---

---

## UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549




# FORM10-Q

#### (Mark One)

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

#### FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003

#### OR

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

#### FOR THE TRANSITION PERIOD FROM                  TO

|Commission
File Number | Registrants, State of Incorporation,
Address, and Telephone Number | I.R.S. Employer
Identification No.
|---------------------- | ------------------------------------------------------------------ | ----------------------------------
|                       | 001-09120                                                          |                                   
|                       | 001-00973                                                          |                                   
|                       | 000-49614                                                          |                                   
|                       | 000-32503                                                          |                                   




Indicate
  by check mark whether the registrants (1) have filed all reports required to
  be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
  the preceding 12 months (or for such shorter period that the registrants were
  required to file such reports) and (2) have been subject to such filing requirements
  for the past 90 days. Yes [X]No[
  ]

As of October 15, 2003, Public Service Enterprise Group Incorporated had outstanding 235,160,221 shares of its sole class of Common Stock, without par value.

As of October 15, 2003, Public Service Electric and Gas Company had issued and outstanding 132,450,344 shares of Common Stock, without nominal or par value, all of which were privately held, beneficially and of record by Public Service Enterprise Group Incorporated.

PSEG Power LLC and PSEG Energy Holdings LLC are wholly-owned subsidiaries of Public Service Enterprise Group Incorporated and meet the conditions set forth in General Instruction H(1) (a) and (b) of Form 10-Q and are filing their respective Quarterly Reports on Form 10-Q with the reduced disclosure format authorized by General Instruction H.

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



| | Public Service Enterprise Group Incorporated      Yes [X]    No [
      ] | 
| | ------------------------------------------------------------------------- | 



| | Public Service Electric and Gas Company      Yes [
      ]    No [X] | 
| | -------------------------------------------------------------------- | 



| | PSEG Power LLC      Yes [
      ]    No [X] | 
| | ------------------------------------------- | 



| | PSEG Energy Holdings LLC      Yes [
      ]    No [X] | 
| | ----------------------------------------------------- | 





---

TABLE OF CONTENTS
PageFORWARD-LOOKING STATEMENTS


iiPART I. FINANCIAL INFORMATIONItem 1.

Financial StatementsPublic Service Enterprise Group Incorporated


1Public Service Electric and Gas Company


5PSEG Power LLC


    8PSEG Energy Holdings LLC


    11Notes to Consolidated Financial StatementsNote 1. Organization and Basis of Presentation


15Note 2. New Accounting Standards


16Note 3. Adoption of SFAS 143


22Note 4. Regulatory Issues


23Note 5. Earnings Per Share


24Note 6. Discontinued Operations


25Note 7. Commitments and Contingent Liabilities


26Note 8. Risk Management


34Note 9. Comprehensive Income


37Note 10. Other Income and Deductions


38Note 11. Income Taxes


39Note 12. Financial Information by Business Segments


40Note 13. Stock-Based Compensation


41Note 14. Related-Party Transactions


41Note 15. Guarantees of Debt


43Note 16. Subsequent Events


45Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations


46Overview


46Results of Operations


50Liquidity and Capital Resources


61Capital Requirements


68Accounting Matters


69Item 3.

Qualitative and Quantitative Disclosures About Market Risk


73Item 4.

Controls and Procedures


78PART II. OTHER INFORMATIONItem 1.

Legal Proceedings


80Item 5.

Other Information


80Item 6.

Exhibits and Reports on Form 8-K


83Signatures


    86i

FORWARD-LOOKING STATEMENTS
Except for the historical information contained herein, certain of the matters discussed in this report constitute ''forward-looking statements'' within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to risks and uncertainties, which could cause actual results to differ materially from those anticipated. Such statements are based on management's beliefs as well as assumptions made by and information currently available to management. When used herein, the words ''will'', ''anticipate'', ''intend'', ''estimate'', ''believe'', ''expect'', ''plan'', ''hypothetical'', ''potential'', ''forecast'', ''projections'', variations of such words and similar expressions are intended to identify forward-looking statements. Public Service Enterprise Group Incorporated
(PSEG), Public Service Electric and Gas Company (PSE&G), PSEG Power LLC (Power) and PSEG Energy Holdings LLC (Energy Holdings) undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The following review of factors should not be construed as exhaustive.
In addition to any assumptions and other factors referred to specifically in connection with such forward-looking statements discussed above, factors that could cause actual results to differ materially from those contemplated in any forward-looking statements include, among others, the following:
PSEG, PSE&G, Power and Energy Holdings
•

credit, commodity, interest rate, counterparty and other financial market risks;•

liquidity and the ability to access capital and credit markets;•

acquisitions, divestitures, mergers, restructurings or strategic initiatives that change PSEG's, PSE&G's, Power's and Energy Holdings' structure;•

business combinations among competitors and major customers;•

general economic conditions including inflation;•

regulatory issues that significantly impact operations;•

changes to accounting standards or accounting principles generally accepted in the U.S., which may require adjustments to financial statements;•

changes in tax laws and regulations;•

energy obligations, available supply and trading risks;•

adverse weather conditions that significantly impact operations;•

changes in the electric industry including changes to power pools;•

changes in the number of market participants and the risk profiles of such participants;•

regulation and availability of power transmission facilities that impact the ability to deliver output to customers;•

growth in costs and expenses;•

environmental regulation that significantly impact operations;•

changes in rates of return on overall debt and equity markets could have an adverse impact on the value of pension assets and the Nuclear Decommissioning Trust Fund;•

changes in political conditions, recession, acts of war or terrorism;•

insufficient insurance coverage;•

involvement in lawsuits including liability claims and commercial disputes could affect profits or the ability to sell and market products;•

inability to attract and retain management and other key employees;•

ability to service debt as a result of any of the aforementioned events;ii
PSE&G and Energy Holdings
•
    ability to
      obtain adequate and timely rate relief;Power and Energy Holdings
•

adverse changes in the market place for energy, capacity, natural gas, emissions credits, congestion credits and other commodity prices;•

excess supply due to overbuild in the industry;•

generation operating performance may fall below projected levels;•

substantial competition from well capitalized participants in the worldwide energy markets;•

inability to effectively manage portfolios of electric generation assets, gas supply contracts and electric and gas supply obligations;•

margin posting requirements;•

availability of fuel at reasonable prices;•

competitive position could be adversely affected by actions involving competitors or major customers;•

changes in product or sourcing mix;•

delays or cost escalations or unsuccessful acquisition, construction and development;•

changes in technology that make power generation assets less competitive;Power
•
    changes in
      regulation and security measures at nuclear facilities;Energy Holdings
•

adverse international developments that negatively impact its business;•

changes in foreign currency exchange rates;•

substandard operating performance or cash flow from investments could fall below projected levels, adversely impacting the ability to service its debt; and•

credit of lessees and their ability to adequately service lease rentals.Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements and PSEG, PSE&G, Power and Energy Holdings cannot assure you that the results or developments anticipated by management will be realized, or even if realized, will have the expected consequences to, or effects on PSEG, PSE&G, Power and Energy Holdings or their business prospects, financial condition or results of operations. Undue reliance should not be placed on these forward-looking statements in making any investment decision. Each of PSEG, PSE&G, Power and Energy Holdings expressly disclaim any obligation or undertaking to release publicly any updates or revisions to these forward-looking statements to reflect events or circumstances that occur or arise or are anticipated to occur or arise
after the date hereof. In making any investment decision regarding PSEG, PSE&G, Power and Energy Holdings' securities, PSEG, PSE&G, Power and Energy Holdings are not making, and you should not infer, any representation about the likely existence of any particular future set of facts or circumstances. The forward-looking statements contained in this report are intended to qualify for the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
iii
PART I.
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PUBLIC SERVICE ENTERPRISE GROUP INCORPORATEDCONSOLIDATED STATEMENTS OF OPERATIONS
For the Quarter Ended
September 30,

For the Nine Months Ended
September 30,2003

2002

2003

2002(Millions, except for Share Data)
(Unaudited)OPERATING REVENUES

$
2,805


$
2,314


$
8,530


$
5,631OPERATING EXPENSESEnergy Costs


1,581



1,167



4,957



2,375Operation and Maintenance


527



451



1,534



1,371Write-down of Project Investments


—



—



—



506Depreciation and Amortization


167



168



370



434Taxes Other Than Income Taxes


29



31



101



95Total Operating Expenses


2,304



1,817



6,962



4,781Income from Equity Method Investments


33



32



82



95OPERATING INCOME


534



529



1,650



945Other Income


38



22



126



29Other Deductions


(30
)


(4
)


(94
)


(72
)Interest Expense


(211
)


(215
)


(623
)


(620
)Preferred Stock Dividends


(1
)


(1
)


(3
)


(3
)INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES


330



331



1,056



279Income Taxes


(117
)


(124
)


(372
)


(118
)INCOME FROM CONTINUING
      OPERATIONS


213



207



684



161Loss from Discontinued
      Operations, including Loss on Disposal, net of tax benefit of $2, $2, $9
      and $14 for the quarters and nine months ended 2003 and 2002, respectively


(3
)


(3
)


(20
)


(41
)INCOME BEFORE EXTRAORDINARY
      ITEM AND CUMULATIVE EFFECT
         OF A CHANGE IN ACCOUNTING PRINCIPLE


210



204



664



120Extraordinary Item, net of tax benefit of $12


—



—



(18
)


—Cumulative Effect of a Change in Accounting Principle, net of tax (expense) benefit of ($255) and $66 in 2003 and 2002, respectively


—



—



370



(120
)NET INCOME

$
210


$
204


$
1,016


$
—WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:BASIC


226,414



206,723



225,893



206,277DILUTED


227,593



206,782



226,455



206,552EARNINGS PER SHARE:BASICINCOME FROM CONTINUING OPERATIONS

$
0.94


$
1.00


$
3.03


$
0.78NET INCOME

$
0.93


$
0.99


$
4.50


$
—DILUTEDINCOME FROM CONTINUING OPERATIONS

$
0.93


$
1.00


$
3.02


$
0.78NET INCOME

$
0.92


$
0.99


$
4.49


$
—DIVIDENDS PAID PER SHARE OF COMMON STOCK

$
0.54


$
0.54


$
1.62


$
1.62See Notes to Consolidated Financial Statements.
1

PUBLIC SERVICE ENTERPRISE GROUP INCORPORATEDCONSOLIDATED BALANCE SHEETS
September 30,
2003

December 31,
2002(Millions)
(Unaudited)ASSETSCURRENT ASSETSCash and Cash Equivalents

$
191


$
166Accounts Receivable, net of allowances of $79 and $34 in 2003 and 2002, respectively


1,310



1,391Unbilled Revenues


138



275Fuel


607



413Materials and Supplies


231



208Energy Trading Contracts


82



157Restricted Cash


80



32Assets Held for Sale


71



83Prepayments


211



60Current Assets of Discontinued Operations


—



107Other


95



103Total Current Assets


3,016



2,995PROPERTY, PLANT AND EQUIPMENT


17,710



16,625Less: Accumulated Depreciation and Amortization


(5,358
)


(5,138
)Net Property, Plant and Equipment


12,352



11,487NONCURRENT ASSETSRegulatory Assets


4,933



5,002Long-Term Investments


4,773



4,615Nuclear Decommissioning Trust (NDT) Funds


906



766Other Special Funds


92



72Goodwill


447



452Other Intangibles


200



206Energy Trading Contracts


25



21Other


192



207Total Noncurrent Assets


11,568



11,341TOTAL ASSETS

$
26,936


$
25,823See Notes to Consolidated Financial Statements.
2
PUBLIC SERVICE ENTERPRISE GROUP INCORPORATEDCONSOLIDATED BALANCE SHEETS
September 30,
2003

December 31,
2002(Millions)
(Unaudited)LIABILITIES AND CAPITALIZATIONCURRENT LIABILITIESLong-Term Debt Due Within One Year

$
777


$
749Commercial Paper and Loans


946



762Accounts Payable


903



1,131Energy Trading Contracts


62



101Accrued Taxes


36



229Current Liabilities of Discontinued Operations


—



95Other


678



742Total Current Liabilities


3,402



3,809NONCURRENT LIABILITIESDeferred Income Taxes and Investment Tax Credits (ITC)


3,782



2,921Regulatory Liabilities


316



252Nuclear Decommissioning Liabilities


278



766Other Postemployment Benefit (OPEB) Costs


519



501Accrued Pension Costs


260



336Cost of Removal


—



131Other


588



663Total Noncurrent Liabilities


5,743



5,570COMMITMENTS AND CONTINGENT LIABILITIES (See Note 7)CAPITALIZATIONLONG-TERM DEBTLong-Term Debt


7,365



7,116Securitization Debt


2,124



2,222Project Level, Non-Recourse Debt


2,016



1,680Debt Supporting Trust Preferred Securities


1,361



1,361Total Long-Term Debt


12,866



12,379SUBSIDIARIES' PREFERRED SECURITIESPreferred Stock Without Mandatory Redemption


80



80COMMON STOCKHOLDERS' EQUITYCommon
      Stock, issued; 2003—252,964,099 shares 2002—251,385,937 shares


4,113



4,051Treasury Stock, at cost; 2003 and 2002—26,118,590 shares


(981
)


(981
)Retained Earnings


2,256



1,606Accumulated Other Comprehensive Loss


(543
)


(691
)Total Common Stockholders' Equity


4,845



3,985Total Capitalization


17,791



16,444TOTAL LIABILITIES AND CAPITALIZATION

$
26,936


$
25,823See Notes to Consolidated Financial Statements.
3
PUBLIC SERVICE ENTERPRISE GROUP INCORPORATEDCONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended
September 30,2003

2002(Millions)
(Unaudited)CASH FLOWS FROM OPERATING ACTIVITIESNet Income

$
1,016


$
—Adjustments to Reconcile Net Income to Net Cash Flows from Operating Activities:Extraordinary Item, net of tax


18



—Loss on Disposal of Discontinued Operations, net of tax


9



34Cumulative Effect of a Change in Accounting Principle, net of tax


(370
)


120Write-down of Project Investments


—



506Depreciation and Amortization


370



    434Amortization of Nuclear Fuel


68



65Provision for Deferred Income Taxes (Other than Leases) and ITC


161



(196
)Non-Cash Employee Benefit Plan Costs


    192



141Leveraged Lease Income, Adjusted for Rents Received


66



72Undistributed Earnings from Affiliates


—



(42
)Foreign Currency Transaction (Gain) Loss


(3
)


71Unrealized Losses (Gains) on Energy Contracts and Other Derivatives


36



(65
)Under Recovery of Electric Energy Costs (BGS and NTC) and Gas Costs


(85
)


(19
)Over Recovery of SBC


69



54Net Realized Gains and Income from NDT Fund


(38
)


—Other Non-Cash Charges


    41



    27Net Change in Certain Current Assets and Liabilities


    (442
)


    (24
)Employee Benefit Plan Funding and Related Payments


    (246
)


(262
)Proceeds from the Withdrawal of Partnership Interests and Other Distributions


52



52Other


    (33
)


    (109
)Net Cash Provided By Operating Activities


    881



    859CASH FLOWS FROM INVESTING ACTIVITIESAdditions to Property, Plant and Equipment


(1,057
)


    (1,306
)Investments in Joint Ventures, Partnerships and Capital Leases


(31
)


(272
)Proceeds from the Sale of Investments and Return of Capital from Partnerships


5



121Other


(8
)


4Net Cash Used In Investing Activities


(1,091
)


    (1,453
)CASH FLOWS FROM FINANCING ACTIVITIESNet Change in Short-Term Debt


(64
)


310Issuance of Long-Term Debt


    790



    1,160Issuance of Non-Recourse Debt


578



30Issuance of Participating Units


—



460Issuance of Common Stock


63



57Redemptions of Long-Term Debt


    (659
)


(1,107
)Restricted
      Cash


    (46
)


    —Distribution
      to Minority Shareholder


    (42
)


    —Cash Dividends Paid on Common Stock


(366
)


(334
)Other


    (19
)


    —Net Cash Provided By Financing Activities


    235



576Effect of Exchange Rate
      Change


—



(2
)Net Change In Cash and Cash Equivalents


25



(20
)Cash and Cash Equivalents at Beginning of Period


166



167Cash and Cash Equivalents at End of Period

$
191


$
147Supplemental Disclosure of Cash Flow Information:Income Taxes Paid

$
116


$
188Interest Paid, Net of Amounts Capitalized

$
603


$
611See Notes to Consolidated Financial Statements.
4

PUBLIC SERVICE ELECTRIC AND GAS COMPANYCONSOLIDATED STATEMENTS OF OPERATIONS
For The Quarter Ended
September 30,

For The Nine Months Ended
September 30,2003

2002

2003

2002(Millions)
(Unaudited)OPERATING REVENUES

$
1,530


$
1,405


$
5,020


$
4,294OPERATING EXPENSESEnergy Costs


915



837



3,341



2,654Operation and Maintenance


263



229



773



723Depreciation and Amortization


121



124



250



316Taxes Other Than Income Taxes


29



31



101



95Total Operating Expenses


1,328



1,221



4,465



3,788OPERATING INCOME


202



184



555



506Other Income


1



3



14



5Other Deductions


—



—



(1
)


(1
)Interest Expense


(96
)


(100
)


(290
)


(306
)INCOME BEFORE INCOME TAXES
      AND EXTRAORDINARY
         ITEM


107



87



278



204Income Taxes


(38
)


(31
)


(86
)


(73
)INCOME BEFORE EXTRAORDINARY
      ITEM


69



56



192



131Extraordinary Item, net of tax benefit of $12


—



—



(18
)


—NET INCOME


69



56



174



131Preferred Stock Dividends


(1
)


(1
)


(3
)


(3
)EARNINGS AVAILABLE TO PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED

$
68


$
55


$
171


$
128See disclosures regarding Public Service Electric and Gas Company
included in the Notes to Consolidated Financial Statements.
5

PUBLIC SERVICE ELECTRIC AND GAS COMPANYCONSOLIDATED BALANCE SHEETS
September 30,
2003

December 31,
2002(Millions)
(Unaudited)ASSETSCURRENT ASSETSCash and Cash Equivalents

$
38


$
35Accounts Receivable, net of allowances of $37 and $32 in 2003 and 2002, respectively


705



755Unbilled Revenues


138



275Materials and Supplies


55



45Prepayments


147



25Restricted Cash


14



14Other


21



16Total Current Assets


1,118



1,165PROPERTY, PLANT AND EQUIPMENT


9,725



9,581Less: Accumulated Depreciation and Amortization


(3,600
)


(3,604
)Net Property, Plant and Equipment


6,125



5,977NONCURRENT ASSETSRegulatory Assets


4,933



5,002Long-Term Investments


134



128Other Special Funds


44



44Intangibles


60



60Other


61



58Total Noncurrent Assets


5,232



5,292TOTAL ASSETS

$
12,475


$
12,434LIABILITIES AND CAPITALIZATIONCURRENT LIABILITIESLong-Term Debt Due Within One Year

$
421


$
429Commercial Paper and Loans


273



224Accounts Payable


485



724Other


291



315Total Current Liabilities


1,470



1,692NONCURRENT LIABILITIESDeferred Income Taxes and ITC


2,530



2,436Regulatory Liabilities


316



252OPEB Costs


501



486Accrued Pension Costs


127



175Other


141



209Total Noncurrent Liabilities


3,615



3,558COMMITMENTS AND CONTINGENT LIABILITIES (See Note 7)CAPITALIZATIONLONG-TERM DEBTLong-Term Debt


2,791



2,627Securitization Debt


2,124



2,222Debt Supporting Trust Preferred Securities


160



160Total Long-Term Debt


5,075



5,009PREFERRED SECURITIESPreferred Stock Without Mandatory Redemption


80



80COMMON STOCKHOLDER'S EQUITYCommon Stock; 150,000,000 shares authorized, 132,450,344 shares issued and outstanding


892



892Contributed Capital


170



—Basis Adjustment


986



986Retained Earnings


360



389Accumulated Other Comprehensive Loss


(173
)


(172
)Total Common Stockholder's Equity


2,235



2,095Total Capitalization


7,390



7,184TOTAL LIABILITIES AND CAPITALIZATION

$
12,475


$
12,434See disclosures regarding Public Service Electric and Gas Company
included in the Notes to Consolidated Financial Statements.
6

PUBLIC SERVICE ELECTRIC AND GAS COMPANYCONSOLIDATED STATEMENTS OF CASH FLOWS
For The Nine Months Ended
September 30,2003

2002(Millions)
(Unaudited)CASH FLOWS FROM OPERATING ACTIVITIESNet Income

$
174


$
131Adjustments to Reconcile Net Income to Net Cash Flows from Operating Activities:Extraordinary Item, net of tax benefit


18



—Depreciation and Amortization


250



316Provision for Deferred Income Taxes and ITC


46



(32
)Non-Cash Employee Benefit Plan Costs


134



106Non-Cash Interest Expense


31



16(Under) Over Recovery of Electric Energy Costs (BGS and NTC)


(144
)


47Over (Under) Recovery of Gas Costs


59



(66
)Over Recovery of SBC


69



54Gain on the Sale of Property, Plant and Equipment


(8
)


—Other Non-Cash Regulatory Credits


(10
)


—Net Changes in Certain Current Assets and Liabilities:Accounts Receivable and Unbilled Revenues


187



159Natural Gas


—



415Materials and Supplies


(10
)


(3
)Prepayments


(122
)


(82
)Accrued Taxes


6



(26
)Accrued Interest


(11
)


(19
)Accounts Payable


(239
)


(147
)Other Current Assets and Liabilities


7



(21
)Employee Benefit Plan Funding and Related Payments


(156
)


(187
)Other


    (64
)


(28
)Net Cash Provided By Operating Activities


    217



633CASH FLOWS FROM INVESTING ACTIVITIESAdditions to Property, Plant and Equipment


(343
)


(319
)Proceeds from the Sale of Property, Plant and Equipment—Affiliate


53



—Proceeds from the Sale of Property, Plant and Equipment


9



1Net Cash Used In Investing Activities


(281
)


(318
)CASH FLOWS FROM FINANCING ACTIVITIESNet Change in Short-Term Debt


49



131Issuance of Long-Term Debt


450



300Redemption of Securitization Debt


(93
)


(92
)Redemption of Long-Term Debt


(300
)


(540
)Capital Lease Payments


(3
)


(3
)Contributed Capital


170



—Deferred Issuance Costs


    (3
    )


(2
)Dividends on Common Stock


(200
)


(150
)Preferred Stock Dividends


(3
)


(3
)Net Cash Provided By (Used In) Financing Activities


    67



(359
)Net Change In Cash and Cash Equivalents


3



(44
)Cash and Cash Equivalents at Beginning of Period


35



102Cash and Cash Equivalents at End of Period

$
38


$
58Supplemental Disclosure of Cash Flow Information:Income Taxes Paid

$
77


$
124Interest Paid, Net of Amounts Capitalized

$
294


$
347See disclosures regarding Public Service Electric and Gas Company
included in the Notes to Consolidated Financial Statements.
7

PSEG POWER LLCCONSOLIDATED STATEMENTS OF OPERATIONS
For the Quarter Ended
September 30,

For the Nine Months Ended
September 30,2003

2002

2003

2002(Millions)
(Unaudited)OPERATING REVENUES

$
1,248


$
1,073


$
4,313


$
2,341OPERATING EXPENSESEnergy Costs


797



625



2,875



1,068Operation and Maintenance


222



178



652



553Depreciation and Amortization


27



29



74



79Total Operating Expenses


1,046



832



3,601



1,700OPERATING INCOME


202



241



712



641Other Income


33



—



107



—Other Deductions


(22
)


—



(67
)


—Interest Expense


(26
)


(35
)


(82
)


(90
)INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF A
         CHANGE IN ACCOUNTING PRINCIPLE


187



206



670



551Income Taxes


(77
)


(85
)


(274
)


(226
)INCOME BEFORE CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING
         PRINCIPLE


110



121



396



325Cumulative Effect of a Change in Accounting Principle, net of tax expense of $255


—



—



370



—EARNINGS AVAILABLE TO PUBLIC SERVICE ENTERPRISE GROUP
         INCORPORATED

$
110


$
121


$
766


$
325See disclosures regarding PSEG Power LLC
included in the Notes to Consolidated Financial Statements.
8

PSEG POWER LLCCONSOLIDATED BALANCE SHEETS
September 30,
2003

December 31,
2002(Millions)
(Unaudited)ASSETSCURRENT ASSETSCash and Cash Equivalents

$
38


$
26Accounts Receivable, net of allowances of $31 and $0 in 2003 and 2002, respectively


438



519Accounts
      Receivable—Affiliated Companies


36



238Fuel


600



406Materials and Supplies


160



148Energy Trading Contracts


82



157Other


    85



72Total Current Assets


1,439



1,566PROPERTY, PLANT AND EQUIPMENT


5,865



5,342Less: Accumulated Depreciation and Amortization


(1,413
)


(1,302
)Net Property, Plant and Equipment


4,452



4,040NONCURRENT ASSETSDeferred Income Taxes and Investment Tax Credits (ITC)


107



547Nuclear Decommissioning Trust (NDT) Funds


906



766Intangibles


134



141Energy Trading Contracts


25



21Other


93



128Total Noncurrent Assets


1,265



1,603TOTAL ASSETS

$
7,156


$
7,209LIABILITIES AND MEMBER'S EQUITYCURRENT LIABILITIESAccounts Payable

$
489


$
690Short-Term Loan from Affiliate


256



239Energy Trading Contracts


62



101Other


223



282Total Current Liabilities


1,030



1,312NONCURRENT LIABILITIESNuclear Decommissioning Liabilities


278



766Cost of Removal


—



131Accrued Pension Costs


76



101Other


141



144Total Noncurrent Liabilities


495



1,142COMMITMENTS AND CONTINGENT LIABILITIES (See Note 7)LONG-TERM DEBTProject Level, Non-Recourse Debt


800



800Long-Term Debt


2,516



2,516Total Long-Term Debt


3,316



3,316MEMBER'S EQUITYContributed Capital


1,550



1,550Basis Adjustment


(986
)


(986
)Retained Earnings


1,732



966Accumulated Other Comprehensive Income (Loss)


19



(91
)Total Member's Equity


2,315



1,439TOTAL LIABILITIES AND MEMBER'S EQUITY

$
7,156


$
7,209See disclosures regarding PSEG Power LLC
included in the Notes to Consolidated Financial Statements.
9

PSEG POWER LLCCONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended
September 30,2003

2002(Millions)
(Unaudited)CASH FLOWS FROM OPERATING ACTIVITIESNet Income

$
766


$
325Adjustments to Reconcile Net Income to Net Cash Flows from Operating Activities:Cumulative Effect of a Change in Accounting Principle, net of tax


(370
)


—Depreciation and Amortization


74



79Amortization of Nuclear Fuel


68



65Interest Accretion on NDT Liability


18



—Provision for Deferred Income Taxes


112



43Unrealized Losses (Gains) on Energy Contracts and Derivatives


22



(50
)Non-Cash Employee Benefit Plan Costs


40



24Net Realized Gains and Income on NDT Fund


(38
)


—Net Changes in Certain Current Assets and Liabilities:Fuel, Materials and Supplies


(206
)


(405
)Accounts Receivable


283



(64
)Accounts Payable


(201
)


138Other Current Assets and Liabilities


(39
)


197Employee
      Benefit Plan Funding and Other Payments


(62
)


(75
)Other


53



(88
)Net Cash Provided By Operating Activities


520



189CASH FLOWS FROM INVESTING ACTIVITIESAdditions to Property, Plant and Equipment


(507
)


(792
)Proceeds from the Sale of Property, Plant and Equipment


—



47Other


(18
)


(25
)Net Cash Used In Investing Activities


(525
)


(770
)CASH FLOWS FROM FINANCING ACTIVITIESIssuance of Long-Term Debt


—



630Deferred Issuance Costs


—



(4
)Short-Term Loan (Repayment)—Affiliate


17



(39
)Net Cash Provided By Financing Activities


17



587Net Change In Cash and Cash Equivalents


12



6Cash and Cash Equivalents at Beginning of Period


26



9Cash and Cash Equivalents at End of Period

$
38


$
15Supplemental Disclosure of Cash Flow Information:Income Taxes Paid

$
138


$
148Interest Paid, Net of Amounts Capitalized

$
117


$
101See disclosures regarding PSEG Power LLC
included in the Notes to Consolidated Financial Statements.
10

PSEG ENERGY HOLDINGS LLCCONSOLIDATED STATEMENTS OF OPERATIONS
For The Quarter Ended
September 30,

For The Nine Months Ended
September 30,2003

2002

2003

2002(Millions)
(Unaudited)OPERATING REVENUESElectric Generation and Distribution Revenues

$
143


$
112


$
378


$
244Income from Capital and Operating Leases


53



57



162



173Gain on Withdrawal from/Sale of Partnerships


—



—



45



47Net Investment Gains (Losses)


—



1



(5
)


(37
)Other


15



17



28



29Total Operating Revenues


211



187



608



456OPERATING EXPENSESEnergy Costs


53



55



152



113Operation and Maintenance


47



48



123



112Write-down of Project Investments


—



—



—



506Depreciation and Amortization


16



11



40



25Total Operating Expenses


116



114



315



756Income from Equity Method Investments


33



32



82



95OPERATING INCOME (LOSS)


128



105



375



(205
)Other Income


3



19



3



21Other Deductions


(3
)


(2
)


(14
)


(71
)Interest Expense


(60
)


(61
)


(164
)


(168
)INCOME (LOSS) BEFORE INCOME
      TAXES, MINORITY INTEREST,
         DISCONTINUED OPERATIONS AND CUMULATIVE EFFECT OF A CHANGE
         IN ACCOUNTING
      PRINCIPLE


68



61



200



(423
)Income Tax (Expense) Benefit


(15
)


(16
)


(48
)


160Minority Interests in (Earnings) Losses of Subsidiaries


(5
)


(2
)


(12
)


2INCOME (LOSS) BEFORE DISCONTINUED
      OPERATIONS AND CUMULATIVE
         EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE


48



43



140



(261
)DISCONTINUED OPERATIONSLoss
      From Discontinued Operations, net of tax benefit of $2, $2, $7 and $3 for
      the
	              quarters and nine months ended 2003 and 2002, respectively


(3
)


(3
)


(11
)


(7
)Loss
      on Disposal of Discontinued Operations, net of tax benefit of
                  $2
      and $11 in 2003 and 2002, respectively


—



—



(9
)


(34
)INCOME (LOSS) BEFORE CUMULATIVE
      EFFECT OF A CHANGE IN
         
      ACCOUNTING PRINCIPLE


45



40



120



(302
)Cumulative Effect of a Change in Accounting Principle, net of tax benefit of $66


—



—



—



(120
)NET INCOME (LOSS)


45



40



120



(422
)Preference Units Distributions/Preferred Stock Dividends


(6
)


(6
)


(17
)


(17
)EARNINGS (LOSS) AVAILABLE TO PUBLIC SERVICE ENTERPRISE GROUP
         INCORPORATED

$
39


$
34


$
103


$
(439
)See disclosures
  regarding PSEG Energy Holdings LLC
included in the Notes to Consolidated Financial Statements.
11

PSEG ENERGY HOLDINGS LLCCONSOLIDATED BALANCE SHEETS
September 30,
2003

December 31,
2002(Millions)
(Unaudited)ASSETSCURRENT ASSETSCash and Cash Equivalents

$
114


$
104Accounts Receivable:Trade—net of allowances of $11 and $15 in 2003 and 2002, respectively


123



91Other Accounts Receivable


37



24Affiliated Companies—Tax Benefits


133



—Assets Held for Sale


71



83Notes Receivable:Affiliated Companies


166



62Other


1



12Inventory


23



22Prepayments


9



5Restricted Cash


66



18Current Assets of Discontinued Operations


—



107Total Current Assets


743



528PROPERTY, PLANT AND EQUIPMENT


1,854



1,602Less: Accumulated Depreciation and Amortization


(206
)


(164
)Net Property, Plant and Equipment


1,648



1,438INVESTMENTSCapital Leases-net


2,967



2,844Corporate Joint Ventures


1,098



1,012Partnership Interests


455



468Other Investments


34



39Total Investments


4,554



4,363OTHER ASSETSGoodwill


431



436Other


95



103Total Other Assets


526



539TOTAL ASSETS

$
7,471


$
6,868See disclosures regarding PSEG Energy Holdings LLC
included in the Notes to Consolidated Financial Statements.
12

PSEG ENERGY HOLDINGS LLCCONSOLIDATED BALANCE SHEETS
September 30,
2003

December 31,
2002(Millions)
(Unaudited)LIABILITIES AND MEMBER'S EQUITYCURRENT LIABILITIESLong-Term Debt Due Within One Year

$
356


$
320Accounts Payable


198



248Notes Payable


2



137Current Liabilities of Discontinued Operations


—



95Total Current Liabilities


556



800NONCURRENT LIABILITIESDeferred Income Taxes and Investment and Energy Tax Credits


1,365



1,041Other Noncurrent Liabilities


199



188Total Noncurrent Liabilities


1,564



1,229COMMITMENTS AND CONTINGENT LIABILITIES (See Note 7)MINORITY INTERESTS


73



109LONG-TERM DEBTProject Level, Non-Recourse Debt


1,216



880Senior Notes


1,801



1,725Total Long-Term Debt


3,017



2,605MEMBER'S EQUITYOrdinary Unit


1,888



1,888Preference Units


509



509Retained Earnings


210



107Accumulated Other Comprehensive Loss


(346
)


(379
)Total Member's Equity


2,261



2,125TOTAL LIABILITIES AND MEMBER'S EQUITY

$
7,471


$
6,868See disclosures regarding PSEG Energy
  Holdings LLC
included in the Notes to Consolidated Financial Statements.
13
PSEG ENERGY HOLDINGS LLCCONSOLIDATED STATEMENTS OF CASH FLOWS
For The Nine Months Ended
September 30,2003

2002(Millions)
(Unaudited)CASH FLOWS FROM OPERATING ACTIVITIESNet Income (Loss)

$
120


$
(422
)Adjustments to Reconcile Net Income (Loss) to Net Cash Flows from Operating Activities:Write-down of Project Investment


—



506Cumulative Effect of a Change in Accounting Principle, net of tax


—



120Loss on Disposal of Discontinued Operations, net of tax


9



34Depreciation and Amortization


49



40Deferred Income Taxes (Other than Leases)


(1
)


(206
)Leveraged Lease Income, Adjusted for Rents Received


66



72Investment Distributions


7



5Change in Fair Value of Derivative Financial Instruments


14



(15
)Undistributed Earnings from Affiliates


—



(42
)Net Gain on Investments


(40
)


(9
)Foreign Currency Transaction (Gain) Loss


(3
)


71Proceeds on Withdrawal from Partnership


45



47Net Changes in Certain Current Assets and Liabilities:Accounts Receivable


26



(79
)Accounts Payable


(126
)


(30
)Other Current Assets and Liabilities


(4
)


6Other


8



22Net Cash Provided By Operating Activities


170



120CASH FLOWS FROM INVESTING ACTIVITIESAdditions to Property, Plant and Equipment


(199
)


(242
)Investments in Joint Ventures and Partnerships


(31
)


(241
)Investment in Capital Leases


—



(31
)Return of Capital from Partnerships


3



92Change in Note Receivable—Affiliated Company


(105
)


—Other


3



33Net Cash Used In Investing Activities


(329
)


(389
)CASH FLOWS FROM FINANCING ACTIVITIESProceeds from Capital Contributions


—



300Proceeds from Project-Level Non-Recourse Long-Term Debt


577



164Net Change in Short-Term Debt


—



(85
)Cash Dividends Paid


(17
)


(17
)Proceeds from Sale of Senior Notes


343



115Distribution to Minority Shareholder


(42
)


4Restricted Cash


(46
)


—Repayment of Medium-Term and Project-Level Non-Recourse Debt


(633
)


(199
)Other


(13
)


(1
)Net Cash Provided By Financing Activities


169



281Effect of Exchange Rate Changes


—



(2
)Net Change In Cash and Cash Equivalents


10



10Cash and Cash Equivalents at Beginning of Period


104



54Cash and Cash Equivalents at End of Period

$
114


$
64Supplemental Disclosure of Cash Flow Information:Income Tax Benefits

$
(94
)

$
(89
)Interest Paid, Net of Amounts Capitalized

$
111


$
126See disclosures regarding PSEG Energy
  Holdings LLC
included in the Notes to Consolidated Financial Statements.
14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
This combined Form 10-Q is separately filed by Public Service Enterprise Group Incorporated (PSEG), Public Service Electric and Gas Company (PSE&G), PSEG Power LLC (Power) and PSEG Energy Holdings LLC (Energy Holdings). Information contained herein relating to any individual company is filed by such company on its own behalf. PSE&G, Power and Energy Holdings each make representations only as to itself and makes no representations as to any other company.
Note 1. Organization and Basis of Presentation
Organization
PSEG
PSEG has four principal direct wholly-owned subsidiaries: PSE&G, Power, Energy Holdings and PSEG Services Corporation (Services).
PSE&G
PSE&G is an operating public utility providing electric and gas transmission and distribution service in certain areas within the State of New Jersey. PSE&G owns PSE&G Transition Funding LLC, a bankruptcy remote entity established for the purpose of purchasing intangible transition property and issuing transition bonds.
Power
Power is a multi-regional wholesale energy supply business that utilizes energy trading to optimize the value of its portfolio of electric generation assets, gas supply contracts and electric and gas supply obligations. Power has three principal direct wholly-owned subsidiaries: PSEG Nuclear LLC (Nuclear), PSEG Fossil LLC (Fossil) and PSEG Energy Resources & Trade LLC (ER&T). Power also has a finance company subsidiary, PSEG Power Capital Investment Co., which provides certain financing for Power and its subsidiaries.
Energy Holdings
Energy Holdings is the parent of PSEG Global LLC (Global), which invests and participates in the development and operation of international and domestic projects in the generation and distribution of energy, which include cogeneration and independent power production facilities and electric distribution companies; PSEG Resources LLC (Resources), which makes investments primarily in energy-related leveraged leases; Enterprise Group Development Corporation (EGDC), a commercial real estate property management business which has been conducting a controlled exit from this business since 1993. During the third quarter of 2003, Energy Holdings sold PSEG Energy Technologies Inc. (Energy Technologies). For additional information relating to Energy Technologies, see Note 6. Discontinued Operations.
Basis of Presentation
PSEG, PSE&G, Power and Energy Holdings
The respective financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) for Quarterly Reports on Form 10-Q. Certain information and note disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, in the opinion of management, the disclosures herein are adequate to make the information presented not misleading. These consolidated financial statements and Notes to Consolidated Financial Statements (Notes) should be read in conjunction with and update and
15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
supplement matters discussed in the respective 2002 Annual Report on Form 10-K and the Quarterly Reports on Form 10-Q for the quarters ended March 31, 2003 and June 30, 2003.
The unaudited financial information furnished herein reflects all adjustments which are, in the opinion of management, necessary to fairly state the results for the interim periods presented. All such adjustments are of a normal recurring nature. The year-end consolidated balance sheets were derived from the audited consolidated financial statements included in the 2002 Annual Report on Form 10-K. Certain reclassifications of prior period data have been made to conform with the current presentation.
Note 2. New Accounting Standards
Statement of Financial Accounting Standards (SFAS) No. 150, ''Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity'' (SFAS 150)
PSEG and PSE&G
SFAS 150, which became effective July 1, 2003, established standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. Many of these instruments that were previously classified as equity in the ''mezzanine'' section (between liabilities and equity) must now be recorded as liabilities. SFAS 150 requires an issuer to classify qualifying instruments issued in the form of shares that are mandatorily redeemable as liabilities. The adoption of SFAS 150 did not have any effect on PSEG's, PSE&G's, Power's or Energy Holdings' financial statements. Had PSEG and PSE&G not adopted Financial Interpretation (FIN) No. 46, ''Consolidation of Variable Interest Entities (VIE)'' (FIN 46), as discussed below, the preferred securities associated
with the capital trusts would have been reclassed to debt and preferred securities dividends would have been classified as interest expense under SFAS 150.
SFAS No. 149, ''Amendment of Statement 133 on Derivative Instruments and Hedging Activities'' (SFAS 149)
PSEG, PSE&G, Power and Energy Holdings
SFAS 149 amends and clarifies the accounting guidance for derivative instruments (including certain derivative instruments embedded in other contracts) and hedging activities that fall within the scope of SFAS No. 133, ''Accounting for Derivative Instruments and Hedging Activities'' (SFAS 133).
In particular, SFAS 149 clarifies circumstances under which a contract with an initial net investment meets the characteristic of a derivative discussed in SFAS 133 and clarifies when a derivative contains a financing component and amends the definition to conform it to language used in FIN No. 45, ''Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others'' (FIN 45).
Additionally, SFAS 149 amends SFAS 133's criteria for electing the normal purchase and sale exception, which exempts certain derivatives that meet the normal purchase and sales criteria from fair value reporting. The new guidance allows ''normal'' treatment for power capacity contracts (as defined by SFAS 133 and SFAS 149) even if the contracts are subject to unplanned netting. However, any non-power commodity contracts (i.e. gas contracts) and power contracts that do not meet the definition in SFAS 133 and SFAS 149 that are subject to unplanned netting, will be ineligible for ''normal'' treatment, which would result in those contracts being marked to market.
SFAS 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. There was no impact on PSEG's, PSE&G's, Power's or Energy Holdings' respective financial statements due to the adoption of these rules.
16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SFAS No. 143, ''Accounting for Asset Retirement Obligations'' (SFAS 143)
PSEG, PSE&G, Power and Energy Holdings
Effective January 1, 2003, PSEG, PSE&G, Power and Energy Holdings each adopted SFAS 143. SFAS 143 addresses accounting and reporting for legal obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. A legal obligation is a liability that a party is required to settle as a result of an existing or enacted law, statute, ordinance or contract.
Under SFAS 143, a company must initially recognize the fair value of a liability for an asset retirement obligation in the period in which it is incurred and concurrently capitalize an asset retirement cost by increasing the carrying amount of the related long-lived asset by the same amount as the liability. A company is required to subsequently depreciate that asset retirement cost to expense over its useful life. In periods subsequent to initial measurement, an entity is required to recognize changes in the liability resulting from the passage of time (accretion) or due to revisions to either the timing or the amount of the originally estimated cash flows. Changes in the liability due to accretion are charged to Operation and Maintenance expense on the Consolidated Statements of Operations, whereas changes due
to the timing or amount of cash flows are adjustments to the carrying amount of the related asset. See Note 3. Adoption of SFAS 143 for additional information.
SFAS No. 142, ''Goodwill and Other Intangible Assets'' (SFAS 142)
PSEG, PSE&G, Power and Energy Holdings
On January 1, 2002, PSEG, PSE&G, Power and Energy Holdings each adopted SFAS 142. Under this standard, PSEG, PSE&G, Power and Energy Holdings were required to complete an impairment analysis of goodwill before June 30, 2002 and record any required impairment retroactive to January 1, 2002. Under SFAS 142, goodwill is considered a nonamortizable asset and is subject to an annual review for impairment and an interim review when certain events or changes in circumstances occur. At the time of adoption, PSE&G had no goodwill. The effect of no longer amortizing goodwill on an annual basis was not material to PSEG's or Power's financial position and results of operations upon adoption.
Power and Energy Holdings evaluated the recoverability of the recorded amount of goodwill based on certain operating and financial factors. Such impairment testing included discounted cash flow tests, which require broad assumptions and significant judgment to be exercised by management.
In addition to goodwill, PSEG's total intangible assets as of September 30, 2003 were $200 million, all of which are not subject to amortization. These intangible assets totaled $114 million, $46 million and $40 million and related to defined benefit pension plans, emissions allowances, which are expensed as used, and various access rights, respectively. In addition to goodwill, PSEG's total intangible assets as of December 31, 2002 were $206 million, all of which are not subject to amortization, of which $114 million, $52 million and $40 million, related to defined benefit pension plans, emissions allowances, which are expensed as used, and various access rights, respectively.
PSE&G
As of September 30, 2003 and December 31, 2002, PSE&G had intangible assets related to its defined benefit pension plans totaling $60 million. These intangible assets are not subject to amortization.
Power
In addition to goodwill displayed in the table below, as of September 30, 2003, Power's intangible assets were $118 million, of which $32 million, $46 million and $40 million, related to its defined benefit pension plans, emissions allowances, which are expensed as used, and various access rights at its Albany Station, respectively. As of December 31, 2002, Power's intangible assets were $125 million, of which
17
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
$33 million, $52 million and $40 million, related to its defined benefit pension plans, emissions allowances, which are expensed as used, and various access rights at its Albany Station, respectively.
Energy Holdings
In addition to goodwill displayed in the table below, Energy Holdings has an intangible asset related to its defined benefit pension plans of $5 million as of September 30, 2003 and December 31, 2002, which is not subject to amortization.
On January 1, 2002, Energy Holdings recorded the results of its evaluation of the effect of SFAS 142. The total amount of goodwill impairments was $120 million, net of tax of $66 million.
Power and Energy Holdings
As of September 30, 2003 and December 31, 2002, Power and Energy Holdings' goodwill and pro-rata share of goodwill in equity method investments was as follows:
As ofSeptember 30,
2003

December 31,
2002(Millions)Consolidated InvestmentsEnergy Holdings—GlobalSociedad Austral de Electricidad S.A. (SAESA) (A)

$
292


$
290Empresa de Electricidad de los Andes S.A. (Electroandes) (B)


133



140Elektrocieplownia Chorzow Sp. Z o.o. (ELCHO)


6



6Total Energy Holdings-Global


431



436Power—Albany Steam Station


16



16Total PSEG Consolidated Goodwill


447



452Pro-Rata Share of Equity Method InvestmentsEnergy Holdings-GlobalRio Grande Energia (RGE) (A)


72



60Chilquinta
      Energia S.A. (Chilquinta) (A)(C)


142



163Luz del Sur S.A.A (C)


64



39Kalaeloa


25



25Pro-Rata Share of Equity Investment Goodwill


303



287Total PSEG Goodwill

$
750


$
739
(A)

Changes relate to changes in foreign exchange rates.(B)

Changes relate to purchase price allocation adjustments.(C)

Changes relate to a realignment of existing investments in Chile and Peru.FIN 46
PSEG, PSE&G, Power and Energy Holdings
FIN 46 clarifies the application of Accounting Research Bulletin No. 51, ''Consolidated Financial Statements'', to VIEs. A VIE does not have equity capital sufficient to finance its activities (i.e. the entity requires additional support from its investors) and its equity investors as a group lack the essential characteristics of a controlling interest. FIN 46 requires that the potential risks and rewards for each investor be measured and compared. The investor that holds the most risks (downside variability) (primary measure) and/or is entitled to the most rewards (upside variability) is known as the primary beneficiary and is required to consolidate the entity.
18

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Financial Accounting Standards Board (FASB) Staff Position 46-6 permits a company to delay, partially or fully, the adoption of FIN 46 from July 1, 2003 to the period ending after December 15, 2003 for VIEs created before February 1, 2003. PSEG, PSE&G, Power and Energy Holdings have adopted the provisions of FIN 46 as of July 1, 2003.
PSEG and PSE&G

PSEG
  and PSE&G evaluated their respective interests in PSEG Capital Trust I-IV,
  PSEG Funding Trust I (trust holding Participating Equity Preference Securities
  (PEPS)), PSE&G Capital Trust LP and Capital Trust I-II and determined them
  to be VIEs under FIN 46. It was further determined that PSEG and PSE&G
  were not the primary beneficiaries of those entities and therefore were prohibited
  from consolidating them into the financial statements. Accordingly, these entities
  were deconsolidated as of July 1, 2003 and were recorded under the equity
  method of accounting. Prior period financial statements have been reclassified
  for comparability as permitted by FIN 46. This resulted in the removal
  of the preferred securities issued by the trusts from the balance sheet and
  the addition to the balance sheet of long-term debt in an equal amount between
  PSEG and PSE&G and the trusts, which previously had been eliminated in consolidation.
  Additionally, PSEG's and PSE&G's balance sheets will reflect their equity
  investment in these entities, which also was previously eliminated in consolidation
  and will result in equal amounts of additional assets and long-term debt of
  $41 million for PSEG and $5 million for PSE&G as of September 30, 2003 and
  December 31, 2002. The invested cash was loaned back to PSEG and PSE&G
  in connection with the issuance of the preferred securities. The following table
  displays the securities, and their original issuance amounts, held by the trusts
  that have now been deconsolidated.
As ofSeptember 30, 2003

December 31, 2002(Millions)PSEGPSEG
      Quarterly Guaranteed Preferred Beneficial Interest in PSEG's 
                   Subordinated
      Debentures7.44%

$
225


$
225Floating Rate


150



1507.25%


150



1508.75%


180



180PSEG Participating Units10.25%


460



460Total PSEG (Parent)


1,165



1,165PSE&GPSE&G
      8.00% Monthly Guaranteed Preferred Beneficial Interest in
                   Subordinated
      Debentures


60



60PSE&G
      Quarterly Guaranteed Preferred Beneficial Interest in PSE&G's 8.125%
      
                   Subordinated
      Debentures


95



95Total PSE&G


155



155Total PSEG Consolidated

$
1,320


$
1,320PSEG and PSE&G now record interest expense (previously eliminated against the interest income of the trust) instead of preferred securities dividends expense (since the preferred dividends are in the trusts that are no longer consolidated). For PSEG, these amounts totaled $17 million and $13 million for the three months ending September 30, 2003 and 2002, respectively and totaled $52 million and $39 million for the nine months ending September 30, 2003 and 2002, respectively. For PSE&G, these amounts totaled $3 million for the three months ending September 30, 2003 and 2002 and totaled $10 million for the nine months ending September 30, 2003 and 2002.
19

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
PSEG and Energy Holdings
Energy
  Holdings evaluated its interests in four real estate partnerships previously
  accounted for under the equity method of accounting. These entities were determined
  to be VIEs and Energy Holdings was determined to be the primary beneficiary
  and is therefore required to consolidate these entities. The current presentation
  reflects these entities on a fully consolidated basis and all prior periods
  have been restated as permitted by FIN 46.
The impact of consolidating the real estate partnerships on the Consolidated Balance Sheets is as follows:
As ofSeptember 30,
2003

December 31,
2002(Millions)Amount Recorded under
      Equity Method of AccountingInvestment in Real Estate Partnerships

$
23


$
23Amount Recorded under
      ConsolidationCurrent Assets

$
5


$
4Noncurrent Assets


50



51Total Assets

$
55


$
55Current Liabilities

$
1


$
—Noncurrent Liabilities


25



26Minority Interest


6



6Total Liabilities and Minority Interest

$
32


$
32The impact of consolidating the real estate partnerships' Statements of Operations on Operating Revenues and Operating Expenses was immaterial.
Emerging Issues Task Force (EITF) Issue No. 03-11, ''Reporting Realized Gains and Losses on Derivative Instruments That Are Subject to FASB Statement No. 133, ''Accounting for Derivative Instruments and Hedging Activities'', and Not ''Held for Trading Purposes'' as Defined in EITF Issue No. 02-3, ''Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities'' (EITF 02-3)''
PSEG, PSE&G, Power and Energy Holdings
The EITF has previously discussed the income statement presentation of gains and losses on contracts held for trading purposes in EITF 02-3. The EITF reached a consensus that gains and losses (realized and unrealized) on all derivative instruments within the scope of SFAS 133 should be shown net when recognized in the income statement, whether or not settled physically, if the derivative instruments are ''held for trading purposes'' as defined in EITF 02-3. This issue contemplates whether realized gains and losses should be shown gross or net in the income statement for contracts that are not held for trading purposes (as defined in EITF 02-3) but are derivatives subject to SFAS 133 (whether or not the derivative is designated as a hedging instrument pursuant to SFAS 133). On July 31, 2003,
the EITF determined that whether realized gains and losses on physically settled derivative contracts not ''held for trading purposes'' should be reported in the income statement on a gross or net basis is a matter of judgment that depends on the relevant facts and circumstances. PSEG, PSE&G, Power and Energy Holdings are currently evaluating this interpretation and the impact, if any, this interpretation will have on their contracts. Because this issue pertains to financial statement presentation only, there will be no net effect on financial position, results of operations or cash flows.
20

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
EITF Issue No. 03-4, ''Accounting for Cash Balance Pension Plans'' (EITF 03-4)
PSEG, PSE&G, Power and Energy Holdings
EITF 03-4 requires that cash balance pension plans be accounted for as defined benefit plans. This standard states that cash balance plans are forms of accumulation plans with variable crediting formulas and are therefore not pay-related. As a result, a company would apply a traditional unit credit method for determining the expense associated with these plans. The effect of remeasuring the pension obligation using the guidance in this standard should be applied at PSEG's plans' next measurement date of December 31, 2003, with any adjustment being treated as an actuarial gain or loss pursuant to SFAS 87, ''Employer's Accounting for Pensions'' (SFAS 87).
PSEG, PSE&G, Power and Energy Holdings each have previously accounted for these plans as defined benefit plans. The effect of these rules on PSEG's, PSE&G's, Power's and Energy Holdings' cash balance plans is still being evaluated. Although PSEG, PSE&G, Power and Energy Holdings do not believe that there will be a material impact, no assurances can be given.
EITF 02-3
PSEG and Power
EITF 02-3 requires all gains and losses on energy trading derivatives to be reported on a net basis. Also, energy trading contracts that are not derivatives will no longer be marked to market. Instead, settlement accounting will be used. EITF 02-3 became fully effective January 1, 2003. Substantially all of Power's energy trading contracts qualify as derivatives under SFAS 133 and will therefore continue to be marked to market. The impact of implementing these rules had no effect on PSEG's or Power's earnings. Prior period Operating Revenues and Energy Costs on the Consolidated Statements of Operations have been reclassified on a net basis for comparability.
EITF Issue No. 01-8, ''Determining Whether an Arrangement is a Lease'' (EITF 01-8)
PSEG, PSE&G, Power and Energy Holdings
EITF 01-8 provides guidance in determining whether an arrangement should be considered a lease subject to the requirements of FASB Statement No. 13, ''Accounting for Leases'' (SFAS 13). EITF 01-8 states that the evaluation of whether an arrangement contains a lease within the scope of SFAS 13 should be based on the substance of the arrangement. EITF 01-8 is applied to arrangements agreed or committed to, modified, or acquired in business combinations initiated on or after October 1, 2003.
Other
PSEG, PSE&G, Power and Energy Holdings
In January 2001, PSEG, PSE&G, Power and Energy Holdings each adopted SFAS 133. In accordance with SFAS 133, all derivative instruments are recognized on the Consolidated Balance Sheets at their fair values. In relation to this standard, the FASB Derivative Implementation Group (DIG) issued certain interpretive guidance, including DIG Issue C-11 that relates to contracts which include broad market indices (i.e. Consumer Price Index). That interpretation sets forth the guidelines under which a contract could qualify as a normal purchase or sale under SFAS 133. In 2003, the FASB issued DIG Issue C-20 to amend the previous interpretation stating that the phrase ''not clearly and closely related to the asset being sold or purchased'' should involve an analysis of both qualitative and quantitative
considerations. PSE&G, Power and Energy Holdings have reviewed their respective contracts and each have determined that there was no impact resulting from the adoption of this interpretation.
21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 3. Adoption of SFAS 143
PSEG and Power
In the first quarter of 2003, Power completed its review of potential obligations under SFAS 143 and determined that these obligations are primarily related to the decommissioning of its nuclear power plants. Power's liability as of December 31, 2002 was approximately $766 million, which equaled the balance of its Nuclear Decommissioning Trust (NDT) Fund, as discussed below. As of January 1, 2003, as calculated under SFAS 143, the liability was approximately $261 million and the asset was approximately $50 million. This asset and liability were calculated using a probability-weighted average of multiple scenarios. The scenarios were each based on estimated cash flows, which were discounted using Power's risk-adjusted interest rate at the required effective date of the standard and
considering the expected time period of the cash outflows. The scenarios included estimates for inflation, contingencies and assumptions related to the timing of decommissioning costs, using the current license lives for each unit, as well as early shutdown and license extensions scenarios.
In addition to the $261 million nuclear decommissioning liability, Power identified certain other legal obligations that meet the criteria of SFAS 143, which at this time are not quantifiable, but could be material in the future. These obligations relate to certain industrial establishments subject to the New Jersey Industrial Site Recovery Act (ISRA), underground storage tanks subject to closure requirements, permits and authorizations, the restoration of an area to be occupied by a reservoir at the end of its useful life, an obligation to retire certain plants prior to the start up of a new plant and the demolition and restoration of certain other plant sites once they are no longer in service.
Power
  also had $131 million of cost of removal liabilities as of December 31,
  2002, which did not meet the requirements of an asset retirement obligation
  (ARO) and were therefore reversed and included in the Cumulative Effect of a
  Change in Accounting Principle recorded in the first quarter of 2003. As a result
  of reducing the existing nuclear decommissioning and cost of removal liabilities
  to their fair value and recording an ARO asset, PSEG and Power recorded a Cumulative
  Effect of a Change in Accounting Principle of $370 million (after-tax)
  in the first quarter of 2003. Of this amount, $292 million (after-tax)
  relates to Nuclear and $78 million (after-tax) relates to the cost of removal
  liabilities for the fossil units being reversed. For additional information
  regarding nuclear decommissioning cost responsibility, see Note 4. Regulatory
  Issues.
PSE&G
PSE&G has identified certain other legal obligations that meet the criteria of SFAS 143, which at this time are not quantifiable and therefore are unable to be recorded. These obligations relate to certain industrial establishments subject to the ISRA, underground storage tanks subject to closure requirements, leases and licenses and the requirement to seal natural gas pipelines at all sources of gas when the pipelines are no longer in service.
As of January 1, 2003, PSE&G had no legal liabilities, as contemplated under SFAS 143, recorded on its Consolidated Balance Sheets and, therefore, the effect of adoption did not result in an adjustment to the Consolidated Financial Statements. PSE&G does, however, have cost of removal liabilities, which total approximately $390 million as of September 30, 2003.
Energy Holdings
Energy Holdings has identified certain legal obligations that meet the criteria of SFAS 143. However, it has determined that they are not material to its financial position, results of operations or net cash flows.
22

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Effect on the NDT Fund
Power
Prior to the adoption of SFAS 143, amounts collected from PSE&G customers that have been deposited into the NDT Fund and realized and unrealized gains and losses in the trust were all recorded as changes in the NDT Fund with an offsetting charge to the nuclear decommissioning liability. Due to the summary order decision issued by the New Jersey Board of Public Utilities (BPU) that PSE&G's customers will no longer fund the NDT Fund, deferral accounting is no longer appropriate. In anticipation of this decision, beginning January 1, 2003, realized gains and losses were recorded in earnings and unrealized gains and losses were recorded as a component of Other Comprehensive Income (OCI), as required under SFAS No. 115, ''Accounting for Certain Investments in Debt and Equity Securities'' (SFAS 115).
Additionally, because deferral accounting was no longer appropriate, as of January 1, 2003, Power recognized $68 million of pre-tax unrealized losses on securities in the NDT Fund, approximately $40 million of which were other than temporarily impaired and recorded this amount against earnings in the Cumulative Effect of a Change in an Accounting Principle in the first quarter of 2003.
Note 4. Regulatory Issues
PSE&G
Electric Base Rate Case
In May 2002, PSE&G filed an Electric Base Rate Case with the BPU requesting an annual $250 million increase for its electric distribution business. In June 2003, a proposed settlement was filed with the Administrative Law Judge (ALJ) who recommended approval of the settlement to the BPU. In July 2003, PSE&G received an oral decision from the BPU approving the proposed settlement with certain modifications. As a result of the oral decision and summary written order, in the second quarter of 2003, PSE&G:
•

recorded a regulatory liability by reducing its depreciation reserve for its electric distribution assets by $155 million, which will be amortized from August 1, 2003 through December 31, 2005; and•

recorded certain adjustments in connection with the resolution of various issues relating to the Final Order PSE&G received from the BPU in 1999 relating to PSE&G's rate unbundling, stranded costs and restructuring proceedings. These amounts include a $30 million pre-tax refund related to revenues previously collected through the Societal Benefits Clause (SBC) for nuclear decommissioning. Because this amount reflects the final accounting for PSEG's generation-related business pursuant to the four-year transition plan mandated by the Final Order received from the BPU in 1999 relating to the New Jersey Electric Discount and Energy Competition Act, the adjustment has been recorded as an $18 million, after-tax, Extraordinary Item as required under Accounting Principles Board (APB) No. 30, ''Reporting the Results of Operations—Reporting the Effects of Disposal
of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions'' (APB 30) and SFAS 101, ''Regulated Enterprises—Accounting for the Discontinuation of Application of FASB Statement No. 71'' (SFAS 101). Also included is an $18 million, pre-tax, increase in Market Transition Charge (MTC) overcollections which was recorded as a reduction to Operating Revenues and a $4 million, pre-tax, reduction in interest capitalized on various deferred balances during the transition period which was recorded as a charge to Interest Expense.In July 2003, the BPU issued a summary written order, which was substantially consistent with the oral decision, determining that PSE&G's customers will no longer pay, and do not have responsibility for nuclear decommissioning costs after July 31, 2003. Beginning August 1, 2003, the responsibility rests with the owners of the nuclear power plants. The BPU also indicated in the summary written order that
23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
there is no obligation to return to PSE&G's ratepayers any previously collected funds deposited into external trusts.
A final written order from the BPU has not been issued, although PSE&G does not expect any material changes from the summary written order.
Note 5. Earnings Per Share
PSEG
Diluted earnings per share are calculated by dividing Net Income by the weighted average number of shares of common stock outstanding, including shares issuable upon exercise of stock options outstanding under PSEG's stock option plans. The following table shows the effect of these stock options on the weighted average number of shares outstanding used in calculating diluted earnings per share:
Quarter Ended September 30,

Nine Months Ended September 30,2003

2002

2003

2002Basic

Diluted

Basic

Diluted

Basic

Diluted

Basic

DilutedEPS Numerator:Earnings (Millions)Continuing Operations

$
213


$
213


$
207


$
207


$
684


$
684


$
161


$
161Discontinued Operations


(3
)


(3
)


(3
)


(3
)


(20
)


(20
)


(41
)


(41
)Extraordinary Item


—



—



—



—



(18
)


(18
)


—



—Cumulative Effect of a Change in Accounting Principle


—



—



—



—



370



370



(120
)


(120
)Net Income

$
210


$
210


$
204


$
204


$
1,016


$
1,016


$
—


$
—EPS Denominator (Thousands):Weighted Average Common Shares Outstanding


226,414



226,414



206,723



206,723



225,893



225,893



206,277



206,277Effect of Stock Options


—



774



—



59



—



562



—



275Effect of Forward Contracts (PEPS)


—



405



—



—



—



—



—



—Total Shares


226,414



227,593



206,723



206,782



225,893



226,455



206,277



206,552Earnings per share:Continuing Operations

$
0.94


$
0.93


$
1.00


$
1.00


$
3.03


$
3.02


$
0.78


$
0.78Discontinued Operations


(0.01
)


(0.01
)


(0.01
)


(0.01
)


(0.09
)


(0.09
)


(0.20
)


(0.20
)Extraordinary Item


—



—



—



—



(0.08
)


(0.08
)


—



—Cumulative Effect of a Change in Accounting Principle


—



—



—



—



1.64



1.64



(0.58
)


(0.58
)Net Income

$
0.93


$
0.92


$
0.99


$
0.99


$
4.50


$
4.49


$
—


$
—There were approximately 3.3 million stock options not included in the weighted average common shares calculation used for diluted earnings per share due to their antidilutive effect for the quarter ended September 30, 2003. There were approximately 6.1 million stock options and 9.2 million participating units not included in the weighted average common shares calculation used for diluted earnings per share due to their antidilutive effect for the nine months ended September 30, 2003.
24

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 6. Discontinued Operations
Energy Holdings
Energy Technologies' Investments
In June 2002, Energy Holdings adopted a plan to sell its heating, ventilating and air conditioning (HVAC)/mechanical operating companies. The HVAC/mechanical operating companies meet the criteria for classification as components of discontinued operations and all prior periods have been reclassified to conform to the current year's presentation.
During 2003, Energy Holdings re-evaluated the carrying value of Energy Technologies' assets and liabilities and determined that market conditions required an additional write-down to fair value less cost to sell. Energy Holdings recorded an additional loss on disposal of Energy Technologies of $9 million, net of a $2 million tax benefit. The sale of the HVAC/mechanical operating companies and Energy Technologies was completed by September 30, 2003.
Energy Holdings has retained certain assets and liabilities previously owned by Energy Technologies. As of September 30, 2003, the value of these investments consisted of $62 million in assets and $29 million in liabilities. Of the $62 million in assets, approximately $36 million relates to tax assets associated with the sale of the HVAC/mechanical operating companies, with the remaining balance relating primarily to accounts receivable not sold with the HVAC/mechanical operating companies.
The revenues and results of operations of Energy Technologies for the quarter and nine months ended September 30, 2003 and 2002 are displayed below:
Quarter Ended
September 30,

Nine Months Ended
September 30,2003

2002

2003

2002(Millions)Operating Revenues

$
7


$
107


$
68


$
292Pre-Tax Operating Loss

$
(5
)

$
(5
)

$
(18
)

$
(19
)Net Loss

$
(3
)

$
(3
)

$
(11
)

$
(12
)The carrying amounts of the assets and liabilities of the HVAC/mechanical operating companies, as of September 30, 2003 and December 31, 2002 are summarized in the following table:
As ofSeptember 30,
2003

December 31,
2002(Millions)Current Assets

$
—


$
82Noncurrent Assets


—



25Total Assets

$
—


$
107Current Liabilities

$
—


$
85Noncurrent Liabilities


—



5Long-Term Debt


—



5Total Liabilities

$
—


$
95Tanir Bavi Power Company Ltd. (Tanir Bavi)
In the fourth quarter of 2002, Global sold its 74% interest in the Tanir Bavi generating facility in India for approximately $45 million. The facility met the criteria for classification as a component of discontinued operations and all prior periods were reclassified to conform to that presentation. The
25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
operating results of Tanir Bavi for the quarter and nine months ended September 30, 2002 are summarized below:
Quarter Ended
September 30, 2002

Nine Months Ended
September 30, 2002(Millions)Operating Revenues

$
—


$
61Pre-Tax Operating Income

$
—


$
9Net Income

$
—


$
5Note 7. Commitments and Contingent Liabilities
Guaranteed Obligations
Power
Power
  has issued a continuing guarantee of all indebtedness of its subsidiary, ER&T
  for the purpose of enabling it to obtain the credit it needs to conduct its
  business. The guarantee is subordinate and junior in right of payment prior
  to the repayment of Power's Senior Notes. The Senior Notes have varying principal
  amounts and maturity dates, with the final maturity occurring in 2031.
Power
  has guaranteed certain commodity related transactions for ER&T, which is
  involved in energy marketing activities. These guarantees are pari pasu with
  Power's Senior Notes and were provided to counterparties in order to facilitate
  physical and financial agreements in gas, pipeline capacity, transportation,
  oil, electricity and related commodities and services. These guarantees support
  the current exposure, interest and other costs on sums due and payable by ER&T
  under these agreements. Guarantees offered for trading and marketing cover the
  granting of lines of credit between entities and are often reciprocal in nature.
  The exposure between counterparties can go either direction. The face value
  of the guarantees outstanding as of September 30, 2003 and December 31, 2002
  was $1.5 billion and $1.1 billion, respectively. In order for Power to experience
  a liability for the face value of the outstanding guarantees, ER&T would
  have to fully utilize the credit granted to it by every counterparty to whom
  Power has provided a guarantee and all of ER&T's contracts would have to
  be ''out-of-the-money'' (if the contracts are terminated, Power would owe money
  to the counterparties). The probability of all contracts at ER&T being simultaneously
  ''out-of-the-money'' is highly unlikely. For this reason, the current exposure
  at any point in time is a more meaningful representation of the potential liability
  to Power under these guarantees. The current exposure consists of the net of
  accounts receivable and accounts payable (AR/AP) and the forward value on open
  positions, less any margins posted. The current exposure from such liabilities
  was $148 million and $268 million as of September 30, 2003 and December 31,
  2002, respectively. Of the $148 million, $143 million is recorded on Power's
  Consolidated Balance Sheets as of September 30, 2003. A significant portion
  of the current exposure under such guarantees is attributable to the load contracts
  recently signed through the New Jersey Basic Generation Service (BGS) auction
  for the period beginning August 1, 2003. The load contracts are accounted for
  on a settlement basis. As energy is delivered under all of these contracts,
  Power's exposure under such guarantees decreases.
In addition, all Master Agreements and other supply contracts contain margin and/or other collateral requirements that, as of September 30, 2003, could require Power to post additional collateral of approximately $232 million if a) Power were to lose its investment grade credit rating, and b) all counterparties with whom Power is ''out-of-the money'' under such contracts, were entitled to and called for collateral.
As of September 30, 2003, letters of credit issued by Power were outstanding in the amount of approximately $86 million in support of various contractual obligations, environmental liabilities and to satisfy trading collateral obligations.
26

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Power has also guaranteed equity contributions by its subsidiaries relating to the construction of its Lawrenceburg, Indiana facility. Should Power lose its investment grade credit rating, it would be required to post $63 million in letters of credit for the project. This guarantee will be cancelled upon satisfaction of Power's equity commitment, which is included in its anticipated capital expenditures through the first quarter 2004.
Energy Holdings
Energy Holdings and/or Global have guaranteed certain obligations of their subsidiaries or affiliates, including the successful completion, performance or other obligations related to certain projects in an aggregate amount of approximately $221 million as of September 30, 2003. The guarantees include a $49 million standby equity commitment for Skawina CHP Plant in Poland (Skawina), a $37 million equity commitment for ELCHO in Poland, and a $25 million contingent guarantee related to debt service obligations of Chilquinta in connection with electric distribution companies in Chile and Peru. Additional guarantees consist of a $39 million leasing agreement guarantee for Prisma 2000 S.p.A. (Prisma) in Italy, $25 million of performance guarantees related to Energy Technologies that are supported by letters of credit discussed
below and various other guarantees comprising the remaining $46 million. Approximately $37 million of such guarantees will be cancelled upon satisfaction of Global's equity commitments, which are included in Energy Holdings' anticipated capital expenditures for the remainder of 2003.
As a
  result of Energy Holdings' credit ratings falling below investment grade, as
  required by the applicable agreements Energy Holdings posted letters of credit
  of approximately $9 million and $35 million in September 2003 and October 2003,
  respectively, for certain of their equity commitments, discussed above. Energy
  Holdings does not anticipate that any additional letters of credit will need
  to be posted should there be a further downgrade.
In September 2003, Energy Technologies was sold. However, Energy Holdings retained certain outstanding construction and warranty obligations related to ongoing construction projects previously performed by Energy Technologies. These construction obligations have performance bonds issued by insurance companies. As of September 30, 2003, there were $148 million of such bonds outstanding, of which $26 million related to the yet to be completed construction projects. The performance bonds are not included in the $221 million of guaranteed obligations discussed above. In January 2003, Energy Holdings provided an indemnification agreement and $31 million of letters of credit in support of Energy Technologies' obligations. As of September 30, 2003, $25 million in letters of credit remain, including obligations relating to
certain of the HVAC/mechanical operating companies that have been previously sold. These amounts are expected to decrease over time as each of the HVAC/mechanical operating companies complete the work needed to satisfy the obligations, including inspection of the projects following their completion.
Environmental Matters
PSEG, PSE&G and Power
Hazardous Waste
The New Jersey Department of Environmental Protection (NJDEP) regulations concerning site investigation and remediation require an ecological evaluation of potential damages to natural resources in connection with an environmental investigation of contaminated sites. The NJDEP is presently working with the industry to develop procedures for implementing these regulations. These regulations may substantially increase the costs of environmental investigations and remediations, where necessary, particularly at sites situated on surface water bodies. PSE&G, Power and predecessor companies own or owned and/or operate or operated certain facilities situated on surface water bodies, certain of which are currently the subject of remedial activities. The financial impact of these regulations on these projects is not currently
estimable other than for the Passaic River Site, as discussed below. PSE&G and
27

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Power do not anticipate that compliance with these regulations will have a material adverse effect on their respective financial positions, results of operations or net cash flows.
In September 2003, the NJDEP notified PSE&G and Power as potentially responsible parties (PRP) related to the Passaic River Site, see discussion below.
Passaic River Site
The United States Environmental Protection Agency (EPA) has determined that a six mile stretch of the Passaic River in the area of Newark, New Jersey is a ''facility'' within the meaning of that term under the Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 and that, to date, at least thirteen corporations, including PSE&G, may be potentially liable for performing required remedial actions to address potential environmental pollution in the Passaic River ''facility.''
PSE&G and certain of its predecessors conducted industrial operations at properties adjacent to the Passaic River facility. The operations included one operating and one former generating station and four former Manufactured Gas Plants (MGPs). PSE&G's costs to clean up former MGPs are recoverable from utility customers through the SBC. PSE&G has sold the site of the former generating station and obtained releases and indemnities for liabilities arising out of the site in connection with the sale. The operating generating station was transferred to Power in August 2000.
In September
  2003, the EPA notified 41 PRPs, including PSE&G and Power, that it was expanding
  its assessment of the Passaic River Study Area to the entire 17-mile tidal reach
  of the lower Passaic River. The EPA further indicated that it believes that
  hazardous substances were being released from the Essex Generating Station,
  an operating electric generating station, and a former MGP located in Harrison,
  NJ, which also includes facilities for PSE&G's ongoing gas operations. The
  EPA estimated that its study would require five to seven years and would cost
  approximately $20 million, of which it would seek to recover $10 million from
  the PRPs. Power assumed all environmental liabilities associated with the electric
  generating stations that PSE&G transferred to it, including the Essex Generating
  Station. Power will consider seeking recovery of any disbursed amounts from
  its insurance carriers, although no assurances can be given.
Also, in September 2003, PSE&G, Power and 56 other PRPs received from the NJDEP a Directive and Notice to Insurers for the PRPs to arrange for a natural resource damage assessment and interim restoration of the lower Passaic River pursuant to the New Jersey Spill Compensation and Control Act. The NJDEP alleged in the Directive that it had determined that hazardous substances had been discharged from the Essex Site and the Harrison Site. PSEG and PSE&G and the other PRPs have 45 days to respond to the Directive.
On October 24, 2003, NJDEP met with the PRPs and indicated that it had estimated that the cost to restore natural resources along the 17-mile stretch of the Passaic River was approximately $950 million. NJDEP also indicated that PRPs who are interested in settling NJDEP's natural resource damage claims with respect to the Passaic River could respond with a good faith offer to engage in settlement discussions and NJDEP would extend the deadline for response to the directive by an additional 90 days to allow the PRPs and NJDEP to negotiate a settlement. Many of the PRPs that received the directive, including PSE&G, are working together to determine an appropriate response.
None of PSEG, PSE&G or Power can predict what further actions, if any, or the costs or the timing thereof, that may be required with respect to the Passaic River or natural resource damages. However, such costs could be material.
PSE&G and Power
MGP Remediation Program
PSE&G is currently working with the NJDEP under a program (Remediation Program) to assess, investigate and, if necessary, remediate environmental conditions at PSE&G's former MGP sites. To
28

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
date, 38 sites have been identified. The Remediation Program is periodically reviewed and revised by PSE&G based on regulatory requirements, experience with the Remediation Program and available remediation technologies. The long-term costs of the Remediation Program cannot be reasonably estimated, but experience to date indicates that at least $20 million per year could be incurred over a period of about 30 years since the inception of the program in 1988 and that the overall cost could be material. The costs for this remediation effort are recovered through SBC charges to utility customers.
As of September 30, 2003, PSE&G's estimated net liability for remediation costs through 2005 totaled $115 million. Expenditures beyond 2005 cannot be reasonably estimated and are therefore not accrued.
In September 2003, the EPA and NJDEP notified PRPs, including PSE&G and Power, that it was expanding its assessment of the Passaic River Study Area to the entire 17-mile tidal reach of the lower Passaic River. The EPA and NJDEP both indicated that they believed that hazardous substances were being released from a former MGP located in Harrison, NJ, among other locations. For further discussion related to this matter see ''Passaic River Site'' above.
Power
Prevention of Significant Deterioration (PSD)/New Source Review (NSR)
The EPA and the NJDEP issued a demand in March 2000 under the Federal Clean Air Act (CAA) requiring information to assess whether projects completed since 1978 at the Hudson and Mercer coal burning units were implemented in accordance with applicable PSD/NSR regulations. Power completed its response to the information request in November 2000. In January 2002, Power reached an agreement with New Jersey and the federal government to resolve allegations of noncompliance with federal and New Jersey PSD/NSR regulations. Under that agreement, over the course of 10 years, Power must install advanced air pollution controls that are designed to reduce emissions of Nitrogen Oxide (NOx), Sulfur Dioxide (SO2), particulate matter and mercury. The
estimated cost of the program at the time of the settlement was $337 million to be incurred through 2011. Power also paid a $1.4 million civil penalty and has agreed to spend up to $6 million on supplemental environmental projects. The agreement resolving the NSR allegations concerning the Hudson and Mercer coal burning units also resolved the dispute over Bergen 2 regarding the applicability of PSD requirements and allowed construction of the unit to be completed and operation to commence.
Power has notified the EPA and the NJDEP that it is evaluating the continued operation of the Hudson coal burning unit, in light of market changes and increases in the cost of pollution control equipment and other necessary modifications. Power is exploring the feasibility of installing less costly pollution control equipment at the Hudson coal burning unit to satisfy the requirements of its agreement with the EPA and the NJDEP. The related costs associated with these modifications have not been included in Power's capital expenditure projections.

Industrial Site Recovery Act

Potential environmental liabilities related to subsurface contamination at
certain generating stations have been identified. The New Jersey statute that
led to the identification is the Industrial Site Recovery Act (ISRA) that
applies to the sale of certain assets. In the second quarter of 1999, in
anticipation of the transfer of PSE&G's generation-related assets to Power, a
study was conducted to identify potential environmental liabilities and PSEG
recorded a $53 million liability related to these obligations, which is
represented on the Consolidated Balance Sheets.


New Generation and Development
Power and Energy Holdings
Completion of the projects discussed below, within the estimated time frames and cost estimates cannot be assured. Construction delays, cost increases and various other factors could result in changes in the operational dates or ultimate costs to complete.
29

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Power
Through an indirect, wholly-owned subsidiary, Power is developing the Bethlehem Energy Center that will replace the Albany, NY Steam Station. Total costs for this project are expected to be approximately $500 million with expenditures to date of approximately $275 million. Construction began in 2002 with the expected completion date in 2005.


Power
  is constructing a generation plant at Linden, New Jersey. Total costs are estimated
  at approximately $775 million with expenditures to date of approximately $600
  million. Completion is expected in 2005.
Power
  has constructed, through an indirect, wholly-owned subsidiary, a natural gas-fired
  generation plant in Waterford, Ohio which achieved commercial operation in August
  2003. Power is constructing, through a separate indirect, wholly-owned subsidiary,
  a natural gas-fired generation plant in Lawrenceburg, Indiana. Both plants combined
  have an estimated aggregate total cost of $1.2 billion. Total expenditures to
  date on these projects have been approximately $1.1 billion. The required estimated
  equity investment in these projects is approximately $400 million, with the
  remainder being financed with non-recourse bank financing. As of September 30,
  2003, approximately $375 million of equity has been invested in these projects.
  In connection with these projects, ER&T has entered into a five-year tolling
  agreement pursuant to which it is obligated to purchase the output of these
  facilities. Based on current prices, the purchase price under this contract
  is above market. ER&T may terminate the agreement upon repayment of the
  current financing scheduled for August 2005. The make-whole tolling agreements
  may result in additional equity investments being contributed into Lawrenceburg
  and Waterford to cover the required payments under the bank financing. The Lawrenceburg
  facility's commercial operation date has been delayed from the fourth quarter
  of 2003 to the first quarter of 2004.
Power
  also has contracts with outside parties to purchase upgraded turbines for the
  Salem Nuclear Generating Station (Salem) Units 1 and 2 and to purchase upgraded
  turbines and complete a power uprate for Hope Creek Generating Station (Hope
  Creek) to increase its generating capacity. The power uprate for Hope Creek
  is currently scheduled to be completed by 2006, assuming timely approval from
  the Nuclear Regulatory Commission (NRC). The turbine replacements are currently
  scheduled to be completed by 2004 for Salem Unit 1 and 2006 for Salem Unit 2
  and Hope Creek. Power's aggregate estimated costs for these projects are $211
  million, with expenditures to date of approximately $84 million.
Power
  has successfully renegotiated certain of its contracts relating to commitments
  of approximately $110 million for purchases of hardware and services, for which
  Power is no longer subject to cancellation penalties of up to $24 million.
In addition,
  Power has entered into a long-term contractual service agreement with a vendor
  who will provide the outage and service needs for certain of Power's generating
  units at market rates. The contract covers approximately twenty-five years and
  could result in annual payments ranging from approximately $10 million to $50
  million for services, parts, and materials rendered.
Energy Holdings
California
GWF
  Energy LLC (GWF Energy), which is jointly owned by Global and Harbinger GWF
  LLC (Harbinger), owns and operates three peaker plants in California, including
  the Tracy Peaker Plant, a 170 MW facility that completed construction and achieved
  commercial operation under GWF Energy's power purchase agreement with the California
  Department of Water Resources in the second quarter of 2003.
In September
  2003, GWF Energy issued $226 million of 6.131% senior secured notes that mature
  on December 30, 2011. The note proceeds were used by GWF Energy to repay a $45
  million bank loan that matured on September 30, 2003, and to make distributions
  to its members and for general corporate purposes. GWF Energy also closed a
  $35 million letter of credit reimbursement and working capital facility simultaneous
  with issuance of the notes.
30

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Poland
In 2002,
  Global acquired a 50% interest in the electric and thermal coal-fired Skawina
  plant, located in Poland. In accordance with the original agreement, Global
  increased its equity interest in Skawina to approximately 63% in August 2003.
  Additionally, the agreement obligates Global to offer to purchase an additional
  12% from Skawina's employees in 2004, increasing Global's potential ownership
  interest to approximately 75%. Global's total equity investment is expected
  to be approximately $50 million. In addition, Global has approximately $49 million
  of equity commitment guarantees related to the modernization of the plant for
  environmental upgrades over an eight-year period, which could increase Global's
  total equity investment to $99 million. Global expects that cash generated from
  Skawina's operations will be sufficient to fund all modernization costs.
Minimum Fuel Purchase Requirements
Power
Power purchases coal for certain of its fossil generation stations through various contracts and in the spot market for its generation plants. The total minimum purchase requirements included in these contracts amount to approximately $187 million through 2008.
Power has several long-term purchase contracts with uranium suppliers, converters, enrichers and fabricators to meet the currently projected fuel requirements for Salem and Hope Creek nuclear power plants. On average, Power has various multi-year requirements-based purchase commitments that total approximately $88 million per year to meet Salem's and Hope Creek's fuel needs. Power has been advised by Exelon Generation LLC (Exelon), the co-owner and operator of Peach Bottom Atomic Power Station (Peach Bottom), that it has similar purchase contracts to satisfy the fuel requirements for Peach Bottom, through 2006 of which Power's share is approximately $49 million.
In addition to its fuel requirements, Power has entered into various multi-year contracts for firm transportation and storage capacity for natural gas. As of September 30, 2003, the total minimum purchase requirements under these contracts were approximately $1.1 billion through 2016.
Nuclear Fuel Disposal
Power
Under the Nuclear Waste Policy Act of 1982, as amended (NWPA), the Federal government has entered into contracts with the operators of nuclear power plants for transportation and ultimate disposal of spent nuclear fuel. To pay for this service, nuclear plant owners are required to contribute to a Nuclear Waste Fund at a rate of one mil ($0.001) per Kilowatt-hour (kWh) of nuclear generation, subject to such escalation as may be required to assure full cost recovery by the Federal government. Under the NWPA, the US Department of Energy (DOE) was required to begin taking possession of the spent nuclear fuel by no later than 1998. The DOE has announced that it does not expect a facility to be available earlier than 2010.
Pursuant to NRC rules, spent nuclear fuel generated in any reactor can be stored in reactor facility storage pools or in independent spent fuel storage installations located at reactors or away-from-reactor sites for at least 30 years beyond the licensed life for reactor operation (which may include the term of a revised or renewed license). The availability of adequate spent fuel storage capacity is estimated through 2011 for Salem 1, 2015 for Salem 2 and 2007 for Hope Creek. Power presently expects to construct an on-site storage facility that would satisfy the spent fuel storage needs of both Salem and Hope Creek through the end of their respective license lives. This construction will require certain regulatory approvals, the timely receipt of which cannot be assured. Exelon has advised Power that it has constructed
an on-site storage facility at Peach Bottom that is now licensed and operational. This on-site storage facility will satisfy Peach Bottom's fuel storage until at least 2014.
Exelon
  previously has advised Power that it had signed an agreement with the DOE applicable
  to Peach Bottom under which Exelon would be reimbursed for costs incurred resulting
  from the DOE's delay in accepting spent nuclear fuel. Under this agreement,
  Power's portion of Peach Bottom's Nuclear Waste Fund fees have been reduced
  by approximately $18 million through August 31, 2002, at which point the credits
  were fully utilized and covered the cost of Exelon's storage facility. In 2000,
  a petition
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
was filed against the DOE in the US Court
  of Appeals for the Eleventh Circuit, seeking to set aside the receipt of credits
  by Exelon. In September 2002, the Court issued an opinion upholding the challenge
  by the petitioners. The DOE and Exelon are required to meet and discuss alternative
  funding sources for the settlement credits. The Eleventh Circuit's opinion suggests
  that the federal judgment fund should be available as an alternate source. On
  August 14, 2003, Exelon received a letter from the DOE demanding repayment of
  previously received credits from the Nuclear Waste Fund. The letter also demanded
  approximately $1 million of accrued interest. PSEG and Power continue to believe
  that it is the Federal government's obligation to pay for storage related costs
  due to DOE's failure to take possession of the spent nuclear fuel. Further,
  PSEG and Power also believe that any current payments potentially required relating
  to the past Nuclear Waste Fund fees will ultimately be recovered and accordingly
  no amounts have been accrued.
In September
  2001, Nuclear filed a complaint in the US Court of Federal Claims seeking damages
  caused by the DOE not taking possession of spent nuclear fuel in 1998. No assurances
  can be given as to any damage recovery or the ultimate availability of a disposal
  facility.
In October
  2001, Power filed a complaint in the US Court of Federal Claims, along with
  a number of other plaintiffs, seeking $28 million in relief from past overcharges
  by the DOE for enrichment services. No assurances can be given as to any damage
  recovery.
Other
PSE&G
Basic Gas Supply Service (BGSS) Filing
On May 30, 2003, PSE&G filed to increase its Residential BGSS Commodity Charge effective October 1, 2003 to recover approximately $102 million in additional revenues. On June 10, 2003, the case was transferred to the Office of Administrative Law (OAL) for hearings. On July 16, 2003, PSE&G filed a motion to implement the BGSS increase effective September 1, 2003, instead of October 1, 2003, on a provisional basis, which was approved by the New Jersey Board of Public Utilities (BPU). The New Jersey Ratepayer Advocate has filed its recommendation for the return of approximately $7 million to commercial and industrial customers representing amounts received from pipeline companies applicable to the periods prior to the effective date of the gas contract transfer on May 1, 2002 and overcollection from commercial
and industrial customers as of that date. PSE&G cannot predict the outcome of this matter.
Placement of Gas Meters
In March 2003, a resident of a housing complex in Mount Laurel, New Jersey filed a purported class action lawsuit against PSE&G in New Jersey Superior Court demanding the utility move or shield gas meters located in allegedly dangerous locations. PSE&G filed a motion to dismiss the case or move the case to the BPU. The Court transferred the case to the BPU, which will review PSE&G's compliance with applicable standards for gas meter location and protection, while the Court retained jurisdiction with respect to negligence claims and damages following the BPU's proceeding. In October 2003, the township of Mount Laurel filed a motion to join the class action lawsuit. The BPU has set public hearings for December 1 and 2, 2003. PSE&G believes that its facilities are installed in accordance with applicable
requirements to provide safe, adequate and proper service. If the BPU were to require changes in installation requirements, PSE&G would seek rate recovery for any costs associated with the changes. PSE&G cannot predict the ultimate outcome of this matter.
Energy Holdings
Argentina
In the second quarter 2003, the shares formerly held by Global in Empresa Distribuidora La Plata S.A. (EDELAP) were transferred to The AES Corporation (AES). In connection with that transfer, certain contingent obligations Global had with respect to the project loans relating to EDELAP have been terminated by agreement with the lenders.
32

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
In August
  2003, the shares held by Global in the AES Parana companies were transferred
  to AES. In connection with the transfer, all contingent obligations Global had
  with respect to the project loans relating to the AES Parana project, except
  for one contingent obligation relating to an operating guarantee for $4 million,
  have been terminated by consent of the lenders.
India
Global has a 20% interest in PPN Power Generating Station (PPN) in the Indian State of Tamil Nadu. Output from the facility is sold under a long-term Power Purchase Agreement (PPA) with the Tamil Nadu Electricity Board (TNEB) which sells the power to retail end-user customers. TNEB has not made full payment to PPN for the purchase of energy under contract. The past due receivable at PPN as of September 30, 2003 was approximately $91 million, of which Global's share is approximately $9 million, net of a $9 million reserve.
On April
  1, 2003, PPN did not receive expected payments from TNEB, which resulted in
  PPN defaulting on a debt payment of $10 million to its project lenders. Additionally,
  PPN was unable to pay working capital interest, amounts due under letters of
  credit covering fuel supplies, gas supply invoices and fuel supply letters of
  credit due in April 2003. As a result, PPN closed the plant as of April 10,
  2003. TNEB was notified of the plant closing resulting from PPN's inability
  to procure fuel and fund operating expenses due to non-payment by TNEB. Subsequently,
  TNEB has made adequate payments to enable PPN to pay its lenders and fuel suppliers
  through September 2003. The plant restarted on May 30, 2003 and has been in
  operation since then. As a result of these issues, Energy Holdings performed
  an impairment test in the second quarter of 2003 on this investment and determined
  that no impairment was necessary. If TNEB further fails to make required payments
  under the PPA, PPN may have further liquidity problems. Of the $91 million,
  discussed above, the TNEB has agreed to pay approximately $30 million and negotiations
  have begun regarding the remaining $61 million. Energy Holdings cannot predict
  the outcome of this matter. An adverse outcome to such negotiations could potentially
  result in an impairment of this investment, which could be material to PSEG's
  and Energy Holdings' respective results of operations. As of September 30, 2003,
  Energy Holdings' total investment exposure in PPN was approximately $40 million.
Peru
Electroandes
In November 2002, the Peruvian Government created a subsidy in favor of the construction of the Camisea gas pipeline, in the form of a surcharge to the electric transmission tariffs paid by all end users. Two of Electroandes' largest customers (representing about 67% of its contracted capacity) refused to pay the surcharge, thus preventing Electroandes, in its role as collection agent, from transferring the associated funds to the beneficiaries of the surcharge. This situation prompted the electric regulator to initiate an investigation aimed at determining the reasons for Electroandes' alleged non-payment. Electroandes believes that its role is limited to collection of the surcharge from its customers and payment to the beneficiaries in a manner proportional to its collections. Subsequently, an agreement was reached
with the company's largest customer, by virtue of which the customer assumed full payment of all past-due and future amounts associated with this surcharge (comprising 65% of the total subsidy amounts due by all customers).
Seeking further protection from regulatory actions stemming from the remaining uncollected amounts, Electroandes filed a judicial process aimed at determining which party is responsible for payment of the subsidy. Associated with this process, it obtained a temporary restraining order preventing any party from taking action against Electroandes until a judge or panel of arbitrators determines which party is responsible. In the event that a judge or panel of arbitrators determines that Electroandes is liable for payment regardless of current laws, the total impact to Energy Holdings would be approximately $10 million over several years.
Luz del Sur (LDS)
The
  Superintendencia Nacional de Administracion Tributaria (SUNAT), the governing
  tax authority in Peru, claimed past-due taxes for the period between 1996-1999,
  plus penalties and interest,
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
resulting from an interpretation of the
  law that allowed LDS to restate its assets to fair market value and take advantage
  of the resulting higher deductions from depreciation. While LDS prevailed on
  this issue in arbitration proceedings that ended in December 2001, SUNAT pursued
  the claim in the local Tax Court. The Tax Court ordered SUNAT to rule according
  to the arbitration, which was favorable to LDS. The Tax Court did make a reference
  to Article 8 of the law, which requires consideration of the legitimacy of the
  business motives leading to a corporate reorganization, such as the one made
  by LDS and which gave rise to the original dispute. LDS believes it had legitimate
  business motives to reorganize when it did and management believed that it acted
  in accordance with the applicable law and accordingly LDS's position prevailed
  as SUNAT agreed that Article 8 did not apply.
Further,
  SUNAT stated that the revaluation study, performed in 1996, was not performed
  correctly and invalidates the study as if it never existed. It is LDS's position
  that laws and regulations did not define the methodology to be used in these
  matters and its study was based on generally accepted practices. LDS's total
  potential liability relating to this matter is approximately $55 million, of
  which $18 million is currently recorded as a deferred tax liability at LDS.
  Global's share of the net potential liability related to the claim by SUNAT
  is estimated at $16 million. No assurance can be given to the outcome of this
  case.
Note 8. Risk Management
PSEG, PSE&G, Power and Energy Holdings
The operations of PSEG, PSE&G, Power and Energy Holdings are exposed to market risks from changes in commodity prices, foreign currency exchange rates, interest rates and equity prices that could affect their results of operations and financial conditions. PSEG, PSE&G, Power and Energy Holdings manage exposure to these market risks through their regular operating and financing activities and, when deemed appropriate, hedge these risks through the use of derivative financial instruments. PSEG, PSE&G, Power and Energy Holdings use the term ''hedge'' to mean a strategy designed to manage risks of volatility in prices or rate movements on certain assets, liabilities or anticipated transactions and by creating a relationship in which gains or losses on derivative instruments are expected to counterbalance the
losses or gains on the assets, liabilities or anticipated transactions exposed to such market risks. Each of PSEG, PSE&G, Power and Energy Holdings use derivative instruments as risk management tools consistent with their respective business plans and prudent business practices.
Derivative Instruments and Hedging Activities
Energy Trading Contracts
Power
Power actively trades energy and energy-related products, including electricity, natural gas, electric capacity, fixed transmission rights (FTRs), coal and emission allowances in the spot, forward and futures markets, primarily in the Pennsylvania-New Jersey-Maryland Power Pool (PJM), but also in the surrounding region, which extends from Maine to the Carolinas and the Atlantic Coast to Indiana and natural gas in the producing region.
Power maintains a strategy of entering into trading positions to optimize the value of its portfolio of generation assets, gas supply contracts and its electric and gas supply obligations. Power engages in physical and financial transactions in the electricity wholesale markets and executes an overall risk management strategy to mitigate the effects of adverse movements in the fuel and electricity markets. These contracts also involve financial transactions including swaps, options and futures.
Power marks to market its energy trading contracts in accordance with SFAS 133. Wherever possible, fair values for these contracts were obtained from quoted market sources. For contracts where no quoted market exists, modeling techniques were employed using assumptions reflective of current market rates, yield curves and forward prices as applicable to interpolate certain prices. The effect of using such modeling techniques is not material to Power's financial results.
34

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Power
  routinely enters into exchange-traded futures and options transactions for electricity
  and natural gas as part of its operations. Generally, exchange-traded futures
  contracts require a deposit of margin cash, the amount of which is subject to
  change based on market movement and in accordance with exchange rules. The amount
  of Power's margin deposits as of September 30, 2003 was approximately $32 million.
Commodity Contracts
Power
The availability and price of energy commodities are subject to fluctuations from factors such as weather, environmental policies, changes in supply and demand, state and federal regulatory policies and other events. Power manages its risk of fluctuations of energy price and availability through derivative instruments, such as forward purchase contracts, swaps, options, futures and FTRs.
Cash Flow Hedges
Power uses forward sale and purchase contracts, swaps and FTR contracts to hedge forecasted energy sales from its generation stations and to hedge related load obligations. Power also enters into swaps, options and futures transactions to hedge the price of fuel to meet its fuel purchase requirements for generation. These derivative transactions are designated and effective as cash flow hedges under SFAS 133. As of September 30, 2003, the fair value of these hedges was $52 million. During the next 12 months, $2 million of unrealized gains (net of taxes) on these commodity derivatives accumulated in OCI is expected to be reclassified to earnings. As defined in SFAS 133, there was no ineffectiveness associated with these hedges since the terms of the instruments perfectly match the forecasted transaction the instruments
are hedging. The maximum term of these cash flow hedges will expire in 2008.
Effective with the transfer of PSE&G's gas contracts to Power on May 1, 2002, Power acquired all of the gas-related derivatives entered into by PSE&G. The derivatives used to hedge the forecasted purchase and sale of natural gas are designated and effective as cash flow hedges. Gains or losses from the derivatives entered into to hedge residential customer requirements are deferred and recovered from PSE&G's customers as part of the monthly billing to PSE&G. Unrealized gains or losses on the derivatives entered to hedge commercial and industrial customer requirements are recorded to OCI. There was no ineffectiveness realized on these hedges. As of September 30, 2003, the fair value of hedge instruments associated with hedging residential customer requirements was $(19) million. These hedges will mature
through 2005.
Other Derivatives
Power also enters into certain other contracts which are derivatives, but do not qualify for hedge accounting under SFAS 133. Most of these contracts are used for fuel purchases for generation requirements. Therefore, the changes in fair market value of these derivative contracts are recorded in Energy Costs on the Consolidated Statements of Operations. The fair value of these instruments as of September 30, 2003 was $3 million.
Interest Rates
PSEG, PSE&G, Power and Energy Holdings
PSEG, PSE&G, Power and Energy Holdings are subject to the risk of fluctuating interest rates in the normal course of business. PSEG's policy is to manage interest rate risk through the use of fixed rate debt, floating rate debt and interest rate derivatives.
35

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Fair Value Hedges
Energy Holdings
In April 2003, Energy Holdings, in a private placement, issued $350 million of 7.75% Senior Notes due in 2007. Energy Holdings has used interest rate swaps to convert a portion of this fixed-rate debt into variable-rate debt. The interest rate swaps are designated and effective as fair value hedges. The fair value changes of these interest rate swaps are fully offset by the fair value changes in the underlying debt. As of September 30, 2003, the fair value of these hedges was $1 million. There was no ineffectiveness related to these hedges.
Cash Flow Hedges
PSEG, PSE&G, Power and Energy Holdings
PSEG, PSE&G, Power and Energy Holdings use interest rate swaps and other interest rate derivatives to manage their exposures to the variability of cash flows, primarily related to variable-rate debt instruments. The interest rate derivatives used are designated and effective as cash flow hedges. The fair value changes of these derivatives are initially recorded in OCI. As of September 30, 2003, the fair value of these cash flow hedges was $(227) million, including $(19) million, $(61) million, $(8) million and $(139) million at PSEG, PSE&G, Power and Energy Holdings, respectively. The $(61) million at PSE&G is deferred and will be recovered from PSE&G's customers. During the next 12 months, $28 million of unrealized loss (net of taxes) on interest rate derivatives accumulated in OCI is expected to be
reclassified to earnings, including $4 million, $4 million and $20 million at PSEG, Power and Energy Holdings, respectively.
Foreign Currencies
Energy Holdings
Global is exposed to foreign currency risk and other foreign operations risk that arise from investments in foreign subsidiaries and affiliates. A key component of this risk is that some of its foreign subsidiaries and affiliates have functional currencies other than the consolidated reporting currency, the US Dollar. Additionally, certain of Global's foreign subsidiaries and affiliates have entered into monetary obligations and maintain receipts/receivables in US Dollars or currencies other than their own functional currencies. Global, a US Dollar functional currency entity, is primarily exposed to changes in the US Dollar against the Brazilian Real, the Euro, the Polish Zloty, the Peruvian Nuevo Sol and the Chilean Peso. With respect to the foreign currency risk associated with the Brazilian Real and the Chilean Peso,
there has already been significant devaluation since the initial acquisition of these investments, which has resulted in reduced US Dollar earnings and cash flows relative to initial projections. Whenever possible, these subsidiaries and affiliates have attempted to limit potential foreign exchange exposure by entering into revenue contracts that adjust for changes in foreign exchange rates. Global also uses foreign currency forward, swap and option agreements, wherever possible, to manage risk related to certain foreign currency fluctuations.
As of September 30, 2003, net cumulative foreign currency devaluations have reduced the total amount of Energy Holdings' Member's Equity by $273 million, of which $181 million and $101 million were caused by the devaluation of the Brazilian Real and the Chilean Peso, respectively.
Cash Flow Hedges
Affiliates of Energy Holdings purchase forward-exchange contracts as hedges of anticipated payments to contractors for projects under construction. These contracts are designed to hedge against the risk that the future cash payments will be adversely affected by changes in foreign currency rates.
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
As of September 30, 2003, Energy Holdings' pro-rata share of the fair value on the forward-exchange contracts was immaterial. There was no ineffectiveness associated with these hedges.
Additionally, an affiliate of Energy Holdings entered into a PPA that contained an embedded derivative. The embedded derivative was designated as a cash flow hedge of foreign currency debt exposure. To the extent that the derivative is effective in offsetting foreign currency exposure, the amount is recorded in OCI. Amounts are reclassified from OCI to earnings over the life of the debt. To the extent that the derivative is provided to hedge an equity return in US Dollars, the offsetting amount is recorded in earnings, which amounted to approximately $4 million for the nine months ended September 30, 2003. As of September 30, 2003, the fair value of the derivative was $10 million. The ineffectiveness associated with this hedge was immaterial to earnings. The maximum term of these cash flow hedges is related to the embedded
derivative, which will expire in 2022.
Equity Securities
Energy Holdings
For the nine months ended September 30, 2003, Resources recognized $10 million of other than temporary impairments of non-publicly traded equity securities, which are held within its investment in certain leveraged buyout funds. For the nine months ended September 30, 2003, Resources has recognized a $6 million gain on the publicly traded equity securities within those funds. These gains and losses are included in Operating Revenues in the Consolidated Statements of Operations. As of September 30, 2003, Resources had investments in leveraged buyout funds of approximately $84 million, of which $26 million was comprised of public securities with available market prices and $58 million was comprised of non-publicly traded securities. As of December 31, 2002, Resources had investments in leveraged buyout funds of approximately
$93 million, of which $24 million was comprised of public securities with available market prices and $69 million was comprised of non-publicly traded securities.
Note 9. Comprehensive Income
PSE&G

Power (A)

Energy
Holdings (B)

Other (C)

Consolidated
Total(Millions)For the Quarter Ended September 30, 2003:Net Income (Loss)

$
69


$
110


$
45


$
(14
)

$
210Other Comprehensive Income (Loss)


(1
)


50



18



1



68Comprehensive Income (Loss)

$
68


$
160


$
63


$
(13
)

$
278For the Quarter Ended September 30, 2002:Net Income (Loss)

$
56


$
121


$
40


$
(13
)

$
204Other Comprehensive Loss


—



—



(68
)


(6
)


(74
)Comprehensive Income (Loss)

$
56


$
121


$
(28
)

$
(19
)

$
130For the Nine Months Ended September 30, 2003:Net Income (Loss)

$
174


$
766


$
120


$
(44
)

$
1,016Other Comprehensive Income (Loss)


(1
)


110



33



6



148Comprehensive Income (Loss)

$
173


$
876


$
153


$
(38
)

$
1,164For the Nine Months Ended September 30, 2002:Net Income (Loss)

$
131


$
325


$
(422
)

$
(34
)

$
—Other Comprehensive Loss


(1
)


(7
)


(106
)


(10
)


(124
)Comprehensive Income (Loss)

$
130


$
318


$
(528
)

$
(44
)

$
(124
)
(A)

Changes at Power primarily relate to unrealized gains and losses in the NDT Fund in 2003.(B)

Changes at Energy Holdings primarily relate to foreign currency translation adjustments.(C)

Other primarily consists of activity at PSEG (parent company), Services and intercompany eliminations.37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 10. Other Income and Deductions
PSE&G
    
    Power
    
    Energy
      Holdings
    
    Other
      (A)
    
    Consolidated
      Total(Millions)Other Income:For the
      Quarter Ended September 30, 2003:Interest
      Income
    
    $
    1
    
    
    $
    —
    
    
    $
    —
    
    
    $
    —
    
    
    $
    1NDT
      Fund Realized Gains
    
    
    —
    
    
    
    26
    
    
    
    —
    
    
    
    —
    
    
    
    26NDT
      Interest and Dividend Income
    
    
    —
    
    
    
    7
    
    
    
    —
    
    
    
    —
    
    
    
    7Foreign
      Currency Gains
    
    
    —
    
    
    
    —
    
    
    
    3
    
    
    
    —
    
    
    
    3Other
    
    
    —
    
    
    
    —
    
    
    
    —
    
    
    
    1
    
    
    
    1Total
      Other Income
    
    $
    1
    
    
    $
    33
    
    
    $
    3
    
    
    $
    1
    
    
    $
    38For the
      Quarter Ended September 30, 2002:Interest
      Income
    
    $
    3
    
    
    $
    —
    
    
    $
    —
    
    
    $
    —
    
    
    $
    3Change
      in Derivative Fair Value
    
    
    —
    
    
    
    —
    
    
    
    13
    
    
    
    —
    
    
    
    13Gain
      on Early Retirement of Debt
    
    
    —
    
    
    
    —
    
    
    
    4
    
    
    
    —
    
    
    
    4Other
    
    
    —
    
    
    
    —
    
    
    
    2
    
    
    
    —
    
    
    
    2Total
      Other Income
    
    $
    3
    
    
    $
    —
    
    
    $
    19
    
    
    $
    —
    
    
    $
    22For the
      Nine Months Ended September 30, 2003:Interest
      Income
    
    $
    6
    
    
    $
    —
    
    
    $
    —
    
    
    $
    —
    
    
    $
    6Gain
      on Disposition of Property
    
    
    8
    
    
    
    —
    
    
    
    —
    
    
    
    —
    
    
    
    8NDT
      Fund Realized Gains
    
    
    —
    
    
    
    86
    
    
    
    —
    
    
    
    —
    
    
    
    86NDT
      Interest and Dividend Income
    
    
    —
    
    
    
    20
    
    
    
    —
    
    
    
    —
    
    
    
    20Foreign
      Currency Gains
    
    
    —
    
    
    
    —
    
    
    
    3
    
    
    
    —
    
    
    
    3Other
    
    
    —
    
    
    
    1
    
    
    
    —
    
    
    
    2
    
    
    
    3Total
      Other Income
    
    $
    14
    
    
    $
    107
    
    
    $
    3
    
    
    $
    2
    
    
    $
    126For the
      Nine Months Ended September 30, 2002:Interest
      Income
    
    $
    3
    
    
    $
    —
    
    
    $
    —
    
    
    $
    —
    
    
    $
    3Gain
      on Disposition of Property
    
    
    1
    
    
    
    —
    
    
    
    —
    
    
    
    —
    
    
    
    1Change
      in Derivative Fair Value
    
    
    —
    
    
    
    —
    
    
    
    15
    
    
    
    —
    
    
    
    15Minority
      Interest
    
    
    —
    
    
    
    —
    
    
    
    —
    
    
    
    2
    
    
    
    2Gain
      on Early Retirement of Debt
    
    
    —
    
    
    
    —
    
    
    
    4
    
    
    
    —
    
    
    
    4Other
    
    
    1
    
    
    
    —
    
    
    
    2
    
    
    
    1
    
    
    
    4Total
      Other Income
    
    $
    5
    
    
    $
    —
    
    
    $
    21
    
    
    $
    3
    
    
    $
    29PSE&G

Power

Energy
Holdings

Other (A)

Consolidated
Total(Millions)Other Deductions:For the Quarter Ended September 30, 2003:NDT Fund Realized Losses and Expenses

$
—


$
22


$
—


$
—


$
22Minority Interest


—



—



—



5



5Change in Derivative Fair Value


—



—



2



—



2Other


—



—



1



—



1Total Other Deductions

$
—


$
22


$
3


$
5


$
30For the Quarter Ended September 30, 2002:Minority Interest

$
—


$
—


$
—


$
2


$
2Foreign Currency Losses


—



—



2



—



2Total Other Deductions

$
—


$
—


$
2


$
2


$
4For the Nine Months Ended September 30, 2003:Donations

$
1


$
—


$
—


$
—


$
1NDT Fund Realized Losses and Expenses


—



67



—



—



67Minority Interest


—



—



—



12



12Change in Derivative Fair Value


—



—



14



—



14Total Other Deductions

$
1


$
67


$
14


$
12


$
94For the Nine Months Ended September 30, 2002:Donations

$
1


$
—


$
—


$
—


$
1Foreign Currency Losses


—



—



71



—



71Total Other Deductions

$
1


$
—


$
71


$
—


$
72
(A)

Other consists of reclassifications for minority interests in PSEG's consolidated results of operations and intercompany eliminations at PSEG (parent company).38

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 11. Income Taxes
An analysis of the tax provision expense is as follows:
PSE&G

Power

Energy
Holdings

Other (A)

Consolidated
Total(Millions)For the Quarter Ended September 30, 2003:Income (Loss) before Income Taxes

$
107


$
187


$
68


$
(32
)

$
330Tax computed at the statutory rate


37



65



24



(11
)


115Increase (decrease) attributable to flow through of certain tax adjustments:State Income Taxes after Federal Benefit


8



11



—



(2
)


17Rate Differential of Foreign Operations


—



—



(10
)


—



(10
)Plant Related Items


(7
)


—



—



—



(7
)Other


—



1



1



—



2Total Income Tax Expense (Benefit)

$
38


$
77


$
15


$
(13
)

$
117Effective income tax rate


35.5
%


41.2
%


22.1
%


40.6
%


35.5
%For the Quarter Ended September 30, 2002:Income (Loss) before Income Taxes

$
87


$
206


$
61


$
(23
)

$
331Tax computed at the statutory rate


30



72



21



(9
)


114Increase (decrease) attributable to flow through of certain tax adjustments:State Income Taxes after Federal Benefit


7



12



1



(1
)


19Rate Differential of Foreign Operations


—



—



(5
)


—



(5
)Plant Related Items


(3
)


—



—



—



(3
)Other


(3
)


1



(1
)


2



(1
)Total Income Tax Expense (Benefit)

$
31


$
85


$
16


$
(8
)

$
124Effective income tax rate


35.6
%


41.3
%


26.2
%


34.8
%


37.5
%For the Nine Months Ended September 30, 2003:Income (Loss) before Income Taxes

$
278


$
670


$
200


$
(92
)

$
1,056Tax computed at the statutory rate


97



235



70



(32
)


370Increase (decrease) attributable to flow through of certain tax adjustments:State Income Taxes after Federal Benefit


22



39



—



(5
)


56Rate Differential of Foreign Operations


—



—



(23
)


—



(23
)Plant Related Items


(33
)


—



—



—



(33
)Other


—



—



1



1



2Total Income Tax Expense (Benefit)

$
86


$
274


$
48


$
(36
)

$
372Effective income tax rate


30.9
%


40.9
%


24.0
%


39.1
%


35.2
%For the Nine Months Ended September 30, 2002:Income (Loss) before Income Taxes

$
204


$
551


$
(423
)

$
(53
)

$
279Tax computed at the statutory rate


71



193



(148
)


(19
)


97Increase (decrease) attributable to flow through of certain tax adjustments:State Income Taxes after Federal Benefit


17



32



2



(3
)


48Rate Differential of Foreign Operations


—



—



(14
)


—



(14
)Plant Related Items


(10
)


—



—



—



(10
)Other


(5
)


1



—



1



(3
)Total Income Tax Expense (Benefit)

$
73


$
226


$
(160
)

$
(21
)

$
118Effective income tax rate


35.8
%


41.0
%


37.8
%


39.6
%


42.3
%
(A)

PSEG's other activities include amounts applicable to PSEG (parent corporation) that primarily relate to financing and certain administrative and general costs.39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 12. Financial Information by Business
  Segments
Information related to the segments of PSEG and its subsidiaries is detailed below:
Energy HoldingsPSE&G

Power

Resources

Global

Other (A)

Other (B)

Consolidated Total(Millions)For the Quarter Ended September 30, 2003:Total Operating Revenues

$
1,530


$
1,248


$
61


$
143


$
7


$
(184
)

$
2,805Income (Loss) from Continuing Operations


69



110



17



32



(1
)


(14
)


213Loss from Discontinued Operations, net of tax


—



—



—



—



(3
)


—



(3
)Net Income (Loss)


69



110



17



32



(4
)


(14
)


210Segment Earnings (Loss)


68



110



15



28



(4
)


(7
)


210Gross Additions to Long-Lived Assets


114



177



—



61



—



(14
)


338For the Nine Months Ended September 30, 2003:Total Operating Revenues

$
5,020


$
4,313


$
178


$
422


$
8


$
(1,411
)

$
8,530Income (Loss) from Continuing Operations


192



396



54



89



(3
)


(44
)


684Loss from Discontinued Operations, net of tax


—



—



—



—



(20
)


—



(20
)Extraordinary Item, net of tax


(18
)


—



—



—



—



—



(18
)Cumulative Effect of a Change In Accounting Principle, net of tax


—



370



—



—



—



—



370Net Income (Loss)


174



766



54



89



(23
)


(44
)


1,016Segment Earnings (Loss)


171



766



50



76



(23
)


(24
)


1,016Gross Additions to Long-Lived Assets


343



507



—



228



2



(10
)


1,070As of September 30, 2003:Total Assets

$
12,475


$
7,156


$
3,238


$
4,026


$
207


$
(166
)

$
26,936Investments in Equity Method Subsidiaries

$
—


$
—


$
105


$
1,396


$
4


$
—


$
1,505For the Quarter Ended September 30, 2002:Total Operating Revenues

$
1,405


$
1,073


$
67


$
112


$
8


$
(351
)

$
2,314Income (Loss) from Continuing Operations


56



121



21



24



(2
)


(13
)


207Loss from Discontinued Operations, net of tax


—



—



—



—



(3
)


—



(3
)Net Income (Loss)


56



121



21



24



(5
)


(13
)


204Segment Earnings (Loss)


55



121



19



20



(5
)


(6
)


204Gross Additions to Long-Lived Assets


126



247



—



64



1



(34
)


404For the Nine Months Ended September 30, 2002:Total Operating Revenues

$
4,294


$
2,341


$
158


$
291


$
7


$
(1,460
)

$
5,631Income (Loss) from Continuing Operations


131



325



35



(290
)


(6
)


(34
)


161Loss from Discontinued Operations, net of tax


—



—



—



(9
)


(32
)


—



(41
)Cumulative Effect of a Change In Accounting Principle, net of tax


—



—



—



(88
)


(32
)


—



(120
)Net Income (Loss)


131



325



35



(386
)


(71
)


(34
)


—Segment Earnings (Loss)


128



325



30



(399
)


(70
)


(14
)


—Gross Additions to Long-Lived Assets


322



792



6



470



7



(41
)


1,556As of December 31, 2002:Total Assets

$
12,434


$
7,209


$
3,086


$
3,804


$
(22
)

$
(688
)

$
25,823Investments in Equity Method Subsidiaries

$
—


$
—


$
118


$
1,314


$
4


$
—


$
1,436
(A)

Energy Holdings' other activities include amounts applicable to Energy Holdings (parent company), the HVAC/operating companies of Energy Technologies, which are classified in discontinued operations and EGDC. The net losses primarily relate to financing and certain administrative and general costs at the Energy Holdings parent corporation. For a discussion of the charges relating to Discontinued Operations at Energy Technologies, see Note 6. Discontinued Operations.(B)

    PSEG's other activities include
      amounts applicable to PSEG (parent corporation), and intercompany eliminations,
      primarily relating to intercompany transactions between Power and PSE&G.
      No gains or losses are recorded on any intercompany transactions, rather,
      all intercompany transactions are at cost or, in the case of the BGS and
      BGSS contracts between40

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Power and PSE&G, at rates prescribed by the BPU. For a further discussion
of the intercompany transactions between Power and PSE&G, see Note 14. Related-Party Transactions. The net losses primarily relate to financing and certain administrative and general costs at the PSEG parent corporation.
Note 13. Stock-Based Compensation
PSEG applies APB Opinion No. 25, ''Accounting for Stock Issued to Employees,'' and related interpretations in accounting for stock-based compensation plans. Accordingly, no compensation cost has been recognized for fixed stock option grants since the exercise price of the stock options equaled the market price of the underlying stock on the date of grant.
The following table illustrates the effect on Net Income and Earnings Per Share if PSEG had applied the fair value recognition provisions of SFAS No. 123, ''Accounting for Stock-Based Compensation,'' to stock-based employee compensation:
Quarter
Ended
September 30,

Nine Months Ended
September 30,2003

2002

2003

2002(Millions, except Share Data)Net Income, as reported

$
210


$
204


$
1,016


$
—Deduct: Total stock-based employee compensation expense determined under fair value    based method for all awards, net of related tax effects


(2
)


(2
)


(6
)


(8
)Pro forma Net Income (Loss)

$
208


$
202


$
1,010


$
(8
)Earnings per share:Basic—as reported

$
0.93


$
0.99


$
4.50


$
—Basic—pro forma

$
0.92


$
0.98


$
4.47


$
(0.04
)Diluted—as reported

$
0.92


$
0.99


$
4.49


$
—Diluted—pro forma

$
0.91


$
0.98


$
4.46


$
(0.04
)Note 14. Related-Party Transactions
The majority of the following discussion relates to intercompany transactions, which are eliminated during the PSEG consolidation process in accordance with GAAP.
BGSS and BGS Contracts
PSE&G and Power
Effective May 1, 2002, PSE&G transferred its gas supply contracts and gas inventory requirements to Power. On the same date, PSE&G entered into a requirements contract with Power under which Power provides the gas supply services needed to meet PSE&G's BGSS and other contractual requirements.
For
  the quarters ended September 30, 2003 and 2002, Power billed PSE&G
  approximately $153 million and $111 million, respectively, for BGSS. For the
  nine months ended September 30, 2003 and 2002, Power billed PSE&G approximately
  $1.3 billion and $211 million, respectively, for BGSS. As of September 30,
  2003 and December 31, 2002, PSE&G's payable to Power related to the
  BGSS contract was approximately $53 million and $241 million, respectively.
Power charged PSE&G for the energy and capacity provided to meet its year four BGS requirements through July 31, 2002. Power also charged PSE&G for the MTC through July 31, 2003. For the quarters ended September 30, 2003 and 2002, Power charged PSE&G approximately $10 million and $215 million, respectively, for the MTC and BGS. For the nine months ended September 30, 2003 and 2002, Power charged PSE&G approximately $111 million and $1.2 billion, respectively, for the
41

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

MTC and BGS. As of September 30, 2003, Power did not have a payable to PSE&G related to these costs. As of December 31, 2002, PSE&G's payable to Power relating to these costs was approximately $2 million.
Power was a participant in the year five BGS auction held in February 2003. As a result of this participation, Power entered into contracts for a ten-month period beginning August 1, 2003, to supply hourly priced energy, capacity and ancillary services to PSE&G, which in turn provides these services to certain large industrial and commercial customers. For the quarter ended September 30, 2003, Power charged PSE&G approximately $15 million under this agreement. As of September 30, 2003, PSE&G's payable to Power was approximately $6 million.
For the quarter and nine months ended September 30, 2002, PSE&G sold energy and capacity to Power at the market price of approximately $18 million and $80 million, respectively, which PSE&G purchased under various Non Utility Generation (NUG) contracts at costs above market prices.
Affiliate Loans
PSEG and Power
As of September 30, 2003 and December 31, 2002, Power had a payable to PSEG of approximately $256 million and $239 million, respectively, for short-term funding needs. There was $1 million of interest expense related to these borrowings for the nine months ended September 30, 2003, as compared to $3 million for the nine months ended September 30, 2002.
PSEG and Energy Holdings
As of September 30, 2003 and December 31, 2002, Energy Holdings had a note receivable due from PSEG of $166 million and $62 million, respectively, reflecting the investment of its excess cash with PSEG. Interest income related to this intercompany transaction was immaterial.
Energy Holdings
Loans to Texas Independent Energy, L.P. (TIE)
Global and its partner, TECO Energy, Inc. (Teco), own and operate two electric generation facilities in Texas through TIE, a 50/50 joint venture. In January 2003, Panda Energy International, Inc. (Panda) indirectly transferred 50% of its interest in TIE to Teco. In September 2003, Panda indirectly transferred its remaining interest in TIE to Teco. As of September 30, 2003, Global had outstanding approximately $70 million of loans to TIE that earn interest at an annual rate of 12% and that are scheduled to be repaid in quarterly installments through 2012. The quarterly loan installments due to Global are expected to be repaid out of the project cash flows or additional contributions from project partners in the event of insufficient project cash flows. For the quarter and nine months ended September 30,
2003, Global recorded approximately $3 million and $8 million, respectively, of interest income related to this loan.
In March 2003, Global funded $14 million of convertible preferred equity to the two TIE projects as part of its negotiations with project lenders to amend the projects' credit agreements. The convertible preferred equity has a 15% coupon and is convertible at Global's option into an approximate 13% equity interest in TIE if not repaid in full by June 2004. This 13% equity interest is derived from the dilution of all existing general partners including Global and would give Global a net increase in ownership of approximately 7%.
Loans to GWF Energy
GWF Energy LLC (GWF Energy), which is jointly owned by Global and Harbinger GWF LLC (Harbinger), owns and operates three gas-fired peaker plants aggregating approximately 363 MW in
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
California. In the third quarter 2003, Global's working capital loans to GWF Energy of approximately $4 million were paid back in full.
In September 2003, GWF Energy issued $226 million of 6.131% senior secured notes that mature on December 30, 2011. The note proceeds were used by GWF Energy to repay a $45 million bank loan that matured on September 30, 2003, and to make distributions to its members and for general corporate purposes. GWF Energy made cash distributions to Global of approximately $137 million.
As of
  September 30, 2003, Global's ownership interest in GWF Energy was approximately
  76%. Harbinger has the right to buy back from Global up to one-half of the reduction
  of its equity ownership in GWF Energy from the 50% ownership level. Global and
  Harbinger are currently in arbitration over allegations that Global wrongfully
  diluted Harbinger's ownership percentage interest in GWF Energy. On June 4,
  2003, Global and Harbinger agreed that the deadline for Harbinger to buy back
  from Global up to 50% of the dilution of its ownership interest in GWF Energy
  would be extended to 30 days after the issuance of the decision in the arbitration.
  The parties anticipate completion of the arbitration by November 30, 2003,
  although no assurances can be given.
Changes in Capitalization
PSE&G
On January 21, 2003, PSEG contributed $170 million of equity to PSE&G.
Services
PSE&G, Power and Energy Holdings
Services provides and bills administrative services to PSE&G, Power and Energy Holdings as follows:
Services Billings
for the Quarter
Ended September 30,

Services Billings
for the Nine Months
Ended September 30,

Payable to Services as of2003

2002

2003

2002

September 30,
2003

December 31,
2002(Millions)PSE&G

$
50


$
46


$
151


$
149


$
16


$
16Power


27



27



81



93



13



2Energy Holdings


4



5



12



15



1



3These transactions were recognized on each company's stand-alone financial statements and eliminated when preparing PSEG's consolidated financial statements. The cost of services provided by Services approximates market value for such services.
On July 31,
  2003, the BPU approved the sale by PSE&G to Services, of certain non-operating
  assets related to PSE&G's transmission and distribution operations with
  a net book value of approximately $53 million, together with associated rights
  and liabilities. The sale was completed on September 30, 2003 at net book
  value. A service agreement between PSE&G, Power, Energy Holdings and Services
  governs the level of services rendered between the companies.
Note 15. Guarantees of Debt
Power
In April 2001, Power issued $500 million of 6.875% Senior Notes due 2006, $800 million of 7.75% Senior Notes due 2011 and $500 million of 8.625% Senior Notes due 2031. Additionally, in June 2002, Power issued $600 million of 6.95% Senior
  Notes due 2012. Each series of the Senior Notes and Pollution Control Bonds
  is fully and unconditionally and jointly and severally guaranteed by Fossil,
  Nuclear and ER&T. The following table presents condensed financial information
  for the guarantor
43

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
subsidiaries, as well as Power's non-guarantor
  subsidiaries, for the quarters and nine months ended September 30, 2003
  and 2002.
Power
    
    
    
    Guarantor
        Subsidiaries
    
    
    
    Other
        Subsidiaries
    
    
    
    Consolidating
        Adjustments
    
    
    
    Total(Millions)For
      the Quarter Ended September 30, 2003:Operating
      Revenues
    
    $
    —
    
    
    $
    1,417
    
    
    $
    70
    
    
    $
    (239
    )
    
    $
    1,248Operating
      Expenses
    
    
    —
    
    
    
    1,216
    
    
    
    69
    
    
    
    (239
    )
    
    
    1,046Operating
      Income
    
    
    —
    
    
    
    201
    
    
    
    1
    
    
    
    —
    
    
    
    202Other
      Income
    
    
    168
    
    
    
    33
    
    
    
    29
    
    
    
    (197
    )
    
    
    33Other
      Deductions
    
    
    —
    
    
    
    (22
    )
    
    
    —
    
    
    
    —
    
    
    
    (22
    )Interest
      Expense
    
    
    (35
    )
    
    
    (25
    )
    
    
    (10
    )
    
    
    44
    
    
    
    (26
    )Income
      Taxes
    
    
    (23
    )
    
    
    (35
    )
    
    
    (19
    )
    
    
    —
    
    
    
    (77
    )Net
      Income (Loss)
    
    $
    110
    
    
    $
    152
    
    
    $
    1
    
    
    $
    (153
    )
    
    $
    110For
      the Nine Months Ended September 30, 2003:Operating
      Revenues
    
    $
    —
    
    
    $
    4,790
    
    
    $
    214
    
    
    $
    (691
    )
    
    $
    4,313Operating
      Expenses
    
    
    —
    
    
    
    4,113
    
    
    
    179
    
    
    
    (691
    )
    
    
    3,601Operating
      Income
    
    
    —
    
    
    
    677
    
    
    
    35
    
    
    
    —
    
    
    
    712Other
      Income
    
    
    844
    
    
    
    112
    
    
    
    87
    
    
    
    (936
    )
    
    
    107Other
      Deductions
    
    
    —
    
    
    
    (67
    )
    
    
    —
    
    
    
    —
    
    
    
    (67
    )Interest
      Expense
    
    
    (126
    )
    
    
    (64
    )
    
    
    6
    
    
    
    102
    
    
    
    (82
    )Income
      Taxes
    
    
    48
    
    
    
    (267
    )
    
    
    (55
    )
    
    
    —
    
    
    
    (274
    )Cumulative
      Effect of a Change in
              Accounting Principle
    
    
    —
    
    
    
    366
    
    
    
    4
    
    
    
    —
    
    
    
    370Net
      Income (Loss)
    
    $
    766
    
    
    $
    757
    
    
    $
    77
    
    
    $
    (834
    )
    
    $
    766For
      the Nine Months Ended September 30, 2003:Net
      Cash (Used In) Provided By
              Operating Activities
    
    $
    (146
    )
    
    $
    645
    
    
    $
    43
    
    
    $
    (22
    )
    
    $
    520Net
      Cash Provided By (Used In)
              Investing Activities
    
    $
    177
    
    
    $
    (389
    )
    
    $
    (22
    )
    
    $
    (291
    )
    
    $
    (525
    )Net
      Cash (Used In) Provided By
              Financing Activities
    
    $
    (26
    )
    
    $
    (270
    )
    
    $
    —
    
    
    $
    313
    
    
    $
    17For the Quarter
      Ended September 30, 2002:Operating
      Revenues
    
    $
    1
    
    
    $
    1,203
    
    
    $
    8
    
    
    $
    (139
    )
    
    $
    1,073Operating
      Expenses
    
    
    —
    
    
    
    964
    
    
    
    8
    
    
    
    (140
    )
    
    
    832Operating
      (Loss) Income
    
    
    1
    
    
    
    239
    
    
    
    —
    
    
    
    1
    
    
    
    241Other
      Income
    
    
    150
    
    
    
    —
    
    
    
    —
    
    
    
    (150
    )
    
    
    —Interest
      Expense
    
    
    (50
    )
    
    
    (15
    )
    
    
    31
    
    
    
    (1
    )
    
    
    (35
    )Income
      Taxes
    
    
    20
    
    
    
    (94
    )
    
    
    (11
    )
    
    
    —
    
    
    
    (85
    )Net
      Income (Loss)
    
    $
    121
    
    
    $
    130
    
    
    $
    20
    
    
    $
    (150
    )
    
    $
    121For
      the Nine Months Ended September 30, 2002:Operating
      Revenues
    
    $
    2
    
    
    $
    2,923
    
    
    $
    14
    
    
    $
    (598
    )
    
    $
    2,341Operating
      Expenses
    
    
    —
    
    
    
    2,280
    
    
    
    18
    
    
    
    (598
    )
    
    
    1,700Operating
      (Loss) Income
    
    
    2
    
    
    
    643
    
    
    
    (4
    )
    
    
    —
    
    
    
    641Other
      Income
    
    
    402
    
    
    
    —
    
    
    
    —
    
    
    
    (402
    )
    
    
    —Interest
      Expense
    
    
    (132
    )
    
    
    (45
    )
    
    
    87
    
    
    
    —
    
    
    
    (90
    )Income
      Taxes
    
    
    53
    
    
    
    (249
    )
    
    
    (30
    )
    
    
    —
    
    
    
    (226
    )Net
      Income (Loss)
    
    $
    325
    
    
    $
    349
    
    
    $
    53
    
    
    $
    (402
    )
    
    $
    32544

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Power
    
    
    
    Guarantor
        Subsidiaries
    
    
    
    Other
        Subsidiaries
    
    
    
    Consolidating
        Adjustments
    
    
    
    Total(Millions)For the Nine
      Months Ended September 30, 2002:Net
      Cash (Used In) Provided By
              Operating Activities
    
    $
    (371
    )
    
    $
    706
    
    
    $
    66
    
    
    $
    (212
    )
    
    $
    189Net
      Cash (Used In) Provided By
              Investing Activities
    
    $
    (2
    )
    
    $
    (489
    )
    
    $
    (280
    )
    
    $
    1
    
    
    $
    (770
    )Net
      Cash Provided By (Used In)
              Financing Activities
    
    $
    685
    
    
    $
    15
    
    
    $
    215
    
    
    $
    (328
    )
    
    $
    587As of September
      30, 2003:Current
      Assets
    
    $
    1,741
    
    
    $
    1,744
    
    
    $
    133
    
    
    $
    (2,179
    )
    
    $
    1,439Property,
      Plant and Equipment, net
    
    
    35
    
    
    
    2,640
    
    
    
    1,777
    
    
    
    —
    
    
    
    4,452Noncurrent
      Assets
    
    
    3,786
    
    
    
    1,610
    
    
    
    1,330
    
    
    
    (5,461
    )
    
    
    1,265Total
      Assets
    
    $
    5,562
    
    
    $
    5,994
    
    
    $
    3,240
    
    
    $
    (7,640
    )
    
    $
    7,156Current
      Liabilities
    
    $
    575
    
    
    $
    2,062
    
    
    $
    664
    
    
    $
    (2,271
    )
    
    $
    1,030Noncurrent
      Liabilities
    
    
    86
    
    
    
    457
    
    
    
    24
    
    
    
    (72
    )
    
    
    495Note
      Payable— Affiliated Company
    
    
    70
    
    
    
    1,150
    
    
    
    —
    
    
    
    (1,220
    )
    
    
    —Long-Term
      Debt
    
    
    2,516
    
    
    
    —
    
    
    
    800
    
    
    
    —
    
    
    
    3,316Member's
      Equity
    
    
    2,315
    
    
    
    2,325
    
    
    
    1,752
    
    
    
    (4,077
    )
    
    
    2,315Total
      Liabilities and Member's Equity
    
    $
    5,562
    
    
    $
    5,994
    
    
    $
    3,240
    
    
    $
    (7,640
    )
    
    $
    7,156As of December
      31, 2002:Current
      Assets
    
    $
    1,329
    
    
    $
    1,614
    
    
    $
    102
    
    
    $
    (1,479
    )
    
    $
    1,566Property,
      Plant and Equipment, net
    
    
    42
    
    
    
    2,430
    
    
    
    1,568
    
    
    
    —
    
    
    
    4,040Noncurrent
      Assets
    
    
    3,258
    
    
    
    1,772
    
    
    
    1,360
    
    
    
    (4,787
    )
    
    
    1,603Total
      Assets
    
    $
    4,629
    
    
    $
    5,816
    
    
    $
    3,030
    
    
    $
    (6,266
    )
    
    $
    7,209Current
      Liabilities
    
    $
    367
    
    
    $
    1,926
    
    
    $
    522
    
    
    $
    (1,503
    )
    
    $
    1,312Noncurrent
      Liabilities
    
    
    209
    
    
    
    1,006
    
    
    
    29
    
    
    
    (102
    )
    
    
    1,142Note
      Payable—Affiliated Company
    
    
    97
    
    
    
    1,150
    
    
    
    —
    
    
    
    (1,247
    )
    
    
    —Long-Term
      Debt
    
    
    2,516
    
    
    
    —
    
    
    
    800
    
    
    
    —
    
    
    
    3,316Member's
      Equity
    
    
    1,440
    
    
    
    1,734
    
    
    
    1,679
    
    
    
    (3,414
    )
    
    
    1,439Total
      Liabilities and Member's Equity
    
    $
    4,629
    
    
    $
    5,816
    
    
    $
    3,030
    
    
    $
    (6,266
    )
    
    $
    7,209Note 16. Subsequent Events
PSEG
On October
  7, 2003, PSEG issued approximately 8.8 million shares of its common stock for
  $356 million. The net proceeds from the offering were used for repayment of
  short-term debt.
PSEG and Power
In November
  1997, the Federal Energy Regulatory Commission (FERC) issued the Pennsylvania-New
  Jersey-Maryland Power Pool (PJM) Restructuring Order, which required PSE&G
  to modify its contract with Old Dominion Electric Cooperative (ODEC) to remove
  pancaked transmission rates. While PSE&G sought rehearing of this order,
  it was nonetheless required to reduce its rate to ODEC by approximately $6 million
  per year, effective April 1, 1998. On December 19, 2002, based on
  a court ruling, FERC reversed its November 1997 order, thereby reinstating the
  original contract terms. This allowed Power to collect amounts for April 1998
  through December 2002 pursuant to the original contract. Power billed ODEC for
  this amount in January 2003. Power has been billing, recording and receiving
  payment on the higher rate for services provided since January 2003. ODEC is
  paying such increased rates currently under protest, but had refused to pay
  past due amounts aggregating $31 million. On October 22, 2003, FERC issued
  its order denying ODEC's request for reconsideration and its request for a stay
  and allowing the contract rates to stand. The difference in revenues between
  the contracted rate and the FERC-ordered reduced rate of approximately $31 million,
  inclusive of back interest, will be recorded as Operating Revenues in the fourth
  quarter of 2003.
45

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (MD&A)
Following are the significant changes in or additions to information reported in the 2002 Annual Report on Form 10-K and Quarterly Reports on Form 10-Q for the quarters ending March 31, 2003 and June 30, 2003, affecting the consolidated financial condition and the results of operations of the registrants. This discussion refers to the registrants' Consolidated Financial Statements (Statements) and the related Notes to Consolidated Financial Statements (Notes) and should be read in conjunction with such Statements and Notes.
This combined MD&A is separately filed by Public Service Enterprise Group Incorporated (PSEG), Public Service Electric and Gas Company (PSE&G), PSEG Power LLC (Power), and PSEG Energy Holdings LLC (Energy Holdings). Information contained herein relating to any individual company is filed by such company on its own behalf. PSE&G, Power and Energy Holdings each make representations only as to itself and make no representations as to any other company.
OVERVIEW
PSEG
PSEG's business consists of four reportable segments, which are PSE&G and Power and two direct subsidiaries of Energy Holdings, PSEG Global LLC (Global) and PSEG Resources LLC (Resources). The following is a discussion of the major financial statement variances and follows the financial statement presentation as it relates to each of the segments. PSEG's results of operations are primarily comprised of the results of operations of its operating subsidiaries, PSE&G, Power and Energy Holdings. For a more detailed discussion of the changes referenced for PSEG, see the applicable results of operations discussion for each respective subsidiary registrant.
In the third quarter of 2003, PSEG reduced its earnings projection for 2003 Income from Continuing Operations from $3.70 to $3.90 per share to $3.60 to $3.75 per share. The reduction in earnings projections was principally a result of the effects of storm-related weather, including Hurricane Isabel in September 2003, on nuclear generation, electric distribution assets and related replacement power costs and also reflect a dilutive effect which will occur in the fourth quarter relating to the issuance of additional common equity in October 2003. In addition, PSEG has reviewed its 2004 guidance for Income from Continuing Operations and its long-term annual growth rate target in earnings per share and has indicated that the outcome will likely result in a reduction from a targeted 7% compound annual growth rate to a range
of 4% to 6%. The long-term earnings per share growth rate is affected by, among other things, electric capacity and energy prices, capital expenditures, potential dividend increases and changes in its capital structure. The dilutive effect of the issuance of the additional equity and other factors caused PSEG to reduce its 2004 earnings per share projections from $3.75 to $3.95 per share to a range of $3.60 to $3.80 per share.
In addition to factors affecting
  near-term earnings and the long-term growth rate referenced above, the results
  of the 2004 New Jersey Basic Generation Service (BGS) auction, expected to be
  held in February 2004, could have a material impact on this estimate. In October
  2003, the BPU approved the New Jersey Electric Distribution Companies' (EDCs)
  proposal relating to the auction process for 2004, under which contracts will
  be entered into for one-year and three-year tranches, similar to the 2003 process.
  Power's strategy is to continue to explore opportunities to enter into longer-term
  contracts to provide power in New Jersey, as well as other states which have
  issued requests to suppliers to provide energy, such as Connecticut and Maryland,
  and through bilateral agreements in its target markets.
Included
  in the revised 2003 earnings projection is an anticipated decline in Income
  from Continuing Operations for the fourth quarter of 2003 as compared to the
  same period in the prior year. The decrease is primarily at Power as a result
  of lower seasonal power rates approved in the New Jersey BGS auction for the
  fourth quarter of 2003 compared to the higher fixed annual rates in effect last
  year. Power experienced high margins in the fourth quarter of 2002 as its revenues
  were priced at the fixed annual BGS rate while it met its load obligations by
  sourcing low cost power in the shoulder months. Anticipated variations in both
  electric and gas volumes are also expected to contribute to the change. Also,
  Operation and Maintenance costs are expected to be higher due to several additional
  planned
46

outages in the fourth quarter of 2003 compared
  to 2002. At PSE&G, higher Operation and Maintenance costs are expected in
  the fourth quarter of 2003 due to higher pension costs and the absence of a
  temporary cost containment effort that was in effect for the latter part of
  2002. PSE&G's margins are also expected to be lower due to the effects of
  normal weather expected in the fourth quarter of 2003 compared to the cold weather
  in the fourth quarter of 2002, partially offset by the effects of the electric
  base rate case. Finally, the effect of the October 2003 stock issuance will
  also dilute earnings per share.
On October
  7, 2003, PSEG issued approximately 8.8 million shares of its common equity for
  $356 million in order to strengthen its capital structure and enhance its credit
  quality. Proceeds were used for the repayment of short-term debt.
The results for PSEG, PSE&G, Power and Energy Holdings for the quarter and nine months ended September 30, 2003 and 2002 are presented below:
Earnings (Losses)Quarter Ended
September 30,

Nine Months Ended
September 30,2003

2002

2003

2002(Millions)

(Millions)PSE&G

$
69


$
56


$
192


$
131Power


110



121



396



325Energy Holdings:Global (A)


32



24



89



(290
)Resources


17



21



54



35Other (B)


(1
)


(2
)


(3
)


(6
)Total Energy Holdings (A)


48



43



140



(261
)Other (C)


(14
)


(13
)


(44
)


(34
)PSEG Income from Continuing Operations (A)


213


    
207


    
684


    
161Loss from Discontinued Operations, including Loss on Disposal (D)


(3
)


(3
)


(20
)


(41
)Extraordinary Item (E)


—



—



(18
)


—Cumulative Effect of a Change in Accounting Principle (F)


—



—



370



(120
)PSEG Net Income (A)

$
210


$
204


$
1,016


$
—Contribution to Earnings Per Share (Diluted)Quarter Ended
September 30,

Nine Months Ended
September 30,2003

2002

2003

2002PSE&G

$
0.30


$
0.27


$
0.85


$
0.63Power


0.48



0.59



1.75



1.57Energy Holdings:Global (A)


0.14



    0.11



0.39



(1.40
)Resources


0.07



    0.10



0.24



0.17Other (B)


—



(0.01
)


(0.01
)


(0.03
)Total Energy Holdings (A)


0.21



0.20



0.62



(1.26
)Other (C)


(0.06
)


    (0.06
    )


(0.20
)


(0.16
)PSEG Income from Continuing Operations (A)

    
0.93


    
1.00


    
3.02


    
0.78Loss from Discontinued Operations, including Loss on Disposal (D)


(0.01
)


(0.01
)


(0.09
)


(0.20
)Extraordinary Item (E)


—



—



(0.08
)


—Cumulative Effect of a Change in Accounting Principle (F)


—



—



1.64



(0.58
)PSEG Net Income (A)

$
0.92


$
0.99


$
4.49


$
—47

(A)
    
    Includes after-tax write-down
      and losses related to Argentine investments of $374 million or $1.81 for
      the nine months ended September 30, 2002.(B)
    
    Other activities include
      non-segment amounts of Energy Holdings, PSEG Energy Technologies Inc. (Energy
      Technologies), Enterprise Group Development Corporation (EGDC) and intercompany
      eliminations. Specific amounts include interest on certain financing transactions
      and certain other administrative and general expenses at Energy Holdings.(C)
    
    Other activities include
      non-segment amounts of PSEG (parent company) and intercompany eliminations.
      Specific amounts include preferred securities dividends requirements for
      PSE&G and Energy Holdings, interest on certain financing transactions
      and certain other administrative and general expenses at PSEG (parent company).(D)
    
    Includes Discontinued
      Operations of Energy Technologies in 2003 and 2002 and Global's Tanir Bavi
      facility in 2002. See Note 6. Discontinued Operations of the Notes.(E)
    
    Relates to charge recorded
      in the second quarter of 2003 at PSE&G resulting from the decision issued
      by the New Jersey Board of Public Utilities (BPU) in PSE&G's Electric
      Base Rate Case in July 2003. See Note 4. Regulatory Issues of the Notes.(F)
    
    Relates to the adoption
      of Statement of Financial Accounting Standard (SFAS) No. 143, ''Asset
      Retirement Obligations'' (SFAS 143) in 2003 and the adoption of SFAS No. 142,
      ''Goodwill and Other Intangible Assets'' (SFAS 142) in 2002. See Note 2.
      New Accounting Standards and Note 3. Adoption of SFAS 143 of the
      Notes.The
  increase in Income from Continuing Operations for the quarter ended September 30,
  2003, as compared to the same period in 2002 was primarily due to improved earnings
  at PSE&G relating to increased electric base rates, seasonality in those
  rates as a result of the Electric Base Rate Case and lower interest costs, partially
  offset by higher Operation and Maintenance expense. Also contributing to the
  increase were higher earnings from Energy Holdings relating to operations at
  Global. Partially offsetting these increases were lower earnings at Power primarily
  related to the effects of storm-related weather and higher Operation and Maintenance
  expense offset by the benefits resulting from the operation of the two generating
  facilities in Connecticut that were acquired in December 2002. The growth in
  Income from Continuing Operations is not evidenced by the per share amounts
  shown above due to dilution caused mainly by the common stock issuance in the
  fourth quarter of 2002.
In addition
  to the items discussed above for the quarter, significant period-to-period increases
  in Income from Continuing Operations for the nine months ended September 30,
  2003, as compared to the same period in the prior year, was due primarily to
  the after-tax write-down of $374 million related to Energy Holdings' Argentine
  investments that were recorded in 2002. Also contributing to the increase were
  higher margins at Power driven by an increase in volume as a result of the BGS
  contracts that went into effect August 2002 and realized gains in its Nuclear
  Decommissioning Trust (NDT) portfolio, improved earnings at PSE&G due to
  favorable weather effects and improvements at Energy Holdings, largely due to
  the absence of write-downs of securities at Resources held within certain leveraged
  buyout funds recorded in the second quarter of 2002.
Included
  in PSEG's Net Income was an after-tax benefit in the amount of $370 million
  related to the adoption of SFAS 143 during the first quarter of 2003. This benefit
  was due mainly to the required remeasurement of Power's nuclear decommissioning
  obligations. Conversely, for the first quarter of 2002, PSEG adopted SFAS 142
  and incurred an after-tax charge of $120 million related to goodwill impairments
  at certain of Energy Holdings' investments.
Also
  contributing to the changes in Net Income was a decrease in Energy Holdings'
  Loss from Discontinued Operations of $21 million for the nine months ended September 30,
  2003, as compared to the same period in 2002, and an $18 million, after-tax,
  extraordinary charge recorded at PSE&G in the second quarter of 2003 related
  to the outcome of its Electric Base Rate Case, discussed below in PSE&G's
  Overview.

PSE&G
Income
  from Continuing Operations increased $13 million and $61 million for the quarter
  and nine months ended September 30, 2003, respectively, as compared to
  the same periods in 2002. PSE&G's

48

Earnings Available to PSEG increased $13
  million or 24% and $43 million or 34% for the quarter and nine months ended
  September 30, 2003, respectively, as compared to the same periods in 2002.
  The increases for the quarter were primarily due to the outcome of the Electric
  Base Rate Case as discussed further below. This resulted in increased electric
  distribution rates, and the seasonality of those rates, which significantly
  increased commercial and industrial customers' rates in the summer months. Also
  contributing to the increase in Income from Continuing Operations was lower
  interest expense due to reduced debt levels. This was offset by an increase
  in Operation and Maintenance expense as a result of increased labor and benefits
  charges, higher pension costs and storm-related costs. In addition to the items
  discussed for the quarter, the increases for the nine months ended September
  30, 2003, as compared to the same period in 2002, were attributable to higher
  gas volumes and favorable weather conditions, which were partially offset by
  certain charges recognized in the second quarter of 2003 in accordance with
  the Electric Base Rate Case. These changes include a pre-tax charge to Operating
  Revenues of $18 million relating to the Market Transition Charge (MTC) and a
  $30 million pre-tax, $18 million after-tax, extraordinary charge relating to
  the treatment of recoveries of nuclear decommissioning costs from ratepayers
  in the Electric Base Rate Case. A summary of the rate case outcome is discussed
  below.
PSE&G filed an Electric Base Rate Case in 2002 with the BPU requesting an annual increase of $250 million for its electric distribution business. In June 2003, a proposed settlement was filed with the Administrative Law Judge (ALJ) who subsequently recommended approval of the settlement to the BPU. In July 2003, PSE&G received an oral decision from the BPU approving the proposed settlement with certain modifications.
The following is a summary of the significant issues provided for in the oral decision and summary written order:
•
    
    PSE&G began charging
      its customers $159.5 million annual increase in its electric distribution
      rates August 1, 2003.•
    
    PSE&G has reduced
      its electric distribution depreciation rates from 3.52% to 2.49%, effective
      August 1, 2003. This change will reduce depreciation expense by approximately
      $40 million per year.•
    
    PSE&G recorded a
      regulatory liability in the second quarter of 2003 by reducing its depreciation
      reserve for its electric distribution assets by $155 million and will amortize
      the liability from August 1, 2003 through December 31, 2005. The
      annual amortization of this liability is $64 million and will result in
      a reduction of Depreciation and Amortization expense. Subsequent to the
      amortization of this reserve, the BPU's oral decision allows PSE&G to
      file for an additional $64 million annual increase in electric distribution
      rates effective January 1, 2006, subject to BPU approval, including
      a review of PSE&G's earnings and other relevant financial information.•
    
    PSE&G is refunding
      approximately $238 million to ratepayers through an adjustment of rates
      which include certain amounts related to the order PSE&G received from
      the BPU in 1999 relating to PSE&G's rate unbundling, stranded costs
      and restructuring proceedings. These amounts include a $30 million pre-tax
      refund related to amounts previously collected through the rates for nuclear
      decommissioning, which was accounted for as an Extraordinary Item as discussed
      further in Note 4. Regulatory Issues of the Notes. Also, PSE&G
      has begun to refund through rates an $18 million, pre-tax, amount for MTC
      overcollections which was recorded in full during the second quarter of
      2003 as a reduction to Operating Revenues and a $4 million, pre-tax, reduction
      in interest capitalized on various deferred balances and was recorded as
      a charge to Interest Expense.•
    
    PSE&G began to recover
      deferred Repair Allowances and deferred Restructuring Costs over a ten-year
      period commencing August 1, 2003.•
    
    PSE&G sold approximately
      $53 million of non-operating assets, at book value, to PSEG Services Corporation
      (Services) in the third quarter of 2003. For additional information, see
      Note 14. Related-Party Transactions of the Notes.49

Power
Power's
  Income from Continuing Operations decreased $11 million to $110 million and
  increased $71 million to $396 million for the quarter and nine months ended
  September 30, 2003, respectively, as compared to the same periods in 2002.
  The decrease for the quarter was mainly attributable to storm-related weather,
  including Hurricane Isabel in September 2003, which affected the transmission
  switchyards of Power's New Jersey nuclear generation facilities, and resulted
  in a temporary outage of the Salem and Hope Creek nuclear units, resulting in
  the need to purchase higher cost replacement power. The increase for the nine
  months ended September 30, 2003 was primarily due to higher margins from
  Power's electric load contracts driven by increased volume as a result of the
  August 2002 BGS contracts. Power also benefited throughout 2003 from its operation
  of two generating facilities in Connecticut that were acquired in December 2002.
  In addition, net gains realized in Power's NDT Fund were favorable for the quarter
  and nine months ended September 30, 2003 as compared to the same periods
  in 2002. Partially offsetting the increase was an increase in Operation and
  Maintenance expense as a result of storm-related weather and higher pension
  costs.
Earnings
  Available to PSEG were $110 million and $766 million for the quarter and nine
  months ended September 30, 2003, respectively, as compared to $121 million
  and $325 million for the same periods in 2002. Included in the nine months ended
  September 30, 2003 was the effect of the adoption of SFAS 143 resulting
  in an after-tax benefit of $370 million. The benefit is related to the required
  remeasurement of Power's asset retirement obligations, mainly nuclear decommissioning,
  within its businesses.
Energy Holdings
Energy Holdings' Income from Continuing Operations was $48 million and $140 million for the quarter and nine months ended September 30, 2003, respectively. Income (Losses) from Continuing Operations for the quarter and nine months ended September 30, 2002 were $43 million and $(261) million, respectively, which included after tax losses of $374 million for the nine months ended September 30, 2002, related to Global's abandoned investments in Argentina. Also contributing to the increase for the quarter and nine months ended September 30, 2003 was improved earnings from operations at Global, particularly its investments in Texas Independent Energy (TIE) and GWF Energy LLC (GWF Energy).
Earnings Available to PSEG were $39 million and $103 million for the quarter and nine months ended September 30, 2003, respectively, as compared to Earnings (Losses) Available to PSEG of $34 million and $(439) million in the same periods in 2002. The change was largely attributable to losses related to Global's investments in Argentina discussed above, and higher losses in 2002 from Discontinued Operations. The adoption of SFAS 142 in the first quarter of 2002, which resulted in an after-tax charge of $120 million, also contributed to the increase for the nine months ended September 30, 2003.
RESULTS OF OPERATIONS
PSEG
Operating Revenues
For
  the quarter ended September 30, 2003, Operating Revenues increased by $491
  million or 21%, as compared to the same period in 2002. This was primarily due
  to a change in the manner by which the BGS is purchased and sold, as discussed
  below. Also contributing to the increase were increased revenues of approximately
  $130 million from Power, primarily related to new load contracts with third-party
  wholesale electric suppliers which went into effect August 1, 2002 and increased
  energy sales into the New England Power Pool resulting from Power's operation
  of two generation facilities in Connecticut that were
  acquired in December 2002. In addition, PSE&G contributed increased Operating
  Revenues of $125 million due primarily to increased prices for gas and electricity
  and Energy Holdings' Operating Revenues increased $24 million primarily relating
  to higher generation revenues
50

from Global's projects, partially offset
  by lower distribution revenues and lower revenues from Resources.
For the nine months ended September 30, 2003, Operating Revenues increased by $2.9 billion or 51%, as compared to the same period in 2002. This was also due primarily to the BGS changes discussed below. Also contributing to the increase was an approximate $900 million increase in revenues from Power mainly related to load contract volume increases under the load contracts which commenced on August 1, 2002 and increased revenues from the two generation facilities in Connecticut, a $726 million increase in PSE&G's Operating Revenues due primarily to increased prices and sales volumes for gas and a $152 million increase in Energy Holdings' Operating Revenues relating to higher revenues from Global's generation projects and increased revenues at Resources.
As discussed
  above, a portion of the increase in Operating Revenues for the quarter and nine
  months ended September 30, 2003, as compared to the same periods in 2002,
  is due to the fact that Power's electric revenues are not being eliminated in
  consolidation subsequent to July 2002 by PSEG. Under the prior BGS contracts,
  which terminated on July 31, 2002, Power sold energy directly to PSE&G,
  which in turn sold this energy to its customers. These revenues were properly
  recognized on each company's stand-alone financial statements and were eliminated
  when preparing PSEG's Consolidated Financial Statements. For the BGS contract
  period beginning August 1, 2002, Power entered into contracts with third parties
  who are direct suppliers of New Jersey's Electric Distribution Companies (EDCs)
  and PSE&G purchases the energy for its customers' needs from direct third
  party suppliers. Due to this change in the BGS model, with the exception of
  a small portion of energy sold under the new contracts effective August 1,
  2003, as discussed below, these revenues are no longer intercompany revenues
  and, therefore, are not eliminated in consolidation. For the quarter and nine
  months ended September 30, 2003, PSEG's elimination related to the combined
  intercompany BGS and MTC revenues, decreased for those periods by approximately
  $190 million and $1 billion, respectively, as compared to the comparable periods
  in the prior year due primarily to this change. Also related to this change
  in the BGS model, PSE&G, in August 2002, began selling energy purchased
  under non-utility generation (NUG) contracts, which it had previously sold to
  Power, to the Pennsylvania-New Jersey-Maryland Power Pool (PJM), with the capacity
  purchased under these contracts being provided to the BGS suppliers on a pro-rata
  basis. As a result, for the quarter and nine months ended September 30,
  2003, PSEG's revenues related to NUG contracts increased by approximately $18
  million and $80 million, respectively.
As a participant in the BGS auction held in February 2003, Power entered into hourly energy price contracts to be a direct supplier of certain large customers for a ten-month period beginning August 1, 2003. Power also entered into contracts with third parties who are direct suppliers of New Jersey's EDCs. Under these load contracts, which took effect on August 1, 2003, Power supplies a small portion of energy and capacity directly to PSE&G while acting as a direct supplier for certain large customers of PSE&G. These intercompany amounts between PSE&G and Power are eliminated when preparing PSEG's Consolidated Financial Statements. For the quarter ended September 30, 2003, Power charged PSE&G approximately $15 million under this agreement, which is included in the amounts discussed above.
Operating Expenses
Energy Costs
For
  the quarter ended September 30, 2003, as compared to the quarter ended
  September 30, 2002, Energy Costs increased approximately $414 million or
  35% primarily due to the fact that PSE&G no longer purchases electric energy
  directly from Power, as discussed above in Operating Revenues. Amounts attributable
  to this change totaled approximately $208 million between the quarters ended
  September 30, 2003 and 2002. Also contributing to the increase were a $111
  million net increase in natural gas costs, an $80 million increase at Power
  primarily related to increased energy purchases and third-party wholesale electric
  supply contracts, discussed further below under Power, a $16 million increase
  in electric energy costs at PSE&G discussed further below under PSE&G.
51

For the nine months ended September 30, 2003, as compared to the nine months ended September 30, 2002, Energy Costs increased approximately $2.6 billion or 109% due primarily to the fact that PSE&G no longer purchases electric energy directly from Power, as discussed above in Operating Revenues. Amounts attributable to this change totaled approximately $1.1 billion between the nine months ended September 30, 2003 and 2002. Also contributing to the increase were an approximate $700 million net increase in gas costs, a $634 million increase at Power primarily related to increased power purchases and third-party wholesale electric supply contracts, discussed further below under Power, a $99 million increase in electric energy costs at PSE&G discussed further below under PSE&G and a $39 million
increase at Energy Holdings, relating to projects at Global, discussed further below under Energy Holdings.
Operation and Maintenance
For
  the quarter ended September 30, 2003, Operation and Maintenance expense
  increased $76 million or 17%, as compared to the quarter ended September 30,
  2002, due to a $44 million increase at Power primarily due to the acquisition
  of the generating facilities in Connecticut in December 2002, higher pension
  costs, higher accretion expense and higher nuclear refueling outage costs and
  a $34 million increase at PSE&G due primarily to higher labor and fringe
  benefit costs and storm-related costs, discussed further below under PSE&G.
For
  the nine months ended September 30, 2003, Operation and Maintenance expense
  increased $163 million or 12%, as compared to the nine months ended September 30,
  2002 due to a $99 million increase at Power primarily due to the acquisition
  of the generating facilities in Connecticut in December 2002, higher pension
  costs, higher accretion expense and higher nuclear refueling outage costs and
  a $50 million increase at PSE&G due primarily to higher labor and fringe
  benefit costs, higher Demand Side Management (DSM) amortization, higher bad
  debt expense and storm-related costs, discussed further below under PSE&G.
  In addition, Operation and Maintenance expense increased at Energy Holdings
  by $11 million, due mainly to costs associated with projects at Global as discussed
  further below under Energy Holdings.
Depreciation and Amortization
For
  the quarter and nine months ended September 30, 2003, Depreciation and
  Amortization decreased by $1 million and $64 million, respectively, as compared
  to the same periods in 2002. The decrease for the nine months was primarily
  due to a $66 million decrease at PSE&G as discussed further below under
  PSE&G.
Taxes Other Than Income Taxes
Taxes Other Than Income Taxes is comprised of the Transitional Energy Facility Assessment (TEFA) tax at PSE&G. Taxes Other Than Income Taxes decreased $2 million or 6% and increased $6 million or 6% for the quarter and nine months ended September 30, 2003, respectively, as compared to the same periods in 2002. The changes in the amount of the TEFA related to changes in PSE&G's taxable sales in 2003. Legislation enacted in January 2002 freezes the TEFA unit rate surcharges at the 2001 levels through 2004 and then reduces the rates over the next three years, phasing out the TEFA by 2007.
Income from Equity Method Investments
For
  the quarter ended September 30, 2003, Income from Equity Method Investments
  increased by $1 million or 3% to $33 million from $32 million for the quarter
  ended September 30, 2002. For the nine months ended September 30,
  2003, Income from Equity Method Investments decreased by $13 million or 14%
  to $82 million from $95 million for the nine months ended September 30,
  2002. These decreases are primarily due to lower earnings in 2003 of $12 million
  at Rio Grande Energia (RGE) and lower interest income of $4 million related
  to the Eagle Point Cogeneration Partnership (EPCP).
52

Other Income
For
  the quarter ended September 30, 2003, Other Income increased by $16 million,
  as compared to the quarter ended September 30, 2002, due primarily to a
  $33 million increase at Power mainly related to realized gains and the recognition
  of interest and dividend income in its Nuclear Decommissioning Trust (NDT) Fund.
  This was partially offset by the absence of favorable changes in derivative
  fair values at Energy Holdings of $12 million.
For the nine months ended September 30, 2003, Other Income increased by $97 million, as compared to the nine months ended September 30, 2002, due primarily to a $107 million increase at Power and an $9 million increase at PSE&G, partially offset by a $18 million decrease at Energy Holdings. Power's increase was due to realized gains and the recognition of interest and dividend income in its NDT Fund. The increase at PSE&G was primarily due to gains on the disposal of various electric properties and gains from short-term investments. The decrease at Energy Holdings was primarily related to the change in derivative fair values.
Other Deductions
For the quarter ended September 30, 2003, Other Deductions increased by $26 million, as compared to the quarter ended September 30, 2002, primarily due to the recognition of $22 million of realized losses in Power's NDT Fund.
For
  the nine months ended September 30, 2003, Other Deductions increased by
  $22 million, as compared to the nine months ended September 30, 2002, due
  primarily to the recognition of $67 million of realized losses in Power's NDT
  Fund combined with $14 million in net derivative losses and $12 million in minority
  interest losses at Energy Holdings. This was partially offset by a decrease
  of $71 million in foreign currency transaction losses, primarily related to
  US Dollar debt in Argentina recorded in 2002.
Interest Expense
For the quarter ended September 30, 2003, Interest Expense decreased by $4 million or 2%, as compared to the quarter ended September 30, 2002, primarily due to a $4 million, $9 million and $1 million decrease at PSE&G, Power and Energy Holdings, respectively, as discussed below, partially offset by a $10 million increase at PSEG related to higher levels of debt outstanding.
For the nine months ended September 30, 2003, Interest Expense increased by $3 million, as compared to the nine months ended September 30, 2002, primarily due to a $31 million increase at PSEG related to higher levels of debt outstanding, partially offset by decreases of $16 million, $8 million and $4 million at PSE&G, Power and Energy Holdings, respectively, as discussed below.
Income Taxes
For the quarter and nine months ended September 30, 2003, Income Taxes decreased by $7 million and increased by $254 million, respectively, as compared to the quarter and nine months ended September 30, 2002, due primarily to a decrease for the quarter and an increase for the nine months in pre-tax income.
Losses From Discontinued Operations
Operating
  results of Energy Technologies' HVAC/mechanical operating companies have been
  reclassified into Discontinued Operations in the Consolidated Statements of
  Operations. The results of operations of these discontinued operations for the
  quarter ended September 30, 2003 and 2002 yielded after-tax losses of $3
  million in each period. The results of operations of these discontinued operations
  for the nine months ended September 30, 2003 and 2002 yielded after-tax
  losses of $11 million and $12 million, respectively. During 2003, Energy Holdings
  re-evaluated the carrying value of Energy Technologies' assets and liabilities
  and determined that market conditions required
  an additional write-down to fair value less cost to sell. Energy Holdings recorded
  an additional loss on disposal of
  Energy
53

Technologies of $9 million, net of a $2 million tax benefit. The sale of the HVAC companies was complete as of September 30, 2003.
In addition, Tanir Bavi Power Company Ltd. (Tanir Bavi) was sold in the fourth quarter of 2002. The operating results of Tanir Bavi for the nine months ended September 30, 2002 yielded after-tax income of $5 million. For additional information, see Note 6. Discontinued Operations of the Notes.
Extraordinary Item
As discussed
  previously, included in the Electric Base Rate Case summary written order issued
  by the BPU was a $30 million refund related to revenues collected through rates
  for nuclear decommissioning. These nuclear decommissioning revenues were included
  in PSE&G's impairment analysis performed in 1999 and in accordance with
  SFAS No. 101, ''Regulated Enterprises—Accounting for the Discontinuation
  of Application of FASB Statement No. 71'' (SFAS 101) which resulted in
  an extraordinary charge to earnings. Because this amount is an adjustment to
  the original charge, PSE&G has recorded it as an $18 million, after-tax,
  Extraordinary Item as required under Accounting Principles Board (APB) No. 30,
  ''Reporting the Results of Operations—Reporting the Effects of Disposal
  of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
  Events and Transactions'' (APB 30). For additional information, see Note 4.
  Regulatory Issues of the Notes.
Cumulative Effect of a Change in Accounting Principle
For the nine months ended September 30, 2003, Power recorded a $370 million, after-tax, benefit relating to the adoption of SFAS 143, as detailed further below under Power. For the nine months ended September 30, 2002, Energy Holdings recorded a $120 million, after-tax, charge due to goodwill impairments relating to the adoption of SFAS 142, as detailed further below under Energy Holdings.
PSE&G
Operating Revenues
PSE&G's
  Operating Revenues increased by $125 million or 9% for the quarter ended September 30,
  2003 as compared to the quarter ended September 30, 2002, due to a $66
  million increase in gas revenues and a $59 million increase in electric revenues.
The
  increase in gas revenues was primarily related to a $62 million increase due
  to price changes and $3 million due to higher sales volumes. The commodity price
  of gas for commercial and industrial customers varies monthly while changes
  for residential customers must be approved by the BPU. The average cost for
  gas purchased during the quarter ended September 30, 2003 increased by
  55%, as compared to the same period in 2002. Total sales volumes increased by
  9% for the quarter ended September 30, 2003, as compared to the same period
  in 2002.
The increase in electric revenues resulted from a $140 million increase due to price changes primarily relating to higher rates set in the BGS auction and the impact of the summary written order received in the Electric Base Rate Case, both of which took effect on August 1, 2003. See the Overview for a discussion of the impact of the Electric Base Rate Case. This increase was offset by $80 million in lower sales volumes. Distribution sales volumes are lower by 3% primarily due to a milder summer in 2003 and lower BGS volumes by 10% due to the milder weather plus large customers switching to third party suppliers. The switching is driven by the addition of a retail adder to the BGS rates, which took effect August 1, 2003.
PSE&G's
  Operating Revenues increased by $726 million or 17% for the nine months ended
  September 30, 2003, as compared to the nine months ended September 30,
  2002, due to a $697 increase in gas revenues and a $29 million increase in electric
  revenues for the nine months ended September 30, 2003.

The
  increase in gas revenues primarily related to a $413 million increase due to
  price changes and $284 million due to higher sales volumes. The average cost
  for gas purchased during the nine months ended September 30, 2003 increased
  by 29%, as compared to the same period in 2002. Total gas sales


54

volumes increased
  by 20% for the nine months ended September 30, 2003, as compared to the same
  period in 2002, due primarily to favorable weather conditions this past winter.
The
  $29 million increase in electric revenues resulted from a $73 million increase
  due to price changes primarily relating to higher rates set in the BGS auction
  and the impact of the summary written order received in the Electric Base Rate
  Case, as discussed above, which was partially offset the 4.9% rate reduction
  which was effective on August 1, 2002 through July 31, 2003, combined with increased
  sales of NUG power, primarily due to higher locational marginal pricing in the
  PJM market. The increases related to price changes was partially offset by $44
  million in lower sales volumes. While distribution sales volumes are higher
  by 1%, BGS volumes are down 3% due to large customers switching to third party
  suppliers, as discussed above.
Operating Expenses
Energy Costs
For the quarter and nine months ended September 30, 2003, Energy Costs increased $78 million and $687 million, respectively, as compared to the same periods in 2002. Energy costs represent the cost of electric and gas purchases necessary to meet customer load. The differences between energy cost incurred and associated energy revenue is deferred for future collection or refund to customers.
Gas costs increased $62 million and $588 million for the quarter and nine months ended September 30, 2003 respectively, as compared to the same periods in 2002. The $62 million increase for the quarter was entirely driven by a 55% increase in the price of gas. The $588 million increase for the nine months ended is a combination of a 29% increase in the price of gas ($416 million) and a 20% increase in sales volumes ($172 million).
Electric
  costs increased $16 million and $99 million for the quarter and nine months
  ended September 30, 2003 respectively, as compared to the same periods
  in 2002. The $16 million increase for the quarter is a combination of higher
  prices for BGS and NUG purchases ($91 million) offset by lower BGS and NUG volumes
  ($75 million). The $99 million increase for the nine months ended is the combination
  of higher prices for BGS and NUG purchases and higher MTC payments ($174 million)
  offset by lower BGS and NUG volumes ($75 million). As described above under
  revenues, BGS volumes are declining due to large customers switching to third
  party suppliers. NUG volumes are determined by the function of the NUG generator
  and contract limits.
Operation and Maintenance
Operation
  and Maintenance costs increased $34 million or 15% and $50 million or 7% for
  the quarter and nine months ended September 30, 2003 respectively, as compared
  to the same periods in 2002.
The
  increase for the quarter primarily relates to increased labor and fringe benefits
  of $17 million, due primarily to higher health and medical costs, Other Postretirement
  Benefit (OPEB) and pension costs combined. Also contributing to the increase
  were higher general and administrative costs and higher outside services primarily
  due to storm-related expenses attributable to Hurricane Isabel in September 2003.
The increase for the nine months ended September 30, 2003 primarily relates to higher labor and fringe benefits of $38 million, due primarily to wage and incentive increases and the cost of a severance program and higher pension costs. Also contributing to the increase were higher bad debt expense of $9 million due to high gas sales volumes last winter, increased weather and storm-related expenses of $6 million, due to Hurricane Isabel and the extreme weather last winter and higher DSM costs of approximately $28 million relating to the increased sales volumes, discussed above. DSM costs are deferred when incurred and amortized to expense when recovered in revenues. Partially offsetting these increases is the reduction in real estate tax expense of $18 million and the reversal of a $10 million reserve against a
regulatory asset that is now being recovered.
55

Depreciation and Amortization
Depreciation and Amortization decreased $3 million or 2% for the third quarter of 2003, as compared to the third quarter of 2002, primarily due to a decrease in the book depreciation rate for distribution plant, which took effect in August 2003 with the conclusion of the Electric Base Rate Case.
Depreciation and Amortization decreased $66 million or 21% for the nine months ended September 30, 2003, as compared to the nine months ended September 30, 2002, due primarily to a $73 million reduction relating to the amortization of an excess electric distribution depreciation reserve and a decrease in the book depreciation rate for electric distribution plant, discussed above. Partially offsetting this decrease was a $9 million increase in depreciation expense due to increased plant in service.
Taxes Other Than Income Taxes
Taxes Other Than Income Taxes is comprised of the Transitional Energy Facility Assessment (TEFA) tax at PSE&G. Taxes Other Than Income Taxes decreased $2 million or 6% and increased $6 million or 6% for the quarter and nine months ended September 30, 2003, respectively, as compared to the same periods in 2002. The changes in the amount of the TEFA related to changes in taxable sales in 2003. Legislation enacted in January 2002 freezes the TEFA unit rate surcharges at the 2001 levels through 2004 and then reduces the rates over the next three years, phasing out the TEFA by 2007.
Other Income
Other Income decreased $2 million for the quarter ended September 30, 2003, as compared to the same period of 2002, due primarily to declines in short-term investments.
Other Income increased $9 million for the nine months ended September 30, 2003, as compared to the nine months ended September 30, 2002 due primarily to gains on the disposal of various electric transmission properties.
Interest Expense
Interest Expense decreased by $4 million or 4% and $16 million or 5% for the quarter and nine months ended September 30, 2003, respectively, as compared to the same periods in 2002. These decreases were due primarily to lower interest on long-term debt of $7 million and $23 million for the quarter and nine months ended September 30, 2003, respectively, as compared to the same periods in 2002, primarily due to lower average debt outstanding for the periods in 2003 as compared to the periods in 2002. These decreases were partially offset by increased short-term interest expense due to higher short-term debt balances outstanding and increased interest associated with carrying charges on certain regulatory assets.
Income Taxes
Income Taxes increased by $7 million or 23% and $13 million or 18% for the quarter and nine months ended September 30, 2003, respectively, as compared to the same periods in 2002, due primarily to increases in pre-tax income offset by increased benefits primarily attributable to the excess depreciation reserve adjustment in 2003.
Extraordinary Item
As discussed previously, included in the Electric Base Rate Case decision issued by the BPU was a $30 million refund related to revenues collected through the SBC for nuclear decommissioning. These nuclear decommissioning revenues were included in PSE&G's impairment analysis performed in 1999, and in accordance with SFAS 101 resulted in an extraordinary charge to earnings. Because this amount is an adjustment to the original charge, it has been recorded as an $18 million, after-tax, Extraordinary Item as required under APB 30. For additional information, see Note 4. Regulatory Issues of the Notes.
56
Power
Operating Revenues
For
  the quarter ended September 30, 2003, Operating Revenues increased $175
  million, as compared to the quarter ended September 30, 2002 primarily
  related to increased generation revenues of approximately $90 million resulting
  from an increased supply of generation under the load contracts with third party
  suppliers of BGS, which went into effect on August 1, 2002. Also contributing
  to the increased generation revenues was the participation in the New England
  Power Market, mainly as the result of the acquisition of two Connecticut facilities
  in December 2002 and the revenues from the generating facility in Waterford,
  Ohio, which commenced operation in August 2003. Gas supply revenues also increased
  by approximately $80 million due primarily to higher sales volumes and higher
  gas prices. For the quarter ended September 30, 2003, residential sales
  volumes were up approximately 10%, as compared to the prior period in 2002.
For
  the nine months ended September 30, 2003, Operating Revenues increased
  approximately $2 billion, as compared to the nine months ended September 30,
  2002, primarily due to an increase in gas supply revenues of approximately $1.2
  billion. The increase for the nine months ended September 30, 2003 primarily
  relates to the fact that the BGSS contract with PSE&G did not commence until
  May 2002, therefore, Power did not have an operational gas business for the
  first four months of 2002. Gas revenues for the first four months of 2003, totaled
  $1.1 billion. Also contributing to the increase in gas revenues were higher
  sales volumes and higher gas prices, as discussed above. Generation revenues
  also increased approximately $740 million for the nine months ended September 30,
  2003 as compared to the same period in 2002 due to the increased supply obligations
  and new operations, as discussed above, combined with additional MTC revenues
  of $19 million, as compared to the same period in 2002.
Operating Expenses
Energy Costs
Energy
  costs represent the cost of generation, which includes fuel purchases for generation,
  as well as purchased energy in the market and gas purchases to meet Power's
  obligation under its BGSS contract with PSE&G. For the quarter ended September 30,
  2003, Energy Costs increased $172 million, as compared to the same periods in
  2002, primarily due to higher gas costs relating to the BGSS contract with PSE&G
  and higher fuel expenses for generation which together contributed approximately
  $99 million. In addition, increased energy purchases in the spot market and
  bilateral energy purchases necessary to meet the increased obligations under
  the new load contracts, which went into effect on August 1, 2002 and to satisfy
  additional load requirements as a result of Power's storm-related nuclear outages
  in the third quarter amounted to approximately $55 million. Also, Power incurred
  additional charges associated with energy purchases to satisfy wholesale power
  agreements related to its Connecticut generating facilities, which totaled approximately
  $20 million for the quarter ended September 30, 2003.
For the nine months ended September 30, 2003, Energy Costs increased approximately $1.8 billion, as compared to the same periods in 2002, primarily due to a $1.3 billion increase relating to the fact that Power did not have an operational gas business for the first four months of 2002 combined with higher gas sales volumes and prices and higher gas, oil and coal costs for generation. Additionally, the increase in Energy Costs was due to increased energy purchases on the spot market, as well as bilateral energy purchases, as discussed above, which amounted to approximately $320 million. Also, Power incurred an increase of approximately $140 million in network transmission expenses for the nine months ended September 30, 2003 as compared to the same period in 2002 given that there were no payments for the first
seven months in 2002. Additional charges associated with energy purchases to satisfy wholesale power agreements related to its Connecticut generating facilities totaled approximately $40 million for the nine months ended September 30, 2003.
57

Operation and Maintenance
Operation
  and Maintenance expense increased $44 million or 25% and $99 million or 18%
  for the quarter and nine months ended September 30, 2003, respectively,
  from the comparable periods in 2002. This was primarily due to the acquisition
  of the generating facilities in Connecticut in December 2002, which increased
  Operation and Maintenance expenses by $14 million and $36 million for the quarter
  and nine months ended September 30, 2003, respectively, as compared to
  the same periods in 2002. Also contributing to the increase were accretion expense
  of $6 million and $18 million for the quarter and nine months ended September 30,
  2003, respectively, associated with the nuclear decommissioning liabilities,
  higher pension expenses of $6 million and $14 million for the quarter and nine
  months ended September 30, 2003, respectively, as compared to the prior
  periods and higher nuclear refueling outage costs of $4 million and $23 million
  for the quarter and nine months ended September 30, 2003, as compared to
  the prior periods. Higher real estate taxes also contributed to the increase
  for the quarter and nine months ended September 30, 2003, as compared to
  the same period in 2002.
Depreciation and Amortization
Depreciation
  and Amortization expense decreased $2 million or 7% and $5 million or 6% for
  the quarter and nine months ended September 30, 2003, respectively, from
  the comparable periods in 2002. Power had higher depreciation expense of approximately
  $5 million and $14 million for the quarter and nine months ended September 30,
  2003, respectively, due primarily to the acquisition of the generating facilities
  in Connecticut in December 2002 and a higher asset base. However, these increases
  were more than offset by the absence of decommissioning charges, which are no
  longer recorded as a result of the implementation of SFAS 143. Such charges
  amounted to $7 million and $22 million for the quarter and nine months ended
  September 30, 2002, respectively.
Other Income
Other Income increased $33 million and $107 million for the quarter and nine months ended September 30, 2003, respectively, from the comparable periods in 2002, due primarily to the recording of realized gains and income on the NDT Fund.
Other Deductions
Other Deductions increased $22 million and $67 million for the quarter and nine months ended September 30, 2003, respectively, from the comparable periods in 2002, due primarily to the recording of realized losses on the NDT Fund.
Interest Expense
Interest Expense decreased by $9 million and $8 million for the quarter and nine months ended September 30, 2003, respectively, as compared to the same periods in 2002. Power incurred lower interest expense of approximately $4 million for the quarter ended September 30, 2003, as compared to the prior period in 2002, due primarily to lower interest rates and lower amortization expense associated with the Waterford and Lawrenceburg non-recourse variable rate debt. Power incurred additional interest charges of $18 million for the nine months ended September 30, 2003, due primarily to the new financing of $600 million in June 2002, this increase was offset by lower interest expense on variable rate debt and other lower charges of approximately $6 million. Additionally, capitalized interest relating to various
construction projects reduced interest expense by approximately $4 million and $20 million for the quarter and nine months ended September 30, 2003, as compared to the prior periods in 2002.
Income Taxes
Income taxes decreased by $8 million or 9% and increased by $48 million or 21% for the quarter and nine months ended September 30, 2003, respectively, as compared to the quarter ended September 30, 2002, due primarily to a changes in pre-tax income.
58

Cumulative Effect of Change in Accounting Principle
Power has performed a review of its potential obligations under SFAS 143 and believes that its quantifiable obligations are primarily related to the decommissioning of its nuclear power plants. Upon adoption of this standard on January 1, 2003, Power recorded a Cumulative Effect of a Change in Accounting Principle in the amount of $370 million, after-tax. For additional information, see Note 3. Adoption of SFAS 143 of the Notes.
Energy Holdings
Operating Revenues
For the quarter ended September 30, 2003, Energy Holdings' Operating Revenues increased $24 million, or 13%, to $211 million from the comparable period in 2002. This increase was driven by higher electric generation revenues at Global of $37 million. Partially offsetting this increase was lower electric distribution revenue at Global of $5 million, as well as decreased revenues at Resources of $6 million, as discussed below.
For the nine months ended September 30, 2003, Energy Holdings' Operating Revenues increased $152 million, or 33%, to $608 million from the comparable period in 2002. This increase was driven by higher electric generation revenues at Global of $163 million and an increase in revenues at Resources of $20 million. This increase was partially offset by lower electric distribution and other electric revenue at Global in 2003 of $29 million, as discussed below.
Global
For the quarter ended September 30, 2003, Operating Revenues increased by $31 million or 28% to $143 million from $112 million for the quarter ended September 30, 2002. The increase in revenue was primarily due to increased revenue from GWF Energy of $19 million. In the second half of 2002, Global's ownership of GWF Energy exceeded 75% and under the operating agreement Global gained a controlling interest. Accordingly, Global consolidates GWF Energy, as compared to the third quarter 2002 when it was recorded under the equity method. Also contributing to the increase was a $14 million increase from Salalah, a generation facility in Oman, which began commercial operation in May 2003, a $6 million increase from Skawina, a generation facility in Poland, in which Global purchased a majority ownership in June 2002,
and a $4 million increase from SAESA, a distribution facility in Chile due to improved sales volume compared to same period in 2002. These increases were partially offset by the absence of $10 million from Empresa Distribuidora de Electricidad de Entre Rios S.A. (EDEERSA), in Argentina, which was fully written off in 2002. Also offsetting the increase was a decrease of $4 million from Rades, a generation facility in Tunisia.
For the nine months ended September 30, 2003, Operating Revenues increased $131 million or 45% to $422 million from $291 million for the nine months ended September 30, 2002. The increase in revenue was due to increases of $56 million, $41 million, $38 million, and $24 million from Skawina, GWF Energy, Rades, and Salalah, respectively. These increases were partially offset by a decrease of $30 million from EDEERSA.
Resources
For the quarter ended September 30, 2003, Operating Revenues decreased $6 million or 9% to $61 million from $67 million for the quarter ended September 30, 2002. The decrease was primarily related to lower lease income of $4 million compared to the same period in 2002, as well as $2 million decrease of other than temporary impairments of non-publicly traded equity securities held within the leveraged buyout funds.
For the nine months ended September 30, 2003, Operating Revenues increased $20 million or 13% to $178 million from $158 million for the nine months ended September 30, 2002. This increase was primarily related to a $31 million net decrease of other than temporary impairments of non-publicly traded equity securities held within the leveraged buyout funds. Partially offsetting this increase is was a $10 million decrease in income from capital leases due to terminated leases.
59
Operating Expenses
For the quarter ended September 30, 2003, Operating Expenses increased $2 million or 2% to $116 million from $114 million for the quarter ended September 30, 2002. This increase was primarily due to increases in operating expenses of $10 million, $6 million and $5 million from Salalah, GWF Energy and Skawina, respectively, all due to those plants being in operation for the full quarter of 2003 and, for GWF Energy, recorded as a consolidated company in the current year. These increases were partially offset by decreased operating expenses in the third quarter 2003 compared to the same period in 2002 for EDEERSA of $6 million, which was fully written off in 2002. Also partially offsetting this increase was decreased general and administrative expenses at Global of $6 million and decreased operating expenses at Rades
of $5 million.
For the nine months ended September 30, 2003, Operating Expenses decreased $441 million or 58% to $315 million from $756 million for the nine months ended September 30, 2002. This decrease was primarily due to the write-off of project investments in Argentina at Global of $506 million in the second quarter of 2002, as well as decreased operating expenses in the 2003 compared to the same period in 2002 in EDEERSA of $19 million due to EDEERSA being fully written off in 2002. Also contributing was decreased general and administrative expenses at Global of $15 million. Partially offsetting this decrease was an increase in operating expenses of $38 million from Skawina, $24 million from Rades, $16 million from Salalah and a $12 million from GWF Energy, all of which were in operation in 2003 and only partially
in operation for the same period in 2002. Also partially offsetting this decrease is increased Operation and Maintenance expense of $18 million in 2003 compared to the same period in 2002 due to additional plants being in operation in 2003.
Income from Equity Method Investments
For
  the quarter ended September 30, 2003, Income from Equity Method Investments
  increased by $1 million or 3% to $33 million from $32 million for the quarter
  ended September 30, 2002. For the nine months ended September 30,
  2003 Income from Equity Method Investments decreased by $13 million or 14% to
  $82 million from $95 million for the nine months ended September 30, 2002.
  These decreases are primarily due to lower earnings in 2003 of $12 million at
  RGE and lower interest income in 2003 of $4 million from EPCP.
Other Income
For the quarter and nine months ended September 30, 2003, Other Income decreased by $16 million and $18 million, respectively, compared to the same prior year periods due primarily to the absence of favorable changes in fair value relating to derivative instruments held by Energy Holdings.
Other Deductions
For the quarter ended September 30, 2003, Other Deductions increased by $1 million due primarily to changes in fair value relating to derivative instruments held by Energy Holdings.
For
  the nine months ended September 30, 2003, Other Deductions decreased by
  $57 million to $14 million. The decrease was largely due to a $71 million foreign
  currency transaction loss in 2002. This decrease was partially offset by an
  increase of $12 million in net derivative losses in 2003.
Interest Expense
For the quarter ended September 30, 2003, net Interest Expense decreased by $1 million or 2% to $60 million from $61 million for the quarter ended September 30, 2002. For the nine months ended September 30, 2003, net Interest Expense decreased $4 million or 2% to $164 million from $168 million for the nine months ended September 30, 2002.
Income
  Taxes
Income
  Taxes decreased $1 million for the quarter ended September 30, 2003, as
  compared to same period in 2002. Income Taxes increased $208 million to $48
  million for the nine months ended September 30, 2003 from the comparable
  period in 2002. This increase is attributed to the increase in

60

taxable
  income for the nine months ended September 30, 2003, as compared to tax
  benefits in the same period in 2002 related to pre-tax losses.
Losses From Discontinued Operations
In September 2003, Energy Holdings completed the sale of the remaining companies of Energy Technologies. Operating results of Energy Technologies' HVAC/mechanical operating companies have been reclassified into Discontinued Operations in the Consolidated Statements of Operations. The results of operations of these discontinued operations for the quarter ended September 30, 2003 and 2002 yielded after-tax losses of $3 million. The results of operations of these discontinued operations for the nine months ended September 30, 2003 and 2002 yielded after-tax losses of $11 million and $12 million, respectively.
In addition, Tanir Bavi was sold in the fourth quarter of 2002. The operating results of Tanir Bavi for the nine months ended September 30, 2002 yielded after-tax income of $5 million. For additional information, see Note 6. Discontinued Operations of the Notes.
Cumulative Effect of Change in Accounting Principle
In 2002, Energy Holdings finalized the evaluation of the effect of adopting SFAS 142 on the recorded amount of goodwill. The total amount of goodwill impairments was $120 million, net of tax of $66 million and was comprised of write-downs of $36 million (after-tax) at EDEERSA, $34 million (after-tax) at RGE, $32 million (after-tax) at Energy Technologies and $18 million (after-tax) at Tanir Bavi. All of the goodwill related to these companies, other than RGE, was fully written off.
LIQUIDITY AND CAPITAL RESOURCES
The following discussion of liquidity and capital resources is on a consolidated basis for PSEG, noting the uses and contributions of PSEG's three direct operating subsidiaries, PSE&G, Power and Energy Holdings.
Operating Cash Flows
PSEG
PSEG's
  operating cash flow increased approximately $22 million from $859 million to
  $881 million for the nine months ended September 30, 2003, as compared
  to the nine months ended September 30, 2002, due primarily to increases
  of $49 million at PSEG, $331 million at Power and $50 million at Energy Holdings,
  largely offset by a $416 million decrease at PSE&G. PSEG's operating cashflow
  increased by $49 million primarily as a result of decreased working capital
  needs. PSEG expects operating cash flows to be sufficient to fund the majority
  of future capital requirements and dividend payments.
Additionally, in October 2003, PSEG received approximately $150 million in cash relating to a return of estimated tax payments.
Dividend payments on common stock for the quarter ended September 30, 2003 were $0.54 per share and totaled approximately $122 million. Dividend payments on common stock for the nine months ended September 30, 2003 were $1.62 per share and totaled approximately $366 million. Future dividends declared will be dependent upon PSEG's future earnings, cash flows, financial requirements, alternative investment opportunities and other factors.
PSE&G
PSE&G's
  operating cash flow decreased approximately $416 million from $633 million to
  $217 million for the nine months ended September 30, 2003, as compared
  to the nine months ended September 30, 2002. In 2002, operating cash flow
  was higher than normal due primarily to the sale of its gas inventory totaling
  approximately $415 million in 2002, $183 million of which related to PSE&G's
  sale of the gas commodity business to Power.

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Power
Power's operating cash flow increased approximately $331 million from $189 million to $520 million for the nine months ended September 30, 2003, as compared to the nine months ended September 30, 2002. The 2002 operating cash flow was lower than normal, due to the purchase of the gas contracts from PSE&G in May 2002 for approximately $183 million and gas storage volume requirements, including higher gas prices, to meet its BGSS and generation requirements in 2002.
Energy Holdings
Energy Holdings' operating cash flow increased approximately $50 million from $120 million to $170 million for the nine months ended September 30, 2003, as compared to the nine months ended September 30, 2002. This increase is primarily related to increased earnings and realization of deferred tax assets, partially offset by a tax payment in the first quarter of 2003 related to two leveraged lease transactions with affiliates of TXU-Europe that were terminated in the fourth quarter of 2002 and other miscellaneous items.
Debt Covenants
PSEG, PSE&G, Power and Energy Holdings
PSEG's, PSE&G's, Power's and Energy Holdings' respective credit agreements generally contain customary provisions under which the lenders could refuse to advance loans in the event of a material adverse change in the borrower's business or financial condition.
As explained in detail below, some of these credit agreements also contain maximum debt-to-equity ratios, minimum cash flow tests and other restrictive covenants and conditions to borrowing. Compliance with applicable financial covenants will depend upon the future financial position, level of earnings and cash flows of PSEG, PSE&G, Power and Energy Holdings, as to which no assurances can be given. The ratios presented below are for the benefit of the investors of the related securities to which the covenants apply. They are not intended as a financial performance or liquidity measure. The debt underlying the preferred securities of PSEG and PSE&G, which are presented in Long-Term Debt, effective July 1, 2003 in accordance with Financial Interpretation (FIN) No. 46, ''Consolidation of Variable Interest
Entities (VIE)'' (FIN 46), is not included as debt when calculating these ratios, as provided for in the various credit agreements.
PSEG
Financial covenants contained in PSEG's credit facilities include a ratio of debt (excluding non-recourse project financings and securitization debt and including commercial paper and loans, certain letters of credit and similar instruments) to total capitalization covenant. This covenant requires that at the end of any quarterly financial period, such ratio not be more than 70.0%. As of September 30, 2003, PSEG's ratio of debt to capitalization (as defined above) was 59.3%. The adjusted debt to capitalization ratio, inclusive of the effects of the $356 million common stock issuance that closed on October 7, 2003, would have been 57.0% as of September 30, 2003. The proceeds of the stock issuance were used to reduce short-term debt.
PSE&G
Financial
  covenants contained in PSE&G's credit facilities include a ratio of long-term
  debt (excluding securitization debt and long-term debt maturing within one year)
  to total capitalization covenant. This covenant requires that at the end of
  any quarterly financial period, such ratio will not be more than 65.0%. As of
  September 30, 2003, PSE&G's ratio of long-term debt to total capitalization
  was 54.7%.
In addition,
  under its Mortgage, PSE&G may issue new First and Refunding Mortgage Bonds
  against previous additions and improvements, provided that its ratio of earnings
  to fixed charges calculated in accordance with its Mortgage is at least 2:1,
  and/or against retired Mortgage Bonds. At September 30, 2003, PSE&G's
  Mortgage coverage ratio was 3:1 and the Mortgage would permit up to
62

approximately $1.5 billion aggregate principal
  amount of new Mortgage Bonds to be issued against previous additions and improvements.
PSEG and Power
Financial covenants contained in the PSEG/Power joint and several credit facility include a ratio of debt to total capitalization for each specific borrower. Where PSEG is the borrower, the covenant described above in PSEG is applicable. Where Power is the borrower, a debt (excluding non-recourse project financings and including loans, certain letters of credit and similar instruments) to total capitalization, adjusted for the $986 million Basis Adjustment (see Consolidated Balance Sheets), covenant applies. This covenant requires that at the end of any quarterly financial period, such ratio will not be more than 65.0%. As of September 30, 2003, Power's ratio of debt to capitalization (as defined above) was 44.2%.
Energy Holdings
On April 16, 2003, Energy Holdings issued $350 million in Senior Notes which contain financial covenants that include debt incurrence tests consisting of a debt service coverage test and a ratio of consolidated recourse indebtedness to recourse capitalization test which require that Energy Holdings will not incur additional consolidated recourse indebtedness, other than certain permitted indebtedness, unless, on a pro forma basis giving effect to the incurrence of the additional consolidated recourse indebtedness, (i) the debt service coverage ratio would be at least 2 to 1 and (ii) the ratio of consolidated recourse indebtedness to recourse capitalization would not exceed 0.60 to 1. Certain permitted indebtedness, such as permitted refinancings and borrowings are excluded from the requirements under this test. The
provisions of the Senior Notes also restrict Energy Holdings from selling assets with a net book value greater than 10% of its assets in any four consecutive quarters, unless the proceeds are used to reduce debt of Energy Holdings or its subsidiaries or are retained by Energy Holdings.
As discussed below, Energy
  Holdings has received commitments for a $200
  million three-year bank revolving credit agreement that is expected to be signed
  and in effect in the near future. The agreement will not include PSEG-level
  covenants other than the maintenance of ownership of at least 80% of Energy
  Holdings. It is expected that the agreement will require Energy Holdings' ratio
  of Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA)
  (excluding noncash asset impairments and interest on nonrecourse debt) to fixed
  charges (excluding certain principal payments) to be greater than 1.75. As of
  September 30, 2003, Energy Holdings' coverage of this covenant was 2.58.
  Additionally, Energy Holdings expects that it would be required to maintain
  a
  ratio of net recourse debt (excluding unrestricted cash) to EBITDA of less than
  5.25. As of September 30, 2003, Energy Holdings' coverage under this covenant
  was 4.07.
Cross Default Provisions
Certain
  information reported in the 2002 Annual Report on Form 10-K and the Quarterly
  Reports on Form 10-Q for the quarters ended March 31, 2003 and June 30, 2003,
  is updated below.
PSEG,
  PSE&G and Power
PSEG's
  bank credit agreements and note purchase agreements (Credit Agreements) relating
  to its private placement of debt contain cross default provisions under which
  certain payment defaults by PSE&G or Power, certain
  bankruptcy events relating to PSE&G or Power, the failure by PSE&G or
  Power to satisfy certain final judgments or the occurrence of certain events
  of default under the financing agreements of PSE&G or Power, would each
  constitute an event of default under the PSEG Credit Agreements. It is also
  an event of default under the PSEG Credit Agreements, if PSE&G or Power
  ceases to be wholly-owned by PSEG.
PSEG
  and Energy Holdings
PSEG
  has amended all of its credit agreements and note agreements to remove Energy
  Holdings from all cross default provisions effective with the cancellation of
  Energy Holdings' $495 million
63

revolving
  credit agreement. Energy Holdings has received commitments for a three-year
  bank revolving credit agreement in the amount of $200 million that will not
  include PSEG-level covenants other than the maintenance of ownership of at least
  80% of Energy Holdings.
Energy
  Holdings
Energy
  Holdings' $200 million three-year bank revolving credit agreement that is expected
  to be signed and in effect in the near future will contain default provisions
  under which a default by it, Resources or Global in an aggregate amount of $25
  million would result in an event of default and the potential acceleration of
  payment under this agreement.
Ratings
  Triggers
PSEG, PSE&G, Power and Energy Holdings
The debt indentures and credit agreements of PSEG, PSE&G, Power and Energy Holdings do not contain any material ''ratings triggers'' that would cause an acceleration of the required interest and principal payments in the event of a ratings downgrade. However, in the event of a downgrade, any one or more of the affected companies may be subject to increased interest costs on certain bank debt and collateral requirements.
Power
In connection with its energy marketing and trading activities, Power must meet certain credit quality standards required by counterparties. If Power loses its investment grade credit rating, PSEG Energy Resources & Trade LLC (ER&T) would have to provide credit support (letters of credit or cash), which would significantly impact the cost of its energy trading activities. In addition, all master agreements and other supply contracts contain margin and/or other collateral requirements that, as of September 30, 2003, could require Power to post additional collateral of approximately $232 million if Power were to lose its investment grade credit rating and all counterparties, where Power is ''out-of-the money'' under such contracts, were entitled to and called for collateral. Providing this credit support
would increase Power's costs of doing business and could limit Power's ability to successfully conduct its energy trading operations.
Energy Holdings
Energy Holdings and Global posted letters of credit of approximately $9 million and $35 million for certain of their equity commitments in September 2003 and October 2003, respectively, as a result of Energy Holdings' ratings falling below investment grade, see Credit Ratings below. Energy Holdings does not anticipate that any further letters of credit will need to be posted should there be a further downgrade.
Credit Ratings
PSEG, PSE&G, Power and Energy Holdings
Standard & Poor's (S&P) has recently affirmed the corporate credit ratings of PSEG, PSE&G and Power, and downgraded the corporate credit rating of Energy Holdings to BB- from BBB-. Moody's Investors Service (Moody's) similarly has recently affirmed the credit ratings of PSEG, PSE&G and Power and downgraded Energy Holdings' credit rating from Baa3 to Ba3. These actions concluded the review for possible downgrade of Power and Energy Holdings that was initiated by Moody's on June 16, 2003. On September 26, 2003, Moody's confirmed PSEG's P2 commercial paper rating. The current ratings of securities of PSEG and its subsidiaries are shown below:
64

Moody's

S&P

FitchPSEG:Preferred Securities

Baa3(N)

BB+

BBB(N)Commercial Paper

P2(N)

A2

Not RatedPSE&G:Mortgage Bonds

A3

A-

A(N)Preferred Securities

Baa2

BB+

BBB+(N)Commercial Paper

P2

A2

F1Power:Senior Notes

Baa1

BBB

BBB+Energy Holdings:Senior Notes

Ba3(N)

BB-

BBB-All ratings have a stable outlook unless otherwise noted. (N) denotes a negative outlook. There is no assurance that the above ratings will continue for any given period of time or that they will not be revised by the rating agencies, if, in their respective judgments, circumstances so warrant.
Short-Term Liquidity
PSEG, PSE&G, Power and Energy Holdings
As of September 30, 2003, PSEG had a total of approximately $1.7 billion of committed credit facilities, with approximately $694 million reserved for commercial paper program liquidity support and an additional $19 million drawn for letters of credit at Power. This resulted in approximately $942 million of available liquidity prior to the issuance of $356 million of common stock at PSEG on October 7, 2003, which was used to repay short-term indebtedness further increasing liquidity. In addition to this amount, PSEG and PSE&G had access to certain uncommitted credit facilities under which PSEG had $58 million and PSE&G had $193 million outstanding as of September 30, 2003. The following table summarizes the various revolving credit facilities of PSEG and its subsidiaries and the liquidity available
as of September 30, 2003.
Company

Expiration Date

Total Facility

Primary Purpose

Usage at 09/30/2003

Available Liquidity at 09/30/2003(Millions)PSEG:364-day
      Credit Facility
    
    March 2004
    
    $
    350
    
    
    CP Support
    
    $
    350
    
    
    $
    —5-year
      Credit Facility
    
    March 2005
    
    $
    280
    
    
    CP Support
    
    $
    264
    
    
    $
    163-year
      Credit Facility
    
    December 2005
    
    $
    350
    
    
    CP Support/
Funding
    
    $
    —
    
    
    $
    350Uncommitted Bilateral Agreement
    
    N/A
    
    
    N/A
    
    
    Funding
    
    $
    58
    
    
    
    N/APSE&G:364-day
      Credit Facility
    
    June 2004
    
    $
    200
    
    
    CP Support
    
    $
    80
    
    
    $
    1203-year
      Credit Facility
    
    June 2005
    
    $
    200
    
    
    CP Support
    
    $
    —
    
    
    $
    200Uncommitted
      Bilateral
        Agreement
    
    N/A
    
    
    N/A
    
    
    Funding
    
    $
    193
    
    
    
    N/APSEG and Power:364-day
      Credit Facility (A)
    
    March 2004
    
    $
    250
    
    
    CP Support/
Funding
    
    $
    —
    
    
    $
    250Power:3-year
      Credit Facility
    
    August 2005
    
    $
    25
    
    
    Funding
    
    $
    19
    
    
    $
    6Energy Holdings:Interim
      Facility (B)
    
    May 2004
    
    $
    55
    
    
    Letters of
Credit
    
    $
    46
    
    
    
    N/A
(A) PSEG/Power co-borrower facility
(B) Increased to $85 in October 2003 and will be cancelled upon signing of the three-year, $200 million facility, discussed below.
65

PSEG
In order to support its short-term financing requirements, as well as those of Power, PSEG has revolving credit facilities that are used both as a source of short-term funding and to provide backup liquidity for its $1 billion commercial paper program.
PSEG has a $350 million facility expiring in December 2005 that provides liquidity support for its commercial paper program and can also be used as a source of short-term funding and to issue letters of credit. PSEG also has a $350 million facility expiring in March 2004 and a $280 million facility expiring in March 2005, both of which are used to provide liquidity support for its commercial paper program.
The $250 million, 364-day PSEG/Power joint and several facility provides liquidity support for the PSEG commercial paper program and can be used by either PSEG or Power as a source of short-term funding and to issue letters of credit. Under this facility, either PSEG or Power may borrow and both are joint and severally liable to repay the loans.
PSE&G
On June 26, 2003, PSE&G renewed its $200 million 364-day credit facility. In addition, PSE&G has a $200 million 3-year credit facility expiring in June 2005. The purpose of both facilities is to provide liquidity support for PSE&G's $400 million commercial paper program.
Power
Power has access to the $250 million, 364-day joint and several PSEG/Power credit facility and a separate $25 million credit facility, but primarily relies on PSEG for its short-term financing needs. For information regarding affiliate borrowings, see Note 14. Related-Party Transactions of the Notes.
As of September 30, 2003, letters of credit issued by Power were outstanding in the amount of approximately $86 million, including the $19 million drawn against its credit facilities, in support of various contractual obligations, environmental liabilities and to satisfy trading collateral obligations.
Energy Holdings
Energy Holdings cancelled its $495 million revolving credit agreement on September 26, 2003 and entered into a $55 million interim, cash collateralized letter of credit facility expiring May 2004. As of September 30, 2003, Energy Holdings had $46 million of letters of credit outstanding under this facility, including $9 million, which was posted in September 2003 as a result of the downgrade in Energy Holdings credit rating. As of September 30, 2003, in addition to amounts outstanding under Energy Holdings' credit facilities shown in the above table, subsidiaries of Global had $2 million of non-recourse short-term financing at the project level. In October 2003, Energy Holdings increased the size of the interim facility to $85 million by posting additional collateral and posted an additional $35 million
letter of credit. As of September 30, 2003, Energy Holdings had loaned $166 million of excess cash to PSEG. For information regarding affiliate borrowings, see Note 14. Related-Party Transactions of the Notes.
Energy Holdings has received
  commitments for a three-year bank revolving credit agreement in the amount of
  $200 million to provide liquidity and letters of credit. The facility is expected
  to be signed and in effect in the near future. This facility will replace the
  cancelled $495 million facility as well as the interim letter of credit facility.
  Energy Holdings is a co-borrower under the facility with Global and Resources,
  which will be joint and several obligors. The terms of the agreement include
  a pledge of Energy Holdings' membership interest in Global, restrictions on
  the use of proceeds related to sales of assets and the satisfaction of certain
  financial covenants. The facility could be reduced to a total of $100 million
  on June 30, 2004 if available liquidity during the period from the repayment
  of the Energy Holdings Senior Notes due in February 2004 to June 30, 2004 does
  not reach $100 million for 15 days. Cash proceeds from asset sales in excess
  of 5% of total assets of Energy Holdings must be used to repay any outstanding
  amounts under the credit agreement. Cash proceeds in excess of 10% must be retained
  by Energy Holdings or used to repay the debt of Energy Holdings, Global or Resources.
  For
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information regarding the
  financial covenants included in the agreement, see Debt Covenants, discussed
  above.
External Financings
PSEG
On October
  7, 2003, PSEG issued $356 million of its common stock in order to strengthen
  its capital structure. Proceeds from the offering were used for the repayment
  of short-term debt.
In 2002, PSEG began issuing shares of its common stock under its Dividend Reinvestment Program and Employee Stock Purchase Plan, rather than purchasing them on the open market. For the quarter ended September 30, 2003, PSEG issued approximately 504,000 shares for approximately $21 million pursuant to these plans. For the nine months ended September 30, 2003, PSEG issued approximately 1,578,000 shares for approximately $63 million pursuant to these plans.
PSE&G
In January 2003, PSE&G issued $150 million of 5.00% Medium-Term Notes due 2013. The proceeds of this issuance were used to repay $150 million of 6.875% Series MM Mortgage Bonds which matured in January 2003.
Also in January 2003, PSEG contributed $170 million to PSE&G to support its capital structure.
In June 2003, $150 million of 8.875% Series DD Mortgage Bonds matured.
In September 2003, PSE&G issued $300 million of 5.375% Medium-Term Notes due 2013. The proceeds of this issuance were used to both refinance the previously matured $150 million of Series DD Mortgage Bonds, as well as to reduce short-term debt.
Energy Holdings
During January and February of 2003, Sociedad Austral de Electricidad S.A. (SAESA) and Empresa Electrica de la Frontera S.A. (Frontel), two distribution companies in Chile, refinanced certain short-term obligations through a combination of bonds, a syndicated bank facility and equity from Global. SAESA issued two series of bonds equivalent to $117 million with final maturity in 2009 and 2023. Frontel executed a syndicated loan facility equivalent to $23 million with final maturity in 2010. In addition, during January 2003, Global made equity contributions to SAESA and Frontel totaling $55 million.
Part of the purchase price of Electroandes, a generation facility in Peru, was financed with a $100 million one-year bridge loan with an original maturity date in December 2002 that was subsequently extended to September 2003. In March 2003, Electroandes refinanced the $100 million bridge loan with a $70 million seven-year amortizing facility and two $15 million one-year facilities (each guaranteed by Energy Holdings). Additionally, in June 2003, Electroandes sold $50 million of bonds in the local market. These bonds have a 6.44% coupon and mature in 2013. The bonds include a 5-year grace period on principal payments. Proceeds from this bond issue were used to repay the two $15 million one-year facilities, at which time the related guarantees by Energy Holdings were eliminated, and $20 million of the $70 million seven-year
facility.
In September
  2003, Electroandes sold an additional $30 million of bonds in the local market.
  The bonds have a coupon of 6.00%. The proceeds from this bond issue were used
  to repay $30 million of the $50 million seven-year facility. Electroandes expects
  to complete the refinancing of the final $20 million of the seven-year facility
  from future bond issues.
In April
  2003, Energy Holdings, in a private placement, issued $350 million of its 7.75%
  Senior Notes due in 2007. The proceeds were used in part to repay PSEG Capital
  Corporation's (PSEG Capital) remaining $252 million of 6.25% Medium-Term Notes
  that matured in May 2003. Energy Holdings does not plan to use PSEG Capital
  as a financing vehicle in the future and is in the process of dissolving that
  company. The remaining proceeds from the sale of the Senior Notes were used
  for
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general
  corporate purposes. In July 2003, Energy Holdings completed an exchange offer
  for these securities.
In May 2003, GWF Power Systems, L.P. (GWF) and Hanford L.P. (Hanford), closed on $55 million in syndicated bank loans along with an additional $7 million in a letter of credit facility. Global and Harbert Power (Harbert) each own 50% of GWF and Hanford. GWF and Hanford used the net proceeds from the bank loan to pay back investments from Global and Harbert. Global received a cash distribution of approximately $27 million in May and reduced its investment in GWF to $66 million as of September 30, 2003.


In September 2003, GWF Energy issued $226 million of 6.131% senior secured notes that mature on December 30, 2011. The note proceeds were used by GWF Energy to repay a $45 million bank loan that matured on September 30, 2003, and to make distributions to its members and for general corporate purposes. GWF Energy also closed a $35 million letter of credit reimbursement and working capital facility simultaneous with issuance of the notes. The bank facility is available to GWF Energy to provide letters of credit to fund the debt service reserve account required by the notes' indenture and to secure project obligations. The portion of the bank facility that is not used to provide letters of credit may be used to provide working capital loans to GWF Energy up to a maximum of $7.5 million. GWF Energy initially has approximately
$33 million of issued and undrawn letters of credit outstanding under the bank facility and approximately $2 million available for working capital loans and/or additional letters of credit. GWF Energy made cash distributions to Global prior to September 30, 2003 of approximately $137 million.
In September
  2003, Energy Holdings repurchased approximately $11 million of its outstanding
  Senior Notes that mature in February 2004, reducing the maturity amount to $267
  million. With cash on hand at September 30, 2003 of over $160 million, cash
  generated from operations, expected asset sales, and its credit facility, Energy
  Holdings' expects to meet its February 2004 Senior Note maturity and maintain
  sufficient liquidity. After this maturity, the next Senior Note maturity is
  in 2007.
CAPITAL REQUIREMENTS
PSEG, PSE&G, Power and Energy Holdings
PSEG, Power and Energy Holdings have substantially reduced their respective capital expenditure forecasts in response to tightening market conditions resulting from market and lender concerns regarding the overall economy and the industry in particular, including an investor and rating agency focus on leverage ratios.
It is expected that the majority of PSE&G's, Power's and Energy Holdings' capital requirements will come from internally generated funds. The balance will be provided by the issuance of debt at the respective subsidiary or project level and, for PSE&G and Power, equity contributions from PSEG. PSEG does not presently expect to contribute additional equity to Energy Holdings.
PSE&G
During
  the nine months ended September 30, 2003, PSE&G made approximately $343
  million of capital expenditures related to improvements in its transmission
  and distribution system, gas system and common facilities.
Power
During the nine months ended September 30, 2003, Power made approximately $507 million of capital expenditures, primarily related to developing the Lawrenceburg, Indiana, Waterford, Ohio and Bethlehem, New York (Albany) sites and adding capacity to the Linden station in New Jersey. The Waterford, Ohio facility was placed in service in August 2003.
68

Energy Holdings
During
  the nine months ended September 30, 2003, Energy Holdings made approximately
  $230 million of capital expenditures, primarily related to capital investments
  at SAESA, Salalah, and the GWF Energy plants. Of this amount, approximately
  $162 million was provided by Energy Holdings primarily to fulfill commitments
  for projects in construction. The balance relates to capital requirements of
  consolidated subsidiaries financed from internally generated cash flow within
  the projects, or from local sources on a non-recourse basis.
ACCOUNTING MATTERS
Statement of Financial Accounting Standards (SFAS) No. 150, ''Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity'' (SFAS 150)

PSEG and PSE&G
SFAS 150, which became effective July 1, 2003, established standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. Many of these instruments that were previously classified as equity in the ''mezzanine'' section (between liabilities and equity) must now be recorded as liabilities. SFAS 150 requires an issuer to classify qualifying instruments issued in the form of shares that are mandatorily redeemable as liabilities. The adoption of SFAS 150 did not have any effect on PSEG's, PSE&G's, Power's or Energy Holdings' financial statements. Had PSEG and PSE&G not adopted Financial Interpretation (FIN) No. 46, ''Consolidation of Variable Interest Entities (VIE)'' (FIN 46), as discussed below, the preferred securities
associated with the capital trusts would have been reclassed to debt and preferred securities dividends would have been classified as interest expense under SFAS 150.
SFAS No. 149, ''Amendment of Statement 133 on Derivative Instruments and Hedging Activities'' (SFAS 149)
PSEG, PSE&G, Power and Energy Holdings
SFAS 149 amends and clarifies the accounting guidance for derivative instruments (including certain derivative instruments embedded in other contracts) and hedging activities that fall within the scope of SFAS No. 133, ''Accounting for Derivative Instruments and Hedging Activities'' (SFAS 133).
In particular, SFAS 149 clarifies circumstances under which a contract with an initial net investment meets the characteristic of a derivative discussed in SFAS 133 and clarifies when a derivative contains a financing component and amends the definition to conform it to language used in FIN No. 45, ''Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others'' (FIN 45).
Additionally, SFAS 149 amends SFAS 133's criteria for electing the normal purchase and sale exception, which exempts certain derivatives that meet the normal purchase and sales criteria from fair value reporting. The new guidance allows ''normal'' treatment for power capacity contracts (as defined by SFAS 133 and SFAS 149) even if the contracts are subject to unplanned netting. However, any non-power commodity contracts (i.e. gas contracts) and power contracts that do not meet the definition in SFAS 133 and SFAS 149 and that are subject to unplanned netting, will be ineligible for ''normal'' treatment, which would result in those contracts being marked to market.
SFAS 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. There was no impact on PSEG's, PSE&G's, Power's or Energy Holdings' respective financial statements due to the adoption of these rules.
69

SFAS No. 143, ''Accounting for Asset Retirement Obligations'' (SFAS 143)
PSEG, PSE&G, Power and Energy Holdings
Effective January 1, 2003, PSEG, PSE&G, Power and Energy Holdings each adopted SFAS 143. SFAS 143 addresses accounting and reporting for legal obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. A legal obligation is a liability that a party is required to settle as a result of an existing or enacted law, statute, ordinance or contract.
Under SFAS 143, a company must initially recognize the fair value of a liability for an asset retirement obligation in the period in which it is incurred and concurrently capitalize an asset retirement cost by increasing the carrying amount of the related long-lived asset by the same amount as the liability. A company is required to subsequently depreciate that asset retirement cost to expense over its useful life. In periods subsequent to initial measurement, an entity is required to recognize changes in the liability resulting from the passage of time (accretion) or due to revisions to either the timing or the amount of the originally estimated cash flows. Changes in the liability due to accretion are charged to Operation and Maintenance expense on the Consolidated Statements of Operations, whereas changes due to
the timing or amount of cash flows are adjustments to the carrying amount of the related asset. See Note 3. Adoption of SFAS 143 for additional information.




SFAS No. 142, ''Goodwill and Other Intangible Assets'' (SFAS 142)
PSEG, PSE&G, Power and Energy Holdings
On January 1, 2002, PSEG, PSE&G, Power and Energy Holdings each adopted SFAS 142. Under this standard, PSEG, PSE&G, Power and Energy Holdings were required to complete an impairment analysis of goodwill before June 30, 2002 and record any required impairment retroactive to January 1, 2002. Under SFAS 142, goodwill is considered a nonamortizable asset and is subject to an annual review for impairment and an interim review when certain events or changes in circumstances occur. At the time of adoption, PSE&G had no goodwill. The effect of no longer amortizing goodwill on an annual basis was not material to PSEG's or Power's financial position and results of operations upon adoption.
Power and Energy Holdings evaluated the recoverability of the recorded amount of goodwill based on certain operating and financial factors. Such impairment testing included discounted cash flow tests, which require broad assumptions and significant judgment to be exercised by management.
FIN 46
PSEG, PSE&G, Power and Energy Holdings
FIN 46 clarifies the application of Accounting Research Bulletin No. 51, ''Consolidated Financial Statements'', to VIEs. A VIE does not have equity capital sufficient to finance its activities (i.e. the entity requires additional support from its investors) and its equity investors as a group lack the essential characteristics of a controlling interest. FIN 46 requires that the potential risks and rewards for each investor be measured and compared. The investor that holds the most risks (downside variability) (primary measure) and/or is entitled to the most rewards (upside variability) is known as the primary beneficiary and is required to consolidate the entity.
Financial Accounting Standards Board (FASB) Staff Position 46-6 permits a company to delay, partially or fully, the adoption of FIN 46 from July 1, 2003 to the period ending after December 15, 2003 for VIEs created before February 1, 2003. PSEG, PSE&G, Power and Energy Holdings have adopted the provisions of FIN 46 as of July 1, 2003.
PSEG and PSE&G

PSEG
  and PSE&G evaluated their respective interests in PSEG Capital Trust I-IV,
  PSEG Funding Trust I (trust holding Participating Equity Preference Securities
  (PEPS)), PSE&G Capital Trust LP and Capital Trust I-II and determined
  them to be VIEs under FIN 46. It was further determined that PSEG and PSE&G
  were not the primary beneficiaries of those entities and therefore were prohibited
  from consolidating them into the financial statements. Accordingly, these entities
  were deconsolidated as of
70

July 1, 2003 and were recorded under
  the equity method of accounting. Prior period financial statements have been
  reclassified for comparability as permitted by FIN 46. This resulted in the
  removal of the preferred securities issued by the trusts from the balance sheet
  and the addition to the balance sheet of long-term debt in an equal amount between
  PSEG and PSE&G and the trusts, which previously had been eliminated in consolidation.
  Additionally, PSEG's and PSE&G's balance sheets will reflect their equity
  investment in these entities, which also was previously eliminated in consolidation
  and will result in equal amounts of additional assets and long-term debt of
  $41 million for PSEG and $5 million for PSE&G as of September 30, 2003
  and December 31, 2002. The invested cash was loaned back to PSEG and PSE&G
  in connection with the issuance of the preferred securities. The following table
  displays the securities, and their original issuance amounts, held by the trusts
  that have now been deconsolidated.






As ofSeptember 30,
2003

December 31,
2002(Millions)PSEGPSEG Quarterly Guaranteed Preferred Beneficial Interest in PSEG's Subordinated
Debentures7.44%

$
225


$
225Floating Rate


150



1507.25%


150



1508.75%


180



180PSEG Participating Units10.25%


460



460Total PSEG (Parent)


1,165



1,165PSE&GPSE&G 8.00% Monthly Guaranteed Preferred Beneficial Interest in Subordinated Debentures


60



60PSE&G Quarterly Guaranteed Preferred Beneficial Interest in PSE&G's 8.125% Subordinated 
        Debentures


95



95Total PSE&G


155



155Total PSEG Consolidated

$
1,320


$
1,320PSEG and PSE&G now record interest expense (previously eliminated against the interest income of the trust) instead of preferred securities dividends expense (since the preferred dividends are in the trusts that are no longer consolidated). For PSEG, these amounts totaled $17 million and $13 million for the three months ending September 30, 2003 and 2002, respectively and totaled $52 million and $39 million for the nine months ending September 30, 2003 and 2002, respectively. For PSE&G, these amounts totaled $3 million for the three months ending September 30, 2003 and 2002 and totaled $10 million for the nine months ending September 30, 2003 and 2002.
Energy Holdings evaluated its interests in four real estate partnerships previously accounted for under the equity method of accounting. These entities were determined to be VIEs and Energy Holdings was determined to be the primary beneficiary and therefore is required to consolidate these entities. The current presentation reflects these entities on a fully consolidated basis and all prior periods have been restated in accordance with FIN 46.
PSEG and Energy Holdings
Energy
  Holdings evaluated its interests in four real estate partnerships previously
  accounted for under the equity method of accounting. These entities were determined
  to be VIEs and Energy Holdings was determined to be the primary beneficiary
  and is therefore required to consolidate these entities. The current presentation
  reflects these entities on a fully consolidated basis and all prior periods
  have been restated as permitted by FIN 46.

71

The impact of consolidating the real estate partnerships on the Consolidated Balance Sheets is as follows:
As ofSeptember 30,
2003

December 31,
2002(Millions)Amount Recorded under Equity Method of AccountingInvestment in Real Estate Partnerships

$
23


$
23Amount Recorded under ConsolidationCurrent Assets

$
5


$
4Noncurrent Assets


50



51Total Assets

$
55


$
55Current Liabilities

$
1


$
—Noncurrent Liabilities


25



26Minority Interest


6



6Total Liabilities and Minority Interest

$
32


$
32The impact of consolidating the real estate partnerships' Statements of Operations on Operating Revenues and Operating Expenses was immaterial.
Emerging Issues Task Force (EITF) Issue No. 03-11, ''Reporting Realized Gains and Losses on Derivative Instruments That Are Subject to FASB Statement No. 133, ''Accounting for Derivative Instruments and Hedging Activities'', and Not ''Held for Trading Purposes'' as Defined in EITF Issue No. 02-3, ''Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities'' (EITF 02-3)''
PSEG, PSE&G, Power and Energy Holdings
The EITF has previously discussed the income statement presentation of gains and losses on contracts held for trading purposes in EITF 02-3. The EITF reached a consensus that gains and losses (realized and unrealized) on all derivative instruments within the scope of SFAS 133 should be shown net when recognized in the income statement, whether or not settled physically, if the derivative instruments are ''held for trading purposes'' as defined in EITF 02-3. This issue contemplates whether realized gains and losses should be shown gross or net in the income statement for contracts that are not held for trading purposes (as defined in EITF 02-3) but are derivatives subject to SFAS 133 (whether or not the derivative is designated as a hedging instrument pursuant to SFAS 133). On July 31, 2003 the EITF
determined that whether realized gains and losses on physically settled derivative contracts not ''held for trading purposes'' should be reported in the income statement on a gross or net basis is a matter of judgment that depends on the relevant facts and circumstances. PSEG, PSE&G, Power and Energy Holdings are currently evaluating this interpretation and the impact, if any, this interpretation will have on their contracts. Because this issue pertains to financial statement presentation only, there will be no net effect on financial position, results of operations or cash flows.
EITF Issue No. 03-4, ''Accounting for Cash Balance Pension Plans'' (EITF 03-4)
PSEG, PSE&G, Power and Energy Holdings
EITF 03-4 requires that cash balance pension plans be accounted for as defined benefit plans. This standard states that cash balance plans are forms of accumulation plans with variable crediting formulas and are therefore not pay-related. As a result, a company would apply a traditional unit credit method for determining the expense associated with these plans. The effect of remeasuring the pension obligation using the guidance in this standard should be applied at PSEG's plans' next measurement date of December 31, 2003, with any adjustment being treated as an actuarial gain or loss pursuant to SFAS 87, ''Employer's Accounting for Pensions'' (SFAS 87).
PSEG, PSE&G, Power and Energy Holdings each have previously accounted for these plans as defined benefit plans. The effect of these rules on PSEG's, PSE&G's, Power's and Energy Holdings' cash balance plans is still being evaluated.

72

EITF 02-3
PSEG and Power
EITF 02-3 requires all gains and losses on energy trading derivatives to be reported on a net basis. Also, energy trading contracts that are not derivatives will no longer be marked to market. Instead, settlement accounting will be used. EITF 02-3 became fully effective January 1, 2003. Substantially all of Power's energy trading contracts qualify as derivatives under SFAS 133 and will therefore continue to be marked to market. The impact of implementing these rules had no effect on PSEG's or Power's earnings. Prior period Operating Revenues and Energy Costs on the Consolidated Statement of Operations have been reclassified on a net basis for comparability.







EITF Issue No. 01-8, ''Determining Whether an Arrangement is a Lease'' (EITF 01-8)
PSEG, PSE&G, Power and Energy Holdings
EITF 01-8 provides guidance in determining whether an arrangement should be considered a lease subject to the requirements of FASB Statement No. 13, ''Accounting for Leases'' (SFAS 13). EITF 01-8 states that the evaluation of whether an arrangement contains a lease within the scope of SFAS 13 should be based on the substance of the arrangement. EITF 01-8 is applied to arrangements agreed or committed to, modified, or acquired in business combinations initiated on or after October 1, 2003.
Other
PSEG, PSE&G, Power and Energy Holdings
In January 2001, PSEG, PSE&G, Power and Energy Holdings each adopted SFAS 133. In accordance with SFAS 133, all derivative instruments are recognized on the Consolidated Balance Sheets at their fair values. In relation to this standard, the FASB Derivative Implementation Group (DIG) issued certain interpretive guidance, including DIG Issue C-11 that relates to contracts which include broad market indices (i.e. Consumer Price Index). That interpretation sets forth the guidelines under which a contract could qualify as a normal purchase or sale under SFAS 133. In 2003, the FASB issued DIG Issue C-20 to amend the previous interpretation stating that the phrase ''not clearly and closely related to the asset being sold or purchased'' should involve an analysis of both qualitative and quantitative considerations.
PSE&G, Power and Energy Holdings have reviewed their respective contracts and each have determined that there was no impact resulting from the adoption of this interpretation.
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES
ABOUT MARKET RISK
PSEG, PSE&G, Power and Energy Holdings
The market risk inherent in PSEG's, PSE&G's, Power's and Energy Holdings' market risk sensitive instruments and positions is the potential loss arising from adverse changes in foreign currency exchange rates, commodity prices, equity security prices and interest rates as discussed in Note 8. Risk Management to the Notes to the Consolidated Financial Statements (Notes). Each of PSEG, PSE&G, Power and Energy Holdings' policy is to use derivatives to manage risk consistent with its respective business plans and prudent practices. PSEG, PSE&G, Power and Energy Holdings use a Risk Management Committee (RMC) comprised of executive officers which utilize an independent risk oversight function to ensure compliance with corporate policies and prudent risk management practices. Except as discussed below, there were
no material changes from the disclosures in PSEG, PSE&G, Power and Energy Holdings' Annual Report on Form 10-K for the year ended December 31, 2002 or Quarterly Reports on Form 10-Q for the quarters ended March 31, 2003 and June 30, 2003.
73

Commodity Contracts
PSEG and Power
The availability and price of energy commodities are subject to fluctuations from factors such as weather, environmental policies, changes in supply and demand, state and federal regulatory policies and other events. To reduce price risk caused by market fluctuations, Power enters into supply contracts and derivative contracts, including forwards, futures, swaps and options with approved counterparties, to hedge its anticipated supply and demand differential. These contracts, in conjunction with owned electric generation capacity and demand obligations, make up the portfolio.







Power uses value-at-risk (VaR) models to assess the market risk of their respective commodity businesses. The model for Power includes its owned generation and physical contracts, as well as fixed price sales requirements, load requirements and financial derivative instruments. VaR represents the potential gains or losses, under normal market conditions, for instruments or portfolios due to changes in market factors, for a specified time period and confidence level. Power estimates VaR across their respective commodity businesses.
VaR Model
Power manages its exposure at the portfolio level. Its portfolio consists of owned generation, load-serving contracts (both gas and electric), gas supply contracts and energy derivatives designed to manage the risk around the differential between generation and load.
The RMC of PSEG established a VaR threshold of $50 million for a one-week (5 business days) holding period at a 95% (two-tailed) confidence level. The RMC will be notified if the VaR reaches $40 million and the portfolio will be closely monitored. The Board of Directors of PSEG is notified if a VaR threshold of $75 million is reached.
The current modeling process and methodology has previously been reviewed by a third party consulting firm. This review included analysis and comparison of Power's current VaR process and methodology to other processes and methodologies used in the energy industry. PSEG believes the evaluation indicates that Power's methodology to calculate VaR is reasonable.
The model is an augmented variance/covariance model adjusted for the delta of positions with a 95% two-tailed confidence level for a one-week holding period. The model is augmented to incorporate the non log-normality of energy-related commodity prices, especially emissions and capacity and the non-stationary nature of energy volatility. In many commodities the natural log of prices is normally distributed. This is not true of energy commodities which have a higher frequency of extreme events than would be predicted by a normal distribution. The model also assumes no hedging activity throughout the holding period whereas Power actively manages its portfolio.
As of September 30, 2003, VaR was approximately $10 million, compared to the December 31, 2002 level of $7 million. At present, Power's load obligation is determined by the results of the annual New Jersey Basic Generation Service (BGS) auction. To maintain an actionable VaR, generation and load (based on an assumed success rate in the auction) are both modeled at 100% of their assumed value through May 2004 and at one-third of the assumed value of each from June 2004 through May 2006.



74

For the Quarter Ended September 30, 2003

Total VAR(Millions)95% Confidence Level, Five-Day Holding Period, Two-Tailed:Period End

$
10Average for the Period

$
12High

$
19Low

$
1099% Confidence Level, One-Day Holding Period, Two-Tailed:Period End

$
6Average for the Period

$
7High

$
11Low

$
6For the Nine Months Ended September 30, 2003

Total VAR(Millions)95% Confidence Level, Five-Day Holding Period, Two-Tailed:Period End

$
10Average for the Period

$
19High

$
35Low

$
1099% Confidence Level, One-Day Holding Period, Two-Tailed:Period End

$
6Average for the Period

$
11High

$
20Low

$
6Other Supplemental Information Regarding Market Risk
PSEG and Power
The following presentation of the activities of Power is included to address the recommended disclosures by the energy industry's Committee of Chief Risk Officers. For additional information, see Note 8. Risk Management of the Notes.
Normal Operations and Hedging Activities
Power enters into physical contracts, as well as derivative contracts, including forwards, futures, swaps and options designed to eliminate risk associated with volatile commodity prices. Commodity price risk is associated with market price movements resulting from market generation demand, changes in fuel costs and various other factors.
Power's derivative contracts are accounted for under SFAS No. 133, ''Accounting for Derivative Instruments and Hedging Activities'' (SFAS 133), its amendments and related guidance. Most non-trading contracts qualify for the normal purchases and normal sales exemption under SFAS 133 and/or SFAS 149. Changes in the fair value of qualifying cash flow hedge transactions are recorded in OCI, and gains and losses are recognized in earnings when the underlying transaction occurs. Changes in the fair value of derivative contracts that do not meet hedge criteria under SFAS 133 and the ineffective portion of hedge contracts are recognized in earnings on a current basis. Additionally, changes in the fair value attributable to fair value hedges are similarly recognized in earnings.
Trading
Power's objective for its trading activities is to produce net earnings from trading energy-related products around its owned electric generation assets, gas supply contracts and electric and gas supply obligations. These activities are marked to market in accordance with SFAS 133, its amendments and related guidance, with gains and losses recognized in earnings.
The following table describes the drivers of Power's energy trading and marketing activities and operating revenues included in its Consolidated Statements of Operations for the quarter and nine
75

months ended September 30, 2003. Normal operations and hedging activities represent the marketing of electricity available from Power's owned or contracted generation sold into the wholesale market. Additionally, normal operations and hedging activities include primarily contracts used to hedge fuel purchases for generation requirements that do not qualify for hedge accounting. As the information in this table highlights, mark-to- market activities represent a small portion of the total Operating Revenues for Power. Accrual activities, including normal purchases and sales, account for the majority of the revenue. The mark-to-market
activities reported here are those relating to changes in fair value due to external movement in prices.




Operating Revenues
For the Quarter Ended September 30, 2003
Normal
Operations and
Hedging (A)

Trading

Total(Millions)Mark-to-Market Activities:Unrealized Mark-to-Market Gains (Losses)Due to Changes in Fair Value of Open Positions

$
(3
)

$
17


$
14Due to Origination Unrealized Gain at Inception


—



—



—Due to Changes in Valuation Techniques and Assumptions


—



—



—Due to Realization at Settlement of Contracts


(6
)


(27
)


(33
)Total Change in Unrealized Fair Value


(9
)


(10
)


(19
)Realized Net Settlement of Transactions Subject to Mark-to-Market


6



27



33Broker Fees and Other Related Expenses


—



(1
)


(1
)Net Mark-to-Market (Losses) Gains


(3
)


16



13Accrual ActivitiesAccrual Activities—Revenue, Including Hedge—Reclassifications


1,235



—



1,235Total Operating Revenues

$
1,232


$
16


$
1,248Operating Revenues
For the Nine Months Ended September 30, 2003
Normal
Operations and
Hedging (A)

Trading

Total(Millions)Mark-to-Market Activities:Unrealized Mark-to-Market Gains (Losses)Due to Changes in Fair Value of Open Positions

$
24


$
62


$
86Due to Origination Unrealized Gain at Inception


—



—



—Due to Changes in Valuation Techniques and Assumptions


—



—



—Due to Realization at Settlement of Contracts


(41
)


(67
)


(108
)Total Change in Unrealized Fair Value


(17
)


(5
)


(22
)Realized Net Settlement of Transactions Subject to Mark-to-Market


41



67



108Broker Fees and Other Related Expenses


—



(5
)


(5
)Net Mark-to-Market Gains


24



57



81Accrual ActivitiesAccrual Activities—Revenue, Including Hedge Reclassifications


4,232



—



4,232Total Operating Revenues

$
4,256


$
57


$
4,313
(A)

Includes derivative contracts that Power enters into to hedge anticipated exposures related to its owned and contracted generation supply, all asset backed transactions (ABT) and hedging activities, but excludes owned and contracted generation assets.76

The following table indicates Power's energy trading assets and liabilities, as well as Power's hedging activity related to asset backed transactions and derivative instruments that qualify for hedge accounting under SFAS 133. This table presents amounts segregated by portfolio which are then netted for those counterparties with whom Power has the right of offset and therefore, are not necessarily indicative of amounts presented on the Consolidated Balance Sheets since balances with many counterparties are subject to offset and are shown net on the Consolidated Balance Sheets regardless of the portfolio in which they are included.
Energy Contract Net Assets
As of September 30, 2003
Normal
Operations and
Hedging

Trading

Total(Millions)Mark-to-Market Energy AssetsCurrent Assets

$
92


$
85


$
177Noncurrent Assets


1



23



24Total Mark-to-Market Energy Assets

$
93


$
108


$
201Mark-to-Market Energy LiabilitiesCurrent Liabilities

$
18


$
77


$
95Noncurrent Liabilities


—



12



12Total Mark-to-Market Current Liabilities

$
18


$
89


$
107Total Mark-to-Market Energy Contract Net Assets

$
75


$
19


$
94The following table presents maturity of net fair value of mark-to-market energy trading contracts.
Maturity of Net Fair Value of Mark-to-Market Energy Trading Contracts
As of September 30, 2003
Maturities within2003

2004

2005

    2006-2010

Total(Millions)Trading

$
—


$
9


$
10


$
—


$
19Normal Operations and Hedging


5



31



17



22



75Total Net Unrealized Gains on Mark-to-Market Contracts

$
5


$
40


$
27


$
22


$
94Wherever possible, fair values for these contracts were obtained from quoted market sources. For contracts where no quoted market exists, modeling techniques were employed using assumptions reflective of current market rates, yield curves and forward prices as applicable to interpolate certain prices. The effect of using such modeling techniques is not material to Power's financial results.
PSEG, PSE&G, Power and Energy Holdings
The
  following table identifies gains (losses) on cash flow hedges that are currently
  in Accumulated Other Comprehensive Income (OCI), a separate component of equity.
  Power uses forward sale and purchase contracts, swaps and fixed transmission
  rights (FTRs) contracts to hedge forecasted energy sales from its generation
  stations. Power also enters into swaps, options and futures transactions to
  hedge the price of fuel to meet its fuel purchase requirements for generation.
  PSEG, PSE&G, Power and Energy Holdings are subject to the risk of fluctuating
  interest rates in the normal course of business. PSEG's policy is to manage
  interest rate risk through the use of fixed rate debt, floating rate debt and
  interest rate derivatives. Affiliates of Energy Holdings purchase forward-exchange
  contracts as hedges of anticipated payments to contractors for projects under
  construction. These contracts are designed to hedge against the risk that the
  future cash payments will be adversely affected by changes in foreign currency
  rates. The table also provides an estimate of the gains (losses) that are expected
  to be reclassified out of OCI and into earnings over the next twelve months.
77

Cash Flow Hedges Included in OCI
As of September 30, 2003
Accumulated OCI

Portion Expected
to be Reclassified
in next 12 months(Millions)Cash Flow Hedges Included in OCICommodities

$
27


$
2Interest Rates


(89
)


(28
)Foreign Currency


(1
)


—Net Cash Flow Hedge Loss Included in OCI

$
(63
)

$
(26
)PSEG and Power
Credit Risk
Counterparties expose Power to credit losses in the event of non-performance or non-payment. Power has a credit management process which is used to assess, monitor and mitigate counterparty exposure for Power and its subsidiaries. Power's counterparty credit limits are based on a scoring model that considers a variety of factors, including leverage, liquidity, profitability, credit ratings and risk management capabilities. Power has entered into payment netting agreements or enabling agreements that allow for payment netting with the majority of its large counterparties, which reduce Power's exposure to counterparty risk by providing for the offset of amounts payable to the counterparty against amounts receivable from the counterparty.
The following table provides information on Power's credit exposure, net of collateral, as of September 30, 2003. Credit exposure, in the table below, is defined as net accounts receivable as well as any net ''in-the-money'' forward mark-to-market exposure. It further delineates that exposure by the credit rating of the counterparties and provides guidance on the concentration of credit risk to individual counterparties and an indication of the maturity of a company's credit risk by credit rating of the counterparties.
Schedule of Credit Risk Exposure on Energy Contracts Net Assets
As of September 30, 2003
Rating

Current
Exposure

Securities Held
as Collateral

Net
Exposure

Number of
Counterparties>10%

Net Exposure of
Counterparties>10%(Millions)Investment Grade—External Rating

$
330


$
13


$
317



—



—Non-Investment Grade—External Rating


28



20



10



—



—Investment Grade—No External Rating


21



3



21



—



—Non-Investment Grade—No External Rating


8



    —



    8



—



    —Total

$
387


$
36


$
356



—



—The net exposure listed above, in some cases, will not be the difference between the current exposure and the collateral held. A counterparty may have posted more collateral than the outstanding exposure, in which case there would not be exposure. As of September 30, 2003, Power's trading operations had approximately 150 active counterparties.
ITEM 4. CONTROLS AND PROCEDURES
PSEG, PSE&G, Power and Energy Holdings
PSEG, PSE&G, Power and Energy Holdings have established and maintain disclosure controls and procedures which are designed to provide reasonable assurance that material information relating to each company, including their respective consolidated subsidiaries, is made known to the Chief Executive Officer and Chief Financial Officer of each company by others within those entities. PSEG,
78

PSE&G, Power and Energy Holdings have
  established a Disclosure Committee, which is made up of several key management
  employees and reports directly to the Chief Financial Officer and Chief Executive
  Officer of each company, to monitor and evaluate these disclosure controls and
  procedures. The Chief Financial Officer and Chief Executive Officer of each
  company have evaluated the effectiveness of the disclosure controls and procedures
  as of the end of the reporting period and, based on this evaluation, it was
  concluded that the disclosure controls and procedures were effective in providing
  reasonable assurance during the period covered in these quarterly reports. There
  were no significant changes in internal controls or in other factors during
  the quarter that could significantly affect internal controls. It should be noted that the
  design of any system of controls is based in part upon certain assumptions about
  the likelihood of future events, and there can be no assurance that any design
  will succeed in achieving its stated goals under all potential future conditions,
  regardless of how remote.
79

PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Certain information reported under Item 3 of Part I of the 2002 Annual Report on Form 10-K and under Item 1 of part II of the Quarterly Reports on Form 10-Q for the quarter ended March 31, 2003 and June 30, 2003 is updated below.
See information on the following proceedings at the pages indicated:
(1)

    Pages 23 and 49. (PSE&G)
      PSE&G's Electric Base Rate Case filed with the BPU, OAL No. PUC5744-02;
      
          Docket No. ERO2050303.(2)

    Page 28. (PSE&G)
      Investigation and additional investigation by the EPA regarding the Passaic
      River site,
          Docket No. EX93060255.(3)

    Pages 28 and 80. (PSE&G)
      PSE&G's Manufactured Gas Plants (MGP) Remediation Program.(4)

    Page 31. (Power) DOE
      Overcharges, Docket No. 01-592C.(5)

    Page 31. (Power) DOE not
      taking possession of spent nuclear fuel, Docket No. 01-551C.(6)

    Page 32. (PSE&G)
      PSE&G's Basic Gas Supply Service filing with the BPU, Docket No. EO03050394.(7)

    Page 32. (PSE&G)
      Purported class action lawsuit against PSE&G demanding the utility move
      or shield gas meters located
          in allegedly dangerous locations, Docket No. GO03080640.(8)

    Page 32. (Energy Holdings)
      AES termination of the Stock Purchase Agreement, relating to the sale of
      certain Argentine
          assets. New York State Supreme Court for New York County (Docket No. 60155/2002) PSEG Global,
          et al vs. The AES Corporation, et al.(9)

    Page 33. (Energy Holdings)
      Peru's Internal Revenue Agency's (SUNAT) claim for past-due taxes at Luz
      de Sur (LDS),
          Resolution No. 0150150000030, dated July 10, 2003.(10)

    Page 43. (Energy Holdings)
      Complaint filed by Harbinger with the Circuit Court of Shelby, Co., Alabama
      addressing ownership
          interest in GWF. Harbinger GWF LLC, et al. v. PSEG California Corp., et al, Civil Action No. CV-2003-201.(11)

    Pages 45 and 81. (Power)
      Protest filed by Old Dominion Electric Cooperative (ODEC) at FERC against
      Power,
          Docket No. EL98-6-001.(12)

    Page 83. (Energy Holdings)
      Criminal charge against certain government officials and officers of LDS
      relating to claims
          made by the Peruvian housing authority (FONAVI), for certain projects. First Special Criminal
          Court of Lima, No. 23-2002.ITEM 5. OTHER INFORMATION
Certain information reported under the 2002 Annual Report on Form 10-K and the Quarterly Reports on Form 10-Q for the quarters ended March 31, 2003 and June 30, 2003, is updated below. Additionally, certain information is provided for new matters that have arisen subsequent to the filing of the 2002 Annual Report on Form 10-K. References are to the related pages on the Form 10-K as printed and distributed.
PSE&G
Remediation Adjustment Clause (RAC) Filing
On June
  6, 2003, PSE&G filed its RAC petition with the BPU for recovery of approximately
  $36 million for remediation costs incurred at PSE&G's former Manufactured
  Gas Plant (MGP) sites. The costs cover the period from August 1, 2001 through
  July 31, 2002. On July 11, 2003, the case was transferred to the OAL
  for hearings. Public hearings and discussions between PSE&G, the RPA
80

and the OAL will continue through the fourth
  quarter 2003. For further information, see Note 7. Commitments and Contingent
  Liabilities of the Notes.
PSE&G and Power
ODEC
2002 Form 10-K, page 159, March 31, 2003 Form 10-Q, page 23 and June 30, 2003 Form 10-Q, page 76.In 1995, PSE&G entered into a ten-year wholesale power contract with ODEC. The contract was transferred to Power in conjunction with the generation asset transfer in 2000. The contract provides for Power to supply ODEC with capacity and energy for a bundled rate that includes a component to recover multiple transmission charges (referred to as ''pancaked transmission rates''). For additional information related to ODEC, see Note 16. Subsequent Events of the Notes.
Power
Nuclear Regulatory Commission (NRC)
2002 Form 10-K, page 16 and June 30, 2003 Form 10-Q, page 77.Exelon has informed Power that the application for operating license extension for Peach Bottom 2 and 3 was approved by the NRC on May 7, 2003. The 20-year license extension expires in 2033 for Unit 2 and 2034 for Unit 3.
In August 2002, the NRC issued a bulletin requiring that all operators of pressurized water reactor (PWR) nuclear units submit certain information related to potential degradation of reactor vessel heads. In September 2002, Power provided the requested information for Salem. Bare metal visual inspections for Salem 1 and 2 were completed during 2002 and 2003, respectively, and no degradation of the reactor heads was observed. On February 11, 2003 the NRC issued an order to all operators of PWR units concerning reactor vessel head inspections. The order confirms the previous bulletin's requirements and adds more intrusive and frequent future inspections, which apply to Salem 1 and 2. If repairs are determined to be necessary, it is estimated that the repair would extend the outage by approximately four weeks.
Power plans to replace Salem Units 1 and 2 reactor heads in 2005 as a preventive maintenance measure, based upon generic industry experience.
In August 2003, the NRC issued a bulletin requiring that all operators of PWR nuclear units also perform inspections of the reactor vessel lower head, due to leakage observed at another nuclear unit not owned by Power. Bare metal visual examinations were completed during Salem 2's October 2003 outage, and no degradation was observed. Examinations of Salem 1's reactor vessel lower head will be performed during its Spring outage in 2004. Power's Hope Creek nuclear unit and Peach Bottom 2 and 3 are unaffected by either of these bulletins as they are Boiling Water Reactor nuclear units. Power cannot predict what other actions the NRC may take on this issue.
Energy Holdings
Leveraged Leases
2002
  Form 10-K, page 89.Resources is the lessor/equity participant
  of the Collins facility, as well
  as the Powerton and Joliet stations to Midwest Generation LLC (Midwest), an
  indirect subsidiary of Edison Mission Energy (EME). Edison Mission Midwest
  Holdings (EMM Holdings) is also an indirect subsidiary of EME. On October 28,
  2003, these entities' corporate credit ratings were lowered to B and are on
  credit watch with negative implications.
In its second quarter 2003 Form
  10-Q filing, EME indicated that a failure
  to repay, extend, or refinance certain debt due December 11, 2003 could make
  it
  necessary for EME to file a petition for reorganization under Chapter 11 of
  the
  United States Bankruptcy Code.
Resources has lease covenants
  that include historical and forward cash flow coverage tests that prohibit certain
  capital expenditures and dividend payments to the parent/lessee if stated minimum
  coverages are not met, and similar cash flow restrictions if ratings are not
  maintained at stated levels. The covenants are designed to maintain cash reserves
  in the transaction entity for the benefit of the
81

non-recourse lenders and the lessor/equity participants in the
  event of a market downturn or degradation in operating performance of the leased
  assets. These restrictions are sometimes called "cash traps". In the
  event of default under the lease covenants, Resources among others would have
  rights to the cash trapped at EMM Holdings. While these covenants help to provide
  liquidity to the creditors and the lease equity in the transaction, no assurances
  can be given that such covenants will be sufficient to prevent Resources from
  incurring a material loss of its equity investment and future earnings and cash
  flow.

As of September 30, 2003,
  lease payments on these facilities were current. If the collection of rental
  payments could not be reasonably assured, Resources would stop accruing earnings
  on these investments in accordance with SFAS 13, "Accounting for Leases".
  The after-tax income currently expected from these leases in 2004 is approximately
  $8 million for the Collins facility and $6 million for the Powerton and Joliet
  facilities respectively. If that occurred, Resources would need to review the
  investments for impairment and, if necessary, reduce them to net realizable
  value. In the event of a default, Energy Holdings would exercise its rights
  and attempt to seek recovery of its investment. The results of such efforts
  may not be known fo a period of time. A bankruptcy of EME and failure to recover
  adequate value could lead to a foreclosure of the lease.
Under a worst-case scenario,
  if a foreclosure were to occur, Resources would record a pre-tax write-off up
  to its gross investment in these facilities. The investment balance increases
  as earnings are recognized and decreases as rental payments are received by
  the lessor. At September 30, 2003, the gross investment balances for the Collins
  facility and the Powerton and Joliet facilities were $196 million and $180 million,
  respectively. Also, in the event of a potential foreclosure, the net tax benefits
  generated by Resources' portfolio of investments could be materially reduced
  in the period in which gains associated with the potential forgiveness of debt
  at these projects occurs. The amount and timing of any potential reduction in
  net tax benefits is dependent upon a number of factors including, but not limited
  to, the time of a potential foreclosure, the amount of lease debt outstanding,
  any cash trapped at the projects and negotiations during such potential foreclosure
  process. If a foreclosure had occurred at the Collins, Powerton and Joliet facilities
  at September 30, 2003, based on the levels of debt then outstanding and assuming
  there was no cash available at the projects for debt and equity payments, such
  net tax benefit reduction would have been approximately $17 million and $28
  million related to the Collins facility and the Powerton and Joliet facilities,
  respectively. The potential loss of earnings, impairment and/or tax payments
  could have a material impact to PSEG's and Energy Holdings' financial position,
  results of operations and net cash flows.
Poland
Elektrocieplownia Chorzow Sp. Z.o.o. (Elcho)
2002 Form 10-K, page 33 and June 30, 2003 Form 10-Q, page 78.Global owns a 90% stake in Elcho, a company developing combined heat and power plant located in the city of Chorzow, Poland that is expected to be operational by the end of 2003. Elcho also owns an older smaller combined heat and power plant, which will be retired some time after the new plant goes into commercial operation. Elcho has a 20-year power purchase agreement (Elcho PPA) with Polskie Sieci Elektroenergetyczne SA (PSE), the Polish government power grid company.
The Polish government has embarked on a process with the intention of terminating all of the more than 30 existing long-term power purchase agreements signed with PSE and to compensate each affected power plant for the difference in value between a project with a long-term commitment for its output and one that sells its output into a short-term market.
The
  termination of the Elcho PPA could constitute an event of default under the
  project financing and could result in the breakage of the interest rate swap
  contracts entered into in connection with such financing. While the process
  for determining the compensation amounts with respect to the termination of
  the Elcho PPA is still in its early stages, Global considers the preliminary
  figures indicated to be insufficient to properly address the impacts of such
  termination. An adverse outcome could potentially effect Global's financial
  position, results of operations and net cash flows.
82



Global
  and Elcho's management continue discussions with the Polish government in order
  to facilitate a fair resolution to this matter. However, no assurances can be
  given.
Italy
Prisma
2002
  Form 10-K, pages 31 and 49.Global has
  entered into a memorandum of understanding to sell its interest in Prisma, a
  generation business in Italy, to its partner for approximately $69 million.
  The sale is currently expected to close in 2004, contingent upon successful
  financing.

Peru
LDS
June 30, 2003 Form 10-Q, page 78.In 1999, Global acquired an interest in LDS, an electric distribution company based in Peru. On May 12, 2003, a criminal complaint was filed against certain government officials, and utility officials as accomplices, including the Chief Executive Officer and Chief Financial Officer of LDS, alleging that certain settlements did not provide the government with adequate compensation in a dispute with Fondo Nacional de Vivienda (FONAVI). On September 12, 2003, a Peruvian court ordered the prosecutors case to be dismissed. The prosecutor has appealed this decision. Global has investigated this matter and believes that the negotiated resolution was conducted properly.

Brazil
Rio Grande Energia (RGE)
As of
  September 30, 2003, RGE had total outstanding debt equivalent to approximately
  $245 million of which approximately $127 million matures over the next two years.
  The company is currently in discussions with various financial institutions
  to obtain financing for the equivalent of approximately $40 million as of September
  30, 2003. Proceeds from these facilities will be used to refinance certain short-term
  obligations and to fund capital expenditures. Due to the macroeconomic conditions
  in Brazil, its debt markets have become increasingly short term in nature, impacting
  RGE's ability to refinance on a long-term basis, which could negatively impact
  RGE's liquidity and increase their costs of borrowing. RGE's current interest
  rate is approximately 24%.
Directors and Executive Officers of the Registrants
PSE&G
Alfred C. Koeppe, President and Chief Operating Officer of PSE&G retired in October 2003 and was replaced by Ralph Izzo.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) A listing of exhibits being filed with this document is as follows:
a. PSEG:
Exhibit 12: Computation of Ratios of Earnings to Fixed Charges
Exhibit 31: Certification by E. James Ferland Pursuant to Rules 13a-14 and 15d-14 of the    Securities Exchange Act of 1934
Exhibit 31.1: Certification by Thomas M. O'Flynn Pursuant to Rules 13a-14 and 15d-14 of the    Securities Exchange Act of 1934
Exhibit 32: Certification by E. James Ferland Pursuant to Section 1350 of Chapter 63 of Title 18 of the    United States Code

83

Exhibit 32.1: Certification by Thomas M. O'Flynn
      Pursuant to Section 1350 of Chapter 63 of Title 18 of the
          United States Code
b. PSE&G:
Exhibit 10: Employment Agreement with Ralph Izzo
      dated October 18, 2003
Exhibit 12.1: Computation of Ratios of Earnings
      to Fixed Charges
Exhibit 12.2: Computation of Ratios of Earnings
      to Fixed Charges Plus Preferred Securities Dividend Requirements
Exhibit 31.2: Certification by E. James Ferland
      Pursuant to Rules 13a-14 and 15d-14 of the
          Securities Exchange Act of 1934
Exhibit 31.3: Certification by Robert E. Busch Pursuant to Rules 13a-14 and 15d-14 of the    Securities Exchange Act of 1934
Exhibit 32.2: Certification by E. James Ferland Pursuant to Section 1350 of Chapter 63 of Title 18 of the    United States Code
Exhibit 32.3: Certification by Robert
      E. Busch Pursuant to Section 1350 of Chapter 63 of Title 18
      of the    United States Code
c. Power:
Exhibit 12.3: Computation of Ratios of Earnings to Fixed Charges
Exhibit 31.4: Certification by E. James Ferland Pursuant to Rules 13a-14 and 15d-14 of the    Securities Exchange Act of 1934Exhibit 31.5: Certification by Thomas M. O'Flynn
      Pursuant to Rules 13a-14 and 15d-14 of the    
      Securities Exchange Act of 1934
Exhibit 32.4: Certification by E. James Ferland Pursuant to Section 1350 of Chapter 63 of Title 18 of the    United States Code
Exhibit 32.5: Certification by Thomas M. O'Flynn
      Pursuant to Section 1350 of Chapter 63 of Title 18 of the    
      United States Code
d. Energy Holdings:
Exhibit 12.4: Computation of Ratios of Earnings to Fixed Charges
Exhibit 31.6: Certification by E. James Ferland Pursuant to Rules 13a-14 and 15d-14 of the    Securities Exchange Act of 1934
Exhibit 31.7: Certification by Thomas M. O'Flynn Pursuant to Rules 13a-14 and 15d-14 of the    Securities Exchange Act of 1934
Exhibit 32.6: Certification by E. James Ferland Pursuant to Section 1350 of Chapter 63 of Title 18 of the    United States Code
Exhibit 32.7: Certification by Thomas M. O'Flynn Pursuant to Section 1350 of Chapter 63 of Title 18 of the    United States Code
84

(B) Reports on Form 8-K:
a. PSEG:Items
      ReportedItems 5 and 9
      Item 5
      Items 5 and 9
    Date
      of ReportJuly 22, 2003
      September 30, 2003
      October 22, 2003b. PSE&G:Items
      ReportedItem 5
      Item 5
      Items 5 and 9
    Date
      of ReportJuly 22, 2003
      September 30, 2003
      October 22, 2003c. Power:Items
      ReportedItem 5
      Item 5
      Items 5 and 9
    Date
      of ReportJuly 22, 2003
      September 30, 2003
      October 22, 2003d. Energy
      Holdings:Items
      ReportedItem 5
      Item 5
      Items 5 and 9
    Date
      of ReportJuly 22, 2003
      September 30, 2003
      October 22, 2003
85

SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.
PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED(Registrant)By:PATRICIAA. RADO
             Patricia A. Rado
      Vice President and Controller
      (Principal Accounting Officer)Date: October 30, 2003
86
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.
PUBLIC SERVICE ELECTRIC AND GAS COMPANY(Registrant)By:PATRICIAA. RADO         
            Patricia A. Rado
      Vice President and Controller
      (Principal Accounting Officer)Date: October 30, 2003
87
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.
PSEG POWER LLC(Registrant)By:PATRICIAA. RADO
             Patricia A. Rado
      Vice President and Controller
      (Principal Accounting Officer)Date: October 30, 2003
88
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.
PSEG ENERGY HOLDINGS LLC(Registrant)By:DEREKM. DIRISIO
             Derek M. DiRisio
      Vice President and Controller
      (Principal Accounting Officer)Date: October 30, 2003
89