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Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2007, for Public Service Enterprise Group Incorporated (PSEG) and its principal subsidiaries: Public Service Electric and Gas Company (PSE&G), PSEG Power LLC (Power), and PSEG Energy Holdings L.L.C. (Energy Holdings). PSEG operates as a holding company with four reportable segments: PSE&G (regulated utility), Power (wholesale generation and trading), and two subsidiaries of Energy Holdings (Global and Resources). The filing includes unaudited condensed consolidated financial statements for all entities.

Key Financial Metrics

Segment Performance (Net Income)

• PSE&G: $132 million (vs. $78 million in Q1 2006)
• Power: $213 million (vs. $112 million in Q1 2006)
• Energy Holdings: $3 million (vs. $28 million in Q1 2006)

Material Changes vs. Prior Period

• Revenue Growth: Consolidated operating revenues increased 4% to $3.614 billion, driven by higher volumes due to weather and rate increases from settlements in late 2006.
• Profitability Surge: Net income increased 62% to $329 million. Income from continuing operations rose to $335 million from $208 million.
• Segment Drivers:
  • PSE&G: Net income rose 69% due to increased delivery volumes (14% increase in degree days) and rate relief from the November 2006 base rate cases.
  • Power: Net income rose 90% due to higher realized prices from recontracting, increased sales volumes, and lower generation costs. The PJM Reliability Pricing Model (RPM) is expected to add incremental margin.
  • Energy Holdings: Net income declined 93% due to mark-to-market losses at Texas generation facilities, the adoption of new accounting standards (FIN 48), and the absence of equity earnings from a sold asset (RGE).
• Discontinued Operations: A loss of $6 million was recorded, primarily related to the Lawrenceburg facility pending sale.

Guidance, Outlook, and Risks

Outlook and Management Commentary

• Capacity Markets: Power expects the implementation of the PJM Reliability Pricing Model (RPM) to generate incremental margins of $125 million to $175 million in 2007.
• Dividends: PSEG declared a quarterly dividend of $0.585 per share. Power paid a $125 million dividend to PSEG, and Energy Holdings made a $145 million return of capital distribution.
• Capital Allocation: Excess cash is currently being used to reduce debt. Beginning mid-2008, excess cash is expected to be available for new investments or share repurchases.
• Accounting Changes: Adoption of FIN 48 (Accounting for Uncertainty in Income Taxes) and FSP 13-2 resulted in a reduction of opening 2007 Retained Earnings of approximately $160 million for Energy Holdings and a $6 million after-tax earnings decrease for PSEG in Q1 2007.

Risks and Contingencies

• Environmental Liabilities: Significant exposure exists regarding the Passaic River remediation (estimated costs could be material) and MGP site remediation ($408 million accrued). Power faces potential costs up to $1 billion for cooling water intake structures at the Salem facility if regulatory requirements change.
• Regulatory and Tax: PSEG faces an IRS audit regarding leveraged lease transactions (potential $796 million deferred tax liability at risk). Energy Holdings faces tax audit claims in Peru and Chile.
• Market Risk: Power is exposed to commodity price volatility. Unrealized losses on derivative hedges increased Accumulated Other Comprehensive Loss by $159 million in Q1 2007 due to higher electricity prices.
• Legal Proceedings: Ongoing disputes include a class action challenging the New Jersey Competition Act, FERC proceedings regarding transmission cost allocation, and an Italian criminal investigation into the Bioenergie facility (operations resumed April 2007).

Investor Verification Checklist

• Debt Covenants: Verify compliance with debt-to-capitalization ratios (PSEG: 50.7%, PSE&G: 47.5%, Power: 37.5%) and EBITDA coverage ratios.
• Environmental Reserves: Review the adequacy of the $408 million MGP remediation accrual and potential future costs for the Passaic River and Salem cooling towers.
• Tax Position: Assess the impact of the IRS audit on leveraged leases and the $479 million in unrecognized tax benefits recorded under FIN 48.
• Derivative Exposure: Monitor the $460 million net unrealized loss on mark-to-market energy contracts and the potential for reclassification to earnings over the next 12 months ($186 million).
• Asset Sales: Confirm the closing of the Lawrenceburg facility sale (expected Q2 2007) and the potential sale of Electroandes in Peru.