<PAGE>   1

 
 
================================================================================
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                                    ---------
                                    FORM 10-K
(Mark One)

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

                 For the fiscal year ended December 31, 1997, or

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

             For the transition period from            to
                                            ----------   -----------

                          Commission file number 1-7310

     Michigan  Consolidated  Gas  Company,  a  Michigan  corporation,  meets the
conditions  set forth in General  Instruction I (1) (a) and (b) of Form 10-K and
is, therefore, filing this form with the reduced disclosure format.

                        MICHIGAN CONSOLIDATED GAS COMPANY
             (Exact name of registrant as specified in its charter)

       Michigan                                               38-0478040
(State or other jurisdiction of                            (I.R.S. Employer
   incorporation or organization)                           Identification No.)

 500 Griswold Street, Detroit, Michigan                          48226
(Address of principal executive offices)                      (Zip Code)

                                  313-965-2430
              (Registrant's telephone number, including area code)

        Securities registered pursuant to Section 12(b) of the Act: None

        Securities registered pursuant to Section 12(g) of the Act: None

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

     Indicate by check mark if disclosure of delinquent  filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's  knowledge,  in definitive proxy or information  statements
incorporated  by  reference in Part III of this Form 10-K or any  amendments  to
this Form 10-K. X
               ---

     All of the registrant's  10,300,000 outstanding shares of common stock, par
value $1 per share, are owned by MCN Energy Group Inc.

                    Documents Incorporated by Reference: None
                                                                                

================================================================================
<PAGE>   2

 
 
                       
                            KEY TO ABBREVIATED TERMS
<TABLE>
<CAPTION>
<S>                                                    <C>
Antrim Gas...........................................    Natural  gas  produced from  shallow wells in the Devonian  
                                                         (Antrim) shale formations.

Degree Days..........................................    A measure  of the  coldness  of the  weather  based on how
                                                         much the  average  daily  temperature  is below 65 degrees
                                                         Fahrenheit.

End User Transportation..............................    A  gas   delivery   service   provided   to   large-volume
                                                         commercial and industrial  customers who purchase  natural
                                                         gas directly from producers or brokerage companies.

FERC.................................................    Federal  Energy  Regulatory  Commission;  a federal agency
                                                         that  determines  the rates and  regulations of interstate
                                                         pipelines.

Gas Markets..........................................    Gas  sales,  end  user   transportation  and  intermediate
                                                         transportation deliveries.

Gas Storage..........................................    The  process  of   injecting,   storing  and   withdrawing
                                                         natural  gas  from  a  depleted  underground  natural  gas
                                                         field or salt cavern.

GCR..................................................    Gas Cost  Recovery;  a process by which  MichCon,  through
                                                         annual gas cost  proceedings  before the  Michigan  Public
                                                         Service  Commission,  is allowed to recover its reasonable
                                                         and prudent cost of gas sold.

Intermediate Transportation..........................    A gas  delivery  service  provided to gas  producers,  gas
                                                         brokers  and  other  gas  companies  that own the  natural
                                                         gas, but are not the ultimate consumers.

MCN..................................................    MCN Energy Group Inc. and its subsidiaries.

MichCon..............................................    Michigan   Consolidated   Gas  Company;   a  wholly  owned
                                                         natural  gas  distribution  and  intrastate   transmission
                                                         subsidiary of MCN.


MichCon Pipeline Co..................................    A wholly  owned  subsidiary  of  MichCon  that  engages in
                                                         pipeline projects through its subsidiaries.
</TABLE>

                                       ii
<PAGE>   3
                            KEY TO ABBREVIATED TERMS
                                   (concluded)

<TABLE>
<CAPTION>
<S>                                                    <C>
MPSC.................................................    Michigan  Public  Service  Commission;  the  regulator  of
                                                         intrastate  aspects of the  natural  gas  industry  within
                                                         the State of Michigan.

Normal Weather.......................................    The average daily  temperature  within  MichCon's  service
                                                         area during a recent 30-year period.

Spot Market..........................................    The buying and  selling  of  natural  gas on a  short-term
                                                         basis, typically month to month.

Units of Measurement

Bcf..................................................    One billion cubic feet of natural gas.

Mcf..................................................    One thousand cubic feet of natural gas.

MMcf.................................................    One million cubic feet of natural gas.

/d...................................................    Added to MMcf or Bcf to denote average volumes per day.
</TABLE>


                                      iii
<PAGE>   4

 
 


                                                   
                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
 
CONTENTS                                                                                                  PAGE
--------                                                                                                 NUMBER
                                                                                                         ------
<S>                                                                                                      <C>
Part I

   Item 1.    Business.....................................................................................  1

   Item 2.    Properties...................................................................................  9

   Item 3.    Legal Proceedings............................................................................  9

   Item 4.    Submission of Matters to a Vote of Security Holders.......................................... 10

Part II

   Item 5.    Market for Registrant's Common Equity and Related Stockholder Matters........................ 11

   Item 6.    Selected Financial Data...................................................................... 12

   Item 7.    Management's Discussion and Analysis of Financial Condition and
              Results of Operations........................................................................ 13

   Item 8.    Financial Statements and Supplementary Data.................................................. 21

   Item 9.    Changes in and Disagreements with Accountants on Accounting and
              Financial Disclosure......................................................................... 44

Part III

   Item 10.   Directors and Executive Officers of the Registrant........................................... 44

   Item 11.   Executive Compensation....................................................................... 44

   Item 12.   Security Ownership of Certain Beneficial Owners and Management............................... 44

   Item 13.   Certain Relationships and Related Transactions............................................... 44

Part IV

   Item 14.   Exhibits, Financial Statement Schedule, and Reports on Form 8-K.............................. 45

Signatures    ............................................................................................. 47
</TABLE>

                                       iv


<PAGE>   5
                                     Part I

Item 1.  Business

     MichCon is a Michigan  corporation that was organized in 1898 and, with its
predecessors,  has been in business  for nearly 150 years.  MichCon is a natural
gas utility  primarily  engaged in the  distribution and transmission of natural
gas in the state of  Michigan.  MichCon  also has  subsidiaries  involved in the
gathering  and  transmission  of natural gas in northern  Michigan.  MichCon,  a
wholly-owned  subsidiary  of  MCN,  operates  one of  the  largest  natural  gas
distribution  and  transmission  systems in the United States and the largest in
Michigan.

        At December 31, 1997, MichCon and its subsidiaries  employed 2,867
persons. Of that  number,  slightly less  than  half are  covered  by five 
collective  bargaining agreements.  In December 1997,  MichCon  successfully 
negotiated and signed two collective  bargaining  agreements.  The  remaining 
three  agreements  covering approximately 15% of the workforce will expire in
June 1998.

Gas Sales & Transportation

     MichCon  serves 1.2 million  customers in the Detroit,  Grand  Rapids,  Ann
Arbor,  Traverse  City and  Muskegon  metropolitan  areas and in  various  other
communities  throughout  the  state of  Michigan.  The  following  services  are
provided by MichCon:

     Gas Sales - Includes  the sale and  delivery of natural gas to  residential
and small-volume commercial customers.

     End User Transportation - Through this service, large-volume commercial and
industrial  customers  that  purchase  natural gas  directly  from  producers or
brokerage  companies utilize the Company's network to transport the gas to their
facilities.

     Intermediate  Transportation - Provides  transportation service through the
Company's gathering and high pressure transmission system to producers,  brokers
and other local distribution companies that own the natural gas, but are not the
ultimate consumer.
<TABLE>
<CAPTION>

                                                                       1997               1996                1995
                                                                  ---------------    ----------------   -----------------
<S>                                                               <C>                 <C>                <C>
REVENUE (In millions of dollars)
Gas Sales................................................          $     1,062.8.     $     1,085.8       $        917.2
End User Transportation..................................                   84.5.              82.2                 80.4
Intermediate Transportation..............................                   55.2.              48.6                 31.9
                                                                   --------------    ---------------     ----------------
    Total Sales and Transportation ......................                1,202.5.           1,216.6              1,029.5
                                                                   --------------    ---------------     ----------------
Other ...................................................                   51.2.              42.2                 51.3
                                                                   ==============    ===============     ================
   Total Operating Revenues ............................           $     1,253.7.     $     1,258.8       $      1,080.8
                                                                   ==============    ===============     ================

MARKETS (Bcf)
Gas Sales................................................                  205.8              217.7               206.9
End User Transportation..................................                  145.0              146.7               145.3
Intermediate Transportation..............................                  586.4              527.5               341.6
                                                                   ==============    ===============    ================
   Total Sales and Transportation ......................                   937.2              891.9               693.8
                                                                   ==============    ===============    ================
</TABLE>
                                       1
<PAGE>   6

     EFFECT OF WEATHER: MichCon's gas sales and end user transportation volumes,
revenues  and net income are impacted by weather.  Given the seasonal  nature of
the business,  revenues and net income tend to be higher in the first and fourth
quarters of the calendar year.

Effect of Weather on Gas Markets and Earnings 
---------------------------------------------
<TABLE>
<CAPTION>

                                                                                       1997      1996    1995
                                                                                    -------   -------   -----
          <S>                                                                     <C>         <C>       <C>
          Percentage Colder Than Normal.......................................       0.8%        5.4%      0.3%
          Increase From Normal in:
              Gas Markets (in Bcf)............................................       0.6        10.9       1.5
              Net Income (in Millions)........................................    $  0.5      $  9.9     $ 1.4
</TABLE>

     GAS  SALES:  Revenues  decreased  $23.0  million in 1997 due  primarily  to
reduced  gas  sales as a result of warmer  weather,  partially  offset by higher
prices to recover gas costs.  This market represents 22% of total deliveries and
produced  approximately  75% of  MichCon's  gross  profit  margin from sales and
transportation  services (gross profit margin).  The average margin per Mcf from
gas sales was $2.09 in 1997 and $2.06 in 1996.

     Competition in the gas sales market comes primarily from alternative  fuels
such as  electricity,  propane and, to a lesser degree,  oil and wood, and other
natural gas providers in a few areas.  Natural gas continues to be the preferred
fuel for  Michigan  residences  and  businesses.  Nearly every  residential  and
commercial developer in MichCon's service territories selects natural gas in new
construction  because of the  convenience,  cleanliness  and price  advantage of
natural gas compared to propane,  fuel oil and other alternative fuels.  Service
and price are the primary factors affecting this market.

     MichCon continues to take steps to become the preferred provider of natural
gas and high-value  energy services  within  Michigan and to maintain  financial
results.  To  accomplish  this,  MichCon will increase  penetration  of existing
markets by focusing on meeting the needs of customers and the marketplace,  will
increase  efforts  to  reduce  cost of gas and  operating  costs,  and will take
advantage of growth opportunities to expand to new geographic areas.

     MichCon's Market  Expansion  Program is intended to spur demand for natural
gas in areas  currently  not  served.  The  program  is  primarily  targeted  at
residential and small-volume  commercial  markets. By financing the cost of main
extensions,  this program makes it easier for users of other higher-cost  fuels,
such as propane  and fuel oil, to switch to natural gas for space heat and other
applications. This program has contributed 15% of the 72,673 new customers added
during  the past 3 years.  In 1997,  9 new  areas of  Michigan  were  served  by
MichCon,  bringing  the  total  number of new areas  added  since the  program's
inception in 1984 to 137.

     Cost of gas sold per Mcf for 1997 was $3.11,  an  increase  of $.19  (6.5%)
over 1996.  MichCon still  retained a significant  cost advantage over competing
fuels.  Cost of gas sold per Mcf for 1996 increased from 1995 by $.56 (24%). 

     END USER TRANSPORTATION: Deliveries decreased in 1997 as a result of warmer
weather.  In 1997,  this market  accounted for 15% of total gas  deliveries  and
produced approximately 15% of MichCon's gross profit margin.

                                       2

<PAGE>   7

     At  December  31,  1997,  MichCon  had end user  transportation  agreements
representing  annual volumes of 151 Bcf.  Approximately 56% of these volumes are
under  contracts  that extend to 1999 or beyond and include the  majority of the
large, and most price-sensitive,  customers. Contracts for the remaining volumes
are typically  one-year  contracts  that expire at various times during 1998 and
relate  to a  large  number  of low  volume  users  with  relatively  low  price
sensitivity.

     Through  technical  and financial  assistance,  industrial  and  commercial
customers  have been  encouraged to increase the use of natural gas. The natural
gas-fueled  power generation  market  accounted for  approximately 31 Bcf of gas
deliveries  in both 1996 and 1997.  Air  compressors  and other small engines in
certain  commercial  applications  also provide  possibilities for conversion to
natural  gas-powered  equipment.  The efficiencies and price  competitiveness of
natural gas can significantly reduce operating costs for customers,  even though
a higher initial outlay for gas-burning equipment may be required.

     The primary focus of competition in this market is total cost of fuel. Some
large  commercial  and  industrial  customers  have the  capacity  to  switch to
alternative fuel sources such as coal, electricity,  oil and steam. In addition,
some of these customers could bypass  MichCon's  distribution  system and obtain
gas  directly  from a pipeline  company.  However,  cost  differentials  must be
sufficient to offset the substantial  investment costs and risks associated with
fuel switching or bypass.  MichCon competes against  alternative fuel sources by
providing  competitive  pricing  and  reliable  supply  through  the  use of the
company's  extensive  storage  capacity and multiple supply sources.  Almost all
significant  customers  that  are  in  proximity  to  other  company's  pipeline
facilities are under long-term contracts.

     In the past several years,  MichCon has been  successful in converting many
customers'  facilities  to natural gas from  alternative  fuels and in retaining
those customers after conversion.  Also, in the past several years,  MichCon has
not  experienced  any  significant  fuel  switching by its  customers.  In 1997,
approximately  22 Bcf of MichCon's  transportation  deliveries were to customers
who displaced coal with natural gas.

     Although the MPSC has approved a direct access  program for the state's two
largest  electric  utilities  which will allow large  electric users to directly
purchase lower priced  electricity,  beginning in mid-1998,  this program is not
expected to materially impact the competitiveness of natural gas.

     INTERMEDIATE  TRANSPORTATION:  This  service  accounts for 63% of total gas
volumes but, due to the lower rates applicable to this service,  represents only
10%  of  MichCon's   gross  profit   margin.   The  increases  in   intermediate
transportation  deliveries  in 1997 and 1996  are due  primarily  to the sale of
additional transportation services including increased transportation volumes of
Michigan gas production. Volumes were also impacted by lower deliveries to major
fixed-fee  customers in 1997 compared to increased  deliveries in 1996. Although
volumes for these fixed-fee customers have varied, the related revenues were not
significantly affected.

     MichCon's extensive transmission pipeline system has enabled it to increase
the volumes  transported  for Michigan gas  producers,  marketers,  distribution
companies and other pipelines. MichCon operates in a pivotal geographic location
with links to major  interstate  pipelines  that reach markets  elsewhere in the
Midwest, the eastern United States and eastern Canada.

     In 1997,  through  efficient use of transmission and storage assets as well
as upstream supply,  MichCon sold significant  short-term  services resulting in
increased revenues from 1996.

                                       3
<PAGE>   8

     There has been a  significant  increase in Michigan  Antrim gas  production
over the past several years,  resulting in a growing demand by gas producers and
brokers for intermediate transportation services. In order to meet the increased
demand,  MichCon expanded the  transportation  capacity of its northern Michigan
gathering system, which is owned by MichCon Pipeline Company (MichCon Pipeline).
This expansion  contributed 128.5 Bcf in volumes  transported during 1997 and 75
Bcf in 1996.

     MichCon Pipeline,  a wholly-owned,  non-utility  subsidiary of MichCon,  is
involved in ventures  that  transport  natural gas and natural gas liquids  from
northern  and  east-central  Michigan  gas  fields to  processing  plants in the
northern  part of the state.  In December  1997,  MichCon  Pipeline  purchased a
pipeline  to  expand  the  transportation  capacity  of  its  northern  Michigan
gathering system.  The cost of the pipeline was approximately $13 million and is
expected to transport approximately 44 Bcf of Antrim gas annually.  During 1997,
MichCon Pipeline transported an average of 646 MMcf/d of natural gas and related
liquids.  The  transportation  rate on the  Saginaw Bay  Pipeline,  which was to
decrease  40% in  accordance  with the  terms of a  contract  that  reduces  the
transportation  rate for the last 10 years  of the  agreement  was  successfully
renegotiated  at the maximum MPSC approved rate during 1997.  Moreover,  Saginaw
Bay was successful in restructuring all transportation contracts relating to the
Saginaw Bay Pipeline to the maximum tariff rates.

     In January 1997, MichCon placed into service a 59-mile loop of its existing
Milford to Belle River  Pipeline at a cost of  approximately  $91  million.  The
pipeline has improved the overall  reliability  and  efficiency of MichCon's gas
storage and  transmission  system by  mitigating  the risk of  disruption in the
operation of the  existing  pipeline or other  facilities  used to supply gas to
MichCon's customers.  In addition,  the pipeline provides significant off-system
transportation opportunities as discussed below.

     With  significant new  supplies of  western Canadian gas projected into the
Chicago  area beginning in  November 1998, MichCon is in  an  excellent position
to  increase  revenues  through  transportation to  growing  markets in  eastern
Canada  and  the   Northeast  U.S.  In  December  1997,  MichCon  entered into a
long-term   lease  of  capacity  on  its Milford to  Belle  River  Pipeline with
Vector Pipeline to  effectuate transportation  from Chicago  supplies  to  Dawn,
Ontario  if  and  when Vector is constructed and placed in service,  potentially
in  late  1999 or 2000. Additional opportunities for transportation services are
being  pursued  which  will  further  maximize  the  use  of  MichCon's existing
transmission infrastructure.

     In 1998  MichCon  expects to exercise its option to purchase a 50% interest
in an additional  pipeline  under the St. Clair River to link  MichCon's  system
with Consumers' Gas of Toronto's pipeline facilities.  This project will further
enhance MichCon's ability to transport gas bound for both Canadian and Northeast
U.S. markets.

ENERGY ASSISTANCE PROGRAMS

        Energy assistance  programs funded by the federal  government and the
State of Michigan,  including the Home Heating Credit for low-income customers
and the Family Independence Agencys' State Emergency Relief  Program,  remain
critical to MichCon's ability to control its uncollectible expenses. MichCon
has historically obtained favorable regulatory treatment of its uncollectible
costs, including those related to these energy assistance programs.

     MichCon  receives a significant  amount of its heating  assistance  funding
from the federal  Low-Income Home Energy Assistance Program (LIHEAP) which funds
the State of Michigan's Home Heating Credit program.  In 1997 Congress  provided
$1.0 billion for LIHEAP and  supplemented it 

                                       4

<PAGE>   9

with a $300 million  emergency  fund that could be tapped only upon order of the
President.  The State of Michigan received $64 million of the total $1.2 billion
that was  released  in 1997.  The bulk of this money was passed on to  qualified
taxpayers in the form of Michigan Home Heating  Credits.  MichCon received $12.7
million  through this  program in 1997.  Home Heating  Credits  assisted  83,000
MichCon  customers in 1997.  Congress voted to continue LIHEAP in 1998 and 1999.
For federal Fiscal Year 1998,  which began October 1, 1997,  Congress  continued
funding at the $1.0 billion level and again authorized a $300 million  emergency
fund. In addition,  it  appropriated  $1.1 billion for federal  Fiscal Year 1999
subject to revision as part of Congress' 1999 budget  deliberations.  MichCon is
currently  working  with federal and state  officials to identify  other ways to
obtain energy  assistance  for  low-income  customers,  and is taking actions to
minimize  the  impact a  reduction  in  LIHEAP  funds  could  have on  MichCon's
financial position.

GAS SUPPLY

     MichCon  obtains its natural gas supply from  various  sources in different
geographic  areas under  agreements  that vary in both  pricing and terms.  This
geographic and contractual diversity of supply ensures that MichCon will be able
to meet the  requirements  of its present  and future  customers  with  reliable
supplies of natural gas at competitive,  market responsive prices. The company's
objective is to rank in the lowest quartile for cost of gas among comparable gas
utilities in the Midwest. Although MichCon's gas costs rose 6.5% during the year
to $3.11 per Mcf,  they  remained  in the  lowest  quartile  among a group of 22
utilities in the region,  having decreased 15% over the last ten years.  MichCon
believes that its gas purchasing  strategies  will enable it to maintain its low
cost  position.  Cost of gas sold  decreased  in 1997 as a result of lower sales
volumes, due primarily to warmer weather as well as supplier refunds.  Under its
gas cost recovery  mechanism,  MichCon expects to continue to collect all of its
cost of gas sold.

Gas Supply Purchases(Bcf) 
<TABLE>
<CAPTION>

                                                                        1997              1996                1995
                                                                   ---------------   ----------------   -----------------
<S>                                                                 <C>               <C>                 <C>   
Long-term Supply:
   Michigan Producers.....................................                   66.0               86.3                90.9
   Interstate Suppliers...................................                   13.8               14.5                18.2
   Canadian Suppliers.....................................                   31.3               37.3                31.5
Spot Market...............................................                   85.8               90.6                52.2
                                                                    --------------    ---------------    ----------------
                                                                            196.9              228.7               192.8
                                                                    ==============    ===============    ================
</TABLE>

     MichCon purchased 34% of its 1997 supply from Michigan producers,  50% from
producers in the southern and midcontinent  regions of the United States and 16%
from Canadian  producers.  These supplies are complemented by 130 Bcf of working
storage  capacity from storage fields owned and operated by MichCon in Michigan,
of which 25 Bcf is leased to others.

     MichCon has long-term  firm  transportation  agreements  with ANR and Great
Lakes  Gas  Transmission   Limited   Partnership  (Great  Lakes).   Under  these
agreements,  ANR is obligated to  transport  approximately  375 MMcf/d of supply
during the summer  months and 310 MMcf/d of supply  during the winter months for
MichCon,   while  Great  Lakes  is  obligated  to  transport  30  MMcf/d.  These
transportation agreements expire on various dates between 1999 and 2011.

                                       5
<PAGE>   10

     MichCon also has contracts with independent  Michigan producers that expire
on  various  dates  through  2011.  MichCon  continues  its supply  strategy  of
purchasing gas under  contracts that tie purchase  prices to spot market prices.
To mitigate price volatility  related to spot market prices for sales customers,
MichCon  has been  authorized  by the MPSC to  change  its  supply  strategy  to
purchase up to one-third of its gas under fixed price contracts.

     MichCon has also  developed  a program for fixing the prices of  individual
forward  months for a maximum of one-third of its supply.  This program is based
on an analysis of the  historic  price  activity  over the past five years,  and
would  give  MichCon  the  flexibility  to take  advantage  of price  dips below
historical  averages.  This program was implemented in March 1997 and since that
time small blocks of gas have been purchased at fixed prices for 1998.

     At December 31, 1997,  MichCon  owned and operated five natural gas storage
fields in Michigan with a working  storage  capacity of  approximately  130 Bcf.
These facilities play an important role in providing reliable and cost-effective
service.  MichCon uses its storage  capacity to supplement its supply during the
winter months,  replacing the gas in April through October when demand is at its
lowest.  The use of this  storage  capacity  also  allows  MichCon  to lower its
peak-day  entitlement,  thereby reducing interstate pipeline costs. During 1997,
MichCon's  maximum one-day sendout exceeded 2.3 Bcf, of which  approximately 70%
came from its underground storage fields.  MichCon's gas distribution system has
a maximum daily sendout  capability  of 2.8 Bcf, with  approximately  70% coming
from underground storage.  MichCon also leases 25 Bcf of its natural gas storage
capacity to an affiliated company and third parties.

REGULATION AND RATES

     MichCon is subject to the  jurisdiction of the MPSC as to various phases of
its  operations,  including  gas sales and  transportation  rates,  service  and
accounting.  MichCon is also  subject to the  requirements  of other  regulatory
agencies with respect to safety, the environment and health.

     GENERAL RATE PROCEEDINGS:   MichCon  received   authorization  to  defer
manufactured gas plant (MGP)  investigation  and remediation  costs in excess of
the $11.7 million previously reserved by MichCon.  The remaining balance of this
initial reserve at December 31, 1997 is approximately  $1.7 million.  Any excess
costs are to be amortized over a 10 year period beginning in the year subsequent
to the year  environmental  investigation  and  remediation  costs are paid. The
recovery of any  remediation  costs  incurred  will be reviewed in a future rate
case.

     MichCon  filed an  application  with the MPSC in  October  1996  requesting
authority to decrease  depreciation  rates from the existing 4.09% to 3.44%.  In
December  1997  the MPSC  issued  an  order  approving  a  reduction  in  annual
depreciation costs by more than $16 million. While the Michigan Attorney General
has  appealed  the  depreciation  order,  management  believes  the  MPSC  order
approving the lower depreciation rates will be upheld.

     GAS COST  RECOVERY:  The GCR process  allows MichCon to recover its cost of
gas sold if the MPSC determines that such costs are reasonable and prudent. This
determination  includes an annual Gas Supply and Cost Review,  in which the MPSC
approves  maximum monthly GCR factors.  A subsequent  annual GCR  reconciliation
proceeding  provides a review of gas costs incurred during the year,  determines
whether approved gas costs have been  overcollected or undercollected  and, as a
result,  whether a refund or surcharge,  including  interest,  is required to be
returned to or collected  from 

                                       6
<PAGE>   11

GCR customers using the rolled-in  prospective refunding methodology approved by
the MPSC on June 30, 1994.

     In February 1996, MichCon filed its 1995 GCR reconciliation case indicating
an under-recovery of less than $0.1 million,  including interest,  which will be
collected  from GCR  customers  using the new  rolled-in  prospective  refunding
methodology.  In February  1997,  the MPSC issued an order  finding  that all of
MichCon's 1995 gas costs were reasonable and prudent.

     In February 1997, MichCon filed its 1996 GCR reconciliation case indicating
a net under-recovery of approximately $28 million, including interest. The total
1996 underrecovery was rolled into MichCon's 1997 GCR cost recovery, pursuant to
the prospective  refunding  methodology  discussed above. In September 1997, the
MPSC  issued  an  order  finding  that all of  MichCon's  1996  gas  costs  were
reasonable and prudent,  including $4.4 million in interest costs from Panhandle
related to certain direct billings.

     In July  1997,  MichCon  filed  its 1998 GCR Plan  Case.  An MPSC  order is
expected in May 1998.

     In February 1998, MichCon filed its 1997 GCR reconciliation case indicating
a net under-recovery of approximately $13 million,  including interest.  An MPSC
order is expected in late 1998.

ENVIRONMENTAL MATTERS

     Prior to the 1940's when major natural gas pipelines  became  sufficient to
meet  MichCon's  supply  requirements,  gas  for  heating  and  other  uses  was
manufactured  from  processes  involving  coal,  coke or oil.  MichCon  owns, or
previously owned, 16 former manufactured gas plant (MGP) sites.

     During  the  mid-1980s,   MichCon   conducted   preliminary   environmental
investigations  at former  MGP  sites,  and some  contamination  related  to the
by-products of gas  manufacturing  was discovered at each site. The existence of
these  sites  and the  results  of the  environmental  investigations  have been
reported to the Michigan  Department  of  Environmental  Quality.  None of these
former  MGP  sites  is on the  National  Priorities  List  prepared  by the U.S.
Environmental Protection Agency.

     MichCon is not involved in any administrative  proceedings  regarding these
former  MGP  sites,  but is  currently  remediating  four  of  these  sites  and
conducting more extensive investigations at four other former MGP sites.

     In 1984,  MichCon  established an $11.7 million  reserve for  environmental
investigation and remediation.  During 1993, MichCon received MPSC approval of a
cost deferral and rate  recovery  mechanism for  investigation  and  remediation
costs incurred at former MGP sites in excess of this reserve.

     MichCon employed outside consultants to evaluate  remediation  alternatives
for these sites, to assist in estimating its potential liabilities and to review
its archived insurance polices. The findings of these  investigations  indicated
that  the  estimated  total   expenditures  for  investigation  and  remediation
activities for these sites could range from $30 million to $170 million based on
undiscounted  1995  costs.  As a result of these  studies,  MichCon  accrued  an
additional  liability and a corresponding  regulatory asset of approximately $32
million during 1995.

                                       7

<PAGE>   12

     MichCon notified more than 40 current and former insurance  carriers of the
environmental conditions at these former MGP sites. MichCon concluded settlement
negotiations  with certain  carriers in 1996 and 1997 and has received  payments
from  several  carriers.  In October  1997,  MichCon  filed suit  against  major
nonsettling  carriers  seeking  recovery  of  incurred  costs and a  declaratory
judgment  of  the  carriers'   liability  for  future  costs  of   environmental
investigation and remediation costs at former MGP sites.

     During 1997,  1996 and 1995,  MichCon spent $0.8 million,  $0.9 million and
$2.1  million,  respectively,  investigating  and  remediating  these former MGP
sites.  At December 31, 1997, the reserve  balance was $33.7  million,  of which
$1.7 million was classified as current.  Any significant  change in assumptions,
such  as  remediation  techniques,   nature  and  extent  of  contamination  and
regulatory requirements,  could impact the estimate of remedial action costs for
the sites and therefore have an effect on MichCon's  financial position and cash
flows. However, management believes insurance coverage and the cost deferral and
rate recovery  mechanism approved by the MPSC will prevent  environmental  costs
from having a material adverse impact on MichCon's results of operations.

FRANCHISES

     MichCon  operates  in  over  530  cities,   villages  and  townships  under
franchises  or permits that  typically  are revocable at will and have a 30-year
maximum  duration.  In 1993,  MichCon  began a  structured  process  to renew or
re-establish previously expired formal franchises in 233 municipalities.  During
the period between 1994 and 1997 an additional 168 franchises  expired. To date,
381 franchises have been renewed, 11 of which were renewed in 1997 which account
for gas sales volumes of  approximately 40 Bcf annually.  Additionally,  two new
franchises were acquired. There were no franchises lost.

     As for  the  20  franchises  that  are  currently  expired,  MichCon's  gas
distribution  systems are  rightfully  occupying the streets with the consent or
acquiescence  of the  municipalities.  While  MichCon  could be  ordered  by any
municipality in which its franchise has expired to remove its property, it could
be deprived of  ownership  only by its consent and the payment of an agreed upon
price,  or by  condemnation  and the  payment of the fair  market  value of such
property.  Should  any of  these  municipalities  seek  to  terminate  MichCon's
operations  therein and substitute  another gas utility  operation,  publicly or
privately owned, the municipality  must either (i) acquire and operate MichCon's
system,  (ii)  construct  a new  system or (iii)  grant a  franchise  to another
privately owned utility to construct or acquire its own distribution system.

     Public utility franchises in Michigan are non-exclusive. Construction under
a second franchise  granted to another public utility requires  authorization by
the MPSC,  which  considers,  among other  things,  the service  rendered by the
existing utility,  the investment by such utility,  and the benefit,  if any, to
the  public  of  having a second  utility  serve in the area.  In June  1996,  a
statutory amendment was adopted which provides that only irrevocable  franchises
need  municipal  voter  confirmation.   The  amendment  further  clarified  that
franchises  which are not voter  confirmed are valid but revocable.  In light of
that amendment, the Michigan Supreme Court dismissed as moot an appeal involving
MichCon concerning the status of utility franchises which had not received voter
confirmation.

                                       8

<PAGE>   13

ITEM 2.  PROPERTIES

     MichCon  operates  natural  gas  distribution,   transmission  and  storage
facilities  in  the  state  of  Michigan.   At  December  31,  1997,   MichCon's
distribution  system  included  16,537 miles of  distribution  mains,  1,076,212
service  lines  and  1,190,314  active  meters.  MichCon  owns  2,549  miles  of
transmission  and production  lines that deliver natural gas to the distribution
districts and interconnect its storage fields with the sources of supply and the
market areas.  MichCon also owns properties relating to five underground storage
fields  with  an  aggregate   storage   capacity  of   approximately   130  Bcf.
Additionally,  MichCon owns district office buildings, service buildings and gas
receiving and metering stations. In January 1998 MichCon purchased its principal
office building in Detroit, The Guardian Building,  ending its long-term capital
lease obligation. MichCon occupies its principal office building in Grand Rapids
under a long-term lease. Portions of these buildings are subleased to affiliates
and others.

     Most of MichCon's  properties are held in fee, by easement,  or under lease
agreements  expiring at various dates to 2006,  with renewal  options  extending
beyond  that date.  The  principal  plants and  properties  of MichCon  are held
subject to the lien of  MichCon's  Indenture of Mortgage and Deed of Trust under
which  MichCon's First Mortgage Bonds are issued.  Some existing  properties are
being fully utilized and new properties are being added to meet the requirements
of expansion into new areas.  MichCon's  capital  expenditures  for 1997 totaled
$155.2 million.  MichCon's  capital  requirements for 1998 are anticipated to be
approximately $200 million for capital investments.

     The Saginaw Bay  Pipeline  Company,  a wholly owned  subsidiary  of MichCon
Pipeline  Co.,  owns  a 66  2/3%  interest  in  the  Saginaw  Bay  Area  Limited
Partnership,  which owns substantially all of the properties used in the conduct
of its business,  primarily a 126-mile  major  gathering  line.  The Saginaw Bay
Lateral  Company,  a wholly owned subsidiary of MichCon Pipeline Co., owns a 46%
interest  in  the  Saginaw  Bay   Lateral   Limited   Partnership,   which  owns
substantially  all of  the  properties  used  in the  conduct  of its  business,
primarily  lateral  lines  related  to the  Saginaw  Bay major  gathering  line.
Westside  Pipeline  Company,  a wholly owned subsidiary of MichCon Pipeline Co.,
owns an 82.62%  interest in Jordan Valley  Pipeline,  a 14-mile major  gathering
line and the Terra-Hayes Pipeline, a 18-mile major gathering line.

     MichCon  Gathering  Company,  a wholly owned subsidiary of MichCon Pipeline
Co.,  owns  substantially  all of the  properties  used  in the  conduct  of its
business,  including 44.7-mile,  8.6-mile, 11-mile and 25.2 mile major gathering
lines and a 2400 horsepower compressor station.

     Thunder  Bay  Gathering  Company,  a wholly  owned  subsidiary  of  MichCon
Pipeline Co., owns  substantially  all of the properties  used in the conduct of
its business, including 44 miles of gathering lines.

ITEM 3.  LEGAL PROCEEDINGS

     In addition to the regulatory  proceedings  and other matters  described in
Item 1,  "Business,"  MichCon  is also  involved  in a number  of  lawsuits  and
administrative  proceedings  in the ordinary  course of business with respect to
taxes, environmental matters, contracts, personal injury, property damage claims
and other matters.


                                       9

<PAGE>   14
ENVIRONMENTAL

     In 1994,  MichCon  received a general  notice of liability  letter from the
U.S.  Environmental  Protection  Agency  (USEPA)  stating that it was one of two
potentially  responsible  parties at  the Lower   Ecorse Creek Superfund site in
Wyandotte,  Michigan.  USEPA   requested  that  MichCon   conduct   a   remedial
investigation  and feasibility   study  at that site.  MichCon investigated  its
prior  activities  in the  area    and  USEPA's  bases  for its conclusion,  and
concluded  that  it  was  not   responsible  for   contamination  discovered  at
that  site.   MichCon  informed  USEPA of this  belief and did not undertake the
requested activities.
        
     In September 1996,  USEPA sent MichCon a second general notice of liability
letter for the site and demanded  reimbursement of approximately $2.3 million in
past costs,  plus interest.  USEPA then issued MichCon and the other potentially
responsible  party a unilateral  administrative  order under  section 106 of the
Comprehensive Environmental Response Compensation and Liability Act to implement
the remedy. USEPA estimates the cost of the remedy to be approximately $650,000.
MichCon again reviewed  USEPA's bases for  determining  that it is a potentially
responsible   party  and  concluded  again  that  it  was  not  responsible  for
contamination  discovered at that site and informed USEPA of its decision. USEPA
has not taken any subsequent  action against  MichCon.  USEPA may sue MichCon to
force compliance with the order or may implement the remedy and then sue MichCon
for recovery of all incurred costs.  If USEPA  institutes and prevails in such a
suit and if the court  determines that MichCon did not have sufficient cause not
to comply with the order,  the court may impose  civil  penalties  and  punitive
damages.  Management  believes MichCon was not responsible for  contamination at
the site and has  sufficient  cause not to comply  with this  order and that the
resolution of this matter will not have a material  adverse  effect on MichCon's
financial statements.

ENERGY CONSERVATION PROGRAMS

     In December 1994, a suit was filed against MichCon in Wayne County Michigan
Circuit  Court by six  customers  who had  participated  in one of three  energy
conservation programs sponsored by MichCon. Under these programs, which had been
approved  by  the  MPSC  and  operated  from  1990  to  1996,   MichCon  offered
low-interest  loans,  rebates  and other  arrangements  to assist  approximately
46,000 qualified residential customers in purchasing  high-efficiency  furnaces.
MichCon did not manufacture,  sell or install any of the furnaces. The complaint
alleged  that  MichCon  induced  the  purchase  of these  furnaces  through  its
conservation  programs  and  that it had a duty  to,  but  failed  to,  warn its
customers  that harmful levels of carbon  monoxide could  backdraft if a chimney
was not properly sized and a chimney liner installed.  No personal injuries were
claimed.  Plaintiffs sought injunctive relief,  unspecified monetary damages and
class action  certification.  The trial court denied such  certification  on two
separate occasions; the Michigan Court of Appeals denied plaintiffs' request for
an appeal of those rulings.

     MichCon  impleaded,  as third-party  defendants,  all of the manufacturers,
contractors and installers of the plaintiffs'  furnaces.  On September 13, 1996,
plaintiffs'  third  motion to certify the lawsuit as a class action was granted.
MichCon  appealed the granting of  certification  and, on December 2, 1996,  the
Michigan Court of Appeals granted  MichCon's Motion for Immediate  Consideration
and stayed all further proceedings until the Court issues its decision.  MichCon
believes that the plaintiffs' allegations are without merit and will continue to
defend the case vigorously.


                                      10
<PAGE>   15
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     Omitted per  general  instruction  I (2) (c) of Form 10-K for  wholly-owned
subsidiaries (reduced disclosure format).
    

                                     PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

     All of the  10,300,000  issued and  outstanding  shares of common  stock of
MichCon,  par value $1 per share,  are owned by MCN and  constitute  100% of the
voting  securities of MichCon.  Therefore,  no market exists for MichCon  common
stock. On January 31, 1996,  MichCon called for redemption the remaining 104,732
shares of its redeemable cumulative preferred stock.

     MichCon paid cash dividends of $40.0 million in 1997, $11.3 million in 1996
and $6.5 million in 1995 on its common stock.

                                       11
<PAGE>   16
                 ITEM 6. SELECTED FINANCIAL DATA (UNAUDITED)


<TABLE>
<CAPTION>
Selected Financial Data                                 1997           1996            1995          1994              1993    
-------------------------------------------------    ----------    ------------   -------------   ------------     ----------- 
<S>                                                 <C>             <C>             <C>            <C>             <C>         
(Dollars in thousands)                                                                                                         
                                                                                                                               
INCOME AVAILABLE FOR COMMON STOCK ...............   $    79,020     $    79,824     $    71,488    $    59,387     $    61,649 
                                                    ===========     ===========     ===========    ===========     =========== 
                                                                                                                               
Cash Dividends Declared on Common Stock .........   $    40,000     $    11,000     $     6,500    $     8,500     $    75,000 
                                                    ===========     ===========     ===========    ===========     =========== 
                                                                                                                               
RETURN ON AVERAGE COMMON SHAREHOLDER'S EQUITY....          13.3%           14.7%           15.8%          15.2%           16.6%
                                                    ===========     ===========     ===========    ===========     =========== 
                                                                                                                               
PROPERTY, PLANT AND EQUIPMENT ...................   $ 2,790,352     $ 2,668,294     $ 2,413,120    $ 2,189,150     $ 2,084,516 
                                                                                                                               
Less - accumulated depreciation and depletion....     1,322,392       1,243,060       1,151,160      1,071,588       1,024,009 
                                                    -----------     -----------     -----------    -----------     ----------- 
                                                                                                                               
Net property, plant and equipment ...............   $ 1,467,960     $ 1,425,234     $ 1,261,960    $ 1,117,562     $ 1,060,507 
                                                    ===========     ===========     ===========    ===========     =========== 
                                                                                                                               
TOTAL ASSETS ....................................   $ 2,136,336     $ 2,058,344     $ 1,798,493    $ 1,571,910     $ 1,509,120 
                                                    ===========     ===========     ===========    ===========     =========== 
                                                                                                                               
CAPITAL EXPENDITURES ............................   $   155,208     $   212,668     $   235,767    $   145,421     $   141,279 
                                                    ===========     ===========     ===========    ===========     =========== 
                                                                                                                               
CAPITALIZATION                                                                                                                 
Long-term debt ..................................   $   611,763     $   536,561     $   501,396    $   431,870     $   353,214 
Long-term capital lease obligations .............         5,344          13,757          15,168         16,459          17,625 
Redeemable cumulative preferred stock ...........            --              --              --          2,618           5,618 
Common shareholder's equity .....................       616,024         577,004         489,821        417,833         365,785 
                                                    -----------     -----------     -----------    -----------     ----------- 
                                                                                                                               
Total capitalization ............................   $ 1,233,131     $ 1,127,322     $ 1,006,385    $   868,780     $   742,242 
                                                    ===========     ===========     ===========    ===========     =========== 
                                                                                                                               
SOURCES OF OPERATING REVENUES                                                                                                  
Gas sales .......................................   $ 1,079,530     $ 1,058,499     $   896,707    $   954,537     $ 1,079,020 
Application of (provision for) refunds-net ......       (16,736)         27,346          20,473            223          (3,164)
End user transportation .........................        84,516          82,210          80,360         76,228          71,412 
Intermediate transportation .....................        55,221          48,570          31,913         28,745          19,638 
Storage services ................................         7,630           6,956           8,857          8,054           9,084 
Conservation and other assistance programs ......        (2,914)         (2,483)         14,499         18,716          23,935 
Other ...........................................        46,432          37,687          28,004         25,175          23,590 
                                                    -----------     -----------     -----------    -----------     ----------- 
                                                                                                                               
Total operating revenues ........................   $ 1,253,679     $ 1,258,785     $ 1,080,813    $ 1,111,678     $ 1,223,515 
                                                    ===========     ===========     ===========    ===========     =========== 
                                                                                                                               
DISPOSITION OF GAS (MMCF)                                                                                                      
Gas sales .......................................       205,760         217,672         206,951        201,423         250,510 
End user transportation .........................       144,963         146,662         145,288        139,800         128,409 
Intermediate transportation .....................       586,496         527,510         341,550        303,617         281,116 
                                                    -----------     -----------     -----------    -----------     ----------- 
                                                        937,219         891,844         693,789        644,840         660,035 
Company use and lost gas ........................         3,896           5,746           2,990          2,239           3,828 
                                                    -----------     -----------     -----------    -----------     ----------- 
                                                                                                                               
Total disposition of gas ........................       941,115         897,590         696,779        647,079         663,863 
                                                    ===========     ===========     ===========    ===========     =========== 
                                                                                                                               
DEGREE DAYS                                                                                                                    
For calendar period .............................         6,830           7,171           6,777          6,489           6,675 
Percent colder (warmer) than normal .............           0.8%            5.4%            0.3%          (4.2)%          (2.2)%
                                                                                                                               
UTILITY CUSTOMERS                                                                                                              
Residential .....................................     1,092,334       1,087,450       1,077,668      1,061,300       1,050,188 
Total ...........................................     1,178,543       1,169,690       1,159,140      1,141,463       1,129,416 
                                                                                                                               
EMPLOYEES .......................................         2,867           3,062           3,128          3,273           3,364 
</TABLE> 






                                      12
<PAGE>   17
ITEM 7.  MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                CONDITION AND RESULTS OF OPERATIONS



RESULTS OF OPERATIONS

     Earnings for 1997 were $79.0 million, a decrease of $0.8 million from 1996.
The 1997  decrease  is due  primarily  to lower gross  margins  caused by warmer
weather, and higher depreciation and financing costs due to capital investments,
partially offset by lower operation and maintenance expenses.  Earnings for 1996
increased  by $8.3 million over 1995 due  primarily to increased  gross  margins
resulting  from  higher gas sales and  transportation  deliveries  due to colder
weather.

<TABLE>
<CAPTION>


                                     EARNINGS COMPONENTS (IN MILLIONS)
                                         COMPARING 1997 TO 1996                     COMPARING 1996 TO 1995
                                     ---------------------------------             ------------------------
                                          DOLLAR      PERCENTAGE                     DOLLAR      PERCENTAGE
                                          CHANGE        CHANGE                       CHANGE        CHANGE
                                          ------        ------                       ------        -------
<S>                                     <C>            <C>                           <C>         <C>
Operating Revenues .................      $(5.1)          (0.4)%                     $178.0          16.5%
Cost of Gas ........................       (4.4)          (0.7)                       152.6          31.5
Gross Margin .......................       (0.7)          (0.1)                        25.4           4.3
Operation and Maintenance ..........      (11.6)          (4.0)                        (0.1)         (0.1)
Depreciation and Depletion .........        5.6            5.7                          9.0          10.1
Property and Other Taxes ...........       (1.0)          (1.7)                         4.8           8.3
Other Income and Deductions ........        3.3            7.0                          3.3           7.4
Income Tax Provision ...............        4.2           10.1                          0.5           1.2
</TABLE>


GROSS MARGIN

     Gross margin  (operating  revenues less cost of gas)  decreased in 1997 and
increased  in 1996,  reflecting  varying  gas sales and end user  transportation
deliveries due primarily to significantly colder weather in 1996.  Additionally,
gross margins  increased in both periods as a result of the continued  growth in
intermediate  transportation  services.  Margins in 1997 were also  impacted  by
increased other operating  revenues  resulting from initiatives to grow revenues
by providing gas-related services.


                  EFFECT OF WEATHER ON GAS MARKETS AND EARNINGS
                  ---------------------------------------------

<TABLE>
<CAPTION>


                                                                    1997          1996         1995
                                                                    ----          ----         -----
<S>                                                              <C>           <C>        <C>
Percentage Colder than Normal...............................         0.8%          5.4%         0.3%
                                                                                            
Increase from Normal in:
   Gas Markets (Bcf) .......................................         0.6          10.9          1.5
   Net Income (Millions) ...................................        $0.5          $9.9         $1.4

</TABLE>

                                       13
<PAGE>   18

               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
                MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                 CONDITION AND RESULTS OF OPERATIONS (Continued)

<TABLE>
<CAPTION>


                                                              1997             1996            1995
                                                            ---------        ----------     ----------
<S>                                                         <C>            <C>            <C>
Gas Markets ($ Millions)
  Gas Sales..........................................       $ 1,062.8        $ 1,085.8      $    917.2
  End User Transportation............................            84.5             82.2            80.4
  Intermediate Transportation........................            55.2             48.6            31.9
  Other .............................................            51.2             42.2            51.3
                                                            ---------        ---------      ----------
                                                            $ 1,253.7        $ 1,258.8      $  1,080.8
                                                            =========        =========      ==========
Gas Markets (Bcf)
  Gas Sales..........................................           205.8            217.7           206.9
  End User Transportation ...........................           145.0            146.7           145.3
  Intermediate Transportation .......................           586.4            527.5           341.6
                                                                -----            -----           -----
                                                                937.2            891.9           693.8
                                                                =====            =====           =====
</TABLE>



Operating Revenues

     Gas sales and end user  transportation  revenues in total  decreased  $20.7
million in 1997 and increased  $170.4  million in 1996. The decrease in revenues
for 1997 is due  primarily  to  reduced  gas sales  and end user  transportation
deliveries as a result of warmer weather,  partially  offset by higher prices to
recover gas costs.  The  increase in 1996 gas sales and end user  transportation
revenues was due  primarily to colder  weather and higher  prices to recover gas
costs, as well as marketing initiatives that expanded gas markets.

     Gas sales and gross  margins  have also  been  affected  by  variations  in
revenues associated with lost gas costs. Gas sales rates are set to recover lost
gas costs using an averaging  method based on  historical  lost gas  experience.
Prior to 1993,  MichCon  deferred or accrued  revenues for  differences  between
historical average lost gas amounts and the actual amount experienced.  However,
as a result of an October  1993 order issued in  MichCon's  most recent  general
rate case, MichCon no longer defers or accrues revenues for these differences in
lost gas amounts.  Amortization of previously  deferred amounts was completed in
1995 and  increased  revenues by $3.4 million in 1995. As discussed in the "Cost
of Gas"  section  that  follows,  gross  margins  have  also  been  impacted  by
variations in lost gas costs.

     The increases in  intermediate  transportation  deliveries in 1997 and 1996
are due  primarily  to increased  transportation  of Antrim gas for Michigan gas
producers and brokers.  There has been a significant increase in Michigan Antrim
gas production over the past several years, resulting in a growing demand by gas
producers and brokers for intermediate transportation services. In order to meet
the  increased  demand,  MichCon  expanded  the  transportation  capacity of its
northern  Michigan  gathering  system.  This expansion  contributed 128.5 Bcf in
volumes transported during 1997 and 75 Bcf in 1996.

     In December 1997, MichCon purchased a pipeline to expand the transportation
capacity of its northern Michigan gathering system. The cost of the pipeline was
approximately  $13 million and is expected to transport  approximately 44 Bcf of
Antrim gas annually.

     In January  1996,  MCN  transferred  its Michigan  pipeline  operations  to
MichCon in order to consolidate  MCN's Michigan  gathering  pipeline  activities
within one business unit. The pipeline operation contributed 76.5 Bcf in volumes
transported during 1997 and 63.3 Bcf in 1996.

                                       14
<PAGE>   19
               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
                MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                 CONDITION AND RESULTS OF OPERATIONS (Continued)

     Other  operating  revenue  increased  $9.0 million in 1997 due primarily to
increased merchandise sales and other gas-related services. The decrease of $9.2
million  in  the  1996  other  operating   revenue  was  due  primarily  to  the
discontinuance  of  MichCon's  conservation  program,  partially  offset  by  an
increase  in gas  processing  revenues  generated  from  the  Michigan  pipeline
operations which were transferred from MCN to MichCon at the beginning of 1996.

COST OF GAS

     Cost of gas is  affected  by  variations  in sales  volumes and cost of gas
rates.  Through the Gas Cost Recovery (GCR)  mechanism,  MichCon recovers all of
its  reasonably  and  prudently   incurred  cost  of  gas  sold.  As  a  result,
fluctuations in cost of gas sold have little or no effect on gross margins.

     Cost of gas  sold  decreased  in  1997  due to  lower  sales  volumes,  due
primarily  to  warmer  weather,  as  well  as  supplier  refunds.  Substantially
offsetting  this  decrease  was higher spot market  prices  resulting  in a $.19
(6.5%)  increase  in the cost of good  sold per Mcf.  In 1996,  cost of gas sold
increased  as a result of  significantly  higher  spot  market  prices  paid for
natural gas purchased and higher gas sales volumes due to colder  weather.  Cost
of gas sold for 1996  increased  from 1995 by $.56  (24%) per Mcf.  To  mitigate
price volatility related to spot market prices for sales customers,  MichCon has
been authorized by the Michigan Public Service  Commission  (MPSC) to change its
supply  strategy  to  purchase  up to  one-third  of its gas under  fixed  price
contracts.

     As previously discussed,  cost of gas is affected by variations in lost gas
amounts. Lost gas costs for 1997 decreased by $0.5 million and increased in 1996
by $6.6 million.

OPERATION AND MAINTENANCE

     Operation  and  maintenance  expenses  decreased  in 1997 due to  decreased
pension and retiree health care costs and  uncollectible  gas accounts  expense.
Partially offsetting the decrease in 1997 were higher operating expenses related
to the  increase  in  merchandise  sales.  Operation  and  maintenance  expenses
decreased  slightly  in 1996.  This was a result  of  decreased  benefit  costs,
primarily  pension  and  retiree  health  care costs and a decrease  in expenses
related to the  conservation  program.  This  decrease  was offset by  increased
uncollectible  gas  accounts  expense  and  additional  expenses  related to the
transfer of the Michigan pipeline operations from MCN to MichCon.  Uncollectible
gas accounts  were driven higher by 1996's  colder  temperatures  and rising gas
prices which  significantly  increased  customers'  heating bills. The impact of
higher heating bills was aggravated by a reduction and delay in the home heating
assistance funding obtained by low-income customers.
 
     MichCon  receives a significant  amount of its heating  assistance  funding
from the federal  Low-Income Home Energy Assistance  Program (LIHEAP).  Congress
increased  the  program's  funding to $1 billion for the 1997 fiscal  year.  The
State of Michigan's  share of LIHEAP funds was  increased  from $47.5 million in
fiscal year 1996 to $64 million in 1997. The bulk of this money was passed on to
qualified  taxpayers  in the form of  Michigan  Home  Heating  Credits.  MichCon
received $12.7 million through this effort, $3.5 million more than in 1996. Home
Heating Credits assisted 83,000 MichCon customers in 1997, compared to 74,000 in
1996. During 1997,  Congress approved a budget which provides for federal LIHEAP
funding  at $1  billion  and $1.1  billion  for  fiscal  years  1998  and  1999,
respectively. A portion of any future increase or decrease in funding may impact
MichCon's uncollectible accounts.  MichCon is currently working with federal and
state  officials  to  identify  other  ways  to  obtain  energy  assistance  for
low-income  customers,  and is taking actions to minimize the impact a reduction
in LIHEAP funds could have on MichCon's  financial  position.  

                                       15
<PAGE>   20
               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
                MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                 CONDITION AND RESULTS OF OPERATIONS (Continued)


DEPRECIATION AND DEPLETION

     The increases in depreciation  and depletion in both 1997 and 1996 were due
to higher plant balances reflecting capital  expenditures of $603.6 million over
the past three years.  The MPSC approved  lower  depreciation  rates for MichCon
effective  January 1, 1998. In 1998, these new  depreciation  rates will largely
offset the increase in depreciation  expense  resulting from additional  capital
expenditures.  While the Michigan Attorney General has appealed the depreciation
order, management believes the MPSC order approving the lower depreciation rates
will be upheld.

PROPERTY AND OTHER TAXES

     Property  and other  taxes  decreased  in 1997.  The  Company  reduced  its
property  taxes for 1997  based on  pending  appeals of  personal  property  tax
assessments.  The Company has been assessed  additional  amounts which are being
protested.  The Company does not believe payments of these additional amounts is
probable.  Offsetting  the  reduction  in 1997  property  and other taxes was an
increase in Michigan single  business taxes.  Property and other taxes increased
in 1996 as a result of higher plant balances.

OTHER INCOME AND DEDUCTIONS

     Other income and  deductions  increased in 1997 and 1996 due to  additional
interest  expense on long-term  debt  required to finance  capital  investments.
Other income and deductions for 1997 was partially offset by reduced interest on
lower  outstanding  commercial  paper.  In 1996 other income and  deductions was
partially offset by an increase in the  capitalization of the cost of funds used
during construction resulting from higher construction balances.

     Interest on long-term  debt  increased in 1997 as a result of issuing first
mortgage  bonds  in  the  aggregate  of $85  million  and  MichCon's  nonutility
subsidiaries borrowing $40 million under a nonrecourse credit agreement.

INCOME TAX PROVISION

     Income  taxes  for 1997  increased  as a result  of  higher  earnings.  The
increase in income taxes was also  impacted by the amounts  recorded in 1996 for
the  favorable  resolution  of prior years' tax issues and tax  credits.  Income
taxes for 1996  remained  consistent  with 1995 despite the increase in earnings
due to an increase  resulting  from the  favorable  resolution of prior year tax
issues.

ENVIRONMENTAL MATTERS

     Prior to the 1940's when major natural gas pipelines  became  sufficient to
meet  MichCon's  supply  requirements,  gas  for  heating  and  other  uses  was
manufactured  from  processes  involving  coal,  coke  or oil.  MichCon  owns or
previously owned 16 such former manufactured gas plant (MGP) sites.

     During  the  mid-1980's,   MichCon  conducted   preliminary   environmental
investigations at these former MGP sites, and some contamination  related to the
by-products of gas  manufacturing  was discovered at each site. The existence of
these  sites  and the  results  of the  environmental  investigations  have been
reported to the Michigan  Department  of  Environmental  Quality.  None of these
former  MGP  sites  is on the  National  Priorities  List  prepared  by the U.S.
Environmental Protection Agency.

                                       16
<PAGE>   21
               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
                MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                 CONDITION AND RESULTS OF OPERATIONS (Continued)

     MichCon is not involved in any administrative  proceedings  regarding these
former  MGP  sites,  but is  currently  remediating  four  of  these  sites  and
conducting more extensive investigations at four other former MGP sites.

     In 1984 MichCon  established  an $11.7  million  reserve for  environmental
investigation and remediation.  During 1993, MichCon received MPSC approval of a
cost deferral and rate  recovery  mechanism for  investigation  and  remediation
costs incurred at former MGP sites in excess of this reserve.

     MichCon employed outside consultants to evaluate  remediation  alternatives
for these sites, to assist in estimating its potential liabilities and to review
its archived insurance policies. The findings of these investigations  indicated
that  the  estimated  total   expenditures  for  investigation  and  remediation
activities for these sites could range from $30 million to $170 million based on
undiscounted  1995  costs.  As a result of these  studies,  MichCon  accrued  an
additional liability and a corresponding  regulatory asset of $32 million during
1995.

     MichCon notified more than 40 current and former insurance  carriers of the
environmental conditions at these former MGP sites. MichCon concluded settlement
negotiations  with certain  carriers in 1996 and 1997 and has received  payments
from  several  carriers.  In October  1997,  MichCon  filed suit  against  major
nonsettling  carriers  seeking  recovery  of  incurred  costs and a  declaratory
judgment  of  the  carriers'   liability  for  future  costs  of   environmental
investigation and remediation costs at former MGP sites.

     During 1997,  1996 and 1995,  MichCon spent $0.8 million,  $0.9 million and
$2.1  million,  respectively,  investigating  and  remediating  these former MGP
sites. At December 31, 1997, the reserve balance is $33.7 million, of which $1.7
million is classified as current. Any significant change in assumptions, such as
remediation  techniques,  nature  and  extent of  contamination  and  regulatory
requirements,  could impact the estimate of remedial actions costs and therefore
have an  effect  on  MichCon's  financial  position  and  cash  flows.  However,
management  believes  that  insurance  coverage  and the cost  deferral and rate
recovery  mechanism approved by the MPSC will prevent  environmental  costs from
having a material adverse impact on MichCon's results of operations.

CAPITAL RESOURCES AND LIQUIDITY

OPERATING ACTIVITIES

     MichCon's cash flow from operating  activities  increased  $85.6 million in
1997 from 1996 and decreased  $56.5  million in 1996 compared to 1995.  The 1997
increase was due primarily to lower working  capital  requirements  reflecting a
reduction  in the  gas  cost  recovery  undercollection  and  gas in  inventory,
partially  offset by lower net  income  after  adjusting  for  depreciation  and
deferred taxes. The 1996 decrease in cash flow from operating activities was due
primarily to higher working capital requirements, partially offset by higher net
income,  after adjusting for  depreciation  and deferred  taxes.  Operating cash
flows were  sufficient  for the payment of cash  dividends on common stock and a
portion of capital investments.

FINANCING ACTIVITIES

     During the latter part of the year,  short-term debt is generally  incurred
to finance  increases  in gas  inventories  and  customer  accounts  receivable.
Short-term  debt is  normally  reduced  in the  first  part of each  year as gas
inventories  are depleted and funds are received from winter heating  sales.  To
meet its 

                                       17
<PAGE>   22
               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
                MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                 CONDITION AND RESULTS OF OPERATIONS (Continued)

seasonal  short-term  borrowing needs,  MichCon normally issues commercial paper
which is backed by credit  lines with  several  banks.  MichCon has  established
credit  lines to allow  for  borrowings  of up to $150  million  under a 364-day
revolving  credit  facility and up to $150 million under a three-year  revolving
credit  facility  both of which  expire  July 1998.  Commercial  paper of $236.7
million was outstanding as of December 31, 1997.

     During 1997,  MichCon  issued $85 million of first mortgage bonds under its
existing shelf  registrations.  The funds from this issuance were used to retire
first  mortgage  bonds,  fund  capital  expenditures  and for general  corporate
purposes. The existing shelf registration will allow MichCon to issue up to $215
million of debt securities.  MichCon's  capital  requirements and general market
conditions will affect the timing and amount of future issuances.

     MichCon  issued $70 million of first  mortgage bonds in both 1996 and 1995.
The 1996 and 1995 proceeds were used to repay short-term obligations, to finance
capital expenditures and for general corporate purposes.

     During  1997,   subsidiaries  of  MichCon  borrowed  $40  million  under  a
nonrecourse credit agreement that matures in 2005. Proceeds were used to finance
the expansion of its northern Michigan gathering system.

     During the 1997 second quarter,  MichCon  redeemed $17 million of long-term
debt.  MichCon  also  repaid $50 million of first  mortgage  bonds on its stated
maturity date in May 1997.

     MichCon  repaid all amounts  owing under its Trust  Demand Note and did not
renew this program which expired in March 1997 and allowed for  borrowings of up
to $25 million.

     The  following  table  sets  forth the  ratings  for  securities  issued by
MichCon:

<TABLE>
<CAPTION>

                                    Standard                                Duff &
                                     & Poors            Moody's             Phelp's             Fitch
                                     -------            -------             -------             -----
<S>                                  <C>                 <C>               <C>                  <C>
Commercial paper...............         A1                 P1                 D1                 F1
Long-term debt.................          A                 A2                 A+                  A
</TABLE>

These ratings are considered investment grade by each rating agency.

     Consistent with MichCon's  capitalization  objective, at December 31, 1997,
the  capitalization  ratio was  approximately  50% debt and 50% equity excluding
nonrecourse debt.

INVESTING ACTIVITIES

     MichCon's capital expenditures for 1997 totaled $155.2 million representing
a decrease of $57.5 million compared to 1996. MichCon's capital requirements for
1998 are expected to approximate $200 million for capital  investments.  Capital
expenditures  primarily represent the construction of transportation  pipelines,
the construction of new distribution  lines to reach  communities not previously
served  by  MichCon  and   improvements  to  existing   storage,   distribution,
transmission and information systems.

                                       18
<PAGE>   23
               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
                MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                 CONDITION AND RESULTS OF OPERATIONS (Continued)

     As  described  in  Note  9 to the  consolidated  financial  statements,  in
December 1997,  MichCon invested $31.3 million in a Grantor Trust to meet future
cash flow obligations related to certain postretirement health care costs.

     It is  management's  opinion  that  MichCon  will have  sufficient  capital
resources, both internal and external, to meet anticipated capital requirements.

OUTLOOK

     MichCon's  strategy is to aggressively  expand its role as a major provider
of natural gas and high-value  energy  services  within  Michigan.  Accordingly,
MichCon's  objectives are to increase  revenues and reduce its costs in order to
maintain  strong  returns and provide  customers  with  high-quality  service at
competitive  prices.  Revenue  growth will be achieved  through the expansion of
MichCon's 1.2 million  residential,  commercial  and  industrial  customer base.
MichCon expects to provide natural gas to approximately  20,000 new customers in
1998.   MichCon's  market  share  for  residential   heating  customers  in  the
communities in which it serves is approximately  80%. While this saturation rate
is high,  significant  opportunities  exist through conversion of existing homes
from other fuels as well as from new  construction.  MichCon continues to expand
the industrial and commercial  markets by aggressively  facilitating  the use of
existing gas technologies and equipment as well as by developing new natural gas
technologies.

     Management is continually  assessing ways to improve cost  competitiveness.
Among other cost saving  initiatives,  MichCon has signed contracts with Detroit
Edison  and other  utilities  to share  the cost of  payment  processing,  meter
reading and staking of underground facilities.  MichCon is continuing to explore
opportunities to share the cost of common, duplicative operating functions.

     In December 1997, MichCon announced an early retirement  incentive program.
This  program  is  available  to  approximately  10% of  MichCon's  work  force.
Management does not believe that these costs will have a material impact on 1998
net income.  However,  it is expected to contribute to lower  operating costs in
future years.

     The challenges and  opportunities  resulting from increased  competition in
the natural gas industry have been a catalyst for MPSC action in the development
of major  reforms in utility  regulation  aimed at giving  all  customers  added
choices and more price  certainty.  The overall  package of  regulatory  changes
connected with the gas industry restructuring is expected to generate additional
revenue and cost savings opportunities as the restructuring advances. MichCon is
positioning itself to respond to changes in regulation and increased competition
by reducing its cost of operations while  maintaining a safe and reliable system
for customers. MichCon remains focused on these goals in 1998 and beyond.

As described in Note 7   to  the  consolidated   financial  statements,  MichCon
complies with the provisions of Statement of Financial Accounting Standards, No.
71 (SFAS 71),  "Accounting  for the  Effects  of  Certain  Types of Regulation."
Future regulatory changes or changes in the competitive environment could result
in   MichCon   discontinuing   the   application  of SFAS 71 for  all or part if
its  business  and  requires  the   write-off  of the portion of any  regulatory
asset  or  liability  that  is  no  longer   probable of recovery or refund.  If
MichCon  were to have  discontinued  the  application  of SFAS 71 for all of its
operations  as  of  December 31, 1997,  it  would  have  had  an  extraordinary,
non-cash  increase  to net income  of   approximately   $46  million.   Criteria
that   give   rise   to   the discontinuance  of SFAS 71 include (1)  increasing
competition   that   restricts  MichCon's ability to establish prices to recover
specific costs, and (2)
        



                                       19
<PAGE>   24

               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
                MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                 CONDITION AND RESULTS OF OPERATIONS (Concluded)

a  significant  change in the manner in which rates are set by  regulators  from
cost-based  regulation  to  another  form  of  regulation.  Based  on a  current
evaluation  of the various  factors and  conditions  that are expected to impact
future  regulation,  MichCon believes that its regulatory assets are probable of
future recovery.

NEW ACCOUNTING PRONOUNCEMENTS

     In 1996 the Emerging  Issues Task Force (EITF) of the Financial  Accounting
Standards  Board reached a consensus  that the costs  associated  with modifying
internal use software for the year 2000 should be expensed as incurred. The year
2000 issue is the result of computer  programs  being  written  using two digits
rather  than four  digits  to  define  the  year.  Any  programs  that have time
sensitive  software may recognize a date using "00" as the year 1900 rather than
the  year  2000.  This  could  cause  computer  systems  to  perform  inaccurate
calculations.

     MichCon has established processes for evaluating and managing the risks and
costs  associated  with the year 2000 issue.  MichCon has  conducted a review to
identify  computer  systems  that could be  affected by the  inability  of these
systems  to  properly  recognize  the  digits  for the year  2000.  MichCon  has
developed a corrective plan and is currently  implementing  such plan.  Based on
the corrective  plan, costs associated with the year 2000 issue are estimated to
total  approximately  $3  million to $4  million  over the next two  years.  The
anticipated  costs are not  higher  due in part to the  ongoing  replacement  of
significant  old systems.  New systems in process of being  installed as well as
those installed over the past few years are year 2000  compliant.  These systems
were necessary to maintain a high level of customer  satisfaction and to respond
to changes in regulation and increased competition within the energy industry.

     MichCon is working with its suppliers and operators to mitigate any adverse
effects of their  system  failures on MichCon.  As a result,  management  cannot
quantify the impact to MichCon of other companies' system failures, but does not
expect it to be material.

     In 1997 the EITF  reached a  consensus  that the cost of  business  process
re-engineering activities, whether done internally or by third parties, is to be
expensed as incurred.  This  consensus  also  applies when the business  process
re-engineering activities are part of a project to acquire, develop or implement
internal-use  software.  Management does not expect the financial impact of such
activities to be material to MichCon's financial results or operations.

FORWARD-LOOKING STATEMENTS

     The Annual Report on Form 10-K includes  forward-looking  statements within
the  meaning  of  the  Private   Securities   Litigation  Reform  Act  of  1995.
Forward-looking  statements  involve  certain risks and  uncertainties  that may
cause  actual  future  results to differ  materially  from  those  contemplated,
projected,  estimated or budgeted in such  forward-looking  statements.  Factors
that may impact forward-looking  statements include, but are not limited to, the
following:  (i) the  effects  of  weather  and other  natural  phenomenon;  (ii)
increased  competition from other energy suppliers as well as alternative  forms
of energy;  (iii) the  capital  intensive  nature of  MichCon's  business;  (iv)
economic  climate  and  growth in the  geographic  areas in which  MichCon  does
business;  (v) the  uncertainty  of gas reserve  estimates;  (vi) the timing and
extent of changes in  commodity  prices for natural gas,  electricity  and crude
oil;  (vii)  conditions of capital  markets and equity  markets,  and (viii) the
effects of changes in governmental  policies and regulatory  actions,  including
income taxes, environmental compliance and authorized rates.

                                       20
<PAGE>   25

 
 




               ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

<TABLE>
<CAPTION>


                                                                                                              PAGE
                                                                                                              ----
<S>                                                                                                           <C>
Consolidated Statement of Income...........................................................................    22

Consolidated Statement of Financial Position...............................................................    23

Consolidated Statement of Capitalization...................................................................    24

Consolidated Statement of Cash Flows.......................................................................    25

Notes to the Consolidated Financial Statements.............................................................    26

Independent Auditors' Report...............................................................................    41

Supplementary Financial Information - Quarterly Operating Results (Unaudited)..............................    42

Financial Statement Schedule for each of the three years in the period ended
  December 31, 1997, unless otherwise noted-
    Schedule II - Valuation and Qualifying Accounts........................................................    43

</TABLE>

                                       21
<PAGE>   26
             MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
                      CONSOLIDATED STATEMENT OF INCOME


<TABLE>
<CAPTION>

Year ended December 31,                                            1997             1996              1995           
----------------------------------------------------           -------------    -------------     -------------
(Thousands of Dollars)                               Note(s)                                                         
<S>                                                    <C>     <C>              <C>               <C>                      
OPERATING REVENUES                                                                                                   
  Gas Sales.........................................           $   1,062,794    $   1,085,845     $     917,180      
  Transportation and storage services...............    11           147,367          137,737           121,130      
  Other.............................................                  43,518           35,203            42,503      
                                                               -------------    -------------     -------------
    Total Operating Revenues........................               1,253,679        1,258,785         1,080,813      
                                                               -------------    -------------     -------------
OPERATING EXPENSES                                                                                                   
  Cost of gas.......................................                 632,229          636,594           483,962      
  Operation and maintenance.........................    11           282,640          294,281           294,424      
  Depreciation and depletion........................                 103,703           98,147            89,128      
  Property and other taxes..........................                  60,744           61,762            57,012      
                                                               -------------    -------------     -------------
    Total operating expenses........................               1,079,316        1,090,784           924,526      
                                                               -------------    -------------     -------------
OPERATING INCOME....................................                 174,363          168,001           156,287      
                                                               -------------    -------------     -------------
EQUITY IN EARNINGS OF JOINT VENTURES................                   1,199              886               739      
                                                               -------------    -------------     -------------
OTHER INCOME AND (DEDUCTIONS)                                                                                        
  Interest income...................................                   4,659            3,900             3,983      
  Interest on long-term debt........................                 (45,526)         (40,703)          (35,047)     
  Other interest expense............................                  (8,664)          (8,012)           (7,053)     
  Minority interest.................................     5            (1,882)            (988)                -      
  Other.............................................                     536           (1,756)           (6,182)     
                                                               -------------    -------------     -------------
    Total other income and (deductions).............                 (50,877)         (47,559)          (44,299)     
                                                               -------------    -------------     -------------
INCOME BEFORE INCOME TAXES..........................                 124,685          121,328           112,727      
INCOME TAX PROVISION................................    12            45,665           41,486            41,004      
                                                               -------------    -------------     -------------
NET INCOME..........................................                  79,020           79,842            71,723      
DIVIDENDS ON PREFERRED STOCK........................                       -               18               235      
                                                               -------------    -------------     -------------
NET INCOME AVAILABLE FOR COMMON STOCK...............           $      79,020    $      79,824     $      71,488
                                                               =============    =============     =============
</TABLE>


The notes to the consolidated financial statements are an integral part of this
                                  statement.

                                      22

<PAGE>   27
             MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
                CONSOLIDATED STATEMENT OF FINANCIAL POSITION

<TABLE>
<CAPTION>

December 31                                                                                    1997                   1996
-----------------------------------------------------------------------------               -----------            -----------
(Thousands of Dollars)                                                          Note(s)
<S>                                                                              <C>        <C>                    <C>
ASSETS                                                                          
  CURRENT ASSETS                                                                
    Cash and cash equivalents................................................               $    14,353            $    10,010
    Accounts receivable, less allowance for doubtful accounts of                
      $15,015 and $17,707 respectively.......................................                   195,662                169,436
    Accrued unbilled revenues................................................                    91,896                107,377
    Gas in inventory.........................................................       2            40,201                 67,910
    Property taxes assessed applicable to future periods.....................                    64,827                 60,592
    Accrued gas cost recovery revenues.......................................       7            12,862                 27,672
    Other....................................................................                    33,361                 23,025
                                                                                            -----------            -----------
                                                                                                453,162                466,022
                                                                                            -----------            -----------
  DEFERRED CHARGES AND OTHER ASSETS                                                                               
    Investment in and advances to joint ventures.............................                    19,643                 19,479
    Long-term investments....................................................      9c,10         35,110                  3,735
    Deferred postretirement benefit costs....................................      7, 9b             -                  4,863
    Deferred environmental costs.............................................      6b, 7         27,699                 28,233
    Prepaid benefit costs....................................................       9            85,790                 64,307
    Other....................................................................                    46,972                 46,471
                                                                                            -----------            -----------
                                                                                                215,214                167,088
                                                                                            -----------            -----------
                                                                                                                  
  PROPERTY, PLANT AND EQUIPMENT, at cost.....................................       8         2,790,352              2,668,294
    Less - Accumulated depreciation and depletion............................                 1,322,392              1,243,060
                                                                                            -----------            -----------
                                                                                              1,467,960              1,425,234
                                                                                            -----------            -----------
                                                                                                                  
                                                                                            $ 2,136,336            $ 2,058,344
                                                                                            ===========            ===========
                                                                                                                  
LIABILITIES AND CAPITALIZATION                                                                                    
  CURRENT LIABILITIES                                                                                              
    Accounts payable.........................................................               $   130,267            $   130,725
    Notes payable............................................................       4           241,691                265,126
    Current portion of long-term debt and capital lease obligations..........      3a, 8         34,956                 53,232
    Federal income, property and other taxes payable.........................                    78,630                 84,788
    Customer deposits........................................................                    16,363                 12,860
    Other....................................................................                    67,780                 63,309
                                                                                            -----------            -----------
                                                                                                569,687                610,040
                                                                                            -----------            -----------
  DEFERRED CREDITS AND OTHER LIABILITIES                                                                          
    Accumulated deferred income taxes........................................       12           83,905                 76,523
    Unamortized investment tax credit........................................                    32,745                 34,588
    Tax benefits amortizable to customers....................................       7           122,922                116,313
    Accrued environmental costs..............................................       6b           32,000                 32,000
    Minority interest........................................................       5            17,283                 17,604
    Other....................................................................                    44,663                 43,954
                                                                                            -----------            -----------
                                                                                                333,518                320,982
                                                                                            -----------            -----------
                                                                                                                  
                                                                                                                  
                                                                                                                  
  COMMITMENTS AND CONTINGENCIES                                                    6, 8                              
                                                                                                                  
  CAPITALIZATION (see accompanying statement)                                                                     
    Long-term debt, including capital lease obligations......................    3a, 8, 10      617,107                550,318
    Common shareholder's equity..............................................                   616,024                577,004
                                                                                            -----------            -----------
                                                                                              1,233,131              1,127,322
                                                                                            -----------            -----------
                                                                                
                                                                                            $ 2,136,336            $ 2,058,344
                                                                                            ===========            ===========
</TABLE>


The notes to the consolidated financial statements are an integral part of this
statement.

                                       23
<PAGE>   28
                MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
                     CONSOLIDATED STATEMENT OF CAPITALIZATION

<TABLE>
<CAPTION>
Year Ended December 31                                                                1997              1996             1995
-------------------------------------------------------------------------          ----------        ----------       ----------
(Thousands of Dollars)                                                     Note(s)
<S>                                                                        <C>     <C>              <C>               <C>
LONG-TERM DEBT, excluding current requirements                             3a, 10
  First Mortgage Bonds, interest payable semi-annually
    6.25 % series due 1997.................................................        $        -        $        -       $   50,000
    6.3 % series due 1998..................................................                 -            20,000           20,000
    6.51 % series due 1999.................................................            30,000            30,000               -
    5.75 % series due 2001.................................................            60,000            60,000           60,000
    8 % series due 2002....................................................            70,000            70,000           70,000
    6.72 % series due 2003.................................................             4,150             4,150            4,150
    6.8 % series due 2003..................................................            15,850            15,850           15,850
    9.125 % series due 2004................................................            55,000            55,000           55,000
    7.15 % series due 2006.................................................            40,000            40,000               -
    7.21 % series due 2007.................................................            30,000                -                -
    7.06 % series due 2012.................................................            40,000                -                -
    8.25 % series due 2014.................................................            80,000            80,000           80,000
    7.6 % series due 2017..................................................            14,990                -                -
    9.5 % series due 2019..................................................                -              5,000            5,000
    7.5 % series due 2020..................................................            29,641            29,812           30,000
    9.5 % series due 2021..................................................            40,000            40,000           40,000
    6.75 % series due 2023.................................................            17,177            17,782           18,416
    7 % series due 2025....................................................            40,000            40,000           40,000
    Unamortized discount ..................................................            (1,235)           (1,349)          (1,390)
  Unsecured Notes - 9.750 % series due 2000                                
    interest payable semi-annually.........................................                -             12,000           12,000
  Long-term capital lease obligations......................................     8       5,344            13,757           15,168
  Other long-term debt.....................................................     5      46,190            18,316            2,370
                                                                                   ----------        ----------       ----------
  Total....................................................................           617,107           550,318          516,564
                                                                                   ----------        ----------       ----------

COMMON SHAREHOLDER'S EQUITY
  COMMON STOCK, par value $1 per share - authorized, for
    all periods, 15,100,000 shares; outstanding 10,300,000 shares..........            10,300            10,300           10,300
                                                                                   ----------        ----------       ----------

  ADDITIONAL PAID-IN CAPITAL
    Balance - beginning of period..........................................           230,399           211,777          204,777
    Equity investment......................................................     5           -            18,622            7,000
                                                                                   ----------        ----------       ----------

    Balance - end of period................................................           230,399           230,399          211,777
                                                                                   ----------        ----------       ----------
                                                                           
  RETAINED EARNINGS                                                        
    Balance - beginning of period..........................................           336,305           267,744          202,756
    Net income.............................................................            79,020            79,842           71,723
    Cash dividends declared:                                               
      Common stock.........................................................           (40,000)          (11,263)          (6,500)
      Preferred stock......................................................    3b           -               (18)            (235)
                                                                                   ----------        ----------       ----------
                                                                           
    Balance - end of period................................................           375,325           336,305          267,744
                                                                                   ----------        ----------       ----------
                                                                           
Total common shareholder's equity..........................................           616,024           577,004          489,821
                                                                                   ----------        ----------       ----------
                                                                           
Total capitalization.......................................................        $1,233,131        $1,127,322       $1,006,385
                                                                                   ==========        ==========       ==========
</TABLE>


The notes to the consolidated financial statements are an integral part of this
                                  statement.

                                      24




<PAGE>   29
              MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
                     CONSOLIDATED STATEMENT OF CASH FLOWS


<TABLE>
<CAPTION>
Year ended December 31,                                                                1997           1996          1995
--------------------------------------------------------------------------------    ----------      -------       -------
(Thousands of Dollars)                                                          Note(s)

CASH FLOW FROM OPERATING ACTIVITIES

<S>                                                                               <C> <C>          <C>          <C>      
  Net income .....................................................................    $  79,020    $  79,842    $  71,723
  Adjustments to reconcile net income to net cash flow provided 
    from operating activities:
      Depreciation and depletion
        Per statement of income ..................................................      103,703       98,147       89,128
        Charged to other accounts ................................................        7,663        7,579        7,318
      Deferred income taxes - current ............................................       (3,130)       4,963        9,739
      Deferred income taxes and investment tax credit - net....................... 12    10,853        6,999        6,474
      Other ......................................................................         (679)      (2,629)         878
      Changes in assets and liabilities, exclusive of changes
        shown separately .........................................................      (10,167)     (93,207)     (27,033)
                                                                                      ---------    ---------    ---------
          Net cash provided from operating activities ............................      187,263      101,694      158,227
                                                                                      ---------    ---------    ---------

CASH FLOW FROM FINANCING ACTIVITIES
  Notes payable - net.............................................................4     (23,435)      68,491       28,178
  Issuance of long-term debt......................................................3a    124,051       69,645       68,764
  Equity investment ..............................................................           --        1,614        7,000
  Cash dividend paid:
    Common stock .................................................................      (40,000)     (11,263)      (6,500)
    Preferred stock ..............................................................           --          (54)        (276)
  Retirement of long-term debt and preferred stock................................3     (76,854)      (6,384)      (4,757)
                                                                                      ---------    ---------    ---------
          Net cash (used for) provided from financing activities .................      (16,238)     122,049       92,409
                                                                                      ---------    ---------    ---------

CASH FLOW FROM INVESTING ACTIVITIES
  Capital expenditures ...........................................................     (155,208)    (212,668)    (235,767)
  Other - net ....................................................................      (11,474)      (9,534)      (7,705)
                                                                                      ---------    ---------    ---------
          Net cash used for investing activities .................................     (166,682)    (222,202)    (243,472)
                                                                                      ---------    ---------    ---------

Net Increase in Cash and Cash Equivalents ........................................        4,343        1,541        7,164
Cash and Cash Equivalents, January 1 .............................................       10,010        8,469        1,305
                                                                                      ---------    ---------    ---------
Cash and Cash Equivalents, December 31 ...........................................    $  14,353    $  10,010    $   8,469
                                                                                      =========    =========    =========

CHANGES IN ASSETS AND LIABILITIES, EXCLUSIVE OF CHANGES SHOWN SEPARATELY
    Accounts receivable - net ....................................................    $ (43,510)   $   7,807    $ (37,782)
    Accrued gas cost recovery revenues ...........................................       14,810      (28,250)     (18,495)
    Accrued unbilled revenues ....................................................       15,481      (16,243)      (8,901)
    Gas in inventory .............................................................       28,008      (27,719)      37,652
    Accounts payable .............................................................         (585)      21,401       27,537
    Federal income, property and other taxes payable .............................       (6,228)      (2,424)        (611)
    Other current assets and liabilities .........................................       (4,525)       2,669      (11,059)
    Deferred and prepaid benefit costs ...........................................      (16,620)     (44,021)     (20,471)
    Deferred assets and liabilities ..............................................        3,002       (6,427)       5,097
                                                                                      ---------    ---------    ---------
                                                                                      $ (10,167)   $ (93,207)   $ (27,033)
                                                                                      =========    =========    =========
SUPPLEMENTAL DISCLOSURES
  Cash paid for:
    Interest, net of amounts capitalized .........................................    $  52,978    $  45,896    $  40,037
                                                                                      =========    =========    =========
    Federal income taxes .........................................................    $  46,984    $  31,927    $  30,874
                                                                                      =========    =========    =========
  Noncash financing activities:
    Transfer of pipeline net assets from MCN......................................5   $      --    $  17,008    $      --
                                                                                      =========    =========    =========

</TABLE>


The notes to the consolidated financial statements are an integral part of this
statement.


                                      25
<PAGE>   30

 
 
               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS



1.   SUMMARY OF ACCOUNTING POLICIES

NATURE OF OPERATIONS

     MichCon is a public utility engaged in the distribution and transmission of
natural  gas in the state of  Michigan.  MichCon is  subject  to the  accounting
requirements of and rate  regulation by the Michigan  Public Service  Commission
(MPSC) with respect to the distribution and intrastate transportation of natural
gas.  The  major  services   provided  by  MichCon  are  gas  sales,   end  user
transportation  and  intermediate  transportation.  MichCon serves more than 1.2
million  residential,  commercial and industrial  customers.  The Company is not
dependent upon any one customer or group of customers. Its principal markets are
located in the Detroit,  Grand Rapids,  Ann Arbor,  Traverse  City, and Muskegon
metropolitan  areas.  MichCon's  non-regulated   operations  are  insignificant.
MichCon is a wholly owned subsidiary of MCN Energy Group Inc.

     Less than half of MichCon's labor force is covered by collective bargaining
agreements,  with the earliest  agreements  set to expire in June 1998.  Fifteen
percent of the Company's labor force is covered under the agreements expiring in
June 1998.

PRINCIPLES OF CONSOLIDATION

     The consolidated  financial  statements include the accounts of MichCon and
all of its  subsidiaries.  Investments  in 50% or less owned  entities have been
accounted for under the equity method because  MichCon has  significant  but not
controlling influence over these entities.

BASIS OF PRESENTATION

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

     Certain  reclassifications  have been made to prior  years'  statements  to
conform with the 1997 presentation.

REVENUES AND COST OF GAS

     MichCon  accrues  revenues  for gas service  provided but unbilled at month
end. Annual gas cost recovery (GCR)  proceedings  before the MPSC permit MichCon
to recover the prudent and reasonable  cost of gas sold. Any  overcollection  or
undercollection of costs, including interest, will be reflected in future rates.


                                       26

<PAGE>   31

               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

PROPERTY, PLANT AND EQUIPMENT

     Property,  plant and  equipment is stated at cost and includes  amounts for
labor, materials, overhead,  non-depreciable base gas and an allowance for funds
used during  construction.  Upon  retirement,  the cost of  property,  plant and
equipment and net removal costs are charged to accumulated depreciation.

ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION

     MichCon capitalizes an allowance for both debt and equity funds used during
construction in the cost of major  additions to utility plant.  The total amount
capitalized  was  $3,188,000,  $5,233,000 and $1,644,000 in 1997, 1996 and 1995,
respectively.

DEPRECIATION AND DEPLETION

     MichCon records depreciation for a major portion of its property, plant and
equipment on the basis of  straight-line  rates  prescribed by the MPSC. Unit of
production  depreciation  and  depletion  is used  for  certain  production  and
transmission  property.  Depreciation rates vary by class of property. The ratio
of the provision for  depreciation  to the average cost of depreciable  property
was 4.1% in 1997 and 4.4% in 1996 and 1995.

FINANCIAL INSTRUMENTS

     To manage interest rate exposure,  MichCon and its  subsidiaries  engage in
interest  rate swaps that  exchange  fixed and variable  rate  interest  payment
obligations  over  the  life  of the  agreements  without  the  exchange  of the
underlying  principal  amounts.  The  difference to be paid or received on these
swaps is accrued and recorded as an adjustment to interest expense over the life
of the agreements.

DEFERRED DEBT COSTS

     In accordance  with MPSC  regulations,  MichCon  defers  reacquisition  and
unamortized  issuance  costs of  reacquired  long-term  debt  when  such debt is
refinanced. These costs are amortized over the term of the replacement debt.

INCOME TAXES AND INVESTMENT TAX CREDIT

     Tax benefits amortizable to customers represents the net revenue equivalent
of the difference in property-related accumulated deferred income taxes computed
in accordance  with SFAS No. 109,  "Accounting for Income Taxes," as compared to
the  amounts  previously  reflected  in setting  utility  rates.  This amount is
primarily due to current tax rates being lower than the rates in effect when the
original  deferred  taxes were  recorded and because of  temporary  differences,
including  accumulated  investment tax credits,  for which deferred income taxes
were not previously  recorded in setting  utility rates.  These net tax benefits
are being amortized in accordance with the regulatory treatment over the life of
the related plant, as the temporary differences reverse.
 
     Investment  tax  credits  relating to property  placed  into  service  were
deferred and are being credited to income over the life of the related property.

                                       27
<PAGE>   32
               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

CONSOLIDATED STATEMENT OF CASH FLOWS

     MichCon  considers  all highly  liquid  investments,  excluding  restricted
investments,  purchased  with a  maturity  of  three  months  or less to be cash
equivalents.

2.   GAS IN INVENTORY

     Inventory gas is priced on a last-in,  first-out  (LIFO) basis. At December
31,  1997,  the  replacement   cost  exceeded  the  $40,201,000   LIFO  cost  by
$170,240,000  and at December  31,  1996,  the  replacement  cost  exceeded  the
$67,910,000 LIFO cost by $240,442,000.  MichCon's  current GCR tariff provisions
prevent  MichCon  from  retaining  any  benefits  from a lower  cost of gas sold
resulting from liquidating its LIFO inventory.  MichCon's LIFO inventory balance
was 64.8 Bcf and 73.6 Bcf as of December 31, 1997 and 1996, respectively.
 
     A portion of gas in underground storage used as a pressure base is included
in "Property,  Plant and Equipment" in the amount of $32,493,000 at December 31,
1997 and $32,792,000 at December 31, 1996.

3.   CAPITALIZATION

     A.   LONG-TERM DEBT

          MichCon issued long-term debt totaling $85,000,000 during 1997.

          Substantially  all of the net  utility  properties  of  MichCon in the
     approximate  amount of  $1,200,000,000  are  pledged  as  security  for the
     payment of outstanding first mortgage bonds.

          During  1997,  MichCon  subsidiaries   borrowed  $40,000,000  under  a
     nonrecourse  credit  agreement.  Under  terms  of  the  agreement,  certain
     alternative  variable interest rates are available at the borrowers' option
     during the life of the agreement. Quarterly principal payments commenced in
     June 1997 with a final  installment  due November 2005. The loan is secured
     by a pledge of stock of the borrowers and a security interest in certain of
     their  assets.  MichCon may be  required  to support  the credit  agreement
     through limited capital  contributions  to the subsidiaries if certain cash
     flow and operating  targets are not met. At December 31, 1997,  $36,400,000
     was outstanding at a weighted average interest rate 6.43%.
 
          In the second quarter of 1997,  MichCon  redeemed  $5,000,000 of 9.50%
     first mortgage bonds and $12,000,000 of 9.75% unsecured notes.  MichCon had
     a  variable  interest  rate  swap  agreement  through  April  2000  on  the
     $12,000,000 unsecured notes. This agreement reduced the cost of debt of the
     fixed-rate  unsecured  notes from  9.75% to 5.77% for the six months  ended
     June 30, 1997.  This swap has been  redesignated as a hedge for $12,000,000
     of the  outstanding  $80,000,000  first mortgage bond due May 1, 2004. This
     redesignation  reduced  the cost of debt of this fixed rate bond from 8.25%
     to 7.73% for the six months ended December 31, 1997.
 
 
                                       28
<PAGE>   33
               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


          MichCon  entered into  variable  interest  rate swap  agreements  with
     notional principal amounts  aggregating  $80,000,000 in connection with the
     first  mortgage  bonds  issued May 1997.  Swap  agreements  of  $40,000,000
     through May 2002 have  reduced the average cost of debt from 7.31% to 6.32%
     for the year ended  December  31,  1997.  Swap  agreements  of  $40,000,000
     through May 2005 have  reduced the average cost of debt from 7.06% to 5.91%
     for the year ended  December  31,  1997.  A  subsidiary  of MichCon  has an
     interest rate swap agreement on the $15,840,000  outstanding balance of its
     project loan agreement at December 31, 1997,  which  effectively  fixes the
     interest rate at 7.5% through February 2003.

          Maturities  and sinking fund  requirements  during the next five years
     for long-term debt  outstanding  at December 31, 1997,  are  $26,560,000 in
     1998,  $57,360,000 in 1999,  $26,960,000 in 2000,  $26,560,000 in 2001, and
     $76,360,000 in 2002.

     B.   CUMULATIVE PREFERRED AND PREFERENCE STOCK

          During  January  1996,   MichCon   redeemed  all  of  its  outstanding
     Redeemable  Cumulative  Preferred Stock, $2.05 Series shares at the sinking
     fund redemption price of $25 per share.  MichCon has 7,000,000 shares of $1
     per share par value  Redeemable  Cumulative  Preferred Stock  authorized at
     December 31, 1997.  MichCon has 4,000,000  shares of $1 per share par value
     Preference  Stock  authorized;  however,  no  shares  were  outstanding  at
     December 31, 1997.

4.   CREDIT FACILITIES AND SHORT-TERM BORROWINGS

     MichCon   maintains   credit   lines  to   allow  for  borrowings  of up to
$150,000,000    under   a   364-day    revolving   credit  facility  and  up  to
$150,000,000   under  a  three-year   revolving   credit  facility.  Both credit
facilities  expire  in  July  1998.   MichCon usually issues commercial paper in
lieu  of  an   equivalent   amount  of  borrowings  under these lines of credit.
Commercial   paper   outstanding   at   December  31,  1997   and  1996  totaled
$236,740,000  and  $238,251,000,   respectively,   at  weighted average interest
rates  of  5.8%  and  5.5%,  respectively. This debt is classified as short-term
based  upon   management's  intent to repay it within one year. Fees are paid to
compensate banks for lines of credit.

     During  1996,   MichCon  had  a  Trust Demand Note  program  which  allowed
MichCon  to  borrow  up  to   $25,000,000  through  March 1997.  At December 31,
1996,   borrowings  of  $25,000,000  were  outstanding  under this program at an
interest   rate  of  5.9%.   The  Trust  Demand Note  program was not renewed in
1997.

5.   TRANSFER OF SUBSIDIARIES

        In  January  1996,  MCN's Michigan pipeline operations were transferred,
at  book  value,  to  MichCon  in  order to consolidate MCN's Michigan gathering
pipeline  activities  within  one  business unit.   Net  assets  transferred  to
MichCon  totaled  approximately  $18,622,000  including  cash  of $1,614,000 and
long-term  debt of $17,600,000.  The contribution from these pipeline operations
to MichCon's  consolidated net income was approximately $1,714,000  and $626,000
for  the  years  ended 1997 and 1996, respectively. The pipeline operations have
investments  in  certain    partnerships.   Outside  partners  have interests in
these partnerships ranging from 17% to 54%.
 
                                       29
<PAGE>   34
               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

6.   COMMITMENTS AND CONTINGENCIES

     A.   GUARANTY

          A subsidiary of MichCon and an unaffiliated  corporation have formed a
     series of  partnerships  engaged in the  construction  and development of a
     residential  community on the Detroit riverfront  (Harbortown).  One of the
     partnerships  obtained  $12,000,000  of tax-exempt  financing due June 2004
     through the Michigan State Housing Development Authority. Both partners and
     their parent  corporations  have issued  guaranties  for the full amount of
     this  financing  and each parent  corporation  has agreed to reimburse  the
     other for 50% of any payments made as a result of these guaranties.

     B.   ENVIRONMENTAL MATTERS

          Prior to the 1940's when major natural gas pipelines became sufficient
     to meet MichCon's supply  requirements,  gas for heating and other uses was
     manufactured  from processes  involving coal, coke or oil.  MichCon owns or
     previously owned 16 such former manufactured gas plant (MGP) sites.

          During the mid-1980's,  MichCon  conducted  preliminary  environmental
     investigations at these former MGP sites, and some contamination related to
     the  by-products  of gas  manufacturing  was  discovered at each site.  The
     existence   of  these   sites  and  the   results   of  the   environmental
     investigations   have  been   reported  to  the  Michigan   Department   of
     Environmental  Quality.  None of these former MGP sites are on the National
     Priorities List prepared by the U.S. Environmental Protection Agency.

          MichCon is not involved in any  administrative  proceedings  regarding
     these former MGP sites,  but is currently  remediating four of these sites.
     More extensive investigations are underway at four other former MGP sites.

          In 1984 MichCon  established an $11,700,000  reserve for environmental
     investigation and remediation.  During 1993, MichCon received MPSC approval
     of a cost  deferral  and rate  recovery  mechanism  for  investigation  and
     remediation costs incurred at former MGP sites in excess of this reserve.

          MichCon   employed   outside   consultants  to  evaluate   remediation
     alternatives  for  these  sites,  to  assist in  estimating  its  potential
     liabilities and to review its archived insurance policies.  The findings of
     these  investigations  indicate that the estimated total  expenditures  for
     investigation  and remediation  activities for these sites could range from
     $30,000,000 to $170,000,000  based on undiscounted  1995 costs. As a result
     of  these  studies,   MichCon   accrued  an  additional   liability  and  a
     corresponding regulatory asset of $32,000,000 during 1995.
 
          MichCon notified more than 40 current and former insurance carriers of
     the environmental  conditions at these former MGP sites.  MichCon concluded
     settlement  negotiations  with  certain  carriers  in 1996 and 1997 and has
     received  payments from several  carriers.  In October 1997,  MichCon filed
     suit against major nonsettling  carriers seeking recovery of incurred costs
     and a declaratory  judgment of the carriers'  liability for future costs of
     environmental investigation and remediation costs at former MGP sites.

                                       30
<PAGE>   35
               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

          During 1997,  1996,  and 1995,  MichCon spent  $835,000,  $900,000 and
     $2,100,000,  respectively,  investigating  and remediating these former MGP
     sites.  At  December  31,  1997,  the  reserve  balance  is   approximately
     $33,741,000,  of which $1,741,000 is classified as current. Any significant
     change in assumptions, such as remediation techniques, nature and extent of
     contamination  and  regulatory  requirements,  could impact the estimate of
     remedial  action  costs for the  sites  and,  therefore,  have an effect on
     MichCon's financial position and cash flows.  However,  management believes
     that insurance  coverage and the cost deferral and rate recovery  mechanism
     approved  by the  MPSC  will  prevent  environmental  costs  from  having a
     material adverse impact on MichCon's results of operations.

     C.   COMMITMENTS

          MichCon  has  entered  into  long-term   purchase  and  transportation
     contracts with various  suppliers and producers.  In general,  prices under
     the purchase  contracts are  determined by formulas based on market prices.
     In 1998, MichCon has firm purchase commitments for approximately 124 Bcf of
     gas.  The  Company  expects  that sales will  exceed its  minimum  purchase
     commitments.  MichCon has long-term  transportation  contracts with various
     interstate  pipeline  companies  which expire on various  dates through the
     year 2011. The Company is committed to pay demand charges of  approximately
     $53,000,000 during 1998 related to firm  transportation  agreements.  These
     demand charges are recoverable through the GCR mechanism.

          Capital investments for 1998 are expected to approximate  $200,000,000
     and certain commitments have been made in connection therewith.

     D.   OTHER

          MichCon receives a significant  amount of heating  assistance  funding
     from the  federal  Low-Income  Home  Energy  Assistance  Program  (LIHEAP).
     Congress  increased  the  program's  funding  for the 1997  fiscal  year to
     $1,000,000,000. The State of Michigan's share of LIHEAP funds was increased
     from  $47,500,000 in fiscal year 1996 to $64,000,000 in 1997.  During 1997,
     Congress  approved a budget which  provides for federal  LIHEAP  funding at
     $1,000,000,000   and   $1,100,000,000  for  fiscal  years  1998  and  1999,
     respectively.  A portion of any future  increase or decrease in funding may
     impact MichCon's uncollectible accounts.
 
          MichCon is involved in certain  legal and  administrative  proceedings
     before various courts and governmental  agencies  concerning claims arising
     in the ordinary  course of business.  Management  cannot  predict the final
     disposition of such proceedings,  but believes that adequate  provision has
     been made for probable losses. It is management's  belief, after discussion
     with legal counsel, that the ultimate resolution of those proceedings still
     pending  will not have a material  adverse  effect on  MichCon's  financial
     statements.


                                       31
<PAGE>   36
               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


7.   REGULATORY MATTERS

     Regulatory Assets and Liabilities

          MichCon's  operations  are  subject  to the  provisions  SFAS No.  71,
     "Accounting  for the Effects of Certain Types of  Regulation." As a result,
     several  regulatory  assets  and  liabilities  are  recorded  in  MichCon's
     financial  statements.  Regulatory  assets  represent  costs  which will be
     recovered  from  customers  through  the  ratemaking  process.   Regulatory
     liabilities  represent  benefits  which will flow  through to  customers as
     refunds or reduced rates. The following  regulatory  assets and liabilities
     were reflected in the  Consolidated  Statement of Financial  Position as of
     December 31:
<TABLE>
<CAPTION>

  (Thousands of Dollars)                                                      1997                 1996
  -------------------------------------------------------------------   -----------------   -------------------
  <S>                                                                  <C>                  <C> 
       
   Regulatory Assets:
     Deferred postretirement benefit costs (Note 9b)................     $          -         $        4,863
     Unamortized loss on retirement of debt.........................             10,181                9,237
     Accrued gas cost recovery revenues.............................             12,862               27,672
     Environmental costs (Note 6b)..................................             27,699               28,233
     Conservation program costs....................................                 -                  2,908
     Other .........................................................                986                1,681
                                                                        ---------------       --------------
                                                                         $       51,728       $       74,594
                                                                        ===============       ==============


   Regulatory Liabilities:
     Tax benefits amortizable to customers..........................     $      122,922       $      116,313
     Refunds payable................................................                 -                   405
                                                                        ---------------       --------------  
                                                                         $      122,922       $      116,718
                                                                        ===============       ==============

</TABLE>
 
     MichCon  currently  has  regulatory  precedents  and orders in effect which
provide  for the  probable  recovery  or refund  of its  regulatory  assets  and
liabilities. Future regulatory changes or changes in the competitive environment
could result in MichCon  discontinuing the application of SFAS No. 71 for all or
part of its business and require the write-off of the portion of any  regulatory
asset or  liability  which was no longer  probable  of  recovery  or refund.  If
MichCon were to have  discontinued the application of SFAS No. 71 for all of its
operations as of December 31, 1997, it would have had an extraordinary,  noncash
increase to net income of approximately  $46,000,000.  Management  believes that
evidence currently available supports the continued application of SFAS No. 71.

8.   CAPITAL AND OPERATING LEASES

     MichCon  leases  certain  property   (principally  an  office  building,  a
warehouse and a parking structure) under lease arrangements  expiring at various
dates to 2006, with renewal options extending beyond that date.  Portions of the
office building and parking structure are subleased to various tenants.

                                       32
<PAGE>   37
               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


     The gross amount of assets  recorded  under capital  leases and the related
accumulated  depreciation at December 31, 1997, are $26,887,000 and $13,146,000,
respectively. The gross amount of assets and related accumulated depreciation at
December 31, 1996, were $26,887,000 and $11,719,000, respectively.

     In January 1998 MichCon purchased the office building, ending its long-term
capital  lease  obligation  existing  at December  31,  1997.  As a result,  the
long-term lease  obligation of $6,818,000 was  reclassified as a current capital
lease  obligation  at December  31, 1997;  therefore,  no future  minimum  lease
payments associated with the building lease are disclosed.

     Operating  lease payments for the years ended December 31, 1997,  1996, and
1995 consist of $2,015,000, $2,239,000 and $2,378,000, respectively.

9.   RETIREMENT BENEFITS AND TRUSTEED ASSETS

     A.   PENSION PLAN BENEFITS

          MichCon  participates in separate defined benefit retirement plans for
     union  and  nonunion  employees.  The  plans  are  noncontributory,   cover
     substantially  all employees  and provide for normal  retirement at age 65,
     but with the option to retire  earlier or later under  certain  conditions.
     The  plans  provide  pension  benefits  that are  based  on the  employee's
     compensation and years of credited service.  MichCon's funding policy is to
     fund each year's actuarially  determined funding requirements of the plans,
     subject to regulations  issued by the Internal Revenue Service.  Currently,
     these plans meet the full funding limitations of the Internal Revenue Code.
     Accordingly,  no  contributions  for the 1997, 1996 or 1995 plan years were
     made and none are expected to be made for the 1998 plan year.

          Net pension cost for these plans included the following components:
<TABLE>
<CAPTION>


         (Thousands of Dollars)                                      1997              1996              1995
         ------------------------------------------------------  -------------     -------------     --------------
        <S>                                                     <C>               <C>               <C>

         Service cost - benefits earned during the period......  $      9,406      $     10,400       $      8,735
         Interest cost on projected benefit obligation.........        34,408            33,262             31,197
         Net amortization and deferral.........................        66,915            15,675             64,435
         Actual return on plan assets..........................      (138,863)          (78,260)          (121,508)
                                                                 -------------     -------------     --------------

         Net pension credit....................................  $    (28,134)     $    (18,923)      $    (17,141)
                                                                 =============     =============     ==============

</TABLE>

          MichCon  settled a portion of its pension  liabilities  by paying lump
     sum amounts to employees who retired or otherwise terminated employment.  A
     gain of  $3,250,000  was  recognized  in 1997 related to the  settlement of
     these liabilities.


                                       33
<PAGE>   38
               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


 
          The following table sets forth a  reconciliation  of the funded status
     of the  plans and the  amounts  recorded  as  prepaid  pension  cost in the
     Consolidated Statement of Financial Position:

<TABLE>
<CAPTION>


      (Thousands of Dollars)                                                        1997            1996
      -----------------------------------------------------------------        --------------     ------------
     <S>                                                                       <C>                <C> 
      Measurement date...................................................        OCTOBER 31       October 31
      Actuarial present value of:
        Accumulated vested benefit obligation............................       $     365,336     $    349,809
        Accumulated nonvested benefit obligation.........................              30,929           27,280
                                                                               --------------     ------------

          Total accumulated benefit obligation...........................       $     396,265     $    377,089
                                                                               ==============     ============

      Projected benefit obligation for service rendered to date..........       $     465,098     $    430,100
      Plan assets at measurement date....................................             814,548          707,987
                                                                               --------------     ------------ 

      Plan assets in excess of projected benefit obligation..............             349,450          277,887
      Unrecognized net asset at transition...............................             (34,342)         (39,702)
      Unrecognized prior service cost....................................              (1,439)          (1,602)
       Unrecognized net gain.............................................            (237,923)        (192,221) 
                                                                               --------------     ------------ 
                                                                                 
      Prepaid pension cost recognized in the Consolidated
        Statement of Financial Position..................................       $      75,746     $     44,362
                                                                               ==============     ============ 

</TABLE>

          In determining  the actuarial  present value of the projected  benefit
     obligation,  the weighted  average discount rate was 7.5% for 1997 and 8.0%
     for 1996.  The rate of increase in future  compensation  levels used was 5%
     for 1997 and 1996.  The expected  long-term  rate of return on plan assets,
     which are invested  primarily in equity and fixed  income  securities,  was
     9.25% for 1997 and 1996, and 9.0% for 1995.

          MichCon also sponsors  several  defined  contribution  pension  plans.
     Participation in one of these plans is available to substantially all union
     and non-union  employees.  Company  contributions  to these plans are based
     upon  salary  and the  matching  of  employee  contributions  up to certain
     limits. The cost of these plans was $5,200,000 in 1997, $5,300,000 in 1996,
     and $5,200,000 in 1995.


     B.   OTHER POSTRETIREMENT BENEFITS                                     


          MichCon provides  certain health care and life insurance  benefits for
     retired  employees who may become eligible for these benefits if they reach
     retirement age while working for MichCon. Upon adoption in 1993 of SFAS No.
     106,  "Employers'  Accounting  for  Postretirement   Benefits  Other  Than
     Pensions," MichCon deferred  postretirement  costs in excess of claims paid
     (including the  amortization of the initial  transition  obligation)  until
     January  1994 when new rates to recover such costs  became  effective.  The
     deferred costs were amortized over 1994 through 1997.



                                       34
<PAGE>   39
               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

          MichCon's  policy is to fund its  postretirement  benefit costs to the
     extent such amounts are recognized in rates.  Separate qualified  Voluntary
     Employees'  Beneficiary  Association  (VEBA)  trusts  exist  for  union and
     nonunion  employees.   Funding  to  the  VEBA  trusts  totaled  $6,500,000,
     $41,600,000  and  $27,300,000  in 1997,  1996 and 1995,  respectively.  The
     expected  weighted average  long-term rate of return on plan assets,  which
     are invested in life insurance policies, equity securities and fixed income
     securities, was 9.1% for 1997 and 1996.

          Net postretirement  cost for the years ended December 31, includes the
     following components:
<TABLE>
<CAPTION>


          (Thousands of Dollars)                                        1997            1996             1995
          --------------------------------------------------------  -------------   -------------    ------------
          <S>                                                      <C>             <C>              <C>
          Service cost - benefits earned during the period.......   $      4,094     $     4,259      $    5,017
          Interest cost on accumulated benefit obligation........         17,430          16,395          18,315
          Amortization of transition obligation..................         13,391          13,391          13,528
          Net amortization and deferral..........................         10,227          (1,915)          7,445
          Actual (return) loss on plan assets ...................        (26,125)        (12,230)        (15,634)
                                                                    -------------   -------------    ------------
                                                                          19,017          19,900          28,671
          Regulatory adjustment..................................          4,863           7,509           7,515
                                                                    -------------   -------------    ------------

          Net postretirement cost................................   $     23,880     $    27,409      $   36,186
                                                                    =============   =============    ============

</TABLE>

               The  following  table sets forth a  reconciliation  of the funded
          status of the plans and the amounts recorded as accrued postretirement
          cost in the Consolidated Statement of Financial Position:

<TABLE>
<CAPTION>

       (Thousands of Dollars)                                                      1997                 1996
       -------------------------------------------------------------------     --------------       -------------
<S>                                                                            <C>                  <C>

       Measurement Date...................................................      OCTOBER 31           October 31

       Accumulated postretirement benefit obligation:
         Retirees.........................................................     $     131,576        $    138,753
         Fully eligible active participants...............................            30,343              25,346
         Participants with less than 30 years of service..................            61,205              53,784
                                                                               -------------        ------------
                                                                                     223,124             217,883
       Plan assets at measurement date....................................           151,645             126,282
                                                                               -------------        ------------ 
       Accumulated postretirement benefit obligation in excess
         of plan assets...................................................           (71,479)            (91,601)

       Unrecognized transition obligation.................................           200,728             214,119
       Unrecognized net gain..............................................          (125,705)           (109,625)
       Contributions and adjustments made after measurement date..........             6,500               7,052 
                                                                               -------------        ------------
        
       Accrued postretirement asset (liability) recognized in the
         Consolidated Statement of Financial Position.....................     $      10,044        $     19,945
                                                                               =============        ============ 

</TABLE>

                                       35
<PAGE>   40
               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

     The rate at which  health  care costs are  assumed to  increase is the most
significant factor in establishing MichCon's  postretirement benefit obligation.
MichCon used a rate of 6.5% in 1997,  and a rate that  gradually  declines  each
year until it stabilizes at 5% in 2003. A one  percentage  point increase in the
assumed rate would increase the accumulated postretirement benefit obligation at
December 31, 1997 by 12.2% and increase the sum of the service cost and interest
cost by 14.7% for the year then ended. The discount rate used in determining the
accumulated postretirement benefit obligation was 7.5% and 8% for 1997 and 1996,
respectively.

C.   GRANTOR TRUST

     In December  1997,  MichCon  established  a Grantor  Trust and  contributed
$31,300,000  to  the  trust,  which  invested  such  proceeds  in  fixed  income
securities.  By funding the Grantor Trust and the VEBA trusts (Note 9b), MichCon
is complying with MPSC  directives that it fund various trusts to the extent its
postretirement  benefit  costs  to are  recognized  in  rates.  Subject  to MPSC
notification,  MichCon can revoke the Grantor Trust,  and employees and retirees
have no right, title or interest in the assets of the trust.  MichCon classifies
the Grantor  Trust as  available-for-sale  and as such  records it at fair value
with changes in the fair value recorded in Common Shareholder's Equity.

10.  FINANCIAL INSTRUMENTS

     MichCon has  estimated the fair value of its  financial  instruments  using
available   market   information   and  appropriate   valuation   methodologies.
Considerable  judgment is required in  developing  the  estimates  of fair value
presented herein;  therefore,  the values are not necessarily  indicative of the
amounts that MichCon could realize in a current  market  exchange.  The carrying
amounts  of certain  financial  instruments  such as  customer  deposits,  notes
payable and notes  receivable and advances are assumed to  approximate  the fair
value due to the short-term nature of these items.

     The  carrying  amount  and the  estimated  fair  value of  other  financial
instruments consist of the following:

<TABLE>
<CAPTION>


(Thousands of Dollars)                                           1997                             1996
-------------------------------------------------   -------------------------------   -----------------------------
                                                      CARRYING        ESTIMATED         Carrying        Estimated
                                                       AMOUNT         FAIR VALUE         Amount        Fair Value
                                                    --------------  ---------------   -------------   --------------
<S>                                                      <C>              <C>         <C>             <C>
Assets:
   Grantor Trust..................................         31,300           31,300               -               -
                                                  

Liabilities and Shareholders' Equity:
   Long-term debt, excluding capital lease             
   obligations....................................        611,763          651,980         536,561         567,011

Derivative Financial Instruments:
   Interest rate swap agreements
     with unrealized gains........................                           4,048                           1,154
     with unrealized losses.......................                             415                             294

</TABLE>

                                       36
<PAGE>   41
               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

The estimated fair values are determined based on the following:
 
     Grantor  Trust  -  carrying   amount  is assumed to  approximate  market at
     December  31,  1997  as  the investment was purchased on December 31, 1997.

     Long-term  debt -  interest   rates   available  to MichCon for issuance of
     debt with similar terms and remaining maturities.

     Interest  rate  swaps  -  the  estimated  amount that MichCon would receive
     or pay to  terminate  the swap  agreements,  taking  into  account  current
     interest rates and the  creditworthiness of the swap counterparties and the
     fact that there is no similar market for the instruments.

     Guaranty  -  management  is  unable  to practicably estimate the fair value
     of the Harbortown guaranty (Note 6a) due to the nature of the related party
     transaction and the fact there is no similar market for the instrument.

     Other  long-term   investments  -  management   is  unable  to  practicably
     estimate the fair value of the various other long-term  investments because
     there is no readily determinable market for the investments.

     The  fair  value  estimates  presented  herein  are  based  on  information
available  to  management  as of December 31, 1997 and 1996.  Management  is not
aware of any subsequent  factors that would  significantly  affect the estimated
fair value amounts.

11.  RELATED PARTY TRANSACTIONS

     MichCon  enters  into  transactions  with  affiliated   companies  to  sell
transportation  and storage  services.  MichCon  purchased  computer  operations
services from an affiliate that was sold in June 1996. Under a service agreement
with its parent  company,  MichCon  receives  various tax,  financial  and legal
services.  The  following  is a  summary  of  transactions  with the  affiliated
companies:
<TABLE>
<CAPTION>


       (Thousands of Dollars)                                               1997           1996           1995
       --------------------------------------------------------------   -------------  -------------  -------------
      <S>                                                             <C>             <C>             <C> 


       Storage and transportation sales.............................    $     14,744   $     14,400   $     11,100

       Purchase of computer operations services.....................               -          6,800         15,300
       Corporate expenses...........................................          18,546         15,700         15,561

</TABLE>
 
     MichCon's  accounts  receivable  from and  accounts  payable to  affiliated
companies were $20,990,000 and $25,863,000 at December 31, 1997, respectively.

                                       37

<PAGE>   42
               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)



12.   SUMMARY OF INCOME TAXES
<TABLE>
<CAPTION>
 

     (Thousands of Dollars)                                                1997           1996             1995
     ----------------------------------------------------------------    ---------      ---------       -----------
<S>                                                                   <C>            <C>              <C>


     Effective Federal Income Tax Rate..............................         36.4 %         33.8 %            36.4 %
                                                                       ===========    ===========     =============

     Income taxes consist of:
        Current provision...........................................   $   37,901     $   31,318      $     22,873
        Deferred provision..........................................        9,607         12,018            19,988
        Amortization of investment tax credits......................       (1,843)        (1,850)           (1,857)
                                                                       -----------    -----------     -------------
     Total income taxes.............................................   $   45,665     $   41,486      $     41,004
                                                                       ===========    ===========     =============

     Reconciliation between statutory and actual income taxes:
     Statutory federal income taxes at a rate of 35%................   $   43,640     $   42,465      $     39,454

     Adjustments to federal tax expense:
        Excess of book over tax depreciation .......................        5,301          6,367             7,365
        Adjustments to taxes provided in prior periods..............          300         (3,368)           (1,343)
        Amortization of investment tax credits......................       (1,843)        (1,850)           (1,857)
        Other - net.................................................       (1,733)        (2,128)           (2,615)
                                                                       -----------    -----------     -------------
     Total income taxes.............................................   $   45,665     $   41,486      $     41,004
                                                                       ===========    ===========     =============

</TABLE>
 
 
                                       38


<PAGE>   43
               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)



     Deferred tax assets and liabilities are recognized for the estimated future
tax  effect  of  temporary  differences  between  the tax  basis  of  assets  or
liabilities and the reported amounts in the financial  statements.  Deferred tax
assets and liabilities are classified as current or noncurrent  according to the
classification of the related assets or liabilities. The tax effect of temporary
differences  that gave rise to  MichCon's  deferred  tax assets and  liabilities
consisted of the following:
<TABLE>
<CAPTION>


       (Thousands of Dollars)                                                      1997              1996
       -------------------------------------------------------------------    ----------------   -------------
      <S>                                                                     <C>               <C>  
       Deferred tax assets:
          Employee Benefits.............................................        $       9,391    $      9,323
          Uncollectibles................................................                4,671           6,130
          Vacation Accrual..............................................                3,442           3,355
          Other.........................................................                2,283           5,613
                                                                              ----------------   -------------
       Total deferred tax assets........................................               19,787          24,421
                                                                              ----------------   -------------

       Deferred tax liabilities:
          Depreciation and other property related basis
             differences, net...........................................               58,215          62,443
          Pensions......................................................               24,564          13,926
          Property taxes................................................               13,313          11,040
          Gas cost recovery undercollection.............................                4,502           8,455
          Postretirement benefit........................................                3,515           9,186
          Other.........................................................                9,795           9,236
                                                                              ----------------   -------------
       Total deferred tax liabilities...................................              113,904         114,286
                                                                              ----------------   -------------
       Net deferred tax liability.......................................               94,117          89,865
       Less:  Net deferred tax  liability-current.......................               10,212          13,342
                                                                              ----------------   -------------
       Net deferred tax liability-noncurrent............................        $      83,905    $     76,523
                                                                              ================   =============

</TABLE>

     MichCon is part of the  consolidated  federal income tax return of MCN. The
federal income tax expense for MichCon and its  subsidiaries is determined on an
individual  company  basis with no  allocation  of tax benefits or expenses from
other affiliates of MCN.






                                       39
<PAGE>   44


               MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
          NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONCLUDED)

13.  STOCK INCENTIVE PLAN

     MCN's  Stock  Incentive  Plan  authorizes  the  use of  performance  units,
restricted  stock or other  stock-related  awards  to key  employees,  primarily
management.  MichCon's  current  policy  is to  issue  performance  units  which
encourage a strategic  focus on long-term  performance  and have a high employee
retention value.  The performance  units are denominated in shares of MCN common
stock and issued to employees based on total shareholder  return over a six year
period,  as  compared  to a group  of peer  companies.  The  initial  number  of
performance  units  granted  is based on total  shareholder  return  during  the
previous three year period.  Participants  receive  dividend  equivalents on the
units granted.  The initial grants will be adjusted  upward or downward based on
total shareholder return for the subsequent  three-year period. The final awards
are then  payable in shares of MCN common stock or deferred  performance  units.
Participants  must retain fifty  percent of any common shares paid until certain
stock  ownership  guidelines are met. The deferred units must be retained by the
participants until their employment with MichCon ceases.

     During  February 1997,  MichCon granted  102,750  performance  units with a
weighted-average  grant date fair value of $31.00 per unit. During February 1996
and 1995, MichCon granted 122,669 and 191,500  performance units,  respectively.
In May 1996,  MichCon  modified  its 1995  performance  units  granted  to allow
limited  acceleration  in the vesting for a portion of the awards.  As a result,
the 1995 awards have been accounted for under the recognition provisions of SFAS
No. 123 from the date of  modification.  The weighted  average fair value at the
modification date for 1995 awards was $24.875 per unit. Stock-based compensation
cost recognized  during 1997, 1996 and 1995 for all awards  outstanding  totaled
$7,430,000,  $6,885,000,  and  $7,919,000,  respectively.  At December 31, 1997,
there were 2,530,148 MCN shares available to be issued under the Stock Incentive
Plan.


                                       40
<PAGE>   45
INDEPENDENT AUDITORS' REPORT

Michigan Consolidated Gas Company:

We have audited the accompanying  consolidated  statements of financial position
of Michigan  Consolidated  Gas Company and  subsidiaries  (the  "Company") as of
December 31, 1997 and 1996, and the related  consolidated  statements of income,
cash flows and  capitalization  for each of the three years in the period  ended
December 31, 1997. Our audits also included the consolidated financial statement
schedule  listed in Item 8. These financial  statements and financial  statement
schedule are the responsibility of the Company's management.  Our responsibility
is to express an opinion on the financial  statements  and  financial  statement
schedule based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly,  in  all  material   respects,   the  financial   position  of  Michigan
Consolidated  Gas Company and subsidiaries as of December 31, 1997 and 1996, and
the results of their operations and their cash flows for each of the three years
in the period ended  December 31, 1997 in  conformity  with  generally  accepted
accounting  principles.  Also,  in  our  opinion,  such  consolidated  financial
statement  schedule,  when  considered  in  relation  to the basic  consolidated
financial  statements  taken  as a  whole,  presents  fairly,  in  all  material
respects, the information shown therein.

As discussed in Note 13 to the consolidated financial statements, in 1996 the
Company adopted Statement of Financial Accounting Standard No. 123, "Accounting
for Stock-Based Compensation."



DELOITTE & TOUCHE LLP
Detroit, Michigan
February 12, 1998






                                      41
<PAGE>   46
              MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
                     SUPPLEMENTARY FINANCIAL INFORMATION



QUARTERLY OPERATING RESULTS (UNAUDITED)

     Due to the seasonal nature of MichCon's business, revenues and net income
tend to be higher in the first and fourth quarters of the calendar year.

<TABLE>
<CAPTION>

                                                                    First            Second             Third            Fourth
                                                                   Quarter           Quarter           Quarter           Quarter
--------------------------------------------------------------  --------------    --------------    --------------    --------------
(Thousands of Dollars)
<S>                                                              <C>               <C>               <C>               <C>
1997                                                                                                                      
Operating Revenue.............................................    $527,445          $209,800          $119,114          $397,320
Operating Income (loss).......................................     106,772            14,810           (11,369)           64,150
Net Income (loss).............................................      62,193               931           (16,036)           31,932
Net Income (loss) applicable to common stock..................      62,193               931           (16,036)           31,932



1996
Operating Revenues............................................    $531,392          $222,327          $117,251          $387,815
Operating Income (loss).......................................     120,904            11,690           (18,630)           54,037
Net Income (loss).............................................      70,040               851           (18,437)           27,388
Net Income (loss) applicable to common stock..................      70,022               851           (18,437)           27,388

</TABLE>

                                      42

<PAGE>   47

                                                                     SCHEDULE II
              MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
                SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
                            (Thousands of Dollars)

<TABLE>
<CAPTION>
                 COLUMN A                                 COLUMN B                 COLUMN C                    COLUMN D    COLUMN E

                                                                                   Additions                        
                                                                          ------------------------------
                                                                               Provisions charged to      Deductions  
                                                                          ------------------------------  for Purposes
                                                           Balance at                     Utility Plant/   for Which the    Balance
                                                           Beginning                      Regulatory       Reserves Were    at End
                 Description                               of Period       Income            Asset          Provided       of Period
---------------------------------------------------     ----------------  ----------      ------------   ---------------   ---------
<S>                                                         <C>            <C>            <C>               <C>          <C>    
YEAR ENDED DECEMBER 31, 1997

Reserve deducted from Assets in
  Consolidated Statement of Financial Position:
    Allowance for doubtful accounts ................        $17,707        $ 21,680       $     --          $24,372      $15,015
                                                            =======        ========       ========          =======      =======
                                                                                                                                
Reserve included in Current Liabilities - Other                                                                                 
  and in Accrued Environmental Costs                                                                                            
  in Consolidated Statement of Financial Position:                                                                              
    Environmental testing ..........................        $34,576        $     --       $     --          $   835      $33,741
                                                            =======        ========       ========          =======      =======
                                                                                                                                
Reserves included in Deferred Credits and                                                                                       
  Other Liabilities - Other                                                                                                     
    in Consolidated Statement of Financial Position:                                                                            
      Injuries and damages .........................        $ 9,182        $  1,400       $    608          $ 6,352      $ 4,838
                                                            =======        ========       ========          =======      =======
                                                                                                                                
YEAR ENDED DECEMBER 31, 1996                                                                                                    
                                                                                                                                
Reserve deducted from Assets in                                                                                                 
  Consolidated Statement of Financial Position:                                                                                 
    Allowance for doubtful accounts ................        $13,250        $ 29,052       $     --          $24,595      $17,707
                                                            =======        ========       ========          =======      =======
                                                                                                                                
Reserve included in Current Liabilities - Other                                                                                 
  in Consolidated Statement of Financial Position:                                                                              
    Environmental testing ..........................        $35,451        $     --       $     --          $   875      $34,576
                                                            =======        ========       ========          =======      =======
                                                                                                                                
Reserves included in Deferred Credits and                                                                                       
  Other Liabilities - Other                                                                                                     
    in Consolidated Statement of Financial Position:                                                                            
      Injuries and damages .........................        $ 8,013        $  3,052       $    674          $ 2,557      $ 9,182
                                                            =======        ========       ========          =======      =======
                                                                                                                                
YEAR ENDED DECEMBER 31, 1995                                                                                                    
                                                                                                                                
Reserve deducted from Assets in                                                                                                 
  Consolidated Statement of Financial Position:                                                                                 
    Allowance for doubtful accounts ................        $15,322        $ 15,367       $     --          $17,439      $13,250
                                                            =======        ========       ========          =======      =======
                                                                                                                                
Reserve included in Current Liabilities - Other                                                                                 
  in Consolidated Statement of Financial Position:                                                                              
    Environmental testing ..........................        $ 5,540        $     --       $ 32,000          $ 2,089      $35,451
                                                            =======        ========       ========          =======      =======
                                                                                                                                
Reserves included in Deferred Credits and                                                                                       
  Other Liabilities - Other                                                                                                     
    in Consolidated Statement of Financial Position:                                                                            
      Injuries and damages .........................        $ 8,402        $  1,026       $    686          $ 2,101      $ 8,013
                                                            =======        ========       ========          =======      =======
</TABLE>



                                       43


<PAGE>   48
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
        AND FINANCIAL DISCLOSURE

      None.


                                    Part III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     Omitted per general instruction  I (2) (c) of Form 10-K for  wholly-owned
subsidiaries (reduced disclosure format).

ITEM 11. EXECUTIVE COMPENSATION

     Omitted per  general  instruction  I (2) (c) of Form 10-K for  wholly-owned
subsidiaries (reduced disclosure format).

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT

     Omitted per  general  instruction  I (2) (c) of Form 10-K for  wholly-owned
subsidiaries (reduced disclosure format).

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Omitted per  general  instruction  I (2) (c) of Form 10-K for  wholly-owned
subsidiaries (reduced disclosure format).


                                       44
<PAGE>   49

                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 10-K

(A)  LIST OF DOCUMENTS FILED AS PART OF THE REPORT:

     1. For a list of the financial  statements included herein, see the section
titled "Financial Statements and Supplementary Data", page 21 in Part II, Item 8
of this Report.

     2. For the financial  statement  schedule included herein,  see the section
titled "Financial Statements and Supplementary Data", page 21 in Part II, Item 8
of this Report.

     Schedules  other than those referred to above are omitted as not applicable
or  not  required,  or the  required  information  is  shown  in  the  financial
statements or notes thereto.

     3. Exhibits, including those incorporated by reference:


<TABLE>
<CAPTION>
  Exhibit
    No.                                     Description
  -------                                   -----------
<S>           <C>
3-1            Restated Articles of Incorporation of MichCon (Exhibit 3-1 to 
               March 31, 1993 Form 10-Q).

3-2            By-Laws of MichCon (Exhibit 3-2 to March 31, 1993 Form 10-Q).

4-1            MichCon's Indenture of Mortgage and Deed of Trust dated March
               1, 1944  (Exhibit  7-D to  Registration  Statement  No.  2-5252);
               Twenty-ninth Supplemental Indenture, dated July 15, 1989 (Exhibit
               4-1 to July 27, 1989 Form 8-K); Thirtieth Supplemental Indenture,
               dated  September 1, 1991  (Exhibit 4-1 to September 27, 1991 Form
               8-K);  Thirty-first  Supplemental  Indenture,  dated December 15,
               1991  (Exhibit 4-1 to February 28, 1992 Form 8-K);  Thirty-second
               Supplemental  Indenture,  dated  January 1, 1993  (Exhibit 4-1 to
               1992 Form 10-K); Thirty-third  Supplemental Indenture,  dated May
               5, 1995 (Exhibit 4-2 to Registration Statement No. 33-59093); and
               Thirty-fourth  Supplemental  Indenture,  dated  November  1, 1996
               (Exhibit 4-2 to  Registration  Statement  No.  333-16285;  Note -
               MichCon hereby agrees to furnish to the SEC, upon request, a copy
               of any  instruments  defining  the rights of holders of long-term
               debt issued by MichCon. 

10-1           MCN Stock Option Plan Post-Effective Amendment No. 1 (MCN
               Registration Statement No. 33-21930-99). 

10-2           Form of Employment Agreement (Exhibit 99-2 to MCN's June 30, 
               1997 Form 10-Q).

10-3           MCN Energy Group Inc. Annual Performance Plan (Exhibit 10-6 to 
               MCN's 1993 Form 10-K).

10-4           MCN Energy Group Inc. Stock Incentive Plan (Exhibit 10-1 to MCN's
               March 31, 1995 Form 10-Q).

10-5           MCN Executive Deferred Compensation Plan, as amended (Exhibit 
               10-1 to MCN's September 30, 1996 Form 10-Q).

</TABLE>

                                       45
<PAGE>   50

<TABLE>
<CAPTION>

Exhibit
  No.                                      Description
-------                                    -----------
<S>            <C>
10-6           MichCon Supplemental Death Benefit and Retirement Income Plan 
               (Exhibit 10-2 to MCN's September 30, 1996 Form 10-Q).

10-7           MichCon Supplemental Retirement Plan (Exhibit 10-3 to MCN's 
               September 30, 1996 Form 10-Q).

10-8           MCN Mandatory Deferred Compensation Plan, as amended (Exhibit
               10-11 to MCN's 1996 Form 10-K).

10-9           MCN Energy Group Inc. Supplemental Savings Plan (Exhibit 10-12 
               to MCN's 1996 Form 10-K).

12-1           Computation of Ratio of Earnings to Fixed Charges.*

23-1           Independent Auditors' Consent - Deloitte & Touche LLP.*

24-1           Powers of Attorney.*

27-1           Financial Data Schedule.*

99-1           MichCon Investment and Stock Ownership Plan, as amended (Exhibit
               99-1 to MCN's March 31, 1997 Form 10-Q).

99-2           MCN Energy Group Savings and Stock Ownership Plan, as amended 
               (Exhibit 99-22 to MCN's March 31, 1997 Form 10-Q).

</TABLE>

(B)  REPORTS ON FORM 8-K:

      None.

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

*     Indicates document filed herewith.

References are to MichCon (File No. 1-7310) for MichCon  documents  incorporated
by  reference.  References  are to MCN  (File  No.  1-10070)  for MCN  documents
incorporated by reference.

                                       46


<PAGE>   51


                                  SIGNATURES

     Pursuant  to the  requirements  of  Section  13 or 15(d) of the  Securities
Exchange Act of 1934,  the  registrant  has duly caused this Annual Report to be
signed on its behalf by the undersigned, thereunto duly authorized.

                                    MICHIGAN CONSOLIDATED GAS COMPANY
                                                 (Registrant)

                                    By:     /s/Howard L. Dow III          
                                            ---------------------------
                                               Howard L. Dow III
                                               SENIOR VICE PRESIDENT AND
                                               CHIEF FINANCIAL OFFICER
                                               FEBRUARY 27, 1998

     Pursuant to the  requirements of the Securities  Exchange Act of 1934, this
report has been signed by the following  persons on behalf of the registrant and
in the capacities and on the date indicated.
<TABLE>
<CAPTION>

                                                   Title                                                Date
                                                   -----                                                ----
<S>                                        <C>                                                <C>

                *                           Director and Chairman                                February 27, 1998
    Alfred R. Glancy III

                *                           Director, President and Chief                        February 27, 1998
     Stephen E. Ewing                       Executive Officer

     /s/Howard L. Dow III                   Director, Senior Vice President                      February 27, 1998
     --------------------                   and Chief Financial Officer
     Howard L. Dow III                      
 
                 *                          Director, Senior Vice President,                     February 27, 1998
     --------------------                   Business Development
        Carl J. Croskey

                 *                          Director                                             February 27, 1998
     --------------------
     William K. McCrackin
 
                 *                          Director                                             February 27, 1998
     --------------------
       Daniel L. Schiffer

                 *                          Director, Senior Vice President,                     February 27, 1998
     --------------------                   Process Development
       John E. vonRosen                     

</TABLE>

*By: /s/ Howard L. Dow III
     ---------------------
        Howard L. Dow III
        Attorney-in-Fact


                                       47


<PAGE>   52
                              INDEX OF EXHIBITS


EXHIBIT NO.             DESCRIPTION
-----------             -----------


3-1             Restated Articles of Incorporation of MichCon (Exhibit
                3-1 to March 31, 1993 Form 10-Q).

3-2             By-Laws of MichCon (Exhibit 3-2 to March 31, 1993 Form 10-Q).

4-1             MichCon's Indenture of Mortgage and Deed of Trust dated March
                1, 1944 (Exhibit 7-D to Registration Statement No. 2-5252);
                Twenty-ninth Supplemental Indenture, dated July 15, 1989
                (Exhibit 4-1 to July 27, 1989 Form 8-K); Thirteith Supplemental
                Indenture, dated September 1, 1991 (Exhibit 4-1 to 
                September 27, 1991 Form 8-K); Thirty-first Supplemental 
                Indenture, dated December 15, 1991 (Exhibit 4-1 to February 28,
                1992 Form 10-K); Thirty-third Supplemental Indenture, dated
                January 1, 1993 (Exhibit 4-1 to 1992 Form 10-K); Thirty-third
                Supplemental Indenture, dated May 5, 1995 (Exhibit 4-2 to
                Registration Statement No. 33-59093); and Thirty-fourth
                Supplemental Indenture, dated November 1, 1996 (Exhibit 4-2
                to Registration Statement No. 333-16285; Note - MichCon hereby
                agrees to furnish to the SEC, upon request, a copy of any
                instruments defining the rights of holders of long-term debt
                issued by MichCon.

10-1            MCN Stock Option Plan Post-Effective Amendment No. 1 (MCN
                Registration Statement No. 33-21930-99).

10-2            Form of Employment Agreement (Exhibit 99-2 to MCN's June 30, 
                1997 Form 10-Q).

10-3            MCN Energy Group Inc. Annual Performance Plan (Exhibit 10-6
                to MCN's 1993 Form 10-K).

10-4            MCN Energy Group Inc. Stock Incentive Plan (Exhibit 10-1 to
                MCN's March 31, 1995 Form 10-Q).

10-5            MCN Executive Deferred Compensation Plan, as amended (Exhibit
                10-1 to MCN's September 30, 1996 Form 10-Q).

10-6            MichCon Supplemental Death Benefit and Retirement Income Plan 
                (Exhibit 10-2 to MCN's September 30, 1996 Form 10-Q).

10-7            MichCon Supplemental Retirement Plan (Exhibit 10-3 to MCN's
                September 30, 1996 Form 10-Q).

10-8            MCN Mandatory Deferred Compensation Plan, as amended (Exhibit
                10-11 to MCN's 1996 Form 10-K).

10-9            MCN Energy Group Inc. Supplemental Savings Plan (Exhibit 10-12
                to MCN's 1996 Form 10-K).

12-1            Computation of Ratio of Earnings to Fixed Charges.*

23-1            Independent Auditors' Consent - Deloitte & Touche LLP.*

24-1            Powers of Attorney.*

27-1            Financial Data Schedule.*

99-1            MichCon Investment and Stock Ownership Plan, as amended 
                (Exhibit 99-1 to MCN's March 31, 1997 Form 10-Q).

99-2            MCN Energy Group Savings and Stock Ownership Plan, as amended
                (Exhibit 99-22 to MCN's march 31, 1997 Form 10-Q).

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

* Indicates document filed herewith.

References are to MichCon (File No. 1-7310) for MichCon documents incorporated
by reference.
References are to MCN (File No. 1-10070) for MCN documents incorporated by
refernece.