           1998             1997              1998              1997
                                                           ----             ----              ----              ----
                                                                                 (In Millions)

<S>                                                       <C>               <C>              <C>               <C>     
Revenues                                                  $800.2            $696.4           $1,737.2          $1,656.2
                                                          ======            ======           ========          ========

Operating Income (Loss)                                   $  2.2            $ (0.4)          $    3.3          $    1.1
                                                          ======            ======           ========          ========

Earnings (Loss) Before Interest
    and Taxes                                             $  1.7            $ (0.2)          $    2.5          $    0.7
                                                          ======            ======           ========          ========

Physical Volumes:
    Sonat Marketing Gas Sales
       Volumes (100%)
          (Billion Cubic Feet)                               284               299                644               603
                                                          ======            ======           ========          ========

    Sonat Power Marketing Sales
       Volumes (100%)
          (Thousands of Megawatt Hours)                    2,729             1,921              5,899             3,318
                                                          ======            ======           ========          ========

Financial Settlements (Notional):
    (Bcf/d)                                                  7.3               3.0                7.0               3.0
                                                          ======            ======           ========          ========
</TABLE>


Second Quarter 1998 to Second Quarter 1997 Analysis

         Second quarter 1998 financial results improved from second quarter 1997
levels as EBIT rose to $1.7  million  from a loss of $.2  million  in 1997.  The
improvement reflects higher volumes,  better margins and the contribution of the
Mid-Georgia  Cogen power  plant,  which  began  operations  in June 1998.  Sonat
Marketing's  physical  sales volumes were slightly  below 1997 levels.  Notional
volumes  from  natural gas  derivative  transactions  more than doubled from the
second  quarter of 1997.  Sonat Power  Marketing's  sales  volumes  increased 42
percent.  Sonat Power Marketing's  trading margins improved due to opportunities
created by very  volatile  electric  power prices  during the second  quarter of
1998. Operating results were better than expected at the Mid-Georgia Cogen plant
due to very hot weather in the Southeast,  which caused this facility to operate
almost every day since it began  operating.  Results for 1998  reflect  start-up
losses for Sonat Power Systems, which slightly offset these favorable factors.

Six Months 1998 to Six Months 1997 Analysis

         EBIT for the first six  months  of 1998 rose to $2.5  million  compared
with $.7 million for the first six months of 1997. The improved  results reflect
higher volumes,  better margins and the  contribution  of the Mid-Georgia  Cogen
power plant. Sonat Marketing's  physical sales volume rose to 4 Bcf per day from
3 Bcf per day in 1997. Notional volumes from natural gas derivative transactions
increased  sharply.  Sonat Power  Marketing's  sales volumes reached 5.9 million
megawatt hours, up  significantly  from 3.3 million  megawatt hours in the first
six months of 1997. The initiation of commercial  operations at the  Mid-Georgia
power plant in June 1998 and very hot weather in the  Southeast  contributed  to
the increase in EBIT.  Results for 1998 reflect  start-up losses for Sonat Power
Systems, which slightly offset these favorable factors.




<PAGE>

Income Statement Items
<TABLE>
<CAPTION>

                                                                    Three Months                        Six Months
                                                                   Ended June 30,                     Ended June 30,
                                                                --------------------               -----------------
                                                           1998             1997              1998              1997
                                                           ----             ----              ----              ----
                                                                                 (In Millions)

<S>                                                      <C>                 <C>            <C>                <C>   
Interest Expense, Net                                    $  32.3             $23.7          $  60.8            $ 45.3
</TABLE>

         Net interest  expense  increased in both the  three-month and six-month
periods of 1998 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 six-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)                             $(143.3)            $ 7.5          $(125.1)           $ 42.5
</TABLE>

         Income  tax  expense  decreased  in  both  periods  due  to  the  taxes
associated  with the  restructuring  and  impairment  charge  recorded  at Sonat
Exploration  in the second  quarter  of 1998.  Absent  this  unusual  item,  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.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flows
<TABLE>
<CAPTION>

                                                                                                        Six Months
                                                                                                      Ended June 30,
                                                                                              1998              1997
                                                                                                    (In Millions)

<S>                                                                                         <C>                <C>   
Operating Activities                                                                        $ 360.8            $364.1
</TABLE>

         Cash flow from operations was essentially  flat as compared to the 1997
period,  with lower  cash flows at Sonat  Exploration  essentially  offset  with
higher cash flows from Sonat Energy Services.  Operating  results were discussed
earlier in the operating sections.
<PAGE>

         Depreciation,  depletion,  and  amortization  and deferred income taxes
include  $429.8  million  and  $155.7  million,  respectively,  related  to  the
restructuring  and impairment charge recorded at Sonat Exploration in the second
quarter of 1998. Net accounts  receivable and accounts  payable was  essentially
flat  as  compared  to the  1997  period.  The  change  in  inventory  primarily
represents  the purchase of natural gas  inventory  by Sonat Energy  Services in
1997 as well as material for Sonat  Exploration's  Cotton  Valley  Pinnacle Reef
trend  drilling  program  in the 1997  period.  The change in  restricted  cash,
accrued  long-term  compensation,  and  other  current  assets  and  liabilities
primarily  represents  the payment of certain  expenses in  connection  with the
merger  between the Company and Zilkha Energy in January 1998 (see Note 2 of the
Notes to Condensed Consolidated Financial Statements).
<TABLE>
<CAPTION>

                                                                                                        Six Months
                                                                                                      Ended June 30,
                                                                                              1998              1997
                                                                                                    (In Millions)

<S>                                                                                         <C>               <C>     
Investing Activities                                                                        $(549.3)          $(463.9)
</TABLE>

         Net cash used in investing  activities was $85.4 million higher in 1998
compared to 1997. The increase was primarily  attributable to higher investments
in  unconsolidated  affiliates,   specifically,  the  Destin  Pipeline  and  the
Mid-Georgia  Cogen power  plant  joint  ventures.  Higher  capital  expenditures
resulting  from  increased  developmental  drilling  at  Sonat  Exploration  and
expansions at Southern also contributed to the increase.

         Capital  expenditures for the Company's  business  segments  (excluding
exploratory costs and unconsolidated affiliates) were as follows:
<TABLE>
<CAPTION>

                                                                                                        Six Months
                                                                                                      Ended June 30,
                                                                                              1998              1997
                                                                                                    (In Millions)

<S>                                                                                         <C>               <C>    
         Exploration and Production                                                         $ 360.3           $ 350.7
         Natural Gas Transmission                                                              82.2              59.0
         Energy Services                                                                        5.9               5.2
         Other                                                                                  3.0               1.9
                                                                                            -------           -------

         Total                                                                              $ 451.4           $ 416.8
                                                                                            =======           =======
</TABLE>

     The  Company's  share  of  capital   expenditures  by  its   unconsolidated
affiliates  was $66.1  million and $8.5  million in the first six months of 1998
and 1997, respectively.

<TABLE>
<S>                                                                                         <C>               <C>    
Financing Activities                                                                        $ 172.3           $  92.5
</TABLE>

         Net cash provided by financing  activities  was $79.8 million higher in
1998 compared to 1997.  The change was primarily  attributable  to increased net
borrowings  in  the  current  period  to  fund  investments  in   unconsolidated
affiliates and capital expenditures.
<PAGE>

CAPITAL RESOURCES

         At June 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 $804.2
million of commercial  paper and $12.7 million of borrowings from the short-term
lines of credit, $433.1 million was available to the Company under such lines of
credit and revolving credit agreement at June 30, 1998.

         Southern has a shelf  registration  statement  with the  Securities and
Exchange  Commission  which  provides  for the issuance of up to $500 million in
debt securities.  Sonat plans to file a similar shelf registration  statement in
1998.

         The Company's capital expenditures and other investing requirements for
1998 are expected to aggregate $860.1 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 2 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.

         The Company has a stock repurchase program in effect through the end of
1998.  As of June 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 spot-market 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.  In June 1997,  Sonat
Energy  Services,  through its  subsidiary,  Sonat  Marketing,  also began using
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.
<PAGE>

         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 3 of the Notes to Condensed  Consolidated  Financial  Statements.  The Risk
Oversight   Committee  and  management   monitor  the  portfolio   Value-at-Risk
frequently 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.

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  and  non-IT  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
larger  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 and developing  contingency  plans for
critical systems and service providers.  The Company has not completely finished
analyzing the most  reasonably  likely worst case scenarios and cannot  estimate
potential  lost  revenue at this time.  The Company is scheduled to be completed
with the implementation and testing phases by December 31, 1998.

         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 June 30, 1998, the Company has incurred approximately $800,000 in
Year  2000  project  costs.  The  Company  expects  to be able to fund Year 2000
expenditures from normal operations.
<PAGE>

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.

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 habor  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 and the success of the
Company's  internal cost reduction  activities;  and the requirements to receive
various  governmental  approvals to proceed with expansion projects at Southern,
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.

         The Company  believes  that actual  sales  proceeds  from its  property
divestiture  program will equal or exceed current estimates.  Such estimates are
based on signed  purchase  and sale  agreements  for the Austin Chalk and Arkoma
Basin properties and offers for certain of the remaining properties. Final sales
proceeds will be determined, however, only as such sales are closed.

         Estimates  of future  production  of oil and gas  depend on a number of
assumptions,  including  the  timing  and  success  of  the  Company's  drilling
programs,  performance of wells, expected levels of capital spending and oil and
natural gas prices.  In addition,  estimates of future unit costs of  production
depend on assumptions of production levels and expected future costs. Because of
these and other  variables,  there can be no assurances that the actual level of
production will equal projected  volumes or that the actual future unit costs of
production will equal the current estimate.




<PAGE>


                           PART II. OTHER INFORMATION


Item 5. Legal Proceedings

         As reported in Item 3 of the Company's Report on Form 10-K for the year
ended December 31, 1997, Tennessee Gas Pipeline Company  ("Tennessee") had filed
an  application  with the FERC  seeking to have the exchange  agreement  between
Southern and Tennessee,  pursuant to which Southern delivers and receives gas to
and from the Bear Creek  Storage Field at no charge,  converted  into a standard
transportation  agreement by which  Tennessee would charge Southern tariff rates
for providing that service. In May 1998 the FERC denied Tennessee's application.

Item 6.  Exhibits and Reports on Form 8-K

(a)      Exhibits 1

Exhibit
Number                              Exhibits


12*  Computation of Ratio of Earnings to Fixed Charges

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

-------------
*   Filed herewith

(b)      Reports on Form 8-K

         The  Company  filed a Report on Form 8-K on April 23,  1998,  reporting
certain  information  under Item 5 with  respect to the  restructuring  of Sonat
Exploration Company,  which was included in the Company's press release relating
to first quarter earnings.

         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.










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:       August 13, 1998               By:      /s/ James E. Moylan, Jr.
       -------------------------                 --------------------------
                                                 James E. Moylan, Jr.
                                                 Senior Vice President and
                                                 Chief Financial Officer





Date:       August 13, 1998               By:      /s/ Thomas W. Barker, Jr.
       -------------------------                 ---------------------------
                                                 Thomas W. Barker, Jr.
                                                 Vice President-Finance