This combined MD&A is separately filed by PSEG, Power and PSE&G. Information contained herein relating to any individual company is filed by such company on its own behalf. Power and PSE&G each make representations only as to itself and make no representations whatsoever as to any other company.

PSEG's business consists of three reportable segments, which are:

• Power, our wholesale energy supply company that integrates its generating asset operations with its wholesale energy, fuel supply, energy trading and marketing and risk management activities primarily in the Northeast and Mid Atlantic U.S.;

• PSE&G, our public utility company which provides transmission and distribution of electric energy and gas in New Jersey; and

• Energy Holdings, which owns our other generation assets and holds other energy-related investments.

OVERVIEW OF 2008 AND FUTURE OUTLOOK

Our business discussion in Item 1 provides a review of the regions and markets where we operate and compete, as well as our strategy for conducting our businesses within these markets, focusing on operational excellence, financial strength and making disciplined investments. The following discussion expands upon that discussion by describing significant events and business developments that have occurred during 2008 and key factors that will drive our future performance.

Operational Excellence

Market prices for electricity, fuels and other commodities related to our generation business are volatile, which can impact our business results positively or negatively, especially if sustained beyond our current contract periods.

Given this volatility in the market, a key factor in our success is our ability to operate our nuclear and fossil generating stations at sufficient capacity factors in order to limit the need to purchase higher-priced electricity to satisfy obligations under our sales contracts.

In 2008, we completed projects at Hope Creek and Salem stations, increasing our nominal generating capacity by a total of approximately 173 MW. This additional capacity, combined with an increase in the capacity factor at our nuclear facilities from 91% in 2007 to 93% in 2008 and the improved output from our fossil plants drove an increase in the total output from our Northeast/Mid Atlantic generating facilities from approximately 53,200 GWh in 2007 to 55,300 GWh in 2008.

Our estimated fuel needs are subject to change based upon the level of our operations as well as upon market demands for, and on the price of, coal. We have recently renegotiated our coal contract with a key supplier which will increase coal costs. For additional information, see Item 1. Business. We believe we can continue to manage our fuel sourcing needs in this dynamic market but changes in prices and demand could impact our future operations or financial results.

Over the long-term, our success also depends on the continuation of reasonable prices in the energy and capacity markets. We must also be able to effectively manage our construction projects and continue to economically operate our generation facilities under increasingly stringent environmental requirements, including legislation, regulation and voluntary restrictions that address:

• the control of carbon dioxide emissions to reduce the effects of global climate change and greenhouse gas;

• other emissions such as nitrogen oxide, sulfur dioxide and mercury; and

• the potential need for significant upgrades to existing intake structures and cooling systems at our larger once-through cooled plants, including Salem, Hudson, Mercer, Sewaren, New Haven and Bridgeport.

Our operations could also be impacted by regulatory or legislative actions favoring non-competitive markets, energy efficiency initiatives, and regulatory policies favoring the construction of rate-based transmission that may result in increased imports of generation, which may be subject to less stringent environmental regulation, into areas served by our generation assets. Also, at times, some of the market-based mechanisms in which we participate, including BGS auctions and RPM capacity payments, are the subject of review or discussion in the regulatory and political arenas by participants including FERC, the BPU, and the PJM market monitor. Accordingly, we can provide no assurance that any or all of these mechanisms will continue to exist in their current form. For additional information, see Item 1. Business-Regulatory Issues.

Due to market volatility, strong competition, market complexity and constantly changing forward prices, there can be no assurance that we will be able to continue to contract our generation output at attractive prices. While higher forward prices may have a potentially significant beneficial impact on margins, they would also raise any replacement power costs that we may incur in the event of unanticipated outages, and could also further increase liquidity requirements as a result of contract obligations. For additional information on liquidity requirements, see Liquidity and Capital Resources.

Our operations focus on maintaining system reliability and safety levels. During 2008, we continued to attain top decile performance in our ability to limit service interruptions, outage restoration times and gas leaks per mile.

Our utility operation results depend on the treatment of the various rate and other issues by the BPU and FERC, as well as other state and federal regulatory agencies. Therefore, our success will depend on our ability to:

• continue cost containment initiatives;

• attain an adequate return on the investments we plan to make in our electric and gas transmission and distribution system; and

• continue recovery of the regulatory assets we have deferred.

We expect to file a joint electric and gas rate case by mid 2009 with a request that rates become effective in 2010.

The FERC has recently approved our petition to implement formula rates for our existing and future transmission investments. This forward-looking formula rate mechanism allows us to update our transmission rates annually based on forecasted Operation and Maintenance Expense and capital expenditures for the coming year, with no lag of recovery, and will provide for a true-up to actual expenditures in the subsequent year.

Financial Strength

We continued to take steps to strengthen our financial position during 2008. We reduced our international investment exposure through the sale of the SAESA Group in Chile and our 85% ownership interest in Bioenergie in Italy and used the proceeds from these assets sales and other cash on hand to reduce outstanding debt. We repurchased 2,382,200 shares of our Common Stock under a program authorized by the Board of Directors in August and added capacity to our credit facilities during the year. We also reduced our financial risk by establishing a reserve for a significant percentage of our leveraged lease related tax exposure.

We believe that our strong operations and strong financial position will allow us to manage through the current weakening financial markets which has resulted in increased costs of borrowing as well as significant reductions in the value of both our pension trust and Nuclear Decommissioning Trust (NDT) funds. The reduction in value of the pension trust fund during the year is expected to result in an increase

Total pension costs were $37 million in 2008 and are projected to be approximately $215 million in 2009. Of the total amount of pension expense, the amounts recognized in 2008 and expected to be recognized in 2009 in the Consolidated Statements of Operations are as follows:

                                     2009
                     2008          Expected
                            Millions
Power               $   14         $     77
PSE&G                   15               82
Energy Holdings          2                3

Total               $   31         $    162

The amounts above include the portion of Services' costs charged to each company. The difference between total cost and amounts recognized in the Consolidated Statements of Operations is due to amounts capitalized.

We have and will continue to review our other proposed spending in response to these market concerns. Going forward, we will continue to focus on reducing costs while maintaining our safety and reliability standards.

We expect that our cash from our operations, when combined with cash on hand, will be the primary source used to:

• support our projected capital expenditure program,

• fund shareholder dividends,

• fund contributions to the pension funds, and

• provide for potential payments to address income tax claims related to our leveraged lease transactions, discussed in Note 11. Commitments and Contingent Liabilities.

Any funds remaining after satisfying these obligations, when combined with potential additional financing capacity, would be discretionary cash that could be used to invest in the business, reduce debt and/or repurchase common stock.

Disciplined Investment

During 2008, we also continued to pursue investments focusing on areas that complement our existing businesses and provide prudent growth opportunities. These areas include responding to climate change and continuing to improve environmental performance, upgrading critical energy infrastructure and providing new energy supplies in a disciplined manner. Some examples of actions taken pursuant to this investment philosophy include:

• Construction of back end technology at Mercer, Hudson and Keystone stations to meet our environmental commitments.

• Conducting engineering and design work in connection with the Susquehanna-Roseland 500 kV transmission project with construction expected to begin in early 2010 to meet a 2012 in-service date. Our share of this transmission project is expected to cost $750 million over the next four years.

• Proposing stimulus programs to the BPU for us to invest approximately $888 million in capital infrastructure and energy efficiency programs over a two-year period beginning in April 2009.

• Making funds available for approximately $105 million in a solar energy pilot program designed to spur investment in solar power in New Jersey to meet energy goals under the Energy Master Plan.

• Filing a new solar initiative with the BPU seeking to invest approximately $773 million to develop 120 MW of solar power over a five-year horizon.

• Pursuing construction of 130 MW of gas-fired peaking capacity in Connecticut for an estimated cost of $130 million to $140 million, with construction commencing in June 2011.

• Pursuing the potential development of an offshore wind project, and a modest amount of solar and other renewable energy projects at Energy Holdings.

There is no guarantee that these or future initiatives will be achieved since many issues need to be favorably resolved, such as system reliability concerns, regulatory approvals and construction or development costs.

RESULTS OF OPERATIONS

                                                Years Ended
Earnings (Losses) In Millions                  December 31,        2008              2007             2006

Power                                                           $   1,050         $     949         $   515
PSE&G                                                                 364               380             265
Energy Holdings (A)                                                  (403 )              63             (30 )
Other (B)                                                             (28 )             (67 )           (77 )

PSEG Income from Continuing Operations                                983             1,325             673
Income from Discontinued Operations, Including Gain on
Disposal (C)                                                          205                10              66

PSEG Net Income                                                 $   1,188         $   1,335         $   739





                                               Years Ended
Earnings Per Share (Diluted)                  December 31,       2008            2007            2006

PSEG Income from Continuing Operations                         $   1.93        $   2.60        $   1.33

PSEG Net Income $ 2.34 $ 2.62 $ 1.46

(A) Energy Holdings results include after-tax charges of $490 million taken in 2008 related to leveraged lease transactions, $23 million of after-tax loss resulting from the sale of Chilquinta and Luz del Sur (LDS) in 2007; and a $178 million after-tax loss on the sale of Rio Grande Energia S.A. in 2006.

(B) Other includes parent company interest and financing costs, donations and certain administrative and general expenses.

(C) See Note 3. Discontinued Operations, Dispositions and Impairments.

Our results include the realized gains, losses and earnings on Power's NDT Funds and other related activity. This includes the net realized gains and other-than-temporary impairments, as well as interest and dividend income and other costs related to the NDT Funds which are recorded in Other Income and Deductions. The total amounts recorded in Other Income and Deductions related to the NDT Funds, including the net realized gains (losses), were $(115) million, $48 million and $64 million for the years ended December 31, 2008, 2007 and 2006, respectively. The interest accretion expense on Power's asset retirement obligation, which primarily relates to the decommissioning of the nuclear power plants for which the NDT Funds are maintained, is recorded in Operation and Maintenance Expense and was $25 million, $23 million and $33 million for the years ended December 31, 2008, 2007 and 2006, respectively. The combined after-tax impact on earnings of this activity for the years ended December 31, 2008, 2007 and 2006 was as follows:

NDT Fund Activity
In Millions, after tax
2008 2007 2006

$(71) $12 $11

Our results also include the following after-tax impacts of mark-to-market (MTM) activity.

Non-Trading Mark-to-Market

                            In Millions, after tax
                      2008           2007           2006

Power                $   14        $   (6 )       $   (1 )
Energy Holdings           2            16             29

Total                $   16        $   10         $   28

PSEG

Our results of operations are primarily comprised of the results of operations
of our operating subsidiaries, Power, PSE&G and Energy Holdings, excluding
changes related to intercompany transactions, which are eliminated in
consolidation. We also include certain financing costs, donations and general
and administrative costs at the parent company. For additional information on
intercompany transactions, see Note 21. Related-Party Transactions.


                                                 For the Years Ended                               Increase /                      Increase /
                                                     December 31,                                  (Decrease)                      (Decrease)
                                      2008               2007               2006                  2008 vs 2007                    2007 vs 2006
                                                       Millions                             Millions            %           Millions            %
Operating Revenues                $   13,322         $   12,677         $   11,735         $    645               5         $   942               8
Energy Costs                           7,295              6,512              6,544              783              12             (32 )            (0 )
Operation and Maintenance              2,486              2,406              2,260               80               3             146               6
Depreciation and Amortization            792                774                808               18               2             (34 )            (4 )
Income from Equity Method
Investments                               37                115                115              (78 )           (68 )             -               -
Gain (Loss) on Sale of and
(Impairment) on Equity Method
Investments                              (27 )              137               (272 )           (164 )           N/A             409             N/A
Other Income and Deductions             (116 )               22                 89             (138 )           N/A             (67 )           (75 )
Interest Expense                        (594 )             (727 )             (788 )           (133 )           (18 )           (61 )            (8 )
Income Tax Expense                      (926 )           (1,064 )             (457 )           (138 )           (13 )           607             N/A
Income (Loss) from
Discontinued Operations, net
of tax                                    33                (38 )               47               71             N/A             (85 )           N/A
Gain on Disposal of
Discontinued Operations, net
of tax                                   172                 48                 19              124             N/A              29             N/A

The 2008 year-over-year decrease in our Income from Continuing Operations reflects the following:

¡ After-tax charges of $490 million were recorded in June 2008 associated with deductions taken for tax purposes on certain types of leveraged lease transactions at Energy Holdings that are being challenged by the IRS. See Note 11. Commitments and Contingent Liabilities for additional information.

¡ Earnings were slightly lower at PSE&G due to lower gas delivery sales and higher Operations and Maintenance expense.

¡ Earnings were higher at Power due to higher prices realized under sales contracts and higher sales volumes, partially offset by higher generation costs, losses in the NDT Funds and higher Operation and Maintenance Costs.

¡ Excluding the lease transaction charges, Energy Holdings earnings were higher due to lower interest and bond premiums and improved operations at the Texas generation facilities, partially offset by lower income from assets sold.

For a detailed explanation of the variances, see the discussions for Power, PSE&G and Energy Holdings below.

Power


                                                     For the Years Ended                     Increase /           Increase /
                                                        December 31,                         (Decrease)           (Decrease)
                                            2008            2007             2006           2008 vs 2007         2007 vs 2006
                                                                               Millions
Income from Continuing Operations        $   1,050        $   949         $    515           $      101           $      434
Loss from Discontinued Operations,
including Loss on Disposal, net of
tax                                              -             (8 )           (239 )                 (8 )               (231 )
Net Income                               $   1,050        $   941         $    276           $       93           $      203

For the year ended December 31, 2008, the primary reasons for the increase in Income from Continuing Operations were

• higher prices and sales volumes on BGS contracts and in the various power pools, partially offset by higher generation costs, and

• higher prices on a reduced sales volume under the BGSS contract due to customer conservation and a milder winter heating season in 2008,

• partially offset by net losses on investments in the NDT Funds.

For the year ended December 31, 2007, the primary reasons for the increase in Income from Continuing Operations were

• higher prices realized from new contracts, including BGS contracts, combined with higher sales volumes and lower generation costs, and

• improved margins and higher sales volumes under the BGSS contract due to a colder winter heating season and more favorable fuel pricing in 2007.

                                                For the Years Ended                             Increase /                        Increase /
                                                   December 31,                                 (Decrease)                        (Decrease)
Power                                2008              2007              2006                  2008 vs 2007                      2007 vs 2006
                                                     Millions                            Millions            %             Millions            %
Operating Revenues                $   7,770         $   6,796         $   6,057         $    974               14         $    739             N/A
Energy Costs                          4,556             3,975             3,955              581               15               20               1
Operation and Maintenance             1,054             1,001             1,002               53                5               (1 )             -
Depreciation and Amortization           164               140               140               24               17                -               -
Other Income and Deductions            (121 )              69                66             (190 )           (275 )              3               5
Interest Expense                       (164 )            (159 )            (148 )              5                3               11               7
Income Tax Expense                     (661 )            (641 )            (363 )             20                3              278              77
Loss from Discontinued
Operations, including Loss on
Disposal, net of tax              $       -         $      (8 )       $    (239 )       $      8              100         $   (231 )           (97 )

For the year ended December 31, 2008 as compared to 2007

Operating Revenues increased $974 million due to:

• Generation revenues increased $797 million due to

¡ a net increase of $355 million from higher prices on a higher volume of BGS contracts modestly offset by the expiration of several contracts in May 2008,

¡ higher revenues of $331 million and $20 million resulting from a higher volume of generation being sold at higher prices into PJM and NEPOOL, respectively,

¡ $33 million from higher prices on a lower volume of sales in the New York power pool,

¡ $67 million from higher capacity prices resulting from the changes in the capacity markets in PJM, New York and Connecticut, and

¡ $32 million for ancillary and other services as well as a damage claim awarded by the federal government for an oil spill in the Delaware River in 2004,

¡ partially offset by $25 million of net losses on financial hedging transactions.

• Gas Supply revenues increased $154 million

¡ including $130 million resulting from sales under the BGSS contract, comprised of $208 million from higher prices partly offset by lower sales volumes of $78 million due to customer conservation and milder winter temperatures in 2008, and

¡ a net increase of $27 million due to higher prices on sales to third party customers on a reduced sales volume.

• Trading revenues increased $23 million principally due to gains on electric-related contracts and contracts related to financial transmission rights.

Operating Expenses

• Energy Costs represent the cost of generation, which includes fuel purchases for generation as well as purchased energy in the market, and gas purchases to meet Power's obligation under its BGSS contract with PSE&G. Energy Costs increased by $581 million due to:

¡ Generation costs increased by $410 million due to $445 million of higher fuel costs related to higher prices and higher volumes of natural gas and $17 million of higher costs of purchases reflecting higher prices, partly offset by net gains of $59 million from financial hedging transactions.

¡ Gas costs increased $171 million, reflecting net increases of $150 million and $34 million related to Power's obligations under the BGSS contract and sales to third party customers, respectively, reflecting higher inventory costs partially offset by reduced volumes. These increases were partially offset by a reduction of $14 million in losses on financial hedging transactions in 2008 as compared to 2007.

• Operation and Maintenance increased $53 million primarily due to

¡ a net increase of $47 million due to planned outages and higher maintenance costs at our fossil stations, primarily Hudson and Linden, and

¡ an increase of $10 million related to planned outages at the Peach Bottom and Salem stations.

• Depreciation and Amortization increased $24 million due to

¡ an increase of $14 million resulting from a larger depreciable nuclear and fossil asset base in 2008, and

¡ an increase of $9 million due to depreciation of pollution control equipment being placed into service at our Bridgeport generating facility.

Other Income and Deductions decreased $190 million due to

• higher charges of $147 million ($219 million in 2008 versus $72 million in 2007) for other-than-temporary impairments related to the NDT Fund securities,

• net unrealized losses of $24 million on the NDT Fund derivative instruments,

• lower interest income of $13 million from short-term loans to our parent company, and

• a $13 million charge for the purchase of net operating loss carryforwards under the State of New Jersey Tax Benefit Purchase Program,

• partially offset by an increase of $5 million from net realized income related to the NDT Funds.

Interest Expense increased $5 million primarily due to the issuance of $40 million of 5.75% Pollution Control Bonds due 2037 in November 2007 and $44 million of 4.00% Pollution Control Bonds due 2042 in December 2007.

Income Tax Expense increased $20 million in 2008 primarily due to

• an increase of $50 million due to higher pre-tax income,

• partially offset by a reduction of $16 million due to lower earnings from the NDT Funds, and

• a reduction of $9 million due to increased benefits from a manufacturing deduction under the American Jobs Creation Act of 2004.

For the year ended December 31, 2007 as compared to 2006

. . .