Management's Discussion and Analysis of Financial Condition and Results of Operations

Introduction and Overview

Constellation Energy Group, Inc. (Constellation Energy) is an energy company that conducts its business through various subsidiaries including a merchant energy business and Baltimore Gas and Electric Company (BGE). We describe our operating segments in the Notes to Consolidated Financial Statements beginning on page 18.

This Quarterly Report on Form 10-Q is a combined report of Constellation Energy and BGE. References in this report to "we" and "our" are to Constellation Energy and its subsidiaries, collectively. References in this report to the "regulated business(es)" are to BGE. We discuss our business in more detail in Item 1-Business section of our 2007 Annual Report on Form 10-K and we discuss the risks affecting our business in Item 1A. Risk Factors section beginning on page 68.

Our 2007 Annual Report on Form 10-K includes a detailed discussion of various items impacting our business, our results of operations, and our financial condition. These include:

º •
º Introduction and Overview section which provides a description of our business segments, º •
º Strategy section, º •
º Business Environment section, including how regulation, weather, and other factors affect our business, and º •
º Critical Accounting Policies section.

Critical accounting policies are the accounting policies that are most important to the portrayal of our financial condition and results of operations and require management's most difficult, subjective, or complex judgment. Our critical accounting policies include derivative accounting, evaluation of assets for impairment and other than temporary decline in value, and asset retirement obligations.

Effective January 1, 2008, we adopted SFAS No. 157, Fair Value Measurements, as discussed in the Notes to Consolidated Financial Statements beginning on page 31. We discuss our accounting policy for determining fair value in more detail in the Notes to Consolidated Financial Statements as well as in our Critical Accounting Policies section and Note 1 in our 2007 Annual Report on Form 10-K.

In this discussion and analysis, we explain the general financial condition and the results of operations for Constellation Energy and BGE including:

º •
º factors which affect our businesses, º •
º our earnings and costs in the periods presented, º •
º changes in earnings and costs between periods, º •
º sources of earnings, º •
º impact of these factors on our overall financial condition, º •
º expected future expenditures for capital projects, and º •
º expected sources of cash for further capital expenditures.

As you read this discussion and analysis, refer to our Consolidated Statements of Income (Loss) on page 3, which present the results of our operations for the quarters and nine months ended September 30, 2008 and 2007. We analyze and explain the differences between periods in the specific line items of the Consolidated Statements of Income (Loss).

We have organized our discussion and analysis as follows:

º •
º We describe changes to our strategy and our business environment during the year. º •
º We highlight significant events that occurred in 2008 that are important to understanding our results of operations and financial condition. º •
º We then review our results of operations beginning with an overview of our total company results, followed by a more detailed review of those results by operating segment. º •
º We review our financial condition, addressing our sources and uses of cash, capital resources, commitments, and liquidity. º •
º We conclude with a discussion of our exposure to various market risks.

Strategy

We discuss our business strategy in detail in the Strategy section of our 2007 Annual Report on Form 10-K. In that discussion, we indicate that we are constantly reevaluating our strategies. As a result of the unprecedented events of 2008 as discussed below, in addition to focusing on our basic business plan, we have made substantial changes in our strategy, including focusing on the following immediate goals:

º •
º reducing the capital requirements, economic risk and collateral needs of our merchant energy businesses, which we discuss in further detail beginning on page 62,

The execution of our strategy in the future will be affected by our ability to achieve these goals as well as by continued instability in financial and commodities markets. Execution of our goals could have a substantial effect on the nature and mix of our business activities. In turn, this could affect our financial position, results of operations, and cash flows in material amounts, and these amounts could vary substantially from historical results.

Business Environment

Various factors affect our financial results. We discuss these various factors in the Forward Looking Statements section on page 74 and in Item 1A. Risk Factors section beginning on page 68. We discuss our market risks in the Market Risk section beginning on page 64.

In this section, we discuss in more detail events which have impacted our business during 2008.

Federal Regulation

In May 2008, five state public service commissions, including the Public Service Commission of Maryland (Maryland PSC), consumer advocates and others filed a complaint against PJM Interconnection (PJM), the regional transmission organization for the Mid-Atlantic region, at the Federal Energy Regulatory Commission (FERC) alleging that the PJM reliability pricing model (RPM) produced unreasonable prices during the period from June 1, 2008 through May 31, 2011. The complaint requests that FERC establish a refund effective date of June 1, 2008, reject the results of the 2007/08 through 2010/11 RPM capacity auction results, and significantly reduce prices for capacity beginning as of June 1, 2008 through 2011/12. We, along with other power suppliers and supplier trade groups, have filed protests to the complaint. In September 2008, FERC dismissed the complaint and in October 2008, the complainants requested a rehearing at FERC. We cannot predict the outcome of this proceeding or the amount of refunds that may be owed by or due to us, if any. However, the outcome, and any refunds that are ultimately assessed, could have a material impact on our financial results.

Environmental Matters

Air Quality

National Ambient Air Quality Standards (NAAQS)

In March 2008, the Environmental Protection Agency (EPA) adopted a stricter NAAQS for ozone. We are unable to determine the impact that complying with the stricter NAAQS for ozone will have on our financial results until the states in which our generating facilities are located adopt plans to meet the new standards.

In July 2008, the United States Court of Appeals for the District of Columbia Circuit issued a ruling that effectively repealed the Clean Air Interstate Rule (CAIR). We do not believe that the decision will result in a material change to our emissions reduction plan in Maryland as the emissions reduction requirements of Maryland's Healthy Air Act and Clean Power Rule are more stringent and apply sooner than those under CAIR. On September 24, 2008, the EPA petitioned the District of Columbia Circuit for rehearing. We cannot predict what additional judicial, legislative or regulatory actions will be taken in response to the court's decision or the EPA's petition for rehearing or whether such actions may affect our financial results. We discuss the impact that this ruling had on our third quarter of 2008 results in the Merchant Energy Business section on page 45. We discuss this ruling in more detail in the Notes to Consolidated Financial Statements beginning on page 17.

Capital Expenditures

As discussed in our 2007 Annual Report on Form 10-K, we expect to incur additional environmental capital expenditures to comply with air quality laws and regulations. Based on updated information from vendors, we expect our estimated environmental capital requirements for these air quality projects to be approximately $550 million in 2008, $305 million in 2009, $40 million in 2010 and $35 million from 2011-2012.

Our estimates may change further as we implement our compliance plan. As discussed in our 2007 Annual Report on Form 10-K, our estimates of capital expenditures continue to be subject to significant uncertainties.

Accounting Standards Issued and Adopted

We discuss recently issued and adopted accounting standards in the Accounting Standards Issued and Accounting Standards Adopted sections of the Notes to Consolidated Financial Statements beginning on page 30.

Events of 2008

Pending Merger with MidAmerican

On September 19, 2008, Constellation Energy entered into an Agreement and Plan of Merger with MidAmerican. We discuss the details of this pending merger in the Notes to Consolidated Financial Statements beginning on page 11.

Current Market Developments

Volatility in the financial markets throughout 2008 intensified in the third quarter, leading to dramatic declines in equity prices and substantially reducing liquidity in the credit markets. Most equity indices declined significantly, the cost of credit default swaps and bond spreads increased substantially, and credit markets effectively ceased to be accessible for all but the most highly rated borrowers.

Precipitated by these conditions, major financial institutions experienced significant financial difficulty and widespread fears developed about the viability of any business that required access to credit markets to support liquidity needs or that required substantial access to the capital markets to function. During the week of September 15, 2008, Constellation Energy faced rapidly growing doubts among investors and business partners about its ability to navigate through this market crisis. Concerns focused on our liquidity, and the trading price of our common stock fell to a 52-week low of $13.00 during the day on September 16, 2008. Despite having announced a number of actions to address our liquidity situation, we needed to raise immediate equity capital and take other steps to enhance our overall liquidity, and as a result on September 19, 2008, we entered into a definitive merger agreement with MidAmerican. We discuss our pending merger with MidAmerican in more detail in the Notes to Consolidated Financial Statements beginning on page 11.

This market environment contributed to the following:

º •
º Our senior unsecured debt was downgraded one level by all three major credit rating agencies and we remain under review for possible downgrade by Moody's Investors Service. We discuss our security ratings and downgrade collateral in more detail beginning on page 59. º •
º We were required to post additional collateral with counterparties. We discuss our collateral requirements in more detail beginning on page 58. º •
º We initiated strategic alternatives for our upstream gas properties, our international business, and our gas trading operations as well as other strategies to improve liquidity and reduce invested capital. We discuss our strategy in more detail beginning on page 36. º •
º We anticipate closing in November 2008 on a new credit facility of approximately $1.2 billion. We discuss this in more detail in the Notes to Consolidated Financial Statements on page 21. º •
º We took various other steps to reduce our exposure to the credit risk of other parties and to improve our own liquidity. We discuss our liquidity beginning on page 60. º •
º In connection with the proposed merger with MidAmerican, we received a capital infusion of $1 billion from MidAmerican on September 22, 2008. We discuss the $1 billion in proceeds from MidAmerican in the Notes to Consolidated Financial Statements beginning on page 21. º •
º We recorded significant impairment charges in the third quarter of 2008. We discuss these impairment charges in more detail in the Notes to Consolidated Financial Statements beginning on page 12. º •
º We incurred losses on our pension plan assets. We discuss our pension plan assets in more detail on page 57.

Commodity Prices

During the six months ended June 30, 2008 and nine months ended September 30,
2008, the energy markets were affected by large fluctuations in commodity prices
as indicated in the following table:

                                  Six months ended     Nine months ended
          Increases (decreases)     June 30, 2008     September 30, 2008

          Power                                  33 %                  (8 )%
          Natural gas                            44 %                  (5 )%
          Coal                                  153 %                  58 %
          Crude oil                              55 %                   1 %

During the third quarter of 2008 and continuing into the fourth quarter of 2008, prices for most commodities, including energy, fell sharply after peaking early in July. The commodity price environment contributed to the following impacts on our results:

º •
º As a result of volatile commodity prices, we experienced significant mark-to-market gains during the six months ended June 30, 2008 and significant mark-to-market losses during the quarter ended September 30, 2008. We discuss our mark-to-market results in our Mark-to-Market section beginning on page 46. º •
º Our total derivative assets increased $819.9 million and total derivative liabilities increased $33.7 million since December 31, 2007. We discuss our derivative assets and liabilities in more detail beginning on page 48. º •
º During the third quarter of 2008, we were required to return portions of counterparty collateral we held and to post additional collateral with counterparties. We discuss our collateral requirements in more detail beginning on page 58. º •
º We experienced an increase in our exposure to lower credit quality wholesale counterparties during the six months ended June 30, 2008 and a decrease in our exposure to lower credit quality wholesale counterparties during the quarter ended September 30, 2008 primarily due to the volatility of coal prices. We discuss our wholesale credit risk

º •
º One of our domestic coal suppliers was unable to meet production targets and filed for bankruptcy. As a result, in the quarter ended March 31, 2008, we incurred a credit loss related to this supplier. We discuss the impact of this event on our results in more detail on page 46. º •
º We executed several contract settlements and amended certain other contracts, primarily in the quarter ended March 31, 2008, to reduce our exposure to supplier nonperformance risk and/or credit risk. We discuss these transactions in more detail on page 46.

Merger and Strategic Alternatives Costs

We incurred costs during the third quarter of 2008 related to our pending merger with MidAmerican and the pursuit of other strategic alternatives to that merger. We discuss these costs in more detail in the Notes to Consolidated Financial Statements on page 12.

Workforce Reduction Costs

During the third quarter of 2008, our merchant energy business approved a restructuring of its Customer Supply operations and recognized a $2.2 million pre-tax charge. We discuss our workforce reduction costs in more detail in the Notes to Consolidated Financial Statements on page 16.

Emission Allowances

During the third quarter of 2008, as a result of a July 11, 2008 decision by the United States Court of Appeals for the D. C. Circuit that vacated the Clean Air Interstate Rule and the subsequent decline in market price for our emission allowance inventory, we recorded a write-down of our emissions inventory and recognized partially offsetting gains on certain forward sales contracts. We discuss this net charge in the Notes to Consolidated Financial Statements beginning on page 17.

Acquisitions

Hillabee Energy Center

On February 14, 2008, we acquired a partially completed gas-fired power generating facility in Alabama. We discuss this acquisition in more detail in the Notes to Consolidated Financial Statements on page 16.

West Valley Power Plant

On June 1, 2008, we acquired a gas-fired peaking plant in Utah. We discuss this acquisition in more detail in the Notes to Consolidated Financial Statements on page 16.

Nufcor International Limited

On June 26, 2008, we acquired a uranium marketing services company in the United Kingdom. We discuss this acquisition in more detail in the Notes to Consolidated Financial Statements beginning on page 16.

Asset Sales

Working Interests in Gas Producing Property

On June 30, 2008, we sold a portion of our working interests in certain proved and unproved oil and gas properties. We discuss this asset sale in more detail in the Notes to Consolidated Financial Statements on page 17.

Dry Bulk Vessel

On July 10, 2008, a shipping joint venture in which our merchant energy business owns a 50% ownership interest sold one of six dry bulk vessels it owns for a gain to us of approximately $29 million. We discuss this sale in more detail in the Notes to Consolidated Financial Statements on page 17.

Financing Activities

In June 2008, we issued the following:

º •
º $250.0 million of Zero Coupon Senior Notes due June 2023, and º •
º $450.0 million of Series A Junior Subordinated Debentures due June 2063.

Also, in June 2008, BGE issued $400.0 million of 6.125% Notes due July 1, 2013.

In connection with the merger with MidAmerican, Constellation Energy issued 10,000 shares of 8% Series A Convertible Preferred Stock (Preferred Stock) that are mandatorily redeemable on September 22, 2010 to MidAmerican for $1 billion. If the merger is terminated other than because of a breach by MidAmerican or is not completed by June 19, 2009 (which may be extended to September 19, 2009), the Preferred Stock automatically converts into $1 billion of 14% Senior Notes of Constellation Energy and requires a payment to MidAmerican of Constellation Energy common stock or cash if approvals to issue shares have not yet been received. We discuss the Preferred Stock in more detail in the Notes to Consolidated Financial Statements beginning on page 21.

We discuss our financing activities in more detail in the Notes to Consolidated Financial Statements beginning on page 20.

Maryland Settlement Agreement

In March 2008, Constellation Energy, BGE and a Constellation Energy affiliate entered into a settlement agreement with the State of Maryland, the Maryland PSC and certain State of Maryland officials to resolve pending litigation and to settle other prior legal, regulatory and legislative issues. We discuss this settlement in more detail in the Notes to Consolidated Financial Statements on page 23.

Results of Operations for the Quarter and Nine Months Ended September 30, 2008 Compared with the Same Periods of 2007

In this section, we discuss our earnings and the factors affecting them. We begin with a general overview, then separately discuss earnings for our operating segments. Changes in other income, fixed charges, and income taxes are discussed, as necessary, in the aggregate for all segments in the Consolidated Nonoperating Income and Expenses section beginning on page 56.

Overview

Results

                                         Quarter            Nine Months
                                          Ended                Ended
                                      September 30,        September 30,
                                      2008      2007       2008      2007

                                           (In millions, after-tax)
                Merchant energy     $ (246.0 ) $ 226.5   $  105.9   $ 450.3
                Regulated
                electric                31.7      34.3      (38.8 )    85.9
                Regulated gas          (12.2 )    (9.8 )     24.1      18.2
                Other
                nonregulated             0.8      (0.3 )      0.3       9.9

                (Loss) Income
                from Continuing
                Operations            (225.7 )   250.7       91.5     564.3
                  Income (loss)
                  from
                  discontinued
                  operations               -       0.7          -      (0.9 )

                Net (Loss) Income   $ (225.7 ) $ 251.4   $   91.5   $ 563.4

                Other Items Included in Operations (after-tax)
                  Impairments and
                  other costs       $ (298.8 ) $     -   $ (298.8 ) $ (12.2 )
                  Merger and
                  strategic
                  alternatives
                  costs                (37.3 )       -      (37.3 )       -
                  Accrual of
                  Maryland
                  settlement
                  credit                   -         -     (125.3 )       -
                  Effective tax
                  rate impact of
                  Maryland
                  settlement
                  agreement              2.0         -       10.7         -
                  Impairment of
                  nuclear
                  decommissioning
                  trust assets         (15.3 )       -      (21.5 )       -
                  Emission
                  allowance
                  write-down, net      (22.8 )       -      (36.2 )       -
                  Non-qualifying
                  hedges                12.0       1.9      (57.3 )    (6.0 )
                  Workforce
                  reduction costs       (1.6 )       -       (1.6 )    (1.5 )

                Total Other Items   $ (361.8 ) $   1.9   $ (567.3 ) $ (19.7 )

Quarter and Nine Months Ended September 30, 2008

Our total net income for the quarter and nine months ended September 30, 2008
compared to the same periods of 2007 decreased primarily due to the following:

                                       Quarter         Nine Months
                                        Ended             Ended
                                    September 30,     September 30,
                                             2008 vs. 2007

                                       (In millions, after-tax)
                Generation gross
                margin             $            78   $           105
                Customer Supply
                gross margin                   (28 )              (4 )
                Global
                Commodities
                gross margin                  (200 )              47
                Sale of upstream
                gas assets                       -                55
                2007 sale of
                CEP LLC equity                 (24 )             (31 )
                Hedge
                ineffectiveness                (28 )             (43 )
                Credit loss-coal
                supplier
                bankruptcy                       -               (33 )
                Merchant
                operating
                expenses,
                primarily labor
                and benefit
                costs                           99                24
                Merchant
                interest expense               (19 )             (35 )
                Synthetic fuel
                facilities                      15               (11 )
                Other
                nonregulated
                businesses                       -               (10 )
                Total Other
                Items included
                in operations
                per
                Overview-Results
                table                         (364 )            (548 )
                Interest and
                investment
                income                          (9 )             (27 )
                All other
                changes                          3                39

                Total              $          (477 ) $          (472 )

In the following sections, we discuss our net income by business segment in greater detail.

Background

Our merchant energy business is a competitive provider of energy solutions for various customers. We discuss the impact of deregulation on our merchant energy business in Item 1. Business-Competition section of our 2007 Annual Report on Form 10-K.

Our merchant energy business focuses on delivery of physical, customer-oriented products to producers and consumers, manages the risk and optimizes the value of our owned generation assets, and uses our portfolio management and trading capabilities both to manage risk and to deploy risk capital to generate additional returns. Currently, we are assessing the ongoing capital requirements of the merchant energy business, including evaluating the proper size of our Customer Supply business, and with respect to our Global Commodities business we are considering various strategic alternatives. As previously discussed, we have made substantial changes in our strategy, including focusing on the following immediate goals:

º •
º reducing the capital requirements, economic risk and collateral needs of our Global Commodities and Customer Supply operations, and, º •
º executing strategic alternatives for our Global Commodities business, which include the sale of our upstream gas properties, our international business, which includes our coal sourcing, freight, uranium, power, natural gas and emissions marketing activities outside North America, and our gas trading activities.

The execution of our strategy in the future will be affected by our ability to achieve these goals as well as by continued instability in financial and commodities markets. Execution of our goals could have a substantial effect on the nature and mix of our business activities. In turn, this could affect our financial position, results of operations, and cash flows in material amounts, and these amounts could vary substantially from historical results. We discuss our strategy in more detail beginning on page 36.

We record merchant energy revenues and expenses in our financial results in different periods depending upon which portion of our business they affect and based on the associated accounting policies. We discuss our revenue recognition policies in the Critical Accounting Policies section and Note 1 of our 2007 Annual Report on Form 10-K. We summarize our revenue and expense recognition policies as follows:

º •
º We record revenues as they are earned and fuel and purchased energy costs as they are incurred for contracts and activities subject to accrual accounting, including certain load-serving activities. º •
º Prior to the settlement of the forecasted transaction being hedged, we record changes in the fair value of contracts designated as cash-flow . . .