See Notes to Condensed Consolidated Financial Statements (Unaudited).

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See Notes to Condensed Consolidated Financial Statements (Unaudited).

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See Notes to Condensed Consolidated Financial Statements (Unaudited).

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See Notes to Condensed Consolidated Financial Statements (Unaudited).

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See Notes to Condensed Consolidated Financial Statements (Unaudited).

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AGL RESOURCES INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. Nature of Business and Significant Accounting Policies

Distribution OperationsGeneral

Distribution operations includesUnless the results of operationscontext requires otherwise, references to “we”, “us”, “our” or the “company” are intended to mean consolidated AGL Resources Inc. and its subsidiaries (AGL Resources). We have prepared the accompanying unaudited consolidated financial condition of AGL Resources' three natural gas local distribution companies: AGLC, VNG and CGC. AGLC conducts its primary business,statements under the distribution of natural gas, throughout most of Georgia. VNG distributes and sells natural gas in southeastern Virginia. CGC distributes and sells natural gas in the Chattanooga area of Tennessee. The GPSC regulates AGLC; the VSCC regulates VNG; and the TRA regulates CGC, with respect to rates, maintenance of accounting records and various other service and safety matters.

Wholesale Services

Wholesale services includes the results of operations and financial condition of Sequent, AGL Resources' asset optimization, gas supply services, and wholesale marketing and risk management subsidiary. Asset optimization focuses on capturing the value from idle or underutilized natural gas assets, typically by participating in transactions that balance the needs of varying markets and time horizons. Such assets include rights to pipeline capacity, underground storage, and natural gas peaking services and facilities. Sequent aggregates gas from other marketers and producers and sells it to third parties. In addition, Sequent bundles commodity with transportation and storage service and redelivers short and long-term transported commodity.

Although Sequent is a nonregulated business, under varying agreements and practices, Sequent acts as asset manager for AGL Resources' regulated utilities. In its capacity as asset manager, Sequent captures value from idle or underutilized assetsrules of the utilities by arbitraging pricing differentials across different locationsSecurities and over time. The VSCC has approved an asset management agreement, which provides for a sharing of profits between SequentExchange Commission (SEC). Under such rules and VNG's customers.  Sequentregulations, we have condensed or omitted certain information and CGC have an agreement whereby Sequent pays CGC's ratepayers an annual fee for the right to act as CGC's asset manager.  Sequent also operates as asset manager for AGLC.  By statute, earnings from capacity release transactions are required to be shared 90%notes normally included in financial statements prepared in conformity with Georgia's USF.  By GPSC order, net margin earned by Sequent, for transactions involving AGLC assets other than capacity release, are required to be shared equally with Georgia's USF.

Energy Investments

Energy investments include AGL Resources' investments in SouthStar, US Propane and the results of operations and financial condition of AGL Networks.

SouthStar was formed in 1998 by subsidiaries of AGL Resources, Piedmont Natural Gas Company and Dynegy Inc. to market natural gas and related services to retail customers, principally in Georgia. SouthStar, operating under the trade name Georgia Natural Gas, is the largest retail marketer of natural gas in Georgia with a market share of 38%. Until March 2003, AGL Resources’ subsidiary owned a 50% interest, Piedmont’s subsidiary owned 30% interest and Dynegy’s subsidiary owned the remaining 20% interest in SouthStar.

On January 24, 2003, AGL Resources announced that its wholly-owned subsidiary, Georgia Natural Gas Company, had reached an agreement to purchase Dynegy Inc.’s 20% ownership interest of SouthStar. The purchase agreement enumerated a number of conditions to the completion of the transaction, all of which were substantially fulfilled or waived by February 18, 2003. The transaction closed March 11, 2003 and has an effective date for accounting purposes of February 18, 2003. Upon closing, AGL Resources’ subsidiary, Georgia Natural Gas Company, owned a non-controlling, 70% financial interest in SouthStar and a subsidiary of Piedmont Natural Gas Company owned the remaining 30% interest.  Although AGL Resources owns 70% of SouthStar, it does not have a controlling interest as most matters of significance require the unanimous vote of both Owners’ representatives to the governing board of SouthStar. The purchase agreement provided, among othe r things, that Dynegy Marketing and Trade would no longer provide asset management and gas procurement and supply services for SouthStar. This relationship was terminated on January 31, 2003. As of that date, SouthStar assumed the asset manager role. Additionally, as part of the agreement to purchase the Owners agreed to dismiss all of the outstanding litigation related to these relationships.

US Propane owns all the general partnership interests directly or indirectly and approximately 28% or 4.6 million common units of the limited partnership interests in Heritage (NYSE: HPG), a publicly traded marketer of propane. Heritage is the fourth largest retail marketer of propaneprinciples generally accepted in the United States delivering approximately 350 million gallons per yearof America (GAAP). We believe, however, that our disclosures are adequate to approximately 650,000 customers in 29 states. AGL Resources owns 22.36% of the limited partnership interests in US Propane and 22.36% of the limited liability company that serves as US Propane's general partner. The other limited partners are subsidiaries of TECO Energy, Inc., Piedmont Natural Gas Company, and Atmos Energy Corporation. These other companies also are owners of US Propane's general partner.  Heritage competes with electricity, natural gas and fuel oil providers, as well as with other companies in the retail propane distribution business. The propane business, like the natural gas business, is seasonal, with weather conditions significantly affecting demand.

AGL Networks a wholly owned subsidiary of AGL Resources serves the demand for high-speed network capacity in metropolitan areas within the United States. Under a certificate of authority from the GPSC, AGL Networks owns and operates a 175 mile fiber network and provides last-mile conduit and dark fiber infrastructure solutions to a variety of customers in metro Atlanta, including local, regional and national telecommunications companies; wireless service providers; educational institutions; and other commercial entities.  Additionally, AGL Networks owns and operates a 60 mile fiber network in Phoenix, serving the central business district, midtown and the airport areas.  Conduit and dark fiber is typically provided to these customers under lease arrangements with term lengths that vary from 3 to 20 years. In addition to conduit and dark fiber leasing, AGL Networks provides turnkey telecommunications network construction services. AGL Networks has also entered into back-to-back lease or fiber exchange arrangements in St. Louis, Missouri, Kansas City, Missouri and Richmond, Virginia,  under which AGL Networks has contracted for last mile dark fiber on behalf of a customer. These arrangements are dedicated to the customer and AGL Networks is fully compensated for the costs of such arrangements.

Corporate

Corporate includes the results of operations and financial condition of AGL Resources' nonoperating business units, principally AGSC and AGL Capital. AGSC is a service company established in accordance with PUHCA. AGL Capital provides for the ongoing financing needs of AGL Resources through a commercial paper program, the issuance of various debt and hybrid securities, and other financing arrangements. All operating expenses and interest costs associated with AGSC and AGL Capital are allocated to the operating segments in accordance with PUHCA. The corporate segment also includes intercompany eliminations for transactions between operating business segments.

Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all ofmake the information and footnote disclosures required by GAAP for a complete set of financial statements. In the opinion of management, thepresented not misleading. The consolidated financial statements reflect all adjustments consideredthat are, in the opinion of management, necessary for a fair presentation of theour financial results of operations and financial condition for the interim periods presented. All such adjustments are of a normal, recurring nature. These unauditedperiods. You should read these condensed consolidated financial statements should be read in conjunctionc onjunction with the auditedour consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2002, and notes thereto contained in AGL Resources Inc.'s Annual Report on Form 10-K filed with the SEC on March 19, 2003. For a glossary of key terms and reference d accounting standards, see the glossary included in this filing on page three priorDue to the Condensed Consolidated Balance Sheets. Theseasonal nature of our business, the results of operations for the first quarterthree and six months ended June 30, 2003 are not necessarily indicative of theour results of operations to be expected for any other interim period or for the year ending December 31, 2003.

# For a glossary of key terms and referenced accounting standards, see the glossary on page three of this filing.

Wholesale ServicesBasis of Presentation

Wholesale services’ revenues are recorded when physical salesOur consolidated financial statements include our accounts and those of natural gasour majority-owned and natural gas storage volumes are deliveredcontrolled subsidiaries. All significant intercompany items have been eliminated in consolidation. Certain amounts from prior periods have been reclassified to conform to the specified delivery point based on contracted prices.   Revenues from commodities sold as part of wholesale services’ trading and derivative activities that are not designated as hedges are reflected net of the cost of these sales.  Derivative transactions are recorded at their fair value.  current presentation.

In calendar 2002 certain of the physical transactions, primarily pertaining to wholesale services storage transactions, were reflected at fair value with unrealized gains and/or losses reflected in earnings each reporting period pursuant to EITF Issue No. 98-10.  Effective January 1, 2003, wholesale services adopted consensus two of EITF  02-03and began reflecting these transactions in the financial statements on an accrual basis unless such transactions  that met the definition of a derivative.  See a discussion pertaining to EITF 02-03 below underRisk Management.

Risk Management

AGL Capital is a party to interest rate swap transactions (Swaps) in the aggregate amount of $175.0 million of which $100.0 million were executed as a hedge against the fair value of the 7.125% Senior Notes due 2011 and $75.0 million were executed as a hedge against the fair value of AGL Capital Trust II's 8% Trust Preferred Securities due 2041.

Pursuant to the Swaps on the Senior Notes, AGL Capital receives future interest rate payments on $100.0 million at an annual 7.125% interest rate, and pays floating interest rates on $100.0 million. AGL Capital pays floating interest each January 14 and July 14 at six-month LIBOR plus 3.4%. At March 31, 2003, the rate was 4.7%. The expiration date of these Swaps is January 14, 2011, unless terminated earlier.

Pursuant to the Swaps on the AGL Capital Trust II’s Trust Preferred Securities, AGL Capital receives future interest rate payments on $75.0 million at an annual 8% interest rate, and pays floating interest rates on $75.0 million. AGL Capital pays floating interest rates each February 15, May 15, August 15 and November 15 at three-month LIBOR plus 1.315%. At March 31, 2003, the rate was 2.7%. The expiration date of these Swaps is May 15, 2041, unless terminated earlier or called.

Each quarter, under hedge accounting treatment, AGL Capital records a “long-term asset or liability” and a corresponding adjustment to “senior and medium-term notes” and “trust preferred securities” to reflect the assessed change in fair value of the Swaps to AGL Capital with any ineffective portion charged to earnings. The Swaps’ fair value changes as interest rates change from those that were in effect on the original settlement date. The fair value of these Swaps at March 31, 2003 and December 31, 2002, was $4.5 million and $6.1 million, respectively.

Accounting for Asset Retirement Obligations

In June 2001, the FASBFinancial Accounting Standards Board (FASB) issued FASStatement of Financial Accounting Standards (SFAS) 143, “Accounting for Obligations Associated with the Retirement of Long-Lived Assets,” (SFAS 143), which is effective for fiscal years beginning after June 15, 2002. FASSFAS 143 requires legal obligations associated with the retirement of long-lived assets to be recognized at their fair value at the time that the obligations are incurred. Upon initial recognition of a liability, that cost should be recognized as an obligation of AGL Resources and capitalized as part of the related long-lived asset. AGL ResourcesWe adopted FASSFAS 143 on January 1, 2003, and it did not have a material impact on AGL Resources’our financial position or results of operations because no legally enforceable retirement obligations were identifiable and measurable.identified.

AGL Resources’Our regulated entities currently accrue removal costs in accordance with rates approved by their regulators on many of our regulated, long-lived assets through depreciation expense, with a corresponding charge to accumulated depreciation, as allowedin accordance with rates approved by itstheir state jurisdictions.  As of March 31,June 30, 2003, we included accumulated removal costs o of $103.3$103.9 million are included in AGL Resources’our total accumulated depreciation.

Stock-based Compensation

In December 2002, the FASB issued FAS 148. This pronouncement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. Under the fair value based method, compensation cost for stock options is measured when options are issued. In addition, FAS 148 amends the disclosure requirements of FAS 123 to require more prominent and more frequent disclosures in financial statements of the effects of stock-based compensation.

The transition guidance and annual disclosure provisions of FAS 148 were effective for fiscal years ending after December 15, 2002. As of December 31, 2002, AGL Resources adopted FAS 148 through continued application of the intrinsic value method of accounting under APB 25, and enhanced financial statement disclosures of the effect on net income and earnings per share if fair value provisions of FAS 148 had been applied.

AGL Resources hasWe have several stock-based employee compensation plans and accountsaccount for these plans under the recognition and measurement principles of APBAccounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25) and related interpretations. For our stock option plans, we generally nodo not reflect stock-based employee compensation cost is reflected in net income, as options for those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. However, if we subsequently modify the terms of the option granted are modified subsequent to the grant date, AGL Resources re-measureswe re-measure the intrinsic value of the options and recordsrecord compensation expense in accordance with FINFASB Interpretation No. 44, if“Accounting for Certain Transactions Involving Stock Compensation,” when the market value of the underlying stock aton the modification date is greater than the market value of the underlying stock aton the original measurement date or grant date.

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In December 2002, the FASB issued SFAS 148, “Accounting for Stock-Based Compensation – Transition and Disclosure – an amendment of FASB Statement No. 123” (SFAS 148). SFAS 148 provides alternative methods of transition for a voluntary change from other methods of accounting to the fair value based method of accounting for stock-based employee compensation. Under the fair value based method, compensation cost for stock options is measured when options are granted. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 “Accounting for Stock-Based Compensation” (SFAS 123), which requires more prominent and more frequent disclosures in financial statements of the effects of stock-based compensation.

As of December 31, 2002, we adopted SFAS 148 through continued application of the intrinsic value method of accounting under APB 25, and we disclosed the effect on our net income and earnings per share of total stock-based employee compensation expense determined under the fair value based method. The following table illustrates the effect on our net income and earnings per share if AGL Resourceswe had instead applied the fair value recognition provisions of FASSFAS 123.

Comprehensive Income

ComprehensiveOur comprehensive income consists ofincludes net income and other gains and losses affecting shareholders’ equity that under GAAP are excludedexcludes from net income. For AGL Resources, suchSuch items consist primarily of unrealized gains and losses on certain derivatives and minimum pension liability adjustments. At March 31,There were no such items during the six months ended June 30, 2003 and March 31, 2002, and as a result, our total comprehensive income was equal to net income.

Earnings per common shareCommon Share

BasicWe compute basic earnings per common share are computed by dividing our income available to common shareholders by the weighted-average number of common shares outstanding daily. Diluted earnings per common share reflect the potential dilution that could occur when potential diluted common shares are added to common shares outstanding.  Diluted earnings per common share are calculated quarterly and the number of incremental shares to be included at year-end is the weighted average of each quarterly calculation.

AGL Resources'We derive our potential diluted common shares were derived from performance units whoseand stock options. The future issuance is contingent uponof the performance units depends on the satisfaction of certain performance criteria andcriteria. The future issuance of outstanding stock options whosedepends upon the exercise prices wereof the stock options, which are less than the average market price of the common shares for the respective periods.

The following table shows our calculation of our diluted earnings per share.

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Common Shareholders’ Equity

On February 14, 2003, AGL Resourceswe announced the completion of itsour public offering of 6.4 million shares of its common stock including the exercise of the entire over-allotment option. This offering was made under AGL Resources’ existingour shelf registration statement. TheWe priced the offering was priced at $22.00 per share, and generated net proceeds of approximately $136.7 million, which werewe used to repay outstanding short-term debt and for general corporate purposes.

The following table provides details of AGL Resources’our authorized, issued and outstanding common stock as of December 31, 2002 and March 31,June 30, 2003 and theour common shares issuedshare activity during the first quartersix months ended June 30, 2003:

On April 16, 2003, we announced a 4% increase in our common stock dividend, raising the quarterly dividend from $0.27 per share to $0.28 per share, for an indicated annual dividend of $1.12 per share. Our new quarterly dividend became effective with the June 1, 2003 dividend that we paid to our shareholders of record as of the close of business on May 16, 2003.

The following table depicts the 6.4 million shares of common stock issued fromand the average price received as a result of our equity offering and the average issuance price of our stock out of treasury shares, and the average market price, under ResourcesDirect, aour direct stock purchase and dividend reinvestment plan; theour Retirement Savings Plus Plan; theour Long-Term Stock Incentive Plan; theour Long-Term Incentive Plan; and theour Directors Plan.

Other incomeIncome

OtherOur other income consists of the following:

(1)

SouthStar Energy Services, LLC

(2)

US Propane, L.L.C.

Recent Accounting Developments

In JanuaryApril 2003, the FASB released FIN 46,issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (SFAS 149). This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS 133. Our adoption of SFAS 149 had no impact on our condensed consolidated financial statements.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (SFAS 150). This statement revises the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity in a “mezzanine” section of the balance sheet between debt and equity. We adopted the provisions of SFAS 150 effective March 31, 2003, which separates unconsolidated entities, including specialrequired us to classify our Trust Preferred Securities initially at fair value as long-term liabilities in our Condensed Consolidated Balance Sheet.

Financial Instruments, Derivatives and Hedging Activities

SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133) established accounting and reporting standards requiring that every derivative financial instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. However, if the derivative transaction qualifies for and is designated as a normal purchase and sale, it is exempted from the fair value accounting requirements of SFAS 133 and is accounted for using traditional accrual accounting.

SFAS 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. If the derivatives meet those criteria, SFAS 133 allows a derivative's gains and losses to offset related results on the hedged item in the income statement in the case of a fair value hedge, or to record the gains and losses in other comprehensive income until maturity in the case of a cash flow hedge, and requires that a company formally designate a derivative as a hedge as well as document and assess the effectiveness of derivatives associated with transactions that receive hedge accounting.

Interest Rate Swaps

In order to maintain a cost effective capital structure, it is our policy to borrow funds using a mix of fixed rate debt and variable rate debt. We have entered into interest rate swap agreements through our wholly-owned subsidiary, AGL Capital Corporation (AGL Capital), for the purpose entities, investments in equity interestsof hedging the interest rate risk associated with our fixed and partnerships, into two categories:variable rate debt obligations. As of June 30, 2003, a notional principal amount of $175.0 million of these agreements effectively converts the interest expense associated with a portion of our Senior Notes and Trust Preferred Securities from fixed rates to variable rates based on an interest rate equal to the London Interbank Offered Rate (LIBOR), plus a spread determined at the swap date. As of June 30, 2003, our interest rate swaps are:

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entities for which$100.0 million principal amount of our 7.125% Senior Notes due 2011, we pay floating interest each January 14 and July 14 at six-month LIBOR plus 3.4%. For the consolidation decision should be based on voting intereststhree and therefore are subject to SOP 78-9 and EITF 96-16six months ended June 30, 2003, the effective variable interest rate was 4.7%. These interest rate swaps expire January 14, 2011, unless terminated earlier.

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entities$75.0 million principal amount of our 8.0% Trust Preferred Securities due 2041, we pay floating interest rates each February 15, May 15, August 15 and November 15 at three-month LIBOR plus 1.315%. The effective interest rate for which the consolidation decision should be based on variable intereststhree months ended June 30, 2003 was 2.6% and therefore are subject to FIN 46for the six months ended June 30, 2003 was 2.7%. These interest rate swaps expire May 15, 2041, unless terminated earlier.

All companies whose unconsolidated entities are subjectThese interest rate swaps have been designated as fair value hedges as defined by SFAS 133, which allows us to FIN 46 and are issuing financial statements ondesignate derivatives that hedge a recognized asset’s or after January 31, 2003 are required to disclose the nature, purpose, size and activities and the company’s maximumliability's exposure to changes in their fair value. We recognize the gain or loss as a resulton fair value hedges in earnings in the period of its involvementchange together with the variable interest entity. AGL Resources has determinedoffsetting loss or gain on the hedged item attributable to the risk being hedged. The effect of that its consolidation decision should be based on voting interests and therefore will continueaccounting is to use SOP 78-9 and EITF 96-16reflect in reporting its investmentsearnings only that portion of the hedge that is not effective in equity interestsachieving offsetting changes in SouthStar and US Propane.fair value.

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Our interest rate swaps meet the conditions required to assume no ineffectiveness under SFAS 133, and therefore, we have accounted for them using the "shortcut" method prescribed for fair value hedges by SFAS 133. Accordingly, we adjust the carrying value of each interest rate swap to its fair value each quarter, with an offsetting and equal adjustment to the carrying value of the debt securities whose fair value is being hedged. Consequently, our earnings are not affected negatively or positively with changes in fair value of the interest rate swaps each quarter. The aggregate fair value of these interest rate swaps at June 30, 2003 was $9.0 million and at December 31, 2002 was $6.1 million.

Derivative Instruments

We are exposed to risks associated with changes in the market price of natural gas. Through Sequent Energy Management, LP, (Sequent) we use derivative financial instruments to reduce our exposure to the risk of changes in the prices of natural gas as discussed below. Additionally, SouthStar manages a portion of its commodity price risks through hedging activities using derivative financial instruments and physical commodity contracts. The fair value of these derivative financial instruments reflects the estimated amounts that we would receive or pay to terminate or close the contracts at the reporting date, taking into account the current unrealized gains or losses on open contracts. We use external market quotes and indices to value substantially all of the financial instruments we utilize.

Under our risk management policy, we attempt to mitigate substantially all of our commodity price risk associated with Sequent’s storage gas portfolio to lock in the economic margin at the time we enter into gas purchase transactions for our storage gas. We purchase gas for storage when the difference in the current market price we pay to buy gas plus the cost to store the gas is less than the market price we could receive in the future, resulting in a positive net profit margin. We use contracts to sell gas at that future price to substantially lock-in the profit margin we will ultimately realize when the stored gas is actually sold. These contracts meet the definition of a derivative under SFAS 133. The purchase, storage and sale of natural gas is accounted for differently than the derivatives we use to mitigate the commodity price risk associated with our storage portfolio. The difference in accounting can result in volatility in our reported ne t income, even though the economic margin is essentially unchanged from when the transactions were consummated. We do not currently use hedge accounting under SFAS 133 to account for this activity.   

Gas that we purchase and inject into storage is accounted for at the lower of average cost or market as inventory in our condensed consolidated balance sheet, and is no longer marked to market following our implementation of the accounting guidance in EITF 02-03, which is discussed in greater detail later in this note. Under EITF 02-03 we would recognize a loss in any period when the market price for gas is lower than our carrying amount for our purchased gas inventory. Costs to store the gas are recognized in the period the costs are incurred. We recognize revenues and cost of gas sold in our condensed statements of consolidated income in the period we sell gas and it is delivered out of the storage facility. The derivatives we use to mitigate commodity price risk and to substantially lock in the margin upon sale of storage gas are accounted for at fair value and marked to market each period, with changes in fair value recognized as gains or losses in the period of change. This difference in accounting, the accrual basis for our storage gas inventory versus mark to market accounting for the derivatives used to mitigate commodity price risk, can result in volatility in our reported net income. Over time, gains or losses on the sale of storage gas inventory will be offset by losses or gains on the derivatives, resulting in our realization of the economic profit margin we expected when we entered into the transactions. This accounting difference causes Sequent’s earnings on its storage gas positions to be affected by natural gas price changes, even though the economic profits remain essentially unchanged.

Commodity-related activities of our wholesale services segment, which includes Sequent, are monitored by our Risk Management Committee, which is charged with the review and enforcement of our risk management policy. Our risk management policy limits our risk management activities to hedging against price volatility to protect profit margins. Our policy explicitly prohibits the use of speculative trading. We use the following derivative financial instruments and physical transactions to manage such risks:

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forward contracts;

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futures contracts;

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options contracts;

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price and basis swaps; and

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storage and transportation capacity transactions.

Our risk management policy limits the use of these derivative financial instruments and physical transactions to hedge only those price risks associated with:

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pre-existing or anticipated physical natural gas sales;

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pre-existing or anticipated physical natural gas purchases; and

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system use and storage

During 2002, our wholesale services segment accounted for transactions in connection with energy marketing and risk management activities under the fair value, or mark-to-market method of accounting, in accordance with SFAS 133 and with Emerging Issues Task Force (EITF) Issue No. 98-10, “Accounting for Contracts Involved in Energy Trading and Risk Management Activities” (EITF 98-10).  Under these methods, we recorded energy commodity contracts, including both physical transactions and financial instruments, at fair value, and reflected unrealized gains and/or losses in earnings in the period of change.  

Effective January 1, 2003, we adopted  EITF Issue No. 02-03 “Accounting for Contracts Involved in Energy Trading and Risk Management Activities” (EITF 02-03).  EITF 02-03 rescinded the provisions of EITF 98-10 and reached two general conclusions:

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contracts that do not meet the definition of a derivative under SFAS 133 should not be marked to fair market value; and

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revenues should be shown in the income statement net of costs associated with trading activities, whether or not the trades are physically settled

We recorded the following as a result of our adoption of EITF 02-03:  

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adjusted the carrying value of our non-derivative trading instruments (principally storage capacity contracts) to zero and now account for them using the accrual method of accounting;

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adjusted the value of our natural gas inventories used in our wholesale services segment to the lower of average  cost or market, which were previously recorded at fair value. This resulted in a cumulative effect of a change in accounting principle in our condensed consolidated income statement of $12.6 million ($7.8 million net of taxes), that resulted in a decrease of $12.6 million to our energy marketing and risk management assets and a decrease to accumulated deferred income taxes of $4.8 million in our condensed consolidated balance sheets, and

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began reporting our trading activity on a net basis (revenues net of associated costs) effective July 1, 2002, and applied guidance from EITF 02-03 to all prior periods resulting in costs totaling approximately $435.9 million for the three months ended June 30, 2002 and $676.8 million for the six months ended June 30, 2002 being reclassified as a component of our revenues. This reclassification had no impact on our previously reported net income or shareholders’ equity

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Our derivative financial instruments have a weighted average maturity of one to three years, except for our interest rate swaps discussed earlier.  Our derivative financial instruments for the three months ended June 30, 2003 and six months ended June 30, 2003 represented purchases (long) of 179.8 billion cubic feet and 411.3 billion cubic feet and sales (short) of 200.5 billion cubic feet and 382.4 billion cubic feet.

We recorded unrealized losses of $3.6 million for the three months ended June 30, 2003 and unrealized gains of $1.1 million for the three months ended June 30, 2002 as a result of our energy marketing and risk management activities. Excluding the cumulative effect of a change in accounting principle, our unrealized gains during the six months ended June 30, 2003 were $6.0 million and we recorded unrealized losses of $1.0 million for the six months ended June 30, 2002.

The following table includes the fair values and average values of Sequent's energy marketing and risk management assets and liabilities at June 30, 2003. We based the average values on a monthly average for the three months ended and the six months ended June 30, 2003.

Concentration of Credit Risk

Concentration of credit risk occurs at AGLC, where costs for distribution operations are charged out and collected from both Georgia Public Service Commission (GPSC) Certificated Marketers (Marketers) selling retail natural gas in Georgia and poolers. For the six months ended June 30, 2003, the four largest Marketers based on customer count, one of which is our partially owned affiliate, accounted for approximately 55.1% of the Company’s and 61.5% of distribution operations' operating margin.

Several factors are designed to mitigate our risks from the increased concentration of credit that has resulted from deregulation. The provisions of AGLC's tariff allow AGLC to obtain credit support in an amount equal to a minimum of two times a Marketer's highest month's estimated bill from AGLC. In addition, AGLC bills intrastate delivery service to the Marketers in advance rather than in arrears. We accept credit support in the form of cash deposits, letters of credit/surety bonds from acceptable issuers and corporate guarantees from investment grade entities. Our risk management committee reviews the adequacy of credit support coverage, credit rating profiles of credit support providers and payment status of each Marketer on a monthly basis. We believe that adequate policies and procedures have been put in place to properly quantify, manage and report on AGLC's credit risk exposure to Marketers.

Sequent, which provides services to Marketers, utility and industrial customers, also has a concentration of credit risk measured by 60-day receivable exposure. By this measure, Sequent’s top 20 counterparties represent approximately 76% of our total exposure of $242 million. All of Sequent’s counterparties are assigned internal ratings determined from the counterparty’s external ratings with Standard & Poor’s and Moody’s. The internal rating is multiplied by the counterparty’s credit exposure with Sequent and divided by our total counterparty credit exposure. As of June 30, 2003, Sequent’s counterparties or the counterparty’s guarantor have a weighted average Standard & Poor’s equivalent credit rating of BBB.

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2. Regulatory Assets and Liabilities

AGL Resources hasWe have recorded regulatory assets and liabilities in itsour condensed consolidated balance sheets in accordance with FAS 71.SFAS 71, “Accounting for the Effects of Certain Types of Regulation,” excluding regulatory assets of approximately $1.0 million at Virginia Natural Gas (VNG), which are subject to reduction to the extent that VNG’s return on pro-forma equity exceeds 10% as included in VNG’s weather normalization adjustment program order. These regulatory assets are recoverable either through a rate rider or through base rates specifically authorized by a state commission. Certain assets have associated liabilities that are disclosed here. AGL Resources'Our regulatory assets and liabilities, and associated liabilities for our unrecovered pipeline replacement program costs and unrecovered environmental response costs are summarized in the following table:table below:

Pipeline Replacement

AGLC hasAtlanta Gas Light Company (AGLC) recorded a long-term liability of $436.2$364.5 million as of June 30, 2003 and $444.0 million as of March 31, 2003 and December 31, 2002, respectively, which representsrepresent engineering estimates for remaining capital expenditure costs in the PRP.pipeline replacement program.  The PRPpipeline replacement program represents an approved settlement between AGLC and the staff of the GPSC that detailed a 10-year replacement of 2,300 miles of cast iron and bare steel pipe. TheAGLC recovers the costs are recoverable through a combination of SFV ratesa straight fixed variable rate design, which spreads AGLC’s delivery service revenue evenly throughout the year, and a pipeline replacement revenue rider. As of March 31,June 30, 2003, AGLC had recorded a current liability of $50.0$67.1 million representing the expected pipeline replacement program expenditures of the program for the next 12 months.

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Environmental Matters

Before natural gas was widely available in the Southeast AGLC andor its predecessor companies manufactured gas from coal and other fuels. Those manufacturing facilities were known as MGPs,manufactured gas plants (MGPs), which AGLC ceased operating in the 1950’s. Because of contemporary environmental standards, AGLC is required to investigate possible environmental contamination at those plants and, if necessary, clean up any contamination.

AGLC has been associated with ten MGPidentified 13 sites in Georgia and three in Florida.Florida where AGLC or its predecessors operated MGPs. In connection with these operations, AGLC is aware of the presence of coal tar and certain other by-products of the gas manufacturing process at or near some of these former sites. Based on investigations to date, AGLC believes that some cleanup is likely at most of thethese sites. In Georgia, the investigation and cleanup of MGPAGLC has active environmental remediation or monitoring programs in effect at 11 sites in Georgia. There is supervised by the state Environmental Protection Division. In Florida, the U.S. Environmental Protection Agency has that responsibility.

#no active remediation or monitoring program at two sites in Georgia.

As of March 31,June 30, 2003, theour MGP remediation program was approximately 63%67% complete. TheWhere the soil remediation for all ofis required at our Georgia sites, the Georgia siteswork is targeted to be complete by January 2005. TheTwo of the three sites in Sanford, FL, and Orlando, FLFlorida are currently in the preliminary investigation or engineering design phase. Additionally, one Macon, GA site is non-active because the site currently meets an acceptable standard for non-residential commercial property.

AGLC has historically reported estimates of future remediation costs for MGPs based on probabilistic models of potential costs. As cleanup options and plans mature and cleanup contracts are entered into, AGLC is increasingly able to provide conventional engineering estimates of the likely costs of many elements of its MGP program. These estimates contain various engineering uncertainties, and AGLC continuously attempts to refine and update these engineering estimates. In addition, AGLC continues to review technologies available for the cleanup of AGLC’s two largest sites, Savannah and Augusta, which, if proven, could have the effect of reducing AGLC’s total future expenditures. As

Our last engineering estimate was as of DecemberMarch 31, 2002,2003. This estimate projected costs associated with AGLC’s engineering estimates and in-place contracts are $89.5to be $85.2 million. For those remaining elements of the MGP program where AGLC still cannotis unable to perform engineering cost estimates at the current state of investigation, there remains considerable va riabilityvariability in availablethe estimates for future cost estimates.remediation costs. For these elements, the estimates for the remaining cost of future actions at the MGP sites is $10.5range from $7.5 million to $28.7$28.2 million. AGLC cannot at this time identifyestimate any single number within this range as a better estimate of its likely future costs. As a result, AGLC accrued the lower end of the range, or $7.5 million for these remaining elements in our environmental response costs. Finally, AGLC has estimates of certain other costs paid directly by AGLC related to administering the MGP program. Through January 2005, AGLC estimates those costs are estimated to be $2.5$2.6 million; at this time AGLC generally cannot estimate expenses beyond this period generally cannot be estimated at this time. Consequently, asperiod.

As of MarchJune 30, 2003 and December 31, 2003, AGLC has recorded the sum of $89.5 million plus the lower end of the remaining range, $10.5 million and the direct pay expenses of $2.5 million, less the cash payments made during the first quarter of calendar 2003 of $5.7 million, or a total of $96.8 million, as a2002, AGLC’s environmental response cost liability andis comprised of:

The environmental response cost liability is included in a corresponding regulatory asset. As of June 30, 2003, the regulatory asset was $179.1 million, which is a combination of an equal amount.the accrued environmental response costs and unrecovered cash expenditures. The liability does not include other potential expenses, such as unasserted property damage claims, personal injury or natura lnatural resource damage claims, unbudgeted legal expenses, or other costs for which AGLC may be held liable but with respect to which we cannot reasonably estimate the amount cannot be reasonably estimated.amount. The liability also does not include certain potential cost savings as described above.

The decrease in the liability from $105.0 million reported at December 31, 2002 to $96.8 million at March 31, 2003 is the result of expenditures paid for cleanup for the various sites, $5.7 million for the first quarter 2003, plus a net decrease in projected future costs. #

AGLC has two ways of recovering investigation and cleanup costs. First, the GPSC has approved an ERCenvironmental response cost recovery rider. It allows the recovery of costs of investigation, testing, cleanup and litigation. Because of that rider, AGLC has recorded a regulatory asset forthese actual and projected future costs related to investigation and cleanup to be recovered from customers in future years.years are included in our regulatory asset. During the first quarterthree and six months ended June 30, 2003, AGLC recovered $5.5 million and $11.1 million through its ERCenvironmental response cost recovery rider. The second way AGLC can recover costs is by exercising the legal rights AGLC believes it has to recover a share of its costs from other potentially responsible parties, typically former owners or operators of the MGP si tes.sites. There were no material recoveries from potentially responsible parties during the first quartersix months ended June 30, 2003.

The significant years for spending for this program are 2002, 2003 and 2004. The ERCenvironmental response cost recovery mechanism allows for recovery of expenditures over thea five-year period subsequent to the period in which the expenditures were incurred. As of March 31,June 30, 2003, the MGP expenditures expected to be incurred over the next twelve months are reflected as a current liability of $45.9$48.4 million. In addition, AGLC expects to collect $23.1$23.8 million in revenues over the next twelve months under the ERCenvironmental response cost recovery rider, which is reflected as a current asset.

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3. Financing

(1)

The daily weighted average rate was 1.6%1.5% for the six months ended June 30, 2003 and 2.2% for the first quarter 2003 and calendar 2002, respectively.twelve months ended December 31, 2002.

(2)

On July 2, 2003, we issued $225.0 million in Senior Notes. The proceeds were used to repay approximately $110.0 million of commercial paper and $65.3 million of long-term debt. Additionally, we entered into interest rate swaps of $100.0 million to effectively convert a portion of the fixed rate obligation on the $225.0 million Senior Notes to variable rate obligations. For more information see Note 8, “Subsequent Events.”

(3)

The daily weighted average rate was 1.7% and 2.2%1.8% for the first quartersix months ended June 30, 2003 and calendar 2002, respectively.2.3% for the twelve months ended December 31, 2002.

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4. Commitments and Contingencies

The following table illustrates AGL Resources'our expected future contractual cash obligations as of March 31,June 30, 2003.

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In January 2003, the FASB released FIN 45.FASB Interpretation No. 45, “Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN 45). For many of the guarantees or indemnification agreements AGL Resources issues,we issue, FIN 45 requires disclosure of the nature of the guarantee and the maximum potential amount of future payments that could be required of us as the guarantor. The table below illustrates theour other expected commercial commitments that are outstanding as of March 31,June 30, 2003 and metmeet the disclosure criteria required by FIN 45.

The Owners of SouthStarCaroline Street Campus

We have entered into a capital contributionan agreement to sell our 34-acre Caroline Street campus, where the majority of our Atlanta-based employees were located prior to our move to Ten Peachtree Place, our new corporate headquarters. This transaction, previously expected to close no later than December 31, 2003 is now expected to close before September 30, 2003. We anticipate that, requires each Owner to contribute additional capital to SouthStar to pay invoices for goods and services received from any vendor that is affiliated with an Owner whenever funds are not otherwise available to pay those invoices. The capital contributions to pay affiliated vendor invoices are repaid by SouthStar as funds become available, but repayment is subordinated to SouthStar's obligations under its revolving line of credit with financial institutions. There were no capital contributions made byupon closing, the Owners during the first quarter 2003 or first quarter 2002 under this arrangement.estimated net gain will be approximately $10.0 million.

In the normal course of business, AGL Resources guarantees, or provides collateral for, the obligations of its subsidiaries and affiliates. The limited partnership agreement of US Propane requires that, in the event of liquidation, all limited partners would be required to restore capital account deficiencies, including any unsatisfied obligations of the partnership. AGL Resources’ maximum capital account restoration would be $13.6 million. Currently AGL Resources’ capital account is positive. Management believes that the occurrence of US Propane’s liquidation is not probable and, accordingly, no liability has been recorded at March 31, 2003.Litigation

Asset Management

On December 23, 2002, the GPSC issued an order finalizing the results of a USF audit conducted by the GPSC staff. This audit was designed to examine the USF’s operation from its inception through September 30, 2001. Following the completion of the audit, AGLC submitted $4.7 million to the USF in January 2003. Of the $4.7 million AGLC submitted, $0.8 million related to timing differences and $3.9 million related to the use of capacity assets by AGLC’s asset manager, Sequent.

Litigation

On May 24, 2002, one of AGLC's AMR vendors, IMServ, Inc., sent AGLC a notice under the AMR agreement, alleging various breaches of contract by AGLC and asserting that it had incurred damages. On March 6, 2003, the parties executed a settlement agreement and release with respect to the AMR agreement and the related dispute, the terms of which the parties have agreed to keep confidential. In calendar 2002, AGL Resources had established a reserve related to this dispute, and the reserve was sufficient to cover the costs of this settlement.

AGL Resources isWe are involved in litigation arising in the normal course of business. AGL Resources believesWe believe the ultimate resolution of such litigation will not have a material adverse effect on theour consolidated financial statements.position, results of operations and cash flows.

On July 1, 2003, the city of Augusta, Georgia served AGLC with a complaint that was filed in the Superior Court of Richmond County, Georgia against AGLC. Augusta’s allegations include fraud and deceit and damages to realty. The allegations arise from negotiations between the city and AGLC regarding our environmental cleanup obligations connected with AGLC’s former manufactured gas plant operations in Augusta. The city of Augusta seeks relief in the form of damages including an amount to be determined by a jury for the alleged fraud and deceit, together with attorney fees and punitive damages. We believe the claims asserted in this complaint are without merit, and we have remained in active settlement negotiations with the City. For more information about the manufactured gas plants and our environmental cleanup obligations, please see Item 1, Financial Statements, Note 2 “Regulatory Assets and Liabilities – Environmental Matters. 8;

5. Related Party Transactions

Distribution operationsWe recognized revenue and had accounts receivable from SouthStar of the following:

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AGL Resources'

6. Investments in Equity Interests

We use the equity method to account for our equity interests where we hold a 20% to 50% voting interest, unless control can be exercised over the entity. Under the equity method, our ownership interest in the entity is reported as an investment within our condensed consolidated balance sheets. Additionally, our percentage ownership in our equity interest’s earnings or losses is reported in our condensed statements of consolidated income under other income.

In January 2003, the FASB released FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46). Companies with unconsolidated entities subject to FIN 46, or referred to as variable interest entities and issuing financial statements on or after January 31, 2003 are required to disclose the nature, purpose, size and activities of the variable interest entity as well as the company’s maximum exposure to a loss as a result of its involvement with the variable interest entity. FIN 46 separates unconsolidated entities, including special purpose entities and investments in equity interests and partnerships, into two categories:

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entities for which the consolidation decision should be based on voting interests; and

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entities for which the consolidation decision should be based on variable interests and therefore are subject to FIN 46.

We have determined that our consolidation decision should be based on voting interests in reporting our investments in equity interests in SouthStar and US Propane, L.L.C. (US Propane).

Our investment in US Propane did not have a material effect on our financial position, results of operations and cash flows for the three and six months ended June 30, 2003 and 2002. Our investment in SouthStar, in which we currently hold a non-controlling 70% financial interest, had a material effect on AGL Resources'our financial position and results of operations for first quarterthe three and six months ended June 30, of 2003 and 2002.  The unaudited amounts below represent 100% of the results of SouthStar, in which AGL Resources currently holds a non-controlling 70% financial interest, and as a result these amountsSouthStar. The results are not comparable to AGL Resources' percentage ownership inwith SouthStar’s earnings or losses reported as other income in AGL Resources’our condensed consolidated statements of income.income, since those amounts are reported based on our percentage ownership.SouthStar’s net income from continuing operations and net income is equal as they do not incur income tax expenses.

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6.

7. Segment Information

AGL ResourcesOur business is organized into three operating segments:

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Distribution operations consists of AGLC, VNG and CGC.Chattanooga Gas Company (CGC).

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Wholesale services consists primarily of Sequent.

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Energy investments consists of SouthStar, AGL Networks, SouthStar,LLC (AGL Networks), US Propane and several other nonregulated, energy-related subsidiaries.

Additionally, AGL Resources treats theWe treat our corporate segment as a nonoperating business segment. The corporate segment, which includes AGL Resources Inc., AGSC,AGL Services Company, nonregulated financing and captive insurance subsidiaries, and the effect of intercompany eliminations. IntersegmentWe eliminated intersegment sales infor the three and six months ended March 31,June 30, 2003 and March 31, 2002 were eliminated from theour condensed consolidated statements of income.

Management evaluates segment performance based on EBIT,a non-GAAP measure of earnings before interest and taxes (EBIT), which includes the effects of corporate expense allocations. Items that arewe do not includedinclude in EBIT are financing costs, including interest and debt expense, income taxes and the cumulative effect of change in accounting principle, each of which are evaluatedwe evaluate on a consolidated level. AGL Resources believesWe believe EBIT is a useful measurement of itsour performance for investorsyou because it provides information that can be used to evaluate the effectiveness of our businesses from an operational perspective, exclusive of the costs to finance those activities and exclusive of income taxes, neither of which are directly relevant to the efficiency of those operations.

As an indicator of AGL Resources' operating performance, EBIT should not be considered an alternative to, or more meaningful an indicator of our operating performance than operating income or net income as determined in accordance with GAAP. AGL Resources'In addition, our EBIT may not be comparable to a similarly titled measure of another company.

The reconciliations of our EBIT to operating income and net income are presented below for the three and six months ended June 30, 2003 and 2002:

(1)

Identifiable assets are those assets used in each segment'ssegment’s operations. AGL Resources'Our corporate segment’s assets consist primarily of intercompany eliminations, cash and cash equivalents and property, plant and equipment.

(2)

Includes intercompany eliminations.

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