General

We are primarily a natural gas company, engaged in finding, producing, gathering, processing, and transporting natural gas. Our operations are located principally in the United States and are organized into the following reporting segments: Exploration & Production, Gas Pipeline, Midstream Gas & Liquids (Midstream), and Gas Marketing Services. (See Note 1 of Notes to Consolidated Financial Statements and Part I Item 1 for further discussion of these segments.)

Unless indicated otherwise, the following discussion and analysis of critical accounting estimates, results of operations, and financial condition and liquidity relates to our current continuing operations and should be read in conjunction with the consolidated financial statements and notes thereto included in Part II Item 8 of this document.

Overview of 2008

Our plan for 2008 was focused on continued disciplined growth. Objectives and
highlights of this plan included:


               Objectives                                  Highlights
Continuing to improve both EVA® and          2008 segment profit of $2.9 billion,
segment profit.                              an increase of $749 million from 2007,
                                             contributed to improving our EVA®.
Continuing to increase natural gas           We invested $2.5 billion in capital
production and reserves.                     expenditures in Exploration &
                                             Production, increasing average daily
                                             domestic production by approximately
                                             20 percent over last year while adding
                                             602 billion cubic feet equivalent in
                                             net reserves. Total year-end 2008
                                             proved domestic natural gas reserves
                                             are 4.3 trillion cubic feet
                                             equivalent, up 5 percent from year-end
                                             2007 reserves.
Increasing the scale of our gathering        We invested $608 million in capital
and processing business in key growth        expenditures in Midstream, primarily
basins.                                      Deepwater Gulf expansion projects and
                                             gas-processing capacity in the western
                                             United States.
Continue to invest in expansion projects     We invested $306 million in capital
on our interstate natural gas pipelines.     expenditures in Gas Pipeline during
                                             2008.

Our 2008 income from continuing operations increased to $1.3 billion, as compared to $847 million in 2007. Our net cash provided by operating activities was almost $3.4 billion in 2008 compared to $2.2 billion in 2007.

While these annual measures are favorable compared to the prior year, the overall trend of results was significantly different when considering the first three quarters of the year versus the last quarter. Through September 30, 2008, our Exploration & Production business benefited from increased levels of production and higher net realized average natural gas prices, while our Midstream business realized higher margins from a favorable energy commodity price environment. However, energy commodity prices declined sharply during the last months of 2008, contributing to significantly lower fourth quarter operating results for these segments. The impact of the declining energy commodity prices on our consolidated results was partially mitigated by:

• Strong earnings from Gas Pipeline, which benefited from new rates enacted during 2007, and the nature of its contracts;

• Hedge positions at Exploration & Production related to a significant portion of its production;

• Fee-based revenues from certain gathering and processing services at Midstream.

See additional discussion in Results of Operations.

Other Significant 2008 Events

We completed our stock repurchase program by reaching the $1 billion limit authorized by our Board of Directors. (See Note 12 of Notes to Consolidated Financial Statements.)

Exploration & Production increased its positions by acquiring undeveloped leasehold acreage, producing properties and gathering facilities in the Piceance basin and undeveloped leasehold acreage and producing properties in the Fort Worth basin. See additional discussion in Results of Operations - Segments, Exploration & Production.

We recognized pre-tax income of $183 million in income from discontinued operations related to our former Alaska operations. (See Note 2 of Notes to Consolidated Financial Statements.)

Exploration & Production recognized pre-tax income of $148 million related to the sale of a contractual right to a production payment on certain future international hydrocarbon production. See additional discussion in Results of Operations - Segments, Exploration & Production.

Williams Pipeline Partners L.P. completed its initial public offering. See additional discussion in Results of Operations - Segments, Gas Pipeline.

In September 2008, Hurricanes Gustav and Ike impacted our operations, primarily at Midstream. As a result, we estimate that our segment profit for 2008 was decreased by approximately $60 million to $85 million due to downtime and charges for repairs and property insurance deductibles. See additional discussion in Results of Operations - Segments, Gas Pipeline and Midstream Gas & Liquids.

The overall decline in equity markets in 2008 negatively impacted our employee benefit plan assets and will significantly increase our net periodic benefit expense in future periods. (See Note 7 of Notes to Consolidated Financial Statements.)

Outlook for 2009

We expect the overall economic recession and related lower energy commodity price environment as well as the challenging financial markets to continue throughout the year. This is expected to result in sharply lower results of operations and cash flow from operations compared to 2008 levels and could also result in a further reduction in capital expenditures. The impacts could include the future nonperformance of counterparties or impairments of goodwill and long-lived assets. Considering this environment, our plan for 2009 is built around the transition from significant growth to a focus on sustaining our current operations and reducing costs where appropriate. However, we believe we are well positioned to capture growth opportunities when commodity prices strengthen and as economic conditions improve. Although we expect a reduction in capital expenditures compared to the prior year, near-term investment in our businesses will remain significant and focused on completing major projects, meeting legal, regulatory, and/or contractual commitments, and maintaining a reduced level of natural gas production development.

We will continue to operate with a focus on EVA® and invest in our businesses in a way that meets customer needs and enhances our competitive position by:

• Continuing to invest our gathering and processing and interstate natural gas pipeline systems, primarily through the completion of projects currently underway;

• Continuing to invest in our natural gas production development, although at a lower level than in recent years;

• Retaining the flexibility to adjust our planned levels of capital and investment expenditures in response to changes in economic conditions, as well as seizing attractive opportunities.

Potential risks and/or obstacles that could impact the execution of our plan include:

• Lower than anticipated commodity prices;

• Lower than expected levels of cash flow from operations;

• Availability of capital;

• Counterparty credit and performance risk;

• Decreased drilling success at Exploration & Production;

• Decreased drilling success or abandonment of projects by third parties served by Midstream and Gas Pipeline;

• Additional general economic, financial markets, or industry downturn;

• Changes in the political and regulatory environments;

• Exposure associated with our efforts to resolve regulatory and litigation issues (see Note 16 of Notes to Consolidated Financial Statements).

We continue to address these risks through utilization of commodity hedging strategies, focused efforts to resolve regulatory issues and litigation claims, disciplined investment strategies, and maintaining at least $1 billion in liquidity from cash and cash equivalents and unused revolving credit facilities. In addition, we utilize master netting agreements and collateral requirements with our counterparties.

We have completed a review of potential changes to our company structure with a goal of enhancing shareholder value and determined to leave our company structure unchanged. Major factors in our decision were the sharp decline in energy commodity prices and a further deterioration in the macroeconomic environment since the initiation of the review in early November 2008. Our business mix and strong credit profile position us to weather the challenging economic and market conditions in 2009 and benefit as the economy recovers.

Accounting Pronouncements Issued But Not Yet Adopted

Accounting pronouncements that have been issued but not yet adopted may have an effect on our Consolidated Financial Statements in the future.

See Recent Accounting Standards in Note 1 of Notes to Consolidated Financial Statements for further information on recently issued accounting standards.

Modernization of Oil & Gas Reporting Requirements

The SEC has revised its oil and gas reserves reporting requirements effective for fiscal years ending on or after December 31, 2009, with early adoption prohibited. These changes include:

• Expanding the definition of oil and gas reserves and providing clarification of certain concepts and technologies used in the reserve estimation process.

• Allowing optional disclosure of probable and possible reserves and permitting optional disclosure of price sensitivity analysis.

• Modifying prices used to estimate reserves for SEC disclosure purposes to a 12-month average price instead of a single-day, period-end price.

• Requiring certain additional disclosures around proved undeveloped reserves, internal controls used to ensure objectivity of the estimation process, and qualifications of those preparing and/or auditing the reserves.

Historically, the reserves calculated based on the SEC's reporting requirements were also used to calculate depletion on our producing properties, as required by SFAS 69, "Disclosures about Oil and Gas Producing Activities" (SFAS 69). However, the change in the SEC reporting requirements has not yet been adopted by the FASB. The SEC has announced its intent to discuss potential amendments to SFAS 69 with the FASB so that the reserves disclosed remain consistent with the reserves used to calculate depletion on our producing properties. Any such change would impact our future financial results. The SEC has indicated that it may delay the effective date of the revised reporting requirements if the FASB does not make conforming amendments by December 31, 2009.

Critical Accounting Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. We have discussed the following accounting estimates and assumptions as well as related disclosures with our Audit Committee. We believe that the nature of these estimates and assumptions is material due to the subjectivity and judgment necessary, or the susceptibility of such matters to change, and the impact of these on our financial condition or results of operations.

Impairments of Long-Lived Assets and Goodwill

We evaluate our long-lived assets for impairment when we believe events or changes in circumstances indicate that we may not be able to recover the carrying value. Our computations utilize judgments and assumptions that may include the estimated fair value of the asset, undiscounted future cash flows, discounted future cash flows, and the current and future economic environment in which the asset is operated.

Based on our assessment of the undiscounted and discounted cash flows on natural gas-producing properties and associated unproved leasehold costs in the Arkoma basin, Exploration & Production recorded an impairment charge of $129 million in December 2008. Significant judgments and assumptions in this impairment analysis included year-end natural gas reserves quantities, estimates of future natural gas prices using a forward NYMEX curve adjusted for locational basis differentials, drilling plans, capital costs, and a pre-tax discount rate of 15 percent. The recorded impairment was largely the result of lower forward pricing estimates at year-end and lower reserve estimates resulting from lower year-end prices.

In addition to those long-lived assets for which impairment charges were recorded (see Note 4 of Notes to Consolidated Financial Statements), certain others were reviewed for which no impairment was required. These reviews included Exploration & Production's properties in other basins and utilized inputs consistent with those described above for the Arkoma basin. Certain assets within our Midstream segment were also evaluated for impairment utilizing judgments and assumptions including future fees, margins and volumes. The use of alternate judgments and/or assumptions could result in the recognition of different levels of impairment charges in the consolidated financial statements.

We have goodwill of approximately $1 billion at Exploration & Production primarily resulting from a 2001 acquisition. We assess goodwill for impairment annually as of the end of the year. For purposes of our assessment, the reporting unit is Exploration & Production's domestic operations. As of December 31, 2008, the estimated fair value of the reporting unit exceeds its carrying value, including goodwill, indicating no impairment of Exploration & Production's goodwill.

We estimated the fair value of the reporting unit on a stand-alone basis primarily by valuing proved and unproved reserves. We used an income approach (discounted cash flows) for valuing reserves. The significant inputs into the valuation of proved reserves included reserve quantities, forward natural gas prices, anticipated drilling and operating costs, anticipated production curves and appropriate discount rates. Unproved reserves were valued using similar assumptions adjusted further for the uncertainty associated with these reserves.

In estimating the inputs, management must make assumptions that require judgments and are subject to change in response to changing market conditions and other future events. Significant assumptions in valuing proved reserves included reserve quantities of more than 4.3 Tcfe, natural gas prices, adjusted for locational differences, averaging approximately $5.80 per Mcfe and a pre-tax discount rate of 15 percent.

We further reviewed the estimated fair value of the stand-alone reporting unit by reconciling the sum of the fair values of all our businesses to our total market capitalization, including a control premium. In estimating the fair value of our businesses and a control premium, we considered a range of market comparables from historical sales transactions of energy companies. Market capitalization was based on our traded stock price for a reasonably short period of time before and after December 31, 2008. In evaluating these items in our reconciliation analysis, management considered a range of reasonable judgments. This reconciliation allowed management to consider market expectations in corroborating the reasonableness of the estimated stand-alone fair value of the Exploration & Production reporting unit.

We also perform interim assessments of goodwill if impairment triggering events or circumstances are present. Examples of impairment triggering events or circumstances include:

• The testing for recoverability of a significant long-lived asset group within the reporting unit;

• Recent operating losses or negative cash flows at the reporting unit level;

• A decline in natural gas prices or reserve quantities;

• Not meeting internal forecasts, or downward adjustments to future forecasts;

• A decline in enterprise market capitalization below our consolidated stockholders' equity;

• Industry trends.

We cannot predict future market conditions and events that might adversely affect the estimated fair value of the Exploration & Production reporting unit and possibly the reported value of goodwill. The estimated fair value of the reporting unit is significantly affected by natural gas prices, reserve quantities and market expectations for required rates of return. Further declines in natural gas prices would lower our estimates of fair value. There are numerous uncertainties inherent in estimating quantities of reserves that could affect our reserve quantities. Low prices for natural gas, regulatory limitations, or the lack of available capital for projects could adversely affect the development and production of additional reserves. Given the significant challenges affecting our businesses and the energy industry in 2009, these factors could impact us and require us to assess goodwill for possible impairment more frequently during 2009.

Subsequent to December 31, 2008, as a result of overall market and energy commodity price declines, we have witnessed periodic reductions in our total market capitalization below our December 31, 2008, consolidated stockholders' equity balance. If our total market capitalization is below our consolidated stockholders' equity balance at a future reporting date, we consider this an indicator of potential impairment of goodwill under recent SEC communications and our accounting considerations. We utilize market capitalization in corroborating our assessment of the fair value of our Exploration & Production reporting unit. Considering this, it is reasonably possible that we may be required to conduct an interim goodwill impairment evaluation, which could result in a material impairment of our goodwill.

Accounting for Derivative Instruments and Hedging Activities

We review our energy contracts to determine whether they are, or contain derivatives. We further assess the appropriate accounting method for any derivatives identified, which could include:

• Qualifying for and electing cash flow hedge accounting, which recognizes changes in the fair value of the derivative in other comprehensive income (to the extent the hedge is effective) until the hedged item is recognized in earnings;

• Qualifying for and electing accrual accounting under the normal purchases and normal sales exception, or;

• Applying mark-to-market accounting, which recognizes changes in the fair value of the derivative in earnings.

If cash flow hedge accounting or accrual accounting is not applied, a derivative is subject to mark-to-market accounting. Determination of the accounting method involves significant judgments and assumptions, which are further described below.

The determination of whether a derivative contract qualifies as a cash flow hedge includes an analysis of historical market price information to assess whether the derivative is expected to be highly effective in offsetting the cash flows attributed to the hedged risk. We also assess whether the hedged forecasted transaction is probable of occurring. This assessment requires us to exercise judgment and consider a wide variety of factors in addition to our intent, including internal and external forecasts, historical experience, changing market and business conditions, our financial and operational ability to carry out the forecasted transaction, the length of time until the forecasted transaction is projected to occur, and the quantity of the forecasted transaction. In addition, we compare actual cash flows to those that were expected from the underlying risk. If a hedged forecasted transaction is not probable of occurring, or if the derivative contract is not expected to be highly effective, the derivative does not qualify for hedge accounting.

For derivatives designated as cash flow hedges, we must periodically assess whether they continue to qualify for hedge accounting. We prospectively discontinue hedge accounting and recognize future changes in fair value directly in earnings if we no longer expect the hedge to be highly effective, or if we believe that the hedged forecasted transaction is no longer probable of occurring. If the forecasted transaction becomes probable of not occurring, we reclassify amounts previously recorded in other comprehensive income into earnings in addition to prospectively discontinuing hedge accounting. If the effectiveness of the derivative improves and is again expected to be highly effective in offsetting the cash flows attributed to the hedged risk, or if the forecasted transaction again becomes probable, we may prospectively re-designate the derivative as a hedge of the underlying risk.

Derivatives for which the normal purchases and normal sales exception has been elected are accounted for on an accrual basis. In determining whether a derivative is eligible for this exception, we assess whether the contract provides for the purchase or sale of a commodity that will be physically delivered in quantities expected to be used or sold over a reasonable period in the normal course of business. In making this assessment, we consider numerous factors, including the quantities provided under the contract in relation to our business needs, delivery locations per the contract in relation to our operating locations, duration of time between entering the contract and delivery, past trends and expected future demand, and our past practices and customs with regard to such contracts. Additionally, we assess whether it is probable that the contract will result in physical delivery of the commodity and not net financial settlement.

Since our energy derivative contracts could be accounted for in three different ways, two of which are elective, our accounting method could be different from that used by another party for a similar transaction. Furthermore, the accounting method may influence the level of volatility in the financial statements associated with changes in the fair value of derivatives, as generally depicted below:

                                Consolidated Statement of Income         Consolidated Balance Sheet
Accounting Method                  Drivers              Impact           Drivers           Impact

Accrual Accounting              Realizations        Less Volatility        None           No Impact
                               Realizations &                           Fair Value
Cash Flow Hedge Accounting     Ineffectiveness      Less Volatility      Changes       More Volatility
                                                                        Fair Value
Mark-to-Market Accounting    Fair Value Changes     More Volatility      Changes       More Volatility

Our determination of the accounting method does not impact our cash flows related to derivatives.

Additional discussion of the accounting for energy contracts at fair value is included in Notes 1 and 15 of Notes to Consolidated Financial Statements.

Oil- and Gas-Producing Activities

We use the successful efforts method of accounting for our oil- and gas-producing activities. Estimated natural gas and oil reserves and forward market prices for oil and gas are a significant part of our financial calculations. Following are examples of how these estimates affect financial results:

• An increase (decrease) in estimated proved oil and gas reserves can reduce (increase) our unit-of-production depreciation, depletion and amortization rates.

• Changes in oil and gas reserves and forward market prices both impact projected future cash flows from our oil and gas properties. This, in turn, can impact our periodic impairment analyses, including that for goodwill.

The process of estimating natural gas and oil reserves is very complex, requiring significant judgment in the evaluation of all available geological, geophysical, engineering, and economic data. After being estimated internally, 99 percent of our reserve estimates are either audited or prepared by independent experts. (See Part I Item 1 for further discussion.) The data may change substantially over time as a result of numerous factors, including additional development cost and activity, evolving production history, and a continual reassessment of the viability of production under changing economic conditions. As a result, material revisions to existing reserve estimates could occur from time to time. Such changes could trigger an impairment of our oil- and gas-producing properties and/or goodwill and have an impact on our depletion expense prospectively. For example, a change of approximately 10 percent in our total oil and gas reserves could change our annual depreciation, depletion and

amortization expense between approximately $46 million and $56 million. The actual impact would depend on the specific basins impacted and whether the change resulted from proved developed, proved undeveloped or a combination of these reserve categories.

Forward market prices, which are utilized in our impairment analyses, include estimates of prices for periods that extend beyond those with quoted market prices. This forward market price information is consistent with that generally used in evaluating our drilling decisions and acquisition plans. These market prices for future periods impact the production economics underlying oil and gas reserve estimates. The prices of natural gas and oil are volatile and change from period to period, thus impacting our estimates. Significant unfavorable changes in the forward price curve could result in an impairment of our oil and gas properties and/or goodwill.

Contingent Liabilities

We record liabilities for estimated loss contingencies, including environmental matters, when we assess that a loss is probable and the amount of the loss can be reasonably estimated. Revisions to contingent liabilities are generally reflected in income when new or different facts or information become known or circumstances change that affect the previous assumptions with respect to the likelihood or amount of loss. Liabilities for contingent losses are based upon our assumptions and estimates and upon advice of legal counsel, engineers, or other third parties regarding the probable outcomes of the matter. As new developments occur or more information becomes available, our assumptions and estimates of these liabilities may change. Changes in our assumptions and estimates or outcomes different from our current assumptions and estimates could materially affect future results of operations for any particular quarterly or annual period. See Note 16 of Notes to Consolidated Financial Statements.

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