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, 2008
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2009
OR
[ ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) ~~OF THE SECURITIES EXCHANGE ACT OF 1934~~
For the transition period from ________________ to ________________
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________to __________

Commission File Number	Registrant; State of Incorporation; Address; and Telephone Number	IRS Employer Identification No.
2-35965	NORTH SHORE GAS COMPANY	36-1558720
	(An Illinois Corporation)
	130 East Randolph Drive
	130 East Randolph Drive, 18th Floor
	18th Floor
	Chicago, Illinois 60601-6207
	(312) 240-4000

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [X]

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.

Yes [X] No [ ]

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 whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). (Registrant is not yet required to provide financial disclosure in an Interactive Data File format.) Yes [ ] 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. [X]

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer [ ] Accelerated filer [ ]

Non-accelerated filer [X] Smaller Reporting Company [ ]

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]

State the aggregate market value of the voting and

non-voting common equity held by non-affiliates of the Registrant.

None.

Number of shares outstanding of each class of common stock, as of February 2524, ~~2009.~~2010 Common Stock, no par value, 3,625,887 shares (all of which are owned beneficially and of record by Peoples Energy Corporation, a wholly owned subsidiary of Integrys Energy Group, Inc.)

DOCUMENT INCORPORATED BY REFERENCE

Definitive proxy statement for the Integrys Energy Group, Inc. Annual Meeting of Shareholders to be held on May 13, ~~2009~~2010, is incorporated by reference into ~~Item 14 of~~ Part III. The Registrant meets the conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K and is therefore filing this Form with the reduced disclosure format permitted by General Instruction I(2)(b) and (c).

NORTH SHORE GAS COMPANY

ANNUAL REPORT ON FORM 10-K

For the Year Ended December 31, ~~2008~~2009

TABLE OF CONTENTS

			Page
Forward-Looking Statements			1
PART I			2
ITEM 1.	BUSINESS		2
	A.	GENERAL	2
	B.	REGULATED NATURAL GAS UTILITY OPERATIONS	2
	C.	ENVIRONMENTAL MATTERS	64
	D.	CAPITAL REQUIREMENTS	64
	E.	EMPLOYEES	65
	F.	AVAILABLE INFORMATION	65
ITEM 1A.	RISK FACTORS		76
ITEM 1B	UNRESOLVED STAFF COMMENTS		10
ITEM 2.	PROPERTIES		11
ITEM 3.	LEGAL PROCEEDINGS		12
ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS		12

PART II			12	12
ITEM 5.	MARKET FOR ~~REGISTRANT’S~~NSG's COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES		12	12
ITEM 6.	SELECTED FINANCIAL DATA		13	13
ITEM 7.	MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		14	14-26
ITEM 7A.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		28	26
ITEM 8.	FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA		29	27
	A.	~~Management Report on Internal Control over Financial Reporting~~	29Management Report on Internal Control over Financial Reporting	27
	B.	~~Statements of Income~~	30Statements of Income	28
	C.	~~Balance Sheets~~	31Balance Sheets	29
	D.	~~Statements of Capitalization~~	32Statements of Capitalization	30
	E.	~~Statements of Common Shareholder's Equity~~	33Statements of Common Shareholder's Equity	31

- i -

	F.	Statements of Cash Flows			3432
	G.	Notes to Financial Statements			3533-53
		Note 1	Summary of Significant Accounting Policies	3533
		Note 2	Risk Management Activities	3936
		Note 3	~~Property,~~Restructuring ~~Plant, and Equipment~~Expense	3937
		Note 4	~~Regulatory~~Property, ~~Assets~~Plant, ~~And~~and ~~Liabilities~~Equipment	3938
		Note 5	~~Long-Term~~Regulatory ~~Debt~~Assets And Liabilities	4038
		Note 6	~~Asset~~Long-Term ~~Retirement Obligations~~Debt	4139
		Note 7	~~Income~~Asset ~~Taxes~~Retirement Obligations	4239
		Note 8	~~Commitments~~Income ~~and Contingencies~~Taxes	4340
		Note 9	~~Employee~~Commitments ~~Benefit~~and ~~Plans~~Contingencies	4642
		Note 10	~~Preferred~~Employee ~~Stock~~Benefit Plans	5244
		Note 11	~~Common~~Preferred ~~Equity~~Stock	5249
		Note 12	~~Fair~~Common ~~Value~~Equity	5249
		Note 13	~~Miscellaneous~~Fair ~~Income~~Value	5350
		Note 14	~~Regulatory~~Miscellaneous ~~Environment~~Income	5351
		Note 15	~~Segments~~Regulatory ~~of Business~~Environment	5551
		Note 16	~~Related~~Segments ~~Party~~of ~~Transactions~~Business	5552
		Note 17	~~Quarterly~~Related ~~Financial~~Party ~~Information (Unaudited)~~Transactions	5652
	H.	Report of Independent Registered Public Accounting Firm on Financial Statements			57
		Note 18	Quarterly Financial Information (Unaudited)	53
ITEM 9.	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE				58
	H.	Report of Independent Registered Public Accounting Firm on Financial Statements			54
ITEM 9A.	CONTROLS AND PROCEDURES				58
ITEM 9.	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE				55
ITEM 9B.	OTHER INFORMATION				58
ITEM 9A.	CONTROLS AND PROCEDURES				55
PART III					59
ITEM 9B.	OTHER INFORMATION				55
ITEM 10.	DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE				59
PART III					56
ITEM 11.	EXECUTIVE COMPENSATION				59
ITEM 10.	DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE				56
ITEM 12.	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS				59
ITEM 11.	EXECUTIVE COMPENSATION				56
ITEM 13.	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE				59
ITEM 12.	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS				56
ITEM 14.	PRINCIPAL ACCOUNTING FEES AND SERVICES				59
ITEM 13.	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE				56
PART IV					61
ITEM 14.	PRINCIPAL ACCOUNTING FEES AND SERVICES				56
ITEM 15.	EXHIBITS AND FINANCIAL STATEMENT SCHEDULES				61
PART IV					58
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS					62
ITEM 15.	EXHIBITS AND FINANCIAL STATEMENT SCHEDULES				58
SIGNATURES					6359
EXHIBIT INDEX					64
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS					60
EXHIBIT INDEX					61

- ii -

Acronyms Used in this Annual Report on Form 10-K

ASC Accounting Standards Codification EEP Enhanced Efficiency Program EPA United States Environmental Protection Agency ESOP Employee Stock Ownership Plan FASB Financial Accounting Standards Board FERC Federal Energy Regulatory Commission GAAP United States Generally Accepted Accounting Principles IBS Integrys Business Support, LLC ICC Illinois Commerce Commission IRS United States Internal Revenue Service LIFO Last -in, ~~first~~ First-out N/A Not Applicable NSG North Shore Gas Company NYMEX New York Mercantile Exchange PEC Peoples Energy Corporation PGL The Peoples Gas Light and Coke Company SEC United States Securities and Exchange Commission SFAS Statement of Financial Accounting Standards

- iii -

Forward-Looking Statements

In this report, NSG makes statements concerning expectations, beliefs, plans, objectives, goals, strategies, and future events or performance. Such statements are "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are subject to assumptions and uncertainties; therefore, actual results may differ materially from those expressed or implied by such forward-looking statements. Although NSG believes that these forward-looking statements and the underlying assumptions are reasonable, it cannot provide assurance that such statements will prove correct.

Forward-looking statements include, among other things, statements concerning management's expectations and projections regarding earnings, regulatory matters, ~~fuel~~natural gas costs, natural gas deliveries, remediation costs, environmental and other ~~capital~~ capital expenditures, liquidity and capital resources, trends, estimates, and ~~other~~ other matters.

Forward-looking statements involve a number of risks and uncertainties. Some ~~risk~~risks ~~factors~~ that could cause results to differ from any forward-looking statement ~~include~~ include those described in Item 1A of this Annual Report on Form 10-K for the year ended December 31, ~~2008~~2009. Other factors include:

● Resolution of pending and future rate cases and negotiations (including the recovery of deferred costs) and other regulatory decisions impacting NSG; ● The impact of recent and future federal, ~~state,~~ and ~~local~~state regulatory changes, including legislative and regulatory initiatives regarding deregulation and restructuring of the natural gas utility industry, changes in environmental and ~~possible~~other ~~future~~regulations, ~~initiatives~~including but not limited to, ~~address~~greenhouse ~~concerns~~gas ~~about~~emissions, ~~global~~energy ~~climate~~efficiency ~~change~~mandates, ~~changes~~and inreliability ~~environmental~~standards, and changes in tax, and other laws and regulations to which NSG is subject~~, as well as changes in the application of existing laws and regulations~~; ● Current and future litigation, and regulatory investigations, ~~proceedings,~~enforcement actions or inquiries, including but not limited to, manufactured gas plant site cleanup, third-party intervention in permitting and licensing projects, and prudence and reconciliation of ~~revenues~~costs ~~from~~recovered ~~the~~in ~~Gas~~revenues ~~Charge~~through ~~and~~an ~~related~~automatic ~~natural~~ gas ~~costs~~cost recovery mechanism; ● The impacts of changing financial market conditions, credit ratings, and interest rates on the liquidity and financing efforts of NSG; ● The risks associated with changing commodity prices (particularly natural gas), and the available sources of natural gas; ● Resolution of audits or other tax disputes with the IRS, Illinois state revenue agencies, or other ~~taxing~~revenue ~~authorities~~agencies; ● The effects, extent, and timing of additional competition or regulation in the markets in which NSG operates; ● Investment performance of employee benefit plan assets; ●and ~~Advances~~the inrelated ~~technology~~impact on future funding requirements; ● Effects of and changes in political and legal developments, as well as economic conditions and the related impact on customer demand; ● Potential business strategies, including acquisitions and construction or disposition of assets or businesses, which cannot be assured to be completed timely or within budgets; ● The direct or indirect effects of terrorist incidents, natural disasters, or responses to such events; ● The effectiveness of risk management strategies, ~~and~~ the use of financial and derivative instruments, and the ability to recover costs from customers in rates associated with the use of those strategies and financial instruments; ● The ~~risks~~risk of financial loss associated with the inability of NSG's counterparties, ~~affiliates,~~ and ~~customers~~affiliates to meet their obligations; ● Customer usage, weather, and other natural phenomena; ● The effect of accounting pronouncements issued periodically by standard-setting bodies; and ● Other factors discussed elsewhere herein and in other reports filed by NSG and/or Integrys Energy Group from time to time with the SEC.

Except to the extent required by the federal securities laws, NSG undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

- 1 -

PART I

ITEM 1. BUSINESS

A. GENERAL

~~For~~References ~~purposes of this Annual Report on Form 10-K, unless the context otherwise indicates, when we refer~~ to "~~us,~~Notes" ~~"we," "our," or "ours," we~~ are ~~referring~~ to ~~NSG. References~~ ~~to “Notes” are to~~ the Notes to the Financial Statements included in this Annual Report on Form 10-K.

NSG, a regulated natural gas utility, was formed in 1900. NSG is an Illinois corporation and is wholly owned by PEC. ~~On July 8, 2006, WPS Resources Corporation entered into an agreement and plan of merger with~~ PEC ~~pursuant~~ tois ~~which, among other things, PEC became~~ a wholly owned subsidiary of ~~WPS~~ ~~Resources on February 21, 2007. Effective with the closing of the merger, WPS Resources changed its name to~~ Integrys Energy Group, Inc.

AsFor financial ~~previously~~information ~~disclosed~~about ~~in the combined PEC, PGL, and~~ NSG’s ~~Transition~~regulated ~~Report~~natural ongas ~~Form 10-Q~~utility ~~for the Transition Period from October 1~~segment, ~~2006,~~see toItem ~~December 31~~7, ~~2006, NSG~~ ~~changed~~"Management's ~~its~~Discussion ~~fiscal year end from September 30 to December~~and ~~31. References~~Analysis toof ~~fiscal~~Financial ~~2006~~Condition ~~represent~~and ~~balances~~Results as of orOperations ~~activity for~~– ~~the~~Results ~~12 months ended September 30, 2006~~of Operations."

B. REGULATED NATURAL GAS UTILITY OPERATIONS

~~Principal~~NSG provides ~~Products~~regulated natural gas utility service to approximately 157,900 residential, commercial and ~~Markets~~industrial, and transportation customers located in 54 communities within the northern suburbs of Chicago. The regulated natural gas utility segment accounts for 100% of NSG's revenues.

The natural gas utility segment is NSG’s core business. NSG purchases, stores, distributes, sells, and transports natural gas to its customers through an approximate 2,300-mile system of distribution mains serving 54 communities in the northern suburbs of Chicago representing a service area of approximately 275 square miles. The customer base includes residential users, commercial and industrial users, and transportation accounts that provide what NSG believes is a broad and diversified foundation for its business. Transportation accounts are those natural gas users that purchase their natural gas requirements directly from a supplier other than NSG and utilize NSG’s natural gas distribution system for delivery to their premises.

- 2 -

Regulated Natural Gas Segment Operating Statistics
	Year Ended December 31, 2008		Year Ended December 31, 2007		Transition Period Ended December 31, 2006		Year Ended September 30, 2006
Operating revenues (Millions)
Residential	$	246.7	$	209.7	$	57.0	$	221.3
Commercial and industrial		50.0		45.8		12.2		47.8
Transportation		14.7		14.1		4.0		14.3
Other		1.5		1.4		0.3		1.7
Total	$	312.9	$	271.0	$	73.5	$	285.1
Therms delivered (Millions)
Residential		205.6		193.3		59.0		182.8
Commercial and industrial		44.4		41.7		12.4		39.1
Total therm sales		250.0		235.0		71.4		221.9
Transportation		137.2		129.3		36.0		127.4
Total		387.2		364.3		107.4		349.3
Customers served (End of period)
Residential		139,185		141,204		141,578		139,844
Commercial and industrial		9,783		9,666		9,707		9,538
Transportation		8,941		7,268		6,300		5,960
Total		157,909		158,138		157,585		155,342
Average therm price (Cents)
Residential		119.99		108.48		96.61		121.06
Commercial and industrial		112.61		109.83		98.39		122.25

For 2008, the natural gas utility segment accounted for 100% of NSG's revenues. On December 31, 2008, the natural gas utility segment accounted for 100% of its capital assets. NSG had no nonutility activity in 2008.

The basic marketing plan of NSG is to maintain and grow a strong regulated utility base in traditional market segments, which include space heating, water heating, clothes drying, and cooking. NSG’s service territory has potential for expansion through increasing population density.

Facilities

For information regarding NSG’s regulated natural gas facilities, see “Item 2 – , "Properties.”" For NSG's regulated natural gas utility plant asset book value, see Note 4, "Property, Plant, and Equipment."

Natural Gas Supply

NSG ~~has entered~~manages ~~into~~portfolios ~~long-term~~of ~~and short-term firm~~ natural gas supply contracts, ~~with various suppliers. When used in conjunction with contract~~ storage ~~and peak-shaving facilities~~services, ~~NSG~~and ~~deems~~pipeline transportation ~~such~~services ~~supply~~designed ~~sufficient~~ to meet ~~current~~its ~~and reasonably~~varying ~~foreseeable~~customer ~~peak~~usage ~~and~~patterns ~~annual~~at the ~~market~~lowest ~~requirements~~reasonable cost.

NSG ~~purchases~~has ~~firm~~entered ~~transportation~~into long-term and ~~storage~~short-term ~~services~~firm ~~from~~natural ~~interstate~~gas ~~pipelines~~supply ~~and~~contracts ~~local~~with various ~~distribution~~suppliers ~~companies~~each inyear ~~the~~to ~~ordinary~~meet ~~course~~the ofNovember ~~business. Two interstate~~through ~~pipelines~~March ~~and~~winter ~~one~~period ~~local~~demand ~~distribution~~of firm ~~company’s~~system ~~pipeline~~sales ~~interconnect with~~customers. NSG’'s ~~utility~~regulated ~~system. NSG~~natural ~~believes~~gas ~~that~~supply ~~having~~requirements ~~multiple~~are ~~pipelines~~met ~~that~~through ~~serve~~a ~~its~~combination ~~service~~of ~~territory~~physical ~~benefits~~fixed ~~its~~price ~~customers~~purchases, bycontracted ~~improving~~storage, ~~reliability~~peak-shaving facilities, ~~providing~~natural ~~access~~gas tocall ~~diverse supply~~options, and ~~fostering~~physical ~~competition~~index ~~among~~price ~~these~~purchases. To ~~service~~supplement ~~providers~~natural ~~that~~gas ~~can~~supplies ~~lead~~and tominimize ~~favorable~~risk, ~~conditions~~NSG purchases ~~for~~additional ~~NSG~~natural gas supplies on the monthly spot market through fixed-term firm contracts rather than on the daily spot market. During periods of colder than normal weather or when the ~~negotiating~~opportunity ~~new~~arises, ~~agreements~~natural gas may be purchased in the daily spot market.

-NSG 3contracts with PGL and interstate pipelines that own underground storage fields to purchase underground storage capacity. NSG contracts with interstate pipelines and another service provider to purchase firm transportation. Two interstate pipelines and one local distribution company’s pipeline interconnect with NSG’s utility system. NSG believes that having multiple pipelines that serve its service territory benefits its customers by improving reliability, providing access to diverse supply, and fostering competition among these service providers that can lead to favorable conditions for NSG when negotiating new agreements. Besides providing the ability to manage significant changes in daily natural gas demand, storage also provides NSG with the ability to purchase steady levels of natural gas on a year-round basis, thus lowering supply cost volatility.

~~The~~NSG ~~following~~had ~~table~~adequate ~~shows~~capacity ~~the~~to ~~expected~~meet ~~design~~all firm natural gas load obligations during 2009 and expects to have adequate capacity to meet all firm obligations during 2010. NSG forecasts peak-day ~~availability~~throughput of ~~natural~~435 ~~gas in~~ thousands of dekatherms (MDth) ~~during~~for the ~~2008~~2009 through ~~2009~~2010 heating season ~~for NSG:~~.

	Design Peak-Day	Year of Contract
Source (MDth)	Availability	Expiration
Firm pipeline capacity	58	2013-2017
Firm city-gate supply	60	2009
Liquefied petroleum gas	40	N/A
Natural gas in storage:
Contracted from PGL	63	N/A
Contracted from others	170	2010-2017
Customer-owned	48	N/A
Total expected design peak-day availability	439

- 2 -

~~NSG~~The ~~forecasts~~deliveries to ~~design~~customers ~~peak-day~~(including ~~demand~~transportation ofcustomers) ~~427~~in MDth for ~~the~~NSG ~~2008~~were ~~through 2009 heating~~as ~~season.~~follows:

Deliveries to customers (including transportation customers) in MDth for NSG were as follows:

(MDth)	2009			2008			2007
Natural gas purchases		24,329			26,137			23,432
Customer-owned natural gas received		13,686			13,589			12,782
Liquefied petroleum gas		12			5			7
Underground storage, net		(158	)		95			767
Contracted pipeline and storage compressor fuel, franchise requirements, and unaccounted-for natural gas		(972	)		(1,110	)		(559	)
Total		36,897			38,716			36,429

(MDth)	Year Ended December 31, 2008	Year Ended December 31, 2007	Transition Period Ended December 31, 2006	Year Ended September 30, 2006
Natural gas purchases	26,137	23,432	5,930	23,523
Liquefied petroleum gas	5	7	-	10
Customer-owned natural gas received	13,589	12,782	3,646	12,793
Underground storage, net	95	767	1,612	(883)
Contracted pipeline and storage compressor fuel, franchise requirements, and unaccounted-for natural gas	(1,110)	(559)	(451)	(517)
Total	38,716	36,429	10,737	34,926

Regulatory Matters

Legislation and Regulation at State Level

~~NSG~~The isnatural ~~subject to~~gas ~~the~~retail ~~jurisdiction~~rates of ~~and~~NSG ~~regulation~~are regulated by the ICC, which has general supervisory and regulatory powers over ~~practically all phases of the~~ public ~~utility~~utilities ~~business~~ in Illinois. ~~These include rates and charges, issuance of securities, services and facilities, systems of accounts, investments, safety standards, transactions with affiliated interests, and other matters.~~

~~NSG~~Sales isare ~~authorized,~~made and services rendered by ~~statute~~NSG ~~and/or~~pursuant ~~certificates~~to ofrate ~~public~~schedules ~~convenience~~on ~~and~~file ~~necessity,~~with tothe ~~conduct~~ICC ~~operations~~containing invarious ~~the~~service ~~territories~~classifications itlargely ~~serves~~reflecting customers’ different uses and levels of consumption. In addition to the rates for distribution of natural gas, NSG ~~operates~~bills customers a natural gas charge (Gas ~~under~~Charge) ~~franchises~~representing prudently incurred costs of delivered natural gas, transportation, and ~~license~~storage ~~agreements~~services ~~granted~~purchased, toas itwell byas ~~the~~gains, ~~municipalities~~losses, itand ~~serves.~~ costs incurred under NSG’s ~~franchises~~hedging ~~with~~program, ~~municipalities~~the ~~within~~amount ~~its~~of ~~service~~which is also subject ~~territory~~to ~~are~~ICC authority. Changes in the cost of ~~various~~natural ~~terms~~gas are reflected in both natural gas revenues and ~~expiration~~natural ~~dates~~gas purchases.

~~Sales~~NSG ~~are~~is ~~made and~~authorized, ~~services rendered~~ by ~~NSG~~statute ~~pursuant~~and/or tocertificates ~~rate~~of ~~schedules~~public onconvenience ~~file~~and ~~with~~necessity, ~~the~~to ~~ICC~~conduct ~~containing~~operations ~~various~~in ~~service~~the ~~classifications~~territories ~~largely~~it ~~reflecting~~serves. In ~~customers’~~addition, NSG operates ~~different~~under ~~uses~~franchises and ~~levels~~license ofagreements ~~consumption~~granted ~~(see~~to ~~Note~~it ~~14,~~by ~~"Regulatory~~the ~~Environment,"~~municipalities ~~for~~it ~~a discussion of~~ serves. NSG'’s ~~recent~~franchises ~~rate filings~~ with ~~the~~municipalities ~~ICC). In~~within ~~addition~~its service toterritory ~~the~~are ~~rate for distribution~~ of ~~natural~~various ~~gas,~~terms ~~NSG~~and ~~bills~~expiration ~~its~~dates. ICC ~~customers~~rules ~~a natural~~place ~~gas~~restrictions ~~charge~~on ~~representing~~when ~~the~~NSG ~~cost~~may ofterminate ~~natural~~or ~~gas~~deny ~~and~~service ~~transportation~~to ~~and~~customers ~~storage services~~who ~~purchased~~do bynot pay ~~NSG,~~their asbills ~~well~~for asutility ~~gains,~~service. Both ~~losses,~~federal and ~~costs incurred under~~state ~~NSG’s~~governments ~~hedging~~have ~~program,~~legislation ~~the~~that ~~amount~~provides offor ~~which~~additional isfunding ~~also~~for ~~subject~~ assistance to ~~ICC~~low-income ~~authority~~energy ~~(Gas Charge). See Note 8~~users, ~~“Commitments~~including ~~and Contingencies,”~~customers ~~for~~of ~~further discussion~~NSG.

~~Effective~~See ~~March~~Note 115, ~~2008,~~ as"Regulatory aEnvironment," ~~four-year~~for recent ~~pilot~~Illinois ~~program,~~legislation ~~NSG~~regarding ~~received~~bad ~~approval~~debt ~~from~~expense ~~the~~and ~~ICC~~new ~~for~~customer assistance programs. As a ~~decoupling~~ ~~mechanism~~result ~~for~~of ~~residential~~the ~~and~~implementation ~~small~~of ~~commercial~~this ~~sales~~new Illinois ~~that~~legislation, ~~allows~~all of NSG to’s ~~adjust~~bad ~~rates~~debt ~~going~~expense is recovered through rates.

- 4 -

forward to recover or refund the difference between the actual and authorized margin impact of variations in volumes. (See Note 14, "Regulatory Environment," for further discussion of the 2008 rate case and decoupling mechanism.)

ICC rules place restrictions on when NSG may terminate or deny service to customers who do not pay their bills for utility service. Though NSG’s current rates were established to recover an estimated bad debt expense, actual bad debt expense can exceed these estimates. Both federal and state governments have legislation that provides for additional funding for assistance to low-income energy users, including customers of NSG. The state legislation creates a fund, financed by charges to electric and natural gas customers of public utilities, participating municipal utilities, and electric co-ops, which supplements currently available federal energy assistance.

Legislation and Regulation at Federal Level

Most of the natural gas distributed by NSG is transported to its distribution systems by interstate pipelines. The pipelines’ services (transportation and storage) are regulated by the FERC under the Natural Gas Act and the Natural Gas Policy Act of 1978 ~~(see "Natural Gas Supply" section above)~~.

Under United States Department of Transportation regulations, the ICC is responsible for monitoring NSG’s safety compliance program for its pipelines under 49 Code of Federal Regulations (CFR) Part 192 (Transportation of Natural and Other Gas by Pipeline: Minimum Federal Safety Standards) and 49 CFR Part 195 (Transportation of Hazardous Liquids by Pipeline).

- 3 -

Other Matters

Seasonality

The natural gas throughput of NSG follows a seasonal pattern because the heating requirements of customers are temperature driven. Specifically, customers typically use more natural gas during the winter months. During ~~2008~~2009, NSG recorded approximately 6872% of ~~NSG’s~~its ~~operating~~ revenues ~~were~~in ~~recorded from~~ January, ~~through~~ February, March, November, and ~~November through~~ December.

Competition

Competition in varying degrees exists between natural gas and other ~~fuels or~~ forms of energy ~~available~~ available to consumers in the Midwest and NSG’s service territory, such as electricity, heating ~~and~~oil, ~~diesel~~propane, ~~fuel~~and coal.

Absent extraordinary circumstances, potential competitors are barred from constructing competing natural gas distribution systems in NSG’s service territory by a judicial doctrine known as the “"first in the field.” " In addition, the high cost of installing duplicate distribution facilities would render the construction of a competing system impractical.

AnNatural gas ~~interstate~~transportation service is offered to enable customers to better manage their energy costs. Transportation customers purchase natural gas directly from third-party natural gas suppliers and contract with NSG to transport the natural gas from pipelines to their facilities. An interstate pipeline may seek to provide transportation service directly to end users. Such direct service by a pipeline to an end user in NSG’s service territory would bypass NSG’s service. Only one end user in NSG’s service territory is served directly by aan interstate pipeline supplier. NSG has a bypass rate approved by the ICC, which allows NSG to negotiate rates with customers that are potential bypass candidates.

Since 2002, all NSG customers have had the opportunity to choose a natural gas supplier. A substantial portion of the natural gas that NSG delivers to its customers consists of natural gas that NSG’s customers purchase directly from producers and marketers rather than from NSG. These direct customer purchases have little negative effect on net income because NSG ~~provides~~ provides transportation service for such natural gas volumes at margins similar to those applicable to conventional natural gas sales.

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Working Capital Requirements

The ~~seasonality~~working capital needs of NSG's regulated natural gas utility operations vary significantly over time due to volatility in levels of natural gas inventories and the price of natural gas. NSG's working capital needs are met by cash generated from operations, equity infusions, and short-term debt. The seasonality of natural gas revenues causes the timing of cash collections to be concentrated from January through June. A portion of the winter natural gas supply needs is typically purchased and stored from April through November. Also, planned capital spending on the natural gas distribution facilities is concentrated in April through November. Because of these timing differences, the cash flow from customers is typically supplemented with temporary increases in short-term borrowings from affiliates during the late summer and fall. Short-term debt is typically reduced over the January through June period.

C. ENVIRONMENTAL MATTERS

For information on environmental matters related to NSG, see Note 89, “"Commitments and Contingencies.”"

D. CAPITAL REQUIREMENTS

For information on NSG’s capital requirements, see Item 7, “"Management's Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources.”"

- 4 -

E. EMPLOYEES

At December 31, ~~2008~~2009, NSG had ~~168~~166 employees, of which approximately 81% were union employees represented by Local 2285 of the International Brotherhood of Electrical Workers. The current collective bargaining agreement with NSG union employees expires on June 30, 2013.

The reduction in the number of NSG employees, compared with what was reported in NSG’s 2007 Annual Report on Form 10-K, was partially due to the 2008 formation of IBS, a wholly owned subsidiary of Integrys Energy Group. A portion of NSG’s administrative employees were transferred to IBS on January 1, 2008.

F. AVAILABLE INFORMATION

NSG files the following reports with the SEC:

· Annual Report on Form 10-K; · Quarterly Reports on Form 10-Q; · Current Reports on Form 8-K; and · Any amendments to these documents.

·NSG ~~Quarterly~~makes ~~Reports~~these reports available, free of charge, on Integrys Energy Group's Internet website, www.integrysgroup.com, as soon as reasonably practicable after they are filed with the SEC. Integrys Energy Group's Code of Conduct, which applies to NSG, may also be accessed on Integrys Energy Group's website, and any amendments to or waivers from the Code of Conduct will be timely disclosed on Integrys Energy Group's website. Statements and amendments posted on Integrys Energy Group's website do not include access to exhibits and supplemental schedules electronically filed with the reports or amendments. NSG is not including the information contained on or available through the Integrys Energy Group website as a part of, or incorporating such information by reference into, this Annual Report on Form 10-Q;K.

·You ~~Current~~may ~~Reports~~obtain materials filed with the SEC by NSG at the SEC Public Reference Room at 100 F Street, NE, Washington, DC 20549. To obtain information on the ~~Form~~operation 8of the Public Reference Room, you may call the SEC at 1-K;800-SEC-0330. You may also view NSG’s reports and other information (including exhibits) filed electronically with the SEC, at the SEC’s website at www.sec.gov.

·- ~~Any~~5 ~~amendments to these documents~~-

NSG makes these reports available, free of charge, on Integrys Energy Group's Internet website, www.integrysgroup.com, as soon as reasonably practicable after they are filed with the SEC. Integrys Energy Group's Code of Conduct, which applies to NSG, may also be accessed on Integrys Energy Group's website, and any amendments to, or waivers from the Code of Conduct will be timely disclosed on Integrys Energy Group's website. Statements and amendments posted on Integrys Energy Group's website do not include access to exhibits and supplemental schedules electronically filed with the reports or amendments. NSG is not including the information contained on or available through the Integrys Energy Group website as a part of, or incorporating such information by reference into, this Annual Report on Form 10-K.

You may also obtain materials filed with the SEC by NSG at the SEC Public Reference Room at 100 F Street, N.E., Washington, DC 20549. To obtain information on the operation of the Public Reference Room, you may call 1-800-SEC-0330. You may also view reports and other information regarding NSG (including exhibits), filed with the SEC, at the SEC’s website at www.sec.gov.

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ITEM 1A. RISK FACTORS

You should carefully consider the following risk factors, as well as the other information included or incorporated by reference in this Annual Report on Form 10-K, when making an investment decision. The risks and uncertainties described below are not the only ones NSG faces. Additional risks and uncertainties not presently known or that NSG currently believes to be immaterial may also adversely affect NSG.

NSG is subject to changes in government regulation, which may have a negative impact on its business, financial position, and results of operations.

The rates that NSG is allowed to charge for retail services are some of the most important items influencing its business, financial position, results of operations, and liquidity. While rate regulation is premised on providing an opportunity to earn a reasonable rate of return on invested capital, there is no assurance that the applicable regulatory commission will judge all the costs of the regulated utilities to have been prudently incurred or that the regulatory process in which rates are determined will always result in rates that will produce full recovery of such costs or provide for a reasonable return on equity. Certain items that would otherwise be immediately recognized as revenues and expenses are deferred as regulatory assets and regulatory liabilities for future recovery or refund to customers, as authorized by regulators. Future recovery of regulatory assets is not assured, and is generally subject to review by regulators in rate proceedings for matters such as prudence and reasonableness. If recovery of costs is not approved or is no longer deemed probable, regulatory assets would be recognized in current period expense and could have a material impact on NSG's financial results.

NSG is subject to comprehensive regulation by federal and state regulatory agencies, which significantly influences its operating environment and may affect NSG’s ability to recover costs from utility customers. In particular, the ICC, SEC, EPA, United States Department of Transportation, and Illinois Environmental Protection Agency regulate many aspects of NSG’s utility operations, including, but not limited to, construction and operation of facilities, conditions of service, the issuance of securities, and the rates that NSG can charge customers. NSG is required to have numerous permits, approvals, and certificates from these agencies to operate its business. Failure to comply with any applicable rules or regulations may lead to penalties, customer refunds, or other amounts, which could have a material impact on the financial results of NSG.

Existing statutes and regulations may be revised or reinterpreted by these agencies or these agencies may adopt new laws and regulations that apply to NSG. NSG is unable to predict the impact on its business and operating results of any such actions by these agencies. However, changes in regulations or the imposition of additional regulations may require NSG to incur additional expenses or change business operations, which may have an adverse impact on results of operations. In addition, federal regulatory reforms may produce unexpected changes and costs in the public utility industry.

NSG may face significant costs to comply with the regulation of greenhouse gas emissions.

Climate change and the effect of greenhouse gas emissions, most notably carbon dioxide, are increasingly becoming a concern for the energy industry. NSG's natural gas delivery systems may generate fugitive gas as a result of normal operations and as a result of excavation, construction, and repair of natural gas delivery systems. Fugitive gas typically vents to the atmosphere and consists primarily of methane, a greenhouse gas. Also, carbon dioxide is a byproduct of natural gas consumption. While there is currently no federal legislation in the United States that mandates the reduction of greenhouse gas emissions, it is possible that such legislation may be enacted in the future. To that end, federal and state legislative proposals have been introduced to regulate the emission of greenhouse gases, including bills pending in the United States Congress that would regulate greenhouse gas emissions through a cap-and-trade system under which emitters would be required to buy allowances to offset greenhouse gas emissions. Such regulation could increase the price of natural gas, restrict the use of natural gas, adversely affect the ability to operate our natural gas facilities, and/or reduce natural gas demand. However, until legislation is passed at the federal or state level, it remains unclear as to (1)

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what industry sectors will be impacted, (2) when compliance will be required, (3) the magnitude of the greenhouse gas emissions reductions that will be required, and (4) the costs and opportunities associated with compliance. NSG is evaluating both the technical and cost implications which may result from future state, regional, or federal greenhouse gas regulatory programs, but, at this time, it is uncertain as to the effect climate change regulation may have on NSG's future operations, capital expenditures, and financial results.

Costs of environmental compliance, liabilities, fines, penalties, and litigation could exceed NSG’s estimates.

Compliance with current and future federal and state environmental laws and regulations may result in increased capital, operating and other costs, including remediation and containment expenses and monitoring obligations. NSG cannot predict with certainty the amount and timing of all future expenditures (including the potential or magnitude of fines or penalties) related to environmental matters because of the difficulty of estimating cleanup and compliance costs and the possibility that changes will be made to the current environmental laws and regulations.

NSG is accruing liabilities and deferring costs (recorded as regulatory assets) incurred in connection with its former manufactured gas plant sites, including related legal expenses, pending recovery through rates or from other entities. Regulatory assets reflect the net amount of (1) costs incurred to date, (2) carrying costs, (3) amounts recovered from insurance companies, other entities and customers, and (4) management's best estimates of the costs NSG will spend in the future for investigating and remediating the manufactured gas plant sites. NSG believes that any of these costs that are not recoverable from other entities or from insurance carriers are recoverable through rates for utility services under ICC-approved mechanisms for the recovery of prudently incurred costs. A change in these rate recovery mechanisms, however, or a decision by the ICC that some or all of these costs were not prudently incurred, could result in the present recognition as expense of some or all of these costs. For more information, see Note 9, “Commitments and Contingencies.”

In addition, there is uncertainty in quantifying liabilities under environmental laws that impose joint and several liability on all potentially responsible parties.

Citizen groups that feel there are compliance issues not sufficiently enforced by environmental regulatory agencies may also bring citizen enforcement actions against NSG. Such actions could seek penalties, injunctive relief, and costs of litigation. Private citizens can also bring lawsuits to recover environmental damages they believe they have incurred.

NSG’s operations are subject to risks beyond its control, including but not limited to customer usage, weather, terrorist attacks, or acts of war.

NSG's revenues are affected by the demand for natural gas. That demand can vary greatly based upon:

·	Fluctuations in economic activity and growth in NSG's regulated service areas; and
·	Weather conditions, seasonality, and temperature extremes.

General economic conditions and customers focusing on energy efficiency in NSG's service areas may result in a decrease in demand for natural gas, which could have an adverse impact on NSG's results of operations, financial condition, and cash flows.

Weather conditions directly influence the demand for natural gas and affect the price of energy commodities.

In addition, the cost of repairing damage to NSG’s facilities due to natural disasters, wars, terrorist acts, and other catastrophic events that is in excess of insurance limits established for such repairs or excluded by insurance policies, may adversely impact NSG's results of operations, financial condition, and cash flows. The occurrence or risk of occurrence of future terrorist activity and the high cost or potential

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unavailability of insurance to cover such terrorist activity may impact NSG’s results of operations and financial condition in unpredictable ways. These actions could also result in disruptions of fuel markets. In addition, NSG’s natural gas distribution system and pipelines could be directly or indirectly harmed by future terrorist activity.

Adverse capital and credit market conditions could negatively affect NSG's ability to meet liquidity needs, access capital, and/or grow or sustain its current business. Cost of capital and disruptions, uncertainty, and/or volatility in the financial markets could also adversely impact the results of operations and financial condition of NSG.

~~The capital and credit markets experienced extreme volatility, uncertainty, and disruption in 2008, which has continued into 2009.~~ Having access to the credit and capital markets, at a reasonable cost, is necessary for NSG to fund its operations, including capital requirements. The capital and ~~credit~~ credit markets provide NSG with liquidity to operate and grow its business that is not otherwise provided from operating cash flows. Disruptions, uncertainty, and/or volatility in those markets could increase NSG's cost of capital. If NSG or Integrys Energy Group is unable to access the credit and capital markets on terms that are reasonable, they may have to delay raising capital, issue shorter-term securities, and/or bear an increased cost of capital. This, in turn, could impact NSG's ability to grow or sustain its current business or cause a reduction in earnings.

A reduction in NSG’s credit ratings could materially and adversely affect its business, financial position, results of operations, and liquidity.

NSG cannot be sure that any of its credit ratings will remain in effect for any given period of time or that a credit rating will not be lowered by a rating agency if, in the rating agency’s judgment, circumstances in the future so warrant. Any downgrade could:

·	Require the payment of higher interest rates in future financings and possibly reduce the potential pool of creditors;
·	Increase borrowing costs under certain of its existing credit facilities; and
·	Require provision of additional credit assurance to contract counterparties.

Counterparties and customers may not meet their obligations.

NSG is exposed to the risk that counterparties to various arrangements who owe NSG money, natural gas, or other commodities or services will not be able to perform their obligations. Should the counterparties to these arrangements fail to perform, NSG might be forced to replace or to sell the underlying commitment at then-current market prices. In such event, NSG might incur losses, or its results of operations, financial position, or liquidity could otherwise be adversely affected.

Some of NSG’s customers are experiencing, or may experience, financial problems that could have a significant impact on their creditworthiness. NSG cannot provide assurance that its financially distressed customers will not default on their obligations to NSG and that such a default will not have a material adverse effect on NSG’s business, financial position, results of operations, or cash flows. Furthermore, the bankruptcy of one or more of its customers, or some other similar proceeding or liquidity constraint, might make it unlikely that NSG would be able to collect all or a significant portion of amounts owed by distressed entities or residential customers. Such events could adversely impact NSG’s receivable collections and additional allowances may be required, which could adversely affect its operating results. In addition, such events might force customers to reduce or curtail their future use of NSG’s products and services, which could have a material adverse effect on NSG’s results of operations and financial condition.

- 7 -

NSG is subject to changes in government regulation, which may have a negative impact on its business, financial position, and results of operations.

The rates that NSG is allowed to charge for retail services are some of the most important items influencing its business, financial position, results of operations, and liquidity.

NSG is subject to comprehensive regulation by federal and state regulatory agencies, which significantly influences its operating environment and may affect NSG’s ability to recover costs from utility customers. In particular, the ICC, SEC, EPA, United States Department of Transportation, and Illinois Environmental Protection Agency regulate many aspects of NSG’s utility operations, including, but not limited to, construction of facilities, conditions of service, the issuance of securities, and the rates that NSG can charge customers. NSG is required to have numerous permits, approvals, and certificates from these agencies to operate its business.

An adverse decision in proceedings before the ICC concerning the prudence review of NSG’s natural gas purchases could require a significant refund obligation.

The ICC conducts annual proceedings regarding the reconciliation of revenues from the Gas Charge and related natural gas costs. In these proceedings, the accuracy of the reconciliation of revenues and costs is reviewed and the prudence of natural gas costs recovered through the Gas Charge is examined by interested parties. If the ICC were to find that the reconciliation was inaccurate or any natural gas costs were imprudently incurred, the ICC would order NSG to refund the affected amount to customers through subsequent Gas Charge filings. The ICC has ordered refunds to NSG's utility customers in connection with prior years' gas charge reconciliation proceedings. Proceedings regarding NSG’s costs for calendar years 2009, 2008 and 2007, fiscal year 2006, and for the transition period ended December 31, 2006, are currently pending before the ICC. The outcome of these proceedings cannot be predicted. For more information, see Note 89, “Commitments and Contingencies.”

NSG may face significant costs to comply with the regulation of greenhouse gas emissions.

Climate change and the effect of greenhouse gas emissions, most notably carbon dioxide, are increasingly becoming a concern for the energy industry. NSG's natural gas delivery systems may generate fugitive gas as a result of normal operations and as a result of excavation, construction, and repair of natural gas delivery systems. Fugitive gas typically vents to the atmosphere and consists primarily of methane, a greenhouse gas. While there is currently no federal regulation in the United States that mandates the reduction of greenhouse gas emissions, it is possible that such legislation may be enacted in the future. To that end, federal and state legislative proposals have been introduced to regulate the emission of greenhouse gases. Until legislation is passed at the federal or state level, it remains unclear as to (1) what industry sectors will be impacted, (2) when compliance will be required, (3) the magnitude of the greenhouse gas emissions reductions that will be required, and (4) the costs and opportunities associated with compliance. NSG is evaluating both the technical and cost implications which may result from future state, regional, or federal greenhouse gas regulatory programs, but, at this time, it is uncertain as to the effect climate change regulation may have on NSG's future operations, capital expenditures, and financial results.

- 8 -

Costs of environmental compliance, liabilities, fines, penalties, and litigation could exceed NSG’s estimates.

Compliance with current and future federal and state environmental laws and regulations may result in increased capital, operating and other costs, including remediation and containment expenses and monitoring obligations. NSG cannot predict with certainty the amount and timing of all future expenditures (including the potential or magnitude of fines or penalties) related to environmental matters because of the difficulty of estimating clean-up and compliance costs and the possibility that changes will be made to the current environmental laws and regulations.

In addition, there is uncertainty in quantifying liabilities under environmental laws that impose joint and several liability on all potentially responsible parties.

NSG’s operations are subject to risks beyond its control, including but not limited to weather, terrorist attacks, or acts of war.

The cost of repairing damage to NSG’s facilities due to storms, natural disasters, wars, terrorist acts, and other catastrophic events that is in excess of insurance limits established for such repairs or excluded by insurance policies, may adversely impact NSG's results of operations, financial condition, and cash flows. The occurrence or risk of occurrence of future terrorist activity and the high cost or potential unavailability of insurance to cover such terrorist activity may impact NSG’s results of operations and financial condition in unpredictable ways. These actions could also result in disruptions of fuel markets. In addition, NSG’s natural gas distribution system and pipelines could be directly or indirectly harmed by future terrorist activity.

Poor investment performance of retirement plan investments and other factors impacting retirement plan costs could unfavorably impact NSG's liquidity and results of operations.

NSG participates in employee benefit plans that cover substantially all of its employees and retirees. NSG’s cost of providing these benefits is dependent upon actual plan experience and assumptions concerning the future, such as earnings on and/or valuations of plan assets, discount rates, the level of interest rates used to measure the required minimum funding levels of the plans, future government regulation, and required or voluntary contributions to the plans. Depending upon the investment performance over time and other factors impacting NSG’s costs as listed above, NSG could be required to make larger contributions in the future to fund these plans. These additional funding obligations could have a material adverse impact on NSG’s cash flows, financial condition and/or results of operations. Changes made to the plans may also impact current and future pension and other postretirement benefit costs.

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Fluctuating commodity prices may affect the operating costs and competitive position of NSG's business, thereby adversely impacting its liquidity and results of operations.

NSG’s natural gas business is sensitive to changes in natural gas commodity prices. Any changes could affect the prices NSG charges, its operating costs, and the competitive position of its products and services. Prudently incurred costs for purchased natural gas and pipeline transportation and storage services are fully recoverable through the Gas Charge. However, increases in natural gas costs affect total retail prices and, therefore, the competitive position of NSG’s natural gas business relative to other forms of energy. In addition, the timing and extent of ~~high~~higher natural gas prices can adversely affect ~~NSG’s accounts receivable, bad debts, fuel cost, and~~ interest expense. NSG is also subject to margin requirements in connection with its use of forward contracts and these requirements could escalate if prices move adversely relative to these positions.

~~NSG depends~~Counterparties onmay ~~natural~~not ~~gas storage and transportation services purchased from interstate pipelines and on a storage field owned by PGL to~~ meet ~~its customers’~~their ~~natural gas requirements~~obligations.

NSG ~~meets~~is ~~a significant~~exposed ~~percentage of its customers’ peak day, seasonal, and annual natural~~to ~~gas~~the ~~requirements~~risk ~~through~~that ~~withdrawals,~~counterparties ~~pursuant~~ to ~~contracts,~~various ~~from~~arrangements ~~natural~~who ~~gas storage~~owe ~~facilities~~NSG ~~owned~~money, ~~and operated by interstate pipelines and through deliveries of~~ natural gas, ~~transported~~or onother ~~interstate~~commodities ~~pipelines with which NSG~~ or ~~its~~ ~~natural gas suppliers have contracts. NSG contracts with multiple pipelines for these~~ services, ~~and~~will itnot ~~has~~be ~~natural~~able ~~gas~~to ~~supply~~perform ~~contracts with multiple~~their ~~suppliers~~obligations. IfShould athe ~~pipeline~~counterparties ~~were~~ to these arrangements fail to perform ~~storage or transportation service~~, NSG ~~including~~might ~~for~~be ~~reasons~~forced ofto ~~force~~replace ~~majeure, on a peak day~~ or ~~other day with high volume natural gas requirements, NSG’s ability~~ to ~~meet~~sell ~~all~~the ~~its~~underlying ~~customers’ natural~~commitment ~~gas requirements would be impaired unless or until alternative supply~~at ~~arrangements~~then-current ~~were~~market ~~put in place~~prices. In ~~addition~~such event, NSG ~~purchases~~might aincur ~~storage service from PGL~~losses, ~~and~~or its results ~~ability~~of tooperations, ~~serve~~financial ~~its~~position, ~~customers~~or liquidity could beotherwise ~~adversely~~be ~~affected~~adversely ~~by failures at PGL’s storage field~~affected.

NSG depends on natural gas storage and transportation services purchased from interstate pipelines and on a storage field owned by PGL to meet its customers’ natural gas requirements. NSG meets a significant percentage of its customers’ peak day, seasonal, and annual natural gas requirements through withdrawals, pursuant to contracts, from natural gas storage facilities owned and operated by interstate pipelines and through deliveries of natural gas transported on interstate pipelines with which NSG or its natural gas suppliers have contracts. NSG contracts with multiple pipelines for these services, and it has natural gas supply contracts with multiple suppliers. If a pipeline were to fail to perform storage or transportation service, including for reasons of force majeure, on a peak day or other day with high volume natural gas requirements, NSG’s ability to meet all its customers’ natural gas requirements would be impaired unless or until alternative supply arrangements were put in place. In addition, NSG purchases a storage service from PGL, and its ability to serve its customers could be adversely affected by failures at PGL’s storage field.

Actual results could differ from estimates used to prepare NSG’s financial statements.

In preparing the financial statements in accordance with GAAP, management must often make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosures at the date of the financial statements and during the reporting period. Some of those judgments can be subjective and complex and actual results could differ from those estimates. For more information about these estimates and assumptions, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies."

- 9 -

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

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ITEM 2. PROPERTIES

Natural Gas Facilities

At December 31, ~~2008~~2009, NSG’s natural gas properties consisted of the following:

● Approximately 2,~~300~~400 miles of natural gas distribution mains located in Illinois, ● Approximately 30 miles of natural gas transmission mains located in Illinois and Wisconsin, ● 6 natural gas distribution and transmission gate stations, and ● Approximately ~~143~~144,000 natural gas lateral services.

PGL owns and operates a 36.5 billion-cubic-foot underground natural gas storage reservoir at Manlove Field located in central Illinois, which provides service to NSG under a contractual arrangement.

General

Most of the principal plants and properties of NSG, other than mains, services, meters, regulators, and cushion gas in underground storage are located on property owned in fee. Substantially all natural gas mains are located under public streets, alleys and highways, or under property owned by others under grants of easements. Meters and house regulators in use and a portion of services are located on premises being served. Certain portions of the transmission system are located on land held pursuant to leases, easements, or permits.

Substantially all of NSG’s utility plant is subject to a first mortgage lien.

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ITEM 3. LEGAL PROCEEDINGS

For information on material legal proceedings and matters related to NSG, see Note 89, "Commitments and Contingencies."

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

None

PART II

~~PEC is the sole~~ITEM ~~holder~~5. MARKET ofFOR NSG’s'S ~~outstanding~~COMMON ~~common~~EQUITY, ~~stock. NSG~~RELATED ~~made~~STOCKHOLDER MATTERS ~~no purchases of~~AND ~~equity~~ISSUER ~~securities~~PURCHASES inOF ~~2008. Integrys~~EQUITY ~~Energy Group is the sole holder of PEC’s common stock.~~SECURITIES

PEC is the sole holder of NSG’s outstanding common stock, and Integrys Energy Group is the sole holder of PEC’s common stock. NSG made no purchases of equity securities in 2009. For information on dividend restrictions, see Note 12, "Common Equity."

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ITEM 6. SELECTED FINANCIAL DATA

ITEM 6. SELECTED FINANCIAL DATA

NORTH SHORE GAS COMPANY
COMPARATIVE FINANCIAL DATA AND
OTHER STATISTICS (2005 TO 2009)


	Year Ended			Year Ended			Year Ended
	December 31,			December 31,			December 31,
(Millions, except weather information)	2009			2008			2007

Natural gas operating revenues	$	228.2		$	312.9		$	271.0
Net income		4.3			7.0			7.9
Total assets		453.7			483.6			424.9
Long-term debt (excluding current portion)		75.0			75.3			69.0

Weather information
Heating degree days		6,429			6,688			6,025
Heating degree days as a percent of normal *		105.5	%		109.7	%		97.6	%


	Transition
	Period Ended			Year Ended			Year Ended
	December 31,			September 30,			September 30,
(Millions, except weather information)	2006			2006			2005

Natural gas operating revenues	$	73.5		$	285.1		$	246.3
Net income		4.4			6.7			11.4
Total assets		410.9			400.0			371.2
Long-term debt (excluding current portion)		69.1			69.2			69.3

Weather information
Heating degree days		2,116			5,775			5,864
Heating degree days as a percent of normal *		95.4	%		90.1	%		91.2	%

NORTH SHORE GAS COMPANY
COMPARATIVE FINANCIAL STATEMENTS AND
FINANCIAL AND OTHER STATISTICS (2004 TO 2008)
							Transition
	Year Ended			Year Ended			Period Ended
	December 31,			December 31,			December 31,
(Millions, except weather and per share information)	2008			2007			2006
Gas operating revenues	$	312.9		$	271.0		$	73.5
Net income		7.0			7.9			4.4
Total assets		483.6			424.9			410.9
Long-term debt (excluding current portion)		75.3			69.0			69.1
Weather information
Heating degree days		6,688			6,025			2,116
Heating degree days as a percent of normal *		109.7	%		97.6	%		95.4	%
	Year Ended			Year Ended			Year Ended
	September 30,			September 30,			September 30,
(Millions, except weather information)	2006			2005			2004
Gas operating revenues	$	285.1		$	246.3		$	209.4
Net income		6.7			11.4			11.1
Total assets		400.0			371.2			323.0
Long-term debt (excluding current portion)		69.2			69.3			69.3
Weather information
Heating degree days		5,775			5,864			6,091
Heating degree days as a percent of normal *		90.1	%		91.2	%		94.8	%
* Normal heating degree days for fiscal years 2004 through 2005 were based on a 30-year average of monthly
temperatures at Chicago's O'Hare Airport for the years 1970 through 1999. Normal heating degree days for fiscal
2006 were based on a 30-year average of monthly temperatures at Chicago's O'Hare Airport for the years 1975
through 2004. Normal heating degree days for the transition period ended December 31, 2006, and fiscal 2007 were
based on a 10-year average of monthly total heating degree days at Chicago’s O’Hare Airport for the fiscal years
1996 through 2005. Normal heating degree days for fiscal 2008 are based on a 12-year average of monthly total
heating degree days at Chicago’s O’Hare Airport for the fiscal years 1996 through 2007.

	* Normal heating degree days for fiscal 2005 were based on a 30-year average of monthly temperatures at Chicago's
	O'Hare Airport for the years 1970 through 1999. Normal heating degree days for fiscal 2006 were based on a
	30-year average of monthly temperatures at Chicago's O'Hare Airport for the years 1975 through 2004. Normal
	heating degree days for the transition period ended December 31, 2006, and fiscal 2007 were based on a 10-year
	average of monthly total heating degree days at Chicago’s O’Hare Airport for the years 1996 through 2005. Normal
	heating degree days for fiscal 2008 and 2009 were based on a 12-year average of monthly total heating degree
	days at Chicago’s O’Hare Airport for the years 1996 through 2007.

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ITEM 7.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

INTRODUCTION

NSG, an indirect wholly owned subsidiary of Integrys Energy Group, Inc., is a regulated ~~natural~~ natural gas utility, which purchases, stores, distributes, sells, and transports ~~natural~~ natural gas to ~~about 158,000~~ customers in 54 communities in the northern suburbs of of Chicago. NSG is subject to the jurisdiction of and regulation by ~~the~~ the ICC, which has general supervisory and regulatory powers over ~~practically all phases of the~~ public ~~utility business~~ utilities in Illinois.

Strategic Overview

The focus of NSG's business plan is the creation of long-term value for Integrys Energy Group’s shareholders and NSG's customers through growth, operational excellence, customer focus, asset management, risk management, and the continued emphasis on safe, reliable, competitively priced, and environmentally sound natural gas delivery services. ~~A discussion of the essential components of NSG's business strategy is set forth below.~~

~~Maintain~~The ~~and Grow~~essential acomponents ~~Strong~~of Regulated Utility Base – A strong regulated utility base is important in order to maintain a strong balance sheet, predictable cash flows, a desired risk profile, and quality credit ratings, which are critical to NSG's ~~success. To~~business ~~this~~strategy end, NSG continues to upgrade its natural gas distribution facilities, related systems, and processes, seeking to enhance safety, reliability, and value for NSG's customers and Integrys Energy Group's shareholders.are:

~~Integrate~~Maintaining and ~~Resources~~Growing toa ~~Provide~~Strong Regulated ~~Operational~~Utility ~~Excellence~~Base – A ~~NSG~~strong regulated utility base is ~~committed~~essential to ~~integrating~~ ~~resources~~maintain ~~and~~a ~~finding~~strong ~~the~~balance ~~best~~sheet, ~~most~~predictable ~~efficient processes while~~cash ~~adhering~~flows, toa ~~any~~desired ~~and~~risk ~~all~~profile, ~~applicable regulatory~~ and ~~legal requirements. Through~~quality ~~innovative~~credit ~~ideas~~ratings, ~~embracing~~which ~~change,~~are ~~leveraging~~critical to ~~individual~~NSG's ~~capabilities~~success. To ~~and~~this ~~expertise~~end, ~~and~~NSG ~~utilizing~~continues ~~creative solutions~~ to ~~meet and~~upgrade ~~exceed~~ its ~~customers'~~natural ~~expectations~~gas distribution facilities, ~~NSG~~related ~~strives~~systems, toand ~~provide~~processes, ~~value~~seeking to ~~Integrys~~enhance ~~Energy~~safety, ~~Group's~~reliability, ~~shareholders~~ and value for NSG's customers and ~~assist~~Integrys inEnergy ~~lowering costs for~~Group's ~~certain activities~~shareholders.

~~Place Strong~~Integrating ~~Emphasis~~Resources onto ~~Risk~~Provide ~~Management~~Operational Excellence and Customer Focus – NSG's ~~risk~~is ~~management~~committed ~~strategy~~to integrating ~~includes~~resources ~~the management~~and offinding ~~market,~~the ~~credit~~best, ~~and~~most ~~operational~~efficient ~~risk~~processes ~~through~~while meeting ~~the~~all ~~normal~~applicable ~~course~~regulatory ~~of business~~and legal requirements. ~~Forward~~Through innovative ~~purchases~~ideas, ~~and~~embracing ~~sales~~change, ofleveraging ~~natural~~capabilities ~~gas~~ and ~~the~~expertise, ~~use of~~and ~~derivative~~utilizing ~~financial~~creative ~~instruments,~~solutions ~~including~~to ~~commodity~~meet ~~swaps~~ and ~~options~~exceed its customers' expectations, ~~allow~~NSG ~~for~~strives ~~opportunities~~ to ~~reduce~~provide ~~the~~value ~~risk~~to ~~associated~~Integrys ~~with~~Energy ~~price~~Group's ~~movement~~shareholders inand aNSG's ~~volatile energy market~~customers. ~~Overview~~ ofNSG believes the ~~risk~~following ~~profile~~activities ~~related~~have tohelped, ~~these~~and will continue ~~instruments~~to ishelp, ~~monitored~~integrate ~~consistent~~resources ~~with~~and ~~NSG's~~provide ~~risk~~operational ~~management~~excellence and customer ~~policy.~~focus:

~~Continued Emphasis~~· ~~on Safe~~IBS, ~~Reliable,~~a ~~Competitively~~wholly ~~Priced,~~owned ~~and~~service ~~Environmentally~~company ~~Sound Natural~~of ~~Gas~~Integrys ~~Services~~Energy ~~– NSG's~~Group, ~~mission~~was isformed to ~~provide~~ ~~customers~~achieve ~~with~~consolidation ~~the~~and ~~best~~efficient ~~value~~delivery inof ~~natural~~various ~~gas~~support services~~. By effectively~~, ~~operating~~and ~~its~~to ~~natural~~provide ~~gas~~more ~~distribution~~consistent ~~facilities,~~and ~~while~~transparent ~~maintaining or~~allocation ~~exceeding~~of ~~environmental~~costs ~~standards,~~throughout ~~NSG~~Integrys ~~seeks~~Energy toGroup ~~provide a safe, reliable,~~ and ~~value~~ ~~priced service to~~ its ~~customers~~subsidiaries. ~~NSG~~ ~~concentrates~~· ~~its~~"Operational ~~efforts on~~Excellence" ~~improving~~initiatives ~~and~~were ~~operating~~implemented ~~efficiently~~to ~~and~~provide ~~effectively~~top performance in ~~order~~the toareas ~~reduce~~of ~~costs and~~project ~~maintain~~management, aprocess ~~low~~improvement, ~~risk~~contract ~~profile~~administration, asand ~~well~~compliance asin ~~managing~~order ~~its operations~~ to reduce ~~the~~ ~~impact~~costs itand ~~might~~manage ~~have~~projects onand ~~the~~activities ~~environment~~within appropriate budgets, schedules, and regulations.

Placing Strong Emphasis on Risk Management – NSG's risk management strategy includes the management of market, credit, and operational risks through the normal course of business. Forward purchases and sales of natural gas and the use of derivative financial instruments, including commodity swaps and options, allow for opportunities to reduce the risk associated with price movement in a volatile energy market. The risk profile related to these instruments is managed in a manner consistent with Integrys Energy Group's risk management policy for regulated affiliates, which is approved by the Integrys Energy Group Board of Directors. The Integrys Energy Group Corporate Risk Management Group, which reports through the Chief Financial Officer, provides oversight for NSG.

Continuing Emphasis on Safe, Reliable, Competitively Priced, and Environmentally Sound Natural Gas Services – NSG's mission is to provide customers with the best value in natural gas services. By effectively operating its natural gas distribution facilities, while maintaining or exceeding environmental standards, NSG is able to provide a safe, reliable, and value-priced service to its customers. NSG concentrates its efforts on improving and operating efficiently and effectively in order to reduce costs and

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maintain a low risk profile, as well as managing its operations to reduce the impact it might have on the environment.

RESULTS OF OPERATIONS

	Year Ended				Year Ended		Change in			Change in
	Year Ended December 31						Change in			Change in
	December 31				September 30		2008 Over			2007 Over
(Millions)	2009		2008		2007		2009 Over 2008			2008 Over 2007
(Millions)	2008		2007		2006		2007			2006
Net income	$	4.3	$	7.0	$	7.9		(38.6	)%		(11.4	)%
Net income	$	7.0	$	7.9	$	6.7		(11.4	)%		17.9	%

~~NSG's~~Earnings ~~net~~Summary ~~income~~– 2009 ~~decreased~~Compared ~~$0.9 million for the year ended December 31, 2008, compared~~ with the year ended December 31, 2007. As discussed in more detail below, this decrease in net income was driven by a $9.8 million ($5.9 million after-tax) increase in operating and maintenance expenses, partially offset by a $6.5 million ($3.9 million after-tax) increase in natural gas margin and the positive year-over-year impact of a $2.0 million ($1.2 million after-tax) natural gas charge settlement recorded in 2007 (see Note 8, "Commitments and Contingencies," for more information).2008

NSG's ~~net~~recognized ~~income~~net ~~increased~~income of $14.3 million in 2009 compared with $7.0 million in 2008. Significant factors contributing to the $2.7 million ~~for~~decrease in earnings were the year-over-year ~~ended~~$1.2 ~~December~~million ~~31,~~after-tax ~~2007,~~decrease ~~compared~~in ~~with~~margin resulting from the ~~fiscal~~ ~~year~~negative ~~ended~~impact ~~September~~of ~~30,~~the ~~2006. This~~rate ~~increase~~order that was ~~primarily~~effective February ~~driven~~14, by2008 aand ~~$2.3~~lower ~~million~~year-over-year volumes ($including the impact of a decoupling mechanism that was implemented on March 1, 2008).4 A $0.3 million after-tax) decrease in ~~the~~interest ~~natural~~income ~~gas~~and restructuring expense related ~~charge~~to ~~settlement~~workforce inreductions ~~2007,~~of ~~compared~~$0.2 million after-tax also contributed to ~~2006~~the decrease in earnings.

Earnings Summary – 2008 Compared with 2007

NSG recognized net income of $7.0 million in 2008 compared with $7.9 million in 2007. Significant factors contributing to the $0.9 million decrease in net income were a $5.9 million after-tax increase in operating and maintenance expenses, partially offset by a $3.9 million after-tax increase in natural gas margin and the positive $1.2 million after-tax year-over-year impact of a natural gas charge settlement recorded in 2007.

As part of the regulatory approval for the PEC merger, Integrys Energy Group formed a service company, IBS, which became operational on January 1, 2008. As a result, the methodology used to allocate certain costs to NSG in 2008 was based on an affiliated interest agreement filed and approved in Illinois and was different than the methodology used prior to January 1, 2008. This methodology will be reviewed annually and will be adjusted, if necessary, with the approval of the applicable regulatory bodies.

NSG's results of operations for the years ended December 31, 2008, December 31, 2007, and September 30, 2006, are shown in the following table:

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	Year Ended						Year Ended			Change in			Change in
	December 31						September 30			2008 Over			2007 Over
(Millions, except heating degree days)	2008			2007			2006			2007			2006
Natural gas operating revenues	$	312.9		$	271.0		$	285.1			15.5	%		(4.9	)%
Natural gas purchased for resale		240.6			205.2			220.3			17.3	%		(6.9	)%
Margins		72.3			65.8			64.8			9.9	%		1.5	%
Operating and maintenance expense		49.1			39.3			39.5			24.9	%		(0.5	)%
Natural gas charge settlement		-			2.0			4.3			(100.0	)%		(53.5	)%
Depreciation and amortization expense		6.6			6.0			5.7			10.0	%		5.3	%
Taxes other than income taxes		2.1			2.4			2.0			(12.5	)%		20.0	%
Operating income		14.5			16.1			13.3			(9.9	)%		21.1	%
Miscellaneous income		0.8			1.2			1.3			(33.3	)%		(7.7	)%
Interest expense		(4.2	)		(4.2	)		(4.1	)		-	%		2.4	%
Other expense		(3.4	)		(3.0	)		(2.8	)		13.3	%		7.1	%
Income before taxes		11.1			13.1			10.5			(15.3	)%		24.8	%
Provision for income taxes		4.1			5.2			3.8			(21.2	)%		36.8	%
Net income	$	7.0		$	7.9		$	6.7			(11.4	)%		17.9	%
Throughput in therms
Residential		205.6			193.3			182.8			6.4	%		5.7	%
Commercial and industrial		44.4			41.7			39.1			6.5	%		6.6	%
Transport		137.2			129.3			127.4			6.1	%		1.5	%
Total sales in therms		387.2			364.3			349.3			6.3	%		4.3	%
Weather
Heating degree days		6,688			6,025			5,775			11.0	%		4.3	%

Natural Gas Utility Segment Operations

Revenue


	Year Ended December 31									Change in			Change in
(Millions, except heating degree days)	2009			2008			2007			2009 Over 2008			2008 Over 2007

Natural gas operating revenues	$	228.2		$	312.9		$	271.0			(27.1	)%		15.5	%
Natural gas purchased for resale		157.9			240.6			205.2			(34.4	)%		17.3	%
Margins		70.3			72.3			65.8			(2.8	)%		9.9	%

Operating and maintenance expense		50.7			49.1			39.3			3.3	%		24.9	%
Natural gas charge settlement		-			-			2.0			N/A			(100.0	)%
Restructuring expense *		0.4			-			-			N/A			N/A
Depreciation and amortization expense		6.2			6.6			6.0			(6.1	)%		10.0	%
Taxes other than income taxes		2.4			2.1			2.4			14.3	%		(12.5	)%
Operating income		10.6			14.5			16.1			(26.9	)%		(9.9	)%

Miscellaneous income		0.4			0.8			1.2			(50.0	)%		(33.3	)%
Interest expense		(4.3	)		(4.2	)		(4.2	)		2.4	%		-	%
Other expense		(3.9	)		(3.4	)		(3.0	)		14.7	%		13.3	%

Income before taxes		6.7			11.1			13.1			(39.6	)%		(15.3	)%
Provision for income taxes		2.4			4.1			5.2			(41.5	)%		(21.2	)%
Net income	$	4.3		$	7.0		$	7.9			(38.6	)%		(11.4	)%

Throughput in therms
Residential		194.2			205.6			193.3			(5.5	)%		6.4	%
Commercial and industrial		39.9			44.4			41.7			(10.1	)%		6.5	%
Transport		134.9			137.2			129.3			(1.7	)%		6.1	%
Total sales in therms		369.0			387.2			364.3			(4.7	)%		6.3	%

Weather
Heating degree days		6,429			6,688			6,025			(3.9	)%		11.0	%

~~2008~~* See ~~Compared~~Note ~~with~~3, "Restructuring ~~2007:~~Expense," for more information.

~~Revenues increased~~2009 ~~$41.9 million~~Compared ~~year-over-year. The~~with ~~major factors contributing to the increase were as follows:~~2008

· Weather that was 11.0% colder than the prior year led to a $21.7 million increase in revenues. · The per-unit cost of natural gas increased 9.8% year-over-year. This drove a $21.0 million increase in revenues, as increases in natural gas commodity costs are passed directly through to customers in rates. · Revenues increased $3.3 million due to NSG's recovery of higher year-over-year expenditures related to the cleanup of former manufactured gas plant sites. This increase in revenues was offset by an increase in operating expenses due to the amortization of the related regulatory asset. · Partially offsetting the increases discussed above was a decrease in revenues of $3.4 million resulting from a decrease in natural gas throughput volumes, excluding the impact of weather, which we believe is primarily due to customer conservation efforts related to higher energy prices and a general slowdown in the economy.

Natural gas utility segment revenue decreased $84.7 million year-over-year, driven by:

·	An approximate $72 million decrease in revenue as a result of an approximate 30% decrease in the per-unit cost of natural gas sold during 2009, compared with 2008. Prudently incurred natural gas commodity costs are passed directly through to customers in current rates.

·	An approximate $9 million decrease in revenue from warmer year-over-year weather during the heating season as evidenced by the 3.9% decrease in heating degree days.

·	An approximate $5 million decrease in revenue as a result of lower weather-normalized natural gas throughput volumes, attributed primarily to the negative impact of the general economic slowdown and customer conservation and efficiency efforts.

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~~2007 Compared with 2006:~~Margins

~~Revenues~~Natural ~~decreased~~gas utility segment margin decreased $142.1 0 million ~~for the~~ year ~~ended December 31, 2007, compared with the fiscal~~ -over-year ~~ended September 30~~, ~~2006. The~~primarily ~~major factors contributing to the~~due ~~decrease were as follows~~to:

·	The per-unit cost of natural gas decreased approximately 12% year-over-year. This drove a decrease of approximately $27 million in revenues.
·	Partially offsetting the decrease discussed above was an approximate increase of $12 million due to weather that was 4.3% colder than fiscal 2006, as well as an increase of approximately $2 million driven by an increase in natural gas throughput volumes, excluding the impact of weather.

·	An approximate $2 million decrease related to the negative impact of the rate order that was effective February 14, 2008. Lower volumetric rates under this rate order were fully in place for all of 2009, resulting in this decrease in margin.

·	An approximate $1 million decrease in margin resulting from a 4.7% decrease in natural gas throughput volumes attributed to the negative impact of the general economic slowdown, customer conservation and efficiency efforts, and warmer year-over-year weather. This decrease in margin includes the impact of a decoupling mechanism that was first effective for NSG on March 1, 2008. Decoupling allows NSG to adjust rates going forward to recover or refund the difference between the actual and authorized margin per customer impact of variations in volumes. The mechanism does not adjust for changes in volumes resulting from changes in customer counts.

·	An approximate $1 million decrease driven by the accrual of refunds to customers in January and February 2009 related to the decoupling mechanism that was implemented on March 1, 2008. The decoupling mechanism was fully in place for all of 2009 resulting in this decrease in margin.

·	The decrease in margin was partially offset by $1.4 million of both higher recovery of environmental cleanup expenditures related to former manufactured gas plant sites and higher recovery of EEP expenses. This increase in margin was offset by an increase in operating and maintenance expense from both the amortization of the related regulatory asset and EEP expenses and, therefore, had no impact on earnings.

Margin

2008 Compared with 2007:

NSG's margin increased $6.5 million in 2008, compared with 2007, primarily due to the $3.3 million year-over-year increase in the recovery of environmental costs; a $0.7 million increase due to the new rate design that was effective February 14, 2008; a $0.7 million increase due to revenues collected for the Enhanced Efficiency Program, which is designed to encourage energy efficient initiatives; and an increase in other revenues, including late fees, of $0.4 million. The new rate design incorporates higher fixed customer charges and lower volumetric rates.

2007 Compared with 2006:

NSG's margin increased $1.0 million for the year ended December 31, 2007, compared with the fiscal year ended September 30, 2006, primarily due to the impact of weather that was 4.3% colder in 2007.

Operating Income

~~2008~~Operating ~~Compared~~income ~~with~~at ~~2007~~the natural gas utility segment decreased $3.9 million year-over-year, driven by the $2.0 million decrease in margin and a $1.9 million increase in operating expense. The increase in operating expense was driven by:

Operating income decreased $1.6 million, primarily driven by a $9.8 million increase in operating and maintenance expenses, partially offset by the $6.5 million increase in margin and the positive period-over-period impact of a $2.0 million natural gas charge settlement recorded in 2007. The increase in operating and maintenance expenses primarily related to:

·	A $1.4 million increase in both the amortization of the regulatory asset related to environmental cleanup expenditures of former manufactured gas plant sites and EEP expenses. Both of these costs were recovered from customers in rates.

·	Restructuring expenses of $0.4 million related to a reduction in workforce at NSG and IBS. See Note 3, "Restructuring Expense," for more information.

· A $5.2 million increase in various operating costs, driven by increases in legal expenses, customer call center expenses, and intercompany service costs. · An increase of $3.3 million in the amortization of the regulatory asset related to cleanup costs of manufactured gas plant sites. These costs were recovered in revenues. · A $1.1 million increase in the combined amortization expense related to costs to achieve merger synergies and costs pertaining to the 2007/2008 rate case, which were initially deferred as regulatory assets. The increase in operating expenses related to these costs was offset in margin through an increase in revenues. As a result, there was no significant impact on earnings related to the amortization of these regulatory assets.Other Expense

~~2007~~Other ~~Compared~~expense ~~with~~at ~~2006:~~the natural gas utility segment increased $0.5 million year-over-year, primarily due to decreased interest income resulting from lower interest rates on loans to related parties and short-term cash investments.

~~Operating income~~2008 ~~increased~~Compared ~~$2.8 million,~~with primarily driven by a $2.3 million decrease in the natural gas charge settlement, as well as the $1.0 million increase in margin. These changes were partially offset by a $0.3 million increase in depreciation and amortization expense due to increases in property, plant, and equipment, and a $0.4 million increase in taxes other than income taxes, primarily due to higher real estate and payroll taxes.2007

Revenues

Natural gas utility segment revenue increased $41.9 million year-over-year. The major factors contributing to the increase were as follows:

·	Weather was 11.0% colder than the prior year, which led to a $21.7 million increase in revenues.

·	The per-unit cost of natural gas increased 9.8% year-over-year, which drove a $21.0 million increase in revenues.

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·	Revenues increased $3.3 million due to NSG's higher year-over-year recovery of expenditures related to the cleanup of former manufactured gas plant sites. This increase in revenues was offset by an increase in operating and maintenance expense due to the amortization of the related regulatory asset.

·	Partially offsetting the increases discussed above was a decrease in revenues of $3.4 million resulting from a decrease in natural gas throughput volumes, excluding the impact of weather, which NSG believed was primarily due to customer conservation efforts related to higher energy prices and a general slowdown in the economy.

Margins

Natural gas utility segment margin increased $6.5 million in 2008, compared with 2007, primarily due to the $3.3 million year-over-year increase in the recovery of environmental costs; a $0.7 million increase due to the new rate design that was effective February 14, 2008; a $0.7 million increase due to revenues collected for EEP, which is designed to encourage energy efficient initiatives; and an increase in other revenues, including late fees, of $0.4 million. The new rate design incorporates higher fixed customer charges and lower volumetric rates.

Operating Income

Operating income at the natural gas utility segment decreased $1.6 million, primarily driven by a $9.8 million increase in operating and maintenance expenses, partially offset by the $6.5 million increase in margin and the positive year-over-year impact of a $2.0 million natural gas charge settlement recorded in 2007. The increase in operating and maintenance expenses primarily related to:

·	A $5.2 million increase in various operating costs, driven by increases in legal expenses, customer call center expenses, and intercompany service costs.

·	An increase of $3.3 million in the amortization of the regulatory asset related to cleanup costs of manufactured gas plant sites. These costs were recovered from customers in rates.

·	A $1.1 million increase in the combined amortization expense related to costs to achieve merger synergies and costs pertaining to the 2007/2008 rate case, which were initially deferred as regulatory assets. The increase in operating expenses related to these costs was offset in margin through an increase in revenues. As a result, there was no significant impact on earnings related to the amortization of these regulatory assets.

Other Expense

~~2008~~Other ~~Compared~~expense ~~with~~at ~~2007:~~the natural gas utility segment increased $0.4 million year-over-year, primarily due to decreased interest income resulting from lower interest rates on loans to related parties.

Other expense increased $0.4 million year-over-year, primarily due to decreased interest income resulting from lower interest rates on loans to related parties.

2007 Compared with 2006:

Other expense increased $0.2 million year-over-year, as a result of a $0.1 million decrease in miscellaneous income due to decreased interest income, as well as a $0.1 million increase in interest expense due to higher interest rates and higher amounts of short-term borrowing balances.

Provision for Income Taxes

	Year Ended December 31						~~Year Ended September 30,~~
	2008			2007			2006
	2009			2008			2007
Effective Tax Rate		3635.98	%		3936.79	%		3639.27	%

~~2008~~ 2009 Compared with ~~2007:~~ 2008

The decrease in the effective tax rate ~~year-over-year~~for 2009 was primarily ~~caused~~due byto ~~the~~an ~~impact~~adjustment ~~of substantially consistent permanent tax adjustments on lower pre-tax income. These tax adjustments include items~~ related to ~~benefit and~~ ~~compensation~~uncertain ~~incentives,~~ tax ~~credits,~~positions ~~interest~~recorded ~~and~~in ~~penalty accruals, and the accrual for uncertain tax positions~~2008.

2007 Compared with 2006:

The increase in the effective tax rate year-over-year was primarily caused by the impact of substantially consistent permanent tax adjustments on higher pre-tax income.

Transition Period Ended December 31, 2006, Compared with Quarter Ended December 31, 2005

As previously disclosed in the combined PEC, PGL, and NSG Transition Report on Form 10-Q for the Transition Period from October 1, 2006, to December 31, 2006, NSG changed its fiscal year end from September 30 to December 31. The quarter ended December 31, 2006, represents a transitional period, and results for that period are included in the financial statements and notes thereto.

Overview of Operations

NSG’s financial results increased $10.1 million period-over-period, to net income of $4.4 million for the transition period ended December 31, 2006, from net loss of $5.7 million for the quarter ended December 31, 2005. Results for the quarter ended December 31, 2005, were impacted by a natural gas charge settlement of $17.0 million ($10.2 million after-tax).

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~~NSG's results of~~2008 ~~operations~~Compared ~~for~~with ~~the quarters ended December 31 are shown in the following table:~~2007

	Transition			Quarter
	Period Ended			Ended
	December 31,			December 31,			% Increase
(Millions, except heating degree days)	2006			2005			(Decrease)
Natural gas operating revenues	$	73.5		$	110.3			(33.4	)%
Natural gas purchased for resale		54.6			90.3			(39.5	)%
Margins		18.9			20.0			(5.5	)%
Operating and maintenance expense		9.0			10.0			(10.0	)%
Natural gas charge settlement		-			17.0			(100.0	)%
Depreciation and amortization expense		1.5			1.4			7.1	%
Taxes other than income taxes		0.5			0.4			25.0	%
Operating income (loss)		7.9			(8.8	)		N/A
Miscellaneous income		0.2			0.1			100.0	%
Interest expense		(1.1	)		(1.0	)		10.0	%
Other expense		(0.9	)		(0.9	)		-	%
Income before taxes		7.0			(9.7	)		N/A
Provision for income taxes		2.6			(4.0	)		N/A
Net income (loss)	$	4.4		$	(5.7	)		N/A
Throughput in therms
Residential		59.0			64.7			(8.8	)%
Commercial and industrial		12.4			13.6			(8.8	)%
Transport		36.0			37.4			(3.7	)%
Total sales in therms		107.4			115.7			(7.2	)%
Weather
Heating degree days		2,116			2,302			(8.1	)%

The decrease in the effective tax rate for 2008 was primarily due to the impact of substantially consistent permanent tax adjustments on lower pre-tax income. These tax adjustments include items related to benefit and compensation incentives, tax credits, interest and penalty accruals, and the accrual for uncertain tax positions.

Revenue

Revenues decreased $36.8 million period-over-period. The major factors contributing to the decrease were as follows:

·	An approximate 34% decrease in the per-unit cost of natural gas drove an approximate $30 million decrease in revenues.
·	Weather that was 8.1% warmer led to a decrease in revenues of approximately $8 million.

Margin

NSG's margin decreased $1.1 million for period-over-period, primarily due to the impact of lower deliveries resulting from weather that was 8.1% warmer.

Operating Income

Operating income increased $16.7 million, primarily due to the impact in 2005 of a charge of $17.0 million related to the settlement of Natural Gas Charge proceedings for fiscal years 2001 through 2004. A $1.0 million decrease in operating and maintenance expenses driven by a decrease in bad debt expense also positively impacted operating income period-over-period. These increases were partially offset by the $1.1 million decrease in margin.

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Provision for Income Taxes

Income tax expense increased $6.6 million period-over-period, primarily due to a higher level of taxable income. See Note 1(k) “Summary of Significant Accounting Policies – Income Taxes,” and Note 7, “Income Taxes,” for a discussion of accounting for income taxes.

BALANCE SHEET

~~Accounts~~Net ~~receivable~~accounts receivable and accrued unbilled revenues ~~increased~~decreased $1325.38 million (2641.51%) from $5062.2 7 million at December 31, ~~2007~~2008, to $6336.59 million at December 31, ~~2008~~2009, ~~primarily due to a~~ ~~year-over-year~~driven ~~increase~~by inlower ~~accrued unbilled~~ revenues ~~related~~due to ~~higher~~lower natural gas prices and ~~colder~~warmer weather during in the fourth quarter of ~~2008~~2009, compared with the same ~~quarter~~period in ~~2007~~ 2008.

~~Total regulatory~~At December 31, 2009, compared to December 31, 2008, total assets ~~increased~~from risk management activities decreased $490.18 million (44.04%) ~~year-over-year~~and total liabilities from risk management activities decreased $24.1 million (84.9%). The ~~regulatory~~ ~~asset~~decrease ~~related~~in toassets ~~derivatives~~and ~~increased~~liabilities ~~$23.2~~from ~~million,~~risk ~~primarily~~management ~~due~~activities towas ~~changes~~driven by changes in the fair values of the underlying derivative contracts, ~~and~~driven ~~the regulatory~~by ~~asset~~decreases ~~related~~in tothe ~~environmental~~forward ~~remediation~~price ~~costs~~of ~~increased~~natural ~~$18.2~~gas ~~million due to revisions~~ in ~~the estimate~~2009. See Note 42, ~~“Regulatory~~"Risk ~~Assets~~Management ~~and Liabilities~~Activities,” " for more information.

Detailed explanations for changes in the short-term and long-term debt balances at December 31, ~~2008~~2009, compared to December 31, ~~2007~~2008, are included in Note 56, “"Long-Term Debt,”" and Note 1617, “"Related Party Transactions.”"

Total liabilities from risk management activities increased $22.7 million (398.3%) year-over-year, primarily due to changes in the fair values of the underlying derivative contracts.

Environmental remediation liabilities increased $16.8 million (19.9%) year-over-year, from $84.6 million at December 31, 2007, to $101.4 million at December 31, 2008. See Note 8, "Commitments and Contingencies," for more information.

Pension and other postretirement benefit obligations increased $7.4 million (29.5%) year-over-year, primarily related to a decrease in the value of plan assets during 2008, which caused an increase in the unfunded status of the pension and other postretirement benefit plans. See Note 9, "Employee Benefit Plans," for more information.

LIQUIDITY AND CAPITAL RESOURCES

NSG believes that its cash balances, liquid assets, operating cash flows, and available borrowing capacity (related party and third party) provide adequate resources to fund ongoing operating requirements and future capital expenditures. However, NSG’s operating cash flows and access to capital markets can be impacted by macroeconomic factors outside of its control. In addition, ~~its~~NSG’s borrowing costs can be impacted by short-term and long-term debt ratings assigned by independent credit rating agencies.

Operating Cash Flows

~~2008~~ 2009 Compared with ~~2007:~~ 2008

During the year ended December 31, 2009, net cash provided by operating activities was $27.8 million compared with $12.2 million for the same period in 2008. The $15.6 million year-over-year increase was driven by:

·	A $22.4 million increase related to lower working capital requirements, primarily due to a $24.3 million decrease in accounts receivable and accrued unbilled revenues in 2009, compared with a $12.2 million increase in accounts receivable and accrued unbilled revenues in 2008, driven by the impact that higher natural gas prices and colder weather at the end of 2008 had on the overall change in accounts receivable balances.

·	Partially offsetting the net increase in cash provided by operating activities was a $4.9 million increase in pension and other postretirement funding.

2008 Compared with 2007

During the year ended December 31, 2008, net cash provided by operating activities was $12.2 million, compared with $7.0 million for the same period in 2007. The $5.2 million year-over-year increase was driven by a $5.4 million increase in net income adjusted for non-cash items, primarily related to an increase in deferred income taxes.

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2007 Compared with 2006:

Cash provided by operating activities decreased $15.3 million, from $22.3 million for the fiscal year ended September 30, 2006, to $7.0 million for the year ended December 31, 2007, primarily due to unfavorable net changes in working capital.

Transition Period Ended December 31, 2006, Compared with Quarter Ended December 31, 2005:

Cash used for operating activities was $8.3 million for the transition period ended December 31, 2006, compared with $9.1 million during the quarter ended December 31, 2005. The $0.8 million period-over-period decrease in cash used for operating activities was primarily due to favorable net changes in working capital.

Investing Cash Flows

~~2008~~ 2009 Compared with ~~2007:~~ 2008

Net cash used for investing activities increased $4.2 million, from $9.8 million during the year ended December 31, 2008, to $14.0 million during the year ended December 31, 2009, mainly due to a $4.1 million year-over-year increase in cash used to fund capital expenditure projects, primarily related to NSG’s natural gas pipe distribution system.

2008 Compared with 2007

Net cash used for investing activities increased $0.1 million, from $9.7 million during the year ended December 31, 2007, to $9.8 million during the year ended December 31, 2008, primarily due to a $0.3 million year-over-year increase in capital spending, partially offset by a $0.2 million increase in notes receivable from related parties.

2007 Compared with 2006:

Net cash used for investing activities increased $0.7 million, from $9.0 million for the fiscal year ended September 30, 2006, to $9.7 million for the year ended December 31, 2007, due to an increase in notes receivable from related parties of $0.4 million in the fiscal year ended September 30, 2006, and an increase in capital spending in 2007.

Transition Period Ended December 31, 2006, Compared with Quarter Ended December 31, 2005:

Net cash used for investing activities for the transition period ended December 31, 2006 was $1.7 million, as compared to $2.1 million for the quarter ended December 31, 2005. The $0.4 million period-over-period decrease was primarily due to a decrease in capital spending.

Capital Expenditures

Capital expenditures for the years ended December 31, 2008, and 2007, and for the fiscal year ended September 30, 2006 were $10.0 million, $9.7 million, and $9.4 million, respectively. Capital expenditures for the transition period ended December 31, 2006, were $1.6 million and for the quarter ended December 31, 2005, were $2.1 million.

Financing Cash Flows

~~2008~~ 2009 Compared with ~~2007:~~ 2008

Net cash used for financing activities was $213.3 million during the year ended December 31, ~~2008~~2009, compared with ~~net cash provided by financing activities of~~ $2.63 million for the same period in ~~2007~~2008. The $411.9 0 million year-over-year change was primarily due to ~~the~~a ~~repayment in 2008 of an~~ $115.98 million ~~related~~increase ~~party loan~~in ~~entered~~dividends ~~into~~paid ~~with~~to ~~PGL~~NSG’s ~~in 2007~~parent, ~~partially~~as ~~offset~~well byas ~~a $9.0 million related party loan with PEC obtained in 2008,~~ the issuance of $6.5 million of First Mortgage Bonds in November 2008~~, and a year-over-year reduction in dividends paid on common stock~~. ~~The repayment of related party loans was made possible by a year-over-year increase in cash provided by operating activities.~~

-2008 Compared 21with -2007

Net cash used for financing activities was $2.3 million during the year ended December 31, 2008, compared with net cash provided by financing activities of $2.6 million for the same period in 2007. The ~~Compared~~$4.9 million year-over-year change was primarily due to the repayment in 2008 of an $11.9 million related party loan entered into with PGL in 2007, partially offset by a $9.0 million related party ~~2006:~~loan with PEC obtained in 2008, the issuance of $6.5 million of First Mortgage Bonds in November 2008, and a year-over-year reduction in dividends paid on common stock. The repayment of related party loans was made possible by a year-over-year increase in net cash provided by operating activities.

Net cash provided by financing activities was $2.6 million for the year ended December 31, 2007, compared with net cash used for financing activities of $11.0 million for the fiscal year ended September 30, 2006. The $13.6 million year-over-year change was primarily due to the increase in the related party note payable to PGL in 2007.

Transition Period Ended December 31, 2006, Compared with Quarter Ended December 31, 2005:

Net cash used for financing activities increased $4.6 million, from $1.9 million provided by financing activities for the quarter ended December 31, 2005, to $2.7 million used for financing activities for the transition period ended December 31, 2006, primarily due to the reduction in the related party note payable to PGL in 2006, partially offset by the impact in a reduction in dividends paid on common stock.

Significant Financing Activities

~~In November 2008,~~For ~~NSG~~information ~~issued $6.5 million of 7.0% five-year First Mortgage~~on ~~Bonds. The net proceeds from~~ the issuance ofand ~~the~~redemption ~~first~~of ~~mortgage~~long-term ~~bonds were~~debt ~~used~~at ~~for~~NSG, ~~general~~see ~~corporate~~Note ~~utility~~6, ~~purposes. The~~"Long-Term ~~bonds were offered in a private placement and are not registered under the Securities Act of 1933~~Debt."

Credit Ratings

NSG periodically issues long-term debt in order to reduce short-term debt, refinance maturing securities, maintain desired capitalization ratios, and fund future growth. The specific forms of long-term financing, amounts, and timing depend on business needs, market conditions, and other factors.

The current credit ratings for NSG are listed in the table below.

	Standard & Poor's	Moody's
Issuer credit rating	A-BBB+	~~N/A~~A3
Senior secured debt	A	A1A2

Credit ratings are not recommendations to buy or sell securities and are subject to change, and each rating should be evaluated independently of any other rating.

On ~~November 25~~ January 26, ~~2008~~2010, Standard & and Poor’'s revised the outlook onfor ~~NSG~~Integrys Energy Group and all of its subsidiaries to ~~negative~~stable from ~~stable~~negative. The revised outlook ~~reflects~~reflected ~~pressure on the current credit ratings given~~ Integrys Energy Group’'s ~~liquidity~~decision ~~needs for its nonregulated business, as well as cash flow measures that have not met Standard & Poor’s expectations since the PEC merger.~~to

On November 13, 2007, Standard & Poor's revised the outlook on NSG to stable from negative. Standard & Poor’s outlook had been negative since February 21, 2007, as discussed below. The revised outlook reflected Integrys Energy Group's progress to improve its financial position and business profiles since its one-~~notch~~ ~~downgrade~~20 ~~on February 21, 2007.~~-

~~On September~~retain 6,a ~~2007,~~selected portion ~~Standard~~of &its ~~Poor's~~nonregulated ~~raised~~operations, ~~the~~which ~~senior~~resulted ~~secured~~in ~~debt~~a ~~for~~revision ~~NSG~~to Integrys ~~one~~Energy ~~notch~~Group's ~~from~~business A-risk profile to A"strong" from "excellent." The ~~new~~revised ~~rating~~outlook ~~was~~also ~~the~~reflected ~~result~~Integrys ofEnergy Group’s aimproved ~~review~~financial measures and ~~changes~~ ~~made~~decreasing toregulatory ~~the~~risk, ~~collateral~~which resulted ~~coverage~~in ~~requirements~~a ~~Standard~~change ~~and~~in ~~Poor's~~its ~~uses when~~financial ~~assigning~~risk ~~recovery~~profile ~~ratings~~ to ~~United~~"significant" ~~States Utility First Mortgage~~from ~~Bonds~~"aggressive."

On ~~February~~June 219, ~~2007~~2009, ~~Standard~~Moody’s &lowered ~~Poor's~~the ~~affirmed~~senior ~~all~~secured debt rating for NSG from "A1" ~~ratings~~to "A2." ~~Standard~~According &to ~~Poor'~~Moody’s, ~~outlook~~the ~~for~~downgrade ~~NSG~~reflects ~~was~~the ~~negative~~risk ~~pending~~that NSG’s internal cash flow could be pressured to support Integrys Energy Group’s continuing ~~successful~~cash ~~integration~~needs ofand ~~recent~~that near-term financial metrics will be negatively ~~acquisitions~~impacted by reduced demand for energy. Also, Moody’s assigned NSG an "A3" issuer credit rating.

-On March 225, 2009, Standard & Poor’s lowered the issuer credit rating for NSG from "A-" to "BBB+." According to Standard and Poor’s, the downgrade reflects Integrys Energy Group’s weak financial measures that do not support an "A" category credit profile. Standard and Poor’s also stated that the downgrade reflects the changes to Integrys Energy Group’s business and financial risk profiles. Standard & Poor’s revised Integrys Energy Group’s business risk profile to "excellent" from "strong" and changed its financial risk profile to "aggressive" from "intermediate." The change in the business risk profile reflected Integrys Energy Group’s strategy change with respect to Integrys Energy Services and helped to moderate the downgrade.

Future Capital Requirements and Resources

Contractual Obligations

The following table shows the contractual obligations of NSG as of December 31, ~~2008~~2009:

			Payments Due By Period
(Millions)	Total Amounts Committed		~~2009~~2010		2011 to 2012	~~2010-2011~~	2013 to 2014	~~2012 - 2013~~	~~2014~~2015 and Thereafter
Long-term debt principal and interest payments (1)	$	~~114~~109.78	$	3.7	$	7.5	$	5350.13	$	5048.43
Commodity purchase obligations (2)		7689.41		1419.72		2436.01		2224.43		159.35
Purchase orders (3)		37.23		37.23		-		-		-
Pension and other postretirementfunding obligations (4)		2632.73		67.01		914.38		5.93		5.51
Total contractual cash obligations	$	~~221~~238.05	$	2737.63	$	4058.84	$	8179.49	$	7162.29

(1) Represents bonds issued by NSG. NSG records all principal obligations on the balance sheet.

(2) The costs of commodity purchase obligations are expected to be recovered in future customer rates.

(3) Includes obligations related to normal business operations and construction obligations.

(4) Obligations for ~~certain~~ pension and other postretirement benefit plans, ~~cannot~~other than the Integrys Energy Group Retirement Plan, cannot be estimated beyond ~~2011~~ 2012.

The table above does not reflect any payments related to the manufactured gas plant remediation liability of $~~101~~106.48 million at December 31, ~~2008~~2009, as the amount and timing of payments are uncertain. NSG anticipates incurring costs annually to remediate these sites, but management believes that any costs incurred for environmental activities relating to former manufactured gas plant operations that are not recoverable through contributions from other entities or from insurance carriers have been prudently incurred and are, therefore, recoverable through rates. See Note 89, "Commitments and Contingencies," for more information. In addition, the table does not reflect any payments for the December 31, ~~2008~~2009, liability related to uncertain tax positions, as the amount and timing of payments are uncertain. See Note 78, "Income Taxes," for more information about this liability.

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Capital Requirements

Construction expenditures for NSG ~~makes~~for ~~large investments~~the inthree-year ~~capital~~period ~~assets. Net~~2010 ~~construction~~through ~~expenditures~~2012 are expected to be $3545.19 million ~~in the aggregate for the 2009 through 2011 period~~. The largest of these expenditures relates to NSG’s natural gas pipe distribution system. All projected capital and ~~investment~~ investment expenditures are subject to periodic review and ~~revision and~~ may vary significantly from the estimates depending on a number of factors, including, but not limited to, industry restructuring, regulatory constraints, market volatility, and economic trends.

Capital Resources

~~NSG~~As of ~~has~~December 31, ~~the~~2009, ~~ability to~~NSG ~~borrow~~was upin tocompliance ~~$50~~with ~~million~~all ~~from~~covenants ~~PEC~~related ~~and~~ to outstanding ~~loan~~long-term todebt orand ~~borrow~~expects ~~from~~to ~~PGL~~be upin ~~to $50 million. As~~compliance ofwith ~~December~~all ~~31,~~such ~~2008,~~debt covenants ~~NSG~~for ~~had~~the aforeseeable $9future.0 See ~~million loan~~Note ~~outstanding~~6, ~~from~~"Long-Term ~~PEC~~Debt," nofor ~~loans~~more information ~~from~~on ~~PGL,~~NSG's ~~and~~long-term nodebt ~~loans to PGL~~covenants.

NSG's ~~indenture relating~~plans to meet its ~~first mortgage bonds contains provisions and covenants restricting the payment of cash dividends and the purchase or redemption of~~ capital ~~stock. At~~requirements ~~December 31,~~for ~~2008, such restrictions amounted to $6.9 million of NSG's total retained earnings of $77.4 million. As of December 31, 2008, NSG was in compliance with all of~~ the ~~covenants under its credit facilities and other obligations. For the~~ period ~~2009~~2010 through ~~2011,~~2012 ~~NSG~~primarily ~~plans to use~~through internally generated funds, ~~net~~debt offinancings, ~~forecasted dividend payments~~ and equity infusions ~~to fund capital requirements~~. NSG plans to maintain current debt to equity ratios at appropriate levels to support current credit ratings and ~~corporate~~ corporate growth. Management believes NSG has adequate financial ~~flexibility~~ flexibility and resources to meet its future needs.

-NSG 23has -the ability to borrow up to $50.0 million from PEC and up to $50.0 million from PGL. At December 31, 2009, NSG had no borrowings outstanding with PEC and $7.6 million of borrowings outstanding with PGL under these debt agreements.

Other Future Considerations

~~Impact~~Uncollectible ~~of Financial Market Turmoil~~Accounts

~~As widely~~The ~~reported,~~reserve ~~the financial markets and overall economies in the United~~for ~~States~~uncollectible ~~and~~accounts ~~abroad~~reflects ~~are~~NSG's ~~currently~~best ~~undergoing~~estimate aof ~~period~~probable oflosses ~~significant~~on ~~uncertainty~~its ~~and~~accounts ~~volatility~~receivable balances. AsThe areserve ~~result~~is ofbased ~~recent~~on ~~events,~~known ~~NSG's management has~~troubled ~~placed~~accounts, ~~increased~~historical ~~emphasis~~experience, onand ~~monitoring~~other ~~the~~currently ~~risks~~available evidence. Provisions ~~associated~~for ~~with~~bad ~~the~~debt ~~current credit~~expense ~~market~~are ~~environment. While~~affected ~~the~~by ~~impact~~changes ~~of continued market~~in ~~volatility~~various ~~and~~factors, including the ~~extent and~~ impacts of ~~any~~the ~~economic~~economy, ~~downturn~~natural ~~cannot~~gas beprices, ~~predicted~~weather, ~~management~~and ~~currently~~recoveries ~~believes~~(or ~~that~~refunds) ~~NSG~~under Illinois ~~has~~Senate ~~sufficient~~Bill ~~operating~~1918 ~~flexibility~~described ~~and~~in ~~access~~Note to15, ~~funding sources to maintain adequate amounts of~~"Regulatory ~~liquidity~~Environment."

~~The recent~~Customer volatility in global capital markets has led to a reduction in the current market value of NSG's share of long-term investments held in the pension benefit plan trusts sponsored by IBS and the other postretirement benefit plan trusts sponsored by PEC. The recent decline in asset value of the plans will likely result in higher pension and other postretirement benefit expenses, and additional future funding requirements.Usage

~~Reserve~~Due to the general economic slowdown and the increased focus on energy efficiency, sales volumes excluding the impact of weather have been decreasing at NSG. Decoupling was approved for ~~Uncollectible~~NSG’s ~~Accounts~~residential and small commercial sales by the ICC on a four-year trial basis, effective March 1, 2008. Decoupling allows NSG to adjust rates going forward to recover or refund the differences between the actual and authorized margin per customer impact of variations in volumes. The mechanism does not adjust for changes in volume resulting from changes in customer count. Interveners, including the Illinois Attorney General, oppose decoupling and have appealed the ICC's approval. NSG is actively supporting the ICC's decision to approve decoupling. See Note 15, "Regulatory Environment," for more information.

The reserve for uncollectible accounts reflects NSG's best estimate of probable losses on its accounts receivable balances. The reserve is based on known troubled accounts, historical experience, and other currently available evidence. Provisions for bad debt expense are affected by changes in various factors, including the impacts of the economy, natural gas prices, and weather.

The impact of higher natural gas prices and the declining economic environment on customers could cause more of NSG's accounts receivable to become uncollectible. Higher levels of uncollectible balances from customers would negatively impact NSG's results of operations and could result in higher working capital requirements.

Decoupling

In the current political, economic, and regulatory environment, the focus on energy efficiency can lead to the implementation of decoupling mechanisms. Decoupling was approved for residential and small commercial sales by the ICC on a four-year trial basis on February 5, 2008, and became effective on March 1, 2008. Under decoupling, NSG is allowed to adjust rates going forward to recover or refund the difference between the actual and authorized margin impact of variations in volumes. Interveners, including the Illinois Attorney General, oppose decoupling and have appealed the ICC's approval. NSG is actively supporting the ICC's decision to approve decoupling. See Note 14, "Regulatory Environment," for more information.

American Recovery and Reinvestment Act of 2009

In February 2009, the American Recovery and Reinvestment Act of 2009 (ARRA) was signed into law. ARRA contains various provisions intended to stimulate the economy. ~~NSG~~Included isin ~~currently~~ARRA ~~evaluating~~are ~~the~~several ~~impacts~~tax ofprovisions that may affect NSG. Most notably, a provision of ARRA onprovides ~~its~~NSG with ~~financial~~additional ~~condition~~opportunities to claim tax deductions for bonus depreciation for certain assets placed in service during 2009, ~~results~~extending the bonus depreciation period established by the Economic Stimulus Act of ~~operations~~2008. The additional ~~and~~first ~~cash~~year ~~flows~~deduction ~~from~~for bonus depreciation is estimated to be $3.0 ~~operations~~million.

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Property Tax Assessment on Natural Gas

NSG purchases storage services from pipeline companies on the pipelines’ interstate natural gas storage and transmission systems. Once a shipper delivers gas to the pipeline’s system, that specific gas cannot be physically traced back to the shipper and the physical location of that specific gas is not ascertainable. Some states tax natural gas as personal property and have recently sought to assess personal property tax obligations against natural gas quantities held as "working" gas in facilities located in their states. Because the pipeline does not have title to the working gas inventory in these facilities, the state imposes the tax on the shippers as of the assessment date, based on allocated quantities. Shippers that are being assessed a tax are actively protesting these property tax assessments. As of December 31, 2009, NSG had not been assessed such a tax.

CRITICAL ACCOUNTING POLICIES

The following accounting policies have been determined to be critical to the understanding of NSG's financial statements because their application requires significant judgment and reliance on estimations of matters that are inherently uncertain. NSG's management has discussed these critical accounting policies with ~~its~~the Audit Committee of the Board of Directors of Integrys Energy Group.

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Receivables and Reserves

NSG accrues estimated amounts of revenue for services rendered but not yet billed. Estimated unbilled revenues are calculated using a variety of factors based on customer class. At December 31, ~~2008~~2009, and ~~2007~~2008, NSG's unbilled revenues were $3019.93 million and $2330.9 million, respectively. Any difference between actual revenues and the estimates are recorded in revenue in the next period. Differences historically have not been significant.

~~The reserve for~~As ~~uncollectible~~a ~~accounts~~result ~~reflects NSG’s best estimates~~ of ~~probable losses on~~ the ~~accounts~~ ~~receivable~~implementation ~~balances. The~~of ~~reserve~~Illinois isSenate ~~based~~Bill on1918 ~~known~~in ~~troubled accounts~~2009, ~~historical~~all ~~experience and other currently available~~of ~~evidence. Provisions~~NSG’s ~~for~~ bad debt expense ~~are~~is ~~affected~~recovered bythrough ~~changes in various factors, including the impacts of the economy, natural gas prices, and weather~~rates. ~~Each~~See ~~quarter,~~Note ~~NSG evaluates the adequacy of the reserve for uncollectible accounts based on the most currently available information~~15, ~~and~~ ~~adjusts the reserve for changes in estimated probable accounts receivable~~"Regulatory ~~losses. At December 31~~Environment," ~~2008 and 2007, NSG's reserve~~ for ~~uncollectible~~ ~~accounts~~more ~~was $1~~information.~~7 million and $2.0 million, respectively.~~

Pension and Other Postretirement Benefits

The costs of providing non-contributory defined benefit pension benefits and other postretirement benefits, described in Note 910, "Employee Benefit Plans," are dependent upon numerous factors resulting from actual plan experience and assumptions regarding future experience.

Pension and other postretirement benefit costs are impacted by actual employee demographics (including age, compensation levels, and employment periods), the level of contributions made to the plans, and earnings on plan assets. Pension and other postretirement benefit costs may be significantly affected by changes in key actuarial assumptions, including anticipated rates of return on plan assets, discount rates used in determining the projected pension and other postretirement benefit obligations and costs, and health care cost trends. Changes made to the plan provisions may also impact current and future pension and other postretirement benefit costs.

The pension and other postretirement benefit plan assets are primarily made up of equity and fixed income investments. Fluctuations in actual equity and fixed income market returns, as well as changes in general interest rates, may result in increased or decreased benefit costs in future periods. Management believes that such changes in costs would be recovered through the ratemaking process.

The following ~~chart~~table shows how a given change in certain actuarial assumptions would impact the projected benefit obligation and the reported ~~annual~~net ~~pension~~periodic ~~cost on the income~~pension ~~statement~~cost. Each factor below reflects an evaluation of the change based on a change in that assumption only.

Actuarial Assumption (Millions, except percentages)	Percentage-Point Change in Assumption			Impact on Projected Benefit Obligation			Impact on 2008 Pension Cost
Discount rate		(0.5	)	$	1.2		$	0.1
Discount rate		0.5			(1.1	)		(0.1	)
Rate of return on plan assets		(0.5	)		N/A			0.1
Rate of return on plan assets		0.5			N/A			(0.1	)

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- 25 -

Actuarial Assumption (Millions, except percentages)	Percentage-Point Change in Assumption	Impact on Projected Benefit Obligation	Impact on 2009 Pension Cost
Discount rate	(0.5)	$2.6	$0.3
Discount rate	0.5	(2.3)	(0.3)
Rate of return on plan assets	(0.5)	N/A	0.1
Rate of return on plan assets	0.5	N/A	(0.1)

The following ~~chart~~table shows how a given change in certain actuarial assumptions would impact the accumulated other postretirement benefit obligation and the reported ~~annual~~net periodic other postretirement benefit cost ~~on the income statement~~. Each factor below reflects an evaluation of the change based on a change in that ~~assumption~~ assumption only.

Actuarial Assumption (Millions, except percentages)	Percentage-Point Change in Assumption	~~Percentage-Point~~Impact ~~Change~~on inPostretirement ~~Assumption~~Benefit Obligation	Impact on 2009 Postretirement Benefit Cost		~~Impact on Postretirement Benefit Obligation~~			~~Impact on 2008 Postretirement Benefit Cost~~
Discount rate	(0.5)	$0.8	~~(0.5~~$ -	)	$	~~0.8~~		$	~~0.1~~
Discount rate	0.5	(0.8)	~~0.5~~-			~~(0.7~~	)		~~(0.1~~	)
Health care cost trend rate	(1.0)	(1.5)	(1.0.2)	)		~~(1.5~~	)		~~(0.3~~	)
Health care cost trend rate	1.0	1.7	1.0.2			~~1.7~~			~~0.4~~
Rate of return on plan assets	(0.5)	N/A	~~(0.5~~-	)		~~N/A~~			-
Rate of return on plan assets	0.5	N/A	~~0.5~~-			~~N/A~~			-

An interest rate yield curve ~~was~~is ~~developed~~used to enable appropriate judgments to be made ~~pursuant~~ toabout ~~Emerging~~discount ~~Issues Task Force Topic No~~rates. ~~D-36, “Selection of Discount Rates Used for Measuring Defined Benefit Pension Obligations and Obligations of Post Retirement Benefit Plans Other Than Pensions.”~~ The yield curve is comprised of non-callable (or callable with make-whole provisions), high-quality corporate bonds with maturities between 0 and 30 years. The included bonds are ~~generally~~ generally rated ~~by Moody’s as Aaa and~~ "Aa" with a minimum amount outstanding of $50 million. The expected annual benefit cash flows are discounted for each of the pension and retiree welfare plans using this yield curve, and a single-point discount rate is developed matching each plan’s expected payout structure.

The expected return on asset assumption is based on consideration of historical and projected asset class returns, as well as the target allocations of the benefit trust portfolios. The assumed long-term rate of return was 8.505% in ~~2008 and 2007~~2009, 2008, and 82007.~~75% in 2006.~~ For ~~2008~~2009, ~~2007~~2008, and ~~2006~~2007, the actual rates of return on pension plan assets, net of fees, were ~~(27~~22.50%), 7(27.35)%, and 137.3%, respectively.

The determination of expected return on qualified plan assets is based on a market-related valuation of assets, which reduces year-to-year volatility. Cumulative gains and losses in excess of 10% of the greater of the pension or other postretirement benefit obligation or market-related value are amortized over the average remaining future service to expected retirement ages. The difference between the expected return and the actual return on pension plan assets is recognized over a five-year period for purposes of calculating benefit cost. In addition, the expected return on plan assets, which is a component of cost, is applied to the market -related value of plan assets. Because of this method, the future value of assets used in the cost calculations will be impacted as previously deferred gains or losses are included in market -related value.

In selecting assumed health care cost trend rates, past performance and forecasts of health care costs are considered. ~~More~~For more information on health ~~care~~ care cost trend rates ~~can~~and bea ~~found~~table inshowing future payments that NSG expects to make for pension and other postretirement benefits, see Note 910, "Employee Benefit Plans."

Additionally, when an employee retires and takes his/her retirement benefit as a lump sum, a settlement amount under SFAS No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits,” is calculated representing a portion of unrecognized gains and losses. NSG’s accounting policy is to record the effects of the settlements in the current period instead of amortizing the actuarial differences over the expected average service life of the remaining participants. Both methods are acceptable under generally accepted accounting principles. Therefore, the timing of retirements can have an effect on the amount recorded in any given year. See Note 9, “Employee Benefit Plans,” for current year amounts.

For a table showing future payments that NSG expects to make for pension and other postretirement benefits, see Note 9, "Employee Benefit Plans."

- 26 -

Regulatory Accounting

NSG’s natural gas utility segment follows ~~SFAS~~the ~~No.~~guidance 71under the Regulated Operations Topic of the FASB ASC, ~~“Accounting~~and ~~for~~the financial statements reflect the ~~Effects~~effects of ~~Certain~~the ratemaking ~~Types~~principles offollowed ~~Regulation~~by the ICC.” Certain items that would otherwise be immediately recognized as revenues and expenses are deferred as regulatory assets and regulatory liabilities for future recovery or refund to customers, as authorized by the ICC. Future recovery of regulatory assets is not assured, and is generally subject to review by the ICC in rate proceedings for matters such as prudence and reasonableness. Management regularly assesses whether these regulatory assets and liabilities are probable of future recovery or refund by considering factors such as changes in the regulatory environment, earnings, and the status of any pending or potential deregulation legislation. Once approved, the regulatory assets and liabilities are amortized into income over the rate recovery period. If recovery of costs is not approved or is no longer deemed probable, these regulatory assets or liabilities are recognized in current period income.

If all or a separable portion of the utility operations no longer remain subject to the provisions of SFAS No. 71, we would discontinue its application as defined under SFAS No. 101, “Regulated Enterprises – Accounting for the Discontinuation of Application of SFAS No. 71.” Assets and liabilities recognized solely due to the actions of rate regulation would no longer be recognized on the balance sheet, but rather would be classified as an extraordinary item in income for the period in which the discontinuation occurred. A write-~~off~~ of24 all of NSG’s regulatory assets and regulatory liabilities at December 31, 2008, would result in a 33.2% decrease in total assets and a 2.6% decrease in total liabilities. See Note 4, “Regulatory Assets and Liabilities,” for more information.-

ICC. Future recovery of regulatory assets is not assured, and is generally subject to review by the ICC in rate proceedings for matters such as prudence and reasonableness. Management regularly assesses whether these regulatory assets and liabilities are probable of future recovery or refund by considering factors such as changes in the regulatory environment, earnings, and the status of any pending or potential deregulation legislation. Once approved, the regulatory assets and liabilities are amortized into income over the rate recovery period. If recovery or refund of costs is not approved or is no longer deemed probable, these regulatory assets or liabilities are recognized in current period income.

The application of the Regulated Operations Topic of the FASB ASC would be discontinued if all or a separable portion of NSG’s operations would no longer meet the criteria for application. Assets and liabilities recognized solely due to the actions of rate regulation would no longer be recognized on the balance sheet, but rather classified as an extraordinary item in income for the period in which the discontinuation occurred. A write-off of all of NSG’s regulatory assets and regulatory liabilities at December 31, 2009, would result in a 33.0% decrease in total assets and a 3.3% decrease in total liabilities. See Note 5, "Regulatory Assets and Liabilities," for more information.

Environmental Activities Relating to Former Manufactured Gas Plant Sites

NSG, its predecessors, and certain former affiliates operated facilities in the past at multiple ~~manufactured gas plant~~ sites for the purpose of manufacturing ~~gas~~ and storing manufactured gas. NSG is accruing and deferring the costs incurred in connection with environmental activities at the manufactured gas plant sites pending recovery through rates or from other entities. The amounts deferred include costs incurred but not yet recovered through rates and management’s best estimates of the costs that NSG will incur in investigating and remediating the manufactured gas plant sites. Management’s estimates are based upon a probabilistic model and an ongoing review by management of future investigative and remedial costs.

Management considers this policy critical due to the substantial uncertainty in the estimation of future costs with respect to the amount and timing of costs, and the extent of recovery from other potential responsible parties. See Note 89, “"Commitments and Contingencies,”" for further discussion of environmental matters.

Tax Provision

~~As part~~NSG ofis ~~the process of preparing our Financial Statements, we are~~ required to estimate ~~our~~ income taxes for each of the jurisdictions in which weit operates as part ~~operate~~of the process of preparing NSG's financial statements. This process involves estimating ~~our~~ actual current tax ~~exposure~~ liabilities together with assessing temporary differences resulting from differing treatment of items, such as depreciation, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within ~~our~~ NSG's Balance Sheets. WeNSG must also assess the likelihood that ~~our~~its deferred tax assets will be recovered through future taxable income. To ~~and, to~~ the extent weNSG ~~believe~~believes that recovery is not likely, weit must establish a valuation allowance, which is offset by an adjustment to ~~income~~the ~~tax~~provision ~~expense~~for ~~in the~~ income ~~statement. The interpretation~~taxes ~~of tax laws involves uncertainty, since tax authorities may~~in ~~interpret them differently. In 2007, we adopted~~ the ~~provisions~~Statements of ~~FASB~~ ~~Interpretation No.48, "Accounting for Uncertainty in~~ Income ~~Taxes – an Interpretation of FAS 109~~.~~" As allowed under Interpretation No. 48, NSG elected to change its method of accounting to record interest and penalties paid on income tax obligations as a component of income tax expense.~~

-Uncertainty associated 27with -the application of tax statutes and regulations and the outcomes of tax audits and appeals require that judgment and estimates be made in the accrual process and in the calculation of effective tax rates. NSG adopted the provisions of FASB Interpretation No.48, "Accounting for Uncertainty in Income Taxes – an Interpretation of FAS 109" (now incorporated as part of the Income Taxes Topic of the FASB ASC), which requires that only income tax benefits that meet the "more likely than not" recognition threshold be recognized or continue to be recognized. The change in the unrecognized tax benefits needs to be reasonably estimated based on an evaluation of the nature of uncertainty, the nature of events that could cause the change, and an estimate of the range of reasonably possible changes.

Significant management judgment is required in determining ~~our~~NSG's provision for income taxes, ~~our~~ deferred tax assets and liabilities, and any valuation allowance recorded against ~~our~~ deferred tax assets. The assumptions involved are ~~supported~~ supported by historical data, reasonable projections, and technical interpretations of applicable tax ~~law~~laws and ~~regulation~~regulations across multiple taxing jurisdictions. Significant changes in these assumptions could have a material impact on ~~our~~NSG's financial condition and results of ~~operations. See~~ ~~Note 1(k), “Summary of Significant Accounting Policies – Income Taxes,” and Note 7, “Income Taxes,” for a discussion of accounting for income taxes.~~

- 25 -

operations. See Note 1(k), "Summary of Significant Accounting Policies – Income Taxes," and Note 8, "Income Taxes," for a discussion of accounting for income taxes.

IMPACT OF INFLATION

~~Our~~NSG’s financial statements are prepared in accordance with ~~accounting principles generally accepted in the United States of America and report operating results in terms of historic cost~~GAAP. The statements provide a reasonable, objective, and quantifiable statement of financial results, but ~~they~~generally do not evaluate the impact of inflation. To the extent weNSG ~~are~~is not recovering the effects of inflation, weit will file rate cases as necessary.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

NSG currently funds liabilities related to employee benefits through various external trust funds, resulting in exposure to equity return and principal preservation risk. The trust funds are managed by numerous investment managers and hold investments in debt and equity securities. Changes in the market value of these investments can have an impact on the future expenses related to these liabilities. Declines in the equity markets or declines in interest rates may result in increased future costs for the plans and possible future required contributions for the pension plans. The trust fund portfolio is monitored by benchmarking the performance of the investments against certain security indices. The employee benefit costs are recovered in customers' rates, mitigating the equity return and principal preservation risk on these exposures. ~~During~~Effective July 1, 2008, ~~Integrys Energy~~the ~~Group~~defined ~~closed~~pension ~~its~~plans ~~qualified~~were ~~pension~~closed ~~plan~~ to ~~NSG's~~ new union hires, ~~reducing NSG's~~at ~~future exposure to equity return and principal preservation risk~~NSG.

- 2826 -

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

A. MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The management of NSG is responsible for establishing and maintaining adequate internal control over financial reporting. NSG's control systems were designed to provide reasonable assurance to NSG's management and the Board of Directors regarding the preparation and fair presentation of published financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

NSG's management assessed the effectiveness of its internal control over financial reporting as of December 31, ~~2008~~2009. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control- – Integrated Framework. Based on this assessment, management believes that, as of December 31, ~~2008~~2009, NSG's internal control over financial reporting is effective based on those criteria.

This annual report does not include an attestation report of NSG's independent registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by NSG's independent registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit NSG to provide only management's report in this annual report.

- 27 -

B. STATEMENTS OF INCOME


Year Ended December 31
(Millions)	2009			2008			2007

Natural gas operating revenues	$	228.2		$	312.9		$	271.0

Natural gas purchased for resale		157.9			240.6			205.2
Operating and maintenance expense		50.7			49.1			39.3
Natural gas charge settlement		-			-			2.0
Restructuring expense		0.4			-			-
Depreciation and amortization expense		6.2			6.6			6.0
Taxes other than income taxes		2.4			2.1			2.4
Operating income		10.6			14.5			16.1

Miscellaneous income		0.4			0.8			1.2
Interest expense		(4.3	)		(4.2	)		(4.2	)
Other expense		(3.9	)		(3.4	)		(3.0	)

Income before taxes		6.7			11.1			13.1
Provision for income taxes		2.4			4.1			5.2
Net income	$	4.3		$	7.0		$	7.9

The accompanying notes to NSG's financial statements are an integral part of these statements.

- 28 -

C. BALANCE SHEETS

At December 31
(Millions)	2009			2008

Assets
Cash and cash equivalents	$	0.6		$	0.1
Collateral on deposit		-			0.8
Accounts receivable and accrued unbilled revenues, net of reserves of $0.9 and $1.7, respectively		36.9			62.7
Natural gas in storage, primarily at LIFO		9.7			8.8
Assets from risk management activities		0.7			1.8
Regulatory assets		15.3			32.3
Prepaid federal income tax		4.1			-
Other current assets		2.2			1.6
Current assets		69.5			108.1

Property, plant, and equipment, net of accumulated depreciation of $163.5 and $160.2, respectively		248.2			245.8
Regulatory assets		134.5			128.3
Other long-term assets		1.5			1.4
Total assets	$	453.7		$	483.6

Liabilities and Shareholder's Equity
Accounts payable	$	21.7		$	26.6
Payables to related parties		7.3			6.7
Notes payable to related parties		7.6			9.0
Liabilities from risk management activities		4.1			26.7
Accrued taxes		3.9			6.1
Customer credit balances		6.7			6.5
Regulatory liabilities		10.4			8.1
Other current liabilities		5.9			7.8
Current liabilities		67.6			97.5

Long-term debt		75.0			75.3
Deferred income taxes		48.2			41.0
Environmental remediation liabilities		106.8			101.4
Pension and other postretirement benefit obligations		32.4			32.5
Asset retirement obligations		20.1			24.2
Other long-term liabilities		8.7			9.6
Long-term liabilities		291.2			284.0

Commitments and contingencies

Common stock - without par value, 5,000,000 shares authorized; 3,625,887 shares issued and outstanding		24.8			24.8
Retained earnings		70.2			77.4
Accumulated other comprehensive loss		(0.1	)		(0.1	)
Total liabilities and shareholder's equity	$	453.7		$	483.6

The accompanying notes to NSG's financial statements are an integral part of these statements.

- 29 -

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

D. STATEMENTS OF CAPITALIZATION

At December 31
(Millions, except share amounts)					2009			2008

Common stock equity
Common stock, without par value, 5,000,000 shares authorized,
3,625,887 shares outstanding				$	24.8		$	24.8
Accumulated other comprehensive loss					(0.1	)		(0.1	)
Retained earnings					70.2			77.4
Total common stock equity					94.9			102.1

Long-term debt
First Mortgage Bonds
	Series		Year Due
	M	5.000%	2028		28.5			28.8
	N-2	4.625%	2013		40.0			40.0
	O	7.000%	2013		6.5			6.5
Total long-term debt					75.0			75.3
Total capitalization				$	169.9		$	177.4

The accompanying notes to NSG's financial statements are an integral part of these statements.

B. STATEMENTS OF INCOME
							Transition
	Year Ended			Year Ended			Period Ended			Year Ended
	December 31,			December 31,			December 31,			September 30,
(Millions)	2008			2007			2006			2006
Natural gas operating revenues	$	312.9		$	271.0		$	73.5		$	285.1
Natural gas purchased for resale		240.6			205.2			54.6			220.3
Operating and maintenance expense		49.1			39.3			9.0			39.5
Natural gas charge settlement		-			2.0			-			4.3
Depreciation and amortization expense		6.6			6.0			1.5			5.7
Taxes other than income taxes		2.1			2.4			0.5			2.0
Operating income		14.5			16.1			7.9			13.3
Miscellaneous income		0.8			1.2			0.2			1.3
Interest expense		(4.2	)		(4.2	)		(1.1	)		(4.1	)
Other expense		(3.4	)		(3.0	)		(0.9	)		(2.8	)
Income before taxes		11.1			13.1			7.0			10.5
Provision for income taxes		4.1			5.2			2.6			3.8
Net income	$	7.0		$	7.9		$	4.4		$	6.7
The accompanying notes to NSG's financial statements are an integral part of these statements.

- 30 -

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

E. STATEMENTS OF COMMON SHAREHOLDER'S EQUITY

											Accumulated Other
											Comprehensive
											Loss
	Comprehensive					Common		Retained			Cash Flow
(Millions)	Income		Total			Stock		Earnings			Hedges

Balance at December 31, 2006			$	102.8		$	24.8	$	78.2		$	(0.2	)
Net income	$	7.9		7.9					7.9
Other comprehensive income - net unrealized gain on cash flow hedges (net of tax of $0.1)		0.1		0.1								0.1
Comprehensive income		8.0
Dividends on common stock				(9.4	)				(9.4	)

Balance at December 31, 2007			$	101.4		$	24.8	$	76.7		$	(0.1	)
Net income	$	7.0		7.0					7.0
Effects of changing pension plan measurement date pursuant to SFAS No. 158				(0.6	)				(0.6	)
Dividends on common stock				(5.7	)				(5.7	)

Balance at December 31, 2008			$	102.1		$	24.8	$	77.4		$	(0.1	)
Net income	$	4.3		4.3					4.3
Dividends on common stock				(11.5	)				(11.5	)

Balance at December 31, 2009			$	94.9		$	24.8	$	70.2		$	(0.1	)

The accompanying notes to NSG's financial statements are an integral part of these statements.

C. BALANCE SHEETS
	December 31			December 31
(Millions)	2008			2007
Assets
Cash and cash equivalents	$	0.1		$	-
Accounts receivable and accrued unbilled revenues, net of reserves of $1.7 and $2.0, respectively		63.5			50.2
Receivables from related parties		-			2.3
Natural gas in storage, primarily at LIFO		8.8			8.9
Assets from risk management activities		1.8			2.0
Regulatory assets		32.3			9.8
Other current assets		1.6			2.0
Current assets		108.1			75.2
Property, plant, and equipment, net of accumulated depreciation of $160.2 and $154.2, respectively		245.8			244.8
Regulatory assets		128.3			101.7
Other		1.4			3.2
Total assets	$	483.6		$	424.9
Liabilities and Shareholder's Equity
Accounts payable	$	26.6		$	25.8
Payables to related parties		6.7			7.3
Notes payable to related parties		9.0			11.9
Liabilities from risk management activities		26.7			5.7
Accrued taxes		6.1			2.5
Customer credit balances		6.5			8.1
Regulatory liabilities		8.1			8.9
Other current liabilities		7.8			5.6
Current liabilities		97.5			75.8
Long-term debt		75.3			69.0
Deferred income taxes		41.0			39.0
Environmental remediation liabilities		101.4			84.6
Pension and other postretirement benefit obligations		32.5			25.1
Asset retirement obligations		24.2			23.0
Other		9.6			7.0
Long-term liabilities		284.0			247.7
Commitments and contingencies
Common stock - without par value, 5,000,000 shares authorized; 3,625,887 shares issued and outstanding		24.8			24.8
Retained earnings		77.4			76.7
Accumulated other comprehensive loss		(0.1	)		(0.1	)
Total liabilities and shareholder's equity	$	483.6		$	424.9
The accompanying notes to NSG's financial statements are an integral part of these statements.

- 31 -

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

F. STATEMENTS OF CASH FLOWS

Year Ended December 31
(Millions)	2009			2008			2007
Operating Activities
Net income	$	4.3		$	7.0		$	7.9
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization expense		6.2			6.6			6.0
Bad debt expense		1.5			2.3			2.1
Deferred income taxes and investment tax credits, net		6.1			4.3			(1.3	)
Pension and other postretirement expense		4.4			4.1			4.2
Pension and other postretirement funding		(6.2	)		(1.3	)		(0.1	)
Natural gas charge settlement		-			-			1.6
Other, net		0.1			0.2			(2.6	)
Changes in working capital
Collateral on deposit		0.8			(0.6	)		(0.1	)
Accounts receivable and accrued unbilled revenues		24.3			(12.2	)		(11.4	)
Natural gas in storage		(0.9	)		0.1			1.1
Other current assets		(7.4	)		(0.1	)		6.5
Accounts payable		(5.2	)		(0.1	)		4.3
Accrued taxes		(2.2	)		3.6			(6.1	)
Other current liabilities		2.0			(1.7	)		(5.1	)
Net cash provided by operating activities		27.8			12.2			7.0

Investing Activities
Capital expenditures		(14.1	)		(10.0	)		(9.7	)
Proceeds from sale of property		0.2			-			-
Other		(0.1	)		0.2			-
Net cash used for investing activities		(14.0	)		(9.8	)		(9.7	)

Financing Activities
Net payments of related-party short-term debt		(1.5	)		(2.9	)		11.9
Issuance of long-term debt		-			6.5			-
Retirement of long-term debt		(0.3	)		(0.2	)		-
Dividends to parent		(11.5	)		(5.7	)		(9.3	)
Net cash (used for) provided by financing activities		(13.3	)		(2.3	)		2.6
Net change in cash and cash equivalemnts		0.5			0.1			(0.1	)
Cash and cash equivalents at beginning of year		0.1			-			0.1
Cash and cash equivalents at end of year	$	0.6		$	0.1		$	-

The accompanying notes to NSG's financial statements are an integral part of these statements.

D. STATEMENTS OF CAPITALIZATION
					December 31			December 31
(Millions, except share amounts)					2008			2007
Common stock equity
Common stock, without par value, 5,000,000 shares authorized, 3,625,887 shares outstanding				$	24.8		$	24.8
Accumulated other comprehensive loss					(0.1	)		(0.1	)
Retained earnings					77.4			76.7
Total common stock equity					102.1			101.4
Long-term debt
First Mortgage Bonds
	Series		Year Due
	M	5.000%	2028		28.8			29.0
	N-2	4.625%	2013		40.0			40.0
	O	7.000%	2013		6.5			-
Total long-term debt					75.3			69.0
Total capitalization				$	177.4		$	170.4
The accompanying notes to NSG's financial statements are an integral part of these statements.

- 32 -

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

E. STATEMENTS OF COMMON SHAREHOLDER'S EQUITY
											Accumulated Other Comprehensive
											Income (Loss)
	Comprehensive					Common		Retained			Cash Flow			Minimum Pension
(Millions)	Income		Total			Stock		Earnings			Hedges			Liability
Balance at September 30, 2005			$	103.0		$	24.8	$	80.6		$	(0.2	)	$	(2.2	)
Net income	$	6.7		6.7					6.7
Other comprehensive income - minimum pension liability (net of tax of $1.5)		2.2		2.2											2.2
Comprehensive income		8.9
Dividends on common stock				(11.0	)				(11.0	)
Balance at September 30, 2006			$	100.9		$	24.8	$	76.3		$	(0.2	)	$	-
Net income	$	4.4		4.4					4.4
Dividends on common stock				(2.5	)				(2.5	)
Balance at December 31, 2006			$	102.8		$	24.8	$	78.2		$	(0.2	)	$	-
Net income	$	7.9		7.9					7.9
Other comprehensive income - net unrealized gain on cash flow hedges (net of tax of $0.1)		0.1		0.1								0.1
Comprehensive income		8.0
Dividends on common stock				(9.4	)				(9.4	)
Balance at December 31, 2007			$	101.4		$	24.8	$	76.7		$	(0.1	)	$	-
Net income	$	7.0		7.0					7.0
Effects of changing pension plan measurement date pursuant to SFAS No. 158				(0.6	)				(0.6	)
Dividends on common stock				(5.7	)				(5.7	)
Balance at December 31, 2008			$	102.1		$	24.8	$	77.4		$	(0.1	)	$	-
The accompanying notes to NSG's financial statements are an integral part of these statements.

- 33 -

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

F. STATEMENTS OF CASH FLOWS
							Transition
	Year Ended			Year Ended			Period Ended			Year Ended
	December 31,			December 31,			December 31,			September 30,
(Millions)	2008			2007			2006			2006
Operating Activities:
Net income	$	7.0		$	7.9		$	4.4		$	6.7
Adjustments to reconcile net income to cash provided by (used for) operations:
Depreciation and amortization expense		6.6			6.0			1.5			5.7
Bad debt expense		2.3			2.1			0.3			1.6
Deferred income taxes and investment tax credits, net		4.3			(1.3	)		-			3.4
Pension and other postretirement expense		4.1			4.2			0.9			4.8
Pension and other postretirement funding		(1.3	)		(0.1	)		-			(2.0	)
Natural gas charge settlement		-			1.6			-			-
Other, net		0.2			(2.6	)		1.2			0.9
Net changes in:
Accounts receivable and accrued unbilled revenues		(12.8	)		(11.5	)		(27.4	)		2.5
Natural gas in storage		0.1			1.1			11.7			(7.5	)
Other current assets		(0.1	)		6.5			(8.6	)		11.7
Accounts payable		(0.1	)		4.3			5.1			(5.5	)
Accrued taxes		3.6			(6.1	)		3.6			(4.2	)
Other current liabilities		(1.7	)		(5.1	)		(1.0	)		4.2
Net cash provided by (used for) operating activities		12.2			7.0			(8.3	)		22.3
Investing Activities:
Capital expenditures		(10.0	)		(9.7	)		(1.6	)		(9.4	)
Notes receivable from related parties		0.2			-			(0.1	)		0.4
Net cash used for investing activities		(9.8	)		(9.7	)		(1.7	)		(9.0	)
Financing Activities:
Notes payable to related parties		(2.9	)		11.9			-			-
Issuance of long-term debt		6.5			-			-			-
Retirement of long-term debt		(0.2	)		-			(0.2	)		-
Dividends to parent		(5.7	)		(9.3	)		(2.5	)		(11.0	)
Net cash provided by (used for) financing activities		(2.3	)		2.6			(2.7	)		(11.0	)
Net increase (decrease) in cash and cash equivalents		0.1			(0.1	)		(12.7	)		2.3
Cash and cash equivalents at beginning of period		-			0.1			12.8			10.5
Cash and cash equivalents at end of period	$	0.1		$	-		$	0.1		$	12.8
The accompanying notes to NSG's financial statements are an integral part of these statements.

- 34 -

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

G. NOTES TO FINANCIAL STATEMENTS

NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) Nature of Operations-- NSG is a a regulated natural gas utility, which purchases, stores, distributes, sells, ~~and~~ and transports natural gas to ~~about 158,000~~ customers in ~~54 communities in~~ the northern suburbs of Chicago. NSG is subject to the jurisdiction of and regulation by the ICC, which has general supervisory and regulatory powers over ~~practically all phases of the~~ public ~~utility business in~~utilities in Illinois.

(b) Use of Estimates--WeNSG ~~prepare~~prepares ~~our~~its financial statements in conformity with accounting principles generally accepted in the United States of America. WeNSG ~~make~~makes estimates ~~and~~ and assumptions that affect assets, liabilities, the disclosure of contingent ~~assets~~ assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from these estimates.

(c) Cash and Cash Equivalents--Short-term investments with an original maturity of three months or less are reported as cash equivalents.

The following is supplemental disclosure to the NSG Statements of Cash Flows:

	Year Ended December 31,			Year Ended December 31,			Transition Period Ended December 31,		Year Ended September 30,
(Millions)	2009			2008			2007
(Millions)	2008			2007			2006		2006
Cash paid for interest	$	3.9		$	3.8		$	3.8
Cash paid for interest	$	3.8		$	3.8		$	1.8	$	3.6
Cash paid (received) for income taxes		2.9			(3.2	)		12.3
Cash paid (received) for income taxes		(3.2	)		12.3			0.5		3.9

~~(d) Revenue~~Construction ~~and Customer Receivables--~~costs ~~Revenues~~funded ~~are~~through ~~recognized~~accounts onpayable ~~the~~and ~~accrual~~treated ~~basis~~as ~~and~~non-cash ~~include~~investing ~~estimated~~activities ~~amounts~~totaled ~~for natural gas services provided but not billed~~$1. At3 ~~December 31~~million, ~~2008, and 2007, NSG's unbilled revenues were~~ $300.94 million, and $230.9 1 million, ~~respectively. Currently~~at ~~there~~December ~~are~~31, no2009, ~~customers or industries~~2008, ~~that~~and ~~account~~2007, ~~for more than 10% of NSG's revenues~~respectively.

~~The~~(d) Revenue ~~costs~~and ofCustomer Receivables--Revenues are recognized on the accrual basis and include estimated amounts for natural gas ~~prudently~~services ~~incurred~~provided bybut ~~NSG~~not billed. At ~~are~~December ~~recovered~~31, ~~from~~2009, ~~customers~~and ~~under~~2008, aNSG's unbilled revenues were ~~one-for-one~~$19.3 ~~recovery~~million ~~mechanism,~~and ~~which~~$30.9 ~~provides~~million, ~~for~~respectively. At ~~subsequent~~December ~~adjustments~~31, to2009, ~~rates~~there ~~for~~were ~~all~~no ~~changes~~customers inor ~~natural~~industries ~~gas~~that ~~costs~~accounted for more than 10% of NSG's revenues.

~~NSG~~The iscost ~~required~~of tonatural ~~provide~~gas ~~service~~prudently ~~and~~incurred ~~grant~~by ~~credit to customers within its service territories.~~ NSG ~~continually~~is ~~reviews~~recovered ~~its~~from customers’ ~~credit~~under a one-~~worthiness~~for-one ~~and~~recovery ~~obtains~~mechanism, orwhich ~~refunds~~provides ~~deposits~~for ~~accordingly. NSG~~subsequent isadjustments ~~precluded from discontinuing service~~ to ~~residential~~rates ~~customers during December through March~~for ~~when~~changes ~~the~~in ~~weather~~natural ~~forecast~~gas ~~includes temperatures of 32 degrees or lower~~costs.

NSG is required to provide service and grant credit (with applicable deposit requirements) to customers within its service territory. NSG continually reviews its customers’ credit-worthiness and obtains or refunds deposits accordingly. NSG is precluded from discontinuing service to residential customers during December through March when the weather forecast includes temperatures of 32 degrees or lower.

NSG presents revenues net of pass-through taxes on the Statements of Income.

(e) Inventories--~~NSG prices~~Inventories consist of natural gas in storage ~~injections,~~and ~~except~~liquid propane. NSG accounts for liquid propane, inventory using the average cost method. NSG prices natural gas storage injections at the calendar year average of the costs of natural gas supply purchased. Withdrawals from storage~~, except~~ ~~for liquid propane,~~ are priced on the LIFO cost method. ~~NSG accounts for liquid propane inventory using the average cost method.~~ The estimated replacement cost of natural gas in inventory ~~exclusive~~ ~~of the liquid propane~~ for NSG at December 31, ~~2008~~2009, and December 31, ~~2007~~ 2008, exceeded the LIFO cost by approximately $3134.71 million and $4231.87 million, respectively. In calculating these replacement amounts, NSG used a Chicago city-gate natural gas price per dekatherm of $56.8014 at December 31, ~~2008~~2009, and $75.3380 at December 31, ~~2007~~2008.

- 3533 -

(f) Risk Management Activities--As part of its regular operations, NSG enters into contracts, including options, forwards, swaps, and other contractual commitments, to manage changes in commodity prices, which are described more fully in Note 2, "Risk Management Activities."

~~NSG~~All ~~accounts~~derivatives ~~for~~are ~~derivative~~recognized ~~instruments~~on ~~pursuant~~the tobalance ~~SFAS~~sheet ~~No.~~at ~~133,~~their ~~“Accounting~~fair ~~for~~value ~~Derivatives Instruments~~unless ~~and~~they ~~Hedging~~qualify ~~Activities,”~~for asthe normal ~~amended~~purchases and ~~interpreted. Under~~ ~~the~~sales ~~provisions of SFAS No~~exception. NSG ~~133,~~continually ~~all~~assesses ~~derivatives~~its ~~are~~contracts ~~recognized~~designated onas ~~the~~normal ~~balance~~and ~~sheet~~will atdiscontinue ~~their~~the ~~fair~~treatment ~~value~~of ~~unless~~these contracts ~~they~~as ~~qualify~~normal ~~for~~ if the ~~normal~~required ~~purchases~~criteria ~~and~~are ~~sales~~no ~~exception~~longer met. NSG's tariffs allow for full recovery from its customers of prudently incurred natural gas supply costs, including gains or losses on these derivative instruments. Therefore, ~~under~~ ~~SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation,"~~ these unrealized derivative gains or losses are recorded as regulatory assets or liabilities.

FASB ~~Interpretation No. 39,~~ASC ~~"Offsetting of Amounts Related to Certain Contracts," as amended,~~815-10-45 provides the option to present certain asset and liability derivative positions net on the balance sheet and to net the related cash collateral against these net derivative positions. NSG has elected to present these items on a net basis inon its Balance Sheets.

(g) Property, Plant, and Equipment--Utility plant is stated at ~~the original~~ cost ~~of construction~~, including anany associated allowance for funds used during construction and asset retirement costs. The costs of renewals and betterments of units of property (as distinguished from minor items of property) are capitalized as additions to the utility plant accounts. Except for land, no gain or loss is recognized in connection with ordinary retirements of utility property units. Maintenance, repair, replacement, and renewal costs associated with items not qualifying as units of property are considered operating expenses. NSG charges the cost of units of property retired, sold, or otherwise disposed of to the accumulated provision for depreciation and records the cost of removal, less salvage value, associated with the retirement to depreciation expense.

NSG records straight-line depreciation expense over the estimated useful life of utility property, using depreciation rates as approved by the ICC. Annual utility composite depreciation rates for NSG were 1.87%, 1.98%, ~~1.9%,~~ and 1.89% for ~~calendar~~ ~~years~~ 2009, 2008, and 2007, ~~the~~respectively. These ~~transition~~depreciation ~~period-ended~~rates ~~December~~include ~~31,~~net dismantling ~~2006,~~costs ~~and~~that are charged to depreciation expense as incurred. Consistent with the ~~fiscal~~ICC ~~year~~rate ~~ended~~order ~~September~~issued ~~30,~~January ~~2006~~22, ~~respectively. These~~2010, ~~depreciation~~NSG ~~rates~~changed ~~include~~its ~~removal~~method ~~costs~~for ~~that~~recognizing ~~are~~net ~~charged~~dismantling tocosts ~~depreciation expense~~from as incurred to allocating the cost over the life of the asset.

See Note 34, "Property, Plant, and Equipment," for details regarding NSG's property, plant, and equipment balances.

(h) Regulatory Assets and Liabilities--~~NSG’s utility operations are subject to the provisions of SFAS No. 71.~~ Regulatory assets represent probable future revenue associated with certain costs or liabilities that have been deferred and are expected to be recovered from customers through the ratemaking process. Regulatory liabilities represent amounts that are expected to be refunded to customers in future rates or amounts collected in rates for future costs. If at any reporting date a previously recorded regulatory asset is no longer probable of recovery, the regulatory asset is reduced to the amount considered probable of recovery with the reduction charged to expense in the year the determination is made. See Note 45, "Regulatory Assets and Liabilities," for more information.

(i) Retirement of Debt-- Any call premiums or unamortized expenses associated with refinancing utility debt obligations are amortized consistent with regulatory treatment of those items. Any gains or losses resulting from the retirement of utility debt that is not refinanced are amortized over the remaining life of the original debt.

(j) Asset Retirement Obligations--NSG 36recognizes legal obligations at fair value associated with the retirement of tangible long-lived assets that result from the acquisition, construction or development, and/or normal operation of the assets. A liability is recorded for these obligations as long as the fair value can be reasonably estimated, even if the timing or method of settling the obligation is unknown. The asset retirement obligations are accreted using a credit-adjusted risk-free interest rate commensurate with the expected settlement dates of the asset retirement obligations; this rate is determined at the date the

~~(k) Income Taxes~~-- ~~NSG~~34 accounts for income taxes using the liability method as prescribed by SFAS No. 109, "Accounting for Income Taxes." Under this method, deferred income taxes have been recorded using currently enacted tax rates for the differences between the tax basis of assets and liabilities and the basis reported in the financial statements. Due to the effects of the regulation of NSG, certain adjustments made to defer income taxes are, in turn, recorded as regulatory assets or liabilities.-

~~NSG~~obligation ~~adopted the~~is ~~provisions~~incurred. The ofassociated ~~FASB~~retirement ~~Interpretation~~costs ~~No. 48,~~are ~~"Accounting~~capitalized ~~for~~as ~~Uncertainty~~part inof ~~Income~~the ~~Taxes~~related long-lived assets anand ~~Interpretation~~are ofdepreciated ~~FAS~~over ~~109,"~~the onuseful ~~January 1, 2007. As~~lives ~~a result~~ of the ~~implementation~~assets. See ofNote ~~Interpretation No. 48~~7, ~~NSG~~"Asset ~~recognized $0.1 million decrease in the liability for~~Retirement ~~unrecognized tax benefits~~Obligations," ~~which was accounted~~ for asmore ~~an increase in the January 1, 2007, balance of retained earnings~~information.

~~For~~(k) Income ~~investment~~Taxes--Deferred income taxes have been recorded to recognize the expected future tax consequences of ~~credits~~events ~~generated~~that byhave ~~NSG,~~been included in the ~~ICC~~financial ~~reduces~~statements ~~our~~by ~~future~~using currently enacted tax rates ~~over~~for the ~~lives~~differences ofbetween the tax basis of assets and ~~property~~liabilities toand ~~which~~the basis reported in the financial statements. NSG records valuation allowances for deferred tax ~~credits~~assets ~~relate;~~when ~~accordingly,~~it ~~NSG~~is ~~defers~~uncertain ~~the~~if ~~investment~~the ~~tax~~benefit ~~credits~~will be realized in the ~~year~~future. ~~its~~NSG ~~taxes~~is ~~payable~~allowed ~~are~~to ~~reduced,~~defer ~~and~~certain adjustments ~~NSG~~made ~~reduces~~to income ~~tax~~ ~~expense~~taxes ~~over~~that ~~the~~will ~~useful~~impact ~~lives~~future ofrates ~~the~~and record regulatory assets or liabilities related ~~property~~to these adjustments.

~~NSG~~For isinvestment ~~included in~~tax ~~the~~credits ~~consolidated~~generated ~~United States income tax return filed~~ by ~~Integrys Energy Group.~~ NSG, isthe ~~party~~ICC toreduces afuture ~~tax~~rates ~~allocation~~over ~~arrangement~~the ~~with~~lives ~~Integrys~~of the ~~Energy~~property ~~Group~~to ~~and its subsidiaries under~~ which ~~each~~the ~~entity determines its income~~ tax ~~provision~~credits ~~on a separate company basis~~relate. Accordingly, NSG ~~settles~~defers the ~~intercompany~~investment ~~liabilities~~tax atcredits in the ~~time~~year ~~that~~the ~~payments~~taxes payable are ~~made~~reduced, toand ~~the applicable~~NSG ~~taxing~~reduces ~~authority. At~~the ~~December~~provision ~~31,~~for ~~2008,~~income ~~there~~taxes ~~were~~over nothe ~~significant intercompany~~useful ~~payables~~lives orof ~~receivables~~the ~~for income taxes~~related property.

~~For~~NSG ~~information~~is included in ~~regarding~~the consolidated United States income tax return filed by Integrys Energy Group. NSG's ~~accounting~~is party to a federal and state tax allocation arrangement with Integrys Energy Group and its subsidiaries under which each entity determines its provision for income taxes, ~~see~~on ~~Note~~a 7stand-alone basis. NSG settles the intercompany liabilities at the time that payments are made to the applicable taxing authority. At December 31, ~~"Income~~2009, ~~Taxes~~there were no significant intercompany payables or receivables for income taxes."

~~l) Employee~~NSG ~~Benefits--The costs~~reports ofinterest ~~pension~~ and ~~other~~penalties ~~postretirement~~accrued ~~benefits are expensed over the period during which the employees render service. The transition obligation~~ related to ~~the~~income ~~other~~taxes ~~postretirement~~as ~~plans is being recognized over~~ a ~~20-year~~component ~~period beginning in 1993. In computing the expected return on plan assets, a market related value~~ of ~~plan assets is used that recognizes differences between~~ ~~actual~~provision ~~investment~~for ~~returns~~income ~~and~~taxes ~~the expected return on plan assets over the subsequent five years. NSG’s regulators allow recovery~~ in ~~rates for~~ the ~~net~~Statements ~~periodic~~of ~~benefit cost calculated under GAAP~~Income.

~~NSG~~For ~~adopted the~~more ~~change~~information inregarding measurement date transition requirements of SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106, and 132(R)," effective January 1, 2008, by remeasuring plan assets and benefit obligations as of that date. Previously, NSG used a September 30 measurement date for its defined pension and other postretirement plans. As a result of the change in measurement date, a $1.0 million pre-tax reduction to retained earnings was recognized on January 1, 2008. SFAS No. 158 also requires employers to recognize a defined benefit postretirement plan's ~~funded status~~accounting infor ~~the~~income ~~balance sheet~~taxes, ~~and~~see ~~recognize~~Note ~~changes in the plan's funded status in comprehensive income in the year in which the changes occur. NSG records changes in the funded status to regulatory asset or liability accounts~~8, ~~pursuant~~ to"Income ~~SFAS No~~Taxes. ~~71.~~"

~~NSG~~(l) Employee ~~accounts~~Benefits--The ~~for~~costs ~~its~~of ~~participation~~pension inand ~~benefit~~other ~~plans~~postretirement ~~sponsored~~benefits byare ~~IBS~~expensed ~~and~~over ~~PEC~~the asperiod ~~multiple~~during which ~~employer~~employees render service. The transition obligation related to the other postretirement plans is being recognized over a 20-year period beginning in 1993. ~~Under~~In ~~affiliate~~computing ~~agreements~~the expected return on pension plan assets, ~~NSG~~a market-related value of plan assets is ~~responsible~~used that recognizes differences between actual investment returns and the expected return on plan assets over the subsequent five years. NSG’s regulators allow recovery in rates for ~~its~~the ~~share~~net periodic benefit cost calculated under ofGAAP. Effective with new rates implemented in 2010, NSG will reflect pension and other postretirement benefit costs in rates using Integrys Energy Group’s basis in the related plan assets and obligations and ismethod ~~entitled~~of determining tothese ~~its~~costs, ~~share~~which Integrys Energy Group established at the time of the ~~plan~~February ~~assets;~~2007 ~~accordingly~~PEC merger. In addition, the cumulative difference between the accounting bases of NSG ~~accounts~~and ~~for~~Integrys ~~its~~Energy ~~pro~~Group ~~rata~~in ~~share~~NSG’s pension and postretirement benefit obligations will be amortized as a component of NSG’s rates over the ~~IBS~~average ~~and~~remaining ~~PEC~~service ~~plans~~lives asof ~~its~~the ~~own~~participating ~~plans~~employees.

~~For~~NSG ~~additional~~adopted the ~~information~~change onin measurement date transition requirements of SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106, and 132(R)" (now incorporated as part of FASB ASC 715), effective January 1, 2008, by remeasuring plan assets and benefit obligations as of that date. NSG changed from a September 30 to a December 31 measurement date for its defined pension and other postretirement plans. As a result of the change in measurement date, a $1.0 million pre-tax reduction to retained earnings was recognized on January 1, 2008. SFAS No. 158 also required employers to recognize a defined benefit postretirement plan's ~~employee~~funded ~~benefits~~status on the balance sheet, ~~see~~and recognize ~~Note~~changes 9in the plan's funded status in comprehensive income in the year in which the changes occur. NSG records changes in the funded status to regulatory asset or liability accounts, ~~"Employee~~pursuant ~~Benefit~~to the Regulated ~~Plans~~Operations Topic of the FASB ASC."

-NSG 37accounts -for its participation in benefit plans sponsored by IBS and PEC as multiple employer plans. Under affiliate agreements, NSG is responsible for its share of plan obligations and is entitled to its share

~~(m) Fair Value~~-~~-Effective~~ ~~January 1,~~35 2008, NSG adopted SFAS No. 157, "Fair Value Measurements." This standard defines fair value and requires enhanced disclosures about assets and liabilities carried at fair value. As of December 31, 2008, these additional disclosures are required only for financial assets and liabilities measured at fair value and for nonfinancial assets and liabilities measured at fair value on a recurring basis, following the guidance in FASB Staff Position FAS 157-~~2, "Effective Date of FASB Statement No. 157." These disclosures can be found in Note 12, "Fair Value."~~

~~According to SFAS~~of ~~No. 157,~~plan ~~fair~~assets; value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). As permitted under SFAS No. 157accordingly, NSG ~~utilizes~~accounts afor ~~mid-market~~its ~~pricing~~pro ~~convention~~rata ~~(the~~share ~~mid-point price~~of ~~between~~the ~~bid~~IBS and ~~ask~~PEC plans ~~prices)~~ as ~~a practical expedient for valuing the majority of~~ its ~~derivative~~own ~~assets and liabilities~~plans.

~~SFAS~~For ~~No. 157~~additional ~~establishes~~information aon ~~fair~~NSG's ~~value~~employee ~~hierarchy~~benefits, ~~that~~see ~~prioritizes~~Note ~~the~~10, ~~inputs~~"Employee ~~used to measure~~Benefit ~~fair value~~Plans. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The three levels of the fair value hierarchy defined by SFAS No. 157 are as follows:"

(m) Fair Value--Effective January 1, 2008, NSG adopted SFAS No. 157, "Fair Value Measurements" (now incorporated as part of the Fair Value Measurements and Disclosures Topic of the FASB ASC). This standard defined fair value and required enhanced disclosures about assets and liabilities carried at fair value. These disclosures can be found in Note 13, "Fair Value."

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). NSG utilizes a mid-market pricing convention (the mid-point price between bid and ask prices) as a practical expedient for valuing the majority of its derivative assets and liabilities.

SFAS No. 157 established a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The three levels of the fair value hierarchy are defined as follows:

Level 1 – Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

Level 2 – Pricing inputs are observable, either directly or indirectly, but are not quoted prices included within Level 1. Level 2 includes those financial instruments that are valued using external inputs within models or other valuation methodologies.

Level 3 – Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methodologies that result in management's best estimate of fair value.

~~As required~~Financial ~~by SFAS No. 157, financial~~ assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

(n) ~~New~~Subsequent ~~Accounting Pronouncements~~Events--~~In March 2008, the FASB issued SFAS No. 161,~~Subsequent ~~"Disclosures~~events ~~about~~at ~~Derivative~~NSG ~~Instruments~~were ~~and~~evaluated Hedging Activities — an amendment of FASB Statement No. 133." SFAS No. 161 requires enhanced disclosures about (1) how and why an entity uses derivative instruments, (2) how derivative instruments and related hedged items are accounted for ~~under~~potential ~~SFAS~~recognition ~~No. 133,~~or asdisclosure ~~amended, and~~through ~~(3) how~~February ~~derivative instruments and related hedged items affect an entity's financial position~~25, ~~financial performance~~2010, ~~and~~which ~~cash flows. SFAS No. 161~~ is ~~effective~~the ~~for~~date ~~NSG for~~ the ~~reporting~~ ~~period~~financial ~~ending~~statements ~~March 31, 2009, and will result in expanded~~were ~~disclosures for derivative instruments~~issued.

~~FASB Staff Position~~ (~~FSP~~o) New Accounting Pronouncements--SFAS No. ~~FAS~~167, ~~132~~"Amendments to FASB Interpretation No. 46(R)~~-1,~~ "~~Employers'~~ ~~Disclosures~~(now ~~about~~incorporated ~~Postretirement~~as ~~Benefit Plan~~part ~~Assets,"~~of the Consolidation Topic of the FASB ASC), was issued in ~~December 2008~~June 2009. This ~~FSP~~statement ~~amends~~introduces ~~SFAS~~a ~~No.~~requirement ~~132(R),~~to ~~"Employers'~~perform ~~Disclosures~~ongoing ~~about~~assessments ~~Pensions~~to ~~and~~determine ~~Other~~whether ~~Postretirement~~an entity is a variable ~~Benefits,"~~interest entity and ~~requires~~whether ~~additional~~an ~~disclosures~~enterprise ~~about~~is ~~plan~~the primary beneficiary of a ~~assets~~variable interest entity. ~~These~~In ~~disclosures~~addition, ~~include:~~this statement clarifies that the enterprise that is required to consolidate a ~~description~~variable ofinterest ~~investment~~entity will ~~policies~~have ~~and~~a ~~strategies,~~controlling ~~disclosures~~financial ofinterest evidenced by (1) the ~~fair~~power ~~value~~to direct ofthe ~~each~~activities ~~major~~that ~~category~~most ~~of plan~~significantly ~~assets~~affect the entity’s economic performance, ~~information~~and ~~about~~(2) the ~~fair~~obligation ~~value~~to ~~measurements~~absorb oflosses ~~plan~~or ~~assets,~~the ~~and~~right to receive ~~disclosures~~benefits ~~about~~that are potentially significant ~~concentrations~~to ofthe ~~risk~~variable ininterest entity. Additional ~~plan~~disclosures are required regarding involvement ~~assets~~with variable interest entities, as well as the methodology used to determine the primary beneficiary of any variable interest entities. This standard ~~FSP~~was is effective for NSG ~~for~~beginning ~~the~~January ~~reporting~~1, ~~period ending~~2010. Management ~~December~~is ~~31,~~currently ~~2009,~~evaluating ~~and~~the ~~will~~impact ~~result~~that inthe ~~expanded~~adoption ~~disclosures~~will ~~related~~have toon NSG’s first ~~postretirement~~quarter ~~benefit~~2010 ~~plan~~financial ~~assets~~statements.

- 38 -

NOTE 2--RISK MANAGEMENT ACTIVITIES

~~The~~NSG ~~following~~uses ~~table~~derivative ~~shows~~instruments ~~NSG's~~to ~~assets~~manage ~~and~~commodity ~~liabilities~~costs. None ~~from~~of ~~risk~~these ~~management~~derivatives ~~activities~~are designated as ofhedges for accounting purposes. The derivatives include ~~December 31, 2008,~~natural gas purchase contracts as well as financial derivative contracts (commodity swaps and ~~December 31, 2007:~~options) used to mitigate the risks associated with

	Assets				Liabilities
(Millions)	December 31, 2008		December 31, 2007		December 31, 2008		December 31, 2007
Commodity contracts	$	1.8	$	2.1	$	28.4	$	5.7
Balance Sheet Presentation
Current	$	1.8	$	2.0	$	26.7	$	5.7
Other long-term		-		0.1		1.7		-
Total	$	1.8	$	2.1	$	28.4	$	5.7

- 36 -

the market price volatility of natural gas supply costs and the costs of gasoline and diesel fuel used by NSG’s utility vehicles.

The following tables show NSG’s assets and liabilities from risk management activities:

		Risk Management Assets
		December 31, 2009						December 31, 2008
(Millions)	Classification	Gross Derivative Position		Netting		Balance Sheet Presentation		Gross Derivative Position		Netting		Balance Sheet Presentation
Commodity contracts	Current	$	0.8	$	0.1	$	0.7	$	4.3	$	2.5	$	1.8
Commodity contracts	Other Long-term		0.4		0.1		0.3		-		-		-
Total		$	1.2	$	0.2	$	1.0	$	4.3	$	2.5	$	1.8

		Risk Management Liabilities
		December 31, 2009						December 31, 2008
(Millions)	Classification	Gross Derivative Position		Netting		Balance Sheet Presentation		Gross Derivative Position		Netting		Balance Sheet Presentation
Commodity contracts	Current	$	4.2	$	0.1	$	4.1	$	29.2	$	2.5	$	26.7
Commodity contracts	Other Long-term		0.3		0.1		0.2		1.7		-		1.7
Total		$	4.5	$	0.2	$	4.3	$	30.9	$	2.5	$	28.4

Assets and liabilities from risk management activities are classified as current or long-term based upon the maturities of the underlying contracts.

The ~~derivatives listed in the above~~ table ~~as "commodity contracts" include natural gas purchase~~below ~~contracts~~shows asthe ~~well~~net asunrealized ~~financial~~gains ~~derivative~~recorded ~~contracts~~on ~~(commodity~~the ~~swaps~~balance ~~and options)~~sheet ~~used~~related to derivatives ~~manage~~at ~~volatility in natural gas supply costs~~NSG.

At December 31, 2008 and 2007, the cash collateral amounts that were netted against the related derivative positions were insignificant.

(Millions)	Balance Sheet Presentation	2009
Commodity contracts	Balance Sheet – Regulatory assets (current)	$	21.8
Commodity contracts	Balance Sheet – Regulatory assets (long-term)		1.4

~~NOTE~~At ~~3--PROPERTY~~December 31, ~~PLANT~~2009, ~~AND~~NSG ~~EQUIPMENT~~had the following notional volumes of outstanding derivative contracts:

Property, plant, and equipment in service at December 31 consisted of the following utility assets:

	Purchases
Natural gas (millions of therms)		128.4
Petroleum products (barrels)		3,414

(Millions)	2008		2007
Total utility plant	$	405.7	$	396.8
Less: Accumulated depreciation		160.2		154.2
Net		245.5		242.6
Construction work in progress		0.3		2.2
Total property, plant, and equipment	$	245.8	$	244.8

Certain of NSG's derivative and nonderivative commodity instruments contain provisions that could require "adequate assurance" in the event of a material adverse change in NSG’s creditworthiness, or the posting of additional collateral for instruments in net liability positions, if triggered by a decrease in credit ratings. The aggregate fair value of all derivative instruments with credit-risk related contingent features that were in a liability position at December 31, 2009, was $4.4 million, and NSG had not posted any cash collateral related to the credit-risk related contingent features of these commodity instruments. If all of the credit-risk related contingent features contained in commodity derivative instruments had been triggered at December 31, 2009, NSG would have been required to post collateral of $3.3 million.

~~NOTE~~NSG's cash ~~4--REGULATORY~~collateral ~~ASSETS~~amounts ~~AND~~that ~~LIABILITIES~~were netted against the related derivative positions were insignificant at December 31, 2009, and 2008.

NOTE 3--RESTRUCTURING EXPENSE

In an effort to permanently remove costs from its operations, Integrys Energy Group developed a strategy at the end of 2009 that will include a reduction in the workforce supporting NSG. In connection with this strategy, $0.4 million of employee-related costs are shown separately in the restructuring expense line item on the Statements of Income. None of these costs had been paid out as of December 31, 2009.

- 37 -

NOTE 4--PROPERTY, PLANT, AND EQUIPMENT

Property, plant, and equipment at December 31 consisted of the following utility assets:

(Millions)	2009		2008
Total utility plant	$	411.2	$	405.7
Less: Accumulated depreciation		163.5		160.2
Net		247.7		245.5
Construction work in progress		0.5		0.3
Total property, plant, and equipment	$	248.2	$	245.8

NOTE 5--REGULATORY ASSETS AND LIABILITIES

The following regulatory assets and liabilities were reflected in NSG’s Balance Sheets as of December 31:

- 39 -

(Millions)	2009		2008

Regulatory assets
Environmental remediation costs (net of insurance recoveries)	$	114.4	$	105.8
Pension and other postretirement benefit related items		17.9		16.4
Asset retirement obligations		5.4		4.4
Derivatives		5.0		28.2
Rate case costs		3.0		2.1
Unamortized loss on debt		1.7		1.8
Other		2.4		1.9
Total	$	149.8	$	160.6
Balance Sheet Presentation
Current	$	15.3	$	32.3
Long-term		134.5		128.3
Total	$	149.8	$	160.6

Regulatory liabilities
Gas costs refundable through rate adjustments	$	9.8	$	6.5
Income tax related items		1.6		1.7
Other		0.5		1.5
Total	$	11.9	$	9.7
Balance Sheet Presentation
Current	$	10.4	$	8.1
Long-term – included in other long-term liabilities		1.5		1.6
Total	$	11.9	$	9.7

(Millions)	2008		2007
Regulatory assets
Environmental remediation costs (net of insurance recoveries)	$	105.8	$	87.6
Derivatives		28.2		5.0
Pension and other postretirement benefit related items		16.4		12.6
Asset retirement obligations		4.4		2.2
Rate case costs		2.1		-
Unamortized loss on debt		1.8		1.8
Costs to achieve merger synergies		1.5		1.6
Other		0.4		0.7
Total	$	160.6	$	111.5
Balance Sheet Presentation
Current	$	32.3	$	9.8
Long-term		128.3		101.7
Total	$	160.6	$	111.5
Regulatory liabilities
Gas costs refundable through rate adjustments	$	6.5	$	8.9
Income tax related items		1.7		2.0
Other		1.5		-
Total	$	9.7	$	10.9
Balance Sheet Presentation
Current	$	8.1	$	8.9
Long-term – included in other long-term liabilities		1.6		2.0
Total	$	9.7	$	10.9

NSG expects to recover its regulatory assets and incur future costs or refund its regulatory liabilities through rates charged to customers based on specific ratemaking decisions made by regulators over periods specified by the regulators or over the normal operating period of the assets and liabilities to which they relate. Based on prior and current rate treatment for such costs, NSG believes it is probable that it will continue to recover from customers the regulatory assets described above.

~~NSG~~Certain ~~expects to~~regulatory ~~recover~~assets ~~its~~do ~~regulatory~~not ~~assets~~result ~~and~~from ~~incur~~cash ~~future~~expenditures, ~~costs~~and ortherefore ~~refund~~do ~~its~~not ~~regulatory~~represent ~~liabilities~~investments ~~through~~included ~~rates~~in ~~charged~~rate tobase ~~customers~~or ~~based~~have onoffsetting ~~specific~~liabilities ~~ratemaking~~that reduce the ~~decisions~~rate ~~made~~base byof ~~regulators~~NSG. Incremental ~~over~~environmental ~~periods~~costs ~~specified~~incurred byand ~~the~~not yet ~~regulators~~recovered orfrom ~~over the~~customers ~~normal~~and ~~operating~~recoverable ~~period~~gas ofcosts, ~~the~~which ~~assets~~are ~~and~~generally recovered ~~liabilities~~within toone ~~which~~year, ~~they relate~~are not included in rate base. ~~Based~~However, NSG onis ~~prior~~allowed ~~and~~to ~~current~~recover ~~rate~~a ~~treatment~~carrying cost for ~~such~~amounts ~~costs,~~spent itbut not yet iscollected ~~probable~~from ~~that~~customers. The ~~NSG~~regulatory ~~will~~asset ~~continue~~related to ~~recover~~the unamortized ~~from~~loss ~~customers~~on ~~the~~debt ~~regulatory assets~~is ~~described~~not ~~above.~~included in rate base, but is recovered over the term

~~Certain~~- ~~regulatory assets~~38 do not result from cash expenditures, and therefore do not represent investments included in rate base or have offsetting liabilities that reduce the rate base of NSG. Incremental environmental costs incurred and not yet recovered from customers and recoverable gas costs, which are generally recovered within one year, are not include in rate base. However, NSG is allowed to recover a carrying cost for amounts spent but not yet collected from customers. The regulatory assets related to debt are not included in rate base, but are recovered over the term of the debt through the rate of return authorized by the ICC. The regulatory asset related to rate case costs is authorized recovery over a five-~~year period.~~

~~See Note 1(f),~~of ~~”Summary~~the ofdebt ~~Significant Accounting~~through ~~Policies--Risk~~the ~~Management~~rate ~~Activities,”~~of ~~Note~~return 8,authorized ~~“Commitments~~by ~~and~~the ICC. The ~~Contingencies,”~~regulatory ~~and~~asset ~~Note~~related 9,to ~~“Employee~~rate ~~Benefit~~case ~~Plans,”~~costs ~~for more~~is ~~information~~authorized onrecovery ~~some~~by of the ~~more~~ICC over ~~significant~~a ~~regulatory~~five-year ~~assets~~period for 2008 rates and ~~liabilities~~ ~~listed~~a inthree-year ~~the~~period ~~above~~for ~~table~~2010 rates.

~~NOTE~~See Note 1(f), ~~5--LONG-TERM~~"Summary ~~DEBT~~of Significant Accounting Policies – Risk Management Activities," Note 9, "Commitments and Contingencies," and Note 10, "Employee Benefit Plans," for more information on some of the more significant regulatory assets and liabilities listed in the above table.

NOTE 6--LONG-TERM DEBT

See NSG's Statements of Capitalization for more information on NSG's long-term debt.

In November 2008, NSG issued $6.5 million of Series O, 7.0% 5-year First Mortgage Bonds due November 1, 2013. The net proceeds from the issuance of the First Mortgage Bonds were used for general corporate utility purposes. The First Mortgage Bonds were sold in a private placement and are not registered under the Securities Act of 1933.

- 40 -

NSG's First Mortgage Bonds are subject to the terms and conditions of NSG's First Mortgage Indenture dated April 1, 1955, as supplemented. Under the terms of the Indenture, substantially all property owned by NSG is pledged as collateral for these outstanding debt securities.

NSG has utilized First Mortgage Bonds to secure tax exempt interest rates. The Illinois Finance Authority has issued Tax Exempt Bonds, and the proceeds from the sale of these bonds were loaned to NSG. In return, NSG issued equal principal amounts of certain collateralized ~~Series M and Series N-2~~ First Mortgage Bonds.

At December 31, ~~2008~~2009, NSG was in compliance with all financial covenants related ~~relating~~ to outstanding long-term debt ~~and expects to be in compliance with all debt covenants for the foreseeable future~~. NSG's long-term debt obligations contain covenants related to payment of principal and interest when due and various financial reporting obligations. Failure to comply with these covenants could result in an event of default which, if not cured or waived, could result in the acceleration of outstanding debt obligations. In addition, provisions and covenants restrict the payment of cash dividends and the purchase or redemption of capital stock. At December 31, ~~2008~~2009, such restrictions amounted to $6.9 million of NSG’s total retained earnings of $7770.42 million.

A schedule of all principal debt payment amounts, ~~including~~related to bond maturities ~~and early retirement payments~~ is as follows:

Year ending December 31
(Millions)
2009	$	-
2010	$	-
2010		-
2011		-
2012		-
2013		46.5
Later years		28.8
2014		-
Total payments	$	75.3
Later years		28.5
Total payments	$	75.0

NOTE 67--ASSET RETIREMENT OBLIGATIONS

NSG has asset retirement obligations primarily related to distribution pipe removal (including asbestos and PCBs in pipes), asbestos and PCBs in buildings, and removal of above ground storage tanks. ~~In accordance with SFAS No. 71,~~ NSG establishes regulatory assets and liabilities to record the differences between ongoing expense recognition under the ~~SFAS~~Asset ~~No.~~Retirement ~~143~~ and ~~FASB~~Environmental ~~Interpretation No. 47~~Obligations accounting rules, and the ratemaking practices for retirement costs authorized by the ICC.

- 39 -

Changes to Asset Retirement Obligation Liabilities

The following table ~~describes~~shows changes to NSG's asset retirement obligations through December 31, ~~2008~~ 2009.

(Millions)
Asset retirement obligations at September 30, 2005	$	-
Asset retirement obligations at December 31, 2006	$	19.5
Adoption of FIN 47		19.3
Asset retirement obligations at September 30, 2006		19.3
Accretion		0.2
Asset retirement obligations at December 31, 2006		19.5
Accretion		1.2
Additions and revisions to estimated cash flows		2.3
Asset retirement obligations at December 31, 2007		23.0
Accretion		1.2
Asset retirement obligations at December 31, 2008	$	24.2
Accretion		1.3
Additions and revisions to estimated cash flows		(5.4	)
Asset retirement obligations at December 31, 2009	$	20.1

NOTE 8- 41 -INCOME TAXES

~~NOTE~~Deferred ~~7--INCOME~~Income ~~TAXES~~Tax Assets and Liabilities

~~Deferred~~Certain temporary ~~Tax~~book ~~Assets~~to tax differences, for which the offsetting amount is recorded as a regulatory asset or liability, are presented in the table below as net amounts, consistent with regulatory treatment. The principal components of deferred income tax assets and ~~Liabilities~~liabilities recognized in the Balance Sheets as of December 31 are as follows:

Certain temporary book to tax differences, for which the offsetting amount is recorded as a regulatory asset or liability, are presented in the table below as net amounts, consistent with regulatory treatment. The principal components of our deferred tax assets and liabilities recognized in the Balance Sheets as of December 31 are as follows:

(Millions)	2009		2008

Deferred income tax assets:
Employee benefits	$	6.8	$	7.8
Other		1.0		2.0
Total deferred income tax assets	$	7.8	$	9.8

Deferred income tax liabilities:
Plant related	$	51.3	$	48.4
Regulatory deferrals		5.4		4.0
Total deferred income tax liabilities	$	56.7	$	52.4

Balance Sheet Presentation:
Current deferred income tax liabilities – included in other current liabilities	$	0.7	$	1.6
Long-term deferred income tax liabilities		48.2		41.0
Net deferred income tax liabilities	$	48.9	$	42.6

(Millions)	2008		2007
Deferred tax assets:
Employee benefits	$	7.8	$	5.7
Other		2.0		3.0
Total deferred tax assets	$	9.8	$	8.7
Deferred tax liabilities:
Plant related	$	48.4	$	45.3
Regulatory deferrals		4.0		1.7
Total deferred tax liabilities	$	52.4	$	47.0
Balance Sheet Presentation:
Current deferred tax assets – included in other current assets	$	-	$	0.7
Current deferred tax liabilities – included in other current liabilities		1.6		-
Long-term deferred tax liabilities		41.0		39.0
Net deferred tax liabilities	$	42.6	$	38.3

- 40 -

Federal Income Tax Expense

The following table presents a reconciliation of federal income taxes to the provision for income taxes reported in the Statements of Income for the periods ended December 31. The taxes are calculated by multiplying the statutory federal income tax rate by book income before federal income tax.

(Millions, except for percentages)	2008						2007						Transition Period Ended December 31, 2006						Year Ended September 30, 2006
	2009						2008						2007
	Rate			Amount			Rate			Amount			Rate			Amount			Rate			Amount
(Millions, except for percentages)	Rate			Amount			Rate			Amount			Rate			Amount
Statutory federal income tax		35.0	%	$	32.93			35.0	%	$	43.69			35.0	%	$	2.4.6			~~35.0~~	%	$	~~3.7~~
State income taxes, net		4.35			0.53			4.5			0.65			4.6	%		0.36			~~4.7~~			~~0.5~~
Unrecognized tax benefits		~~0.5~~-			~~0.1~~-			20.39			0.31			-2.3			-0.3			-			-
Other differences, net		(2.9	)		(0.4	)		(2.1	)		(0.3	)		(2.5	)		(0.1	)		(3.5	)		(0.4	)
Benefits and compensation		(1.5	)		(0.1	)		(1.8	)		(0.2	)		(1.5	)		(0.2	)
Effective income tax		36.9	%	$	4.1			39.7	%	$	5.2			37.1	%	$	2.6			36.2	%	$	3.8
Other differences, net		(2.2	)		(0.1	)		(1.7	)		(0.2	)		(0.7	)		(0.1	)
Current provision
Effective income tax		35.8	%	$	2.4			36.9	%	$	4.1			39.7	%	$	5.2
Federal				$	(0.1	)				$	3.9					$	2.3					$	0.7
Current provision
State					-						2.3						0.3						(0.3	)
Federal				$	(3.2	)				$	(0.1	)				$	3.9
Total current provision					(0.1	)					6.2						2.6						0.4
State					(0.5	)					-						2.3
Deferred provision					4.2						(1.3	)					-						3.4
Total current provision					(3.7	)					(0.1	)					6.2
Unrecognized tax benefits					0.1						0.3						-						-
Deferred provision					6.1						4.2						(1.3	)
Investment tax credit restored					(0.1	)					-						-						-
Unrecognized tax benefits					-						0.1						0.3
Total income tax expense				$	4.1					$	5.2					$	2.6					$	3.8
Investment tax credit - net					-						(0.1	)					-
Total provision for income taxes				$	2.4					$	4.1					$	5.2

As the related temporary differences reverse, NSG is prospectively refunding taxes to or collecting taxes from customers for which deferred taxes were recorded in prior years at rates different than current rates. The regulatory liability for these and other regulatory tax effects totaled $1.6 million and $1.7 million as of December 31, 2009, and 2008, respectively.

-NSG 42reports -accrued interest and penalties related to income taxes as a component of provision for income taxes. NSG had accrued interest expense of $0.1 million and no accrued penalties related to unrecognized tax benefits at December 31, 2009 and 2008.

liability for these and other regulatory tax effects totaled $1.7 million and $1.9 million as of December 31, 2008, and 2007, respectively.

Unrecognized Tax Benefits

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

(Millions)	~~2008~~2009			~~2007~~2008			2007
Balance at January 1	$	0.43		$	0.14		$	0.1
Increase related to tax positions taken in prior years		0.41			0.14			0.1
Decrease related to tax positions taken in prior years		~~(0.4~~-	)		-(0.4	)		-
Increase related to tax positions taken in current year		-			~~0.2~~-			0.2
Decrease related to settlements		~~(0.1~~-	)		-(0.1	)		-
Balance at December 31	$	0.34		$	0.43		$	0.4

~~NSG records~~At ~~penalties~~December 31, ~~and~~2009, ~~accrued~~recognition ~~interest~~in ~~related~~subsequent toperiods ~~income taxes as a component~~ of ~~income~~the unrecognized tax ~~expense. NSG~~benefits ~~recognized~~could noaffect ~~significant income or expense related to interest and penalties in 2008, and recognized expense of $0.1 million in 2007.~~ NSG's ~~had~~net ~~accrued~~income ~~interest~~by ~~and penalties related to uncertain tax positions of~~ $0.~~1 million~~3 ~~at December 31, 2008 and 2007 and at January 1, 2007~~million.

AtNSG files income ~~December 31,~~tax ~~2008,~~returns ~~unrecognized~~in ~~tax~~the ~~benefits~~United States federal jurisdiction and in various state and local jurisdictions on a stand-alone basis or as part of ~~$0.3 million~~Integrys ~~could~~Energy Group ~~affect~~filings. Subject to the following major exceptions listed below, NSG's is ~~effective~~no ~~tax~~longer ~~rate~~subject ifto ~~recognized~~United inStates ~~subsequent~~federal, state, or local income tax ~~periods~~examinations by tax authorities for years prior to 2004.

~~NSG files income tax returns in the United States federal jurisdiction, and in various state and local jurisdictions, on a stand~~-~~alone~~ ~~basis~~41 ~~or as part of Integrys Energy Group filings.~~-

·	Illinois Department of Revenue - NSG has agreed to a statute extension for the September 30, 2003 tax year.

Integrys Energy Group has the following open examinations involving NSG:

· IRS – PEC and consolidated subsidiaries have an open ~~examination~~examinations for the September 30, 2004 through December 31, 2006, tax years.

· IRS – Integrys Energy Group and consolidated subsidiaries ~~has~~have an open ~~examination~~examinations for the 2006 and 2007 tax years along with the February 21, 2007, PEC short year.

· Illinois Department of Revenue – PEC and ~~combined~~consolidated subsidiaries have an open ~~examination~~examinations for the September 30, 2003, through December 31, 2006, tax years.

In the next 12 months, it is reasonably possible that NSG will settle its open examinations in multiple taxing jurisdictions related to tax years prior to ~~2006~~2007, resulting in a decrease in unrecognized tax benefits of as much as $0.3 million.

NOTE 89--COMMITMENTS AND CONTINGENCIES

Commodity Purchase Obligations and Purchase Order Commitments

AsNSG routinely ofenters ~~December~~into ~~31,~~long-term ~~2008,~~purchase ~~NSG~~and ~~had~~sale ~~obligations~~commitments ~~related~~that tohave ~~natural~~various ~~gas~~quantity requirements ~~supply~~ and ~~transportation~~ ~~contracts~~durations. NSG ~~with~~has ~~total~~obligations ~~estimated~~to ~~demand~~distribute ~~payments~~and sell ofnatural ~~$76.4~~gas ~~million through~~to ~~2017. NSG~~customers, and expects to recover ~~these~~ costs related to these obligations in future customer rates. ~~Additionally~~As of December 31, 2009, NSG had ~~has~~obligations ~~contracts~~related to ~~sell~~ natural gas tosupply and transportation contracts ~~customers~~totaling $89.1 million, some of which extend through 2017.

NSG also has commitments in the form of purchase orders issued to various vendors, which totaled $7. At3 million at December 31, ~~2008, these purchase orders totaled $3~~2009.~~2 million.~~

~~- 43 -~~General

Amounts ultimately paid as penalties, or eventually determined to be paid in lieu of penalties, will not be deductible for income tax purposes.

Environmental

Manufactured Gas Plant Remediation

NSG, its predecessors, and certain former affiliates operated facilities in the past at multiple sites for the ~~purposes~~purpose of manufacturing ~~gas~~ and storing manufactured gas. In connection with manufacturing and storing manufactured gas, ~~waste~~ waste materials were produced that may have resulted in soil and groundwater contamination at these sites. Under certain laws and regulations relating to the protection of the environment, NSG is required to undertake remedial action with respect to some of these materials.

NSG is addressing five manufactured gas plant sites located in Illinois, including one site described in more detail below. ~~Until~~All ~~July~~are ~~2007,~~former ~~NSG~~regulated ~~was~~utility sites ~~addressing~~and ~~four~~are ofbeing ~~the~~remediated, ~~five~~with ~~sites under~~costs acharged ~~program~~to ~~supervised~~existing byratepayers ~~the~~at NSG. NSG ~~Illinois~~estimated ~~Environmental~~and ~~Protection~~accrued ~~Agency (IEPA)~~for $106. As8 ~~discussed~~million ~~below,~~of infuture undiscounted ~~July~~investigation ~~2007,~~and ~~NSG~~cleanup ~~transferred~~costs ~~two~~for all sites as of ~~these~~ ~~four~~December ~~sites~~31, 2009. NSG tomay aadjust ~~program~~these ~~administered~~estimates byin the ~~EPA. Investigations have~~future, ~~been~~contingent ~~completed~~upon remedial attechnology, ~~all~~regulatory orrequirements, ~~portions~~remedy ofdeterminations, ~~four~~and any claims of ~~the~~natural ~~five~~resource ~~sites~~damages. NSG recorded a regulatory asset ~~has~~of ~~determined~~$114.4 ~~that~~million, ~~cleanup~~which is ~~not~~net ~~required~~of atinsurance ~~one~~recoveries received of ~~these four sites~~$8. ~~Cleanups~~3 million, ~~have~~related ~~not~~to ~~yet~~the ~~been~~expected ~~completed~~recovery atof ~~any~~both deferred expenditures and estimated future expenditures as of ~~the~~December ~~other~~31, ~~three sites~~2009.

~~The~~Until ~~EPA~~July ~~has~~2007, ~~identified~~ NSG aswas aaddressing ~~potentially~~four ~~responsible party (PRP) under the Comprehensive Environmental Response, Compensation and Liability Act~~ of ~~1980, as amended, at~~ the ~~Waukegan~~five ~~Coke~~sites ~~Plant~~under Site, located in Waukegan, Illinois ("Waukegan Site"). The Waukegan Site is part of the Outboard Marine Corporation (OMC) Superfund Site. The EPA also identified OMC, General Motors Corporation and certain other parties as PRPs at the Waukegan Site. NSG and the other PRPs are parties to a ~~consent~~program ~~decree~~supervised ~~that requires~~by ~~NSG and General Motors, jointly and severally, to perform~~ the ~~remedial~~ ~~action~~Illinois ~~and~~Environmental ~~establish~~Protection ~~and~~Agency ~~maintain financial assurance of $27.0 million~~ (~~in the form of certain defined net worth levels which NSG has met~~IEPA). ~~The~~In ~~soil component~~July ~~of the remedial action was completed in August 2005. The final design for the groundwater component of the remedial action has been completed~~2007, ~~and construction of the groundwater treatment plant was completed in~~NSG ~~August~~transferred ~~2008. Operation~~two of ~~the~~these ~~groundwater~~four ~~treatment~~sites ~~unit began in September 2008 and is expected~~ to ~~be up to full capacity during~~ the ~~first quarter of 2009. The EPA reduced the financial assurance requirement to $21.0 million to reflect completion of the soil component of the remedial action.~~

In July 2007, NSG transferred two of its largest manufactured gas plant sites which were being addressed under IEPA supervision to the EPA Superfund Alternative Sites Program. Under the EPA’s program, the remedy decisions at these sites will be based on risk-~~based~~ ~~criteria~~42 ~~typically used at Superfund sites.~~-

~~NSG~~EPA ~~is coordinating~~Superfund ~~the~~Alternative ~~investigation~~Sites ~~and~~Program. Under the ~~cleanup~~EPA’s ofprogram, the ~~Illinois~~remedy decisions ~~manufactured~~at ~~gas~~these ~~plant~~ sites ~~under~~ ~~what~~will isbe ~~called~~based aon ~~“multi~~risk-~~site”~~based ~~program. This~~criteria ~~program~~typically ~~involves prioritizing~~used ~~the work to be done~~ at ~~the sites, preparation and approval of~~ ~~documents~~Superfund ~~common to all of the~~ sites~~, and utilization of a consistent approach in selecting remedies~~.

NSG ~~estimated~~is ~~the~~coordinating ~~future~~the ~~undiscounted~~ investigation and cleanup ~~costs~~of ~~for~~its ~~remaining work to be done at the Illinois~~ manufactured gas plant sites itsubject isto ~~addressing (namely,~~EPA ~~those~~jurisdiction ~~being~~under ~~addressed~~what byis ~~both~~called ~~the~~a ~~IEPA~~"multi-site" ~~and the EPA) as of December 31, 2008, to be $101~~program.~~4 million.~~ This ~~estimate (1) takes into account the transfer~~ ofprogram ~~sites~~involves toprioritizing the ~~EPA,~~work ~~which allows for estimates with greater certainty for sediment cleanup and remediation of sites where access~~ to ~~the sites could not previously~~ be ~~obtained~~done ~~under~~at the ~~IEPA~~sites, ~~program;~~preparation ~~(2) is based on assumptions~~ and ~~calculation~~approval ~~methodology~~of ~~consistent~~documents ~~with~~common ~~that~~to ~~used by~~ all ~~Integrys~~of ~~Energy~~the ~~Group utilities in determining investigative and cleanup costs for manufactured gas plant~~ sites;, and ~~(3)~~utilization ~~includes~~of ~~increased construction and operation costs at the~~a ~~Waukegan~~consistent ~~Site. NSG~~approach ~~may adjust these estimates~~ in ~~the~~selecting ~~future, contingent upon remedial technology, regulatory requirements, remedy determinations and any claims of natural resource damages~~remedies.

~~Management~~The ~~believes~~EPA identified ~~that~~NSG ~~any~~as ~~costs~~a ~~incurred~~potentially ~~for~~responsible ~~environmental~~party ~~activities~~(PRP) ~~relating~~under tothe ~~former~~Comprehensive ~~manufactured~~Environmental ~~gas~~Response, ~~operations~~Compensation ~~that~~and ~~are~~Liability ~~not~~Act ~~recoverable~~of ~~through~~1980, ~~contributions~~as ~~from~~amended ~~other~~(CERCLA), ~~entities~~at orthe ~~from~~Waukegan ~~insurance~~Coke ~~carriers~~Plant ~~have~~Site ~~been~~located ~~prudently~~in ~~incurred~~Waukegan, Illinois (Waukegan Site). The Waukegan Site is part of the Outboard Marine Corporation (OMC) Superfund Site. The EPA also identified OMC, General Motors Corporation (GM), and certain other parties as PRPs at the Waukegan Site. NSG and the other PRPs are, parties to a consent decree ~~therefore~~that requires NSG and GM, ~~recoverable~~jointly ~~through~~and ~~rates~~severally, ~~for~~to perform the remedial action and establish and maintain financial assurance of $27.0 million. The EPA reduced the financial assurance requirement to $21.0 million to reflect completion of the soil component of the remedial action in August 2005. NSG has met its financial assurance requirement in the form of a net worth test while GM met the requirement by providing a performance and payment bond in favor of the EPA. As a result of the GM bankruptcy filing, the EPA has contacted the surety and the surety has stated that it will provide the EPA access to the surety bond funds which are expected to fund a significant portion of GM’s liability. The potential exposure related to the GM bankruptcy that is not expected to be covered by the bond proceeds has been reflected in the accrual identified above.

-Management 44believes that -any costs incurred for environmental activities relating to former manufactured gas plant operations that are not recoverable through contributions from other entities or from insurance carriers have been prudently incurred and are, therefore, recoverable through rates for NSG. Accordingly, management believes that the costs incurred in connection with former manufactured gas plant operations will not have a material adverse effect on the financial position or results of operations of NSG. However, any changes in NSG’s approved rate mechanisms for recovery of these costs, or any adverse conclusions by the ICC with respect to the prudence of costs actually incurred, could materially adversely affect NSG’s recovery of such costs through rates.

NSG recorded a regulatory asset of $105.8 million, which is net of insurance recoveries received of $8.3 million, related to the recovery of both unrecovered expenditures and estimated future expenditures as of December 31, 2008. Incurred costs are expensed in the Statements of Income in the same period they are billed to customers and recognized as revenues.

Former Mineral Processing Site in Denver, Colorado

In 1994, NSG received a demand for reimbursement, indemnification, and contribution for response costs incurred with respect to the cleanup of a former mineral processing site in Denver, Colorado. The demand from the S.W. Shattuck Chemical Company, Inc. alleging that NSG is a successor to the liability of a former entity that was allegedly responsible during the period 1934 through 1941 for the disposal of mineral processing wastes containing radium and other hazardous substances at the site. In 1992, the EPA issued a Record of Decision (ROD) for the Denver site and remediation work began. The remedy selected in the ROD consisted of the on-site stabilization, solidification, and capping of soils containing radioactive wastes. In 1998, the remedial action under the 1992 ROD was completed. In 2002, the EPA issued an amended ROD that required removing the monolith cap and undertaking additional soil excavation. The work performed under the amended ROD began in September 2002 and was completed in September 2006.

NSG does not believe that it has liability for the costs related to this site, but cannot determine the matter with certainty. At this time, NSG cannot reasonably estimate what range of loss, if any, may occur. In the event that NSG incurs liability, it would pursue reimbursement from insurance carriers and other responsible parties, if any.

Natural Gas Charge Reconciliation Proceedings and Related Matters

Natural Gas Charge Settlement

For NSG, the ICC conducts annual proceedings regarding the reconciliation of revenues from the natural gas charge and related natural gas costs. The natural gas charge represents the cost of natural gas and transportation and storage services purchased by NSG, as well as gains, losses, and costs incurred under NSG’s hedging program (Gas Charge). In these proceedings, interested parties review the accuracy of the reconciliation of revenues and costs and the prudence of natural gas costs recovered through the Gas Charge. If the ICC were to find that the reconciliation was inaccurate or any natural gas costs were imprudently incurred, the ICC would order NSG to refund the affected amount to customers through subsequent Gas Charge filings.

In March 28, 2006 orders, the ICC adopted a settlement agreement related to fiscal years 2001 through 2004 natural gas costs. Under certain provisions of the settlement agreement, PEC agreed to: (1) provide the Illinois Attorney ~~General~~ General (AG) and the City of Chicago (Chicago) up to $30.0 million for conservation and weatherization programs for which NSG may not seek rate ~~recovery. NSG~~ ~~also~~recovery; ~~agreed~~(2) to implement a reconnection program for certain customers; ~~identified~~and as(3) ~~hardship cases on the date of the agreement. Finally, NSG agreed to~~ internal audits and an external audit of natural gas supply practices.

With respect to the conservation and weatherization funding, as of December 31, ~~2008~~2009, $10.46 million remained unpaid, of which $0.64 million was included in other current liabilities, and $0.82 million was included in other long-term liabilities. Under the reconnection program, NSG ~~reconnected customers who participated in the program and~~ took ~~other~~all steps it believed were required by the agreement. The AG and Chicago have indicated that they believe the terms of the ~~reconnection program are broader than what NSG~~

- 4543 -

~~Concerning the~~reconnection ~~audit~~program ~~requirements,~~are ~~two of the five required annual internal audits have been completed~~broader. AnManagement ~~auditor~~believes ~~hired~~that byNSG ~~the~~has ~~ICC~~fully ~~conducted the external audit,~~complied ~~and~~with the ~~report~~reconnection ~~was~~program ~~filed~~obligations ~~on April 10, 2008. The report included 32 recommendations, none~~ of ~~which quantified natural gas costs that~~ the ~~auditor believed~~settlement ~~should~~agreement; ~~not be recovered by NSG. By March 31~~however, ~~2009, NSG~~ ~~expects to complete its responses to the 25 recommendations it agreed to implement in a June 30~~NSG, ~~2008 response to~~ the ~~audit. The~~AG ~~ICC~~and ~~staff~~Chicago ~~has not~~are ~~filed~~discussing ahow ~~reply~~ to ~~NSG’s~~resolve ~~response~~this disagreement.

~~The~~Four ~~fiscal~~of ~~2005~~the ~~Gas~~five ~~Charge~~annual ~~reconciliation~~internal ~~case~~audits ~~was~~required ~~initiated~~by inthe ~~November~~settlement ~~2005~~agreement have been completed. ~~The settlement~~An ofauditor ~~the~~hired ~~prior~~by ~~fiscal~~the ~~years’~~ICC ~~Gas~~conducted ~~Charge~~the ~~reconciliation~~external ~~proceedings did~~audit, ~~not~~and ~~affect~~filed ~~this case. The ICC issued~~ its ~~orders~~report on ~~January~~April 1610, 2008. ~~The~~On ~~natural gas cost disallowance was $1.0 million~~March 31, ~~which was~~ 2009, anNSG ~~adjustment~~completed ~~for~~its ~~transportation~~responses ~~customers’ bank (storage) natural gas. Pursuant~~ to the ~~ICC~~auditor’s ~~order, NSG refunded customers $1~~recommendations.~~1 million, including interest, during 2008.~~

The fiscal 2006 Gas Charge reconciliation case was initiated on November 21, 2006. The ICC staff and interveners (the AG and the Citizens Utility Board, filing jointly) each filed testimony recommending a disallowance for a bank natural gas adjustment similar to that addressed in the fiscal 2005 Gas Charge reconciliation case, which NSG did not contest. The amount recorded at NSG at December 31, 2008, related to the bank natural gas adjustment was not significant. A hearing was held on December 11, 2008. There were no contested issues, and the parties filed an agreed form of order in January 2009.

Class Action

In February 2004, a purported class action suit was filed in Cook County Circuit ~~Court~~ Court against ~~NSG~~PEC, ~~PEC~~PGL, and ~~PGL~~NSG by customers of ~~NSG~~PGL and ~~PGL~~NSG, alleging, among ~~other~~ other things, violation of the Illinois Consumer Fraud and Deceptive Business Practices Act related to matters at issue in the utilities’ fiscal year 2001 Gas Charge reconciliation proceedings. In the suit, Alport et al. v. Peoples Energy Corporation, the plaintiffs seek disgorgement and punitive damages. ~~NSG~~PGL and ~~PGL~~NSG have been dismissed as defendants and the only remaining counts of the suit allege violations of the Consumer Fraud and Deceptive Business Practices Act by PEC and that PEC acted in concert with others to commit a tortious act. PEC denies the allegations and is ~~vigorously~~ vigorously defending the suit. On ~~July~~November 3019, ~~2008~~2009, the ~~plaintiffs~~Court entered ~~filed~~an aorder ~~motion for~~certifying a class ~~certification~~composed ~~and~~of ~~PEC~~customers ~~responded~~of inPGL ~~opposition~~and ofNSG ~~this~~during ~~motion~~the period April 26, 2000, through September 30, 2002. On ~~October 31~~December 17, ~~2008~~2009, PEC filed a ~~motion~~Petition for ~~summary judgment. At~~Leave ~~the~~to ~~plaintiffs’~~Appeal ~~request,~~to ~~their~~the ~~reply~~Appellate toCourt challenging ~~PEC’s~~ class certification ~~response~~and ~~was~~on ~~postponed~~February ~~pending~~19, a2010, ~~decision~~this onappeal ~~PEC’s summary~~was ~~judgment motion~~denied.

~~Builders Class~~NOTE ~~Action~~10--EMPLOYEE BENEFIT PLANS

In June 2005, a purported class action was filed against NSG by Birchwood Builders, LLC in the Circuit Court of Cook County, Illinois alleging that NSG was fraudulently and improperly charging fees to customers with respect to utility connections, disconnections, reconnections, relocations, extensions of natural gas service pipes, extensions of distribution natural gas mains, and failing to return related customer deposits. In November 2008, NSG entered into a settlement with the plaintiffs. The settlement amount was not material to NSG. The plaintiffs filed a motion to dismiss their appeal, which was granted by the appellate court on December 5, 2008. This matter is now resolved.

NOTE 9--EMPLOYEE BENEFIT PLANS

Defined Benefit Plans

On September 30, 2008, the PEC Service Annuity System was merged into the PEC Retirement Plan, which was then renamed the Integrys Energy Group Retirement Plan. The merger of these pension plans had no effect on the level of plan benefits provided to participants or the management of plan assets. NSG now participates in one non-contributory, qualified defined benefit pension plan, ~~covering~~sponsored by IBS, as well as an unfunded, nonqualified retirement plan, sponsored by PEC. NSG is responsible for its share of the plan assets and obligations of these plans and the NSG Balance Sheets reflect only the liabilities associated with past and current NSG employees and its share of the plan assets. In addition, NSG offers multiple other postretirement benefits to employees.

-Integrys 46Energy Group -also currently offers medical, dental, and life insurance benefits to active NSG employees and their dependents. The costs of these benefits are expensed as incurred.

~~Integrys~~Retiring ~~Energy~~employees ~~Group~~have ~~also~~the ~~currently~~option ~~offers~~of ~~medical~~receiving retirement benefits in the form of an annuity or a lump sum payment. During 2009, ~~dental~~2008, and ~~life~~2007, ~~insurance~~a ~~benefits~~portion toof ~~NSG~~each ~~employees~~pension ~~and~~plan's ~~their~~projected ~~dependents. The~~benefit ~~costs~~obligation ofwas ~~these~~settled ~~benefits~~by ~~are~~the payment of lump ~~expensed~~sum ~~for~~benefits, ~~active~~resulting ~~employees~~in asa ~~incurred~~settlement cost.

Retiring employees have the option of receiving retirement benefits in the form of an annuity or a lump sum payment. During 2008, 2007, and 2006, a portion of each pension plan's projected benefit obligation was settled by the payment of lump sum benefits, resulting in a settlement cost under SFAS No. 88, "Employer's Accounting for Settlements and Curtailments of Defined Benefit Plans and for Termination Benefits."

During the third quarter of 2007, NSG made a series of changes to certain of its retirement benefits. Specifically, the changes included:

·	Closure of the defined benefit pension plans to non-union new hires, effective January 1, 2008;

·	A freeze in defined benefit pension service accruals for non-union employees, effective January 1, 2013;

·	A freeze in compensation amounts used for determining defined benefit pension amounts for non-union employees, effective January 1, 2018;

·	Revised eligibility requirements for retiree medical benefits for employees hired on or after January 1, 2008, and the introduction of an annual premium reduction credit for employees eligible to retire after December 31, 2012; and

·	Closure of the retiree dental and life benefit programs to all new hires, effective January 1, 2008, and elimination of these benefits for any existing employees who are not eligible to retire before December 31, 2012.

~~As a~~- ~~result~~44 of the changes described above, NSG remeasured certain of its pension and other postretirement benefit obligations as of August 1, 2007, and reflected the remeasurement on November 1, 2007, as it had not yet adopted the measurement date provisions of SFAS No. 158 which became effective January 1, 2008. The curtailment gains and losses recognized as a result of the plan design changes are included in the tables below.-

As a result of the changes described above, NSG remeasured certain of its pension and other postretirement benefit obligations as of August 1, 2007, and reflected the remeasurement on November 1, 2007, as it had not yet adopted the measurement date provisions of SFAS No. 158 which became effective January 1, 2008. The curtailment gains and losses recognized as a result of the plan design changes were not significant.

Effective July 1, 2008, the defined benefit pension plans were closed to union new hires.

The following tables provide a reconciliation of the changes in the plans' benefit obligations and fair value of assets during ~~2008~~2009 and ~~2007~~2008.

	Pension Benefits						Other Benefits
(Millions)	~~2008~~2009			~~2007~~2008			~~2008~~2009			~~2007~~2008
Reconciliation of benefit obligation
Obligation at beginning of measurement period	$	28.30		$	28.63		$	1415.65		$	1214.6
Service cost		1.23			1.32			0.98			0.79
Interest cost		1.8			1.68			0.9			0.89
Participant contributions		-			-			~~0.2~~-			0.72
Plan curtailments		-			(0.8	)		-			(0.1	)
Transfers from (to) affiliates		0.8			(0.1	)		-			-
Transfers to affiliates		(0.1	)		(0.2	)		-			-
Actuarial (gain) loss, net		3.5			(1.1	)		0.1			(0.5	)
Actuarial (gain) loss, net		(1.1	)		0.4			(0.5	)		1.0
Benefit payments		(2.0	)		(2.6	)		(0.8	)		(0.9	)
Benefit payments		(2.6	)		(2.6	)		(0.9	)		(1.2	)
Federal subsidy on benefits paid		-			-			0.1			0.1
Elimination of early measurement period		~~0.5~~-			-0.5			~~0.2~~-			-0.2
Obligation at end of measurement period	$	2833.04		$	28.30		$	1516.56		$	1415.65

- 47 -

Reconciliation of fair value of plan assets
Fair value of plan assets at beginning of measurement period	$	9.6		$	15.7		$	1.4		$	2.4
Actual return on plan assets		2.3			(4.0	)		0.1			(0.5	)
Employer contributions		4.0			1.0			2.2			0.3
Transfers from (to) affiliates		0.8			(0.1	)		-			-
Participant contributions		-			-			-			0.2
Benefit payments		(2.0	)		(2.6	)		(0.8	)		(0.9	)
Elimination of early measurement period		-			(0.4	)		-			(0.1	)
Fair value of plan assets at end of measurement period	$	14.7		$	9.6		$	2.9		$	1.4

	Pension Benefits					Other Benefits
(Millions)	2008			2007		2008			2007
Reconciliation of fair value of plan assets
Fair value of plan assets at beginning of measurement period	$	15.7		$	16.4	$	2.4		$	2.3
Actual return on plan assets		(4.0	)		2.1		(0.5	)		0.5

Amounts recognized on NSG’s Balance Sheets at December 31 related to the funded status of the benefit plans consisted of:

Employer contributions		1.0			-			0.3			0.1
	Pension Benefits						Other Benefits
Transfers to affiliates		(0.1	)		(0.2	)		-			-
(Millions)	2009			2008			2009			2008
Participant contributions		-			-			0.2			0.7
Noncurrent liabilities	$	18.7		$	18.4		$	13.7		$	14.1
Benefit payments		(2.6	)		(2.6	)		(0.9	)		(1.2	)
Elimination of early measurement period		(0.4	)		-			(0.1	)		-
Fair value of plan assets at end of measurement period	$	9.6		$	15.7		$	1.4		$	2.4

~~Amounts~~The ~~recognized~~accumulated inbenefit ~~NSG’s~~obligation ~~Balance~~for ~~Sheets~~all defined benefit pension plans was $25.7 million and $21.9 million at December 31, ~~related~~2009, toand ~~the~~2008, respectively. Information ~~funded~~for ~~status~~pension ofplans ~~the~~with an accumulated benefit ~~plans~~obligation ~~consisted~~in excess of: plan assets is presented in the following table.

	Pension Benefits				Other Benefits
	December 31
(Millions)	~~2008~~2009		~~2007~~2008		~~2008~~		~~2007~~
Noncurrent liabilities	$	18.4	$	12.6	$	14.1	$	12.2
Projected benefit obligation	$	33.4	$	28.0
Accumulated benefit obligation		25.7		21.9
Fair value of plan assets		14.7		9.6

~~The~~- ~~accumulated benefit~~45 obligation for all defined benefit pension plans was $21.9 million and $22.6 million at December 31, 2008, and 2007, respectively. Information for pension plans with an accumulated benefit obligation in excess of plan assets is presented in the following table.-

	December 31,
(Millions)	2008		2007
Projected benefit obligation	$	28.0	$	28.3
Accumulated benefit obligation		21.9		22.6
Fair value of plan assets		9.6		15.7

The following table shows the amounts that had not yet been recognized in NSG's net periodic benefit cost as of December 31.

	Pension Benefits				Other Benefits
(Millions)	~~2008~~2009		~~2007~~2008		~~2008~~2009		~~2007~~2008
Regulatory assets
Net regulatory assets
Net actuarial loss	$	1113.75	$	711.67	$	2.4	$	2.34
Prior service costs		1.7		1.9		-		-
Prior service cost		1.5		1.7		-		-
Transition obligation		-		-		0.65		0.86
Total	$	1315.40	$	913.54	$	32.09	$	3.10

The estimated net ~~loss~~losses ~~and prior service cost~~ for defined benefit pension plans that will be ~~amortized~~ as a component of net periodic benefit cost during 2009 are $0.2 million and $0.2 million, respectively. The estimated net loss and transition obligation for other postretirement benefit plans that will be amortized as a component of net periodic benefit cost during ~~2009~~2010 are ~~$0.1 million~~ ~~and~~ $0.13 million~~, respectively~~.

The ~~components~~following oftable shows the ~~net~~components ~~periodic~~of ~~benefit cost recorded for~~ NSG’'s ~~employees~~net ~~are~~pension ~~shown~~and inother ~~the following~~postretirement ~~tables~~benefit costs:

- 48 -

	Pension Benefits									Other Benefits
(Millions)	2009			2008			2007			2009			2008			2007
Net periodic benefit cost
Service cost	$	1.3		$	1.2		$	1.3		$	0.8		$	0.8		$	0.8
Interest cost		1.8			1.8			1.7			0.9			0.9			0.8
Expected return on plan assets		(1.2	)		(1.2	)		(1.2	)		(0.1	)		(0.1	)		(0.2	)
Amortization of transition obligation		-			-			-			0.1			0.1			0.1
Amortization of prior service cost		0.2			0.2			0.2			-			-			-
Amortization of net actuarial loss		0.2			0.1			0.3			-			0.1			0.1
Net periodic benefit cost		2.3			2.1			2.3			1.7			1.8			1.6
Effects of lump sum settlements upon retirement		0.4			0.2			0.3			-			-			-
Net benefit cost	$	2.7		$	2.3		$	2.6		$	1.7		$	1.8		$	1.6

	Pension Benefits
(Millions)	Year Ended December 31, 2008			Year Ended December 31, 2007			Transition Period Ended December 31, 2006			Year Ended September 30, 2006
Service cost	$	1.2		$	1.3		$	0.3		$	1.5
Interest cost		1.8			1.7			0.4			1.6
Expected return on plan assets		(1.2	)		(1.2	)		(0.3	)		(1.3	)
Amortization of prior service cost		0.2			0.2			-			0.2
Amortization of net actuarial loss		0.1			0.3			0.1			0.6
Net periodic benefit cost		2.1			2.3			0.5			2.6
Effects of lump sum settlements upon retirement		0.2			0.3			-			0.8
Net benefit cost	$	2.3		$	2.6		$	0.5		$	3.4

	Other Benefits
(Millions)	Year Ended December 31, 2008			Year Ended December 31, 2007			Transition Period Ended December 31, 2006		Year Ended September 30, 2006
Service cost	$	0.8		$	0.8		$	0.2	$	0.6
Interest cost		0.9			0.8			0.2		0.6
Expected return on plan assets		(0.1	)		(0.2	)		-		(0.1	)
Amortization of transition obligation		0.1			0.1			-		0.1
Amortization of net actuarial loss		0.1			0.1			-		0.2
Net periodic benefit cost	$	1.8		$	1.6		$	0.4	$	1.4

Assumptions – Pension and Other Postretirement Benefit Plans

The weighted-average assumptions used at December 31 to determine benefit obligations for the plans were as follows:

- 49 -

	Pension Benefits		Other Benefits
	2009	2008	2009	2008
Discount rate	6.15%	6.45%	5.80%	6.45%
Rate of compensation increase	4.17%	4.17%	N/A	N/A
Assumed medical cost trend rate (under age 65)	N/A	N/A	8.0%	9.0%
Ultimate trend rate	N/A	N/A	5.0%	5.0%
Ultimate trend rate reached in	N/A	N/A	2013	2013
Assumed medical cost trend rate (over age 65)	N/A	N/A	8.5%	9.5%
Ultimate trend rate	N/A	N/A	5.5%	5.5%
Ultimate trend rate reached in	N/A	N/A	2013	2013
Assumed dental cost trend rate	N/A	N/A	5.0%	5.0%

	Pension Benefits		Other Benefits
	2008	2007	2008	2007
Discount rate	6.45%	6.35%	6.45%	6.25%
Rate of compensation increase	4.17%	4.18%	N/A	N/A
Assumed medical cost trend rate (under age 65)	N/A	N/A	9.0%	10.0%
Ultimate trend rate	N/A	N/A	5.0%	5.0%
Ultimate trend rate reached in	N/A	N/A	2013	2013
Assumed medical cost trend rate (over age 65)	N/A	N/A	9.5%	10.5%
Ultimate trend rate	N/A	N/A	5.5%	5.5%
Ultimate trend rate reached in	N/A	N/A	2013	2013
Assumed dental cost trend rate	N/A	N/A	5.0%	5.0%

- 46 -

The weighted-average assumptions used to determine net periodic benefit cost for the plans were as follows:

	Pension Benefits	~~Pension Benefits~~
		Year Ended December 31, 2008			Year Ended December 31, 2007			Year Ended September 30, 2006
	2009	2008	2007
Discount rate	6.45%	6.40%	6.4000%	%		~~6.00~~	%		~~5.25~~	%
Expected return on assets	8.50%	8.50%	8.50%	%		~~8.50~~	%		~~8.75~~	%
Rate of compensation increase	4.17%	4.18%	43.1875%	%		~~3.75~~	%		~~3.75~~	%

	Other Benefits	~~Other Benefits~~
		Year Ended December 31, 2008			Year Ended December 31, 2007			Year Ended September 30, 2006
	2009	2008	2007
Discount rate	6.45%	6.25%	65.2575%	%		~~5.75~~	%		~~5.00~~	%
Expected return on assets	8.50%	8.50%	8.50%	%		~~8.50~~	%		~~8.75~~	%
Assumed medical cost trend rate (under age 65)	9.0%	10.0%	108.0%	%		~~8.0~~	%

Filing Compare · NORTH SHORE GAS CO /IL/