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Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 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 (merchant generation and trading), and Energy Holdings (international investments and leveraged leases).

Key Financial Metrics (Six Months Ended June 30, 2007)

Material Changes vs. Prior Period

• Profitability Surge: Net Income increased 47% year-over-year ($604M vs. $412M). Income from Continuing Operations more than tripled ($627M vs. $197M), driven primarily by the absence of a $263 million write-down of project investments recorded in the prior year related to the sale of Rio Grande Energia (RGE).
• Segment Performance:
  • Power: Net income rose to $397M (from $189M) due to higher energy prices, improved margins on nuclear and coal generation, and favorable gas supply contracts.
  • PSE&G: Net income increased to $195M (from $112M) driven by higher delivery volumes due to weather and rate increases approved in late 2006.
  • Energy Holdings: Income from Continuing Operations improved to $61M (from a loss of $82M) primarily due to the absence of the RGE write-down, though margins were pressured by lower spark spreads and accounting changes.
• Discontinued Operations: The prior year included a $228 million gain on the disposal of Polish assets (Elcho and Skawina). The current period reflects losses from discontinued operations of $23 million, related to the Lawrenceburg facility and Electroandes.
• Capital Structure: Total long-term debt decreased by approximately $402 million as the company utilized strong cash flows to redeem debt, including $375 million of Floating Rate Notes.

Guidance, Outlook, and Risks

• Outlook: Management expects margin improvements to continue in 2007 for Power due to the rolling nature of forward hedge positions and the Reliability Pricing Model (RPM) in PJM, which could add $125 million to $175 million in incremental margin. PSE&G anticipates improved margins from rate case settlements and normal weather conditions.
• Capital Requirements: Projected construction and investment expenditures for 2007-2011 total approximately $7.0 billion. Significant upcoming costs include environmental controls for Hudson and Mercer coal stations and new transmission lines for PSE&G.
• Key Risks and Contingencies:
  • Environmental Liabilities: Significant uncertainty remains regarding the cost of the Passaic River cleanup (estimated $900M-$2.3B) and MGP remediation ($798M-$838M total program cost).
  • Regulatory: Risks include potential changes to Market Based Rate (MBR) authority, new greenhouse gas regulations, and the outcome of the BPU audit of gas procurement practices.
  • International Exposure: Energy Holdings faces risks from the nationalization of assets in Venezuela (Turboven) and tax disputes in Peru (Electroandes) and Chile.
  • Tax Matters: The adoption of FIN 48 (Accounting for Uncertainty in Income Taxes) resulted in a $123 million reduction to Retained Earnings at adoption and ongoing exposure to tax audits regarding leveraged lease transactions.

Investor Verification Checklist

• Discontinued Operations Impact: Verify the extent to which the year-over-year earnings improvement is driven by the absence of the 2006 RGE write-down versus organic operational growth.
• Environmental Accruals: Review the sufficiency of the $398 million accrued for MGP remediation and the potential exposure from the Passaic River cleanup, which could be material.
• Power Margin Sustainability: Assess the durability of Power's margin improvements given the volatility of commodity prices and the impact of the RPM capacity market changes.
• Debt Covenants: Confirm compliance with debt-to-capitalization covenants (PSEG at 50.3%, PSE&G at 49.8%, Power at 39.0%) and monitor credit rating outlooks (S&P upgraded PSEG/PSE&G commercial paper to A2).
• International Asset Recovery: Monitor the status of the Venezuelan nationalization proceedings and the potential recovery of the $34 million book value of Turboven investments.