<PAGE>   1
                                 UNITED STATES
                       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, 1998 or

  [ ] Transition report pursuant to Section 13 or 15(d) of the Securities

                              Exchange Act of 1934

             For the transition period from _________ to _________

                         Commission file number 1-12426

                        AQUILA GAS PIPELINE CORPORATION
             (Exact name of registrant as specified in its charter)

          DELAWARE                                            47-0731171
(State or other jurisdiction of                            (I.R.S. Employer
 incorporation or organization)                           Identification No.)

        100 N.E. Loop 410
           Suite 1000
        San Antonio, Texas                                     78216-4754
(Address of principal executive offices)                       (Zip Code)

       Registrant's telephone number, including area code (210) 476-1100

          Securities registered pursuant to Section 12(b) of the Act:

                                                       Name of each exchange
        Title of each class                             on which registered
        -------------------                             -------------------
Common Stock, par value $.01 per share                New York Stock Exchange

        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
amendment to this Form 10-K [ ].

       The aggregate market value of the voting stock held by nonaffiliates of
the registrant is $43,476,789 based on the March 18, 1999 New York Stock
Exchange closing price of $8.0625.

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

           Class                                  Outstanding on March 18, 1999
           -----                                  -----------------------------
Common Stock, par value $.01 per share                     29,400,000

                      DOCUMENTS INCORPORATED BY REFERENCE

                                      None


<PAGE>   2

                        AQUILA GAS PIPELINE CORPORATION

                        1998 ANNUAL REPORT ON FORM 10-K

                               TABLE OF CONTENTS


<TABLE>
<CAPTION>
                          DESCRIPTION                                                                             PAGE
                          -----------                                                                             ----
<S>                        <C>                                                                                   <C>
    PART I

          Item  1.         Business.........................................................................        1
                              General Development of Business...............................................        1
                              Narrative Description of Business.............................................        2
                                Gathering and Processing....................................................        2
                                Sales and Marketing.........................................................        4
                                Competition.................................................................        5
                                Governmental Regulation.....................................................        5
                                Environmental...............................................................        6
                                Insurance and Operational Risks.............................................        7
                                Employees...................................................................        7

          Item  2.         Properties.......................................................................        7
          Item  3.         Legal Proceedings................................................................        8
          Item  4.         Submission of Matters to a Vote of Security Holders..............................        9


    PART II

          Item  5.         Market for Registrant's Common Equity and Related
                              Stockholder Matters...........................................................        9
          Item  6.         Selected Financial Data..........................................................       10
          Item  7.         Management's Discussion and Analysis of Financial Condition
                              and Results of Operations.....................................................       11
          Item 7a.         Quantitative and Qualitative Disclosures.........................................       16
          Item  8.         Financial Statements and Supplementary Data......................................       17
          Item  9.         Changes in and Disagreements With Accountants on
                              Accounting and Financial Disclosure...........................................       17


    PART III

          Item  10.        Directors and Executive Officers of the Registrant...............................       18
          Item  11.        Executive Compensation...........................................................       19
          Item  12.        Security Ownership of Certain Beneficial
                              Owners and Management.........................................................       22
          Item  13.        Certain Relationships and Related Transactions...................................       24


    PART IV

          Item  14.        Exhibits, Financial Statement Schedules,
                              and Reports on Form 8-K.......................................................       26
</TABLE>


<PAGE>   3
PART I


ITEM 1. BUSINESS

     Aquila Gas Pipeline Corporation (the Company) is engaged in the business
of purchasing, gathering, processing, transporting and marketing natural gas
and natural gas liquids (NGLs). The Company, through its direct and indirect
subsidiaries, owns and/or operates an interest in eleven active natural gas
gathering systems and four natural gas processing plants in Texas and Oklahoma.
In addition, the Company currently owns a 35% interest in Oasis Pipe Line
Company (Oasis) which owns an intrastate pipeline system that connects the
Waha, Texas hub to major marketing pipelines at the Katy, Texas hub. The
Company provides essential services to natural gas producers by connecting
producers' wells to the Company's gathering systems, compressing and treating
the natural gas, gathering the natural gas for delivery to its processing
plants, processing the gas to remove NGLs and providing access for the natural
gas and NGLs to various markets. The Company ranks as one of the leading
independent producers of NGLs in the United States. In addition, the Company
purchases, markets and arranges for delivery of natural gas outside of its
pipeline systems.

     Substantially all of the Company's revenues are attributable to sales of
natural gas and NGLs. These sales occur on the Company's facilities as well as
on third party gathering and transport lines (off-system). The Company performs
three functions that add value to the natural gas stream received at the
wellhead and enable the Company to realize a profit upon such sales. First, the
Company provides gathering, compression and treatment services prior to
delivery of the natural gas to processing facilities or transport pipelines.
Second, the Company processes natural gas at its processing facilities, thereby
separating the stream into NGLs and residue gas which can generally be sold
separately for a greater combined price than the price of natural gas from the
wellhead. Third, the Company purchases natural gas from producers in the field
and other gas marketing companies and sells natural gas to large volume
customers, of which off-system sales represent 66% of the Company's operating
revenues in 1998. The Company also transports third party natural gas for a
fee, which presently represents less than 1% of operating revenues.

     The Company's principal assets are located in major gas producing areas in
southeast Texas and western Oklahoma. The Company's Southeast Texas Pipeline
System (the SETPS) is located in the Austin Chalk trend in southeast Texas and
consists of approximately 2,338 miles of pipe with total gross gas throughput
capacity of approximately 732 million cubic feet per day (MMcf/d). The
Company's western Oklahoma pipeline systems, located in the Anadarko Basin,
consist of approximately 487 miles of pipe with total gross gas throughput
capacity of approximately 140 MMcf/d. The Company has several other gathering
systems located in east, west and south Texas totaling approximately 578 miles
of pipe with total gas throughput capacity of approximately 348 MMcf/d.

     The Company's LaGrange, Texas natural gas processing plant, which is
connected to the SETPS, is one of the largest NGLs producing facilities in the
United States with a gas throughput capacity of approximately 230 MMcf/d. The
Company also has an interest in three additional natural gas processing plants
with gas throughput capacity aggregating 268 MMcf/d.

     The Company's principal executive offices are located at One International
Centre, 100 N.E. Loop 410, Suite 1000, San Antonio, Texas, 78216.

GENERAL DEVELOPMENT OF BUSINESS

     The Company, a Delaware corporation, is a majority-owned subsidiary of
Aquila Energy Corporation (Aquila Energy), which is principally a natural gas
marketing company. Aquila Energy was formed in 1985 by UtiliCorp United Inc.
(UtiliCorp), a New York Stock Exchange energy and services company, to take
advantage of natural gas marketing and transportation opportunities created by
the deregulation of the natural gas industry. The Company was founded in 1989
under the name of Aquila Gas Systems to acquire natural gas gathering and
processing assets which would support the natural gas production and marketing
activities of Aquila Energy. In 1993, the Company sold 5.4 million shares of
common stock to the public in an initial public offering. Aquila Energy
currently owns approximately 82% of the common stock outstanding.

     Since its formation, the Company's primary objective has been to achieve
growth in cash flow and earnings by increasing the volume of gas that it
gathers, processes, transports and markets through internal project development
and acquisitions.


                                       1

<PAGE>   4

     BLUE BOX JOINT OPERATING AGREEMENT

     In 1998, the Company entered into an agreement with a third party in the
Austin Chalk trend. The primary purpose of this agreement is for the gathering
and transportation of the natural gas produced from specified wells in the
designated area. Costs and expenses will be shared jointly within this
designated area. The sales and purchase contracts associated with this
agreement are long-term and will expire upon exhaustion of the reserves. The
sales contracts accounted for approximately 2% of the Company's total natural
gas revenues in 1998.

     OASIS PIPE LINE COMPANY

     In July and November 1996, the Company acquired 15% and 25%, respectively,
of the outstanding capital stock of Oasis and related transportation rights
from Dow Hydrocarbons and Resources Inc. (DHRI) for a cost of $133.6 million
including liabilities assumed. The Company can deliver and receive natural gas
at various points along the Oasis Pipeline. The Oasis Pipeline system consists
of an approximately 600-mile pipeline system and related mainline compression
which connects the Waha, Texas hub located in the Permian Basin producing area
of West Texas to major marketing pipelines at the Katy, Texas hub near Houston,
Texas. Oasis has a nominal one (1) billion cubic feet per day (Bcf/d) of
throughput capacity to move gas between West Texas and the Katy, Texas hub. The
Oasis Pipeline is in proximity to many of the Company's existing gathering
systems.

     On April 1, 1997, the Company received $16.8 million from El Paso Natural
Gas Company (El Paso) for its exercise of an option to acquire 5% of all the
capital stock of Oasis and the related transportation rights. The Company,
after the exercise of the option, owns 35% of the capital stock of Oasis and
has 280 MMcf/d of intrastate transportation capacity.

     In 1998, Oasis restructured its commercial operations and amended its
owner transportation agreements to permit the release of firm owner capacity to
third parties and to eliminate demand charges on this capacity. Prior to this
restructuring, the owner transportation agreements permitted the Company to
conduct additional off-system marketing activities not otherwise available to
the Company. This benefit was realized by the Company in off-system marketing
gross margin. Under the restructured agreements, Oasis expects to realize
higher transportation revenues, which will benefit the equity in earnings
recognized by the Company.

NARRATIVE DESCRIPTION OF BUSINESS

     The Company's primary source of revenues has historically been sales of
natural gas. Set out below are the types of sales for the last three years
(dollars in thousands):

<TABLE>
<CAPTION>
                                                       YEAR ENDED DECEMBER 31,
                           --------------------------------------------------------------------------------
                              1998           %            1997            %           1996            %
                           ----------    ----------    ----------    ----------    ----------    ----------
<S>                        <C>           <C>           <C>           <C>           <C>           <C>
         Natural Gas       $  854,820            96    $  926,403            91    $  706,023            88
         NGLs                  38,362             4        87,516             9        93,255            12
                           ----------    ==========    ----------    ==========    ----------    ----------

                           $  893,182           100    $1,013,919           100    $  799,278           100
                           ==========    ==========    ==========    ==========    ==========    ==========
</TABLE>

GATHERING AND PROCESSING

     The Company's gas gathering and processing activities include locating and
contracting to purchase natural gas supplies, operating and maintaining systems
of gathering pipelines that connect these gas supplies to transport lines and
natural gas processing plants, and operating and maintaining processing plants
linked to its gathering systems.

     PURCHASING

     The natural gas supplied to the Company's gathering systems is generally
purchased under individually negotiated long-term contracts. The Company
purchases substantially all of its gas supplies pursuant to contracts that
require producers to commit or dedicate all gas produced from designated
properties. The contracts vary, however, based upon pricing provisions and
whether the contract includes gas processing provisions.

     Generally, the contract price may be a specified percentage of the
Company's resale price or other reference price (percentage-of-proceeds
contract) or may be a fixed price per million British thermal units (MMBtu)
that does not vary with the resale price obtained by the Company (fixed price
contract). Most new contracts are percentage-of-proceeds contracts.


                                       2

<PAGE>   5

     Under percentage-of-proceeds contracts, the producer shares the risk of
price fluctuations. Contracts under which the Company purchases a majority of
its gas include provisions that permit the Company to reduce the purchase price
paid for gas based on market conditions.

     The Company's gas purchase contracts may be further classified as either
processing contracts or wellhead purchase contracts. Generally, the Company
seeks contracts which have processing provisions in those areas where the
Company operates gas processing plants. Under processing contracts, the Company
agrees to gather and process raw gas from the wells on behalf of the producers
and to allocate the NGLs recovered and the residue gas to each well connected
to its gathering system. The Company retains a percentage of the value of the
NGLs and residue gas extracted and delivered to customers. The producer bears
most of the cost of NGLs extracted in return for a share of NGLs revenue. The
Company also pays either a fixed price or the applicable percentage-of-proceeds
upon sale of residue gas, depending on the form of the contract.

     Under a wellhead purchase contract the Company pays for gas measured at
the wellhead generally at market related prices. The Company then gathers and
delivers the gas to transmission lines for resale at a higher price or
processes the gas for its own account at its processing facilities and derives
a gross margin equal to the difference between sales proceeds of both the NGLs
and the residue gas and the cost of the natural gas purchased at the wellhead.

     In addition to revenue from the sale of NGLs and natural gas, the Company
customarily receives additional fees for compression and treatment services if
a producer's gas does not meet contract specifications.

     Certain of the Company's purchase contracts have take-or-pay or minimum
take provisions. Historically, such contracts have not had any material adverse
effect on the Company because the Company has requested and taken all required
natural gas and the contract price has not prevented such natural gas from
being marketed. As a result, the Company believes that its contracts with
take-or-pay or minimum take provisions will not have a material adverse effect
on the Company.

     SUPPLY

     The performance of the Company depends upon its ability to contract for
additional gas supply. The SETPS has, generally, experienced increased gas
throughput since mid-1990 primarily as the result of the application of
horizontal drilling technology in the Giddings Field of the Austin Chalk trend.
The Company believes this new technology has significantly increased the
economically recoverable reserves within the Austin Chalk trend and the number
of possible drilling locations that could provide natural gas supplies to the
Company. Certain exploitation possibilities may also exist for additional
production within the Austin Chalk trend from existing or new well bores in the
areas that were previously developed using vertical well bores. In addition,
exploration and development opportunities may exist for recompletion of
existing vertical and horizontal wells or drilling new wells into the Taylor,
Wilcox, Buda, Georgetown and Edwards formations, each of which has been proven
to be productive in certain areas served by the SETPS.

     The Company expects to be able to continue to add well connections to the
SETPS and to maintain or increase the SETPS throughput in the foreseeable
future. The number of new wells being drilled and, therefore, the opportunities
for the Company to connect new wells to its system will be dependent upon,
among other things, the prices of crude oil and natural gas.

     PROCESSING

     The Company is one of the largest independent producers of NGLs in the
United States. The Company owns and/or operates an interest in four natural gas
processing plants, each of which is associated with a pipeline gathering system
of the Company. Additionally, the Company has access to process significant
volumes of natural gas at a third party plant described below. The processing
plants complement the Company's gathering operations by enabling the Company to
offer directly to producers the option of wellhead purchase or processing
contracts. The sale of NGLs contributes materially to the overall earnings of
the Company because of the added value from NGLs extraction. In addition, gas
processing supplements and diversifies the earnings derived from natural gas
sales.

     The Company's gas processing plants are modern plants with efficient
liquid recovery processes. The plants generally operate at high production
levels which the Company believes result in low operating costs per barrel
produced. Plant locations provide access to nearby markets for the sale of
NGLs, thus reducing transportation costs. The Company believes its processing
plants provide it with a significant competitive advantage in the acquisition
of gas supplies. Most of the Company's gas volume processing capacity has
ethane rejection capability, which allows the Company to optimize margins
during periods when NGLs prices decline significantly relative to gas prices.


                                       3
<PAGE>   6

     The Company has a long-term contract to process natural gas at Exxon
Company, U.S.A.'s (Exxon) natural gas processing plant at Katy, Texas.
Deliveries of gas to the plant began in 1995 upon the completion of the Katy
Pipeline. This long-term contract allows the Company to process up to 275
MMcf/d at the Exxon plant. In 1998, due to the depressed NGLs prices, the
Company elected to bypass the Exxon natural gas processing plant and receive
payment in British thermal unit (Btu) value.

SALES AND MARKETING

     Substantially all of the Company's revenue is derived from sales of
natural gas and NGLs. In addition to such revenue, the Company customarily
receives additional fees for compression and treatment services if a producer's
gas does not meet contract specifications, as well as transportation
arrangements whereby the Company transports third party natural gas for a fee.

     NATURAL GAS

     The Company sells natural gas to numerous utility, industrial and pipeline
customers on a day-to-day, month-to-month or longer time period. The majority
of the sales of natural gas are based on applicable spot market prices for the
month in which the gas is sold.

     The Company and DHRI entered into a long-term gas supply agreement which
expires in 2006 whereby the Company will supply DHRI with 100 MMcf/d of gas in
the Katy, Texas area at prevailing market rates. Natural gas sales to DHRI in
1998 accounted for approximately 9% of the Company's total natural gas
revenues.

     The Company has multiple delivery connections at the tailgate of most of
its gas gathering systems, which it believes allow it to negotiate favorable
spot sales contracts while being able to avoid curtailments of gas deliveries.
With the SETPS, Katy Pipeline and Oasis Pipeline, the Company is connected to
all major intrastate systems via its gathering systems and at Katy, Texas which
is one of the largest natural gas hubs in the state. The Company also has
access to several key interstate pipelines. Due to the flexibility derived from
multiple delivery points, the Company believes that the loss of any one of its
customers would not have a material adverse effect on the Company.

     The Company has significant sales and purchases of natural gas outside its
own gathering and transport lines. These off-system marketing activities grew
substantially in 1998 achieving over 1 Bcf of natural gas moved in the state of
Texas. These activities contributed $590.0 million of operating revenues and
gross margin of $7.6 million to the Company in 1998, and also assisted the
Company in avoiding the curtailment of gas deliveries from its gathering
systems and avoiding the curtailment of firm markets during periods of
production fluctuations on the systems. In addition, such activities provide
the Company with access to new markets and suppliers from which valuable market
information is obtained regarding possible new gathering systems and
acquisition opportunities.

     Effective January 1, 1999, the Company entered into an agreement with
Aquila Energy Marketing (AEM), a wholly-owned subsidiary of Aquila Energy, to
conduct its natural gas marketing activities. Under the agreement, AEM will
conduct all natural gas marketing activities on behalf of the Company. The
Company will receive all gross margins associated with such marketing
activities and will reimburse to AEM all direct costs associated with
performing these services. All previous employees of the Company in this
natural gas marketing capacity have been employed by AEM.

     The Company, as part of its acquisition of the capital stock of Oasis,
acquired transportation rights on the Oasis Pipeline which amount to 280 MMcf/d
of intrastate transportation between the Waha, Texas hub and Katy, Texas hub,
plus the opportunity to utilize excess capacity on an interruptible basis. The
Company can deliver and receive gas at various points along the Oasis Pipeline.

     In 1998, Oasis restructured its commercial operations and amended its
owner transportation agreements to permit the release of firm owner capacity to
third parties and to eliminate demand charges on this capacity. Prior to the
restructuring, the owner transportation agreements permitted the Company to
conduct additional off-system marketing activities not otherwise available to
the Company. This benefit was realized by the Company in off-system marketing
gross margin. Under the restructured agreements, Oasis expects to realize
higher transportation revenues, which will benefit the equity in earnings
recognized by the Company.

     Natural gas is sold primarily for electric power generation and for
end-use as a heating fuel for homes and industry. A majority of the Company's
natural gas sales occur in the Texas intrastate market. Volumes of natural gas
sold are not typically seasonal; however, natural gas sales prices have
historically been higher in the winter months.


                                       4
<PAGE>   7
     The Company generally attempts to match its gas purchases and sales
transactions. However, when appropriate, the Company uses financial instruments
such as futures and options to hedge the risk associated with fluctuating
natural gas prices. See Note 1 and Note 9 of Notes to Consolidated Financial
Statements.

     NGLS MARKETING

     The Company sells NGLs to various petrochemical firms, refiners, and
marketers. A long-term sales agreement with Phillips Chemical Company provides
for the sale of approximately 41% and 30% of the Company's 1998 and 1997 gross
NGLs production, respectively. The balance of the NGLs production is sold to
various parties under short-term contracts generally at a spot index based
price.

     Prices for certain NGLs closely follow crude oil related products. Gas
processing increases the value of throughput when natural gas prices are low in
relation to NGLs prices. The sale of NGLs contributes materially to the overall
profitability of the Company and reduces its dependence on natural gas sales
and related margins.

     In 1998, the Company discontinued the use of financial instruments
including swaps and forward contracts to hedge the risk associated with
volatile NGLs prices due to the decline in the price of NGLs as well as other
hydrocarbon liquid prices. See Note 1 and Note 9 of Notes to Consolidated
Financial Statements.

     NGLs are typically used as petrochemical feedstocks, petroleum refinery
blendstocks or fuel. Petrochemical plants use ethane, propane, normal butane,
and natural gasoline as feedstocks in the production of ethylene, which has
widespread applications in the production of plastics and plastic products,
building materials, automobile antifreeze and other products. Refineries
enhance the vapor pressure of gasoline in order to improve cold weather
starting of automobile motors with normal butane and iso-butane as a motor fuel
additive after further processing. Propane is used as fuel for home heating and
cooking, industrial heaters and boilers, vehicles, and agricultural
applications.

     Global demand for NGLs suffered in 1998 due to the mild weather in the
United States and declining global economies, particularly in the Pacific Rim.
Normal seasonal weather patterns in the United States and Europe in 1999, and
the stabilization of Asian economies, could potentially increase NGLs demand.
Domestic NGLs production is sensitive to the price relationship of the
commodity values and the value of the gas from which it is extracted. This
price relationship defines the upper limits of domestic NGLs production. The
United States consumes NGLs in excess of domestic production and this shortfall
is filled with Canadian and waterborne imports. Domestic production
curtailments only increase the dependency on foreign supplies. Global NGLs
surpluses from time to time impact the value of domestic NGLs.

COMPETITION

     The Company operates in a highly competitive environment. The Company
competes in the gathering, processing, marketing and transport business for
supplies of natural gas. Many of the Company's competitors have greater
financial and other resources than the Company. Competition for gas supplies is
primarily based on price, service and the availability of facilities. The
Company believes that its competitive advantages include (i) management
expertise in gas purchasing and marketing, (ii) its ability to connect wells
promptly and efficiently operate pipelines, (iii) its ability to ensure
reliable gas deliveries, and (iv) favorable supplier and market relationships.

     There is intense competition in the marketing of natural gas and NGLs. The
Company has numerous competitors, including marketing affiliates of intrastate
and interstate pipelines, the major integrated oil companies and intrastate and
interstate pipelines and other gas gatherers, gas processors and marketers of
widely varying sizes, financial resources, experience and supplies of gas.
Distributors of gas (some of whom are customers of the Company) are, in some
cases, engaged directly and through affiliates, in marketing activities that
compete with those of the Company.

GOVERNMENTAL REGULATION

     Currently, federal, state and local regulations do not materially affect
the purchase and sale of gas and the fees received for gathering and processing
by the Company. Therefore, except as constrained by competitive factors and
contracts, the Company has considerable pricing flexibility. However, federal,
state and local laws and regulations, directly or indirectly, govern some
aspects of the operations of the Company. These laws and regulations may in the
future have a significant impact upon the Company's overall operations.


                                       5
<PAGE>   8

     Certain activities of the Company are subject to regulation by the
Railroad Commission of Texas (RRC) pursuant to its jurisdiction over common
purchasers and natural gas utilities. Certain subsidiaries of the Company are
subject to the common purchaser statutes and regulations and the regulations as
an intrastate gas utility.

     The RRC has authority to regulate the volumes of natural gas purchased by
common purchasers and the rates charged for the intrastate transportation and
sale to natural gas utilities in Texas. Under the Gas Utility Regulatory Act
and other Texas statutes, the RRC has the duty to ensure that rates for the
transportation and sale of natural gas are just and reasonable and that gas
utilities are prohibited from charging rates that are unreasonably
preferential, prejudicial or discriminatory. The Company believes that its RRC
jurisdictional activities and tariffs are in compliance with applicable laws
and regulations.

     The Company's Oklahoma operations are subject to regulation by the State
of Oklahoma. The majority of these regulations are administered by the Oklahoma
Corporation Commission (OCC). Any entity engaged in the business of carrying or
transporting natural gas by pipeline is declared to be a common carrier under
Oklahoma law and is prohibited from any unjust or unlawful discrimination in
the carriage, transportation or delivery of gas. Although Oklahoma law may be
sufficiently broad to permit the OCC to set rates and terms of service for the
transportation and delivery of natural gas involving the Company's Oklahoma
assets, the OCC has not done so to date. There can be no assurance that the OCC
will not do so in the future. Recent Oklahoma legislation prohibits entities
which engage in gathering gas from charging any fee which is unjustly or
unlawfully discriminatory. The Company does not expect this legislation to have
any significant impact on the Company's operations.

     An entity carrying or transporting natural gas by pipeline which is
engaged in the business of purchasing natural gas is declared to be a common
purchaser under Oklahoma law and is required to purchase, without
discrimination in favor of persons or price, all natural gas in the vicinity of
its lines. Ratable purchase is required if a purchaser is unable to purchase
all gas offered. To date, such legislation has not had any significant effect
on the Company's Oklahoma operations.

     The OCC regulates the amount of gas which producers can sell or deliver to
the Company. Currently, substantially all gas received by the Company in its
Oklahoma operations is produced from wells for which the OCC establishes
allowable production rates at quarterly hearings based upon the OCC's
determination of the market demand.

     All of the Company's pipeline operations are subject to federal safety
standards promulgated by the Department of Transportation under applicable
federal pipeline safety legislation, as supplemented by various state safety
statutes and regulations.

ENVIRONMENTAL

     The Company's operations are subject to numerous laws and regulations
relating to the protection of the environment or the discharge of materials
into the environment which are administered by federal and state regulatory
agencies, including the Federal Environmental Protection Agency (EPA), the
Texas Natural Resources Conservation Commission and the Oklahoma Department of
Environmental Quality. Currently, there are no existing or pending actions,
suits or proceedings relating to any environmental laws or regulations and all
material notices, permits and similar authorizations required to be obtained or
filed to operate the business have been duly obtained or filed.

     The Company believes that it is in substantial compliance with
environmental laws and regulations and that such laws and regulations do not
pose a burden on the operations of the Company dissimilar to that placed on its
competitors. Such laws and regulations could impose significant liability on
the Company for damages, cleanup costs and penalties in the event of certain
discharges into the environment. In addition, product sales and markets may be
affected by such laws and regulations. Such laws and regulations have generally
become more stringent in recent years, often imposing greater liability on a
larger number of parties. Because the requirements imposed by such laws and
regulations frequently change, the Company is unable to predict the ultimate
costs of compliance with such requirements or whether the incurrence of such
costs would have a material adverse effect on the operations of the Company.


                                       6
<PAGE>   9

INSURANCE AND OPERATIONAL RISKS

     The Company is subject to various hazards which are inherent in the
industry in which it operates such as explosions, product spills, leaks and
fires, each of which could cause personal injury and loss of life, severe
damage to and destruction of property and equipment, and pollution or other
environmental damage, and may result in curtailment or suspension of operations
at the affected facility. The Company maintains physical damage, comprehensive
general liability, workers' compensation and business interruption insurance.
Such insurance is subject to deductibles that the Company considers reasonable.
The Company is not fully insured against all risks in its business; however,
the Company believes that the coverage it maintains is adequate and consistent
with other companies in the industry. Consistent with insurance coverage
typically available to the natural gas industry, the Company's insurance
policies do not provide coverage for losses or liabilities relating to
pollution, except for sudden and accidental occurrences.

EMPLOYEES

     At December 31, 1998, the Company had 287 employees. None of the Company's
employees is a party to a collective bargaining agreement.

ITEM 2. PROPERTIES

     The Company's operations are conducted from its San Antonio, Texas
headquarters, and several smaller administrative operations offices. The
Company leases its headquarters in San Antonio, Texas, a marketing office in
Dallas, Texas and a field office in Fort Stockton, Texas and owns field offices
in Giddings, Texas, LaGrange, Texas, College Station, Texas, Somerville, Texas,
Navasota, Texas, Elk City, Oklahoma and Woodward, Oklahoma.

     At December 31, 1998, the Company owned and/or operated an interest in
eleven active natural gas pipeline systems. Set forth below is information with
respect to the Company's gathering systems at and for the year ended December
31, 1998:

<TABLE>
<CAPTION>
                                                                                            NET
                                                                       GROSS GAS        AVERAGE GAS
                                                                      THROUGHPUT        THROUGHPUT
                                                        MILES OF     CAPACITY (a)(b)    (a) (b) (c)
    GATHERING SYSTEM            LOCATION              PIPELINE (a)      (MMcf/d)         (MMcf/d)
    -------------------------   --------------------  ------------    ------------     ------------
<S>                             <C>                   <C>            <C>               <C>
    SETPS/Katy                  Southeast Texas              2,338             732              381
    Mentone                     West Texas                      13              60               --
    Gomez                       West Texas                      11              40               --
    Menard County               Central Texas                  120              30                2
    Maverick County             West Texas                     121              20                2
    Rhoda Walker                West Texas                      21              20                2
    Panola County               East Texas                      23               8                1
    Elk City                    Southwest Oklahoma             163             100               69
    Mooreland                   Northwest Oklahoma             324              40               11
    Brooks-Hidalgo - 23% (d)    South Texas                     --              --                1
    Dorado - 40%                South Texas                     58              40                9
    Benedum/Wilshire - 20%      West Texas                     211             130               14
                                                      ------------    ------------     ------------
                                                             3,403           1,220              492
    Fuel and Shrinkage                                          --              --              (17)
                                                      ============    ============     ============
            Total Systems                                    3,403           1,220              475
                                                      ============    ============     ============
</TABLE>

     ---------
      (a)  All mileage, capacity and volume information is approximate.
           Capacity figures are management's estimates based on existing
           facilities without regard to the present availability of natural
           gas.
      (b)  Gross gas throughput capacity is included at 100% while net average
           gas throughput is presented at the Company's present joint venture
           ownership interest.
      (c)  Excludes off-system marketing sales with average daily volumes of
           795 MMcf/d sold from other companies' facilities.
      (d)  In March 1998, Brooks-Hidalgo Joint Venture's ownership interests in
           its assets were sold.


     The Company also owns 35% of the capital stock of Oasis and the right to
transport 280 MMcf/d of natural gas on the Oasis Pipeline, plus the opportunity
to utilize excess capacity on an interruptible basis.


                                       7
<PAGE>   10

     At December 31, 1998, the Company owned and/or operated an interest in
four natural gas processing plants. Set forth below is information with respect
to the Company's processing plants at and for the year ended December 31, 1998:

<TABLE>
<CAPTION>
                                  GAS             GAS            NGLS
                              THROUGHPUT      THROUGHPUT      PRODUCTION
                              CAPACITY (a)      (a) (b)       (a) (b) (c)
PLANT                          (MMcf/d)        (MMcf/d)        (MBbls/d)
---------------------        ------------    ------------    ------------

<S>                          <C>             <C>            <C> 
LaGrange, Texas                       230             165            20.2
Somerville, Texas                      28              19              .5
Elk City, Oklahoma                    115              69             3.5
Benedum, Texas - 20%                  125              14              .9
                             ------------    ------------    ------------
  Total owned plants                  498             267            25.1
                             ============
Katy, Texas (d)(e)                                    173              --
                                             ------------    ------------
      Total                                           440            25.1
                                             ============    ============
</TABLE>
     ----------
     (a)   All capacity and volume information is approximate. Capacity figures
           are management's estimates based on existing facilities without
           regard to the present availability of natural gas.
     (b)   Volumes from joint ventures have been included at the Company's
           present ownership interest. 
     (c)   Thousands of barrels per day (MBbls/d).
     (d)   This plant is owned and operated by a third party from which the
           Company receives a portion of the NGLs produced from gas the Company
           delivers to the plant. This plant is included in this section for
           informational purposes to show the gas throughput and NGLs
           production the Company received utilizing the access to this plant.
     (e)   In 1998, the Company elected to bypass the Katy, Texas plant and
           receive payment in Btu value due to the depressed NGLs commodity
           prices.

ITEM 3. LEGAL PROCEEDINGS

     On February 26, 1999, Harmony Exploration, Inc. (Harmony) sought to amend
a complaint it had previously filed against the Company. Harmony had filed an
action for breach of contract and discrimination by a common carrier against
the Company in Bexar County, Texas. Harmony is a producer of several wells in
Burleson County, Texas, with whom the Company had contracts to purchase
casinghead gas. Harmony claims that the Company paid them an inadequate price
under the contracts, improperly charged compression and processing fees with
respect to gas produced from Harmony's wells, improperly failed to hook up
several of Harmony's wells to the Company's gathering system, and improperly
failed to process 100% of the gas from some of Harmony's wells. Harmony seeks
actual damages of an unspecified amount plus attorneys' fees. Harmony sought to
amend its complaint to obtain certification of the case as a class action, and
to include as class members forty (40) or more producers in Burleson County who
allegedly entered into similar contracts with the Company. The Company is
vigorously defending the claim by Harmony, and believes it has meritorious
defenses to the claim. The Company intends to vigorously oppose the efforts to
obtain certification of a class action in the case.

     On November 12, 1998, four shareholders of the Company filed separate but
identical suits in the Court of Chancery in Wilmington, Delaware against the
Company, UtiliCorp and the members of the Company's Board of Directors. The
suits were filed following UtiliCorp's announcement that it was proposing to
offer $8.00 per share to purchase the 18% of the Company's common stock held by
the public. UtiliCorp, through Aquila Energy, owns approximately 82% of the
Company's outstanding shares. Plaintiffs allege that the amount which UtiliCorp
proposes to offer is inadequate and thus unfair to the minority public
shareholders of the Company. The suit seeks to enjoin any tender offer and ask
for unspecified monetary damages. The filing of a response by the Company to
the complaints filed in the four suits has been delayed indefinitely by the
agreement of the parties pending the outcome of negotiations between UtiliCorp
and an independent committee of the Company's Board of Directors concerning the
offer made by UtiliCorp for the minority shares.

     The Internal Revenue Service (IRS) has examined and proposed adjustments
to UtiliCorp's consolidated federal income tax returns for 1988 through 1993.
The proposed adjustment affecting the Company is to lengthen the depreciable
life of certain pipeline assets owned by the Company. The Company has filed a
petition in U.S. Tax Court contesting the IRS proposed adjustments for the
years 1990 through 1991. The IRS has also proposed an adjustment on the same
issue for 1992 and 1993. The Company has tentatively agreed with the IRS to
hold this issue in abeyance pending the outcome of the earlier petition. The
Company intends to vigorously contest the proposed adjustment and believes it
is reasonably possible they will prevail. It is expected that additional
assessments for the years 1994 through the present would be made on the same
issue. Under the provisions



                                       8
<PAGE>   11
of the tax sharing agreement with Aquila Energy and UtiliCorp, the Company
would be liable to UtiliCorp for additional taxes of approximately $12.6
million for the audit period and through the present plus potential interest of
approximately $3.3 million. The additional taxes would result in an adjustment
to the deferred tax liability with no effect on net income, while any payment
of interest would affect net income. The Company expects that the ultimate
resolution of this matter will not have a material adverse effect on its
financial position.

     The Company is also a party to additional claims and is involved in
various other litigation and administrative proceedings arising in the normal
course of business. The Company believes it is unlikely that the final outcome
of any of the claims, litigation or proceedings, including those discussed
above, to which the Company is a party would have a material adverse effect on
the Company's financial position or results of operations. However, due to the
inherent uncertainty of litigation, there can be no assurance that the
resolution of any particular claim or proceeding would not have an adverse
effect on the Company's results of operations for the fiscal period in which
such resolution occurred.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     There were no matters submitted to a vote of security holders in the
fourth quarter of 1998.

                                    PART II


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

     The common stock of the Company is listed on the New York Stock Exchange
(NYSE) under the symbol AQP. Set forth below is the high and low sales prices
of the common stock for 1997 and 1998:

<TABLE>
<CAPTION>
                                                         PRICE RANGE PER SHARE              
                                                     -------------------------------         DIVIDENDS
                                                        HIGH               LOW            PAID PER SHARE
                                                     ------------      -------------    -------------------
<S>                                                   <C>                <C>            <C>    
      1997:
           First Quarter......................        $ 15 5/8           $ 12 1/2            $ .0125
           Second Quarter.....................        $ 15 1/4           $ 13 1/4            $ .0125
           Third Quarter......................        $ 14               $  9 5/8            $ .0125
           Fourth Quarter.....................        $ 14 5/16          $ 12 7/16           $ .0125

      1998:
           First Quarter......................        $ 16 3/8           $ 10                $ .0125
           Second Quarter.....................        $ 19               $ 11 15/16          $ .0125
           Third Quarter......................        $ 12 9/16          $  6                $ .0125
           Fourth Quarter.....................        $  8 11/16         $  4 5/8            $ .0125
</TABLE>


     On March 18, 1999, the last reported sales price for the common stock, as
reported on the NYSE Composite Tape, was $8.0625 per share and the Company had
99 stockholders of record and approximately 1,300 beneficial owners.

     On February 1, 1999 the Board of Directors of the Company declared the
quarterly common stock dividend payable on March 12, 1999 to shareholders of
record on February 26, 1999. The majority of the Company's earnings are
generated by Aquila Southwest Energy Corporation (Aquila Southwest), a
wholly-owned subsidiary. The amount available for the payment of dividends to
the Company by Aquila Southwest under the financial covenants contained in the
indenture governing the 8.29% Senior Notes due 2002 (8.29% Senior Notes) was
approximately $69.8 million as of December 31, 1998. These covenants provide
that no dividends may be paid by Aquila Southwest unless (i) there are no
existing defaults under the indenture, (ii) Aquila Southwest's ratio of
consolidated debt to consolidated capitalization does not exceed .55 to 1.0
through December 31, 1995 and thereafter, (iii) the pro forma fixed charges
coverage ratio is not less than 1.5 to 1.0, and (iv) the aggregate dividend
payment does not exceed the sum of (a) 50% of consolidated net income from July
1, 1992 through December 31, 1995, plus (b) increasing percentages of net
income subsequent to December 31, 1995, plus (c) the net cash proceeds from the
sale of Aquila Southwest stock after June 30, 1992, plus (d) the net cash
proceeds from the conversion of any convertible debt securities. Accordingly,
there can be no assurance that dividends will be paid by the Company in the
future.


                                       9
<PAGE>   12

ITEM 6. SELECTED FINANCIAL DATA

     The following table sets forth selected consolidated financial and
operating data of the Company. The selected consolidated financial data for
each of the five years in the period ended December 31, 1998, was derived from
the audited consolidated financial statements of the Company. The financial
data set forth below should be read in conjunction with the Consolidated
Financial Statements and the Notes thereto and Management's Discussion and
Analysis of Financial Condition and Results of Operations:


                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES
          (Dollars in Thousands, Except Per Share and Operating Data)

<TABLE>
<CAPTION>
                                                                            YEAR ENDED DECEMBER 31,
                                                    ------------------------------------------------------------------
INCOME STATEMENT DATA:                                 1998          1997        1996(a)      1995(b)(c)       1994
                                                    ----------    ----------    ----------    ----------    ----------
<S>                                                 <C>           <C>           <C>           <C>           <C>       
  Operating revenues                                $  893,182    $1,013,919    $  799,278    $  485,828    $  328,687
  Costs and expenses                                $  876,586    $  958,387    $  730,952    $  459,063    $  294,836
  Income from operations                            $   16,596    $   55,532    $   68,326    $   26,765    $   33,851
  Net income                                        $    4,869    $   25,166    $   32,453    $    9,065    $   15,259
  Basic and diluted earnings per share              $      .17    $      .86    $     1.10    $      .31    $      .52
  Cash dividends per share                          $      .05    $      .05    $      .05    $      .05    $      .05

CASH FLOW DATA:
  Business acquisitions                             $       --    $       --    $  133,138    $   16,278    $      735
  Capital expenditures                              $   22,643    $   28,486    $   27,496    $   76,164    $   32,579

  BALANCE SHEET DATA:
  Net pipeline, property, plant and equipment       $  399,596    $  402,191    $  396,701    $  389,996    $  334,520
  Total assets                                      $  635,420    $  646,333    $  728,482    $  506,638    $  402,042
  Long-term obligations and current maturities
     of long-term debt                              $  209,950    $  236,595    $  290,742    $  193,287    $  136,800
  Stockholders' equity                              $  226,755    $  223,355    $  199,658    $  168,673    $  161,078

  OPERATING DATA:
  Total natural gas throughput (MMcf/d)                    475           483           493           506           371
  Total natural gas marketed off-system (MMcf/d)           795           687           482           360           129
  Gross NGLs production (MBbls/d)                           25            37            41            32            31
  Average natural gas price ($/Mcf)                 $     2.03    $     2.46    $     2.33    $     1.56    $     1.87
  Average NGLs price ($/gallon)                     $      .25    $      .34    $      .35    $      .28    $      .28
</TABLE>


   (a) The amounts for the investment in Oasis and the Oasis marketing
       activities have been included since July 1, 1996. These per day volumes
       are being averaged over the entire year. Volumes included are only those
       volumes marketed by the Company.
   (b) The fourth quarter of 1995 includes a pretax provision for asset
       impairments of $13,163. 
   (c) Includes the acquisition of Tristar Gas Company in January 1995 and 
       completion of the construction of the Katy Pipeline and Southern
       Extension in late 1995.


                                      10
<PAGE>   13

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

RECENT DEVELOPMENTS

      On March 2, 1999, the Company announced the implementation of a plan to
restructure its operations. This plan includes a reduction of approximately 60
employees affecting personnel in both the San Antonio corporate office as well
as in the various field locations. The Company will take a pretax charge of
approximately $1.7 million against first quarter 1999 operating results to
cover the costs of the plan. It is anticipated that the Company will save
approximately $4.0 to $5.0 million pretax annually. These savings would result
primarily from reduced employee costs with additional savings expected to be
realized from streamlining operations and business processes.

      On November 11, 1998, the Company received a proposal from UtiliCorp to
purchase the 18% of outstanding common shares of the Company which UtiliCorp,
through Aquila Energy, does not already own, for $8.00 per share. An
independent committee, consisting of the outside directors of the Company, is
handling all negotiations with UtiliCorp concerning any agreement for the
proposed buyback of shares, including the form of consideration to be paid.

      The following discussion and analysis relates to the consolidated
financial position and results of operations of the Company for the three years
ended December 31, 1998. Reference should be made to the Consolidated Financial
Statements and the Notes thereto:

<TABLE>
<CAPTION>
                                                                                       PERIOD 1997               PERIOD 1996
                                                  YEAR ENDED DECEMBER 31,             TO 1998 CHANGE            TO 1997 CHANGE
                                           -----------------------------------    ----------------------   -----------------------
                                              1998         1997       1996(a)       AMOUNT      PERCENT      AMOUNT       PERCENT
                                           ----------   ----------   ---------    ----------   ---------   ----------    ---------
                                                                       (dollars in thousands, except price data)
<S>                                        <C>          <C>         <C>           <C>           <C>        <C>           <C> 
FINANCIAL DATA:
Natural gas revenues                       $  854,820   $  926,403  $  706,023    $  (71,583)      (8)%    $  220,380      31 %
NGLs revenues                                  38,362       87,516      93,255       (49,154)     (56)%        (5,739)     (6)%
                                           ----------   ----------   ---------    ----------               ----------

Total operating revenues                      893,182    1,013,919     799,278      (120,737)     (12)%       214,641      27 %
                                           ----------   ----------   ---------    ----------               ----------

Cost of sales                                 812,551      894,591     664,096       (82,040)      (9)%       230,495      35 %
                                           ----------   ----------   ---------    ----------               ----------

   Gross margin                                80,631      119,328     135,182       (38,697)     (32)%       (15,854)    (12)%

Operating expenses                             21,268       22,597      23,637        (1,329)      (6)%        (1,040)     (4)%
General and administrative expenses            16,350       15,611      19,485           739        5 %        (3,874)    (20)%
Depreciation and amortization                  26,417       25,588      23,734           829        3 %         1,854       8 %
Interest and debt expenses, net                14,125       17,237      15,678        (3,112)     (18)%         1,559      10 %
Other income and (expense), net                   135          931        (211)         (796)     (85)%         1,142     541 %
Equity in net income of affiliate               1,105          903         105           202       22 %           798     760 %
(Benefit) provision in lieu of income tax      (1,158)      14,963      20,089       (16,121)    (108)%        (5,126)    (26)%
expense
                                           ----------   ----------   ---------    ----------               ----------
  Net income                               $    4,869   $   25,166   $  32,453    $  (20,297)     (81)%    $   (7,287)    (22)%
                                           ==========   ==========   =========    ==========               ==========

OPERATING DATA:
Natural gas (MMcf/d):
  Throughput sold                                 355          340         343            15        4 %            (3)     (1)%
  Throughput transported                          120          143         150           (23)     (16)%            (7)     (5)%
                                           ----------   ----------   ---------    ----------               ----------
     Total throughput                             475          483         493            (8)      (2)%           (10)     (2)%
                                           ----------   ----------   ---------    ----------               ----------
  Marketed off-system, excluding Oasis            630          497         381           133       27%            116      30 %
  Marketed off-system, Oasis                      165          190         101           (25)     (13)%            89      88 %
                                           ----------   ----------   ---------    ----------               ----------
     Total marketed off-system                    795          687         482           108       16 %           205      43 %
                                           ----------   ----------   ---------    ----------               ----------
      Total throughput and marketed             1,270        1,170         975           100        9 %           195      20 %
      off-system
                                           ==========   ==========   =========    ==========               ==========

Gross NGLs production (MBbls/d)                    25           37          41           (12)     (32)%            (4)    (10)%
Average natural gas price ($/Mcf)          $     2.03   $     2.46   $    2.33    $     (.43)     (17)%    $      .13       6 %
Average NGLs price ($/gallon)              $      .25   $      .34   $     .35    $     (.09)     (26)%    $     (.01)     (3)%
</TABLE>
---------------------------------

(a)  In 1996, the amounts for the investment in Oasis and the Oasis marketing
     activities have been included since July 1, 1996. These per day volumes
     are being averaged over the entire year. Volumes included are only those
     volumes marketed by the Company.


                                      11
<PAGE>   14

RESULTS OF OPERATIONS

     The Company's results of operations are determined primarily by the volume
of gas purchased, processed and resold in its gas gathering systems and natural
gas processing plants, as well as its off-system marketing activities.
Fluctuations in the price levels of natural gas and NGLs affect results of
operations since the Company generally receives a portion of the natural gas
and NGLs revenue from natural gas throughput. The Company, from time to time,
enters into hedging transactions such as contracts for future deliveries in
order to minimize the risk associated with changes in the price of natural gas
and NGLs. The price of NGLs has declined precipitously in 1998 along with other
hydrocarbon liquid prices. The Company has not entered into any significant
hedging transactions in 1998 to mitigate the effect of lower NGLs price on its
results of operations. Most of the Company's operating costs do not vary
directly with volumes on existing systems; thus, increases or decreases in
volumes on existing systems generally have a direct effect on net income.

     YEARS ENDED DECEMBER 31, 1998 COMPARED TO DECEMBER 31, 1997

     Total operating revenues inclusive of natural gas and NGLs decreased 12%
to $893.2 million in 1998 compared to $1,013.9 million in 1997. Natural gas
revenues decreased 8% to $854.8 million in 1998 compared to $926.4 million in
1997 as a result of a decrease in the average natural gas price of 17% to $2.03
per Mcf in 1998 from $2.46 per Mcf in 1997 offset by an increase of 12% in
natural gas throughput sold and marketed to 1,150 MMcf/d in 1998 from 1,027
MMcf/d in 1997.

     NGLs revenues decreased 56% to $38.4 million in 1998 compared to $87.5
million in 1997 as the result of a 26% decrease in the average NGLs price to
$.25 per gallon from $.34 per gallon and a 32% decrease in gross NGLs
production to 25,000 Bbls/d in 1998 compared to 37,000 Bbls/d in 1997. This
decrease resulted from a reduction in NGLs content in the natural gas delivered
to the Company at the wellhead and voluntarily bypassing significant volumes of
lower liquid content gas due to the depressed NGLs prices. The decrease in NGLs
content is due to recent wells connected on the SETPS which are from a lean,
high volume gas stream, a trend the Company expects to continue for the
foreseeable future. In 1998, the Company recognized a gain of less than $.1
million compared to $3.1 million in 1997 associated with its NGLs hedging
activities.

     Cost of sales was $812.6 million, or 91% of operating revenues, in 1998
compared to $894.6 million, or 88% of operating revenues, in 1997. The increase
in the percentage is primarily due to the increase in overall off-system
marketing activities which have lower gross margin percentages. Cost of sales
decreased as the result of a decrease in the average natural gas price offset
by an increase in natural gas throughput sold and marketed.

     Gross margin (operating revenues less cost of sales, which includes only
the direct cost of gas sold and does not include any related operating
expenses) was $80.6 million, or 9% of operating revenues, in 1998 compared to
$119.3 million, or 12% of operating revenues, in 1997. The decrease in the
gross margin is due to decreased throughput volumes, a decrease in off-system
marketing results, a decrease in average natural gas prices and a decrease in
gross production and the average NGLs price. The decrease in percentage is due
to the increase in overall off-system marketing activities which have lower
gross margin percentages and a decrease in average NGLs and natural gas prices.

     Operating expenses decreased 6% to $21.3 million in 1998 compared to $22.6
million in 1997 primarily as a result of the sale of the Company's ownership
interest in the Warwink Joint Venture in December 1997 and a reduction in
maintenance and construction expenses on the gathering systems and plants
offset by an increase in expenses due to the purchase of a treating facility
which had previously been leased.

     General and administrative expenses increased 5% to $16.4 million in 1998
compared to $15.6 million in 1997 due primarily to compensation expense
attributable to stock appreciation rights (SARs) and strategic alternative
costs. The Company accrues compensation related to the SARs based on the price
of the Company's common stock. Based on the Company's stock price in 1998, the
Company increased its accrual for SARs while in 1997 the Company decreased its
accrual for SARs, which resulted in an increase between periods of $.9 million.
The increase in expenses is also due to the recognition of $.7 million in costs
associated with the costs incurred during the Company's exploration of
strategic alternatives.

     Depreciation and amortization increased 3% to $26.4 million in 1998
compared to $25.6 million in 1997 primarily as the result of fixed asset
additions on the SETPS in recent periods.

     Interest and debt expenses decreased 18% to $14.1 million in 1998 compared
to $17.2 million in 1997 primarily as a result of decreased debt balances.


                                      12
<PAGE>   15

     Other income and (expense) decreased 85% to $.1 million of income in 1998
compared to income of $.9 million in 1997 as a result of the gain on sale of
the Company's ownership interest in the assets of the joint venture,
Brooks-Hidalgo Joint Venture, of less than $.1 million in 1998 compared to a
gain on sale of the Company's ownership interest in Warwink Joint Venture of
$1.2 million in 1997. See Note 8 of Notes to Consolidated Financial Statements.

     The (benefit) provision in lieu of income tax expense decreased due to the
decrease in income before tax in 1998 compared to 1997, the decline in the
percentage from 37.9% in 1997 to 35.0% in 1998 as a result of the Company's
recent tax restructuring of certain reporting entities, and the recognition of
a $2.0 million tax benefit due to certain tax entity restructuring and other
adjustments.

     YEARS ENDED DECEMBER 31, 1997 COMPARED TO DECEMBER 31, 1996

     Total operating revenues increased 27% to $1,013.9 million in 1997
compared to $799.3 million in 1996. Natural gas revenues increased 31% to
$926.4 million in 1997 compared to $706.0 million in 1996 partially as the
result of the activity related to the Oasis off-system marketing which
contributed natural gas revenues of $184.2 million with associated marketed
natural gas volumes of 190 MMcf/d. Excluding Oasis off-system marketing
activity, natural gas revenues increased 25% to $742.2 million due to a 6%
increase in the average natural gas price to $2.46 per Mcf in 1997 from $2.33
per Mcf in 1996 and a 16% increase in natural gas throughput sold and marketed
to 837 MMcf/d in 1997 from 724 MMcf/d in 1996.

     NGLs revenues decreased 6% to $87.5 million in 1997 compared to $93.3
million in 1996 as the result of a 3% decrease in the average NGLs price to
$.34 per gallon from $.35 per gallon and a 10% decrease in gross NGLs
production to 37,000 Bbls/d in 1997 compared to 41,000 Bbls/d in 1996. In 1997,
the Company recognized a gain of approximately $3.1 million associated with its
NGLs hedging activities.

     Cost of sales was $894.6 million, or 88% of operating revenues, in 1997
compared to $664.1 million, or 83% of operating revenues, in 1996. The increase
in the percentage is primarily due to a higher cost of gas supply for the
pipeline systems and the increase in overall off-system marketing activities
which have lower gross margin percentages. Cost of sales increased primarily as
the result of an increase in the average natural gas price and the Oasis
off-system marketing activity.

     Gross margin (operating revenues less cost of sales, which includes only
the direct cost of gas sold and does not include any related operating
expenses) was $119.3 million, or 12% of operating revenues, in 1997 compared to
$135.2 million, or 17% of operating revenues, in 1996. The decrease in
percentage is primarily due to a higher cost of gas supply for the pipeline
systems and to the increase in overall off-system marketing activities which
have lower gross margin percentages. The decrease in the gross margin is due to
lower gross margins from the pipeline systems as a result of decreased
throughput volumes, higher cost of gas supply and a decrease in NGLs revenues.

     Operating expenses decreased 4% to $22.6 million in 1997 compared to $23.6
million in 1996 primarily as a result of a reduction in the insurance expense
and maintenance on the plant and gathering systems offset by recording
additional expenses associated with an increase in the ownership percentage of
the Company's interest in a joint venture.

     General and administrative expenses decreased 20% to $15.6 million in 1997
compared to $19.5 million in 1996 due primarily to decreased compensation and
service agreement costs. The Company accrues compensation related to the Stock
Appreciation Rights (SARs) based on the price of the Company's common stock.
The accrual for SARs between 1997 and 1996 decreased $1.6 million. In 1997, the
Company's service agreement costs were lower by $.4 million as compared to
1996.

     Depreciation and amortization increased 8% to $25.6 million in 1997
compared to $23.7 million in 1996 primarily as the result of asset additions on
the SETPS and the amortization of the transportation rights related to Oasis.

     Interest and debt expenses increased 10% to $17.2 million in 1997 compared
to $15.7 million in 1996 primarily as a result of the Oasis acquisition offset
by the reduction of $1.3 million of interest recorded in 1997 as compared to
1996 associated with certain agreed-upon tax issues with the IRS resulting from
the IRS examination of certain UtiliCorp federal income tax returns (further
discussed below).

     Other income and (expense) increased 541% to $.9 million of income in 1997
compared to an expense of $.2 million in 1996 primarily as a result of the gain
on sale of the Warwink Joint Venture of $1.2 million. See Note 8 of Notes to
Consolidated Financial Statements.

                                      13
<PAGE>   16

     Provision in lieu of income tax expense decreased 26% to $15.0 million in
1997 compared to $20.1 million in 1996 due primarily to a decrease in income
before income taxes in 1997 compared to 1996. UtiliCorp has agreed with the IRS
on certain tax issues as a result of the IRS audits of 1990 through 1993
UtiliCorp federal income tax returns (hereinafter referred to as "agreed-upon
tax issues"). In accordance with the provisions of the tax sharing agreement,
UtiliCorp assessed the Company $3.5 million for these agreed-upon tax issues.
The Company paid UtiliCorp these amounts in 1997 and the first quarter of 1998.
The payment of the income taxes associated with these agreed-upon tax issues
had no effect on net income but an adjustment was made to the deferred tax
liability. Also, see Note 4 of Notes to Consolidated Financial Statements.

LIQUIDITY AND CAPITAL RESOURCES

     The Company generates significant cash from operations and expects such
cash and borrowings to be its primary source of liquidity. The Company's
primary uses of cash consist of capital expenditures, acquisitions, working
capital requirements, dividends and debt repayment. The Company's historical
net additions to pipeline, property, plant and equipment were $22.6 million and
$28.5 million for the years ended December 31, 1998 and 1997, respectively.
Excluding business acquisitions, if any, capital expenditures are expected to
be approximately $15.6 million in 1999 which the Company expects it can fund
from operating cash flow.

     In March 1998, the Company received $1.5 million for the sale of its
ownership interest in the assets of the Brooks-Hidalgo Joint Venture. The
proceeds were utilized to pay down the Company's revolving debt.

     The Company maintains revolving credit agreements (the Revolvers), as
amended, of $118.0 million after voluntarily reducing its commitment by $10.0
million in February 1998, with Aquila Energy to provide general funds for
general corporate purposes. The available borrowing on the Revolvers at
December 31, 1998 was $24.3 million with $93.7 million outstanding. The
maturity dates on the Revolvers automatically renew in one year periods from
each commitment period. Currently the maturity dates of the Revolvers are in
the fourth quarter of 2000.

     The Company has two general corporate purpose loan agreements with Aquila
Energy in the amounts of $50.0 million maturing in 2005 and $16.3 million
maturing in 2006. At December 31, 1998, $50.0 million and $16.3 million were
outstanding on the loan agreements. Each loan requires the Company to maintain
certain financial covenants and limits the activities of the Company in other
ways. At December 31, 1998, the Company was in compliance with the covenants.

     The 8.29% Senior Notes issued by Aquila Southwest Energy Corporation
(Aquila Southwest) in 1992 require principal payments of $12.5 million
annually. Such principal payments are expected to be made from cash flows from
operations and borrowings. The 8.29% Senior Note purchase agreement has
numerous covenants that affect the Company and Aquila Southwest. These
covenants limit the ability to make dividend payments (currently, limited to
$69.8 million) and incur debt, require maintenance of certain financial ratios
and limit the activities of Aquila Southwest in other ways. Failure to maintain
the required ratios may ultimately result in an acceleration of payments due.
At December 31, 1998, $50.0 million was outstanding on the Senior Notes and the
Company was in compliance with the covenants.

     The Company believes that cash generated from operations and borrowings
under the Revolvers will be adequate to fund working capital requirements, debt
service payments and planned capital expenditures. Future acquisitions or large
capital expenditures in excess of current plans would require additional
financing that the Company expects would be available through additional debt
facilities.

NEW ACCOUNTING STANDARDS

     In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 133 establishes
accounting and reporting standards for derivative instruments and for hedging
activities. Adoption of SFAS No. 133 is required for all fiscal quarters of all
fiscal years beginning after June 15, 1999, although earlier adoption is
encouraged. The Company is currently evaluating the potential impact of SFAS
No. 133.

     In 1998, the FASB's Emerging Issues Task Force issued abstract No. 98-10,
"Accounting for Energy Trading and Risk Management Activities." This abstract
focuses on the accounting for the purchase and sale of energy trading
contracts. The Company is analyzing the potential impact of this abstract upon
issuance.


                                      14
<PAGE>   17

YEAR 2000 ISSUE

     The Company's systems as presently configured may not recognize the
two-digit date of "00" as the year 2000. This could cause systems to shut down
or malfunction. In order to address potential year 2000 issues, UtiliCorp
established a Year 2000 Project Office (Project Office) to coordinate efforts
in its operating units to ensure that computer systems and applications will
function properly beyond 1999.

     Many of the Company's information systems and related software are already
year 2000 ready and associated costs are not significant. The Project Office is
coordinating the identification and testing of remaining software, information
technology devices, embedded technology systems, and services provided by third
parties that may be impacted by the year 2000. The Project Office completed the
identification and testing phases in 1998 and will begin remediation in 1999.
At this time, the Project Office does not have a contingency plan to address
unforeseen issues, but the Company expects the Project Office to have one by
mid-1999. The Company is currently preparing budgets and estimates of
remediation of mission critical systems. The remediation of certain non-mission
critical systems is expected to extend beyond 1999. The estimated cost to the
Company of administering the year 2000 efforts through the UtiliCorp Project
Office is not significant.

     The Project Office is conducting internal evaluations and participating in
industry-wide efforts being conducted by the Gas Industry Standards Board to
appropriately prepare and ensure the Company's efforts are in line with the
rest of the industry.

FORWARD-LOOKING INFORMATION

     The Company is including the following cautionary statement to make
applicable and take advantage of the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995 for any forward-looking statement made
by, or on behalf of, the Company. The factors identified in this cautionary
statement are important factors (but not necessarily all of the important
factors) that could cause actual results to differ materially from those
expressed in any forward-looking statement made by, or on behalf of, the
Company.

     Where any such forward-looking statement includes a statement of the
assumptions or basis underlying such forward-looking statement, the Company
cautions that, while it believes such assumptions or basis to be reasonable and
makes them in good faith, assumed facts or basis almost always vary from actual
results, and the differences between assumed facts or basis and actual results
can be material, depending upon the circumstances. Where, in any
forward-looking statement, the Company, or its management, expresses an
expectation or belief as to future results, such expectation or belief is
expressed in good faith and believed to have a reasonable basis, but there can
be no assurance that the statement of expectation or belief will result or be
achieved or accomplished.

     Taking into account the foregoing, the following are identified as
important factors that could cause actual results to differ materially from
those expressed in any forward-looking statement made by, or on behalf of, the
Company:

a)   The ability to increase transmission, gathering, processing, and sales
     volumes can be subject to the impact of price; drilling activity and
     success of producers; and service competition, especially due to excess
     pipeline availability. Existing volumes are subject to depletion without
     addition of future developed gas supplies. The ability to contract
     additional gas supplies for the existing systems also is affected by the
     available number of drilling locations in the proximity of these existing
     gas systems and the related economic reserves of these drilling locations.

b)   Growth strategies through acquisition, internal project development, and
     investments in joint ventures may face legal and regulatory delays,
     financing difficulties, competition from other acquirers and competitors,
     and other unforeseeable obstacles beyond the Company's control.

c)   Future profitability will be affected by the Company's ability to compete
     with the services and economic contractual terms offered by other energy
     enterprises which may be larger, offer more services, and possess greater
     resources. Future profitability also will be affected by the level of
     prices of natural gas, NGLs and competitive fuels and feedstocks.

                                      15
<PAGE>   18

d)   Future operating results and success of business ventures may be subject
     to the effects of and changes in laws and regulations, political and
     governmental changes, inflation rates, taxes, and operating conditions.
     Also, future operating results are subject to unexpected items resulting
     from such events as, but not limited to, litigation settlements, adverse
     rulings or judgments, and unexpected environmental remediation.

e)   The Company's operations are subject to the risks incident to the
     gathering, transportation, processing and storage of natural gas and NGLs,
     such as explosions, product spills, leaks and fires, any of which could
     result in substantial losses to the Company and curtailment or suspension
     of operations at a Company facility.

f)   The ability of the Company to successfully implement the initiatives
     included in the restructuring plan and realize the anticipated cost
     savings.

ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

COMMODITY PRICE SENSITIVITY:

      The Company is exposed to market risks related to the volatility in the
prices of natural gas and NGLs. The Company utilizes commodity financial
instruments, primarily futures, options, forward contracts and swaps (hedges or
hedging), to reduce the risk of commodity price fluctuations for its revenue
share of natural gas throughput and NGLs production and for its off-system
natural gas transportation. However, hedging and related activities may expose
the Company to other risks of financial loss in certain circumstances,
including variances from hedging assumptions and counterparty risk. All
financial commodity hedges disclosed have Aquila Energy as the counterparty
because Aquila Energy maintains a centralized commodity risk management
function for its subsidiaries. The following table provides information about
the Company's derivative financial instruments at December 31, 1998 that are
sensitive to changes in natural gas commodity prices.

Natural Gas Derivatives (dollars in thousands):

<TABLE>
<CAPTION>
                             ----------   ----------   ----------   ----------   ----------   ----------
                                1999         2000         2001         2002         2003         Total
                             ----------   ----------   ----------   ----------   ----------   ----------
<S>                          <C>          <C>           <C>          <C>          <C>         <C>   
Trading Activities:
   Swap contracts
     Notional volumes (Bcf)       2.406       (3.835)       1.356        (.482)       (.027)       (.582)
     Fair Value              $   (1,766)  $      (78)  $     (101)  $       (3)  $       --   $   (1,948)
   Future contracts
     Notional volumes (Bcf)       4.227       (0.636)          --           --           --        3.591
     Fair Value              $     (601)  $        2   $       --   $       --   $       --   $     (599)

Non-Trading Activities:
   Swap contracts
     Notional volumes (Bcf)      (1.550)          --           --           --           --       (1.550)
     Fair Value              $      (17)          --           --           --           --   $      (17)
   Future contracts
     Notional volumes (Bcf)      (3.205)          --           --           --           --       (3.205)
     Fair Value              $     (620)          --           --           --           --   $     (620)
</TABLE>


                                      16
<PAGE>   19

INTEREST RATE SENSITIVITY:

     The Company has financial instruments which are sensitive to changes in
interest rates. The financial instruments which are sensitive to interest rates
bear interest at the Company's election of either a base rate (the higher of a
bank prime rate or 1/2 of 1% above the Federal Funds rate), an adjusted
certificate of deposit rate or a Eurodollar rate. The debt obligations are
presented in the table at their contractual maturity dates together with the
weighted average interest rates expected to be paid on the debt. The following
table provides information about the Company's financial instruments at
December 31, 1998 that are sensitive to interest rates.

  Debt Obligations (dollars in thousands):

<TABLE>
<CAPTION>
                                            ----------    ----------  ----------  ----------  ----------    ----------
                                               1999          2000        2001        2002        2003         Total
                                            ----------    ----------  ----------  ----------  ----------    ----------
<S>                                         <C>           <C>         <C>         <C>         <C>           <C>
     Obligation-Revolving Credit
       Agreements                                   --    $   93,700          --          --          --    $   93,700
     Weighted Average Interest Rate                 --          6.29%         --          --          --          6.29%
</TABLE>

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     Reference is made to the consolidated financial statements, the report
thereon, the notes thereto and supplementary data beginning on page F-1 of this
Form 10-K Annual Report which is incorporated by reference herein.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

     None.


                                      17
<PAGE>   20
                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

      Set forth below are the names and positions of the directors and
executive officers of the Company.

<TABLE>
<CAPTION>
NAME                                                        POSITION WITH THE COMPANY                          AGE
----                                                        -------------------------                          ---
<S>                                                  <C>                                                       <C>
  Charles K. Dempster (1)  ......................    Chairman of the Board of Directors                         56
  Gary L. Downey (2)  ...........................    Director                                                   62
  Edward K. Mills (3)............................    Director                                                   38
  Jon L. Mosle, Jr. (2)  ........................    Director                                                   69
  F. Joseph Becraft (1)  ........................    President, Chief Executive Officer and Director            56
  Travis H. Lynch  ..............................    Vice President, Gas Supply                                 60
  Douglas H. Westmoreland  ......................    Vice President, Operations and Engineering                 52
  John G. Pascador  .............................    Controller and Chief Accounting Officer                    33
</TABLE>
-----------

(1)  Term expires in 1999.
(2)  Term expires in 2000.
(3)  Term expires in 2001.

     Charles K. Dempster is the Chairman of the Board of Directors of the
Company and has held such position since August 1993. From August 1993 to
August 1997, Mr. Dempster also served as Chief Executive Officer of the
Company. Mr. Dempster has served as Chairman of the Board of Directors and
Chief Executive Officer of UtiliCorp U.K., Inc. from November 29, 1995 to
present. From January 1993 through November 28, 1995, Mr. Dempster served as
President of Aquila Energy and director of various affiliates of the Company.
From 1986 to December 1992, Mr. Dempster served as President of Reliance
Pipeline Company.

     Gary L. Downey is a Director of the Company and has held such position
since August 1993. From 1988 until he retired in 1992, Mr. Downey served as
Senior Vice President, ARCO International Oil and Gas Co., a division of
Atlantic Richfield Company.

     Edward K. Mills is a Director of the Company and has held such position
since February 1999. From July 1998 to present, Mr. Mills served as President
and Chief Operating Officer of Aquila Energy Corporation. From March 1993 until
July 1998, Mr. Mills held various positions with Aquila Energy Corporation.

     Jon L. Mosle, Jr. is a Director of the Company and has held such position
since August 1993. From 1992 to the present, Mr. Mosle served as an independent
consultant. From 1984 to 1992, Mr. Mosle served as Director, Private Capital,
of AmeriTrust Texas, n.a.

     F. Joseph Becraft is President, Chief Executive Officer and Director of
the Company and has held such position since August 1997. From May 1995 through
November 1996, Mr. Becraft served in various capacities including President and
Chief Executive Officer of Valero Energy Corporation. From 1989 through April
1995, Mr. Becraft served as President and Chief Executive Officer of Transok
Inc.

     Travis H. Lynch is Vice President, Gas Supply, of the Company and has held
such position with the Company since August 1993. From July 1992 to July 1993,
Mr. Lynch held the same position with Aquila Southwest Energy Corporation. From
1978 to July 1992, Mr. Lynch held the same position with the general partner of
Clajon Holdings, L.P. and its predecessor.

     Douglas H. Westmoreland is Vice President, Operations and Engineering, of
the Company and has held such position since August 1993. From 1991 to 1993,
Mr. Westmoreland served a subsidiary of the Company as Director of Operations,
and for more than three years prior to 1991 as District Engineering Supervisor.

     John G. Pascador is the Controller and Chief Accounting Officer of the
Company and has held such position since November 1998. Mr. Pascador was the
Controller of the Company from December 1995 until November 1998 and held
various positions with the Company since May 1994. Prior to May 1994, Mr.
Pascador was an Audit Manager with Arthur Andersen LLP.

                                       18

<PAGE>   21
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

     Charles K. Dempster is Chairman of the Board of Directors and until August
1997 was Chief Executive Officer of the Company in addition to being Chairman
of the Board and Chief Executive Officer of UtiliCorp U.K., Inc., an affiliate
of UtiliCorp, the parent company of Aquila Energy, which is an 81.6% beneficial
owner of common stock of the Company. No executive officer of the Company
serves as a member of the compensation committee or other board committee
performing similar functions of any other entity.

ITEM 11. EXECUTIVE COMPENSATION

     The following table sets forth a summary of compensation for the three
fiscal years ended December 31, 1998 for the Chief Executive Officer and the
four other most highly compensated executive officers of the Company.

                           SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
                                                                              LONG-TERM
                                                                            COMPENSATION
                                           ANNUAL                  --------------------------------     PAYOUTS
                                       COMPENSATION                 RESTRICTED        SECURITIES       -------
    NAME AND PRINCIPAL         ---------------------------------       STOCK           UNDERLYING         LTIP         ALL OTHER
        POSITION               YEAR       SALARY($)     BONUS($)      AWARDS($)      OPTIONS/SARS(#)    PAYOUTS($)   COMPENSATION($)
        --------               ----      -----------   ---------   -------------     ---------------   -----------  ----------------

<S>                            <C>       <C>           <C>         <C>              <C>                <C>          <C>
F. Joseph Becraft(1)           1998      $  283,885    $ 100,000   $      --          14,067 (2)(3)     $     --    $    8,516 (9)
  President and Chief          1997         106,827      115,000      54,700 (5)      45,000 (2)(3)           --         9,420 (6)
  Executive Officer            1996              --           --          --              --                  --            --

Damon C. Button(11)            1998      $  155,096    $      --   $      --              --            $     --    $   67,806 (7)
  Vice President,              1997         189,916       30,818      50,000 (10)      6,000 (2)              --        51,709 (7)
  Treasurer and Chief          1996         174,316      142,930      15,733 (8)      12,000 (4)              --        10,459 (9)
  Financial Officer

Travis H. Lynch                1998      $  181,289    $  15,000   $      --           2,000 (2)        $     --    $   10,877 (9)
  Vice President,              1997         176,231       30,000          --           2,000 (2)              --        10,573 (9)
  Gas  Supply                  1996         171,385       79,752      14,938 (8)       8,000 (4)              --        10,283 (9)

James E. Wade(12)              1998      $  111,185    $      --   $      --              --            $     --    $   91,765 (7)
  Vice President,              1997         130,154       30,000          --           2,000 (2)              --        26,559 (7)
  Gas Marketing                1996         120,000      103,127      10,794 (8)       8,000 (4)              --         7,200 (9)

Douglas H. Westmoreland        1998      $  142,662    $  15,000   $      --           2,000 (2)        $     --    $    8,560 (9)
  Vice President, Operations   1997         130,154       25,000          --           2,000 (2)              --         7,809 (9)
  and Engineering              1996         119,092       61,255      10,220 (8)       5,000 (4)              --         4,850 (6)
</TABLE>


(1)      Mr. Becraft was elected President and Chief Executive Officer of the
         Company in August 1997.

(2)      Options to purchase Company common stock. The options become
         exercisable in increments of 25%, 25% and 50% on the second, third and
         fourth anniversary date, respectively, following the date of grant and
         have a term of ten years. The exercise price of the options are 100% of
         the fair market value of the Company's common stock on the date of the
         grant. For 1997, 25,000 options were granted to Mr. Becraft, 6,000
         options were granted to Mr. Button, 2,000 options were granted to Mr.
         Lynch, 2,000 options were granted to Mr. Wade, and 2,000 options were
         granted to Mr. Westmoreland. For 1998, 11,000 options were granted to
         Mr. Becraft, 2,000 options were granted to Mr. Lynch, and 2,000 shares
         were granted to Mr. Westmoreland.

(3)      Options to purchase UtiliCorp common stock. All options fully vest one
         year from the date of grant, have a term of ten years, and an exercise
         price of 100% of the fair market value of UtiliCorp common stock on
         the date of grant. Mr. Becraft was granted 20,000 and 3,067 options in
         1997 and 1998, respectively.


                                      19
<PAGE>   22
(4)      Grants of stock appreciation rights (Rights) pursuant to a stock
         appreciation rights plan. Each Right shall continue in effect for ten
         years from the date of grant, subject to earlier termination upon the
         occurrence of certain events and are exercisable one year from date of
         grant. Upon exercise, the employee shall receive a cash payment equal
         to the appreciation in the fair market value per share of common stock
         of the Company from the date of grant.

(5)      Grant of Aquila Gas Pipeline Corporation restricted stock on August
         12, 1997. Restriction lapses on the second year after the date of
         grant. Dividends are paid on restricted stock awards at the same rate
         as paid to all Company stockholders. On December 31, 1998, Mr. Becraft
         held a total of 5,000 shares of restricted stock valued at $48,813.

(6)      Contributions by Aquila Gas Pipeline Corporation to the UtiliCorp
         401(k) plan.

(7)      Contributions by Aquila Gas Pipeline Corporation to the UtiliCorp
         401(k) plan and the UtiliCorp Supplemental Contributory Retirement
         Plan. A payment was made to Mr. Button of $41,250 and $58,500 for
         Rights exercised in 1997 and 1998 respectively. A payment of $85,094
         was made to Mr. Wade for Rights exercised in 1998.

(8)      Grants of Aquila Gas Pipeline Corporation restricted stock under
         Company incentive plans. Restriction lapses on the second or third
         year after the date of grant. Dividends are paid on restricted stock
         awards at the same rate as paid to all Company stockholders. On
         December 31, 1998, Mr. Lynch held a total of 2,080 shares of
         restricted stock valued at $17,810 and Mr. Westmoreland held a total
         of 1,467 shares of restricted stock valued at $12,562.

(9)      Contributions by Aquila Gas Pipeline Corporation to the UtiliCorp 
         401(k) plan and the UtiliCorp Supplementary Contributory Retirement
         Plan.

(10)     Grants of UtiliCorp restricted stock under incentive plans of the
         Company. Restriction lapses on the first year after the date of grant.
         Dividends are paid on restricted stock awards at the same rate as paid
         to all UtiliCorp stockholders.

(11)     Mr. Button resigned from the Company on September 1, 1998.

(12)     Mr. Wade resigned from the Company on August 14, 1998.



                                      20
<PAGE>   23

                     OPTION GRANTS DURING 1998 FISCAL YEAR

<TABLE>
<CAPTION>
                                                       INDIVIDUAL GRANTS
                                                       -----------------
                                   NUMBER OF
                                   SECURITIES             % OF TOTAL
                                   UNDERLYING         OPTIONS/SARS GRANTED       EXERCISE OR
                                   OPTIONS/SARS      TO EMPLOYEES IN FISCABASE      PRICE      EXPIRATION        GRANT DATE
               NAME                GRANTED (#)                YEAR                 ($/SH)         DATE         PRESENT VALUE $
               ----                -----------       -------------------------   ------------  ----------      ---------------
<S>                                <C>               <C>                         <C>           <C>             <C>
F. Joseph Becraft................       11,000 (1)               31%             $      11.44    2-10-08        $  94,270 (3)
                                         3,067 (2)                0%             $      37.50    3-12-08        $  11,317 (4)
Damon C. Button..................        6,000 (1)               17%             $      11.44    2-10-08        $       --(5)
Travis H. Lynch..................        2,000 (1)                6%             $      11.44    2-10-08        $  17,140 (3)
James E. Wade....................        2,000 (1)                6%             $      11.44    2-10-08        $      -- (5)
Douglas H. Westmoreland..........        2,000 (1)                6%             $      11.44    2-10-08        $  17,140 (3)
</TABLE>

(1)      Options to purchase Company common stock granted on February 10, 1998.
         The options become exercisable in increments of 25%, 25% and 50% on
         the second, third and fourth anniversary date, respectively, following
         the date of grant. All options fully vest four years from the date of
         grant, have a term of ten years, and an exercise price of 100% of the
         fair market value of Company common stock on the date of grant.

(2)      Options to purchase UtiliCorp common stock granted on March 12, 1998.
         The options become exercisable on the first anniversary date of the
         grant. All options have a term of ten years, and an exercise price of
         100% of the fair market value of UtiliCorp common stock on the date of
         grant.

(3)      Based upon an option pricing model adapted for use in valuing
         executive stock options. The actual value, if any, an executive may
         realize will depend on the excess of the stock price over the exercise
         price on the date the option is exercised, so that there is no
         assurance the value realized by an executive will be at or near the
         value estimated by the model. Assumptions used in the model include a
         risk-free interest rate of 5.0%, dividend yield of .5%, and a
         volatility factor of .70. No adjustments for non-transferability, risk
         of forfeiture or exercise of option prior to maturity have been
         included.

(4)      Based upon an option pricing model adapted for use in valuing
         executive stock options. The actual value, if any, an executive may
         realize will depend on the excess of the stock price over the exercise
         price on the date the option is exercised, so that there is no
         assurance the value realized by an executive will be at or near the
         value estimated by the model. Assumptions used in the model include a
         risk-free interest rate of 4.7%, dividend yield of 5.2%, and a
         volatility factor of .20. No adjustments for non-transferability, risk
         of forfeiture or exercise of option prior to maturity have been
         included.

(5)      Options lapsed upon voluntary termination of employment.


                                      21
<PAGE>   24

  AGGREGATED OPTION/SAR EXERCISES DURING 1998 FISCAL YEAR AND FISCAL YEAR-END
                               OPTION/SAR VALUES

<TABLE>
<CAPTION>
                                  ACQUIRED ON                           NUMBER OF SECURITIES        VALUE OF UNEXERCISED
                                   EXERCISE                           UNDERLYING UNEXERCISED            IN-THE-MONEY
                                     (#)                                  OPTIONS/SARS AT             OPTIONS/SARS AT
                                 OPTIONS/SARS       VALUE                     FY-END (#)                  FY-END ($)
NAME                             EXERCISED(1)     REALIZED($)        EXERCISABLE/UNEXERCISABLE   EXERCISABLE/UNEXERCISABLE
----                             ------------     -----------        -------------------------   -------------------------
<S>                              <C>              <C>                <C>                         <C>   
F. Joseph Becraft.........                 --             --                0 /  59,067          $        0 /   $  140,000
Damon C. Button...........             12,000     $   58,500                0 /       0          $        0 /   $        0
Travis H. Lynch...........                 --             --           35,400 /   4,000          $        0 /   $        0
James E. Wade.............             12,500     $   85,094                0 /       0          $        0 /   $        0
Douglas H. Westmoreland...                 --             --           10,000 /   4,000          $        0 /   $        0
</TABLE>

(1) Number of Options and SARs exercised for which cash was received.

EMPLOYMENT CONTRACT

         Mr. Becraft does not have an employment contract with the Company;
however, he does have a Change of Control Agreement in place. In the event a
change of control occurs (as defined in the agreement) and Mr. Becraft does not
continue as an employee of the Company, he will receive a severance payment
equal to one and one half times his base salary at the time of his separation
from the Company.

DIRECTOR COMPENSATION

         Outside directors will receive $2,000 per board meeting attended and
$500 for each committee meeting attended regardless of whether such committee
meeting is held separately or in conjunction with a board meeting. In addition,
outside directors are reimbursed for their reasonable expenses in attending
meetings of the Board of Directors or any committee and each outside director
receives $2,000 of Company common stock each quarter pursuant to the Company's
1996 Non-Employee Director Stock Plan.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS

         The following table sets forth the only persons (or "group" within the
meaning of Section 13(d)(3) of the Securities Exchange Act of 1934) who are
known to the Company to have beneficially owned on March 18, 1999, more than 5%
of the common stock entitled to vote at any meeting of stockholders of the
Company.

<TABLE>
<CAPTION>
                                                              NUMBER OF SHARES         PERCENTAGE OF COMMON
         NAME AND ADDRESS OF BENEFICIAL OWNER                BENEFICIALLY OWNED             STOCK OWNED
         ------------------------------------                ------------------        --------------------
<S>                                                        <C>                       <C>  
         Aquila Energy Corporation(1)  ................          24,000,000                    81.6%
            2533 North 117th Avenue, Suite 300
            Omaha, NE 68164-8618
</TABLE>

-----------

(1)      UtiliCorp, the parent of Aquila Energy, and Richard C. Green, Jr., the
         Chairman of the Board and Chief Executive Officer of UtiliCorp, may be
         considered beneficial owners of the common stock held of record by
         Aquila Energy due to their control position with respect to Aquila
         Energy.



                                      22
<PAGE>   25

SECURITY OWNERSHIP OF MANAGEMENT

         The following table sets forth information as of March 18, 1999,
concerning the shares of Common Stock beneficially owned by (i) each of the
Directors of the Company, (ii) each of the executive officers of the Company
named in the Summary Compensation Table and (iii) executive officers and
Directors as a group. The beneficial owner has sole voting and investment power
over the shares shown, unless otherwise indicated.

<TABLE>
<CAPTION>
                                                                                       NUMBER OF     PERCENT OF
         NAME OF INDIVIDUAL OR GROUP                                                    SHARES        CLASS(1)
                                                                                      ------------  ------------
<S>                                                                                   <C>           <C>
         Charles K. Dempster  ....................................................          1,251         -
         Gary L. Downey  .........................................................          2,726         -
         Travis H. Lynch  ........................................................          4,911         -
         Jon L. Mosle, Jr.  ......................................................          3,726         -
         F. Joseph Becraft  ......................................................          7,000         -
         Edward K. Mills  ........................................................              0         -
         Douglas H. Westmoreland  ................................................          2,579         -
         Directors and Executive Officers - as a group (8 persons) ...............         22,193         -
</TABLE>

-----------

(1)      Less than 1% of common stock outstanding.


SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

         Section 16(a) of the Securities Exchange Act of 1934 requires that the
Company's directors, executive officers, and any persons holding more than ten
percent of the Company's common stock to report their initial ownership of the
Company's common stock and any subsequent changes in that ownership to the
Securities and Exchange Commission (SEC) and the New York Stock Exchange, and
to provide copies of such reports to the Company.

         To the Company's knowledge, based solely on the Company's review of
the copies of such reports received by the Company and written representations
of its directors, executive officers and ten percent holders, the Company
believes that during the year ended December 31, 1998, all Section 16(a) filing
requirements applicable to its directors, executive officers and ten percent
holders were satisfied except that Mr. Jon L. Mosle, Jr., and Mr. Gary L.
Downey each filed a Form 5 late on which each reported three transactions for
common stock received pursuant to the Company's 1996 Non-Employee Director
Stock Plan and Mr. John G. Pascador filed a Form 3 late on which he reported
that he did not own any of the Company's common stock.


                                      23
<PAGE>   26

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         Aquila Energy and UtiliCorp Services Agreement. The Company has
entered into services agreements with each of Aquila Energy and UtiliCorp (the
Services Agreements) effective August 1, 1993, pursuant to which Aquila Energy
and UtiliCorp provide various services to the Company, including certain
treasury, legal, tax, accounting, human resources, corporate secretarial,
investor relations, risk management, management information, marketing,
administrative and other services. Such services have historically been
supplied to the Company by Aquila Energy and UtiliCorp and the Services
Agreements provide for the further delivery of such services substantially
similar in nature and quality to those services previously provided. The
Company has agreed to reimburse Aquila Energy and UtiliCorp for all costs
incurred in rendering such services and to pay Aquila Energy and UtiliCorp for
allocated indirect costs incurred in rendering such services. The initial term
of each of the Services Agreements is until December 31, 1994, and
automatically renews for successive periods of one fiscal year unless
terminated by either party. The Services Agreements are reviewed annually by
the Affiliate Transaction Review Committee.

         Agency Agreement with Aquila Energy Marketing. Effective January 1,
1999, the Company entered into an agreement with AEM, a wholly-owned subsidiary
of Aquila Energy, to conduct its natural gas marketing activities. Under the
agreement, AEM will conduct all natural gas marketing activities on behalf of
the Company. The Company will receive all gross margins associated with such
marketing activities and will reimburse to AEM all costs associated with
performing these services. All previous employees of the Company in this
natural gas marketing capacity have been employed by AEM.

         Gas Sales Agreements. The Company has entered into two gas sales
agreements (the Gas Sales Agreements) effective September 1, 1993, pursuant to
which the Company sells to a subsidiary of Aquila Energy substantially all of
its gas quantities available from its Elk City and Mooreland systems located in
Oklahoma. The Gas Sales Agreements provide pricing terms for the gas based on
published monthly index prices of interstate pipelines connected to the Elk
City and Mooreland systems. The Gas Sales Agreements expired on September 1,
1998, and the pricing terms for such gas is being redetermined on a monthly
basis.

         Tax Sharing Agreement. The Company, Aquila Energy and UtiliCorp have
entered into a tax sharing agreement (the Tax Sharing Agreement) which provides
for the allocation of liabilities, procedures to be followed and other matters
with respect to certain taxes for tax years beginning after December 31, 1992,
in which UtiliCorp, Aquila Energy, the Company and its subsidiaries (the
Combined Consolidated Group) are included in a consolidated federal income tax
return filed for the Combined Consolidated Group.

         Under the Tax Sharing Agreement, UtiliCorp has sole and exclusive
responsibility for the preparation and filing of the consolidated U.S. federal
income tax return of the Combined Consolidated Group beginning in 1993.
UtiliCorp is responsible for making all federal income tax payments on behalf
of the Combined Consolidated Group. Estimated tax sharing payments will be made
by the Company to UtiliCorp for each taxable year in which a combined
consolidated return is filed. If a return reflects a net operating loss, net
capital loss, excess tax credit or other tax attributes, UtiliCorp will pay the
Company the refund which the Company would have received as a result of the
carryback of such attribute to any taxable year or years subsequent to December
31, 1992 in which the Company and its subsidiaries are included in the Combined
Consolidated Group. An amendment to the Tax Sharing Agreement was signed
effective December 1, 1995, that specifies the manner in which the Company
would be liable to UtiliCorp in the event of a potential adjustment by the
Internal Revenue Service (IRS) relating to UtiliCorp's consolidated federal
income tax returns for a certain depreciation expense issue through 1992. The
amendment also provides for UtiliCorp to pay the interest, if any, relating to
the potential adjustment up to $1.5 million.

         The principles expressed above with respect to federal income tax
matters apply equally to state and local income and franchise tax matters under
the Tax Sharing Agreement.

         Aquila Energy Revolvers. A Company subsidiary, Aquila Southwest Energy
Corporation (ASW), has entered into a $50.0 million revolving credit agreement
between ASW and Aquila Energy (the Aquila Revolver). As of December 31, 1998,
there was $30.1 million outstanding under this credit agreement. This revolver
bears interest at ASW's election of either a base rate (the higher of a bank
prime rate or one-half of 1% above the Federal Funds rate), an adjusted
certificate of deposit rate or a Eurodollar rate. The maturity date on this
revolver automatically renews in one-year periods from each commitment period
(October of each year) unless Aquila Energy gives at least a one-year notice not
to renew from the commitment period. Currently, the maturity date is October of
2000. ASW is obligated to pay a commitment fee on any unused portion of the
Aquila Revolver at the rate of one-fourth of 1% per annum. All principal
outstanding is due at the end of the Aquila Revolver's term. Amounts may be
prepaid at any time.


                                      24
<PAGE>   27
         Under the Aquila Revolver, ASW may not pledge its assets to secure
indebtedness except for certain permitted liens. Amounts outstanding under the
Aquila Revolver are expressly subordinate to the Aquila Southwest 8.29% Senior
Notes due 2002 (8.29% Senior Notes). Certain limitations are placed on ASW's
obligation to make payments on the Aquila Revolver in the event of default
under the terms of the 8.29% Senior Notes.

         In September 1994, the Company entered into an additional agreement
with Aquila Energy that provides an unsecured revolving credit facility for
borrowing up to an amount equal to the difference between $125.0 million and
the balance outstanding on the $50.0 million revolving credit facility
described above. As of December 31, 1998, there was $63.6 million outstanding
under this credit agreement. On February 1, 1998, the revolving credit
facility's commitment was voluntarily reduced by $10.0 million to $115.0
million. This revolver bears interest at the Company's election of either a
base rate (the higher of a bank prime rate or one-half of 1% above the Federal
Funds rate), an adjusted certificate of deposit rate or a Eurodollar rate. The
maturity date on this revolver automatically renews in one-year periods from
each commitment period (December of each year) unless Aquila Energy gives at
least a one-year notice not to renew from the commitment period. Currently, the
maturity date is December of 2000. The Company must pay an annual commitment
fee to Aquila Energy of one-fourth of 1% on the unutilized portion of the
revolving credit facility.

         In July 1996, a Company subsidiary, AQP Holdings L.P. (Holdings),
entered into an unsecured $3.0 million revolving note agreement with Aquila
Energy. The note bears interest at a bank prime rate and matures in December of
1999. In February 1997, the revolving note agreement was paid off and there was
not a balance outstanding at December 31, 1998.

         Aquila Loan Agreements. In September 1995, the Company entered into a
Loan Agreement (the Loan) with Aquila Energy for an amount of $50.0 million.
The Loan is unsecured and bears interest at 6.47% due semi-annually. The
principal amount of the Loan is required to be repaid to Aquila Energy by June
1, 2005. The Loan contains various covenants including certain financial
covenants related to net worth. As of December 31, 1998, there was $50.0
million outstanding under the Loan.

         The Company has another Loan Agreement (the Loan Agreement) with
Aquila Energy for an amount of $16.3 million. The Loan Agreement is unsecured
and bears interest at 6.83% due semi-annually. The principal amount of the Loan
Agreement shall be repaid to Aquila Energy by October 15, 2006. The Loan
Agreement also requires the Company to comply with certain financial covenants
and limits the activities of the Company in other ways. As of December 31,
1998, there was $16.3 million outstanding under the Loan Agreement.



                                      25
<PAGE>   28

                                    PART IV


ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K


<TABLE>
<CAPTION>
                                                                                                                     PAGE(S)
                                                                                                                     -------
(a)       The following documents are filed as part of this report:

          (1)  Aquila Gas Pipeline Corporation and Subsidiaries Consolidated Financial Statements:
<S>                                                                                                                  <C>
                   Report of Independent Public Accountants.........................................................   F-2
                   Consolidated Balance Sheets as of December 31, 1998 and 1997.....................................   F-3
                   Consolidated Statements of Income for the years ended December 31, 1998,
                     1997 and 1996..................................................................................   F-4
                   Consolidated Statements of Stockholders' Equity for the years ended
                     December 31, 1998, 1997 and 1996...............................................................   F-5
                   Consolidated Statements of Cash Flows for the years ended December 31,
                     1998, 1997 and 1996............................................................................   F-6
                   Notes to Consolidated Financial Statements.......................................................   F-7

          (2)  Financial Statement Schedule:
                   Aquila Gas Pipeline Corporation
                     Schedule I-Parent Company Only Financial Statements............................................  F-25

                   ----

                   All other schedules are omitted because they are not
                   applicable or the required information is shown in the
                   financial statements or notes thereto.

          (3)  List of Exhibits:
                   Incorporated herein by reference to the Index to Exhibits.
</TABLE>

(b)       Reports on Form 8-K.

                   There were no reports on Form 8-K during the fourth quarter
                   of 1998.


                                      26
<PAGE>   29

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

                                    AQUILA GAS PIPELINE CORPORATION



                                    By /s/ F. Joesph Becraft
                                       -------------------------
                                       F. Joseph Becraft
                                       Chief Executive Officer,
                                       President and Director




Date March 18, 1999

       Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Company and in the capacities and on the dates indicated.

<TABLE>
<S>                    <C>                                     <C>
March 18, 1999         Chairman of the Board                   /s/ Charles K. Dempster
                                                               -----------------------
                                                               Charles K. Dempster

March 18, 1999         Chief Executive Officer, President      /s/ F. Joesph Becraft
                       And Director                            -----------------------
                                                               F. Joseph Becraft
                                                               
March 18, 1999         Principal Accounting Officer            /s/ John G. Pascador
                                                               -----------------------
                                                               John G. Pascador

March 18, 1999         Director                                /s/ Jon L. Mosle, Jr.
                                                               -----------------------
                                                               Jon L. Mosle, Jr.

March 18, 1999         Director                                /s/ Gary L. Downey
                                                               -----------------------
                                                               Gary L. Downey

March 18, 1999         Director                                /s/ Edward K. Mills
                                                               -----------------------
                                                               Edward K. Mills
</TABLE>


                                      27
<PAGE>   30

                               INDEX TO EXHIBITS
<TABLE>
<CAPTION>
                                                                                                      SEQUENTIALLY
   EXHIBIT                                                                                              NUMBERED
   NUMBER                                      DESCRIPTION                                                PAGE
--------------      -------------------------------------------------------------                     ------------
<S>                 <C>                                                                               <C>
   * 3.1            Restated Certificate of Incorporation of Aquila Gas Pipeline
                       Corporation (Incorporated by reference herein to Exhibit
                       3.1 to the Registrant's Registration Statement on Form 
                       S-1, Registration Number 33-68226 dated September 1, 1993)
   * 3.2            Restated Bylaws of Aquila Gas Pipeline Corporation  
                       (Incorporated by reference herein to Exhibit 3.2 to the 
                       Registrant's Registration Statement on Form S-1, 
                       Registration Number 33-68226 dated September 1, 1993)
   *10.1            Purchase and Sale Agreement dated January 12, 1990 between
                       Phillips 66 Company and Aquila Southwest Energy 
                       Corporation (Incorporated by reference herein to Exhibit
                       10.1 to the Registrant's Registration Statement on Form 
                       S-1, Registration Number 33-68226 dated September 1, 
                       1993)
   *10.2            Note Purchase Agreement relating to 8.29% Senior Notes Due 
                       September 15, 2002 (Incorporated by reference herein to 
                       Exhibit 10.2 to the Registrant's Registration Statement 
                       on Form S-1, Registration Number 33-68226 dated 
                       September 1, 1993)
   *10.3            Revolving Credit Agreement dated August 1, 1992 between 
                       Aquila Energy Corporation and Aquila Southwest Energy 
                       Corporation (Incorporated by reference herein to Exhibit
                       10.5 to the Registrant's Registration Statement on Form 
                       S-1, Registration Number 33-68226 dated September 1, 1993)
   *10.4            Amendment No. 1 to Revolving Credit Agreement  dated August 1,
                       1992 between Aquila Energy Corporation and Aquila
                       Southwest Energy Corporation (Incorporated by reference
                       herein to Exhibit 10.6 to the Registrant's Registration
                       Statement on Form S-1, Registration Number 33-68226
                       dated September 1, 1993)
   *10.5            Agreement Relating to Services and Other Matters dated
                       as of August 1, 1993 between UtiliCorp United Inc. and
                       Aquila Gas Pipeline Corporation (Incorporated by
                       reference herein to Exhibit 10.7 to the Registrant's
                       Registration Statement on Form S-1, Registration Number
                       33-68226 dated September 1, 1993)
   *10.6            Agreement Relating to Services and Other Matters dated
                       as of August 1, 1993 between Aquila Energy Corporation
                       and Aquila Gas Pipeline Corporation (Incorporated by
                       reference herein to Exhibit 10.8 to the Registrant's
                       Registration Statement on Form S-1, Registration Number
                       33-68226 dated September 1, 1993)
   *10.7            Mooreland Gas Sale Agreement  between Aquila Energy Marketing
                       Corporation and Aquila Gas Systems Marketing Corporation
                       (Incorporated by reference herein to Exhibit 10.9 to the
                       Registrant's Registration Statement on Form S-1,
                       Registration Number 33-68226 dated September 1, 1993)
   *10.8            Elk City Gas Sale Agreement between Aquila Energy
                       Marketing Corporation and Aquila Gas Processing
                       Corporation (Incorporated by reference herein to Exhibit
                       10.10 to the Registrant's Registration Statement on Form
                       S-1, Registration Number 33-68226 dated September 1,
                       1993) 
</TABLE>




<PAGE>   31

<TABLE>
<CAPTION>
                                                                                                      SEQUENTIALLY
   EXHIBIT                                                                                              NUMBERED
   NUMBER                                      DESCRIPTION                                                PAGE
--------------      -------------------------------------------------------------                     ------------
<S>                 <C>                                                                               <C>
   *10.9            Tax Sharing Agreement dated August 27, 1993 among UtiliCorp
                       United Inc., Aquila Energy Corporation and Aquila Gas
                       Pipeline Corporation (Incorporated by reference herein
                       to Exhibit 10.11 to the Registrant's Registration
                       Statement on Form S-1, Registration Number 33-68226
                       dated September 1, 1993)
   *10.10           Form of gas purchase agreement between Aquila Gas Pipeline
                       Corporation and Clayton Williams, Jr., et. al., as
                       amended (Incorporated by reference herein to Exhibit
                       10.14 to the Registrant's Registration Statement on Form
                       S-1, Registration Number 33-68226 dated September 1,
                       1993)
   *10.11           Form of gas purchase agreement between Aquila Gas Pipeline 
                       Corporation and Union Pacific Resources Company
                       (Incorporated by reference herein to Exhibit 10.15 to
                       the Registrant's Registration Statement on Form S-1,
                       Registration Number 33-68226 dated September 1, 1993)
   *10.12           Revolving Credit Agreement dated September 26, 1994 between
                       Aquila Energy Corporation and Aquila Gas Pipeline
                       Corporation (Incorporated by reference herein to Exhibit
                       10.16 of the Form 10-Q for the quarterly period ended
                       September 30, 1994, File No. 1-12426)
   *10.13           First Amendment to Note Purchase Agreement dated November 10,
                       1994 relating to 8.29% Senior Notes due September 15,
                       2002 (Incorporated by reference herein to Exhibit 10.15
                       of the Form 10-K for the year ended December 31, 1994,
                       File No. 1-12426)
   *10.14           Acquisition Agreement for Tristar Gas Company and related 
                       companies dated January 17, 1995 (Incorporated by
                       reference herein to Exhibit 10.16 of the Form 10-K for
                       the year ended December 31, 1994, File No. 1-12426)
   *10.15           Amendment No. 2 to Revolving Credit Agreement dated August
                       1, 1992 between Aquila Energy Corporation and Aquila
                       Southwest Energy Corporation. (Incorporated by reference
                       herein to Exhibit 10.20 of the Form 10-Q for the
                       quarterly period ended September 30, 1995, File No.
                       1-12426)
   *10.16           Amendment Nz.1 to Revolving Credit Agreement dated September
                       26, 1994 between Aquila Energy Corporation and Aquila
                       Gas Pipeline Corporation (Incorporated by reference
                       herein to Exhibit 10.21 of the Form 10-Q for the
                       quarterly period ended September 30, 1995, File No.
                       1-12426)
   *10.17           Loan Agreement dated September 1, 1995 between Aquila Energy
                       Corporation and Aquila Gas Pipeline Corporation
                       (Incorporated by reference herein to Exhibit 10.22 of
                       the Form 10-Q for the quarterly period ended September
                       30, 1995, File No. 1-12426)
   *10.18           Amendment No.1 to Loan Agreement dated September 1, 1995 
                       between Aquila Energy Corporation and Aquila Gas
                       Pipeline Corporation (Incorporated by reference herein
                       to the Form 10-K for the year ended December 31, 1995,
                       File No. 1-12426)
   *10.19           Amendment No. 1 to Tax Sharing Agreement dated August 27, 
                       1993 among UtiliCorp United Inc., Aquila Energy
                       Corporation and Aquila Gas Pipeline Corporation
                       (Incorporated by reference herein to Exhibit 10.21 of
                       the Form 10-K for the year ended December 31, 1995, File
                       No. 1-12426)
   *10.20           Acquisition Agreement for Oasis Pipe Line Company dated June
                       6, 1996 between Dow Hydrocarbons and Resources Inc. and
                       AQP Holdings L.P. (Incorporated by reference herein to
                       Exhibit 10.1 of the Form 10-Q for the quarterly period
                       ended June 30, 1996, File No. 1-12426)
</TABLE>




<PAGE>   32

<TABLE>
<CAPTION>
                                                                                                      SEQUENTIALLY
   EXHIBIT                                                                                              NUMBERED
   NUMBER                                      DESCRIPTION                                                PAGE
--------------      -------------------------------------------------------------                     ------------
<S>                 <C>                                                                               <C>
   *10.21           Acquisition Agreement for Oasis Pipe Line Company dated 
                       August 28, 1996 between Dow Hydrocarbons and Resources
                       Inc. and AQP Holdings L.P. (Incorporated by reference
                       herein to Exhibit 10.1 of the Form 10-Q for the
                       quarterly period ended September 30, 1996, File No.
                       1-12426)
   *10.22           Note Agreement dated July 1, 1996 between Aquila Energy 
                       Corporation and AQP Holdings L.P. (Incorporated by
                       reference herein to Exhibit 10.2 of the Form 10-Q for
                       the quarterly period ended September 30, 1996, File No.
                       1-12426)
   *10.23           Amendment No. 3 to Revolving Credit Agreement dated August
                       1, 1992 between Aquila Energy Corporation and Aquila
                       Southwest Energy Corporation (Incorporated by reference
                       herein to Exhibit 10.3 of the Form 8-K Current Report
                       dated November 15, 1996, File No. 1-12426)
   *10.24           Amendment No. 2 to Revolving Credit Agreement dated September
                       26, 1994 between Aquila Energy Corporation and Aquila
                       Gas Pipeline Corporation (Incorporated by reference
                       herein to Exhibit 10.2 of the Form 8-K Current Report
                       dated November 15, 1996, File No. 1-12426)
   *10.25           Loan Agreement dated April 1, 1997 between Aquila Energy
                       Corporation and Aquila Gas Pipeline Corporation
                       (Incorporated by reference herein to Exhibit 10.1 of the
                       Form 10-Q for the quarterly period ended June 30, 1997,
                       File No. 1-12426)
    10.26           Agency Agreement Relating to Certain Marketing and Trading 
                       Services between Aquila Energy Marketing Corporation and
                       Aquila Gas Pipeline Corporation, et al, effective
                       January 1, 1999

          Management Contracts and Compensatory Plans or Arrangements

   *10.27           Stock Option Agreement dated October 29, 1996, between AQP 
                       Holdings L.P. and El Paso Natural Gas Company
                       (Incorporated by reference herein to Exhibit 10.1 of the
                       Form 8-K Current Report dated November 15, 1996, File
                       No. 1-12426)
   *10.28           Aquila Gas Pipeline Corporation Stock Appreciation Rights 
                       Plan (Incorporated by reference herein to Exhibit 10.12
                       to the Registrant's Registration Statement on Form S-1,
                       Registration Number 33-68226 dated September 1, 1993)
   *10.29           Employment Contract with Craig F. Strehl dated as of 
                       September 1, 1993, (Incorporated by reference herein to
                       Exhibit 10.13 to the Registrant's Registration Statement
                       on Form S-1, Registration Number 33-68226 dated
                       September 1, 1993)
   *10.30           Aquila Gas Pipeline Corporation 1994 Restricted Stock Plan
                       ( Incorporated by reference herein to Exhibit 10.19 of
                       the Form 10-K for the year ended December 31, 1994, File
                       No. 1-12426)
   *10.31           Change of Control Agreement dated June 29, 1995 between 
                       Aquila Gas Pipeline Corporation and Craig F. Strehl
                       (Incorporated by reference herein to Exhibit 10.23 of
                       the Form 10-Q for the quarterly period ended September
                       30, 1995, File No. 1-12426)
   *10.32           Amendment to Employment Contract dated June 12, 1995 between
                       Aquila Gas Pipeline Corporation and Craig F. Strehl
                       (Incorporated by reference herein to Exhibit 10.24 of
                       the Form 10-Q for the quarterly period ended September
                       30, 1995, File No. 1-12426)
   *10.33           Aquila Gas Pipeline Corporation Amended Stock Appreciation 
                       Rights Plan (Incorporated by reference herein to Exhibit
                       10.27 of the Form 10-K for the year ended December 31,
                       1995, File No. 1-12426)
   *10.34           Aquila Gas Pipeline Corporation 1996 Non-Employee Director
                       Stock Plan (Incorporated by reference herein to Exhibit
                       10.2 of the Form 10-Q for the quarterly period ended
                       June 30, 1996, File No. 1-12426)
</TABLE>


<PAGE>   33

<TABLE>
<CAPTION>
                                                                                                      SEQUENTIALLY
   EXHIBIT                                                                                              NUMBERED
   NUMBER                                      DESCRIPTION                                                PAGE
--------------      -------------------------------------------------------------                     ------------
<S>                 <C>                                                                               <C>
   *10.35           Aquila Gas Pipeline Corporation 1997 Stock Incentive Plan 
                       (Incorporated by reference herein to Appendix A to the 
                       Proxy Statement on Schedule 14A dated April 14, 1997,
                       File No. 1-12426)
   *10.36           Employment Letter Agreement with F. Joseph Becraft dated as
                       of July 11, 1997 (Incorporated  by reference herein to 
                       Exhibit 10.35 of the Form 10-K for the year ended 
                       December 31, 1997, File No. 1-12426)
    21.1            Subsidiaries of the Registrant
    23.1            Consent of Independent Public Accountants
    27.1            Financial Data Schedule
</TABLE>

---------------------------
     *    Exhibits marked with an asterisk are incorporated by reference as
          indicated pursuant to Rule 12(b)-23.



<PAGE>   34
            INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL
                               STATEMENT SCHEDULE


<TABLE>
<CAPTION>
                                                                                                        Page
                                                                                                      --------

<S>                                                                                                   <C>
Aquila Gas Pipeline Corporation and Subsidiaries Consolidated Financial Statements:
     Report of Independent Public Accountants.....................................................       F-2
     Consolidated Balance Sheets as of December 31, 1998 and 1997.................................       F-3
     Consolidated Statements of Income for the years ended December 31, 1998,
        1997 and 1996.............................................................................       F-4
     Consolidated Statements of Stockholders' Equity for the years ended
        December 31, 1998, 1997 and 1996..........................................................       F-5
     Consolidated Statements of Cash Flows for the years ended December 31, 1998,
        1997 and 1996.............................................................................       F-6
     Notes to Consolidated Financial Statements...................................................       F-7

Aquila Gas Pipeline Corporation Financial Statement Schedule:
     Schedule I-Parent Company Only Financial Statements..........................................       F-25
</TABLE>


                                      F-1

<PAGE>   35
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To Aquila Gas Pipeline Corporation:


We have audited the accompanying consolidated balance sheets of Aquila Gas
Pipeline Corporation (a Delaware corporation) and subsidiaries as of December
31, 1998 and 1997, and the related consolidated statements of income,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1998. These consolidated financial statements and the
schedule referred to below are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements and the 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 financial statements referred to above present fairly, in
all material respects, the financial position of Aquila Gas Pipeline
Corporation and subsidiaries as of December 31, 1998 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted
accounting principles.

Our audit was made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The supplemental Schedule I is presented for
purposes of complying with the Securities and Exchange Commission's rules and
is not a required part of the basic financial statements. The schedule has been
subjected to the auditing procedures applied in our audit of the basic
financial statements and, in our opinion, fairly states in all material
respects the financial data required to be set forth therein in relation to the
basic financial statements taken as a whole.


                                               /s/ ARTHUR ANDERSEN LLP

San Antonio, Texas
March 3, 1999


                                      F-2
<PAGE>   36

                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS

               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


<TABLE>
<CAPTION>
                                                                                             December 31,
                                                                                     ---------------------------
                                                                                         1998           1997
                                                                                     ------------   ------------
<S>                                                                                  <C>            <C>         
                                     ASSETS

       CURRENT ASSETS:
          Cash and cash equivalents ...............................................  $      2,121   $      5,276
          Income taxes receivable from UtiliCorp United Inc. ......................         3,307             --
          Accounts receivable .....................................................        92,011        102,420
          Inventories and exchanges ...............................................         5,929          1,637
          Materials and supplies ..................................................         5,918          6,026
                                                                                     ------------   ------------
              Total current assets ................................................       109,286        115,359
                                                                                     ------------   ------------

       INVESTMENT IN AFFILIATE, net ...............................................        97,100         96,257
                                                                                     ------------   ------------

       PIPELINE, PROPERTY, PLANT AND EQUIPMENT, at cost:
          Natural gas pipelines ...................................................       458,212        442,995
          Plants and processing equipment .........................................        80,882         76,375
                                                                                     ------------   ------------
                                                                                          539,094        519,370
          Less - Accumulated depreciation .........................................      (139,498)      (117,179)
                                                                                     ------------   ------------
                                                                                          399,596        402,191
                                                                                     ------------   ------------

       INTANGIBLE ASSETS, net .....................................................        27,766         30,926
                                                                                     ------------   ------------

       OTHER, net .................................................................         1,672          1,600
                                                                                     ------------   ------------

       TOTAL ASSETS ...............................................................  $    635,420   $    646,333
                                                                                     ============   ============

                      LIABILITIES AND STOCKHOLDERS' EQUITY

       CURRENT LIABILITIES:
          Current maturities of long-term debt ....................................  $     12,500   $     12,500
          Accounts payable ........................................................       106,452         91,425
          Accrued expenses ........................................................         5,733          6,002
          Accrued interest ........................................................         2,405          3,971
          Income taxes payable to UtiliCorp United Inc. ...........................            --          2,189
          Intercompany payable due to affiliated companies, net ...................         6,209          7,022
                                                                                     ------------   ------------
              Total current liabilities ...........................................       133,299        123,109
                                                                                     ------------   ------------

       LONG-TERM DEBT .............................................................       197,450        223,950
                                                                                     ------------   ------------
       DEFERRED INCOME TAXES ......................................................        77,916         75,774
                                                                                     ------------   ------------
       OTHER LONG-TERM LIABILITIES ................................................            --            145
                                                                                     ------------   ------------
       COMMITMENTS AND CONTINGENCIES (Note 7)
       STOCKHOLDERS' EQUITY:
          Preferred stock, $.01 par value, 10,000,000 shares authorized,
            none outstanding at December 31, 1998 and 1997 ........................            --             --
          Common stock, $.01 par value, 50,000,000 shares authorized, 29,400,000
            shares issued and outstanding at December 31, 1998 and 1997 ...........           294            294
          Additional paid-in capital ..............................................        90,297         90,297
          Retained earnings .......................................................       136,164        132,764
                                                                                     ------------   ------------
              Total stockholders' equity ..........................................       226,755        223,355
                                                                                     ------------   ------------

       TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY .................................  $    635,420   $    646,333
                                                                                     ============   ============
</TABLE>

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


                                      F-3
<PAGE>   37

                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

                       CONSOLIDATED STATEMENTS OF INCOME

                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)



<TABLE>
<CAPTION>
                                                                    Year Ended December 31,
                                                              -----------------------------------
                                                                 1998         1997        1996
                                                              ----------   ----------  ----------

<S>                                                           <C>          <C>         <C>       
       OPERATING REVENUES ..................................  $  893,182   $1,013,919  $  799,278
       ING REVENUES
                                                              ----------   ----------  ----------

       COSTS AND EXPENSES:
          Cost of sales ....................................     812,551      894,591     664,096
          Operating ........................................      21,268       22,597      23,637
          General and administrative .......................      16,350       15,611      19,485
          Depreciation and amortization ....................      26,417       25,588      23,734
                                                              ----------   ----------  ----------

              Total costs and expenses .....................     876,586      958,387     730,952
                                                              ----------   ----------  ----------

       INCOME FROM OPERATIONS ..............................      16,596       55,532      68,326

       INTEREST AND DEBT EXPENSES, net .....................      14,125       17,237      15,678

       OTHER INCOME AND (EXPENSE), net .....................         135          931        (211)

       EQUITY IN NET INCOME OF AFFILIATE ...................       1,105          903         105
                                                              ----------   ----------  ----------

       INCOME BEFORE INCOME TAXES ..........................       3,711       40,129      52,542

       (BENEFIT) PROVISION IN LIEU OF INCOME TAX EXPENSE ...      (1,158)      14,963      20,089
                                                              ----------   ----------  ----------

       NET INCOME ..........................................  $    4,869   $   25,166  $   32,453
                                                              ==========   ==========  ==========

       BASIC AND DILUTED EARNINGS PER SHARE ................  $      .17   $      .86  $     1.10
                                                              ==========   ==========  ==========
</TABLE>

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


                                      F-4
<PAGE>   38
                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


<TABLE>
<CAPTION>
                                                                                
                                                    Common Stock       Additional                 Total
                                               ----------------------   Paid-in     Retained   Stockholders'
                                                 Shares      Amount     Capital     Earnings      Equity
                                               ----------  ----------  ----------  ----------   ----------

<S>                                            <C>         <C>         <C>         <C>          <C>       
  BALANCE, December 31, 1995 ................  29,400,000  $      294  $   90,297  $   78,082   $  168,673
     Cash dividends paid, $.05 per share ....          --          --          --      (1,468)      (1,468)
     Net income .............................          --          --          --      32,453       32,453
                                               ----------  ----------  ----------  ----------   ----------

  BALANCE, December 31, 1996 ................  29,400,000         294      90,297     109,067      199,658
     Cash dividends paid, $.05 per share ....          --          --          --      (1,469)      (1,469)
     Net income .............................          --          --          --      25,166       25,166
                                               ----------  ----------  ----------  ----------   ----------

  BALANCE, December 31, 1997 ................  29,400,000         294      90,297     132,764      223,355
     Cash dividends paid, $.05 per share ....          --          --          --      (1,469)      (1,469)
     Net income .............................          --          --          --       4,869        4,869
                                               ----------  ----------  ----------  ----------   ----------

  BALANCE, December 31, 1998 ................  29,400,000  $      294  $   90,297  $  136,164   $  226,755
                                               ==========  ==========  ==========  ==========   ==========
</TABLE>



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


                                      F-5
<PAGE>   39

                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

                                 (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                                Year Ended December 31,
                                                                         ------------------------------------
                                                                            1998         1997         1996
                                                                         ----------   ----------   ----------

     CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                                      <C>          <C>          <C>       
        Net  income ...................................................  $    4,869   $   25,166   $   32,453
        Adjustments to reconcile net income to net cash provided by
           operating activities:
          Depreciation and amortization ...............................      26,417       25,588       23,734
          Deferred income taxes .......................................       2,142        6,787       10,507
          Dividends from affiliate ....................................         262        1,142          585
          Equity in net income of affiliate ...........................      (1,105)        (903)        (105)
          Other non-cash items ........................................          15       (1,032)         755
       Changes in operating assets and liabilities,
          net of the effect of acquisitions and dispositions ..........      13,108       (5,219)       6,648
                                                                         ----------   ----------   ----------

          Net cash provided by operating activities ...................      45,708       51,529       74,577
                                                                         ----------   ----------   ----------

     CASH FLOWS FROM INVESTING ACTIVITIES:
       Business acquisitions, net of cash acquired ....................          --           --     (133,138)
       Additions to pipeline, property, plant and equipment ...........     (22,643)     (28,486)     (27,496)
       Proceeds from asset dispositions ...............................       1,888       20,426          168
       Other ..........................................................          --          848         (827)
                                                                         ----------   ----------   ----------

          Net cash used in investing activities .......................     (20,755)      (7,212)    (161,293)
                                                                         ----------   ----------   ----------

     CASH FLOWS FROM FINANCING ACTIVITIES:
        (Payments) borrowings under revolving credit agreements, net ..     (14,000)     (56,624)     110,324
        Borrowings under loan agreements ..............................          --       16,250           --
        Principal payments of debt ....................................     (12,500)     (14,566)     (12,835)
        Dividends paid ................................................      (1,469)      (1,469)      (1,468)
        Other .........................................................        (139)        (351)        (252)
                                                                         ----------   ----------   ----------

          Net cash (used in) provided by financing activities .........     (28,108)     (56,760)      95,769
                                                                         ----------   ----------   ----------

     NET (DECREASE) INCREASE  IN CASH AND CASH EQUIVALENTS ............      (3,155)     (12,443)       9,053

     CASH AND CASH EQUIVALENTS, beginning of year .....................       5,276       17,719        8,666
                                                                         ----------   ----------   ----------

     CASH AND CASH EQUIVALENTS, end of year ...........................  $    2,121   $    5,276   $   17,719
                                                                         ==========   ==========   ==========
</TABLE>



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


                                      F-6
<PAGE>   40
                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


1.    SUMMARY OF BUSINESS, BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING
      POLICIES:

      BUSINESS

      Aquila Gas Pipeline Corporation owns and operates natural gas gathering
and pipeline systems and gas processing plants and is engaged in the business
of purchasing, gathering, transporting, processing, storing and marketing
natural gas and natural gas liquids (NGLs), primarily in the states of Texas
and Oklahoma.

      PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION

      The accompanying consolidated financial statements include the historical
operations and accounts of Aquila Gas Pipeline Corporation and subsidiaries
(referred to herein as the Company). The Company's interests in certain
business entities similar to joint ventures are proportionately consolidated.
The Company's 35% investment in the capital stock of Oasis Pipe Line Company
(Oasis), acquired in 1996 (see Note 8), is accounted for using the equity
method of accounting; see Note 11 for additional information. All significant
intercompany transactions have been eliminated in consolidation.

      Approximately 18% of the Company's common stock is held by the public
while Aquila Energy Corporation (Aquila Energy) holds the remaining 82%. Aquila
Energy is a wholly-owned subsidiary of UtiliCorp United Inc. (UtiliCorp).

      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 and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. The more significant areas requiring the use of estimates
relate to the fair value of financial instruments and useful lives for
depreciation and amortization. Actual results may differ from those estimates.

      The Company is subject to a number of risks inherent in the industry in
which it operates, primarily fluctuating prices and gas supply. The Company's
financial condition and results of operations will depend significantly upon
the prices received for natural gas and NGLs. These prices are subject to wide
fluctuation due to a variety of factors that are beyond the control of the
Company. In addition, the Company must continually connect new wells to its
gathering systems in order to maintain or increase throughput levels to offset
natural declines in dedicated volumes. The number of new wells drilled will
depend on a variety of factors that are beyond the control of the Company.


                                      F-7
<PAGE>   41

                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


1.    SUMMARY OF BUSINESS, BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING
      POLICIES: (CONTINUED)

      STATEMENTS OF CASH FLOWS

      In order to determine net cash provided by operating activities, net
income has been adjusted by, among other things, changes in current assets and
current liabilities, excluding changes in cash and cash equivalents. The
Company's cash equivalents are all liquid, short-term investments with original
maturities of three months or less. The changes in operating assets and
liabilities, net of the effects of acquisitions and dispositions, are as
follows:

<TABLE>
<CAPTION>
                                                                      Year Ended December 31,
                                                               ------------------------------------
                                                                  1998         1997         1996
                                                               ----------   ----------   ----------
<S>                                                            <C>          <C>          <C>       
                  (Increase) Decrease in:
                    Income taxes receivable from UtiliCorp ..  $   (3,307)  $       --   $       --
                    Accounts receivable .....................      10,409       54,998      (79,464)
                    Inventories and exchanges ...............      (4,292)       1,127        1,591
                    Materials and supplies ..................         108       (1,941)       1,624

                  Increase (Decrease) in:
                    Accounts payable ........................      15,027      (61,870)      76,810
                    Accrued expenses ........................        (269)      (2,848)       2,962
                    Accrued interest ........................      (1,566)        (422)       1,639
                    Income taxes payable to UtiliCorp .......      (2,189)        (645)       2,005
                    Intercompany payable due to
                     affiliated companies, net ..............        (813)       6,382         (519)
                                                               ----------   ----------   ----------

                        Total ...............................  $   13,108   $   (5,219)  $    6,648
                                                               ==========   ==========   ==========
</TABLE>

      The following provides information related to cash paid for interest and
income taxes by the Company:

<TABLE>
<CAPTION>
                                                                     Year Ended December 31,
                                                               ----------------------------------
                                                                  1998        1997        1996
                                                               ----------  ----------  ----------

<S>                                                            <C>         <C>         <C>       
                  Interest, net of amount capitalized .......  $   15,712  $   17,787  $   14,462
                  Taxes .....................................  $    2,248  $    9,061  $    7,577
</TABLE>

      REVENUE RECOGNITION

      Operating revenues are recognized upon the delivery of natural gas or
NGLs to the buyer of the related products or services.

      INVENTORIES AND EXCHANGES

      Inventories consist of NGLs products, which are stated at the lower of
cost (determined on a first-in, first-out basis) or market value, and natural
gas in storage, which is stated on a mark-to-market basis. Exchanges consist of
natural gas and NGLs delivery imbalances which are presented net on the
accompanying consolidated balance sheets. NGLs imbalances are stated at amounts
not in excess of market value. Natural gas imbalances are accounted for on a
mark-to-market basis.

      MATERIALS AND SUPPLIES

      Materials and supplies are stated at the lower of cost (determined on a
first-in, first-out basis) or market.


                                      F-8
<PAGE>   42
                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)



1.    SUMMARY OF BUSINESS, BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING
      POLICIES: (CONTINUED)

      COMMODITY RISK MANAGEMENT:

      NON-TRADING ACTIVITIES

      The Company utilizes various exchange-traded and over-the-counter
commodity financial instrument contracts to hedge natural gas and NGLs. These
consist primarily of futures, options, forward contracts and swaps. Financial
instruments are designated as a hedge at inception. Hedges of anticipated
transactions are accounted for under the deferral method with gains and losses
on these transactions recognized in revenues when the hedged transaction
occurs.

      Gains and losses on the early termination or maturity of commodity
financial instrument contracts designated as hedges are deferred and included
in revenues in the period the hedged transaction is recorded. If the direct
relationship to price risk ceases to exist, the difference in the carrying
value and fair value is recognized as a gain or loss in revenues in the period
the direct relationship ceases to exist. Changes in fair value are recognized
as gains or losses in revenues in the period of change. Most of the Company's
hedging activities have tended to reduce the Company's participation in rising
margins but are intended to limit the Company's exposure to loss during periods
of declining margins.

      TRADING ACTIVITIES

      Contracts entered into for trading purposes are accounted for under the
mark-to-market method. Under mark-to-market accounting, these contracts,
including both physical transactions and financial instruments, are recorded at
market value, net of allowances. The market prices used to value these
transactions reflect management's estimates considering various factors
including closing exchange and over-the-counter quotations, time value and
volatility factors of the underlying commitments. The values are adjusted to
reflect the potential impact of liquidating a position in an orderly manner
over a reasonable period of time under present market conditions. Changes in
the market value of these contracts are recognized as gains or losses in
revenues currently and are recorded in the consolidated balance sheet as
current assets and current liabilities at market value at the reporting date.

      PIPELINE, PROPERTY, PLANT AND EQUIPMENT

      Pipeline, property, plant and equipment are stated at cost. Additions and
improvements that add to the productive capacity or extend the useful life of
the asset are capitalized. Expenditures for maintenance and repairs are charged
to expense as incurred. Upon disposition or retirement of pipeline components
or gas plant components, any gain or loss is recorded to accumulated
depreciation. When entire pipeline systems, gas plants or other property and
equipment are retired or sold, any gain or loss is included in operations.

      Depreciation of the pipeline systems, gas plants and processing equipment
is provided using the straight-line composite method rate primarily based on an
estimated useful life of 25 years. Interest cost on funds used to finance major
pipeline projects during their construction period is capitalized. Capitalized
interest cost was $126, $155 and $173 during 1998, 1997 and 1996, respectively.

      Construction work in progress at December 31, 1998 and 1997 was $2,179
and $4,329, respectively.


                                      F-9

<PAGE>   43
                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


1.    SUMMARY OF BUSINESS, BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING
      POLICIES: (CONTINUED)


      INTANGIBLE ASSETS

      Intangible assets are recorded at cost and are generally amortized on a
straight-line basis over their estimated useful lives. Intangible assets
consist of the following:


<TABLE>
<CAPTION>
                                                        Estimated               December 31,
                                                       Useful Life      -----------------------------
                                                        In Years           1998             1997
                                                      -------------     -----------      ------------

<S>                                                   <C>               <C>              <C>         
  Gathering producer relationship..................        12           $    14,015      $     14,015
  Transportation rights............................        23                18,620            18,620
  Excess cost over the fair value
    of net assets acquired.........................        10                11,472            11,472
                                                                        -----------      ------------
                                                                             44,107            44,107
  Less:  Accumulated amortization..................                         (16,341)          (13,181)
                                                                        -----------      ------------
       Total.......................................                     $    27,766      $     30,926
                                                                        ===========      ============
</TABLE>

      The transportation rights (see Note 8) had an estimated useful life of
approximately 23 years at acquisition. In 1998, Oasis restructured its
commercial operations and amended its owner transportation agreements to permit
the release of firm owner capacity to third parties. Management believes the
restructuring and amended transportation agreements provide the Company with
similar economic value.

      Amortization expense associated with intangible assets was $3,160, $3,414
and $2,753 for the years ended December 31, 1998, 1997 and 1996, respectively.

      INCOME TAXES

      The Company is included in the consolidated federal income tax return
filed by UtiliCorp. Under a formal tax sharing agreement, as amended, between
the Company, Aquila Energy and UtiliCorp, the Company will pay to UtiliCorp the
amount of its current tax liability as if the Company were filing a separate
tax return for tax years in which the Company generates current taxable income.
For tax periods in which the Company generates current tax losses, the Company
will receive the benefit of such losses only to the extent it is able to offset
taxable income generated in years subsequent to the 1992 tax year. In the event
additional income taxes, penalties and interest are assessed by tax authorities
as a result of examinations, the formal tax sharing agreement provides for the
payment terms by the Company of assessed amounts.

      The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards (SFAS) No. 109 which requires that deferred tax
assets and liabilities be established for the basis differences between the
reported amounts of assets and liabilities for financial reporting purposes and
income tax purposes.



                                     F-10

<PAGE>   44

                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


1.    SUMMARY OF BUSINESS, BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING
      POLICIES: (CONTINUED)

      EARNINGS PER SHARE

      In 1997, the Financial Accounting Standards Board (FASB) issued SFAS No.
128, "Earnings per Share." SFAS No. 128 established new standards for computing
and presenting earnings per share (EPS). At December 31, 1997, the Company
adopted SFAS No. 128. The following is a reconciliation of the weighted average
number of common shares outstanding for basic and diluted EPS for each
respective period:

<TABLE>
<CAPTION>
                                                               Year Ended December 31,
                                                      ----------------------------------------
                                                          1998          1997          1996
                                                      ------------  ------------  ------------
<S>                                                   <C>           <C>           <C>         
          Income available to common stockholders ..  $      4,869  $     25,166  $     32,453
                                                      ------------  ------------  ------------

          Weighed average shares outstanding:
            Basic shares outstanding ...............    29,400,000    29,400,000    29,400,000
          Effect of dilutive securities:
            Options ................................         9,069         1,331            --
                                                      ------------  ------------  ------------
            Diluted shares outstanding .............    29,409,069    29,401,331    29,400,000
                                                      ------------  ------------  ------------

          Basic and diluted earnings per share .....  $        .17  $        .86  $       1.10
                                                      ============  ============  ============
</TABLE>

      Certain options to purchase 131,000 and 45,000 weighted average shares of
common stock at prices ranging from $10.94 to $14.00 per share were outstanding
during 1998 and 1997, respectively, but were not included in the computation of
diluted EPS because the options' exercise price was greater than the average
market price of the underlying common shares and the impact of including such
shares would be anti-dilutive. The Company began issuing its stock options in
1997.

      NEW ACCOUNTING STANDARDS

      In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards for derivative instruments and for hedging activities.
Adoption of SFAS No. 133 is required for all fiscal quarters of all fiscal
years beginning after June 15, 1999, although earlier adoption is encouraged.
The Company is currently evaluating the potential impact of SFAS No. 133.

      In 1998, the FASB's Emerging Issues Task Force issued abstract No. 98-10,
"Accounting for Energy Trading and Risk Management Activities." This abstract
focuses on the accounting for the purchase and sale of energy trading
contracts. The Company is analyzing the potential impact of this abstract upon
issuance.


                                     F-11
<PAGE>   45
                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


2.    RELATED PARTY TRANSACTIONS:

      The Company enters into various types of transactions with Oasis, Aquila
Energy and UtiliCorp. The Company sells natural gas to Aquila Energy and
subsidiaries of UtiliCorp and purchases natural gas from Aquila Energy. Aquila
Energy enters into certain natural gas and NGLs hedging transactions with or on
behalf of the Company. Additionally, the Company reimburses Aquila Energy and
UtiliCorp, under a formal service agreement, for the direct and indirect costs
of certain Aquila Energy and UtiliCorp employees who provide services to the
Company and for other costs (primarily general and administrative expenses)
related to the Company's operations. Aquila Energy and UtiliCorp allocate
indirect costs to the Company using a formula based upon the ratio of the
Company's levels of revenues, net pipeline, property, plant and equipment and
number of personnel to the total consolidated Aquila Energy or UtiliCorp levels
for such factors. Management of the Company believes that the use of such a
formula results in a reasonable allocation of indirect costs. Aquila Energy
also provides the Company and its subsidiaries with financing agreements, as
described in Note 3. Additionally, the Company transports gas on the Oasis
Pipeline (see Note 8).

     Effective January 1, 1999, the Company entered into an agreement with
Aquila Energy Marketing (AEM), a wholly-owned subsidiary of Aquila Energy, to
conduct its natural gas marketing activities. Under the agreement, AEM will
conduct all natural gas marketing activities on behalf of the Company. The
Company will receive all gross margins associated with such marketing
activities and will reimburse to AEM all costs associated with performing these
services. All previous employees of the Company in this natural gas marketing
capacity have been employed by AEM.

      The following table summarizes transactions between the Company and
related parties for the indicated periods:

<TABLE>
<CAPTION>
                                                                      Year Ended December 31,
                                                               -----------------------------------
                                                                  1998        1997         1996
                                                               ----------  ----------   ----------
<S>                                                            <C>         <C>          <C>       
          Natural gas sales to UtiliCorp subsidiaries
            and Aquila Energy ...............................  $   64,977  $   55,886   $   24,929
          Purchases of natural gas from Aquila Energy .......      31,639      45,190       14,278
          Oasis transport fees ..............................       7,560       7,757        2,728
          Recognized loss (gain) from hedging transactions
            with Aquila Energy ..............................       1,247      (7,545)      (1,628)
          Interest expense with Aquila Energy and UtiliCorp..      10,136      11,403        9,061
          Reimbursement of direct costs to
            Aquila Energy and UtiliCorp .....................       2,304       2,012        2,808
          Service agreement expenses charged by
            Aquila Energy and UtiliCorp .....................       3,795       3,972        4,374
</TABLE>

<TABLE>
<CAPTION>
                                                                     December 31,
                                                               -----------------------
                                                                  1998         1997
                                                               ----------   ----------
<S>                                                            <C>          <C>       
          Trade accounts (payable to) receivable from
            affiliated companies, net .......................  $     (783)  $    6,792
          Accrued interest payable to affiliated companies ..       1,119        2,460
</TABLE>



                                     F-12

<PAGE>   46

                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


2.    RELATED PARTY TRANSACTIONS:  (CONTINUED)

      The following table summarizes the activity in the intercompany payable
account between the Company and affiliated companies:


<TABLE>
<CAPTION>
                                                                     Year Ended December 31,
                                                               -----------------------------------
                                                                  1998         1997        1996
                                                               ----------   ----------  ----------

<S>                                                            <C>          <C>         <C>       
         Balance at beginning of year .......................  $    7,022   $    1,038  $    1,557
           Service agreement expenses and direct costs ......       6,099        5,984       7,182
           Repayments .......................................      (6,912)          --      (7,701)
                                                               ----------   ----------  ----------
         Balance at end of year .............................  $    6,209   $    7,022  $    1,038
                                                               ==========   ==========  ==========

         Weighted average balance outstanding during year ...  $    5,385   $    3,957  $    2,497
                                                               ==========   ==========  ==========
</TABLE>


3.    DEBT:

      The following table summarizes the long-term debt of the Company:


<TABLE>
<CAPTION>
                                                                               December 31,
                                                                         -----------------------
                                                                            1998         1997
                                                                         ----------   ----------
<S>                                                                      <C>          <C>       
Revolving credit agreements, bearing interest at the Eurodollar loan
 rate (6.29% at December 31, 1998 and 6.59% at December 31, 1997).....   $   93,700   $  107,700
Loan agreement bearing interest at 6.47%, due 2005 ....................      50,000       50,000
Loan agreement bearing interest at 6.83%, due 2006 ....................      16,250       16,250
8.29% Senior notes, due 2002 ..........................................      50,000       62,500
                                                                         ----------   ----------
  Total debt ..........................................................     209,950      236,450
Less:  Current maturities of long-term debt ...........................     (12,500)     (12,500)
                                                                         ----------   ----------
   Total long-term debt ...............................................  $  197,450   $  223,950
                                                                         ==========   ==========
</TABLE>

      Maturities of long-term debt as of December 31, 1998 are $12,500 in 1999,
$106,200 in 2000, $12,500 in 2001, $12,500 in 2002, $0 in 2003 and $66,250
thereafter.

      REVOLVING CREDIT AGREEMENTS

      The Company and its subsidiaries maintain credit agreements, as amended,
with Aquila Energy that provide revolving credit facilities for borrowings. On
February 1, 1998, the Company voluntarily reduced the commitment, by $10,000,
of its revolving credit agreements with Aquila Energy. The Company had a
commitment of $115,000 with $21,300 unused as of December 31, 1998. The
revolvers bear interest at the Company's election of either a base rate (the
higher of a bank prime rate or 1/2 of 1% above the Federal Funds rate), an
adjusted certificate of deposit rate or a Eurodollar rate. The maturity dates
of the revolvers automatically renew in one-year periods from each commitment
period (the fourth quarter of any given year) unless Aquila Energy gives at
least a one-year notice not to renew from the commitment period. Currently, the
maturity dates are in the fourth quarter of 2000. The notes are unsecured and
$50,000 of the revolving credit facilities are subordinate to the 8.29% senior
notes described below. Annual commitment fees of 1/4 of 1% on the unutilized
portion of the revolving credit facilities are paid to Aquila Energy.



                                     F-13
<PAGE>   47

                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


3.    DEBT: (CONTINUED)

      The revolving credit agreements require the Company to comply with
certain restrictive covenants. At December 31, 1998, the Company was in
compliance with such covenants.

      In 1996, the Company entered into an unsecured $3,000 revolving note
agreement with Aquila Energy. The note bears interest at a bank prime rate and
matures in December 1999. In 1997, the revolving note agreement was paid off
and there was not a balance outstanding at December 31, 1998 or 1997.

      LOAN AGREEMENTS

      The Company has a loan agreement (the Loan) with Aquila Energy for
$50,000. The Loan is unsecured and bears interest at 6.47% due semi-annually.
The principal amount of the Loan shall be repaid to Aquila Energy by June 1,
2005. In 1997, the Company entered into another Loan Agreement (the Loan
Agreement) with Aquila Energy for $16,250. This Loan Agreement is unsecured and
bears interest at 6.83% due semi-annually. The principal amount of the Loan
Agreement shall be repaid to Aquila Energy by October 15, 2006.

      Both loans require the Company to comply with certain financial covenants
as well as limit the activities of the Company in other ways. At December 31,
1998, the Company was in compliance with such covenants.

      SENIOR NOTES

      The 8.29% senior notes (Senior Notes) are unsecured and bear interest at
8.29% due semi-annually. Principal payments of $12,500 are required each year
until final maturity in September 2002. Upon issuance of the Senior Notes the
Company deferred approximately $1,886 of initial fees and expenses and is
amortizing such deferred financing costs over the life of the notes.

      The Senior Notes contain various restrictive covenants, which among
others, limit the sale of assets, additional indebtedness of a subsidiary, and
the ability to make certain restricted payments, including restrictions on the
ability to make dividend payments for amounts in excess of those calculated in
accordance with the covenants. The Senior Notes also require a subsidiary of
the Company to maintain certain financial covenants related to cash flow, fixed
charges and net worth. At December 31, 1998, the subsidiary of the Company was
in compliance with such requirements and had the ability to pay restricted
payments of approximately $69,816.

      LINE OF CREDIT

      The Company had an agreement with a bank whereby standby letters of
credit could be issued (see Note 7) in an aggregate amount not to exceed the
lesser of $16,000 or a borrowing base as calculated monthly under the
agreement. At December 31, 1998, the borrowing base was $16,000 with no
principal outstanding. This line of credit was secured by the accounts
receivable of certain subsidiaries of the Company and any draw under a letter
of credit beared interest at the bank's prime rate plus 2%, payable monthly.
This line of credit expired on December 31, 1998 and any outstanding letters of
credit will expire no later than March 31, 1999.

4.    INCOME TAXES:

      Components of income tax (benefit) provision in lieu of income tax
expense are as follows:

<TABLE>
<CAPTION>
                                        Year Ended December 31,
                                 -----------------------------------
                                    1998         1997         1996
                                 ----------   ----------  ----------
<S>                              <C>          <C>         <C>       
               Federal:
                 Current ......  $   (3,300)  $    7,890  $    9,279
                 Deferred .....       4,183        5,268       8,445
               State:
                 Current ......          --          287         303
                 Deferred .....      (2,041)       1,518       2,062
                                 ==========   ==========  ==========
                   Total ......  $   (1,158)  $   14,963  $   20,089
                                 ==========   ==========  ==========
</TABLE>


                                     F-14

<PAGE>   48

                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


4.    INCOME TAXES: (CONTINUED)

      Income tax (benefit) provision in lieu of income tax expense is different
than the amount computed by applying the statutory federal income tax rate to
income before income taxes. The reasons for these differences are as follows:

<TABLE>
<CAPTION>
                                                                      Year Ended December 31,
                                                              --------------------------------------
                                                                 1998          1997          1996
                                                              ----------    ----------    ----------

<S>                                                           <C>           <C>           <C>  
            Federal statutory tax rate .....................        35.0%         35.0%         35.0%
            State income taxes, net of federal benefit .....       (55.0)          2.9           2.9
            Other ..........................................       (11.2)         (0.6)          0.3
                                                              ----------    ----------    ----------
                                                                   (31.2)%        37.3%         38.2%
                                                              ==========    ==========    ==========
</TABLE>

      The components of the net deferred tax liability of the Company are as
follows:

<TABLE>
<CAPTION>
                                                                    December 31,
                                                              -----------------------
                                                                 1998         1997
                                                              ----------   ----------

<S>                                                           <C>          <C>       
            Deferred tax liabilities .......................  $  105,946   $   99,613
            Deferred tax assets ............................     (28,030)     (23,839)
            Valuation allowance on deferred tax assets .....          --           --
                                                              ----------   ----------
                                                              $   77,916   $   75,774
                                                              ==========   ==========
</TABLE>

      The deferred tax liabilities noted above arise primarily from the excess
of tax depreciation over book depreciation. The deferred tax assets noted above
relate primarily to alternative minimum tax (AMT) credit carryforwards and net
operating loss carryforwards (NOL). See Note 1, "Income Taxes," for a
description of the tax sharing agreement between the Company, Aquila Energy and
UtiliCorp. A valuation allowance is provided when it is more likely than not
that some portion of the deferred tax assets will not be realized.

      At December 31, 1998, the Company has NOLs of approximately $13,400 which
will expire in 2018 and AMT credit carryforwards of approximately $23,000 which
have no expiration date.

      UtiliCorp has agreed with the Internal Revenue Service (IRS) on certain
tax issues as a result of the IRS audits of certain UtiliCorp federal income
tax returns for the years 1990 through 1993 (herein referred to as "agreed-upon
tax issues"). In accordance with the provisions of the tax sharing agreement
(see Note 1), UtiliCorp assessed the Company $3,502 for these agreed-upon tax
issues. The Company paid UtiliCorp this amount in 1997 and the first quarter of
1998. The payment of the income taxes associated with these agreed-upon tax
issues had no effect on net income but an adjustment was made to the deferred
tax liability.

5.    MAJOR CUSTOMERS:

      The Company had gross sales as a percentage of total revenues to
non-affiliated major customers as follows:

<TABLE>
<CAPTION>
                                       Year Ended December 31,
                                ------------------------------------
                                   1998         1997         1996
                                ----------   ----------   ----------

<S>                             <C>          <C>          <C>
           Customer A ........          10%          12%          11%
           Customer B ........           9%          11%          11%
</TABLE>


                                     F-15

<PAGE>   49
                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


5     MAJOR CUSTOMERS: (CONTINUED)

      The Company's natural gas operations have a concentration of customers in
natural gas transmission, distribution and marketing as well as industrial
end-users while its NGLs operations have a concentration of customers in the
refining and petrochemical industries. These concentrations of customers may
impact the Company's overall exposure to credit risk, either positively or
negatively, in that the customers may be similarly affected by changes in
economic or other conditions. However, management believes that the Company's
portfolio of accounts receivable is sufficiently diversified to minimize any
potential credit risk. Historically, the Company has not incurred significant
problems in collecting its accounts receivable and, as such, no allowance for
doubtful accounts has been provided in the accompanying consolidated financial
statements. The Company's accounts receivable are generally not collateralized.

6     RETIREMENT AND BENEFIT PLANS:

      UtiliCorp and its subsidiaries have a defined contribution plan for
virtually all employees. Pursuant to the plan, employees can defer a portion of
their compensation and contribute it to a deferred account. The Company's
matching contribution to the plan was $698, $679 and $639 in 1998, 1997 and
1996, respectively.

      The Company has a stock contribution plan under which eligible employees
receive a Company contribution of 3% of their base income in UtiliCorp's common
stock. The Company's expense associated with this plan was $356, $357 and $345
for 1998, 1997 and 1996, respectively.

      The Company has a stock option plan under which eligible employees were
granted options to purchase shares of UtiliCorp's common stock. The plan
provides that the options will not be granted at a price below the market price
at the date of grant. The options vest one year from the date of grant and
expire ten years from the date of grant.

      The following table summarizes the UtiliCorp options granted to company
employees:

<TABLE>
<CAPTION>
                                                             Year Ended December 31,
                                     -------------------------------------------------------------------------
                                              1998                      1997                     1996
                                     -----------------------  -----------------------  -----------------------
                                                   Average                  Average                 Average
                                      Options       Price      Options       Price      Options       Price
                                     ----------   ----------  ----------   ----------  ----------   ----------
<S>                                  <C>          <C>         <C>          <C>         <C>          <C>       
Outstanding, beginning of period ..      21,100   $    27.31      26,050   $    27.31      26,750   $    27.31
  Granted .........................      49,950   $    36.03          --           --          --           --
  Exercised .......................     (15,950)  $    27.31      (4,100)  $    27.31        (400)  $    27.31
  Forfeited .......................        (850)  $    36.03        (850)  $    27.31        (300)  $    27.31
                                     ----------               ----------               ----------             
Outstanding, end of period ........      54,250   $    35.20      21,100   $    27.31      26,050   $    27.31
                                     ==========               ==========               ==========             
</TABLE>

      Options granted prior to 1996 are not subject to the provisions of SFAS
No. 123, "Accounting for Stock-Based Compensation."

                                     F-16

<PAGE>   50
                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


6.    RETIREMENT AND BENEFIT PLANS: (CONTINUED)

      The Company has a stock appreciation rights plan, as amended, for key
members of management. Under the plan, the Company can award a total of 700,000
stock appreciation rights (SAR), each SAR giving the holder, upon exercise, the
right to receive a cash payment for the difference between the fair market
value of the Company's common stock on the date of grant and the fair market
value on the exercise date. Each SAR has a term of ten years from the date of
grant in which the employee may exercise the SAR. At the end of each reporting
period within the exercise period, the Company records an adjustment to
deferred compensation expense based upon the excess, if any, of the fair market
value of the Company's common stock and the option price of the related SAR. At
December 31, 1998, there were 104,844 SARs outstanding at an average price of
$11.879 per SAR. The Company's expense with respect to this plan in 1998 was
$175 while the benefit associated with this plan was $711 in 1997 with an
expense of $873 in 1996.

      The Company awards its common stock to certain employees of the Company
as restricted stock awards. The shares issued as restricted stock awards are
held by the Company until certain restrictions lapse, generally on the second
or third award anniversary. The restricted stock, when awarded, is amortized to
compensation expense over a two to three year period. At December 31, 1998,
there were 8,547 stock awards outstanding. The Company's expense associated
with the restricted stock awards was $24, $81 and $75 for 1998, 1997 and 1996,
respectively.

      In 1996, the Company's stockholders approved the 1996 Non-Employee
Director Stock Plan (Stock Plan). The Stock Plan authorizes the issuance of a
maximum of 100,000 shares of the Company's common stock based on the fair
market value of the Company's common stock on the date of issuance. Each
non-employee director is to receive common stock of the Company equal to $2 on
a quarterly basis for services performed in the preceding quarter. In 1998,
1997 and 1996, 1,534, 1,124 and 298 shares, respectively, of the Company's
common stock were issued and $16, $16 and $4 of expense was recognized under
the Stock Plan.

      In 1997, the Company's stockholders approved the Aquila Gas Pipeline
Corporation 1997 Stock Incentive Plan (the Plan), which provides for the
granting of incentive stock options, nonqualified stock options, awards of
restricted stock, stock appreciation rights, performance units or performance
shares and other stock-based awards to eligible employees. The Company has
reserved 500,000 shares of common stock for issuance in accordance with the
Plan. Stock options vest pursuant to the individual stock option agreements
with unexercised options expiring 10 years from the date of grant. These
options vest at 25% after the second anniversary, 25% after the third
anniversary and the remaining 50% after the fourth anniversary of the grant
date.

      The Company has adopted SFAS No. 123 but has elected to continue to
account for employee stock-based compensation under the provisions of
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees." Accordingly, no compensation expense has been recognized for
options granted to employees where the exercise price is greater than or equal
to the market price of the underlying stock at the date of grant.

      Option activity with respect to the Plan for the years ended December 31,
1998 and 1997 is summarized as follows:

<TABLE>
<CAPTION>
                                                                   Weighted
                                                      Number        Average
                                                        Of          Exercise
                                                      Shares     Price Per Share
                                                    ----------   ---------------
<S>                                                 <C>          <C>    
              Outstanding, December 31, 1996 .....           0              --
                  Granted ........................      81,000      $    13.05
                  Forfeited ......................     (11,000)     $    14.00
                                                    ----------      ----------
              Outstanding, December 31, 1997 .....      70,000      $    12.91
                  Granted ........................      61,000      $    11.44
                  Forfeited ......................     (52,000)     $    12.72
                                                    ----------      ----------
              Outstanding, December 31, 1998 .....      79,000      $    11.90
                                                    ==========      ==========
</TABLE>


                                     F-17

<PAGE>   51
                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

              (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS )


6     RETIREMENT AND BENEFIT PLANS: (CONTINUED)


      At December 31, 1998 and 1997, there were no options exercisable. The
weighted average fair value and weighted average exercise price, respectively,
of options granted where the exercise price was equal to the market price of
the underlying stock at the grant date were $8.57 and $11.44 for the year ended
December 31, 1998 and $6.97 and $12.72 for the year ended December 31, 1997.
The weighted average fair value and weighted average exercise price of options
granted during the year ended December 31, 1997 where the exercise price
exceeded the market price of the underlying stock at the grant date were $5.96
and $14.00, respectively.

      The following table summarizes information about the Company's stock
options outstanding at December 31, 1998:

<TABLE>
<CAPTION>
                                         Weighted            Weighted 
                                         Average              Average
                            Options     Remaining            Exercise
         Exercise Price  Outstanding  Contractual Life   Price Per Share
         --------------  -----------  ----------------   ---------------
<S>                      <C>          <C>                <C>        
         $         14.00       19,000    8.4 years          $     14.00
         $         11.44       35,000    9.1 years          $     11.44
         $         10.94       25,000    8.6 years          $     10.94
                               ------                       -----------
                               79,000    8.8 years          $     11.90
                               ======                       ===========
</TABLE>

      Had compensation expense for the Company's stock-based compensation plans
been determined based on the fair value at the grant date for the UtiliCorp
awards previously described and the awards under this Plan consistent with the
method prescribed by SFAS No. 123, the Company's net income and earnings per
share would have been reduced to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                                               Year Ended December 31,
                                                              ------------------------
                                                                  1998         1997
                                                              -----------  -----------
<S>                                                           <C>          <C>        
       Net income, as reported .............................  $     4,869  $    25,166
       Net income, pro forma ...............................  $     4,751  $    25,130

       Basic and diluted earnings per share, as reported ...  $        .17 $       .86
       Basic and diluted earnings per share, pro forma .....  $        .16 $       .85
</TABLE>

      The fair value of each option granted is estimated on the date of grant
using an option-pricing model with the following assumptions:


<TABLE>
<CAPTION>
                                                                               Year Ended December 31,
                                                                              --------------------------
                                                                                 1998           1997
                                                                              -----------    -----------
<S>                                                                           <C>            <C>  
       Expected dividend yield (Aquila Gas Pipeline).......................           .50 %          .50 %
       Expected dividend yield (UtiliCorp).................................          5.10 %           --
       Expected stock price volatility (Aquila Gas Pipeline)...............         70.00 %        32.50 %
       Expected stock price volatility (UtiliCorp).........................         17.00 %           --
       Risk-free interest rate (Aquila Gas Pipeline and UtiliCorp).........          5.00 %         6.40 %
       Expected life of options (Aquila Gas Pipeline and UtiliCorp)........       10 Years       10 Years
</TABLE>

       No disclosures are presented for the period ended December 31, 1996, as
the Company had not issued common stock options prior to 1997.


                                     F-18

<PAGE>   52
                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


7.    COMMITMENTS AND CONTINGENCIES:

      LEASE OBLIGATIONS

      The Company has various non-cancelable operating leases. Total rent
expense amounted to approximately $995, $1,382, and $1,186 for 1998, 1997 and
1996, respectively. Future minimum rental payments of the Company under the
existing non-cancelable operating lease agreements with original terms of one
year or longer as of December 31, 1998 are as follows:

<TABLE>
<S>                                             <C>      
              1999..........................    $   1,097
              2000..........................          951
              2001..........................           40
              2002..........................           --
              2003..........................           --
              Thereafter....................           --
                                                ---------
                                                $   2,088
                                                =========
</TABLE>

      LETTERS OF CREDIT AND GUARANTEES

      The Company has issued irrevocable standby letters of credit totaling
$11,914 at December 31, 1998. The standby letters of credit, which generally
have terms from one to three months, collateralize obligations to third parties
for the purchase of natural gas. The standby letters of credit are issued
pursuant to the line of credit discussed in Note 3.

      The Company had issued financial guarantees of approximately $1,950 as of
December 31, 1998, related to business activities of a 50% owned subsidiary.
Management does not believe it is probable that the financial guarantees will
be exercised.

      LITIGATION

      On February 26, 1999, Harmony Exploration, Inc. (Harmony) sought to amend
a complaint it had previously filed against the Company. Harmony had filed an
action for breach of contract and discrimination by a common carrier against
the Company in Bexar County, Texas. Harmony is a producer of several wells in
Burleson County, Texas, with whom the Company had contracts to purchase
casinghead gas. Harmony claims that the Company paid them an inadequate price
under the contracts, improperly charged compression and processing fees with
respect to gas produced from Harmony's wells, improperly failed to hook up
several of Harmony's wells to the Company's gathering system, and improperly
failed to process 100% of the gas from some of Harmony's wells. Harmony seeks
actual damages of an unspecified amount plus attorneys' fees. Harmony sought to
amend its complaint to obtain certification of the case as a class action, and
to include as class members forty (40) or more producers in Burleson County who
allegedly entered into similar contracts with the Company. The Company is
vigorously defending the claim by Harmony, and believes it has meritorious
defenses to the claim. The Company intends to vigorously oppose the efforts to
obtain certification of a class action in the case.

      On November 12, 1998, shareholders of the Company filed separate but
identical suits in the Court of Chancery in Wilmington, Delaware against the
Company, UtiliCorp and the members of the Company's Board of Directors. The
suits were filed following UtiliCorp's announcement that it was proposing to
offer $8.00 per share to purchase the 18% of the Company's common stock held by
the public. UtiliCorp, through Aquila Energy, owns approximately 82% of the
Company's outstanding shares. Plaintiffs allege that the amount which UtiliCorp
proposes to offer is inadequate and thus unfair to the minority public
shareholders of the Company. The suit seeks to enjoin any tender offer and ask
for unspecified monetary damages. The filing of a response by the Company to
the complaints filed in the four suits has been delayed indefinitely by
agreement of the parties pending the outcome of negotiations between UtiliCorp
and an independent committee of the Company's Board of Directors concerning the
offer made by UtiliCorp for the minority shares.


                                     F-19
<PAGE>   53
                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


7.    COMMITMENTS AND CONTINGENCIES: (CONTINUED)

      TAXES

      The IRS has examined and proposed adjustments to UtiliCorp's consolidated
federal income tax returns for 1988 through 1993. The proposed adjustment
affecting the Company is to lengthen the depreciable life of certain pipeline
assets owned by the Company. The Company has filed a petition in U.S. Tax Court
contesting the IRS proposed adjustments for the years 1990 through 1991. The
IRS has also proposed an adjustment on the same issue for 1992 and 1993. The
Company has tentatively agreed with the IRS to hold this issue in abeyance
pending the outcome of the earlier petition. The Company intends to vigorously
contest the proposed adjustment and believes it is reasonably possible they
will prevail. It is expected that additional assessments for the years 1994
through the present would be made on the same issue. Under the provisions of
the tax sharing agreement with Aquila Energy and UtiliCorp (see Note 1) the
Company would be liable to UtiliCorp for additional taxes of approximately
$12,621 for the audit period and through the present plus potential interest of
approximately $3,346. The additional taxes would result in an adjustment to the
deferred tax liability with no effect on net income, while any payment of
interest would affect net income. The Company expects that the ultimate
resolution of this matter will not have a material adverse effect on its
financial position.

      The Company is also a party to additional claims and is involved in
various other litigation and administrative proceedings arising in the normal
course of business. The Company believes it is unlikely that the final outcome
of any of the claims, litigation or proceedings, including those discussed
above, to which the Company is a party would have a material adverse effect on
the Company's financial position or results of operations. However, due to the
inherent uncertainty of litigation, there can be no assurance that the
resolution of any particular claim or proceeding would not have an adverse
effect on the Company's results of operations for the fiscal period in which
such resolution occurred.

      The Company, in the normal course of business of its natural gas pipeline
operations, purchases and sells natural gas pursuant to long-term contracts.
Such contracts contain terms which are customary in the industry. The Company
believes that such terms are commercially reasonable and will not have a
material adverse effect on the Company's financial position or results of
operations.

8.    ACQUISITIONS AND SALES:

      OASIS PIPE LINE COMPANY

      On July 1, 1996 and November 1, 1996, the Company completed the
acquisition of 15% and 25%, respectively, of the outstanding capital stock of
Oasis and related transportation rights from Dow Hydrocarbons and Resources
Inc. (DHRI) for a cash purchase price of $47,143 and $84,000, respectively. The
acquisition cost exceeded the Company's share of the underlying net assets of
Oasis by approximately $97,000. The transportation rights related to the 15%
and 25% capital stock acquisitions of Oasis amounted to approximately 120 and
200 million cubic feet per day (MMcf/d), respectively, of firm intrastate
transportation between the Waha, Texas hub and the Katy, Texas hub, plus the
opportunity to utilize excess capacity on an interruptible basis. The
acquisitions were accounted for using the purchase method and are reflected in
the consolidated financial statements using the equity method of accounting.

      On April 1, 1997, the Company received $16,800 from El Paso Natural Gas
Company (El Paso) for its exercise of an option to acquire 5% of all the
capital stock of Oasis and the related transportation rights. The Company,
after the exercise of the option, owns 35% of the capital stock of Oasis and
has 280 MMcf/d of intrastate transportation capacity. The exercise of the
option resulted in no gain or loss on disposition to the Company. The proceeds
were utilized to pay down on the Company's revolving debt.

      In 1998, Oasis restructured its commercial operations and amended its
owner transportation agreements to permit the release of firm owner capacity to
third parties and to eliminate demand charges on this capacity. Prior to the
restructuring, the owner transportation agreements permitted the Company to
conduct additional off-system marketing activities not otherwise available to
the Company. This benefit was realized by the Company in off-system marketing
gross margin. Under the restructured agreements, Oasis expects to realize
higher transportation revenues, which will benefit the equity in earnings
recognized by the Company.


                                     F-20

<PAGE>   54

                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


      The unaudited pro forma results of operations assuming the acquisitions
of Oasis had occurred as of January 1, 1996 are as follows:

<TABLE>
<CAPTION>
                                                  Year Ended December 31, 1996(a)
                                                  -------------------------------

<S>                                                          <C>
                                                               (unaudited)
      Operating revenues..................................   $    799,278
      Net income..........................................   $     28,940
      Earnings per common share...........................   $        .98
</TABLE>


      (a)    The pro forma amounts are presented at the Company's 40% ownership
             and do not include any adjustments to reflect the potential
             marketing activity that might have occurred if the Company had
             acquired Oasis as of January 1, 1996.

      The unaudited pro forma information is based upon available information
and certain estimates and assumptions related to the accounting for the Oasis
acquisition. The unaudited pro forma information is not necessarily indicative
of the results that would have occurred had such transaction actually taken
place at the beginning of the period specified nor does such information
purport to project the results to operations for any future date or period.

      WARWINK JOINT VENTURE

      On December 1, 1997, the Company through its subsidiary, Tristar Gas
Company, sold its ownership interest in Warwink Joint Venture for a gain of
$1,167.

      BROOKS-HIDALGO JOINT VENTURE

      On March 31, 1998, the Company sold its ownership interest in the assets
of the Brooks-Hidalgo Joint Venture for a gain of $99.


                                     F-21
<PAGE>   55
                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


9.    COMMODITY RISK MANAGEMENT:

      NON-TRADING ACTIVITIES

      The Company utilizes commodity financial instruments, primarily futures,
options, forward contracts and swaps (hedges or hedging), to reduce the risk of
commodity price fluctuations for its revenue share of natural gas throughput
and NGLs production and for its off-system natural gas transportation. However,
hedging and related activities may expose the Company to other risks of
financial loss in certain circumstances, including variances from hedging
assumptions and counterparty risk.

      The following tables detail information on the Company's non-trading
hedges as of December 31, 1998 and 1997. The fair value of the hedges is the
estimated amount the Company would receive or (pay) to terminate the hedges at:

<TABLE>
<CAPTION>
       DECEMBER 31, 1998:                                               Years To
                                   Notional                              Which
                                    Volume    Carrying       Fair     Instruments
                                    Bcf (1)     Amount       Value       Extend
                                  ----------  ---------   ----------   ----------

<S>                               <C>         <C>         <C>          <C> 
       Swap contracts
          Payor ..............          18.0  $      --   $      640   up to 1999
          Receiver ...........          16.4         --         (657)  up to 1999
       Future Contracts
          Payor ..............          15.5         --       (7,925)  up to 1999
          Receiver ...........          12.3         --        7,305   up to 1999
                                              ---------   ----------
       Total .................                $      --   $     (637)
                                              =========   ==========
</TABLE>


<TABLE>
<CAPTION>
       DECEMBER 31, 1997:                                               Years To
                                   Notional                              Which
                                    Volume    Carrying       Fair     Instruments
                                    Bcf (1)     Amount       Value       Extend
                                  ----------  ---------   ----------   ----------

<S>                               <C>         <C>         <C>          <C> 
       Swap contracts
          Payor...............          14.9  $      --   $      256   up to 1998
          Receiver ...........          13.2         --         (121)  up to 1998
       Future Contracts
          Payor...............          18.6         --       (4,244)  up to 1998
          Receiver............          16.6         --        4,687   up to 1998
                                              ---------   ----------
       Total..................                $      --   $      578
                                              =========   ==========
</TABLE>


(1) Billion Cubic Feet

      All financial commodity hedges disclosed have Aquila Energy as the
counterparty because Aquila Energy maintains a centralized commodity risk
management function for its subsidiaries.


                                     F-22
<PAGE>   56
                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


9.    COMMODITY RISK MANAGEMENT: (CONTINUED)

      TRADING ACTIVITIES

      The following table details information on the Company's contracts held
or issued for trading purposes as of:

<TABLE>
<CAPTION>
                                            December 31,
                      ------------------------------------------------------
                                 1998                        1997
                      --------------------------  --------------------------
                                      Years To                    Years To
                       Notional        Which        Notional       Which
                        Volume      Instruments      Volume      Instruments
                          Bcf          Extend         Bcf          Extend
                      ------------  ------------  ------------  ------------

<S>                   <C>           <C>           <C>            <C> 
Swap contracts
   Payor ...........         415.5    up to 2003         164.2    up to 1999
   Receiver ........         414.9    up to 2001         161.6    up to 1999
Future Contracts
   Payor ...........          56.4    up to 2000          55.5    up to 1999
   Receiver ........          60.0    up to 2000          49.5    up to 1999
</TABLE>


     The following table details the fair values of contracts held or issued
for trading purposes as of:

<TABLE>
<CAPTION>
                                         December 31,
                      -------------------------------------------------
                               1998                      1997
                      -----------------------   -----------------------
                       Average       Ending      Average       Ending
                      ----------   ----------   ----------   ----------
<S>                   <C>          <C>          <C>          <C>       
Assets .............  $    3,197   $    2,159   $    2,056   $    2,391
Liabilities ........      (1,537)      (2,717)      (1,019)        (491)
                                   ----------                ----------
Net amount .........               $     (558)               $    1,900
                                   ==========                ==========
</TABLE>

     The net gain from trading activities for the years ended December 31, 1998
and 1997 was $1,713 and $8,053, respectively.


10.  FINANCIAL INSTRUMENTS:

     CASH AND CASH EQUIVALENTS, OTHER CURRENT ASSETS AND OTHER CURRENT
     LIABILITIES

     The Company's carrying amounts for cash and cash equivalents, other
current assets and other current liabilities approximate fair value.

      DEBT

      The carrying value of the debt approximates the fair value of the debt.
This determination is based on management's estimate of the fair value at which
such instruments could be obtained in an unrelated third party transaction.

      LETTERS OF CREDIT

      The fair value of the outstanding standby letters of credit of $11,914 at
December 31, 1998 is estimated to be the same as the contract value based on
the nature of the fee arrangements with the bank.


                                     F-23
<PAGE>   57
                AQUILA GAS PIPELINE CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


11.   INVESTMENT IN AFFILIATED COMPANY:

      The Company holds an investment in Oasis, which is accounted for by the
equity method of accounting. Dividends received from Oasis were $262, $1,142
and $585 during 1998, 1997 and 1996, respectively. The Company's net cost basis
in Oasis is greater than the Company's share of the underlying net assets of
Oasis by $83,114 at December 31, 1998. The cost over the underlying net assets
is being amortized over approximately 35 years based on the depreciable lives
of those underlying assets. The amortization is included in the equity in net
income of affiliate.

      Summarized financial information of Oasis is as follows:

<TABLE>
<CAPTION>
                                                                   December 31,
                                                              ----------------------
                                                                 1998        1997
                                                              ----------  ----------

<S>                                                           <C>         <C>       
                   SUMMARIZED BALANCE SHEET INFORMATION:

                   Current assets ..........................  $    6,512  $    8,069
                   Non-current assets ......................      46,374      43,801
                                                              ----------  ----------
                       Total assets ........................  $   52,886  $   51,870
                                                              ==========  ==========

                   Current liabilities .....................  $    1,768  $    7,819
                   Non-current liabilities .................      11,375      11,738
                                                              ----------  ----------
                       Total liabilities ...................  $   13,143  $   19,557
                                                              ==========  ==========

                       Net assets ..........................  $   39,743  $   32,313
                                                              ==========  ==========
</TABLE>

<TABLE>
<CAPTION>
                                                                       Year Ended December 31,
                                                                 ---------------------------------
                   SUMMARIZED STATEMENTS OF INCOME INFORMATION:     1998       1997         1996
                                                                 ----------  ---------   ---------
<S>                                                              <C>         <C>         <C>      
                   Revenues.................................     $   23,960  $  24,357   $  28,127
                   Cost and expenses........................     $   15,859  $  17,154   $  20,774
                   Net income...............................     $    8,101  $   7,203   $   7,353
</TABLE>

12.   QUARTERLY FINANCIAL DATA:  (UNAUDITED)


<TABLE>
<CAPTION>
                                                First       Second       Third        Fourth
                                               Quarter      Quarter      Quarter     Quarter
                                             -----------  -----------  -----------  -----------
<S>                                          <C>          <C>          <C>          <C>        
       1998:
       Operating revenues .................  $   237,105  $   265,674  $   202,689  $   187,714
       Gross margin .......................  $    22,894  $    21,444  $    18,139  $    18,154
       Net income .........................  $     2,319  $     1,447  $        40  $     1,063
       Basic and diluted earnings per share  $       .08  $       .05  $       .00  $       .04

       1997:
       Operating revenues .................  $   273,198  $   208,164  $   254,544  $   278,013
       Gross margin .......................  $    34,628  $    31,012  $    27,617  $    26,071
       Net income .........................  $     8,693  $     7,036  $     4,753  $     4,684
       Basic and diluted earnings per share  $       .30  $       .24  $       .16  $       .16
</TABLE>



                                     F-24
<PAGE>   58

                        AQUILA GAS PIPELINE CORPORATION

                          FINANCIAL STATEMENT SCHEDULE


<PAGE>   59
                                                                     SCHEDULE I

                        AQUILA GAS PIPELINE CORPORATION
                              PARENT COMPANY ONLY

                            CONDENSED BALANCE SHEETS

                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                     December 31,
                                                              ---------------------------
                                                                  1998           1997
                                                              ------------   ------------

<S>                                                           <C>            <C>         
                            ASSETS

Current amounts due from affiliated subsidiaries ...........  $     37,373   $     38,044
Federal income taxes receivable ............................            --            559
Other current assets .......................................           134            189
Investment in subsidiaries (equity method) .................       188,677        185,722
Pipeline, property, plant and equipment, net ...............            61             97
Long-term advances to affiliated subsidiaries ..............       150,258        143,139
                                                              ------------   ------------

TOTAL ASSETS ...............................................  $    376,503   $    367,750
                                                              ============   ============

             LIABILITIES AND STOCKHOLDERS' EQUITY

Current amounts due to Aquila Energy Corporation, net ......  $      6,055   $      6,905
Federal income taxes payable ...............................        10,576             --
Other current liabilities ..................................        11,499         11,136
Long-term debt .............................................       129,850        123,950
Deferred income taxes (Note 4) .............................        (8,232)         2,404
Commitments and contingencies (Note 3)
Stockholders' equity:
   Common stock ............................................           294            294
   Additional paid-in capital ..............................        90,297         90,297
   Retained earnings .......................................       136,164        132,764
                                                              ------------   ------------

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY .................  $    376,503   $    367,750
                                                              ============   ============
</TABLE>




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


                                     F-26

<PAGE>   60
                                                                     SCHEDULE I
                                                                    (CONTINUED)


                        AQUILA GAS PIPELINE CORPORATION
                        PARENT COMPANY ONLY (CONTINUED)

                         CONDENSED STATEMENTS OF INCOME

                                 (IN THOUSANDS)



<TABLE>
<CAPTION>
                                                                  Year Ended December 31,
                                                         ---------------------------------------
                                                             1998         1997           1996
                                                         -----------   -----------   -----------

<S>                                                      <C>           <C>           <C>        
       INCOME AND EXPENSES:
         Interest (income) expense, net ...............  $    (2,950)  $    (2,703)  $     1,280
         Depreciation and amortization ................           37            32            26
         Federal income tax expense (benefit) .........          999         1,012          (495)
                                                         -----------   -----------   -----------
           Total (income) and expenses ................       (1,914)       (1,659)          811
                                                         -----------   -----------   -----------

       INCOME (LOSS) BEFORE EQUITY IN EARNINGS
         OF SUBSIDIARIES ..............................        1,914         1,659          (811)

       EQUITY IN NET EARNINGS OF SUBSIDIARIES .........        2,955        23,507        33,264
                                                         -----------   -----------   -----------

       NET INCOME .....................................  $     4,869   $    25,166   $    32,453
                                                         ===========   ===========   ===========
</TABLE>




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



                                     F-27

<PAGE>   61
                                                                     SCHEDULE I
                                                                    (CONTINUED)


                        AQUILA GAS PIPELINE CORPORATION
                        PARENT COMPANY ONLY (CONTINUED)

                       CONDENSED STATEMENTS OF CASH FLOWS

                                 (IN THOUSANDS)



<TABLE>
<CAPTION>
                                                                                 Year Ended December 31,
                                                                        ------------------------------------------
                                                                            1998           1997           1996
                                                                        ------------   ------------   ------------

<S>                                                                     <C>            <C>            <C>         
     CASH FLOWS FROM OPERATING ACTIVITIES:
      Net  income ....................................................  $      4,869   $     25,166   $     32,453
       Adjustments to reconcile net income to net cash provided by
       operating activities:
         Equity in net earnings of subsidiaries ......................        (2,955)       (23,507)       (33,264)
         Dividends received from affiliated subsidiaries .............            --         30,000             --
         Depreciation and amortization ...............................            37             32             26
         Deferred income taxes .......................................       (10,636)         3,371           (241)
       Changes in current assets and current liabilities .............        11,374         14,793         12,793
                                                                        ------------   ------------   ------------

         Net cash provided by operating activities ...................         2,689         49,855         11,767
                                                                        ------------   ------------   ------------

     CASH FLOWS FROM INVESTING ACTIVITIES:
       Additions to pipeline, property, plant and equipment ..........            (1)           (37)           (31)
                                                                        ------------   ------------   ------------

     CASH FLOWS FROM FINANCING ACTIVITIES:
       Borrowings (repayments) under revolving
         credit agreement, net .......................................         5,900        (66,501)       114,201
       Borrowings under loan agreements ..............................            --         16,250             --
       Advances to affiliates ........................................        (7,119)        (1,441)      (123,667)
       Dividends paid ................................................        (1,469)        (1,469)        (1,468)
                                                                        ------------   ------------   ------------

        Net cash used in financing activities ........................        (2,688)       (53,161)       (10,934)
                                                                        ------------   ------------   ------------

     NET (DECREASE) INCREASE IN CASH
       AND CASH EQUIVALENTS ..........................................             0         (3,343)           802
                                                                        ------------   ------------   ------------

     CASH AND CASH EQUIVALENTS, beginning of year ....................             0          3,343          2,541
                                                                        ------------   ------------   ------------

     CASH AND CASH EQUIVALENTS, end of year ..........................  $          0   $          0   $      3,343
                                                                        ============   ============   ============
</TABLE>



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



                                     F-28

<PAGE>   62

                                                                     SCHEDULE I
                                                                    (CONTINUED)


                        AQUILA GAS PIPELINE CORPORATION
                        PARENT COMPANY ONLY (CONTINUED)

                    NOTES TO CONDENSED FINANCIAL STATEMENTS


1.  DEBT

    See Note 3 of Notes to Consolidated Financial Statements.

2.  PIPELINE, PROPERTY, PLANT AND EQUIPMENT

    See Note 1 of Notes to Consolidated Financial Statements. Certain
    reclassifications to prior period amounts have been made to conform to the
    1998 presentation.

3.  COMMITMENTS AND CONTINGENCIES

    See Note 7 of Notes to Consolidated Financial Statements.

4.  INCOME TAXES

    See Note 4 of Notes to Consolidated Financial Statements.



                                     F-29