<PAGE>
 
                                                                      EXHIBIT 13

MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

  Providence Energy Corporation (the Company) and its subsidiaries and their
representatives may from time to time make written or oral statements, including
statements contained in the Company's filings with the Securities and Exchange
Commission (SEC) and in its reports to shareholders, including this annual
report to shareholders, which constitute "forward-looking" statements as that
term is defined in the Private Securities Litigation Reform Act of 1995 or by
the SEC in its rules, regulations and releases.

  All statements other than statements of historical facts included in this
annual report regarding the Company's financial position and strategic
initiatives and addressing industry developments, including for example
statements in the President's message (pages 2 to 3), are forward-looking
statements.  Where, in any forward-looking statement, the Company or its
management expresses an expectation or belief as to future results, such
expectation or belief is expressed in good faith and believed to have a
reasonable basis, but there can be no assurance that the statement of
expectation or belief will result or be achieved or accomplished.  The following
are some of the factors which could cause actual results to differ materially
from those anticipated: general economic, financial and business conditions;
changes in government regulations; competition in the energy services sector;
regional weather conditions; the availability and cost of natural gas and oil;
development and operating costs; the success and costs of advertising and
promotional efforts; the availability and terms of capital; the business
abilities and judgment of personnel; the ability of the Company and its
suppliers and customers to modify or redesign their computer systems to work
properly in the year 2000; unanticipated environmental liabilities; the
Company's ability to grow its business through acquisitions and/or significant
customer growth;  the costs and effects of unanticipated legal proceedings; the
impacts of unusual items resulting from ongoing evaluations of business
strategies and asset valuations; and changes in business strategy.

SUMMARY

  The Company's current energy revenues and operating margin have increased,
while net income has decreased over the comparable periods presented, as shown
in the table below:

<TABLE>
<CAPTION>
                     (000's)
                                                   Percent
                      1998       1997     Change    Change
                    ---------  --------  --------  --------
<S>                 <C>        <C>       <C>       <C>
Energy Revenues     $221,306   $220,420  $   886        .4
Operating Margin      98,573     96,044    2,529       2.6
Net Income             6,442      7,831   (1,389)    (17.7)
</TABLE>

RESULTS OF OPERATIONS - 1998 VERSUS 1997

Operating Margin

  During the current year, Providence Gas Company (ProvGas) experienced weather
that was 8.0 percent warmer than last year. The warmer temperatures resulted in
decreased margin of approximately $4.0 million compared to last year.
Offsetting the warmer than normal weather was $7.2 million of margin generated
under the Price Stabilization Plan Settlement Agreement (Energize RI or the
Plan), which became effective October 1, 1997.  The components of this
additional margin include $10.4 million associated with adjusting the Gas Charge
Clause (GCC) mechanism, offset by the funding of the Low-Income and Demand Side
Management programs of $1.7 million and the write-off of $1.5 million of
previously deferred gas costs.  In the prior year, ProvGas funded the Demand
Side Management and Low-Income Weatherization programs under the Integrated
Resource Plan (IRP) for $.7 million.

                                    Page-1
<PAGE>
 
     Additionally, non-firm margin decreased $2.2 million when compared with
last year. Prior to Energize RI, ProvGas was allowed to recover approximately
$3.0 million in non-firm margin under the terms of the IRP, subject to ProvGas'
ability to generate sufficient gas cost savings for customers. As a result of
Energize RI, ProvGas retains the actual non-firm margin earned. Due to an
unfavorable pricing difference between natural gas and alternate fuels, ProvGas
experienced a decrease in non-firm sales and transportation margin.

     As part of Energize RI, the performance-based ratemaking mechanism
(Mechanism) under the IRP was terminated in September 1997.  In 1997, ProvGas
recorded $1.5 million in additional margin as a result of this Mechanism.  Thus,
a decrease in margin from 1997 to 1998 occurred because this Mechanism was no
longer available in 1998.

     In a decision issued September 1, 1998, the RI Division of Public Utilities
and Carriers (Division) rejected allegations made in a complaint brought by
Aurora Natural Gas that ProvGas provided advance information and undue
preference in pricing to its marketing affiliate, Providence Energy Services,
Inc.(ProvEnergy Services).  As part of its investigation, the Division ordered
marketer refunds of approximately $.3 million.  The Division ordered this refund
based on its belief that an unfair rate was charged to customers who did not
have operational telemeters in place when they began transporting gas.  ProvGas
intends to pursue all available options in order to reverse this decision.

     Nonregulated operating margin increased by $3.5 million compared to the
same period last year. The Company's acquisition of oil distribution companies
during 1998 contributed the majority of this increase. However, the margin
earned from oil sales was lower than expected due to warmer than normal weather,
lower than anticipated commercial margins, and costs associated with liquidating
fixed-purchase commitments and option contracts for oil when market prices
dropped significantly. Increased natural gas business volumes at ProvEnergy
Services also contributed to an increase in nonregulated operating margin.
ProvEnergy Services experienced sales volume growth of 150 percent and a 
fifteen-fold increase in the number of customers.

Operating and Maintenance Expenses

     Overall, operating and maintenance expenses increased approximately $3.2
million or 6.6 percent versus last year. The increase is primarily attributable
to the Company's acquisition of oil companies during the current fiscal year
resulting in a $4.1 million increase.  This increase was partially offset by
decreases in ProvGas' expenses, primarily bad debts.  The decrease in bad debts
was attributable to improved collection experience and the implementation of new
credit policies, as well as decreased operating revenues from warmer than normal
weather.  ProvGas' other operating and maintenance expenses were essentially
flat due to cost management.

          The Company continually reviews its operating expenses in order to
keep expenses as low as possible; however, expenses can vary from year to year.

Depreciation and Amortization

     Depreciation and amortization expense increased approximately $1.6 million
or 12.5 percent versus last year. This increase is the result of increased
capital spending for Energize RI commitments as well as the amortization of
previously deferred environmental costs. Effective October 1, 1997, ProvGas
began amortizing environmental costs over a ten-year period in accordance with
Energize RI. Due to expected future increases in environmental expenditures,
which were projected under Energize RI, ProvGas will have increased
environmental amortization expense in future years.

Taxes

     Taxes decreased approximately $.7 million or 4.0 percent versus last year.
The overall change in taxes is primarily due to a decrease in pretax income this
year compared to last year.  Additionally, local property and other taxes have
increased as a result of capital spending.

                                    Page-2
<PAGE>
 
Other, net

   Other, net has increased approximately $.6 million versus last year. The
majority of the increase consists of approximately $.2 million of fees earned by
the Company for providing energy management services and approximately $.2
million of interest income earned as a result of Federal income tax refunds
resulting from amended tax returns.

Interest Expense

   Interest expense increased approximately $.5 million or 7.0 percent versus
last year. ProvGas' interest expense increased by approximately $.3 million as 
a result of the Series S First Mortgage Bond issuance in April 1998. The
Company's acquisition of oil distribution companies in November 1997 resulted in
increased interest expense of approximately $.5 million. Offsetting the
increases was a decrease in weighted average short-term borrowings, as a result
of the Series S First Mortgage Bond issuance, which caused short-term interest
expense to decrease.

FUTURE OUTLOOK

A) Regulatory

   Under Energize RI, ProvGas may earn up to 10.9 percent annually on its
average common equity of up to $81.0 million, $86.2 million, and $92.0 million
in fiscal 1998, 1999 and 2000, respectively.  In addition, ProvGas may not earn
less than a seven percent return on average common equity.  In the event that
ProvGas earns in excess of 10.9 percent or less than seven percent, ProvGas will
defer revenues or costs through a deferred revenue account over the term of the
Plan.  Any balance in the deferred revenue account at the end of the Plan will
be refunded to or recovered from customers in a manner to be determined by all
parties to the Plan and to be approved by the Rhode Island Public Utilities
Commission (RIPUC).

   The implementation of Energize RI this year changed how ProvGas recorded its
gas costs, resulting in higher margin reflected in the first half of the fiscal
year and lower margin in the second half. This change did not impact annual
earnings.

   As part of Energize RI, ProvGas is permitted to file with the Division for
the recovery of the impact of exogenous Changes (Changes) which may occur during
the three-year term of the Plan.  Changes are defined as "...significant
increases or decreases in ProvGas' costs or revenues which are beyond ProvGas'
reasonable control."  Any disputes regarding either the nature or quantification
of the Changes are to be resolved by the RIPUC.  The impact of any such Changes
will be debited or credited to a regulatory asset or liability account
throughout the term of Energize RI and will be recovered or refunded at the
expiration of the Plan through a method to be determined.

   During 1998, due to the extremely warm temperatures, ProvGas experienced a
margin loss of approximately $4.0 million.  ProvGas also experienced a non-firm
margin loss of approximately $2.2 million due to adverse market prices of
natural gas versus alternate fuels.  ProvGas believes the causes of these two
events were beyond its control and thus considers them as Changes. In fiscal
1999, ProvGas intends to file with the Division for recovery of a portion of
these losses.

   In 1998, ProvGas did not earn its allowed rate of return primarily as a
result of the extremely warm weather and the loss of non-firm margin as
previously discussed in "Operating Margin".  Under the Plan's design, which
assumed normal weather, ProvGas should have had earnings in year one of the Plan
in excess of 10.9 percent.  The earnings in excess of 10.9 percent were to be
deferred in the deferred revenue account to fund capital investments and other
Plan commitments in the remaining two years of the Plan.  Absent favorable
recovery for the Changes as discussed above, and/or other factors such as colder
than normal weather, ProvGas' ability to earn a 10.9 percent return on average
common equity in future Plan years is substantially impaired.

                                    Page-3
<PAGE>
 
          In May 1996, the RIPUC approved a Rate Design Settlement Agreement
(the Agreement) among ProvGas, the Division, TEC-RI, and a consortium of oil
heat organizations. The Agreement began a process of unbundling natural gas
service in Rhode Island, enabling customers to choose their gas suppliers.

     The Agreement went into effect in June 1996. The initial phase of
unbundling was available to approximately 120 of the largest commercial and
industrial customers. In August 1997, the RIPUC approved a plan, called Business
Choice, to further unbundle services to an additional 3,400 medium and large
commercial and industrial customers. ProvGas commenced Business Choice in
December 1997. Energize RI continues the process of unbundling by requiring
ProvGas to provide unbundled service offerings for up to 10 percent per year of
firm deliveries. At the conclusion of the latest enrollment period on October 1,
1998, an additional 530 customers had signed up for Business Choice. The program
now has approximately 1,500 firm transportation customers with annual deliveries
of over 5 billion cubic feet per year which is approximately 25 percent of
ProvGas' total annual firm deliveries. There are 14 different marketers serving
ProvGas' customers and transporting on the system.

     In 1998, North Attleboro Gas Company, a small distribution subsidiary with
over 3,500 customers located in Massachusetts, received approval from the
Massachusetts Department of Telecommunications and Energy (MDTE) of a settlement
agreement unbundling its rates.  This agreement, which unbundled the cost of gas
from the cost of distribution, was part of a comprehensive statewide unbundling
initiative being directed by the MDTE.  In 1999, it is expected that North
Attleboro Gas Company will introduce new unbundled service offerings and make
competitive choice available to all customers, both residential and commercial.

B)   Business Opportunities

          The Company has significant regulated and nonregulated growth
opportunities as it evolves into a local provider of natural gas, oil,
electricity and energy services for homes and businesses throughout New England.

     In addition to funding investments related to system integrity, Energize RI
provides opportunities for ProvGas to expand sales.  For example, high pressure
service to Quonset/Davisville Industrial Port & Commerce Park, a key area for
State economic development, provides tremendous opportunities for sales growth
as commercial and industrial businesses locate within the park.  In addition,
Demand Side Management, an equipment rebate program, provides opportunities to
expand sales to nontraditional applications, such as air conditioning and fuel
cells.  ProvGas has redirected its sales and marketing efforts to leverage
Energize RI, as well as other opportunities to promote sales growth within its
service territory.

     In November 1997, as part of the Company's strategic plan to strengthen its
position in the energy industry, the Company purchased two Rhode Island-based
oil distribution companies, Super Service Oil and Mohawk Oil.  Together with
three smaller acquisitions that the Company also completed during 1998, the
Company's oil business serves over 4,000 residential customers and a large
commercial base.  While these acquisitions further the Company's transition to a
diversified energy provider, the oil business sustained substantial operating
losses in 1998 during the first year of operations.  These losses were primarily
due to lost operating margin from warmer than normal weather, lower than
anticipated commercial margins, and the costs associated with liquidating fixed
purchase commitments and option contracts for oil when market prices dropped
significantly.

     An increase in sales to customers to be acquired by acquisition, as well as
a planned return to typical profit margins are expected to reduce the loss
sustained in 1998 so that only a small loss is generated in 1999. More favorable
profit margins should be achieved as substantially all sales commitments have
been hedged with financial instruments to protect the business from the impact
of dramatic price movements. Additionally, management is focusing its marketing
efforts on the higher margin residential segment.

                                    Page-4
<PAGE>
 
   The Company's retail energy marketing subsidiary, ProvEnergy Services, also
has substantial growth opportunities as the New England energy markets
deregulate.  ProvEnergy Services experienced natural gas sales volume growth of
150 percent and a fifteen-fold increase in the number of customers in 1998.
ProvEnergy Services expects significant customer growth again in 1999 but
forecasts a small operating loss.

   In May 1998, the Company and Southern Energy, Inc. (Southern) agreed to end
their joint efforts to develop a New England retail energy business using
ProvEnergy Services, which was doing business under the name Providence-
Southern.  The Company will continue to use ProvEnergy Services as the vehicle
to grow its natural gas, oil and electricity business to retail accounts
throughout New England.

   During 1998, ProvEnergy Services made a successful transition from Southern
to other natural gas suppliers, including Duke Energy Trading and Marketing,
L.L.C.(DETM) to provide its wholesale natural gas supply. In the future,
ProvEnergy Services anticipates the continued availability of competitively
priced wholesale energy supplies.

   Through May 1998, Southern funded 60 percent of the net retail start-up
operating expenses incurred by ProvEnergy Services.  ProvEnergy Services
anticipates growing the business sufficiently to generate only a small operating
loss for 1999.

   In July 1998, the Company and ERI Services, Inc. (ERI Services) formed a
joint venture, Capital Center Energy Company, LLC (CCEC).  CCEC is owned 50
percent by the Company's subsidiary, ProvEnergy Power Company, LLC, and 50
percent by ERI Services' subsidiary, ERI Providence, LLC.  CCEC's wholly-owned
subsidiary, DownCity Energy Company, LLC (DownCity Energy), was selected as the
exclusive electric, heat and air conditioning (HVAC) and related service
provider for most of the Providence Place Mall (the Mall) for the next thirty
years.

   DownCity Energy will serve more than three million square feet of retail
stores, common areas, offices and parking facilities in the Mall.  Currently,
the Mall's three anchor stores and the cinema are not included in the plan.  The
electric demand to be met by DownCity Energy is expected to be 12 megawatts, the
approximate consumption of more than 6,500 households. The system being
developed for the Mall includes three on-site natural gas powered electric
generators.

   Under the agreement with Commonwealth Development Group, developers of the
Mall, DownCity Energy will perform the following:

   . Own, operate and maintain the HVAC systems.
   . Provide electric supply and emergency power.
   . Own, operate and maintain a six megawatt on-site generation plant to
      provide electric and emergency supply.
   . Provide metering services for each of the tenants.
   . Manage all energy billing to the tenants and the developer.

   Construction of the energy systems began this summer. The entire energy
project will be operational in advance of the scheduled August 1999 opening of
the Mall. DownCity Energy did not have a significant impact on the Company's
results of operations in 1998.  The projected investment in CCEC is $30 million.
As of September 30, 1998, the Company had invested $2 million of its total
projected investment of $15 million. This contract, the largest of its kind in
New England, has the potential to increase the Company's earnings by five
percent within five years.

C) New Accounting Pronouncements

   Please refer to Footnote 17 of the accompanying Consolidated Financial 
Statements.

                                    Page-5
<PAGE>
 
RESULTS OF OPERATIONS - 1997 VERSUS 1996

Energy Revenues and Operating Margin

  During 1997, the Company experienced normal weather as opposed to colder-than-
normal weather in 1996, which resulted in 1997 temperatures that were 5.2
percent warmer than 1996. The decrease in heating load due to the warmer
temperatures resulted in decreased margin of approximately $1.7 million, which
was offset by increased margin of $.7 million as a result of load growth and an
increase in the average annual number of customers during 1997 over 1996 of
1,707 or one percent.  Primarily as a result of the warmer temperatures
experienced in 1997, residential sales decreased 570 million cubic feet (MMcf)
or four percent.  The Company's commercial and industrial firm sales decreased
approximately 1,608 MMcf or 16.6 percent as a result of warmer weather and
customer migrations from sales service to transportation service in connection
with unbundling natural gas service in Rhode Island. In 1996, approximately 120
of the largest commercial and industrial customers were eligible for unbundled
service offerings.  In December 1997, an additional 3,400 medium and large
commercial and industrial customers were eligible.  This migration of customers
to transportation did not have a material effect on margin.

  The decrease due to weather was also offset by increases in margin of $.8
million as a result of the rate increase effective December 17, 1995, and $.4
million as the result of an increase in revenues associated with the phase-in of
post-retirement expenses related to Statement of Financial Accounting Standards
No. 106.  The remaining increase in margin was primarily due to ProvEnergy
Services, which was doing business as Providence-Southern, and improved
operating efficiencies in the tracking and delivery of gas.

  Interruptible and other volumes remained consistent with last year.  Operating
margin from interruptible and other sales did not affect the Company's operating
margin or results of operations because the RIPUC required the Company to return
any margins earned from these non-firm customers to firm customers through the
GCC.  Beginning October 1, 1997, under Energize RI discussed in Note 9 to the
accompanying Consolidated Financial Statements, the Company will retain all
margins earned from these non-firm sales.

  The Company's transportation volumes increased approximately 1,345 MMcf as the
result of the unbundling process described above.  As the unbundling process
continues, the Company expects transportation revenues and volumes will continue
to increase as customers migrate from sales to transportation.

Operating and Maintenance Expenses

  Overall, operating and maintenance expenses have decreased approximately $.3
million or .5 percent versus 1996. The Company had an $.8 million decrease in
outside services due to expenditures made in the prior year to develop new
energy service offerings as well as expenses related to the IRP.  This decrease
was offset by an increase in operating expenses of $.7 million from ProvEnergy
Services.  In addition, the Company's labor increased by $.8 million related to
cost of living and negotiated union contract increases.  This increase in labor
was offset by an increase in capitalized labor and administrative expenses of
$.7 million.  This increase was the result of increased capital projects in 1997
as well as an increase in expenses allocated to capital projects. The Company
also incurred increased post-retirement benefit expenses of $.3 million as the
result of the continued phasing of these expenses into the Company's rates in
1997.  The remaining decrease of $.6 million relates primarily to cost
management.

Depreciation and Amortization

  Depreciation and amortization expense increased approximately $.9 million or
7.3 percent primarily as the result of increased capital additions, including
technology related assets with shorter depreciable lives, as well as an increase
in depreciation rates that became effective with the rate increase on December
17, 1995.

                                    Page-6
                                        
<PAGE>
 
Taxes

  Taxes increased approximately $.7 million or 3.7 percent primarily as the
result of increased property taxes due to increased capital spending as well as
increased property tax rates in 1997.

Other, net

  Other, net decreased approximately $.9 million.  This decrease was the result
of increased energy venture costs of approximately $.3 million in 1997.  The
remainder of the decrease was primarily due to regulatory adjustments of $.9
million in 1996 as the result of the rate decision effective December 17, 1995.
This was offset by increases in the allowance for funds used during construction
of $.2 million as the result of increased capital spending.

Interest Expense

  Interest expense for 1997 was stable when compared to 1996.  Interest expense
increased approximately $.1 million primarily as the result of an increase in
interest on long-term debt due to the Series R First Mortgage Bond issuance by
ProvGas in December 1995.

LIQUIDITY AND CAPITAL RESOURCES

  The Company meets seasonal cash requirements and finances its capital
expenditures program on an interim basis through short-term borrowings.
Management believes its available financings are sufficient to meet these
seasonal needs.

  During the current year, the Company's cash flow from operations increased
approximately $13.7 million compared to the same period last year.  This
increase was primarily due to the sale of ProvGas' working gas in storage to
Duke Energy Trading and Marketing, L.L.C. as well as the impact of Energize RI
changes.

  Capital expenditures for 1998 of $28.6 million increased $7.8 million or 37.2
percent when compared to the $20.9 million last year.  As part of Energize RI,
ProvGas' spending increased as a result of making significant capital
improvements to its distribution system.  These improvements will expand the
distribution system into economically developing areas of Rhode Island, as well
as accelerate the replacement of older mains and services. Additional
expenditures relating to ProvGas' decision to move to a client server
environment, as well as to computerize existing paper records of its
distribution system, have also contributed to this increase.  Anticipated
capital expenditures during the next two fiscal years are expected to total
approximately $58.5 million.

  To finance capital expenditures, ProvGas issued $15 million of Series S First
Mortgage Bonds in April 1998 at 6.82 percent.  These bonds require semi-annual
interest payments and a lump sum repayment of principal in 20 years.

  To reduce its long-term borrowing costs, ProvGas repurchased $6.4 million of
Series M First Mortgage Bonds in September 1998.  The cost to repurchase was
comprised of $6.4 million in principal and $1.4 million in premium.  ProvGas is
planning to issue $15 million in First Mortgage Bonds to cover the cost of the
repurchase as well as for general corporate purposes.  The future bond issuance
is anticipated to be for a 30 year term at an interest rate expected to be less
than 7.0 percent.  ProvGas estimates savings of approximately $1.8 million over
the life of the new debt based on a projected interest rate of 6.75 percent.
ProvGas has received an order from the Division which permits the amortization
of the bond premium over the life of the new debt.

                                    Page-7
<PAGE>
 
HEDGING

   The Company's strategy is to use financial instruments for hedging purposes
to manage the impact of market fluctuations on contractual sales commitments.
Two of the Company's wholly-owned subsidiaries, ProvEnergy Oil Enterprises, Inc.
(ProvEnergy Oil), and Providence Energy Services, use financial instruments to
manage market risks and reduce their exposure to fluctuations in the market
prices of home heating oil, diesel, heavy oil and natural gas.

   At September 30, 1998, ProvEnergy Oil held futures and option contracts with
a fair market value of approximately $.2 million.  The estimated fair market
value of these contracts is based on quoted market prices.  The contracts have
maturities of one year or less.  Net unrealized gains related to these
instruments of approximately $.1 million have been deferred on the accompanying
Consolidated Balance Sheets as a component of common stockholders' equity at
September 30, 1998.  During 1998, ProvEnergy Oil incurred approximately $.5
million of costs associated with liquidating fixed purchase commitments and
option contracts for oil when market prices dropped.

   At September 30, 1998, ProvEnergy Services and ProvEnergy Oil held forward
purchase commitments for their supply needs with a fair market value of
approximately $15.2 million which were acquired at a cost of approximately $15.6
million.  The fair market value of these forward contracts is based on quoted
market prices and the contracts have maturities of less than two years.

YEAR 2000 DISCLOSURE

   Many companies' software programs and computing infrastructure use two-digit
years to define the applicable year, rather than four-digit years, and have
time-sensitive software that may recognize a date using "00" as the last two
digits of the year 1900, rather than the year 2000.  This could result in the
computer or embedded hardware shutting down or performing incorrect
computations. On July 29, 1998, the Securities and Exchange Commission issued an
Interpretation entitled "Disclosure of Year 2000 Issues and Consequences by
Public Companies, Investment Advisers, Investment Companies, and Municipal
Securities Issuers," requiring extensive detailed reporting and disclosure of a
company's progress in addressing the Year 2000 impact.  Pursuant to this
Interpretation, the Company is providing the following disclosure.

Readiness

   The Company recognizes that the products and services that the Company
provides to its customers are essential.  The Year 2000 computer problem poses a
significant challenge to the Company's ability to continue to provide these
products and services.  Senior management has made Year 2000 readiness a top
priority, and in response to that challenge, has established a Year 2000 Project
Office to ensure the continuity of mission critical business systems and
processes before and beyond the Year 2000.  The Company has hired two
international consulting firms to assist the Company in the areas of assessment,
strategy, staffing and the selection and execution of a recognized methodology
to assess Year 2000 readiness.  The Project Office oversees work in the
following four areas:

1. Information Technology (IT) Systems

   The Company continues to implement its technology plan developed in 1992
which includes the migration from a mainframe centric to a client server centric
environment.  The migration includes the replacement of the Customer Information
System (CIS) which supports the business function of customer inquiry, service
orders and billing.  It also includes the replacement of its business
applications such as financial, human resources, and procurement with an
Enterprise Resource Planning (ERP) system. These new systems have been
represented by the suppliers to be Year 2000 ready.  The migration of CIS and
ERP, including testing of these new systems, is expected to be completed by June
30, 1999.

   The Company has completed an inventory of its remaining IT systems and is in
the process of assessing these systems. The Company is preparing procurement
policies as part of its efforts to ensure Year 2000 readiness for any future
changes to its IT systems environment or future acquisitions of IT systems.

                                    Page-8
<PAGE>
 
2.  Embedded Systems

    The Company is working with an international management consulting and
engineering firm with industry-specific experience to address the Year 2000
readiness of embedded microprocessors deployed in its distribution and facility
operations.  The distribution area covers, but is not limited to, the
monitoring, storage, measurement and control of the flow of natural gas.  The
facility area covers, but is not limited to, back-up power supply, HVAC and
security at the Company's offices.

    The Company has completed reviewing 99 percent of its embedded components
inventory.  This inventory has been loaded into the Company's database and has
been matched against the consultant's proprietary database to assess which
components are Year 2000 ready.  The consultant's proprietary database contains
important information collected by the consultant through its industry network.
To date, the consultant's database immediately identified 69 percent of the
components.  Ninety-four percent of the identified components were determined to
be compliant and six percent were determined to be non-compliant.  The
components associated with the Company's mission critical systems have been
identified in the database, and many of these components are compliant.
Remediation planning is underway to address the remaining components. The
Company will work closely with the consultants to assess the segment of
components that could not be matched or identified in the consultant's
proprietary database.  This work includes direct follow-up with the
manufacturers of those components.  This assessment is expected to be completed
by December 1998 at which point the Company can better evaluate the impact of
any system failure.  Remediation and testing of mission critical systems is
scheduled to be completed by June 30, 1999 and remediation and testing of all
other embedded systems is planned to be completed by September 30, 1999.

3.  Upstream/Downstream

    The Company has developed a communication plan to keep shareholders,
customers, employees, and other major constituencies informed about the
Company's plans and the state of readiness concerning the Year 2000 computer
problem. The Company has developed a plan to address the readiness of its major
suppliers which includes a combination of written requests, telephone
interviews, and leveraging of customer groups and site visits. The Company is
actively participating with the Rhode Island Y2K (Year 2000) Group which acts as
a communication forum for key customers as well as the other essential suppliers
of services such as: telecommunications, water and electric. The Company expects
to have its assessment of its supply chain completed by January 31, 1999. The
Company's strategy includes the continual monitoring of any risk areas that
surface as a result of that assessment.

4.  Contingency Planning

    The Company has contingency plans in place for response to certain emergency
operational situations.  The Company also intends to begin developing actionable
contingency plans pertinent to the Year 2000 computer problem following
substantial completion of the assessment of its systems and third party
relationships. Representatives from the Company are participating in industry
consortiums related to contingency planning.  The planning will factor the
results of the risk assessments in the three areas mentioned above, taking into
account the major business processes of the Company.  The Company expects its
Year 2000 contingency plans to be finalized and in place by June 30, 1999.


YEAR 2000 COSTS

    The Company expects to complete its comprehensive budget for all phases of
its Year 2000 effort by January 31, 1999.  ProvGas will capitalize Year 2000
costs with a five-year amortization period consistent with the regulatory
treatment approved by the RIPUC under ProvGas' Energize RI program.  As of
September 30, 1998, ProvGas has deferred Year 2000 costs of $2.5 million.  The
Company estimates the cost of the assessment phase of its Year 2000 effort to be
less than $1 million.  The Company does not yet have a cost estimate applicable
to remediation at this time.

                                    Page-9
<PAGE>
 
POTENTIAL RISKS

   The Company must complete its migration to a client server environment and
must complete the implementation of CIS and ERP and the upgrade of its System
Control and Data Acquisition software application.  Although the Company expects
to achieve these goals in a timely manner, the Company cannot guarantee these
results.  A delay in completing these projects or the inability of any of these
systems to perform their respective fundamental functions would result in the
Company experiencing significant business disruption.

   The majority of the Company's natural gas supply is delivered over third-
party interstate transmission lines from the Gulf coast to Rhode Island.  These
interstate transmission lines use many compressor stations to move the gas.
These compressor stations are controlled and monitored remotely, each station
using hundreds of embedded components.  If these embedded systems reach critical
failure without manual backup, the Company will experience an indeterminate
amount of gas supply loss.  Although the Company expects the natural gas
delivery systems to operate in the Year 2000, the Company cannot guarantee this
will occur.  If the loss of gas supply exceeds the Company's access to its
reserves in storage and its liquefied natural gas capability, the Company will
not be able to serve certain customer segments.  The Company's inability to
serve its customers would result in a loss of revenue and potential claims.

COMMON STOCK INFORMATION

<TABLE> 
<CAPTION> 
                                                   Dividend Paid
Quarter Ended                 High        Low        Per Share
--------------------------  ---------  ---------   -------------
<S>                         <C>        <C>         <C>
September 30, 1998          $  21 3/8  $  19 1/4           $.27
June 30, 1998                  21 1/4     19 1/2            .27
March 31, 1998                 22 1/8     20 5/8            .27
December 31, 1997              22         17 11/16          .27
 
September 30, 1997          $19 11/16  $  17 1/4           $.27
June 30, 1997                18 3/8       17 1/8            .27
March 31, 1997               20 1/2       16 1/2            .27
December 31, 1996            18 3/4       16 3/4            .27
</TABLE>

                                    Page-10
<PAGE>
 
FINANCIAL AND OPERATING STATISTICS - NATURAL GAS DISTRIBUTION
For the Years Ended September 30

<TABLE>
<CAPTION>
                                      1998      1997     1996      1995      1994      1993
                                    --------  -------- --------  --------  --------  --------
<S>                                 <C>       <C>      <C>       <C>       <C>       <C>
Natural gas distribution revenue
 (thousands of dollars):
  Residential                       $126,479  $135,259 $128,875  $106,387  $130,888  $120,997
  Commercial/
   industrial                         47,629    66,352   74,625    61,491    76,174    72,974
  Firm transportation                  7,682     2,251      330       171         -         -
                                    --------   -------  -------  --------  --------  --------
  Total firm                         181,790   203,862  203,830   168,049   207,062   193,971
  Interruptible and other              5,502    10,299    9,882    14,026    14,471    14,336
  Non-firm transportation                792       504      411       633       287        54
  Other                                  650       593      623     1,284       958       954
                                    --------   -------  -------  --------  --------  --------
   Total natural gas
    distribution revenue            $188,734  $215,258 $214,746  $183,992  $222,778  $209,315
                                    ========  ======== ========  ========  ========  ========
 
Gas sold and transported (MMcf):
  Residential                         13,007    13,853   14,423    12,709    14,122    13,783
  Commercial/
  industrial                           5,727     8,086    9,694     8,772     9,360     8,926
  Firm transportation                  4,223     1,818      379       208         -         -
                                    --------   -------  -------  --------  --------  --------
  Total firm                          22,957    23,757   24,496    21,689    23,482    22,709
  Interruptible and other              1,409     2,633    2,610     4,950     4,547     3,985
  Non-firm transportation                999       907    1,001     1,473       656       386
  Company use and
   other                                 946       871    1,017       919     1,182     1,187
                                    --------   -------  -------  --------  --------  --------
 Total gas sold and transported       26,311    28,168   29,124    29,031    29,867    28,267
 Less: off-system sales                    -       280      412     1,682     2,179       501
                                    --------   -------  -------  --------  --------  --------
   Total gas delivered                26,311    27,888   28,712    27,349    27,688    27,766
                                    ========   =======  =======  ========  ========  ========
 
Gas purchased, produced and
  transported (MMcf):
  Pipeline natural
   gas-contract                       21,008    17,328   17,979    16,591    22,880    18,044
  Pipeline natural
   gas-spot purchases                      -     3,271    5,197     7,935     3,533     7,936
  Pipeline natural
   gas-transportation                  5,222     2,725    1,380     1,681       656       386
  Underground storage                     81     4,163    3,129     2,270     1,697       879
  Liquefied natural gas                    -       681    1,439       554     1,101     1,022
                                    --------   ------- --------  --------  --------  --------
   Total gas sold and 
    transported                       26,311    28,168   29,124    29,031    29,867    28,267
                                    ========   =======   ======  ========  ========  ========
Average annual number of
gas distribution customers:
  Residential                        152,837   151,152  149,487   147,935   145,793   143,771
  Commercial/
  industrial                          15,981    16,656   16,645    16,509    16,337    16,264
  Firm transportation                    884        50        6         1         -         -
                                    --------   -------  -------  --------  --------  --------
  Total firm                         169,702   167,858  166,138   164,445   162,130   160,035
  Interruptible and
  non-firm transportation                123       125      138       142       141       123
                                    --------   -------  -------  --------  --------  --------
    Total                            169,825   167,983  166,276   164,587   162,271   160,158
                                    ========   =======  =======  ========  ========  ========
</TABLE>

                                    Page-11

<PAGE>
 
<TABLE> 
<S>                          <C>       <C>        <C>       <C>        <C>        <C> 
Total number of gas
 distribution customers
 at year-end                  168,180   166,535    164,312   163,294    159,375    159,135  
                              =======   =======    =======   =======    =======    =======
Residential heating:
 Average consumption per
   customer (Mcf)                 101       109        116       103        117        116
 Average revenue per
   customer                  $    957  $  1,043   $  1,016  $    844   $  1,068   $  1,008
 Average rate per                                                                   
   Mcf                       $   9.51  $   9.55   $   8.77  $   8.19   $   9.10   $   8.68
 Average annual number
   of customers               123,023   120,826    118,724   116,826    114,461    112,497
 Maximum daily sendout
 (MMcf)                           181       188        189       202        206        185
 Actual calendar degree
  days                          5,206     5,657      5,967     5,111      5,977      5,718
 Normal calendar degree
  days                          5,652     5,652      5,682     5,709      5,709      5,811
</TABLE> 

1 Mcf is one thousand cubic feet; 1 MMcf is one million cubic feet.

                                    Page-12
<PAGE>
 
SELECTED FINANCIAL DATA - SUMMARY OF OPERATIONS
For the Years Ended September 30

(thousands, except per share amounts)

<TABLE>
<CAPTION>
                               1998      1997       1996      1995       1994      1993 
                               ----      ----       ----      ----       ----      ----
<S>                          <C>       <C>        <C>       <C>        <C>       <C>
Energy revenues              $221,306  $220,420   $215,152  $183,992   $222,778  $209,315
Cost of energy                122,733   124,376    120,246   100,944    135,104   126,314
                             --------  --------   --------  --------   --------  --------
Operating margin               98,573    96,044     94,906    83,048     87,674    83,001
                             --------  --------   --------  --------   --------  -------- 
Other operating expenses,
  excluding taxes              66,478    61,642     61,030    54,838     55,838    52,921
Taxes, other than income       13,981    13,732     13,007    11,769     12,540    12,597
Federal income taxes            3,628     4,608      4,683     3,104      4,460     3,554 
                             --------  --------   --------  --------   --------  -------- 
Total operating
  expenses                     84,087    79,982     78,720    69,711     72,838    69,072
                             --------  --------   --------  --------   --------  -------- 
Operating income               14,486    16,062     16,186    13,337     14,836    13,929
Other, net                        576        (2)       945       865        196        37
                             --------  --------   --------  --------   --------  -------- 
Income before interest
  expense and preferred
  dividends of subsidiary      15,062    16,060     17,131    14,202     15,032    13,966
Interest expense                8,133     7,603      7,465     7,379      6,247     6,653
                             --------  --------   --------  --------   --------  -------- 
Income after interest
 expense                        6,929     8,457      9,666     6,823      8,785     7,313
Preferred dividends of
 subsidiary                      (487)     (626)      (696)     (696)      (696)     (696)
                             --------  --------   --------  --------   --------  -------- 
Net income                      6,442     7,831      8,970     6,127      8,089     6,617 
Common dividends                6,377     6,242      6,155     6,062      5,856     4,889  
                             --------  --------   --------  --------   --------  -------- 
Earnings reinvested in
  the corporation            $     65  $  1,589   $  2,815  $     65   $  2,233  $  1,728
                             ========  ========   ========  ========   ========  ======== 

Weighted average common
  shares outstanding          5,919.7   5,790.1    5,709.2   5,624.2    5,534.1   4,761.8 
                             ========  ========   ========  ========   ========  ======== 
Net income per
common share - basic         $   1.09  $   1.35   $   1.57  $   1.09   $   1.46  $   1.39 
                             ========  ========   ========  ========   ========  ========   
Net income per
common share - diluted       $   1.09  $   1.35   $   1.57  $   1.09   $   1.46  $   1.39
                             ========  ========   ========  ========   ========  ========      
Common dividends             $   1.08  $   1.08   $   1.08  $   1.08   $   1.06  $   1.02
                             ========  ========   ========  ========   ========  ======== 
</TABLE> 

                                    Page-13
<PAGE>
 
OTHER FINANCIAL DATA
September 30
 
(thousands, except per share amounts)

<TABLE>
<CAPTION>
                                           1998      1997      1996      1995      1994      1993
                                           ----      ----      ----      ----      ----      ----
<S>                                      <C>       <C>       <C>       <C>       <C>       <C>
Total assets                             $253,410  $255,510  $250,150  $227,127  $233,311  $224,550
Gas plant--at
  original cost                           324,502   300,829   279,849   262,769   239,830   221,769
Gas plant--net of
  depreciation                            202,313   190,307   179,473   169,792   159,012   149,272
Capitalization:
  Common stockholders'
    equity                                 88,234    85,661    82,565    78,524    77,156    73,368
  Redeemable cumulative
    preferred stock                         4,800     6,400     8,000     8,000     8,000     8,000
  Long-term debt                           80,155    72,372    72,456    74,482    60,079    62,163
Shares of common stock
    at year-end                             5,969     5,832     5,748     5,668     5,581     5,486
Book value per share                     $  14.78  $  14.69  $  14.36  $  13.85  $  13.82  $  13.37
                                          =======   =======   =======   =======   =======   =======
</TABLE> 

                                    Page-14
<PAGE>
 
CONSOLIDATED BALANCE SHEETS
September 30

 
<TABLE>
<CAPTION>
(thousands of dollars)                                 1998      1997
----------------------------------------------------------------------- 
<S>                                                  <C>       <C>
ASSETS
Gas plant, at original cost (notes 1,4,7, and 9)     $324,502  $300,829
  Less--Accumulated depreciation and plant
      acquisition adjustments (notes 1 and 9)         122,007   110,365
                                                     --------  --------
                                                      202,495   190,464
                                                     --------  --------
Other property, net                                     2,692     1,182
                                                     --------  --------
Current assets:
  Cash and temporary cash
    investments (notes 1 and 8)                         2,006     1,063
  Accounts receivable, less allowance of
    $2,720 in 1998 and $1,886 in 1997
    (notes 1 and 3)                                    14,067    14,852
  Unbilled revenues (note 1)                            1,665     2,683
  Deferred gas costs (notes 1,7, and 9)                     -     7,231
  Inventories, at average cost-
    Liquefied natural gas, propane, and under-
      ground storage                                      656    18,217
    Materials and supplies                              1,433     1,287
  Prepaid and refundable taxes (note 2)                 5,377     4,005
  Prepayments                                           1,853     1,039
                                                     --------  --------
                                                       27,057    50,377
                                                     --------  --------
 
Investments (notes 11 and 13)                           2,169         -
Deferred charges and other assets
  (notes 1,3,and 6)                                    18,997    13,487
                                                     --------  --------
    Total assets                                     $253,410  $255,510
                                                     ========  ========
 
CAPITALIZATION AND LIABILITIES
Capitalization (see accompanying statement)          $173,254  $164,433
                                                     --------  --------
Current liabilities:
  Notes payable (notes 5 and 8)                        20,079    23,675
  Current portion of long-term debt (note 4)            3,233     3,707
  Accounts payable (notes 6, 7, and 8)                  9,325    16,755
  Accrued taxes                                         2,714     2,506
  Accrued vacation                                      1,706     1,715
  Customer deposits                                     3,034     3,461
  Other                                                 6,773     5,531
                                                     --------  --------
                                                       46,864    57,350
                                                     --------  --------
Deferred credits and reserves:
  Accumulated deferred Federal income taxes (note 2)   22,292    21,495
  Unamortized investment tax credits (note 2)           2,217     2,375
  Other (notes 6 and 7)                                 8,783     9,857
                                                     --------  --------
                                                       33,292    33,727
                                                     --------  --------
 
Commitments and contingencies (notes 7 and 9)               -         -
 
   Total capitalization and liabilities              $253,410  $255,510
                                                     ========  ========
</TABLE> 

The accompanying notes are an integral part of these consolidated financial
statements.

                                    Page-15
<PAGE>
 
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended September 30

<TABLE>
<CAPTION>
(thousands, except per share amounts)      1998       1997       1996
---------------------------------------  ---------  ---------  ---------
<S>                                      <C>        <C>        <C>
 
Energy revenues                          $221,306   $220,420   $215,152
Cost of energy                            122,733    124,376    120,246
                                         --------   --------   --------
  Operating margin                         98,573     96,044     94,906
                                         --------   --------   --------
Operating expenses:
  Operation and maintenance                51,993     48,768     49,033
  Depreciation and amortization            14,485     12,874     11,997
  Taxes:
    State gross earnings                    5,618      6,045      6,063
    Local property and other                8,363      7,687      6,944
    Federal income (note 2)                 3,628      4,608      4,683
                                         --------   --------   --------
Total operating expenses                   84,087     79,982     78,720
                                         --------   --------   --------
Operating income                           14,486     16,062     16,186
Other, net (note 1, 2, and 16)                576         (2)       945
                                         --------   --------   --------
Income before interest expense and
   preferred dividends of subsidiary       15,062     16,060     17,131
                                         --------   --------   --------
 
Interest expense:
  Long-term debt                            6,391      6,042      5,889
  Other                                     1,998      1,786      1,682
  Interest capitalized                       (256)      (225)      (106)
                                         --------   --------   --------
                                            8,133      7,603      7,465
                                         --------   --------   --------
Income after interest expense               6,929      8,457      9,666
 
Preferred dividends of subsidiary
(note 4)                                     (487)      (626)      (696)
                                         --------   --------   --------
 
Net income                               $  6,442   $  7,831   $  8,970
                                         ========   ========   ========
Net income per common
  share - basic                          $   1.09   $   1.35   $   1.57
                                         ========   ========   ========
Net income per common
  share - diluted                        $   1.09   $   1.35   $   1.57
                                         ========   ========   ========
Weighted average common
  shares outstanding (note 12):
  Basic                                   5,919.7    5,790.1    5,709.2
                                         ========   ========   ========
  Diluted                                 5,929.7    5,794.3    5,712.0
                                         ========   ========   ========
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

                                    Page-16
<PAGE>
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended September 30

<TABLE>
<CAPTION>
(thousands of dollars)                                     1998       1997       1996
----------------------------------------------------     ---------  ---------  ---------
<S>                                                      <C>        <C>        <C>
Cash provided by -
  Operating Activities:
    Income after interest expense                        $  6,929   $  8,457   $  9,666
    Items not requiring cash:
      Depreciation and amortization                        14,294     12,846     12,012
      Changes as a result of regulatory action              1,500          -     (1,453)
      Deferred Federal income taxes                         1,131        703      1,943
      Loss/(gain) on sale of other property (note 16)          37          -       (699)
      Write-down of other property (note 16)                    -          -        714
      Amortization of investment tax credits                 (158)      (158)      (158)
      Changes in assets and liabilities
        which provided (used) cash:
         Accounts receivable                               21,504       (187)      (634)
         Unbilled revenues                                  1,018       (326)       298
         Deferred gas costs                                    78      6,041    (12,079)
         Inventories                                         (169)    (2,222)    (5,626)
         Prepaid and refundable taxes                      (1,646)        14      1,857
         Prepayments                                         (800)       501       (174)
         Accounts payable                                  (3,495)      (617)     3,270
         Accrued taxes                                        202        526        (21)
         Accrued vacation, customer deposits,
            and other                                         796       (388)     1,462
         Deferred charges and other                           383      2,697      1,307
                                                         --------   --------   --------
         Net cash provided by operating activities         41,604     27,887     11,685
                                                         --------   --------   --------
 
 
 Investment Activities:
    Expenditures for property, plant
      and equipment, net                                  (28,632)   (20,875)   (20,781)
    Expenditures for business acquistions (note 14)        (2,744)         -          -
    Investment in joint venture (note 13)                  (2,000)         -          -
    Proceeds from sale of other property (note 16)            698          -        725
    Cash paid for financial instruments                      (104)         -          -
                                                         --------   --------   --------
        Net cash used in investing activities             (32,782)   (20,875)   (20,056)
                                                         --------   --------   --------
 
 
  Financing Activities:
    Issuance of common stock                                    -         44         31
    Proceeds from exercise of stock options                   115         34          -
    Issuance of mortgage bonds                             15,000          -     15,000
    Repurchase of mortgage bonds                           (6,363)         -          -
    Premium payment on bonds                               (1,392)         -          -
    Redemption of preferred stock                          (1,600)    (1,600)         -
    Issuance of long-term debt                                  -      1,345          -
    Payments on long-term debt                             (3,799)    (2,164)    (1,954)
    Increase (decrease) in notes payable                   (4,462)       405        933
    Cash dividends on preferred shares (note 4)              (487)      (626)      (696)
    Cash dividends on common shares                        (4,891)    (4,811)    (4,797)
                                                         --------   --------   --------
    Net cash provided (used) by financing
     activities                                            (7,879)    (7,373)     8,517
                                                         --------   --------   --------
 
Increase (decrease) in cash                                943       (361)       146
Cash and temporary cash investments at beginning
   of year                                               1,063      1,424      1,278
                                                      --------   --------   --------
Cash and temporary cash investments at the end
   of year                                            $  2,006   $  1,063   $  1,424
                                                      ========   ========   ========
</TABLE>

                                    Page-17
<PAGE>
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended September 30 (continued)

<TABLE>
<CAPTION>
(thousands of dollars)                                  1998        1997         1996 
----------------------------------------------------------------------------------------------
<S>                                                  <C>         <C>           <C>    
Supplemental disclosure of cash flow information:
  Cash paid during the year for-
    Interest (net of amount capitalized)             $  7,606    $   7,476     $  6,738
    Income taxes (net of refunds)                    $  3,750    $   2,036     $  2,851
  Schedule of non-cash investing activities:                                          
    Capital lease obligations for equipment          $     -     $     437     $     -
    Other long-term debt for equipment               $     -     $   1,983     $     - 
</TABLE> 

The accompanying notes are an integral part of these consolidated financial
statements.

                                    Page-18
<PAGE>
 

CONSOLIDATED STATEMENTS OF CAPITALIZATION
September 30

<TABLE>
<CAPTION>
(thousands)                                                     1998      1997  
--------------------------------------------------------------------------------
<S>                                                           <C>       <C>    
Common stockholders' investment (notes 4, 6, and 10):                         
  Common stock, $1 Par, Authorized - 20,000 shares                            
  Outstanding - 5,969 shares in 1998 and 5,832 shares                          
   in 1997                                                    $  5,969  $  5,832
  Amount paid in excess of par                                  59,198    56,827
  Retained earnings                                             23,067    23,002
                                                              --------  --------
Common equity                                                   88,234    85,661
                                                              --------  --------
                                                                                
Unrealized gain on financial instruments (note 11)                  65         -
                                                              --------  --------
                                                              
Cumulative preferred stock of subsidiary (notes 4 and 8):     
  Redeemable 8.7% Series, $100 Par                            
  Authorized - 80 shares                                      
  Outstanding - 48 shares as of 1998 and                      
   64 shares as of 1997                                          4,800     6,400
                                                              --------  --------
Long-term debt (notes 4, 7, and 8):                                            
 First Mortgage Bonds, secured by property                                     
   Series M, 10.25%, due July 31, 2008                           2,728    10,000
   Series N, 9.63%, due May 30, 2020                            10,000    10,000
   Series O, 8.46%, due September 30, 2022                      12,500    12,500
   Series P, 8.09%, due September 30, 2022                      12,500    12,500
   Series Q, 5.62%, due November 30, 2003                        9,600    11,200
   Series R, 7.50%, due December 30, 2025                       15,000    15,000
   Series S, 6.82%, due April 1, 2018                           15,000         -
                                                                               
 Other long-term debt                                            4,890     3,207
 Capital leases                                                  1,170     1,672
                                                              --------  --------
                                                                83,388    76,079
 Less-current portion                                            3,233     3,707
                                                              --------  --------
                                                                80,155    72,372
                                                              --------  --------
                                                                                
Total capitalization                                          $173,254  $164,433
                                                              ========  ========
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.

                                    Page-19
<PAGE>
 
CONSOLIDATED STATEMENTS OF CHANGES IN COMMON STOCKHOLDERS' INVESTMENT
For the Three Years Ended September 30

<TABLE>
<CAPTION>
                                               Shares           Amount Paid                Unrealized Gain   
                                        Issued and Outstanding   In Excess   Retained            on
                                        ----------------------                     
(thousands)                              Number        Amount      of Par    Earnings    Financial instruments 
---------------------------------------------------------------------------------------------------------------
<S>                                     <C>           <C>        <C>        <C>            <C>
Balance, September 30, 1995              5,668         $5,668     $54,258    $18,598         $       -
Add (deduct):
 Net income                                  -              -           -      8,970                 - 
 Dividends ($1.08 per share)                 -              -           -     (6,155)                -
 Dividend reinvestment, cash
   stock purchase plan, and employee
   benefit plans                            80             80       1,309          -                 -
 Accrual for stock compensation
   plans                                     -              -        (227)         -                 -
 Amortization of deferred
   compensation for stock
   compensation plans                        -              -          64          -                 - 
                                         -----       --------    --------   --------           ------- 

Balance, September 30, 1996              5,748          5,748      55,404     21,413                 -
Add (deduct):
 Net income                                  -              -           -      7,831                 -
 Dividends ($1.08 per share)                 -              -           -     (6,242)                -
 Dividend reinvestment, cash
   stock purchase plan, and employee
   benefit plans                            82             82       1,392          -                 -
 Exercise of stock options                   2              2          32          -                 -
 Accrual for stock compensation
   plan                                      -              -        (110)         -                 -
 Amortization of deferred
   compensation for stock
   compensation plans                        -              -         109          -                 -
                                         -----       --------    --------   --------           -------  

Balance, September 30, 1997              5,832          5,832      56,827     23,002                 -
Add (deduct):
 Net income                                  -              -           -      6,442                 -
 Dividends ($1.08 per share)                 -              -           -     (6,377)                -
 Dividend reinvestment, cash
   stock purchase plan, and employee
   benefit plans                            76             76       1,410          -                 -
 Exercise of stock options                   7              7         108          -                 -
 Accrual for stock compensation
   plan                                      -              -        (266)         -                 -
 Amortization of deferred
   compensation for stock
   compensation plans                        -              -         163          -                 -
 Unrealized gain on
   financial instruments                     -              -           -          -                65
 Shares issued for acquisition              54             54         956          -                 -
                                         -----       --------    --------   --------           -------  
Balance, September 30, 1998              5,969       $  5,969    $ 59,198   $ 23,067           $    65
                                         =====       ========    ========   ========           =======
</TABLE> 

The accompanying notes are an integral part of these consolidated financial
statements.

                                    Page-20
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SIGNIFICANT ACCOUNTING POLICIES

 CONSOLIDATION

     The consolidated financial statements include the accounts of Providence
Energy Corporation and its wholly-owned subsidiaries (the Company). Energy
revenues from natural gas sales and distribution as well as oil businesses are
reflected in the accompanying Consolidated Statements of Income to arrive at
operating income. Revenues and expenses of other operations include sales and
rentals of appliances as well as real estate rentals and are presented after
operating income in the accompanying Consolidated Statements of Income. All
significant intercompany transactions have been eliminated in consolidation. The
Company accounts for its investment in the Capital Center Energy Company, LLC
joint venture under the equity method of accounting.

 USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS

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

 REGULATION

     The Providence Gas Company (ProvGas) is subject to regulation by the Rhode
Island Public Utilities Commission (RIPUC). North Attleboro Gas Company (North
Attleboro Gas) is subject to regulation by the Massachusetts Department of
Telecommunications and Energy (MDTE). The accounting policies of ProvGas and
North Attleboro Gas conform to GAAP as applied in the case of regulated public
utilities and are in accordance with the regulators' accounting requirements and
rate-making practices.

 ENERGY REVENUES

     Energy revenues are generated principally from natural gas and oil
activities. The natural gas distribution companies record accrued natural gas
distribution revenues based on estimates of gas volumes delivered but not billed
at the end of an accounting period in order to match revenues with related 
costs.

 HEDGING

     Two of the Company's wholly-owned subsidiaries, Providence Energy Oil
Enterprises, Inc. (ProvEnergy Oil) and Providence Energy Services, Inc.
(ProvEnergy Services), use financial instruments to manage market risks and
reduce their exposure to fluctuations in the market prices of home heating oil,
diesel, heavy oil and natural gas. The Company's policy is not to hold or issue
financial instruments for trading purposes but to utilize such instruments to
hedge the impact of market price fluctuations.

     ProvEnergy Oil's and ProvEnergy Services' financial instruments qualify for
hedge accounting. Hedge accounting is used in non-trading activities when there
is a high degree of correlation between price movements in the instrument and
the item designated as being hedged. Under hedge accounting, financial
instruments with third parties are carried at market value with related
unrealized gains and losses recorded as adjustments to equity in the
Consolidated Statements of Capitalization. Realized gains and losses are
recognized in the Consolidated Statements of Income when the hedge transaction
occurs.

 LEASE ACCOUNTING

     Previously, the Company leased water heaters and other appliances to
customers under finance leases. These leases are recorded on the accompanying
Consolidated Balance Sheets at the gross investment in the leases less unearned
income. Unearned income is recognized in such a manner as to produce a constant
periodic rate of return on the net investment in the finance leases.

 GAS PLANT

     Gas plant is stated at the original cost of construction. In accordance
with the uniform system of accounts prescribed by the RIPUC, the difference
between the original cost of gas plant acquired and the cost to ProvGas is
recorded as a Plant Acquisition Adjustment and is being amortized over
periods ranging from 1 to 24 years.

     The Company capitalizes the costs of all technology investments with the
exception of system maintenance costs unless deferral is approved by regulators.

                                    Page-21
<PAGE>
 IMPAIRMENT OF LONG-LIVED ASSETS 

     Statement of Financial Accounting Standards (SFAS) No. 121 "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of"
which became effective for the Company in 1997, established accounting standards
for the impairment of long-lived assets. SFAS No. 121 also required that
regulatory assets which are no longer probable of recovery through future
revenues be charged to earnings. SFAS No. 121 did not have an impact on the
Company's financial position or results of operations.

 DEPRECIATION

     Depreciation is provided on the straight-line basis at rates approved by
the RIPUC and the MDTE which are designed to amortize the cost of depreciable
plant over its estimated useful life. The composite depreciation rate expressed
as a percentage of the average depreciable gas plant in service was
approximately 3.85 percent for 1998, 1997 and 1996.

     The Company retires property units by charging original cost, cost of
removal, including environmental investigation and remediation costs, and
salvage value to accumulated depreciation.

 GAS CHARGE CLAUSES

     In May 1996, the RIPUC approved a Rate Design Settlement Agreement (the
Agreement). The Agreement included changes to ProvGas' gas cost recovery
mechanism. Specifically, the Agreement replaced the previous Cost of Gas
Adjustment Clause (CGA) with Gas Charge Clauses (GCC) effective June 2, 1996. In
addition to the commodity and related pipeline transportation costs historically
included in the CGA, the GCC provided for the recovery of: (1) inventory
financing costs; (2) working capital associated with gas supply purchases; (3)
bad debt expenses associated with the gas revenue portion of customer bills; and
(4) a substantial portion of liquefied natural gas operating and maintenance
expenses, all of which were previously recovered in base rates. Similar to the
former CGA, the GCC provided for reconciliation of total gas costs billed with
the actual cost of gas incurred. Any excess or deficiency in amounts billed as
compared to costs incurred was deferred and either refunded to, or recovered
from, customers over a subsequent period. As a result of the Price Stabilization
Plan Settlement Agreement described in Note 9, the GCC will be suspended for the
period from October 1, 1997 through September 30, 2000. Any excess or deficiency
in amounts billed as compared to costs incurred will be retained or borne by
ProvGas during this period.

 ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION (AFUDC)

     The Company capitalizes interest and an allowance for equity funds in
accordance with established policies of the RIPUC and MDTE. The rates used are
based on the actual cost of debt and the allowed equity return. Interest
capitalized is shown as a reduction of interest expense and the equity allowance
is included in Other, net in the accompanying Consolidated Statements of Income.

 DEFERRED CHARGES AND OTHER ASSETS

     The Company defers and amortizes certain costs in a manner consistent with
authorized or probable rate-making treatment.

     Deferred financing costs are amortized over the life of the related
security while the remaining deferred regulatory charges and other assets are
amortized over a recovery period specified by the respective regulatory
commissions.

Deferred Charges and Other Assets include the following:

<TABLE> 
<CAPTION> 
(thousands of dollars)                  1998     1997
-------------------------------------------------------
<S>                                    <C>      <C>
Pension costs                          $ 6,401  $ 7,379
Unamortized debt expense                 3,204    1,901
Goodwill, net                            2,839      106
Year 2000 costs                          2,518        -
Cost of fuel assistance program            895      808
Post-retirement benefits                   346      691
Deferred rate case expense (note 9)        183      164
Deferred costs related to
  phase-in plan                             75      272
Other deferred charges                   2,536    2,166
                                       -------  -------
   Total                               $18,997  $13,487
                                       =======  =======
</TABLE>

                                    Page-22
<PAGE>
 
TEMPORARY CASH INVESTMENTS

     Temporary cash investments are short-term, highly liquid investments
with original maturities to the Company of not more than 90 days.

STOCK-BASED COMPENSATION

     Compensation expense associated with awards of stock or options to
employees is measured using the intrinsic value method of Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees" (See Note 10).

INTANGIBLES

     All intangible assets are amortized on a straight-line basis over their
estimated useful lives. The goodwill and customer list amortization periods
associated with the recent oil acquisitions are 25 years and 10 years,
respectively.

RECLASSIFICATIONS

     Certain prior year amounts have been reclassified for consistent
presentation with the current year.

2. FEDERAL INCOME TAXES

     The Company records income taxes in accordance with the Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes", which
requires deferred taxes to be provided for all temporary differences.

     The following is a summary of the provision for Federal income taxes for
the three years in the period ended September 30:

<TABLE>
<CAPTION>
(thousands of dollars)               1998    1997     1996
-----------------------------------------------------------
<S>                                 <C>     <C>      <C>
Current                             $2,526  $3,688   $2,989
Deferred                             1,131     703    1,943
                                    ------  ------   ------
Total Federal income tax
 provision                          $3,657  $4,391   $4,932
                                    ======  ======   ======
 
Income tax is charged (credited)
 to the following:
 
Charged to operating
 expenses                           $3,628  $4,608   $4,683
Included in other, net                  29    (217)     249
                                    ------  ------   ------
Total Federal income tax
 provision                          $3,657  $4,391   $4,932
                                    ======  ======   ======
</TABLE>

     The effective Federal income tax rates and the reasons for their
differences from the statutory Federal income tax rates are as follows:

<TABLE>
<CAPTION>
                                     1998     1997    1996
-----------------------------------------------------------
<S>                                  <C>      <C>     <C>
Statutory Federal income
 tax rates                           34.0%    34.0%    34.0%
Reversing temporary differences       (.1)     (.3)      .5
Charitable contribution                 -        -      (.4)
Amortization of
 investment tax credits               (.5)     (.4)     (.4)
Non-deductible goodwill                .3        -        -
Other                                  .8       .9       .1
                                     ----     ----     ----
Effective Federal income
 tax rate                            34.5%    34.2%    33.8%
                                     ====     ====     ====
</TABLE>

                                    Page-23
<PAGE>
 
     The Company's deferred tax assets and liabilities for each of the two years
in the period ended September 30 are the result of the following temporary
differences:

<TABLE>
<CAPTION>
 
 
(thousands of dollars)                             1998       1997
---------------------------------------------------------------------
<S>                                              <C>        <C>
LONG-TERM DEFERRED TAXES
------------------------
Tax assets
  Unamortized ITC                                $    773   $    828
  Other                                               413        305
Tax liabilities
  Property related                                (22,730)   (21,828)
  Pension costs                                      (237)      (222)
  Deferred charges                                   (511)      (578)
                                                 --------   --------
 Net deferred tax liability included in
  in accompanying Consolidated Balance Sheets    $(22,292)  $(21,495)
                                                 ========   ========
Prepaid taxes
-------------
Tax assets
  Accounts receivable reserves                   $    970   $    458
  Property tax reserves                              (136)      (229)
  Alternative minimum tax                               -        703
  Other                                               949      1,229
Tax liabilities
  Employee severance                                   56         56
  Other                                              (109)      (111)
                                                 --------   --------
Net prepaid taxes                                   1,730      2,106
Prepaid gross earnings tax
 and other                                          3,647      1,899
                                                 --------   --------
Net prepaid and refundable taxes
 included in accompanying
 Consolidated Balance Sheets                     $  5,377   $  4,005
                                                 ========   ========
</TABLE>

     Investment tax credits are amortized through credits to other, net over the
estimated lives of related property.

3.  LEASE RECEIVABLES

     Previously, the Company financed the installation of water heaters and
other appliances for its customers under one to three-year finance agreements.
Additionally, the Company leased water heaters and appliances to customers under
10-year sales-type leases.

<TABLE> 
<CAPTION> 
Future minimum lease payments to be received are:
(thousands of dollars)
-------------------------------------------------
<S>                                       <C>  
1999                                      $  450
2000                                         450
2001                                         340
                                          ------
                                           1,240
Amount representing interest                 197
                                          ------
Amount representing principal             $1,043
                                          ======
</TABLE> 

4.  CAPITALIZATION

A.  FIRST MORTGAGE BONDS

     In December 1995, ProvGas issued $15 million of Series R First Mortgage
Bonds. These First Mortgage Bonds bear interest at the rate of 7.5 percent and
mature in December 2025. The net proceeds provided by this indebtedness were
used to pay down ProvGas' short-term debt.

                                    Page-24
<PAGE>
 
     In April 1998, ProvGas issued $15 million of Series S First Mortgage Bonds.
These First Mortgage Bonds bear interest at the rate of 6.82 percent and mature
in April 2018. The net proceeds provided by this indebtedness were used to
finance capital expenditures and pay down short-term debt.

     ProvGas' First Mortgage Bonds are secured by a lien on substantially all of
the tangible and real property.

     As of September 30, 1998, the annual sinking fund requirements and
maturities of long-term debt for each of the next five fiscal years are
$1,873,000.

     In September 1998, ProvGas repurchased $6.4 million of Series M First
Mortgage Bonds. The cost of repurchase was comprised of $6.4 million in
principal and $1.4 million in premium. The premium will be amortized over the
life of new debt which ProvGas expects to issue in fiscal 1999. ProvGas has
received an order from the RI Division of Public Utilities and Carriers
(Division) which permits the amortization of the bond premium over the life of
the new debt.

     The Company's ability to pay dividends is largely dependent on the
continuing operations of ProvGas. Approximately $15 million of ProvGas' retained
earnings is available for dividends under the most restrictive terms of ProvGas'
First Mortgage Bond Indenture.

B.  OTHER LONG-TERM DEBT

     During 1997, the Company financed equipment purchases of approximately
$3,328,000 through the issuance of long-term notes to IBM Credit Corporation.
The notes have five-year terms and interest rates ranging from 4.9 to 7.5
percent. As of September 30, 1998, the maturities of these long-term notes over
the next five years are $632,000 in 1999, $670,000 in 2000, $708,000 in 2001,
$485,000 in 2002, and $74,000 in 2003.

C. REDEEMABLE PREFERRED STOCK

     ProvGas' preferred stock, which consists of 80,000 shares of $100 par
value, has an 8.7 percent cumulative annual dividend rate payable on a quarterly
basis, and has no voting power or privileges. The stock is subject to a
cumulative annual sinking fund requirement of 16,000 shares per year at par
($1,600,000) plus accrued or unpaid dividends which commenced in February 1997.
Accordingly, 16,000 shares were redeemed by ProvGas at par value in February
1998 and 1997, respectively.

5.  NOTES PAYABLE

     The Company meets seasonal cash requirements and finances capital
expenditures on an interim basis through short-term bank borrowings. As of
September 30, 1998, the Company had lines of credit totaling $68,950,000 with
borrowings outstanding of $20,079,000. The Company pays a fee for its lines of
credit rather than maintaining compensating balances. The weighted average 
short-term interest rate for borrowings outstanding at the end of the year was
5.86 percent in 1998, 5.79 percent in 1997, and 5.65 percent in 1996.

6.  EMPLOYEE BENEFITS

A.  RETIREMENT PLANS

     The Company has two pension plans providing retirement benefits for
substantially all of its employees. The benefits under the plans are based on
years of service and the employee's final average compensation. It is the
Company's policy to fund at least the minimum required contribution.

     The following table sets forth the funding status of the pension plans and
amounts recognized in the Company's Consolidated Balance Sheets at September 30,
1998 and 1997:

                                    Page-25
<PAGE>
 
<TABLE>
<CAPTION>
 
(thousands of dollars)                                     1998         1997
--------------------------------------------------------------------------------
<S>                                                     <C>          <C>
Accumulated benefit obligation,
  including vested benefit obligation
  of $(46,175) as of September 30,
  1998 and $(38,094)
  as of September 30, 1997                              $ (54,986)   $ (45,022)
                                                        =========    =========
Projected benefit obligation for
  service rendered to date                              $ (71,540)   $ (60,323)
Plan assets at fair value (primarily
  listed stocks, corporate bonds, and
  U.S. bonds)                                              74,862       76,479
                                                        ---------    ---------
Excess of plan assets over
  projected benefit obligation                              3,322       16,156
Unrecognized (gain)                                        (9,872)     (23,813)
Unrecognized prior service cost                             2,559        2,842
Unrecognized net transition asset
  being recognized over 15 years
  from October 1, 1985                                       (272)        (408)
                                                        ---------    ---------
Net accrued pension cost included
  in other deferred credits and
  accounts payable at September 30,
  1998 and 1997                                         $  (4,263)   $  (5,223)
                                                        =========    =========
</TABLE> 
 
Net pension cost for fiscal years 1998, 1997, and 1996 included the following
components:

<TABLE> 
<CAPTION> 
 
(thousands of dollars)                              1998       1997        1996
-----------------------------------------------------------------------------------
<S>                                               <C>       <C>         <C> 
Service cost                                      $ 1,989   $  1,824    $  1,709                                            
Interest cost on benefit obligations                4,904      4,583       4,262                                            
Actual return on plan assets                       (1,338)   (16,458)     (7,481)                                           
Net amortization and deferral                      (6,515)    10,526       2,091                                            
                                                  -------   --------    --------                                            
Net periodic pension cost                            (960)       475         581                                            
Adjustments due to regulatory                                                                                               
  action                                              960       (475)       (442)                                           
                                                  -------   --------    --------                                            
Net periodic pension cost recognized
  in earnings                                     $     -   $      -    $    139
                                                  =======   ========    ========
</TABLE>

   In 1998, the discount rate and rate of increase in future compensation levels
used in determining the projected benefit obligation were 6.75 percent and 
5 percent, respectively.  The expected long-term rate of return on assets was 
9 percent in 1998.

   In 1997 and 1996, the discount rate and rate of increase in future
compensation levels used in determining the projected benefit obligation were 
8 percent and 6 percent, respectively. The expected long-term rate of return on
assets was 9 percent in 1997 and 1996.

   ProvGas recovers pension costs in rates when such costs are funded.
Therefore, the amount by which funding differs from pension expense, determined
in accordance with GAAP, is deferred and recorded as a regulatory asset or
liability.

B. POST-RETIREMENT BENEFITS OTHER THAN PENSIONS

   ProvGas currently offers retirees who have attained age 55 and worked five
years for ProvGas, healthcare and life insurance benefits during retirement (the
Benefit Plan).  These benefits are similar to the benefits offered to active
employees.  Although retirees are not required to make contributions to the
Benefit Plan currently, future contributions may be required if the cost of the
Benefit Plan exceeds certain limits.

   Since 1993, post-retirement benefit costs for active employees are recorded
by ProvGas on an accrual basis, ratably over their service periods.  Benefits of
$10,526,000 earned prior to 1993 have been deferred as an unrecognized
transition obligation, which ProvGas will amortize over a 20-year period.

   ProvGas funds its post-retirement benefit obligation by contributions to a
Voluntary Employee Benefit Association (VEBA) Trust. Total contributions of
$1,308,000 in 1998, $1,372,000 in 1997, and $1,454,000 in 1996, were made to the
VEBA Trust.

                                    Page-26
<PAGE>
 
   ProvGas recovers its post-retirement benefit obligation in rates to the
extent allowed by the RIPUC.  The RIPUC generally allows such costs to be
recovered if amounts are funded into tax favored investment funds, such as the
VEBA Trust.  Accordingly, ProvGas fully recovered its 1998, 1997, and 1996 post-
retirement obligations because such obligations were funded through the VEBA
Trust.  In addition, in September 1996, the RIPUC approved a ratable recovery of
the cumulative unrecovered difference of $1,041,000 during 1997, 1998, and 1999.
Of the total post-retirement benefit obligations, $1,654,000, $1,718,000, and
$1,454,000 were included in rates during 1998, 1997, and 1996, respectively.

   The Benefit Plan's costs and accumulated post-retirement benefit obligation
for 1998, 1997 and 1996 are calculated by ProvGas' actuaries using assumptions
and estimates which include:

<TABLE>
<CAPTION>
                                                  1998   1997   1996
----------------------------------------------------------------------
<S>                                               <C>    <C>    <C>
Healthcare cost annual growth rate                 9.0%  10.2%  11.4%
Healthcare cost annual growth rate - long-term     6.0    6.0    6.0
Expected long-term rate of return (union)          8.5    8.5    8.5
Expected long-term rate of return (non-union)      5.5    5.5    5.5
Discount rate                                      6.75   8.0    8.0
</TABLE>

   The healthcare cost annual growth rate significantly impacts the estimated
Benefit Plan obligation and annual expense.  For example, in 1998, a one
percent change in the above rates would change the obligation by $773,000 and
would change the annual expense by $86,000.

   The obligations and assets of the Benefit Plan at September 30, 1998 and 1997
are as follows:

<TABLE>
<CAPTION>
(thousands of dollars)                          1998        1997
----------------------------------------------------------------------
<S>                                              <C>        <C> 
Accumulated post-retirement
  benefit obligation:
  Current retirees                                $ (6,444)  $ (6,626)
  Active employees-eligible for
    benefits                                        (1,469)    (1,361)
  Active employees                                  (4,973)    (3,761)       
                                                   -------    -------       
  Total post-retirement benefit                                             
   obligation                                      (12,886)   (11,748)       
  Plan assets at fair value                          5,684      4,704        
                                                   -------    -------       
  Unfunded post-retirement benefit                                          
   obligation                                       (7,202)    (7,044)       
  Unrecognized transition obligation                 7,895      8,421        
  Unrecognized net (gain) or loss                     (693)    (1,360)       
                                                   -------    -------       
  Prepaid post-retirement
   benefit obligation included
   in the accompanying Consolidated
   Balance Sheets                                 $      -   $     17
                                                   =======    =======
</TABLE> 
 
     ProvGas' actuarially determined Benefit Plan costs for 1998, 1997, and 1996
include the following:

<TABLE> 
<CAPTION>  
(thousands)                                      1998       1997      1996
------------------------------------------------------------------------------
<S>                                               <C>        <C>        <C>  
Service cost                                      $    243   $    228   $  222  
Interest cost                                          945        896      896  
Actual return on plan assets                          (406)      (278)     (98) 
Amortization and deferral                              526        526      434  
                                                  --------   --------   ------
Total annual plan costs                           $  1,308   $  1,372   $1,454
                                                  ========   ========   ======

</TABLE>

C.  SUPPLEMENTAL RETIREMENT PLANS

   ProvGas provides certain supplemental retirement plans for key employees.
The projected benefit obligation is approximately $1,837,000 which is being
accrued over the service period of these key employees.  The supplemental
retirement plans are unfunded.  ProvGas accrued and expensed $61,000, $612,000,
and $310,000 related to these benefits in 1998, 1997, and 1996, respectively.

                                    Page-27
<PAGE>
 
D.  PERFORMANCE AND EQUITY INCENTIVE PLAN

   The Providence Energy Corporation Performance and Equity Incentive Plan (the
Plan) provides that up to 225,000 shares of common stock, as well as cash
awards, may be granted to key employees, including employees of ProvGas, at no
cost to the employees.  Key employees who received common shares are entitled to
receive dividends, but full beneficial ownership vests on the fifth anniversary
of the date of the grant provided the participant is still employed by the
Company.  Vesting may be accelerated under certain circumstances.  The Plan also
provides for cash compensation to key employees.

   The executive compensation incentive awards totaled approximately $459,000
for 1998, $439,000 for 1997, and $381,000 for 1996.  Amounts paid in cash are
charged to expense when earned.   However, amounts paid in restricted stock are
deferred and amortized to expense over the five-year vesting period.

   Of the $459,000 1998 award, $310,000 will be paid in cash during 1999.
Of the $439,000 1997 award, $297,000 was paid in cash during 1998.  Of the
$381,000 1996 award, $269,000 was paid in cash during 1997.  Grant shares
totaling 7,230, 5,989, and 4,491 were purchased by the Company and reissued to
key employees during 1998, 1997, and 1996, respectively.

E.  RESTRICTED STOCK INCENTIVE PLAN

   The Restricted Stock Incentive Plan provides that up to 60,000 shares of
common stock may be granted to employees of the Company with at least three
months of service, who are not officers or covered by a collective bargaining
agreement, at no cost to the employee.  All participants are entitled to receive
dividends; however, full beneficial ownership vests on the third anniversary of
the date of the grant provided that the participant is still employed by the
Company.  Vesting may be accelerated under certain circumstances.

   Awards under the Restricted Stock Incentive Plan totaled approximately
$90,000 in 1998 consisting of 4,230 shares and approximately $146,000 in 1996
consisting of 7,954 shares.  There were no awards under the Restricted Stock
Incentive Plan in 1997.  All amounts awarded under the Restricted Stock
Incentive Plan are deferred and amortized to expense over a three-year period.

F.  1998 PERFORMANCE SHARE PLAN

   Effective October 1, 1998, the Board of Directors adopted a Performance Share
Plan to encourage executives' interest in longer-term performance by keying
incentive payouts to the total return performance of the Company's common stock
in relation to that of other companies in the E.D. Jones gas distribution group
of approximately 30 companies and to the change in the Company's stock price
over three-year performance periods.  The number of shares earned will range
from 50 percent to 150 percent of awarded shares, if based on the relative total
shareholder return method, and 50 percent to 100 percent, if based on the
increase in the Company's stock price during the three-year period.  These
levels were developed to bring total compensation levels at the Company more in
line with survey data for the relevant labor market.  No shares will be earned
unless shareholders have earned a minimum annual return over the three-year
period equal to the total annual return for thirty-year Treasury notes during
such period.  Dividends will not be paid on the shares until they are earned.
Awards will be paid half in cash and half in stock.

7. COMMITMENTS AND CONTINGENCIES

A. LEGAL PROCEEDINGS

   The Company is involved in legal and administrative proceedings in the normal
course of business, including certain proceedings involving material amounts in
which claims have been or may be made. However, management believes, after
review of insurance coverage and consultation with legal counsel, that the
ultimate resolution of the legal proceedings to which it is or can at the
present time be reasonably expected to be a party, will not have a materially
adverse effect on the Company's results of operations or financial condition.

B. CAPITAL LEASES

   ProvGas has a capital lease with Algonquin Gas Transmission Company
(Algonquin) for storage space in a liquefied natural gas (LNG) tank.  The
capital lease arrangement also provides that Algonquin lease from ProvGas, for a
corresponding term at an annual amount of $150,000, the land on which the tank
is situated.  ProvGas also leases certain information systems and other
equipment under capital leases.

                                    Page-28
<PAGE>
 
Property under Capital Leases:
----------------------------- 

<TABLE>
<CAPTION>
(thousands of dollars)                 1998          1997
------------------------------------------------------------
<S>                                   <C>          <C> 
 Gas Plant                            $ 6,116      $ 6,116                
 Computer and other equipment           1,988        1,988                
 Accumulated depreciation              (6,937)      (6,484)               
                                      -------      -------                
                                      $ 1,167      $ 1,620                
                                      =======      =======                
<CAPTION>  
Commitments for Capital Leases are:
----------------------------------

                                     LNG     Computer
(thousands of dollars)             Storage   Equipment   Total
----------------------------------------------------------------
<S>                                <C>       <C>        <C> 
1999                               $  136     $   484   $   620
2000                                  136         297       433
2001                                  135         111       246
2002                                    -          35        35
                                   ------     -------   -------
                                   $  407     $   927   $ 1,334
                                   ======     =======   =======
</TABLE>

C.  OPERATING LEASES

   The Company also leases facilities and equipment under operating leases with
a total future obligation of approximately $578,000 as of September 30, 1998.


D.  GAS SUPPLY

   As part of the Price Stabilization Plan Settlement Agreement described in
Note 9, the Company's largest subsidiary, ProvGas, entered into a full
requirements gas supply contract with Duke Energy Trading and Marketing, L.L.C.
(DETM) for a term of three years. Under the contract, DETM guarantees to meet
ProvGas' supply requirements; however, ProvGas must purchase all of its gas
supply exclusively from DETM. Under the contract, ProvGas transferred
responsibility for its pipeline capacity resources, storage contracts, and LNG
capacity to DETM. As a result, ProvGas' gas inventories of approximately $18
million at September 30, 1997 were sold at book value to DETM on October 1,
1997.

   As a result of Federal Energy Regulatory Commission (FERC) Order 636 and
other related orders (the Orders), pipeline transportation companies have
incurred significant costs, collectively known as transition costs.  The
majority of these costs will be reimbursed by the pipeline's customers,
including ProvGas.  ProvGas estimates its transition costs to be approximately
$21.7 million, of which $16.2 million has been included in the GCC and collected
from customers through September 30, 1997.  At September 30, 1997, the remaining
minimum obligation of $5.5 million has been recorded in the accompanying
Consolidated Balance Sheets along with a regulatory asset anticipating future
recovery. As part of the above supply contract, DETM assumed liability for these
transition costs during the contract's three-year term. At the end of the three-
year term of the contract, the Company will assume any remaining liability,
which is not expected to be material.

E.  ENVIRONMENTAL MATTERS

   Federal, state and local laws and regulations establishing standards and
requirements for the protection of the environment have increased in number and
in scope within recent years. The Company cannot predict the future impact of
such standards and requirements, which are subject to change and can take effect
retroactively. The Company continues to monitor the status of these laws and
regulations. Such monitoring involves the review of past activities and current
operations, and may include expending funds to investigate or clean up certain
sites. To the best of its knowledge, subject to the following, the Company
believes it is in substantial compliance with such laws and regulations.

   At September 30, 1998, the Company was aware of five sites at which future
costs may be incurred.

                                    Page-29
<PAGE>
 
   The Company has been designated as a potentially responsible party (PRP)
under the Comprehensive Environmental Response Compensation and Liability Act of
1980 at two sites in Plympton, Massachusetts on which waste material is alleged
to have been deposited by disposal contractors employed in the past either
directly or indirectly by the Company and other PRPs. With respect to one of the
Plympton sites, the Company has joined with other PRPs in entering into an
Administrative Consent Order with the Massachusetts Department of Environmental
Protection. The costs to be borne by the Company, in connection with both
Plympton sites, are not anticipated to be material to the financial condition of
the Company.

   During 1995, the Company began a study at its primary gas distribution
facility located in Providence, Rhode Island. This site formerly contained a
manufactured gas plant operated by the Company. As of September 30, 1998,
approximately $2.0 million had been spent primarily on studies at this site. In
accordance with state laws, such a study is monitored by the Rhode Island
Department of Environmental Management (DEM). The purpose of this study was to
determine the extent of environmental contamination at the site. The Company has
completed the study which indicated that remediation will be required for two-
thirds of the property. The remediation is expected to begin in February 1999
and will continue for a duration of three to six months. During the remediation
process, the remaining one-third of the property will also be investigated and
remediated if necessary.

   At September 30, 1998, the Company compiled a preliminary range of costs,
based on removal and off-site disposal or recycling of contaminated soil,
ranging from $1.8 million to in excess of $5.0 million.  However, because of the
uncertainties associated with environmental assessment and remediation
activities, the future cost of remediation could be higher than the range noted.
Based on the proposals for remediation work, the Company has accrued $1.8
million at September 30, 1998, for anticipated future remediation costs at this
site.

   Tests conducted following the discovery of an abandoned underground oil
storage tank at the Company's Westerly, Rhode Island operations center in 1996
confirmed the existence of contaminants at this site. The Company is currently
conducting tests at this site, the costs of which are being shared equally with
the prior owner, to determine the nature and extent of the contamination.  Due
to the early stages of investigation, management cannot offer any conclusions as
to whether any remediation will be required at this site.  In addition, in 1997,
contamination from scrapped meters and regulators was discovered at this site.
The Company has reported this to DEM and the Rhode Island Department of Health
and is in the process of remediation.  It is anticipated that remediation will
cost approximately $10,000. Accordingly, the Company has accrued $10,000 at
September 30, 1998 for anticipated future remediation costs.

   In November 1998, the Company received a letter of responsibility from DEM
relating to possible contamination on previously-owned property on Allens Avenue
in Providence.  The current owner of the property has been similarly notified.
The Company lacks sufficient information at this time to determine the validity
of the claim, the amount of the clean-up costs or any defenses which may be
available with respect to such claim.

   In prior rate cases filed with the RIPUC, ProvGas requested that
environmental investigation and remediation costs be recovered by inclusion in
its depreciation factors consistent with the rate recovery treatment for all
types of cost of removal. Due to the magnitude of ProvGas' environmental
investigation and remediation expenditures, ProvGas sought current recovery for
these amounts. As a result, in accordance with the Price Stabilization Plan
Settlement Agreement described in Note 9, effective October 1,
1997, all environmental investigation and remediation costs incurred through
September 30, 1997, as well as all costs incurred during the three-year term of
the Plan, will be amortized over a ten-year period. Additionally, it is ProvGas'
practice to consult with the RIPUC on a periodic basis when, in management's
opinion, significant amounts might be expended for environmental-related costs.
As of September 30, 1998, ProvGas has charged environmental assessment and
remediation costs of $2.6 million and an estimated $1.8 million to the
accumulated depreciation reserve and has amortized $.4 million of these costs.

   Management has begun discussions with other parties who may assist ProvGas in
paying any future costs at the above sites. Management believes that its program
for managing environmental issues, combined with rate recovery and financial
contributions from others, will likely avoid any material adverse effect on its
results of operations or its financial condition as a result of the ultimate
resolution of the above sites.

                                    Page-30
<PAGE>
 
F.  PURCHASE COMMITMENTS

   At September 30, 1998, ProvEnergy Services and ProvEnergy Oil have forward
purchase commitments for their supply needs with a market value of approximately
$15.2 million.  These contracts were acquired at a cost of approximately $15.6
million and have maturities of less than two years.  All financial instruments
held by the Company qualify as hedges due to either anticipated sales contracts
or firm sales commitments.


8.  FAIR VALUE OF FINANCIAL INSTRUMENTS

   The following methods and assumptions were used to estimate the fair value
disclosures for the following financial instruments:

Cash, Cash Equivalents, Accounts Payable and Short-term Debt
------------------------------------------------------------
  The carrying amount approximates fair value due to the short-term maturity of
these instruments.

Financial Instruments for Hedging
---------------------------------
   The fair value of financial instruments for hedging are the same as the
carrying amount as these instruments were marked to market at September 30,
1998.

Long-term Debt and Preferred Stock
----------------------------------
   The fair value of long-term debt and preferred stock is estimated based on
currently quoted market prices for similar types of issues.

   The carrying amounts and estimated fair values of the Company's financial
instruments at September 30 are as follows:

<TABLE>
<CAPTION>
 
 
                                 1998               1997
                           -----------------  -------------------
                           Carrying   Fair    Carrying   Fair
(thousands of dollars)      Amount    Value    Amount    Value
--------------------------------------------  -------------------
<S>                        <C>       <C>      <C>       <C>
 
Cash and cash equivalents   $ 2,006  $ 2,006   $ 1,063  $ 1,063
financial instruments
for hedging                     169      169         -        -
Accounts payable              9,325    9,325    16,755   16,755
Short-term debt              20,079   20,079    23,675   23,675
Long-term debt               83,388   96,024    76,079   84,039
Preferred stock               4,800    5,040     6,400    7,030
</TABLE>

   The difference between the carrying amount and the fair value of ProvGas'
preferred stock and long-term debt, if they were settled at amounts reflected
above, would likely be recovered in ProvGas' rates over a prescribed
amortization period.  Accordingly, any settlement should not result in a
material impact on ProvGas' financial position or results of operations.

9. RATE CHANGES

A.  PRICE STABILIZATION PLAN SETTLEMENT AGREEMENT

   In August 1997, the RIPUC approved the Price Stabilization Plan Settlement
Agreement (Energize RI or the Plan) among ProvGas, the Division, the Energy
Council of Rhode Island, and the George Wiley Center.  Effective for the period
from October 1, 1997 to September 30, 2000, Energize RI provides customers with
a price decrease of approximately four percent in addition to a three-year price
freeze. Under Energize RI, the GCC will be suspended for the entire term.
Energize RI also requires ProvGas to make significant capital investments to
improve its distribution system.  Capital investments required by Energize RI
are estimated to total approximately $26 million over its three-year term.  In
addition, Energize RI requires ProvGas to fund the Low-Income Assistance Program
at an annual level of $1 million, the Demand Side Management Rebate Program at
an annual level of $.5 million and the Low-Income Weatherization Program at an
annual level of $.2 million.  Energize RI also continues the process of
unbundling by requiring ProvGas to provide unbundled service offerings up to 10
percent per year of firm deliveries.

                                    Page-31
<PAGE>
 
       As part of Energize RI, ProvGas will amortize approximately $4.0 million
of environmental costs previously charged to the accumulated depreciation
reserve. These costs and all environmental costs incurred during the term of the
Plan will be amortized over a 10-year period. Also, in connection with the Plan,
ProvGas wrote-off approximately $1.5 million of previously deferred gas costs in
October 1997.

       Under Energize RI, ProvGas may earn up to 10.9 percent annually on its
average common equity of up to $81.0 million, $86.2 million, and $92.0 million
in fiscal 1998, 1999, and 2000, respectively. In addition, ProvGas may not earn
less than a seven percent return on average common equity. In the event that
ProvGas earns in excess of 10.9 percent or less than seven percent, ProvGas will
defer revenues or costs through a deferred revenue account over the term of the
Plan. Any balance in the deferred revenue account at the end of the Plan will be
refunded to or recovered from customers in a manner to be determined by all
parties to the Plan and approved by the RIPUC.

       As part of Energize RI, ProvGas is permitted to file with the Division
for the recovery of the impact of exogenous Changes (Changes) which may occur
during the three-year term of the Plan. Changes are defined as "...significant
increases or decreases in ProvGas' costs or revenues which are beyond ProvGas'
reasonable control." Any disputes regarding either the nature or quantification
of the Changes are to be resolved by the RIPUC. The impact of any such Changes
will be debited or credited to a regulatory asset or liability account
throughout the term of Energize RI and will be recovered or refunded at the
expiration of the Plan through a method to be determined.

       During 1998, due to the extremely warm temperatures, ProvGas experienced
a margin loss of approximately $4.0 million. ProvGas also experienced a non-firm
margin loss of approximately $2.2 million due to adverse market prices of
natural gas versus alternate fuels. ProvGas believes the causes of these two
events were beyond its control and thus considers them as Changes. In fiscal
1999, ProvGas intends to file with the Division for recovery of a portion of
these losses.

       In 1998, ProvGas did not earn its allowed rate of return primarily as a
result of the extremely warm weather and the loss of non-firm margin as
previously discussed in "Operating Margin" in the Management's Discussion and
Analysis of Financial Condition and Results of Operations. Under the Plan's
design, which assumed normal weather, ProvGas should have had earnings in year
one of the Plan in excess of 10.9 percent. The earnings in excess of 10.9
percent were to be deferred in the deferred revenue account to fund capital
investments and other Plan commitments in the remaining two years of the Plan.
Absent favorable recovery for the Changes as discussed above and/or other
factors such as colder than normal weather, ProvGas' ability to earn a 10.9
percent return on average common equity in future years of the Plan is
substantially impaired.


B. NORTH ATTLEBORO GAS RATE INCREASE

       In October 1991, the MDTE released its settlement order in regards to a
rate request which included a qualified phase-in plan.

       The rate settlement required North Attleboro Gas to classify $545,000 of
gas plant as plant held for future use. This plant will be included in future
rates if North Attleboro Gas meets certain growth requirements by the year 2000.
North Attleboro Gas capitalized AFUDC and other costs of approximately $18,000
in 1998, $37,000 in 1997, and $61,000 in 1996 that related primarily to the gas
plant not yet phased into North Attleboro Gas' rates under the plan. North
Attleboro Gas amortized $214,000 in 1998, $214,000 in 1997, and $212,000 in 1996
of amounts previously deferred.


10.  STOCK RIGHTS AND OPTIONS

       Currently, one common stock purchase Right (Right) is attached to each
outstanding share of common stock. Each Right entitles the holder to purchase
one share of common stock at a price of $70 per share, subject to adjustment. In
the event that certain transactions as defined in the Rights Agreement occur,
each Right will become exercisable for that number of shares of common stock of
the acquiring company (or of the Company in certain circumstances) which at the
time of the transaction has a market value of two times the exercisable price.
These Rights expire on August 17, 2008 and may be redeemed by a vote of the
directors at a redemption price of $.01 per Right. Due to the antidilutive
characteristics of these Rights, there is no assumed impact on earnings per
share.

                                   Page-32
<PAGE>
 
   The Company offers two stock option plans for officers, directors, and key
employees covering 250,000 shares of the Company's common stock.  Options under
the plans are granted at an exercise price equal to fair market value at the
date of grant.  The options expire 10 years from the date of grant and in the
case of options granted to the directors, the options become exercisable after
the first anniversary of the date of such grant.

   Pursuant to the provisions of the plans, each plan terminated on November 3,
1998 which was 10 years from the effective date of the plan.  Any options
outstanding under either of the plans shall remain in effect according to the
plans' terms and conditions.

   Under the stock option plans, stock appreciation rights may be granted in
conjunction with all or part of any stock option grants to employees.  Such
Rights offer optionees the alternative of electing not to exercise the related
stock option, but to receive instead an amount in cash, stock or a combination
of cash and stock equivalents for the difference between the option price and
the fair market value of the share.

   In connection with the purchase of the oil distribution companies, the
Company issued an option to purchase 100,000 shares of its common stock to a
former owner.

    Stock option data are summarized as follows for the years ended September
30, 1998, 1997, and 1996:

<TABLE>
<CAPTION>
                                                                          Weighted
                                                             Number       Average
                                                           of Shares   Exercise Price
--------------------------------------------------------------------------------------
<S>                                                        <C>         <C>                                                          

Outstanding, September 30, 1995                               54,789           $16.74
                                                          
Granted                                                        7,449            17.00
Exercised                                                          -                -
Expired                                                            -                -
                                                            --------           ------
Outstanding, September 30, 1996                               62,238            16.77
                                                          
Granted                                                        9,319            17.50
Exercised                                                     (2,130)           16.11
Expired                                                      (10,009)           17.71
                                                            --------           ------
Outstanding, September 30, 1997                               59,418            16.75
                                                          
Granted                                                      100,000            23.00
Exercised                                                     (6,852)           16.79
Expired                                                            -                -
                                                            --------           ------
Outstanding, September 30, 1998                              152,566           $20.85
                                                            ========           ======
</TABLE> 
 

   The following table sets forth information regarding options outstanding at 
September 30, 1998:
 
<TABLE> 
<S>                                                       <C>    
Number of Options                                           152,566
Range of Exercise Prices                                   $13.875 - $23
Number Currently Exercisable                                152,566
Weighted Average Exercise Price                            $20.85
Weighted Average Remaining Life                              4.20 years
Weighted Average Exercise Price for     
 Currently Exercisable                                     $20.85
</TABLE>

   At September 30, 1997 and 1996, 50,927 and 54,789 were currently exercisable,
respectively.

   As described in Note 1, the Company uses the intrinsic method to measure
compensation expense associated with grants of stock options or awards to
employees.  Had the Company used the fair value method to measure compensation,
reported net income would have been $6,396,000 in 1998 and $7,822,000 in 1997.
Earnings per share for fiscal year 1998 would have been $1.08.  Earnings per
share for fiscal 1997 would not have been affected.

                                    Page-33
<PAGE>
 
   For purposes of determining the above disclosure required by Statement of
Financial Accounting Standards No. 123, the fair value of options on their grant
date was measured using the Black-Scholes option pricing model.  Key assumptions
used to apply this pricing model were as follows:

<TABLE>
<CAPTION>
                                            1998   1997
                                           -----  -----
<S>                                        <C>    <C>
Risk-free interest rate                    5.01%  5.43%
Expected life of option grants (years)      4.0    7.0
Expected volatility of underlying stock      15%    15%
</TABLE>

  The pro-forma presentation only includes the effects of grants made subsequent
to October 1, 1996.  The estimated fair value of option grants made during 1998
and 1997 was $.70 and $1.41, respectively, per option.

  The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable.  In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.

  In January 1997, the shareholders of the Company adopted the Non-Employee
Director Stock Plan, which provides that up to 50,000 shares of common stock may
be granted to non-employee directors.  The shares are granted, at no cost to the
director, on the first day of each fiscal year based on each director's
aggregate fees earned in the prior fiscal year. All participants are entitled to
vote the grant shares and receive dividends on the grant share, however, full
beneficial ownership vests on the third anniversary of the grant date provided
the participant is still a director of the Company. Vesting may be accelerated
under certain circumstances. The Company issued 2,131 shares under the Non-
Employee Director Stock Plan in 1998.

11.  HEDGING

     The Company's strategy is to use financial instruments for hedging purposes
to manage the impact of market fluctuations on contractual sales commitments.
Two of the Company's wholly-owned subsidiaries, ProvEnergy Services and
ProvEnergy Oil, use financial instruments to manage market risks and reduce
their exposure to fluctuations in the market prices of home heating oil, diesel,
kerosene and natural gas.

     The futures and option contracts had net unrealized gains of approximately
$.1 million which have been deferred on the accompanying Consolidated Balance
Sheets at September 30, 1998.

     At September 30, 1998, the estimated fair market value of the forward
contracts totaled approximately $15.2 million and were acquired at a cost of
approximately $15.6 million. The fair market value of these forward contracts is
based on quoted market prices and the contracts have maturities of less than two
years.

12.  NET INCOME PER COMMON SHARE

     During 1998, the Company adopted the provisions of SFAS No. 128 "Earnings
Per Share". Under the provisions of SFAS 128, basic earnings per share replaces
primary earnings per share and the dilutive effect of stock options are excluded
from the calculation. Fully diluted earnings per share are replaced by diluted
earnings per share and include the dilutive effect of stock options and
warrants, using the treasury stock method. All prior period earnings per share
data have been restated to conform to the requirements of SFAS No. 128.

     A reconciliation of the weighted average number of shares outstanding used
in the computation of basic and diluted earnings per share for the three years
ended September 30, 1998 is as follows:

                                    Page-34
<PAGE>
 
<TABLE>
<CAPTION> 
                              1998       1997       1996
                            ---------  ---------  ---------
<S>                         <C>        <C>        <C>
Weighted average
  shares                    5,919,699  5,790,087  5,709,198
 
Effect of dilutive stock
  options                       9,963      4,260      2,773
                            ---------  ---------  ---------
 
Weighted average
  shares diluted            5,929,662  5,794,347  5,711,971
                            =========  =========  =========
</TABLE>

   The net income used in the calculation for basic and diluted earnings per
share calculations agrees with the net income appearing in the consolidated
financial statements.

13.  INVESTMENTS

   In July 1998, the Company and ERI Services, Inc agreed to form Capital Center
Energy Company, LLC (CCEC).  The joint venture is owned 50 percent by the
Company's subsidiary, ProvEnergy Power Company, LLC and 50 percent by ERI
Services' subsidiary, ERI Providence, LLC.  CCEC's wholly-owned subsidiary
DownCity Energy Company, LLC, was selected as the exclusive electric, heat, air
conditioning and related service provider for most of the Providence Place Mall
for the next thirty years.  The Company had invested $2 million of its total
projected investment of $15 million at September 30, 1998.

14.  ACQUISITIONS

   In November 1997, the Company acquired all of the outstanding capital stock
of the Super Service Companies.  These companies provide a full service
distribution of oil products, selling fuel oil, diesel, gasoline and lubricants.
Also, in November 1997, the Company acquired all of the assets of the Mohawk
Companies.  Mohawk Oil Company is a full service oil company.  In addition to
its oil business, Mohawk installs and services air conditioning and heating
equipment through its affiliate, Mohawk Environmental Technologies.

   The amounts related to the purchases of these companies are not material to
the financial position of the Company. These acquisitions have been accounted
for as purchases and, accordingly, operating results of these businesses
subsequent to the date of acquisition have been consolidated in the financial
statements of the Company. Pro-forma results of operations, which include the
operating results of these acquisitions, are not materially different than the
operating results presented.

   During 1998, the Company purchased the customer lists of three small oil
companies servicing the greater Providence area.  Together, these acquisitions
are part of the Company's vision to be the "First Choice" energy provider.  The
Company believes these acquisitions will offer a valuable entry into the
heating-oil business market.

   The Company continues to assess the energy market for potential acquisitions
to fulfill its vision.

15.  SEGMENTS OF BUSINESS

   Information about the Company's operations in different industry segments is
presented below:

<TABLE>
<CAPTION>
(thousands of dollars)         1998        1997       1996
------------------------------------------------------------
<S>                         <C>         <C>         <C>
ENERGY REVENUES
---------------
Natural gas distribution     $188,734    $215,258   $214,745
Energy services                32,572       5,162        407
                             --------    --------   --------
 Total                       $221,306    $220,420   $215,152
                             ========    ========   ========

OPERATING INCOME (LOSS)
-----------------------
 
Natural gas distribution     $ 16,060    $ 16,336   $ 16,212
Energy services                (1,574)       (274)       (26)
                             --------    --------   --------
 Total                       $ 14,486    $ 16,062   $ 16,186
                             ========    ========   ========
</TABLE>

                                    Page-35
<PAGE>
 
<TABLE>
<CAPTION> 
(thousands of dollars)              1998       1997      1996
---------------------------------------------------------------
<S>                              <C>        <C>        <C>
IDENTIFIABLE ASSETS
-------------------
Natural gas distribution          $238,515   $251,759  $247,026
Energy services                     13,148      2,879     1,981
General corporate                    1,747        872     1,143
                                  --------   --------  --------
 Total                            $253,410   $255,510  $250,150
                                  ========   ========  ========
 
ADDITIONS TO PROPERTY, PLANT
----------------------------
& EQUIPMENT, NET
----------------
 
Natural gas distribution          $ 28,265   $ 20,785  $ 20,781
Energy services                        367         90         -
                                  --------   --------  --------
 Total                            $ 28,632   $ 20,875  $ 20,781
                                  ========   ========  ========

DEPRECIATION AND AMORTIZATION
-----------------------------
 
Natural gas distribution          $ 13,962   $ 12,869  $ 11,997
Energy services                        523          5         -
                                  --------   --------  --------
 Total                            $ 14,485   $ 12,874  $ 11,997
                                  ========   ========  ========
</TABLE>


   Natural gas distribution consists primarily of natural gas sales and
distribution to residential, commercial and industrial customers.  Energy
services consists of heating oil, motor oil, and gas commodity sales to
residential, commercial and industrial customers.

   Total energy revenues by industry segment consist of unaffiliated customers,
as reported in the Company's Statements of Consolidated Income.

   Operating income is total revenues less operating expenses and Federal income
taxes, as shown on the Statements of Consolidated Income.  Included in operating
income is $.5 million of costs associated with liquidating fixed purchase
commitments and option contracts for oil when market prices dropped
significantly.

   Identifiable assets are those assets that are used in each segment of the
Company's operations. Corporate assets consists primarily of the Company's
equity investment in CCEC (See Note 13).

16.  OTHER PROPERTY

   During 1996, the Company sold land which was previously being rented to a
third party for use as a parking lot.  The land was sold for $.7 million
generating a gain, net of taxes, of $.5 million.  Additionally, in accordance
with SFAS No. 5, "Accounting for Contingencies", the Company performed an
economic analysis of the value of its significant real estate in 1996.  Based on
the results of that analysis, the Company wrote down the carrying value of its
real estate by $.5 million, net of taxes, due to a decline in real estate
prices.

17.  NEW ACCOUNTING PRONOUNCEMENTS

   Effective October 1, 1997, the Company adopted the provisions of Statement of
Position (SOP) 96-1, "Environmental Remediation Liabilities". This Statement
provides authoritative guidance for recognition, measurement, display and
disclosure of environmental remediation liabilities in financial statements.
The Company has recorded environmental remediation liabilities of approximately
$1.8 million at September 30, 1998.  SOP 96-1 did not have an impact on the
Company's financial position or results of operations upon adoption.  Also see
Note 7E "Environmental Matters".

   In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS 
No. 130, "Reporting Comprehensive Income" and SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information". SFAS No. 130, which is
effective for the Company's fiscal year ending September 30, 1999, requires that
an enterprise (a) classify items of other comprehensive income by their nature
in a financial statement and (b) display the accumulated balance of other
comprehensive income separately from retained earnings and additional paid-in
capital in the equity section of a statement of financial position. SFAS No.
131, which is effective for the Company's fiscal year ending September 30, 1999,
requires that a public business enterprise report financial and descriptive
information about its reportable operating segments. These statements require
additional disclosure only and will not affect the financial position or results
of operations of the Company.

                                    Page-36
<PAGE>
 
  In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities".  This Statement establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded on the
balance sheet as either an asset or liability measured at its fair value.  SFAS
No. 133 requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met.
Special accounting for qualifying hedges allows a derivative's gains and losses
to offset related results on the hedged item in the income statement, and
requires that a company must formally document, designate, and assess the
effectiveness of transactions that receive hedge accounting.

  SFAS No. 133 is effective for the Company's fiscal year ending September 30,
2000.  A company may also implement the Statement as of the beginning of any
fiscal quarter after issuance (that is, fiscal quarters beginning June 16, 1998
and thereafter).  SFAS No. 133 cannot be applied retroactively.  SFAS No. 133
must be applied to (a) derivative instruments and (b) certain derivative
instruments embedded in hybrid contracts that were issued, acquired, or
substantively modified after December 31, 1997 (and, at a company's election,
before January 1, 1998).

  The Company has not yet quantified the impact of adopting SFAS No. 133 on the
financial statements and has not determined the timing of or method of adoption
of SFAS No. 133.

  In March 1998, the American Institute of Certified Public Accountants issued
SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use".  It applies to all nongovernmental entities and is effective
for the Company's financial statements for fiscal year ending September 30,
2000.  The provisions of this SOP should be applied to internal-use software
costs incurred in fiscal years subsequent to December 15, 1998 for all projects,
including those projects in progress upon initial application of the SOP.

     The SOP establishes accounting standards for the determination of
capital or expense treatment of expenditures for computer software developed or
obtained for internal use based upon the stage of development. The SOP defines
three stages as (1) Preliminary Project, (2) Application Development and (3)
Post-Implementation/Operation. As a general rule, the Preliminary Project and
Post-Implementation/Operation phase expenditures are expensed and Application
Development expenditures are capitalized.

     The Company will adopt the SOP upon the effective date and assess its
impact at that time.

18.  UNAUDITED QUARTERLY FINANCIAL INFORMATION

     The following is unaudited quarterly financial information for the two
years ended September 30, 1998 and 1997. Quarterly variations between periods
are caused primarily by the seasonal nature of energy sales and the availability
of energy products.


<TABLE>
<CAPTION>


(thousands, except                       Quarter Ended
per share amounts)         Dec. 31  Mar. 31   June 30  Sept. 30
                           ------------------------------------------
<S> 
Fiscal 1998
---------------------------------------------------------------------
                           <C>      <C>      <C>       <C>
Energy revenues            $67,942  $87,796  $39,462   $26,106
Operating income (loss)      6,371   11,559      113    (3,557)
Net income (loss)            4,403    9,535   (1,843)   (5,653)
Net income (loss)                                      
  per share*                   .75     1.61     (.31)     (.96)
 
Fiscal 1997
---------------------------------------------------------------------
Energy revenues            $64,038  $79,946  $42,921   $33,515
Operating income (loss)      6,355    8,782    2,210    (1,285)
Net income (loss)            4,264    6,737      135    (3,305)
Net income (loss)                                      
  per share*                   .74     1.17      .02      (.58)
</TABLE>

*  Calculated on the basis of the weighted average shares outstanding during the
quarter.

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