UNION LIGHT HEAT & POWER CO Quarterly Report (10-Q) MANAGEMENT'S DISCUSSION & ANALYSIS

The following is an excerpt from a 10-Q SEC Filing, filed by UNION LIGHT HEAT & POWER CO on 11/5/2004.

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MANAGEMENT'S DISCUSSION & ANALYSIS

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

In this report Cinergy (which includes Cinergy Corp.and all of our regulated and non-regulated subsidiaries) is, at times, referred to in the first person as "we", "our", or "us". In addition, when discussing Cinergy'sfinancial information, it necessarily includes the results of The Cincinnati Gas & Electric Company (CG&E), PSI Energy, Inc. (PSI), The Union Light, Heat and Power Company (ULH&P), and all of Cinergy's other consolidated subsidiaries. When discussing CG&E's financial information, it necessarily includes the results of ULH&P and all of CG&E'sother consolidated subsidiaries.

The following discussion should be read in conjunction with the accompanying financial statements and related notes included elsewhere in this report and the combined Form 10-K for the year ended December 31, 2003 (2003 10-K). The results discussed below are not necessarily indicative of the results to be expected in any future periods.

INTRODUCTION

In Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A), we explain our general operating environment, as well as our liquidity, capital resources, and results of operations. Specifically, we discuss the following:

• factors affecting current and future operations;

• potential sources of cash for future capital expenditures;

• why revenues and expenses changed from period to period; and

• how the above items affect our overall financial condition.

ORGANIZATION

Cinergy Corp., a Delaware corporation organized in 1993, owns all outstanding common stock of CG&E and PSI, both of which are public utilities. As a result of this ownership, we are considered a utility holding company. Because we are a holding company with material utility subsidiaries operating in multiple states, we are registered with and are subject to regulation by the Securities and Exchange Commission (SEC) under the Public Utility Holding Company Act of 1935, as amended (PUHCA). Our other principal subsidiaries are Cinergy Services, Inc. (Services) and Cinergy Investments, Inc. (Investments).

CG&E, an Ohio corporation organized in 1837, is a combination electric and gas public utility company that provides service primarily in the southwestern portion of Ohio and, through ULH&P, in nearby areas of Kentucky. CG&E is responsible for the majority of our power marketing and trading activity. CG&E's principal subsidiary, ULH&P, is a Kentucky corporation organized in 1901, that provides electric and gas service in northern Kentucky. CG&E's other subsidiaries are insignificant to its results of operations.

PSI, an Indiana corporation organized in 1942, is a vertically integrated and regulated electric utility that provides service in north central, central, and southern Indiana.

MD&A -LIQUIDITY AND CAPITAL RESOURCES

Services is a service company that provides our subsidiaries with a variety of centralized administrative, management, and support services. Investments holds most of our domestic non-regulated, energy-related businesses and investments, including gas marketing and trading operations.

The majority of our operating revenues are derived from the sale of electricity and the sale and/or transportation of natural gas.

LIQUIDITY AND CAPITAL RESOURCES

Environmental Issues

In December 2003, the United States Environmental Protection Agency (EPA) proposed the Clean Air Interstate Rule (CAIR), formerly the Interstate Air Quality Rule, that would require states to revise their State Implementation Plans (SIP) to address alleged contributions to downwind non-attainment with the revised National Ambient Air Quality Standards for ozone and fine particulate matter. The proposed rule would establish a two-phase, regional cap and trade program for sulfur dioxide (SO2) and nitrogen oxide (NOX), affecting approximately 30 states, including Ohio, Indiana, and Kentucky, and would require SO2 and NOXemissions to be cut approximately 70 percent and 65 percent, respectively, by 2015. The EPA is expected to issue final rules by December 2004.

In December 2003, the EPA also issued draft regulations regarding required reductions in mercury emissions from coal-fired power plants. The draft regulations include two possible alternatives to address emissions reductions. One alternative would include a cap and trade approach to mercury. The other would be a source specific reduction in emissions, without a cap and trade approach. The cap and trade approach would provide a longer compliance horizon and provide more flexible compliance options for coal-fired generators. The cap and trade approach would require a reduction of approximately 30 percent by 2010 and 70 percent by 2018. The source specific reduction approach would require a reduction of approximately 30 percent by 2008. The EPA must issue final rules by March 2005.

Over the 2004-2008 time period, estimated capital costs associated with reducing mercury, SO2, and NOX in compliance with the currently proposed CAIR and mercury rule are not expected to exceed approximately $1.65 billion if the EPA approves the mercury cap and trade approach and approximately $2.15 billion if the EPA approves the source specific reduction approach without a cap and trade. Approximately 55 percent of these estimated environmental costs would be incurred at PSI's coal-fired plants, for which recovery would be pursued in accordance with regulatory statutes governing environmental cost recovery. CG&E has proposed three alternatives to the Public Utilities Commission of Ohio (PUCO) for determining rates after the market development period ends. Two of these alternatives include partial recovery of depreciation and financing costs for 2005-2008. See Note 6(b)(ii) of the "Notes to Condensed Financial Statements" in "Item 1. Financial Statements" for more details.

The mercury cap and trade approach would provide Cinergywith more flexible compliance options, including the purchase of allowances in lieu of further capital expenditures with respect to these investments. The above estimates include estimated costs to comply at plants that we own but do not operate (which includes 14 percent and 34 percent of Cinergy's and CG&E's megawatt hour (MWh) capacity, respectively). These costs may change when taking into consideration compliance plans of

MD&A -LIQUIDITY AND CAPITAL RESOURCES

co-owners or operators involved. Moreover, as market conditions change, additional compliance options may become available and our plans will be adjusted accordingly. Costs associated with mercury reduction may be different than those predicted, depending on the type of program the EPA finalizes and the stringency and timing of the ultimate requirements.

In May 2004, the EPA issued proposed revisions to its regional haze rules and implementing guidelines in response to a 2002 judicial ruling overturning key provisions of the original program. The regional haze program is aimed at reducing certain emissions impacting visibility in national parks and wilderness areas. The EPA is currently considering whether SO2 and NOX reductions under the CAIR regulation will also satisfy the reduction requirements under the regional haze rule. However, the regional haze rule, when finalized, could potentially require significant additional SO2and NOX reductions necessitating the installation of pollution controls for certain generating units at Cinergy'spower plants. In light of the EPA's ongoing rulemaking efforts and the fact that the states have yet to announce how they will implement the final rule, at this time, it is not possible to predict whether the regional haze rule will have a material effect on our financial position or results of operations.

In April 2004, the EPA made final state non-attainment area designations to implement the revised ozone standard. Several counties in which we operate have been designated as being in non-attainment with the new ozone standard. The EPA is also under a court ordered deadline to make final non-attainment area designations for the new fine particulate standard by December 15, 2004. Several counties in which we operate are likely to be designated as non-attainment for the fine particulate standard. Those counties that are designated as being in non-attainment with the new ozone and/or fine particulate standards are required to develop a plan of compliance. Although the EPA has attempted to structure the CAIR to resolve purported utility contributions to ozone and fine particulate non-attainment, at this time, Cinergycannot predict the effect of current or future non-attainment designations on its financial position or results of operations.

Carbon Dioxide (CO2) Lawsuit

In July 2004, the states of Connecticut, New York, California, Iowa, New Jersey, Rhode Island, Vermont, Wisconsin, and the City of New York brought a lawsuit in the United States District Court for the Southern District of New York against Cinergy and American Electric Power Company, Inc., American Electric Power Service Corporation, The Southern Company, Tennessee Valley Authority, and Xcel Energy Inc. That same day, a similar lawsuit was filed against the same companies by Open Space Institute, Inc., Open Space Conservancy, Inc., and The Audubon Society of New Hampshire. These lawsuits allege that the defendants' emissions of CO2 from the combustion of fossil fuels at electric generating facilities contribute to global warming and amount to a public nuisance. The complaints also allege that the defendants could generate the same amount of electricity while emitting significantly less CO2. Plaintiffs are seeking an injunction requiring each defendant to cap its CO2 emissions and then reduce them by a specified percentage each year for at least a decade. Cinergy intends to defend this lawsuit vigorously in court and filed a motion to dismiss with the other defendants in September 2004; however, we are not able to predict whether resolution of these matters would have a material effect on our financial position or results of operations.

MD&A -LIQUIDITY AND CAPITAL RESOURCES

Notice of Intent to Sue at Zimmer Generating Station (Zimmer Station)

In July 2004, Cinergy received a notice of intent to sue under the Clean Air Act (CAA) from attorneys representing citizens of the Village of Moscow, Ohio, the town adjacent to CG&E'sZimmer Station, which notice is required as a predicate to a citizen's enforcement suit under the CAA. The letter alleges that emissions from Zimmer Station violate the CAA and the Ohio SIP and are causing a public nuisance. At this time, we cannot predict whether the outcome of this matter will have a material impact on our financial position or results of operations.

Selective Catalytic Reduction Units (SCR) at Gibson Generating Station (Gibson Station)

In May 2004, SCRs and other pollution control equipment became operational at Units 4 and 5 of PSI's Gibson Station in accordance with compliance deadlines under the NOX SIP Call. In June and July 2004, Gibson Station temporarily shut down the equipment on these units due to a concern over an acid aerosol mist haze (plume) sometimes occurring in areas near the plant. Portions of the plume from those units' stacks appeared to break apart and descend to ground level at certain times under certain weather conditions. As a result, and, working with the City of Mt. Carmel, Illinois, Illinois EPA, Indiana Department of Environmental Management, United States EPA, and the State of Illinois, we developed a protocol regarding the use of the SCRs while we explore alternatives to address this issue. After the protocol was finalized, the Illinois Attorney General brought an action in Wabash County Circuit Court against PSIseeking a preliminary injunction to enforce the protocol. In August 2004, the court granted that preliminary injunction. PSI is appealing that decision to the Fifth District Appellate Court, but we cannot predict the ultimate outcome of that appeal or of the underlying action by the Illinois Attorney General.

We will seek recovery of any related capital as well as increased emission allowance expenditures through the regulatory process. We do not believe costs related to resolving this matter will have a material impact on our financial position or results of operations.

Other Investing Activities

Our ability to invest in growth initiatives is limited by certain legal and regulatory requirements, including PUHCA. The PUHCA limits the types of non-utility businesses in which Cinergyand other registered holding companies under PUHCA can invest as well as the amount of capital that can be invested in permissible non-utility businesses. Also, the timing and amount of investments in the non-utility businesses is dependent on the development and favorable evaluations of opportunities. Under the PUHCA restrictions, we are allowed to invest or commit to invest in certain non-utility businesses, including:

• Exempt Wholesale Generators (EWG) and Foreign Utility Companies
(FUCO)

An EWG is an entity, certified by the Federal Energy Regulatory Commission (FERC), devoted exclusively to owning and/or operating, and selling power from one or more electric generating facilities. An EWG whose generating facilities are located in the United States is limited to making only wholesale sales of electricity. An entity claiming status as an EWG must provide notification thereof to the SEC under PUHCA.

A FUCO is a company all of whose utility assets and operations are located outside the United States and which are used for the generation, transmission, or distribution of

MD&A -LIQUIDITY AND CAPITAL RESOURCES

electric energy for sale at retail or wholesale, or the distribution of gas at retail. A FUCO may not derive any income, directly or indirectly, from the generation, transmission, or distribution of electric energy for sale or the distribution of gas at retail within the United States. An entity claiming status as a FUCO must provide notification thereof to the SEC under PUHCA.

Cinergy has been granted SEC authority under PUHCA to invest (including by way of guarantees) an aggregate amount in EWGs and FUCOs equal to the sum of (1) our average consolidated retained earnings from time to time plus (2) $2 billion. As of September 30, 2004, we had invested or committed to invest approximately $0.9 billion in EWGs and FUCOs, leaving available investment capacity under the order of approximately $2.7 billion.

• Qualifying Facilities and Energy-Related Non-utility Entities

SEC regulations under the PUHCA permit Cinergy and other registered holding companies to invest and/or guarantee an amount equal to 15 percent of consolidated capitalization (consolidated capitalization is the sum of Notes payable and other short-term obligations, Long-term debt(including amounts due within one year), Cumulative Preferred Stock of Subsidiaries, and total Common Stock Equity) in domestic qualifying cogeneration and small power production plants (qualifying facilities) and certain other domestic energy-related non-utility entities. At September 30, 2004, we had invested and/or guaranteed approximately $0.9 billion of the $1.4 billion available.

In August 2004, Cinergy filed an application with the SEC requesting authority under PUHCA to increase its investment and/or guarantee amount by $2 billion above the current authorized amount. Cinergy has requested the SEC to issue an order authorizing the increase in the fourth quarter of 2004.

• Energy-Related Assets

Cinergy has been granted SEC authority under PUHCA to invest up to $1 billion in non-utility Energy-Related Assets within the United States, Canada, and Mexico. Energy-Related Assets include natural gas exploration, development, production, gathering, processing, storage and transportation facilities and equipment, liquid oil reserves and storage facilities, and associated assets, facilities and equipment, but would exclude any assets, facilities, or equipment that would cause the owner or operator thereof to be deemed a public utility company. As of September 30, 2004, we did not have any investments in these Energy-Related Assets.

• Infrastructure Services Companies

Cinergy has been granted SEC authority under PUHCA to invest up to $500 million in companies that derive or will derive substantially all of their operating revenues from the sale of Infrastructure Services including:

MD&A -LIQUIDITY AND CAPITAL RESOURCES

• Design, construction, retrofit, and maintenance of utility transmission and distribution systems;

• Installation and maintenance of natural gas pipelines, water and sewer pipelines, and underground and overhead telecommunications networks; and

• Installation and servicing of meter reading devices and related communications networks, including fiber optic cable.

At September 30, 2004, we had invested approximately $29 million in Infrastructure Services companies.

Guarantees

We are subject to an SEC order under the PUHCA, which limits the amounts Cinergy Corp. can have outstanding under guarantees at any one time to $2 billion. As of September 30, 2004, we had $705 million outstanding under the guarantees issued, of which approximately 93 percent represents guarantees of obligations for entities consolidated in Cinergy's financial statements. The amount outstanding represents Cinergy Corp.'sguarantees of liabilities and commitments of its consolidated subsidiaries, unconsolidated subsidiaries, and joint ventures. See Note 6(c)(v) of the "Notes to Condensed Financial Statements" in "Item 1. Financial Statements" for a discussion of guarantees in accordance with Financial Accounting Standards Board (FASB) Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others(Interpretation 45). Interpretation 45 requires disclosure of maximum potential liabilities for guarantees issued on behalf of unconsolidated subsidiaries and joint ventures and under indemnification clauses in various contracts. The Interpretation 45 disclosure differs from the PUHCA restrictions in that it requires a calculation of maximum potential liability, rather than actual amounts outstanding; it excludes guarantees issued on behalf of consolidated subsidiaries; and it includes potential liabilities under indemnification clauses.

Marketing & Trading Liquidity Risks

Cinergy has certain contracts in place, primarily with trading counterparties, that may require the settlement of open positions or the issuance of collateral in the event our debt ratings are downgraded below investment grade. Based upon our September 30, 2004 trading portfolio, if such an event were to occur, Cinergy would be required to issue up to approximately $140 million related to its gas and power trading operations, of which $78 million is related to CG&E.

Capital Resources

Cinergy, CG&E, PSI, and ULH&P meet current and future capital requirement needs through a combination of internally and externally generated funds, including the issuance of debt and/or equity securities. Cinergy, CG&E, PSI, and ULH&Pbelieve that they have adequate financial resources to meet their future needs.

Sales of Accounts Receivable

CG&E, PSI, and ULH&P have an agreement with Cinergy Receivables Company, LLC (Cinergy Receivables), an affiliate, to sell, on a revolving basis, nearly all of the retail accounts receivable and

MD&A -LIQUIDITY AND CAPITAL RESOURCES

related collections of CG&E, PSI, and ULH&P. Cinergy Receivables funds its purchase with borrowings from commercial paper conduits that obtain a security interest in the receivables. This program accelerates the collection of cash for CG&E, PSI, and ULH&P related to these retail receivables. Cinergy Corp. does not consolidate Cinergy Receivables since it meets the requirements to be accounted for as a qualifying special purpose entity (SPE). A decline in the long-term senior unsecured credit ratings of CG&E, PSI, and ULH&P below investment grade would result in the termination of the sale program and discontinuance of future sales of receivables.

Notes Payable and Other Short-term Obligations

We are required to secure authority to issue short-term debt from the SEC under the PUHCA and from the PUCO. The SEC under the PUHCA regulates the issuance of short-term debt by Cinergy Corp., PSI, and ULH&P. The PUCO has regulatory jurisdiction over the issuance of short-term debt by CG&E.

Short-term Regulatory Authority September 30, 2004

(in millions)

Authority Outstanding

Cinergy Corp. $ 5,000 (1) $ 912 CG&E and subsidiaries 665 242 PSI 600 154 ULH&P 65 37

(1) Cinergy Corp., under the PUHCA, has approval to increase total capitalization (excluding retained earnings and accumulated other comprehensive income (loss)), which may be any combination of short-term debt, long-term debt, and equity securities, to $5 billion. Outside this requirement, Cinergy Corp. is not subject to specific regulatory debt authorizations.

For the purposes of quantifying regulatory authority, short-term debt includes revolving credit and uncommitted credit line borrowings, intercompany money pool obligations, and commercial paper. Cinergy Corp.'s short-term borrowings consist primarily of unsecured revolving lines of credit and the sale of commercial paper. Cinergy Corp.'s $1.5 billion revolving credit facilities and commercial paper program also support the short-term borrowing needs of CG&E, PSI, and ULH&P. In addition, Cinergy Corp., CG&E, and PSI maintain uncommitted lines of credit. These facilities are not firm sources of capital but rather informal agreements to lend money, subject to availability, with pricing determined at the time of advance.

Variable Rate Pollution Control Notes

In August 2004, PSI borrowed the proceeds from the issuance by the Indiana Development Finance Authority of $55 million principal amount of its Environmental Revenue Bonds, Series 2004A, due August 2039. The initial interest rate for the bonds was 1.13 percent and is reset weekly. Proceeds from the borrowing will be used for the acquisition and construction of various solid waste disposal facilities located at various generating stations in Indiana. The $55 million is being held in escrow by an independent trustee and will be drawn upon as facilities are built. Holders of these notes are entitled to credit enhancement in the form of a standby letter of credit, which if drawn upon, provides for the payment of both interest and principal on the notes. Because the holders of these notes have

MD&A -LIQUIDITY AND CAPITAL RESOURCES

the right to have their notes redeemed on a weekly basis, they are reflected in Notes payable and other short-term obligations on the balance sheets of Cinergy and PSI.

The following is a summary of outstanding short-term borrowings for Cinergy, CG&E, PSI, and ULH&P, including variable rate pollution control notes:

Short-term Borrowings September 30, 2004 Available Revolving Established Standby Lines of Lines Outstanding Unused Liquidity(3) Credit

(in millions)

Cinergy
Cinergy Corp.
Revolving lines $ 1,500 $ - $ 1,500 $ 918 $ 582 Uncommitted lines(1) 40 - 40 Commercial paper(2) 912 588

Utility operating companies
Uncommitted lines(1) 75 - 75 Pollution control notes 248

Non-regulated subsidiaries
Revolving lines 14 10 4 4 Short-term debt 2 Pollution control notes 25

Cinergy Total $ 1,197 $ 586

CG&E and subsidiaries
Uncommitted lines(1) $ 15 $ - $ 15 Pollution control notes 112 Money pool 242

CG&E Total $ 354

PSI
Uncommitted lines(1) $ 60 $ - $ 60 Pollution control notes 136 Money pool 154

PSI Total $ 290

ULH&P
Money pool $ 37

ULH&P Total $ 37

(1) These facilities are not guaranteed sources of capital and represent an informal agreement to lend money, subject to availability, with pricing to be determined at the time of advance.
(2) In September 2004, Cinergy Corp. increased its commercial paper program limit from $800 million to $1.5 billion. The commercial paper program is supported by Cinergy Corp.'s revolving lines of credit.
(3) Standby liquidity is reserved against the revolving lines to support the commercial paper program and outstanding letters of credit (currently $912 million and $6 million, respectively).

In April 2004, Cinergy Corp. successfully placed two senior unsecured revolving credit facilities with an aggregate borrowing capacity of $1.5 billion, comprised of a $500 million 364-day facility

MD&A -LIQUIDITY AND CAPITAL RESOURCES

and a $1 billion three-year facility. These facilities replaced two facilities that expired in April and May 2004.

At September 30, 2004, Cinergy Corp. had approximately $582 million remaining unused and available capacity relating to its $1.5 billion revolving credit facilities. These revolving credit facilities include the following:

Outstanding and Unused and Credit Facility Expiration Established Lines Committed Available

(in millions)

364-day senior revolving April 2005 Direct borrowing $ $ - $ Commercial paper support -

Total 364-day facility 500 - 500

Three-year senior revolving April 2007 Direct borrowing - Commercial paper support 912 Letter of credit support 6

Total three-year facility 1,000 918 82

Total Credit Facilities $ 1,500 $ 918 $ 582

In our credit facilities, Cinergy Corp. has covenanted to maintain:

• a consolidated net worth of $2 billion; and

• a ratio of consolidated indebtedness to consolidated total capitalization not in excess of 65 percent.

A breach of these covenants could result in the termination of the credit facilities and the acceleration of the related indebtedness. In addition to breaches of covenants, certain other events that could result in the termination of available credit and acceleration of the related indebtedness include:

• bankruptcy;

• defaults in the payment of other indebtedness; and

• judgments against the company that are not paid or insured.

The latter two events, however, are subject to dollar-based materiality thresholds.

Long-term Debt

We are required to secure authority to issue long-term debt from the SEC under the PUHCA and the state utility commissions of Ohio, Kentucky, and Indiana. The SEC under the PUHCA regulates the issuance of long-term debt by Cinergy Corp. The respective state utility commissions regulate the issuance of long-term debt by our utility operating companies.

MD&A -LIQUIDITY AND CAPITAL RESOURCES

A current summary of our long-term debt authorizations at September 30, 2004, was as follows:

Authorized Used Available (in millions)

Cinergy Corp.
PUHCA total capitalization(1) $ 5,000 $ 1,705 $ 3,295

CG&E and subsidiaries(2)
State Public Utility Commissions $ 575 $ - $ 575 State Public Utility Commission - Tax-Exempt 250 - 250

PSI State Public Utility Commission $ 500 $ - $ 500 State Public Utility Commission - Tax-Exempt 250 55 195

ULH&P State Public Utility Commission $ 75 $ - $ 75

(1) Cinergy Corp., under PUHCA, has approval to increase total capitalization (excluding retained earnings and accumulated other comprehensive income
(loss)), which may be any combination of short-term debt, long-term debt, and equity securities, by $5 billion. Outside this requirement, Cinergy Corp. is not subject to specific regulatory debt authorizations.
(2) Includes amounts for ULH&P.

Cinergy Corp. has an effective shelf registration statement with the SEC relating to the issuance of up to $750 million in any combination of common stock, preferred stock, stock purchase contracts or unsecured debt securities, of which approximately $574 million remains available for issuance. CG&E has an effective shelf registration statement with the SEC relating to the issuance of up to $800 million in any combination of unsecured debt securities, first mortgage bonds, or preferred stock, all of which remains available for issuance. PSIhas an effective shelf registration statement with the SEC relating to the issuance of up to $800 million in any combination of unsecured debt securities, first mortgage bonds, or preferred stock, all of which remains available for issuance. ULH&Phas an effective shelf registration statement with the SEC for the issuance of up to $75 million in unsecured debt securities, all of which remains available for issuance. ULH&Palso has effective shelf registration statements with the SEC relating to the issuance of up to $40 million in first mortgage bonds, of which $20 million remains available for issuance.

Off-Balance Sheet Arrangements

As discussed in the 2003 10-K, Cinergy uses off-balance sheet arrangements from time to time to facilitate financing of various projects. Cinergy's primary off-balance sheet arrangements involve (a) the sale of accounts receivable to a qualifying SPE, and (b) a forward stock contract that will result in the issuances of between 9.2 and 10.8 million Cinergy Corp. common shares in February 2005.

MD&A -LIQUIDITY AND CAPITAL RESOURCES

Securities Ratings

As of September 30, 2004, the major credit rating agencies rated our securities as follows:

Fitch(1) Moody's(2) S&P(3)

Cinergy Corp.
Corporate Credit BBB+ Baa2 BBB+ Senior Unsecured Debt BBB+ Baa2 BBB Commercial Paper F-2 P-2 A-2 Preferred Trust Securities BBB+ Baa2 BBB

CG&E Senior Secured Debt A- A3 A- Senior Unsecured Debt BBB+ Baa1 BBB Junior Unsecured Debt BBB Baa2 BBB- Preferred Stock BBB Baa3 BBB- Commercial Paper F-2 P-2 Not Rated

PSI Senior Secured Debt A- A3 A- Senior Unsecured Debt BBB+ Baa1 BBB Junior Unsecured Debt BBB Baa2 BBB- Preferred Stock BBB Baa3 BBB- Commercial Paper F-2 P-2 Not Rated

ULH&P Senior Unsecured Debt Not Rated Baa1 BBB

(1) Fitch Ratings (Fitch)
(2) Moody's Investors Service (Moody's)
(3) Standard & Poor's (S&P)

The highest investment grade credit rating for Fitch is AAA, Moody's is Aaal, and S&P is AAA.
The lowest investment grade credit rating for Fitch is BBB-, Moody's is Baa3, and S&P is BBB-.

A security rating is not a recommendation to buy, sell, or hold securities. These securities ratings may be revised or withdrawn at any time, and each rating should be evaluated independently of any other rating.

Equity

As discussed in the 2003 10-K, Cinergy issues new Cinergy Corp. common stock shares to satisfy obligations under certain of its employee stock plans and the Cinergy Corp. Direct Stock Purchase and Dividend Reinvestment Plan. During the nine months ended September 30, 2004, Cinergy issued approximately 2.7 million shares under these plans.

MD&A -QUARTERLY RESULTS OF OPERATIONS - HISTORICAL

The Results of Operations discussions for Cinergy, CG&E, and PSI are combined within this section.

2004 QUARTERLY RESULTS OF OPERATIONS - HISTORICAL

Summary of Results

Electric and gas gross margins and net income for Cinergy, CG&E, and PSI for the quarters ended September 30, 2004 and 2003 were as follows:

Cinergy(1) CG&E and subsidiaries PSI % % % 2004 2003 Change Change 2004 2003 Change Change 2004 2003 Change Change

(in thousands)

Net income $ 92,923 $ 111,981 (19,058 ) (17 ) $ 64,073 $ 78,863 $ (14,790 ) (19 ) $ 48,487 $ 37,592 $ 10,895 29

Electric
gross
margin(2) 660,303 590,641 69,662 12 337,779 330,046 7,733 2 319,548 259,298 60,250 23 Gas gross
margin(3) 45,506 44,951 555 1 40,334 34,176 6,158 18 - - - -

(1) The results of Cinergy also include amounts related to non-registrants.
(2) Electric gross margin is calculated as Electric operating revenues less Fuel and purchased power expense from the Condensed Consolidated Statements of Income.
(3) Gas gross margin is calculated as Gas operating revenues less Gas purchased expense from the Condensed Consolidated Statements of Income.

Cinergy's decrease in net income was primarily attributable to the following factors:

• Higher Operation and maintenance expense due, in part, to increased emission allowance expenses;

• Higher Depreciationexpense; and

• Impairment and disposal charges on certain investments in the Power Technology and Infrastructure Services Business Unit (Power Technology and Infrastructure) (reflected in Miscellaneous Income (Expense) - Net).

• These expenses were offset by higher electric gross margins and an adjustment to decrease the estimated annual effective tax rate.

CG&E's decrease in net income was primarily attributable to the following factors:

• Higher Operation and maintenance expense due primarily to increased emission allowance expenses.

• These higher expenses were offset, in part, by higher electric and gas gross margins.

PSI's increase in net income was primarily attributable to the following factors:

• Higher electric gross margins.

• These higher margins were offset, in part, by higher Operation and maintenance expense, higher Depreciation expense and an adjustment to increase the estimated annual effective tax rate.

MD&A -QUARTERLY RESULTS OF OPERATIONS - HISTORICAL

Electric Margins

Cinergy's, CG&E's, and PSI's electric gross margins increased for the quarter ended September 30, 2004, as compared to the same period last year. Cinergy's and PSI's variances include a higher price received per MWh primarily due to the Indiana Utility Regulatory Commission's (IURC) approval of PSI's average base retail electric rate increase of eight percent in May 2004. This is discussed further in Note 6(b)(i) of the "Notes to Condensed Financial Statements" in "Item 1. Financial Statements". For all three companies, growth in non-weather related demand was offset by a decline in MWh sales due to milder weather in the current period. Cinergy's and CG&E's variances reflect an increase in net revenues on power marketing, trading, and origination contracts.

Cinergy's and CG&E's variances also reflect a decline due to an increase in the average price of fuel for the period. Offsetting most of this decline was an increase in coal origination, which includes contract structuring and marketing of physical coal.

Electric Operating Revenues

Cinergy(1) CG&E and subsidiaries PSI % % % 2004 2003 Change Change 2004 2003 Change Change 2004 2003 Change Change

(in millions)

Retail $ 792 $ 744 $ 48 6 $ 383 $ 377 $ 6 2 $ 409 $ 367 $ 42 11 Wholesale 139 141 (2 ) (1 ) 59 65 (6 ) (9 ) 56 61 (5 ) (8 ) Other 63 36 27 75 52 33 19 58 15 9 6 67 Total $ 994 $ 921 $ 73 8 $ 494 $ 475 $ 19 4 $ 480 $ 437 $ 43 10

(1) The results of Cinergy also include amounts related to non-registrants.

Heating degree-days and cooling degree-days are metrics commonly used in the utility industry as a measure of the impact weather has on results of operations. Heating degree-days and cooling degree-days in CG&E's and PSI's service territories for the quarters ended September 30, 2004 and 2003, were as follows:

CG&E and subsidiaries PSI % % 2004 2003 Change Change 2004 2003 Change Change

Heating degree-days(1) 36 72 (36 ) (50 ) 42 91 (49 ) (54 ) Cooling degree-days(2) 540 638 (98 ) (15 ) 535 642 (107 ) (17 )

(1) Heating degree-days are the differences between the average temperature for each day and 65 degrees, assuming the average temperature is less than 65 degrees.
(2) Cooling degree-days are the differences between the average temperature for each day and 65 degrees, assuming the average temperature is greater than 65 degrees.

Although cooling degree-days declined, retail electric operating revenues increased for Cinergy and PSI in the third quarter of 2004 as compared to 2003. This was mainly due to an increase in the average retail price per MWh, which resulted in approximately $49 million and $45 million higher retail revenues for Cinergy and PSI, respectively. The higher retail prices primarily reflect a higher

MD&A -QUARTERLY RESULTS OF OPERATIONS - HISTORICAL

price received per MWh due to PSI's base retail electric rate case. For all three companies, growth in non-weather related demand was offset by a decline in MWh sales due to milder weather in the current period.

Electric wholesale revenues remained relatively flat for Cinergy and decreased for CG&E and PSI for the quarter ended September 30, 2004, as compared to 2003. Cinergy's wholesale revenues increased approximately $14 million from non-regulated energy service subsidiaries that started operations, or became fully consolidated, after September 30, 2003. Additionally, net revenues on power marketing, trading, and origination contracts increased approximately $11 million. The increase in power trading results is attributable to higher margins on physical and financial trading primarily related to regional spreads between the mideast and midwest markets. These increases were offset by decreases in wholesale sales from generation available after serving regulated retail customers.

CG&E's variance reflects decreases in wholesale sales from generation available after serving regulated retail customers. Partially offsetting this decrease was an approximate $15 million increase in net revenues on power marketing, trading, and origination contracts. The increase in power trading results is attributable to higher margins on physical and financial trading primarily related to regional spreads between the mideast and midwest markets. The majority of PSI's decrease was attributable to decreases in wholesale sales from generation available after serving regulated retail customers.

The decreases in wholesale sales from generation available after serving regulated retail customers were primarily caused by lower demand. In addition, lower market prices caused our generation to be less economic when it was available for wholesale transactions. As a result, there were fewer opportunities to sell into the wholesale market from generation in the third quarter of 2004, as compared to 2003.

Other electric operating revenues increased for Cinergy, CG&E, and PSI for the quarter ended September 30, 2004, as compared to 2003. Cinergy'sand CG&E's higher other electric operating revenues reflect increases in coal origination of approximately $23 million. Coal origination includes contract structuring and marketing of physical coal. Cinergy's, CG&E's, and PSI's increases also reflect approximately $8 million, $2 million, and $6 million, respectively, of higher transmission revenues primarily resulting from Midwest Independent System Operator, Inc. (Midwest ISO) operations.

Fuel and Purchased Power

Cinergy(1) CG&E and subsidiaries PSI % % % 2004 2003 Change Change 2004 2003 Change Change 2004 2003 Change Change
(in millions)

Fuel used for
generation $ 259 $ 270 $ (11 ) (4 ) $ 99 $ 94 $ 5 5 $ 139 $ 164 $ (25 ) (15 ) Coal
origination
costs 29 17 12 71 29 17 12 71 - - - - Total fuel $ 288 $ 287 $ 1 - $ 128 $ 111 $ 17 15 $ 139 $ 164 $ (25 ) (15 ) Purchased
power 46 43 3 7 28 34 (6 ) (18 ) 22 14 8 57 Fuel and
purchased
power $ 334 $ 330 $ 4 1 $ 156 $ 145 $ 11 8 $ 161 $ 178 $ (17 ) (10 )

(1) The results of Cinergy also include amounts related to non-registrants.

MD&A -QUARTERLY RESULTS OF OPERATIONS - HISTORICAL

Fuel

Fuel expense represents the cost of coal, natural gas, and oil that is used to generate electricity, and the cost of coal origination, which includes contract structuring and marketing of physical coal. The following table details the changes to expense for fuel used in generation from the quarter ended September 30, 2003, to the quarter ended September 30, 2004:

Cinergy(1) CG&E PSI (in millions)

Fuel Expense - September 30, 2003 $ 270 $ 94 $ 164

Increase (Decrease) due to changes in: Price of fuel 12 13 (1 ) Deferred fuel cost (14 ) - (14 ) Fuel consumption (18 ) (8 ) (10 ) Non-regulated subsidiaries 9 - -

Fuel Expense - September 30, 2004 $ 259 $ 99 $ 139

(1) The results of Cinergy also include amounts related to non-registrants.

Deferred fuel cost represents changes in fuel expense associated with PSI'sfuel adjustment charge, which recovers retail fuel costs from customers on a dollar-for-dollar basis. The fuel adjustment charge is calculated based on the estimated cost of fuel in the next three-month period. PSI records any under-recovery or over-recovery resulting from these differences as a deferred asset or liability until it is billed or refunded to its customers, at which point it is adjusted through fuel expense.

Purchased Power

Purchased power expense increased for Cinergy and PSI and decreased for CG&Efor the quarter ended September 30, 2004, as compared to 2003. Cinergy'sand PSI's increases primarily reflect a greater volume of MWhs purchased to serve PSI's native load and wholesale full requirements customers. Partially offsetting Cinergy'sincrease and primarily causing CG&E'sdecrease was a reduction in the amount of MWhs purchased to serve CG&E's wholesale full requirements customers and a lower price paid per MWh for these purchases.

Gas Margins

CG&E's gas gross margins increased and Cinergy's remained relatively flat for the quarter ended September 30, 2004, as compared to the same period last year. CG&E'sgas margins increased by approximately $6 million primarily due to rate tariff adjustments.

Cinergy's gas margins remained relatively flat as CG&E'sincrease was offset by lower margins from our gas marketing and trading business. Margins for our gas marketing and trading business decreased primarily due to timing differences in revenue recognition between physical storage activities and the associated derivative contracts that hedge the physical storage. Our gas marketing and trading business regularly hedges its price exposure of natural gas held in storage by selling derivative contracts for winter month delivery. The majority of the gas held in storage is designated as being hedged under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities' (Statement 133) fair value hedge accounting model, which allows the gas to be accounted for at its fair value (based on spot prices). Under generally accepted

MD&A -QUARTERLY RESULTS OF OPERATIONS - HISTORICAL

accounting principles (GAAP), the derivative contracts hedging the gas are accounted for at fair value (based on forward winter prices). Conversely, the agreements with pipelines to store this natural gas until the winter periods are not derivatives and are not adjusted for changes in fair value (see footnote 1 in the table below). Significant increases in natural gas prices during the third quarter of 2004, especially prices for winter months, resulted in an unrealized loss on the derivative contracts that is included in current earnings. However, the economic benefit of these increased prices for the gas held in storage will not be recognized in revenues until spot and winter prices of gas converge (which we expect will occur in the winter months when the natural gas is withdrawn from storage and sold).

For a more complete understanding of our gas marketing and trading results, we have prepared the following table which reconciles the gas margins under GAAP, the impact of adjusting these margins for the fair value of pipeline agreements and certain gas held in storage, and the resulting adjusted gas margins:

2004 2003 Change (dollars in millions)

Gas margins, as reported (GAAP) $ 5 $ 11 $ (6 )

Fair value adjustments not recognized under GAAP(1) 21 (2) 1 20

Adjusted gas margins $ 26 $ 12 $ 14

(1) Relates to fair value of storage agreements. The value of a storage agreement is the ability to store and optimize gas between periods of lower prices (typically summer) and periods of higher prices (typically winter). A large component of the fair value is therefore the differences between winter prices and spot prices. As this spread gets wider, the value of a storage agreement increases.
(2) The magnitude of the adjustment in 2004 is driven by forward price increases in the winter months that are significantly larger than spot price increases, which caused a recognized loss on the derivative sales in winter offset by an unrecognized gain on the related storage agreements. While such price changes from one quarter to the next are not unprecedented, they are the most significant they have been since we discontinued the application of fair value accounting to natural gas held in storage and pipeline agreements on January 1, 2003, with the rescission of Emerging Issues Task Force Issue 98-10, Accounting for Contracts Involved in Energy Trading and Risk Management Activities (EITF 98-10).

Adjusted gas margins represent a more economic view of the business with all elements of the business reflected at fair value. The resulting increase in adjusted gas margins from our gas marketing and trading business is primarily a result of an increase in physical and financial trading margins resulting from favorable price movements in the third quarter of 2004.

Other Revenues

Other revenues for Cinergy increased for the quarter ended September 30, 2004, as compared to 2003, primarily due to increased revenues of approximately $22 million from the sale of synthetic fuel as a result of an increase in demand for our synthetic fuel.

Operating Expenses

Operation and Maintenance

Operation and maintenanceexpense increased for Cinergy, CG&E, and PSI for the quarter ended September 30, 2004, as compared to 2003. Approximately $27 million of Cinergy's increase is due to an increase in the production of synthetic fuel as a result of an increase in demand for our synthetic fuel. Cinergy's, CG&E's, and PSI's increases include approximately $15 million, $7 million, and $8

MD&A -QUARTERLY RESULTS OF OPERATIONS - HISTORICAL

million, respectively, of higher expenses related to emission allowances. These increases primarily reflect higher expenses due to an increase in the cost of SO2 emission allowances as market prices have increased. Cinergy's and PSI's increases also resulted from timing differences in the recovery of SO2 emission allowances costs under PSI's emission allowances tracking mechanism authorized by the IURC.

Maintenance expenses, primarily production and distribution related, were higher by approximately $7 million for both Cinergy and CG&E. The increases for Cinergy, CG&E, and PSI also reflect costs incurred in the third quarter of 2004 related to a continuous improvement initiative of approximately $6 million, $3 million, and $2 million, respectively. Approximately $5 million of Cinergy's increase relates to non-regulated energy service subsidiaries that started operations, or became fully consolidated, after the second quarter of 2003. Partially offsetting Cinergy'sincreases were approximately $12 million of costs incurred in 2003 associated with the bankruptcy of Enron Corp.

Depreciation

Depreciation expense increased for Cinergy and PSI for the quarter ended September 30, 2004, as compared to 2003. Approximately $12 million of Cinergy's and PSI's increase was due to the addition of depreciable plant primarily for pollution control equipment. Also contributing to Cinergy'sand PSI's higher depreciation expense was an approximate $7.5 million increase due to higher depreciation rates effective June 2004 that were approved in PSI's latest retail rate case.

Miscellaneous Income (Expense) - Net

Miscellaneous Income (Expense) - Net decreased for Cinergy and CG&E and increased for PSI for the quarter ended September 30, 2004, as compared to 2003. Cinergy's decrease reflects approximately $15 million in impairment and disposal charges on certain investments in Power Technology and Infrastructure. The values of these investments reflect our estimates and judgments about the future performance of these investments, for which actual results may differ. CG&E's decrease and PSI's increase was primarily a result of a final reconciliation recorded in 2003 between the two entities of a previous demutualization of a medical insurance carrier used by both companies.

Income Taxes

The effective income tax rate decreased for Cinergy and increased for CG&E and PSIfor the quarter ended September 30, 2004, as compared to 2003. Cinergy's2004 effective tax rate is expected to be approximately 23 percent, a decrease of one percent from our prior estimate. The change results from a revision in estimated 2004 pre-tax income with no adjustment to the estimated annual tax credits associated with the production and sale of synthetic fuel for the year. CG&E's and PSI'sincreases reflect revisions to estimated 2004 pre-tax income and changes in permanent differences which have an incremental effect on tax expense.

In July 2002, Cinergy Capital & Trading, Inc. (Capital & Trading) acquired a coal-based synthetic fuel production facility. The synthetic fuel produced at this facility qualifies for tax credits in accordance with Section 29 of the Internal Revenue Code (IRC). Eligibility for these credits expires after 2007. Cinergy received a private letter ruling from the Internal Revenue Service (IRS) in connection with the acquisition of the facility. To date, Cinergy has recorded approximately $189 million in tax

MD&A -QUARTERLY RESULTS OF OPERATIONS - HISTORICAL

credits, including approximately $69 million in 2004. See Note 6(c)(iv) of the "Notes to Condensed Financial Statements" in "Item 1. Financial Statements" for more detail.

MD&A -year to date results of operations - historical

2004 YEAR TO DATE RESULTS OF OPERATIONS - HISTORICAL

Summary of Results

Electric and gas gross margins and net income for Cinergy, CG&E, and PSI for the nine months ended September 30, 2004 and 2003, were as follows:

Cinergy(1) CG&E and subsidiaries PSI % % % 2004 2003 Change Change 2004 2003 Change Change 2004 2003 Change Change

(in thousands)

Net income $ 254,442 $ 362,719 $ (108,277 ) (30 ) $ 196,837 $ 247,018 $ (50,181 ) (20 ) $ 114,739 $ 94,398 $ 20,341 22

Electric
gross
margin(2) 1,850,064 1,672,622 177,442 11 959,871 919,244 40,627 4 873,875 743,501 130,374 18 Gas gross
margin(3) 233,498 269,482 (35,984 ) (13 ) 187,702 174,912 12,790 7 - - - -

Cinergy's decrease in net income was primarily attributable to the following factors:

• Higher Operation and maintenance expense due, in part, to greater emission allowance expenses;

• Higher Depreciationexpense;

• Impairment and disposal charges on certain investments in Power Technology and Infrastructure (reflected in Miscellaneous Income (Expense) - Net);

• Lower gas margins in our gas marketing and trading business;

• Net gains recognized in the first quarter of 2003 resulting from the implementation of certain accounting changes that have been reflected as cumulative effects of changes in accounting principles; and

• Gains realized in the second quarter of 2003 from the disposal of discontinued operations.

• These variances were offset, in part, by an increase in electric gross margins.

CG&E's decrease in net income was primarily attributable to the following factors:

• Higher Operation and maintenance expense due primarily to greater emission allowance expenses, consulting fees for a continuous improvement initiative and higher employee benefit expenses; and

• These variances were offset, in part, by increases in electric and gas gross margins.

MD&A -year to date results of operations - historical

PSI's increase in net income was primarily attributable to the following factors:

• Higher electric gross margins.

• These higher margins were offset, in part, by higher Operation and maintenance expense, higher Depreciation expense and an adjustment to increase the estimated annual effective tax rate.

Electric Margins

Cinergy's, CG&E's, and PSI's electric gross margins increased for the nine months ended September 30, 2004, as compared to the same period last year. Cinergy's and PSI's increases included a higher price received per MWh primarily due to the IURC's approval of PSI'saverage base retail electric rate increase of eight percent in May 2004 and certain rate tariff adjustments. Also contributing to the increase in electric gross margins for all three companies were additional MWhs delivered due to growth in non-weather related demand. Cinergy's and CG&E's variances reflect an increase in net revenues on power marketing, trading, and origination contracts.

Cinergy's and CG&E's variances also reflect a decline due to an increase in the average price of fuel for the period. This decline was partially offset by an increase in coal origination, which includes contract structuring and marketing of physical coal.

Electric Operating Revenues

Cinergy(1) CG&E and subsidiaries PSI % % % 2004 2003 Change Change 2004 2003 Change Change 2004 2003 Change Change
(in millions)

Retail $ 2,157 $ 2,063 $ 94 5 $ 1,057 $ 1,030 $ 27 3 $ 1,100 $ 1,033 $ 67 6 Wholesale 459 364 95 26 204 194 10 5 177 156 21 13 Other 148 86 62 72 126 77 49 64 34 21 13 62 Total $ 2,764 $ 2,513 $ 251 10 $ 1,387 $ 1,301 $ 86 7 $ 1,311 $ 1,210 $ 101 8

(1) The results of Cinergy also include amounts related to non-registrants.

Heating degree-days and cooling degree-days are metrics commonly used in the utility industry as a measure of the impact weather has on results of operations. Heating degree-days and cooling degree-days in CG&E's and PSI's service territories for the nine months ended September 30, 2004 and 2003, were as follows:

CG&E and subsidiaries PSI % % 2004 2003 Change Change 2004 2003 Change Change

Heating degree-days(1) 3,121 3,387 (266 ) (8 ) 3,256 3,697 (441 ) (12 ) Cooling degree-days(2) 867 804 63 8 879 841 38 5

MD&A -year to date results of operations - historical

The change in degree days for the nine months ended September 30, 2004, as compared to 2003, did not have a material effect on electric operating revenues.

Retail electric operating revenues increased for Cinergy primarily due to a three percent increase in MWhs delivered by CG&E and PSI for the nine months ended September 30, 2004, as compared to 2003. These increases resulted in approximately $59 million, $28 million, and $31 million higher retail revenues for Cinergy, CG&E, and PSI, respectively. The increase in MWhs delivered primarily reflects growth in non-weather related demand.

Also contributing to the increase in retail electric operating revenues for Cinergy and primarily causing the increase in retail electric operating revenues for PSI were two percent and three percent increases, respectively, in the average retail price per MWh for the first nine months of 2004, as compared to 2003. These average increases resulted in approximately $35 million and $36 million higher retail electric operating revenues for Cinergy and PSI, respectively. Contributing to the average price increase was a higher price received per MWh due to PSI's base retail electric rate case. Also contributing to the average price increase were approximately $17 million in increases in rate tariff adjustments related to emission allowances and clean coal technology tracking mechanisms.

Electric wholesale revenues increased for Cinergy, CG&E, and PSI for the nine months ended September 30, 2004, as compared to 2003. Cinergy's increase includes a number of factors. Approximately $41 million of the variance includes increases in wholesale revenues from non-regulated energy service subsidiaries that started operations, or became fully consolidated, after the first half of 2003. Net revenues on power marketing, trading, and origination contracts increased approximately $34 million. The increase in power trading results is attributable to higher margins on physical and financial trading primarily related to regional spreads between the mideast and midwest markets. The majority of the remaining increase was attributable to increases in wholesale sales from generation available after serving regulated retail customers.

CG&E's net revenues on power marketing, trading, and origination contracts increased approximately $35 million. The increase in power trading results is attributable to higher margins on physical and financial trading primarily related to regional spreads between the mideast and midwest markets. This increase was offset by a decrease in MWhs available for wholesale activity due in part to a decrease in generation available for these transactions. The majority of PSI's increase was attributable to a greater amount of wholesale sales from generation available after serving regulated retail customers.

Other electric operating revenues increased for Cinergy, CG&E, and PSI for the nine months ended September 30, 2004, as compared to 2003. Cinergy's and CG&E'shigher other electric operating revenues reflect increases in coal origination of approximately $37 million. Coal origination includes contract structuring and marketing of physical coal. Cinergy's, CG&E's, and PSI's increases also reflect approximately $19 million, $7 million, and $12 million, respectively, of higher transmission revenues primarily resulting from Midwest ISO operations.

MD&A -year to date results of operations - historical

Fuel and Purchased Power

Cinergy(1) CG&E and subsidiaries PSI % % % 2004 2003 Change Change 2004 2003 Change Change 2004 2003 Change Change
(in millions)

Fuel used for
generation $ 719 $ 705 $ 14 2 $ 290 $ 263 $ 27 10 $ 369 $ 415 $ (46 ) (11 ) Coal
origination
costs 68 41 27 66 68 41 27 66 - - - - Total fuel $ 787 $ 746 $ 41 5 $ 358 $ 304 $ 54 18 $ 369 $ 415 $ (46 ) (11 ) Purchased
power 127 94 33 35 69 78 (9 ) (12 ) 68 52 16 31 Fuel and
purchased
power $ 914 $ 840 $ 74 9 $ 427 $ 382 $ 45 12 $ 437 $ 467 $ (30 ) (6 )

(1) The results of Cinergy also include amounts related to non-registrants.

Fuel

Fuel expense represents the cost of coal, natural gas, and oil that is used to generate electricity, and the cost of coal origination, which includes contract structuring and marketing of physical coal. The following table details the changes to expense for fuel used in generation from the nine months ended September 30, 2003, to the nine months ended September 30, 2004:

Cinergy(1) CG&E PSI (in millions)

Fuel expense - September 30, 2003 $ 705 $ 263 $ 415

Increase (decrease) due to changes in:
Price of fuel 39 36 3 Deferred fuel cost (64 ) - (64 ) Fuel consumption 6 (9 ) 15 Non-regulated subsidiaries 33 - -

Fuel expense - September 30, 2004 $ 719 $ 290 $ 369

(1) The results of Cinergy also include amounts related to non-registrants.

Deferred fuel cost represents changes in fuel expense associated with PSI's fuel adjustment charge, which recovers retail fuel costs from customers on a dollar-for-dollar basis. The fuel adjustment charge is calculated based on the estimated cost of fuel in the next three-month period. PSI records any under-recovery or over-recovery resulting from these differences as a deferred asset or liability until it is billed or refunded to its customers, at which point it is adjusted through fuel expense.

Purchased Power

Purchased power expense increased for Cinergy and PSI and decreased for CG&E for the nine months ended September 30, 2004, as compared to 2003. Cinergy's increase was primarily due to a significantly greater number of third party purchases by its subsidiaries in 2004. In 2003, Cinergy's subsidiaries' purchased power expense included certain intercompany purchases that were eliminated in consolidation.

Also contributing to Cinergy's increase and primarily causing PSI's increase were additional costs of purchases made for PSI's wholesale full requirements customers resulting from an increase in both the amount of MWhs purchased for these customers and the price paid per MWh. Partially offsetting Cinergy's increase and primarily causing CG&E's decrease was a reduction in the amount of MWhs

MD&A -year to date results of operations - historical

purchased to serve CG&E's wholesale full requirements customers, partially offset by an increase in the price paid per MWh for these purchases.

Gas Margins

CG&E's gas gross margins increased and Cinergy's decreased for the nine months ended September 30, 2004, as compared to the same period last year. CG&E'sapproximate $13 million increase in gas margins included an increase of approximately $21 million primarily due to rate tariff adjustments associated with the gas main replacement program, a low-income subsidy program, and Ohio excise taxes. This was offset by an approximate $8 million decrease reflecting less volume sold due to milder weather during 2004. Heating degree days decreased approximately eight percent in CG&E'sservice territory in the first nine months of 2004, as compared to 2003.

Lower margins from our gas marketing and trading business caused an overall decline in Cinergy's gas margins. Margins for our gas marketing and trading business decreased, in part, due to timing differences in revenue recognition between physical storage activities and the associated derivative contracts that hedge the physical storage. Our gas marketing and trading business regularly hedges its price exposure of natural gas held in storage by selling derivative contracts for winter month delivery. The majority of the gas held in storage is designated as being hedged under Statement 133's fair value hedge accounting model, which allows the gas to be accounted for at its fair value (based on spot prices). Under GAAP, the derivative contracts hedging the gas are accounted for at fair value (based on forward winter prices). Conversely, the agreements with pipelines to store this natural gas until the winter periods are not derivatives and are not adjusted for changes in fair value (see footnote 1 in the table below). Significant increases in natural gas prices during the third quarter of 2004, especially prices for winter months, resulted in an unrealized loss on the derivative contracts that is included in current earnings. However, the economic benefit of these increased prices for the gas held in storage will not be recognized in revenue until spot and winter prices of gas converge (which we expect will occur in the winter months when the natural gas is withdrawn from storage and sold).

2004 2003 Change (dollars in millions)

Gas margins, as reported (GAAP) $ 46 $ 95 $ (49 )

Fair value adjustments not recognized under GAAP (1) 21 (2) (6 ) 27

Adjusted gas margins $ 67 $ 89 $ (22 )

MD&A -year to date results of operations - historical

Adjusted gas margins represent a more economic view of the business with all elements of the business reflected at fair value. The resulting decrease in adjusted gas margins was primarily a result of an approximate $26 million decline in physical and financial trading margins from our North American gas marketing and trading business, primarily resulting from fewer trading opportunities caused by lower volatility, lower price levels, and milder weather in the first quarter of 2004. Natural gas prices were extremely volatile in the first quarter of 2003.

Other Revenues

Other revenues for Cinergy increased for the nine months ended September 30, 2004, as compared to 2003, primarily due to increased revenues of approximately $22 million from non-regulated energy service subsidiaries that started operations, or became fully consolidated, after the first half of 2003. Also contributing to the increase were increased revenues of approximately $20 million from the sale of synthetic fuel as a result of an increase in demand for our synthetic fuel.

Operating Expenses

Operation and Maintenance

Operation and maintenanceexpense increased for Cinergy, CG&E, and PSI for the nine months ended September 30, 2004, as compared to 2003. Cinergy's, CG&E's, and PSI's increases include approximately $58 million, $25 million, and $33 million, respectively, of higher expenses related to emission allowances. These increases primarily reflect higher expenses due to an increase in the cost of SO2emission allowances as market prices have increased. Cinergy's and PSI's increases also resulted from timing differences in the recovery of SO2 emission allowances costs under PSI's emission allowances tracking mechanism authorized by the IURC and an increase in the number of SO2 emission allowances used during the period. Approximately $35 million of Cinergy'sincrease is due to an increase in the production of synthetic fuel as a result of an increase in demand for our synthetic fuel.

The higher Operation and maintenance expense also reflects costs incurred in 2004 related to a continuous improvement initiative of approximately $18 million, $8 million, and $7 million for Cinergy, CG&E, and PSI, respectively. Employee benefit expenses increased approximately $12 million, $5 million, and $5 million for Cinergy, CG&E, and PSI, respectively. Approximately $18 million of Cinergy's increase is due to non-regulated energy service subsidiaries that started operations, or became fully consolidated, after the second quarter of 2003. In addition, higher costs of approximately $9 million, $7 million, and $2 million for Cinergy, CG&E, and PSI, respectively, were due to changes in transmission costs largely resulting from changes in the Midwest ISO operations in 2003. Maintenance expenses, primarily production and distribution related, were higher by approximately $19 million and $17 million for Cinergy and CG&E, respectively. Partially offsetting Cinergy'sincreases were approximately $12 million of costs incurred in 2003 associated with the bankruptcy of Enron Corp.

Depreciation

Depreciation expense increased for Cinergy and PSI, and decreased for CG&Efor the nine months ended September 30, 2004, as compared to 2003. Approximately $31 million of Cinergy's and PSI's increase was due to the addition of depreciable plant primarily for pollution control equipment. Also contributing to Cinergy's and PSI'shigher depreciation expense was an approximate $10 million

MD&A - YEAR TO DATE RESULTS OF OPERATIONS - HISTORICAL

increase due to higher depreciation rates effective June 2004 that were approved in PSI's latest retail rate case.

Partially offsetting Cinergy's increase and contributing to CG&E's decrease was an approximate $15 million reduction due to longer estimated useful lives of CG&E's generation assets resulting from a depreciation study completed during the third quarter of 2003. Approximately $6 million of Cinergy's increase and partially offsetting CG&E's decrease was the addition of depreciable plant primarily for pollution control equipment and additions related to the accelerated gas main replacement program.

Miscellaneous Income (Expense) - Net

Miscellaneous Income (Expense) - Netdecreased for Cinergy andCG&E and increased slightly forPSI for the nine months ended September 30, 2004. Cinergy's decrease reflects approximately $49 million in impairment and disposal charges on certain investments in Power Technology and Infrastructure. The values of these investments reflect our estimates and judgments about the future performance of these investments, for which actual results may differ. The majority of these charges relate to a company, in which Cinergy holds a non-controlling interest, that agreed to sell its major assets. This company is involved in the development and sale of outage management software. The decrease was partially offset by interest income of approximately $9 million on the notes receivable of two subsidiaries consolidated in the third quarter of 2003, as discussed in the 2003 10-K. CG&E's decrease and PSI's increase was due, in part, to a final reconciliation recorded in 2003 between the two entities of a previous demutualization of a medical insurance carrier used by both companies. Also contributing to CG&E's decrease and partially offsetting PSI's increase was a decline in the allowance for equity funds used during construction resulting from certain assets being placed into service and a decrease in the equity rate applied.

Interest Expense

InterestExpense increased for Cinergy and decreased for CG&E for the nine months ended September 30, 2004, as compared to 2003. Approximately $12 million of Cinergy'sincrease reflects the recognition of a note payable to a trust. Also reflected in Cinergy's increase is approximately $9 million related to additional debt recorded in accordance with the consolidation of two new entities. The note payable and additional debt were both recorded in the third quarter of 2003 resulting from the adoption of FASB Interpretation No. 46, Consolidation of Variable Interest Entities (Interpretation 46), as discussed in the 2003 10-K. Partially offsetting Cinergy's increases and primarily contributing to CG&E's decrease was a decline in CG&E's average long-term debt for the nine months ended September 30, 2004, as compared to 2003. Also partially offsetting Cinergy's increases and contributing to CG&E'sdecrease were charges recorded during 2003 associated with the re-financing of certain debt.

Preferred Dividend Requirement of Subsidiary Trust

Preferred Dividend Requirement of Subsidiary Trust decreased for Cinergy for the nine months ended September 30, 2004, as compared to 2003, as a result of the implementation of Interpretation 46. Effective July 1, 2003, the preferred trust securities and the related dividends are no longer reported in Cinergy's financial statements. However, interest expense is still being incurred on a note payable to this trust as discussed above.

MD&A - YEAR TO DATE RESULTS OF OPERATIONS - HISTORICAL

Income Taxes

The effective income tax rate decreased for Cinergy, remained flat forCG&E, and increased for PSI for the nine months ended September 30, 2004, as compared to 2003. Cinergy's 2004 effective income tax rate is expected to be approximately 23 percent as compared to 24 percent in 2003. The decrease in the effective income tax rate is a result of a greater amount of estimated annual tax credits associated with the production and sale of synthetic fuel for 2004 as compared to 2003. PSI's effective tax rate increase reflects a revision in estimated 2004 pre-tax income and changes in permanent differences which have an incremental effect on tax expense.

In July 2002, Capital & Trading acquired a coal-based synthetic fuel production facility. The synthetic fuel produced at this facility qualifies for tax credits in accordance with Section 29 of the IRC. Eligibility for these credits expires after 2007. Cinergyreceived a private letter ruling from the IRS in connection with the acquisition of the facility. To date, Cinergy has recorded approximately $189 million in tax credits, including approximately $69 million in 2004. See Note 6(c)(iv) of the "Notes to Condensed Financial Statements" in "Item 1. Financial Statements" for more details.

Discontinued Operations

During the second quarter of 2003, Cinergy completed the disposal of its gas distribution operation in South Africa, sold its remaining wind assets in the United States, and substantially sold or liquidated the assets of its energy trading operation in the Czech Republic. Pursuant to Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-lived Assets, these investments have been classified as discontinued operations in our financial statements.

Cumulative Effect of Changes in Accounting Principles, Net of Tax

In 2003, Cinergy,CG&E, and PSI recognized a Cumulative effect of changes in accounting principles, net of tax gain/(loss) of approximately $26 million, $31 million, and $(0.5) million, respectively. The cumulative effect of changes in accounting principles was a result of the adoption of Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligationsand the rescission of EITF 98-10.

MD&A - YEAR TO DATE RESULTS OF OPERATIONS - HISTORICAL

ULH&P

The Results of Operations discussion for ULH&P is presented only for the nine months ended September 30, 2004, in accordance with General Instruction H(2)(a) of Form 10-Q.

Electric and gas gross margins and net income for ULH&Pfor the nine months ended September 30, 2004 and 2003, were as follows:

ULH&P % 2004 2003 Change Change (in thousands)

Electric gross margin(1) $ 51,930 $ 49,419 $ 2,511 5 Gas gross margin(2) 31,715 28,437 3,278 12

Net income 13,279 11,477 1,802 16

(1) Electric gross margin is calculated as Electric operating revenues less Electricity purchased from parent company for resale expense from the Condensed Statements of Income.
(2) Gas gross margin is calculated as Gas operating revenues less Gas purchased expense from the Condensed Statements of Income.

Summary of Results

Electric and gas gross margins increased for ULH&Pfor the nine months ended September 30, 2004, as compared to 2003. The increase in electric gross margins reflects a greater amount of MWhs delivered due to growth in non-weather related demand. The increase in gas gross margins was due, in part, to rate tariff adjustments associated with the gas main replacement program and the demand-side management program, which encourages efficient customer gas usage.

The increase in net income for the year was primarily due to the increased electric and gas gross margins discussed above. Also contributing to the increase was a reduction in property taxes during the first nine months of 2004, as compared to 2003. These increases were partially offset by higher Depreciation expense primarily related to non-utility property and higher Operation and maintenance expense associated with transmission costs, demand-side management programs, and maintenance.

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FUTURE EXPECTATIONS/TRENDS

In the "Future Expectations/Trends" section, we discuss electric and gas industry developments, market risk sensitive instruments and positions, and accounting matters. Each of these discussions will address the current status and potential future impact on our financial position and results of operations.

ELECTRIC INDUSTRY

Ohio

As discussed in more detail in the 2003 10-K, CG&E made multiple rate filings in 2003 with the PUCO seeking approval of CG&E'smethodology for establishing market-based rates for generation service at the end of the market development period and to recover investments made in the transmission and distribution system. In December 2003, these filings, and CG&E'sproposal for establishing its post-market development period market pricing methodology, were consolidated for hearing before the PUCO. In addition, the PUCO requested in these proceedings that CG&E propose a rate stabilization plan as an alternative to market-based rates so as to mitigate the potential for significant rate increases when the market development (frozen rate) period comes to an end. There is no requirement in Ohio law that CG&E file such a plan. However, in January 2004, CG&Efiled its proposed rate stabilization plan.

In May 2004, CG&E entered into a settlement agreement with many of the parties to these proceedings requesting that the PUCO approve a modified version of the rate stabilization plan. Under this plan, CG&E would begin to collect a non-bypassable provider of last resort (POLR) charge intended to provide recovery for increased capacity reserves, environmental compliance and emission allowance expenditures. The plan also established a bypassable generation charge, which included a fuel cost recovery mechanism. It allowed for a two-year extension of the residential regulatory transition charge (RTC) in 2009 and 2010 and a three-year extension of the five percent residential generation rate reduction in the years 2006-2008. Finally, it provided for deferral and recovery of certain transmission and distribution costs.

In September 2004, the PUCO issued an order seeking to modify several key provisions of this settlement. The PUCO order, among other things, would not allow extension of the RTC for residential customers or permit deferral and recovery of certain transmission and distribution costs from residential customers. The PUCO order would allow CG&Eto end the five percent generation rate reduction for residential customers (i.e., increase the residential generation rate by five percent) beginning January 1, 2006, but would also allow certain customers who have switched to another generation supplier to entirely avoid the POLR charge. As a result of these modifications, CG&E filed a petition for rehearing in October 2004. The rehearing petition requests one of the following to be effective January 1, 2005 for non-residential customers and January 1, 2006 for residential customers:

• Approval of the modified rate stabilization plan reflected in the May 2004 settlement (as discussed above);

• Approval of a further modified rate stabilization plan, which includes some of the same provisions as the May 2004 plan. However, this plan (a) changes the POLR charge to provide recovery only for environmental compliance expenditures and allows customers that have switched to by-pass this charge, (b) adds an infrastructure maintenance fund charge, (c) adds a system reliability tracker that would provide recovery primarily for capacity and purchased power, (d) includes recovery of emission allowances costs as part of the fuel cost recovery mechanism, and (e) ends the five percent generation rate reduction for residential customers but does not include an extension of the residential RTC; or,

• Approval to proceed with market-based rates, which is permitted under CG&E's existing transition plan.

A rehearing order is expected in the fourth quarter of 2004. We cannot predict the outcome of this proceeding. Because the rate stabilization plan is a voluntary filing on CG&E's part, CG&E may reject the PUCO's order if it provides for a rate stabilization plan that is unacceptable to CG&E.

In conjunction with the consolidated filings discussed above, CG&E has also filed an application for an annual increase of approximately $78 million in electric distribution base rates, to be effective in the first quarter of 2005 for non-residential customers and January 1, 2006 for residential customers. The proposed rate stabilization plans described above provide for CG&E to withdraw this base rate case upon approval of the rate stabilization plan. In such event, CG&E can then file a new distribution base rate case, with rates to become effective January 1, 2006. If the PUCO's order on rehearing provides for a rate stabilization plan that is unacceptable to CG&E, CG&E may seek to proceed immediately with market-based rates for its commercial, industrial and other public authority customer classes and also proceed immediately with this base rate case for such classes. Market based rates must be approved by the PUCO and would eliminate the various deferral and recovery mechanisms contemplated with the rate stabilization plan.

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FERC and Midwest ISO

Day-Ahead and Real-Time Energy Markets

In response to prior FERC orders, in March 2004, the Midwest ISO filed with the FERC proposed changes to its existing transmission tariff to add terms and conditions to implement a centralized security-constrained economic dispatch platform supported by a Day-Ahead and Real-Time Energy Market design, including Locational Marginal Pricing and Financial Transmission Rights (Energy Markets Tariff). In May 2004, the FERC released an order scheduling the start-up of the Energy Markets Tariff for no earlier than March 1, 2005, and establishing various procedures for resolving outstanding issues. In August and September 2004, FERC issued orders that, among other things, conditionally approved the Energy Markets Tariff. Requests for rehearing of these orders were subsequently filed. At this time, Cinergy cannot predict the outcome of this matter or whether it will have a material effect on our financial position or results of operations.

Blackout Report

In April 2004, the United States-Canada Power System Outage Task Force issued its Final Report on the August 14, 2003 Blackout in the United States and Canada. The report reviewed the causes of the Blackout and made 46 recommendations intended to minimize the likelihood and scope of similar events in the future. One of the recommendations is to make reliability standards mandatory and enforceable with penalties for noncompliance. In the past, compliance with North American Electric Reliability Council's reliability standards and guidelines has largely been voluntary. At this time, we do not believe the recommendations of the Final Report, if implemented, will have a material impact on our financial position or results of operations.

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FERC's Market Screen Orders

In April 2004, FERC issued an order establishing a new, interim set of market power screens for use in evaluating sales of wholesale power at market-based rates. In July 2004, the FERC issued an order generally affirming that order. In April 2004, the FERC also commenced a rulemaking to evaluate whether its overall test for market-based rates should be continued, and to determine a permanent market power test to replace the interim test. That rulemaking process remains pending. Under FERC's interim generation market power analysis, as a member of Midwest ISO, Cinergy could consider the Midwest ISO geographic market for purposes of FERC's market power analysis once Midwest ISO has a sufficient market structure and a single energy market. Cinergy does not believe it has market power in generation. However, if Cinergy was unable to establish that it does not have the ability to exercise market power in generation, it would result in the loss of market-based rate authority in certain regions of the wholesale market and, assuming such loss of market-based rate authority, would require Cinergy to charge certain wholesale customers cost-based rates for wholesale sales of electricity. In October 2004, FERC issued proposed rules that may affect how and when circumstances have changed to an extent that requires FERC review of previously granted authorization to sell at existing market-based rates. At this time, we cannot predict the outcome of these matters and whether they will have a material effect on our financial position or results of operations.

GAS INDUSTRY

Gas Prices

Natural gas prices remained relatively high during the first three quarters of 2004 and are expected to escalate even more in the fourth quarter. It appears likely that the price of natural gas will maintain its historic high level through most of 2005. Price movement will be driven by the effects of weather conditions, availability of supply, and changes in demand and storage inventories. Currently, neither CG&Enor ULH&P profit from changes in the cost of natural gas since natural gas purchase costs are passed directly to the customer dollar-for-dollar under the gas cost recovery mechanism that is mandated under state law.

In May 2003, ULH&Pfiled an application with the Kentucky Public Service Commission (KPSC) requesting approval of a price mitigation program designed to mitigate the effects of gas price volatility on customers. In June 2003, the KPSC approved this program through March 31, 2005. The program will allow the pre-arranging of between 20-75 percent of winter heating season base load gas requirements and up to 50 percent of summer season base load gas requirements. CG&E similarly mitigates its gas procurement costs, however, CG&E's gas price mitigation program has not been pre-approved by the PUCO but rather it is subject to PUCO review as part of the normal gas cost recovery process.

CG&E and ULH&P use primarily long-term fixed price contracts and contracts with a ceiling and floor on the price. These contracts employ the normal purchases and sales scope exception, and do not involve hedges under Statement 133.

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MARKET RISK SENSITIVE INSTRUMENTS AND POSITIONS

The transactions associated with the Commercial Business Unit's (Commercial) energy marketing and trading activities and substantial investment in generation assets give rise to various risks, including price risk. Price risk represents the potential risk of loss from adverse changes in the market price of electricity or other energy commodities. As Commercial continues to develop its energy marketing and trading business, its exposure to movements in the price of electricity and other energy commodities may become greater. As a result, we may be subject to increased future earnings volatility.

As discussed in the 2003 10-K, CG&E and PSI executed a new joint operating agreement in April 2002 whereby we chose to originate all new power marketing and trading contracts since April 2002 on behalf of CG&E only. Historically, such contracts were executed on behalf of PSI and CG&Ejointly. PSI's remaining contracts, entered into prior to the new joint operating agreement, are not material. Additionally, we expect that PSIwill not enter into new power marketing and trading contracts in the future. Therefore, we have not presented PSI separately in the fair value and credit risk tables below.

Changes in Fair Value

The changes in fair value of the energy risk management assets and liabilities, for the periods ended September 30, 2004 and 2003, are presented in the table below:

Change in Fair Value Year to Date September 30, 2004 September 30, 2003 Cinergy(1) CG&E Cinergy(1) CG&E

(in millions)

Fair value of contracts
outstanding at beginning of year $ 41 $ 20 $ 75 $ 42

Changes in fair value attributable
to changes in valuation techniques
and assumptions (2) - - 1 1

Other changes in fair value (3) 129 60 120 40

Option premiums paid/(received) 1 4 (6 ) 3

Accounting changes (4)

Cumulative effect of changes in
accounting principle - - (20 ) (14 )

Consolidation of previously
unconsolidated entities - - 7 -

Contracts settled (93 ) (32 ) (129 ) (48 )

Fair value of contracts
outstanding at end of period $ 78 $ 52 $ 48 $ 24

(1) The results of Cinergy also include amounts related to non-registrants.
(2) Represents changes in fair value recognized in income, caused by changes in assumptions used in calculating fair value or changes in modeling techniques.
(3) Represents changes in fair value, recognized in income, primarily attributable to fluctuations in price. This amount includes both realized and unrealized gains on energy trading contracts.
(4) See Note 1(q)(iv) and Note 1(q)(vi) of the "Notes to Financial Statements" of the 2003 10-K for further information.

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The following are the balances at September 30, 2004 and 2003, of our energy risk management assets and liabilities:

September 30, 2004 September 30, 2003 Cinergy(1) CG&E Cinergy(1) CG&E

(in millions)

Energy risk management assets -
current $ 470 $ 178 $ 224 $ 79 Energy risk management assets -
non-current 137 48 127 62

Energy risk management liabilities
- current 396 126 186 73 Energy risk management liabilities
- non-current 133 48 117 44

$ 78 $ 52 $ 48 $ 24

(1) The results of Cinergy also include amounts related to non-registrants.

The following table presents the expected maturity of the energy risk management assets and liabilities as of September 30, 2004, for Cinergyand CG&E:

Fair Value of Contracts as of September 30, 2004

Maturing Within 12-36 36-60 Total Source of Fair Value(1) 12 months months months Thereafter Fair Value
(in millions)

Cinergy(2)
Prices actively quoted $ 70 $ 5 $ - $ - $ 75

Prices based on models and
other valuation methods(3) 5 3 - (5 ) 3

Total $ 75 $ 8 $ - $ (5 ) $ 78

CG&E
Prices actively quoted $ 44 $ 3 $ - $ - $ 47

Prices based on models and
other valuation methods(3) 8 (2 ) (1 ) - 5

Total $ 52 $ 1 $ (1 ) $ - $ 52

(1) While liquidity varies by trading regions, active quotes are generally available for two years for standard electricity transactions and three years for standard gas transactions. Non-standard transactions are classified based on the extent, if any, of modeling used in determining fair value. Long-term transactions can have portions in both categories depending on the tenor.
(2) The results of Cinergy also include amounts related to non-registrants.
(3) A substantial portion of those amounts include option values.

Energy Trading Credit Risk

Cinergy'sextension of credit for energy marketing and trading is governed by a Corporate Credit Policy. Written guidelines approved by Cinergy's Risk Policy Committee document the management approval levels for credit limits, evaluation of creditworthiness, and credit risk mitigation procedures. Cinergyanalyzes net credit exposure and establishes credit reserves based on the counterparties' credit rating, payment history, and tenor of the outstanding obligation. Exposures to credit risks are monitored daily by the Corporate Credit Risk function, which is independent of all

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trading operations. Energy commodity prices can be extremely volatile and the market can, at times, lack liquidity. Because of these issues, credit risk for energy commodities is generally greater than with other commodity trading.

The following tables provide information regarding Cinergy'sand CG&E's exposure on energy trading contracts as well as the expected maturities of those exposures as of September 30, 2004. The tables include accounts receivable and energy risk management assets, which are net of accounts payable and energy risk management liabilities with the same counterparties when we have the right of offset. The credit collateral shown in the following tables includes cash and letters of credit.

Cinergy(1)

Investment Grade(2) $ 561 $ 70 $ 491 78 % - $ - Internally
Rated-Investment
Grade(3) 77 - 77 12 - - Non-Investment Grade 94 54 40 6 - - Internally
Rated-Non-Investment
Grade 48 23 25 4 - -

Total $ 780 $ 147 $ 633 100 % - $ -

Maturity of Credit Risk Exposure

Exposure Total Exposure Less than Greater than Before Credit Rating 2 Years 2-5 Years 5 Years Collateral
(in millions)

Investment Grade(2) $ 480 $ 66 $ 15 $ 561 Internally Rated-Investment Grade(3) 72 5 - 77 Non-Investment Grade 93 1 - 94 Internally Rated-Non-Investment Grade 48 - - 48

Total $ 693 $ 72 $ 15 $ 780

(1) Includes amounts related to non-registrants.
(2) Includes counterparties rated Investment Grade or the counterparties' obligations are guaranteed or secured by an Investment Grade entity.
(3) Counterparties include a variety of entities, including investor-owned utilities, privately held companies, cities and municipalities. Cinergy assigns internal credit ratings to all counterparties within our credit risk portfolio, applying fundamental analytical tools. Included in this analysis is a review of (but not limited to) counterparty financial statements with consideration given to off-balance sheet obligations and assets, specific business environment, access to capital, and indicators from debt and equity capital markets.
(4) Exposures, positive or negative, with counterparties that are related to one another are not aggregated when no right of offset exists and as a result, credit is extended and evaluated on a separate basis.

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CG&E

Number of Counterparties Total Greater than Net Exposure of Exposure Percentage of 10% Counterparties Before Credit Credit Net Total of Total Net Greater than 10% of Rating Collateral Collateral Exposure Net Exposure Exposure Total Net Exposure(3)
(in millions)
Investment Grade(1) $ 193 $ 41 $ 152 93 % 2 $ 39 Internally
Rated-Investment
Grade(2) 9 - 9 5 - - Non-Investment Grade 24 21 3 2 - - Internally
Rated-Non-Investment
Grade 3 3 - - - -

Total $ 229 $ 65 $ 164 100 % 2 $ 39

Maturity of Credit Risk Exposure

Exposure Total Exposure Less than Greater than Before Credit Rating 2 Years 2-5 Years 5 Years Collateral
(in millions)

Investment Grade(1) $ 168 $ 25 $ - $ 193 Internally Rated-Investment Grade(2) 9 - - 9 Non-Investment Grade 23 1 - 24 Internally Rated-Non-