ITEM 1. BUSINESS
CORPORATE OVERVIEW
KeySpan Corporation ("KeySpan") is a member of the Standard and Poor's 500 Index. KeySpan is a New York corporation and a holding company under the Public Utility Holding Company Act of 2005 ("PUHCA 2005"). KeySpan was formed in May 1998, as a result of the business combination of KeySpan Energy Corporation, the parent of The Brooklyn Union Gas Company, and certain businesses of the Long Island Lighting Company ("LILCO"). On November 8, 2000, we acquired Eastern Enterprises ("Eastern"), now known as KeySpan New England, LLC ("KNE"), a Massachusetts limited liability company, which primarily owns Boston Gas Company ("Boston Gas"), Colonial Gas Company ("Colonial Gas") and Essex Gas Company ("Essex Gas"), gas utilities operating in Massachusetts, as well as EnergyNorth Natural Gas, Inc. ("EnergyNorth"), a gas utility operating principally in central New Hampshire. We also own, lease and operate electric generating plants in Nassau and Suffolk Counties on Long Island and in Queens County in New York City and are the largest electric generation operator in New York State. Under contractual arrangements, we provide power, electric transmission and distribution services, billing and other customer services for approximately 1.1 million electric customers of the Long Island Power Authority ("LIPA"). KeySpan's other operating subsidiaries are primarily involved in gas exploration and production; underground gas storage; liquefied natural gas ("LNG") storage; retail electric marketing; large energy-system ownership, installation and management; service and maintenance of energy systems; and engineering and consulting services. We also invest and participate in the development of natural gas pipelines, electric generation and other energy-related projects.
Recent Developments - -------------------
On February 25, 2006, Keyspan entered into an Agreement and Plan of Merger (the "Merger Agreement"), with National Grid PLC, a public limited company incorporated under the laws of England and Wales ("Parent") and National Grid USA, Inc, a New York Corporation ("Merger Sub"), pursuant to which Merger Sub will merge with and into KeySpan (the "Merger"), with KeySpan continuing as the surviving Company. Pursuant to the Merger Agreement, at the effective time of the Merger, each outstanding share of common stock, par value $.01 per share of KeySpan (the "Shares"), other than shares owned by KeySpan, shall be canceled and shall be converted into the right to receive $42.00 in cash, without interest.
Consummation of the Merger is subject to various closing conditions, including but not limited to the satisfaction or waiver of conditions regarding the receipt of requisite regulatory approvals and the adoption of the Merger Agreement by the stockholders of KeySpan and the Parent. Assuming receipt or waiver of the foregoing, it is currently anticipated that the Merger will be consummated in early 2007. Accordingly, any statements contained herein concerning expectations, beliefs, plans, objectives, goals, strategies, future events or performance and underlying assumptions are "forward-looking statements" and do not take into account the occurrence or impact of any potential strategic transaction on the future operations, financial condition and cash flows of KeySpan. However, no assurance can be given that the Merger will occur, or, the timing of its completion.
At December 31, 2005, KeySpan was a holding company under the Public Utility Holding Company Act of 1935, as amended ("PUHCA 1935"). In August 2005, the Energy Policy Act of 2005 (the "Energy Act") was enacted. The Energy Act is a broad energy bill that places an increased emphasis on the production of energy and promotes the development of new technologies and alternative energy sources and provides tax credits to companies that produce natural gas, oil, coal, electricity and renewable energy. For KeySpan, one of the more significant provisions of the Energy Act was the repeal of PUHCA 1935, which became effective on February 8, 2006. Since that time, the jurisdiction of the Securities and Exchange Commission ("SEC") over certain holding company activities, including the regulation of our affiliate transactions and service companies, has been transferred to the jurisdiction of the Federal Energy Regulatory Commission ("FERC") pursuant to PUHCA 2005. See "Regulation and Rate Matters" for additional information on the Energy Act and PUHCA 2005. As used herein, "KeySpan," "we," "us" and "our" refers to KeySpan, its six principal gas distribution subsidiaries, and its other regulated and unregulated subsidiaries, individually and in the aggregate.
Under our holding company structure, we have no independent operations and conduct substantially all of our operations through our subsidiaries. Our subsidiaries operate in the following four business segments: Gas Distribution, Electric Services, Energy Services and Energy Investments.
The Gas Distribution segment consists of our six regulated gas distribution subsidiaries, which operate in New York, Massachusetts and New Hampshire and serve approximately 2.6 million customers.
The Electric Services segment consists of subsidiaries that manage the electric transmission and distribution ("T&D") system owned by LIPA; provide generating capacity and, to the extent required, energy conversion services for LIPA from our approximately 4,200 megawatts ("MW") of generating facilities located on Long Island; and manage fuel supplies for LIPA to fuel our Long Island generating facilities. The Electric Services segment also includes subsidiaries that own, lease and operate the 2,200 MW Ravenswood electric generation facility (the "Ravenswood Facility"), located in Queens County in New York City, and the 250 MW combined cycle generating unit (the "Ravenswood Expansion") which began full commercial operation in May 2004 (collectively, the Ravenswood Facility and the Ravenswood Expansion are referred to herein as the "Ravenswood Generating Station" and have a total electric capacity of 2,450 MW). Moreover, subsidiaries in this segment also provide retail marketing of electricity to commercial customers.
The Energy Services segment provides energy-related services to customers primarily located within the Northeastern United States, with concentrations in the New York City and Boston metropolitan areas. During January and February 2005, we disposed of our ownership interests in companies engaged in mechanical contracting activities under this segment.
The Energy Investments segment includes our gas exploration and production activities, domestic pipelines, gas storage facilities and LNG facilities and operations.
KeySpan's strategic vision is to be the premier energy company in the Northeastern United States. KeySpan is the largest gas distribution company in the Northeast and the fifth largest in the United States. KeySpan's size and scope enables it to provide enhanced cost-effective customer service; to offer our existing customers other services and products by building upon our existing customer relationships; and to capitalize on growth opportunities for natural gas expansion in the Northeast by expanding our infrastructure, primarily on Long Island and in New England.
KeySpan's principal executive offices are located at One MetroTech Center, Brooklyn, New York 11201 and 175 East Old Country Road, Hicksville, New York 11801, and its telephone numbers are (718) 403-1000 (Brooklyn) and (516) 755-6650 (Hicksville).
KeySpan makes available free of charge on or through its website, http://www.keyspanenergy.com (Investor Relations section), its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. You may also read and copy any of these documents at the SEC's public reference room at 100 F Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. Our SEC filings are also available to the public on the SEC's web site at www.sec.gov.
GAS DISTRIBUTION OVERVIEW
Our gas distribution activities are conducted by our six regulated gas distribution subsidiaries, which operate in three states in the Northeast: New York, Massachusetts and New Hampshire. We are the fifth largest gas distribution company in the United States and the largest in the Northeast, with approximately 2.6 million customers served within an aggregate service area covering 4,273 square miles. In New York, The Brooklyn Union Gas Company, doing business as KeySpan Energy Delivery New York ("KEDNY") provides gas distribution services to customers in the New York City Boroughs of Brooklyn, Queens and Staten Island; and KeySpan Gas East Corporation doing business as KeySpan Energy Delivery Long Island ("KEDLI") provides gas distribution services to customers in the Long Island Counties of Nassau and Suffolk and the Rockaway Peninsula of Queens County. In Massachusetts, Boston Gas provides gas distribution services in eastern and central Massachusetts; Colonial Gas provides gas distribution services on Cape Cod and in eastern Massachusetts; and Essex Gas provides gas distribution services in eastern Massachusetts. In New Hampshire, EnergyNorth provides gas distribution services to customers principally located in central New Hampshire. Our New England gas companies all do business as KeySpan Energy Delivery New England ("KEDNE").
In New York, there are two separate, but contiguous service territories served by KEDNY and KEDLI, comprising approximately 1,417 square miles and 1.68 million customers. In Massachusetts, Boston Gas, Colonial Gas and Essex Gas serve three service territories consisting of 1,934 square miles and approximately 792,000 customers. In New Hampshire, EnergyNorth has a service territory that is contiguous to Colonial Gas' and ranges from within 30 to 85 miles of the greater Boston area. EnergyNorth provides service to approximately 80,000 customers over a service area of approximately 922 square miles. Collectively, KeySpan owns and operates gas distribution, transmission and storage systems that consist of approximately 23,336 miles of gas mains and distribution pipelines.
Natural gas is offered for sale to residential and small commercial customers on a "firm" basis, and to most large commercial and industrial customers on either a "firm" or "interruptible" basis. "Firm" service is offered to customers under tariffed schedules or contracts that anticipate no interruptions, whereas "interruptible" service is offered to customers under tariffed schedules or contracts that anticipate and permit interruption on short notice, generally in peak-load seasons or for system reliability reasons. We maintain a diverse portfolio of firm gas supply, storage and pipeline transportation capacity contracts to adequately serve the requirements of our gas sales customers, to maintain system reliability and system operations, and to meet our obligation to serve. We also engage in the use of derivative financial instruments from time to time to reduce the cash flow volatility associated with the purchase price for a portion of future natural gas purchases.
KeySpan actively promotes a competitive retail gas market by offering tariff firm transportation services to firm gas customers who elect to purchase their gas supplies from natural gas marketers rather than from the utility. In New York, KeySpan further facilitates competition by releasing its pipeline transportation capacity and offering bundled gas supply to natural gas marketers that would otherwise not be able to obtain their own capacity. In Massachusetts and New Hampshire, there are mandatory capacity assignment programs in place whereby capacity is released to natural gas marketers on behalf of customers they serve. However, net gas revenues are not significantly affected by customers opting to purchase their gas supply from other sources since delivery rates charged to transportation customers generally are the same as delivery rates charged to sales service customers.
KeySpan also participates in interstate markets by releasing pipeline capacity and by selling bundled gas services to customers located outside of our service territory ("off-system" customers).
KeySpan purchases natural gas for firm gas customers under both long and short-term supply contracts, as well as on the spot market, and utilizes its firm pipeline transportation contracts to transport the gas from the point of purchase to the market. KeySpan also contracts for firm capacity in natural gas underground storage facilities to store gas during the summer for later withdrawal during the winter heating season when gas customer demand is higher. KeySpan also contracts for firm winter peaking supplies to meet firm gas customer demand on the coldest days of the year.
KeySpan sells gas to firm gas customers at its cost for such gas, plus a charge designed to recover the costs of distribution (including a return of and a return on capital invested in our distribution facilities). We share with our firm gas customers net revenues (operating revenues less the cost of gas and associated revenue taxes) from off-system sales and capacity release transactions. Further, net revenues from tariff gas balancing services and certain interruptible on-system sales are refunded, for most of our subsidiaries, to firm customers subject to certain sharing provisions.
Our gas operations can be significantly affected by seasonal weather conditions. Annual revenues are substantially realized during the heating season as a result of higher sales of gas due to cold weather. Accordingly, operating results historically are most favorable in the first and fourth calendar quarters. KEDNY and KEDLI each operate under a utility tariff that contains a weather normalization adjustment that significantly offsets variations in firm net revenues due to fluctuations in normal weather. However, the tariffs for our four KEDNE gas distribution companies do not contain such a weather normalization adjustment and, therefore, fluctuations in seasonal weather conditions between years may have a significant effect on results of operations and cash flows for these four subsidiaries. We utilize weather derivatives for KEDNE to mitigate variations in firm net revenues due to fluctuations in weather.
New York Gas Distribution Systems - KEDNY and KEDLY Supply and Storage
KEDNY and KEDLI have firm long-term contracts for the purchase of transportation and underground storage services. Gas supplies are purchased under long and short-term firm contracts, as well as on the spot market. Gas supplies are transported by interstate pipelines from domestic and Canadian supply basins. Peaking supplies are available to meet system requirements on the coldest days of the winter season.
Peak-Day Capability. The design criteria for the New York gas system assumes an average temperature of 0(0)F for peak-day demand. Under such criteria, we estimate that the requirements to supply our firm gas customers would amount to approximately 2,093 MDTH (one MDTH equals 1,000 DTH or 1 billion British Thermal Units) of gas for a peak-day during the 2005/06 winter season and that the gas available to us on such a peak-day amounts to approximately 2,177 MDTH.
The highest daily throughput most recently experienced occurred on January 15, 2006 in which the demand of the firm New York customers was 1,654 MDTH, and the average temperature was 20(degree)F. KEDNY and KEDLI have sufficient gas supply available to meet the requirements of their firm gas customers for the 2005/06 winter season.
Our New York firm gas peak-day capability is summarized in the following table:
MDTH per % of Source day Total - ----------------------------------------------------------
Pipeline 842 39% Underground Storage 800 37% Peaking Supplies 535 24% --- ---
Total 2,177 100% ========== =========
Pipelines. Our New York based gas distribution utilities purchase natural gas for sale under contracts with suppliers of natural gas located in domestic and Canadian supply basins and arrange for its transportation to our facilities under firm long-term contracts with interstate pipeline companies. For the 2005/06 gas year, approximately 73% of our New York natural gas supply was available from domestic sources and 27% from Canadian sources. We have available under firm contract 842 MDTH per day of year-round and seasonal pipeline transportation capacity. Our major providers of interstate pipeline capacity and related services include: Transcontinental Gas Pipe Line Corporation ("Transco"), Texas Eastern Transmission Corporation ("Tetco"), Iroquois Gas Transmission System, L.P. ("Iroquois"), Tennessee Gas Pipeline Company ("Tennessee"), Dominion Transmission Incorporated ("Dominion"), and Texas Gas Transmission Company.
Underground Storage. In order to meet winter demand in our New York service territories, we also have long-term contracts with Transco, Tetco, Tennessee, Dominion, Equitrans, Inc., National Fuel Gas Supply Corporation ("National Fuel") and Honeoye Storage Corporation ("Honeoye") for underground storage capacity of 60,766 MDTH and 800 MDTH per day of maximum deliverability.
Peaking Supplies. In addition to the pipeline and underground storage supply, we supplement our winter supply portfolio with peaking supplies that are available on the coldest days of the year to economically meet the increased requirements of our heating customers. Our peaking supplies include: (i) two LNG plants; (ii) peaking supply contracts with dual-fuel power producers located in our franchise areas; and (iii) peaking supply contracts with suppliers located outside our franchise area. For the 2005/06 winter season, we have the capability to provide maximum peaking supplies of 535 MDTH on extremely cold days. The LNG plants provide us with peak-day capacity of 394 MDTH and winter season availability of 2,053 MDTH. The peaking supply contracts with the dual fuel power producers provide us with peak-day capacity of 140 MDTH and winter season availability of 3,446 MDTH.
Gas Supply Management. We currently perform our New York-based gas supply management services internally.
Gas Costs. The current gas rate structure of each of these companies includes a gas adjustment clause pursuant to which variations between actual gas costs incurred and gas costs billed are deferred and subsequently refunded to or collected from firm customers.
Combined Gas Supply Portfolios. Effective November 1, 2005 the New York Department of Public Service authorized KEDNY and KEDLI to combine the planning, management and utilization of their respective gas supply portfolios to enable each company to serve its customers more reliably and cost effectively. Specifically, these companies plan the acquisition of incremental pipeline capacity, underground storage, gas supply and peaking supply contracts to meet projected growth in firm customer demand on a combined portfolio basis. This approach enables these companies to realize synergies that would otherwise not be attainable if they were to plan independently for the development of their respective portfolios. These two companies, by virtue of their geographic proximity, complementary customer demand profiles and similar gas contracts are able to add incremental capacity more effectively to meet expected customer demand growth by planning the portfolios on a combined basis.
Deregulation. Regulatory actions, economic factors and changes in customers and their preferences continue to reshape our gas operations. A number of customers currently purchase their gas supplies from natural gas marketers and then contract with us for local transportation, balancing and other unbundled services. In addition, our New York gas distribution companies release firm capacity on our interstate pipeline transportation contracts to natural gas marketers to ensure the marketers' gas supply is delivered on a firm basis and in a reliable manner. As of January 1, 2006, approximately 105,334 gas customers on the New York gas distribution system are purchasing their gas from marketers. However, net gas revenues are not significantly affected by customers opting to purchase their gas supply from other sources since delivery rates charged to transportation customers generally are the same as delivery rates charged to sales service customers.
New England Gas Distribution Systems - KEDNE Supply and Storage
KEDNE has firm long-term contracts for the purchase of transportation and underground storage services. Gas supplies are purchased under long and short-term firm contracts, as well as on the spot market. Gas supplies are transported by interstate pipelines from domestic and Canadian supply basins. Peaking supplies are available to meet system requirements on the coldest days of the winter season.
Peak-Day Capability. The design criteria for the New England gas systems assumes an average temperature of -6(0)F in Massachusetts and -8(0)F in New Hampshire for peak-day demand. Under such criteria, we estimate that the requirements to supply our firm gas customers would amount to approximately 1,361 MDTH of gas for a peak-day during the 2005/06 winter season and that the gas available to us on such a peak-day amounts to approximately 1,420 MDTH.
The highest daily throughput most recently experienced occurred on January 15, 2006 in which the demand of the firm New England customers (which includes both firm sales and firm transportation) was 1,015 MDTH, and the average temperature was 15*F. KEDNE has sufficient gas supply available to meet the requirements of their firm gas customers for the 2005/06 winter season.
Our New England firm gas peak-day capability is summarized in the following table:
MDTH % of Source per day Total - ---------------------------------------------------------
Pipeline 500 35% Underground Storage 248 18% Peaking Supplies 672 47% --- ---
Total 1,420 100% ======= ======
Pipelines. Our New England based gas distribution utilities purchase natural gas for sale under contracts with suppliers of natural gas located in domestic and Canadian supply basins and arrange for transportation to our facilities under firm long-term contracts with interstate pipeline companies. We have available under firm contract 500 MDTH per day of year-round and seasonal pipeline transportation capacity. Our major providers of interstate pipeline capacity and related services include: Algonquin Gas Transmission Company, Iroquois, Maritimes and Northeast Pipelines, Portland Natural Gas Transmission System, Tennessee and Tetco.
Underground Storage. In order to meet winter demand in our New England service territories, we also have long-term contracts with Tetco, Tennessee, Dominion, National Fuel and Honeoye for underground storage capacity of 23,280 MDTH and 248 MDTH per day of maximum deliverability.
Peaking Supplies. In addition to the pipeline and underground storage supply, we supplement our winter supply portfolio with peaking supplies that are available on the coldest days of the year to economically meet the increased requirements of our heating customers. Our peaking supplies include (i) local production plants that store LNG and liquid propane until vaporized, which are located strategically across the service territory; (ii) contracts for LNG storage and delivery with our LNG subsidiary, KeySpan LNG LP, located in Providence, Rhode Island; and (iii) Distrigas of Massachusetts located in Everett, Massachusetts. For the 2005/06 winter season, we have the capability to provide maximum peaking supplies of 672 MDTH on extremely cold days.
Gas Supply Management. From April 1, 2002 through March 31, 2005, we had an agreement with Coral Resources, L.P. ("Coral"), a subsidiary of Shell Oil Company, under which Coral assisted in the origination, structuring, valuation and execution of energy-related transactions on behalf of KEDNY and KEDLI. Upon the expiration of this agreement, these services are provided by KeySpan employees. We also have a portfolio management contract with Merrill Lynch Trading, under which Merrill Lynch Trading provides all of the city gate supply requirements at market prices and manages certain upstream capacity, underground storage and term supply contracts for KEDNE. This agreement has a three year term expiring on March 31, 2006. A new three year agreement has been negotiated between Merrill Lynch and the Massachusetts KEDNE utilities, whereby Merrill Lynch will assist in the origination, structuring, valuation and execution of energy related transactions for the Massachusetts portfolio. This agreement is pending approval by the Massachusetts Department of Telecommunications and Energy ("MADTE"). In New Hampshire, these services will be provided by KeySpan employees.
Gas Costs. The current gas rate structure of each of these companies includes a gas adjustment clause pursuant to which variations between actual gas costs incurred and gas costs billed are deferred and subsequently refunded to or collected from firm customers.
For additional information and for financial information concerning the gas distribution segment, see the discussion in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - "Gas Distribution" and Note 2 to the Consolidated Financial Statements, "Business Segments".
ELECTRIC SERVICES OVERVIEW
We are the largest electric generator in New York State. Our subsidiaries own and operate 5 large generating plants and 10 smaller facilities which are comprised of 57 generating units in Nassau and Suffolk Counties on Long Island and the Rockaway Peninsula in Queens. In addition, we own, lease and operate the Ravenswood Generating Station located in Queens County, which is the largest generating facility in New York City. The Ravenswood Generating Station is comprised of 3 large steam-generating units, a recently completed 250 MW combined cycle generating unit and 17 gas turbine generators. We also operate and maintain a 55 MW gas turbine unit in Greenport, Long Island under an agreement with a third party.
As more fully described below, we: (i) provide to LIPA all operation, maintenance and construction services and significant administrative services relating to the Long Island electric T&D system pursuant to a Management Services Agreement (the "1998 MSA"); (ii) supply LIPA with electric generating capacity, energy conversion and ancillary services from our Long Island generating units pursuant to a Power Supply Agreement (the "1998 PSA"); and (iii) manage all aspects of the fuel supply for our Long Island generating facilities, as well as all aspects of the capacity and energy owned by or under contract to LIPA pursuant to an Energy Management Agreement (the "1998 EMA"). The 1998 MSA, 1998 PSA and 1998 EMA became effective on May 28, 1998 and are collectively referred to herein as the "1998 LIPA Agreements."
On February 1, 2006, KeySpan and LIPA entered into (i) an amended and restated Management Services Agreement (the "2006 MSA"), pursuant to which KeySpan will continue to operate and maintain the electric T&D System owned by LIPA on Long Island; (ii) a new Option and Purchase and Sale Agreement (the "2006 Option Agreement"), which allows LIPA to purchase either or both of KeySpan's Barrett and Far Rockaway generating stations and which replaces the Generation Purchase Rights Agreement (the "GPRA"), pursuant to which LIPA had the option, through December 15, 2005, to acquire substantially all of the electric generating facilities owned by KeySpan on Long Island; and (iii) a Settlement Agreement (the "2006 Settlement Agreement") resolving outstanding issues between the parties regarding the 1998 LIPA Agreements. The 2006 MSA, the 2006 Option Agreement and the 2006 Settlement Agreement are collectively referred to herein as the "2006 LIPA Agreements". In the event LIPA exercises its rights under the 2006 Option Agreement, KeySpan and LIPA will enter into an operation and maintenance agreement, pursuant to which KeySpan would continue to operate the subject generating units, as well as related amendments to the 1998 PSA and 1998 EMA. The 2006 LIPA Agreements will become effective as of January 1, 2006, following receipt of all necessary governmental approvals, which are pending. The effectiveness of each of the 2006 LIPA Agreements is conditioned upon all of the 2006 LIPA Agreements becoming effective.
Portions of our Electric Services business can be affected by seasonal weather conditions and market conditions. The majority of the capacity revenue associated with the Ravenswood Generating Station is realized during the six months between May and October of each year. Energy and ancillary service sales from our Ravenswood Generating Station are directly correlated to the demand for electricity and competition from other resources. Typically, the demand and price for electricity increases during extreme temperature conditions. However, depending on the availability of alternative competitive supply, extreme temperature conditions may not result in increased revenue. As a result, fluctuations in weather and competitive supply between years may have a significant effect on our results of operations for our Electric Services business.
Generating Facility Operations
In June 1999, we acquired the 2,200 MW Ravenswood Facility located in New York City from Consolidated Edison Company of New York, Inc. ("Consolidated Edison") for approximately $597 million. In order to reduce our initial cash requirements to finance this acquisition, we entered into an arrangement with an unaffiliated variable interest entity through which we lease a portion of the Ravenswood Facility. Under the arrangement, the variable interest entity acquired a portion of the facility directly from Consolidated Edison and leased it to our wholly owned subsidiary, KeySpan-Ravenswood, LLC ("KSR"). For more information concerning this lease arrangement, see Note 7 to the Consolidated Financial Statements, "Contractual Obligations, Financial Guarantees and Contingencies."
In 2004, we completed construction of the Ravenswood Expansion, a 250 MW combined cycle generating unit at the Ravenswood Facility, thereby increasing the total electric capacity of the Ravenswood Facility to 2,450 MW. In mid-May 2004, the Ravenswood Expansion began full commercial operations. To finance the Ravenswood Expansion, we entered into a leveraged lease financing arrangement pursuant to which the Ravenswood Expansion was acquired by an unaffiliated lessor from KSR and simultaneously leased back to it. This lease transaction qualifies as an operating lease under SFAS 98. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation - "Electric Services Revenue Mechanisms" for a further discussion of these matters.
The Ravenswood Generating Station sells capacity, energy and ancillary services into the New York Independent System Operator ("NYISO") electricity market at market-based rates, subject to mitigation. The Ravenswood Generating Station Facility has the ability to provide approximately 25% of New York City's capacity requirements and is a strategic asset that is available to serve residents and businesses in New York City.
The Ravenswood Generating Station and our New York City Operations
Currently, the NYISO's New York City local reliability rules require that 80% of the electric capacity needs of New York City be provided by "in-City" generators. On February 9, 2006, the NYISO Operating Committee increased the "in-City" generator requirement to 83% beginning in May 2006 through the period ending on April 2007, based in part on the statewide reserve margin of 118% set by the New York State Reliability Council. On February 16, 2006, an appeal was filed with the NYISO Management Committee requesting that the February 9th decision be rejected and that the "in-City" requirement be increased to a larger percentage than 83%. A vote on this appeal is expected to occur at the NYISO Management Committee meeting scheduled for February 28, 2006.
Our Ravenswood Generating Station is an "in-City" generator. As the electric infrastructure in New York City and the surrounding areas continues to change and evolve and the demand for electric power increases, the "in-City" generator requirement could be further modified. Construction of new transmission and generation facilities may cause significant changes to the market for sales of capacity, energy and ancillary services from our Ravenswood Generating Station. Recently 500 MW of capacity came on line and it is anticipated that another 500 MW of new capacity may be available during 2006 as a result of the completion of an in-City generation project currently under construction. We cannot, however, be certain as to when the new power plant will be in operation or the nature of future New York City energy, capacity or ancillary services market requirements or design.
KeySpan continues to believe that New York City represents a strong capacity market and has entered into an International Swap Dealers Association ("ISDA") Master Agreement for a fixed for float unforced capacity financial swap (the "Swap Agreement") with Morgan Stanley Capital Group Inc. ("Morgan Stanley") dated as of January 18, 2006. The Swap Agreement has a three year term beginning May 1, 2006, (assuming a condition to effectiveness has been satisfied by such date). The notional quantity is 1,800,000kW (the "Notional Quantity") of In-City Unforced Capacity and the fixed price is $7.57/kW-month ("Fixed Price"), subject to adjustment upon the occurrence of certain events. Settlement would occur on a monthly basis based on the In-City Unforced Capacity price determined by the relevant New York Independent System Operator Spot Demand Curve Auction Market ("Floating Price"). For each monthly settlement period, the price difference will equal the Fixed Price minus the Floating Price. If such price difference is less than zero, Morgan Stanley will pay KeySpan an amount equal to the product of (a) the Notional Quantity and (b) the absolute value of such price difference. Conversely, if such price difference is greater than zero, KeySpan will pay Morgan Stanley an amount equal to the product of (a) the Notional Quantity and (b) the absolute value of such price difference. KeySpan believes that the average annual monthly capacity market price will settle above the Fixed Price.
The New York State competitive wholesale market for capacity, energy and ancillary services administered by the NYISO is still evolving and FERC has adopted several price mitigation measures which are subject to rehearing and possible judicial review. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation - "Regulatory Issues and Competitive Environment" for a further discussion of these matters.
Forty-six of our seventy-eight generating units are dual fuel units. In recent years, we have reconfigured several of our facilities to enable them to burn either natural gas or oil, thus enabling us to switch periodically between fuel alternatives based upon cost and seasonal environmental requirements. Through other innovative technological approaches, we instituted a program to reduce nitrogen oxides for improved environmental performance while recovering 80 MW of energy output.
The following table indicates the 2005 summer capacity of all of our steam generation facilities and gas turbine ("GT") units as reported to the NYISO:
- -------------------------------------------------------------------------------- Location of Units Description Units MW Fuel - -------------------------------------------------------------------------------- Long Island City Steam Turbine Dual* 3 1737 Long Island City Combined Cycle Dual* 1 226 Northport, L.I. Steam Turbine Dual* 4 1550 Port Jefferson, L.I. Steam Turbine Dual* 2 388 Glenwood, L.I. Steam Turbine Gas 2 240 Island Park, L.I. Steam Turbine Dual* 2 396 Far Rockaway, L.I. Steam Turbine Dual* 1 110 Long Island City GT Units Dual* 17 438 Glenwood and Port GT Units Dual 4 154 Jefferson Energy Center, L.I. Throughout L.I. GT Units Dual* 12 301 Throughout L.I. GT Units Oil 30 1060 -- ----
TOTAL 78 6600
================================================================================ *Dual - Oil (#2 oil or #6 residual oil) or kerosene, and natural gas.
For additional information and for financial information concerning the Electric Services segment, see the discussion in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - "Electric Services" and Note 2 to the Consolidated Financial Statements, "Business Segments".
Agreements with LIPA
LIPA is a corporate municipal instrumentality and a political subdivision of the State of New York. On May 28, 1998, certain of LILCO's business units were merged with KeySpan and LILCO's common stock and remaining assets were acquired by LIPA. At the time of this transaction, KeySpan and LIPA entered into three major long-term service agreements, the 1998 MSA, 1998 PSA and 1998 EMA. Under these agreements, as well as through additional power purchase agreements, KeySpan provides: 4,214 MW of power generation capacity and energy conversion services; operation, maintenance and capital improvement services for LIPA's transmission and distribution system; and energy management services.
On February 1, 2006, KeySpan and LIPA entered into the 2006 LIPA Agreements which will become effective as of January 1, 2006, following receipt of all necessary governmental approvals, which are pending. The effectiveness of each of the 2006 LIPA Agreements is conditioned upon all of the 2006 LIPA Agreements becoming effective.
2006 Settlement Agreement. Pursuant to the terms of the 2006 Settlement Agreement, KeySpan and LIPA agreed to resolve issues that have existed between the parties relating to the various agreements effective in May 1998. In addition to the resolution of these matters, KeySpan's entitlement to utilize LILCO's available tax credits and other tax attributes will increase from approximately $50 million to approximately $200 million. These credits and
attributes may be used to satisfy KeySpan's previously incurred indemnity obligation to LIPA for any federal income tax liability that may result from the settlement of a pending Internal Revenue Service ("IRS") audit for LILCO's tax year ended March 31, 1999. In recognition of these items, as well as for the modification and extension of the 1998 MSA and the elimination of the GPRA, upon effectiveness of the 2006 Settlement Agreement KeySpan will record a contractual asset in the amount of approximately $160 million, of which approximately $110 million will be attributed to the right to utilize such additional tax credits and attributes and approximately $50 million will be amortized over the eight year term of the 2006 MSA. In order to compensate LIPA for the foregoing, KeySpan will pay LIPA $69 million in cash and will settle certain accounts receivable in the amount of approximately $90 million due from LIPA.
Generation Purchase Rights Agreement and 2006 Option Agreement. Under an amended GPRA, LIPA had the right to acquire KeySpan's interest in KeySpan Generation LLC, which includes all of our Long Island-based generating assets formerly owned by LILCO, at fair market value at the time of the exercise of such right. LIPA was initially required to exercise its option by May 2005, but KeySpan and LIPA agreed to extend the date by which LIPA was to make this determination to December 15, 2005. Pursuant to the December 2005 settlement between KeySpan and LIPA, the parties entered into the 2006 Option Agreement, whereby LIPA has the option during the period January 1, 2006 to December 31, 2006 to purchase only KeySpan's Far Rockaway and/or E.F. Barrett Generating Stations (and certain related assets) at a price equal to the net book value of each facility. The 2006 Option Agreement replaces the GPRA, the expiration of which has been stayed pending effectiveness of the 2006 LIPA Agreements which are pending governmental approvals. In the event such agreements do not become effective by reason of failure to secure requisite governmental approvals, the GPRA will be reinstated for a period of 90 days. If LIPA were to exercise the option and purchase one or both of the generation facilities (i) LIPA and KeySpan will enter into an operation and maintenance agreement, pursuant to which KeySpan will continue to operate these facilities through May 28, 2013 for a fixed management fee plus reimbursement for certain costs; and (ii) the 1998 PSA and 1998 EMA would be amended to reflect that the purchased generating facilities would no longer be covered by those agreements. It is anticipated that the fees received pursuant to the operation and maintenance agreement will offset the reduction in the operation and maintenance expense recovery component of the 1998 PSA and the reduction in fees under the 1998 EMA.
It is also contemplated that to the extent any emission credits attributable to the acquired facilities are not needed to satisfy the operating requirements of such plants, such excess emissions credits will be pooled and applied pro rata to satisfy the operating requirements of KeySpan's generating facilities subject to the amended PSA. Thereafter, any remaining credits attributable to the acquired plants may be sold by LIPA, who shall retain 100% of the net proceeds.
Management Services Agreement. Pursuant to the 1998 MSA, we perform day-to-day operation and maintenance services and capital improvements for LIPA's transmission and distribution system, including, among other functions, transmission and distribution facility operations, customer service, billing and collection, meter reading, planning, engineering, and construction, all in accordance with policies and procedures adopted by LIPA. KeySpan furnishes such services as an independent contractor and does not have any ownership or leasehold interest in the transmission and distribution system.
In exchange for providing these services, we are reimbursed for our budgeted costs and entitled to earn an annual management fee of $10 million and may also earn certain cost-based incentives, or be responsible for certain cost-based penalties. The incentives provided us the ability to retain 100% of the first $5 million of budget underruns and 50% of any additional budget underruns up to 15% of the total cost budget. Thereafter, all savings accrued to LIPA. The penalties required us to absorb any total cost budget overruns up to a maximum of $15 million in any contract year.
In addition to the foregoing cost-based incentives and penalties, the agreement provided for performance-based incentives for performance above certain threshold target levels and subject to disincentives for performance below certain other threshold levels, with an intermediate band of performance in which neither incentives nor disincentives apply, for system reliability, worker safety, and customer satisfaction. In 2005, we earned $7.4 million in non-cost performance incentives.
The 1998 MSA was originally set to expire on May 28, 2006, but in 2005 it was extended through December 31, 2008, in connection with the extension of the option period under the GPRA as was more fully described in the discussion on "Generation Purchase Rights Agreement and 2006 Option Agreement" above.
As a result of the recent negotiations and settlement between KeySpan and LIPA discussed above, the parties entered into a 2006 MSA. Under the 2006 MSA, KeySpan will continue to perform the day-to-day operation and maintenance services and capital improvements on LIPA's T&D System, including among other functions, T&D facility operations, customer service, meter reading, planning, engineering, and construction, all in accordance with prudent utility practice and policies and procedures adopted by LIPA. The 2006 MSA will not become effective unless and until all governmental approvals are received and, only if all of the 2006 LIPA Agreements are approved. If all governmental approvals are received, then the 2006 MSA will be implemented with an effective date of January 1, 2006 and will operate through December 31, 2013.
In place of the previous compensation structure (whereby KeySpan was reimbursed for budgeted costs, and earned a management fee and certain performance and cost-based incentives), KeySpan's compensation for managing the T&D System under the 2006 MSA consists of two components: a minimum compensation component of $224 million per year and a variable component based on electric sales. The $224 million component will remain unchanged for three years and then increase annually by 1.7%, plus inflation. The variable component, which will comprise no more than 20% of KeySpan's compensation, is based on electric sales on Long Island exceeding a base amount of 16,558 gigawatt hours, increasing by 1.7% in each year. Above that level, KeySpan will receive approximately 1.34 cents per kilowatt hour for the first contract year, 1.29 cents per kilowatt hour in the second contract year (plus an annual inflation adjustment), 1.24 cents per kilowatt hour in the third contract year (plus an annual inflation adjustment), with the per kilowatt hour rate thereafter adjusted annually by inflation. Subject to certain limitations, KeySpan will be able to retain all operational efficiencies realized during the term of the 2006 MSA.
LIPA will continue to reimburse KeySpan for certain expenditures incurred in connection with the operation and maintenance of the T&D System, and other payments made on behalf of LIPA, including: real property and other T&D System taxes, return postage, capital construction expenditures and storm costs.
The 2006 MSA provides for a number of performance metrics measuring various aspects of KeySpan's performance in the operations and customer service areas. Poor performance in any metric may subject KeySpan to financial and other non-cost penalties (such financial penalties not to exceed $7 million in the aggregate for all performance metrics in any contract year). Subject to certain limitations, superior performance in certain metrics can be used to offset underperformance in other metrics. Consistent failure to meet threshold performance levels for two metrics, System Average Interruption Duration Index (two out of three consecutive years) and Customer Satisfaction Index (three consecutive years), will constitute an event of default under the 2006 MSA.
Should LIPA sell the T&D System to a private entity during the term of the 2006 MSA, LIPA shall have the right to terminate the 2006 MSA, provided that LIPA will be required to pay KeySpan's reasonable transition costs and a termination fee of (a) $28 million if the termination date occurs on or before December 31, 2009, and (b) $20 million if the termination date occurs after December 31, 2009.
Power Supply Agreement. A KeySpan subsidiary sells to LIPA all of the capacity and, to the extent requested, energy conversion services from our Long Island-based oil and gas-fired generating plants. Sales of capacity and energy conversion services are made under rates approved by the FERC in accordance with the terms of the PSA. Since October 1, 2004, pursuant to a FERC approved settlement, the rates reflect a cost of equity of 9.5% with no revenue increase in the first year of the new rate period. The FERC also approved updated operating and maintenance expense levels and KeySpan's recovery of certain other costs as agreed to by the parties. Rates charged to LIPA include a fixed and variable component. The variable component is billed to LIPA on a monthly basis and is dependent on the number of megawatt hours ("MWh") dispatched. LIPA has no obligation to purchase energy conversion services from us and is able to purchase energy or energy conversion services on a least-cost basis from all available sources consistent with existing interconnection limitations of the T&D system. The PSA provides incentives and penalties that can total $4 million annually for the maintenance of the output capability and the efficiency of the generating facilities. In 2005, we earned $4 million in incentives under the PSA.
The 1998 PSA runs for an original term of 15 years, expiring in 2013. The 1998 PSA has a renewal provision for an additional 15 years on similar terms at LIPA's option. However, the 1998 PSA provides LIPA the option of electing to reduce or "ramp-down" the capacity it purchases from us in accordance with agreed-upon schedules. In years 7 through 10 of the 1998 PSA, if LIPA elects to ramp-down, we are entitled to receive payment for 100% of the present value of the capacity charges otherwise payable over the remaining term of the 1998 PSA. If LIPA ramps-down the generation capacity in years 11 through 15 of the 1998 PSA, the capacity charges otherwise payable by LIPA will be reduced in accordance with a formula established in the 1998 PSA. If LIPA exercises its ramp-down option, KeySpan may use any capacity released by LIPA to bid on new LIPA capacity requirements or to replace other ramped-down capacity. If we continue to operate the ramped-down capacity, the 1998 PSA requires us to use reasonable efforts to market the capacity and energy from the ramped-down capacity and to share any profits with LIPA. The 1998 PSA will be terminated in the event that LIPA purchases, at fair market value, all of KeySpan's interest in KeySpan Generation LLC pursuant to GPRA discussed in greater detail above
Energy Management Agreement. Pursuant to the 1998 EMA, KeySpan (i) procures and manages fuel supplies for LIPA to fuel our Long Island generating facilities acquired from LILCO in 1998; (ii) performs off-system capacity and energy purchases on a least-cost basis to meet LIPA's needs; and (iii) makes off-system sales of output from the Long Island generating facilities and other power supplies either owned or under contract to LIPA. LIPA is entitled to two-thirds of the profit from any off-system electricity sales arranged by us. The original term for the fuel supply service described in (i) above is fifteen years, expiring May 28, 2013, and the original term for the off-system purchases and sales services described in (ii) and (iii) above is eight years, expiring May 28, 2006. In 2005, the EMA was amended to extend the term for the services described in (ii) and (iii) through December 31, 2006.
In exchange for these services, we earn an annual fee of $1.5 million, plus an allowance for certain costs incurred in performing services under the EMA. The EMA further provides incentives and disincentives up to $5 million annually for control of the cost of fuel purchased on behalf of LIPA. In 2005, we earned EMA incentives in an aggregate of $5 million.
We also have an inventory of sulfur dioxide ("SO2") and nitrogen oxide ("NOx") emission allowances that may be sold to third party purchasers. The amount of allowances varies from year to year relative to the level of emissions from the Long Island generating facilities, which is greatly dependent on the mix of natural gas and fuel oil used for generation and the amount of purchased power that is imported onto Long Island. In accordance with the 1998 PSA, 33% of emission allowance sales revenues attributable to the Long Island generating facilities is retained by KeySpan and the other 67% is credited to LIPA. LIPA also has a right of first refusal on any potential emission allowance sales of the Long Island generating facilities. Additionally, KeySpan voluntarily entered into a memorandum of understanding with the New York State Department of Environmental Conservation ("NYSDEC"), which memorandum prohibits the sale of SO2 allowances into certain states and requires the purchaser to be bound by the same restriction, which may marginally affect the market value of the allowances.
In March 2005, LIPA issued a Request for Proposal ("RFP") to provide system power supply management services beginning May 29, 2006 and fuel management services for certain of its peaking generating units beginning January 1, 2006. A KeySpan subsidiary is currently performing these services. KeySpan submitted a bid in response to the new RFP in April 2005. LIPA was scheduled to select a service provider in June 2005, but has deferred such decision at this time. We cannot predict the outcome or the timing of any decisions by LIPA on this matter at this time. Pending LIPA's determination on the RFP, the EMA was extended through December 31, 2006.
Power Purchase Agreements with KeySpan Glenwood and KeySpan Port Jefferson. KeySpan Glenwood Energy Center, LLC and KeySpan Port Jefferson Energy Center LLC each have 25 year power purchase agreements with LIPA expiring in 2027 (the "2002 LIPA PPAs"). Under the terms of the 2002 LIPA PPAs, these subsidiaries sell capacity, energy conversion services and ancillary services to LIPA. Each plant is designed to produce 79.9 MW. Pursuant to the 2002 LIPA PPAs, LIPA pays a monthly capacity fee, which guarantees full recovery of each plant's construction costs, as well as an appropriate rate of return on investment.
Other Contingencies. In 2005, LIPA completed the strategic organizational review initiative it commenced in 2004. As part of its strategic review, LIPA engaged a team of advisors and consultants, held public hearings and explored its strategic options, including continuing its existing operations, municipalizing,
privatizing, selling some, but not all of its assets, becoming a regulator of rates and services, or merging with one or more utilities. The strategic review team also considered whether LIPA should exercise its option under the GPRA. Upon completion of its strategic review, LIPA determined that it would continue its existing organizational structure and engage KeySpan in the renegotiation of the 1998 MSA, GPRA and related agreements. As stated above, these negotiations culminated in the parties entering into the 2006 LIPA Agreements. As previously noted, the 2006 LIPA Agreements are subject to receipt of governmental approvals. Also, the LIPA Agreements do not preclude LIPA from continuing to explore privatization, municipalization or other strategic alternatives.
Other Rights. Pursuant to other agreements between LIPA and KeySpan, certain future rights have been granted to LIPA. Subject to certain conditions, these rights include the right for 99 years (from May 1998) to lease or purchase, at fair market value, parcels of land and to acquire unlimited access to, as well as appropriate easements at, the Long Island generating facilities for the purpose of constructing new electric generating facilities to be owned by LIPA or its designee. Subject to this right granted to LIPA, KeySpan has the right to sell or lease property on or adjoining the Long Island generating facilities to third parties.
We own common plant assets (such as administrative office buildings and computer systems) formerly owned by LILCO and recover an allocable share of the carrying costs of such plant assets through the MSA. KeySpan has agreed to provide LIPA, for a period of 99 years (from May 1998), the right to enter into leases at fair market value for common plant assets or sub-contract for common services which it may assign to a subsequent manager of the transmission and distribution system. We have also agreed: (i) for a period of 99 years (from May 1998) not to compete with LIPA as a provider of transmission or distribution service on Long Island; (ii) that LIPA will share in synergy (i.e., efficiency) savings over a 10-year period attributed to the May 28, 1998 transaction which resulted in the formation of KeySpan (estimated to be approximately $1 billion), which savings are incorporated into the cost structure under the LIPA Agreements; and (iii) generally not to commence any tax certiorari case (during the pendency of the 1998 PSA) challenging certain property tax assessments relating to the former LILCO Long Island generating facilities.
Guarantees and Indemnities. We have entered into agreements with LIPA to provide for the guarantee of certain obligations, indemnification against certain liabilities and allocation of responsibility and liability for certain pre-existing obligations and liabilities. In general, liabilities associated with the LILCO assets transferred to KeySpan, have been assumed by KeySpan; and liabilities associated with the assets acquired by LIPA, are borne by LIPA, subject to certain specified exceptions. We have assumed all liabilities arising from all manufactured gas plant ("MGP") operations of LILCO and its predecessors, and LIPA has assumed certain liabilities relating to the former LILCO Long Island generating facilities and all liabilities traceable to the business and operations conducted by LIPA after completion of the 1998 KeySpan/LILCO transaction. An agreement also provides for an allocation of liabilities which relates to the assets that were common to the operations of LILCO and/or shared services or liabilities which are not traceable directly to either the business or operations conducted by LIPA or KeySpan. In addition, costs incurred by KeySpan for liabilities for asbestos exposure arising from the activities of the generating facilities previously owned by LILCO are recoverable from LIPA through the PSA.
ENERGY SERVICES OVERVIEW
The Energy Services segment includes companies that provide energy-related services to customers located primarily within the Northeastern United States, with concentrations in the New York City and Boston metropolitan areas. Subsidiaries in this segment provide residential and small commercial customers with service and maintenance of energy systems and appliances, as well as operation and maintenance, design, engineering, consulting and fiber optic services to commercial, institutional and industrial customers. Our subsidiaries in this segment have over 200,000 service contracts in place to provide home energy services, completed over 250,000 service calls during 2005 and completed more than 16,000 installations during 2005.
In January and February of 2005, KeySpan sold its mechanical contracting subsidiaries in this segment and exited such businesses. These subsidiaries were engaged in design, building, installing and servicing heating, ventilation and air conditioning ("HVAC") systems and plumbing systems for industrial and commercial customers. In the fourth quarter of 2004, KeySpan's investment in its discontinued mechanical contracting subsidiaries was written-down to an estimated fair value. For additional information concerning the Energy Services segment, see the discussion in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - "Energy Services" contained herein.
For additional information and financial information concerning the Energy Services segment, see the discussion in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - "Energy Services", Item 8. "Financial Statements and Supplementary Data", Note 2 to the Consolidated Financial Statements, "Business Segments" and Note 10 "Energy Services - "Discontinued Operations".
ENERGY INVESTMENTS OVERVIEW
We are also engaged in Energy Investments which includes gas exploration and production activities, domestic pipelines, gas storage facilities and LNG facilities and operations.
Gas Exploration and Production
KeySpan is engaged in the exploration for and production of domestic natural gas and oil through wholly-owned subsidiaries Seneca-Upshur Petroleum, Inc., d/b/a KeySpan Production & Development Company ("Seneca-Upshur") and KeySpan Exploration and Production, LLC ("KeySpan Exploration and Production"). KeySpan Exploration and Production is involved in a joint venture with The Houston Exploration Company ("Houston Exploration"), a former subsidiary of KeySpan, to explore for and produce natural gas and oil. KeySpan Exploration and Production's remaining venture assets are primarily proved undeveloped oil reserves located off the Gulf of Mexico in the South Timbalier and Mustang Island areas.
In June 2004, KeySpan reduced its ownership in Houston Exploration from 55% to 23.5%, through an exchange of 10.8 million shares of its Houston Exploration common stock for 100% of the stock of Seneca-Upshur, previously a wholly owned subsidiary of Houston Exploration. Seneca-Upshur's assets consist of 50 billion cubic feet of low risk, mature, onshore gas producing properties located predominantly in West Virginia and Pennsylvania. In November 2004, KeySpan decided to sell its remaining ownership interest (approximately 6.6 million shares of common stock) in Houston Exploration. See Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operations - "Energy Investments" for a further discussion of these matters.
As indicated above, as a result of the transactions with Houston Exploration, Seneca-Upshur, headquartered in Buckhannon, West Virginia, owns and operates onshore gas producing properties, and operates approximately 1,300 wells in north central West Virginia and southern Pennsylvania. To manage the inherent volatility in commodity prices, Seneca-Upshur entered into a three-year hedge for a majority of its production.
Domestic Pipelines and Gas Storage Facilities
We own a 20.4% interest in Iroquois Gas Transmission System LP, a partnership of affiliates of six U.S. and Canadian energy companies, which is the owner of a 411-mile interstate natural gas pipeline extending from the U.S.-Canadian border at Waddington, NY through western Connecticut to its terminus in Commack, NY, and from Huntington to the Bronx. Its wholly owned subsidiary, the Iroquois Pipeline Operating Company, headquartered in Shelton, Connecticut, is the agent for and operator of the pipeline. The Iroquois pipeline can transport up to 1,124,500 DTH per day of Canadian gas supply from the New York-Canadian border to markets in the Northeastern United States. KeySpan is also a shipper on Iroquois and currently transports up to 304,950 DTH of gas per day.
We also have a 50% interest in Islander East Pipeline Company, LLC ("Islander East"), which was created to pursue the authorization and construction of an interstate pipeline from Connecticut, across Long Island Sound, to a terminus near Shoreham, Long Island. In addition, we own a 21% ownership interest in the Millennium Pipeline project which is anticipated to transport up to 525,000 DTH of natural gas a day from Corning to Ramapo, New York, interconnecting with the pipeline systems of various other utilities in New York.
We are also the owner and operator of a 600,000 barrel LNG storage and receiving facility located in Providence, Rhode Island, known as KeySpan LNG. We acquired the KeySpan LNG facility from Algonquin LNG, a subsidiary of Duke Energy on December 12, 2002. Our subsidiary, Boston Gas is the facility's largest customer and contracts for more than half of the LNG facility's storage. KeySpan LNG is regulated by FERC.
For additional information concerning these energy related investments in pipelines and gas storage facilities, see the discussion on "Energy Investments" in Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations contained herein.
We also have equity investments in two gas storage facilities in the State of New York: Honeoye Storage Corporation and Steuben Gas Storage Company. We own a 52% interest in Honeoye, an underground gas storage facility which provides up to 4.3 billion cubic feet of storage service to New York and New England. Additionally, we own 34% of a partnership that has a 50% interest in the Steuben facility that provides up to 6.2 billion cubic feet of storage service to New Jersey and Massachusetts.
Former Energy Investments
KeySpan had previously been involved in natural gas distribution and pipeline activities in the United Kingdom. However, on March 18, 2005, KeySpan sold its 50% interest in Premier Transmission Limited ("Premier"), a gas pipeline from southwest Scotland to Northern Ireland pursuant to an agreement among KeySpan, its 50% partner, BG Energy Holdings Limited and Premier Transmission Financing Public Limited Company ("PTFPL"), pursuant to which all of the outstanding shares of PTL were purchased by PTFPL. In two transactions in April and December 2004, KeySpan sold its ownership in KeySpan Energy Canada Partnership ("KeySpan Canada") a company that owned certain midstream natural gas assets in Western Canada.
For additional information and financial information concerning the Energy Investments segment, see the discussion in Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations - "Energy Investments" and Note 2 to the Consolidated Financial Statements, "Business Segments".
ENVIRONMENTAL MATTERS OVERVIEW
KeySpan's ordinary business operations subject it to regulation in accordance with various federal, state and local laws, rules and regulations dealing with the environment, including air, water, and hazardous substances. These requirements govern both our normal, ongoing operations and the remediation of impacted properties historically used in utility operations. Potential liability associated with our historical operations may be imposed without regard to fault, even if the activities were lawful at the time they occurred.
Except as set forth below, or in Note 7 to the Consolidated Financial Statements "Contractual Obligations and Contingencies - Environmental Matters," no material proceedings relating to environmental matters have been commenced or, to our knowledge, are contemplated by any federal, state or local agency against KeySpan, and we are not a defendant in any material litigation with respect to any matter relating to the protection of the environment. We believe that our operations are in substantial compliance with environmental laws and that requirements imposed by existing environmental laws are not likely to have a material adverse impact upon us. We are also pursuing claims against insurance carriers and potentially responsible parties which seek the recovery of certain environmental costs associated with the investigation and remediation of contaminated properties. We believe that investigation and remediation costs prudently incurred at facilities associated with utility operations, not recoverable through insurance or some other means, will be recoverable from our customers in accordance with the terms of our rate recovery agreements for each regulated subsidiary.
Air. The Federal Clean Air Act ("CAA") provides for the regulation of a variety of air emissions from new and existing electric generating plants. Final permits in accordance with the requirements of Title V of the 1990 amendments to the CAA have been issued for all of our electric generating facilities, with the exception of two 79 MW simple cycle gas turbine facilities which were constructed in 2002. These units currently are permitted under New York State Facility permits and Title V permits have been timely applied for and are pending issuance by the NYSDEC. Renewal applications were submitted in a timely manner for 13 existing facilities whose initial permits were to expire in 2004. To date, all of the permits except one were renewed and the remaining renewal application has been deemed complete by NYSDEC and is undergoing final review by the United States Environmental Protection Agency ("EPA"). During 2005, a timely renewal application was submitted for a facility whose permit expires in 2006. The permits and timely renewal applications allow our electric generating plants to continue to operate without any additional significant expenditures, except as described below.
Our generating facilities are located within a CAA ozone non-attainment and PM 2.5 (fine particulate matter) non-attainment area, and are subject to Phase I, II and III NOX reduction requirements established under the Ozone Transport Commission ("OTC") memorandum of understanding and forthcoming requirements under the Clean Air Interstate Rule ("CAIR") designed to address both ozone and particulate matter. Our previous investments in low NOX boiler combustion modifications, the use of natural gas firing systems at our steam electric generating stations, and the compliance flexibility available under these cap and trade programs, have enabled KeySpan to achieve the emission reductions required in a cost-effective manner. KeySpan is developing its compliance strategy in response to the implementation of CAIR, which is expected in 2009. Since detailed requirements under CAIR have not yet been fully articulated, it is not possible to definitively estimate capital expenditures that may be required to meet these regulatory mandates. Although it is anticipated that NOx control equipment may be required at one or more of KeySpan's Long Island facilities at a cost of between $25 to $35 million. However, such amounts are recoverable from LIPA pursuant to the 1998 PSA, or if applicable, the 2006 PSA.
In 2003, New York State promulgated regulations which establish separate NOX and SO2 emission reduction requirements on electric generating facilities in New York State, which commenced in late 2004 for NOX emissions and in 2005 for SO2 emissions. KeySpan's facilities have been able to comply with the NOX requirements without material additional capital expenditures because of previously installed emissions control equipment and gas combustion capability. SO2 compliance was achieved through a reduction in the sulfur content of the fuel oil used in our Northport and Port Jefferson facilities and a further reduction is expected to be required in 2008.
In 2004, the EPA issued regulations that require reductions, on a national basis, of mercury emissions from electric generating facilities on a national basis. The mercury regulations have no impact on KeySpan facilities since their application is limited to coal-fired plants. EPA determined that nickel emissions from oil fired plants do not pose health risks that require regulation. This determination has been challenged and litigation is pending. Until a final outcome is obtained, the nature and extent of the financial impact on KeySpan from nickel regulation, if any, cannot be determined.
In 2003, the Governor of New York initiated a Regional Greenhouse Gas Initiative that seeks to establish a coordinated multi-state plan to reduce greenhouse gas emissions (primarily carbon dioxide ("CO2")) from electric generating emission sources in the Northeast. In December of 2005, seven northeast states, including New York, issued a memorandum of understanding capping CO2 emissions from electric generating facilities in 2009 and, beginning in 2015, gradually requiring a 10 percent reduction in regional emissions by 2018. Each of the seven states will be promulgating individual state rules to implement the MOU. Several congressional initiatives are also under consideration that may also require greenhouse gas reductions from electric generating facilities nationwide. At the present time it is not possible to predict the nature of the requirements which ultimately will be imposed on KeySpan, nor what, if any, financial impact such requirements would have on KeySpan facilities. However, our investments in additional natural gas firing capability have resulted in approximately a 15% reduction in carbon dioxide emissions since 1990, while the electric generation industry as a whole increased carbon dioxide emissions by more than 25%. The addition of the efficient, combined cycle unit which began operation at the Ravenswood Generating Station in 2004 has further reduced average KeySpan CO2 emission rates.
Water. The Federal Clean Water Act provides for effluent limitations, to be implemented by a permit system, to regulate the discharge of pollutants into United States waters. We possess permits for our generating units which authorize discharges from cooling water circulating systems and chemical treatment systems. These permits are renewed from time to time, as required by regulation. Additional capital expenditures associated with the renewal of the surface water discharge permits for our power plants will likely be required by the NYSDEC. We are currently conducting studies as directed by the NYSDEC to determine the impacts of our discharges on aquatic resources and are engaged in discussions with the NYSDEC regarding the nature of capital upgrades or other mitigation measures necessary to satisfy these evolving regulatory requirements. It is difficult to predict with any certainty the costs of such capital investments, but these upgrades are expected to cost up to $60 million. However, such amounts are recoverable from LIPA pursuant to the 1998 PSA, or applicable, the 2006 PSA. The Ravenswood Generating Station may also require upgrades at a cost of up to $15 million. The actual expenditures will depend upon the outcome of the ongoing studies and the subsequent determination by the NYSDEC of how to apply the standards set forth in recently promulgated federal regulations under Section 316 of the Clean Water Act designed to mitigate such impacts.
Land. The Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 and certain similar state laws (collectively "Superfund") impose liability, regardless of fault, upon generators of hazardous substances even before Superfund was enacted for costs associated with investigating and remediating contaminated property. In the course of our business operations, we generate materials which, after disposal, may become subject to Superfund. From time to time, we have received notices under Superfund concerning possible claims with respect to sites where hazardous substances generated by KeySpan or its predecessors and other potentially responsible parties were allegedly disposed. Normally, the costs associated with such claims are allocated among the potentially responsible parties on a pro rata basis. Superfund does, however, provide for joint and several liability against a single potentially responsible party. In the unlikely event that Superfund claims were pursued against us on that basis, the costs may be material to our financial condition, results of operations or cash flows.
KeySpan has identified certain MGP sites which were historically owned or operated by its subsidiaries (or such companies' predecessors). Operations at these sites between the mid-1800s to mid-1900s may have resulted in the release of hazardous substances. For a discussion on our MGP sites and further information concerning environmental matters, see Note 7 to the Consolidated Financial Statements, "Contractual Obligations and Contingencies - Environmental Matters."
COMPETITION, REGULATION AND RATE MATTERS
Competition. Over the last several years, the natural gas and electric industries have undergone significant change as market forces moved towards replacing or supplementing rate regulation through the introduction of competition. A significant number of natural gas and electric utilities reacted to the changing structure of the energy industry by entering into business combinations, with the goal of reducing common costs, gaining size to better withstand competitive pressures and business cycles, and attaining synergies from the combination of operations. We engaged in two such combinations, the KeySpan/LILCO transaction in 1998 and our November 2000 acquisition of Eastern and EnergyNorth.
The Ravenswood Generating Station, the merchant plant in our Electric Services segment, is subject to competitive and other risks that could adversely impact the market price for the plant's output. Such risks include, but are not limited to, the construction of new generation or transmission capacity serving the New York City market.
Regulation. Public utility holding companies, like KeySpan, are now regulated by the FERC pursuant to PUHCA 2005 and to some extent by state utility commissions through the regulation of certain affiliate transaction regulations. Our utility subsidiaries are subject to extensive federal and state regulation by FERC and state utility commissions. Our gas and electric public utility companies are subject to either or both state and federal regulation. In general, state public utility commissions, such as the New York Public Service Commission ("NYPSC"), the MADTE and the New Hampshire Public Utilities Commission ("NHPUC") regulate the provision of retail services, including the distribution and sale of natural gas and electricity to consumers. Each of the federal and state regulators also regulates certain transactions among our affiliates. FERC also regulates interstate natural gas transportation and electric transmission, and has jurisdiction over certain wholesale natural gas sales and wholesale electric sales.
In addition, our non-utility subsidiaries are subject to a wide variety of federal, state and local laws, rules and regulations with respect to their business activities, including but not limited to those affecting public sector projects, environmental and labor laws and regulations, state licensing requirements, as well as state laws and regulations concerning the competitive retail commodity supply.
State Utility Commissions. As noted above, our regulated gas distribution utility subsidiaries are subject to regulation by the NYPSC, MADTE and NHPUC. The NYPSC regulates KEDNY and KEDLI. Although KeySpan is not regulated by the NYPSC, it is impacted by conditions that were included in the NYPSC order authorizing the 1998 KeySpan/LILCO transaction. Those conditions address, among other things, the manner in which KeySpan, its service company subsidiaries and its unregulated subsidiaries may interact with KEDNY and KEDLI. The NYPSC also regulates the safety, reliability and certain financial transactions of our Long Island generating facilities and our Ravenswood Generating Station under a lightened regulatory standard. Our KEDNE subsidiaries and to some extent our service companies are also subject to regulation by the MADTE and NHPUC.
Securities and Exchange Commission. As a result of the acquisition of Eastern and EnergyNorth, we became a holding company under PUHCA 1935. The Energy Act repealed PUHCA 1935 and replaced it with PUHCA 2005 effective February 8, 2006. Whereas our corporate and financial activities and those of our subsidiaries had been subject to regulation by the SEC, FERC now has jurisdiction over certain of our holding company activities. However, the SEC continues to have jurisdiction over the registration and issuance of our securities under the federal securities laws.
Under our holding company structure, we have no independent operations or source of income of our own and conduct substantially all of our operations through our subsidiaries and, as a result, we depend on the earnings and cash flow of, and dividends or distributions from, our subsidiaries to provide the funds necessary to meet our debt and contractual obligations and to pay dividends to our
shareholders. Furthermore, a substantial portion of our consolidated assets, earnings and cash flow is derived from the operations of our regulated utility subsidiaries, whose legal authority to pay dividends or make other distributions to us is subject to regulation by state regulatory authorities.
In addition, in November 2000, KeySpan received authorization from the SEC to operate three mutual service companies. Under this order, the SEC determined that, in accordance with PUHCA 1935, KeySpan Corporate Services LLC ("KCS"), KeySpan Utility Services LLC ("KUS") and KeySpan Engineering & Survey, Inc. ("KENG") may operate to provide various services to KeySpan subsidiaries, including regulated utility companies and LIPA, at cost fairly and equitably allocated among them. The regulation of our three service companies has also been transferred to FERC under PUHCA 2005.
Federal Energy Regulatory Commission. FERC has jurisdiction over certain of our holding company activities, including (i) regulating certain transactions among our affiliates within our holding company system; (ii) governing the issuance, acquisition and disposition of securities and assets by certain of our public utility subsidiaries; and (iii) approving certain utility mergers and acquisitions. In addition to its new authority pursuant to PUHCA 2005, FERC also regulates the sale of electricity at wholesale and the transmission of electricity in interstate commerce as well as certain corporate and financial activities of companies that are engaged in such activities. The Long Island generating facilities and the Ravenswood Generating Station are subject to FERC regulation based on their wholesale energy transactions.
Our Ravenswood Generating Station's rates are based on a market-based rate application approved by FERC. The rates that our Ravenswood Generating Station may charge are subject to FERC mandated mitigation measures due to market power issues. The mitigation measures are administered by the NYISO. FERC retains the ability in future proceedings, either on its own motion or upon a complaint filed with FERC, to modify the Ravenswood Generating Station's rates, as well as the mitigation measures, if FERC concludes that it is in the public interest to do so.
KeySpan currently offers and sells the energy, capacity and ancillary services from the Ravenswood Generating Station through the energy market operated by the NYISO. For information concerning the NYISO, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation - "Regulatory Issues and Competitive Environment."
FERC also has jurisdiction to regulate certain natural gas sales for resale in interstate commerce, the transportation of natural gas in interstate commerce and, unless an exemption applies, companies engaged in such activities. The natural gas distribution activities of KEDNY, KEDLI, KEDNE and certain related intrastate gas transportation functions are not subject to FERC jurisdiction. However, to the extent that KEDNY, KEDLI or KEDNE purchase or sell gas for resale in interstate commerce, such transactions are subject to FERC jurisdiction and have been authorized by FERC. Our interests in Iroquois, Honeoye, Steuben and KeySpan LNG are also fully regulated by FERC as natural gas companies.
Executive Officers of KeySpan
Certain information regarding executive officers of KeySpan and certain of its subsidiaries is set forth below:
Robert B. Catell
Mr. Catell, age 69, has been a Director of KeySpan since its creation in May 1998. He was elected Chairman of the Board and Chief Executive Officer in July 1998. He served as its President and Chief Operating Officer from May 1998 through July 1998. Mr. Catell joined KEDNY in 1958 and became an officer in 1974. He was elected Vice President in 1977, Senior Vice President in 1981 and Executive Vice President in 1984. He was elected Chief Operating Officer in 1986 and President in 1990. Mr. Catell continued to serve as President and Chief Executive Officer of KEDNY from 1991 through 1996, when he was elected Chairman and Chief Executive Officer. In 1997, Mr. Catell was elected Chairman, President and Chief Executive Officer of KEDNY and its parent KeySpan Energy Corporation. Mr. Catell also serves on the Board of Directors for Houston Exploration (NYSE:THX), Independence Community Bank (NASDAQ:ICBC) and Keyera Energy Management Ltd. (TSX:KEY.UN)
Robert J. Fani
Mr. Fani, age 52, was elected to serve on the Board of Directors of KeySpan in January 2005 and was elected its President and Chief Operating Officer in October 2003. Mr. Fani joined KEDNY in 1976, and held a variety of management positions in distribution, engineering, planning, marketing and business development. After being elected Vice President in 1992, he was promoted to Senior Vice President of Marketing and Sales for KEDNY in 1997. In 1998, he assumed the position of Senior Vice President of Marketing and Sales for KeySpan. In September 1999, he became Senior Vice President for Gas Operations and was promoted to Executive Vice President for Strategic Services in February 2000 and then to President of the KeySpan Energy Services and Supply Group in 2001. In January 2003, he was named President of KeySpan's Energy Assets and Supply Group until assuming his current position in October 2003.
Wallace P. Parker Jr.
Mr. Parker, age 56, was elected President of the KeySpan Energy Delivery and Customer Relations Group in January 2003. He also serves as Vice Chairman and Chief Executive Officer of KeySpan Services, Inc. since January 2003. He had previously served as President, KeySpan Energy Delivery, since June 2001, and from February 2000 served as Executive Vice President of Gas Operations. He joined KEDNY in 1971 and served in a wide variety of management positions. In 1987, he was named Assistant Vice President for marketing and advertising and was elected Vice President in 1990. In 1994, Mr. Parker was promoted to Senior Vice President of Human Resources for KEDNY and in August 1998 was promoted to Senior Vice President of Human Resources of KeySpan.
Steven L. Zelkowitz
Mr. Zelkowitz, age 56, was elected President of KeySpan's Energy Assets and Supply Group in October 2003. Prior to that, he served as Executive Vice President and Chief Administrative Officer since January 2003. He joined KeySpan as Senior Vice President and Deputy General Counsel in October 1998, and was elected Senior Vice President and General Counsel in February 2000. In July
2001, Mr. Zelkowitz was promoted to Executive Vice President and General Counsel, and in November 2002, he was named Executive Vice President, Administration and Compliance, with responsibility for the offices of General Counsel, Human Resources, Regulatory Affairs, Enterprise Risk Management and administratively for Internal Auditing. Before joining KeySpan, Mr. Zelkowitz practiced law with Cullen and Dykman LLP in Brooklyn, New York, specializing in energy and utility law and had been a partner since 1984. He served on the firm's Executive Committee and was head of its Corporate/Energy Department.
John J. Bishar, Jr.
Mr. Bishar, age 56, was elected Executive Vice President, General Counsel, Chief Governance Officer and Secretary effective March 1, 2005. He became Senior Vice President, General Counsel and Secretary in May 2003, with responsibility for KeySpan's Legal Department and the Corporate Secretary's Office. Prior to that, he joined KeySpan as Senior Vice President and General Counsel in November 2002. Before joining KeySpan, Mr. Bishar practiced law with Cullen and Dykman LLP since 1987. He was the Managing Partner from 1993 through 2002 and was a member of the firm's Executive Committee. From 1980 to 1987, Mr. Bishar was Vice President, General Counsel and Corporate Secretary of LITCO Bancorporation of New York, Inc.
John A. Caroselli
Mr. Caroselli, age 51, was elected Executive Vice President and Chief Strategy Officer in January 2003. Mr. Caroselli is responsible for Brand Management, Strategic Marketing, Strategic Planning, Strategic Performance, Customer Relations and Information Technology Strategy and Governance. Mr. Caroselli came to KeySpan in 2001 and at that time served as Executive Vice President of Strategic Development. Before joining KeySpan, Mr. Caroselli held the position of Executive Vice President of Corporate Development at AXA Financial. Prior to that, he held senior officer positions with Chase Manhattan, Chemical Bank and Manufacturers Hanover Trust. He has extensive experience in strategic planning, brand management, marketing, communications, human resources, facilities management, e-business, change management and strategic execution.
Gerald Luterman
Mr. Luterman, age 62, was elected Executive Vice President and Chief Financial Officer in February 2002. He previously served as Senior Vice President and Chief Financial Officer since joining KeySpan in July 1999. He formerly served as Chief Financial Officer of barnesandnoble.com and Senior Vice President and Chief Financial Officer of Arrow Electronics, Inc. Prior to that, from 1985 through 1996, he held executive positions with American Express. Mr. Luterman also serves on the Board of Directors for IKON Office Solutions Inc. (NYSE:IKN) and Technology Solutions Company (NASDAQ:TSCC).
David J. Manning
Mr. Manning, age 55, was elected Executive Vice President Corporate Affairs and Chief Environmental Officer effective March 1, 2005. He became Senior Vice President for Corporate Affairs in April 1999. Before joining KeySpan, Mr. Manning had been President of the Canadian Association of Petroleum Producers since 1995. From 1993 to 1995, he was Deputy Minister of Energy for the Province of Alberta, Canada. From 1988 to 1993, he was Senior International Trade Counsel for the Government of Alberta, based in New York City. Previously, he was in the private practice of law in Canada as Queen's Counsel.
Anthony Nozzolillo
Mr. Nozzolillo, age 57, was elected Executive Vice President of Electric Operations in February 2000. He previously served as Senior Vice President of KeySpan's Electric Business Unit from December 1998 to January 2000. He joined LILCO in 1972 and held various positions, including Manager of Financial Planning and Manager of Systems Planning. Mr. Nozzolillo served as LILCO's Treasurer from 1992 to 1994 and as Senior Vice President of Finance and Chief Financial Officer from 1994 to 1998.
Lenore F. Puleo
Ms. Puleo, age 52, was elected Executive Vice President of Shared Services in March 2004. She previously served as Executive Vice President of Client Services since February 2000. Prior to that, she served as Senior Vice President of Customer Relations for KEDNY from May 1994 to May 1998, and for KeySpan from May 1998 to January 2000. She joined KEDNY in 1974 and worked in management positions in KEDNY's Accounting, Treasury, Corporate Planning and Human Resources areas. She was given responsibility for the Human Resources Department in 1987 and was named a Vice President in 1990. Ms. Puleo was promoted to Senior Vice President of KEDNY's Customer Relations in 1994.
Nickolas Stavropoulos
Mr. Stavropoulos, age 47, was elected President, KeySpan Energy Delivery, in June, 2004 and Executive Vice President in April 2002. He previously served as President of KeySpan Energy New England since April 2002, and Senior Vice President of sales and marketing in New England since 2000. Prior to joining KeySpan, Mr. Stavropoulos was Senior Vice President of marketing and gas resources for Boston Gas Company. Before joining Boston Gas, he was Executive Vice President and Chief Financial Officer for Colonial Gas Company. In 1995, Mr. Stavropoulos was elected Executive Vice President - Finance, Marketing and CFO, and assumed responsibility for all of Colonial's financial, marketing, information technology and customer service functions. Mr. Stavropoulos was a director of Colonial Gas Company and currently serves on the Board of Directors for Enterprise Bank and Trust Company (NASDAQ:EBTC) and Dynamics Research Corporation (NASDAQ:DRCO).
Joseph F. Bodanza
Mr. Bodanza, age 58, was elected Senior Vice President Regulatory Affairs and Asset Optimization effective March 1, 2005. He became Senior Vice President, Regulatory Affairs and Chief Accounting Officer in April 2003. Prior to that, he served as Senior Vice President of Finance Operations and Regulatory Affairs since August 2001 and was Senior Vice President and Chief Financial Officer of KEDNE. Mr. Bodanza previously served as Senior Vice President of Finance and Management Information Systems and Treasurer of Eastern Enterprise's Gas Distribution Operations. Mr. Bodanza joined Boston Gas Company in 1972, and held a variety of positions in the financial and regulatory areas before becoming Treasurer in 1984. He was elected Vice President and Treasurer in 1988.
Coleen A. Ceriello
Ms. Ceriello, age 47, was named Senior Vice President of Shared Services of KeySpan Corporate Services, LLC, effective March 1, 2005. She had been KeySpan's Vice President - Property, Security and Employee Related Services since January 2005. Prior to that time, she served as Vice President of Property and Security since June 2004 and Vice President of Strategic Planning since August 1999. She joined KEDNY in 1980 and over the years held a succession of positions in Corporate Planning, Regulatory Relations, Information Technology and Strategic Planning and Performance.
John F. Haran
Mr. Haran, age 55, was elected Senior Vice President of KeySpan Energy Delivery and Chief Gas Engineer in March 2004. He had been Senior Vice President of gas operations for KEDNY and KEDLI in April 2002. Mr. Haran joined KEDNY in 1972, and has held management positions in operations, engineering and marketing and sales. He was named Vice President of KEDNY gas operations in 1996 and in 2000 moved to the position of Vice President of KEDLI gas operations.
Michael J. Taunton
Mr. Taunton, age 50, was elected Senior Vice President, Treasurer and Chief Risk Officer effective March 1, 2005. He became Senior Vice President and Treasurer in March 2004, and had been KeySpan's Vice President and Treasurer since June 2000. Prior to that time, he served as Vice President of Investor Relations since September 1998. He joined KEDNY in 1975 and held a succession of positions in Accounting, Customer Service, Corporate Planning, Budgeting and Forecasting, Marketing and Sales, and Business Process Improvement. During the KeySpan/LILCO merger, Mr. Taunton co-managed the day-to-day transition process of the merger and then served on the Transition Team during the acquisition of Eastern Enterprises.
Elaine Weinstein
Ms. Weinstein, age 59, was named Senior Vice President for Human Resources and Chief Diversity Officer in March 2004. She previously served as Senior Vice President of KeySpan's Human Resources division since November 2000, and as Vice President of Staffing and Organizational Development from September 1998, to her election as Senior Vice President. Prior to that time, Ms. Weinstein was General Manager of Employee Development since joining KEDNY in June of 1995. Prior to 1995, Ms. Weinstein was Vice President of Training and Organizational Development at Merrill Lynch.
Lawrence S. Dryer
Mr. Dryer, age 46, was elected Vice President and General Auditor in June 2003. He previously served in this position from September 1998 to August 2001. In August 2001, he was named Senior Vice President and Chief Financial Officer of KeySpan Services, Inc. Prior to such positions, Mr. Dryer had been with LILCO from 1992 to 1998 as Director of Internal Audit. Prior to joining LILCO, Mr. Dryer was an Audit Manager with Coopers & Lybrand.
Theresa A. Balog
Ms. Balog, age 44, was elected Vice President and Chief Accounting Officer effective March 1, 2005. She became Vice President and Controller of KeySpan in April 2003. She joined KeySpan in 2002 as Assistant Controller. Prior to joining KeySpan, Ms. Balog was Chief Accounting Officer for NiSource and held a variety of positions with the Columbia Energy Group.
Joseph E. Hajjar
Mr. Hajjar, age 53, was named Vice President and Controller effective March 1, 2005. He had been Senior Vice President and Chief Financial Officer of KeySpan Services, Inc. since June 2003 and Senior Vice President and Chief Financial Officer of KeySpan Business Solutions, LLC, since November 2001. Before joining KeySpan from 1998 to 2001, Mr. Hajjar was Executive Vice President and Chief Operating Officer of Opportunity America. He also was previously an officer of the Bovis group and served for over 12 years with Price Waterhouse.
Michael A. Walker
Mr. Walker, age 49, was named Vice President and Deputy General Counsel of KeySpan Corporation, effective March 1, 2005. He had been Senior Vice President of KeySpan Services, Inc. since June 2004 and Senior Vice President and COO of KeySpan Business Solutions, LLC, since June 2003. Prior to that time he was Senior Vice President and General Counsel of KeySpan Services, Inc. from January 2001 to December 2003. Before joining KeySpan, Mr. Walker was a shareholder in the Corporate Finance Section in the law firm of Buchanan Ingersoll. Prior to joining Buchanan Ingersoll he worked for several law firms in the north east representing both private and public sector clients on a wide variety of energy, utility, regulatory, corporate and structured finance matters.
EMPLOYEE MATTERS
As of December 31, 2005, KeySpan and its wholly-owned subsidiaries had approximately 9,700 employees. Of that total, approximately 6,154 employees are covered under collective bargaining agreements. KeySpan has not experienced any work stoppage during the past five years and considers its relationship with employees, including those covered by collective bargaining agreements, to be good.
ITEM 1A.
ITEM 1A. RISK FACTORS
Certain statements contained in this Annual Report on Form 10-K concerning expectations, beliefs, plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements that are other than statements of historical facts, are "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Without limiting the foregoing, all statements under the captions "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Item 7A. Quantitative and Qualitative Disclosures About Market Risk" relating to our future outlook, anticipated capital expenditures, future cash flows and borrowings, pursuit of potential acquisition opportunities and sources of funding, are forward-looking statements. Such forward-looking statements reflect numerous assumptions and involve a number of risks and uncertainties, and actual results may differ materially from those discussed in such statements. The risks, uncertainties and factors that could cause actual results to differ materially include but are not limited to the following:
We are a Holding Company, and Our Subsidiaries are Subject to State Regulation Which Limits Their Ability to Pay Dividends and Make Distributions to Us
We are a holding company with no business operations or sources of income of our own. We conduct all of our operations through our subsidiaries and depend on the earnings and cash flow of, and dividends or distributions from, our subsidiaries to provide the funds necessary to meet our debt and contractual obligations and to pay dividends on our common stock.
In addition, a substantial portion of our consolidated assets, earnings and cash flow is derived from the operation of our regulated utility subsidiaries, whose legal authority to pay dividends or make other distributions to us is subject to regulation by the utility regulatory commissions of New York, Massachusetts and New Hampshire. Pursuant to NYPSC orders, the ability of KEDNY and KEDLI to pay dividends to us is conditioned upon their maintenance of a utility capital structure with debt not exceeding 55% and 58%, respectively, of total utility capitalization. In addition, the level of dividends paid by both utilities may not be increased from current levels if a 40 basis point penalty is incurred under a customer service performance program. At the end of KEDNY's and KEDLI's rate years (September 30, 2005 and November 30, 2005, respectively), their ratios of debt to total utility capitalization were well in compliance with the ratios set forth above and we have incurred no penalties under the outstanding customer service performance program.
Our Gas Distribution and Electric Services Businesses May Be Adversely Affected by Changes in Federal and State Regulation
The regulatory environment applicable to our gas distribution and our electric services businesses has undergone substantial changes in recent years, on both the federal and state levels. These changes have significantly affected the nature of the gas and electric utility and power industries and the manner in which their participants conduct their businesses. Moreover, existing statutes and regulations may be revised or reinterpreted, new laws and regulations may be adopted or become applicable to us or our facilities and future changes in laws and regulations may affect our gas distribution and our electric services businesses in ways that we cannot predict.
In addition, our operations are subject to extensive government regulation and require numerous permits, approvals and certificates from various federal, state and local governmental agencies. A significant portion of our revenues in our Gas Distribution and Electric Services segments are directly dependent on rates established by federal or state regulatory authorities, and any change in these rates and regulatory structure could significantly impact our financial results. Increases in utility costs other than gas, not otherwise offset by increases in revenues or reductions in other expenses, could have an adverse effect on earnings due to the time lag associated with obtaining regulatory approval to recover such increased costs and expenses in rates.
Various rulemaking proposals and market design revisions related to the wholesale power market are being reviewed at the federal level. These proposals, as well as legislative and other attention to the electric power industry could have a material adverse effect on our strategies and results of operations for our electric services business and our financial condition. In particular, we sell capacity, energy and ancillary services from our Ravenswood Generating Station facility into the New York Independent System Operator, or NYISO, energy market at market-based rates, subject to mitigation measures approved by the FERC. The pricing for capacity, energy sales and ancillary services in to the NYISO market is still evolving. and some of the FERC's price mitigation measures are subject to rehearing and possible judicial review, as well as revision in response to market participant complaints or NYISO requests.
Our Risk Mitigation Techniques Such as Hedging and Purchase of Insurance May Not Adequately Provide Protection
To mitigate our financial exposure related to commodity price fluctuations, KeySpan routinely enters into contracts to hedge a portion of our purchase and sale commitments, weather fluctuations, electricity sales, natural gas supply and other commodities. However, we do not always cover the entire exposure of our assets or our positions to market price volatility and the coverage will vary over time. To the extent we have unhedged positions or our hedging procedures do not work as planned, fluctuating commodity prices could cause our sales and net income to be volatile.
In addition, our business is subject to many hazards from which our insurance may not adequately provide coverage. An unexpected outage at our Ravenswood Generating Station, especially in the significant summer period, could materially impact our financial results. Damage to pipelines, equipment, properties and people caused by natural disasters, accidents, terrorism or other damage by third parties could exceed our insurance coverage. Although we do have insurance to protect against many of these contingent liabilities, this insurance is capped at certain levels, has self-insured retentions and does not provide coverage for all liabilities.
SEC Rules for Exploration and Production Companies May Require Us to Recognize a Non-Cash Impairment Charge at the End of Our Reporting Periods
Our investments in natural gas and oil consist of our ownership of KeySpan Exploration and Production and Seneca-Upshur. We use the full cost method for KeySpan Exploration and Production and Seneca-Upshur. Under the full cost method, all costs of acquisition, exploration and development of natural gas and oil reserves are capitalized into a full cost pool as incurred, and properties in the pool are depleted and charged to operations using the unit-of-production method based on production and proved reserve quantities. To the extent that these capitalized costs, net of accumulated depletion, less deferred taxes exceed the present value (using a 10% discount rate) of estimated future net cash flows from proved natural gas and oil reserves and the lower of cost or fair value of unproved properties, those excess costs are charged to operations. If a write-down is required, it would result in a charge to earnings but would not have an impact on cash flows. Once incurred, an impairment of gas properties is not reversible at a later date, even if gas prices increase.
Our Operating Results May Fluctuate on a Seasonal and Quarterly Basis
Our gas distribution business is a seasonal business and is subject to weather conditions. We receive most of our gas distribution revenues in the first and fourth quarters, when demand for natural gas increases due to colder weather conditions. As a result, we are subject to seasonal variations in working capital because we purchase natural gas supplies for storage in the second and third quarters and must finance these purchases. Accordingly, our results of operations fluctuate substantially on a seasonal basis. In addition, our New England-based gas distribution subsidiaries do not have weather normalization tariffs, as we do in New York, and results from our Ravenswood Generating Station facility are directly correlated to the weather as the demand and price for the electricity it generates increases during extreme temperature conditions. As a result, fluctuations in weather between years may have a significant effect on our results of operations for these subsidiaries.
A Substantial Portion Of Our Revenues Are Derived From Our Agreements With LIPA And No Assurances Can Be Made That These Arrangements Will Not Be Discontinued At Some Point In The Future Or That The New Agreements Will Become Effective.
We derive a substantial portion of our revenues in our electric services segment from a series of agreements with LIPA pursuant to which we manage LIPA's transmission and distribution system and supply the majority of LIPA's customers' electricity needs. On February 1, 2006, KeySpan and LIPA entered into amended and restated agreements whereby KeySpan will continue to operate and maintain the electric T&D System owned by LIPA on Long Island. As part of the amended agreements, the GPRA, pursuant to which LIPA had the option, through December 15, 2005, to acquire substantially all of the electric generating facilities owned by KeySpan on Long Island is replaced with the 2006 Option Agreement where LIPA only has the right to acquire two of our facilities, our Far Rockaway and/or E.F. Barrett Generating Stations during the period January 1, 2006 to December 31, 2006. Additionally, the new agreements resolve many outstanding issues between the parties regarding the current LIPA Agreements and provide new pricing and extensions of the Agreements. There is a risk that these agreements will not receive the necessary governmental approvals, which are pending, and the effectiveness of each of the 2006 LIPA Agreements is conditioned upon all of the 2006 LIPA Agreements becoming effective. If the 2006 LIPA Agreements do not become effective, there is uncertainty as to whether LIPA will exercise their option under the GPRA and the status of the resolution of the various disputes between KeySpan and LIPA.
A Decline or an Otherwise Negative Change in the Ratings or Outlook on Our Securities Could Have a Materially Adverse Impact on Our Ability to Secure Additional Financing on Favorable Terms
The credit rating agencies that rate our debt securities regularly review our financial condition and results of operations. We can provide no assurances that the ratings or outlook on our debt securities will not be reduced or otherwise negatively changed. A negative change in the ratings or outlook on our debt securities could have a materially adverse impact on our ability to secure additional financing on favorable terms.
Our Costs of Compliance with Environmental Laws are Significant, and the Cost of Compliance with Future Environmental Laws Could Adversely Affect Us
Our operations are subject to extensive federal, state and local environmental laws and regulations relating to air quality, water quality, waste management, natural resources and the health and safety of our employees. These environmental laws and regulations expose us to costs and liabilities relating to our operations and our current and formerly owned properties. Compliance with these legal requirements requires us to commit significant capital toward environmental monitoring, installation of pollution control equipment and permits at our facilities. Costs of compliance with environmental regulations, and in particular emission regulations, could have a material impact on our Electric Services segment and our results of operations and financial position, especially if emission limits are tightened, more extensive permitting requirements are imposed, additional substances become regulated or the number and type of electric generating plants we operate increase.
In addition, we are responsible for the clean-up of contamination at certain MGP sites and at other sites and are aware of additional MGP sites where we may have responsibility for clean-up costs. While our gas utility subsidiaries' rate plans generally allow for the full recovery of the costs
of investigation and remediation of most of our MGP sites, these rate recovery mechanisms may change in the future. To the extent rate recovery mechanisms change in the future, or if additional environmental matters arise in the future at our currently or historically owned facilities, at sites we may acquire in the future or at third-party waste disposal sites, costs associated with investigating and remediating these sites could have a material adverse effect on our results of operations, financial condition and cash flows.
Our Businesses are Subject to Competition and General Economic Conditions Impacting Demand for Services
We recently expanded the Ravenswood Facility, our merchant generation plant, in our Electric Services segment with the Ravenswood Expansion, a 250 MW combined cycle generating unit. However, the Ravenswood Facility and Ravenswood Expansion continue to be subject to competition that could adversely impact the market price for the capacity, energy and ancillary services they sell. In addition, if new generation and/or transmission facilities are constructed, and/or the availability of our Ravenswood Generating Station deteriorates, then the quantities of capacity and energy sales could be adversely affected. In December 2005, NYPA completed construction of a nominal 500 MW generating facility in New York City, and it began selling its capacity and energy into the NYISO markets. In addition, another nominal 500 MW facility is expected to come on-line in 2006. We cannot predict, however, when or if new power plants or transmission facilities in addition to the above-noted resources will be built or the nature of the future New York City capacity and energy requirements.
Competition facing our unregulated Energy Services businesses, including but not limited to competition from other heating, ventilation and air conditioning, and engineering companies, as well as, other utilities and utility holding companies that are permitted to engage in such activities, could adversely impact our financial results and the value of those businesses, resulting in decreased earnings as well as write-downs of the carrying value of those businesses.
Our Gas Distribution segment faces competition with distributors of alternative fuels and forms of energy, including fuel oil and propane. Our ability to continue to add new gas distribution customers may significantly impact financial results. The gas distribution industry has experienced a decrease in consumption per customer over time, partially due to increased efficiency of customers' appliances, economic factors and price elasticity. In addition, our Gas Distribution segment's future growth is dependent upon the ability to add new customers to our system in a cost-effective manner. While our Long Island and New England utilities have significant growth potential, we cannot be sure new customers will continue to offset the decrease in consumption of our existing customer base. There are a number of factors outside of our control that impact customer conversions from an alternative fuel to gas, including general economic factors impacting customers' willingness to invest in new gas equipment.
Risk Associated with our Financial Swap Agreement for In-City Unforced Capacity
KeySpan believes that the New York City market represents a strong capacity market due to, among other things, its local reliability rules (which recently increased to 83% from 80%), increasing demand and the time required for new resources to be constructed. KeySpan anticipates that demand will increase and that the high cost to construct capacity in New York City will result in favorable In-City Unforced Capacity prices. Therefore, KeySpan entered into an ISDA Master Agreement for a fixed for floating unforced capacity financial swap for a notional quantity of
1,800,000kW at the Fixed Price is $7.57/kW-month. If the demand is less than KeySpan's estimates, additional resources enter the market, or costs are less than forecast, In-City Unforced Capacity prices could be on average less than the Fixed Price resulting in a loss to KeySpan, which under certain circumstances could be material.
Labor Disruptions at Our Facilities Could Adversely Affect Our Results of Operations and Cash Flow
Approximately 6,154 employees, or 63% of our employees, are represented by unions through various collective bargaining agreements that expire between 2006 and 2009. The bargaining agreements expiring in 2006 affect approximately 1,300 employees who primarily work for KEDNE and at our Ravenswood Generating Station. KeySpan is currently engaging in discussions with these unions for new collective bargaining agreements. It is possible that our employees may seek an increase in wages and benefits at the expiration of these agreements, and that we may be unable to negotiate new agreements without labor disruption.
Counterparties to Our Transactions May Fail to Perform their Obligations, Which Could Harm Our Results of Operations
Our operations are exposed to the risk that counterparties to our transactions that owe us money or supplies will not perform their obligations. Should the counterparties to arrangements with us fail to perform, we might be forced to enter into alternative hedging arrangements or honor our underlying commitment at then-current market prices that may exceed our contractual prices. In such event, we might incur additional losses to the extent of amounts, if any, already paid to counterparties. This risk is most significant where we have concentrations of receivables from natural gas and electric utilities and their affiliates, as well as industrial customers and marketers throughout the Northeastern United States.
We Are Exposed to Risks That Are Beyond Our Control
The cost of repairing damage to our operating subsidiaries' facilities and the potential disruption of their operations or supplier operations due to storms, natural disasters, wars, terrorist acts and other catastrophic events could be substantial. The occurrence or risk of occurrence of future terrorist attacks or related acts of war may lead to increased political, economic and financial market instability and volatility in prices for natural gas which could materially adversely affect us in ways we cannot predict at this time. A lower level of economic activity for these or other reasons could result in a decline in energy consumption, which could adversely affect our net revenues.
The Long-Term Financial Condition of Our Gas Distribution Business Depends on the Continued Availability of Natural Gas Reserves
The development of additional natural gas reserves requires significant capital expenditures by others for exploring, drilling and installing production, gathering, storage, transportation and other facilities that permit natural gas to be produced and delivered to our distribution systems. Low prices for natural gas, regulatory restrictions, or the lack of available capital for these projects could adversely affect the
development of additional natural gas reserves. Additional natural gas reserves may not be developed in sufficient amounts to fill the capacities of our distribution systems, thus limiting our prospects for long-term growth.
Gathering, Processing and Transporting Activities Involve Numerous Risks that May Result in Accidents and Other Operating Risks and Costs
Our gas distribution facilities pose a variety of hazards and operating risks, such as leaks, explosions and mechanical problems caused by natural disasters, accidents, terrorism or other damage by third parties, which could cause substantial financial losses. In addition to impairing our operations, these risks could also result in loss of human life and environmental pollution. In accordance with standard industry practice, we maintain insurance against some, but not all, of these potential risks and losses. The occurrence of any of these events not fully covered by insurance could have a material adverse effect on our financial position, results of operations and cash flows.
Additional risks, uncertainties and factors that could cause actual results to differ materially include but are not limited to the following:
- volatility of fuel prices used to generate electricity;
- fluctuations in weather and in gas and electric prices;
- our ability to successfully manage our cost structure and operate efficiently;
- our ability to successfully contract for natural gas supplies required to meet the needs of our customers;
- implementation of new accounting standards or changes in accounting standards or GAAP which may require adjustment to financial statements;
- inflationary trends and interest rates;
- the ability of KeySpan to identify and make complementary acquisitions, as well as the successful integration of such acquisitions;
- retention of key personnel;
- federal, state and local regulatory initiatives that threaten cost and investment recovery, and place limits on the type and manner in which we invest in new businesses and conduct operations;
- the impact of federal, state and local utility regulatory policies and orders on our regulated and unregulated businesses;
- the degree to which we develop unregulated business ventures, as well as federal and state regulatory policies affecting our ability to retain and operate such business ventures profitably;
- a change in the fair market value of our investments that could cause a significant change in the carrying value of such investments or the carrying value of related goodwill;
- timely receipts of payments from LIPA and the NYISO, our two largest customers; and
- other risks detailed from time to time in other reports and other documents filed by KeySpan with the SEC.
For any of these statements, KeySpan claims the protection of the safe harbor for forward-looking information contained in the Private Securities Litigation Reform Act of 1995, as amended. For additional discussion on these risks, uncertainties and assumptions, see Item 1. "Description of the Business," Item 2. "Properties," Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Item 7A. "Quantitative and Qualitative Disclosures About Market Risk" contained herein.
ITEM 1B
ITEM 1B UNRESOLVED STAFF COMMENTS.
None.
ITEM 2.
ITEM 2. PROPERTIES
Information with respect to KeySpan's material properties used in the conduct of its business is set forth in, or incorporated by reference in, Item 1 hereof. Except where otherwise specified, all such properties are owned or, in the case of certain rights-of-way, used in the conduct of its gas distribution business, held pursuant to municipal consents, easements or long-term leases, and in the case of gas and oil properties, held under long-term mineral leases. In addition to the information set forth therein with respect to properties utilized by each business segment, KeySpan leases the executive headquarters located in Brooklyn, New York. In addition, we lease other office and building space, office equipment, vehicles and power operated equipment. Our properties are adequate and suitable to meet our current and expected business requirements. Moreover, their productive capacity and utilization meet our needs for the foreseeable future. KeySpan continually examines its real property and other property for its contribution and relevance to our businesses and when such properties are no longer productive or suitable, they are disposed of as promptly as possible. In the case of leased office space, we anticipate no significant difficulty in leasing alternative space at reasonable rates in the event of the expiration, cancellation or termination of a lease.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
See Note 7 to the Consolidated Financial Statements, "Contractual Obligations and Contingencies - Legal Matters."
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the security holders during the last quarter of the 12 months ended December 31, 2005.
PART II -------
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
KeySpan's common stock is listed and traded on the New York Stock Exchange and the Pacific Stock Exchange under the symbol "KSE." As of February 15, 2006, there were approximately 68,318 registered record holders of KeySpan's common stock. In the fourth quarter of 2005, KeySpan increased its dividend to an annual rate of $1.86 per common share beginning with the quarterly dividend to be paid in February 2006. Our dividend framework is reviewed annually by the Board of Directors. The amount and timing of all dividend payments is subject to the discretion of the Board of Directors and will depend upon business conditions, results of operations, financial conditions and other factors. Based on currently foreseeable market conditions, we intend to maintain the annual dividend at the $1.86 level to be paid on a quarterly basis at a rate of $0.465. KeySpan's scheduled dividend payment dates are February 1, May 1, August 1 and November 1, or the next business day, if such date is not a business day.
The following table sets forth, for the quarters indicated, the high and low sales prices and dividends declared per share for the periods indicated:
2005 High Low Dividends Per Share ----------------------------------------------------------------------------- First Quarter $40.90 $38.04 $0.455 Second Quarter $40.88 $36.83 $0.455 Third Quarter $41.03 $36.35 $0.455 Fourth Quarter $37.10 $32.66 $0.455
2004 High Low Dividends Per Share ----------------------------------------------------------------------------- First Quarter $38.60 $35.72 $0.445 Second Quarter $38.99 $33.87 $0.445 Third Quarter $39.50 $35.19 $0.445 Fourth Quarter $41.53 $37.57 $0.445
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth securities authorized for issuance under equity compensation plans for the year ended December 31, 2005:
(1) Includes grants of options, restricted stock, and performance shares pursuant to KeySpan's Long-Term Incentive Compensation Plan, as amended, and options granted pursuant to the Brooklyn Union Long-Term Incentive Compensation Plan and options granted pursuant to the Eastern Enterprises 1995 Stock Option Plan and the Eastern Enterprises 1996 Non-Employee Trustee's Stock Option Plan.
(2) This total amount reflects the aggregate number of stock options, restricted stock and performance shares available for issuance pursuant to KeySpan's Long Term Incentive Compensation Plan.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
KeySpan Corporation (referred to in the Notes to the Financial Statements as "KeySpan," "we," "us" and "our") is a holding company that operates six regulated utilities that distribute natural gas to approximately 2.6 million customers in New York City, Long Island, Massachusetts and New Hampshire, making KeySpan the fifth largest gas distribution company in the United States and the largest in the Northeast. We also own, lease and operate electric generating plants in Nassau and Suffolk Counties on Long Island and in Queens County in New York City and are the largest electric generation operator in New York State. Under contractual arrangements, we provide power, electric transmission and distribution services, billing and other customer services for approximately 1.1 million electric customers of the Long Island Power Authority ("LIPA"). KeySpan's other operating subsidiaries are primarily involved in gas exploration and production; underground gas storage; liquefied natural gas storage; retail electric marketing; large energy-system ownership, installation and management; service and maintenance of energy systems; and engineering and consulting services. We also invest and participate in the development of natural gas pipelines, electric generation and other energy-related projects. (See Note 2 "Business Segments" for additional information on each operating segment.)
Recent Developments - -------------------
On February 25, 2006, Keyspan entered into an Agreement and Plan of Merger (the "Merger Agreement"), with National Grid PLC, a public limited company incorporated under the laws of England and Wales ("Parent") and National Grid USA, Inc, a New York Corporation ("Merger Sub"), pursuant to which Merger Sub will merge with and into KeySpan (the "Merger"), with KeySpan continuing as the surviving Company. Pursuant to the Merger Agreement, at the effective time of the Merger, each outstanding share of common stock, par value $.01 per share of KeySpan (the "Shares"), other than shares owned by KeySpan, shall be canceled and shall be converted into the right to receive $42.00 in cash, without interest.
Consummation of the Merger is subject to various closing conditions, including but not limited to the satisfaction or waiver of conditions regarding the receipt of requisite regulatory approvals and the adoption of the Merger Agreement by the stockholders of KeySpan and the Parent. Assuming receipt or waiver of the foregoing, it is currently anticipated that the Merger will be consummated in early 2007. Accordingly, any statements contained herein concerning expectations, beliefs, plans, objectives, goals, strategies, future events or performance and underlying assumptions are "forward-looking statements" and do not take into account the occurrence or impact of any potential strategic transaction on the future operations, financial condition and cash flows of KeySpan. However, no assurance can be given that the Merger will occur, or, the timing of its completion.
At December 31, 2005, KeySpan was a holding company under the Public Utility Holding Company Act of 1935, as amended ("PUHCA 1935"). In August 2005, the Energy Policy Act of 2005 (the "Energy Act") was enacted. The Energy Act is a broad energy bill that places an increased emphasis on the production of energy and promotes the development of new technologies and alternative energy sources and provides tax credits to companies that produce natural gas, oil, coal, electricity and renewable energy. For KeySpan, one of the more significant provisions of the Energy Act is the repeal of PUHCA 1935, which became effective on February 8, 2006. Since that time, the jurisdiction of the Securities and Exchange Commission ("SEC") over certain holding company activities, including the regulation of our affiliate transactions and service companies, has been transferred to the jurisdiction of the Federal Energy Regulatory Commission ("FERC") pursuant to the Public Utility Holding Company Act of 2005 ("PUHCA 2005"). See "Regulation and Rate Matters" for additional information on the Energy Act and PUHCA 2005.
Executive Summary
Below is a table comparing the more significant items impacting earnings from continuing operations and earnings available for common stock for the periods indicated.
Earnings from Continuing Operations 2005 vs 2004
KeySpan's earnings from continuing operations, less preferred stock dividends, for the year ended December 31, 2005 were $396.4 million or $2.33 per share, a decrease of $212.7 million, or $1.47 per share compared to $609.1 million, or $3.80 per share realized in 2004. KeySpan's financial results for the year ended December 31, 2005 and 2004, reflect the following items that had a significant impact on comparative results: (i) earnings from core operations; (ii) asset sales of non-core subsidiaries recorded in 2004 and their respective results for 2004; (iii) impairment charges recorded in 2004; and (iv) debt redemption charges recorded in both 2005 and 2004.
As indicated in the above table, KeySpan's earnings from core operations increased $43.8 million or $0.12 per share in 2005, primarily reflecting higher earnings from the Electric Services segment, improved results from the Energy Services segment, and a decrease in interest charges. KeySpan's electric services operations benefited from an increase in net electric revenues principally as a result of improved pricing due, in part, to the warm weather during the 2005 summer. Lower operating losses were incurred at the Energy Services segment as a result of lower operating expenses.
The decrease in interest expense resulted from the benefits attributable to lower outstanding debt resulting from debt redemptions in 2004 and the first quarter of 2005, as well as from the sale of Houston Exploration and KeySpan Canada. These favorable results were somewhat offset by a decrease in operating
income from KeySpan's gas distribution operations as a result of higher operating expenses, primarily due to an increase in the provision for uncollectible accounts receivable as a result of increasing gas costs and the adverse impact from recent collection experience.
The full benefit to earnings per share from the favorable operating results of the Electric Services and Energy Services segments, as well as the decrease in interest charges was offset by the higher level of common shares outstanding. On May 16, 2005, KeySpan issued 12.1 million shares of common stock upon the scheduled conversion of the MEDs Equity Units. The dilutive effect of this issuance on earnings per share for the year ended December 31, 2005, was approximately $0.12 per share. (See Note 6 to the Consolidated Financial Statements "Long-term Debt and Commercial Paper" for additional details on the MEDs Equity Units.)
The remaining items impacting comparative earnings from continuing operations - asset sales, impairment charges and debt redemption charges - are discussed below.
During 2004, KeySpan sold its remaining 55% equity interest in The Houston Exploration Company ("Houston Exploration"), an independent natural gas and oil exploration company based in Houston, Texas. We received cash proceeds of approximately $758 million in two stock transactions that resulted in after-tax gains of $222.7 million, or $1.39 per share. The first transaction occurred in June 2004 and the second transaction was completed in November 2004. The operations of Houston Exploration were fully consolidated in KeySpan's Consolidated Financial Statements during the first five months of 2004, but were then accounted for on the equity method of accounting after the first transaction reduced our ownership interest below 50%.
Also in 2004, KeySpan sold its remaining 60.9% investment in KeySpan Energy Canada Partnership ("KeySpan Canada"), a company that owned certain midstream natural gas assets in Western Canada. We received cash proceeds of approximately $255 million in two transactions that resulted in a total after-tax gain of $34.8 million, or $0.21 per share. The first transaction took place in April 2004 and the second transaction was completed in December 2004. The operations of KeySpan Canada were fully consolidated in KeySpan's Consolidated Financial Statements during the first three months of 2004, but then were accounted for on the equity method of accounting after the first transaction reduced our ownership interest below 50%.
Combined, these asset sales provided KeySpan with approximately $1 billion in cash proceeds and after-tax earnings of $257.5 million, or $1.60 per share. Further, during 2004, KeySpan's share of the after-tax operating earnings of Houston Exploration and KeySpan Canada was $83.9 million or $0.52 per share.
See Note 2 to the Consolidated Financial Statements "Business Segments" and the discussions under the caption "Review of Operating Segments" for a more detailed discussion of each of the above noted non-core transactions.
KeySpan recorded three significant impairment charges during 2004: (i) a goodwill impairment charge recorded in the Energy Services segment; (ii) a ceiling test write-down recorded in the Energy Investments segment; and (iii) a carrying value impairment charge also recorded in the Energy Investments segment. These impairment charges resulted in after-tax charges to continuing operations of $62.4 million, or $0.39 per share.
Specifically, the Energy Services segment recorded an after-tax non-cash goodwill impairment charge of $12.6 million, or $0.08 per share in continuing operations as a result of an evaluation of the carrying value of goodwill recorded in this segment. That evaluation resulted in a total impairment charge of $152.4 million after-tax, or $0.95 per share - $12.6 million of this charge was attributable to continuing operations, while the remaining $139.9 million, or $0.87 per share, was reflected in discontinued operations. (See Note 10 to the Consolidated Financial Statements "Energy Services - Discontinued Operations" for additional details on this charge.)
KeySpan's remaining wholly owned gas exploration and production subsidiaries recorded a non-cash impairment charge of $48.2 million ($31.1 million after-tax, or $0.19 per share) in 2004 to recognize the reduced valuation of proved reserves. (See Note 9 to the Consolidated Financial Statements "Gas Exploration and Production Property - Depletion," for additional details on this charge.)
In addition to the asset sales noted previously, in the fourth quarter of 2004, KeySpan anticipated selling its previous 50% ownership interest in Premier Transmission Limited ("Premier"), a gas pipeline from southwest Scotland to Northern Ireland. In the fourth quarter of 2004, KeySpan recorded a non-cash impairment charge of $26.5 million - $18.8 million after-tax or $0.12 per share, reflecting the difference between the anticipated cash proceeds from the sale of Premier compared to its carrying value. This investment was accounted for under the equity method of accounting in the Energy Investments segment. The sale of Premier was completed in the first quarter of 2005 and resulted in cash proceeds of approximately $48.1 million and a pre-tax gain of $4.1 million reflecting the difference from earlier estimates. (See Note 2 to the Consolidated Financial Statements "Business Segments" and the discussions under the caption "Review of Operating Segments" for a more detailed discussion of the sale.)
The remaining significant item impacting comparative results, as noted above, was debt redemption costs incurred in both 2005 and 2004. In 2005, KeySpan redeemed $500 million of 6.15% Notes due in 2006. KeySpan incurred $20.9 million in call premiums, which were expensed and recorded in other income and deductions on the Consolidated Statement of Income, and wrote-off $1.3 million of previously deferred financing costs. Further, KeySpan accelerated the amortization of approximately $11.2 million of previously unamortized benefits associated with an interest rate swap on these Notes. The accelerated amortization was recorded as a reduction to interest expense. The net after-tax expense of this debt redemption was $6.8 million or $0.04 per share. (See Note 6 to the Consolidated Financial Statements "Long-Term Debt and Commercial Paper" as well as the discussion under the caption "Financing" for additional details on this transaction.) In 2004, KeySpan redeemed approximately $758 million of various series of outstanding long-term debt. KeySpan incurred $54.5 million in call premiums associated with these redemptions, of which $45.9 was expensed and recorded in other income and deductions on the Consolidated Statement of Income. The remaining amount of the call premiums have been deferred for future rate recovery. Further, KeySpan wrote-off $8.2 million of previously deferred financing costs which have been reflected in interest expense on the Consolidated Statement of Income. The total after-tax expense of the 2004 debt redemption was $29.3 million or $0.18 per share.
The net impact of the above mentioned items resulted in a decrease to earnings from continuing operations of $6.8 million or $0.04 per share for the year ended December 31, 2005, compared to a gain of $249.7 million, or $1.55 per share, in 2004.
Earnings Available for Common Stock 2005 vs 2004
Earnings available for common stock also include losses from discontinued operations associated with KeySpan's former mechanical contracting subsidiaries; these companies were discontinued in the fourth quarter of 2004 and sold in early 2005. In the fourth quarter of 2004, KeySpan's investment in its mechanical contracting subsidiaries was written-down to fair value. During 2005, operating losses amounting to $4.1 million after-tax were incurred through the dates of sale of these companies, including, but not limited to, costs incurred for employee related benefits. Partially offsetting these losses was an after tax-gain of $2.3 million associated with the related divestitures, reflecting the difference between the fair value estimates and the financial impact of the actual sale transactions. The net income impact of the operating losses and the disposal gain was a loss of $1.8 million, or $0.01 per share for the year ended December 31, 2005.
Further, earnings available for common stock for 2005 include a $6.6 million, or $0.04 per share, cumulative change in accounting principle charge as a result of implementing the accounting requirements of FASB Interpretation No. 47 ("FIN 47") "Accounting for Conditional Asset Retirement Obligations." This pronouncement required KeySpan to record a liability for the estimated future cost associated with the legal obligation to dispose of long-lived assets at the time of their retirement or disposal date. Upon initial implementation, December 31, 2005, a cumulative change in accounting principle charge was recorded on KeySpan's Consolidated Statement of Income, representing the present value of KeySpan's future retirement obligation. See Note 7 to the Consolidated Financial Statements "Contractual Obligations, Financial Guarantees and Contingencies" for further information on this charge.
As previously noted, in 2004 KeySpan conducted an evaluation of the carrying value of its investments in the Energy Services segment. As a result of this evaluation, KeySpan recorded a loss in discontinued operations of $151.0 million, or $0.94 per share. This loss reflects a $139.9 million after-tax impairment charge to reflect a reduction to the carrying value of assets associated with our mechanical contracting activities and operating losses of $11.1 million. (See Note 10 to the Consolidated Financial Statements "Energy Services - Discontinued Operations" for additional details on these items.)
Earnings from Continuing Operations 2004 vs 2003
KeySpan's earnings from continuing operations, less preferred stock dividends, for the year ended December 31, 2004, were $609.1 million or $3.80 per share, an increase of $188.9 million, or $1.15 per share compared to $420.2 million, or $2.65 per share realized in 2003. KeySpan's financial results for the year ended December 31, 2004 and 2003 reflect the following items that had a significant impact on comparative results: (i) earnings from core operations; (ii) non-core asset sales recorded in both 2004 and 2003; (iii) impairment charges recorded in 2004; and (iv) debt redemption charges recorded in both 2004 and 2003.
As indicated in the table above, KeySpan's earnings from core operations increased $25.2 million or $0.14 per share for the twelve months ended December 31, 2004 compared to 2003, primarily reflecting an increase in net electric revenues associated with KeySpan's Electric Services segment, as well as from higher earnings from the Gas Distribution segment, primarily due to a Boston Gas Company rate increase resulting from a rate proceeding concluded in November 2003.
The remaining items impacting comparative earnings from continuing operations - asset sales, impairment charges and debt redemption charges - are discussed below.
As noted previously, during 2004 KeySpan sold its ownership interests in Houston Exploration and KeySpan Canada. Combined, these asset sales provided KeySpan with approximately $1 billion of cash proceeds and after-tax earnings of $257.5 million, or $1.60 per share. Further, during 2004, KeySpan's share of the after-tax operating earnings of Houston Exploration and KeySpan Canada was $83.9 million or $0.52 per share.
During 2003, KeySpan completed two non-core asset sales. KeySpan sold a 39.09% interest in KeySpan Canada and a 20% interest in Taylor NGL LP which owned and operated two extraction plants in Canada. We recorded an after-tax loss of $34.1 million, or $0.22 per share, associated with these sales. Additionally, we reduced our ownership interest in Houston Exploration from 66% to approximately 55% following the repurchase, by Houston Exploration, of three million shares of common stock owned by KeySpan. We recorded a gain of $19.0 million, or $0.12 per share, on this transaction. Income taxes were not provided on this transaction since the transaction was structured as a return of capital. KeySpan's share of the after-tax operating earnings of Houston Exploration and KeySpan Canada was $98.7 million or $0.62 per share for the twelve months ended December 31, 2003.
Further, in the fourth quarter of 2003, we completed the sale of a 24.5% interest in Phoenix Natural Gas, a natural gas distribution company located in Northern Ireland, and recorded an after-tax gain of $16.0 million, or $0.10 per share. In total, KeySpan recorded a pre-tax gain of $13.3 million from the monetization of non-core assets. The combined after-tax gain from these asset sales was minimal due to the tax treatment associated with each transaction.
See Note 2 to the Consolidated Financial Statements "Business Segments" and the discussions under the caption "Review of Operating Segments" for a more detailed discussion of each of the above noted non-core transactions.
As previously noted, KeySpan recorded three significant impairment charges during 2004: (i) a goodwill impairment charge recorded in the Energy Services segment of $152.4 million after-tax, or $0.95 per share, - $12.6 million of which was attributable to continuing operations, while the remaining $139.9 million, or $0.87 per share, was reflected in discontinued operations; (ii) an after-tax ceiling test write-down of $31.1 million, or $0.19 per share, to recognize the reduced valuation of proved reserves associated with KeySpan's wholly-owned gas exploration and production subsidiaries; and (iii) a non-cash impairment charge of $26.5 million, - $18.8 million after-tax or $0.12 per share, recorded in the Energy Investments segment reflecting the difference between the anticipated cash proceeds from the sale of Premier compared to its carrying value.
The remaining significant item noted above is debt redemption costs incurred in 2004 and 2003. As noted previously, in 2004, KeySpan redeemed approximately $758 million of outstanding long-term debt. The total after-tax expense of this debt redemption was $29.3 million or $0.18 per share. In 2003, KeySpan incurred $18.2 million in debt redemption costs associated with the redemption of approximately $447 million of outstanding promissory notes that were issued to LIPA in connection with the KeySpan/Long Island Lighting Company ("LILCO") business combination completed in May 1998. Further, Houston Exploration, then a consolidated subsidiary, incurred debt redemption costs of $5.9 million, to retire $100 million 8.625% Notes. The total after-tax expense of the debt redemptions in 2003 was $13.6 million or $0.08 per share.
The net impact of the above mentioned items resulted in an increase to earnings from continuing operations of $249.7 million, or $1.55 per share for the year ended December 31, 2004, compared to $86.0 million or $0.54 per share in 2003.
Earnings Available for Common Stock 2004 vs 2003
Earnings available for common stock for the year ended December 31, 2004 also include losses from discontinued operations of $151.0 million, or $0.94 per share. This loss includes $139.9 million of after-tax impairment charges to reflect a reduction to the carrying value of assets associated with KeySpan's former mechanical contracting subsidiaries and operating losses of $11.1 million.
Earnings available for common stock for the year ended December 31, 2003, also reflect an operating loss from discontinued operations associated with KeySpan's former mechanical contracting subsidiaries of $1.9 million, or $0.01 per share and a charge for a cumulative change in accounting principle. In January 2003, the Financial Accounting Standards Board ("FASB") issued Financial Interpretation Number 46 ("FIN 46"), "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51." This Interpretation required KeySpan to, among other things, consolidate the Ravenswood Master Lease (the lease under which KeySpan leases and operates a portion of the Ravenswood electric generating facility (the "Ravenswood Facility") and classify the lease obligation as long-term debt on the Consolidated Balance Sheet starting December 31, 2003. As a result of implementing FIN 46, we recognized a non-cash, after-tax charge of $37.4 million, or $0.23 per share related to "catch-up" depreciation of the facility since its acquisition in June 1999 and recorded the charge as a cumulative change in accounting principle. (See Note 7 to the Consolidated Financial Statements "Contractual Obligations, Financial Guarantees and Contingencies" for an explanation of the leasing arrangement for the Ravenswood Facility, as well as an explanation of the implementation of FIN 46.)
Consolidated Summary of Results
Operating income by segment, as well as consolidated earnings available for common stock is set forth in the following table for the periods indicated.
Operating Income 2005 vs 2004
As indicated in the above table, operating income decreased $27.5 million, or 3%, for the twelve months ended December 31, 2005 compared to the same period of 2004. The comparative operating results reflect the following two items that had a significant impact on results: (i) operating results of non-core subsidiaries recorded in 2004; offset by (ii) impairment charges recorded in 2004. As noted earlier, during 2004 KeySpan held equity ownership interests in Houston Exploration and KeySpan Canada. For the twelve months ended December 31, 2004, KeySpan's share of the combined operating income of Houston Exploration and KeySpan Canada was $155.0 million. KeySpan sold its remaining ownership interest in these non-core operations in the fourth quarter of 2004. Offsetting this income to some extent were pre-tax non-cash impairment charges of $89.1 million recorded in 2004. As noted earlier, KeySpan recorded the following three
impairment charges during 2004: (i) a goodwill impairment charge recorded in the Energy Services segment attributable to continuing operations of $14.4 million; (ii) a ceiling test write-down of $48.2 million to recognize the reduced valuation of proved reserves associated with KeySpan's wholly-owned gas exploration and production subsidiaries; and (iii) a non-cash impairment charge of $26.5 million also recorded in the Energy Investments segment reflecting the difference between the anticipated cash proceeds from the sale of Premier compared to its carrying value.
The combined impact of the non-core operating income recorded in 2004 offset by the impairment charges contributed $65.9 million to operating income for the twelve months ended December 31, 2004. KeySpan's core businesses, therefore, posted an increase in operating income of $38.4 million for the twelve months ended December 31, 2005, compared to the same period of 2004, primarily reflecting an increase of $52.5 million in the Electric Services segment, partially offset by a $13.9 million decrease in the Gas Distribution segment. The favorable results from KeySpan's electric services operations reflect an increase in net electric revenues as a result of higher electric prices that were due, in part, to the warm weather during the summer of 2005. Gas distribution results, however, were adversely impacted by higher operating expenses, primarily due to an increase in the provision for uncollectible accounts receivable as a result of higher gas costs and by higher property taxes. For the most part, the beneficial impact on comparative operating income from lower net operating losses incurred at the Energy Services segment, was offset by an increase in expenses residing at the holding company level. Further, in 2004 KeySpan reached a settlement with certain of its insurance carriers regarding cost recovery for expenses incurred at a non-utility environmental site and recorded an $11.6 million gain from the settlement as a reduction to expense.
Other income and (deductions) reflects interest charges, costs associated with debt redemptions, income from subsidiary stock transactions, minority interest charges and other miscellaneous items. For the twelve months ended December 31, 2005, other income and (deductions) reflects a net expense of $269.9 million compared to income of $4.9 million for the twelve months ended December 31, 2004. This unfavorable variation of $274.8 is due to higher gains from asset sales recorded in 2004 compared to 2005 of $384.2 million, offset by a decrease in interest charges of $62.0 million, lower debt redemption costs of $25.0 million and the absence of minority interest expenses of $36.4 million. The following is a discussion of these items.
As noted earlier, in the first quarter of 2005, KeySpan finalized its sale of Premier. The final sale of Premier resulted in a pre-tax gain of $4.1 million reflecting the difference from earlier estimates and what was recorded in the first quarter of 2005. For the twelve months ended December 31, 2004, KeySpan realized pre-tax income of $388.3 million from subsidiary stock transactions associated with Houston Exploration and KeySpan Canada, as discussed earlier.
Interest expense decreased $62.0 million, or 19%, for the twelve months ended December 31, 2005, compared to the same period of 2004, reflecting the benefits attributable to recent debt redemptions, as well as the sale of Houston Exploration and KeySpan Canada. In addition, as noted earlier, in 2005 KeySpan redeemed $500 million 6.15% Series Notes due 2006. KeySpan incurred $20.9 million in call premiums, wrote-off $1.3 million of previously deferred financing costs and accelerated the amortization of approximately $11.2 million of previously unamortized benefits associated with an interest rate swap on these bonds. The accelerated amortization of the interest rate swap and the write-off of previously deferred financing costs reduced interest expense in 2005 by $9.9 million.
In 2004, KeySpan redeemed approximately $758 million of various series of outstanding debt and incurred $45.9 million in call premiums and wrote-off $8.2 million of previously deferred financing costs. The net impact of the 2005 and 2004 debt redemptions lowered comparative interest expense by $18.1 million.
For the year ended December 31, 2004 other income and (deductions) also includes the effects of minority interest of $36.8 million related to our previous majority ownership interests in Houston Exploration and KeySpan Canada. Finally, other income and (deductions) for the year ended December 31, 2004 reflects a $12.6 million gain recorded on the settlement of a derivative financial instrument entered into in connection with the sale/leaseback transaction associated with the Ravenswood Expansion, a 250 MW combined cycle generating facility located at the Ravenswood site, as well as a $5.5 million foreign currency gain.
Income taxes decreased $86.2 million for the year ended December 31, 2005 compared to last year due, for the most part, to lower pre-tax earnings. In addition, tax expense for 2004 reflects: (i) a $6.0 million benefit resulting from a revised appraisal associated with property that was disposed of in 2003; (ii) a tax benefit of $12 million related to the repatriation of earnings from KeySpan's foreign investments; and (iii) the beneficial tax treatment afforded the stock transaction with Houston Exploration.
As noted earlier, earnings available for common stock for the year ended December 31, 2005, also includes losses of $1.8 million, or $0.01 per share, from discontinued operations, as well as a $6.6 million, or $0.04 per share cumulative change in accounting principles charge. Earnings available for common stock for the year ended December 31, 2004, includes losses of $151.0 million, or $0.94 per share, from discontinued operations.
As a result of the items discussed above, earnings available for common stock were $388.0 million, or $2.28 per share for the year ended December 31, 2005, compared to $458.1 million, or $2.86 per share realized in 2004.
Operating Income 2004 vs 2003
Operating income decreased $112.3 million, or 11%, for the twelve months ended December 31, 2004, compared to the same period of 2003. Comparative operating income was adversely impacted by lower operating income from the Energy Investments segment as a result of KeySpan's reduced ownership interest in Houston Exploration and KeySpan Canada during the latter half of 2004. KeySpan's lower ownership level in these former subsidiaries reduced comparative operating income by $71.0 million. In addition, operating income in the Energy Investments segment was adversely impacted by the $48.2 million non-cash impairment charge to recognize the reduced valuation of proved reserves, as well as the $26.5 million non-cash impairment charge associated with our previous investment in Premier. Further, the decrease in operating income reflects the $14.4 million non-cash goodwill impairment charge recorded in the Energy Services segment. The combined impact of the decrease in non-core operating income and the impairment charges recorded in 2004 reduced operating income for the twelve months ended
December 31, 2004, by $160.1 million. KeySpan's core businesses, therefore, posted an increase in operating income of $47.8 million for the twelve months ended December 31, 2004 compared to the same period of 2003, primarily reflecting increases of $19.9 million in the Electric Services segment, $5.3 million in the Gas Distribution segment and $11.9 million from the continuing operations in the Energy Investments segment.
The increase in comparative operating income in the Electric Services segment in 2004 primarily reflects higher net electric margins associated with the Ravenswood Expansion. The Gas Distribution segment benefited from customer additions and oil-to-gas conversions throughout our service territories, as well as from the full effect of the rate increase resulting from the Boston Gas Company rate proceeding concluded in November 2003. In 2003, we recorded $15.1 million in gains from property sales, primarily the sale of 550 acres of real property located on Long Island, that were recorded in the Gas Distribution segment. The continuing operations in the Energy Investments segment realized higher earnings from the sale of property, as well as from an increase in earnings from gas pipeline investments and generally lower administrative costs. (See the discussion under the caption "Review of Operating Segments" for further details on each segment.)
Other income and (deductions) reflects interest charges, costs associated with debt redemptions, income from subsidiary stock transactions, minority interest charges and other miscellaneous items. For the twelve months ended December 31, 2004, other income and (deductions) reflects a net gain of $4.9 million compared to a net expense of $340.3 million for the twelve months ended December 31, 2003. This favorable variation of $345.2 million is due to higher gains from asset sales recorded in 2004 compared to 2003 of $375.0 million and a lower minority interest adjustment of $27.1 million, offset by an increase in interest charges of $23.6 million and higher debt redemption costs of $21.8 million. The following is a discussion of these items.
As noted earlier, for the twelve months ended December 31, 2004, KeySpan realized pre-tax income of $388.3 million from subsidiary stock transactions associated with Houston Exploration and KeySpan Canada. During 2003, we monetized a portion of our Canadian and Northern Ireland investments, as well as a portion of our ownership interest in Houston Exploration and recorded a net gain of $13.3 million associated with these transactions. Further, the lower ownership level in Houston Exploration and KeySpan Canada in 2004 resulted in an associated decrease in the minority interest adjustment of $27.1 million.
The increase in interest expense of $23.6 million, or 8%, in 2004, compared to the prior year, reflects a number of items. As noted earlier, interest expense for 2004 includes the write-off of $8.2 million of previously deferred issuance costs as a result of the redemption of $758 million of outstanding long-term debt. In addition, interest expense in 2004 was impacted by the implementation of FIN 46, discussed earlier. Beginning January 1, 2004, lease payments associated with the Ravenswood Master Lease have been reflected as interest expense on the Consolidated Statement of Income resulting in an increase to interest expense of approximately $30 million in 2004. (See Note 7 "Contractual Obligations, Financial Guarantees and Contingencies for further information on the Master Lease.")
Further, comparative interest expense also reflects the benefits realized in 2003 associated with interest rate swaps. In 2003, we terminated an interest rate swap agreement with a notional amount of $270 million. This swap was used to hedge a portion of outstanding promissory notes that were issued to LIPA in connection with the KeySpan/LILCO business combination. In March 2003, we redeemed approximately $447 million of the outstanding promissory notes, and settled the outstanding derivative instrument. The cash proceeds from the termination of the interest rate hedge were $18.4 million, of which $8.1 million represented accrued swap interest. The difference between the termination settlement amount and the amount of accrued swap interest, $10.3 million, was recorded to earnings (as an adjustment to interest expense) in 2003 and effectively offset a portion of the redemption charges.
Offsetting, to some extent, these adverse impacts to comparative interest expense are the benefits associated with a lower level of outstanding long-term debt.
As noted previously, during 2004, KeySpan redeemed approximately $758 million of outstanding long-term debt and recorded $45.9 million in debt redemption costs. In 2003, KeySpan incurred debt redemption costs of $24.1 million associated with (i) the redemption of approximately $447 million of outstanding promissory notes issued to LIPA in connection with the KeySpan/LILCO business combination; and (ii) Houston Exploration's debt redemption costs of $5.9 million to retire $100 million 8.625% Notes. The operating results for Houston Exploration were consolidated in 2003.
Other income and (deductions) for 2004 also reflects a $12.6 million gain recorded on the settlement of a derivative financial instrument entered into in connection with the sale/leaseback transaction associated with the Ravenswood Expansion, as well as a $5.5 million foreign currency gain on cash investments held off-shore. Other income and (deductions) for 2003 also reflects severance tax refunds totaling $21.6 million recorded by Houston Exploration for severance taxes paid in 2002 and earlier periods, as well as $6.5 million of realized foreign currency translation gains.
(See Note 7 to the Consolidated Financial Statements, "Contractual Obligations, Financial Guarantees and Contingencies" for additional information regarding the sale/leaseback transaction.)
Income tax expense generally reflects the level of pre-tax income. In addition, tax expense for 2004 reflects: (i) a $6.0 million benefit resulting from a revised appraisal associated with property that was disposed of in 2003; (ii) a tax benefit of $12 million related to the repatriation of earnings from KeySpan's foreign investments; and (iii) the beneficial tax treatment afforded the stock transaction with Houston Exploration.
Income tax expense for 2003 includes a number of items impacting comparative results. During 2003, the partial monetization of our Canadian investments resulted in tax expense of $3.8 million, reflecting certain United States partnership tax rules. In addition, we recorded an adjustment to income tax expense of $6.1 million due to the Commonwealth of Massachusetts disallowing the carry forward of net operating losses incurred by our regulated utilities in Massachusetts. Offsetting, to some extent, these increases to tax expense, was a tax benefit recorded in 2003 of $9.0 million associated with certain New York City general corporation tax issues. In addition, certain costs associated with employee deferred compensation plans were deducted for federal income tax purposes in 2003. These costs, however, are not expensed for "book" purposes resulting in a beneficial permanent book-to-tax difference of $6.3 million.
As noted earlier, earnings available for common stock for the year ended December 31, 2004, also included losses of $151.0 million, or $0.94 per share, from discontinued operations. Earnings available for common stock for the year ended December 31, 2003, included a charge for a cumulative change in accounting principles of $37.4 million, or $0.23 per share, associated with the implementation of FIN 46, as well as operating losses of $1.9 million, or $0.01 per share associated with discontinued operations.
As a result of the items discussed above, earnings available for common stock were $458.1 million, or $2.86 per share for the year ended December 31, 2004, compared to $380.9 million, or $2.41 per share realized in 2003.
Review of Operating Segments - ----------------------------
KeySpan's segment results are reported on an "Operating Income" basis. Management believes that this generally accepted accounting principle ("GAAP") based measure provides a reasonable indication of KeySpan's underlying performance associated with its operations. The following is a discussion of financial results achieved by KeySpan's operating segments presented on an Operating Income basis.
Gas Distribution
KeySpan Energy Delivery New York ("KEDNY") provides gas distribution service to customers in the New York City Boroughs of Brooklyn, Staten Island and a portion of Queens. KeySpan Energy Delivery Long Island ("KEDLI") provides gas distribution service to customers in the Long Island Counties of Nassau and Suffolk and the Rockaway Peninsula of Queens County. Four natural gas distribution companies - Boston Gas Company, Essex Gas Company, Colonial Gas Company and EnergyNorth Natural Gas, Inc., each doing business under the name KeySpan Energy Delivery New England ("KEDNE"), provide gas distribution service to customers in Massachusetts and New Hampshire.
The table below highlights certain significant financial data and operating statistics for the Gas Distribution segment for the periods indicated.
A MDTH is 10,000 therms and reflects the heating content of approximately one million cubic feet of gas. A therm reflects the heating content of approximately 100 cubic feet of gas. One billion cubic feet (BCF) of gas equals approximately 1,000 MDTH.
Executive Summary
Operating Income 2005 vs 2004
Operating income decreased $13.9 million, or 2%, for the twelve months ended December 31, 2005, compared to the same period last year due to higher operating expenses. Operating expenses increased $62.0 million reflecting primarily an increase in the provision for uncollectible accounts receivable and higher property taxes totaling $45.8 million. Partially offsetting the higher operating expenses was an increase of $48.0 million in net gas revenues (revenues less the cost of gas and associated revenue taxes) resulting from customer additions and oil-to-gas conversions in our firm gas sales market, as well as from higher net gas revenues in our large-volume heating markets.
Net Revenues
Net gas revenues from our gas distribution operations increased $48.0 million, or 3%, for the twelve months ended December 31, 2005, compared to the same period last year. Net gas revenues benefited from customer additions and oil-to-gas conversions in our firm gas sales market (residential, commercial and industrial customers), as well as from higher net gas revenues in our large-volume heating and interruptible (non-firm) markets. As measured in heating degree days, weather in 2005 in our New York and New England service territories was approximately 1.0% and 8.6% colder than normal, respectively. Compared to 2004, weather in 2005 was 1.2% colder in KeySpan's New England service territory, while weather was consistent between years in the New York service territory.
Net revenues from firm gas customers (residential, commercial and industrial customers) increased $24.3 million for the twelve months ended December 31, 2005, compared to the same period last year. Customer additions and oil-to-gas conversions, net of attrition and conservation, added $25.1 million to net gas revenues. Further, we realized a benefit of $3.8 million as a result of the Boston Gas Company's Performance Based Rate Plan (the "Plan") that was approved by the Massachusetts Department of Telecommunications and Energy ("MADTE") in 2003. The Plan provides for firm gas sales rates to be adjusted each year based on an inflation factor offset by a productivity factor. (See the caption under "Regulation and Rate Matters" for further information regarding the rate filing.)
Offsetting, to some extent, the beneficial impact of the customer additions and oil-to-gas conversions was the adverse impact to comparative net gas revenues from the additional billing day last year due to the leap year. In 2004, KeySpan realized $5.7 million in additional net gas revenues from the additional billing day. Further, KeySpan earned $8.7 million less in regulatory incentives for the twelve months ended December 31, 2005, compared to the same period last year.
Also included in net revenues is the recovery of certain regulatory items and certain taxes that added $6.6 million to net revenues. However, the recovery of these items through revenues does not impact net income since we expense a similar amount as amortization charges and income taxes, as appropriate on the Consolidated Statement of Income. Firm gas distribution rates for KEDNY, KEDLI and KEDNE in 2005, other than for the recovery of gas costs and as noted, have remained substantially unchanged from rates charged in 2004.
KEDNY and KEDLI each operate under a utility tariff that contains a weather normalization adjustment that significantly offsets variations in firm net revenues due to fluctuations in normal weather. However, the gas distribution operations of our New England based subsidiaries do not have a weather normalization adjustment. To mitigate the effect of fluctuations in normal weather patterns on KEDNE's results of operations and cash flows, weather derivatives were in place for the 2004/2005 and 2005/2006 winter heating seasons. These financial derivatives afforded KeySpan some protection against warmer than normal weather. As a result of the weather fluctuations and financial weather derivatives, weather had a $3.2 million favorable impact on comparative net gas revenues. (See Note 8 to the Consolidated Financial Statements "Hedging, Derivative Financial Instruments and Fair Values" for further information on derivative transactions.)
In our large-volume heating and interruptible (non-firm) markets, which include large apartment houses, government buildings and schools, gas service is provided under rates that are designed to compete with prices of alternative fuel, including No. 2 and No. 6 grade heating oil. These "dual-fuel" customers can consume either natural gas or fuel oil for heating purposes. Net revenues in these markets increased $23.7 million during the twelve months ended December 31, 2005, compared to the same period last year, primarily reflecting higher pricing. Further, since weather during January 2004 was significantly colder than normal, KeySpan interrupted service to a segment of its dual-fuel customers for a number of days during the month, as permitted under its tariff, to ensure reliable service to firm customers. The majority of interruptible profits earned by KEDLI and KEDNE are returned to firm customers as an offset to gas costs.
Firm Sales, Transportation and Other Sales Quantities
Both actual firm gas sales and transportation quantities, as well as weather normalized sales quantities for the twelve months ended December 31, 2005, remained consistent with those quantities realized in 2004. Net revenues are not affected by customers opting to purchase their gas supply from other sources, since delivery rates charged to transportation customers generally are the same as delivery rates charged to full sales service customers. Transportation quantities related to electric generation reflect the transportation of gas to our electric generating facilities located on Long Island. Net revenues from transportation services are not material.
Other sales quantities include on-system interruptible quantities, off-system sales quantities (sales made to customers outside of our service territories) and related transportation. The increase in these sales quantities for the twelve months ended December 31, 2005 compared to the same period of 2004 reflects higher off-system sales. The majority of these profits earned are returned to firm customers as an offset to gas costs. From April 1, 2002 through March 31, 2005, we had an agreement with Coral Resources, L.P. ("Coral"), a subsidiary of Shell Oil Company, under which Coral assisted in the origination, structuring, valuation and execution of energy-related transactions on behalf of KEDNY and KEDLI. Upon the expiration of this agreement, these services are provided by KeySpan employees. We also have a portfolio management contract with Merrill Lynch Trading, under which Merrill Lynch Trading provides all of the city gate supply requirements at market prices and manages certain upstream capacity, underground storage and term supply contracts for KEDNE. A new three year agreement has been negotiated with Merrill Lynch to provide portfolio management services to KeySpan's Massachusetts gas distribution subsidiaries. This agreement is pending MADTE approval. KeySpan will provide these services internally for its New Hampshire gas distribution subsidiary, EnergyNorth.
Purchased Gas for Resale
The increase in gas costs for the twelve months ended December 31, 2005, compared to the same period of 2004, of $942.3 million, or 35%, reflects an increase of 23% in the price per dekatherm of gas purchased for firm gas sales customers, as well as an increase in the quantity of gas purchased for large-volume heating and interruptible (non-firm) customers. The current gas rate structure of each of our gas distribution utilities includes a gas adjustment clause, pursuant to which variations between actual gas costs incurred for resale to firm sales customers and gas costs billed to firm sales customers are deferred and refunded to or collected from customers in a subsequent period.
Operating Expenses
For the twelve months ended December 31, 2005, operating expenses increased $62.0 million, or 6% compared to the same period last year. Operations and maintenance expense increased $54.5 million, or 8%, in 2005 compared to 2004 primarily due to an increase of $38.7 million in the provision for uncollectible accounts as a result of increasing gas costs and the adverse impact from recent collection experience. Further, the gas distribution operations realized an increase in insurance and regulatory fees, as well as postretirement expenses in 2005 compared to 2004. In 2004, KeySpan recognized a benefit of approximately $3 million, net of amounts subject to regulatory deferral treatment, associated with the implementation of the Medicare Prescription Drug Improvement and Modernization Act of 2003 ( the "Medicare Act") and implementation of Financial
Accounting Standards Board Staff Position ("FSP") 106-2. In addition, in 2004, Boston Gas reached an agreement with an insurance carrier for recovery of previously incurred environmental expenditures. Insurance and third-party recoveries, after deducting legal fees, are shared between Boston Gas and its firm gas customers as provided under a previously issued MADTE rate order. As a result of this insurance settlement, Boston Gas recorded a $5 million benefit to operations and maintenance expense.
Comparative operating taxes increased $7.1 million due to the expiration of a five-year property tax assessment agreement with New York City, as well as to a $2.5 million property tax refund received in 2004. Higher depreciation charges of $4.5 million reflecting the continued expansion of the gas distribution system were offset by lower regulatory amortization charges of $4.1 million.
In December 2005, Boston Gas received a MADTE order permitting regulatory recovery of the 2004 gas cost component of bad debt write-offs. This was approved for full recovery as an exogenous cost effective November 1, 2005. In addition, effective January 1, 2006, Boston Gas is permitted to fully recover the gas cost component of bad debt write-offs through its cost-of-gas adjustment clause rather than filing for recovery as an exogenous cost. We have reflected both of these favorable recovery mechanisms in our December 31, 2005 Allowance for Doubtful Accounts reserve requirement and related expense. Boston Gas also plans to request full recovery, as an exogenous cost, of the 2005 gas cost component of bad debt write-offs beginning November 1, 2006.
Executive Summary
Operating Income 2004 vs 2003
Operating income increased $5.3 million for the twelve months ended December 31, 2004, compared to the same period last year, primarily due to an increase in net revenues of $43.0 million resulting, for the most part, from the Boston Gas rate proceeding that was concluded in November 2003. Partially offsetting the increase in net revenues were higher operating expenses of $22.6 million, primarily due to an increase in the provision for uncollectible accounts receivable as a result of higher gas costs, as well as higher depreciation and amortization expenses. It should be noted that during 2003 we recorded $15.1 million in gains from property sales on Long Island.
Net Revenues
Net gas revenues (revenues less the cost of gas and associated revenue taxes) from our gas distribution operations increased by $43.0 million, or 3%, for the year-ended December 31, 2004 compared to the prior year. Net gas revenues benefited from the Boston Gas rate increase granted in the fourth quarter of 2003, as well as from customer additions and oil-to-gas conversions. As measured in heating degree days, weather in 2004 in our New York and New England service territories was approximately 1% and 7% colder than normal, respectively, compared to approximately 8% and 10% colder than normal in 2003, respectively. Weather in 2004 was approximately 6% warmer than 2003 in our New York service territory and approximately 3% warmer than 2003 in our New England service territory.
Net revenues from firm gas customers (residential, commercial and industrial customers) increased $40.8 million for the twelve months ended December 31, 2004 compared to the same period of 2003. As previously mentioned, the MADTE approved a $27 million base rate increase for Boston Gas, which became effective on November 1, 2003. For the twelve months ended December 31, 2004, the rate increase resulted in a benefit to net gas revenues of $29.4 million. (See the caption under "Regulation and Rate Matters" for further information regarding the rate filing.) Customer additions and oil-to-gas conversions, net of attrition and conservation, added $8.0 million to net gas revenues. Further, we realized a $5.7 million benefit to net gas revenues as a result of an additional billing day in the 2004 leap year and $1.6 million associated with regulatory incentives.
Also included in net gas revenues is the recovery of property taxes that were $1.0 million lower in 2004 compared to 2003. These revenues, however, do not impact net income since the taxes they are designed to recover are expensed on the Consolidated Statement of Income. Firm gas distribution rates for KEDNY and KEDLI during 2004, other than for the recovery of gas costs, have remained substantially unchanged from rates charged in 2003.
KEDNY and KEDLI each operate under a utility tariff that contains a weather normalization adjustment that significantly offsets variations in firm net revenues due to fluctuations in normal weather. However, the gas distribution operations of our New England based subsidiaries do not have a weather normalization adjustment. To mitigate the effect of fluctuations in weather patterns on KEDNE's results of operations and cash flows, weather derivatives were in place for the 2003/2004 and 2004/2005 winter heating seasons. These financial derivatives afforded KeySpan some protection against warmer than normal weather. As a result of weather fluctuations year-to-year, offset by the benefits of the financial weather derivatives, weather had a $2.9 million unfavorable impact on comparative net gas revenues.
In our large-volume heating and other interruptible (non-firm) markets, which include large apartment houses, government buildings and schools, gas service is provided under rates that are designed to compete with prices of alternative fuel, including No. 2 and No. 6 grade heating oil. These "dual-fuel" customers can consume either natural gas or fuel oil for heating purposes. Net revenues in these markets increased $2.2 million in 2004 compared to 2003. The majority of interruptible profits earned by KEDLI and KEDNE are returned to firm customers as an offset to gas costs.
Firm Sales, Transportation and Other Sales Quantities
Firm gas sales and transportation quantities for the year-ended December 31, 2004, were approximately 1% lower compared to such quantities for the same period in 2003 reflecting the warmer weather. Weather normalized sales quantities increased 2% in our service territories during 2004. Net revenues are not affected by customers opting to purchase their gas supply from other sources, since delivery rates charged to transportation customers generally are the same as delivery rates charged to full sales service customers. Transportation quantities related to electric generation reflect the transportation of gas to our electric generating facilities located on Long Island. Net revenues from these services are not material.
Purchased Gas for Resale
The increase in gas costs for the twelve months ended December 31, 2004, compared to the same period of 2003 of $220.2 million, or 9%, reflects an increase of 13% in the price per dekatherm of gas purchased, and a 3% decrease in the quantity of gas purchased. The current gas rate structure of each of our gas distribution utilities includes a gas adjustment clause, pursuant to which variations between actual gas costs incurred for sale to firm customers and gas costs billed to firm customers are deferred and refunded to or collected from customers in a subsequent period.
Operating Expenses
Total operating expenses for the year ended December 31, 2004 increased $22.6 million, or 2%, compared to 2003, reflecting higher operations and maintenance and depreciation expense. Operations and maintenance expense increased $12.6 million, or 2%, in 2004 compared to 2003 primarily due to an increase of $13.0 million in the provision for uncollectible accounts receivable as a result of increasing gas costs, as well as higher employee welfare costs, primarily postretirement expenses of approximately $4 million. These increases to operations and maintenance expenses were partially offset by a benefit of $3 million, net of amounts subject to regulatory deferral treatment, associated with the implementation of the Medicare Act and implementation of Financial Accounting Standards Board Staff Position ("FSP") 106-2. In addition, in 2004, Boston Gas reached a settlement with an insurance carrier for recovery of previously incurred environmental expenditures. Insurance and third-party recoveries, after deducting legal fees, are shared between Boston Gas and its firm gas customers under a previously issued MADTE rate order. As a result of this insurance settlement, Boston Gas recorded a $5 million benefit to operations and maintenance expense.
Higher depreciation and amortization expense in 2004 reflects the continued expansion of the gas distribution system, while the lower operating taxes resulted primarily from a property tax refund in our New York service territory.
Sale of Property
During 2003 we recorded $15.1 million in gains from property sales, primarily the sale of 550 acres of real property located on Long Island.
Gas Supply and Pricing
KeySpan has adequate gas supply available to meet its gas load demand in its service territories for the 2005/2006 winter heating season as KeySpan's gas storage was 100% full at the start of the winter heating season. The current gas rate structure of each of our gas distribution utilities includes a gas adjustment clause, pursuant to which gas costs are recovered in billed sales to regulated firm gas sales customers. Although KeySpan is allowed to "pass through" the cost of gas to its customers, management is concerned with the rising natural gas prices and the related impact on customers' gas bills and recovery of customer accounts receivable. As noted, KeySpan has already experienced an increase in bad debt expense and an increase in collection lag. Also, it is likely that the high gas prices will lead to an increase in price elasticity possibly resulting in an increase in customer conservation measures and attrition. The recent MADTE order permitting Boston Gas regulatory recovery of the gas cost component of net bad debt write-offs should help to mitigate the increase in bad debt expense.
With our strategy of having KeySpan's storage facilities 100% full at the start of the heating season and our use of financial derivatives, KeySpan has effectively hedged the price of approximately two-thirds of the gas supply needed to serve its customers during the upcoming 2005/2006 winter. This helps mitigate the impact from rising natural gas prices on customers' winter heating gas bills. Further, KeySpan has programs in place to help customers manage their gas bills, such as balanced billing plans, deferred payment arrangements and the low income home energy assistance program, which we supported the expansion of through the Energy Act. Management believes that these measures will help mitigate the impact of rising gas prices on customers' bills.
Other Matters
We remain committed to our ongoing gas system expansion strategies. We believe that significant growth opportunities exist on Long Island and in our New England service territories, as well as continued growth in the New York service territory, despite the rising gas prices. We estimate that on Long Island approximately 37% of the residential and multi-family markets, and approximately 60% of the commercial market, currently use natural gas for space heating. Further, we estimate that in our New England service territories approximately 50% of the residential and multi-family markets, as well as approximately 60% of the commercial market, currently use natural gas for space heating purposes. We will continue to seek growth, in all our market segments, through the expansion of our gas distribution system for new construction and to penetrate existing communities where no distribution system exists, as well as through the conversion of residential homes from oil-to-gas for space heating purposes where natural gas is already in the home for other uses and the pursuit of opportunities to grow multi-family, industrial and commercial markets.
In order to serve the anticipated market requirements in our New York service territories, KeySpan and Duke Energy Corporation formed Islander East Pipeline Company, LLC ("Islander East") in 2000. Once in service, the pipeline is expected to transport up to 260,000 DTH of natural gas to the Long Island and New York City energy markets, enough natural gas to heat 600,000 homes. In addition, during 2004 KeySpan acquired a 21% interest in the Millennium Pipeline development project which is anticipated to transport up to 525,000 DTH of natural gas a day to the Algonquin pipeline. KEDLI has executed a Precedent Agreement for 150,000 DTH of natural gas per day of transportation capacity from the Millennium Pipeline system, increasing to 200,000 DTH in the third year of the pipeline being in service. These pipeline projects will allow KeySpan to diversify the geographic sources of its gas supply. See the discussion under the caption "Energy Investments" for additional information regarding these pipeline projects.
Electric Services
The Electric Services segment primarily consists of subsidiaries that own and operate oil and gas-fired electric generating plants in the Borough of Queens (including the "Ravenswood Generating Station" which comprises the Ravenswood Facility and Ravenswood Expansion) and the counties of Nassau and Suffolk on Long Island. In addition, through long-term contracts of varying lengths, we (i) provide to LIPA all operation, maintenance and construction services and significant administrative services relating to the Long Island electric transmission and distribution ("T&D") system pursuant to a Management Services Agreement (the "1998 MSA"); (ii) supply LIPA with electric generating capacity, energy conversion and ancillary services from our Long Island generating units pursuant to a Power Supply Agreement (the "1998 PSA"); and (iii) manage all aspects of the fuel supply for our Long Island generating facilities, as well as all aspects of the capacity and energy owned by or under contract to LIPA pursuant to an Energy Management Agreement (the "1998 EMA"). The 1998 MSA, 1998 PSA and 1998 EMA all became effective on May 28, 1998 and are collectively referred to herein as the "1998 LIPA Agreements."
On February 1, 2006, KeySpan and LIPA entered into (i) an amended and restated Management Services Agreement (the "2006 MSA"), pursuant to which KeySpan will continue to operate and maintain the electric T&D System owned by LIPA on Long Island; (ii) a new Option and Purchase and Sale Agreement (the "2006 Option Agreement"), to replace the Generation Purchase Rights Agreement as amended, the ("GPRA"), pursuant to which LIPA had the option, through December 15, 2005, to effectively acquire substantially all of the electric generating facilities owned by KeySpan on Long Island; and (iii) a Settlement Agreement (the "2006 Settlement Agreement") resolving outstanding issues between the parties regarding the 1998 LIPA Agreements. The 2006 MSA, the 2006 Option Agreement and the 2006 Settlement Agreement are collectively referred to herein as the "2006 LIPA Agreements". (For a further discussion on these LIPA agreements see the discussion under the caption "Electric Services - LIPA Agreements" and Note 11 to the Consolidated Financial Statements "2006 LIPA Settlement.") The Electric Services segment also provides retail marketing of electricity to commercial customers.
Selected financial data for the Electric Services segment is set forth in the table below for the periods indicated.
*Reflects the operations of the Ravenswood Generating Station only.
Executive Summary
Operating Income 2005 vs 2004
For the twelve months ended December 31, 2005, operating income increased $52.5 million, or 18%, compared to last year, primarily due to an increase in net revenues from the Ravenswood Generating Station of $78.7 million mainly as a result of improved pricing, partially offset by an increase in operating expenses associated with the Ravenswood Generating Station of $11.8 million, as well as lower net revenues associated with KeySpan's retail electric marketing activities of $7.6 million.
Net Revenues
Total electric net revenues realized during the twelve months ended December 31, 2005, were $96.8 million, or 8% higher than such revenues realized during the corresponding period last year.
For the year ended December 31, 2005, net revenues from the Ravenswood Generating Station increased $78.7 million, or 22%, compared to the same period last year reflecting higher energy margins of $66.0 million, as well as increased capacity revenues of $12.7 million. The increase in capacity revenues reflects the operation of the Ravenswood Expansion which went into full commercial operation in May 2004, as well as load growth in New York City.
The increase in energy margins for 2005 reflects an increase of 45% in realized "spark-spreads" (the selling price of electricity less the cost of fuel, plus hedging gains or losses), as well as from an increase of 2% in the level of megawatt hours ("MWh") sold into the New York Independent System Operator ("NYISO") energy market. These favorable energy results were primarily driven by the pricing differential between number 6-grade fuel oil and natural gas used in the Ravenswood Generating Station in 2005. Due to the dual-fuel nature of the Ravenswood Generating Station, KeySpan was able to take advantage of their ability to switch to cheaper fuel as the gap between number 6 grade fuel oil and gas prices spread during the latter part of the 2005 summer. The two hurricanes which occurred this past summer in the Gulf Coast of the United States contributed to the gap between number 6-grade fuel oil and natural gas prices. Further, in 2005 KeySpan received $9.2 million from the NYISO to settle billing issues regarding the sale of energy provided by the Ravenswood Generating Station to the NYISO in May 2000. Weather for 2005, as measured in cooling degree days, was 40% warmer than last year and 28% warmer than normal.
We employ derivative financial hedging instruments to hedge the cash flow variability for a portion of forecasted purchases of natural gas and fuel oil consumed at the Ravenswood Generating Station. Further, we have engaged in the use of derivative financial hedging instruments to hedge the cash flow variability associated with a portion of forecasted electric energy sales from the Ravenswood Generating Station. These derivative instruments resulted in hedging losses, which are reflected in net electric margins, of $16.0 million in 2005 compared to hedging gains of $23.0 million in 2004. The results derived from KeySpan's hedging strategy are reflected in the calculation of realized spark-spreads. (See Note 8 to the Consolidated Financial Statements "Hedging, Derivative Financial Instruments and Fair Values" as well as Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Financially-Settled Commodity Derivative Instruments - Hedging Activities: From time to time, KeySpan subsidiaries have utilized derivative financial instruments, such as futures, options and swaps, for the purpose of hedging the cash flow variability associated with changes in commodity prices. KeySpan is exposed to commodity price risk primarily with regard to its gas distribution operations, gas exploration and production activities and its electric generating facilities. Seneca-Upshur utilizes OTC natural gas swaps to hedge cash flow variability associated with forecasted sales of natural gas. The Ravenswood Generating Station uses derivative financial instruments to hedge the cash flow variability associated with the purchase of a portion of natural gas or fuel oil that will be consumed during the generation of electricity. The Ravenswood Generating Station also hedges the cash flow variability associated with a portion of electric energy sales. During 2005, our gas distribution operations utilized over-the-counter ("OTC") natural gas and fuel oil swaps to hedge the cash-flow variability of specified portions of gas purchases and sales associated with certain large-volume customers. These derivative positions have all settled as of December 31, 2005.
KeySpan uses standard NYMEX futures prices to value gas futures and market quoted forward prices to value OTC swap contracts.
The following tables set forth selected financial data associated with these derivative financial instruments that were outstanding at December 31, 2005.
The following tables detail the changes in and sources of fair value for the above derivatives: - ------------------------------------------------------------------------------- (In Millions of Dollars) 2005 Change in Fair Value of Derivative Hedging Instruments ($Millions) - ------------------------------------------------------------------------------- Fair value of contracts at January 1, 2005 $ (1.4) Net losses on contracts realized 36.6 Decrease in fair value of all open contracts (53.3) - ------------------------------------------------------------------------------- Fair value of contracts outstanding at December 31, $ (18.1) - -------------------------------------------------------------------------------
We measure the commodity risk of our derivative hedging instruments (indicated in the above table) using a sensitivity analysis. Based on a sensitivity analysis as of December 31, 2005, a 10% increase/decrease in heating oil and natural gas prices would decrease/increase the value of derivative instruments maturing in one year by $2.2 million. Further, a 10% increase/decrease in electricity and fuel prices would decrease/increase the value of derivative instruments maturing in one year by $9.7 million.
Firm Gas Sales Derivative Instruments - Regulated Utilities: We use derivative financial instruments to reduce the cash flow variability associated with the purchase price for a portion of future natural gas purchases associated with our Gas Distribution operations. The accounting for these derivative instruments is subject to SFAS 71 "Accounting for the Effects of Certain Types of Regulation." Therefore, changes in the fair value of these derivatives are recorded as a regulatory asset or regulatory liability on the Consolidated Balance Sheet. Gains or losses on the settlement of these contracts are deferred and then refunded to or collected from our firm gas sales customers consistent with regulatory requirements.
The following table sets forth selected financial data associated with these derivative financial instruments that were outstanding at December 31, 2005.
See Note 8 to the Consolidated Financial Statements "Hedging, Derivative Financial Instruments and Fair Values" for a further description of all our derivative instruments.
Item 8.
Item 8. Financial Statements and Supplementary Data
See accompanying Notes to the Consolidated Financial Statements.
See accompanying Notes to the Consolidated Financial Statements.
See accompanying Notes to the Consolidated Financial Statements.
*Revised - See Note 1
See accompanying Notes to the Consolidated Financial Statements.
See accompanying Notes to the Consolidated Financial Statements.
See accompanying Notes to the Consolidated Financial Statements.
Notes to the Consolidated Financial Statements
Note 1. Summary of Significant Accounting Policies
A. Organization of the Company
KeySpan Corporation, a New York corporation, was formed in May 1998, as a result of the business combination of KeySpan Energy Corporation, the parent of The Brooklyn Union Gas Company, and certain businesses of the Long Island Lighting Company ("LILCO"). On November 8, 2000, KeySpan acquired Eastern Enterprises ("Eastern"), a Massachusetts business trust, and the parent of several gas utilities operating in Massachusetts. Also on November 8, 2000, Eastern acquired EnergyNorth, Inc. ("ENI"), the parent of a gas utility operating in central New Hampshire. KeySpan Corporation will be referred to in these notes to the Consolidated Financial Statements as "KeySpan," "we," "us" and "our."
On February 25, 2006, Keyspan entered into an Agreement and Plan of Merger (the "Merger Agreement"), with National Grid PLC, a public limited company incorporated under the laws of England and Wales ("Parent") and National Grid USA, Inc, a New York Corporation ("Merger Sub"), pursuant to which Merger Sub will merge with and into KeySpan (the "Merger"), with KeySpan continuing as the surviving Company. Pursuant to the Merger Agreement, at the effective time of the Merger, each outstanding share of common stock, par value $.01 per share of KeySpan (the "Shares"), other than shares owned by KeySpan, shall be canceled and shall be converted into the right to receive $42.00 in cash, without interest.
Consummation of the Merger is subject to various closing conditions, including but not limited to the satisfaction or waiver of conditions regarding the receipt of requisite regulatory approvals and the adoption of the Merger Agreement by the stockholders of KeySpan and the Parent. Assuming receipt or waiver of the foregoing, it is currently anticipated that the Merger will be consummated in early 2007. However, no assurance can be given that the Merger will occur, or, the timing of its completion.
KeySpan's core businesses are engaged in gas distribution, electric services and generation and other energy related activities. KeySpan's gas distribution operations are conducted by our six regulated gas utility subsidiaries: The Brooklyn Union Gas Company d/b/a KeySpan Energy Delivery New York ("KEDNY") and KeySpan Gas East Corporation d/b/a KeySpan Energy Delivery Long Island ("KEDLI") distribute gas to customers in the Boroughs of Brooklyn, Staten Island, a portion of the Borough of Queens in New York City, and the counties of Nassau and Suffolk on Long Island and the Rockaway Peninsula in Queens, respectively; Boston Gas Company, Colonial Gas Company and Essex Gas Company, each doing business as KeySpan Energy Delivery New England ("KEDNE"), distribute gas to customers in southern, eastern and central Massachusetts; and EnergyNorth Natural Gas, Inc., d/b/a KeySpan Energy Delivery New England distributes gas to customers in central New Hampshire. Together, these companies distribute gas to approximately 2.6 million customers throughout the Northeast.
We own, lease and operate electric generating plants on Long Island and in New York City. Under contractual arrangements, we provide electric power, electric transmission and distribution services, billing and other customer services for approximately 1.1 million electric customers of the Long Island Power Authority ("LIPA"). On February 1, 2006, KeySpan and LIPA entered into agreements to extend, amend and restate these contractual arrangements. See Note 11 "2006 LIPA Settlement" for a discussion of the settlement.
Our other subsidiaries are involved in gas production; gas storage; liquefied natural gas storage; retail electric marketing; appliance service; fiber optic services; and engineering and consulting services. We also invest in, and participate in the development of natural gas pipelines; electric generation, and other energy-related projects. (See Note 2, "Business Segments" for additional information on each operating segment.)
At December 31, 2005, KeySpan was a holding company under the Public Utility Holding Company Act of 1935, as amended ("PUCHA 1935"). In August 2005, the Energy Policy Act of 2005 (the "Energy Act") was enacted. The Energy Act is a broad energy bill that places an increased emphasis on the production of energy and promotes the development of new technologies and alternative energy sources and provides tax credits to companies that produce natural gas, oil, coal, electricity and renewable energy. For KeySpan, one of the more significant provisions of the Energy Act is the repeal of PUHCA 1935, which became effective on February 8, 2006, and the transfer of certain holding company oversight from the Securities and Exchange Commission ("SEC") to the Federal Energy Regulatory Commission ("FERC") pursuant to the Public Utility Holding Company Act of 2005 ("PUHCA 2005').
Pursuant to PUHCA 2005, the SEC no longer has jurisdiction over our holding company activities, other than those associated with the registration and issuance of our securities under the federal securities laws. FERC now has jurisdiction over certain of our holding company activities, including (i) regulating certain transactions among our affiliates within our holding company system; (ii) governing the issuance, acquisition and disposition of securities and assets by certain of our public utility subsidiaries; and (iii) approving certain utility mergers and acquisitions.
Moreover, our affiliate transactions also remain subject to certain regulations of the Public Service Commission of the State of New York ("NYPSC"), the Massachusetts Department of Telecommunications and Energy ("MADTE") and the New Hampshire Public Utility Commission ("NHPUC") in addition to FERC.
Under our holding company structure, we have no independent operations or source of income of our own and conduct all of our operations through our subsidiaries and, as a result, we depend on the earnings and cash flow of, and dividends or distributions from, our subsidiaries to provide the funds necessary to meet our debt and contractual obligations. Furthermore, a substantial portion of our consolidated assets, earnings and cash flow is derived from the operations of our regulated utility subsidiaries, whose legal authority to pay dividends or make other distributions to us is subject to regulation by state regulatory authorities.
Pursuant to NYPSC orders, the ability of KEDNY and KEDLI to pay dividends to KeySpan is conditioned upon maintenance of a utility capital structure with debt not exceeding 55% and 58%, respectively, of total utility capitalization. In addition, the level of dividends paid by both utilities may not be increased from current levels if a 40 basis point penalty is incurred under the customer service performance program.
B. Basis of Presentation
The Consolidated Financial Statements presented herein reflect the accounts of KeySpan and its subsidiaries. Most of our subsidiaries are fully consolidated in the financial information presented, except for certain subsidiary investments in the Energy Investments segment which are accounted for on the equity method as we do not have a controlling voting interest or otherwise have control over the management of such companies. All intercompany transactions have been eliminated. Certain reclassifications were made to conform prior period financial statements to current period financial statement presentation. For all periods presented, KeySpan revised and has separately disclosed the operating, investing and financing portions of the cash flows attributable to its discontinued operations, which in prior periods were reported on a combined basis as a single amount.
The preparation of financial statements in conformity with generally accepted accounting principles ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
C. Accounting for the Effects of Rate Regulation
The accounting records for our six regulated gas utilities are maintained in accordance with the Uniform System of Accounts prescribed by the NYPSC, the NHPUC, and the MADTE. Our electric generation subsidiaries are not subject to
state rate regulation, but they are subject to FERC regulation. Our financial statements reflect the ratemaking policies and actions of these regulators in conformity with GAAP for rate-regulated enterprises.
Four of our six regulated gas utilities (KEDNY, KEDLI, Boston Gas Company and EnergyNorth Natural Gas, Inc.) and our Long Island based electric generation subsidiaries are subject to the provisions of Statement of Financial Accounting Standards ("SFAS") 71, "Accounting for the Effects of Certain Types of Regulation." This statement recognizes the ability of regulators, through the ratemaking process, to create future economic benefits and obligations affecting rate-regulated companies. Accordingly, we record these future economic benefits and obligations as regulatory assets and regulatory liabilities on the Consolidated Balance Sheet, respectively.
In separate merger related orders issued by the MADTE, the base rates charged by Colonial Gas Company and Essex Gas Company have been frozen at their current levels for ten-year periods ending 2009 and 2008, respectively. Due to the length of these base rate freezes, the Colonial and Essex Gas companies had previously discontinued the application of SFAS 71.
The following table presents our net regulatory assets at December 31, 2005 and December 31, 2004.
The regulatory assets above are not included in utility rate base. However, we record carrying charges on the property tax and costs associated with the KeySpan/LILCO transaction cost deferrals. We also record carrying charges on our regulatory liabilities except for the current market value of our derivative financial instruments. The remaining regulatory assets represent, primarily, costs for which expenditures have not yet been made, and therefore, carrying charges are not recorded. We anticipate recovering these costs in our gas rates concurrently with future cash expenditures. If recovery is not concurrent with the cash expenditures, we will record the appropriate level of carrying charges. Deferred gas costs of $11.3 million and $37.7 million at December 31, 2005 and December 31, 2004, respectively are reflected in accounts receivable on the Consolidated Balance Sheet. Deferred gas costs are subject to current recovery from customers. We estimate that full recovery of our regulatory assets will not exceed 9 years.
Rate regulation is undergoing significant change as regulators and customers seek lower prices for utility service and greater competition among energy service providers. In the event that regulation significantly changes the opportunity to recover costs in the future, all or a portion of our regulated
operations may no longer meet the criteria for the application of SFAS 71. In that event, a write-down of all or a portion of our existing regulatory assets and liabilities could result. If we were unable to continue to apply the provisions of SFAS 71 for any of our rate regulated subsidiaries, we would apply the provisions of SFAS 101, "Regulated Enterprises - Accounting for the Discontinuation of Application of FASB Statement 71." We estimate that the write-off of all net regulatory assets at December 31, 2005, before consideration of removal costs recovered, could result in a charge to net income of $308.0 million after-tax or $1.81 per share, which would be classified as an extraordinary item. In management's opinion, the regulated subsidiaries that are currently subject to the provisions of SFAS 71 will continue to be subject to SFAS 71 for the foreseeable future.
D. Revenues
Gas Distribution: Utility gas customers are billed monthly or bi-monthly on a cycle basis. Revenues include unbilled amounts related to the estimated gas usage that occurred from the most recent meter reading to the end of each month.
The cost of gas used is recovered when billed to firm customers through the operation of gas adjustment clauses ("GAC") included in utility tariffs. The GAC provision requires periodic reconciliation of recoverable gas costs and GAC revenues. Any difference is deferred pending recovery from or refund to firm customers. Further, net revenues from tariff gas balancing services, off-system sales and certain on-system interruptible sales are refunded, for the most part, to firm customers subject to certain sharing provisions.
The New York and Long Island gas utility tariffs contain weather normalization adjustments that largely offset shortfalls or excesses of firm net revenues (revenues less gas costs and revenue taxes) during a heating season due to variations from normal weather. Revenues are adjusted each month the clause is in effect and are generally included in rates in the following month. The New England gas utility rate structures contain no weather normalization feature, therefore their net revenues are subject to weather related demand fluctuations. As a result, fluctuations from normal weather may have a significant positive or negative effect on the results of these operations. To mitigate the effect of fluctuations from normal weather on our financial position and cash flows, we may enter into weather related derivative instruments from time to time. (See Note 8 "Hedging, Derivative Financial Instruments and Fair Values" for additional information on these derivatives.)
In December 2005, Boston Gas received a MADTE order permitting regulatory recovery of the 2004 gas cost component of bad debt write-offs. This was approved for full recovery as an exogenous cost effective November 1, 2005. In addition, effective January 1, 2006 Boston Gas is permitted to fully recover the gas cost component of bad debt write-offs through its cost-of-gas adjustment clause rather than filing for recovery as an exogenous cost. We have reflected both of these favorable recovery mechanisms in our December 31, 2005 Allowance for Doubtful Accounts reserve requirement and related expense. Boston Gas also plans to request full recovery, as an exogenous cost, of the 2005 gas cost component of bad debt write-offs beginning November 1, 2006.
Electric Services: Electric revenues are primarily derived from: (i) billings to LIPA for management of LIPA's transmission and distribution ("T&D") system, electric generation, and procurement of fuel, and (ii): subsidiaries that own, lease and operate the 2,200 megawatt ("MW") Ravenswood electric generation facility ("Ravenswood Facility") and the 250 MW combined cycle generating facility located at the Ravenswood facility site ("Ravenswood Expansion").
LIPA Agreements:
In 1998, KeySpan and LIPA entered into three major long-term service agreements that (i) provide to LIPA all operation, maintenance and construction services and significant administrative services relating to the Long Island T&D system pursuant to the Management Services Agreement (the "1998 MSA"); (ii) supply LIPA with electric generating capacity, energy conversion and ancillary services from our Long Island generating units pursuant to the Power Supply Agreement (the "1998 PSA"); and (iii) manage all aspects of the fuel supply for our Long Island generating facilities, as well as all aspects of the capacity and energy owned by or under contract to LIPA pursuant to the Energy Management Agreement (the "1998 EMA"). The 1998 MSA, 1998 PSA and 1998 EMA all are collectively referred to as the 1998 LIPA Agreements and are discussed in greater detail below.
KeySpan manages the day-to-day operations, maintenance and capital improvements of the T&D system under the 1998 MSA. KeySpan's billings to LIPA are based on certain agreed upon terms. In addition, KeySpan earns a $10 million annual management fee. Annual service incentives or penalties exist under the 1998 MSA if certain targets are achieved or not achieved. In addition, we can earn certain incentives for budget underruns associated with the day-to-day operations, maintenance and capital improvements of LIPA's T&D system. These incentives provide for KeySpan to (i) retain 100% on the first $5 million in annual budget underruns, and (ii) retain 50% of additional annual underruns up to 15% of the total cost budget, thereafter all savings accrue to LIPA. With respect to cost overruns, KeySpan will absorb the first $15 million of overruns, with a sharing of overruns above $15 million. There are certain limitations on the amount of cost sharing of overruns.
In addition, KeySpan sells to LIPA under the 1998 PSA all of the capacity and, to the extent requested, energy conversion services from its existing Long Island based oil and gas-fired generating plants. Sales of capacity and energy conversion services are made under rates approved by the FERC. Rates charged to LIPA include a fixed and variable component. The variable component is billed to LIPA on a monthly per megawatt hour basis and is dependent on the number of megawatt hours dispatched. The 1998 PSA provides incentives and penalties that can total $4 million annually for the maintenance of the output capability and the efficiency of the generating facilities.
KeySpan also procures and manages fuel supplies on behalf of LIPA, under the 1998 EMA, to fuel the generating facilities under contract to it and perform off-system capacity and energy purchases on a least-cost basis to meet LIPA's needs. In exchange for these services KeySpan earns an annual fee of $1.5 million. In addition, we arrange for off-system sales on behalf of LIPA of excess output from the generating facilities and other power supplies either owned or under contract to LIPA. LIPA is entitled to two-thirds of the profit from any off-system energy sales. In addition, the 1998 EMA provides incentives and penalties that can total $5 million annually for performance related to fuel purchases and off-system power purchases. The 1998 EMA is expected to be in effect through 2013 for the procurement of fuel supplies and through 2006 for off-system arrangement services.
On February 1, 2006, KeySpan and LIPA entered into (i) an amended and restated Management Services Agreement (the "2006 MSA"), pursuant to which KeySpan will continue to operate and maintain the electric T&D System owned by LIPA on Long Island; (ii) a new Option and Purchase and Sale Agreement (the "2006 Option Agreement"), to replace the Generation Purchase Rights Agreement (as amended, the "GPRA"), pursuant to which LIPA had the option, through December 15, 2005, to effectively acquire substantially all of the electric generating facilities owned by KeySpan on Long Island; and (iii) a Settlement Agreement (the "2006 Settlement Agreement") resolving outstanding issues between the parties regarding the 1998 LIPA Agreements. The 2006 MSA, the 2006 Option Agreement and the 2006 Settlement Agreement are collectively referred to herein as the "2006 LIPA Agreements". Each of the 2006 LIPA Agreements will become effective as of January 1, 2006 upon all of the 2006 LIPA Agreements receiving the required governmental approvals; otherwise none of the 2006 LIPA Agreements will become effective. See Note 11, "2006 LIPA Settlement" for additional details on these agreements.
KeySpan Glenwood Energy Center LLC and KeySpan Port Jefferson Energy Center LLC have entered into 25 year Power Purchase Agreements with LIPA (the "PPAs"). Under the terms of the PPAs, these subsidiaries sell capacity, energy conversion services and ancillary services to LIPA. Each plant is designed to produce 79.9 megawatts ("MW") each. Under the PPAs, LIPA pays a monthly capacity fee, which guarantees full recovery of each plant's construction costs, as well as an appropriate rate of return on investment. The PPAs also obligate LIPA to pay for each plant's costs of operation and maintenance. These costs are billed on a monthly estimated basis and are subject to true-up for actual costs incurred.
The Electric Services segment also conducts retail marketing of electricity to commercial customers. Energy sales made by our electric marketing subsidiary are recorded upon delivery of the related commodity.
Ravenswood Facilities:
In addition, electric revenues are derived from our investment in the 2,200 MW Ravenswood electric generation facility ("Ravenswood Facility"), (which KeySpan acquired in June 1999). KeySpan has an arrangement with a variable interest entity through which we lease a portion of the Ravenswood Facility. Further, in May 2004 KeySpan completed construction of a 250 MW combined cycle generating facility located at the Ravenswood facility site ("Ravenswood Expansion"). To finance the Ravenswood Expansion, KeySpan entered into a leveraged lease financing arrangement. Collectively the Ravenswood Facility and Ravenswood Expansion will be referred to as the Ravenswood Generation Station. (See Note 7 "Contractual Obligations, Financial Guarantees and Contingencies" for a description of the financing arrangements associated with the Ravenswood Generation Station.) We realize revenues from our investment in the Ravenswood Generation Station through the sale, at wholesale, of energy, capacity, and ancillary services to the New York Independent System Operator ("NYISO"). Energy and ancillary services are sold through a bidding process into the NYISO energy markets on a day ahead or real time basis.
Energy Services: Revenues earned by our Energy Services segment for service and maintenance contracts associated with small commercial and residential appliances are recognized as earned or over the life of the service contract, as appropriate. Revenues earned for engineering services are derived from services rendered under fixed price and cost-plus contracts and generally are recognized on the percentage-of-completion method. Fiber optic service revenue is recognized upon delivery of service access. We have unearned revenue recorded in deferred credits and other liabilities - other on the Consolidated Balance Sheet totaling $29.3 million and $28.5 million as of December 31, 2005, and December 31, 2004, respectively. These balances represent primarily unearned revenues for service contracts and are generally amortized to income over a one year period.
KeySpan completed its sale of its mechanical contracting companies in the first quarter of 2005, and therefore, no longer has revenues form mechanical contracting operations. (See Note 10 "Energy Services - Discontinued Operations" for additional details on the mechanical contracting companies.)
Gas Exploration and Production: Natural gas and oil revenues earned by our gas exploration and production activities are recognized using the entitlements method of accounting. Under this method of accounting, income is recorded based on the net revenue interest in production or nominated deliveries. Production gas volume imbalances are incurred in the ordinary course of business. Net deliveries in excess of entitled amounts are recorded as liabilities, while net under deliveries are recorded as assets. Imbalances are reduced either by subsequent recoupment of over and under deliveries or by cash settlement, as required by applicable contracts. Production imbalances are marked-to-market at the end of each month using the market price at the end of each period. During 2004 KeySpan disposed of its interest in The Houston Exploration Company ("Houston Exploration"), an independent natural gas and oil exploration company. KeySpan continues to maintain, on a significantly smaller scale, gas exploration and production activities. (See Note 2 "Business Segments" for a discussion on the disposition of Houston Exploration and KeySpan's remaining gas exploration activities.)
E. Utility and Other Property - Depreciation and Maintenance
Property, principally utility gas property is stated at original cost of construction, which includes allocations of overheads, including taxes, and an allowance for funds used during construction. The rates at which KeySpan subsidiaries capitalized interest for the year ended December 31, 2005 ranged from 1.80% to 7.02%. Capitalized interest for 2005, 2004 and 2003 was $1.4 million, $7.4 million and $13.5 million, respectively.
Depreciation is provided on a straight-line basis in amounts equivalent to composite rates on average depreciable property. The cost of property retired is charged to accumulated depreciation.
KeySpan recovers cost of removal through rates charged to customers as a portion of depreciation expense. At December 31, 2005 and 2004, KeySpan had costs recovered in excess of costs incurred totaling $516.4 million and $496.5 million, respectively. These amounts are reflected as a regulatory liability.
The cost of repair and minor replacement and renewal of property is charged to maintenance expense. The composite rates on average depreciable property were as follows:
- --------------------------------------------------------------------- Year Ended December 31, 2005 2004 2003 - --------------------------------------------------------------------- Electric 3.75% 3.87% 3.81% Gas 3.72% 3.55% 3.37% - --------------------------------------------------------------------- - ---------------------------------------------------------------------
We also had $416.3 million of other property at December 31, 2005, consisting of assets held primarily by our corporate service subsidiary of $290.0 million and $96.0 million in Energy Services assets. The corporate service assets consist largely of land, buildings, office equipment and furniture, vehicles, computer and telecommunications equipment and systems. These assets have
depreciable lives ranging from three to 40 years. We allocate the carrying cost of these assets to our operating subsidiaries through our filed allocation methodology. Energy Services assets consist largely of computer equipment and fiber optic cable and related electronics and have service lives ranging from seven to 40 years.
KeySpan's repair and maintenance costs, including planned major maintenance in the Electric Services segment for turbine and generator overhauls, are expensed as incurred unless they represent replacement of property to be capitalized. Planned major maintenance cycles primarily range from seven to eight years. Smaller periodic overhauls are performed approximately every 18 months.
KeySpan capitalizes costs incurred in connection with its projects to develop and build energy facilities after a project has been determined to be probable of completion.
F. Gas Exploration and Production Property - Depletion
KeySpan maintains gas exploration and production activities through its two wholly-owned subsidiaries - KeySpan Exploration and Production, LLC ("KeySpan Exploration") and Seneca-Upshur Petroleum, Inc. ("Seneca-Upshur"). At December 31, 2005, these subsidiaries had net exploration and production property in the amount of $75.0 million. These assets are accounted for under the full cost method of accounting. Under the full cost method, costs of acquisition, exploration and development of natural gas and oil reserves plus asset retirement obligations are capitalized into a "full cost pool" as incurred. Unproved properties and related costs are excluded from the depletion and amortization base until a determination is made as to the existence of proved reserves. Properties are depleted and charged to operations using the unit of production method using proved reserve quantities.
To the extent that such capitalized costs (net of accumulated depletion) less deferred taxes exceed the present value (using a 10% discount rate) of estimated future net cash flows from proved natural gas and oil reserves and the lower of cost or fair value of unproved properties, less deferred taxes, such excess costs are charged to operations, but would not have an impact on cash flows. Once incurred, such impairment of gas properties is not reversible at a later date even if gas prices increase.
The ceiling test is calculated using natural gas and oil prices in effect as of the balance sheet date, held flat over the life of the reserves. We use derivative financial instruments that qualify for hedge accounting under SFAS 133 "Accounting for Derivative Instruments and Hedging Activities," to hedge the volatility of natural gas prices. In accordance with current SEC guidelines, we have included estimated future cash flows from our hedging program in ceiling test calculations.
As of December 31, 2005, we estimated that our capitalized costs did not exceed the ceiling test limitation. We used an average wellhead price of $10.43 per MCF, adjusted for derivative instruments.
As a result of the disposition of Houston Exploration in 2004, during 2004 KeySpan calculated the ceiling test on KeySpan Exploration and Production's and Seneca-Uphsur's assets independently of Houston Exploration's assets. Based on a report furnished by an independent reservoir engineer during the second quarter of 2004, it was determined that the remaining proved undeveloped oil reserves held in the joint venture required a substantial investment in order to develop.
Therefore, KeySpan and Houston Exploration elected not to develop these oil reserves. As a result, in the second quarter of 2004, we recorded a $48.2 million non-cash impairment charge to write down our wholly-owned gas exploration and production subsidiaries' assets. This charge was recorded in depreciation, depletion and amortization on the Consolidated Statement of Income.
Natural gas prices continue to be volatile and the risk that a write down to the full cost pool increases when, among other things, natural gas prices are low, there are significant downward revisions in our estimated proved reserves or we have unsuccessful drilling results.
Houston Exploration, for 2004 and 2003, capitalized interest related to their unevaluated natural gas and oil properties, as well as some properties under development which were not being amortized. For years ended December 31, 2004 and 2003, capitalized interest was $3.4 million and $7.3 million, respectively.
G. Goodwill and Other Intangible Assets
The balance of goodwill and other intangible assets was $1.7 billion at December 31, 2005 and December 31, 2004, representing primarily the excess of acquisition cost over the fair value of net assets acquired. Goodwill and other intangible assets reflect the Eastern and EnergyNorth acquisitions, the KeySpan/LILCO transaction, as well as acquisitions of non-utility energy-related service companies and also relates to certain ownership interests of 50% or less in energy-related investments, which are accounted for under the equity method.
The table below summarizes the goodwill and other intangible assets balance for each segment at December 31, 2005 and 2004:
- ----------------------------------------------------------------------- (In Millions of Dollars) At December 31, 2005 2004 - ----------------------------------------------------------------------- Operating Segment
Gas Distribution $1,436.9 $1,436.9 Energy Services 65.2 65.8 Energy Investments and other 164.2 174.9 - ----------------------------------------------------------------------- $1,666.3 $1,677.6 - -----------------------------------------------------------------------
As prescribed in SFAS 142 "Goodwill and Other Intangible Assets," KeySpan is required to compare the fair value of a reporting unit to its carrying amount, including goodwill. This evaluation is required to be performed at least annually, unless facts and circumstances indicated that the evaluation should be performed at an interim period during the year. At December 31, 2005, KeySpan had $1.7 billion of recorded goodwill and has concluded that the fair value of the business units that have recorded goodwill exceed their carrying value.
During 2004, KeySpan conducted an evaluation of the carrying value of goodwill recorded in its Energy Services segment. As a result of this evaluation, KeySpan recorded a non-cash goodwill impairment charge of $108.3 million ($80.3 million after tax, or $0.50 per share) in 2004. This charge was recorded as follows: (i) $14.4 million as an operating expense on the Consolidated Statement of Income reflecting the write-down of goodwill on Energy Services segment's continuing operations; and (ii) $93.9 million as discontinued operations reflecting the impairment on the mechanical contracting companies. (See Note 10 to the Consolidated Financial Statements "Energy Services-Discontinued Operations" for further details.)
At the end of 2004, KeySpan entered into an agreement to sell its then 50% interest in Premier Transmission Limited ("Premier"). This investment was accounted for under the equity method of accounting in the Energy Investments segment. In the fourth quarter of 2004 KeySpan recorded a partial pre-tax non-cash impairment charge of $26.5 million - $18.8 million after-tax or $0.12 per share. The impairment charge reflected the difference between the anticipated cash proceeds from the sale of Premier compared to its carrying value at that time and was recorded as a reduction to goodwill.
H. Hedging and Derivative Financial Instruments
From time to time, we employ derivative instruments to hedge a portion of our exposure to commodity price risk and interest rate risk, as well as to hedge cash flow variability associated with a portion of our peak electric energy sales. Whenever hedge positions are in effect, we are exposed to credit risk in the event of nonperformance by counter-parties to derivative contracts, as well as nonperformance by the counter-parties of the transactions against which they are hedged. We believe that the credit risk related to the futures, options and swap instruments is no greater than that associated with the primary commodity contracts which they hedge. Our currently outstanding derivative instruments do not qualify as energy trading contracts as defined by current accounting literature.
Financially-Settled Commodity Derivative Instruments: We employ derivative financial instruments, such as futures, options and swaps, for the purpose of hedging the cash flow variability associated with forecasted purchases and sales of various energy-related commodities. All such derivative instruments are accounted for pursuant to the requirements of SFAS 133 "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS 149, "Amendment of Statement 133 Derivative Instruments and Hedging Activities" (collectively, "SFAS 133"). With respect to those commodity derivative instruments that are designated and accounted for as cash flow hedges, the effective portion of periodic changes in the fair market value of cash flow hedges is recorded as other comprehensive income on the Consolidated Balance Sheet, while the ineffective portion of such changes in fair value is recognized in earnings. Unrealized gains and losses (on such cash flow hedges) that are recorded as other comprehensive income are subsequently reclassified into earnings concurrent when hedged transactions impact earnings. With respect to those commodity derivative instruments that are not designated as hedging instruments, such derivatives are accounted for on the Consolidated Balance Sheet at fair value, with all changes in fair value reported in earnings.
Firm Gas Sales Derivatives Instruments - Regulated Utilities: We utilize derivative financial instruments to reduce cash flow variability associated with the purchase price for a portion of our future natural gas purchases. Our strategy is to minimize fluctuations in firm gas sales prices to our regulated firm gas sales customers in our New York and New England service territories. Since these derivative instruments are being employed to support our gas sales prices to regulated firm gas sales customers, the accounting for these derivative instruments is subject to SFAS 71. Therefore, changes in the market value of these derivatives are recorded as regulatory assets or regulatory liabilities on our Consolidated Balance Sheet. Gains or losses on the settlement of these contracts are initially deferred and then refunded to or collected from our firm gas sales customers during the appropriate winter heating season consistent with regulatory requirements.
Physically-Settled Commodity Derivative Instruments: Certain of our contracts for the physical purchase of natural gas were assessed as no longer being exempt from the requirements of SFAS 133 as normal purchases. As such, these contracts are recorded on the Consolidated Balance Sheet at fair market value. However, since such contracts were executed for the purchases of natural gas that is sold to regulated firm gas sales customers, and pursuant to the requirements of SFAS 71, changes in the fair market value of these contracts are recorded as a regulatory asset or regulatory liability on the Consolidated Balance Sheet.
Weather Derivatives: The utility tariffs associated with our New England gas distribution operations do not contain a weather normalization adjustment. As a result, fluctuations from normal weather may have a significant positive or negative effect on the results of these operations. To mitigate the effect of fluctuations from normal weather on our financial position and cash flows, we may enter into derivative instruments from time to time. Based on the terms of the contracts, we account for these instruments pursuant to the requirements of Emerging Issues Task Force ("EITF") 99-2 "Accounting for Weather Derivatives." In this regard, we account for weather derivatives using the "intrinsic value method" as set forth in such guidance.
Interest Rate Derivative Instruments: We continually assess the cost relationship between fixed and variable rate debt. Consistent with our objective to minimize our cost of capital, we periodically enter into hedging transactions that effectively convert the terms of underlying debt obligations from fixed to variable or variable to fixed. Payments made or received on these derivative contracts are recognized as an adjustment to interest expense as incurred. Hedging transactions that effectively convert the terms of underlying debt obligations from fixed to variable are designated and accounted for as fair-value hedges pursuant to the requirements of SFAS 133. Hedging transactions that effectively convert the terms of underlying debt obligations from variable to fixed are considered cash flow hedges.
I. Equity Investments
Certain subsidiaries own as their principal assets, investments (including goodwill), representing ownership interests of 50% or less in energy-related businesses that are accounted for under the equity method. None of these current investments are publicly traded.
J. Income and Excise Tax
Upon implementation of SFAS 109, "Accounting for Income Taxes", certain of our regulated subsidiaries recorded a regulatory asset and a net deferred tax liability for the cumulative effect of providing deferred income taxes on certain differences between the financial statement carrying amounts of assets and liabilities, and their respective tax bases. This regulatory asset continues to be amortized over the lives of the individual assets and liabilities to which it relates. Additionally, investment tax credits which were available prior to the Tax Reform Act of 1986, were deferred and generally amortized as a reduction of income tax over the estimated lives of the related property.
We report our collections and payments of excise taxes on a gross basis. Gas distribution revenues include the collection of excise taxes, while operating taxes include the related expense. For the years ended December 31, 2005, 2004 and 2003, excise taxes collected and paid were $65.8 million, $73.3 million, $90.5 million, respectively.
K. Subsidiary Common Stock Issuances to Third Parties
We follow an accounting policy of income statement recognition for parent company gains or losses from issuances of common stock by subsidiaries to unaffiliated third parties.
L. Foreign Currency Translation
We followed the principles of SFAS 52, "Foreign Currency Translation," for recording our investments in foreign affiliates. Under this statement, all elements of the financial statements are translated by using a current exchange rate. Translation adjustments result from changes in exchange rates from one reporting period to another. At December 31, 2004, the foreign currency translation adjustment was included on the Consolidated Balance Sheet. The functional currency for our foreign affiliates was their local currency. At December 31, 2005, SFAS 52 was not applicable to KeySpan since we completed the sale of our remaining foreign investment in the first quarter of 2005.
M. Earnings Per Share
Basic earnings per share ("EPS") is calculated by dividing earnings for common stock by the weighted average number of shares of common stock outstanding during the period. No dilution for any potentially anti-dilutive securities is included. Diluted EPS assumes the conversion of all potentially dilutive securities and is calculated by dividing earnings for common stock, as adjusted, by the sum of the weighted average number of shares of common stock outstanding plus all potentially dilutive securities.
At December 31, 2005, we had approximately 4.6 million options outstanding to purchase KeySpan common stock that were not used in the calculation of diluted EPS since the exercise price associated with these options were greater than the average per share market price of Keyspan's common stock. In addition, there were approximately 384,000 performance shares not used in the calculation of diluted EPS since these shares would not have been issued if December 31, 2005 were the end of the performance period. In 2003, we had 85,676 shares of convertible preferred stock outstanding that could have been converted into 221,153 shares of common stock. These shares were redeemed in 2004.
Under the requirements of SFAS 128, "Earnings Per Share" our basic and diluted EPS are as follows:
N. Stock Options and Other Stock Based Compensation
Stock options are issued to all KeySpan officers and certain other management employees as approved by the Board of Directors. These options generally vest over a three-to-five year period and have exercise periods between five to ten years. Up to approximately 21 million shares have been authorized for the issuance of options and approximately 3.7 million of these shares were available for issuance at December 31, 2005. Under a separate plan, Houston Exploration had issued stock options to its key employees. KeySpan and Houston Exploration adopted the prospective method of transition in accordance with SFAS 148 "Accounting for Stock-Based Compensation - Transition and Disclosure." Accordingly, compensation expense has been recognized by employing the fair value recognition provisions of SFAS 123 "Accounting for Stock-Based Compensation" for grants awarded after January 1, 2003.
KeySpan continues to apply APB Opinion 25, "Accounting for Stock Issued to Employees," and related Interpretations in accounting for grants awarded prior to January 1, 2003. Prior to the disposition of Houston Exploration, Houston Exploration also applied APB Opinion 25, and related Interpretations in accounting for grants awarded prior to January 1, 2003. Accordingly, no compensation cost has been recognized for these fixed stock option plans in the Consolidated Financial Statements since the exercise prices and market values were equal on the grant dates. Had compensation cost for these plans been determined based on the fair value at the grant dates for awards under the plans consistent with SFAS 123, our net income and earnings per share would have decreased to the pro-forma amounts indicated below:
All grants are estimated on the date of the grant using the Black-Scholes option-pricing model. The following table presents the weighted average fair value, exercise price and assumptions used for the periods indicated:
- -------------------------------------------------------------------------------- Year Ended December 31, 2005 2004 2003 - -------------------------------------------------------------------------------- Fair value of grants issued $ 6.15 $ 5.47 $ 4.26 Dividend yield 4.64% 4.74% 5.49% Expected volatility 22.63% 23.48% 24.26% Risk free rate 4.10% 3.22% 3.16% Expected lives 6.4 years 6.5 years 6 years Exercise price $ 39.25 $ 37.54 $ 32.40 - --------------------------------------------------------------------------------
A summary of the status of our fixed stock option plans and changes is presented below for the periods indicated:
Since 2003, KeySpan provides long-term incentive compensation for officers consisting of 50% stock options and 50% performance shares. Performance shares are awarded based upon the attainment of overall corporate performance goals and better aligns incentive compensation with overall corporate performance. These performance shares are measured over a three year period by comparing KeySpan's cumulative total shareholder return to the S&P Utilities Group. The award "cliff" vests after each 3 year period.
During 2005, it became apparent to management that the 2003 performance share award would not be achieved and the 2004 performance share award would not be achieved at the level of expense being recorded. Since these awards meet the definition of a performance condition not achieved under SFAS 123, KeySpan reversed the previously recognized expense for the 2003 award and one half of previously recognized expense for the 2004 award amounting to $3.8 million ($2.5 million after tax). For the 2005 award, it is too early to predict whether the performance condition will be achieved and therefore none of the expense recorded to date for the 2005 performance share award has been reversed.
In December 2004, the FASB issued SFAS 123R "Share-Based Payment" which superseded SFAS 123. The effective date of SFAS 123R is the first quarter of 2006. Under this standard, we will be prohibited from reversing any previously recorded expense for the portion of the 2004 and 2005 performance share awards currently deemed attainable. This is due to the fact that the condition of our current performance share awards will be viewed as market conditions under SFAS 123R.
O. Recent Accounting Pronouncements
On July 14, 2005, the Financial Accounting Standards Board ("FASB") issued an Exposure Draft "Accounting for Uncertain Tax Positions," that would interpret SFAS 109, "Accounting for Income Taxes." This proposal seeks to reduce the diversity in practice associated with certain aspects of the recognition and measurement requirements related to accounting for income taxes. Specifically, the proposal would require that a tax position meet a "probable recognition threshold" for the benefit of an uncertain tax position to be recognized in the financial statements. The proposal would require recognition in the financial statements of the best estimate of the effect of a tax position only if that position is probable of being sustained on audit by the appropriate taxing authorities, based solely on the technical merits of the position.
The proposed effective date has been delayed until the first fiscal year ending after January 1, 2007. KeySpan is currently evaluating this Exposure Draft, and at this time cannot determine the impact, if any, that the potential requirements of this Exposure Draft may have on its results of operations, financial position or cash flows.
In March 2005, the FASB issued FASB Interpretation No. 47 ("FIN 47") "Accounting for Conditional Asset Retirement Obligations - an interpretation of FASB Statement No. 143." FIN 47 clarifies that the term conditional asset retirement obligation as used in SFAS No. 143 "Accounting for Asset Retirement Obligations", refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and/or method of settlement. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. Uncertainty about the timing and/or method of settlement of a conditional asset retirement obligation should be factored into the measurement of the liability when sufficient information exists. An entity shall recognize the cumulative effect of initially applying FIN 47 as a change in accounting principle. KeySpan implemented FIN 47 in December 2005. See Note 1 Item P below and Note 7 "Contractual Obligations, Financial Guarantees and Contingencies" for further information on FIN 47.
In 2004, the FASB issued FASB Staff Position ("FSP") 106-2 "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003." This guidance clarified the accounting and disclosure requirements for employers with postretirement benefit plans that have been affected by the passage of the Medicare Prescription Drug Improvement and Modernization Act of 2003 (the "Medicare Act"). The Act introduced two new features to Medicare that an employer needs to consider in measuring its obligation and net periodic postretirement benefit costs.
KeySpan's retiree health benefit plan currently includes a prescription drug benefit that is provided to retired employees. KeySpan implemented the requirements of FSP 106-2 in 2004 and determined that the savings associated with the Medicare Act reduced KeySpan's retiree health care costs by approximately $10 million in 2004. However, KEDLI and Boston Gas Company are
subject to certain deferral accounting requirements mandated by the NYPSC and MADTE, respectively for pension costs and other postretirement benefit costs. Further, in accordance with our service agreements with LIPA, variations between pension costs and other postretirement benefit costs incurred by KeySpan compared to those costs recovered through rates charged to LIPA are deferred subject to recovery from or refund to LIPA. As a result of these various requirements, approximately $7 million of savings attributable to the implementation of FSP 106-2 and the Medicare Act was deferred and used to offset increases in overall pension and postretirement benefit costs, with the remaining approximately $3 million recorded as a reduction to 2004 postretirement expense. The implementation of FSP 106-2 and the Medicare Act had no immediate impact on KeySpan's cash flow.
In January 2005, the Department of Health and Human Services/Centers for Medicare and Medicaid Services ("CMS") released final regulations with regard to the implementation of the major provisions of the Medicare Act. KeySpan reviewed the new provisions and believes that the new guidance will not have a material impact on its results of operations, financial position or cash flows.
In December 2004 the FASB issued SFAS 123 (revised 2004) "Share-Based Payment." This Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This Statement revises certain provisions of SFAS 123 "Accounting for Stock-Based Compensation" and supersedes APB Opinion 25 "Accounting for Stock Issued to Employees." The fair-value-based method in this Statement is similar to the fair-value-based method in SFAS 123 in most respects. However, the following are key differences between the two: entities are required to measure liabilities incurred to employees in share-based payment transactions at fair value as compared to using the intrinsic method allowed under SFAS 123; entities are required to estimate the number of instruments for which the requisite service is expected to be rendered, as compared to accounting for forfeitures as they occur under SFAS 123; and incremental compensation cost for a modification of the terms or conditions of an award are also measured differently under this Statement compared to Statement 123. This Statement also clarifies and expands SFAS 123's guidance in several areas. The effective date of this Statement is the beginning of the first fiscal year beginning after June 15, 2005. KeySpan adopted the prospective method of transition for stock options in accordance with SFAS 148 "Accounting for Stock-Based Compensation - Transition and Disclosure." Accordingly, compensation expense has been recognized by employing the fair value recognition provisions of SFAS 123 for grants awarded after January 1, 2003. KeySpan believes that implementation of this Statement will not have a material impact on its results of operations or financial position and no impact on its cash flows.
P. Impact of Cumulative Effect of Change in Accounting Principles
As previously discussed, KeySpan implemented FIN 47, effective December 31, 2005. FIN 47 required KeySpan to record a liability and corresponding asset representing the present value of conditional asset retirement obligations associated with the retirement of tangible, long-lived assets on the date the obligations were incurred. At year-end, we recorded a $45.6 million liability and corresponding asset representing the present value of conditional asset retirement obligations associated with the retirement of tangible, long-lived assets on the date the obligations were incurred. For the $45.6 million initial asset recorded, approximately $4.3 million represents asset retirement costs that have been deferred on the Consolidated Balance Sheet and will be depreciated over the remaining life of the underlying associated assets lives.
The remaining $41.3 million represented cumulative accretion and depreciation expense associated with the liability and asset from the dates the various obligations would have been recorded had this Interpretation been in effect at the time the obligations were incurred.
Of the $41.3 million recorded, $11.3 million ($6.6 million, net of taxes), was recorded as a cumulative change in accounting principle on the Consolidated Statement of Income. The remaining $30.0 million was attributable to the Gas Distribution segment and was recorded as a reduction to the removal cost recovered. For asset retirement costs incurred in the Gas Distribution segment, KeySpan is recovering these costs from utility customers and has been expensing a like amount through its depreciation expense. A portion of this depreciation expense represents removal costs not yet incurred. The $30 million recorded to the removal cost recovered is for purposes of reclassifying a portion of this reserve to the asset retirement obligation. (See Note 7, "Contractual Obligations, Financial Guarantees and Contingencies - Asset Retirement Obligations" for further details.)
KeySpan has an arrangement with a variable interest entity through which it leases a portion of the 2,200-megawatt Ravenswood electric generation facility. On December 31, 2003, KeySpan adopted FASB Interpretation No. 46 ("FIN 46"). This pronouncement required KeySpan to consolidate its variable interest entity, which had a fair market value of $425 million at the inception of the lease, June 1999. As a result, in 2003 KeySpan recorded a $37.6 million after-tax charge, or $0.23 per share, cumulative change in accounting principle on the Consolidated Statement of Income, representing approximately four and a half years of depreciation. (See Note 7, "Contractual Obligations, Financial Guarantees and Contingencies - Variable Interest Entity" for a detailed description of the impact of the adoption of this standard.)
Under Accounting Principle Board Opinion No. 20 ("APB 20"), the pro-forma impact of the retroactive application resulting from the adoption of a change in accounting principle is to be disclosed as follows:
In addition to the above disclosure, FIN 47 requires disclosure of the pro-forma impact of the liability for the asset retirement obligation for the beginning of the earliest year presented and at the end of all years presented as if this Interpretation had been applied during all periods effected. The disclosure is as follows:
- -------------------------------------------------------------------------------- (In Millions of Dollars) DECEMBER 31, 2005 2004 - -------------------------------------------------------------------------------- Asset retirement obligation - January 1 $ 44.9 $ 42.5 Accretion 2.5 2.4 - -------------------------------------------------------------------------------- Asset retirement obligation - December 31 $ 47.4 $ 44.9
- --------------------------------------------------------------------------------
Q. Accumulated Other Comprehensive Income
As required by SFAS 130, "Reporting Comprehensive Income," the components of accumulated other comprehensive income are as follows:
Note 2. Business Segments
We have four reportable segments: Gas Distribution, Electric Services, Energy Services and Energy Investments.
The Gas Distribution segment consists of our six gas distribution subsidiaries. KEDNY provides gas distribution services to customers in the New York City Boroughs of Brooklyn, Staten Island and a portion of the Borough of Queens. KEDLI provides gas distribution services to customers in the Long Island counties of Nassau and Suffolk and the Rockaway Peninsula of Queens County. The remaining gas distribution subsidiaries, collectively doing business as KEDNE, provide gas distribution service to customers in Massachusetts and New Hampshire.
The Electric Services segment consists of subsidiaries that: operate the electric transmission and distribution system owned by LIPA; own and provide capacity to and produce energy for LIPA from our generating facilities located on Long Island; and manage fuel supplies for LIPA to fuel our Long Island generating facilities. These services are provided in accordance with long-term service contracts having remaining terms that range from one to seven years and power purchase agreements having remaining terms that range from seven to 21 years. On February 1, 2006, KeySpan and LIPA agreed to extend, amend and restate these contractual arrangements. (See Note 11, "2006 LIPA Settlement" for a further discussion of these agreements.) The Electric Services segment also includes subsidiaries that own or lease and operate the 2,200 megawatt Ravenswood Facility located in Queens, New York, and the 250 MW combined-cycle Ravenswood Expansion. Collectively the Ravenswood Facility and Ravenswood Expansion are referred to as the "Ravenswood Generating Station". All of the energy, capacity and ancillary services related to the Ravenswood Generating Station are sold to the NYISO energy markets. To finance the purchase and/or construction of the Ravenswood Generating Station, KeySpan entered into leasing arrangement for each facility. The Electric Services segment also conducts retail marketing of electricity to commercial customers. (See Note 7 "Contractual Obligations, Financial Guarantees and Contingencies" for further details on the leasing arrangements.)
The Energy Services segment includes companies that provide energy-related services to customers located primarily within the Northeastern United States. Subsidiaries in this segment provide residential and small commercial customers with service and maintenance of energy systems and appliances, as well as operation and maintenance, design, engineering, consulting and fiber optic services to commercial, institutional and industrial customers.
In January and February of 2005, KeySpan sold its mechanical contracting subsidiaries. The operating results and financial position of these companies, which were previously consolidated within the Energy Services segment, have been reflected as discontinued operations on the Consolidated Statement of Income, Consolidated Balance Sheet and Consolidated Statement of Cash Flows.
In regard to the January 2005 transactions, KeySpan received proceeds of approximately $16 million, including approximately $5 million to be paid within a three year period. In addition, KeySpan retained a portion of its previously incurred surety indemnity support obligations related to certain performance and payment bonds issued for the benefit of KeySpan's former subsidiaries prior to closing. In June 2005, the balance to be paid over a three year period was fully collected on a present value basis and a significant portion of the performance bonds were replaced without any remaining indemnification obligation on the part
of KeySpan. The current estimated cost to complete projects supported by the remaining indemnity obligations associated with the January 2005 transactions is approximately $0.2 million. The buyers have agreed to complete the projects for which such indemnity obligations were incurred and to indemnify and hold KeySpan harmless with respect to its liabilities in connection with such bonds.
In connection with the February 2005 transaction, KeySpan paid or contributed approximately $26 million to a former subsidiary prior to closing the sale transaction in exchange for, among other things, the disposition of outstanding shares in the former subsidiary and the settlement of intercompany advances and replacement of a performance and payment bond issued for the benefit of its former subsidiary with respect to a pending project, which bond had been supported by a $150 million indemnity obligation of KeySpan. In addition, KeySpan received from its former subsidiary an indemnity bond issued by a third party surety company, the purpose of which is to reimburse KeySpan in an amount up to $80 million in the event it is required to perform under all other indemnity obligations previously incurred by KeySpan to support the remaining bonded projects of its former subsidiary as of the closing. As of December 31, 2005, the total cost to complete such remaining bonded projects is estimated to be approximately $40 million. The aforementioned guarantees are reflected in Note 7 "Contractual Obligations, Financial Guarantees and Contingencies." KeySpan's former subsidiary has also agreed to complete the projects for which such indemnity obligations were incurred and indemnify and hold KeySpan harmless with respect to any liabilities in connection with such bonds.
In the fourth quarter of 2004, KeySpan's investment in its mechanical contracting subsidiaries was written-down to an estimated fair value. During 2004, KeySpan recorded a non-cash goodwill impairment charge of $108.3 million ($80.3 million after tax, or $0.50 per share) associated with its mechanical contracting operations and certain remaining operations. In addition, an impairment charge of $100.3 million ($72.1 million after-tax or $.45 per share) was also recorded to reduce the carrying value of the remaining assets of the mechanical contracting companies. (See Note 10 "Energy Services - Discontinued Operations" for additional details regarding these charges.) During the first six months of 2005, operating losses were incurred through the dates of sale of these companies of $4.1 million after-tax, including but not limited to costs incurred for employee related benefits. Partially offsetting these losses was a gain of $2.3 million associated with the related divestitures, reflecting the difference between the fair value estimates and the financial impact of the actual sale transactions. The net income impact of the operating losses and the disposal gain was a loss of $1.8 million, or $0.01 per share for the twelve months ended December 31, 2005.
The Energy Investments segment consists of our gas exploration and production investments, as well as certain other domestic energy-related investments. KeySpan's gas exploration and production activities include our wholly-owned subsidiaries Seneca Upshur Petroleum, Inc. ("Seneca-Upshur") and KeySpan Exploration and Production, LLC ("KeySpan Exploration"). Seneca-Upshur is engaged in gas exploration and production activities primarily in West Virginia. KeySpan Exploration is engaged in a joint venture with The Houston Exploration Company ("Houston Exploration"), an independent natural gas and oil exploration company located in Houston, Texas.
During the first five months of 2004, our gas exploration and production investments also included a 55% equity interest in Houston Exploration, the operations of which were fully consolidated in KeySpan's Consolidated Financial Statements. On June 2, 2004, KeySpan exchanged 10.8 million shares of common stock of Houston Exploration for 100% of the stock of Seneca-Upshur, previously
a wholly owned subsidiary of Houston Exploration. This transaction reduced our interest in Houston Exploration from 55% to the then current level of 23.5%. Effective June 1, 2004, Houston Exploration's earnings and our ownership interest in Houston Exploration were accounted for on the equity method of accounting. This transaction resulted in a gain to KeySpan of $150.1 million. The deconsolidation of Houston Exploration required the recognition of certain deferred taxes on our remaining investment resulting in a net deferred tax expense of $44.1 million. Therefore, the net gain on the share exchange less the deferred tax provision was $106 million, or $0.66 per share.
In November 2004, KeySpan sold its remaining 23.5% interest in Houston Exploration (6.6 million shares) and received cash proceeds of approximately $369 million. KeySpan recorded a pre-tax gain of $179.6 million which is reflected in other income and (deductions) on the Consolidated Statement of Income. The after-tax gain was $116.8 million or $0.73 per share.
Houston Exploration's revenues, which are reflected in KeySpan's Consolidated Statement of Income in fiscal years 2004 and 2003, were $268.1 million, and $495.3 million, respectively. Houston Exploration's operating income, including KeySpan's share of equity earnings, was $138.5 million and $196.3 million in fiscal years 2004 and 2003, respectively.
Asset transactions regarding our investment in Houston Exploration were also recorded in 2003. In February 2003, we reduced our ownership interest in Houston Exploration from 66% to approximately 55% following the repurchase, by Houston Exploration, of three million shares of common stock owned by KeySpan. We realized net proceeds of $79 million in connection with this repurchase. KeySpan realized a gain of $19 million on this transaction, which is reflected in other income and (deductions) on the Consolidated Statement of Income. Income taxes were not provided, since this transaction was structured as a return of capital. The per share gain on this transaction was $0.12.
The Energy Investments segment is also engaged in pipeline development activities. KeySpan and Duke Energy Corporation each own a 50% interest in the Islander East Pipeline Company, LLC ("Islander East"). Islander East was created to pursue the authorization and construction of an interstate pipeline from Connecticut, across Long Island Sound, to a terminus near Shoreham, Long Island. Once in service, the pipeline is expected to transport up to 260,000 DTH daily to the Long Island and New York City energy markets. Further, KeySpan has a 21% interest in the Millennium Pipeline project which is expected to transport up to 525,000 DTH of natural gas a day from Corning to Ramapo, New York, where it will connect to an existing pipeline. Additionally, subsidiaries in this segment hold a 20% equity interest in the Iroquois Gas Transmission System LP, a pipeline that transports Canadian gas supply to markets in the Northeastern United States. These subsidiaries are accounted for under the equity method. Accordingly, equity income from these investments is reflected as a component of operating income in the Consolidated Statement of Income.
Through its wholly owned subsidiary, KeySpan LNG, LP, KeySpan owns a liquefied natural gas storage and receiving facility in Providence, Rhode Island, the operations of which are fully consolidated.
During the first quarter of 2004, we also had an approximate 61% investment in certain midstream natural gas assets in Western Canada through KeySpan Energy Canada Partnership ("KeySpan Canada"). These assets included 14 processing plants and associated gathering systems that produced approximately 1.5 BCFe of natural gas daily and provided associated natural gas liquids fractionation.
These operations were fully consolidated in KeySpan's Consolidated Financial Statements. On April 1, 2004, KeySpan and KeySpan Facilities Income Fund (the "Fund"), which previously owned a 39.09% interest in KeySpan Canada, consummated a transaction whereby the Fund sold 15.617 million units of the Fund and acquired an additional 35.91% interest in KeySpan Canada from KeySpan. As a result of this transaction, KeySpan's ownership of KeySpan Canada decreased to 25%. KeySpan recorded a gain of $22.8 million ($10.1 million after-tax, or $0.06 per share) at the time of this transaction. Effective April 1, 2004 KeySpan Canada's earnings and our ownership interest in KeySpan Canada were accounted for on the equity method of accounting.
In July 2004, the Fund issued an additional 10.7 million units, the proceeds of which were used to fund the acquisition of the midstream assets of Chevron Canada Midstream Inc. This transaction had the effect of further diluting KeySpan's ownership of KeySpan Canada to 17.4%. KeySpan continued to account for its investment in KeySpan Canada on the equity basis of accounting since it still exercised significant influence over this entity.
In December 2004, KeySpan sold its remaining 17.4% interest in KeySpan Canada to the Fund and received net proceeds of approximately $119 million and recorded a pre-tax gain of approximately $35.8 million, which is reflected in other income and (deductions) on the Consolidated Statement of Income. The after-tax gain was approximately $24.7 million, or $0.15 per share.
KeySpan Canada's revenues, which are reflected in KeySpan's Consolidated Statement of Income in fiscal years 2004 and 2003, were $25.2 million and $90.3 million, respectively. KeySpan Canada's operating income, including KeySpan's share of equity earnings, was $16.5 million and $29.7 million, respectively.
Asset transactions regarding our investment in KeySpan Canada were also recorded in 2003. In 2003, we sold a portion of our interest in KeySpan Canada through the Fund. The Fund acquired a 39.1% ownership interest in KeySpan Canada through an indirect subsidiary, and then issued 17 million trust units to the public through an initial public offering. Additionally, we sold our 20% interest in Taylor NGL LP that owns and operates two extraction plants in Canada to AltaGas Services, Inc. Net proceeds of $119.4 million from the two sales, plus proceeds of $45.7 million drawn under a credit facility made available to KeySpan Canada, were used to pay down existing KeySpan Canada credit facilities of $160.4 million. A pre-tax loss of $30.3 million was recognized on the transactions and is included in other income and (deductions) on the Consolidated Statement of Income. These transactions produced a tax expense of $3.8 million as a result of certain United States partnership tax rules and resulted in an after-tax loss of $34.1 million, or $0.22 per share.
In the first quarter of 2005, KeySpan sold its 50% interest in Premier Transmission Limited ("Premier"), a gas pipeline from southwest Scotland to Northern Ireland. On February 25, 2005, KeySpan entered into a Share Sale and Purchase Agreement with BG Energy Holdings Limited and Premier Transmission Financing Public Limited Company ("PTFPL"), pursuant to which all of the outstanding shares of Premier were to be purchased by PTFPL. On March 18, 2005, the sale was completed and generated cash proceeds of approximately $48.1 million. In the fourth quarter of 2004, KeySpan recorded a pre-tax non-cash impairment charge of $26.5 million reflecting the difference between the anticipated cash proceeds from the sale of Premier compared to its carrying value. The final sale of Premier resulted in a pre-tax gain of $4.1 million reflecting the difference from earlier estimates; this gain was recorded in the first quarter of 2005.
In the fourth quarter of 2003, we completed the sale of our 24.5% interest in Phoenix Natural Gas Limited for $96 million and recorded a pre-tax gain of $24.7 million in other income and (deductions) on the Consolidated Statement of Income. The after-tax gain was $16.0 million, or $0.10 per share.
The accounting policies of the segments are the same as those used for the preparation of the Consolidated Financial Statements. Our segments are strategic business units that are managed separately because of their different operating and regulatory environments. Operating results of our segments are evaluated by management on an operating income basis. For fiscal years 2004 and 2003, the operating data of Houston Exploration has been separately displayed. The reportable segment information is as follows:
Eliminating items include intercompany interest income and expense and the elimination of certain intercompany accounts as well as activities of our corporate and administrative subsidiaries.
Electric Services revenues from LIPA and the NYISO of $2.0 billion for the year ended December 31, 2005 represents approximately 26% of our consolidated revenues during that period.
Eliminating items include intercompany interest income and expense, the elimination of certain intercompany accounts, as well as activities of our corporate and administrative subsidiaries.
Electric Services revenues from LIPA and the NYISO of $1.7 billion for the year ended December 31, 2004 represents approximately 25% of our consolidated revenues during that period.
Eliminating items include intercompany interest income and expense and the elimination of certain intercompany accounts as well as activities of our corporate and administrative subsidiaries.
Electric Services revenues from LIPA and the NYISO of $1.5 billion for the year ended December 31, 2003 represents approximately 22% of our consolidated revenues during that period.
Note 3. Income Tax
KeySpan files a consolidated federal income tax return. A tax sharing agreement between the holding company and its subsidiaries provides for the allocation of a realized tax liability or asset based upon separate return contributions of each subsidiary to the consolidated taxable income or loss in the consolidated income tax return. The subsidiaries record income tax payable or receivable from KeySpan resulting from the inclusion of their taxable income or loss in the consolidated return.
Income tax expense is reflected as follows in the Consolidated Statement of Income:
- ------------------------------------------------------------------------ Year Ended December 31, (In Millions of Dollars) 2005 2004 2003 - ------------------------------------------------------------------------ Current income tax $ 206.6 $ 201.9 $ (99.8) Deferred income tax 32.7 123.6 381.1 - ------------------------------------------------------------------------ Total income tax $ 239.3 $ 325.5 $ 281.3 - ------------------------------------------------------------------------
At December 31, the significant components of KeySpan's deferred tax assets and liabilities calculated under the provisions of SFAS No.109 "Accounting for Income Taxes" were as follows:
- -------------------------------------------------------------------------- December 31, (In Millions of Dollars) 2005 2004 - -------------------------------------------------------------------------- Reserves not currently deductible $ 28.4 $ 23.9 State income tax (20.6) (19.0) Property related differences (1,080.8) (1,080.0) Regulatory tax asset (24.5) (21.4) Property taxes (84.1) (99.1) Employee benefits and compensation (64.4) (16.6) Other items - net 88.1 88.1 - -------------------------------------------------------------------------- Net deferred tax liability $ (1,157.9) $ (1,124.1) - --------------------------------------------------------------------------
KeySpan is currently in discussions with the Internal Revenue Service ("IRS") at the Appeals level with regard to LILCO's tax returns for the tax years ending December 31, 1996 through March 31, 1999 and KeySpan's and the Brooklyn Union Gas Company's tax returns for the years ending September 30, 1997 through December 31, 1998. The primary issue relates to the valuation of the transferred assets in the KeySpan/LILCO combination. Additionally, the IRS has recently commenced the examination of KeySpan's tax returns for the year ended 2002 and 2003. At this time, we cannot predict the result of these audits. However, KeySpan has evaluated the potential outcomes based on the issues raised and progress of the discussions to date. KeySpan believes that it has adequately provided for the additional tax, if any, which may result.
The federal income tax amounts included in the Consolidated Statement of Income differ from the amounts which result from applying the statutory federal income tax rate to income before income tax.
The table below sets forth the reasons for such differences:
(1) Reflects both federal as well as state income taxes.
The American Jobs Creation Act of 2004, signed into law on October 22, 2004 provides for a special one-time tax deduction, or dividend received deduction ("DRD") of 85% of qualifying foreign earnings that are repatriated in 2004 or 2005. We currently estimate that KeySpan has repatriated dividends of approximately $9.5 million of earnings under this provision and received, as a result, a tax benefit of $2.8 million.
As of December 31, 2005 KeySpan has $285 million of state tax net operating loss carryforwards which, if fully utilized at current rates, will yield tax credits of approximately $25 million. These credits will expire between 2011 and 2022.
Note 4. Postretirement Benefits
Pension Plans: The following information represents the consolidated results for our noncontributory defined benefit pension plans which cover substantially all employees. Benefits are typically based on age, years of service and compensation. Funding for pensions is in accordance with requirements of federal law and regulations. KEDLI and Boston Gas Company are subject to certain deferral accounting requirements mandated by the NYPSC and MADTE, respectively for pension costs and other postretirement benefit costs.
The calculation of net periodic pension cost is as follows:
The following table sets forth the pension plans' funded status at December 31, 2005 and December 31, 2004.
- ------------------------------------------------------------------------------- Year Ended December 31, 2005 2004 2003 - ------------------------------------------------------------------------------- Assumptions: Obligation discount 5.75% 6.00% 6.25% Asset return 8.50% 8.50% 8.50% Average annual increase in compensation 4.00% 4.00% 4.00% - -------------------------------------------------------------------------------
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid in the years indicated:
- ------------------------------------------------- (In Millions of Dollars) Pension Benefits - -------------------------------------------------
2006 $ 132.2 2007 $ 134.1 2008 $ 137.7 2009 $ 141.4 2010 $ 146.0 Years 2011- 2015 $ 839.3 - -------------------------------------------------
Unfunded Pension Obligation: At December 31, 2005 the accumulated benefit obligation was in excess of pension assets. As prescribed by SFAS 87 "Employers' Accounting for Pensions," KeySpan had a $257.3 million minimum liability at December 31, 2005, for this unfunded pension obligation. As permitted under current accounting guidelines, these accruals can be offset by a corresponding debit to a long-term asset up to the amount of accumulated unrecognized prior service costs. Any remaining amount is to be recorded in accumulated other comprehensive income on the Consolidated Balance Sheet.
Therefore, at year-end, we had a long-term asset in deferred charges other of $41.2 million, representing the amount of unrecognized prior service cost and a debit to accumulated other comprehensive income of $97.8 million, or $63.6 million after-tax. The remaining amount of $118.3 million was recorded as a contractual receivable from LIPA of $103.8 million and a regulatory asset of $14.5 million, representing the amounts that could be recovered from LIPA and the Boston Gas ratepayer in accordance with our service and rate agreements if the underlying assumptions giving rise to this minimum liability were realized and recorded as pension expense. Boston Gas has received approval from the MADTE to defer as a regulatory asset the amount of its current and future minimum pension liability to reflect its ability to recover in rates its actual pension liability.
At December 31, 2005 the projected benefit obligation, accumulated benefit obligation and value of assets for plans with accumulated benefit obligations in excess of plan assets were $1.4 billion, $1.3 billion and $997 million, respectively.
At December 31, 2004, the accumulated benefit obligation was also in excess of pension assets. As a result, we had a minimum liability of $255.9 million, a long-term asset in deferred charges other of $49.7 million, and a debit to other comprehensive income of $91.9 million, or $59.8 million after-tax. The remaining amount of $114.3 million was recorded as a contractual receivable from LIPA of $100.1 million and a regulatory asset of $14.2 million.
At December 31, 2004 the projected benefit obligation, accumulated benefit obligation and value of assets for plans with accumulated benefit obligations in plan assets were $1.3 billion, $1.2 billion and $881 million, respectively.
At the end of each year, we will re-measure the accumulated benefit obligation and pension assets, and adjust the accrual and deferrals as appropriate.
Other Postretirement Benefits: The following information represents the consolidated results for our contributory medical and prescription drug programs and non-contributory life insurance programs for retired employees. We have been funding a portion of future benefits over employees' active service lives through Voluntary Employee Beneficiary Association ("VEBA") trusts. Contributions to VEBA trusts are tax deductible, subject to limitations contained in the Internal Revenue Code.
Net periodic other postretirement benefit cost included the following components:
- ------------------------------------------------------------------------------- Year Ended December 31, (In Millions of Dollars) 2005 2004 2003 - ------------------------------------------------------------------------------- Service cost, benefits earned during the period $ 24.4 $ 19.7 $ 18.8 Interest cost on accumulated postretirement benefit obligation 75.7 70.2 69.8 Expected return on plan assets (36.1) (33.9) (27.5) Net amortization and deferral 59.9 41.0 35.8 Special termination benefit 1.7 - - - ------------------------------------------------------------------------------- Other postretirement cost $ 125.6 $ 97.0 $ 96.9 - -------------------------------------------------------------------------------
The following table sets forth the plans' funded status at December 31, 2005 and December 31, 2004.
The measurement of plan liabilities also assumes a health care cost trend rate of 9.5% grading down to 4.75% over six years, and 4.75% thereafter. A 1% increase in the health care cost trend rate would have the effect of increasing the accumulated postretirement benefit obligation as of December 31, 2005 by $173.1 million and the net periodic health care expense by $14.9 million. A 1% decrease in the health care cost trend rate would have the effect of decreasing the accumulated postretirement benefit obligation as of December 31, 2005 by $151.1 million and the net periodic health care expense by $12.6 million.
At December 31, 2005, KeySpan had a contractual receivable from LIPA of $297.4 million representing the pension and other postretirement benefits associated with the electric business unit employees recorded in deferred charges other on the Consolidated Balance Sheet. LIPA has been reimbursing us for costs related to the postretirement benefits of the electric business unit employees in accordance with the LIPA Agreements.
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid in the years indicated:
- ------------------------------------------------------------------------------- Gross Benefit Subsidiary Receipts (In Millions of Dollars) Payments Expected** - -------------------------------------------------------------------------------
2006 $ 65.9 $ 3.5 2007 $ 70.6 $ 3.9 2008 $ 74.9 $ 4.3 2009 $ 79.6 $ 4.7 2010 $ 83.9 $ 5.0 Years 2011- 2015 $ 469.3 $ 28.1 - ------------------------------------------------------------------------------- ** Rebates are based on calendar year in which prescription drug costs are incurred. Actual receipt of rebates may occur in the following year.
Pension/Other Post Retirement Benefit Plan Assets: KeySpan's weighted average asset allocations at December 31, 2005 and 2004, by asset category, for both the pension and other postretirement benefit plans are as follows:
- ----------------------------------------------------------------------------- Pension OPEB Asset Category 2005 2004 2005 2004 - ----------------------------------------------------------------------------- Equity securities 65% 64% 70% 72% Debt securities 27% 28% 23% 23% Cash and equivalents 3% 3% 2% - Venture capital 5% 5% 5% 5% - ----------------------------------------------------------------------------- Total 100% 100% 100% 100% - -----------------------------------------------------------------------------
The long-term rate of return on assets (pre-tax) is assumed to be 8.5% which management believes is an appropriate long-term expected rate of return on assets based on our investment strategy, asset allocation mix and the historical performance of equity and fixed income investments over long periods of time. The actual ten- year compound rate of return for our Plans is greater than 8.5%.
Our master trust investment allocation policy target for the assets of the pension and other postretirement benefit plans is 70% equity and 30% fixed income.
During 2003, KeySpan conducted an asset and liability study projecting asset returns and expected benefit payments over a ten-year period. Based on the results of the study, KeySpan developed a multi-year funding strategy for its plans. We believe that it is reasonable to assume assets can achieve or outperform the assumed long-term rate of return with the target allocation as a result of historical performance of equity investments over long-term periods.
Cash Contributions: In 2006, KeySpan is expected to contribute approximately $90 million to its pension plans and approximately $30 million to its other postretirement benefit plans.
Defined Contribution Plan: KeySpan also offers both its union and management employees a defined contribution plan. Both the KeySpan Energy 401(k) Plan for Management Employees and the KeySpan Energy 401(k) Plan for Union Employees are available to all eligible employees. These Plans are defined contribution plans subject to Title I of the Employee Retirement Income Security Act of 1974 ("ERISA"). Eligible employees contributing to the Plan may receive certain employer contributions including matching contributions and a 10% discount on the purchase of KeySpan Common Stock in the Plan. The matching contributions were in KeySpan's common stock until January 2006. The matching contributions as now determined at the election of KeySpan employees. For the years ended December 31, 2005, 2004 and 2003, we recorded an expense of $15.2 million, $14.7 million, and $11.2 million, respectively.
Note 5. Capital Stock
Common Stock: Currently we have 450,000,000 shares of authorized common stock. At December 31, 2005, we had 10.5 million shares, or $303.9 million of treasury stock outstanding. During 2005, we issued 1.4 million shares out of treasury for the dividend reinvestment feature of our Investor Program, the Employee Stock Discount Stock Purchase Plan, the 401(k) Plan and the Long-Term Incentive Compensation Plan.
On May 16, 2005, KeySpan issued 12.1 million shares of common stock, in association with the MEDS Equity Units conversion, at an issuance price of $37.93 per share pursuant to the terms of the forward purchase contract. KeySpan received proceeds of approximately $460 million from the equity conversion. The number of shares issued was dependent on the average closing price of our common stock over the 20 day trading period ending on the third trading day prior to May 16, 2005. (See Note 6 "Long-Term Debt and Commercial Paper" for further details on the MEDS Equity Units.)
Preferred Stock: We have the authority to issue 100,000,000 shares of preferred stock with the following classifications: 16,000,000 shares of preferred stock, par value $25 per share; 1,000,000 shares of preferred stock, par value $100 per share; and 83,000,000 shares of preferred stock, par value $.01 per share.
At December 31, 2004 we had 553,000 shares outstanding of 7.07% Mandatory Redeemable Preferred Stock Series B par value $100 redeemable in 2005; and 197,000 shares outstanding of 7.17% Mandatory Redeemable Preferred Stock Series C par value $100 redeemable in 2008.
In May 2005, $55.3 million of 7.07% Series B preferred stock was redeemed on its scheduled redemption date. Additionally, also in May 2005, KeySpan called for the optional redemption of $19.7 million of 7.17% Series C of Preferred Stock due 2008. KeySpan no longer has preferred stock outstanding.
Note 6. Long-Term Debt And Commercial Paper
Notes Payable: KEDLI had $125 million of Medium-Term Notes at 6.90% due January 15, 2008, and $400 million of 7.875% Medium-Term Notes due February 1, 2010, outstanding at December 31, 2005 and 2004, each of which is guaranteed by KeySpan.
KeySpan also had $1.96 billion of medium and long term notes outstanding at December 31, 2004 of which $950 million of these notes were associated with the acquisition of Eastern and ENI. These notes were issued in two series as follows: $700 million of 7.625% Notes due 2010 and $250 million of 8.00% Notes due 2030. The remaining debt of approximately $1 billion had interest rates ranging from 4.65% to 9.75%.
During 2005, KeySpan redeemed $500 million 6.15% Notes due 2006 series. We applied the provisions of SFAS 145 "Rescission of FASB Statement No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections" and recorded an expense of $20.9 million associated with call premiums and wrote-off $1.3 million of previously deferred financing costs. Further, KeySpan accelerated the amortization of approximately $11.2 million of previously unamortized benefits associated with an interest rate swap on these bonds. The accelerated amortization was recorded as a reduction to interest expense on the Consolidated Statement of Income. In addition, during the first quarter of 2005, $15 million of 8.87% notes of a KeySpan subsidiary were redeemed at maturity.
Further, in association with the MEDS Equity Units conversion, KeySpan converted $460 million of MEDS Equity Units into $467.2 million of medium and long term bonds. (For further details on the MEDS Equity Units see "MEDS Equity Units" below.) As a result of the aforementioned transactions, at December 31, 2005 KeySpan had $2.4 billion of notes outstanding with interest rates ranging from 4.65% to 9.75% that mature in 2006-2035.
Gas Facilities Revenue Bonds: KEDNY can issue tax-exempt bonds through the New York State Energy Research and Development Authority ("NYSERDA"). Whenever bonds are issued for new gas facilities projects, proceeds are deposited in trust and subsequently withdrawn to finance qualified expenditures. There are no sinking fund requirements on any of our Gas Facilities Revenue Bonds ("GFRBs"). At December 31, 2005, $640.5 million of GFRBs were outstanding. The interest rate on the variable rate series due through December 1, 2026 is reset weekly and ranged from 1.40% to 2.95% during the year ended December 31, 2005, at which time the rate was 2.85%.
In November 2005, KEDNY, issued $137 million of tax-exempt GFRBs through the NYSERDA in the following series: (i) $82 million of 4.70% GFRB, 2005 Series A (the "Series A Bonds"); and (ii) $55 million GFRB, 2005 Series B (the "Series B Bonds"). The interest rate on the Series B bonds is re-set every seven days through an auction process and at December 31, 2005 the interest rate on these bonds was 3.15%. KEDNY used the proceeds from this issuance to redeem the following three series: (i) $41 million Adjustable Rate GFRB Series 1989 A due February 2024; (ii) $41 million Adjustable Rate GFRB Series 1989 B due February 2024; and (iii) $55 million 5.60% GFRB Series 1993 C due June 2025. KEDNY incurred $3.7 million in call premiums and financing fees, all of which have been deferred for future rate recovery.
In December 2005, KEDNY converted $50 million of fixed rate GFRB's (5.64% GFRB Series D1 and D2 due 2026) into variable rate debt. The interest rate on these bonds is reset, through an auction process, every seven days. At December 31, 2005 the interest rate was 3.00%.
Promissory Notes to LIPA: In connection with the KeySpan/LILCO transaction, KeySpan and certain of its subsidiaries issued promissory notes to LIPA to support certain debt obligations assumed by LIPA. At December 31, 2005, $155.4 million of these promissory notes remained outstanding. Under these promissory notes, KeySpan is required to obtain letters of credit to secure its payment obligations if its long-term debt is not rated at least in the "A" range by at least two nationally recognized statistical rating agencies. At December 31, 2005, KeySpan was in compliance with this requirement.
MEDS Equity Units: At December 31, 2004, KeySpan had $460 million of MEDS Equity Units outstanding at 8.75% consisting of a three-year forward purchase contract for our common stock and a six-year note. The purchase contract required us, three years from the date of issuance of the MEDS Equity Units, May 16, 2005, to issue and the investors to purchase, a number of shares of our common stock based on a formula tied to the market price of our common stock at that time. The 8.75% coupon was composed of interest payments on the six-year note of 4.9% and premium payments on the three-year equity forward contract of 3.85%.
In 2005, KeySpan was required to remarket the note component of the Equity Units between February 2005 and May 2005 and reset the interest rate to the then current market rate of interest; however, the reset interest rate could not be set below 4.9%. In March 2005, KeySpan remarketed the note component of $394.9 million of the Equity Units at the reset interest rate of 4.9% through their maturity date of May 2008. The balance of the notes ($65.1 million) were held by the original MEDS equity holders in accordance with their terms and not remarketed. KeySpan then exchanged $300 million of the remarketed notes for $307.2 million of new 30 year notes bearing an interest rate of 5.8%. Therefore, KeySpan now has $160 million of 4.9% notes outstanding with a maturity date of May 2008 and $307.2 million of 5.8% notes outstanding with a maturity date of April 2035 that are classified as Medium and Long Term Notes.
On May 16, 2005 KeySpan issued 12.1 million shares of common stock, at an issuance price of $37.93 per share, pursuant to the terms of the financial purchase contract described above. KeySpan received proceeds of approximately $460 million from the equity conversion. The number of shares issued was dependent on the average closing price of our common stock over the 20 day trading period ending on the third trading day prior to May 16, 2005.
Industrial Development Revenue Bonds: At December 31, 2005 KeySpan had outstanding $128.3 million of tax-exempt bonds with a 5.25% coupon maturing in June 2027. Fifty-three million dollars of these Industrial Development Revenue Bonds were issued in its behalf through the Nassau County Industrial Development Authority for the construction of the Glenwood electric-generation peaking plant and the balance of $75 million was issued in its behalf by the Suffolk County Industrial Development Authority for the Port Jefferson Energy Center an electric-generation peaking plant. KeySpan has guaranteed all payment obligations of these subsidiaries with regard to these bonds.
First Mortgage Bonds: Colonial Gas Company had outstanding $95.0 million of first mortgage bonds at December 31, 2005. These bonds are secured by gas utility property. The first mortgage bond indentures include, among other provisions, limitations on: (i) the issuance of long-term debt; (ii) engaging in additional lease obligations; and (iii) the payment of dividends from retained earnings. At December 31, 2005, these bonds remain outstanding and have interest rates ranging from 6.08% to 8.80% and maturities that range from 2008-2028.
Authority Financing Notes: Certain of our electric generation subsidiaries can issue tax-exempt bonds through the NYSERDA. At December 31, 2005, $41.1 million of Authority Financing Notes 1999 Series A Pollution Control Revenue Bonds due October 1, 2028 were outstanding. The interest rate on these notes is reset based on an auction procedure. The interest rate during 2005 ranged from 1.40% to 2.85%, through December 31, 2005, at which time the rate was 3.00%.
We also have outstanding $24.9 million variable rate 1997 Series A Electric Facilities Revenue Bonds due December 1, 2027. The interest rate on these bonds is reset weekly and ranged from 1.47% to 3.42% for the year ended December 31, 2005, at which time the rate was 3.42%.
Ravenswood Master Lease: We have an arrangement with an unaffiliated variable interest financing entity through which we lease a portion of the Ravenswood Facility. We acquired the Ravenswood Facility, in part, through the variable interest entity, from the Consolidated Edison Company of New York ("Consolidated Edison") on June 18, 1999 for approximately $597 million. In order to reduce the initial cash requirements, we entered into a lease agreement (the "Master Lease") with the variable interest entity that acquired a portion of the facility, or three steam generating units, directly from Consolidated Edison and leased it to a KeySpan subsidiary. The variable interest financing entity acquired the property for $425 million, financed with debt of $412.3 million (97% of capitalization) and equity of $12.7 million (3% of capitalization). KeySpan has no ownership interests in the units or the variable interest entity. KeySpan has guaranteed all payment and performance obligations of our subsidiary under the Master Lease. Monthly lease payments are substantially equal to the monthly interest expense on the debt securities.
We have classified the Master Lease as $412.3 million of long-term debt on the Consolidated Balance Sheet based on our current status as primary beneficiary as defined in Financial Accounting Standards Board Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51." Further, we have an asset on the Consolidated Balance Sheet for an amount substantially equal to the fair market value of the leased assets at the inception of the lease, less depreciation since that date, or approximately $322.8 million. Under the terms of our credit facilities, the Master Lease is considered debt in the ratio of debt-to-total capitalization. (See Note 7 "Contractual Obligations, Financial Guarantees and Contingencies" for additional information regarding the leasing arrangement associated with the Master Lease Agreement.)
Commercial Paper and Revolving Credit Agreements: In June 2005, KeySpan closed on a $920 million revolving credit facility for five years due June 24, 2010, which was syndicated among fifteen banks, and an amended $580 million revolving credit facility due June 24, 2009. These facilities replaced an existing $660 million, 3-year facility due June 2006, and a 5-year $640 million facility due June 2009. The two credit facilities, which now total $1.5 billion - $920 million for five years through 2010, and $580 million for the amended facility through 2009, will continue to support KeySpan's commercial paper program for ongoing working capital needs.
The fees for the facilities are based on KeySpan's current credit ratings and are increased or decreased based on a downgrading or upgrading of our ratings. The current annual facility fee is 0.07% based on our credit rating of A3 by Moody's Investor Services and A by Standard & Poor's for each facility. Both credit facilities allow for KeySpan to borrow using several different types of loans; specifically, Eurodollar loans, ABR loans, or competitively bid loans. Eurodollar loans are based on the Eurodollar rate plus a margin that is tied to our applicable credit ratings. ABR loans are based on the higher of the Prime Rate, the base CD rate plus 1%, or the Federal Funds Effective Rate plus 0.5%. Competitive bid loans are based on bid results requested by KeySpan from the lenders. We do not anticipate borrowing against these facilities; however, if the credit rating on our commercial paper program were to be downgraded, it may be necessary to do so.
The facilities contain certain affirmative and negative operating covenants, including restrictions on KeySpan's ability to mortgage, pledge, encumber or otherwise subject its utility property to any lien, as well as certain financial covenants that require us to, among other things, maintain a consolidated indebtedness to consolidated capitalization ratio of no more than 65% at the last day of any fiscal quarter. Violation of these covenants could result in the termination of the facilities and the required repayment of amounts borrowed thereunder, as well as possible cross defaults under other debt agreements. At December 31, 2005, KeySpan's consolidated indebtedness was 50.7% of its consolidated capitalization and KeySpan was in compliance with all covenants.
Subject to certain conditions set forth in the credit facility, KeySpan has the right, at any time, to increase the commitments under the $920 million facility up to an additional $300 million. In addition, KeySpan has the right to request that the termination date be extended for an additional period of 365 days prior to each anniversary of the closing date. This extension option, however, requires the approval of lenders holding more than 50% of the total commitments to such extension request. Under the agreements, KeySpan has the ability to replace non-consenting lenders with other pre-approved banks or financial institutions.
At December 31, 2005, we had cash and temporary cash investments of $124.5 million. During 2005, we repaid $254.6 million of commercial paper and, at December 31, 2005, $657.6 million of commercial paper was outstanding at a weighted average annualized interest rate of 4.38%. At December 31, 2005, KeySpan had the ability to issue up to an additional $842 million, under its commercial paper program.
Capital Leases: Our subsidiaries lease certain facilities and equipment under long-term leases, which expire on various dates through 2014. The weighted average interest rate on these obligations was 6.0%.
Debt Maturity: The following table reflects the maturity schedule for our debt repayment requirements, including capitalized leases and related maturities, at December 31, 2005:
- ----------------------------------------------------------------------------- - ----------------------------------------------------------------------------- Long-Term Capital (In Millions of Dollars) Debt Leases Total - ----------------------------------------------------------------------------- Repayments: 2006 $ 12.0 $ 1.0 $ 13.0 2007 - 1.1 1.1 2008 305.0 1.1 306.1 2009 412.3 1.2 413.5 2010 1,110.0 1.3 1,111.3 Thereafter 2,095.4 5.1 2,100.5 - ----------------------------------------------------------------------------- $ 3,934.7 $ 10.8 $ 3,945.5 - -----------------------------------------------------------------------------
Note 7. Contractual Obligations, Financial Guarantees and Contingencies
Lease Obligations: Lease costs included in operating expense were $76.5 million in 2005 including, the lease of KeySpan's Brooklyn headquarters of $14.1million. Further, in March 2005, KeySpan renegotiated the lease of the Brooklyn headquarters. The original agreement was to expire in 2012. The current lease will expire in 2025. Yearly lease expense is approximately $11.7 million. In May 2004 KeySpan entered into a leveraged lease financing arrangement associated with the Ravenswood Expansion. The yearly operating lease expense is approximately $17 million per year. (See the caption below "Sale/Leaseback Transaction" for further details of this lease.) Lease costs also include leases for other buildings, office equipment, vehicles and power operated equipment. Lease costs for the year ended December 31, 2004 and 2003 were $67.7 million and $82.1 million, respectively. As previously mentioned, the Master Lease is consolidated and, as a result, lease payments are reflected as interest expense on the Consolidated Statement of Income. The future minimum cash lease payments under various leases, excluding the Master Lease, but including the Ravenswood Expansion lease, all of which are operating leases, are $100.6 million per year over the next five years and $652.4 million, in the aggregate, for all years thereafter. (See discussion below for further information regarding the Master Lease and the Ravenswood Expansion sale/leaseback transaction.)
Variable Interest Entity: As mentioned, KeySpan has an arrangement with an unaffiliated variable interest financing entity through which we lease a portion of the Ravenswood Facility. We acquired the Ravenswood Facility, a 2,200-megawatt electric generating facility located in Queens, New York, in part, through the variable interest entity from Consolidated Edison on June 18, 1999 for approximately $597 million. In order to reduce the initial cash requirements, we entered into the Master Lease with the variable interest entity that acquired a portion of the facility, or three steam generating units, directly from Consolidated Edison and leased it to our subsidiary. The variable interest entity acquired the property for $425 million, financed with debt of $412.3 million (97% of capitalization) and equity of $12.7 million (3% of capitalization). KeySpan has no ownership interests in the units or the variable interest entity. KeySpan has guaranteed all payment and performance obligations of our subsidiary under the Master Lease. Monthly lease payments substantially equal the monthly interest expense on such debt securities. Interest expense for the year ended December 31, 2005 was $29.7 million.
The term of the Master Lease extends through June 20, 2009. On all future semi-annual payment dates, we have the right to: (i) purchase the facility for the original acquisition cost of $425 million, plus the present value of the lease payments that would otherwise have been paid through June 2009; or (ii) terminate the Master Lease and dispose of the facility. In June 2009, when the Master Lease terminates, we may purchase the facility in an amount equal to the original acquisition cost, subject to adjustment, or surrender the facility to the lessor. If we elect not to purchase the property, the Ravenswood Facility will be sold by the lessor. We have guaranteed to the lessor 84% of the residual value of the original cost of the property.
We have classified the Master Lease as $412.3 million of long-term debt on the Consolidated Balance Sheet based on our current status as primary beneficiary. Further, we have an asset on the Consolidated Balance Sheet for an amount substantially equal to the fair market value of the leased assets at the inception of the lease, less depreciation since that date, or approximately $322.8 million.
If our subsidiary that leases the Ravenswood Facility was not able to fulfill its payment obligations with respect to the Master Lease payments, then the maximum amount KeySpan would be exposed to under its current guarantees would be $425 million plus the present value of the remaining lease payments through June 20, 2009.
Sale/leaseback Transaction: KeySpan also has a leveraged lease financing arrangement associated with the Ravenswood Expansion. In May 2004, the unit was acquired by a lessor from our subsidiary, KeySpan Ravenswood, LLC, and simultaneously leased back to that subsidiary. All the obligations of KeySpan Ravenswood, LLC have been unconditionally guaranteed by KeySpan. This lease transaction generated cash proceeds of $385 million, before transaction costs, which approximates the fair market value of the facility, as determined by a third-party appraiser. This lease transaction qualifies as an operating lease under SFAS 98 "Accounting for Leases: Sale/Leaseback Transactions Involving Real Estate; Sales-Type Leases of Real Estate; Definition of the Lease Term; an Initial Direct Costs of Direct Financing Leases, an amendment of FASB Statements No.13, 66, 91 and a rescission of FASB Statement No. 26 and Technical Bulletin No. 79-11." The lease has an initial term of 36 years and the yearly operating lease expense is approximately $17 million per year. Lease payments will fluctuate from year to year, but are substantially paid over the first 16 years. The future minimum cash lease payments under this lease is approximately $152 million over the next five years and $417 million, in the aggregate, for all years thereafter. The sale/leaseback transaction resulted in a pre-tax gain of approximately $6 million which has been deferred and is being amortized over the life of the lease.
Asset Retirement Obligations:
On December 31, 2005, KeySpan implemented FIN 47 "Accounting for Conditional Asset Retirement Obligations." FIN 47 was issued to clarify that the term conditional asset obligation used in SFAS 143 "Accounting for Asset Retirement Obligations" refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. Previously, KeySpan adopted SFAS 143 on January 1, 2003. SFAS 143 required us to record a liability and corresponding asset representing the present value of legal obligations associated with the retirement of tangible, long-lived assets that existed at the inception of the obligation.
At December 31, the following asset retirement obligations are recorded on the Consolidated Balance Sheet at their estimated present values:
(i) Asbestos-containing materials was deemed to exist in roof flashing, floor tiles, pipe insulation and mechanical room insulation within our common facilities as well as in our older generation plants. KeySpan has a legal obligation to remove asbestos upon either a major renovation or demolition.
(ii) KeySpan has numerous storage tanks that contain among other things waste oil, #2 and #6 fuel oil, diesel fuel, multi chemicals, lube oil, kerosene, ammonia, and other waste contaminants. All of these tanks are subject to cleaning and removal requirements prior to demolition and retirement if so specified by law or regulation.
(iii) KeySpan has a legal requirement to cut (disconnect from the gas distribution system), purge (clean of natural gas and PCB contaminants) and cap gas mains within its gas distribution and transmission system when mains are retired in place. Gas mains are generally abandoned in place when retired, unless the main and other equipment needs to be removed due to sewer or water system rerouting or other roadblock work. When such main and equipment are removed certain PCB test procedures must be employed.
(iv) KeySpan owns approximately 52% of an underground gas storage facility in western New York State. The facility includes 39 gas injection and extraction wells. There is a regulatory obligation to close and seal the wells.
(v) KeySpan owns a 600,000 gallon barrel Liquefied Natural Gas ("LNG") tank and ancillary facilities located in Providence, RI under a 30 year contract with New England Gas Company. At the end of the contract, the contract can be; (i) Extended; or (ii) New England Gas Company can require KeySpan to
dismantle and remove the LNG tank and ancillary facilities or; (iii) KeySpan can elect to dismantle and remove the LNG tank and ancillary facilities. Since we may or may not be required to dismantle and remove the LNG tank and ancillary facilities, the obligation to perform was discounted to a 50% probability as allowed under FIN 47.
(vi) KeySpan has several wastewater treatment ponds associated with certain of its power stations. There are closure requirements for wastewater treatment pond systems based on regulations promulgated by the State of New York which were effective May 11, 2003.
(vii) KeySpan Communications has portions of its fiber optic network (underground and above ground) that are required to be removed upon termination of various agreements.
(viii) KeySpan has a regulatory obligation to close and seal the wells primarily associated with its gas exploration and production activities.
Financial Guarantees: KeySpan has issued financial guarantees in the normal course of business, primarily on behalf of its subsidiaries, to various third party creditors. At December 31, 2005, the following amounts would have to be paid by KeySpan in the event of non-payment by the primary obligor at the time payment is due:
The following is a description of KeySpan's outstanding subsidiary guarantees:
(i) KeySpan has fully and unconditionally guaranteed $525 million to holders of Medium-Term Notes issued by KEDLI. These notes are due to be repaid on January 15, 2008 and February 1, 2010. KEDLI is required to comply with certain financial covenants under the debt agreements. The face values of these notes are included in long-term debt on the Consolidated Balance Sheet.
(ii) KeySpan has fully and unconditionally guaranteed the payment obligations of its subsidiaries with regard to $128 million of Industrial Development Revenue Bonds issued through the Nassau County and Suffolk County Industrial Development Authorities for the construction of two electric-generation peaking plants on Long Island. The face values of these notes are included in long-term debt on the Consolidated Balance Sheet.
(iii) KeySpan has guaranteed all payment and performance obligations of KeySpan Ravenswood, LLC, the lessee under the Master Lease. The term extends through June 20, 2009. The Master Lease is classified as $412.3 million long-term debt on the Consolidated Balance Sheet.
(iv) KeySpan has guaranteed all payment and performance obligations of KeySpan Ravenswood, LLC, the lessee under the sale/leaseback transaction associated with the 250 MW Ravenswood Expansion, including future decommissioning costs. The initial term of the lease is for 36 years. As noted previously, this lease qualifies as an operating lease and is not reflected on the Consolidated Balance Sheet.
(v) KeySpan has agreed to indemnify the issuers of various surety and performance bonds associated with certain construction projects being performed by certain current or former subsidiaries. In the event that the subsidiaries fail to perform their obligations under contracts, the injured party may demand that the surety make payments or provide services under the bond. KeySpan would then be obligated to reimburse the surety for any expenses or cash outlays it incurs. Although KeySpan is not guaranteeing any new bonds for any of the former subsidiaries, KeySpan's indemnity obligation supports the contractual obligation of these former subsidiaries. KeySpan has also received from a former subsidiary an indemnity bond issued by a third party insurance company, the purpose of which is to reimburse KeySpan in an amount up to $80 million in the event it is required to perform under all other indemnity obligations previously incurred by KeySpan to support such company's bonded projects existing prior to divestiture. At December 31, 2005, the total cost to complete such remaining bonded projects is estimated to be approximately $40.2 million.
(vi) KeySpan has guaranteed commodity-related payments for subsidiaries within the Energy Services segment, as well as for KeySpan Ravenswood, LLC. These guarantees are provided to third parties to facilitate physical and financial transactions involved in the purchase of natural gas, oil and other petroleum products for electric production and marketing activities. The guarantees cover actual purchases by these subsidiaries that are still outstanding as of December 31, 2005.
(vii) KeySpan has arranged for stand-by letters of credit to be issued to third parties that have extended credit to certain subsidiaries. Certain vendors require us to post letters of credit to guarantee subsidiary performance under our contracts and to ensure payment to our subsidiary subcontractors and vendors under those contracts. Certain of our vendors also require letters of credit to ensure reimbursement for amounts they are disbursing on behalf of our subsidiaries, such as to beneficiaries under our self-funded insurance programs. Such letters of credit are generally issued by a bank or similar financial institution. The letters of credit commit the issuer to pay specified amounts to the holder of the letter of credit if the holder demonstrates that we have failed to perform specified actions. If this were to occur, KeySpan would be required to reimburse the issuer of the letter of credit.
To date, KeySpan has not had a claim made against it for any of the above guarantees and we have no reason to believe that our subsidiaries or former subsidiaries will default on their current obligations. However, we cannot predict when or if any defaults may take place or the impact any such defaults may have on our consolidated results of operations, financial condition or cash flows.
Fixed Charges Under Firm Contracts: Our utility subsidiaries and the Ravenswood Generation Station have entered into various contracts for gas delivery, storage and supply services. Certain of these contracts require payment of annual demand charges in the aggregate amount of approximately $492.7 million. We are liable for these payments regardless of the level of service we require from third parties. Such charges associated with gas distribution operations are currently recovered from utility customers through the gas adjustment clause.
Legal Matters
From time to time we are subject to various legal proceedings arising out of the ordinary course of our business. Except as described below, we do not consider any of such proceedings to be material to our business or likely to result in a material adverse effect on our results of operations, financial condition or cash flows.
KeySpan and certain of its current and former officers and directors were named as defendants in a shareholder derivative action asserting claims on behalf of KeySpan based upon breach of fiduciary duty. The complaint, which was filed in the New York State Supreme Court for the County of Kings on February 9, 2005, also relates to the 2001 Roy Kay-related losses and alleges that KeySpan's directors and certain senior officers breached their fiduciary duties when they placed their own personal interests above the interests of KeySpan by using material non-public information (the fraud at Roy Kay) to sell securities at artificially inflated prices. On January 3, 2006, the parties entered into a settlement agreement to settle the action for a nominal sum of $250,000 for plaintiff's counsel fees and for KeySpan to implement certain corporate governance practices. The settlement agreement is subject to court approval, the timing of which cannot be predicted. While KeySpan denies any wrongdoing, we believe the settlement is in the best interest of KeySpan and its shareholders.
KeySpan subsidiaries, along with several other parties, have been named as defendants in numerous proceedings filed by plaintiffs claiming various degrees of injury from asbestos exposure at generating facilities formerly owned by LILCO and others. In connection with the May 1998 transaction with LIPA, costs incurred by KeySpan for liabilities for asbestos exposure arising from the activities of the generating facilities previously owned by LILCO are recoverable from LIPA through the PSA between LIPA and KeySpan.
KeySpan is unable to determine the outcome of the outstanding asbestos proceedings, but does not believe that such outcome, if adverse, will have a material effect on its financial condition, results of operation or cash flows. KeySpan believes that its cost recovery rights under the 1998 and 2006 PSA, its indemnification rights against third parties and its insurance coverage (above applicable deductible limits) cover its exposure for asbestos liabilities generally.
Other Contingencies: We derive a substantial portion of our revenues in our Electric Services segment from a series of agreements with LIPA pursuant to which we manage LIPA's transmission and distribution system and supply the majority of LIPA's customers' electricity needs. KeySpan and LIPA have entered into agreements to extend, amend, and restate these contractual arrangements. See Note 11 "2006 LIPA Settlement" for a further discussion these agreements.
LIPA completed its strategic review initiative that it had undertaken in connection with among other reasons, its option under the Generation Purchase Rights Agreement As part of its review, LIPA engaged a team of advisors and consultants, held public hearings and explored its strategic options, including continuing its existing operations, municipalizing, privatizing, selling some, but not all of its assets, becoming a regulator of rates and services, or merging with one or more utilities. Upon completion of its strategic review, LIPA determined that it would continue its existing operations, as part of its settlement with KeySpan and the renegotiated 2006 LIPA Agreements noted above. The 2006 LIPA Agreements are subject to governmental approvals, and if such governmental approvals are not received then LIPA may revisit its strategic review alternatives.
Environmental Matters
Air: Our generating facilities are located within a Clean Air Act ("CAA") ozone non-attainment and PM 2.5 (fine particulate matter) non-attainment area, and are subject to Phase I, II and III NOx reduction requirements established under the Ozone Transport Commission memorandum of understanding and forthcoming requirements under the Clean Air Interstate Rule ("CAIR") designed to address both ozone and particulate matter. Our previous investments in low NOx boiler combustion modifications, the use of natural gas firing systems at our steam electric generating stations, and the compliance flexibility available under these cap and trade programs, have enabled KeySpan to achieve the emission reductions required. KeySpan is developing its compliance strategy in response to the implementation of the CAIR rule, which is expected in 2009. Since detailed requirements under the CAIR rule have not yet been fully articulated, it is not possible to definitively estimate capital expenditures that may be required to meet these regulatory mandates. Although, it is anticipated that NOx control equipment may be required at one or more of the KeySpan's Long Island facilities at a cost between $25 to $35 million, such amounts are recoverable from LIPA pursuant to the 1998 PSA or if applicable, the 2006 PSA.
Water: Additional capital expenditures associated with the renewal of the surface water discharge permits for our power plants will likely be required by the Department of Environmental Conservation ("DEC"). We are currently conducting studies as directed by the DEC to determine the impacts of our discharges on aquatic resources and are engaged in discussions with the DEC regarding the nature of capital upgrades or other mitigation measures necessary to satisfy these evolving regulatory requirements. It is not possible at this time to predict the extent of such capital investments but these upgrades are expected to cost up to $60 million, however, such amounts are recoverable from LIPA pursuant to the 1998 PSA or if applicable, the 2006 PSA. The Ravenswood Generating Station may also require upgrades at a cost of up to $15 million. The actual expenditures will depend upon the outcome of the ongoing studies and the subsequent determination by the DEC of how to apply the standards set forth in recently promulgated federal regulations under Section 316 of the Clean Water Act designed to mitigate such impacts.
Land, Manufactured Gas Plants and Related Facilities During 2005, KeySpan undertook an extensive review of all its current and former properties that are or may be subject to environmental cleanup activities. As a result of this study, we adjusted reserve balances for estimated manufactured gas plant ("MGP") related environmental cleanup activities. Through various rate orders issued by the NYPSC, MADTE and NHPUC, costs related to MGP environmental cleanup activities are recovered in rates charged to gas distribution customers and, as a result, adjustments to these reserve balances do not impact earnings.
New York Sites: Within the State of New York we have identified 43 historical MGP sites and related facilities, which were owned or operated by KeySpan subsidiaries or such companies' predecessors. These former sites, some of which are no longer owned by us, have been identified to the NYPSC and the DEC for inclusion on appropriate site inventories. Administrative Orders on Consent ("ACO") or Voluntary Cleanup Agreements ("VCA") have been executed with the DEC to address the investigation and remediation activities associated with certain sites and one waterway. In March 2005, KeySpan withdrew its previously filed applications under the DEC's Brownfield Cleanup Program ("BCP") because of the uncertainty associated with contribution suits which we may need to bring against other parties who impacted these sites for their share of remedial cost. As a result of the December 2004 Cooper Industries v. Aviall Services, Inc. decision by the United States Supreme Court and the emerging case law in New York, KeySpan continues to evaluate how to proceed with respect to participation in the BCP or alternative DEC remediation programs.
We have identified 28 of these sites as being associated with the historical operations of KEDNY. One site has been fully remediated. Subject to the issues described in the preceding paragraph, the remaining 27 sites will be investigated and, if necessary, remediated under the terms and conditions of ACOs, VCAs or Brownfield Cleanup Agreements ("BCA"). Expenditures incurred to date by us with respect to KEDNY MGP-related activities total $60.9 million.
The remaining 15 sites have been identified as being associated with the historical operations of KEDLI. Expenditures incurred to date by us with respect to KEDLI MGP-related activities total $51.8 million. One site has been fully investigated and requires no further action. The remaining sites will be investigated and, if necessary, remediated under the conditions of ACOs, VCAs or BCAs.
We presently estimate the remaining cost of our KEDNY and KEDLI MGP-related environmental remediation activities will be $355.3 million, which amount has been accrued by us as a reasonable estimate of probable cost for known sites, however remediation costs for each site may be materially higher than noted, depending upon changing technologies and regulatory standards, selected end use for each site, and actual environmental conditions encountered. Expenditures incurred to date by us with respect to these MGP-related activities total $112.7 million.
With respect to remediation costs, the KEDNY rate plan provides, among other things, that if the total cost of investigation and remediation varies from that which is specifically estimated for a site under investigation and/or remediation, then KEDNY will retain or absorb up to 10% of the variation. The KEDLI rate plan also provides for the recovery of investigation and remediation costs but with no consideration of the difference between estimated and actual costs. At December 31, 2005, we have reflected a regulatory asset of $388.0 million for our KEDNY/KEDLI MGP sites. In October 2003, KEDNY and KEDLI filed a joint petition with the NYPSC seeking rate treatment for additional environmental costs that may be incurred in the future. That petition is still pending.
We are also responsible for environmental obligations associated with the Ravenswood Facility, purchased from Consolidated Edison in 1999, including remediation activities associated with its historical operations and those of the MGP facilities that formerly operated at the site. We are not responsible
for liabilities arising from disposal of waste at off-site locations prior to the acquisition closing and any monetary fines arising from Consolidated Edison's pre-closing conduct. We presently estimate the remaining environmental clean up activities for this site will be $1.7 million, which amount has been accrued by us. Expenditures incurred to date total $3.3 million.
New England Sites: Within the Commonwealth of Massachusetts and the State of New Hampshire, we are aware of 74 former MGP sites and related facilities within the existing or former service territories of KEDNE.
Boston Gas Company, Colonial Gas Company and Essex Gas Company may have or share responsibility under applicable environmental laws for the remediation of 64 of these sites. A subsidiary of National Grid USA ("National Grid"), formerly New England Electric System, has assumed responsibility for remediating 11 of these sites, subject to a limited contribution from Boston Gas Company, and has provided full indemnification to Boston Gas Company with respect to eight other sites. In addition, Boston Gas Company, Colonial Gas Company, and Essex Gas Company have assumed responsibility for remediating three sites each. At this time, it is uncertain as to whether Boston Gas Company, Colonial Gas Company or Essex Gas Company have or share responsibility for remediating any of the other sites. No notice of responsibility has been issued to us for any of these sites from any governmental environmental authority.
We presently estimate the remaining cost of these Massachusetts KEDNE MGP-related environmental cleanup activities will be $15.5 million, which amount has been accrued by us as a reasonable estimate of probable cost for known sites, however remediation costs for each site may be materially higher than noted, depending upon changing technologies and regulatory standards, selected end use for each site, and actual environmental conditions encountered. Expenditures incurred since November 8, 2000, the date KeySpan acquired Eastern Enterprises, with respect to these MGP-related activities total $27.9 million.
In 2004, Boston Gas Company reached settlements with certain insurance carriers for recovery of a portion of previously incurred environmental expenditures. Under a previously issued MADTE rate order, insurance and third-party recoveries, after deducting legal fees, are shared between Boston Gas and its firm gas customers. As a result of these settlements, in 2004 Boston Gas Company recorded a $5.0 million benefit to operations and maintenance expense.
We may have or share responsibility under applicable environmental laws for the remediation of 10 MGP sites and related facilities associated with the historical operations of EnergyNorth. At four of these sites we have entered into cost sharing agreements with other parties who share responsibility for remediation of these sites. EnergyNorth also has entered into an agreement with the United States Environmental Protection Agency ("EPA") for the contamination from the Nashua site that was allegedly commingled with asbestos at the so-called Nashua River Asbestos Site, adjacent to the Nashua MGP site.
We presently estimate the remaining cost of EnergyNorth MGP-related environmental cleanup activities will be $31.5 million, which amount has been accrued by us as a reasonable estimate of probable cost for known sites, however remediation costs for each site may be materially higher than noted, depending upon changing technologies and regulatory standards, selected end use for each site, and actual environmental conditions encountered. Expenditures incurred since November 8, 2000, with respect to these MGP-related activities total $17.0 million.
By rate orders, the MADTE and the NHPUC provide for the recovery of site investigation and remediation costs and, accordingly, at December 31, 2005, we have reflected a regulatory asset of $66.7 million for the KEDNE MGP sites. As previously mentioned, Colonial Gas Company and Essex Gas Company are not subject to the provisions of SFAS 71 and therefore have recorded no regulatory asset. However, rate orders currently in effect for these subsidiaries provide for the recovery of investigation and remediation costs.
KeySpan New England LLC Sites: We are aware of three non-utility sites associated with KeySpan New England, LLC, a successor company to Eastern Enterprises, for which we may have or share environmental remediation or ongoing maintenance responsibility. These three sites, located in Philadelphia, Pennsylvania, New Haven, Connecticut and Everett, Massachusetts, were associated with historical operations involving the production of coke and related industrial processes. Honeywell International, Inc. and Beazer East, Inc. (both former owners and/or operators of certain facilities at Everett ("the Everett Facility") together with KeySpan, entered into an ACO with the Massachusetts Department of Environmental Protection for the investigation and development of a remedial response plan for a portion of that site. KeySpan, Honeywell and Beazer East entered into a cost-sharing agreement under which each company agreed to pay one-third of the costs of compliance with the consent order, while preserving any claims against the other companies for, among other things, reallocation of proportionate liability. In 2002, Beazer East commenced an action in the U.S. District Court for the Southern District of New York, which sought a judicial determination on the allocation of liability for the Everett Facility. A confidential settlement agreement has been executed on favorable terms to KeySpan and the Beazer lawsuit has been discontinued.
In 2004, KeySpan reached a settlement with insurance carriers regarding cost recovery for expenses at one of the above noted sites and recorded an $11.6 million reduction to operating expenses. We presently estimate the remaining cost of our environmental cleanup activities for the three non-utility sites will be approximately $19.7 million, which amount has been accrued by us as a reasonable estimate of probable costs for known sites, however remediation costs for each site may be materially higher than noted, depending upon changing technologies and regulatory standards, selected end use for each site, and actual environmental conditions encountered. Expenditures incurred since November 8, 2000, with respect to these sites total $13.1 million.
We believe that in the aggregate, the accrued liability for these MGP sites and related facilities identified above are reasonable estimates of the probable cost for the investigation and remediation of these sites and facilities. As circumstances warrant, we periodically re-evaluate the accrued liabilities associated with MGP sites and related facilities. We may be required to investigate and, if necessary, remediate each site previously noted, or other currently unknown former sites and related facility sites, the cost of which is not presently determinable but may be material to our financial position, results of operations or cash flows.
Insurance Reimbursement of MGP Response Costs: We have instituted lawsuits in New York, Massachusetts and New Hampshire against numerous insurance carriers for reimbursement of costs incurred for the investigation and remediation of these MGP sites.
In January 1998 and July 2001, KEDLI and KEDNY, respectively, filed complaints for the recovery of its remediation costs in the New York State Supreme Court against the various insurance companies that issued general comprehensive liability policies to KEDLI and KEDNY. The outcome of these proceedings cannot yet be determined.
In March 1999, Boston Gas Company and a subsidiary of National Grid filed a complaint for the recovery of remediation costs in the Massachusetts Superior Court against various insurance companies that issued comprehensive general liability policies to National Grid and its predecessors with respect to, among other things, the 11 sites for which Boston Gas Company has agreed to make a limited contribution. And in October 2002, Boston Gas Company filed a complaint in the United States District Court - Massachusetts District against one of the insurance companies that issued comprehensive general liability policies to Boston Gas Company for its remaining sites. On November 14, 2005, the trial commenced on the declaratory judgment action of Boston Gas against Century Indemnity for insurance coverage for the costs incurred in the investigation and remediation at the former Boston Gas Everett MGP site and on December 6, 2005, the jury returned a verdict in favor of KeySpan. KeySpan anticipates that Century Indemnity will appeal this verdict. The outcome of these proceedings cannot yet be determined.
EnergyNorth has filed a number of lawsuits in both the New Hampshire Superior Court and the United States District Court for the District of New Hampshire for recovery of its remediation costs against the various insurance companies that issued comprehensive general liability and excess liability insurance policies to EnergyNorth and its predecessors. On October 5, 2004, EnergyNorth's case against the London Market Insurers for the costs incurred investigating and remediating the former MGP site in Laconia went to trial and on October 25, 2004, the jury returned a verdict in favor of EnergyNorth, finding that EnergyNorth was entitled to recover against London Market Insurers. The precise amount of the recovery will depend on the allocation calculations which the court has yet to apply to this case. We anticipate that London Market Insurers will appeal this verdict. On February 15, 2005, the trial of EnergyNorth's coverage action for the Dover MGP site began against the only remaining defendant, Century Indemnity (all other carriers settled prior to trial) and at the conclusion of the trial the federal judge directed a verdict in EnergyNorth's favor on all issues. Century filed an appeal with the First Circuit Court of Appeals and oral argument on Century's appeal was on January 13, 2006. A jury trial in the Nashua MGP action commenced against the London Market Insurers and Century Indemnity on November 1, 2005 and on November 14, 2005, the jury returned a verdict in favor of KeySpan finding that London and Century was obligated to indemnify EnergyNorth of response costs incurred at the site. We anticipate that the carriers will appeal this verdict. The outcome of these proceedings cannot yet be determined.
In 1993 KeySpan New England LLC filed a declaratory judgment action against the Hanover and Travelers insurance companies in the Superior Court for Middlesex County for the Everett Facility ("the Eastern Action"). Eastern sought to have the court compel the Insurers to defend Eastern in connection with the Massachusetts DEP's Notice of Responsibility ("NOR"). In 2004, the Court granted KeySpan's unopposed motion for leave to file a Second Amended Complaint in the Eastern Action to seek a declaratory ruling that the insurers have a duty to indemnify KeySpan for the costs associated with the Everett NOR and certain other related private actions. The Second Amended Complaint also adds certain excess insurance carriers as defendants in the Eastern Action. The outcome of this proceeding cannot yet be determined.
Note 8. Hedging, Derivative Financial Instruments and Fair Values
Financially-Settled Commodity Derivative Instruments - Hedging Activities: From time to time, KeySpan subsidiaries have utilized derivative financial instruments, such as futures, options and swaps, for the purpose of hedging the cash flow variability associated with changes in commodity prices. KeySpan is exposed to commodity price risk primarily with regard to its gas distribution operations, gas exploration and production activities and its electric generating facilities at the Ravenswood site.
Derivative financial instruments are employed by our gas distribution operations to reduce the cash flow variability associated with the purchase price for a portion of future natural gas purchases for our regulated firm gas sales customers. The accounting for these derivative instruments is subject to SFAS 71. See the caption below "Firm Gas Sales Derivative Instruments - Regulated Utilities" for a further discussion of these derivatives. During 2005 our gas distribution operations employed certain derivative instruments associated with large-volume customers that were not subject to SFAS 71. Those derivative financial instruments settled by year-end.
Seneca-Upshur utilizes OTC natural gas swaps to hedge the cash flow variability associated with forecasted sales of a portion of its natural gas production. At December 31, 2005, Seneca-Upshur has hedge positions in place for approximately 85% of its estimated 2005 through 2008 gas production, net of gathering costs. We use market quoted forward prices to value these swap positions. The maximum length of time over which Seneca-Upshur has hedged such cash flow variability is through December 2008. The fair value of these derivative instruments at December 31, 2005 was a liability of $21.8 million. The estimated amount of losses associated with such derivative instruments that are reported in other comprehensive income and that are expected to be reclassified into earnings over the next twelve months is $9.2 million, or approximately $6.0 million after-tax. Ineffectiveness associated with these outstanding derivative financial instruments was immaterial at December 31, 2005.
The Ravenswood Generating Station uses derivative financial instruments to hedge the cash flow variability associated with the purchase of natural gas or fuel oil that will be consumed during the generation of electricity. The Ravenswood Generating Station also hedges the cash flow variability associated with a portion of electric energy sales.
With respect to price exposure associated with fuel purchases for the Ravenswood Generating Station, KeySpan employed the use of financially-settled oil swap contracts to hedge the cash flow variability for a portion of forecasted purchases of fuel oil that was consumed by the Ravenswood Generating Station. We use market quoted forward prices to value oil swap contracts. The maximum length of time over which we have hedged cash flow variability associated with forecasted purchases of fuel oil is through June 2006. The fair value of these derivative instruments at December 31, 2005 was $0.3 million, which is reported in other comprehensive income and is expected to be reclassified into earnings within the next twelve months. Ineffectiveness associated with these outstanding derivative financial instruments was immaterial at December 31, 2005.
We have also engaged in the use of cash-settled swap instruments to hedge the cash flow variability associated with a portion of forecasted electric energy sales from the Ravenswood Generating Station. Our hedging strategy is to hedge at least 50% of forecasted on-peak summer season electric energy sales and a
portion of forecasted electric energy sales for the remainder of the year. The maximum length of time over which we have hedged cash flow variability is through August 2006. To accomplish our stated hedging strategy, KeySpan employs financially-settled electric-power swap contracts with offsetting financially-settled oil swap contracts and OTC natural gas swaps. We use market quoted forward prices to value the electric-power swap contracts. The fair value of these derivative instruments at December 31, 2005 was $9.5 million all of which is expected to be reclassified into earnings within the next twelve months. We use market quoted forward prices to value the oil swap contracts. The fair value of these derivative instruments at December 31, 2005 was a liability of $6.6 million all of which is expected to be reclassified into earnings within the next twelve months. We use market quoted forward prices to value the gas swap contracts. The fair value of these derivative instruments at December 31, 2005 was $0.5 million all of which is expected to be reclassified into earnings within the next twelve months. The after-tax benefit of these derivative instruments is anticipated to be $2.2 million. Ineffectiveness associated with these outstanding derivative financial instruments was immaterial at December 31, 2005.
The above noted derivative financial instruments are cash flow hedges that qualify for hedge accounting under SFAS 133 "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS 149 "Amendment of Statement 133 on Derivative Instruments and Hedging Activities," collectively SFAS 133, and are not considered held for trading purposes as defined by current accounting literature. Accordingly, we carry the fair value of our derivative instruments on the Consolidated Balance Sheet as either a current or deferred asset or liability, as appropriate, and defer the effective portion of unrealized gains or losses in accumulated other comprehensive income. Gains and losses are reclassified from accumulated other comprehensive income to the Consolidated Statement of Income in the period the hedged transaction affects earnings. Gains and losses are reflected as a component of either revenue or fuel and purchased power depending on the hedged transaction. Hedge ineffectiveness, which was negligible for the year ended December 31, 2005, results from changes during the period in the price differentials between the index price of the derivative contract and the price of the purchase or sale for the cash flow that is being hedged, and is recorded directly to earnings.
Firm Gas Sales Derivative Instruments - Regulated Utilities: We use derivative financial instruments to reduce the cash flow variability associated with the purchase price for a portion of future natural gas purchases associated with our Gas Distribution operations. Our strategy is to minimize fluctuations in firm gas sales prices to our regulated firm gas sales customers in our New York and New England service territories. The accounting for these derivative instruments is subject to SFAS 71. Therefore, changes in the fair value of these derivatives have been recorded as a regulatory asset or regulatory liability on the Consolidated Balance Sheet. Gains or losses on the settlement of these contracts are initially deferred and then refunded to or collected from our firm gas sales customers consistent with regulatory requirements. At December 31, 2005, these derivatives had a fair value of $ 157.6 million and are reflected as a current asset of $131.6 million and a deferred asset of $26.0 million, with offsetting positions in regulatory liabilities and deferred credits of $146.5 million and $11.1 million, respectively on the Consolidated Balance Sheet.
Physically-Settled Commodity Derivative Instruments: SFAS 133 establishes criteria that must be satisfied in order for option contracts, forward contracts with optionality features, or contracts that combine a forward contract and a purchase option contract to be exempted as normal purchases and sales. Certain contracts for the physical purchase of natural gas associated with our regulated gas utilities are not exempt as normal purchases from the requirements of SFAS
133. Since these contracts are for the purchase of natural gas sold to regulated firm gas sales customers, the accounting for these contracts is subject to SFAS 71. Therefore, changes in the market value of these contracts have been recorded as a regulatory asset or regulatory liability on the Consolidated Balance Sheet. At December 31, 2005, these derivatives had a fair value of $18.4 million and are reflected as a deferred asset of $49.2 million and a regulatory asset of $30.9 million with offsetting positions in regulatory liabilities, current liabilities and deferred credits of $28.9 million, $30.6 million and $20.6 million, respectively on the Consolidated Balance Sheet.
The table below summarizes the fair value of the above outstanding derivative instruments at December 31, 2005 and December 31, 2004, and the related line item on the Consolidated Balance Sheet. Fair value is the amount at which derivative instruments could be exchanged in a current transaction between willing parties, other than in a forced liquidation sale.
- ----------------------------------------------------------------------------- (In Millions of Dollars) December 31, 2005 December 31, 2004 - ----------------------------------------------------------------------------- Gas Contracts: Other current assets $ 132.1 $ - Other deferred charges 75.2 21.7 Regulatory asset 30.9 20.1 Other current liability (39.8) - Other deferred liabilities (44.3) (43.9) Regulatory liability (175.4) (7.4)
Oil Contracts: Other current assets 0.5 0.3 Other deferred charges - 7.5 Other current liability (6.8) -
Electric Contracts: Other current assets 10.2 0.3 Other current liability (0.7) - ----------------------------------------------------------------------------- $ (18.1) $ (1.4) - -----------------------------------------------------------------------------
Financially-Settled Commodity Derivative Instruments that Do Not Qualify for Hedge Accounting: KeySpan subsidiaries also have employed a limited number of financial derivatives that do not qualify for hedge accounting treatment under SFAS 133. During 2004, we purchased a series of call options on the spread between the price of heating oil and the price of natural gas to further complement our hedging strategy regarding sales to certain large-volume customers. As stated, these positions settled prior to year end. In addition, the Ravenswood Generating Station sold a three year option for 30-day peaking gas service. The 30-day peaking gas service is for the following three winter seasons: October 2004 - March 2005, October 2005 - March 2006 and October 2006 - March 2007. For each of these winter seasons, the counterparty can call on the Ravenswood Generating Station to supply no more than 30,000 Mdth of a gas a day for no more than 30 days. We recorded a $0.8 million gain in other income and deductions on the Consolidated Statement of Income to reflect the change in the market value associated with this derivative instrument for the twelve months ended December 31, 2005.
Interest Rate Derivative Instruments: In January 2005, KeySpan redeemed $500 million of outstanding debt - 6.15% Notes due 2006, and accelerated the amortization of approximately $11.2 million of previously unamortized benefits associated with an interest rate swap on these notes that was previously settled. The accelerated amortization was recorded as a reduction to interest expense. (See Note 6 "Long-term Debt and Commercial Paper" for additional details regarding the debt redemption.) There were no interest rate derivative instruments outstanding at December 31, 2005.
Weather Derivatives: The utility tariffs associated with KEDNE's operations do not contain weather normalization adjustments. As a result, fluctuations from normal weather may have a significant positive or negative effect on the results of these operations.
In 2005, we entered into heating-degree day put options to mitigate the effect of fluctuations from normal weather on KEDNE's financial position and cash flows for the 2005/2006 winter heating season - November 2005 through March 2006. These put options will pay KeySpan up to $40,000 per heating degree day when the actual temperature is below 4,169 heating degree days, or approximately 5% warmer than normal, based on the most recent 20-year average for normal weather. The maximum amount KeySpan will receive on these purchased put options is $16 million. The net premium cost for these options is $1.2 million and will be amortized over the heating season. Since weather was near normal during the fourth quarter of 2005, there was no earnings impact associated with these derivative instruments other than the premium cost for purchasing the options. We account for these derivatives pursuant to the requirements of EITF 99-2, "Accounting for Weather Derivatives." In this regard, such instruments are accounted for using the "intrinsic value method" as set forth in such guidance.
In 2004, we entered into heating-degree day put options to mitigate the effect of fluctuations from normal weather on KEDNE's financial position and cash flows for the 2004/2005 winter heating season - November 2004 through March 2005. These put options would have paid KeySpan up to $40,000 per heating degree day when the actual temperature was below 4,130 heating degree days, or approximately 5% warmer than normal, based on the most recent 20-year average for normal weather. The maximum amount KeySpan would have received on these purchased put options was $16 million. The net premium cost for these options was $1.6 million and was amortized over the heating season. Since weather was colder than normal during the first quarter of 2005, there was no earnings impact associated with these derivative instruments other than the premium cost for purchasing the options.
Credit and Collateral: Derivative contracts are primarily used to manage exposure to market risk arising from changes in commodity prices and interest rates. In the event of non-performance by a counterparty to a derivative contract, the desired impact may not be achieved. The risk of counterparty non-performance is generally considered a credit risk and is actively managed by assessing each counterparty credit profile and negotiating appropriate levels of collateral and credit support. In instances where the counterparties' credit quality has declined, or credit exposure exceeds certain levels, we may limit our credit exposure by restricting new transactions with counterparties, requiring additional collateral or credit support and negotiating the early termination of certain agreements. At December 31, 2005, KeySpan has received $13.2 million from its counterparties as collateral associated with outstanding derivative contracts. This amount has been recorded as restricted cash, with an offsetting position in current liabilities on the Consolidated Balance Sheet. Further, KeySpan has paid $8.9 million in margin calls to its counterparties. This amount has been recorded as an accounts receivable on the December 31, 2005 Consolidated Balance Sheet.
We believe that our credit risk related to the above mentioned derivative financial instruments is no greater than the risk associated with the primary contracts which they hedge and that the elimination of a portion of the price risk reduces volatility in our reported results of operations, financial position and cash flows and lowers overall business risk.
Long-term Debt: The following tables depict the fair values and carrying values of KeySpan's long-term debt at December 31, 2005 and 2004.
Fair Values of Long-Term Debt - ------------------------------------------------------------------------------ December 31, (In Millions of Dollars) 2005 2004 - ------------------------------------------------------------------------------ First Mortgage Bonds $ 114.1 $ 115.8 Notes 2,692.1 2,571.8 Gas Facilities Revenue Bonds 651.3 666.9 Authority Financing Notes 66.0 66.0 Promissory Notes 156.6 159.8 MEDS Equity Units - 480.0 Master Lease 430.5 460.9 Tax Exempt Bonds 130.8 135.0 - ------------------------------------------------------------------------------ $ 4,241.4 $ 4,656.2 - ------------------------------------------------------------------------------
Carrying Values of Long-Term Debt
- ------------------------------------------------------------------------------ December 31, - ------------------------------------------------------------------------------ (In Millions of Dollars) 2005 2004 - ------------------------------------------------------------------------------ First Mortgage Bonds $ 95.0 $ 95.0 Notes 2,437.2 2,485.0 Gas Facilities Revenue Bonds 640.5 640.5 Authority Financing Notes 66.0 66.0 Promissory Notes 155.4 155.4 MEDS Equity Units - 460.0 Master Lease 412.3 412.3 Tax Exempt Bonds 128.3 128.3 - ------------------------------------------------------------------------------ $ 3,934.7 $ 4,442.5 - ------------------------------------------------------------------------------
Our subsidiary debt was carried at an amount approximating fair value because interest rates are based on current market rates. All other financial instruments included in the Consolidated Balance Sheet such as cash, commercial paper, accounts receivable and accounts payable, are also stated at amounts that approximate fair value.
Note 9. Gas Exploration and Production Property - Depletion
As described in Note 2 "Business Segments," during much of 2004 KeySpan's investment in gas exploration and production activities consisted of its ownership interest in Houston Exploration, as well as KeySpan's wholly-owned subsidiary KeySpan Exploration and Production, which is still engaged in a joint drilling program with Houston Exploration. Further, KeySpan's investment in these activities also includes its wholly-owned subsidiary Seneca-Upshur. These assets are accounted for under the full cost method of accounting. Under the full cost method, costs of acquisition, exploration and development of natural gas and oil reserves plus asset retirement obligations are capitalized into a "full cost pool" as incurred. Unproved properties and related costs are excluded from the depletion and amortization base until a determination as to the existence of proved reserves. Properties are depleted and charged to operations using the unit of production method.
To the extent that such capitalized costs (net of accumulated depletion) less deferred taxes exceed the present value (using a 10% discount rate) of estimated future net cash flows from proved natural gas and oil reserves and the lower of cost or fair value of unproved properties, less deferred taxes, such excess costs are charged to operations, but would not have an impact on cash flows. Once incurred, such impairment of gas properties is not reversible at a later date even if prices increase. The ceiling test is calculated using natural gas and oil prices in effect as of the balance sheet date, adjusted for outstanding derivative instruments, held flat over the life of the reserves.
As a result of the June 2004 stock transaction discussed in Note 2 "Business Segments", KeySpan accounted for its investment in Houston Exploration on the equity method from June 2004 through November 19, 2004. Therefore, we were required to calculate a ceiling test on KeySpan Exploration and Production's and Seneca-Uphsur's assets independently of Houston Exploration's assets in the second quarter of 2004. Based on a report furnished by an independent reservoir engineer at that time, it was determined that the remaining proved undeveloped oil reserves held in the joint venture required a substantial investment in order to develop. Therefore, KeySpan and Houston Exploration elected not to develop these oil reserves. As a result, in the second quarter of 2004, KeySpan recorded a $48.2 million non-cash impairment charge to write down its wholly-owned gas exploration and production subsidiaries' assets. This charge was recorded in depreciation, depletion and amortization on the Consolidated Statement of Income.
Note 10. Energy Services - Discontinued Operations
In 2004, the Energy Services segment experienced significantly lower operating profits and cash flows than originally projected. At a meeting held on November 2, 2004, KeySpan's Board of Directors authorized management to begin the process of disposing of a significant portion of its ownership interests in certain companies within the Energy Services segment - specifically those companies engaged in mechanical contracting activities. In January and February of 2005, KeySpan sold its mechanical contracting investments. The operating results and financial position of these companies, are reflected as discontinued operations on the Consolidated Statement of Income, Consolidated Balance Sheet and Consolidated Statement of Cash Flows.
In regard to the January 2005 transactions, KeySpan received proceeds of approximately $16 million, including approximately $5 million to be paid within a three year period. In addition, KeySpan retained its previously incurred indemnity support obligations related to certain surety, performance and payment bonds issued for the benefit of KeySpan's former subsidiaries prior to closing. In June 2005, the balance to be paid over the three year period was fully collected on a present value basis and a significant portion of the performance bonds were replaced without any remaining indemnification obligation on the part of KeySpan. The current estimated cost to complete projects supported by such indemnity obligations is approximately $0.2 million. The buyers have agreed to complete the projects for which such indemnity obligations were incurred and to indemnify and hold KeySpan harmless with respect to its liabilities in connection with such bonds.
In connection with the February 2005 transaction, KeySpan paid or contributed approximately $26 million to its former subsidiary prior to closing the sale transaction in exchange for, among other things, the disposition of outstanding shares in the former subsidiary and the settlement of intercompany advances and replacement of a performance and payment bond issued for the benefit of its former subsidiary with respect to a pending project, which bond had been supported by a $150 million indemnity obligation of KeySpan. In addition, KeySpan received from its former subsidiary an indemnity bond issued by a third party insurance company, the purpose of which is to reimburse KeySpan in an
amount up to $80 million in the event it is required to perform under all other indemnity obligations previously incurred by KeySpan to support the remaining bonded projects of its former subsidiary as of the closing. As of December 31, 2005, the total cost to complete such remaining bonded projects is estimated to be approximately $40 million. The aforementioned guarantees are reflected in Note 7 "Contractual Obligations, Financial Guarantees and Contingencies". KeySpan's former subsidiary has also agreed to complete the projects for which such indemnity obligations were incurred and to indemnify and hold KeySpan harmless with respect to its liabilities in connection with such bonds.
In anticipation of these sales and in connection with the preparation of the third quarter and fourth quarter 2004 financial statements, KeySpan conducted an evaluation of the carrying value of these investments, including recorded goodwill. Further, we evaluated the carrying value of goodwill for the entire Energy Services segment. As noted, KeySpan records goodwill on purchased transactions, representing the excess of acquisition cost over the fair value of net assets acquired.
As a result of these evaluations, KeySpan recorded a non-cash goodwill impairment charge of $108.3 million ($80.3 million after tax, or $0.50 per share) in 2004. This charge was recorded as follows: (i) $14.4 million as an operating expense on the Consolidated Statement of Income reflecting the write-down of goodwill on Energy Services segment's continuing operations; and (ii) $93.9 million ($67.8 million after-tax) as discontinued operations reflecting the impairment on the mechanical contracting companies.
In addition, an impairment charge of $100.3 million ($72.1 million after-tax or $0.45 per share) was also recorded in 2004 to reduce the carrying value of the remaining assets of the mechanical contracting companies. This charge is reflected in discontinued operations on the Consolidated Statement of Income to reflect the estimated loss on disposal.
KeySpan employed a combination of two methodologies in determining the estimated fair value for its investment in the Energy Services segment, a market valuation approach and an income valuation approach. Under the market valuation approach, KeySpan utilized a range of near-term potential realizable values for the mechanical contracting businesses. Under the income valuation approach, the fair value was obtained by discounting the sum of (i) the expected future cash flows and (ii) the terminal value. KeySpan utilized certain significant assumptions in this valuation, specifically the weighted-average cost of capital, short and long-term growth rates and expected future cash flows. Approximately $65 million of goodwill remains in this segment.
The information below highlights the major classes of assets and liabilities of the discontinued mechanical contracting companies, as well as major income and expense captions.
- ----------------------------------------------------------------------- December 31, (In Millions of Dollars) 2004 - -----------------------------------------------------------------------
Property $ 8.7 Current assets $ 42.9
Current liabilities $ 64.2 - -----------------------------------------------------------------------
Note 11. 2006 LIPA Settlement
LIPA is a corporate municipal instrumentality and a political subdivision of the State of New York. On May 28, 1998, certain of LILCO's business units were merged with KeySpan and LILCO's common stock and remaining assets were acquired by LIPA. At the time of this transaction, KeySpan and LIPA entered into three major long-term service agreements that (i) provide to LIPA all operation, maintenance and construction services and significant administrative services relating to the Long Island electric transmission and distribution ("T&D") system pursuant to a Management Services Agreement (the "1998 MSA"); (ii) supply LIPA with electric generating capacity, energy conversion and ancillary services from our Long Island generating units pursuant to a Power Supply Agreement (the "1998 PSA") and other long-term agreements through which we provide LIPA with approximately one half of its customers' energy needs; and (iii) manage all aspects of the fuel supply for our Long Island generating facilities, as well as all aspects of the capacity and energy owned by or under contract to LIPA pursuant to an Energy Management Agreement (the "1998 EMA"). We also purchase energy, capacity and ancillary services in the open market on LIPA's behalf under the 1998 EMA. The 1998 MSA, 1998 PSA and 1998 EMA all became effective on May 28, 1998 and are collectively referred to as the 1998 LIPA Agreements.
On February 1, 2006, KeySpan and LIPA entered into (i) an amended and restated Management Services Agreement (the "2006 MSA"), pursuant to which KeySpan will continue to operate and maintain the electric T&D System owned by LIPA on Long Island; (ii) a new Option and Purchase and Sale Agreement (the "2006 Option Agreement"), to replace the Generation Purchase Rights Agreement (as amended, the "GPRA"), pursuant to which LIPA had the option, through December 15, 2005, to effectively acquire substantially all of the electric generating facilities owned by KeySpan on Long Island; and (iii) a Settlement Agreement (the "2006 Settlement Agreement") resolving outstanding issues between the parties regarding the 1998 LIPA Agreements. The 2006 MSA, the 2006 Option Agreement and the 2006 Settlement Agreement are collectively referred to herein as the "2006 LIPA Agreements". Each of the 2006 LIPA Agreements will become effective as of January 1, 2006 upon all of the 2006 LIPA Agreements receiving the required governmental approvals; otherwise none of the 2006 LIPA Agreements will become effective.
2006 Settlement Agreement
Pursuant to the terms of the 2006 Settlement Agreement, KeySpan and LIPA agreed to resolve issues that have existed between the parties relating to the various 1998 LIPA Agreements. In addition to the resolution of these matters, KeySpan's entitlement to utilize LILCO's available tax credits and other tax attributes will increase from approximately $50 million to approximately $200 million. These credits and attributes may be used to satisfy KeySpan's previously
incurred indemnity obligation to LIPA for any federal income tax liability that may result from the settlement of a pending Internal revenue Service ("IRS") audit for LILCO's tax year ended March 31, 1999. In recognition of these items, as well as for the modification and extension of the 1998 MSA and the elimination of the GPRA, upon effectiveness of the Settlement Agreement KeySpan will record a contractual asset in the amount of approximately $160 million, of which approximately $110 million will be attributed to the right to utilize such additional tax credits and attributes and approximately $50 million will be amortized over the eight year term of the 2006 MSA. In order to compensate LIPA for the foregoing, KeySpan will pay LIPA $69 million in cash and will settle certain accounts receivable in the amount of approximately $90 million due from LIPA.
Generation Purchase Rights Agreement and 2006 Option Agreement.
Under an amended GPRA, LIPA had the right to acquire certain of KeySpan's Long Island-based generating assets formerly owned by LILCO, at fair market value at the time of the exercise of such right. LIPA was initially required to make a determination by May 2005, but KeySpan and LIPA agreed to extend the date by which LIPA was to make this determination to December 15, 2005. As part of the 2006 settlement between KeySpan and LIPA, the parties entered into the 2006 Option Agreement whereby LIPA has the option during the period January 1, 2006 to December 31, 2006 to purchase only KeySpan's Far Rockaway and/or E.F. Barrett Generating Stations (and certain related assets) at a price equal to the net book value of each facility. The 2006 Option Agreement replaces the GPRA, the expiration of which has been stayed pending effectiveness of the 2006 LIPA Agreements. In the event such agreements do not become effective by reason of failure to secure the requisite governmental approvals, the GPRA will be reinstated for a period of 90 days. If LIPA were to exercise the option and purchase one or both of the generation facilities (i) LIPA and KeySpan will enter into an operation and maintenance agreement, pursuant to which KeySpan will continue to operate these facilities for a fixed management fee plus reimbursement for certain costs; and (ii) the 1998 PSA and 1998 EMA will be amended to reflect that the purchased generating facilities would no longer be covered by those agreements. It is anticipated that the fees received pursuant to the operation and maintenance agreement will offset the reduction in the operation and maintenance expense recovery component of the 1998 PSA and the reduction in fees under the 1998 EMA.
Management Services Agreements
In place of the previous compensation structure (whereby KeySpan was reimbursed for budgeted costs, and earned a management fee and certain performance and cost-based incentives), KeySpan's compensation for managing the T&D System under the 2006 MSA consists of two components: a minimum compensation component of $224 million per year and a variable component based on electric sales. The $224 million component will remain unchanged for three years and then increase annually by 1.7%, plus inflation. The variable component, which will comprise no more than 20% of KeySpan's compensation, is based on electric sales on Long Island exceeding a base amount of 16,558 gigawatt hours, increasing by 1.7% in each year. Above that level, KeySpan will receive approximately 1.34 cents per kilowatt hour for the first contract year, 1.29 cents per kilowatt hour in the second contract year (plus an annual inflation adjustment), 1.24 cents per kilowatt hour in the third contract year (plus an annual inflation adjustment), with the per kilowatt hour rate thereafter adjusted annually by inflation. Subject to certain limitations, KeySpan will be able to retain all operational efficiencies realized during the term of the 2006 MSA.
LIPA will continue to reimburse KeySpan for certain expenditures incurred in connection with the operation and maintenance of the T&D System, and other payments made on behalf of LIPA, including: real property and other T&D System taxes, return postage, capital construction expenditures and storm costs.
Note 12. Subsequent Events
On February 25, 2006, Keyspan entered into an Agreement and Plan of Merger (the "Merger Agreement"), with National Grid PLC, a public limited company incorporated under the laws of England and Wales ("Parent") and National Grid USA, Inc, a New York Corporation ("Merger Sub"), pursuant to which Merger Sub will merge with and into KeySpan (the "Merger"), with KeySpan continuing as the surviving Company. Pursuant to the Merger Agreement, at the effective time of the Merger, each outstanding share of common stock, par value $.01 per share of KeySpan (the "Shares"), other than shares owned by KeySpan, shall be canceled and shall be converted into the right to receive $42.00 in cash, without interest.
Consummation of the Merger is subject to various closing conditions, including but not limited to the satisfaction or waiver of conditions regarding the receipt of requisite regulatory approvals and the adoption of the Merger Agreement by the stockholders of KeySpan and the Parent. Assuming receipt or waiver of the foregoing, it is currently anticipated that the Merger will be consummated in early 2007. However, no assurance can be given that the Merger will occur, or, the timing of its completion.
Financial Swap Agreement for In-City Unforced Capacity
Currently, the NYISO's New York City local reliability rules require that 80% of the electric capacity needs of New York City be provided by "in-City" generators. On February 6, 2006, the NYISO Operating Committee increased the "in-City" generator requirement to 83% beginning in May 2006 through the period ending on April 2007, based in part on the statewide reserve margin of 118% set by the New York State Reliability Council. On February 16, 2006, an appeal was filed with the NYISO Management Committee requesting that the February 6th decision be rejected and that the "in-City" requirement be increased to a larger percentage of 83%. A vote on this appeal is expected to occur at the NYISO Management Committee meeting scheduled for February 28, 2006.
Our Ravenswood Generating Station is an "in-City" generator. As the electric infrastructure in New York City and the surrounding areas continues to change and evolve and the demand for electric power increases, the "in-City" generator requirement could be further modified. Construction of new transmission and generation facilities may cause significant changes to the market for sales of capacity, energy and ancillary services from our Ravenswood Generating Station. Recently 500 MW of capacity came on line and it is anticipated that another 500MW of new capacity may be available during 2006 as a result of the completion of an in-City generation project currently under construction. We can not, however, be certain as to when the new power plant will be in operation or the nature of future New York City energy, capacity or ancillary services market requirements or design.
Notwithstanding the foregoing, KeySpan continues to believe that New York City represents a strong capacity market and has entered into an International SWAP Dealers Association Master Agreement for a fixed for float unforced capacity financial swap (the "Agreement") with Morgan Stanley Capital Group Inc. ("Morgan Stanley") dated as of January 18, 2006. The Agreement has a three year term beginning May 1, 2006, (assuming a condition to effectiveness has been satisfied by such date). The notional quantity is 1,800,000kW (the "Notional Quantity") of In-City Unforced Capacity and the fixed price is $7.57/kW-month ("Fixed Price"), subject to adjustment upon the occurrence of certain events. Cash settlement will occur on a monthly basis based on the In-City Unforced Capacity price determined by the relevant New York Independent System Operator Spot Demand Curve Auction Market ("Floating Price"). For each monthly settlement period, the price difference will equal the Fixed Price minus the Floating Price. If such price difference is less than zero, Morgan Stanley will pay KeySpan an amount equal to the product of (a) the Notional Quantity and (b) the absolute value of such price difference. Conversely, if such price difference is greater than zero, KeySpan will pay Morgan Stanley an amount equal to the product of (a) the Notional Quantity and (b) the absolute value of such price difference. KeySpan believes that the average annual monthly capacity market price will settle above the Fixed Price. This derivative instrument will not qualify for hedge accounting treatment under SFAS 133 and will be subject to mark-to-market accounting treatment.
Note 13. KeySpan Gas East Corporation Summary Financial Data
KEDLI is a wholly owned subsidiary of KeySpan. KEDLI was formed on May 7, 1998 and on May 28, 1998 acquired substantially all of the assets related to the gas distribution business of LILCO. KEDLI provides gas distribution services to customers in the Long Island counties of Nassau and Suffolk and the Rockaway peninsula of Queens county. KEDLI established a program for the issuance, from time to time, of up to $600 million aggregate principal amount of Medium-Term
Notes, which will be fully and unconditionally guaranteed by the parent, KeySpan Corporation. On February 1, 2000, KEDLI issued $400 million of 7.875% Medium-Term Notes due 2010. In January 2001, KEDLI issued an additional $125 million of Medium- Term Notes at 6.9% due January 2008. The following condensed financial statements are required to be disclosed by SEC regulations and set forth those of KEDLI, KeySpan Corporation as guarantor of the Medium-Term Notes and our other subsidiaries on a combined basis.
Note 14. Supplemental Gas and Oil Disclosures (Unaudited)
The following information includes amounts attributable to 100% of Houston Exploration and KeySpan Exploration and Production, LLC at December 31, 2003. Shareholders other than KeySpan had a minority interest of approximately 45% in Houston Exploration at December 31, 2003. Gas and oil operations, and reserves, were located in the United States in 2003. As a result of the disposition of Houston Exploration and the immateriality of KeySpan's ongoing gas exploration and production activities supplemental gas and oil disclosures are not required for 2005 or 2004.
Costs Incurred in Property Acquisition, Exploration and Development Activities - ----------------------------------------------------------------------------- (In Millions of Dollars) - ----------------------------------------------------------------------------- At December 31, 2003 - ----------------------------------------------------------------------------- Acquisition of properties - Unproved properties $ 61.5 Proved properties 171.3 Exploration 66.3 Development 170.5 Asset retirement obligation 31.8 - ------------------------------------------------------------------------ Total costs incurred $ 501.4 - ------------------------------------------------------------------------
Costs included in development costs to develop proved undeveloped reserves for the year ended December 31, 2003 were $49.4 million.
Results of Operations from Gas and Oil Producing Activities* - ------------------------------------------------------------------------------ (In Millions of Dollars) - ------------------------------------------------------------------------------ At December 31, 2003 - ------------------------------------------------------------------------------ Revenues $ 497.9 - ------------------------------------------------------------------------------ Production and lifting costs 63.6 Shipping and handling costs 10.4 Depletion 205.1 - ------------------------------------------------------------------------------ Total expenses 279.1 - ------------------------------------------------------------------------------ Income before taxes 218.8 Income taxes 76.6 - ------------------------------------------------------------------------------ Results of operations $ 142.2 - ------------------------------------------------------------------------------
* (Excluding corporate overhead and interest costs)
Summary of Production and Lifting Costs - --------------------------------------------------------------------------- (In Millions of Dollars) - --------------------------------------------------------------------------- At December 31, 2003 - --------------------------------------------------------------------------- Pumping, gauging and other labor $ 11.0 Compressors and other rental equipment 5.1 Property taxes and insurance 7.2 Transportation 2.3 Processing fees 2.4 Workover and well stimulation 5.2 Repairs, maintenance and supplies 3.7 Fuel and chemicals 3.1 Environmental, regulatory and other 7.6 Severance taxes 16.0 - --------------------------------------------------------------------------- Total production and lifting costs $ 63.6 - ---------------------------------------------------------------------------
For December 31, 2003 the gas and oil reserves information reflects Houston Exploration and KeySpan Exploration and Production, LLC. These estimates principally were prepared by independent petroleum consultants. Proved reserves are estimated quantities of natural gas and crude oil which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions.
Reserve Quantity Information Natural Gas (MMcf) - ---------------------------------------------------------------- At December 31, 2003 - ---------------------------------------------------------------- Proved Reserves Beginning of year 614,734 Revisions of previous estimates (32,433) Extensions and discoveries 140,632 Production (100,130) Purchases of reserves in place 89,380 - ---------------------------------------------------------------- Proved reserves - End of year (1) 712,183 Proved developed reserves Beginning of year 435,629 End of Year (2) 488,012 - ---------------------------------------------------------------- (1) Includes minority interest of 318,417. (2) Includes minority interest of 218,190.
Crude Oil, Condensate and Natural Gas Liquids (MBbls) - ------------------------------------------------------------------ At December 31, 2003 - ------------------------------------------------------------------ Proved reserves Beginning of Year 9,548 Revisions of previous estimates (3,542) Extension and discoveries 117 Production (1,514) Purchases of reserves in place 3,753 - ------------------------------------------------------------------ Proved reserves - End of year (1) 8,362 Proved developed reserves Beginning of year 2,413 End of year (2) 4,273 - ------------------------------------------------------------------ (1) Includes minority interest of 3,739. (2) Includes minority interest of 1,910.
The standardized measure of discounted future net cash flows was prepared by applying year-end prices of gas and oil adjusted for the effects of KeySpan's hedging program to the proved reserves. The standardized measure does not purport, nor should it be interpreted, to present the fair value of gas and oil reserves. An estimate of fair value would also take into account, among other things, the recovery of reserves not presently classified as proved, anticipated future changes in prices and costs, and a discount factor more representative of the time value of money and the risks inherent in reserve estimates.
Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Gas and Oil Reserves
(1) Includes minority interest of $672,620.
Changes in Standardized Measure of Discounted Future Net Cash Flows from Proved Reserve Quantities - ------------------------------------------------------------------------------- (In Millions of Dollars) - ------------------------------------------------------------------------------- At December 31, 2003 - ------------------------------------------------------------------------------- Standardized measure - beginning of year $ 1,103.9 Sales and transfers, net of production costs (492.3) Net change in sales and transfer prices, net of production costs 384.3 Extensions and discoveries and improved recovery, net of related costs 434.3 Changes in estimated future development costs (9.4) Development costs incurred during the period that reduced future development costs 81.0 Revisions of quantity estimates (123.9) Accretion of discount 142.3 Net change in income taxes (236.5) Net purchases of reserves in place 254.0 Sales of reserves in place - Changes in production rates (timing) and other (17.2) - ------------------------------------------------------------------------------- Standardized measure - end of year $ 1,520.5 - -------------------------------------------------------------------------------
Average Sales Prices and Production Costs Per Unit - ------------------------------------------------------------------------- Year Ended December 31, 2003 - ------------------------------------------------------------------------- Average Sales Price* Natural gas ($/Mcf) 5.23 Oil, condensate and natural gas liquid ($/Bbl) 28.26 Production cost per equivalent Mcf ($) 0.58 - ------------------------------------------------------------------------- *Represents the cash price received which excludes the effect of any hedging transactions.
Note 15. Summary of Quarterly Information (Unaudited)
The following is a table of financial data for each quarter of KeySpan's year ended December 31, 2005.
(a) Cumulative change in accounting principles for implementation of FASB Interpretation No. 47 ("FIN 47") "Accounting for Conditional Asset Retirement Obligations."
The following is a table of financial data for each quarter of KeySpan's year ended December 31, 2004.
(a) KeySpan's wholly owned gas exploration and production subsidiaries recorded a non-cash impairment charge of $48.2 million ($31.1 million after-tax) or $0.19 per share to recognize the reduced valuation of proved reserves.
(b) In June 2004, KeySpan exchanged 10.8 million shares of common stock of Houston Exploration for 100% of the stock of Seneca Upshur Petroleum, Inc. We recorded a gain of $150.1 million and were required to record deferred tax expense of $44.1 million. The net gain on the share exchange less the deferred tax provision was $106 million or $0.66 per share. In April 2004, KeySpan recorded a gain of $22.8 million ($10.1 million after-tax) or $0.06 per share, resulting from the sale of 35.9% of our ownership interest in KeySpan Canada.
(c) KeySpan recorded a $14.4 million ($12.6 million after-tax) or $0.08 per share non-cash goodwill impairment charge associated with our continuing investments in the Energy Services segment.
(d) In August 2004, we redeemed approximately $758 million of outstanding debt and recorded a charge of $45.9 million ($29.3 million after-tax) or $0.18 per share representing call premiums incurred on this redemption.
(e) In December 2004, we recorded a $26.5 million ($18.8 million after-tax) or $0.12 per share non-cash impairment charge related to our 50% ownership interest in Premier Transmission Pipeline.
(f) In November 2004, KeySpan decided to sell its remaining 6.6 million shares in Houston Exploration and recorded a gain of $179.6 million ($116.8 million after-tax) or $0.73 per share. In December 2004, KeySpan sold its remaining interest in KeySpan Canada and recorded a gain of $35.8 million ($24.7 million after tax) or $0.15 per share.
(g) At December 31, 2004, KeySpan intended to sell a significant portion of its ownership interest in certain companies within the Energy Services segment, specifically those companies engaged in mechanical contracting activities. As a result, KeySpan recorded a loss in discontinued operations of $151.0 million, or $0.94 per share. This loss reflects $139.9 million after-tax impairment charges, which were recorded in the third and fourth quarters, and operating losses at $11.1 million.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors of KeySpan Corporation
We have audited the accompanying Consolidated Balance Sheets and the Consolidated Statement of Capitalization of KeySpan Corporation and subsidiaries (the "Company") as of December 31, 2005 and 2004, and the related Consolidated Statements of Income, Retained Earnings, Comprehensive Income and Cash Flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedules listed in the Index at Item 15. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (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, such consolidated financial statements present fairly, in all material respects, the financial position of KeySpan Corporation and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
As discussed in Note 1(P) to the consolidated financial statements, on December 31, 2003, the Company adopted Financial Accounting Standards Board Interpretation No. ("FIN") 46 "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51". As discussed in Notes 1(O), 1(P) and 7, on December 31, 2005, the Company adopted FIN 47, "Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143."
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company's internal control over financial reporting as of December 31, 2005, based on the criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2006 expressed an unqualified opinion on management's assessment of the effectiveness of the Company's internal control over financial reporting and an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.
/s/Deloitte & Touche LLP - ------------------------ New York, New York February 28, 2006
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures (as defined under Exchange Act Rule 13a-15(e)) that are designed to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to KeySpan's management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Any control system, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2005. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the design and operation of our disclosure controls and procedures provided reasonable assurance that the disclosure controls and procedures are effective to accomplish their objectives.
Furthermore, there has been no change in KeySpan's internal control over financial reporting identified in connection with the evaluation of such control that occurred during KeySpan's last fiscal quarter, which has materially affected, or is reasonably likely to materially affect, KeySpan's internal control over financial reporting.
Management's Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined under Exchange Act Rule 13a-15(f)). KeySpan's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements, errors or fraud. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of or compliance with the policies or procedures may deteriorate.
Under the supervision and with participation of KeySpan's Chief Executive Officer and Chief Financial Officer, our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2005. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in a report entitled Internal Control-Integrated Framework. Our management concluded, as of December 31, 2005, that KeySpan's internal control over financial reporting is effective based on the COSO criteria.
Our independent registered public accounting firm, Deloitte & Touche LLP, has issued their report on management's assessment of KeySpan's internal control over financial reporting as of December 31, 2005, which is included herein.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors of KeySpan Corporation:
We have audited management's assessment, included in the accompanying Management's Report on Internal Control over Financial Reporting, that KeySpan Corporation and subsidiaries (the "Company") maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedules as of and for the year ended December 31, 2005 of the Company and our report dated February 28, 2006 expressed an unqualified opinion on those financial statements and financial statement schedules and included an explanatory paragraph regarding the adoption of Financial Accounting Standards Board Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143", referred to in Notes 1(O), 1 (P) and 7.
/s/Deloitte & Touche LLP - ------------------------ New York, New York February 28, 2006
ITEM 9B.
ITEM 9B. OTHER INFORMATION
The following disclosures would otherwise have been filed on Form 8-K under the heading "Item 1.01 - Entry into a Material Definitive Agreement".
On February 23, 2006, following the recommendation of the Compensation and Management Development Committee (the "Compensation Committee"), KeySpan's Board of Directors set the 2006 annual base salaries for Robert B. Catell, Robert J. Fani, Wallace P. Parker Jr., Steven L. Zelkowitz and Gerald Luterman, each of whom is a KeySpan named executive officer. Such 2006 base salaries are as follows: Mr. Catell - $1,140,000, Mr. Fani - $782,000, Mr. Parker - $625,000, Mr. Zelkowitz - $625,000, and Mr. Luterman - $488,000. All 2006 base salary increases are effective January 1, 2006, with the exception of Mr. Luterman. Mr. Luterman's base salary increase is effective February 1, 2006.
Also on February 23, 2006, following the recommendation of the Compensation Committee, the Board approved the performance-based incentive awards to be paid to our executive officers for the year ending December 31, 2005 ("FY 2005") under the KeySpan Corporate Annual Incentive Compensation Plan (the "Corporate Plan"). The Corporate Plans provides for performance-based incentive awards as a percentage of cumulative base salary paid during the calendar year. The Compensation Committee had approved the target performance award levels applicable to the Corporate Plan for FY 2005 in December 2004. In January 2005, the Compensation Committee approved the performance goals relating to the FY 2005 Corporate Plan for the named executive officers based on financial and performance measures, including goals relating to earnings per share, cash flow, business unit operating income, diversity initiatives, customer satisfaction, work place safety and other individual strategic goals and initiatives. Based upon actual FY 2005 performance, an award payout for each of the named executive officers was approved as follows: Mr. Catell - $1,400,000, Mr. Fani - $741,175, Mr. Parker - $550,090, Mr. Zelkowitz - $513,129, and Mr. Luterman - $388,282.
In December 2005, the Board approved the compensation formulas for incentive awards that may be paid to our executive officers for the year ending December 31, 2006 ("FY 2006") under the Corporate Plan. For FY 2006, the performance-based target award levels for each of the named executive officers will remain the same as last year. The target performance award levels are as follows: Mr. Catell - 100%, Mr. Fani - 75%, Mr. Parker - 70%, Mr. Zelkowitz - 70% and Mr. Luterman - 65%.
Also in December 2005, the Compensation Committee approved the target award levels for performance-based equity awards that may be granted to our executive officers for FY 2006 under the KeySpan Long-Term Performance Incentive Compensation Plan (the "Long-Term Incentive Plan"). The target award levels have been modified from last year. The target award levels are designed to align with industry benchmarks at 50th percentile levels. The FY 2006 target performance award levels for the named executive officers are as follows: Mr. Catell - 240%, Mr. Fani - 160%, Mr. Parker - 125%, Mr. Zelkowitz - 125% and Mr. Luterman - 110%.
On February 23, 2006, the Compensation Committee also approved the FY 2006 grants pursuant to the Long Term Incentive Plan. The Compensation Committee awarded the following grants to the named executive officers based on actual 2005 performance as follows: Mr. Catell - 85,520 shares of restricted stock; Mr. Fani - 38,930 performance shares; Mr. Parker - 24,320 performance shares; Mr. Zelkowitz - 27,490 performance shares; and Mr. Luterman - 18,360 performance shares.
Mr. Catell's restricted stock has a two year restriction period which shall lapse on February 23, 2008 or the Compensation Committee has the ability to accelerate vesting after one year based on certain goals being achieved. The performance shares for the remaining four named executives will be measured over the three year period beginning on January 1, 2006 through December 31, 2008, with performance results linked to the percentage of improvement in Return on Invested Capital ("ROIC") and Total Shareholder Return ("TSR"). The actual number of shares to be awarded at the end of the performance period will be determined using a sliding scale which encompasses both the ROIC and TSR measures. The ROIC goal will act as the primary trigger. If the ROIC goal is below threshold, all shares will be forfeited without payment regardless of the performance of TSR.
For further information on executive compensation see "Item 11. Executive Compensation" herein.
PART III --------
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
A definitive proxy statement will be filed with the SEC on or about March XXX, 2006 (the "Proxy Statement"). The information required by this item is set forth under the caption "Executive Officers of KeySpan" in Part I hereof and under the captions "Proposal 1. Election of Directors", "Certain Relationships and Related Transactions," "Committees of the Board," "Code of Ethics" and "Compliance with Section 16(a) Beneficial Ownership Reporting Compliance" contained in the Proxy Statement, which information is incorporated herein by reference thereto.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is set forth under the captions "Director Compensation" and "Executive Compensation" in the Proxy Statement, which information is incorporated herein by reference thereto.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item is set forth under the captions "Security Ownership of Management" and "Security Ownership of Certain Beneficial Owners" in the Proxy Statement, and in Item 5 of this report, which information is incorporated herein by reference thereto.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is set forth under the caption "Agreements with Executives" and "Certain Relationships and Related Transactions" in the Proxy Statement, which information is incorporated herein by reference thereto.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is set forth under the caption "Proposal 2. Ratification of Deloitte & Touche LLP as Independent Registered Public Accounting Firm," "Fiscal Year 2006 Audit Firm Fee Summary" and "Report of the Audit Committee" in the Proxy Statement, which information is incorporated herein by reference thereto.
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Required Documents
1. Financial Statements
The following consolidated financial statements of KeySpan and its subsidiaries and Reports of the Independent Registered Public Accounting Firm are included in Item 8 and are filed as part of this Report:
o Consolidated Statement of Income for the year ended December 31, 2005, the year ended December 31, 2004, and the year ended December 31, 2003
o Consolidated Statement of Retained Earnings for the year ended December 31, 2005, the year ended December 31, 2004, and the year ended December 31,
o Consolidated Balance Sheet at December 31, 2005 and December 31, 2004
o Consolidated Statement of Capitalization at December 31, 2005 and December 31, 2004
o Consolidated Statement of Cash Flows for the year ended December 31, 2005, the year ended December 31, 2004, and the year ended December 31, 2003
o Consolidated Statement of Comprehensive Income for the Year ended December 31, 2005, the year ended December 31, 2004 and the year ended December 31,
o Notes to Consolidated Financial Statements
o Report of the Independent Registered Public Accounting Firm
2. Financial Statement Schedules
Consolidated Schedule of Valuation and Qualifying Accounts for the year ended December 31, 2005, the year ended December 31, 2004, and the year ended December 31, 2003.
All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.
(b) Exhibits
Exhibits listed below which have been filed with the SEC pursuant to the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, and which were filed as noted below, are hereby incorporated by reference and made a part of this report with the same effect as if filed herewith.
3.1 Certificate of Incorporation of KeySpan effective April 16, 1998, Amendment to Certificate of Incorporation of KeySpan effective May 26, 1998, Amendment to Certificate of Incorporation of KeySpan effective June 1, 1998, Amendment to the Certificate of Incorporation of KeySpan effective April 7, 1999 and Amendment to the Certificate of Incorporation of KeySpan effective May 20, 1999 (filed as Exhibit 3.1 to KeySpan's Form 10-Q for the quarterly period ended June 30, 1999)
3.2 By-Laws of KeySpan in effect as of June 25, 2003, as amended (filed as Exhibit 3.1 to KeySpan's Form 10-Q for the quarterly period ended June 30, 2003)
4.1 Credit Agreement dated as of June 24, 2005 among KeySpan Corporation, the several lenders, The Royal Bank of Scotland PLC and Citibank, N.A., as Co-Syndication Agents, The Bank of New York and The Bank of Nova Scotia, as Co-Documentation Agents, and JPMorgan Chase Bank, N.A., as Administrative Agent (filed as Exhibit 4.1 to KeySpan's Form 8-K dated as of June 29, 2005)
4.2 Amended and Restated Credit Agreement dated as of June 24, 2005 among KeySpan Corporation, the several lenders, The Royal Bank of Scotland PLC and Citibank, N.A., as Co-Syndication Agents, The Bank of New York and The Bank of Nova Scotia, as Co-Documentation Agents, and JPMorgan Chase Bank, N.A., as Administrative Agent (filed as Exhibit 4.2 to KeySpan's Form 8-K dated as of June 29, 2005)
4.3 Indenture, dated as of November 1, 2000, between KeySpan Corporation and the Chase Manhattan Bank, as Trustee, with respect to the issuance of Debt Securities (filed as Exhibit 4-a to Amendment No. 1 to Form S-3 Registration Statement No. 333-43768 and filed as Exhibit 4-a to KeySpan's Form 8-K on November 20, 2000)
4.4 Form of Note issued in connection with the issuance of the KeySpan Corporation $700 million of 7.625% Notes due 2010 issued on November 20, 2000 (filed as Exhibit 4-c to KeySpan's Form 8-K on November 20, 2000)
4.5 Form of Note issued in connection with the issuance of the KeySpan Corporation $250 million of 8.0% Notes due 2030 issued on November 20, 2000 (filed as Exhibit 4-d to KeySpan's Form 8-K on November 20, 2000)
4.6 Form of Note issued in connection with the issuance of the KeySpan Corporation $150 million of 4.65% Notes issued on April 1, 2003 (filed as Exhibit 4.1 to KeySpan's Form 8-K dated as of April 8, 2003)
4.7 Form of Note issued in connection with the issuance of the KeySpan Corporation $150 million of 5.875% Notes issued on April 1, 2003 (filed as Exhibit 4.2 to KeySpan's Form 8-K dated as of April 8, 2003)
4.8 Form of Note issued in connection with the issuance of the KeySpan Corporation $307.2 million of 5.803% Notes issued on March 29, 2005 (filed as Exhibit 4.1 to KeySpan's Form 8-K dated as of March 31, 2005)
4.9 Supplemental Remarketing Agreement dated as of March 21, 2005 among KeySpan Corporation, J.P. Morgan Securities Inc. and JPMorgan Chase Bank, N.A. in connection with the remarketing of the 4.9% Notes due 2008 (filed as Exhibit 99.1 to KeySpan's Form 8-K dated as of March 24, 2005)
4.10 Indenture, dated December 1, 1999, between KeySpan and KeySpan Gas East Corporation, the Registrants, and the Chase Manhattan Bank, as Trustee, with respect to the issuance of Medium-Term Notes, Series A, (filed as Exhibit 4-a to Amendment No. 1 to KeySpan's and KeySpan Gas East Corporation's Form S-3 Registration Statement No. 333-92003)
4.11 Form of Medium-Term Note issued in connection with the issuance of KeySpan Gas East Corporation 7 7/8% Notes issued on February 1, 2000 (filed as Exhibit 4 to KeySpan's Form 8-K on February 1, 2000)
4.12 Form of Medium-Term Note issued in connection with the issuance of KeySpan Gas East Corporation 6.9% Notes issued on January 19, 2001 (filed as Exhibit 4.3 to KeySpan's Form 10-K for the year ended December 31, 2000)
4.13 Participation Agreement, dated as of July 1, 1991, between New York State Energy Research and Development Authority ("NYSERDA") and The Brooklyn Union Gas Company relating to the Gas Facilities Revenue Bonds ("GFRBs") Series 1991A and 1991B (The Brooklyn Union Gas Company Project) (filed as Exhibit 4 to The Brooklyn Union Gas Company's Form 10-K for the year ended September 30, 1991)
4.14 Indenture of Trust, dated as of July 1, 1991, between NYSERDA and Manufacturers Hanover Trust Company, as Trustee, relating to the GFRBs Series 1991A and 1991B (The Brooklyn Union Gas Company Project) (filed as Exhibit 4 to The Brooklyn Union Gas Company's Form 10-K for the year ended September 30, 1991)
4.15 Participation Agreement, dated as of July 1, 1992, between NYSERDA and The Brooklyn Union Gas Company relating to the GFRBs Series 1993A and 1993B (The Brooklyn Union Gas Company Project) (filed as Exhibit 4 to The Brooklyn Union Gas Company's Form 10-K for the year ended September 30, 1992)
4.16 Indenture of Trust, dated as of July 1, 1992, between NYSERDA and Chemical Bank, as Trustee, relating to the GFRBs Series 1993A and 1993B (The Brooklyn Union Gas Company Project) (filed as Exhibit 4 to The Brooklyn Union Gas Company Form 10-K for the year ended September 30, 1992)
4.17 Participation Agreement dated as of July 1, 1991 between NYSERDA and The Brooklyn Union Gas Company relating to the GFRBs Series D (The Brooklyn Union Gas Company Project) (filed as Exhibit 4 to The Brooklyn Union Gas Company's Form 10-K for the year ended September 30, 1991)
4.18 First Supplemental Participation Agreement dated as of June 1, 1993 between NYSERDA and The Brooklyn Union Gas Company relating to GFRBs Series D (The Brooklyn Union Gas Company Project) (filed as Exhibit 4 to The Brooklyn Union Gas Company's Form 10-K for the year ended September 30, 1993)
4.19 Trust Indenture, dated as of July 1, 1991 between NYSERDA and Manufacturers Hanover Trust Company relating to the GFRBs Series D (filed as Exhibit 4 to The Brooklyn Union Gas Company's Form 10-K for the year ended September 30, 1991)
4.20 First Supplemental Trust Indenture, dated as of June 1, 1993 between NYSERDA and Chemical Bank (as successor to Manufacturers Hanover Trust Company) relating to the GFRBs Series D (filed as Exhibit 4 to The Brooklyn Union Gas Company's Form 10-K for the year ended September 30, 1993)
4.21 Participation Agreement, dated January 1, 1996, between NYSERDA and The Brooklyn Union Gas Company relating to GFRBs Series 1996 (The Brooklyn Union Gas Company Project) (filed as Exhibit 4 to The Brooklyn Union Gas Company's Form 10-K for the year ended September 30, 1996)
4.22 Indenture of Trust, dated January 1, 1996, between NYSERDA and Chemical Bank, as Trustee, relating to GFRBs Series 1996 (The Brooklyn Union Gas Company Project) (filed as Exhibit 4 to The Brooklyn Union Gas Company's Form 10-K for the year ended September 30, 1996)
4.23 Participation Agreement, dated as of January 1, 1997, between NYSERDA and The Brooklyn Union Gas Company relating to GFRBs 1997 Series A (The Brooklyn Union Gas Company Project) (filed as Exhibit 4 to The Brooklyn Union Gas Company's Form 10-K for the year ended September 30, 1997)
4.24 Indenture of Trust, dated January 1, 1997, between NYSERDA and Chase Manhattan Bank, as Trustee, relating to GFRBs 1997 Series A (The Brooklyn Union Gas Company Project) (filed as Exhibit 4 to The Brooklyn Union Gas Company's Form 10-K for the year ended September 30, 1997)
4.25 Supplemental Trust Indenture, dated as of January 1, 2000, by and between NYSERDA and The Chase Manhattan Bank, as Trustee, relating to the GFRBs 1997 Series A (The Brooklyn Union Gas Company Project) (filed as Exhibit 4.11 to KeySpan's Form 10-K for the year ended December 31, 1999)
4.26 Bond Purchase Agreement, dated as of October 26, 2005, among The Brooklyn Union Gas Company and NYSERDA and Morgan Stanley & Co. Incorporated, BNY Capital Markets, Inc., Sovereign Securities Corporation, LLC and The Williams Capital Group, L.P., as Series A Underwriters, for the issuance of $82 million aggregate principal amount of 4.7% GFRBs, 2005, Series A. (The Brooklyn Union Gas Company Project) (filed as Exhibit 10.1 to KeySpan's Form 8-K dated November 1, 2005)
4.27 Indenture of Trust, dated as of November 1, 2005, between NYSERDA and Citibank, N.A., as Trustee, relating to the issuance of $82 million GFRBs, 2005 Series A, 4.7% due February 2024 (The Brooklyn Union Gas Company Project) (filed as Exhibit 10.1 to KeySpan's Form 10-Q for the quarterly period ended September 30, 2005)
4.28 Participation Agreement, dated as of November 1, 2005, between NYSERDA and The Brooklyn Union Gas Company relating to the issuance of $82 million GFRBs, 2005 Series A, 4.7% due February 2024 (filed as Exhibit 10.2 to KeySpan's Form 10-Q for the quarterly period ended September 30, 2005)
4.29 Promissory Note, dated as of November 1, 2005, executed by the Brooklyn Union Gas Company for issuance of $82 million GFRBs, 2005 Series A, 4.7% due February 2024 (filed as Exhibit 10.3 to KeySpan's Form 10-Q for the quarterly period ended September 30, 2005)
4.30 Bond Purchase Agreement, dated as of October 26, 2005, among The Brooklyn Union Gas Company and NYSERDA and Goldman Sachs & Co., BNY Capital Markets, Inc., Sovereign Securities Corporation, LLC and The Williams Capital Group, L.P., as Series A Underwriters, for the issuance of $55 million aggregate principal amount of GFRBs, 2005, Series B (filed as Exhibit 10.2 to KeySpan's Form 8-K dated November 1, 2005)
4.31 Indenture of Trust, dated as of November 1, 2005, between NYSERDA and Citibank, N.A., as Trustee, relating to the issuance of $55 million GFRBs, 2005 Series B due June 2025 (filed as Exhibit 10.4 to KeySpan's Form 10-Q for the quarterly period ended September 30, 2005)
4.32 Participation Agreement, dated as of November 1, 2005, between NYSERDA and The Brooklyn Union Gas Company relating to the issuance of $55 million GFRBs, 2005 Series B, due February 2025 (filed as Exhibit 10.5 to KeySpan's Form 10-Q for the quarterly period ended September 30, 2005)
4.33 Promissory Note, dated as of November 1, 2005, executed by the Brooklyn Union Gas Company for the issuance of $55 million GFRBs, 2005 Series B, due June 2025 (filed as Exhibit 10.6 to KeySpan's Form 10-Q for the quarterly period ended September 30, 2005)
4.34 Letter of Credit and Reimbursement Agreement, dated December 9, 2003, by and between KeySpan Generation LLC and Royal Bank of Scotland Bank PLC (filed as Exhibit 4.34 to KeySpan's Form 10-K for the year ended December 31, 2003)
4.35 Participation Agreement dated as of December 1, 1997 by and between NYSERDA and Long Island Lighting Company relating to the 1997 Electric Facilities Revenue Bonds (EFRBs), Series A (KeySpan Generation LLC) (filed as Exhibit 10(a) to KeySpan's Form 10-Q for the quarterly period ended September 30, 1998)
4.36 Indenture of Trust, dated as of December 1, 1997, by and between NYSERDA and The Chase Manhattan Bank, as Trustee, relating to the 1997 EFRBs, Series A (KeySpan Generation LLC) (filed as Exhibit 10(a) to KeySpan's Form 10-Q for the quarterly period ended September 30, 1998)
4.37 Participation Agreement, dated as of October 1, 1999, by and between NYSERDA and KeySpan Generation LLC relating to the 1999 Pollution Control Refunding Revenue Bonds (PCRB's), Series A (filed as Exhibit 4.10 to KeySpan's Form 10-K for the year ended December 31, 1999)
4.38 Trust Indenture, dated as of October 1, 1999, by and between NYSERDA and The Chase Manhattan Bank, as Trustee, relating to the 1999 PCRBs, Series A (filed as Exhibit 4.10 to KeySpan's Form 10-K for the year ended December 31, 1999)
4.39 Indenture, dated as of December 1, 1989, between Boston Gas Company and The Bank of New York, as Trustee (filed as Exhibit 4.2 to Boston Gas Company's Form S-3 (File No. 33-31869))
4.40 Second Amended and Restated First Mortgage Indenture for Colonial Gas Company, dated as of June 1, 1992 (filed as Exhibit 4(b) to Colonial Gas Company's Form 10-Q for the quarter ended June 30, 1992)
4.41 First Supplemental Indenture for Colonial Gas Company dated as of June 15, 1992 (filed as Exhibit 4(c) to Colonial Gas Company's Form 10-Q for the quarter ended June 30, 1992)
4.42 Second Supplemental Indenture for Colonial Gas Company dated as of September 27, 1995 (filed as Exhibit 4(c) to Colonial Gas Company's Form 10-K for the fiscal year ended December 31, 1995)
4.43 Amendment to Second Supplemental Indenture for Colonial Gas Company dated as of October 12, 1995 (filed as Exhibit 4(d) to Colonial Gas Company's Form 10-K for the fiscal year ended December 31, 1995)
4.44 Third Supplemental Indenture for Colonial Gas Company dated as of December 15, 1995 (filed as Exhibit 4(f) to Colonial Gas Company's Form S-3 Registration Statement dated January 5, 1998)
4.45 Fourth Supplemental Indenture for Colonial Gas Company dated as of March 1, 1998 (filed as Exhibit 4(l) to Colonial Gas Company's Form 10-Q for the quarter ended March 31, 1998)
4.46 Trust Agreement, dated as of June 22, 1990, between Colonial Gas Company, as Trustor, and Shawmut Bank, N.A., as Trustee (filed as Exhibit 10(d) to Colonial Gas Company's Form 10-Q for the quarterly period ended June 30, 1990)
4.47 Lease Agreement, dated as of November 1, 2003, by and between the Suffolk County Industrial Development Agency and KeySpan-Port Jefferson Energy Center, LLC (filed as Exhibit 4.14-a to KeySpan's Form 10-K for the year ended December 31, 2003)
4.48 Company Lease Agreement, dated as of November 1, 2003, by and between KeySpan-Port Jefferson Energy Center, LLC and the Suffolk County Industrial Development Agency (filed as Exhibit 4.14-b to KeySpan's Form 10-K for the year ended December 31, 2003)
4.49 Guaranty, dated as of November 26, 2003, from KeySpan Corporation to the Suffolk County Industrial Development Agency (filed as Exhibit 4.14-c to KeySpan's Form 10-K for the year ended December 31, 2003)
4.50 Lease Agreement, dated as of November 1, 2003, by and between the Nassau County Industrial Development Agency and KeySpan-Glenwood Energy Center, LLC (filed as Exhibit 4.15-a to KeySpan's Form 10-K for the year ended December 31, 2003)
4.51 Company Lease Agreement, dated as of November 1, 2003, by and between KeySpan-Glenwood Energy Center, LLC and the Nassau County Industrial Development Agency (filed as Exhibit 4.15-b to KeySpan's Form 10-K for the year ended December 31, 2003)
4.52 Guaranty, dated as of November 26, 2003, from KeySpan Corporation to the Nassau County Industrial Development Agency (filed as Exhibit 4.14-c to KeySpan's Form 10-K for the year ended December 31, 2003)
4.53 Lease Agreement, dated June 9, 1999, between KeySpan-Ravenswood, LLC and LIC Funding, Limited Partnership (filed as Exhibit 10.2 to KeySpan's Form 10-Q for the quarterly period ended June 30, 1999)
4.54 First Amendment to the Lease Agreement between KeySpan-Ravenswood, LLC and LIC Funding, Limited Partnership, dated as of June 27, 2002 (filed as Exhibit 10.25 to KeySpan's Form 10-K for the year ended December 31, 2002)
4.55 KeySpan Corporation Guaranty dated June 9, 1999, from KeySpan in favor of LIC Funding, Limited Partnership (filed as Exhibit 10.1 to KeySpan's Form 10-Q for the quarterly period ended June 30, 1999)
4.56 KeySpan Corporation Guaranty dated May 25, 2004, relating to the 250 MW Ravenswood Expansion (filed as Exhibit 10.1 to KeySpan's Form 10-Q for the quarterly period ended June 30, 2004)
4.57 Facility Lease Agreement, dated as of May 25, 2004, between SE Ravenswood Trust, a Delaware statutory trust, and KeySpan-Ravenswood, LLC relating to the 250 MW Ravenswood Expansion(filed as Exhibit 10.2 to KeySpan's Form 10-Q for the quarterly period ended June 30, 2004)
4.58 Site Lease and Easement Agreement, dated as of May 25, 2004, between KeySpan-Ravenswood, LLC and SE Ravenswood Trust relating to the 250 MW Ravenswood Expansion (filed as Exhibit 10.3 to KeySpan's Form 10-Q for the quarterly period ended June 30, 2004)
4.59 Site Sublease, dated as of May 25, 2004, between SE Ravenswood Trust and KeySpan-Ravenswood, LLC relating to the 250 MW Ravenswood Expansion (filed as Exhibit 10.4 to KeySpan's Form 10-Q for the quarterly period ended June 30, 2004)
4.60 Amendment, Assignment and Assumption Agreement, dated as of September 29, 1997, by and among The Brooklyn Union Gas Company, Long Island Lighting Company and KeySpan Energy Corporation (filed as Exhibit 2.5 to Schedule 13D by Long Island Lighting Company on October 24, 1997)
10.1 Agreement and Plan of Merger, dated as of June 26, 1997, by and among BL Holding Corp., Long Island Lighting Company, Long Island Power Authority and LIPA Acquisition Corp. (filed as Annex D to the Joint Registration Statement on Form S-4 of The Brooklyn Union Gas Company and Long Island Lighting Company, Registration No. 333-30353 on June 30, 1997)
10.2 Management Services Agreement between Long Island Power Authority and Long Island Lighting Company dated as of June 26, 1997 (filed as Annex D to the Joint Registration Statement on Form S-4 of The Brooklyn Union Gas Company and Long Island Lighting Company, Registration No. 333-30353 on June 30, 1997)
10.3 Amendment, dated as of March 29, 2002, to Management Services Agreement between Long Island Lighting Company d/b/a LIPA and KeySpan Electric Services LLC dated as of June 26, 1997 (filed as Exhibit 10.4-b to KeySpan's Form 10-K for the year ended December 31, 2002)
10.4 Management Services Agreement dated as of January 1, 2006 between the Long Island Lighting Company ("LILCO") d/b/a LIPA and KeySpan Electric Services LLC (filed as Exhibit 10.1 to KeySpan's Form 8-K filed on February 6, 2005)
10.5 Power Supply Agreement between Long Island Lighting Company and Long Island Power Authority dated as of June 26, 1997 (filed as Annex D to the Joint Registration Statement on Form S-4 of The Brooklyn Union Gas Company and Long Island Lighting Company, Registration No. 333-30353 on June 30, 1997)
10.6 Energy Management Agreement between Long Island Lighting Company and Long Island Power Authority dated as of June 26, 1997 (filed as Annex D to Registration Statement on Form S-4, No. 333-30353, on June 30, 1997)
10.7 Amendment, dated as of March 29, 2002, to Energy Management Agreement between Long Island Lighting Company d/b/a LIPA and KeySpan Energy Trading Services LLC dated as of June 26, 1997 (filed as Exhibit 10.6-b to KeySpan's Form 10-K for the year ended December 31, 2002)
10.8 Generation Purchase Rights Agreement between Long Island Lighting Company and Long Island Power Authority dated as of June 26, 1997 (filed as Exhibit 10.17 to KeySpan's Form 10-K for the year ended December 31, 2001)
10.9 Amendment, dated as of March 29, 2002, to Generation Purchase Rights Agreement by and between KeySpan Corporation, as Seller, and Long Island Lighting Company d/b/a LIPA, as Buyer, dated as of June 26, 1997 (filed as Exhibit 10.1 to KeySpan's Form 10-Q for the quarterly period ended March 31, 2002)
10.10 Generation Purchase Right Extension Agreement between KeySpan and the Long Island Power Authority dated as of March 28, 2005 (filed as Exhibit 10.1 to KeySpan's Form 10-Q for the quarterly period ended March 31, 2005)
10.11 Option Agreement dated as of January 1, 2006 between LILCO d/b/a LIPA and KeySpan Electric Services LLC (filed as Exhibit 10.2 to KeySpan's Form 8-K filed on February 6, 2005)
10.12 Settlement Agreement dated as of January 1, 2006 among KeySpan, KeySpan Generation LLC, KeySpan Electric Services LLC, KeySpan Energy Trading Services LLC and LIPA (filed as Exhibit 10.3 to KeySpan's Form 8-K filed on February 6, 2005)
10.13 Agreement of Lease between Forest City Jay Street Associates and The Brooklyn Union Gas Company dated September 15, 1988 (filed as an Exhibit to The Brooklyn Union Gas Company's Form 10-K for the year ended September 30, 1996)
10.14 Second Amendment, dated as of March 24, 2005, to the Lease Agreement dated as of September 15, 1998 between The Brooklyn Union Gas Company and Forest City Jay Street Associates, L.P. (filed as Exhibit 10 to KeySpan's Form 8-K dated as of March 30, 2005)
10.15 ISDA Master Agreement, dated as of January 18, 2006, between KeySpan Corporation and Morgan Stanley Capital Group Inc. (filed as Exhibit 10.1 to KeySpan's Form 8-K dated January 24, 2006)
10.16 Restated Exploration Agreement between The Houston Exploration Company and KeySpan Exploration and Production, L.L.C. dated June 30, 2000 (filed as Exhibit 10.1 to The Houston Exploration Company's Form 10-Q for the quarter ended September 30, 2000, File No. 001-11899)
10.17 Distribution Agreement, dated June 2, 2004, by and among The Houston Exploration Company, Seneca-Upshur Petroleum, Inc., THEC Holdings Corp. and KeySpan Corporation (filed as Exhibit 99.2 to The Houston Exploration Company's Form 8-K dated as of June 3, 2004)
10.18 Asset Contribution Agreement, dated June 2, 2004, between The Houston Exploration Company and Seneca-Upshur Petroleum, Inc. (filed as Exhibit 99.3 to The Houston Exploration Company's Form 8-K dated as of June 3, 2004)
10.19 Tax Matters Agreement, dated June 2, 2004, by and among The Houston Exploration Company, Seneca-Upshur Petroleum, Inc., THEC Holdings Corp. and KeySpan Corporation (filed as Exhibit 99.4 to The Houston Exploration Company's Form 8-K dated as of June 3, 2004)
10.20 Share Sale and Purchase Agreement dated February 25, 2005 with BG Energy Holdings Limited and Premier Transmission Financing Public Limited Company (filed as Exhibit 10.37 to KeySpan's Form 10-K for the year ended December 31, 2004)
10.21 Purchase Agreement, dated January 28, 2005, among Robert B. Snyder, Frank J. Sullivan, Robert B. Snyder, Jr., Philip J. Andreoli, William J. McKean, Binsky & Snyder, LLC, Binsky & Snyder Service, LLC and KeySpan Business Solutions, LLC (filed as Exhibit 10.35 to KeySpan's Form 10-K for the year ended December 31, 2004)
10.22 Purchase Agreement, dated February 11, 2005, among WDF Holding Corp., WDF, Inc. and KeySpan Business Solutions, LLC (filed as Exhibit 10.36 to KeySpan's Form 10-K for the year ended December 31, 2004)
Compensation Agreements -----------------------
10.23* Cash Compensation for Non-Management Directors of KeySpan
10.24* Base Salaries of Named Executive Officers of KeySpan in effect as of February 23, 2006
10.25 Employment Agreement, dated February 24, 2005, between KeySpan and Robert B. Catell (filed as Exhibit 10.10 to KeySpan's Form 10-K for the year ended December 31, 2004)
10.26 Employment Agreement, dated January 1, 2005, between KeySpan and Anthony Sartor (filed as Exhibit 10.01 to KeySpan's Form 8-K dated as of January 4, 2005)
10.27 Supplemental Retirement Agreement, dated January 1, 2005, between KeySpan and Anthony Sartor (filed as Exhibit 10.12 to Company's Form 8-K dated as of January 4, 2005)
10.28 Supplemental Retirement Agreement, dated July 1, 2002, between KeySpan and Steven L. Zelkowitz (filed as Exhibit 10.12 to KeySpan's Annual Report on Form 10-K for the year ended December 31, 2002)
10.29 Supplemental Retirement Agreement, dated July 1, 2002, between KeySpan and Gerald Luterman (filed as Exhibit 10.11 to KeySpan's Annual Report on Form 10-K for the year ended December 31, 2002)
10.30 Supplemental Retirement Agreement, dated July 1, 2002, between KeySpan and David J. Manning (filed as Exhibit 10.13 to KeySpan's Annual Report on Form 10-K for the year ended December 31, 2002)
10.31 Supplemental Retirement Agreement, dated July 1, 2002, between KeySpan and Elaine Weinstein (filed as Exhibit 10.15 to KeySpan's Annual Report on Form 10-K for the year ended December 31, 2002)
10.32 Directors' Deferred Compensation Plan effective April 2003 (filed as Exhibit 10.16 to KeySpan's Annual Report on Form 10-K for the year ended December 31, 2003)
10.33 Officers' Deferred Stock Unit Plan of KeySpan Corporation (filed as Exhibit 10.17 to KeySpan's Annual Report on Form 10-K for the year ended December 31, 2002)
10.34 Officers' Deferred Stock Unit Plan of KeySpan Services, Inc. (filed as Exhibit 10.18 to KeySpan's Annual Report on Form 10-K for the year ended December 31, 2002)
10.35 Corporate Annual Incentive Compensation and Gainsharing Plan (filed as Exhibit 10.20 to KeySpan's Form 10-K for the year ended December 31, 2000)
10.36* Corporate Annual Incentive Compensation Plan Target Performance Award Level for Fiscal Year 2006
10.37 Senior Executive Change of Control Severance Plan effective as of October 29, 2003 (filed as Exhibit 10.20 to KeySpan's Form 10-K for the year ended December 31, 2003)
10.38 KeySpan's Amended Long-Term Performance Incentive Compensation Plan (filed as Exhibit A to KeySpan's 2001 Proxy Statement filed on March 23, 2001)
10.39* KeySpan's Long-Term Performance Incentive Compensation Plan Performance Target Award Level for Fiscal 2006
14 Code of Ethics (filed as Exhibit 14 to KeySpan's Annual Report on Form 10-K for the year ended December 31, 2003).
21* Subsidiaries of the Registrant
23.1* Consent of Deloitte & Touche LLP, Independent Registered Public Accounting Firm
24.1* Power of Attorney executed by Andrea S. Christensen on February 22,
24.2* Power of Attorney executed by Robert J. Fani on February 22, 2006
24.3* Power of Attorney executed by Alan H. Fishman on February 22, 2006
24.4* Power of Attorney executed by James R. Jones on February 22, 2006
24.5* Power of Attorney executed by James L. Larocca on February 22, 2006
24.6* Power of Attorney executed by Gloria C. Larson on February 22, 2006
24.7* Power of Attorney executed by Stephen W. McKessy on February 22, 2006
24.8* Power of Attorney executed by Edward D. Miller on February 22, 2006
24.9* Power of Attorney executed by Vikki L. Pryor on February 22, 2006
24.10* Certified copy of the Resolution of the Board of Directors authorizing signatures pursuant to power of attorney
31.1* Certification of the Chairman and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2* Certification of the Executive Vice President and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1* Certification of the Chairman and Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2* Certification of the Executive Vice President and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
* filed herewith
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.
KEYSPAN CORPORATION (Registrant)
Signature: Date:
By: /s/Gerald Luterman February 28, 2006 ------------------ Gerald Luterman Executive Vice President and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signatures: Date:
By: /s/Robert B. Catell February 28, 2006 --------------------------- Robert B. Catell Chairman of the Board of Directors and Chief Executive Officer
By: /s/Gerald Luterman February 28, 2006 ------------------ Gerald Luterman Executive Vice President and Chief Financial Officer
By: /s/Theresa A. Balog February 28, 2006 ------------------- Theresa A. Balog Vice President and Chief Accounting Officer
* - --------------------- Andrea S. Christensen Director
* - --------------------- Robert J. Fani President, Chief Operating Officer and Director
* - --------------- Alan H. Fishman Director
* - -------------- James R. Jones Director
* - ---------------- James L. Larocca Director
* - ---------------- Gloria C. Larson Director
* - ------------------ Stephen W. McKessy Lead Director
* - ---------------- Edward D. Miller Director
* - -------------- Vikki L. Pryor Director
* Such signature has been affixed pursuant to a Power of Attorney filed as an exhibit hereto and incorporated herein by reference thereto