DYNEGY INC /IL/ - 10-K Annual Report

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

------------------------

FORM 10-K

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

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001

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

FOR THE TRANSITION PERIOD FROM __________________ TO __________________

COMMISSION FILE NUMBER: 1-15659

DYNEGY INC.
(Exact name of registrant as specified in its charter)

ILLINOIS 74-2928353
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)

1000 LOUISIANA, SUITE 5800
HOUSTON, TEXAS 77002
(Address of principal executive (Zip Code)
offices)

Registrant's telephone number, including area code: (713) 507-6400

Securities registered pursuant to Section 12(b) of the Act:
Title of each class: Name of each exchange on which registered:
Class A common stock, no par value New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:
Title of each class: Name of each exchange on which registered:
None --

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to the
filing requirements for the past 90 days. Yes /X/ No / /

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

The aggregate market value of voting stock held by non-affiliates of the
registrant as of March 4, 2002, computed by reference to the closing sale price
of the registrant's common stock on the New York Stock Exchange on such date,
was $7,724,959,720, using the definition of beneficial ownership contained in
Rule 13d-3 under the Securities Exchange Act of 1934 and excluding shares held
by directors and executive officers.

Number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date: Class A common stock, no par value per
share, 268,881,299 shares outstanding as of March 4, 2002; Class B common stock,
no par value per share, 96,891,014 shares outstanding as of March 4, 2002.

DOCUMENTS INCORPORATED BY REFERENCE. Portions of Parts I, II and IV incorporate
the Annual Report to Shareholders for the fiscal year ended December 31, 2001.
Part III (items 10, 11, 12 and 13) incorporates the Notice and Proxy Statement
for the 2002 Annual Meeting of Shareholders to be filed not later than 120 days
after December 31, 2001.

DYNEGY INC. FORM 10-K TABLE OF CONTENTS

DYNEGY INC. PART I

ITEM 1. BUSINESS

THE COMPANY
Dynegy Inc. (together with its subsidiaries, "Dynegy" or the "Company") is one
of the world's leading energy merchants. Through our global energy delivery
network and marketing, logistics and risk-management capabilities, we provide
innovative solutions to customers in North America, the United Kingdom and
Continental Europe. Our businesses include power generation and wholesale and
direct commercial and industrial marketing of power, natural gas, coal and other
similar products. We are also engaged in the transportation, gathering and
processing of natural gas liquids and the transmission and distribution of
electricity and natural gas to retail consumers. Dynegy is also engaged in
pursuing and capturing opportunities in the converging energy and communications
marketplace with its global long-haul fiber optic and metropolitan network in
key cities in the United States and Europe.
Dynegy began operations in 1985 and became incorporated in the State of
Illinois in 1999 in connection with the acquisition of Illinova Corporation. The
Company's principal executive office is located at 1000 Louisiana, Suite 5800,
Houston, Texas 77002, and the telephone number of that office is
(713) 507-6400. Dynegy and its affiliates maintain marketing or regional offices
in Atlanta, Georgia; Aurora, Colorado; Boston, Massachusetts; Calgary, Canada;
Chicago, Illinois; Dallas, Texas; Decatur, Illinois; Elida, Ohio; Hong Kong,
China; Hyderabad, India; London, England; Lucerne, Switzerland; Manama, Bahrain;
Midland, Texas; Milan, Italy; Montreal, Canada; Oakville, Canada; Oklahoma City,
Oklahoma; Omaha, Nebraska; Paris, France; Pleasanton, California; Richmond,
England; Tampa, Florida; and Washington, D.C.

SEGMENT DISCUSSION

[REPORTABLE SEGMENTS CHART]
The Company is a holding company and has four reportable business segments:
Wholesale Energy Network ("WEN"), Dynegy Midstream Services ("DMS"),
Transmission and Distribution ("T&D") and Dynegy Global Communications ("DGC").
Financial information, including revenues from external customers by similar
products or services and by geographic area, net
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DYNEGY INC. PART I

income (loss) and total assets by geographic area are disclosed by segment as
set forth in Note 17 to the consolidated financial statements.

WHOLESALE ENERGY NETWORK SEGMENT
WEN is engaged in the physical generation of electricity, the aggregation of
natural gas supplies and the delivery of customer-focused products and services,
such as risk-management services, around wholesale natural gas, power, coal and
other similar products. This segment is focused on optimizing the Company's and
its customers' global portfolio of assets and capacity contracts, as well as
direct commercial and industrial sales and retail marketing alliances. The
Company provides customer and risk-management activities to wholesale energy
consumers in North America, the United Kingdom and Continental Europe and
continues to assess local, regional and national markets, regulatory
environments and other factors in order to support and direct future investment.
WEN is focused on the "Energy Value Chain," which is predicated on the notion
that the economy consumes physical quantities of energy commodities, such as
natural gas, electricity and coal and other similar products, and that consumers
of energy expect reliability of supply as well as management of price. The
logistics needed to move energy commodities from points of production to
end-users requires substantial knowledge of energy infrastructure and the
ability to access and utilize this infrastructure. The management of price risk
requires knowledge of market factors impacting the economic realities of supply
and demand. Dynegy's strength is its ability to capitalize on its extensive
network of energy assets, contractual arrangements and market knowledge to
provide its customers with reliable sources of physical energy, products and
services. Dynegy combines physical delivery of energy through its extensive
logistics infrastructure with its price risk-management capabilities and market
expertise to provide our customers with customized products to meet their
services needs.

[ENERGY VALUE CHAIN CHART]
Dynegy views its gas and power marketing and power generation businesses as an
integrated unit. Control of merchant generation, when coupled with the Company's
national wholesale gas and power marketing franchise, creates a wide range of
value-creation opportunities benefiting both the Company and its customers.
Dynegy's wholesale marketing franchise adds value to its generation assets by
providing national market access, market

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DYNEGY INC. PART I

infrastructure and intelligence, risk-management and arbitrage opportunities,
fuel management and procurement expertise and transmission expertise for inputs
(gas, coal and fuel oil) and outputs (power). Generation capacity, in turn, adds
value to the Company's wholesale marketing franchise by providing an
outlet/market for gas and coal supplies, a source of reliable power supply and
an enhanced ability to structure innovative new products and services for
customers.
NATURAL GAS PURCHASES. As part of our wholesale energy business, Dynegy
purchases natural gas from a wide variety of suppliers. Dynegy also purchases at
various index prices and markets substantially all of the natural gas produced
or controlled by Chevron U.S.A. Inc. in the United States (except Alaska). In
addition, the Company and ChevronTexaco Corp., ("ChevronTexaco") have agreed
pursuant to a term sheet dated December 12, 2001 to expand this commercial
relationship to include the volumes historially produced by Texaco. On March 1,
2002, a subsidiary of the Company began buying the historical Texaco volumes on
an interim basis and is in the late stages of negotiations with ChevronTexaco to
finalize a long term commercial agreement to cover these volumes. This
relationship provides the Company with a significant, stable supply of natural
gas which, when combined with gas supplies available from our network of other
supply sources, allows us to effectively manage gas supplies and reduces the
risk of short-term supply shortages during periods of peak demand. In 2001,
approximately 22 percent of WEN's natural gas purchases were made from Chevron
U.S.A. Inc.
The Company's expanded relationship with ChevronTexaco will increase the
volume of natural gas we purchase from Chevron U.S.A. Inc. and ChevronTexaco
from approximately 2.0 Bcf/d to approximately 3.0 Bcf/d. We also expect to
provide supply and service for approximately 2.0 Bcf/d of natural gas for the
former Texaco's facilities and third-party term markets.
TRANSPORTATION. The Company arranges for transportation of the natural gas it
markets from the supplier's receipt point to the purchaser's requested delivery
point. The Company generally retains title to this natural gas from the receipt
point to the delivery point and obtains pipeline transportation. The Company
believes that its understanding of the United States' pipeline network, along
with the scale and geographic reach of its gas marketing efforts, are important
to the Company's success as a physical supplier of energy. The Company uses a
variety of transportation arrangements to move its customers' volumes, including
short-term and long-term firm and interruptible agreements with pipelines and
brokered firm contracts with its customers.
NATURAL GAS SALES. The Company sells natural gas under sales agreements that
have varying terms and conditions intended to match seasonal and other changes
in demand. The Company's wholesale customer base consists primarily of gas and
electric utilities and industrial and commercial end-users and marketers of
natural gas. For the year ended December 31, 2001, the Company sold an aggregate
average of 12.6 Bcf/d of natural gas. As described above, Dynegy expects future
average physical natural gas sales to increase significantly as a result of
additional supply volumes to be provided by ChevronTexaco.
NATURAL GAS STORAGE. Natural gas storage capacity plays an important role in
the Company's ability to act as a full-service natural gas marketer by allowing
us to manage relatively constant gas supply volumes with uneven demand levels.
Through the use of our storage capabilities, we offer peak delivery services to
satisfy winter heating and summer electric-generating demands. Storage
inventories also provide performance security or "backup" service to our
customers. The Company at various times leases short-term and long-term firm and
interruptible storage. Our recent acquisitions of Northern Natural Gas Company
("Northern Natural") and BG Storage Limited should enable us to expand storage
services in the U.S. and U.K. markets.

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DYNEGY INC. PART I

POWER. Dynegy markets electricity and power products and services, providing
a 24-hour-a-day resource for the sale and purchase of power through access to
wholesale markets throughout North America and Europe. The Company helps
generation customers manage and optimize their fuel supplies, optimize
generation assets and capacity utilization and maximize energy conversion and
tolling opportunities. In addition, the Company provides market aggregation and
sales assistance and risk-management services and strategies. The Company will
at times contract for transmission capacity over regulated transmission lines in
order to facilitate regional movements of power. In 2001, Dynegy sold
317 million megawatt-hours of electricity.
At December 31, 2001, Dynegy had interests in 41 power projects in operation,
under construction or in development, having gross capacity of 18,833 MW (13,738
MW net) of electricity. Approximately 61 percent of these facilities were solely
gas-fired plants, with the remaining facilities fueled by coal, heavy fuel oil
or some combination of coal, fuel oil and natural gas. The combined gross
capacity of owned facilities in operation at December 31, 2001 approximated
15,856 MW (10,761 MW net) of electricity and 2.7 million pounds per hour of
steam available for sale to third parties. Approximately 68 percent of the gross
capacity (55 percent net) in operation at December 31, 2001 was under long-term
power purchase agreements.
Domestically, our power plants are located in California, Georgia, Illinois,
Kentucky, Louisiana, Michigan, Nevada, New York, North Carolina, Ohio, Texas,
Virginia and Washington. In addition, in connection with our 2000 acquisition of
Illinova Corporation, we acquired a total of seven operating power projects in
China, Costa Rica, Honduras, Jamaica, Pakistan and Panama having an aggregate
gross capacity of 918 MW (228 MW net) of electricity.
In addition to ownership and operation of generation facilities, the Company
provides services to affiliated ventures in the areas of project development,
engineering, regulatory and environmental affairs, operating and maintenance
services, business and energy management and fuel supply.
COMMERCIAL AND INDUSTRIAL. Deregulation of the gas and power markets is
evolving to encourage greater competition and access to markets. As a result,
Dynegy is pursuing opportunities to provide energy solutions to regional and
national commercial and industrial customers who need customized energy
solutions for their natural gas and electricity requirements. Dynegy's services
include full requirements energy management, supply delivery or asset management
and price risk-management services. Dynegy believes that its energy network and
physical logistics capability positions the Company to provide mutually
beneficial energy solutions to our customers.
In addition, Dynegy's retail gas and electric strategy is to strengthen key
customer relationships by forming regional retail gas and power alliances, which
require less capital investment and fewer financial risks relative to other
national retail marketing strategies. The combination of Dynegy's low-cost
energy supply with a regional utility's large, installed customer base and local
name recognition positions each alliance to capture a significant portion of the
local gas and power market when those markets fully open to competition.

DYNEGY MIDSTREAM SERVICES SEGMENT
GENERAL. DMS consists primarily of the Company's North American midstream
liquids operations, NGL marketing and global LPG transportation and marketing
operations, located principally along the Gulf Coast and in London. North
American midstream liquids operations are actively engaged in gathering and
processing natural gas and fractionating, storing, terminalling, transporting,
distributing and marketing NGLs. This vertically integrated NGL infrastructure
permits the Company to generate revenues throughout all facets of the NGL
business, from inlet natural gas volumes gathered from producing horizons to
distributing
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DYNEGY INC. PART I

and marketing NGLs to end-users throughout the world. This business provides the
Company with broad-based, real-time market information that allows the Company
to capture capacity, demand and distribution inefficiencies that exist from time
to time in the market.
On February 25, 2002, Dynegy Energy Partners L.P., a newly formed limited
partnership created to own and operate a portion of our NGL business, filed a
Registration Statement on Form S-1 with the Securities and Exchange Commission
for an initial public offering. The partnership will succeed to a portion of
DMS' downstream NGL business. Specifically, it will be engaged in fractionation,
storage, terminalling, transportation, distribution and marketing NGLs to
consumers throughout North America. Dynegy and certain of its affiliates will
own the general partner interest of the partnership.

[LIQUIDS VALUE CHAIN CHART]
DMS attempts to maximize earnings from its vertically integrated core gas
gathering, processing and downstream assets. Similar to WEN's convergence
strategy, ownership and control of upstream processing and downstream
fractionation, storage, terminalling and transportation assets provides
opportunities to DMS' NGL distribution and marketing business. DMS' human and
capital resources are aligned and focused on capturing growth opportunities in
all core areas, including the Gulf of Mexico region and areas outside North
America.
The Company is among the industry leaders in substantially all midstream
component businesses, ranging from natural gas processing to distributing and
marketing NGLs to end-users. Based on recent data, we are the sixth largest
processor of natural gas in the United States. Additionally, our position is
expected to grow as the Company is in the final stages of negotiations with
ChevronTexaco to expand its relationship to include the historical Texaco
volumes. In December 2002, the Company expanded its commercial agreement with
ChevronTexaco to purchase the undedicated liquid production associated with the
processing of Texaco's natural gas. In January 2002, the Company also purchased
Texaco's wholesale propane marketing business and integrated it into Dynegy's
existing wholesale business.
NATURAL GAS GATHERING AND PROCESSING. The natural gas processing industry is
a major oil and gas industry segment, providing the necessary service of
refining raw natural gas into marketable pipeline quality natural gas and NGLs.
We own interests in 23 gas processing plants, including 13 plants we operate, as
well as associated and stand-alone natural gas gathering pipeline systems. These
assets are located in key producing areas of Louisiana, New Mexico
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DYNEGY INC. PART I

and Texas. During 2001, we processed on average 1.9 Bcf/d of natural gas and
produced on average 84 thousand gross barrels per day of NGLs. We have the right
to process substantially all of Chevron U.S.A. Inc's processable natural gas in
those geographic areas where it is economically feasible for us to do so. We are
also in the final stages of negotiations with ChevronTexaco to process the
historial Texaco volumes. In 2002, we estimate that approximately 60 percent of
the volume processed will be under percentage of proceeds contracts, 29 percent
will be under processor economic election contracts (either keep whole or fee
based) and the remaining 11 percent will be under keep whole processing
arrangements. Percent of proceeds contracts give a portion of the NGLs and
natural gas residue as payment for processing, while keep whole contracts
require replacement of all Btus removed from the gas stream during processing.
Our natural gas processing services are provided at two types of plants,
referred to as field and straddle plants. Field plants aggregate volumes from
multiple producing wells into quantities that can be economically processed to
extract NGLs and to remove water vapor, solids and other contaminants. Straddle
plants are situated on mainline natural gas pipelines and allow operators to
extract NGLs from a natural gas stream and replace the equivalent Btus with
pipeline quality gas when the market value of NGLs separated from the natural
gas stream is higher than the market value of the same unprocessed natural gas.
FRACTIONATION. Liquids removed from natural gas at processing plants are
generally in the form of a commingled stream of light liquid hydrocarbons (raw
product). The commingled NGLs are separated at fractionation facilities into
component products of ethane, propane, normal butane, isobutane and natural
gasoline. Fractionation contracts typically include a base fee per gallon
subject to adjustment for certain variable costs, such as energy consumed in
operation. The Company has ownership interests in three stand-alone
fractionation facilities: two in Mont Belvieu, Texas and one in Lake Charles,
Louisiana. We operate the Louisiana facility and one of the Mont Belvieu
facilities. During 2001, these facilities fractionated an aggregate average of
226 thousand gross barrels per day.
TRANSPORTATION OPERATIONS. The Company has developed a NGL transportation and
logistics infrastructure that is comprised of a wide range of transportation and
distribution assets designed to satisfy the various delivery requirements of our
distribution and marketing services business. In the United States, the Company
owns over 9,700 miles of gas gathering and gas liquids pipelines, primarily in
the North Texas, Gulf Coast and Permian Basin regions. We also have access to
approximately 2,000 railcars through a services agreement with ChevronTexaco. We
own and operate 88 tank trucks and 21 pressurized barges. These assets are
deployed to serve our wholesale distribution terminals, Texas Gulf Coast
fractionators, underground storage facilities, pipeline injection terminals and
many of the nation's crude oil refineries. The Company's large-scale marine
terminals are located in Mississippi, Texas, Florida, Tennessee and Louisiana,
offering importers and wholesalers a variety of methods for transporting
products to the marketplace. We control over 108 million barrels of underground
liquids storage capacity in Texas, Louisiana, and Mississippi, providing
customers with the ability to store, buy and sell specification products.
DISTRIBUTION AND MARKETING SERVICES. Dynegy's distribution and marketing
services include: (1) refinery services, (2) wholesale propane marketing and
(3) purchasing mixed NGLs and NGL products from NGL producers and other sources
and selling such NGL products to petrochemical manufacturers, refineries and
other marketing companies.
In connection with our refinery services operations, we purchase NGL products
from refinery customers, such as Chevron U.S.A. Inc, and sell NGL products to
various customers. The Company generally earns a margin in these operations by
retaining a portion of the resale price or a fixed minimum fee per gallon.
Approximately 15 percent of DMS' NGL purchases in

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DYNEGY INC. PART I

2001 were from Chevron U.S.A. Inc and approximately 12 percent were from another
supplier. In 2001, the Company sold an average of 41 thousand barrels per day
through this refinery services business.
Wholesale propane marketing operations include the sale of propane and related
logistical services to major multi-state retailers, independent retailers and
other end users. Our propane supply comes from our refinery services operations
and from our other distribution and marketing operations. We generally sell
propane at a fixed price based on the current market price established at Mont
Belvieu or for the posted price at the time of delivery. In 2001, the Company
sold an average of approximately 51 thousand barrels of propane per day.
We market our own NGL production and also purchase NGLs from third parties for
resale. Our distribution and marketing services business sold an average of
366 thousand barrels per day of NGLs in North America in 2001. The Company
generally purchases NGL products from producers at a monthly pricing index less
applicable fractionation, transportation and marketing fees and resells these
products to petrochemical manufacturers, refineries and other marketing
companies. In addition to margins that the Company earns from purchasing NGL
products from producers pursuant to contract, we also earn a margin by
purchasing and selling NGL products in the spot market and in the forward
market.
Dynegy also markets LPG worldwide via use of chartered large-hull ships. In
2001, 100 thousand barrels per day of LPG were marketed by this business. These
operations acquire and market product from producing areas in the North Sea,
West Africa, Algeria and the Arabian Gulf as well as from the U.S. Gulf Coast
region. Dynegy plans continued expansion of this international business
including developing facilities in producing areas and growing downstream
markets. We charter four VLGC (Very Large Gas Carriers) totaling more than
176,000 tons of capacity supporting our worldwide marketing activities. One
newly built VLGC is committed to charter and is scheduled for September 2002
delivery.
In total, we sold approximately 557 thousand barrels per day of NGLs to
approximately 770 customers (amounts are aggregate totals for marketing,
wholesale and global operations). In 2001, approximately 23 percent of our NGL
sales were made with ChevronTexaco or one of its affiliates and approximately 11
percent were to another customer.

TRANSMISSION & DISTRIBUTION SEGMENT
Our transmission and distribution segment consists of IP's operations acquired
in the Illinova Corporation ("Illinova") acquisition in early 2000. IP is based
in Decatur, Illinois and provides retail electric and natural gas service to
residential, commercial and industrial consumers in substantial portions of
northern, central and southern Illinois. Electric transmission service also is
supplied to numerous utilities, municipalities and power marketing entities.
IP supplies retail electric service to an estimated population of
1.4 million. Retail natural gas service is supplied by IP to a population of
approximately 1 million people. IP holds franchises in all of the incorporated
municipalities that it services. As of January 3, 2002, based on the number of
billable meters, IP served over 588,000 active electric customers and over
412,000 active gas customers.
IP has seven underground gas storage fields having a total capacity of
approximately 11.6 Bcf and a total deliverability on a peak day of approximately
289,000 Mcf. IP also has contracts with various natural gas pipelines for 5.1
Bcf of underground storage capacity, having total deliverability on a peak day
of approximately 93,000 Mcf. Operation of underground storage permits IP to
increase deliverability to its customers during peak load periods by extracting
gas that was previously put into storage during the off-peak months.
IP owns an interconnected electric transmission system of approximately 2,600
circuit miles and a distribution system that includes approximately 37,000
circuit miles of overhead

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DYNEGY INC. PART I

and underground lines. Additionally, IP owns 755 miles of gas transmission pipe
and 7,543 miles of gas distribution pipe. All of these properties are located in
Illinois.
Beginning in the first quarter of 2002, this segment will also include the
results of Northern Natural, which we acquired in January 2002. Northern
Natural's 16,600 miles of pipeline extends from the Permian Basin in Texas to
the Upper Midwest, providing extensive access to major utilities and industrial
customers. Northern Natural's storage capacity is 59 Bcf and its market area
capacity is approximately 4.3 Bcf per day. We acquired Northern Natural as a
result of our terminated merger with Enron Corp. ("Enron").

DYNEGY GLOBAL COMMUNICATIONS SEGMENT
DGC was established during the fourth quarter of 2000 to pursue and capture
opportunities in the converging energy and communications marketplace through
opportunistic asset acquisitions and strategic partnerships. DGC has refined its
strategic business model to include voice services, storage and government sales
and is focused on controlling costs and capital expenditures until the recovery
of the overall communications industry.
DynegyCONNECT, L.P., DGC's North American subsidiary, completed one of the
first optically switched mesh networks in the world in the fourth quarter of
2001. The network spans more than 16,000 route miles and reaches 45 of the
largest cities in the United States.
In May 2001, DGC established its metro strategy with the announcement of a
network services agreement with Telseon, Inc. to develop an 18 city all-optical
network, capable of producing significant, scalable, high-bandwidth solutions
among multiple points of presence ("POPs") in tier 1 metro markets. The metro
strategy is complementary to DynegyCONNECT's long-haul network and will provide
DGC with access to approximately 80 POPs in select U.S. metro areas.
Dynegy Europe Communications ("DEC") was formed following the acquisition of
iaxis, Limited, a privately held, London-based communications company, in
March 2001. As a result of this acquisition, DEC acquired a fiber optic network
that now reaches more than 36 cities in 16 countries. The European network is
linked to the U.S. via a transatlantic connection between New York and London,
providing seamless connectivity to DGC's customers throughout the U.S., the U.K.
and Continental Europe.
DGC believes its network and metro strategy have unique cost advantages and
capability compared to its competitors. As a result, as the telecommunications
industry rebounds, DGC believes it will be able to compete very effectively.

COMPETITION
Dynegy faces strong competition relating to the energy industry in the
development of new electric generating plants, the acquisition of existing
generating facilities and the marketing and transportation of energy
commodities. The Company's primary competition is with merchant energy companies
as well as entities vying for market share in the deregulating domestic
electricity generating and marketing industries.
Dynegy's wholesale energy network competes with international, national and
regional full-service energy providers, merchants, producers and pipelines for
sales based on its ability to aggregate competitively priced supplies from a
variety of sources and locations and to utilize efficient transportation. Dynegy
believes that technological advances in executing transactions will
differentiate the competition in the near term. Operationally, Dynegy believes
its ability to remain a low-cost merchant and to effectively combine value-added
services, competitively priced supplies and price risk-management services will
determine its level of success through its wholesale energy network.
Demand for power may be met by generation capacity based on several competing
technologies, such as gas-fired or coal-fired generation and power generating
facilities fueled by
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DYNEGY INC. PART I

alternative energy sources including hydro power, synthetic fuels, solar, wind,
wood, geothermal, waste heat, solid waste and nuclear sources. The Company's
power generation business competes with other non-utility generators, regulated
utilities, unregulated subsidiaries of regulated utilities and other energy
service companies in the development and operation of energy-producing projects.
The trend towards deregulation in the U.S. electric power industry has resulted
in a highly competitive market for acquisition or development of domestic power
generating facilities. As the nation's regulated utilities seek non-regulated
investments and to the extent states continue to move toward retail electric
competition, these trends can be expected to continue for the foreseeable
future. However, certain recent events in the marketplace have caused some
states to publicly reconsider their approach to deregulation, or to retreat from
deregulation altogether.
The Company's NGL marketing businesses face significant and varied
competitors, including major integrated oil companies, major pipeline companies
and their marketing affiliates and national and local gas gatherers, processors,
brokers, marketers and distributors of varying sizes and experience. The
principal areas of competition include obtaining gas supplies for gathering and
processing operations, obtaining supplies of raw product for fractionation, the
marketing of NGLs, crude oil, residue gas, condensate and sulfur, and the
transportation of natural gas, NGLs and crude oil. Competition typically is
based on the location and operating efficiency of facilities, the reliability of
services and price and delivery capabilities.
Competition has become a dominant issue for the electric utility industry in
which IP operates. The Public Utilities Regulatory Policies Act of 1978
("PURPA") facilitated development of co-generators and independent power
producers. Promotion of competition continued with the enactment of the Energy
Policy Act of 1992, which authorized the FERC to mandate wholesale wheeling of
electricity by utilities at the request of certain authorized generating
entities and electric service providers. Competition arises not only from
co-generation or independent power production, but also from municipalities
seeking to extend their service boundaries to include customers being served by
utilities. Further competition may be introduced by state action, as has
occurred in Illinois, or by federal regulatory action.
Dynegy's entrance into the communications industry also subjects Dynegy to
competition with industry participants having substantial financial resources
and significant industry expertise. Dynegy competes with a substantial number of
communications companies, many of which have greater resources and/or focus only
on one industry or a niche within a single industry.
Dynegy's January 2002 acquisition of Northern Natural subjects the Company to
competition as it relates to the Company's interstate pipeline system. The
profitability of the pipeline depends upon having long-term firm transportation
contracts in place for a significant portion of the capacity. Competition is
impacted by factors beyond the Company's control, including:
- - the construction of additional pipeline capacity in markets served by the
Company's interstate pipelines:
- - actions by regulators that could impact competitiveness;
- - reduced demand due to varying factors; and
- - the availability of alternative energy sources.

REGULATION
The Company is subject to regulation by various federal, state, local and
foreign agencies, including the regulations described below.

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DYNEGY INC. PART I

NATURAL GAS REGULATION. The transportation (including storage) and sale for
resale of natural gas in interstate commerce is subject to regulation by the
FERC under the Natural Gas Act of 1938, as amended ("NGA"), and, to a lesser
extent, the Natural Gas Policy Act of 1978, as amended ("NGPA"). The rates
charged by interstate pipelines for interstate transportation and storage
services, and the terms and conditions for provision of such services, are
regulated by the FERC, which generally also must approve any changes to these
rates or terms and conditions prior to their implementation. The FERC also has
jurisdiction over, among other things, the construction and operation of
pipeline and related facilities used in the transportation and storage of
natural gas in interstate commerce, including the extension, expansion,
acquisition, disposition, or abandonment of such facilities; maintenance of
accounts and records; depreciation and amortization policies; and transactions
with and conduct of interstate pipelines relating to affiliates. Northern
Natural and Venice Gathering System are regulated interstate pipelines.
Commencing in 1992, the FERC issued Order No. 636 and subsequent orders
(collectively, "Order No. 636"), which require interstate pipelines to provide
transportation separate, or "unbundled," from the pipelines' sales of gas. Also,
Order No. 636 requires pipelines to provide open-access transportation on a
basis that is equal for all shippers. The FERC intends for Order No. 636 to
foster increased competition within all phases of the natural gas industry.
Prior to its acquisition of Northern Natural and Venice Gathering System, Order
No. 636 did not directly regulate any of Dynegy's activities; however, like
other interstate pipelines, both Northern Natural and Venice Gathering System
must comply with FERC's open-access transportation regulations. The
implementation of these orders has not had a material adverse effect on Dynegy's
results of operations. The courts have largely affirmed the significant features
of Order No. 636 and numerous related orders pertaining to the individual
pipelines, although certain appeals remain pending and the FERC continues to
review and modify its open-access regulations.
In 2000, the FERC issued Order No. 637 and subsequent orders (collectively,
"Order No. 637"), which imposed a number of additional reforms designed to
enhance competition in natural gas markets. Among other things, Order No. 637
revised the FERC pricing policy by waiving price ceilings for short-term
released interstate pipeline transportation capacity for a two-year period, and
effected changes in FERC regulations relating to interstate transportation
scheduling procedures, capacity segmentation, pipeline penalties, rights of
first refusal and information reporting. Most major aspects of Order No. 637 are
pending judicial review. It is uncertain whether and to what extent FERC's
market reforms will survive judicial review and, if so, whether the FERC's
actions will achieve the goal of further increasing competition in natural gas
markets.
The FERC recently proposed to expand its existing rules governing the conduct
of interstate pipelines and their marketing affiliates to include all energy
affiliates. If adopted, the proposed rule would, among other things, preclude
the exchange of transportation related information among an interstate pipeline
and any of its energy affiliates. The FERC has stated that one purpose of the
proposal is to allow pipeline affiliates and non-affiliates to compete in energy
markets on an even basis. It is uncertain whether or when the FERC may adopt the
proposed rule, or the extent to which it may affect the cost or other aspects of
Dynegy's operations; however, Dynegy does not anticipate that its regulated
transmission providers and their energy affiliates will be impacted any
differently than other similar industry participants.
Pursuant to the NGPA and the Wellhead Decontrol Act of 1989, most sales of
natural gas are no longer subject to price controls. However, the FERC retains
jurisdiction over certain sales made by interstate pipelines or their
affiliates, such as Dynegy has become with its recent

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DYNEGY INC. PART I

acquisitions. Currently, the FERC has authorized such sales to be made at
unregulated prices, terms and conditions. While sales of natural gas can
currently be made at market prices, and upon unregulated terms and conditions,
there is no assurance that such regulatory treatment will continue indefinitely
in the future. Congress or, as to sales remaining subject to its jurisdiction,
the FERC, could re-enact price controls or other regulation in the future.
Certain federal and provincial regulatory authorities require parties to
transactions involving natural gas exports to hold export or removal permits.
The Company's indirect wholly owned Canadian subsidiary, Dynegy Canada Inc.,
holds various Canadian and U.S. permits for such purposes. In the United
Kingdom, the natural gas business is subject to regulation by the Office of Gas
Supply.
GAS PROCESSING. Dynegy's gas processing operations could become subject to
FERC regulation under certain circumstances. The FERC has traditionally
maintained that a processing plant used primarily for removal of NGLs for
economic purposes is not a facility for transportation or sale for resale of
natural gas in interstate commerce, and therefore, is not subject to
jurisdiction under the NGA. However, the FERC considers a processing plant used
primarily for purposes related to transportation safety and efficiency to be
subject to such regulation. Dynegy believes its gas processing plants are
primarily involved in removing NGLs for economic purposes and, therefore, are
exempt from FERC jurisdiction. Nevertheless, the FERC has made no specific
finding as to Dynegy's gas processing plants. In addition, certain facilities
downstream of processing plants are being considered for use in transporting gas
between pipelines, which may invoke FERC's jurisdiction. Such jurisdiction
likely would apply to the downstream facility as a pipeline, however, and not to
the plants themselves.
LIQUIFIED NATURAL GAS (LNG) TERMINALS. LNG terminals operating in interstate
commerce are subject to FERC jurisdiction and regulation of rates, terms and
conditions of service such as is described above concerning interstate natural
gas transportation and storage. Dynegy is in the process of securing approvals
to construct such a facility in Louisiana.
GAS GATHERING. The NGA exempts gas gathering facilities from the jurisdiction
of the FERC, while interstate transmission facilities remain subject to FERC
jurisdiction, as described above. Dynegy believes its gathering facilities and
operations meet the current tests used by the FERC to determine
nonjurisdictional gathering facility status, although the FERC's articulation
and application of such tests have varied over time. Nevertheless, the FERC has
made no specific findings as to the exempt status of any of Dynegy's facilities.
No assurance can be given that all of Dynegy's gas gathering facilities will
remain classified as such and, therefore, remain exempt from FERC regulation.
Some states regulate gathering facilities to varying degrees; generally rates
are not regulated.
ELECTRICITY MARKETING REGULATION. The Company's electricity marketing
operations are regulated by the Federal Power Act ("FPA") and the FERC with
respect to rates, terms and conditions of services and certain reporting
requirements. Current FERC policies permit trading and marketing entities to
market electricity at market-based rates. While FERC has affirmed its desire to
move toward competitive markets with market-based pricing, it is currently
reviewing the specifics of implementing this policy. For further discussion,
please see "Power Generation Regulation" below.
In December 1999, the FERC issued Order No. 2000, which addressed a number of
issues relating to the regional transmission of electricity. In particular,
Order No. 2000 provided for regional transmission organizations ("RTOs") to
control the transmission facilities within a particular region. After a period
of progress toward voluntary creation of RTOs as envisioned by the FERC,
activity has slowed due to uncertainty concerning required standards and
structures for such entities. Recently, the FERC commenced proceedings designed
to result in the adoption of generally standardized market terms and conditions
governing interstate

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DYNEGY INC. PART I

transmission and RTO operation, including generic standards and procedures for
the interconnection of generation to the transmission grid. The FERC plans to
propose new rules respecting these matters this year and has directed electric
industry participants to establish a single organization to assist with the
development of business practices and protocols that will be needed to implement
such standardized terms and conditions. It is uncertain what rules the FERC may
adopt as the result of these proceedings. The impact of these RTOs on the
Company's electricity marketing operations cannot be predicted. (For further
discussion, please see "Illinois Power Company" below.)
POWER GENERATION REGULATION. The Company's generation assets include projects
that are Exempt Wholesale Generators ("EWGs") or qualifying facilities ("QFs").
One form of EWG is a merchant plant, which operates independently from
designated power purchasers and as a result will generate and sell power to
market when electricity sales prices exceed the cost of production. A QF
typically sells the power it generates to a single power purchaser.
The FPA grants the FERC exclusive ratemaking jurisdiction over wholesale sales
of electricity in interstate commerce. The Company's power generation operations
also are subject to regulation by the FERC under PURPA with respect to rates,
the procurement and provision of certain services and operating standards.
Although facilities deemed QFs under PURPA are exempt from ratemaking and
certain other provisions of the FPA, non-QF independent power projects and
certain power marketing activities are subject to the FPA and the FERC's
ratemaking jurisdiction, as well as the Public Utilities Holding Company Act of
1935 ("PUHCA") and the Energy Policy Act of 1992. All of the projects currently
owned or operated by Dynegy as QFs are qualifying facilities and, as such, under
PURPA are exempt from the ratemaking and certain other provisions of the FPA.
Dynegy's EWGs, which are not QFs, have been granted market-based rate authority
and comply with the FPA requirements governing approval of wholesale rates and
subsequent transfers of ownership interests in such projects.
In certain markets where Dynegy owns generation facilities, specifically
California and New York, the FERC has from time to time approved and
subsequently extended temporary price caps on wholesale power sales, or other
market mitigation measures. Due to concerns over potential short supply and high
prices in the summer of 2001, the New York Independent System Operator, Inc.
("NYISO"), the FERC-approved operator of electric transmission facilities and
centralized electric markets in New York, filed an Automated Mitigation
Procedure ("AMP") proposal with the FERC. The AMP caps bid prices based on the
cost characteristics of generating facilities in New York, such as those owned
or operated by the Company. In an order issued on June 28, 2001, the FERC
accepted the AMP proposal for the summer of 2001. In a subsequent order issued
on November 27, 2001, the FERC extended the AMP through April 30, 2002. The AMP
may be further extended in the future.
Price volatility and other market dislocations in the California market have
precipitated a number of FERC actions related to the California market, in
addition to price caps and market mitigation measures. These include an
investigation of gas pipeline marketing affiliate abuse in the region,
proceedings regarding whether, and to what extent, price refunds are owed by
wholesale electricity suppliers serving the state, and complaints requesting the
FERC to reform or void various long-term power sales contracts. Recently, as a
prelude to possible initiation of a new complaint proceeding, the FERC began
investigating whether any entity has manipulated prices for electricity or
natural gas in the West, since January 1, 2000, possibly resulting in unjust and
unreasonable prices under long-term power sales contracts entered into since
that time. Additional matters in California are discussed below under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - California Market/West Coast Power."

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DYNEGY INC. PART I

On November 20, 2001, the FERC issued an order that would subject the sales of
all entities with market-based rate tariffs to "refunds or other remedies" in
the event the seller engages in "anticompetitive behavior or the exercise of
market power." The FERC has postponed the effectiveness of this refund condition
pending its consideration of comments submitted by interested parties. Dynegy
and other similarly-situated generators and power marketers have submitted
comments in opposition to the proposed refund condition. It is uncertain how the
FERC will act respecting this matter. If the FERC were to establish the broad
refund condition proposed, it would increase the risk inherent in electric
marketing activities for all wholesale sellers of electricity, including Dynegy.
STATE REGULATORY REFORMS. The Company's domestic gas and power marketing and
power generation businesses are subject to various regulations from the states
in which they operate. Proposed reforms to these regulations are proceeding in
several states, including California, the results of which could affect the
Company's operations.
ILLINOIS POWER COMPANY. IP is an electric utility as defined in PUHCA. Its
direct parent company, Illinova, and Dynegy are holding companies as defined in
PUHCA. However, each of Illinova and Dynegy generally are exempt from regulation
under section 3(a)(1) of PUHCA. They remain subject to regulation under PUHCA
with respect to the acquisition of certain voting securities of other domestic
public utility companies and utility holding companies.
IP also is subject to regulation by the FERC under the FPA as to transmission
rates, terms and conditions of service, the acquisition and disposition of
certain transmission facilities and certain other matters. The FERC has declared
IP exempt from the NGA and related FERC orders, rules and regulations.
IP is further subject to regulation by the State of Illinois and the Illinois
Commerce Commission ("ICC"). The Illinois Public Utilities Act was significantly
modified in December 1997 by the Electric Service Customer Choice and Rate
Relief Law of 1997, or P.A. 90-561, but the ICC still has broad powers of
supervision and regulation with respect to rates and charges and various other
matters. Under P.A. 90-561, IP must continue to provide bundled retail electric
services to all who choose to continue to take service at tariff rates and must
provide unbundled electric distribution services to all eligible customers as
defined by P.A. 90-561 at rates determined by the ICC.
In January 1998, IP, in conjunction with eight other transmission-owning
entities, filed with the FERC for all approvals necessary to create and to
implement the Midwest Independent System Operator ("MISO"). IP subsequently
withdrew from the MISO to join several transmission owners (the "Alliance
Companies") proposing to form the Alliance RTO. As proposed, the Alliance RTO
would function as an RTO with National Grid, USA ("National Grid") as the
managing member for a period of seven years.
In an order issued on December 20, 2001, the FERC reversed its previous
findings, stated that it would not approve the Alliance RTO, and directed the
Alliance Companies to explore how their business plan could be accommodated with
the MISO or another RTO. Discussions continue with both MISO and another party,
but no agreement has been reached. The Alliance Companies, including IP,
continue to consider other opportunities for participation in an RTO. Any RTO in
which IP ultimately participates will be subject to the outcome of the FERC's
proceedings on standardized market terms and conditions.
IP's retail natural gas sales also are regulated by the ICC. Such sales are
currently priced under a purchased gas adjustment mechanism under which IP's gas
purchase costs are passed through to its customers if such costs are determined
prudent.
PENDING LEGISLATION. The U.S. Congress has before it a number of bills that
could impact regulations applied to Dynegy and its subsidiaries. These include
bills that would repeal PUHCA and portions of PURPA and that would affect FERC's
regulatory authority over energy marketing, generation and trading. Certain
recent events in the marketplace have prompted questions

{ 13 }

DYNEGY INC. PART I

about the wisdom of PUHCA repeal and whether more stringent regulation may be
needed. The outcome of these bills and the effects that they might have cannot
be predicted with certainty.
FOREIGN REGULATION. Dynegy Europe Limited acquired BG Storage Limited in the
fourth quarter of 2001 and, as a result, now owns and operates the Rough and
Hornsea gas storage facilities in the U.K. In connection with that acquisition,
Dynegy Europe Limited gave statutory undertakings to the Secretary of State for
Trade and Industry in the U.K. relating to the operation of these storage
assets. The key aspects of the undertakings, which expire on April 30, 2004, are
as follows:

(1) Dynegy Storage Limited, the Dynegy Europe Limited subsidiary that operates
the assets, will ensure that the maximum physical capacity of the facilities
is made available to the market on non-discriminatory terms and that 20% of
the capacity is sold on one-year terms;

(2) Unless otherwise approved by the regulator, the capacity must be sold in
standard bundled units;

(3) Where there remains any unsold capacity 30 days before the beginning of a
storage year (May 1 to April 30), this capacity must be sold by auction
under prescribed procedures and standard contracts approved by the regulator
(although prior to such time, Dynegy Storage Limited may sell the capacity
in its sole discretion); and

(4) Dynegy Storage Limited must maintain a robust financial information and
systems separation (and separate accounts) of the storage business from
other commercial activities.

ENVIRONMENTAL AND OTHER MATTERS
GENERAL. Dynegy's operations are subject to extensive federal, state and
local statutes, rules and regulations governing the discharge of materials into
the environment or otherwise relating to environmental protection. In addition,
development of projects in international markets creates exposure to and
obligations under the national, provincial and local laws of each host country,
including environmental standards and requirements imposed by these governments.
Environmental laws and regulations are complex, change frequently and have
tended to become more stringent over time. Many environmental laws require
permits from governmental authorities before construction on a project may be
commenced or before wastes or other materials may be discharged into the
environment. The process for obtaining necessary permits can be lengthy and
complex, and can sometimes result in the establishment of permit conditions that
make the project or activity for which the permit was sought either unprofitable
or otherwise unattractive. Even where permits are not required, compliance with
environmental laws and regulations can require significant capital and operating
expenditures, and the Company may be required to incur costs to remediate
contamination from past releases of wastes into the environment. Failure to
comply with these statutes, rules and regulations may result in the assessment
of administrative, civil and even criminal penalties. Furthermore, the failure
to obtain or renew an environmental permit could prevent operation of one or
more Dynegy facilities.
In general, the construction and operation of our facilities are subject to
federal, state and local environmental laws and regulations governing the siting
of energy facilities, the discharge of pollutants and other materials into the
environment, the protection of wetlands, endangered species, and other natural
resources, the control and abatement of noise and other similar requirements. A
variety of permits are typically required before construction of a project
commences, and additional permits are typically required for facility operation.

{ 14 }

DYNEGY INC. PART I

ENVIRONMENTAL EXPENDITURES. Dynegy's aggregate expenditures for compliance
with laws and regulations related to the discharge of materials into the
environment or otherwise related to the protection of the environment were
approximately $81 million in 2001, compared to approximately $121 million in
2000. The 2000 costs exceeded 2001 costs due in large part to expenditures by
the Company to bring certain power generation turbines into compliance with new
environmental regulations ahead of the dates when such compliance was actually
required. The Company estimates that total environmental expenditures (both
capital and operating) in 2002 will be approximately $103 million. Management
does not expect capital spending on environmental matters to increase materially
over the near term; however, changes in environmental regulations or the outcome
of litigation could result in additional legal requirements that would
necessitate increased spending.
THE CLEAN AIR ACT. The federal Clean Air Act ("CAA") and comparable state
laws and regulations relating to air emissions impose responsibilities on owners
and operators of sources of air emissions, including requirements to obtain
construction and operating permits and annual compliance and reporting
obligations. Although the impact of air quality regulations cannot be predicted
with certainty, these regulations are expected to become increasingly stringent,
particularly for electric power generating facilities. CAA requirements include
the following:
- The CAA Amendments of 1990 required a two-phase reduction by electric
utilities in emissions of sulfur dioxide and nitrogen oxide by 2000 as part
of an overall plan to reduce acid rain in the eastern United States.
Installation of control equipment and changes in fuel mix and operating
practices have been completed to comply with the emission reduction
requirements of the acid rain provision of the CAA Amendment of 1990.
- In October 1998, the EPA issued a final rule on regional ozone control that
required 22 eastern states and the District of Columbia to revise their
State Implementation Plans (SIPs) to significantly reduce emissions of
nitrogen oxide. The current compliance deadline for implementation of these
emission reductions is May 31, 2004. In January 2000, the EPA finalized
another ozone-related rule under Section 126 of the CAA that has similar
emission control requirements. Installation of the necessary emission
control equipment may involve large technical, design and construction
projects that require significant time or expense for completion.
- Significant reductions in air emissions from Dynegy's facilities could be
required if the U.S. Congress adopts legislation requiring additional
reductions in emissions of sulfur dioxide, nitrogen oxides and mercury as
outlined in various multi-pollutants proposals. Some of these proposals also
include reductions in carbon dioxide and other "greenhouse gases" that
allegedly contribute to global warming. The emissions reductions
contemplated by these initiatives, if they are enacted, could eventually
require significant capital expenditures for new pollution control
equipment, but the adoption of emission reduction requirements pursuant to
any of the various pending proposals is highly uncertain. Although the
impact of possible future environmental requirements cannot be predicted
with any degree of certainty, any expenditures that are ultimately required
are not anticipated to have a more significant effect on Dynegy's operations
or financial condition than on any similarly situated company that generates
electricity through the burning of fossil fuels.
- The EPA and the Department of Justice ("DOJ") filed complaints against IP
and DMG, alleging certain Clean Air Act violations, which are described in
Item 8, Financial Statements and Supplementary Data, Note 11. In general,
these allegations involve whether certain repair, maintenance, and
replacement projects at the Baldwin facility required permitting under the
Clean Air Act. An adverse ruling could impose liability on Dynegy, as well
as increase the costs of ongoing operations to Dynegy, and the electric
generating industry as a whole.

{ 15 }

DYNEGY INC. PART I

REMEDIAL LAWS. The Company is also subject to environmental remediation
requirements, including provisions of the Comprehensive Environmental Response,
Compensation and Liability Act ("CERCLA" or "Superfund") and the corrective
action provisions of the federal Resource Conservation and Recovery Act ("RCRA")
and similar state laws. The Superfund law imposes liability, regardless of fault
or the legality of the original conduct, on certain classes of persons that
contributed to the release of a "hazardous substance" into the environment.
These persons include the current or previous owner and operator of a facility
and companies that disposed, or arranged for the disposal, of the hazardous
substance found at a facility. CERCLA also authorizes the EPA and, in certain
instances, private parties to take actions in response to threats to public
health or the environment and to seek recovery for the costs of cleaning up the
hazardous substances that have been released and for damages to natural
resources from such responsible party. Further, it is not uncommon for
neighboring landowners and other third parties to file claims for personal
injury and property damage allegedly caused by the hazardous substances released
into the environment. RCRA applies to facilities that have been used to manage
or are currently managing hazardous waste and which are either still in
operation or have recently been closed. RCRA also requires facilities to remedy
any releases of hazardous wastes or hazardous waste constituents at waste
treatment, storage or disposal facilities. CERCLA or RCRA could impose remedial
obligations at a variety of Dynegy facilities, including our electric power
generating plants and NGL facilities.
IP and Northern Natural and their predecessors previously operated more than
two dozen sites at which synthetic gas was manufactured from coal. Operation of
these manufactured gas plant ("MGP") sites was generally discontinued in the
1950s when natural gas became available from interstate gas transmission
pipelines. Many of these MGP sites were contaminated with residues from the gas
manufacturing process and remediation of this historic contamination may be
required under CERCLA or RCRA or analogous state laws.
PIPELINE SAFETY. In addition to environmental regulatory issues, the design,
construction, operation and maintenance of the Company's pipeline facilities are
subject to the safety regulations established by the Secretary of the U.S.
Department of Transportation ("DOT") pursuant to the Natural Gas Pipeline Safety
Act ("NGPSA") and the Hazardous Liquid Pipeline Safety Act ("HLPSA"), or by
state regulations meeting the requirements of the NGPSA and the HLPSA, or to
similar statutes, rules and regulations in Canada or other jurisdictions. In
December 2000, DOT adopted new regulations requiring operators of interstate
pipelines to develop and follow an integrity management program that provides
for continual assessment of the integrity of all pipeline segments that could
affect so-called "high consequence" environmental impact areas, through periodic
internal inspection, pressure testing, or other equally effective assessment
means. An operator's program to comply with the new rule must also provide for
periodically evaluating the pipeline segments through comprehensive information
analysis, remediating potential problems found through the required assessment
and evaluation, and assuring additional protection for the high consequence
segments through preventative and mitigative measures. The requirements of this
new DOT rule could increase the costs of pipeline operations.
HEALTH AND SAFETY. The Company's operations are subject to the requirements
of the Federal Occupational Safety and Health Act ("OSHA") and other comparable
federal, state and provincial statutes. The OSHA hazard communication standard,
the EPA community right-to-know regulations under Title III of the Superfund
Amendments and Reauthorized Act and similar state statutes require that
information be organized and maintained about hazardous materials used or
produced in the Company's operations. Certain of this information must be
provided to employees, state and local government authorities and citizens. The
Company

{ 16 }

DYNEGY INC. PART I

believes it is currently in substantial compliance, and expects to continue to
comply in all material respects, with these rules and regulations.
OTHER ENVIRONMENTAL ISSUES. Dynegy is also subject to a variety of other
environmental laws, such as the Clean Water Act, which regulates facilities that
discharge wastewater into the environment. Under the Clean Water Act and
analogous state laws, permits are required for the discharge of any pollutant,
including heat, into any regulated body of water. Failure to obtain or renew any
environmental permit in a timely manner or the loss of a permit due to legal
challenge could require a cessation of operations that involve discharges of
pollutants or other materials into the environment.
Subject to resolution of the complaints filed by the EPA and the DOJ against
IP and Dynegy Midwest Generation, which are described in Item 8, Financial
Statements and Supplementary Data, Note 11, management believes that it is in
substantial compliance with, and is expected to continue to comply in all
material respects with, applicable environmental statutes, regulations, orders
and rules. Further, to management's knowledge, other than the previously
referenced complaints, there are no existing, pending or threatened actions,
suits, investigations, inquiries, proceedings or clean-up obligations by any
governmental authority or third party relating to any violations of any
environmental laws with respect to the Company's assets or pertaining to any
indemnification obligations with respect to properties previously owned or
operated by the Company, which would have a material adverse effect on the
Company's operations and financial condition.

OPERATIONAL RISKS AND INSURANCE
Dynegy is subject to all risks inherent in the various businesses in which it
operates. These risks include, but are not limited to, explosions, fires,
terrorist attacks and product spillage, which could result in damage to or
destruction of operating assets and other property, or could result in personal
injury, loss of life or pollution of the environment, as well as curtailment or
suspension of operations at the affected facility. Dynegy maintains general
public liability, property and business interruption insurance in amounts that
it considers to be adequate for such risks. Such insurance is subject to
deductibles that the Company considers reasonable and not excessive. The
occurrence of a significant event not fully insured or indemnified against, or
the failure of a party to meet its indemnification obligations, could materially
and adversely affect Dynegy's operations and financial condition. In addition,
the terrorist attacks on September 11, 2001 and the changes in the insurance
markets attributable to those attacks may make some types of insurance more
difficult to obtain. We may be unable to secure the levels and types of
insurance we would otherwise have secured prior to September 11th. No assurance
can be given that Dynegy will be able to maintain insurance in the future at
rates it considers reasonable.

EMPLOYEES
At December 31, 2001, the Company had approximately 3,019 employees at its
administrative offices and approximately 3,120 employees at its operating
facilities. Approximately 1,880 employees at Company-operated facilities are
subject to collective bargaining agreements with one of the following unions:
Paper, Allied-Industrial, Chemical & Workers International Union; International
Brotherhood of Electrical Workers; Laborers International Union of North
America; United Association of Journeymen Plumbers and Gas Fitters;
International Association of Machinists and Aerospace Workers; and
Communications, Energy and Paperworkers Union.

{ 17 }

DYNEGY INC. PART I

ITEM 1A. EXECUTIVE OFFICERS
Set forth below are the names and positions of the current executive officers of
the Company, together with their ages and years of service with the Company.

The executive officers named above will serve in such capacities until the
next annual meeting of the Company's Board of Directors, or until their
respective successors have been duly elected and have been qualified, or until
their earlier death, resignation, disqualification or removal from office.
C. L. Watson is the Chairman and Chief Executive Officer of Dynegy Inc. He
joined the Company as President in 1985 and became Chairman and Chief Executive
Officer in 1989. Prior to his employment with the Company, he served as Director
of Gas Sales for the Western United States for Conoco Inc. Mr. Watson also
serves on the board of directors of Baker Hughes Incorporated.
Stephen W. Bergstrom, President and Chief Operating Officer of Dynegy Inc., is
responsible for the day-to-day execution of Dynegy's strategy across its
operating business units. Mr. Bergstrom was formerly President and Chief
Operating Officer of Dynegy Marketing and Trade and Executive Vice President of
Dynegy Inc. Mr. Bergstrom joined the Company in 1986 as Vice President of Gas
Supply.
Robert D. Doty, Jr., Executive Vice President and Chief Financial Officer,
joined the Company in 1991 and has served as the Company's principal financial
officer since May 2000. He is responsible for accounting, finance, planning and
strategy, investor relations, treasury and tax. Mr. Doty previously served as
Senior Vice President of Finance, Vice President and Treasurer and Vice
President-Tax.
Kenneth E. Randolph is Executive Vice President and General Counsel of the
Company. He has served in this capacity with Dynegy since July 2001. In
addition, he served as a member of the Company's Management Committee from
May 1989 through February 1994 and managed

{ 18 }

DYNEGY INC. PART I

the Company's marketing operations in the Western and Northwestern United States
from July 1984 through July 1987. From July 1987 through July 2001,
Mr. Randolph served as Senior Vice President and General Counsel of the Company.
Prior to his employment with the Company, Mr. Randolph was associated with the
Washington, D.C. office of Akin, Gump, Strauss, Hauer & Feld, L.L.P.
Deborah A. Fiorito is Executive Vice President and Chief Communications
Officer of Dynegy Inc. In that role, she is responsible for the Company's
branding, marketing, internal and external communications, philanthropy and
community relations functions. Prior to joining Dynegy in 2000, Ms. Fiorito
managed public and governmental affairs for Chase Manhattan Bank-Texas and
before that, directed communications for Apache Corp. and Mitchell Energy &
Development Corp.
Lawrence A. McLernon, Executive Vice President of Dynegy Inc. and Chief
Executive Officer, Dynegy Global Communications, is responsible for the
execution of Dynegy's international communications strategy. Mr. McLernon
previously served as Chairman, President and Chief Executive Officer of
Extant, Inc. ("Extant") beginning in 1998, and joined Dynegy with the
acquisition of Extant effective in 2000. Prior to his position at Extant,
Mr. McLernon was the founding President of LiTel Communications Inc., also known
as LCI International, purchased by Qwest International, Inc., in 1999, the
second all fiber network in the U.S. and a premier provider of voice and data
services.
M. K. (Matt) Schatzman is President and Chief Executive Officer of Dynegy's
Wholesale Energy Network. In this capacity, Mr. Schatzman is responsible for
Dynegy's energy marketing business in North America and the operations and
development of Dynegy's power generation facilities. Mr. Schatzman was formerly
President, Energy Trading of Dynegy Marketing and Trade. Mr. Schatzman joined
the company in 1990 as Director of Transportation after spending several years
with Transcontinental Gas Pipe Line Corporation.
Milton L. Scott is Executive Vice President and Chief Administrative Officer
of Dynegy Inc. He is responsible for human resources, supply chain management,
risk control, compliance and internal audit, risk management and insurance,
corporate facilities management and corporate security for Dynegy Inc. Before
joining the Company in 1999, Mr. Scott was employed by Arthur Andersen LLP for
22 years, where he served as a partner in the technology and communications
practice.
Hugh A. Tarpley, Executive Vice President, Strategic Investments of
Dynegy Inc., is responsible for the Company's merger and acquisition activities,
which also includes asset sales and managing Dynegy's strategic investments.
Prior to joining Dynegy in 1997, Mr. Tarpley served as U.S. Country Manager and
Chief Finance Officer of the Americas Group for British Gas and, before that,
served as Treasurer for Virginia International Company.
R. Blake Young, Executive Vice President and President, Global Technology of
Dynegy Inc., is responsible for worldwide technology deployment across Dynegy's
core businesses including business systems development and support, technology
infrastructure, advanced technology initiatives and technology planning and
strategy. He is also responsible for Dynegy's e-commerce and e-business
initiatives, advancing the application of new technology to Dynegy's businesses
and identifying new technology-related alliances and investments. Prior to
joining the Company, Mr. Young was with Campbell Soup Company in 1997 and 1998
and was responsible for technology deployment across its U.S. Grocery Division
and the head of global business systems strategy. Mr. Young was previously
employed by Tenneco Energy for approximately 13 years, where he served as Vice
President and Chief Information Officer.

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DYNEGY INC. PART I

ITEM 2. PROPERTIES
A description of the Company's properties is included in Item 1, Business, and
is incorporated herein by reference.

ITEM 3. LEGAL PROCEEDINGS
See Item 8, Financial Statements and Supplementary Data, Note 11, which is
incorporated herein by reference.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the Company's security holders during the
fourth quarter of 2001.

{ 20 }

DYNEGY INC. PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Class A common stock, no par value per share (the "Class A common
stock"), is listed and traded on the New York Stock Exchange under the ticker
symbol "DYN". The number of stockholders of record of the Class A common stock
as of March 4, 2002, based upon records of registered holders maintained by the
Company's transfer agent, was 23,408.
The Company's Class B common stock, no par value per share, is neither listed
nor traded on any exchange. All of the shares of Class B common stock are owned
by Chevron U.S.A. Inc.
The following table sets forth the high and low sales prices for the Class A
common stock for each full quarterly period during the fiscal years ended
December 31, 2001 and 2000, respectively, as reported on the New York Stock
Exchange Composite Tape, and related dividends paid per share during such
periods. Such prices and dividends paid are adjusted for a two-for-one stock
split on August 22, 2000. Such prices and dividends paid per share prior to
February 1, 2000 are adjusted for the 0.69-to-one exchange ratio used in the
Illinova acquisition.

SUMMARY OF DYNEGY'S COMMON STOCK PRICE AND DIVIDEND PAYMENTS

Dynegy intends to continue to pay a quarterly cash dividend of $0.075 per
common share, subject to the availability of funds legally available therefor
and declaration by the Board of Directors.
In July 2001, the Company established the Dynegy Short-Term Executive Stock
Purchase Loan Program. Under this program, the Company may loan eligible
employees funds to acquire Class A common stock through market purchases. The
related notes have a two-year maturity, bear interest at the greater of
5 percent or the Applicable Federal Rate as of the loan date and are full
recourse to the participants. At December 31, 2001, the Company had issued
approximately $13 million of loans pursuant to this program.
In December 2001, certain officers of the Company purchased approximately
1.2 million shares of Class A common stock in a private placement transaction
pursuant to Section 4(2) of the Securities Act of 1933. These officers received
loans from the Company to purchase the common stock at $19.75 per share, the
same price as the net proceeds to the Company in the December 2001 public
offering. The officers paid for the shares by entering into promissory notes
with the Company for an initial term of 60 days. The maturity date of the notes
was extended for an additional 30 days with the approval of the Board of
Directors. These loans bear interest at a rate of 3.25 percent and are full
recourse to the borrowers. The Company recognized compensation expense in 2001
of approximately $1.2 million related to the shares purchased by these officers,
which was recorded as "General and Administrative Expense."

{ 21 }

DYNEGY INC. PART II

SHAREHOLDER AGREEMENT
Chevron U.S.A. Inc. ("Chevron"), now a subsidiary of ChevronTexaco Corp, in
connection with the Illinova acquisition, entered into a shareholder agreement
with Dynegy governing certain aspects of their relationship, some of which are
discussed below.
The shareholder agreement grants Chevron preemptive rights to acquire shares
of Dynegy common stock in proportion to its then-existing ownership of Dynegy
stock whenever Dynegy issues shares of stock or securities convertible into
stock. In addition, Chevron may freely acquire up to 40 percent of the
outstanding voting securities of Dynegy. If Chevron wishes to acquire more than
40 percent of Dynegy's voting securities, it must make an offer to acquire all
of the outstanding stock of Dynegy. Any offer by Chevron for all of the
outstanding stock is subject to an auction process, the details of which are set
forth in the shareholder agreement.
Upon consummation of the Illinova acquisition, Chevron received shares of
Class B common stock in exchange for the shares of common stock it owned in the
former Dynegy and purchased additional shares of Class B common stock for cash.
Chevron's ownership of Class B common stock entitles it to designate three
members of Dynegy's Board of Directors. The shareholder agreement prohibits
Chevron from selling or transferring shares of Class B common stock except in
the following transactions:
- in a widely-dispersed public offering; or
- a sale to an unaffiliated third party, provided that Dynegy is given the
opportunity to purchase, or to find a different buyer to purchase, the shares
proposed to be sold by Chevron.
Upon the sale or transfer to any person other than an affiliate of Chevron,
the shares of Class B common stock are automatically converted into shares of
Class A common stock.
The shareholder agreement further provides that Dynegy may require Chevron and
its affiliates to sell all of the shares of Class B common stock under certain
circumstances. These rights are triggered if Chevron or its Board designees
block--which they are entitled to do under Dynegy's Bylaws--any of the following
transactions two times in any 24-month period or three times over any period of
time:
- the issuance of new shares of stock where the aggregate consideration to be
received exceeds the greater of $1 billion or one-quarter of Dynegy's total
market capitalization;
- any merger, consolidation, joint venture, liquidation, dissolution,
bankruptcy, acquisition of stock or assets, or issuance of common or
preferred stock, any of which would result in payment or receipt of
consideration having a fair market value exceeding the greater of $1 billion
or one-quarter of Dynegy's total market capitalization; or
- any other transaction or series of related transactions having a fair market
value exceeding the greater of $1 billion or one-quarter of Dynegy's total
market capitalization.
However, upon occurrence of one of these triggering events and in lieu of
selling Class B common stock, Chevron may elect to retain the shares of Class B
common stock but forfeit its right and the right of its Board designees to block
the transaction listed above. A block consists of a vote against a proposed
transaction by either (a) all of Chevron's representatives on the Board of
Directors present at the meeting where the vote is taken (if the transaction
would otherwise be approved by the Board of Directors) or (b) any of the
Class B common stock held by Chevron and its affiliates if the transaction
otherwise would be approved by at least two-thirds of all other shares entitled
to vote on the transaction, excluding shares held by management, directors or
subsidiaries of Dynegy.
The shareholder agreement also prohibits Dynegy from taking the following
actions:
- issuing any shares of Class B common stock to any person other than Chevron
and its affiliates;

{ 22 }

DYNEGY INC. PART II

- amending any provisions in Dynegy's Articles of Incorporation or Bylaws
which, in each case, contain or implement the special rights of holders of
Class B common stock, without the consent of the holders of the shares of
Class B common stock or the three directors elected by such holders;
- adopting a shareholder rights plan, "poison pill" or similar device that
prevents Chevron from exercising its rights to acquire shares of common stock
or from disposing of its shares when required by Dynegy; and
- acquiring, owning or operating a nuclear power facility, other than being a
passive investor in a publicly-traded company that owns a nuclear facility.
Generally, the provisions of the shareholder agreement terminate on the date
Chevron and its affiliates cease to own shares representing at least 15 percent
of the outstanding voting power of Dynegy. At such time all of the shares of
Class B common stock held by Chevron would convert to shares of Class A common
stock.

ITEM 6. SELECTED FINANCIAL DATA
The selected financial information presented below was derived from, and is
qualified by reference to, the Consolidated Financial Statements of the Company,
including the Notes thereto, contained elsewhere herein. The selected financial
information should be read in conjunction with the Consolidated Financial
Statements and related Notes and Management's Discussion and Analysis of
Financial Condition and Results of Operations. Earnings (loss) per share
("EPS"), shares outstanding for EPS calculation and cash dividends per common
share are adjusted for a two-for-one stock split on August 22, 2000 and, for all
periods prior to February 1, 2000, for the 0.69-to-one exchange ratio in the
Illinova acquisition.

DYNEGY'S SELECTED FINANCIAL DATA

{ 23 }

DYNEGY INC. PART II

- ----------------------------------
(1) The following acquisitions were accounted for in accordance with the
purchase method of accounting and the results of operations attributable to
the acquired businesses are included in the Company's financial statements
and operating statistics beginning on the acquisitions' effective date for
accounting purposes:
- BG Storage Limited ("BGSL") - December 1, 2001;
- iaxis, Limited ("iaxis") - March 1, 2001;
- Extant, Inc. ("Extant") - October 1 2000;
- Illinova Corporation ("Illinova") - January 1, 2000; and
- Destec Energy, Inc. ("Destec") - July 1, 1997.

(2) The BGSL, iaxis, Extant, Illinova, and Destec acquisitions were each
accounted for under the purchase method of accounting. Accordingly, the
purchase price was allocated to the assets acquired and liabilities assumed
based on their estimated fair values as of the effective dates of each
transaction. See footnote 1 above for respective effective dates.

(3) Earnings before interest, taxes, depreciation and amortization ("EBITDA")
is presented as a measure of the Company's ability to service its debt and
to make capital expenditures. It is not a measure of operating results and
is not presented in the Consolidated Financial Statements. The 1997 amount
includes the non-cash portion of items associated with the $275 million
impairment and abandonment charge. Certain reclassifications have been made
to prior-period amounts to conform with current-period financial statement
classification.

(4) Includes all value assigned to the assets acquired in various business and
asset acquisitions. The 1997 amount is before reduction for value received
upon sale of Destec's foreign and non-strategic assets of approximately
$735 million.

{ 24 }

DYNEGY INC. PART II

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Dynegy is one of the world's leading energy merchants. Through its global energy
delivery network and marketing, logistics and risk-management capabilities, the
Company provides innovative solutions to customers in North America, the United
Kingdom and Continental Europe. Dynegy's operations are reported in four
segments: Wholesale Energy Network ("WEN"), Dynegy Midstream Services ("DMS"),
Transmission and Distribution ("T&D") and Dynegy Global Communications ("DGC").
WEN is engaged in the physical supply of and risk-management activities around
wholesale natural gas, power, coal and other similar products. This segment is
focused on optimizing the Company's and its customers' global portfolio of
energy assets and contracts, as well as direct commercial and industrial sales
and retail marketing alliances. DMS consists of the Company's North American
midstream liquids processing and marketing businesses and worldwide natural gas
liquids marketing and transportation operations. Dynegy's T&D segment includes
the operations of Illinois Power Company ("IP"), an energy delivery company
engaged in the transmission, distribution and sale of electricity and natural
gas to customers across a 15,000-square-mile area of Illinois. Beginning with
the first quarter 2002, the T&D segment will include results from Northern
Natural Gas Company ("Northern Natural"), which Dynegy acquired in
January 2002. DGC is engaged in pursuing and capturing opportunities in the
converging energy and communications marketplace. DGC has a global long-haul
fiber optic and metropolitan network in key cities in the United States and
Europe.

LIQUIDITY AND CAPITAL RESOURCES
The Company's business strategy has historically focused on acquiring,
constructing or contracting for a regionally diverse network of energy assets to
capture potential synergies existing among these types of assets and Dynegy's
marketing businesses. Dynegy relies upon operating cash flow along with
borrowings under a combination of commercial paper programs, money market lines
of credit, credit facilities and project-specific debt financings, as well as
public debt and equity issuances for its liquidity and capital resource
requirements.
In the fourth quarter of 2001, the Company announced a $1.25 billion capital
restructuring program to address market concerns regarding balance sheet
strength in the merchant energy industry sector. In accordance with the plan,
Dynegy raised $744 million in net proceeds through the sale of approximately
37.9 million shares of common stock (including 27.5 million shares to the public
in December 2001 and approximately 10.4 million shares to ChevronTexaco in
January 2002). Net proceeds from the sale of these shares were used to reduce
outstanding indebtedness and for general corporate purposes.
In addition, the Company reduced its original 2002 capital-spending program by
over $500 million to approximately $1.2 billion. The Company's primary capital
expenditure focus will be the acquisition and/or construction of energy assets
that will enable the Company to expand its energy network. Expenditures will
include maintenance capital at existing asset facilities of approximately
$430 million. The Company also anticipates making limited future capital
expenditures associated with the worldwide development and implementation of
network and connectivity solutions relating to its communications network.
The Company continues to assess other alternative means for raising capital,
including potential dispositions of under-performing or non-strategic assets.
These steps under the capital restructuring program are being implemented
pursuant to management's desire to reduce leverage and to establish revised
targets for debt to capitalization and coverage ratios.
In January 2002, the Company completed its acquisition of Northern Natural.
Enron Corp. ("Enron") has the option to reacquire Northern Natural through
June 30, 2002 for $1.5 billion plus certain adjustments. Dynegy's acquisition of
this asset temporarily increases the

{ 25 }

DYNEGY INC. PART II

Company's financial leverage. This increased leverage results partially from
Northern Natural's $950 million of indebtedness and partially from the
$1.5 billion of Series B Mandatorily Convertible Redeemable Preferred Stock
("Series B Preferred Stock") sold to ChevronTexaco, the proceeds of which were
used to purchase preferred stock in Northern Natural. The Series B Preferred
Stock, as currently structured, is mandatorily redeemable by Dynegy in
November 2003. The Company is actively assessing alternatives regarding the
Series B Preferred Stock and its capital structure to accommodate Northern
Natural in the event Enron does not exercise its repurchase option.

CREDIT RATING DISCUSSION
Credit ratings impact the Company's ability to obtain short- and long-term
financing, the cost of such financing and the execution of its commercial
strategies in a cost-effective manner. In determining the Company's credit
ratings, the rating agencies consider a number of factors. Quantitative factors
that appear to be given significant weight include, among other things, earnings
before interest, taxes and depreciation and amortization ("EBITDA"); operating
cash flow; total debt outstanding; off balance sheet obligations and other
commitments; fixed charges such as interest expense, rent or lease payments;
payments to preferred stockholders; liquidity needs and availability and various
ratios calculated from these factors. Qualitative factors appear to include,
among other things, predictability of cash flows, business strategy, industry
position and contingencies.
Substantially all of the credit ratings of Dynegy Inc. and its subsidiaries
are under review primarily due to uncertainties regarding the litigation by
Enron against Dynegy (which is more fully discussed in Note 11 to the
consolidated financial statements). In addition, as a result of the Enron
bankruptcy, the credit rating agencies have refocused their attention on the
credit characteristics and credit protection measures of industry participants,
and in some cases appear to have tightened the standards for a given rating
level. Before Dynegy's capital restructuring program was announced, Moody's
downgraded its ratings of Dynegy and its subsidiaries. The capital restructuring
program was designed to restore the Moody's ratings and maintain the Fitch and
Standard & Poors' ratings. There can be no assurance that these results will be
achieved, but the Company believes it is taking action to accomplish this
result.
As of February 28, 2002, Dynegy's senior unsecured debt ratings, as assessed
by the three major credit rating agencies, were as follows:

- ----------------------------------
(1) Dynegy Holdings Inc. is the primary debt financing entity for the
enterprise. This entity is a subsidiary of Dynegy Inc. and is a holding
company that includes substantially all of the operations of the WEN and DMS
business segments.
(2) Dynegy Inc. is the parent holding company. This entity generally provides
financing to the enterprise through issuance of capital stock.
(3) Illinois Power is a stand-alone entity from a financial credit perspective.
This entity includes the Company's regulated transmission and distribution
business in Illinois.
(4) Illinova Corporation is the holding company for Illinois Power and is not
used to raise capital.
(5) Fitch's short-term ratings and its ratings on Illinois Power and Illinova
Corporation are affirmed.

{ 26 }

DYNEGY INC. PART II

(6) Ratings have not changed since Dynegy's acquisition of Northern Natural, but
Standard & Poors' has changed its outlook to developing from negative
implications. Moody's has placed the rating under review and Fitch has
changed its watch status to positive from negative.

TRIGGER EVENTS
Dynegy's debt instruments and other financial obligations include routine
provisions, which, if not met, could require early payment, additional
collateral support or similar actions. For Dynegy, these trigger events include
leverage ratios, insolvency events, defaults on scheduled principal or interest
payments, acceleration of other financial obligations and change of control
provisions. Dynegy does not have any trigger events tied to specified credit
ratings or stock price in its debt instruments and has not executed any
transactions that require it to issue equity based on credit rating or other
trigger events.
The Company has two non-commercial agreements that have trigger events tied to
credit ratings. At December 31, 2001, the amount of cash collateral that the
Company could be required to post in the event of a ratings trigger under these
two agreements was $301 million. The Company's investment in Catlin, LLC,
described below, accounts for $270 million of the possible $301 million in
possible cash collateralization and would be triggered only if the senior
unsecured debt ratings for Dynegy Holdings were below investment grade with both
Standard & Poor's and Moody's. The remaining $31 million relates to the
Company's guarantee of certain environmental obligations of West Coast Power, a
50% owned equity investment. This obligation is also triggered by Dynegy
Holdings' credit rating.
The Company's commercial agreements typically include adequate assurance
provisions relating to trade credit and some agreements also have credit rating
triggers. These trigger events typically would give counterparties the right to
suspend or terminate credit if the Company's credit ratings were downgraded to
non-investment grade status. Under such circumstances, Dynegy would need to post
collateral to continue transacting risk-management business with many of its
counterparties under either adequate assurance or specific credit rating trigger
clauses. The cost of posting collateral would have a negative effect on the
Company's profitability. If such collateral was not posted, the Company's
ability to continue transacting business as before the downgrade would be
impaired.

DISCLOSURE OF FINANCIAL OBLIGATIONS AND CONTINGENT FINANCIAL COMMITMENTS
Dynegy has assumed various financial obligations and commitments in the normal
course of its operations and financing activities. Financial obligations are
considered to represent known future cash payments that the enterprise is
required to make under existing contractual arrangements, such as debt and lease
agreements. These obligations may result from both general financing activities
as well as from commercial arrangements that are directly supported by related
revenue-producing activities. Financial commitments represent contingent
obligations of the enterprise, which become payable only if certain pre-defined
events were to occur, such as financial guarantees.
The following table provides a summary of general financial obligations as of
December 31, 2001. This table includes cash obligations related to outstanding
debt, redeemable preferred stock and similar financing transactions. This table
also includes cash obligations for minimum lease payments associated with
general corporate services, such as office and equipment leases.

{ 27 }

DYNEGY INC. PART II

GENERAL FINANCIAL OBLIGATIONS AS OF DECEMBER 31, 2001

* Cash obligations herein are not discounted and do not include related
interest, accretion or dividends.
(1) Total amounts are included in the December 31, 2001 consolidated balance
sheet.
(2) Includes primarily minimum lease payment obligations associated with office
and office equipment leases.
(3) Includes estimated decommissioning costs related to the sale of the Clinton
nuclear facility in 1999.

The following table provides a summary of contingent financial commitments as
of December 31, 2001. These commitments represent contingent obligations of the
Company, which may require a payment of cash upon certain pre-defined events.

CONTINGENT FINANCIAL COMMITMENTS AS OF DECEMBER 31, 2001

* Contingent obligations are presented on an undiscounted basis.
(1) Surety bonds are generally on a rolling twelve-month basis.
(2) Amounts include $657 million of residual value guarantees related to
commercial leasing arrangements, further discussed in footnote (1) to the
Commercial Financial Obligations table below. Based on the current estimated
fair value of the underlying assets, the Company does not anticipate funding
such amounts. Approximately $31 million of the balance represents a cash
collateralization requirement as described in "Trigger Events" above and is
related to West Coast Power. The remaining $25 million relates to an
insurance program also for West Coast Power. These guarantees do not have
specific expiration dates, thus they have been included in the "Thereafter"
category.

In June 2000, Dynegy and a third party invested in Catlin Associates, L.L.C.
("Catlin"), an entity that is consolidated by Dynegy, with the third party's
investment included in Minority Interest in the Consolidated Balance Sheet.
Dynegy invested $100 million in Catlin and the third party invested
$850 million. As a result of its investment, the third party is entitled to a
non-controlling preferred interest in Catlin, which holds economic interests in
midwest generation assets. On or before June 29, 2005, Dynegy and the third
party investor must agree upon whether and how to make future investments on
behalf of Catlin. If the shareholders are not able to reach agreement regarding
permitted investments or Catlin fails to pay the preferred return to the third
party, Dynegy has the option to purchase the investor's interest for
$850 million or liquidate the assets of Catlin. Dynegy retains an option to
acquire the minority investor's interest in Catlin through June 2010 for
$850 million. Catlin has limited recourse to Dynegy, with such recourse building
over time to a maximum of

{ 28 }

DYNEGY INC. PART II

$270 million in 2005. As of December 31, 2001, recourse to Dynegy was
approximately $35 million. In addition, in the event projected cash flow is
insufficient, Dynegy may be required to make an additional capital contribution
of $60 million to Catlin. The $60 million contingent obligation expires on
December 31, 2002. Approximately $270 million of the $301 million cash
collateralization requirement described in "Trigger Events" above is related to
Catlin.
The following table provides a summary of commercial financial obligations,
which are directly associated with revenue-producing activities. These
arrangements provide Dynegy access to assets that provide it with manufacturing
and logistical capacity needed to execute its business strategy, which is
focused upon the physical delivery of energy products to its customers. These
obligations include certain unconditional purchase obligations associated with
generation turbines, minimum lease payments associated with operating leases on
generation assets, long-haul fiber optic network capacity and certain other
assets used in its operations, as well as capacity payments under generation
supply tolling arrangements and transportation, transmission and storage
arrangements. The market value of revenue sources associated with these
obligations is estimated to exceed the aggregate cash obligations under these
contracts as of December 31, 2001.

COMMERCIAL FINANCIAL OBLIGATIONS AS OF DECEMBER 31, 2001

* Cash obligations are presented on an undiscounted basis.
(1) Amounts include the minimum lease payment obligations associated with the
following arrangements. The Company is a party to 13 commercial lease
arrangements with third parties. Six of the arrangements relate to
generation assets, five relate to NGL marketing assets and two relate to
long-haul fiber optic network capacity. The Contingent Financial Commitments
table includes the residual value guarantees of $657 million related to
these arrangements. Such leasing arrangements are accounted for as operating
leases, thus the related future obligations are not recorded as liabilities
on the Company's consolidated balance sheet and the depreciation of these
assets is not included in the consolidated statement of operations. The
Company elected to utilize leasing structures to optimize the capital
resource allocation, earnings and tax attributes of the enterprise. Dynegy
may ultimately acquire some or all of the leased assets through exercise of
purchase options established at lease inception based on the then fair
market value, but does not have any plans to do so at this time.
(2) Amounts include natural gas, coal, systems design, and power purchase
agreements. Approximately $117 million of the $192 million represents
long-term supply contracts that are passed through to end use customers.
(3) Firm capacity payments include payments aggregating $2 billion that provide
Dynegy with the option to convert natural gas to electricity at third-party
owned facilities ("tolling arrangements"). These amounts include tolling
payments that are reflected on the Consolidated Balance Sheet in
"Risk-Management Assets" or "Risk-Management Liabilities" and those that are
accounted for on an accrual basis, each as determined by the applicable
contractual terms and in accordance with generally accepted accounting
principles. Approximately 91 percent of the $2 billion of aggregate tolling
capacity payments are accounted for on an accrual basis. These contracts
provide Dynegy access to regional generation capacity to fulfill physical
contract requirements of its customers. On a discounted basis, these
capacity payments totaled $1.4 billion. Based on current estimates, the
market value of electricity available for sale under these tolling
arrangements exceeds the discounted fair value of the capacity payments by
$325 million, after adjusting for market, credit and other reserves.
Substantially all of this value is attributable to contracts accounted for
under the accrual method. Other firm capacity payments totaling
approximately $715 million include fixed obligations associated with
transmission, transportation and storage arrangements routinely used in the
physical movement and storage of energy consistent with the Company's
business strategy.

{ 29 }

DYNEGY INC. PART II

(4) Amounts include the Company's obligations as of December 31, 2001 to
purchase 11 gas-fired turbines and an information systems service agreement.
Commitments under the turbine purchase orders are payable consistent with
the delivery schedule. The purchase orders include milestone requirements by
the manufacturer and provide the Company with the ability to cancel each
discrete purchase order commitment in exchange for a fee, which escalates
over time. The amounts herein assume all 11 turbines will be purchased.
However, Dynegy can cancel these arrangements at anytime, subject to a
termination fee. If Dynegy had terminated the turbine purchase orders at
December 31, 2001, the termination fee would have been $12 million, reducing
Dynegy's conditional purchase commitment by $358 million. Additionally, if
Dynegy had terminated the service agreement at December 31, 2001, the
termination fee would have been $9 million, reducing Dynegy's commitment by
$21 million.
(5) Amounts primarily relate to leases of the Central Hudson generating assets
discussed further in Note 14 to the consolidated financial statements.

IP has entered into other generating unit specific contracts that stipulate
fixed payments for the supply of energy as well as variable payments for the
reimbursement of operating costs. Currently, the costs associated with these
arrangements are included in IP's revenue requirements under its rate-making
process.
Dynegy has entered into various joint ventures (see Note 6 to the consolidated
financial statements) principally for the purpose of sharing risk or to optimize
existing commercial relationships. These joint ventures maintain independent
capital structures and have financed their operations on a non-recourse basis to
Dynegy.

AVAILABLE CREDIT CAPACITY
The following table provides the components of the Company's available credit
capacity.

AVAILABLE CREDIT CAPACITY AS OF DECEMBER 31, 2001

Due primarily to current market conditions, the Moody's rating action,
concerns about Dynegy's exposure to the Enron litigation (discussion following
under "Enron/Northern Natural") and other factors, access to the Commercial
Paper markets is limited. During this period of market uncertainty, Dynegy has
relied upon existing bank credit lines, operating cash flow and cash balances on
hand for its short-term liquidity requirements. The Company used proceeds from
its December 2001 and January 2002 stock sales to pay down portions of these
bank credit lines and for general working capital purposes. The Company's
364-day revolving credit facilities - a $1.2 billion facility at Holdings and a
$300 million facility at IP - mature in May 2002. The Company anticipates
refinancing these bank credit facilities in the ordinary course of business.
As of February 27, 2002, the Company had committed credit lines of
approximately $2.7 billion. As of such date, it had borrowings of approximately
$1.1 billion and outstanding letters of credit of approximately $427 million
under these credit facilities, leaving approximately $1.2 billion of available
borrowing capacity under these credit facilities. In addition, the Company had
cash of approximately $560 million. As a result, the Company's liquidity
position was approximately $1.7 billion. This reflects the application of
approximately $497 million in net proceeds from the issuance by Holdings of
$500 million 8.750% Senior Notes due 2012, which closed on February 21, 2002.
Management believes this level of

{ 30 }

DYNEGY INC. PART II

liquidity is adequate to allow Dynegy to operate its business, even in the event
of a downgrade in credit rating.

ENRON/NORTHERN NATURAL
On November 9, 2001, Dynegy entered into a merger agreement with Enron. The
closing of the merger was conditioned upon the accuracy of representation and
warranties, approval of the shareholders of both Dynegy and Enron, the receipt
of applicable regulatory approvals, the absence of material adverse changes and
other customary conditions.
On November 13, 2001, in connection with the merger agreement, ChevronTexaco
purchased 150,000 shares of Dynegy's Series B Preferred Stock for $1.5 billion.
Dynegy used the $1.5 billion of proceeds from this issuance to purchase 1,000
shares of Series A Preferred Stock in Northern Natural. The Series A Preferred
Stock has a 6% cumulative dividend which accrues from the issue date but is not
payable until January 31, 2003. In connection with the preferred stock
investment in Northern Natural, Dynegy paid $1 million to acquire an option to
purchase all of the equity of Northern Natural's indirect parent company. The
exercise price for the option was $23 million, subject to adjustment based on
Northern Natural's indebtedness and working capital.
On November 28, 2001, Dynegy exercised its right to terminate the merger
agreement with Enron. The above-mentioned agreements were impacted as follows:
- Dynegy exercised its option to purchase the indirect parent company of
Northern Natural. The closing of the transaction occurred on January 31,
2002. An Enron subsidiary has the option to reacquire Northern Natural
through June 30, 2002 for $1.5 billion plus accrued but unpaid dividends on
the Series A Preferred Stock and the option exercise price, subject to
adjustment based on Northern Natural's indebtedness and working capital.
- At January 31, 2002, Northern Natural had approximately $950 million of debt
outstanding. Approximately $500 million of this debt is in the form of senior
unsecured notes and the remaining $450 million is in the form of a secured
line of credit. Dynegy has agreed to commence a tender offer by April 1, 2002
for $100 million of the senior unsecured notes due May 2005. The significant
terms of such debt are as follows ($ in millions):

Senior Notes, 6.875% due May 2005 $100
Senior Notes, 6.75% due September 2008 150
Senior Notes, 7.00% due June 2011 250
Borrowing under Revolving Credit Agreement, 4.66% due
November 2002 450
- ----------------------------------------------------------------------
Total debt $950
- ----------------------------------------------------------------------

- Each share of Dynegy's Series B Preferred Stock became convertible, at the
option of ChevronTexaco, for a period of two years, into shares of Dynegy
Class B common stock at the conversion price of $31.64. Dynegy incurred an
implied dividend as a result of this event of approximately $65 million. The
intrinsic value of the conversion option given to ChevronTexaco was based on
the conversion price, which was at a 5% discount to market. Dynegy is
recognizing this dividend over the period the Series B Preferred Stock is
outstanding as required by generally accepted accounting principles. Unless
ChevronTexaco exercises its conversion right, Dynegy is required to redeem
the Series B Preferred Stock for $1.5 billion two years from the date of
issuance. The Series B Preferred Stock is not entitled to a dividend.
On December 2, 2001, Enron filed for federal bankruptcy protection in the
United States Bankruptcy Court, Southern District of New York. Enron also filed
an adversary proceeding in the bankruptcy court against Dynegy Inc. and Dynegy
Holdings Inc. seeking damages of $10 billion for wrongful termination of the
merger agreement and the wrongful exercise of its

{ 31 }

DYNEGY INC. PART II

option to take ownership of Northern Natural. (Please refer to Note 11 of the
audited financial statements for further discussion of this dispute). As a
result of the bankruptcy, Dynegy recognized in its fourth quarter 2001 financial
results a pretax charge of $10 million related to costs incurred in the
terminated merger and a $78 million pretax charge related to the Company's net
exposure for commercial transactions with the bankrupt enterprise. The global
netting agreement between Dynegy and Enron as well as the valuation of these
commercial transactions covered by the agreement are subject to approval by the
bankruptcy court.

RECENT ACQUISITIONS
In the fourth quarter of 2001, Dynegy completed the purchase of BG Storage
Limited ("BGSL"), a wholly owned subsidiary of BG Group plc. Under the terms of
the purchase agreement, Dynegy paid approximately L421 million (approximately
$595 million at November 28, 2001) for BGSL. The storage assets, which are
located in the United Kingdom, consist of 30 gas storage injection wells with
five offshore platforms, nine salt caverns, approximately 19 miles of pipelines
and an onshore natural gas processing terminal. The acquisition of BGSL
established Dynegy's physical asset presence in the United Kingdom. In the first
quarter of 2001, Dynegy finalized the acquisition of iaxis, Limited, a
London-based communications company.
Also in the first quarter of 2001, Dynegy completed the acquisition of two
Central Hudson power generation facilities in New York. The Central Hudson
facilities consist of a combination of base load, intermediate and peaking
facilities aggregating approximately 1,700 MW. The facilities are located
approximately 50 miles north of New York City and were acquired for
approximately $903 million cash, plus certain inventory and working capital
adjustments. The acquisition of these facilities established Dynegy's physical
power presence in the region.
In May 2001, subsidiaries of Dynegy completed a sale-leaseback transaction
with a third party to provide term financing with respect to the Central Hudson
facilities. Under the terms of the sale-leaseback transaction, subsidiaries of
Dynegy sold certain plants and equipment and agreed to lease them back for terms
expiring within 34 years, exclusive of renewal options.

CAPITAL SPENDING
The 2002 budget of $1.2 billion includes construction projects in progress,
maintenance capital projects, environmental projects, technology infrastructure
and software enhancements, contributions to equity investments, leasing
transactions and certain discretionary capital investment funds. The capital
budget is subject to revision as opportunities arise or circumstances change.
Funds approved to be spent for the aforementioned items by the various segments
in 2002 are as follows:

CAPITAL BUDGET FOR 2002

{ 32 }

DYNEGY INC. PART II

Included within WEN's capital budget are funds to complete three power plants
under construction that are expected to begin commercial operation during the
summer of 2002. The natural gas-fired facilities will provide additional
generation of approximately 1,500 MW in the aggregate and are located in
Kentucky and Michigan. Additionally, construction has also started on an 800 MW
natural gas-fired peaking facility in Ohio which is expected to begin operations
during the summer of 2003.

COMMITMENTS AND CONTINGENCIES
See Item 8, Financial Statements and Supplementary Data, Note 11, which is
incorporated herein by reference, for a discussion of the Company's commitments
and contingencies.

CALIFORNIA MARKET/WEST COAST POWER
Dynegy and NRG Energy each own 50 percent of West Coast Power, a joint venture
owning power generation plants in southern California. Dynegy's net interest in
West Coast Power represents approximately 1,400 MW of generating capacity.
Dynegy also participates in the California markets independently, as a wholesale
marketer of gas and power. Substantially all of Dynegy's direct sales made in
California represent either gas sales made under securitized arrangements or
bilateral sales made to creditworthy counterparties. Through its interest in
West Coast Power, Dynegy has credit exposure to certain state agencies ("ISO"
and "PX"), which primarily relied on receipts from California utilities to pay
their bills. West Coast Power also sells directly to the California Department
of Water Resources ("DWR") and pursuant to other bilateral agreements. Pursuant
to a November 7, 2001 FERC order, the DWR was ordered for the period of
January 17, 2001 forward to pay for all power purchased on behalf of the net
short loads of PG&E and Southern California Edison. DWR has complied with this
order, though there remain a number of disputes. Additionally, on February 25,
2002, the California Public Utilities Commission and the California Electricity
Oversight Board filed complaints with the FERC asking that it void or reform
power supply contracts between DWR and, among others, West Coast Power. The
complaints allege that prices under the contracts exceed just and reasonable
prices permitted under the Federal Power Act. While the Company believes the
terms of its contracts are just and reasonable and do not reflect alleged market
manipulation, it cannot predict how the FERC will respond to these complaints.
The Company is vigorously defending against these complaints.
Between the fourth quarter of 2000 and the second quarter of 2001, the power
and natural gas markets in California experienced substantial volatility driven
by a fundamental imbalance in supply and demand and the retail electricity price
caps imposed on the state's two largest utilities. The California market
situation had many impacts, the most significant of which include: (a) a Chapter
11 bankruptcy filing by PG&E; (b) Dynegy's inclusion on PG&E's creditor
committee; (c) separate rulings by the Ninth Circuit Court of Appeals and the
FERC acknowledging that generators in California are not required to sell to
noncreditworthy counterparties; (d) the FERC's decision to investigate gas
pipeline marketing affiliate abuse in the region; (e) the FERC's imposition of a
market mitigation plan for the Western States Coordinating Council; (f) FERC
orders directing electricity suppliers to either refund a portion of certain
sales revenue or justify their prices above approved pricing amounts; (g) a
failed settlement conference to determine potential refunds; (h) the scheduling
and subsequent rescheduling of a FERC hearing to calculate any such refunds;
(i) continued debate over the validity and legality of long-term power supply
contracts executed by state agencies; and (j) a settlement agreement between
Southern California Edison and the California Public Utilities Commission that
is designed to allow Southern California Edison to pay its past due debts and
return it to creditworthy status. In addition, Dynegy and certain of its
officers were named in various lawsuits associated with the California
situation, which are more fully

{ 33 }

DYNEGY INC. PART II

discussed in Note 11 to the Consolidated Financial Statements. Additionally, on
March 11, 2002, the California Attorney General filed, on behalf of the People
of the State of California, complaints in San Francisco Superior Court against
several energy generators, including those owned directly by West Coast Power
and indirectly by Dynegy Inc. The complaints allege that since June 1998, these
generators sold power in the open market that should have been held in emergency
reserve for the State. In the aggregate, the complaints seek more than $150
million in penalties, restitution and return profits from the generators. The
Company believes the allegations are without merit and will vigorously defend
these claims. In the opinion of management, the amount of ultimate liability
with respect to this action will not have a material adverse effect on the
financial position or results of operations of the Company.
As a result of West Coast Power's previously announced long-term sales
arrangement with the DWR, ongoing management of credit risk associated with
direct sales to customers in California and the Ninth Circuit Court of Appeals
and the FERC decisions regarding counterparty choice for generators as well as
other factors, management believes that Dynegy's primary exposure relates to the
realization of its share of West Coast Power's receivables from the ISO and PX
and potential refunds or offsets associated with related transactions.
Transactions with the aforementioned counterparties, other than the ISO and PX,
are current under the terms of each individual arrangement. At December 31,
2001, Dynegy's portion of the receivables owed to West Coast Power by the ISO
and PX approximated $227 million. Management is continually assessing Dynegy's
exposure, as well as its exposure through West Coast Power, relative to its
California receivables and establishes reserves to reflect market uncertainties.

CHEVRONTEXACO COMMERCIAL RELATIONSHIP
Dynegy and ChevronTexaco are in the late stages of negotiations to expand
existing commercial relationships to include natural gas and domestic mixed NGLs
and NGL products produced or controlled by the former Texaco. The expanded term
agreements would extend through August 2006. This expanded relationship will
increase the volume of natural gas we purchase from ChevronTexaco from
approximately 2 Bcf/d to approximately 3 Bcf/d. We also expect to provide supply
and service for approximately 2 Bcf/d of natural gas for the former Texaco's
facilities and third-party term markets. In addition, DMS' expanded contract
with ChevronTexaco is expected to include substantially all of the U.S. NGL
production of the former Texaco. Concurrent with the expanded commercial
agreements, the two companies are exploring alternative security provisions that
would be mutually beneficial. Alternatives could include replacement of existing
credit support arrangements with a perfected security interest in a portion of
our trade receivables.

DIVIDEND POLICY
In 2002, Dynegy intends to pay an annual dividend of $0.30 per share of common
stock, subject to declaration by the Board of Directors of the Company and the
availability of funds legally available therefore. The Class B common stock has
certain conversion features and maintains certain preemptive rights under the
Chevron U.S.A. Inc. shareholder agreement (See Item 5. "Shareholder Agreement"
for more details).

{ 34 }

DYNEGY INC. PART II

CONCENTRATION OF CREDIT RISK
As a result of recent volatility in both the commodity and equity markets,
Dynegy has reviewed in-depth its industry credit concentration as well as
specific counterparty credit risks. Based on this reassessment, Dynegy continues
to believe that credit risk imposed by industry concentration is largely offset
by the diversification and creditworthiness of its customer base. The Company
believes that its corporate credit policies are aligned with business risks in
support of minimizing enterprise credit risk.

ACCOUNTING PRONOUNCEMENTS
See Item 8., Financial Statements and Supplementary Data, Note 2, which is
incorporated herein by reference, for a discussion of Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("Statement
No. 142"), Statement of Financial Accounting Standards No. 143, "Accounting for
Asset Retirement Obligations" ("Statement No. 143") and Statement of Financial
Accounting Standards No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" ("Statement No. 144").

CONCLUSION
The Company believes it will meet all foreseeable cash requirements, including
working capital, capital expenditures and debt service, from operating cash
flow, supplemented by borrowings under its various credit facilities and equity
or debt issuances, if required.

RESULTS OF OPERATIONS
The following table reflects certain operating and financial data for the
Company's business segments for the years ended December 31, 2001, 2000 and
1999, respectively. The impact of acquisition and disposition activity during
the three-year period reduces the comparability of certain historical financial
and volumetric data. This is especially true as it relates to power generation,
gas processing and transmission and distribution volumes and to certain
financial data associated with the operations purchased in the Illinova
acquisition and the financial results reflected in the DGC segment.

{ 35 }

DYNEGY INC. PART II

DYNEGY'S RESULTS OF OPERATIONS

- ----------------------------------
(1) EBIT equals pretax earnings before deduction of interest expense. Certain
reclassifications have been made to prior-period amounts to conform with
current-period financial statement presentation.
(2) Recurring Net Income adjusts Net Income for identified non-recurring items
described in the following narrative of the three year results.
{ 36 }

DYNEGY INC. PART II

DYNEGY'S OPERATING DATA

(1) Includes immaterial amounts of inter-affiliate gas sales.
(2) Represents volumes sold by Dynegy Inc.'s Canadian subsidiary.
(3) Represents volumes sold by Dynegy Inc.'s European operations.
(4) Volumes for 1999 reflect the operations of IP prior to its acquisition by
Dynegy.

THREE YEARS ENDED DECEMBER 31, 2001
For the year ended December 31, 2001, the Company realized net income of
$648 million, or $1.90 per diluted share. This compares with $501 million, or
$1.48 per diluted share, and $152 million, or $0.66 per diluted share, in 2000
and 1999, respectively. Recurring net income was $713 million, or $2.10 per
diluted share, in 2001. This compares to $452 million, or $1.43

{ 37 }

DYNEGY INC. PART II

per diluted share, and $146 million, or $0.63 per diluted share, in 2000 and
1999, respectively. Non-recurring items impacting net income and diluted
earnings per share were as follows:

NON-RECURRING NET INCOME ITEMS

(1) The Company recognized an after-tax charge of $51 million ($78 million
pre-tax) related to its net exposure to Enron Corp. as a result of that
company's bankruptcy filing. The pre-tax charge is included in "Cost of
Sales" in the accompanying Consolidated Statements of Operations
("Statements").
(2) The Company terminated its proposed merger with Enron Corp. on November 28,
2001. Transaction costs associated with this terminated merger approximated
$7 million after-tax ($10 million pre-tax). The pre-tax charge is included
in "Other expense" in the accompanying Statements.
(3) The Company incurred approximately $9 million of severance costs ($15
million pre-tax) related to a restructuring at Illinois Power. The pre-tax
charge is included in "General and administrative expense" in the
accompanying Statements.
(4) The special dividend in 2001 relates to the conversion price imbedded in
the Series B Preferred Stock held by ChevronTexaco.
(5) Effective January 1, 2001, the Company adopted Financial Accounting
Standard No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended, realizing an after-tax cumulative effect gain of
approximately $2 million.
(6) The Company sold its 25% participating preferred interest in Accord Energy
Limited in the third quarter of 2000. The after-tax gain of approximately
$58 million ($83 million pre-tax) is included in "Other income and expense,
net" in the accompanying Statements.
(7) The Company sold interests in certain Qualifying Facilities pursuant to
statutory requirements related to the Illinova acquisition. The after-tax
gain of approximately $34 million ($52 million pre-tax) is included in
"Other income and expense, net" in the accompanying Statements.
(8) The Company sold its non-strategic domestic crude oil marketing and trade
business in the first quarter of 2000. The charge of approximately $9
million after-tax ($14.5 million pre-tax) is included in "Other income and
expense, net" in the accompanying Statements.
(9) The Company sold its Mid-Continent liquids processing assets in the first
quarter of 2000. The after-tax charge of approximately $8 million ($13
million pre-tax) is included in "Other income and expense, net" in the
accompanying Statements.
(10) The impairment reserve is associated with a Canadian gas processing asset.
The after-tax charge of approximately $16 million ($25 million pre-tax) is
included in "Depreciation and amortization expense" in the accompanying
Statements.
(11) Amounts relate to non-capitalizable merger related costs associated with
the Illinova acquisition. The after-tax charge of approximately $10
million ($15 million pre-tax) is included in "General and administrative
expense" in the accompanying Statements.
(12) The special dividend in 2000 relates to amounts paid to certain
shareholders pursuant to the execution of the Illinova acquisition.
(13) The Company sold a non-strategic investment in the first quarter of 1999.

{ 38 }

DYNEGY INC. PART II

Revenues in each of the three years in the period ended December 31, 2001
totaled $42.2 billion, $29.4 billion and $15.4 billion, respectively. Operating
cash flows totaled $811 million for the year ended December 31, 2001, compared
with $438 million in 2000 and $9 million in 1999.
The 2001 results compare favorably to recurring net income reported in both
2000 and 1999, principally reflecting the substantial growth in WEN's
operations. Dynegy believes its ability to successfully execute its financial
and operational objectives during a year of significant industry events
validates its focus on customer marketing, origination, risk management and
physical delivery logistics around its network of energy assets.
Consolidated operating margin for each of the three years in the period ended
December 31, 2001 totaled $1.9 billion, $1.5 billion and $544 million,
respectively. For the year ended December 31, 2001, the Company reported
operating income of $970 million, compared with operating income of
$741 million and $214 million for the 2000 and 1999 periods, respectively. The
substantial annual growth in operating margin during the three-year period is
discussed in detail below by segment. This growth in operating margin is
partially offset by higher depreciation and amortization and general and
administrative expenses. Increases in depreciation and amortization expense
during the three-year period reflect the impact of continued expansion of the
Company's depreciable operating and technology asset base. The increased level
of general and administrative expenses period-to-period reflects the
infrastructure required to support a larger, more diverse operation. Increased
overhead costs are primarily a result of expansion of the Company's operations,
primarily in the DGC segment and in Europe. Additionally, variable compensation
costs were higher in 2001 as compared with both the 2000 and 1999 periods.
Incremental to Dynegy's consolidated results was the Company's share in the
earnings of its unconsolidated affiliates, which contributed approximately
$242 million, $205 million and $80 million in 2001, 2000 and 1999, respectively.
West Coast Power contributed approximately $162 million, $122 million and
$16 million to such earnings in 2001, 2000 and 1999, respectively. Increases in
equity earnings in 2001 and 2000 reflect returns on investments in regionally
diverse power generation joint ventures that benefited from higher price
realization. Cash distributions received from these investments during each of
the three years in the period ended December 31, 2001 approximated
$100 million, $118 million and $66 million, respectively. During 2000, the
Company disposed of its investments in Accord and certain QFs for substantial
gains.
Interest expense totaled $259 million for the year ended December 31, 2001,
compared with $251 million and $78 million for the comparable 2000 and 1999
periods, respectively. The increase in interest expense in 2001 is due primarily
to increased principal, partially offset by lower variable rates than in 2000.
The increase in interest expense in 2000 from 1999 is attributable to the
increased indebtedness resulting from the acquisition of Illinova, both in terms
of Illinova indebtedness assumed in the transaction and principal borrowed to
effect the transaction. Additionally, interest rates on the variable rate
borrowings were higher in 2000 than in 1999.
Other income and expenses, net reduced 2001 operating results by $16 million
and benefited operating results in each of the two years in the period ended
December 31, 2000 by $96 million and $28 million, respectively. The variability
in these amounts principally reflects the pre-tax effect of certain of the
previously disclosed non-recurring items. The remaining net amounts for all
three years include the financial effects of minority shareholder investments in
some of the Company's operations and other income and expense items including
interest and dividend income, foreign currency gains and losses, insurance
proceeds and other similar items.

{ 39 }

DYNEGY INC. PART II

The Company reported an income tax provision of $269 million in 2001, compared
to income tax provisions of $261 million and $75 million in 2000 and 1999,
respectively. These amounts reflect effective rates of 29 percent, 34 percent
and 33 percent, respectively. In general, differences between the aforementioned
effective rates and the statutory rate of 35 percent result primarily from
permanent differences attributable to amortization of certain intangibles,
book-tax basis differences and the effect of certain foreign equity investments
and state income taxes. See Item 8, Financial Statements and Supplementary Data,
Note 8, which is incorporated herein by reference.

WHOLESALE ENERGY NETWORK
WEN reported recurring segment net income of $660 million for the year ended
December 31, 2001, compared with recurring net income of $354 million and
$101 million for the years ended December 31, 2000 and 1999, respectively.
Non-recurring items included in the 2001 segment results include WEN's
approximately $49 million exposure to Enron (net of tax) as a result of that
company's bankruptcy filing and an allocation of transaction costs associated
with the terminated proposed merger with Enron. Non-recurring items included in
the 2000 segment results include the gains on sale of Accord and the QF
interests, partially offset by an allocated portion of the Illinova acquisition
costs. Included in 1999 segment reported net income is the gain on sale of the
Quicktrade investment. The growth in recurring results of operations during the
three-year period were influenced positively by:
- New, regionally diverse merchant power generating capacity acquired or placed
in service in 2001 and 2000;
- Pricing environment on the West Coast during 2001, partially due to the
contract with DWR;
- Continued expansion of gas and power marketing in Canada and Continental
Europe;
- Enhanced technology solutions, including DynegyDIRECT; and
- Opportunities created by price volatility.
The new generating capacity in 2001 included the acquisition of the Central
Hudson power generating facilities in New York and development projects in
Georgia, Kentucky and Louisiana for a total of approximately 2,865 MW, while new
capacity in 2000 included the generation assets from the Illinova acquisition
and development projects in Illinois, Louisiana and North Carolina for a total
of 8,091 MW.
European and Canadian marketing operations in 2001 benefited from new
origination and service demand resulting in improved recurring contribution in
2001 from 2000 and 1999.
Total electric power produced and sold during 2001 aggregated 317.1 million
megawatt hours compared to 137.7 million and 79.3 million megawatt hours during
2000 and 1999, respectively. The 2001 and 2000 volumes reflect the impact of
additional generating capacity and improved price volatility period-over-period.
The 1999 volume is particularly low due to lower weather-driven demand for
electricity in that period. Total natural gas volumes sold increased to
12.6 billion cubic feet per day from 10.9 billion cubic feet per day in 2000 and
9.9 billion cubic feet per day in 1999. The 2001 increase in natural gas volumes
sold reflects greater market origination, including sales to commercial and
industrial customers, sales volumes on DynegyDIRECT and increased gas marketing
in Canada. The 2000 increase in natural gas volumes sold reflects the increased
demand by gas-fired generation, expanding European operations and greater
volumes sold to Dynegy's retail alliances.

DYNEGY MIDSTREAM SERVICES
DMS reported recurring net income of approximately $59 million for the year
ended December 31, 2001 compared with recurring net income of $55 million and
$45 million in 2000 and 1999, respectively. Non-recurring items in 2001 included
DMS' approximately

{ 40 }

DYNEGY INC. PART II

$2 million exposure to Enron (net of tax) as a result of that company's
bankruptcy filing and an allocation of transaction costs associated with the
terminated proposed merger with Enron. Non-recurring items included in the 2000
segment results include the losses on sale of the Crude Oil Marketing and Trade
business and Mid-Continent gas processing assets as well as the impairment of a
Canadian gas processing asset. Non-recurring items in 2000 also included an
allocation of certain costs related to the Illinova acquisition. Recurring
results of operations during the three-year period were influenced either
positively or negatively by:
- Higher price realization in 2001, as compared to 2000, resulting from an
active forward sales program and contract restructuring activities, which
were realized despite a depressed pricing environment resulting from larger
industry wide inventories;
- Substantial focus on lowering costs throughout the Liquids Value Chain during
the three-year period;
- Lower price realization in 2000, as compared to 1999, resulting from an
active forward sales program and contract restructuring activities;
- NGL commodity prices in 2000, and the volatility associated therewith, were
generally improved over 1999 levels;
- The sale of approximately one-third of Dynegy's domestic upstream natural gas
processing assets in late 1999 and early 2000;
- Fluctuating world-wide demand for NGLs, particularly in Europe and Asia,
enhanced 2000 revenues from global marketing operations; and
- The domestic Crude Oil Marketing and Trade business, which was sold April 1,
2000, contributed approximately $9 million after-tax in 1999.
Average domestic NGL processing volumes totaled 84 MBbls/d in 2001 compared to
an average of 97 MBbls/d and 123 MBbls/d in 2000 and 1999, respectively. Lower
volumes processed in 2001 reflect the impact of market conditions on straddle
plant production during the three-year period and the aforementioned
non-strategic asset dispositions. Volumes processed in 2000 were flat with
volumes processed in 1999 after adjusting for the effects of the asset sales.
NGL market prices during 2001 averaged $0.45 per gallon compared to $0.55 per
gallon and $0.34 per gallon in 2000 and 1999, respectively.

TRANSMISSION AND DISTRIBUTION
The Transmission and Distribution segment was formed at the beginning of 2000
and reflects the operations of IP acquired in the Illinova acquisition. The
segment had recurring net income of approximately $55 million in each of the
years ended December 31, 2001 and 2000. Non-recurring items in 2001 results
include approximately $9 million of after-tax severance charges related to a
restructuring at IP, while the 2000 results include an approximate $2 million
after-tax non-recurring merger cost charge. While recurring net income was flat
between 2001 and 2000, the operating margin decreased in 2001 as a result of
decreased industrial electricity revenues from competition and economic
downturn. Additionally, operating expenses were higher due to fees paid in
connection with an independent system operator and other costs partially offset
by lower purchased power costs and more favorable weather.

DYNEGY GLOBAL COMMUNICATIONS
This segment was formed at the beginning of the fourth quarter of 2000 and had
$61 million and $12 million net losses for the years ended December 31, 2001 and
2000, respectively, resulting from start-up investments associated with the
expansion of the Company's global communications business, which has operations
in the U.S. and Europe.

{ 41 }

DYNEGY INC. PART II

OPERATING CASH FLOW
The following table is a condensed version of the operating section of the
Consolidated Statements of Cash Flows included in Item 8, Financial Statements
and Supplementary Data:

DYNEGY'S CONDENSED CONSOLIDATED CASH FLOWS

Increases in operating cash flow in 2001 primarily reflect higher net income,
higher non-cash add-backs such as depreciation and amortization, reserve for
doubtful accounts and risk management activities. The depreciation and
amortization is higher due to a larger asset base. The reserve for doubtful
accounts includes the Enron exposure write-off of approximately $78 million on a
pre-tax basis. Changes in working capital had a negative impact on operating
cash flow in 2001 due primarily to the timing of cash inflows and outflows
related to trade accounts and certain other deposits.
Operating cash flow results in 2000 primarily reflected higher net income
compared to 1999, decreased investment in inventories and higher non-cash
expenses such as depreciation and deferred taxes. Also significant to 2000
operating cash flow is the impact of non-cash risk-management activities, which
reflect the significant market volatility in the 2000 period as well as
successful execution of our global convergence business strategy.
Operating cash flow in 1999 primarily reflected increased investment in
inventory and increased non-cash earnings from its marketing operations.
Changes in other working capital accounts, which include prepayments, other
current assets and accrued liabilities, reflect expenditures or recognition of
liabilities for insurance costs, certain deposits, salaries, taxes other than on
income, certain deferred revenue accounts and other similar items. Fluctuations
in these accounts, period-to-period, reflect changes in the timing of payments
or recognition of liabilities and are not directly impacted by seasonal factors.

CAPITAL EXPENDITURES AND INVESTING ACTIVITIES
Funds used in 2001 investing activities totaled $3.4 billion. Included in the
capital expenditures in 2001 is the purchase of the Central Hudson power
generation facilities for $903 million. Additional capital expenditures of
$942 million principally related to the construction of power generation assets,
improvements of existing facilities related to the T&D segment and investments
associated with technology infrastructure. Also during 2001, Dynegy invested
$1.5 billion related to its purchase of Northern Natural Series A Preferred
Stock. Business acquisitions for the year ended December 31, 2001 included
acquisition costs related to the purchase of BGSL of approximately $595 million
and acquisition costs incurred in 2001 related to iaxis, Limited. Proceeds from
asset sales in 2001 included the sale of the Central Hudson facilities in
May 2001 for $920 million pursuant to a leveraged lease transaction, in addition
to proceeds from the disposal of certain non-strategic Canadian assets and

{ 42 }

DYNEGY INC. PART II

investments. Other investing activities in 2001 include net outflows
representing investment and cash collateralization of certain commercial lease
obligations.
In 2000, capital expenditures of approximately $769 million primarily related
to construction of power generation assets, improvements of existing facilities
related to the T&D segment and investments associated with technology
infrastructure. Also during 2000, Dynegy made investments in unconsolidated
affiliates of approximately $141 million, while the $1.2 billion in business
acquisitions in 2000 related primarily to Illinova and Extant Inc. Acquisitions.
Proceeds from asset sales in 2000 of $856 million relate to the sales of certain
QFs and liquids assets.
During the year ended December 31, 1999, the Company invested a net
$319 million principally in power generation assets, including a power
generation partnership, and additional expenditures related to capital
improvements at existing facilities and capital investment associated with
technology infrastructure improvements. Also during 1999, the Company sold
certain DMS assets, an investment held by WEN and a 50 percent interest in a
power generation partnership, netting proceeds of $81 million.

FINANCING ACTIVITIES
Net cash inflows associated with financing activities in 2001 totaled
approximately $2.7 billion.
Dynegy sold approximately 29.8 million shares of common stock during 2001. The
offerings included approximately 27.5 million shares of Class A common stock
sold to the public in December 2001. The Company also sold approximately
1.2 million shares of Class B common stock to ChevronTexaco in private
transactions pursuant to the exercise of ChevronTexaco's preemptive rights.
Total net proceeds to Dynegy from these sales and proceeds from options and
401(k) plan sales approximated $604 million. This amount is net of underwriting
commissions and expenses of approximately $32 million.
Proceeds of $1.5 billion relate to the sale of 150,000 shares of Series B
Mandatorily Convertible Redeemable Preferred Stock to ChevronTexaco, concurrent
with Dynegy's purchase of Northern Natural Series A Preferred Stock.
Additional 2001 proceeds of $496 million, net of issuance costs, resulted from
the issuance of $500 million of 6.875 percent Senior Notes due April 1, 2011.
Such proceeds were used to repay credit facility borrowings obtained to finance
the purchase of the Central Hudson generation facilities, while the acquisition
of BGSL was financed primarily with borrowings under revolving credit
agreements.
Also during 2001, IP received proceeds of $187 million from the issuance of
variable rate pollution control bonds. Contemporaneously, the Company retired
and repaid pollution control bonds with a higher rate. During 2001, IP also
redeemed $100 million of Trust Originated Preferred Securities issued by
Illinois Power Financing I. The redemption was financed with $85 million from
cash on hand and $15 million in commercial paper.
During 2001, the Company repurchased approximately 1.7 million shares of its
outstanding Class A common stock pursuant to its stock repurchase plan at a cost
of $68 million.
Dividends and other distributions paid were $98 million, $112 million and
$8 million in the years ended December 31, 2001, 2000 and 1999, respectively.
The 2000 amount includes a non-recurring dividend payment of approximately
$31.8 million related to the Illinova acquisition.
Financing activities in 2000 resulted in cash inflows of $907 million.
Approximately $1.2 billion was raised through sales of common equity,
$200 million of which includes purchases of Class B common stock by Chevron
U.S.A. Inc. The proceeds of the equity sales, in addition to dispositions of
certain non-strategic assets, proceeds from minority interest

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DYNEGY INC. PART II

contribution and operational cash inflows, were used as long-term financing for
the purchase of Illinova. The Company also issued $300 million of 8.125 percent
Senior Notes due March 5, 2005. Further, IP redeemed $93 million of tax
advantaged Monthly Income Preferred Securities. Other financing, net in 2000
relates primarily to the $850 million received from a third-party investor for a
minority interest in Catlin LLC, which is consolidated by Dynegy. (See Note 10
to the consolidated financial statements for more information.)
In December 2001, Dynegy announced an approximately $1.25 billion
restructuring program designed to strengthen its balance sheet and restore
market confidence. In accordance with the plan, Dynegy reduced the original 2002
capital-spending program by approximately $500 million and raised $744 million
through sales of common stock. The equity offering provided net proceeds of
approximately $539 million in December 2001 resulting from the sale of
27.5 million shares of Class A common stock to the public and proceeds of
approximately $205 million, resulting from the sale of approximately
10.4 million shares of Class B common stock to ChevronTexaco in January 2002.
Concurrent with the December Class A common stock sale, certain officers of the
Company purchased approximately 1.2 million shares of Class A common stock in a
private placement transaction pursuant to Section 4(2) of the Securities Act of
1933. The officers paid $19.75 per share for the stock, the same price as the
net proceeds to the Company in the public offering. The officers paid for the
shares by entering into promissory notes with the Company for an initial term of
60 days. The maturity date of the notes was extended for an additional 30 days
with the approval of the Board of Directors. The loans bear interest at 3.25
percent and are full recourse to the borrowers. Such loans are accounted for as
"Subscriptions Receivable" within Stockholders' Equity on the Consolidated
Balance Sheet at December 31, 2001. The Company recognized compensation expense
in 2001 of approximately $1.2 million, which was recorded as "General and
Administrative Expense."

SEASONALITY
Dynegy's revenues and operating margin are subject to fluctuations during the
year, primarily due to the impact certain seasonal factors have on sales volumes
and the prices of natural gas, electricity and NGLs. Natural gas sales volumes
and operating margin have historically been higher in the winter months than in
the summer months, reflecting increased demand due to greater heating
requirements and, typically, higher natural gas prices. Conversely, power
marketing operations and electricity generating facilities have higher
volatility and demand, respectively, in the summer cooling months, while the
transmission and distribution business has higher seasonal gas sales in the
winter and higher seasonal electricity sales in the summer. These trends may
change over time as demand for natural gas increases in the summer months as a
result of increased gas-fired electricity generation. DMS businesses are also
subject to seasonal factors; however, such factors typically have a greater
impact on sales prices than on sales volumes.

FACTORS AFFECTING FUTURE OPERATING RESULTS
Dynegy's results of operations in 2002 and beyond may be significantly affected
by the following factors:
- changes in demand for the Company's power generation, pipeline, NGL or other
facilities caused by general economic or industry conditions, commodity
pricing or competition;
- the volatility and level of prices for energy commodities in North America
and Europe;
- the timing and pace of energy deregulation in North America and Europe and
the effect of the Enron bankruptcy on the pace of deregulation;

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DYNEGY INC. PART II

- the addition of the historical Texaco U.S. gas and liquids volumes to the
Company's commercial relationship with ChevronTexaco;
- the acquisition of Northern Natural and possible repurchase of Northern
Natural by Enron;
- the effect of market uncertainties and the Enron litigation on Dynegy's
credit ratings, costs of borrowing and trade credit; and
- the execution by DGC of its current business plans in the telecommunications
market and the resulting impact such execution may have on the realizability
of Dynegy's investment in that business segment.
The Company's results also will be significantly affected by its ability to
execute the business plan and strategy described elsewhere herein, including the
2002 capital plan, and the ability to manage risk throughout the enterprise.
Additional information regarding our risk management and governance activities
follows. References are also made to the section "Uncertainty of Forward Looking
Statements and Information" for additional factors which might impact future
operating results.

CORPORATE RISK GOVERNANCE
Dynegy's operations and periodic returns are impacted by a myriad of factors,
some of which may, and some of which may not, be mitigated by risk management
methods. These risks include, but are not limited to, commodity price, interest
rate and foreign exchange rate fluctuations, weather patterns, counterparty
risk, management estimations, strategic investment decisions, changes in
competition, operational risks, environmental risks and changes in regulation.
The effective management of risk is critical to Dynegy's success. Dynegy's
Board of Directors has approved a Risk Policy Statement (referred to herein as
the "Dynegy Risk Policy Statement") that identifies business risks confronting
the enterprise, establishes controls and procedures relating to these risks, and
assigns responsibility for executing the Board's directives. As a complement to
the active management of business risks, Dynegy incorporates a multi-level
control environment that is consistent and aligned with the Dynegy Risk Policy
Statement. The Company's comprehensive risk management process monitors,
evaluates and manages the principal risks assumed in conducting Dynegy's
operations consistent with the Company's corporate strategies and objectives.

GOVERNANCE COMMITTEES STRUCTURE
Dynegy seeks to monitor and control its exposure to risk through a variety of
separate but complementary accounting, financial, credit, operational and legal
reporting systems. Structurally, Dynegy has formed a series of committees at
both the Board and executive leadership levels responsible for establishing
limits, for monitoring adherence to these limits and for general oversight of
the Company's risk management process. Each level of committee has increasingly
greater policy-setting responsibility migrating from a monitoring and managing
role to the role of establishing enterprise-wide risk management policy. These
committees, which are described below, meet regularly and consist of Board
members and senior members of both the Company's revenue-producing units and
departments that are independent of revenue-producing units.

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DYNEGY INC. PART II

GOVERNANCE COMMITTEE STRUCTURE

[STRUCTURE CHART]
BOARD OF DIRECTORS. Ultimate responsibility for ensuring that risks are
appropriately identified and managed lies with the Board of Directors. The
Board's focus is on enterprise risk, which includes market, credit, interest
rate, currency, operational, legal and reputational exposures. All risk
management and control functions ultimately report to the Board. The Board is
solely responsible for approving and amending Dynegy's Risk Policy Statement.
This responsibility has been delegated to the Audit Committee.
AUDIT COMMITTEE. The Audit Committee is a sub-committee of Dynegy's Board. A
key responsibility of this committee is the periodic review of the control
structure governing the enterprise's internal control and risk management
activities, including limit structures, risk procedures and oversight matrices.
The Audit Committee governs internal control and risk-management activities
through the Executive Risk Committee and the Corporate Compliance and Internal
Audit Function.
AUDIT AND COMPLIANCE COMMITTEE. The Vice President of Corporate Compliance
and Internal Audit is the Company's Business Ethics and Chief Audit Executive,
who reports directly to the Audit Committee. This position is responsible for
the planning and execution of internal financial and operational audits
regarding the adequacy and effectiveness of accounting and financial and
operational controls. This individual works with the Chairman of the Audit
Committee in determining the scope of this committee's function.
EXECUTIVE RISK COMMITTEE. The Executive Risk Committee sets limits, capital
allocation and return targets for enterprise risk, including investment,
commodity and financial risks. Dynegy's Chief Executive Officer, Chief Operating
Officer, Chief Financial Officer and Chief Risk Officer comprise this committee.
This committee reports to the Audit Committee.

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DYNEGY INC. PART II

RISK COMMITTEE. The Risk Committee is focused on the assessment of financial
risks inherent in the enterprise and the establishment of policies and limits
around these risks. Activities performed by this committee include review of:
- the activities of existing businesses;
- new businesses and products;
- divisional market risk limits;
- business unit market risk limits; and
- currency and interest rate risk limits.
Dynegy's risk limit structure involves five independent limits, which include:
(a) Value at Risk; (b) equity change limits; (c) stop-loss limits; (d) cash
outlay limits; and (e) option limits related to time decay and volatility
factors. These independent limits are applied to each of the Company's
commodity, interest rate and currency portfolios on a segment and business unit
basis. The business unit managers further allocate business unit risk limits to
individuals or desks responsible for executing the Company's strategies. This
process results in a risk control structure, aggregating risk limits throughout
the organization, culminating in an enterprise-wide risk tolerance assessment.
This committee reports to the Executive Risk Committee.
FINANCE COMMITTEE. The Finance Committee is also a sub-committee of Dynegy's
Board. This committee also functions pursuant to a charter that governs its
responsibilities. The Finance Committee is responsible for oversight of the
Company's capital, liquidity and funding needs as well as reviewing capital
allocation and target return criteria.
RISK AND ENVIRONMENT COMMITTEE. The Risk and Environment Committee provides
oversight of the Company's ongoing development and operational risk policies,
framework and methodologies including policies related to the environment and
occupational health and safety. The committee also determines insurance coverage
and the risk retention policy related thereto. The committee monitors the
effectiveness of this framework. This committee is a sub-committee of Dynegy's
Board.
CREDIT POLICY COMMITTEE. The Credit Policy Committee establishes and reviews
broad credit policies and parameters for the enterprise. This committee reports
to the Finance Committee.

RISK LIMITS AND GOVERNANCE
The Board has appointed a Chief Risk Officer who reports to the Audit Committee.
The Chief Risk Officer heads an enterprise-wide risk control department. This
department is independent of any revenue-producing unit of the organization and
conducts its activities independent of any active management of risk exposures
confronting the enterprise. The enterprise-wide risk department is charged with
assuring adherence to Dynegy's Risk Policy Statement, the independent validation
of valuation methodologies employed by the enterprise as well as assuring
compliance with approved risk strategies. Risk limits are monitored on a daily
basis by this department, and the results of this monitoring activity is
reviewed regularly by the appropriate risk committees. Limit violations are
reported to the appropriate Board and management committees and business unit
managers pursuant to a hierarchical reporting matrix defined in the Dynegy Risk
Policy Statement. Resolution of each limit violation is consistent with protocol
detailed in such statement.
The Chief Risk Officer ensures quality assurance of the Risk Policy Statement
by maintaining the Dynegy Risk Management and Control Policy Manual that governs
all business activity and the risk exposure therein. The Dynegy Risk Management
and Control Policy Manual is a comprehensive manual advising employees of known
and potential risks, processes and procedures and knowledge of all
policy-related matters of risk.

{ 47 }

DYNEGY INC. PART II

ACCOUNTING METHODOLOGY
Dynegy's Controller Department is responsible for the development and
application of accounting policy and control procedures for the organization's
financial and operational accounting functions. This department conducts its
activities independent of any active management of risk exposures confronting
the enterprise, is independent of revenue-producing units and reports to the
Chief Financial Officer.
The Company has identified three critical accounting policies that require a
significant amount of judgment and are considered to be the most important to
the portrayal of Dynegy's financial position and results of operations. These
policies include the accounting for long-lived assets, the evaluation of
counterparty credit and other similar risks and revenue recognition. See Note 3
to the consolidated financial statements for a discussion of the process
surrounding the evaluation of counterparty credit and other similar risks. For
disclosure on the Company's accounting for long-lived assets and revenue
recognition, refer to Note 2 to the consolidated financial statements. The
following narrative provides additional discussion of the Company's revenue
recognition policy. Recent events have placed substantial focus on accounting
principles and the application of these principles. The focus has been around
the transparency of disclosures relating primarily to liquidity and capital
resource matters, the valuation of certain energy trading activities,
transactions with related parties and the use of special purpose entities. As a
result, accounting guidance is expected to continue to evolve and the impact of
potential future revisions in accounting principles will be addressed by the
Company when, and if, they occur.
Dynegy utilizes two comprehensive accounting models in reporting its
consolidated financial position and results of operations as required by
generally accepted accounting principles-an accrual model and a fair value
model. Dynegy determines the appropriate model for its various operations based
on guidance provided in numerous accounting standards and positions adopted by
the Financial Accounting Standards Board ("FASB") or the Securities and Exchange
Commission. The Company has applied these accounting policies on a consistent
basis during the three years in the period ended December 31, 2001, except for
the adoption of Financial Accounting Standard No. 133 ("FAS No. 133"), which was
effective January 1, 2001. The implementation of FAS No. 133 was not material to
the Company's results of operations or financial position.
The accrual model is used to account for substantially all of the operations
conducted in Dynegy's DMS, T&D and DGC segments as well as all physically
operated assets owned by the WEN segment. These businesses consist largely of
the ownership and operation of physical assets. Dynegy uses these physical
assets in various manufacturing and delivery processes. These processes include
the generation of electricity, the separation of natural gas liquids into their
component parts from a stream of natural gas, the transportation or transmission
of commodities through pipelines or over transmission lines and the delivery of
data and voice bits over communication networks. End sales from these businesses
result in physical delivery of commodities to Dynegy's wholesale, commercial and
industrial and retail customers.
The fair value model is used to account for certain forward physical and
financial transactions in the WEN, DMS and DGC segments, which meet criteria
defined by the FASB or the Emerging Issues Task Force. The criteria are complex
but generally require these contracts to be related to future periods and
contain fixed price and volume components and have terms that require or permit
net settlement of the contract in cash or its equivalent. The FASB determined
that the fair value model is the most appropriate method for accounting for
these types of contracts. In part, this conclusion is based on the cash
settlement provisions in these agreements, as well as the volatility in
commodity prices, interest rates and, if applicable,

{ 48 }

DYNEGY INC. PART II

foreign exchange rates, which impact the valuation of these contracts. Since
these transactions may be settled in cash, the value of the assets and
liabilities associated with these transactions is reported at estimated
settlement value based on current prices and rates as of each balance sheet
date. Under currently applicable accounting standards, failure to present these
transactions at other than estimated present settlement value based on current
prices and rates would result in an inaccurate portrayal of the assets and
obligations of an enterprise.
In addition, the Company routinely enters into financial instrument contracts
to hedge purchase and sale commitments, fuel requirements and inventories in its
natural gas, NGLs, electricity and coal businesses in order to minimize the risk
of changes in market prices in these commodities. Dynegy will also execute
financial instrument transactions to hedge exposure to fluctuations in interest
rates and foreign currency exchange rates. These transactions are accounted for
as either cash flow hedges, fair value hedges or foreign currency hedges in
accordance with generally accepted accounting principles.

{ 49 }

DYNEGY INC. PART II

The following chart provides detail on the accounting principle applications
used by the organization:

APPLICATION OF COMPREHENSIVE ACCOUNTING METHODOLOGIES

{ 50 }

DYNEGY INC. PART II

ENTERPRISE RISK MANAGEMENT, VALUATION AND MONITORING
MARKET RISK
The Company is exposed to commodity price variability related to its natural
gas, NGLs, crude oil, electricity and coal businesses. In addition, fuel
requirements at its power generation, gas processing and fractionation
facilities represent additional commodity price risks to the Company. In order
to manage these commodity price risks, Dynegy routinely utilizes certain types
of fixed-price forward purchase and sales contracts, futures and option
contracts traded on the New York Mercantile Exchange and swaps and options
traded in the over-the-counter financial markets to:
- Manage and hedge its fixed-price purchase and sales commitments;
- Provide fixed-price commitments as a service to its customers and suppliers;
- Reduce its exposure to the volatility of cash market prices;
- Protect its investment in storage inventories; and
- Hedge fuel requirements.
The potential for changes in the market value of Dynegy's commodity, interest
rate and currency portfolios is referred to as "market risk." A description of
each market risk category is set forth below:
- Commodity price risks result from exposures to changes in spot prices,
forward prices and volatilities in commodities, such as electricity, natural
gas, coal, NGLs, crude oil and other similar products;
- Interest rate risks primarily result from exposures to changes in the level,
slope and curvature of the yield curve and the volatility of interest rates;
and
- Currency rate risks result from exposures to changes in spot prices, forward
prices and volatilities in currency rates.
Dynegy seeks to manage these market risks through diversification, controlling
position sizes and executing hedging strategies. The ability to manage an
exposure may, however, be limited by adverse changes in market liquidity or
other factors.

VALUATION CRITERIA AND MANAGEMENT ESTIMATES
As discussed previously, Dynegy utilizes a fair value accounting model for
certain aspects of its operations as required by generally accepted accounting
principles. The net gains or losses resulting from the revaluation of these
contracts during the period is recognized currently in the Company's results of
operations. For financial reporting purposes, assets and liabilities associated
with these transactions are reflected on the Company's balance sheet as risk
management assets and liabilities, classified as short- or long-term pursuant to
each contract's individual tenor. Net unrealized gains and losses from these
contracts are classified as revenue in the accompanying statement of operations.
Transactions that have been realized and settled are reflected gross in revenues
and cost of sales.
The following table provides an assessment of the factors impacting the change
in net value of the risk management asset and liability accounts during the year
ended December 31, 2001 ($ in millions).

Fair value of portfolio at January 1, 2001 $512
Gains (losses) recognized through the income statement in
the period, net(1) 423
Cash received related to contracts settled during the
period, net (463)
Changes in fair value as a result of a change in valuation
technique(2) -
Other changes in fair value, net(3) 240
- ----------------------------------------------------------------------
Fair value of portfolio at December 31, 2001 $712
- ----------------------------------------------------------------------

(1) This amount includes approximately $300 million which represents
management's estimate of the initial value of new contracts entered into in
2001.
(2) Dynegy's modeling methodology has been consistently applied year over year.
(3) Consists primarily of the effect of terminating the Company's commercial
positions with Enron.

{ 51 }

DYNEGY INC. PART II

Dynegy estimates the fair value of its marketing portfolio using a liquidation
value approach assuming normal liquidity. The estimated fair value of the
portfolio is computed by multiplying all existing positions in the portfolio by
estimated mid-market prices, reduced by a LIBOR-based time value of money
adjustment and deduction of reserves for credit, price and market risks.
A key aspect of Dynegy's operations and business strategy is its ability to
provide customers with competitively priced bundled products and services that
address customer specific energy and risk management needs. Many of these
customized products and services are not exchange traded. In addition, the
availability of reliable market quotations in certain regions and for certain
commodities is limited as a result of liquidity and other factors. As a result,
Dynegy uses a combination of market quotations, derivatives of market quotations
and proprietary models to periodically value its portfolio as required by
generally accepted accounting principles. Market quotations are validated
against broker quotes or exchanges. Derivatives of market quotations use
validated market quotes, such as actively traded natural gas or power prices, as
key components or inputs in determining market valuations. Examples include the
analogous use of a market quotation in order to value similarly situated
products in a less liquid market or as the basic input value in a pricing model,
such as the determination of an option contract value through use of a Black
Scholes modeling technique. Dynegy believes that estimated market prices
determined through application of derivatives of market quotations is akin to a
market price determined by a market quotation since the derivative value is
computed from an underlying existing liquid market quotation.
In certain markets or for certain products, market quotes or derivatives of
market quotes are not considered appropriate valuation techniques as a result of
the newness of markets or products, the lack of liquidity or other factors.
However, under generally accepted accounting principles, estimating the fair
value of these types of contracts is required. Consequently, Dynegy employs
mathematical models principally derived from fundamental market research and
econometrics to estimate forward price curves for valuing positions in these
markets. Dynegy models generate pricing estimates primarily for regional power
markets in the United States and Europe. Mid-term price curves are derived by
incorporating a number of appropriate factors including near term market
indications, regional studies of supply/demand balance, expected demand growth
rate, as well as cost factors described in the following paragraph. An analysis
group that is independent of commercial functions, and reports to the Chief
Financial Officer, performs these analyses.
Long-term power prices are fundamentally based on the estimated cost of
constructing incremental generation, the cost of fuel, cost of investment
capital and other region specific factors. Dynegy believes that new generation
needs in the United States and Europe will be primarily met through the
construction of new gas fired generation. Power prices, over the long term, will
thus reflect the cost of building new gas fired generation, the cost of natural
gas fuel, and a cost of capital return on new construction investment. Dynegy
believes that the market value of power will likely reflect periods of over and
under capacity of generation resources, and therefore actual power prices may
vary considerably from year to year. However, over the long term, Dynegy
believes power prices will reflect a cost of capital return on investment in new
generation.
Dynegy's cost-based pricing models depend on extensive region specific studies
regarding the cost of new generation, as well as detailed proprietary
competitive intelligence on new generation additions, retirements and estimates
of regional power demand growth. Dynegy believes its pricing models are based on
reasonable and sound assumptions. Risks associated with these assumptions
include actual versus estimated regional supply/demand balance, the accuracy of
cost and cost of capital estimates and assumptions regarding the preferred
future

{ 52 }

DYNEGY INC. PART II

technologies and regulatory factors that could impact the continued formation of
competitive markets. As with pricing curves derived from quoted market prices,
the application of forecasted pricing curves to contractual commitments may
result in realized cash returns on these commitments that vary significantly,
either positively or negatively, from the estimated values.
Dynegy's forward price curves are derived by modeling a combined cycle gas
facility as a "spark spread" in the calculation of required cost of capital
returns. This assumption is based on the premise that a portfolio manager would
be indifferent to holding these two assets, and is reflective of how Dynegy
manages its own portfolio of physical and financial positions. Dynegy's modeling
methodology has been consistently applied during each of the three years in the
period ended December 31, 2001. Dynegy's proprietary models compute forward
prices over a time horizon based on the following set of inputs:

Dynegy's enterprise-wide risk department, led by Dynegy's Chief Risk Officer,
independently verifies the outputs from the Company's proprietary pricing
models. This department routinely applies a mathematical model approach to
independently assess forward price curves. This methodology derives forward
energy prices from assumptions about the random factors driving energy prices
and other key variables such as the long-term price and mean reversion rate.
This method is consistent with market observable forward prices and
volatilities. The method models the evolution of the entire forward curve
conditional on the initial forward curve. Material differences, if any, between
the forward curves developed from Dynegy's proprietary systems and the
mathematical model are reviewed, assessed and adjusted if deemed necessary by
the Chief Risk Officer and Controller, in determining the reported fair value of
the marketing portfolio.

RISK-MANAGEMENT ASSET AND LIABILITY DISCLOSURES
The following chart depicts the mark-to-market value and cash flow components of
the Company's net risk management assets and liabilities at December 31, 2001:

NET RISK-MANAGEMENT ASSET AND LIABILITY DISCLOSURES

- ----------------------------------
(1) The table reflects the fair value of Dynegy's risk-management asset position
after deduction of time value, credit, price and other reserves necessary to
determine fair value. The cash flow value reflects anticipated undiscounted
cash inflows and outflows by contract based on tenor of individual contract
position and have not been adjusted for counterparty credit or other
reserves. These amounts exclude the fair value and cash flows associated
with certain derivative instruments designated as hedges, which are included
in other comprehensive income (a component of Stockholders' Equity).

{ 53 }

DYNEGY INC. PART II

The following table provides an assessment of net contract values by year
based on the Company's valuation methodology described above. Approximately
83 percent of Dynegy's net risk-management asset value at December 31, 2001 was
determined by market quotations or validation against industry posted prices.

NET FAIR VALUE OF MARKETING PORTFOLIO

(1) Prices obtained from actively traded, liquid markets.
(2) Mid-term prices validated against industry posted prices.
(3) See previous discussion of the Company's use of long-term models.

VALUE AT RISK ("VAR")
In addition to applying business judgment, senior management uses a number of
quantitative tools to manage the Company's exposure to market risk. These tools
include:
- Risk limits based on a summary measure of market risk exposure, referred to
as VaR; and
- Stress and scenario analyses performed daily that measure the potential
effects of various market events, including substantial swings in volatility
factors, absolute commodity price changes and the impact of interest rate
movements.
The modeling of the risk characteristics of Dynegy's marketing portfolio
involves a number of assumptions and approximations. Dynegy estimates VaR using
a JP Morgan RiskMetrics-TM- approach assuming a one-day holding period. Inputs
for the VaR calculation are prices, positions, instrument valuations and the
variance-covariance matrix. While management believes that these assumptions and
approximations are reasonable, there is no uniform industry methodology for
estimating VaR, and different assumptions and/or approximations could produce
materially different VaR estimates.
Dynegy uses historical data to estimate the Company's VaR and, to better
reflect current asset and liability volatilities, these historical data are
weighted to give greater importance to more recent observations. Given its
reliance on historical data, VaR is effective in estimating risk exposures in
markets in which there are not sudden fundamental changes or shifts in market
conditions. An inherent limitation of VaR is that past changes in market risk
factors, even when weighted toward more recent observations, may not produce
accurate predictions of future market risk. VaR should be evaluated in light of
this and the methodology's other limitations.
VaR represents the potential loss in value of Dynegy's enterprise-wide
marketing portfolio due to adverse market movements over a defined time horizon
within a specified confidence level. For the VaR numbers reported below, a
one-day time horizon and a 95% confidence level were used. This means that there
is a one in 20 statistical chance that the daily portfolio value will fall below
the expected maximum potential reduction in portfolio value at least as large as
the reported VaR. Thus, a change in portfolio value greater than the expected
change in portfolio value on a single trading day would be anticipated to occur,
on average, about once a month. Gains or losses on a single day can exceed
reported VaR by significant amounts. Gains or losses can also accumulate over a
longer time horizon such as a number of consecutive trading days.
In addition, Dynegy has provided its VaR using a one-day time horizon and a
99% confidence level. The purpose of this disclosure is to provide an indication
of earnings volatility using a higher confidence level. Under this presentation,
there is one in one hundred chance

{ 54 }

DYNEGY INC. PART II

that the daily portfolio value will fall below the expected maximum potential
reduction in portfolio value at least as large as the reported VaR. The Company
has also disclosed an average VaR for the year and a two-year comparison of
daily and average VaR in order to provide context around the one-day amounts.
The following table sets forth the aggregate daily VaR of Dynegy's marketing
portfolio:

DAILY AND AVERAGE VAR FOR MARKETING PORTFOLIO

The following table provides a rolling daily and average VaR for the Company's
marketing portfolio over the past two years:

DAILY AND AVERAGE VAR

EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC

As the graph above illustrates, the growth in one day VaR from 2000 to 2001 is
representative of the Company's growth in business and higher market volatility
in the 2001 period.

CREDIT RISK
Credit risk represents the loss that the Company would incur if a counterparty
fails to perform under its contractual obligations. To reduce the Company's
credit exposure, the Company seeks to enter into netting agreements with
counterparties that permit Dynegy to offset receivables and payables with such
counterparties. Dynegy attempts to further reduce credit risk with certain
counterparties by entering into agreements that enable the Company to obtain
collateral or to terminate or reset the terms of transactions after specified
time periods or upon the occurrence of credit-related events. The Company may,
at times, use credit derivatives or other structures and techniques to provide
for third-party guarantees of the Company's counterparty's obligations.
Dynegy's industry typically operates under negotiated credit lines for
physical delivery contracts. Dynegy's Credit Department, based on guidelines set
by Dynegy's Credit Policy

{ 55 }

DYNEGY INC. PART II

Committee, establishes Dynegy's counterparty credit limits. For collateralized
transactions, the Company also evaluates potential exposure over a shorter
collection period and gives effect to the value of collateral received. The
Company further seeks to measure credit exposure through the use of scenario
analyses and other quantitative tools. Dynegy's credit management systems
monitor current and potential credit exposure to individual counterparties and
on an aggregate basis to counterparties and their affiliates.
The following table displays the value of Dynegy's marketing portfolio,
inclusive of hedging activities, at December 31, 2001:

INTEREST RATE RISK
Interest rate risk results from variable rate debt obligations and from
providing risk-management services to customers, since changing interest rates
impact the discounted value of future cash flows used to value risk-management
assets and liabilities. Management continually monitors its exposure to
fluctuations in interest rates and may execute swaps or other financial
instruments to hedge and mitigate this exposure.
MARKETING PORTFOLIO. The following table sets forth the daily and average VaR
associated with the interest rate component of the marketing portfolio. Dynegy
seeks to manage its interest rate exposure through application of various
hedging strategies. Hedging instruments executed to mitigate such interest rate
exposure in the marketing portfolio are included in the VaR as of December 31,
2001 reflected in the table below.

DAILY AND AVERAGE VAR ON INTEREST COMPONENT OF MARKETING PORTFOLIO

VARIABLE RATE FINANCIAL OBLIGATIONS. Based on sensitivity analysis as of
December 31, 2001, it is estimated that one percentage point interest rate
movement in the average market interest rates (either higher or (lower)) in 2002
would decrease (increase) income before taxes by approximately $35 million. This
amount was determined based on hypothetical interest rate movement on the
Company's variable rate financial obligations as of December 31, 2001. Since
December 31, 2001, the Company has entered into approximately $2.0 billion of
interest rate swaps and increased the ratio of fixed interest obligations to
total financial obligations through the acquisition of Northern Natural and the
sale of $500 million of fixed rate debt in

{ 56 }

DYNEGY INC. PART II

February 2002. Considering these events, the sensitivity at December 31, 2001
would have been reduced from $35 million to $19 million.

FOREIGN CURRENCY EXCHANGE RATE RISK
Foreign currency risk arises from the Company's investments in affiliates and
subsidiaries owned and operated in foreign countries. Such risk is also a result
of risk management transactions with customers in countries outside the U.S.
Management continually monitors its exposure to fluctuations in foreign currency
exchange rates. When possible, contracts are denominated in or indexed to the
U.S. dollar, or such risk may be hedged through debt denominated in the foreign
currency or through financial contracts.
At December 31, 2001, the Company's primary foreign currency exchange rate
exposures were the United Kingdom Pound, Canadian Dollar, European Euro and
Norwegian Kroner. Dynegy seeks to manage its foreign currency exchange rate
exposure through application of various hedging strategies.
The following table sets forth the daily and average Foreign Currency Exchange
VaR:

DAILY AND AVERAGE FOREIGN CURRENCY EXCHANGE VAR

DERIVATIVE CONTRACTS
The absolute notional contract amounts associated with the Company's commodity
risk-management, interest rate and foreign currency exchange contracts were as
follows:

ABSOLUTE NOTIONAL CONTRACT AMOUNTS

LEGAL RISKS
Derivative transactions may also involve the legal risk that they are not
authorized or appropriate for a counterparty, that documentation has not been
properly executed or that executed

{ 57 }

DYNEGY INC. PART II

agreements may not be enforceable against the counterparty. The Company attempts
to minimize these risks by employing the use of standard contracts, where
applicable, or by routinely obtaining advice of counsel on the enforceability of
agreements as well as on the authority of a counterparty to effect the
derivative transaction.

OPERATIONAL RISKS
Dynegy is subject to all risks inherent in the various businesses in which it
operates. These risks include, but are not limited to, explosions, fires,
terrorist attacks and product spillage, any or all of which could result in
damage to or destruction of operating assets and other property or personal
injury, loss of life or pollution of the environment, as well as curtailment or
suspension of operations at the affected facility. Dynegy's Risk and Environment
Committee establishes metrics and assesses compliance with corporate risk
guidelines. Dynegy maintains general public liability, property and business
interruption insurance in amounts that it considers to be adequate for such
risks. Such insurance is subject to deductibles that the Company considers
reasonable and not excessive. The occurrence of a significant event not fully
insured or indemnified against or the failure of a party to meet its
indemnification obligations could materially and adversely affect Dynegy's
results of operations and financial condition. Events impacting the economics of
the insurance industry have brought into question companies' ability to obtain
insurance coverage at reasonable rates. Dynegy will continue to assess the
various coverage alternatives and may decide in the future to increase its
reliance on self-insurance.
In addition to these commercial operational risks, the Company faces
reputational damage and financial loss as a result of inadequate or failed
internal processes, people and systems. A systems failure or failure to enter a
transaction properly into the records may result in an inability to settle
transactions in a timely manner or in a breach of the contract. To minimize
these risks, the Company has developed policies and controls with respect to
data entry and processing of transactions, clearance and settlement of
transactions and the detection and prevention of employee error or improper or
fraudulent activity.

CONCLUSION
Management believes the Company has effective procedures for evaluating and
managing the market, credit and other risks to which it is exposed. Nonetheless,
the effectiveness of these policies and procedures for managing risk exposure
can never be completely predicted or fully assured. For example, unexpectedly
large or rapid movements or disruptions in one or more markets or other
unforeseen developments can have a material adverse effect on results of
operations and financial condition. The consequences of these developments can
include decreases in the liquidity of trading positions, higher earnings
volatility, increased credit exposure to customers and counterparties and
increased general systemic risk.

UNCERTAINTY OF FORWARD-LOOKING STATEMENTS AND INFORMATION
This annual report includes statements reflecting assumptions, expectations,
projections, intentions or beliefs about future events that are intended as
"forward-looking statements" under the Private Securities Litigation Reform Act
of 1995. You can identify these statements by the fact that they do not relate
strictly to historical or current facts. They use words such as "anticipate,"
"estimate," "project," "forecast," "may," "will," "should," "expect" and other
words of similar meaning. In particular, these include, but are not limited to,
statements relating to the following:
- Projected operating or financial results;
- Expectations regarding capital expenditures, dividends and other matters;

{ 58 }

DYNEGY INC. PART II

- Pending or recent acquisitions such as the Northern Natural and BG Storage
Limited acquisitions, including the anticipated closing date, expected cost
savings or synergies and the accretive or dilutive impact of an acquisition
on earnings;
- Expectations regarding transaction volume and liquidity in wholesale energy
markets in the North America and Europe;
- Beliefs or assumptions about the outlook for deregulation of retail and
wholesale energy markets in North America and Europe and anticipated business
developments in such markets;
- The Company's ability to effectively compete for market share with industry
participants;
- Beliefs about the outcome of legal or administrative proceedings, including
matters involving Enron;
- The expected commencement date for commercial operations for new power
plants; and
- Anticipated developments with respect to demand for broadband services and
applications and the Company's strategic plans in connection therewith.
Any or all of Dynegy's forward-looking statements may turn out to be wrong.
They can be affected by inaccurate assumptions or by known or unknown risks and
uncertainties, including the following:
- The timing and extent of changes in commodity prices for energy, particularly
natural gas, electricity and NGLs, or communications products or services;
- The timing and extent of deregulation of energy markets in North America and
Europe and the rules and regulations adopted on a transitional basis in such
markets;
- The condition of the capital markets generally, which will be affected by
interest rates, foreign currency fluctuations and general economic
conditions, as well as Dynegy's ability to maintain its investment grade
credit ratings;
- The effectiveness of Dynegy's risk-management policies and procedures and the
ability of Dynegy's counterparties to satisfy their financial commitments;
- The liquidity and competitiveness of wholesale trading markets for energy
commodities, including the impact of electronic or online trading in these
markets;
- Operational factors affecting the start up or ongoing commercial operations
of Dynegy's power generation or midstream natural gas facilities, including
catastrophic weather related damage, unscheduled outages or repairs,
unanticipated changes in fuel costs or availability or the availability of
fuel emission credits, the unavailability of gas transportation, the
unavailability of electric transmission service or workforce issues;
- Uncertainties regarding the development of, and competition within, the
market for broadband services in North America and Europe, including risks
relating to competing technologies and standards, regulation, capital costs
and the timing and amount of customer demand for high bandwidth applications;
- Cost and other effects of legal and administrative proceedings, settlements,
investigations and claims, including matters involving Enron and
environmental liabilities that may not be covered by indemnity or insurance;
and
- Other North American or European regulatory or legislative developments that
affect the demand for energy generally, increase the environmental compliance
cost for Dynegy's power generation or midstream gas facilities or impose
liabilities on the owners of such facilities; and
- General political conditions, including any extended period of war or
conflict involving North America or Europe.
Many of these factors will be important in determining Dynegy's actual future
results. Consequently, no forward-looking statement can be guaranteed. Dynegy's
actual future results may vary materially from those expressed or implied in any
forward-looking statements.

{ 59 }

DYNEGY INC. PART II

All of Dynegy's forward-looking statements, whether written or oral, are
expressly qualified by these cautionary statements and any other cautionary
statements that may accompany such forward-looking statements. In addition,
Dynegy disclaims any obligation to update any forward-looking statements to
reflect events or circumstances after the date of this report.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Quantitative and Qualitative Disclosures About Market Risk are set forth in
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations-Business Risk-Management Assessment" herein.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and financial statement schedule of the Company are set
forth at pages F-1 through F-45 inclusive, found at the end of this report, and
are incorporated herein by reference.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.

DYNEGY INC. PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Certain of the information required by this Item 10 will be contained in the
definitive Proxy Statement of the Company for its 2002 Annual Meeting of
Stockholders (the "Proxy Statement") under the headings "Proposal 1-Election of
Directors" and "Executive Compensation-Section 16(a) Beneficial Ownership
Reporting Compliance" and is incorporated herein by reference. The Proxy
Statement will be filed with the Securities and Exchange Commission not later
than 120 days after December 31, 2001. Reference is also made to the information
appearing in Part I of this Annual Report on Form 10-K under the caption "Item
1A. Executive Officers."

ITEM 11. EXECUTIVE COMPENSATION
Information with respect to executive compensation will be contained in the
Proxy Statement under the heading "Executive Compensation" and is incorporated
herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding ownership of certain of the Company's outstanding
securities will be contained in the Proxy Statement under the heading "Principal
Stockholders" and is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding related party transactions will be contained in the Proxy
Statement under the headings "Principal Stockholders", "Proposal 1-Election of
Directors" and "Executive Compensation-Indebtedness of Management" and "-Certain
Relationships and Related Transactions" and is incorporated herein by reference.

{ 60 }

DYNEGY INC. PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON 8-K

(a) The following documents, which have been filed by the Company with the SEC
pursuant to the Securities Exchange Act of 1934, as amended, are by this
reference incorporated in and made a part of this report:

1. Financial Statements - Consolidated financial statements of the Company and
its subsidiaries are incorporated under Item 8. of this Form 10-K.

2. Financial Statement Schedules - Financial Statement Schedules are
incorporated under Item 8. of this Form 10-K.

3. Exhibits - The following instruments and documents are included as exhibits
to this Form 10-K. All management contracts or compensation plans or
arrangements set forth in such list are marked with a ++.

{ 61 }

DYNEGY INC. PART IV

{ 62 }

DYNEGY INC. PART IV

{ 63 }

DYNEGY INC. PART IV

{ 64 }

DYNEGY INC. PART IV

- ----------------------------------
+ Filed herewith
* Exhibit omits certain information, which the Company has filed separately
with the SEC pursuant to a confidential treatment request pursuant to
Rule 406 promulgated under the Securities Act of 1933, as amended.
(b) Reports on Form 8-K of Dynegy Inc. for the fourth quarter of 2001.
1. During the quarter ended December 31, 2001, the Company filed a Current
Report on Form 8-K dated November 9, 2001. Items 5 and 7 were reported and
no financial statements were filed.
2. During the quarter ended December 31, 2001, the Company filed a Current
Report on Form 8-K dated November 19, 2001. Items 5 and 7 were reported and
no financial statements were filed.
3. During the quarter ended December 31, 2001, the Company filed a Current
Report on Form 8-K dated November 28, 2001. Items 5, 7 and 9 were reported
and no financial statements were filed.
4. During the quarter ended December 31, 2001, the Company filed a Current
Report on Form 8-K dated December 2, 2001. Items 5, 7 and 9 were reported
and no financial statements were filed.
5. During the quarter ended December 31, 2001, the Company filed a Current
Report on Form 8-K dated December 19, 2001. Items 5, 7 and 9 were reported
and no financial statements were filed.

{ 65 }

DYNEGY INC. SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.

Dynegy Inc.

Date: March 13, 2002 By: /s/ C. L. Watson
-----------------------------------------
C. L. Watson, Chairman of the Board,
Chief Executive Officer and Director

Pursuant to the requirements of the Securities Act of 1934, this report has
been signed below by the following persons on behalf of the registrant and in
the capacity and on the dates indicated.

Date: March 13, 2002 By: /s/ C. L. Watson
-----------------------------------------
C. L. Watson, Chairman of the Board,
Chief Executive Officer and Director
(Principal Executive Officer)

Date: March 13, 2002 By: /s/ Robert D. Doty
-----------------------------------------
Robert D. Doty, Executive Vice Presi-
dent, Chief Financial Officer (Principal
Financial Officer)

Date: March 13, 2002 By: /s/ Michael R. Mott
-----------------------------------------
Michael R. Mott, Senior Vice President
and Controller (Principal Accounting
Officer)

Date: March 13, 2002 By: /s/ Stephen W. Bergstrom
-----------------------------------------
Stephen W. Bergstrom, President and Chief
Operating Officer of Dynegy Inc. and
Director

Date: March 13, 2002 By: /s/ Charles E. Bayless
-----------------------------------------
Charles E. Bayless, Director

Date: March 13, 2002 By: /s/ Darald W. Callahan
-----------------------------------------
Darald W. Callahan, Director

Date: March 13, 2002 By: /s/ Michael D. Capellas
-----------------------------------------
Michael D. Capellas, Director

Date: March 13, 2002 By: /s/ Daniel L. Dienstbier
-----------------------------------------
Daniel L. Dienstbier, Director

Date: March 13, 2002 By: /s/ Patricia M. Eckert
-----------------------------------------
Patricia M. Eckert, Director

{ 66 }

DYNEGY INC. SIGNATURES

Date: March 13, 2002 By: /s/ Jerry Johnson
-----------------------------------------
Jerry Johnson, Director

Date: March 13, 2002 By: /s/ H. John Riley, Jr.
-----------------------------------------
H. John Riley, Jr., Director

Date: March 13, 2002 By: /s/ Sheli Z. Rosenberg
-----------------------------------------
Sheli Z. Rosenberg, Director

Date: March 13, 2002 By: /s/ Joe J. Stewart
-----------------------------------------
Joe J. Stewart, Director

Date: March 13, 2002 By: /s/ Glenn F. Tilton
-----------------------------------------
Glenn F. Tilton, Director

Date: March 13, 2002 By: /s/ John S. Watson
-----------------------------------------
John S. Watson, Director

Date: March 13, 2002 By: /s/ J. Otis Winters
-----------------------------------------
J. Otis Winters, Director

{ 67 }

DYNEGY INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

{ F-1 }

DYNEGY INC. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Stockholders of Dynegy Inc.:

We have audited the accompanying consolidated balance sheets of Dynegy Inc.
(an Illinois corporation) and subsidiaries as of December 31, 2001 and 2000,
and the related consolidated statements of operations, changes in stockholders'
equity and cash flows for each of the three years in the period ended
December 31, 2001. These financial statements and the schedule referred to
below are the responsibility of the Company's management. Our responsibility is
to express an opinion on these financial statements and schedule based on our
audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Dynegy Inc. and subsidiaries
as of December 31, 2001 and 2000, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 2001,
in conformity with accounting principles generally accepted in the United
States.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The information included in Schedule II
is presented for the purposes of complying with the Securities and Exchange
Commission's rules and is not a required part of the basic financial
statements. This schedule has been subjected to the auditing procedures applied
in our audits of the basic financial statements and, in our opinion, is fairly
stated in all material respects in relation to the basic financial statements
taken as a whole.

ARTHUR ANDERSEN LLP

Houston, Texas
February 25, 2002 (except with respect to the matter discussed in Note 20, as
to which the date is March 11, 2002)

{ F-2 }

DYNEGY INC. CONSOLIDATED BALANCE SHEETS

See Notes to Consolidated Financial Statements.

{ F-3 }

DYNEGY INC. CONSOLIDATED STATEMENTS OF OPERATIONS

See Notes to Consolidated Financial Statements.

{ F-4 }

DYNEGY INC. CONSOLIDATED STATEMENTS OF CASH FLOWS

See Notes to Consolidated Financial Statements.

{ F-5 }

DYNEGY INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

See Notes to Consolidated Financial Statements.

{ F-6 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - ORGANIZATION AND OPERATIONS OF THE COMPANY
Dynegy Inc. ("Dynegy" or the "Company") is one of the world's leading energy
merchants. Through its global energy delivery network and marketing, logistics
and risk-management capabilities, the Company provides innovative solutions to
customers in North America, the United Kingdom and Continental Europe. The
Company's businesses include power generation and wholesale and direct
commercial and industrial marketing of power, natural gas, coal and other
similar products. The Company is also engaged in the transportation, gathering
and processing of natural gas liquids ("NGLs") and the transmission and
distribution of electricity and natural gas to retail consumers. Dynegy also is
engaged in pursuing and capturing opportunities in the converging energy and
communications market place with its global long-haul fiber optic and
metropolitan network in key cities in the United States and Europe.

NOTE 2 - ACCOUNTING POLICIES
The accounting policies of Dynegy conform to generally accepted accounting
principles in the United States. The more significant of such accounting
policies are described below. The preparation of the consolidated financial
statements in conformity with generally accepted accounting principles requires
management to develop estimates and make assumptions that affect reported
financial position and results of operations and that impact the nature and
extent of disclosure, if any, of contingent assets and liabilities. Actual
results could differ materially from those estimates.
PRINCIPLES OF CONSOLIDATION. The accompanying consolidated financial
statements include the accounts of the Company and its majority-owned
subsidiaries after elimination of intercompany accounts and transactions.
Certain reclassifications have been made to prior-period amounts to conform with
current-period financial statement classifications.
CASH AND CASH EQUIVALENTS. Cash and cash equivalents consist of all demand
deposits and funds invested in short-term investments with original maturities
of three months or less.
INVESTMENT IN UNCONSOLIDATED AFFILIATES. Investments in affiliates in which
the Company has a significant ownership interest, generally 20 percent to
50 percent, are accounted for by the equity method. Any excess of the Company's
investment in these entities over its equity in the underlying net assets of the
affiliates is amortized over the estimated economic service lives of the
underlying assets. Effective January 1, 2002, the Company adopted Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("Statement No. 142"). Statement No. 142 discontinues the amortization of
goodwill associated with equity investments. Other investments less than
20 percent owned with readily determinable fair value are considered
available-for-sale and are recorded at quoted market value or at the lower of
cost or net realizable value, if there is no readily determinable fair value.
For securities with a readily determinable fair value, the change in the
unrealized gain or loss, net of deferred income tax, is recorded as a separate
component of other comprehensive income in the consolidated statement of
stockholders' equity. Realized gains and losses on investment transactions are
determined on the specific-identification basis.
CONCENTRATION OF CREDIT RISK. Dynegy provides multiple energy commodity
solutions principally to customers in the electric and gas distribution
industries and to entities engaged in industrial and petrochemical businesses.
These industry concentrations have the potential to impact the Company's overall
exposure to credit risk, either positively or negatively, in that the customer
base may be similarly affected by changes in economic, industry, weather or
other conditions. Receivables generally are not collateralized; however, Dynegy
believes the credit risk posed by industry concentration is largely offset by
the diversification and

{ F-7 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

creditworthiness of the Company's customer base.
INVENTORIES. Inventories consisted primarily of natural gas in storage of
$194 million and $70 million, NGLs of $74 million and $135 million and coal of
$58 million and $24 million at December 31, 2001 and 2000, respectively, and
crude oil of $10 million at December 31, 2001. Such inventory is valued at the
lower of weighted average cost or at market. Materials and supplies inventory of
$55 million and $44 million at December 31, 2001 and 2000, respectively, is
carried at the lower of cost or market using the specific-identification method.
PROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment consisting
principally of gas gathering, processing, fractionation, terminaling and storage
facilities, natural gas transmission lines, pipelines, power generating
facilities and communications equipment is recorded at cost. Expenditures for
major replacements, renewals, and major maintenance are capitalized. The Company
considers major maintenance to be expenditures incurred on a cyclical basis in
order to maintain and prolong the efficient operation of its assets.
Expenditures for repairs and minor renewals to maintain facilities in operating
condition are expensed. Depreciation is provided using the straight-line method
over the estimated economic service lives of the assets, ranging from three to
40 years. Composite depreciation rates are applied to functional groups of
property having similar economic characteristics. The approximate depreciation
rates are as follows:

Gains and losses are not recognized for retirements of property, plant and
equipment subject to composite depreciation rates ("composite rate") until the
asset group subject to the composite rate is retired. Through the end of the
period, the Company has reviewed the carrying value of its long-lived assets in
accordance with provisions of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed of" ("Statement No. 121"). In August 2001, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets"
("Statement No. 144"). Statement No. 144 addresses the accounting and reporting
for the impairment or disposal of long-lived assets and supersedes Statement
No. 121 and APB Opinion No. 30, "Reporting the Results of Operations-Reporting
the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions." The Company's adoption of
Statement No. 144 on January 1, 2002 did not have any impact on the Company's
financial position or results of operations.
ENVIRONMENTAL COSTS AND OTHER CONTINGENCIES. Environmental costs relating to
current operations are expensed or capitalized, as

{ F-8 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

appropriate, depending on whether such costs provide future economic benefit.
Liabilities are recorded when environmental assessment indicates that remedial
efforts are probable and the costs can be reasonably estimated. Measurement of
liabilities is based on currently enacted laws and regulations, existing
technology and site-specific costs. Such liabilities may be recognized on a
discounted basis if the amount and timing of anticipated expenditures for a site
are fixed or reliably determinable; otherwise, such liabilities are recognized
on an undiscounted basis. Environmental liabilities in connection with assets
that are sold or closed are recognized upon such sale or closure, to the extent
they are probable, can be estimated and have not previously been reserved. In
assessing environmental liabilities, no offset is made for potential insurance
recoveries. Recognition of any joint and several liability is based upon the
Company's best estimate of its final pro rata share of such liability.
Liabilities for other contingencies are recognized upon identification of an
exposure, which when fully analyzed indicates that it is both probable that an
asset has been impaired or that a liability has been incurred and that such loss
amount can be reasonably estimated. Costs to remedy such contingencies or other
exposures are charged to a reserve, if one exists, or otherwise to current
operations. When a range of probable loss exists, the Company accrues the lesser
end of the range.
During 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, "Accounting for Asset Retirement Obligations" ("Statement No. 143").
Statement No. 143 requires that the fair value of a liability for an asset
retirement obligation be recognized in the period in which it is incurred with
the associated asset retirement costs being capitalized as a part of the
carrying amount of the long-lived asset. The Company is evaluating the future
financial effects of adopting Statement No. 143 and expects to adopt the
standard effective January 1, 2003.
GOODWILL AND OTHER INTANGIBLE ASSETS. Intangible assets, principally
goodwill, have been amortized on a straight-line basis over their estimated
useful lives of 25 to 40 years. However, during 2001, the FASB issued Statement
No. 142 which discontinues goodwill amortization over its estimated useful life;
rather, goodwill will be subject to at least an annual fair-value based
impairment test. The Company is currently analyzing any impact the adoption of
Statement No. 142 effective January 1, 2002 will have on its financial position
and results of operations.
REVENUE RECOGNITION. Dynegy utilizes two comprehensive accounting models in
reporting its consolidated financial position and results of operations as
required by generally accepted accounting principles - an accrual model and a
fair value model. Dynegy determines the appropriateness of application of one
comprehensive accounting model over the other in accounting for its varied
operations based on guidance provided in numerous accounting standards and
positions adopted by the FASB or the Securities and Exchange Commission.
The accrual model is used to account for substantially all of the operations
conducted in the Dynegy Midstream Services ("DMS"), Transmission and
Distribution ("T&D") and Dynegy Global Communications ("DGC") segments as well
as all physically operated assets owned by the Wholesale Energy Network ("WEN")
segment. Ownership and operation of physical assets characterize these
businesses. Dynegy uses these physical assets in various manufacturing and
delivery processes. These processes include the generation of electricity, the
separation of natural gas liquids into their component parts from a stream of
natural gas, the transportation or transmission of commodities through pipelines
or over transmission lines and the delivery of data and voice bits over
communication networks. End sales from these businesses result in physical
delivery of commodities or services to Dynegy wholesale, commercial and
industrial and retail customers.

{ F-9 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Revenues for product sales and gas processing and marketing services are
recognized when title passes to the customer or when the service is performed.
Fractionation and transportation revenues are recognized based on volumes
received in accordance with contractual terms. Revenues derived from power
generation are recognized upon output, product delivery or satisfaction of
specific targets, all as specified by contractual terms. The Company's
transmission and distribution revenues are recognized when services are provided
to customers. Fees derived from engineering and construction contracts and
development and other activities received from joint ventures in which Dynegy
holds an equity interest are deferred to the extent of Dynegy's ownership
interest and amortized on a straight-line basis over appropriate periods, which
vary according to the nature of the service provided and the ventures'
operations. Shipping and handling costs are included in revenue when billed to
customers in conjunction with the sale of products.
Revenues derived from communications activities are recognized in the month
the service is provided. Amounts billed in advance of providing services are
recorded as unearned revenue until the period such services are either provided
or expire unused. Revenue related to installation of service and sale of
customer equipment is recognized when equipment is delivered and installation is
completed.
The fair value model is used to account for certain forward physical and
financial transactions in the WEN, DMS and DGC segments, which meet criteria
defined by the FASB or the Emerging Issues Task Force. These criteria require
these contracts to be related to future periods and contain fixed price and
volume components and must have terms that require or permit net settlement of
the contract in cash or its equivalent. As these transactions may be settled in
cash, the value of the assets and liabilities associated with these transactions
is reported at estimated settlement value based on current prices and rates as
of each balance sheet date. The net gains or losses resulting from the
revaluation of these contracts during the period are recognized currently in the
Company's result of operations. Assets and liabilities associated with these
transactions are reflected on the Company's balance sheet as risk management
assets and liabilities, classified as short-term or long-term pursuant to each
contract's individual tenor. Net unrealized gains and losses from these
contracts are classified as revenue in the accompanying statements of
operations.
The Company routinely enters into financial instrument contracts to hedge
purchase and sale commitments, fuel requirements and inventories in its NGLs,
electricity and coal businesses in order to minimize the risk of changes in
market prices in these commodities. Dynegy also monitors its exposure to
fluctuations in interest rates and foreign currency exchange rates and may
execute swaps, forward-exchange contracts or other financial instruments to
manage these exposures. Gains and losses from hedging transactions are
recognized in income in the periods for which the underlying commodity, interest
rate or foreign currency transaction impacts earnings. If the underlying being
hedged by the commodity, interest rate or foreign currency transaction is
disposed of or otherwise terminated, the gain or loss associated with such
contract is no longer deferred and is recognized in the period the underlying
contract is eliminated.
INCOME TAXES. The Company files a consolidated United States federal income
tax return and, for financial reporting purposes, provides income taxes for the
difference in the tax and financial reporting bases of its assets and
liabilities in accordance with Statement of Financial Accounting Standards
No. 109, "Accounting for Income Taxes."
EARNINGS PER SHARE. Basic earnings per share represents the amount of
earnings for the period available to each share of common

{ F-10 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

stock outstanding during the period. Diluted earnings per share represents the
amount of earnings for the period available to each share of common stock
outstanding during the period plus each share that would have been outstanding
assuming the issuance of common shares for all dilutive potential common shares
outstanding during the period. Dilutive potential common shares consisted of
approximately 10 million common shares subject to stock options and preferred
stock convertible into approximately 4 million common shares. For 2000 and 1999,
dilutive potential common shares consisted of stock options to purchase
approximately 13 million and 17 million common shares, respectively. Common
shares outstanding and the resulting computation of basic and diluted earnings
per share for all periods prior to December 31, 1999 have been restated to give
effect to the 0.69 fixed exchange ratio contained in the terms of the Illinova
acquisition. Also, all common shares outstanding, price per share, dividends per
share and earnings per share amounts relating to transactions or periods prior
to August 22, 2000 have been restated for the two-for-one stock split effected
by means of a stock dividend distributed on August 22, 2000.
FOREIGN CURRENCY TRANSLATIONS. For subsidiaries whose functional currency is
not the U.S. Dollar, assets and liabilities are translated at year-end rates of
exchange and revenues and expenses are translated at average exchange rates
prevailing for each month. Translation adjustments for the asset and liability
accounts are included as a separate component of other comprehensive income in
stockholders' equity. Currency transaction gains and losses are recorded in
income.
EMPLOYEE STOCK OPTIONS. The Company applies the provisions of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB No. 25") and related interpretations in accounting for its stock
compensation plans. Accordingly, compensation expense is not recognized for
employee stock options unless the options were granted at an exercise price
lower than the market value on the grant date. The Company has granted
below-market options in the past and continues to recognize compensation expense
over the applicable vesting periods. Stock options are no longer issued at less
than market price. Additionally, in 2001, a charge of $1 million recognized in
"General and Administrative Expenses" was incurred due to the extension of the
exercise period of various stock options and the acceleration of vesting for
various other stock options.
REGULATORY ASSETS. Financial Accounting Standards No. 71, "Accounting for the
Effects of Certain Types of Regulation" ("Statement No. 71") allows companies
whose service obligations and prices are regulated to maintain balance sheet
assets representing costs they expect to recover through inclusion in future
rates. Illinois Power Company ("IP"), the Company's wholly owned subsidiary,
records regulatory assets in accordance with Statement No. 71. Regulatory assets
represent probable future revenues associated with certain costs that are
expected to be recovered from customers through the ratemaking process. The
significant components of regulatory assets at December 31, 2001 and 2000 were
approximately $336 million and $385 million, respectively, and are included in
other long-term assets.

NOTE 3 - COMMERCIAL OPERATIONS, RISK MANAGEMENT ACTIVITIES AND FINANCIAL
INSTRUMENTS
Dynegy's operations and periodic returns are impacted by a myriad of risk
factors, some of which may, and some of which may not, be mitigated by risk
management methods. These risks include, but are not limited to, commodity
price, interest rate and foreign exchange rate fluctuations, weather patterns,
counterparty risk, management estimations, strategic investment decisions,
changes in competition, operational risks, environmental risks and changes in
regulation.
The potential for changes in the market value of Dynegy's commodity, interest
rate

{ F-11 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

and currency portfolios is referred to as "market risk". A description of each
market risk is set forth below:
- Commodity price risks result from exposures to changes in spot prices,
forward prices and volatilities of commodities, such as electricity, natural
gas, crude oil and other similar products;
- Interest rate risks primarily result from exposures to changes in the level,
slope and curvature of the yield curve and the volatility of interest rates;
and
- Currency rate risks result from exposures to changes in spot prices, forward
prices and volatilities of currency rates.
Dynegy seeks to manage these market risks through diversification, controlling
position sizes and executing hedging strategies. The ability to manage an
exposure may, however, be limited by adverse changes in market liquidity or
other factors. Dynegy cannot guarantee the ultimate effectiveness of its risk
management activities.
Dynegy generally attempts to balance its fixed-price physical and financial
purchase and sales commitments in terms of contract volumes, and the timing of
performance and delivery obligations. However, the Company may, at times, have a
bias in the market within guidelines established by management and Dynegy's
Board of Directors, resulting from the management of its portfolio. In addition,
as a result of marketplace illiquidity and other factors, the Company may, at
times, be unable to hedge its portfolio fully for certain market risks.
The financial performance and cash flow derived from certain merchant
generating capacity (e.g., peaking facilities) are impacted annually, either
favorably or unfavorably, by changes in and the relationship between the cost of
the commodity fueling the facilities and electricity prices, which in turn
influences the volume of electricity generated by these assets.
Operating results associated with natural gas gathering, processing and
fractionation activities are sensitive to changes in NGL prices and the
availability of inlet volumes. In addition, similar to peaking electricity
generating facilities, straddle processing plants are impacted by changes in,
and the relationship between, natural gas and NGL prices, which in turn
influence the volumes of gas processed at these facilities. The impact from
changes in NGL prices on upstream operations results principally from the nature
of contractual terms under which natural gas is processed and products are sold.
The availability of inlet volumes directly affects the utilization and
profitability of this segment's businesses. Commodity price volatility may also
affect operating margins derived from the Company's NGL marketing operations.
Operating results in the transmission and distribution business may be
impacted by commodity price fluctuations resulting from purchases of electricity
used in supplying service to its customers. IP has contracted for volumes from
various suppliers under contracts having various terms. Certain of these
contracts do not obligate the supplier to provide replacement power to IP in the
event of a curtailment or shutdown of operating facilities. If the commodity
volumes supplied from these agreements are inadequate to cover IP's native load,
the Company will be required to purchase its supply needs in open-market
purchases at prevailing market prices. Such purchases would expose IP to
commodity price risk. Price risk associated with the gas marketing operations of
IP is mitigated through contractual terms applicable to the business, as allowed
by the Illinois Commerce Commission (ICC).
Dynegy's commercial groups manage, on a portfolio basis, the resulting market
risks inherent in commercial transactions, subject to parameters established by
the Dynegy Board of Directors. Market risks are monitored by a risk control
group that operates independently from the commercial units to ensure compliance
with Dynegy's risk-management policies. Risk measurement is also practiced daily
against the Dynegy portfolios with Value at Risk, stress

{ F-12 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

testing and scenario analysis on the commercial portfolios.
QUANTITATIVE AND QUALITATIVE MARKET RISK DISCLOSURES. In addition to applying
business judgment, senior management uses a number of quantitative tools to
manage Dynegy's exposure to market risk. These tools include:
- Risk limits based on a summary measure of market risk exposure, referred to
as VaR; and
- Stress and scenario analyses as performed daily that measure the potential
effects of various market events, including substantial swings in volatility
factors, absolute commodity price changes and the impact of interest rate
movements.
VaR represents the potential loss in value of Dynegy's enterprise-wide
marketing portfolio due to adverse market movements over a defined time horizon
with a specified confidence level.
The modeling of the risk characteristics of Dynegy's marketing portfolio
involves a number of assumptions and approximations. Dynegy estimates VaR using
a JP Morgan RiskMetrics-TM- approach assuming a one-day holding period and a
95 percent confidence level. While management believes that these assumptions
and approximations are reasonable, there is no uniform industry methodology for
estimating VaR, and different assumptions and/or approximations could produce
materially different VaR estimates.
Dynegy uses historical data to estimate the Company's VaR and, to better
reflect current asset and liability volatilities, these historical data are
weighted to give greater importance to more recent observations. Given its
reliance on historical data, VaR is most effective in estimating risk exposures
in markets in which there are not sudden fundamental changes or shifts in market
conditions. An inherent limitation of VaR is that past changes in market risk
factors, even when weighted toward more recent observations, may not produce
accurate predictions of future market risk. VaR should be evaluated in light of
this and the methodology's other limitations.
CREDIT AND MARKET RESERVES. In connection with the market valuation of its
energy commodity contracts, the Company maintains certain reserves for a number
of risks associated with these future commitments. Among others, these include
reserves for credit risks based on the financial condition of counterparties,
reserves for price and product location ("basis") differentials and
consideration of the time value of money for long-term contracts. Counterparties
in its marketing portfolio consist principally of financial institutions, major
energy companies and local distribution companies. The creditworthiness of these
counterparties may impact overall exposure to credit risk, either positively or
negatively. However, with regard to its counterparties Dynegy maintains credit
policies that management believes minimize overall credit risk. Determination of
the credit quality of its counterparties is based upon a number of factors,
including credit ratings, financial condition, project economics and collateral
requirements. When applicable, the Company employs standardized agreements that
allow for the netting of positive and negative exposures associated with a
single counterparty.
Based on these policies, its current exposures and its credit reserves, Dynegy
does not anticipate a material adverse effect on its financial position or
results of operations as a result of counterparty nonperformance. As a result of
Enron Corp.'s ("Enron") bankruptcy, the Company reserved an after-tax amount of
$51 million in the fourth quarter of 2001 related to the Company's net exposure
for commercial transactions with the bankrupt enterprise. The global netting
agreement between Dynegy and Enron as well as the valuation of these commercial
transactions covered by the agreement are subject to approval from the
bankruptcy court.

{ F-13 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table displays the value of Dynegy's marketing transactions at
December 31, 2001:

At December 31, 2001, the term of Dynegy's marketing portfolio extends to 2016
and the average remaining life of an individual transaction was five months.
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. The Financial
Accounting Standards Board ("FASB") issued, and subsequently amended, Statement
No. 133, "Accounting for Derivative Instruments and Hedging Activities"
("Statement No. 133"), which became effective January 1, 2001. Provisions in
Statement No. 133, as amended, affect the accounting and disclosure of certain
contractual arrangements and operations of the Company. Under Statement
No. 133, as amended, all derivative instruments are recognized in the balance
sheet at their fair values and changes in fair value are recognized immediately
in earnings, unless the derivatives which are not a part of the Company's
marketing activities qualify and are designated as hedges of future cash flows,
fair values, net investments or qualify and are designated as normal purchases
and sales. For derivatives treated as hedges of future cash flows, the effective
portion of changes in fair value is recorded in other comprehensive income until
the related hedged items impact earnings. Any ineffective portion of a hedge is
reported in earnings immediately. For derivatives treated as fair value hedges,
changes in the fair value of the derivative and changes in the fair value of the
related asset or liability are recorded in current period earnings. For
derivatives treated as hedges of net investment in foreign operations, the
effective portion of changes in the fair value of the derivative is recorded in
the cumulative translation adjustment. Derivatives treated as normal purchases
or sales are recorded and recognized in income using accrual accounting.
The Company recorded the impact of the adoption of Statement No. 133, as
amended, as a cumulative effect adjustment in the Company's consolidated results
on January 1, 2001. The amounts recorded, which are immaterial to net income and
the Company's financial position, are as follows (in millions):

Changes in stockholders' equity related to derivatives for the year ended
December 31, 2001 were as follows, net of taxes (in millions):

Transition adjustment as of
January 1, 2001 $ 41
Current period decline in fair value (35)
Reclassifications to earnings, net 6
- -------------------------------------------
Balance at December 31, 2001 $ 12
- -------------------------------------------

Accumulated Other Comprehensive Income (Loss), Net of Tax is included in

{ F-14 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Stockholders' Equity on the Consolidated Balance Sheet as follows (in millions):

Statement No. 133, Net $ 12
Currency Translation Adjustment (28)
Unrealized Loss on Available-for-Sale
Securities, Net (19)
- -------------------------------------------
Accumulated Other Comprehensive Loss,
Net of Tax, at December 31, 2001 $(35)
- -------------------------------------------

Additional disclosures required by Statement No. 133, as amended, are provided
in the following paragraphs.
The Company enters into various financial derivative instruments which qualify
as cash flow hedges. Instruments related to its energy convergence and midstream
liquids businesses are entered into for purposes of hedging forward fuel
requirements for certain power generation facilities, locking in future margin
in the domestic midstream liquids business and hedging price risk in the global
liquids business. Interest rate swaps are used to convert the floating
interest-rate component of certain obligations to fixed rates.
During the year ended December 31, 2001, there was no material ineffectiveness
from changes in fair value of hedge positions, and no amounts were excluded from
the assessment of hedge effectiveness related to the hedge of future cash flows.
Additionally, no amounts were reclassified to earnings in connection with
forecasted transactions that were no longer considered probable of occurring.
The balance in other comprehensive income at December 31, 2001 is expected to
be reclassified to future earnings, contemporaneously with the related purchases
of fuel, sales of electricity or liquids, payments of interest and recognition
of operating lease expense, as applicable to each type of hedge. Of this amount,
approximately $32 million of income, net of taxes, is estimated to be
reclassified into earnings over the year ending December 31, 2002. A loss of
$20 million is estimated to be reclassified into earnings beyond the year ending
December 31, 2002. The actual amounts that will be reclassified to earnings over
the next year and beyond could vary materially from this estimated amount as a
result of changes in market conditions.
The Company also enters into derivative instruments which qualify as
fair-value hedges. The Company used interest rate-swaps to convert a portion of
its nonprepayable fixed-rate debt into variable-rate debt. During the twelve
months ended December 31, 2001, there was no ineffectiveness from changes in
fair value of hedge positions, and no amounts were excluded from the assessment
of hedge effectiveness. Additionally, no amounts were recognized in relation to
firm commitments that no longer qualified as fair-value hedge items.
The Company has investments in foreign subsidiaries, and the net assets of
these subsidiaries are exposed to currency exchange-rate volatility. The Company
uses derivative financial instruments, including foreign exchange forward
contracts and cross currency interest rate swaps, to hedge this exposure. For
the year ended December 31, 2001, approximately $29 million of net losses
related to these contracts were included in the cumulative translation
adjustment. This amount neutralizes the cumulative translation gains of the
underlying net investments in foreign subsidiaries for the period the derivative
financial instruments were outstanding.
FAIR VALUE OF FINANCIAL INSTRUMENTS. The following disclosure of the
estimated fair value of financial instruments is made in accordance with the
requirements of Statement of Financial Accounting Standards No. 107,
"Disclosures About Fair Value of Financial Instruments." The estimated
fair-value amounts have been determined by the Company using available market
information and selected valuation methodologies. Considerable judgment is
required in interpreting market data to develop the estimates of fair value. The
use of different market assumptions or valuation methodologies could have a
material effect on the estimated fair-value amounts.

{ F-15 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The carrying values of current financial assets and liabilities approximate
fair values due to the short-term maturities of these instruments. The carrying
amounts and fair values of the Company's other financial instruments were:

The financial statement carrying amounts of the Company's credit agreement and
variable-rate debt obligations were assumed to approximate fair value. The fair
values of the Company's other long-term indebtedness, including the Preferred
Securities of a Subsidiary Trust, were based on quoted market prices by
financial institutions that actively trade these debt securities. The fair value
of interest rate, foreign currency and commodity risk-management contracts were
based upon the estimated consideration that would be received to terminate those
contracts in a gain position and the estimated cost that would be incurred to
terminate those contracts in a loss position. The investment in warrants is
recorded at fair value estimated using the Black-Scholes valuation methodology.

{ F-16 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The absolute notional contract amounts associated with the commodity
risk-management, interest rate and foreign currency exchange contracts,
respectively, were as follows:

In 2001, approximately 10% of the Company's consolidated revenues and 12% of
consolidated costs of sales were derived from transactions with Enron. Based on
the terms of these transactions, Dynegy can fulfill these needs through other
counterparties.
Cash inflows (outflows) for the Company's net risk management assets and
liabilities at December 31, 2001 were estimated based upon quoted market prices,
prices validated against industry posted prices as well as forecasted prices
based on long-term models. A majority of the fair value of the marketing
portfolio is based on market prices. For less liquid markets and products,
Dynegy employs mathematical models principally derived from fundamental market
research and econometrics to estimate forward price curves for valuing positions
in the markets. The Company's modeling methodology has been consistently applied
year over year. Dynegy believes its pricing models are based on reasonable and
sound assumptions. There can be no assurances that actual cash returns will not
vary materially from these estimates. The mark-to-market value and cash flow
components of the Company's net risk-management assets and liabilities at
December 31, 2001 are as follows:

{ F-17 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 4 - CASH FLOW INFORMATION
Detail of supplemental disclosures of cash flow and non-cash investing and
financing information was:

NOTE 5 - PROPERTY, PLANT AND EQUIPMENT
Investments in property, plant and equipment consisted of:

Interest capitalized related to costs of projects in process of development
totaled $20 million, $30 million and $17 million for the years ended
December 31, 2001, 2000 and 1999, respectively. In 2000, a $25 million
impairment reserve was recorded related to Canadian gas processing assets.

NOTE 6 - INVESTMENTS IN UNCONSOLIDATED AFFILIATES AND NORTHERN NATURAL GAS
COMPANY
Investments in affiliates that are not controlled by the Company but where the
Company has significant influence over operations are accounted for by the
equity method. The Company's share of net income from these affiliates is
reflected in the Consolidated Statements of Operations as Equity in earnings of
unconsolidated affiliates. The Company's principal equity method investments
consist of entities that operate generation assets and natural gas liquids
assets. These equity investments totaled $843 million and $727 million at
December 31, 2001 and 2000, respectively. The Company entered into these
ventures principally for the purpose of sharing risk and leveraging existing
commercial relationships. These ventures maintain independent capital structures
and have financed their operations on a non-recourse basis to the Company.
GENERATION ASSETS. Investments include ownership interests in seven joint
ventures that own fossil fuel electric generation facilities in diverse
geographic regions. The Company's ownership is generally 50 percent in the
majority of these ventures. The Company's net investment of $609 million at
December 31, 2001 represents approximately 2,400 MW of net generating capacity.
At December 31, 2001, the Company's investment exceeded its equity in the
underlying assets by approximately $143 million. Dynegy's most significant
investment is comprised of its interest in West Coast Power, LLC ("West Coast
Power"), a 50 percent owned venture with NRG, which totaled approximately
$330 million at December 31, 2001 and generated equity earnings of $162 million
in 2001.

{ F-18 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MIDSTREAM INVESTMENTS. Investments include ownership interests in three
ventures that operate natural gas liquids processing, extraction, fractionation
and storage facilities in the Gulf Coast region as well as an interstate NGL
pipeline. The Company's ownership interest in these ventures ranges from
23 percent to 39 percent. At December 31, 2001, the Company's investment
exceeded its equity in the underlying net assets by approximately $43 million.

Summarized aggregate financial information for these investments and Dynegy's
equity share thereof was:

- ----------------------------------
(1) The financial data for 2000 and 1999 are exclusive of amounts attributable
to the Company's investment in Accord Energy Limited ("Accord") as data was
unavailable for these periods. Dynegy's share of Accord earnings for each of
the two years in the period ended December 31, 2000 totaled $9 million and
$21 million, respectively. The Company sold its investment in Accord in the
third quarter of 2000.

OTHER INVESTMENTS. In addition to these equity investments, the Company
holds interests in companies for which it does not have significant influence
over the operations. These investments are accounted for by the cost method.
Such investments totaled $84 million and $55 million at December 31, 2001 and
2000, respectively. The Company also owns securities that have a readily
determinable fair market value and are considered available-for-sale. The market
value of these investments at December 31, 2001 and 2000 was estimated to be
$23 million and $17 million, respectively.
In November 2001, Dynegy acquired 1,000 shares of Series A Preferred Stock
("Series A Preferred Stock") in Northern Natural Gas Company ("Northern
Natural") for $1.5 billion. The Series A Preferred Stock is entitled to
cumulative dividends, as and if declared by the board of directors of Northern
Natural, at a rate of 6%, payable annually beginning on January 31, 2003.
Dividends of $13 million are reflected in "Other Income" on the 2001
Consolidated Statement of Operations. The Series A Preferred Stock is redeemable
at the option of Northern Natural under certain circumstances at a redemption
price equal to the liquidation preference plus accrued and unpaid dividends and
other items. In connection with the investment Dynegy acquired an option to
purchase all of the equity of Northern Natural's indirect parent company. The
exercise price for the option was $23 million subject to adjustment based on
Northern Natural's indebtedness and working capital. Dynegy exercised its option
to acquire the indirect parent of Northern Natural in November 2001 upon
termination of the merger agreement with Enron and closed the acquisition on
January 31, 2002. See further discussion on this transaction under Note 19.

{ F-19 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 7 - DEBT
Long-term debt and transitional funding trust notes outstanding consisted of the
following at December 31:

Aggregate maturities of the principal amounts of all long-term indebtedness
are: 2002 - $402 million; 2003 - $276 million; 2004 - $186 million; 2005 -
$606 million; 2006 - $286 million and beyond $2.8 billion.
COMMERCIAL PAPER, MONEY MARKET LINES OF CREDIT AND EXTENDIBLE FLOATING RATE
LOANS. The Company utilizes commercial paper proceeds and borrowings under
uncommitted money market lines of credit for general corporate purposes,
including short-term working capital requirements. The commercial paper programs
for Dynegy, Dynegy Holdings Inc. ("Holdings") and IP are limited to and fully
supported by committed credit agreements. Weighted average interest rates on
amounts outstanding under the commercial paper program for Holdings were 3.2%
and 8.1% at December 31, 2001 and 2000, respectively. The weighted average
interest rate on amounts outstanding under IP's commercial paper program were
3.3% and 8.0% at December 31, 2001 and 2000, respectively. The Company
classifies outstanding commercial paper and borrowings under money market lines
of credit as long-term debt to the extent of availability under committed credit
facilities, as management's intent is to maintain these obligations for longer
than one year, subject to an overall reduction in corporate debt levels.

{ F-20 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

CREDIT AGREEMENTS: The following table displays certain terms of the
Company's revolving credit agreements as of December 31, 2001:

The Dynegy, Holdings and IP credit agreements provide funding for working
capital, capital expenditures and general corporate purposes, including support
for lines of credit and commercial paper programs. Generally, borrowings under
the credit agreements bear interest at a Eurodollar rate plus a margin that is
determined based on designated unsecured debt ratings. Financial covenants in
the credit agreements are limited to a debt-to-capitalization test. Letters of
credit under the credit agreements aggregated $377 million at December 31, 2001.
LONG-TERM DEBT. The company has a series of notes, debentures, new mortgage
bonds, pollution control bonds and transitional funding trust notes having
maturities that extend through 2032. The transitional funding trust notes are
non-recourse to the Company. Certain of these securities are redeemable at the
Company's option, in whole or in part, from time-to-time, at formula-based
redemption prices as defined in the applicable indenture.
Certain of Dynegy's debt instruments contain routine provisions which, if not
met, could require early payment, additional collateral support or similar
actions. For Dynegy, these events include leverage ratios, bankruptcy or
insolvency, defaults on principal or interest payments and change of control
provisions. These instruments generally provide for a cure period should any of
these events occur.

NOTE 8 - INCOME TAXES
The Company is subject to U.S. federal, foreign and state income taxes on its
operations. Components of income tax expense (benefit) were:

Components of income before income taxes were as follows:

Deferred income taxes are provided for the temporary differences between the
tax basis of Dynegy's assets and liabilities and their reported financial
statement amounts.

{ F-21 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Significant components of deferred tax liabilities and assets were:

Realization of the aggregate deferred tax asset is dependent on the Company's
ability to generate taxable earnings in the future. There was no valuation
allowance established at December 31, 2001 or 2000, as management believes the
aggregate deferred asset is more likely than not to be fully realized in the
future.
Income tax provisions for the years ended December 31, 2001, 2000 and 1999,
were equivalent to effective rates of 29 percent, 34 percent and 33 percent,
respectively. Differences between taxes computed at the U.S. federal statutory
rate and the Company's reported income tax provision were:

At December 31, 2001, the Company had approximately $53 million of regular tax
net operating loss carryforwards, $109 million of AMT credit carryforwards and
$431 million of AMT net operating loss carryforwards. The net operating loss
carryforwards expire from 2009 through 2020. The AMT credit carryforwards do not
expire. Certain provisions of the Internal Revenue Code place an annual
limitation on the Company's ability to utilize tax carryforwards existing as of
the date of a 1995 and a 2000 business acquisition. Management believes such
carryforwards will be fully realized prior to expiration.

NOTE 9 - PREFERRED SECURITIES
In May 1997, NGC Corporation Capital Trust I ("Trust") issued, in a private
transaction, $200 million aggregate liquidation amount of 8.316% Subordinated
Capital Income Securities ("Trust Securities") representing preferred undivided
beneficial interests in the assets of the Trust. The Trust invested the proceeds
from the issuance of the Trust Securities in an equivalent amount of 8.316%
Subordinated Debentures ("Subordinated Debentures") of the Company. The sole
assets of the Trust are the Subordinated Debentures. The Trust Securities are
subject to mandatory redemption in whole but not in part on June 1, 2027, upon
payment of the Subordinated Debentures at maturity, or in whole but not in part
at any time, contemporaneously with the optional prepayment of the Subordinated
Debentures, as allowed by the associated indenture. The Subordinated Debentures
are redeemable, at the option of the Company, in whole at any time or in part
from time to time, at formula-based redemption prices, as defined in the
indenture. The Subordinated Debentures represent unsecured obligations of the
Company and rank subordinate and junior in right of payment to all Senior
Indebtedness to the extent and in the manner set forth in the associated
indenture. The Company has irrevocably and unconditionally guaranteed, on a
subordinated basis, payment for the benefit of the holders of the Trust
Securities the obligations of the Trust to the extent the Trust has funds
legally available for distribution to the holders of the Trust Securities, as
described in the indenture. The Company
{ F-22 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

may defer payment of interest on the subordinated debentures as described in the
indenture.
Illinois Power Financing Inc. ("IPFI") is a statutory business trust in which
IP serves as sponsor. In 1996, IPFI issued $100 million aggregate liquidation
amount of 8% Trust Originated Preferred Securities ("TOPrS") in a private
transaction. The TOPrS were to mature on January 31, 2045 and could be redeemed
at IP's option, in whole or in part, from time to time on or after January 31,
2001. On September 30, 2001, IP redeemed all $100 million of the TOPrS. The
redemption was financed with $85 million cash and $15 million in commercial
paper.
Serial Preferred Securities of a Subsidiary of approximately $46 million
consists of six series of preferred stock issued by IP, with interest rates
ranging from 4.08% to 7.75%. Certain series are redeemable at the option of IP,
in whole or in part. On February 25, 2002, Illinova commenced a tender offer
relating to the shares of IP's preferred stock. Concurrently, IP commenced a
solicitation of consents from its preferred stockholders to amend IP's Restated
Articles of Incorporation to eliminate a provision restricting IP's ability to
incur unsecured debt. The completion of the tender offer and consent
solicitation is conditioned on, among other things, the approval of the proposed
amendment by holders of at least two-thirds of the outstanding shares of
preferred stock, voting together as one class.
On November 13, 2001, ChevronTexaco purchased 150,000 shares of Dynegy's
Series B Mandatorily Convertible Redeemable Preferred Stock ("Series B Preferred
Stock") for $1.5 billion. The proceeds from this issuance were used to finance
Dynegy's investment in Northern Natural, which is discussed in detail in
Note 19. Each share of Dynegy's Series B Preferred Stock is convertible, at the
option of ChevronTexaco, for a period of two years into shares of Dynegy
Class B common stock at the conversion price of $31.64. Dynegy incurred a
special dividend of approximately $65 million based on the intrinsic value of
the conversion option given to ChevronTexaco because the conversion price was an
approximate 5% discount to the market price. Dynegy is recognizing this dividend
over the period the Series B Preferred Stock is outstanding as required by
generally accepted accounting principles. Unless ChevronTexaco exercises its
conversion right, Dynegy is required to redeem the Series B Preferred Stock for
$1.5 billion two years from the date of issuance. The Series B Preferred Stock
does not have a dividend.

NOTE 10 - MINORITY INTEREST
In June 2000, Dynegy and a third party invested in Catlin Associates, L.L.C.
("Catlin"), an entity that is consolidated by Dynegy, with the third party's
investment reflected in Minority interest on the consolidated balance sheet.
Dynegy invested $100 million in Catlin and the third party investor contributed
$850 million. As a result of its investment the third party is entitled to a
non-controlling preferred interest in Catlin, which holds economic interests in
midwest generation assets. On or before June 29, 2005, Dynegy and the third
party investor must agree upon whether and how to make future investments on
behalf of Catlin. If the shareholders are not able to reach agreement regarding
permitted investments or Catlin fails to pay the preferred return to the third
party, Dynegy has the option to purchase the investor's interest for
$850 million or liquidate the assets of Catlin. Dynegy retains an option to
acquire the minority investors' interest in Catlin through June 2010 for
$850 million. Catlin has limited recourse to Dynegy, with such recourse building
over time to a maximum of $270 million in 2005. As of December 31, 2001,
recourse to Dynegy was approximately $35 million. In addition, under certain
circumstances, Dynegy may be required to make an additional capital contribution
of $60 million to Catlin. The $60 million contingent obligation expires on
December 31, 2002. If Dynegy Holdings' credit rating from Standards & Poors' and
Moody's falls below

{ F-23 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

investment grade, the company would be required to post approximately
$270 million of cash collateralization.
Minority interest on the consolidated balance sheet also includes third-party
investments in certain other consolidated entities, principally relating to
Dynegy Midstream Services ("DMS") operations and Dynegy Global Communications
("DGC"). The net pre-tax results attributed to minority interest holders in
consolidated entities are classified in minority interest expense in the
accompanying statements of operations.

NOTE 11 - COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS. On August 3, 1998, Modesto Irrigation District ("MID")
filed a lawsuit against PG&E and Destec Energy, Inc. ("Destec") in federal court
for the Northern District of California, San Francisco division. The lawsuit
alleges violation of federal and state antitrust laws and breach of contract
against Destec. The allegations are related to a power sale and purchase
arrangement in the city of Pittsburg, California. MID seeks actual damages from
PG&E and Destec in amounts not less than $25 million. MID also seeks a trebling
of any portion of damages related to its antitrust claims. By order dated
February 2, 1999, the federal District Court dismissed MID's state and federal
antitrust claims against PG&E and Destec; however, the Court granted MID leave
of thirty days to amend its complaint to state an antitrust cause of action. On
March 3, 1999, MID filed an amended complaint recasting its federal and state
antitrust claims against PG&E and Destec and restated its breach of contract
claim against Destec. PG&E and Destec filed motions to dismiss MID's revised
federal and state antitrust claims and a hearing on the motions to dismiss was
held in July 1999. On August 20, 1999, the District Court again dismissed MID's
antitrust claims against PG&E and Destec, this time without leave to amend the
complaint. As a result of the dismissal of the antitrust claims, the District
Court also dismissed the pendant state law claims. MID has appealed the District
Court's dismissal of its suit to the Ninth Circuit Court of Appeal. Oral
arguments before the Ninth Circuit occurred on March 15, 2001. The Ninth Circuit
has yet to deliver its decision on the case. Although PG&E filed a Chapter 11
bankruptcy proceeding on April 6, 2001, the automatic stay applicable in the
proceeding will be lifted to permit the Ninth Circuit to decide the pending
appeal.
Following dismissal of its federal court suit, MID filed suit in California
state court asserting breach of contract and tortious interference with
prospective economic relations claims against Destec and tortious interference
with contract and interference with prospective economic relations claims
against PG&E. Motions to dismiss MID's state court claims were heard by the
state court and by order dated April 6, 2000, MID was directed to amend its
complaint. MID filed its amended complaint on April 20, 2000, including Dynegy
as a defendant. Dynegy filed a motion to dismiss MID's amended complaint against
Dynegy, and the Court partially granted Dynegy's motion to dismiss while also
granting MID leave to amend its complaint. Before MID filed its amended
complaint, MID agreed with PG&E and Dynegy to execute a tolling agreement on all
claims and to dismiss the state court case until the federal appeal is decided.
After executing the tolling agreement, on October 23, 2000, MID filed in the
state court a Request for Dismissal, which the court granted on October 25,
2000. Dynegy believes the allegations made by MID are without merit and will
continue to vigorously defend MID's claims. In the opinion of management, the
amount of ultimate liability with respect to these actions will not have a
material adverse effect on the financial position or results of operations of
the Company.
On November 3, 1999, the United States Environmental Protection Agency ("EPA")
issued a Notice of Violation ("NOV") against Illinois Power Company ("IP") and,
with the

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DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Department of Justice ("DOJ"), filed a complaint against IP in the U.S. District
Court for the Southern District of Illinois, No. 99C833. Subsequently, the DOJ
and EPA amended the NOV and complaint to include Illinova Power Marketing, Inc.
(now known as Dynegy Midwest Generation Inc. ("DMG")) (IP and DMG collectively
the "Defendants"). Similar notices and lawsuits have been filed against a number
of other utilities. Both the NOV and complaint allege violations of the Clean
Air Act (the "Act") and regulations thereunder. More specifically, both allege,
based on the same events, that certain equipment repairs, replacements and
maintenance activities at the Defendants' three Baldwin Station generating units
constituted "major modifications" under the Prevention of Significant
Deterioration ("PSD") and/or the New Source Performance Standards regulations.
When such activities occur and they are not otherwise exempt the Act and related
regulations generally require that generating facilities meet more stringent
emissions standards, which may entail the installation of potentially costly
pollution control equipment. The DOJ amended its complaint to assert the claims
found in the NOV. The Defendants filed an answer denying all claims and
asserting various specific defenses. By order dated October 19, 2001, a trial
date of February 11, 2003 has been set. The initial trial is limited to
determining whether a violation occurred.
The regulations under the Act provide certain exemptions from the
applicability of these provisions particularly an exemption for routine repair,
replacement or maintenance. The Company has analyzed each of the activities
covered by the EPA's allegations and believes each activity represents prudent
practice regularly performed throughout the utility industry as necessary to
maintain the operational efficiency and safety of equipment. As such, the
Company believes that each of these activities is covered by the exemption for
routine repair, replacement and maintenance and that the EPA is changing, or
attempting to change, through enforcement actions, the intent and meaning of its
regulations. The Company also believes that, even if some of the activities in
question were found not to qualify for routine exemptions, the Act and
regulations also require that the activities cause certain levels of increases
in emissions and there were no such increases either in annual emissions or in
the maximum hourly emissions achievable at any of the units caused by any of the
activities. The regulations include exemptions for increased hours of operations
or production rate and the PSD regulations exclude increases in emissions
resulting from demand growth. None of the Defendants' other facilities are
covered in the complaint and NOV, but the EPA has officially requested
information concerning activities at the Defendants' Vermilion, Wood River,
Hennepin and Danskammer Plants. It is possible that the EPA will eventually
commence enforcement actions against those plants as well. The asset(s) subject
to the complaint are part of the consolidated assets of Dynegy.
The EPA has the authority to seek penalties for the alleged violations in
question at the rate of up to $27,500 per day for each violation. The EPA may
also seek to require installation of the "best available control technology" (or
the equivalent) at the Baldwin Station, and possibly at the Vermilion, Wood
River, Hennepin and Danskammer Plants if the EPA successfully prosecutes
enforcement actions against those plants.
The National Energy Policy Report issued in May 2001 by the National Energy
Policy Development Group recommended that the EPA Administrator examine the new
source review regulations, including the PSD regulations, and report to the
President within 90 days on the impact of new source review on investment in new
utility and refinery generation capacity, energy efficiency and environmental
protection. The report also recommended that the Attorney General review
existing enforcement actions regarding new source review to ensure that the
enforcement actions are consistent with

{ F-25 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

the Clean Air Act and its regulations. The EPA Administrator announced in
August 2001 that the review would be completed in September 2001. The events of
September 11, 2001 have resulted in further delay of the EPA review, which
remains ongoing. The Department of Justice issued its report concerning the
existing enforcement actions on January 15, 2002. The report concluded that EPA
has a reasonable legal basis for proceeding with the cases.
Tampa Electric Company ("TECO") and the government agreed to a Consent Decree
to resolve the similar case brought against TECO and that Consent Decree was
entered by the court hearing that case in 2000. Two other utilities, Virginia
Power and Cinergy, reached agreements in principle with the United States in
2000 concerning their possible liability for similar alleged violations, but
these agreements have still not been finalized. Additionally, PSEG Fossil LLC
entered into a consent decree in January 2002 to resolve similar claims.
Generally, the TECO Consent Decree and the settlements and agreements in
principle would require the utilities to pay civil fines; fund various
environmental projects; reduce nitrogen oxides, sulfur oxides, particulate
matter and mercury emissions through the installation of pollution control
devices over periods extending through 2012 to 2013; and forfeit certain
emission allowances.
The Company believes the allegations are without merit and will vigorously
defend against these claims. In the opinion of management, although significant
capital expenditures could be required, the amount of ultimate liability with
respect to this action will not have a material adverse effect on the financial
position or results of operations of the Company.
The following six class action lawsuits have been filed against various Dynegy
entities, including Dynegy Inc. and Dynegy Power Marketing Inc.:
1. Gordon v. Reliant Energy Inc., et al. was filed on November 27, 2000 in San
Diego Superior court.
2. Hendricks v. Dynegy Power Marketing Inc., et al. was filed on November 29,
2000 in a San Diego Superior Court.
3. People of the State of California v. Dynegy Power Marketing Inc., et al.
was filed on January 19, 2001 in San Francisco Superior Court.
4. Pier 23 Restaurant v. PG&E Energy Trading, et al. was filed on January 24,
2001 in San Francisco Superior Court.
5. Sweetwater Authority et al. v. Dynegy Inc., et al. was filed on
January 16, 2001 in San Diego Superior Court.
6. Bustamante v. Dynegy Inc., et al. was filed on May 2, 2001 in Los Angeles
Superior court. The suit was filed on behalf of California taxpayers by
Lieutenant Governor Cruz Bustamante and Assembly Woman Barbara Matthews,
both acting in their capacity as taxpayers and not in their capacity as
elected officials.
The six class action lawsuits are based on the events occurring in the
California power market during the summer of 2000. The complaints allege
violations of California's Business and Professions Code, Unfair Trade Practices
Act and various other statutes. Specifically, the named plaintiffs allege that
the defendants, including the owners of in-state generation and various power
marketers, conspired to manipulate the California wholesale power market to the
detriment of California consumers. Included among the acts forming the basis of
the plaintiffs' claims are the alleged improper sharing of generation outage
data, improper withholding of generation capacity and the manipulation of power
market bid practices. The plaintiffs seek unspecified treble damages. The
Bustamante suit includes claims against various Dynegy entities, including
Dynegy Inc. and Dynegy Marketing and Trade, as well as against three corporate
officers individually. The allegations in this suit are similar to those in the
other five suits, with the exception that

{ F-26 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

the Bustamante suit includes a claim of unfair business practices based on
"price gouging" during an emergency declared by Governor Gray Davis.
The six lawsuits are at preliminary stages. Defendants in the six lawsuits
have yet to file answers. The plaintiffs filed motions to remand five of the
cases to state court. In respect to the sixth case, the Bustamante suit, the
parties agreed that, based on a judge's decision to remand the other five
lawsuits, the case should go back to state court. All six lawsuits will be
consolidated before a single California state court judge.
After the actions were remanded, the parties agreed that they should be
coordinated. On December 12, 2001, the California Judicial Council resolved a
dispute among the parties as to the county in which the actions should be
coordinated and assigned the Coordination Proceedings (Nos. 4204 & 4205) to the
Superior Court of California, County of San Diego. On December 20, 2001, the
presiding judge of the San Diego Superior Court designated Judge Sammartino as
the Coordination Trial Judge for the Coordination Proceedings. On January 17,
2002, Judge Sammartino set a preliminary trial conference for March 4, 2002 to,
among other things, set schedules for: (a) determining legal issues that might
expedite disposition of the Coordination Proceedings; (b) establishing a
discovery schedule; and (c) resolving matters pertinent to the class action
issue.
The defendants in the six lawsuits have formed various joint defense groups in
an effort to coordinate the defense of the claims and to share certain costs of
defense. The Company believes the allegations are without merit and will
vigorously defend these claims. In the opinion of management, the amount of
ultimate liability with respect to these actions will not have a material
adverse effect on the financial position or results of operations of the
Company.
In addition, in response to the filing of a number of complaints challenging
the level of wholesale prices, the Federal Energy Regulatory Commission ("FERC")
initiated a staff investigation and issued an order on December 15, 2000
implementing a series of wholesale market reforms and made subject to refund all
spot market sales through the California Independent System Operator (the "ISO")
and the California Power Exchange (the "PX") markets beginning October 2, 2000.
FERC also included an interim price review procedure for prices above a $150/MW
hour "breakpoint" on sales to the ISO and PX. The order does not prohibit sales
above the "breakpoint," but the seller was subject to weekly reporting and
monitoring requirements. In an order issued March 9, 2001, FERC determined that
only sales during so-called "Stage 3" emergency hours would be subject to refund
beginning January 1, 2001 though sales between October 2, 2000 and December 31,
2000 remained subject to refund. Various parties sought rehearing of this market
mitigation measure and, as explained below, the FERC ruled on the matter in an
order issued on July 25, 2001.
On April 26, 2001, the FERC revised its market mitigation plan, effective
May 29, 2001, to cover all emergency hours. The mitigated price was to be in
effect only during reserve deficiency hours. Suppliers charging prices above the
mitigated price during those hours could file to justify those prices.
On June 19, 2001, the FERC again revised its market mitigation plan, effective
June 20, 2001. Pursuant to this plan, the FERC is mitigating prices charged in
all hours throughout the Western Systems Coordinating Council based on the
mitigated price in the ISO markets. During reserve deficiency hours, the
mitigated price is set pursuant to an average index for gas times the heat rate
of the last unit dispatched by the ISO during a "Stage 1" emergency, plus a
10 percent adder for credit risk. Nitrogen oxide charges, start-up costs and
additional fuel costs will be collected through an ISO uplift charge. During
non-reserve deficiency hours, the market clearing price is capped at 85 percent
of the mitigated price. The

{ F-27 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Company has filed for rehearing and clarification of the order. The FERC also
ordered all parties to participate in a 15-day settlement conference to
determine refunds, which proved unsuccessful. Pursuant to that order, the
settlement judge has issued a refund recommendation to the FERC, stating that
refunds from all market participants since October 2000 probably total between
several hundred million dollars and a billion dollars. It should be noted that
the April 26 and June 19, 2001 orders apply only to sales made on a daily basis,
that is, within 24 hours of delivery. The vast majority of power sold by West
Coast Power LLC, a 50% equity investee of Dynegy, is committed to long-term
contracts exempt from these orders.
On July 25, 2001, as modified on December 31, 2001,the FERC initiated refund
hearing procedures related to California wholesale spot market sales that
occurred between October 2, 2000 and June 20, 2001. Dynegy Power Marketing (as
Scheduling Coordinator for West Coast Power LLC) is subject to possible refunds.
The July 25th order supercedes prior refund orders issued by the FERC that cover
this period. In the July 25th order, the FERC developed a methodology to
redetermine allegedly competitive market outcomes during each hour of this
period. An administrative law judge has been appointed to determine: (1) the
mitigated price for power during each hour of the refund period; (2) the amount
of refunds owed by each supplier according to the FERC's methodology; and
(3) the amount currently owed to each supplier (with separate quantities
due from each entity) by the ISO, the investor-owned utilities and the State of
California. Any refunds owed would then be offset against amounts not paid.
Management does not expect the administrative law judge to issue his findings
before August 2002. Dynegy is actively participating in these proceedings and is
appealing these and related orders.
On December 19, 2001, FERC issued an order that in part focused on the
FERC-established price mitigation plan, which includes a formula prescribed by
FERC to determine maximum rates for wholesale power transactions in spot markets
in the Western Systems Coordinating Council between June 21, 2001 and
September 30, 2002. In this order, the FERC made some changes in its mitigation
plan. Certain of these changes were put in place retroactively and might have
the effect of reducing the applicable maximum rate in past periods. Dynegy Power
Marketing and West Coast Power have sought rehearing or clarification of this
decision, pointing out that various other aspects of the December 19 order,
coupled with other recent FERC orders, indicate that the FERC did not intend to
modify past prices under this mitigation plan. The Company cannot predict how
the FERC will ultimately resolve this matter.
On February 13, 2002, the FERC initiated an investigation of possible
manipulation of natural gas and power prices in the western United States during
the period from January 2001 through the present. Dynegy has been active in
these markets during the relevant period and, as a result, expects that its
pricing policies will be investigated. Management believes that much of what
would be investigated has already been examined pursuant to other investigations
by government entities and in private litigation. To date, there has been no
finding of market manipulation by Dynegy in these markets and management does
not believe that any factual basis to support such a finding exists.
In addition to the FERC investigation discussed above, several state and other
federal regulatory investigations and complaints have commenced in connection
with the wholesale electricity prices in California and other neighboring
Western states to determine the causes of the high prices and potentially to
recommend remedial action. In California, the California Public

{ F-28 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Utilities Commission, the California Electricity Oversight Board, the California
Bureau of State Audits, the California Office of the Attorney General and
several California state legislative committees all have separate ongoing
investigations into the high prices and their causes. With the exception of a
report by the California Bureau of State Audits, none of these investigations
has been completed and no findings have been made in connection with any of
them. The California state audit report concluded that the primary causes of the
market disruptions in California were fundamental flaws in the structure of the
power market. Additionally, on February 25, 2002, the California Public
Utilities Commission and the California Electricity Oversight Board filed
complaints with the FERC asking that it void or reform power supply contracts
between DWR and, among others, West Coast Power. The complaints allege that
prices under the contracts exceed just and reasonable prices permitted under the
Federal Power Act. While the Company believes the terms of its contracts are
just and reasonable and do not reflect alleged market manipulation, it cannot
predict how the FERC will respond to these complaints.
Management has closely monitored developments in California in an effort to
manage Dynegy's credit risk. The Company and its affiliates recorded reserves to
reflect market uncertainties. Although such reserves may change over time as the
market uncertainties are resolved, management believes such changes will not
ultimately be material to the Company's consolidated financial position or
results of operations.
On December 2, 2001, Enron Corp. and Enron Transportation Services Co.
(collectively, "Enron") filed suit against Dynegy and Holdings in the United
States Bankruptcy Court for the Southern District of New York, Adversary
Proceeding No. 01-03626 (AJG). Enron claims that Dynegy materially breached the
Merger Agreement dated November 9, 2001 between Enron and Dynegy and related
entities by wrongfully terminating that Agreement on November 28, 2001. Enron
also claims that Holdings wrongfully exercised its option to take ownership of
Northern Natural under an Option Agreement dated November 9, 2001. Enron seeks
damages in excess of $10 billion and declaratory relief against Dynegy for
breach of the Merger Agreement. Enron also seeks unspecified damages against
Dynegy and Holdings for breach of the Option Agreement. Dynegy filed an answer
on February 4, 2002, denying all material allegations. Dynegy subsequently filed
a motion to transfer venue in the proceeding to the United States District Court
for the Southern District of Texas (Houston division). Discovery has not yet
commenced.
On December 20, 2001, Dynegy and Holdings were sued by Ann C. Pearl and Joel
Getzler in the United States District Court for the Southern District of New
York, Cause No. 01 CV 11652. Plaintiffs filed the lawsuit as a purported class
action on behalf of all persons or entities who owned common stock of Enron
Corp. as of November 28, 2001. Plaintiffs allege that they are intended third
party beneficiaries of the Merger Agreement dated November 9, 2001 between Enron
and Dynegy and related entities. Plaintiffs claim that Dynegy materially
breached the Merger Agreement by, INTER ALIA, wrongfully terminating that
Agreement. Plaintiffs also claim that Dynegy breached the implied covenant of
good faith and fair dealing. Plaintiffs seek an award of damages and other
relief. On February 4, 2002, Dynegy filed a notice of motion to dismiss or
transfer venue to the United States District Court for the Southern District of
Texas (Houston Division). Discovery has not yet commenced.
On January 3, 2002, Dynegy and Holdings were sued by Bernard D. Shapiro and
Peter Strub in the 129th Judicial District Court for Harris County, Texas, Cause
No. 2002-00080. Plaintiffs filed the lawsuit as a purported class action on
behalf of all persons or entities who owned common stock of Enron Corp. as of
November 28, 2001. Plaintiffs allege that they are intended

{ F-29 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

third party beneficiaries of the Merger Agreement dated November 9, 2001 between
Enron and Dynegy and related entities. Plaintiffs claim that Dynegy materially
breached the Merger Agreement by, INTER ALIA, wrongfully terminating that
Agreement. Plaintiffs also claim that Dynegy breached the implied covenant of
good faith and fair dealing. Plaintiffs seek an award of damages and other
relief. Dynegy filed an answer on February 4, 2002, denying all allegations.
Discovery has not yet commenced.
The Company believes the allegations in Enron's adversary proceeding and the
other cases arising out of the terminated merger are without merit and will
vigorously defend against these claims. An adverse result in these proceedings,
however, could have a material adverse effect on the Company's financial
position and results of operations.
The Company is subject to various other legal proceedings and claims that
arise in the normal course of business. Further, the Company has assumed
liability for various claims, assessments and litigation in connection with some
of its strategic acquisitions. In the opinion of management, the amount of
ultimate liability with respect to these actions will not have a material
adverse effect on the financial position or results of operations of the
Company.
PURCHASE OBLIGATIONS. In conducting its operations, the Company routinely
enters into long-term commodity purchase and sale commitments, as well as
agreements that commit future cash flow to the lease or acquisition of assets
used in its businesses. These commitments are typically associated with
commodity supply arrangements, capital projects, reservation charges associated
with firm transmission, transportation, storage and leases for office space,
equipment, plant sites, ships, power generation assets and long-haul fiber optic
and metropolitan networks. The following describes the more significant
commitments outstanding at December 31, 2001.
The Company has $192 million of unconditional purchase obligations related to
the purchase of gas, coal, systems design and power purchase agreements.
Approximately $117 million of the $192 million represents long-term supply
contracts that are passed through to IP's end use customers.
The Company routinely enters into supply and market contracts for the purchase
and sale of electricity, some of which contain fixed capacity payments. Such
obligations are generally payable on a ratable basis, the terms of which extend
through November 2014. In return for such fixed capacity payments, Dynegy
receives volumes of electricity at agreed prices, which it then may re-market.
These fixed capacity payments totaled approximately $2 billion at December 31,
2001. Based on current estimates, the market value of electricity available for
sale under these contracts, which are not already recorded at fair value on the
balance sheet, exceed the discounted fair value of the capacity payments by
$347 million, after adjusting for market, credit and other reserves.
Dynegy has other firm capacity payments related to storage and transportation
of natural gas and transmission of electricity. Such arrangements are routinely
used in the physical movement and storage of energy consistent with the
Company's business strategy. The total of such obligations was $715 million as
of December 31, 2001, with $305 million of the $715 million due after 2006.
The Company is engaged in a continual capital asset expansion program
consistent with its business plan and growth strategies. The emphasis of this
program is on the acquisition or construction of strategically located power
generation assets. Consistent with this strategy and as a result of the long
lead time required by industry manufacturers, the Company has executed or is
currently negotiating purchase orders to acquire at least 11 gas-fired turbines,
representing a capital commitment of approximately $370 million. Commitments
under these purchase orders are generally payable consistent with the delivery

{ F-30 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

schedule. Approximately 95% are scheduled to be delivered by the end of 2006.
The purchase orders include milestone requirements by the manufacturer and
provide Dynegy with the ability to cancel each discrete purchase order
commitment in exchange for a fee, which escalates over time. At December 31,
2001, the fee would have been approximately $12 million.
The Company also has an information systems service agreement under which it
is obligated to pay $6 million a year through 2006.
ADVANCE AGREEMENT. In 1997, Dynegy received cash from a gas purchaser as an
advance payment for future natural gas deliveries over a ten-year period
("Advance Agreement"). As a condition of the Advance Agreement, Dynegy entered
into a natural gas swap with a third party under which Dynegy became a
fixed-price payer on identical volumes to those to be delivered under the
Advance Agreement at prices based on current market rates. The cash receipt is
included as deferred revenue in "Other Long-Term Liabilities" on the
Consolidated Balance Sheets and is ratably reduced as gas is delivered to the
purchaser under the terms of the Advance Agreement. The balance at December 31,
2001 approximated $65 million. The Advance Agreement contains certain
non-performance penalties that impact both parties and as a condition precedent,
Dynegy purchased a surety bond in support of its obligations under the Advance
Agreement.
OTHER MINIMUM COMMITMENTS. During 2001, the Company entered into lease
arrangements associated with natural gas-fired generating facilities, natural
gas liquids transportation assets and certain fiber optic and
telecommunications-related assets. Under the terms of certain of these
arrangements, the Company provided residual value guarantees associated with the
leased assets while retaining an option to acquire the leased assets from each
of the lessors.
In addition, Company subsidiaries are designing and constructing generating
facilities as agent for a third party, and the Company may be obligated to
guarantee up to approximately 90 percent of the actual cost of these facilities
during the construction phase. It is anticipated that a subsidiary of the
Company will subsequently lease the completed facilities from the relevant third
parties for initial terms of four to five years. Under certain circumstances,
the Company maintains an option to purchase the relevant facility from the third
party.
The Company also has a commitment to pay decommissioning costs of
approximately $5 million a year for the years 2002 to 2004 related to the sale
of the Clinton nuclear facility in 1999.
Minimum commitments in connection with office space, equipment, plant sites
and other leased assets at December 31, 2001, were as follows: 2002 -
$180 million; 2003 - $167 million; 2004 - $230 million, 2005 - $562 million;
2006 - $127 million and beyond - $1.7 billion.
Rental payments made under the terms of these arrangements totaled -
$169 million in 2001, $75 million in 2000 and $31 million in 1999.
GUARANTEES. The Company has $288 million of surety bonds as of December 31,
2001 in which Dynegy indemnifies the respective surety bond companies.
Approximately $204 million of these contingent financial commitments expire in
2002, however, these bonds are generally renewed on a rolling twelve-month
basis.
As mentioned above, the Company has residual value guarantees related to
certain leases. At December 31, 2001, the residual value guarantees totaled
approximately $657 million. Additionally, the Company has made certain
guarantees related to West Coast Power for approximately $56 million.
Approximately $31 million of this $56 million has a cash collateralization
requirement if the Company's debt is downgraded to below investment grade.
Additionally, the Company has posted a $4 million letter of credit for West
Coast Power that expires in 2002.
Other guarantees at December 31, 2001 include additional letters of credit of

{ F-31 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

$470 million and parental guarantees of debt of approximately $3 million in
connection with its power generation projects.

NOTE 12 - REGULATORY ISSUES
The Company is subject to regulation by various federal, state, local and
foreign agencies, including extensive rules and regulations governing
transportation, transmission and sale of energy commodities as well as the
discharge of materials into the environment or otherwise relating to
environmental protection. Compliance with these regulations requires general and
administrative, capital and operating expenditures including those related to
monitoring, pollution control equipment, emission fees and permitting at various
operating facilities and remediation obligations. In addition, the U.S. Congress
has before it a number of bills that could impact regulations or impose new
regulations applicable to Dynegy and its subsidiaries. The Company cannot
predict the outcome of these bills or other regulatory developments or the
effects that they might have on its business.

NOTE 13 - CAPITAL STOCK
At December 31, 2001, the Company had authorized capital stock consisting of
900,000,000 shares of Class A Common stock, 360,000,000 shares of Class B Common
stock and 70,000,000 shares of preferred stock.
PREFERRED STOCK. The Company's preferred stock may be issued from time to
time in one or more series, the shares of each series to have such designations
and powers, preferences, rights, qualifications, limitations and restrictions
thereof as described in the Company's Amended and Restated Articles of
Incorporation.
Pursuant to the terms of the Illinova acquisition, Dynegy established a series
of preferred stock, designated as Series A Convertible Preferred Stock, which
was issued to British Gas Atlantic ("BG") and NOVA Corporation ("NOVA") in
accordance with the exchange ratios provided in the acquisition documents. On
the effective date of the acquisition, BG and NOVA held an aggregate
6.7 million shares of this Series A Convertible Preferred Stock. All of these
shares were converted into share of Class A common stock in the second quarter
of 2000. In addition 8,000,000 shares of preferred stock, previously designated
as Dynegy Series A Participating Preferred Stock ("Series A Preferred"), were
converted to shares of Class B common stock on a 0.69-for-one exchange ratio.
COMMON STOCK. At December 31, 2001, there were 355,218,554 shares of Class A
and B common stock issued in the aggregate and 1,766,800 shares were held in
treasury. During 2001, Dynegy paid quarterly cash dividends on its common stock
of $0.075 per share, or $0.30 per share on an annual basis.
Pursuant to the terms of the Illinova acquisition, Dynegy split its common
shares into two classes, Class A and Class B. All of the Class B common stock is
owned by Chevron U.S.A. Inc. ("Chevron"). Generally, holders of Class A and
Class B common stock are entitled to one vote per share on all matters to be
voted upon by the shareholders. Holders of Class A common stock may cumulate
votes in connection with the election of directors. The election of directors
and all other matters will be by a majority of shares represented and entitled
to vote, except as otherwise provided by law. Holders of Class B common stock
vote together with holders of Class A common stock as a single class on every
matter acted upon by the shareholders except for the following matters:
- the holders of Class B common stock vote as a separate class for the election
of three directors of Dynegy, while the holders of Class A common stock vote
as a separate class for the remaining eleven directors;
- any amendment to the special corporate governance rights of Class B common
stock must be approved by a majority of the directors elected by holders of
Class B common stock and a majority of all

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DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Dynegy directors or by a 66 2/3 percent of the outstanding shares of Class B
common stock voting as a separate class, and the affirmative vote of a
majority of the shares of Class A and Class B common stock, voting together
as a single class; and
- any amendment to the provision of the Amended and Restated Articles of
incorporation addressing the voting rights of holders of Class A and Class B
common stock requires the approval of 66 2/3 percent of the outstanding
shares of Class B common stock voting as a separate class, and the
affirmative vote of a majority of the shares of Class A and Class B common
stock, voting together as a single class.
Subject to the preferences of preferred stock, holders of Class A and Class B
common stock have equal ratable rights to dividends, when and if dividends are
declared by the board of directors. Holders of Class A and Class B common stock
are entitled to share ratably, as a single class, in all of the assets of Dynegy
available for distribution to holders of shares of common stock upon the
liquidation, dissolution or winding up of the affairs of Dynegy, after payment
of Dynegy's liabilities and any amounts to holders of preferred stock.
A share of Class B common stock automatically converts into a share of
Class A common stock upon the transfer to any person other than an affiliate of
Chevron. Additionally, each share of Class B common stock automatically converts
into a share of Class A common stock if the holders of all Class B common stock
cease to own collectively 15 percent of the outstanding common stock of Dynegy.
Conversely, any shares of Class A common stock acquired by Chevron or its
affiliates will automatically convert into shares of Class B common stock, so
long as Chevron and its affiliates continue to own 15 percent or more of the
outstanding voting power of Dynegy.
Holders of Class A and Class B common stock generally are not entitled to
preemptive rights, subscription rights, or redemption rights, except that
Chevron is entitled to certain preemptive rights under the shareholder
agreement. The rights and preferences of holders of Class A common stock are
subject to the rights of any series of preferred stock Dynegy may issue.
In December 2001, 27.5 million shares of Class A common stock were sold
through a public offering which resulted in proceeds of approximately
$539 million, net of underwriting commission and expenses of approximately
$32 million. The proceeds from the offering were used to reduce debt. Concurrent
with the public offering, certain officers of the Company purchased
approximately 1.2 million shares of Class A common stock from the Company in a
private placement. The officers paid $19.75 per share for the stock, the same
price as the net proceeds to the Company in the public offering. The officers
paid for the shares by entering into promissory notes with the Company for an
initial term of 60 days. The maturity date of the notes was extended for an
additional 30 days with the approval of the Board of Directors. The loans bear
interest at 3.25 percent and are full recourse to the borrowers. Such loans are
accounted for as "Subscriptions Receivable" within Stockholders' Equity on the
Consolidated Balance Sheet at December 31, 2001.
Earlier in 2001, approximately 1.2 million shares of Class B common stock were
sold to Chevron in a private transaction, pursuant to the exercise of its
pre-emptive rights under the shareholder agreement. The proceeds from this
transaction were approximately $41 million.
During 2000, Dynegy sold approximately 22.6 million shares of common stock.
The offerings included approximately 18.4 million shares of Class A common stock
sold to the public and approximately 4.2 million shares of Class B common stock
sold to Chevron. Total net proceeds to Dynegy from these sales approximated
$858 million, net of underwriting commissions and expenses of approximately
$10 million. Additionally, Chevron purchased $200 million of Class B common

{ F-33 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

stock concurrent with the acquisition of Illinova.
In the second quarter of 2000, a non-recurring special dividend payment of
$32 million was made to BG and NOVA prior to the conversion of their preferred
shares to Class A common stock.

Common stock activity (in millions) for the three years ended December 31,
2001 was as follows:

STOCK OPTIONS. Each option granted is valued at an option price, which
ranges from $1.47 per share to $57.95 per share at date of grant. The
difference, if any, between the option price and the fair market value of each
option on the date of grant is recorded as compensation expense over the
respective vesting period. Options granted at prices below fair market do not
become exercisable until the fifth anniversary date of the grant, at which time
they become fully exercisable. Options granted at market value vest and become
exercisable ratably over a three-year period. Compensation expense related to
options granted totaled $12.7 million, $15.4 million and $6.0 million for the
years ended December 31, 2001, 2000 and 1999, respectively. Total options
outstanding and exercisable for 2001, 2000 and 1999 were (options in thousands)
as follows:

{ F-34 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Options outstanding as of December 31, 2001 (shares in thousands) are summarized
below:

Pursuant to terms of the Illinova acquisition, certain vesting requirements on
outstanding options were accelerated and the option shares and strike prices
were subject to the exchange ratios described in the acquisition documents.
Additionally, Dynegy instituted new option plans on the effective date of the
acquisition.
The fair value of each option grant was estimated on the date of grant using
the Black-Scholes option-pricing model, with the following weighted-average
assumptions used for grants in 2001, 2000 and 1999: dividend per year of $0.30
per share per annum for 2001 and 2000 and a historical dividend of $0.04 per
share for 1999; expected volatility of 46.4 percent, 42.1 percent and
40.3 percent, respectively; risk-free interest rate of 4.29 percent,
6.10 percent and 6.42 percent, respectively; and an expected life of ten years
for all periods. As stated previously, the Company

{ F-35 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

accounts for its stock option plan in accordance with APB No. 25. Had
compensation cost been determined on a fair value basis consistent with SFAS
No. 123, "Accounting for Stock-Based Compensation," the Company's net income and
per share amounts would have approximated the following pro forma amounts for
the years ended December 31, 2001, 2000 and 1999, respectively.

NOTE 14 - BUSINESS COMBINATIONS AND OTHER ACQUISITIONS
In the first quarter of 2001, Dynegy completed the acquisition of Central Hudson
power generation facilities in New York. The Central Hudson facilities consist
of a combination of base load, intermediate and peaking facilities aggregating
1,700 MW. The facilities are located approximately 50 miles north of New York
City and were acquired for approximately $903 million cash, plus inventory and
certain working capital adjustments. The acquisition of these facilities
established Dynegy's physical presence in the region. In May 2001, subsidiaries
of Dynegy completed a sale-leaseback transaction to provide the term financing
with respect to the Central Hudson facilities. Under the terms of the
sale-leaseback transaction, subsidiaries of Dynegy sold certain plants and
equipment and agreed to lease it back for terms expiring within 34 years,
exclusive of renewal options.
In the fourth quarter of 2001, Dynegy completed the purchase of BG Storage
Limited ("BGSL"), a wholly owned subsidiary of BG Group plc. Under the terms of
the purchase agreement, Dynegy paid approximately L421 million (approximately
$595 million at November 28, 2001) for BGSL and its existing assets. The assets,
which are located in the United Kingdom, consist of 30 gas storage injection
wells with five offshore platforms, nine salt caverns, approximately 19 miles of
pipelines and an onshore natural gas processing terminal. The acquisition of
BGSL established Dynegy's physical presence in the United Kingdom. Also in the
first quarter of 2001, Dynegy finalized the acquisition of iaxis, Limited, a
London-based communications company.
Dynegy completed its acquisition of Illinova on February 1, 2000. The merger
of Dynegy and Illinova involved the creation of a new holding company, now known
as Dynegy Inc. Dynegy accounted for the acquisition as a purchase of Illinova
with an effective date of January 1, 2000. In the combination, Dynegy
shareholders, other than Chevron, NOVA and BG, elected to exchange each former
Dynegy share for 0.69 of a share of Dynegy Class A Common stock, based on a
fixed exchange ratio, or elected to receive $8.25 per share in cash
consideration, subject to proration. NOVA and BG elected cash and thereby
reduced their respective ownership in Dynegy as part of this combination.
Additionally, instead of receiving Dynegy Class A common stock in exchange for
their respective shares of former Dynegy common stock, NOVA and the parent of BG
each received a combination of cash, subject to proration, and shares of Dynegy
Series A Convertible Preferred Stock. Chevron received 0.69 of a share of Dynegy
Class B common stock in exchange for each share of former Dynegy common stock
and Series A Participating Preferred Stock it owned. Additionally, as part of
the combination, Chevron purchased $200 million of additional Dynegy Class B
common stock. Each share of Illinova common stock was converted into one share
of Dynegy Class A common stock. Immediately after the combination, former Dynegy

{ F-36 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

shareholders owned approximately 51 percent of the outstanding shares of Dynegy.
Approximately 60 percent of the consideration received by existing Dynegy
shareholders was in the form of Dynegy stock and 40 percent was cash. In the
aggregate, the cash portion of the consideration approximated $1.1 billion.
Dynegy financed the cash component of the acquisition initially with borrowings
under a debt facility and the issuance of $200 million of Class B common stock
to Chevron. On a long-term basis, Dynegy financed the acquisition of Illinova
through a combination of sales of common equity, the disposition of certain
non-strategic assets, the refinancing of Illinova's unregulated generation
assets and cash flow derived from its operations.
The results of operations of the acquired Illinova assets are consolidated
with Dynegy's operations beginning January 1, 2000. The following table reflects
certain unaudited pro forma information for the period presented as if the
Illinova acquisition had taken place on January 1, 1999 (in millions, except per
share data). Unaudited pro forma results for the year ended December 31, 1999
include non-recurring after-tax gains of $41.8 million, or $0.15 per diluted
share (restated for two-for-one stock split effected by means of a stock
dividend distributed on August 22, 2000).

On September 29, 2000, Dynegy completed the acquisition of Extant, Inc., a
privately held communications solutions company providing centralized
clearinghouse services, OSS (Operations Support System) integration and network
expansion capabilities to communications service providers. Dynegy's net
investment consisted of $92 million in cash and 1.8 million shares of Class A
common stock. Following the transaction, Dynegy established Dynegy Global
Communications, a new segment that, in addition to pursuing other communications
opportunities, owns 80 percent of a limited partnership called Dynegy Connect,
L.P. which conducts many of the activities previously conducted by Extant, Inc.

NOTE 15 - EMPLOYEE COMPENSATION, SAVINGS AND PENSION PLANS
CORPORATE INCENTIVE PLAN. Dynegy maintains a discretionary incentive plan to
provide employees competitive and meaningful rewards for reaching corporate and
individual objectives. Specific awards are at the discretion of the Compensation
Committee of the Board of Directors ("Compensation Committee").
401(K) SAVINGS PLAN. The Company established the Dynegy Inc. 401(k) Savings
Plan ("Dynegy Plan"), which meets the requirements of Section 401(k) of the
Internal Revenue Code, and is a defined contribution plan subject to the
provisions of the Employee Retirement Income Security Act of 1974 ("ERISA"). The
Plan and related trust fund are established and maintained for the exclusive
benefit of participating employees in the United States and certain expatriates.
Similar plans are available to other employees resident in foreign countries and
are subject to the laws of each country. All employees of certain entities are
eligible to participate in the Plan. Employee pre-tax contributions to the Plan
are matched 100%, up to a maximum of five percent of base pay, subject to IRS
limitations. Vesting in Company contributions is based on years of service. The
Company may also make discretionary contributions to employee accounts, subject
to the Company's performance. Matching contributions to the Plan and
discretionary contributions are made in Dynegy common stock. The Company
discontinued the additional 5% profit sharing contribution to active employee
accounts in 2001. However, active employees who normally would have received the
profit sharing contribution under the Dynegy Plan

{ F-37 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

began participating in the pension plan in 2001 (see below).
Certain eligible employees participate in the Illinois Power Company Incentive
Savings Plan and Illinois Power Company Incentive Savings Plan for Employees
Covered Under A Collective Bargaining Agreement ("IP Plans"), which meet the
requirements of Section 401(k) of the Internal Revenue Code and are defined
contribution plans subject to the provisions of ERISA. The Company matches 50%
of employee contributions to the IP Plans, up to a maximum of six percent of
compensation, subject to IRS limitations. Employees are immediately 100% vested
in Company contributions. Matching contributions to the Plan are made in Dynegy
common stock.
Certain eligible employees participate in the Dynegy Northeast
Generation, Inc. Savings Incentive Plan ("Northeast Plan"), which meets the
requirements of Section 401(k) of the Internal Revenue Code and is a defined
contribution plan subject to the provisions of ERISA. The Company matches either
24% or 50% of employee contributions to the Northeast Plan. The Company
guaranteed match is subject to a maximum of six or eight percent of base pay,
subject to IRS limitations. Employees are immediately 100% vested in Company
contributions. Matching contributions to the Northeast Plan are made in cash.
During the years ended December 31, 2001, 2000 and 1999, Dynegy recognized
aggregate costs related to these employee compensation plans of $27 million,
$35 million and $25 million, respectively.
PENSION AND OTHER POST-RETIREMENT BENEFITS. The Company has various defined
benefit pension plans and post-retirement benefit plans. All domestic employees
participate in the pension plans, but only some of the Company's domestic
employees participate in the other post-retirement benefit plans. The Company
added a cash balance feature effective for 2001 and thereafter with respect to
employees who would have otherwise received a profit sharing contribution under
the Dynegy Plan for 2001 and thereafter (the contribution credit under such cash
balance feature shall generally be 6% of base pay). The following tables contain
information about these plans on a combined basis:

{ F-38 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The changes in the projected benefit obligation and in plan assets
attributable to business combination in 2000 are the result of the acquisition
of Illinova. The changes in the projected benefit obligations and in plan assets
attributable to business combination in 2001 are the result of the Central
Hudson acquisition. Special termination benefits of approximately $9 million in
2001 reflect the additional expense of the early retirement window related to
the Illinois Power Company Retirement Income Plan for Salaried Employees.
The components of net periodic benefit cost were:

{ F-39 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Impact of a 1% increase/decrease in medical trend:

NOTE 16 - RELATED PARTY TRANSACTIONS
In addition to related party transactions described elsewhere herein, the
following are additional items requiring disclosure.
Transactions with Chevron U.S.A. Inc. result from purchases and sales of
natural gas, NGLs and crude oil between subsidiaries of Dynegy and Chevron
U.S.A. Inc. affiliates. Management believes that these transactions are executed
at prevailing market rates. During the years ended December 31, 2001, 2000 and
1999, the Company recognized in its statement of operations aggregate sales to
this significant shareholder of $1.3 billion, $1.4 billion and $1.1 billion,
respectively. In the same years, purchases from this shareholder were
$3.6 billion, $3.1 billion and $2.0 billion, respectively.
The Company also has purchases and sales of natural gas, NGLs, crude oil and
power and, in some instances, earns management fees from certain entities in
which it has equity investments. Revenues recognized from these transactions in
2001, 2000 and 1999 were $2.0 billion, $827 million and $377 million,
respectively. Expenses recognized were $385 million, $217 million and
$125 million, respectively. Revenues relate to the supply of fuel for use at
generation facilities, primarily West Coast Power, and the supply of natural gas
sold by retail affiliates. Expenses primarily represent the purchase of natural
gas liquids that are subsequently sold in the Company's marketing operations.
Also during 2001, the Company earned approximately $8 million of interest
income related to cash lent to West Coast Power. The loan was created as a
result of natural gas fuel costs owed from West Coast Power to a subsidiary of
Dynegy. As of December 31, 2001, West Coast Power had repaid in full all amounts
owed to Dynegy. Dynegy has guaranteed $31 million of estimated environmental
obligations as well as $25 million associated with an insurance program for West
Coast Power.
In July 2001, the Company established the Dynegy Short-Term Executive Stock
Purchase Loan Program. Under this program, the Company may loan eligible
employees funds to acquire Class A common stock through market purchases in
return for a two-year note. The notes bear interest at the greater of 5 percent
or the Applicable Federal Rate as of the loan date and are full recourse to each
payee. At December 31, 2001, the Company had issued approximately $13 million of
loans pursuant to this program.
Concurrent with the December 2001 Class A common stock sale, officers of the
Company purchased approximately 1.2 million shares of Class A common stock in a
private placement transaction pursuant to Section 4(2) of the Securities Act of
1933. The officers paid $19.75 per share for the stock, the same price as the
net proceeds to the Company in the public offering. The officers paid for the
shares by entering into promissory notes with the Company for an initial term of
60 days. The maturity date of the notes was extended for an additional 30 days
with the approval of the Board of Directors. The loans bear interest at 3.25
percent and are full recourse to the borrowers. Such loans are accounted for as
"Subscriptions Receivable" within Stockholders' Equity on the Consolidated
Balance Sheet at December 31, 2001. The Company recognized compensation expense
in 2001 of approximately $1.2 million, which was recorded as "General and
Administrative Expense", related to the shares purchased by the officer group.

{ F-40 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 17 - SEGMENT INFORMATION
Dynegy's operations are reported in four segments: Wholesale Energy Network
("WEN"), Dynegy Midstream Services ("DMS"), Transmission and Distribution
("T&D") and Dynegy Global Communications ("DGC"). WEN is engaged in a broad
array of businesses, including physical supply of and risk-management activities
around wholesale natural gas, power, coal, and other similar products. This
segment is focused on optimizing the Company's and its customers' global
portfolio of energy assets and contracts, as well as direct commercial and
industrial sales and retail marketing alliances. DMS consists of the Company's
North American midstream liquids processing and marketing businesses and
worldwide NGLs marketing and transportation operations. Dynegy's T&D segment
includes the operations of IP, an energy-delivery company engaged in the
transmission, distribution and sale of electricity and natural gas to customers
across a 15,000-square-mile area of Illinois. DGC is engaged in pursuing and
capturing opportunities in the converging energy and communications marketplace.
DGC has a global long-haul fiber optic network and metropolitan network in key
cities in the United States and Europe. Dynegy accounts for intercompany
transactions at prevailing market rates. Operating segment information for the
years ended December 31, 2001, 2000 and 1999 is presented below:

DYNEGY'S SEGMENT DATA FOR THE YEAR ENDED DECEMBER 31, 2001

{ F-41 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DYNEGY'S SEGMENT DATA FOR THE YEAR ENDED DECEMBER 31, 2000

DYNEGY'S SEGMENT DATA FOR THE YEAR ENDED DECEMBER 31, 1999

{ F-42 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 18 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following is a summary of the Company's unaudited quarterly financial
information for the years ended December 31, 2001 and 2000.

NOTE 19 - SUBSEQUENT EVENTS
Concurrent with the investment in Northern Natural, Dynegy entered into an
option agreement with a subsidiary of Enron that indirectly owned the common
stock of Northern Natural, under which a Dynegy subsidiary had the option to
purchase all of the equity of that Enron subsidiary. In connection with Dynegy's
termination of a merger agreement with Enron, it gave notice of its intention to
exercise its option to purchase such equity. The exercise price for the option
was $23 million subject to adjustment based on Northern Natural's indebtedness
and for the amount of working capital at closing. Subsequent litigation relating
to the option was settled by the parties on January 3, 2002 and the closing of
the option exercise occurred on January 31, 2002. At January 31, 2001, Northern
Natural had approximately $950 million of debt outstanding. Approximately
$500 million of this debt is in the form of senior unsecured notes with
maturities ranging from 2005 to 2011. The remaining $450 million is in the form
of a secured line of credit due November 2002. Dynegy has agreed to commence a
tender offer by April 1, 2002 for $100 million of the senior unsecured notes
due in 2005. An Enron subsidiary has the option to reacquire Northern Natural
through June 30, 2002 for $1.5 billion plus accrued and unpaid dividends on the
Series A Preferred Stock and the option exercise price, subject to adjustments
based on Northern Natural's indebtedness and working capital.
In January 2002, Chevron purchased approximately 10.4 million shares of
Class B common stock in a private transaction, pursuant to the exercise of its
pre-emptive rights under the shareholder agreement. The proceeds from this sale
were approximately $205 million.
In February 2002, Dynegy Holdings issued $500 million of 8.75% Senior Notes
due 2012. Interest will be paid on a semi-annual basis beginning in
August 2002. These notes can be redeemed prior to 2012, in whole or in part, at
a price equal to the redemption price included in the related prospectus
supplement.
On February 25, 2002, Dynegy Energy Partners L.P., a newly formed limited
partnership created to own and operate a portion of the Company's NGL business,
filed a Registration Statement on Form S-1 with the Securities and Exchange
Commission for an initial public offering. The partnership will succeed to a
portion of DMS' downstream NGL business, specifically, it will be engaged
{ F-43 }

DYNEGY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

in fractionation, storage, terminaling, transportation, distribution and
marketing NGLs to consumers throughout North America. Dynegy and certain of its
affiliates will own the general partner interest of the partnership.

NOTE 20 - OTHER SUBSEQUENT EVENT
On March 11, 2002, the California Attorney General filed, on behalf of the
People of the State of California, complaints in San Francisco Superior Court
against several energy generators, including those owned directly by West Coast
Power and indirectly by Dynegy Inc. The complaints allege that since June 1998,
these generators sold power in the open market that should have been held in
emergency reserve for the State. In the aggregate, the complaints seek more than
$150 million in penalties, restitution and return profits from the generators.
The Company believes the allegations are without merit and will vigorously
defend these claims. In the opinion of management, the amount of ultimate
liability with respect to this action will not have a material adverse effect on
the financial position or results of operations of the Company.

{ F-44 }

DYNEGY INC. VALUATION AND QUALIFYING ACCOUNTS

SCHEDULE II

YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999

- ----------------------------------
(1) Changes in price and credit reserves related to risk management activities
are offset in the net mark-to-market income accounts reported in revenues.

{ F-45 }