UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K
(Mark One)

[X]	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2009

OR

[ ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________to __________

Commission File Number	Registrant; State of Incorporation; Address; and Telephone Number	IRS Employer Identification No.

2-35965	NORTH SHORE GAS COMPANY	36-1558720
	(An Illinois Corporation)
	130 East Randolph Drive, 18th Floor
	Chicago, Illinois 60601-6207
	(312) 240-4000

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes [ ] No [X]

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

Yes [X] No [ ]

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X] No [ ]

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

Yes [ ] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

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

Large accelerated filer [ ] Accelerated filer [ ]

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

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [ ] No [X]

State the aggregate market value of the voting and

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

None.

Number of shares outstanding of each class of

common stock, as of February 24, 2010

Common Stock, no par value, 3,625,887 shares

(all of which are owned beneficially and of record by Peoples Energy Corporation,

a wholly owned subsidiary of Integrys Energy Group, Inc.)

DOCUMENT INCORPORATED BY REFERENCE

Definitive proxy statement for the Integrys Energy Group, Inc. Annual Meeting of Shareholders to be held on May 13, 2010, is incorporated by reference into Part III.

The Registrant meets the conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K and is therefore filing this Form with the reduced disclosure format permitted by General Instruction I(2)(b) and (c).

NORTH SHORE GAS COMPANY

ANNUAL REPORT ON FORM 10-K

For the Year Ended December 31, 2009

TABLE OF CONTENTS


			Page

Forward-Looking Statements			1

PART I			2

ITEM 1.	BUSINESS		2

	A.	GENERAL	2

	B.	REGULATED NATURAL GAS UTILITY OPERATIONS	2

	C.	ENVIRONMENTAL MATTERS	4

	D.	CAPITAL REQUIREMENTS	4

	E.	EMPLOYEES	5

	F.	AVAILABLE INFORMATION	5

ITEM 1A.	RISK FACTORS		6

ITEM 1B	UNRESOLVED STAFF COMMENTS		10

ITEM 2.	PROPERTIES		11

ITEM 3.	LEGAL PROCEEDINGS		12

ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS		12

PART II			12

ITEM 5.	MARKET FOR NSG's COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES		12

ITEM 6.	SELECTED FINANCIAL DATA		13

ITEM 7.	MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		14-26

ITEM 7A.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		26

ITEM 8.	FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA		27

	A.	Management Report on Internal Control over Financial Reporting	27
	B.	Statements of Income	28
	C.	Balance Sheets	29
	D.	Statements of Capitalization	30
	E.	Statements of Common Shareholder's Equity	31

- i -

	F.	Statements of Cash Flows			32
	G.	Notes to Financial Statements			33-53
		Note 1	Summary of Significant Accounting Policies	33
		Note 2	Risk Management Activities	36
		Note 3	Restructuring Expense	37
		Note 4	Property, Plant, and Equipment	38
		Note 5	Regulatory Assets And Liabilities	38
		Note 6	Long-Term Debt	39
		Note 7	Asset Retirement Obligations	39
		Note 8	Income Taxes	40
		Note 9	Commitments and Contingencies	42
		Note 10	Employee Benefit Plans	44
		Note 11	Preferred Stock	49
		Note 12	Common Equity	49
		Note 13	Fair Value	50
		Note 14	Miscellaneous Income	51
		Note 15	Regulatory Environment	51
		Note 16	Segments of Business	52
		Note 17	Related Party Transactions	52
		Note 18	Quarterly Financial Information (Unaudited)	53
	H.	Report of Independent Registered Public Accounting Firm on Financial Statements			54

ITEM 9.	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE				55

ITEM 9A.	CONTROLS AND PROCEDURES				55

ITEM 9B.	OTHER INFORMATION				55

PART III					56

ITEM 10.	DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE				56

ITEM 11.	EXECUTIVE COMPENSATION				56

ITEM 12.	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS				56

ITEM 13.	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE				56

ITEM 14.	PRINCIPAL ACCOUNTING FEES AND SERVICES				56

PART IV					58

ITEM 15.	EXHIBITS AND FINANCIAL STATEMENT SCHEDULES				58

SIGNATURES					59

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS					60

EXHIBIT INDEX					61

- ii -

Acronyms Used in this Annual Report on Form 10-K

ASC	Accounting Standards Codification

EEP	Enhanced Efficiency Program

EPA	United States Environmental Protection Agency

ESOP	Employee Stock Ownership Plan

FASB	Financial Accounting Standards Board

FERC	Federal Energy Regulatory Commission

GAAP	United States Generally Accepted Accounting Principles

IBS	Integrys Business Support, LLC

ICC	Illinois Commerce Commission

IRS	United States Internal Revenue Service

LIFO	Last-in, First-out

N/A	Not Applicable

NSG	North Shore Gas Company

NYMEX	New York Mercantile Exchange

PEC	Peoples Energy Corporation

PGL	The Peoples Gas Light and Coke Company

SEC	United States Securities and Exchange Commission

SFAS	Statement of Financial Accounting Standards

- iii -

Forward-Looking Statements

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

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

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

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

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

- 1 -

PART I

ITEM 1. BUSINESS

A. GENERAL

References to "Notes" are to the Notes to the Financial Statements included in this Annual Report on Form 10-K.

NSG, a regulated natural gas utility, was formed in 1900. NSG is an Illinois corporation and is wholly owned by PEC. PEC is a wholly owned subsidiary of Integrys Energy Group, Inc.

For financial information about NSG’s regulated natural gas utility segment, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations."

B. REGULATED NATURAL GAS UTILITY OPERATIONS

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

Facilities

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

Natural Gas Supply

NSG manages portfolios of natural gas supply contracts, storage services, and pipeline transportation services designed to meet its varying customer usage patterns at the lowest reasonable cost.

NSG has entered into long-term and short-term firm natural gas supply contracts with various suppliers each year to meet the November through March winter period demand of firm system sales customers. NSG's regulated natural gas supply requirements are met through a combination of physical fixed price purchases, contracted storage, peak-shaving facilities, natural gas call options, and physical index price purchases. To supplement natural gas supplies and minimize risk, NSG purchases additional natural gas supplies on the monthly spot market through fixed-term firm contracts rather than on the daily spot market. During periods of colder than normal weather or when the opportunity arises, natural gas may be purchased in the daily spot market.

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

NSG had adequate capacity to meet all firm natural gas load obligations during 2009 and expects to have adequate capacity to meet all firm obligations during 2010. NSG forecasts peak-day throughput of 435 thousands of dekatherms (MDth) for the 2009 through 2010 heating season.

- 2 -

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

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

Regulatory Matters

Legislation and Regulation at State Level

The natural gas retail rates of NSG are regulated by the ICC, which has general supervisory and regulatory powers over public utilities in Illinois.

Sales are made and services rendered by NSG pursuant to rate schedules on file with the ICC containing various service classifications largely reflecting customers’ different uses and levels of consumption. In addition to the rates for distribution of natural gas, NSG bills customers a natural gas charge (Gas Charge) representing prudently incurred costs of delivered natural gas, transportation, and storage services purchased, as well as gains, losses, and costs incurred under NSG’s hedging program, the amount of which is also subject to ICC authority. Changes in the cost of natural gas are reflected in both natural gas revenues and natural gas purchases.

NSG is authorized, by statute and/or certificates of public convenience and necessity, to conduct operations in the territories it serves. In addition, NSG operates under franchises and license agreements granted to it by the municipalities it serves. NSG’s franchises with municipalities within its service territory are of various terms and expiration dates. ICC rules place restrictions on when NSG may terminate or deny service to customers who do not pay their bills for utility service. Both federal and state governments have legislation that provides for additional funding for assistance to low-income energy users, including customers of NSG.

See Note 15, "Regulatory Environment," for recent Illinois legislation regarding bad debt expense and new customer assistance programs. As a result of the implementation of this new Illinois legislation, all of NSG’s bad debt expense is recovered through rates.

Legislation and Regulation at Federal Level

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

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

- 3 -

Other Matters

Seasonality

The natural gas throughput of NSG follows a seasonal pattern because the heating requirements of customers are temperature driven. Specifically, customers typically use more natural gas during the winter months. During 2009, NSG recorded approximately 72% of its revenues in January, February, March, November, and December.

Competition

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

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

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

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

Working Capital Requirements

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

C. ENVIRONMENTAL MATTERS

For information on environmental matters related to NSG, see Note 9, "Commitments and Contingencies."

D. CAPITAL REQUIREMENTS

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

- 4 -

E. EMPLOYEES

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

F. AVAILABLE INFORMATION

NSG files the following reports with the SEC:

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

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

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

- 5 -

ITEM 1A. RISK FACTORS

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

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

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

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

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

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

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

- 6 -

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

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

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

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

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

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

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

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

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

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

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

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

- 7 -

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

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

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

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

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

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

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

The ICC conducts annual proceedings regarding the reconciliation of revenues from the Gas Charge and related natural gas costs. In these proceedings, the accuracy of the reconciliation of revenues and costs is reviewed and the prudence of natural gas costs recovered through the Gas Charge is examined by interested parties. If the ICC were to find that the reconciliation was inaccurate or any natural gas costs were imprudently incurred, the ICC would order NSG to refund the affected amount to customers through subsequent Gas Charge filings. The ICC has ordered refunds to NSG's utility customers in connection with prior years' gas charge reconciliation proceedings. Proceedings regarding NSG’s costs for calendar years 2009, 2008 and 2007, fiscal year 2006, and for the transition period ended December 31, 2006, are currently pending before the ICC. The outcome of these proceedings cannot be predicted. For more information, see Note 9, “Commitments and Contingencies.”

- 8 -

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

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

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

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

Counterparties may not meet their obligations.

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

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

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

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

- 9 -

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

- 10 -

ITEM 2. PROPERTIES

Natural Gas Facilities

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

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

General

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

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

- 11 -

ITEM 3. LEGAL PROCEEDINGS

For information on material legal proceedings and matters related to NSG, see Note 9, "Commitments and Contingencies."

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

None

PART II

ITEM 5. MARKET FOR NSG'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

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

- 12 -

ITEM 6. SELECTED FINANCIAL DATA

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


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

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

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


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

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

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

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

- 13 -

ITEM 7.

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

INTRODUCTION

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

Strategic Overview

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

The essential components of NSG's business strategy are:

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

Integrating Resources to Provide Operational Excellence and Customer Focus – NSG is committed to integrating resources and finding the best, most efficient processes while meeting all applicable regulatory and legal requirements. Through innovative ideas, embracing change, leveraging capabilities and expertise, and utilizing creative solutions to meet and exceed its customers' expectations, NSG strives to provide value to Integrys Energy Group's shareholders and NSG's customers. NSG believes the following activities have helped, and will continue to help, integrate resources and provide operational excellence and customer focus:

·	IBS, a wholly owned service company of Integrys Energy Group, was formed to achieve consolidation and efficient delivery of various support services, and to provide more consistent and transparent allocation of costs throughout Integrys Energy Group and its subsidiaries.

·	"Operational Excellence" initiatives were implemented to provide top performance in the areas of project management, process improvement, contract administration, and compliance in order to reduce costs and manage projects and activities within appropriate budgets, schedules, and regulations.

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

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

- 14 -

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

RESULTS OF OPERATIONS

	Year Ended December 31						Change in			Change in
(Millions)	2009		2008		2007		2009 Over 2008			2008 Over 2007

Net income	$	4.3	$	7.0	$	7.9		(38.6	)%		(11.4	)%

Earnings Summary – 2009 Compared with 2008

NSG recognized net income of $4.3 million in 2009 compared with $7.0 million in 2008. Significant factors contributing to the $2.7 million decrease in earnings were the year-over-year $1.2 million after-tax decrease in margin resulting from the negative impact of the rate order that was effective February 14, 2008 and lower year-over-year volumes (including the impact of a decoupling mechanism that was implemented on March 1, 2008). A $0.3 million after-tax decrease in interest income and restructuring expense related to workforce reductions of $0.2 million after-tax also contributed to the decrease in earnings.

Earnings Summary – 2008 Compared with 2007

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

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

- 15 -

Natural Gas Utility Segment Operations


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

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

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

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

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

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

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

* See Note 3, "Restructuring Expense," for more information.

2009 Compared with 2008

Revenues

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

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

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

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

- 16 -

Margins

Natural gas utility segment margin decreased $2.0 million year-over-year, primarily due to:

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

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

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

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

Operating Income

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

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

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

Other Expense

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

2008 Compared with 2007

Revenues

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

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

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

- 17 -

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

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

Margins

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

Operating Income

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

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

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

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

Other Expense

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

Provision for Income Taxes

	Year Ended December 31
	2009			2008			2007
Effective Tax Rate		35.8	%		36.9	%		39.7	%

2009 Compared with 2008

The decrease in the effective tax rate for 2009 was primarily due to an adjustment related to uncertain tax positions recorded in 2008.

- 18 -

2008 Compared with 2007

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

BALANCE SHEET

Net accounts receivable and accrued unbilled revenues decreased $25.8 million (41.1%) from $62.7 million at December 31, 2008, to $36.9 million at December 31, 2009, driven by lower revenues due to lower natural gas prices and warmer weather during the fourth quarter of 2009, compared with the same period in 2008.

At December 31, 2009, compared to December 31, 2008, total assets from risk management activities decreased $0.8 million (44.4%) and total liabilities from risk management activities decreased $24.1 million (84.9%). The decrease in assets and liabilities from risk management activities was driven by changes in the fair values of the underlying derivative contracts, driven by decreases in the forward price of natural gas in 2009. See Note 2, "Risk Management Activities," for more information.

Detailed explanations for changes in the short-term and long-term debt balances at December 31, 2009, compared to December 31, 2008, are included in Note 6, "Long-Term Debt," and Note 17, "Related Party Transactions."

LIQUIDITY AND CAPITAL RESOURCES

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

Operating Cash Flows

2009 Compared with 2008

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

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

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

2008 Compared with 2007

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

- 19 -

Investing Cash Flows

2009 Compared with 2008

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

2008 Compared with 2007

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

Financing Cash Flows

2009 Compared with 2008

Net cash used for financing activities was $13.3 million during the year ended December 31, 2009, compared with $2.3 million for the same period in 2008. The $11.0 million year-over-year change was primarily due to a $5.8 million increase in dividends paid to NSG’s parent, as well as the issuance of $6.5 million of First Mortgage Bonds in November 2008.

2008 Compared with 2007

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

Significant Financing Activities

For information on the issuance and redemption of long-term debt at NSG, see Note 6, "Long-Term Debt."

Credit Ratings

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

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

	Standard & Poor's	Moody's
Issuer credit rating	BBB+	A3
Senior secured debt	A	A2

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

On January 26, 2010, Standard and Poor's revised the outlook for Integrys Energy Group and all of its subsidiaries to stable from negative. The revised outlook reflected Integrys Energy Group's decision to

- 20 -

retain a selected portion of its nonregulated operations, which resulted in a revision to Integrys Energy Group's business risk profile to "strong" from "excellent." The revised outlook also reflected Integrys Energy Group’s improved financial measures and decreasing regulatory risk, which resulted in a change in its financial risk profile to "significant" from "aggressive."

On June 9, 2009, Moody’s lowered the senior secured debt rating for NSG from "A1" to "A2." According to Moody’s, the downgrade reflects the risk that NSG’s internal cash flow could be pressured to support Integrys Energy Group’s continuing cash needs and that near-term financial metrics will be negatively impacted by reduced demand for energy. Also, Moody’s assigned NSG an "A3" issuer credit rating.

On March 5, 2009, Standard & Poor’s lowered the issuer credit rating for NSG from "A-" to "BBB+." According to Standard and Poor’s, the downgrade reflects Integrys Energy Group’s weak financial measures that do not support an "A" category credit profile. Standard and Poor’s also stated that the downgrade reflects the changes to Integrys Energy Group’s business and financial risk profiles. Standard & Poor’s revised Integrys Energy Group’s business risk profile to "excellent" from "strong" and changed its financial risk profile to "aggressive" from "intermediate." The change in the business risk profile reflected Integrys Energy Group’s strategy change with respect to Integrys Energy Services and helped to moderate the downgrade.

Future Capital Requirements and Resources

Contractual Obligations

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

			Payments Due By Period
(Millions)	Total Amounts Committed		2010		2011 to 2012		2013 to 2014		2015 and Thereafter

Long-term debt principal and interest payments (1)	$	109.8	$	3.7	$	7.5	$	50.3	$	48.3
Commodity purchase obligations (2)		89.1		19.2		36.1		24.3		9.5
Purchase orders (3)		7.3		7.3		-		-		-
Pension and other postretirementfunding obligations (4)		32.3		7.1		14.8		5.3		5.1
Total contractual cash obligations	$	238.5	$	37.3	$	58.4	$	79.9	$	62.9

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

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

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

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

The table above does not reflect any payments related to the manufactured gas plant remediation liability of $106.8 million at December 31, 2009, as the amount and timing of payments are uncertain. NSG anticipates incurring costs annually to remediate these sites, but management believes that any costs incurred for environmental activities relating to former manufactured gas plant operations that are not recoverable through contributions from other entities or from insurance carriers have been prudently incurred and are, therefore, recoverable through rates. See Note 9, "Commitments and Contingencies," for more information. In addition, the table does not reflect any payments for the December 31, 2009, liability related to uncertain tax positions, as the amount and timing of payments are uncertain. See Note 8, "Income Taxes," for more information about this liability.

- 21 -

Capital Requirements

Construction expenditures for NSG for the three-year period 2010 through 2012 are expected to be $45.9 million. The largest of these expenditures relates to NSG’s natural gas pipe distribution system. All projected capital and investment expenditures are subject to periodic review and may vary significantly from the estimates depending on a number of factors, including, but not limited to, industry restructuring, regulatory constraints, market volatility, and economic trends.

Capital Resources

As of December 31, 2009, NSG was in compliance with all covenants related to outstanding long-term debt and expects to be in compliance with all such debt covenants for the foreseeable future. See Note 6, "Long-Term Debt," for more information on NSG's long-term debt covenants.

NSG plans to meet its capital requirements for the period 2010 through 2012 primarily through internally generated funds, debt financings, and equity infusions. NSG plans to maintain current debt to equity ratios at appropriate levels to support current credit ratings and corporate growth. Management believes NSG has adequate financial flexibility and resources to meet its future needs.

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

Other Future Considerations

Uncollectible Accounts

The reserve for uncollectible accounts reflects NSG's best estimate of probable losses on its accounts receivable balances. The reserve is based on known troubled accounts, historical experience, and other currently available evidence. Provisions for bad debt expense are affected by changes in various factors, including the impacts of the economy, natural gas prices, weather, and recoveries (or refunds) under Illinois Senate Bill 1918 described in Note 15, "Regulatory Environment."

Customer Usage

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

American Recovery and Reinvestment Act of 2009

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

- 22 -

Property Tax Assessment on Natural Gas

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

CRITICAL ACCOUNTING POLICIES

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

Receivables and Reserves

NSG accrues estimated amounts of revenue for services rendered but not yet billed. Estimated unbilled revenues are calculated using a variety of factors based on customer class. At December 31, 2009, and 2008, NSG's unbilled revenues were $19.3 million and $30.9 million, respectively. Any difference between actual revenues and the estimates are recorded in revenue in the next period. Differences historically have not been significant.

As a result of the implementation of Illinois Senate Bill 1918 in 2009, all of NSG’s bad debt expense is recovered through rates. See Note 15, "Regulatory Environment," for more information.

Pension and Other Postretirement Benefits

The costs of providing non-contributory defined benefit pension benefits and other postretirement benefits, described in Note 10, "Employee Benefit Plans," are dependent upon numerous factors resulting from actual plan experience and assumptions regarding future experience.

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

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

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

- 23 -

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

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

Actuarial Assumption (Millions, except percentages)	Percentage-Point Change in Assumption	Impact on Postretirement Benefit Obligation	Impact on 2009 Postretirement Benefit Cost
Discount rate	(0.5)	$0.8	$ -
Discount rate	0.5	(0.8)	-
Health care cost trend rate	(1.0)	(1.5)	(0.2)
Health care cost trend rate	1.0	1.7	0.2
Rate of return on plan assets	(0.5)	N/A	-
Rate of return on plan assets	0.5	N/A	-

An interest rate yield curve is used to enable appropriate judgments to be made about discount rates. The yield curve is comprised of non-callable (or callable with make-whole provisions), high-quality corporate bonds with maturities between 0 and 30 years. The included bonds are generally rated "Aa" with a minimum amount outstanding of $50 million. The expected annual benefit cash flows are discounted for each of the pension and retiree welfare plans using this yield curve, and a single-point discount rate is developed matching each plan’s expected payout structure.

The expected return on asset assumption is based on consideration of historical and projected asset class returns, as well as the target allocations of the benefit trust portfolios. The assumed long-term rate of return was 8.5% in 2009, 2008, and 2007. For 2009, 2008, and 2007, the actual rates of return on pension plan assets, net of fees, were 22.0%, (27.5)%, and 7.3%, respectively.

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

In selecting assumed health care cost trend rates, past performance and forecasts of health care costs are considered. For more information on health care cost trend rates and a table showing future payments that NSG expects to make for pension and other postretirement benefits, see Note 10, "Employee Benefit Plans."

Regulatory Accounting

NSG’s natural gas utility segment follows the guidance under the Regulated Operations Topic of the FASB ASC, and the financial statements reflect the effects of the ratemaking principles followed by the ICC. Certain items that would otherwise be immediately recognized as revenues and expenses are deferred as regulatory assets and regulatory liabilities for future recovery or refund to customers, as authorized by the

- 24 -

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

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

Environmental Activities Relating to Former Manufactured Gas Plant Sites

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

Management considers this policy critical due to the substantial uncertainty in the estimation of future costs with respect to the amount and timing of costs, and the extent of recovery from other potential responsible parties. See Note 9, "Commitments and Contingencies," for further discussion of environmental matters.

Tax Provision

NSG is required to estimate income taxes for each of the jurisdictions in which it operates as part of the process of preparing NSG's financial statements. This process involves estimating actual current tax liabilities together with assessing temporary differences resulting from differing treatment of items, such as depreciation, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within NSG's Balance Sheets. NSG must also assess the likelihood that its deferred tax assets will be recovered through future taxable income. To the extent NSG believes that recovery is not likely, it must establish a valuation allowance, which is offset by an adjustment to the provision for income taxes in the Statements of Income.

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

Significant management judgment is required in determining NSG's provision for income taxes, deferred tax assets and liabilities, and any valuation allowance recorded against deferred tax assets. The assumptions involved are supported by historical data, reasonable projections, and technical interpretations of applicable tax laws and regulations across multiple taxing jurisdictions. Significant changes in these assumptions could have a material impact on NSG's financial condition and results of

- 25 -

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

IMPACT OF INFLATION

NSG’s financial statements are prepared in accordance with GAAP. The statements provide a reasonable, objective, and quantifiable statement of financial results, but generally do not evaluate the impact of inflation. To the extent NSG is not recovering the effects of inflation, it will file rate cases as necessary.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

- 26 -

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

A. MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

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

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

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

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

- 27 -

B. STATEMENTS OF INCOME


Year Ended December 31
(Millions)	2009			2008			2007

Natural gas operating revenues	$	228.2		$	312.9		$	271.0

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

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

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

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

- 28 -

C. BALANCE SHEETS

At December 31
(Millions)	2009			2008

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

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

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

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

Commitments and contingencies

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

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

- 29 -

D. STATEMENTS OF CAPITALIZATION

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

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

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

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

- 30 -

E. STATEMENTS OF COMMON SHAREHOLDER'S EQUITY

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

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

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

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

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

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

- 31 -

F. STATEMENTS OF CASH FLOWS

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

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

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

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

- 32 -

G. NOTES TO FINANCIAL STATEMENTS

NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

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

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

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

(Millions)	2009		2008			2007
Cash paid for interest	$	3.9	$	3.8		$	3.8
Cash paid (received) for income taxes		2.9		(3.2	)		12.3

Construction costs funded through accounts payable and treated as non-cash investing activities totaled $1.3 million, $0.4 million, and $0.1 million at December 31, 2009, 2008, and 2007, respectively.

(d) Revenue and Customer Receivables--Revenues are recognized on the accrual basis and include estimated amounts for natural gas services provided but not billed. At December 31, 2009, and 2008, NSG's unbilled revenues were $19.3 million and $30.9 million, respectively. At December 31, 2009, there were no customers or industries that accounted for more than 10% of NSG's revenues.

The cost of natural gas prudently incurred by NSG is recovered from customers under a one-for-one recovery mechanism, which provides for subsequent adjustments to rates for changes in natural gas costs.

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

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

(e) Inventories--Inventories consist of natural gas in storage and liquid propane. NSG accounts for liquid propane inventory using the average cost method. NSG prices natural gas storage injections at the calendar year average of the costs of natural gas supply purchased. Withdrawals from storage are priced on the LIFO cost method. The estimated replacement cost of natural gas in inventory for NSG at December 31, 2009, and December 31, 2008, exceeded the LIFO cost by approximately $34.1 million and $31.7 million, respectively. In calculating these replacement amounts, NSG used a Chicago city-gate natural gas price per dekatherm of $6.14 at December 31, 2009, and $5.80 at December 31, 2008.

- 33 -

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

All derivatives are recognized on the balance sheet at their fair value unless they qualify for the normal purchases and sales exception. NSG continually assesses its contracts designated as normal and will discontinue the treatment of these contracts as normal if the required criteria are no longer met. NSG's tariffs allow for full recovery from its customers of prudently incurred natural gas supply costs, including gains or losses on these derivative instruments. Therefore, these unrealized derivative gains or losses are recorded as regulatory assets or liabilities.

FASB ASC 815-10-45 provides the option to present certain asset and liability derivative positions net on the balance sheet and to net the related cash collateral against these net derivative positions. NSG has elected to present these items on a net basis on its Balance Sheets.

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

NSG records straight-line depreciation expense over the estimated useful life of utility property, using depreciation rates as approved by the ICC. Annual utility composite depreciation rates for NSG were 1.7%, 1.8%, and 1.9% for 2009, 2008, and 2007, respectively. These depreciation rates include net dismantling costs that are charged to depreciation expense as incurred. Consistent with the ICC rate order issued January 22, 2010, NSG changed its method for recognizing net dismantling costs from as incurred to allocating the cost over the life of the asset.

See Note 4, "Property, Plant, and Equipment," for details regarding NSG's property, plant, and equipment balances.

(h) Regulatory Assets and Liabilities--Regulatory assets represent probable future revenue associated with certain costs or liabilities that have been deferred and are expected to be recovered from customers through the ratemaking process. Regulatory liabilities represent amounts that are expected to be refunded to customers in future rates or amounts collected in rates for future costs. If at any reporting date a previously recorded regulatory asset is no longer probable of recovery, the regulatory asset is reduced to the amount considered probable of recovery with the reduction charged to expense in the year the determination is made. See Note 5, "Regulatory Assets and Liabilities," for more information.

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

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

- 34 -

obligation is incurred. The associated retirement costs are capitalized as part of the related long-lived assets and are depreciated over the useful lives of the assets. See Note 7, "Asset Retirement Obligations," for more information.

(k) Income Taxes--Deferred income taxes have been recorded to recognize the expected future tax consequences of events that have been included in the financial statements by using currently enacted tax rates for the differences between the tax basis of assets and liabilities and the basis reported in the financial statements. NSG records valuation allowances for deferred tax assets when it is uncertain if the benefit will be realized in the future. NSG is allowed to defer certain adjustments made to income taxes that will impact future rates and record regulatory assets or liabilities related to these adjustments.

For investment tax credits generated by NSG, the ICC reduces future rates over the lives of the property to which the tax credits relate. Accordingly, NSG defers the investment tax credits in the year the taxes payable are reduced, and NSG reduces the provision for income taxes over the useful lives of the related property.

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

NSG reports interest and penalties accrued related to income taxes as a component of provision for income taxes in the Statements of Income.

For more information regarding NSG's accounting for income taxes, see Note 8, "Income Taxes."

(l) Employee Benefits--The costs of pension and other postretirement benefits are expensed over the period during which employees render service. The transition obligation related to the other postretirement plans is being recognized over a 20-year period beginning in 1993. In computing the expected return on pension plan assets, a market-related value of plan assets is used that recognizes differences between actual investment returns and the expected return on plan assets over the subsequent five years. NSG’s regulators allow recovery in rates for the net periodic benefit cost calculated under GAAP. Effective with new rates implemented in 2010, NSG will reflect pension and other postretirement benefit costs in rates using Integrys Energy Group’s basis in the related plan assets and obligations and method of determining these costs, which Integrys Energy Group established at the time of the February 2007 PEC merger. In addition, the cumulative difference between the accounting bases of NSG and Integrys Energy Group in NSG’s pension and postretirement benefit obligations will be amortized as a component of NSG’s rates over the average remaining service lives of the participating employees.

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

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

- 35 -

of plan assets; accordingly, NSG accounts for its pro rata share of the IBS and PEC plans as its own plans.

For additional information on NSG's employee benefits, see Note 10, "Employee Benefit Plans."

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

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

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

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

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

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

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

(n) Subsequent Events--Subsequent events at NSG were evaluated for potential recognition or disclosure through February 25, 2010, which is the date the financial statements were issued.

(o) New Accounting Pronouncements--SFAS No. 167, "Amendments to FASB Interpretation No. 46(R)" (now incorporated as part of the Consolidation Topic of the FASB ASC), was issued in June 2009. This statement introduces a requirement to perform ongoing assessments to determine whether an entity is a variable interest entity and whether an enterprise is the primary beneficiary of a variable interest entity. In addition, this statement clarifies that the enterprise that is required to consolidate a variable interest entity will have a controlling financial interest evidenced by (1) the power to direct the activities that most significantly affect the entity’s economic performance, and (2) the obligation to absorb losses or the right to receive benefits that are potentially significant to the variable interest entity. Additional disclosures are required regarding involvement with variable interest entities, as well as the methodology used to determine the primary beneficiary of any variable interest entities. This standard was effective for NSG beginning January 1, 2010. Management is currently evaluating the impact that the adoption will have on NSG’s first quarter 2010 financial statements.

NOTE 2--RISK MANAGEMENT ACTIVITIES

NSG uses derivative instruments to manage commodity costs. None of these derivatives are designated as hedges for accounting purposes. The derivatives include natural gas purchase contracts as well as financial derivative contracts (commodity swaps and options) used to mitigate the risks associated with

- 36 -

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

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

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

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

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

The table below shows the net unrealized gains recorded on the balance sheet related to derivatives at NSG.

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

At December 31, 2009, NSG had the following notional volumes of outstanding derivative contracts:

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

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

NSG's cash collateral amounts that were netted against the related derivative positions were insignificant at December 31, 2009, and 2008.

NOTE 3--RESTRUCTURING EXPENSE

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

- 37 -

NOTE 4--PROPERTY, PLANT, AND EQUIPMENT

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

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

NOTE 5--REGULATORY ASSETS AND LIABILITIES

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

(Millions)	2009		2008

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

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

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

Certain regulatory assets do not result from cash expenditures, and therefore do not represent investments included in rate base or have offsetting liabilities that reduce the rate base of NSG. Incremental environmental costs incurred and not yet recovered from customers and recoverable gas costs, which are generally recovered within one year, are not included in rate base. However, NSG is allowed to recover a carrying cost for amounts spent but not yet collected from customers. The regulatory asset related to the unamortized loss on debt is not included in rate base, but is recovered over the term

- 38 -

of the debt through the rate of return authorized by the ICC. The regulatory asset related to rate case costs is authorized recovery by the ICC over a five-year period for 2008 rates and a three-year period for 2010 rates.

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

NOTE 6--LONG-TERM DEBT

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

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

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

At December 31, 2009, NSG was in compliance with all financial covenants related to outstanding long-term debt. NSG's long-term debt obligations contain covenants related to payment of principal and interest when due and various financial reporting obligations. Failure to comply with these covenants could result in an event of default which, if not cured or waived, could result in the acceleration of outstanding debt obligations. In addition, provisions and covenants restrict the payment of cash dividends and the purchase or redemption of capital stock. At December 31, 2009, such restrictions amounted to $6.9 million of NSG’s total retained earnings of $70.2 million.

A schedule of all principal debt payment amounts related to bond maturities is as follows:

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

NOTE 7--ASSET RETIREMENT OBLIGATIONS

NSG has asset retirement obligations primarily related to distribution pipe removal (including asbestos and PCBs in pipes), asbestos and PCBs in buildings, and removal of above ground storage tanks. NSG establishes regulatory assets and liabilities to record the differences between ongoing expense recognition under the Asset Retirement and Environmental Obligations accounting rules, and the ratemaking practices for retirement costs authorized by the ICC.

- 39 -

Changes to Asset Retirement Obligation Liabilities

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

(Millions)
Asset retirement obligations at December 31, 2006	$	19.5
Accretion		1.2
Additions and revisions to estimated cash flows		2.3
Asset retirement obligations at December 31, 2007		23.0
Accretion		1.2
Asset retirement obligations at December 31, 2008		24.2
Accretion		1.3
Additions and revisions to estimated cash flows		(5.4	)
Asset retirement obligations at December 31, 2009	$	20.1

NOTE 8--INCOME TAXES

Deferred Income Tax Assets and Liabilities

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

(Millions)	2009		2008

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

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

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

- 40 -

Federal Income Tax Expense

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

	2009						2008						2007
(Millions, except for percentages)	Rate			Amount			Rate			Amount			Rate			Amount

Statutory federal income tax		35.0	%	$	2.3			35.0	%	$	3.9			35.0	%	$	4.6
State income taxes, net		4.5			0.3			4.5			0.5			4.6			0.6
Unrecognized tax benefits		-			-			0.9			0.1			2.3			0.3
Benefits and compensation		(1.5	)		(0.1	)		(1.8	)		(0.2	)		(1.5	)		(0.2	)
Other differences, net		(2.2	)		(0.1	)		(1.7	)		(0.2	)		(0.7	)		(0.1	)
Effective income tax		35.8	%	$	2.4			36.9	%	$	4.1			39.7	%	$	5.2

Current provision
Federal				$	(3.2	)				$	(0.1	)				$	3.9
State					(0.5	)					-						2.3
Total current provision					(3.7	)					(0.1	)					6.2

Deferred provision					6.1						4.2						(1.3	)
Unrecognized tax benefits					-						0.1						0.3
Investment tax credit - net					-						(0.1	)					-
Total provision for income taxes				$	2.4					$	4.1					$	5.2

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

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

Unrecognized Tax Benefits

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

(Millions)	2009		2008			2007

Balance at January 1	$	0.3	$	0.4		$	0.1
Increase related to tax positions taken in prior years		0.1		0.4			0.1
Decrease related to tax positions taken in prior years		-		(0.4	)		-
Increase related to tax positions taken in current year		-		-			0.2
Decrease related to settlements		-		(0.1	)		-
Balance at December 31	$	0.4	$	0.3		$	0.4

At December 31, 2009, recognition in subsequent periods of the unrecognized tax benefits could affect NSG's net income by $0.3 million.

NSG files income tax returns in the United States federal jurisdiction and in various state and local jurisdictions on a stand-alone basis or as part of Integrys Energy Group filings. Subject to the following major exceptions listed below, NSG is no longer subject to United States federal, state, or local income tax examinations by tax authorities for years prior to 2004.

- 41 -

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

Integrys Energy Group has the following open examinations involving NSG:

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

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

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

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

NOTE 9--COMMITMENTS AND CONTINGENCIES

Commodity Purchase Obligations and Purchase Order Commitments

NSG routinely enters into long-term purchase and sale commitments that have various quantity requirements and durations. NSG has obligations to distribute and sell natural gas to customers, and expects to recover costs related to these obligations in future customer rates. As of December 31, 2009, NSG had obligations related to natural gas supply and transportation contracts totaling $89.1 million, some of which extend through 2017.

NSG also has commitments in the form of purchase orders issued to various vendors, which totaled $7.3 million at December 31, 2009.

General

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

Environmental

Manufactured Gas Plant Remediation

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

NSG is addressing five manufactured gas plant sites located in Illinois, including one site described in more detail below. All are former regulated utility sites and are being remediated, with costs charged to existing ratepayers at NSG. NSG estimated and accrued for $106.8 million of future undiscounted investigation and cleanup costs for all sites as of December 31, 2009. NSG may adjust these estimates in the future, contingent upon remedial technology, regulatory requirements, remedy determinations, and any claims of natural resource damages. NSG recorded a regulatory asset of $114.4 million, which is net of insurance recoveries received of $8.3 million, related to the expected recovery of both deferred expenditures and estimated future expenditures as of December 31, 2009.

Until July 2007, NSG was addressing four of the five sites under a program supervised by the Illinois Environmental Protection Agency (IEPA). In July 2007, NSG transferred two of these four sites to the

- 42 -

EPA Superfund Alternative Sites Program. Under the EPA’s program, the remedy decisions at these sites will be based on risk-based criteria typically used at Superfund sites.

NSG is coordinating the investigation and cleanup of its manufactured gas plant sites subject to EPA jurisdiction under what is called a "multi-site" program. This program involves prioritizing the work to be done at the sites, preparation and approval of documents common to all of the sites, and utilization of a consistent approach in selecting remedies.

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

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

Natural Gas Charge Reconciliation Proceedings and Related Matters

Natural Gas Charge Settlement

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

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

With respect to the conservation and weatherization funding, as of December 31, 2009, $0.6 million remained unpaid, of which $0.4 million was included in other current liabilities, and $0.2 million was included in other long-term liabilities. Under the reconnection program, NSG took all steps it believed were required by the agreement. The AG and Chicago have indicated that they believe the terms of the

- 43 -

reconnection program are broader. Management believes that NSG has fully complied with the reconnection program obligations of the settlement agreement; however, NSG, the AG and Chicago are discussing how to resolve this disagreement.

Four of the five annual internal audits required by the settlement agreement have been completed. An auditor hired by the ICC conducted the external audit, and filed its report on April 10, 2008. On March 31, 2009, NSG completed its responses to the auditor’s recommendations.

Class Action

In February 2004, a purported class action suit was filed in Cook County Circuit Court against PEC, PGL, and NSG by customers of PGL and NSG, alleging among other things, violation of the Illinois Consumer Fraud and Deceptive Business Practices Act related to matters at issue in the utilities’ fiscal year 2001 Gas Charge reconciliation proceedings. In the suit, Alport et al. v. Peoples Energy Corporation, the plaintiffs seek disgorgement and punitive damages. PGL and NSG have been dismissed as defendants and the only remaining counts of the suit allege violations of the Consumer Fraud and Deceptive Business Practices Act by PEC and that PEC acted in concert with others to commit a tortious act. PEC denies the allegations and is vigorously defending the suit. On November 19, 2009, the Court entered an order certifying a class composed of customers of PGL and NSG during the period April 26, 2000, through September 30, 2002. On December 17, 2009, PEC filed a Petition for Leave to Appeal to the Appellate Court challenging class certification and on February 19, 2010, this appeal was denied.

NOTE 10--EMPLOYEE BENEFIT PLANS

Defined Benefit Plans

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

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

Retiring employees have the option of receiving retirement benefits in the form of an annuity or a lump sum payment. During 2009, 2008, and 2007, a portion of each pension plan's projected benefit obligation was settled by the payment of lump sum benefits, resulting in a settlement cost.

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

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

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

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

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

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

- 44 -

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

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

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

	Pension Benefits						Other Benefits
(Millions)	2009			2008			2009			2008
Reconciliation of benefit obligation
Obligation at beginning of measurement period	$	28.0		$	28.3		$	15.5		$	14.6
Service cost		1.3			1.2			0.8			0.9
Interest cost		1.8			1.8			0.9			0.9
Participant contributions		-			-			-			0.2
Transfers from (to) affiliates		0.8			(0.1	)		-			-
Actuarial (gain) loss, net		3.5			(1.1	)		0.1			(0.5	)
Benefit payments		(2.0	)		(2.6	)		(0.8	)		(0.9	)
Federal subsidy on benefits paid		-			-			0.1			0.1
Elimination of early measurement period		-			0.5			-			0.2
Obligation at end of measurement period	$	33.4		$	28.0		$	16.6		$	15.5

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

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

	Pension Benefits				Other Benefits
(Millions)	2009		2008		2009		2008
Noncurrent liabilities	$	18.7	$	18.4	$	13.7	$	14.1

The accumulated benefit obligation for all defined benefit pension plans was $25.7 million and $21.9 million at December 31, 2009, and 2008, respectively. Information for pension plans with an accumulated benefit obligation in excess of plan assets is presented in the following table.

	December 31
(Millions)	2009		2008
Projected benefit obligation	$	33.4	$	28.0
Accumulated benefit obligation		25.7		21.9
Fair value of plan assets		14.7		9.6

- 45 -

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

	Pension Benefits				Other Benefits
(Millions)	2009		2008		2009		2008
Net regulatory assets
Net actuarial loss	$	13.5	$	11.7	$	2.4	$	2.4
Prior service cost		1.5		1.7		-		-
Transition obligation		-		-		0.5		0.6
Total	$	15.0	$	13.4	$	2.9	$	3.0

The estimated net losses for defined benefit pension plans that will be amortized as a component of net periodic benefit cost during 2010 are $0.3 million.

The following table shows the components of NSG's net pension and other postretirement benefit costs:

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

Assumptions – Pension and Other Postretirement Benefit Plans

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

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

- 46 -

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

	Pension Benefits
	2009	2008	2007
Discount rate	6.45%	6.40%	6.00%
Expected return on assets	8.50%	8.50%	8.50%
Rate of compensation increase	4.17%	4.18%	3.75%

	Other Benefits
	2009	2008	2007
Discount rate	6.45%	6.25%	5.75%
Expected return on assets	8.50%	8.50%	8.50%
Assumed medical cost trend rate (under age 65)	9.0%	10.0%	8.0%
Ultimate trend rate	5.0%	5.0%	5.0%
Ultimate trend rate reached in	2013	2013	2010
Assumed medical cost trend rate (over age 65)	9.5%	10.5%	8.0%
Ultimate trend rate	5.5%	5.5%	5.0%
Ultimate trend rate reached in	2013	2013	2010
Assumed dental cost trend rate	5.0%	5.0%	5.0%

NSG establishes its expected return on asset assumption based on consideration of historical and projected asset class returns. For each asset class, the expected return is calculated as the weighted-average of the historical and projected returns, as determined by an independent source. This amount is then compared to the historical investment performance of the trust holding the plan assets, as well as a group of peer companies for reasonableness.

Assumed health care cost trend rates have a significant effect on the amounts reported by NSG for the health care plans. For the year ended December 31, 2009, a one-percentage-point change in assumed health care cost trend rates would have had the following effects:

	One-Percentage-Point
(Millions)	Increase		Decrease
Effect on total of service and interest cost components of net periodic postretirement health care benefit cost	$	0.2	$	(0.2	)
Effect on the health care component of the accumulated postretirement benefit obligation		1.7		(1.5	)

- 47 -

Pension and Other Postretirement Benefit Plan Assets

Integrys Energy Group's investment policy includes various guidelines and procedures designed to ensure assets are invested in an appropriate manner to meet expected future benefits to be earned by participants. The investment guidelines consider a broad range of economic conditions. Central to the policy are target allocation ranges by major asset categories. The policy is established and administered in a manner that is compliant at all times with applicable regulations.

The objectives of the target allocations are to maintain investment portfolios that diversify risk through prudent asset allocation parameters and to achieve asset returns that meet or exceed the plans' actuarial assumptions and that are competitive with like instruments employing similar investment strategies. The portfolio diversification provides protection against significant concentrations of risk in the plan assets. The target asset allocations for pension plans and other postretirement plans that have significant assets are: 70% equity securities and 30% fixed income securities. Equity securities primarily include investments in large-cap and small-cap companies. Fixed income securities primarily include corporate bonds of companies from diversified industries, United States government securities, and mortgage-backed securities.

The Board of Directors of Integrys Energy Group has established the Employee Benefits Administrator Committee (composed of members of Integrys Energy Group management) to manage the operations and administration of all benefit plans and trusts. The committee periodically reviews the asset allocation, and the portfolio is rebalanced when necessary.

The investments recorded at fair value in the pension and other postretirement benefit plan assets at December 31, 2009, by asset category were as follows. See Note 1(m), "Summary of Significant Accounting Policies – Fair Value," for information on the fair value hierarchy and the inputs used to measure fair value.

	Pension Plan Assets										Other Benefit Plan Assets
(Millions)	Level 1		Level 2			Level 3		Total			Level 1		Level 2		Level 3		Total
Asset Category
Cash and cash equivalents	$	-	$	0.5		$	-	$	0.5		$	-	$	1.7	$	-	$	1.7
Equity securities:
United States equity		4.1		3.1			-		7.2			-		0.1		-		0.1
International equity		0.5		2.2			-		2.7			-		-		-		-
Fixed income securities:
United States government		-		1.9			-		1.9			-		-		-		-
Foreign government		-		0.2			-		0.2			-		-		-		-
Corporate debt		-		2.1			0.1		2.2			0.1		-		-		0.1
Asset-backed securities		-		0.7			-		0.7			-		-		-		-
Real estate securities		-		-			0.4		0.4			-		-		-		-
		4.6		10.7			0.5		15.8			0.1		1.8		-		1.9
401(h) other benefit plan assets invested as pension assets *		-		(1.0	)		-		(1.0	)		-		1.0		-		1.0
Total	$	4.6	$	9.7		$	0.5	$	14.8		$	0.1	$	2.8	$	-	$	2.9

*	Pension trust assets are used to pay of other postretirement benefits as allowed under Internal Revenue Code Section 401(h).

- 48 -

The following table sets forth a reconciliation of changes in the fair value of pension plan assets categorized as Level 3 measurements:

(Millions)	Corporate Debt		Real Estate Securities			Total
Beginning balance at December 31, 2008	$	-	$	0.6		$	0.6
Actual return on plan assets:
Relating to assets still held at the reporting date		0.1		(0.2	)		(0.1	)
Ending balance at December 31, 2009	$	0.1	$	0.4		$	0.5

Cash Flows Related to Pension and Other Postretirement Benefit Plans

NSG’s funding policy is to contribute at least the minimum amounts that are required to be funded under the Employee Retirement Income Security Act, but not more than the maximum amounts that are currently deductible for income tax purposes. NSG expects to contribute $4.8 million to pension plans and $2.3 million to other postretirement benefit plans in 2010.

The following table shows the payments, reflecting expected future service, that NSG expects to make for pension and other postretirement benefits. These amounts do not include the participants’ share of the cost. In addition, the table shows the expected federal subsidies, provided under the Medicare Prescription Drug, Improvement and Modernization Act of 2003, that will partially offset other postretirement benefits.

(Millions)	Pension Benefits		Other Benefits		Federal Subsidies
2010	$	1.8	$	1.1	$	(0.1	)
2011		2.2		1.2		(0.1	)
2012		2.3		1.3		(0.1	)
2013		2.7		1.4		(0.2	)
2014		2.5		1.4		(0.2	)
2015-2019		16.6

NORTH SHORE GAS CO /IL/ 10-K