ITEM 1. BUSINESS
General
Energen Corporation, based in Birmingham, Alabama, is a diversified energy holding company engaged primarily in the development, acquisition, exploration and production of oil, natural gas and natural gas liquids in the continental United States and in the purchase, distribution and sale of natural gas in central and north Alabama. Its two principal subsidiaries are Energen Resources Corporation and Alabama Gas Corporation (Alagasco).
Alagasco was formed in 1948 by the merger of Alabama Gas Company into Birmingham Gas Company, the predecessors of which had been in existence since the mid-1800s. Alagasco became publicly traded in 1953. Energen Resources was formed in 1971 as a subsidiary of Alagasco. Energen was incorporated in 1978 in preparation for the 1979 corporate reorganization in which Alagasco and Energen Resources became subsidiaries of Energen.
The Company maintains a Web site with the address www.energen.com. The Company does not include the information contained on its Web site as part of this report nor is the information incorporated by reference into this report. The Company makes available free of charge through its Web site the annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to these reports. Also, these reports are available in print upon shareholder request. These reports are available as soon as reasonably practicable after being electronically filed with or furnished to the Securities and Exchange Commission. The Company’s Web site also includes its Code of Ethics, Corporate Governance Guidelines, Audit Committee Charter, Officers’ Review Committee Charter, Governance and Nominations Committee Charter and Finance Committee Charter, each of which is available in print upon shareholder request.
Index to Financial Statements Financial Information About Industry Segments
The information required by this item is provided in Note 18, Industry Segment Information, in the Notes to Financial Statements.
Narrative Description of Business
•
Oil and Gas Operations
General: Energen’s oil and gas operations focus on increasing production and adding proved reserves through the development and acquisition of oil and gas properties. In addition, Energen Resources explores for and develops new reservoirs, primarily in areas in which it has an operating presence. All gas, oil and natural gas liquids production is sold to third parties. Energen Resources also provides operating services in the Black Warrior, San Juan and Permian basins for its joint interest and third parties. These services include overall project management and day-to-day decision-making relative to project operations.
At the end of 2009, Energen Resources’ proved oil and gas reserves totaled 1,547 billion cubic feet equivalent (Bcfe). Substantially all of these reserves are located in the San Juan Basin in New Mexico and Colorado, the Permian Basin in west Texas and the Black Warrior Basin in Alabama. Approximately 83 percent of Energen Resources’ year-end reserves are proved developed reserves. Energen Resources’ reserves are long-lived, with a year-end reserves-to-production ratio of 14 years. Natural gas represents approximately 58 percent of Energen Resources’ proved reserves, with oil representing approximately 30 percent and natural gas liquids comprising the balance.
Growth Strategy: Energen has operated for nearly fifteen years under a strategy to grow its oil and gas operations. Since the end of fiscal year 1995, Energen Resources has invested approximately $1.4 billion in property acquisitions, $2 billion in related development, and $270 million in exploration and related development. Energen Resources’ capital investment in 2010 is currently expected to approximate $310 million primarily for existing properties. The Company also may allocate additional capital for other oil and gas activities such as property acquisitions, additional development of existing properties and the exploration and further development of potential shales acreage primarily in Alabama.
Energen Resources seeks to acquire onshore North American properties which offer proved undeveloped and behind-pipe reserves as well as operational enhancement potential. Energen Resources prefers properties with long-lived reserves and multiple pay-zone opportunities; however, Energen Resources will consider acquisitions of other types of properties which meet its investment requirements, including acquisitions with unproved properties. In addition, Energen Resources conducts exploration activities primarily in areas in which it has operations and remains open to exploration activities which complement its core expertise and meet its investment requirements. Following an acquisition, Energen Resources focuses on increasing production and reserves through development of the properties’ undeveloped reserves and behind-pipe reserve potential as well as engaging in other activities. These activities include development well drilling, exploration, behind-pipe recompletions, pay-adds, workovers, secondary recovery and operational enhancements. Energen Resources prefers to operate its properties in order to better control the nature and pace of development activities. Energen Resources operated approximately 92 percent of its proved reserves at December 31, 2009.
In October 2006, Energen Resources sold to Chesapeake Energy Corporation (Chesapeake) a 50 percent interest in its unproved lease position of approximately 200,000 gross acres in various shale plays in Alabama for $75 million plus certain net drilling costs (approximately $10.85 million). Currently, Energen Resources’ net acreage position in Alabama shales totals approximately 399,000 acres representing multiple shale opportunities. As of December 31, 2009, Energen Resources had approximately $39 million of unproved leasehold costs related to its lease position in Alabama shales.
Effective April 1, 2009, Chesapeake agreed to farmout its half-interest in Alabama shales to Energen Resources. Under this agreement, Energen Resources had 18 months to drill two wells; one earning the Chattanooga acreage and the other earning the Conasauga acreage. A well drilled in the fall of 2009 earned Chesapeake’s
Index to Financial Statements
portion of the Chattanooga acreage. The farmout agreement was recently amended to extend the period to complete the Conasauga acreage until July 1, 2011. Chesapeake retains a net overriding royalty interest of approximately 1 to 2.5 percent convertible to a proportionately reduced working interest of 25 percent (net 12.5 percent) at 125 percent payout on a well-by-well basis.
During 2009 Energen Resources was unsuccessful in the completion of a Chattanooga shale well. The Company believes a casing leak rendered ineffective two small fracture stimulations in the Chattanooga shale formation. The costs related to this well of approximately $5.6 million pretax were expensed during the fourth quarter of 2009. Also expensed during the fourth quarter, was approximately $1.2 million pretax of costs associated with a well originally drilled by Chesapeake in an area of the Chattanooga shale which the Company no longer intends to pursue. The Company recognized unproved leasehold impairments of $2.1 million associated with these wells. Approximately $13 million of the remaining $39 million of unproved leasehold costs for Alabama shales mentioned above are associated with the Chattanooga shale formation with the remainder associated with the Conasauga shale formation. In the event further efforts are unsuccessful and the Company concludes no further activity is warranted, Energen Resources would expect to record a loss associated with well costs and the non-cash write-off on capitalized unproved leasehold. Energen Resources plans to drill a well during the spring of 2010 in order to determine economic viability of the Chattanooga shale formation and an additional well during the latter half of 2010 to determine economic viability of Conasauga shale formation.
Energen Resources’ development activities can result in the addition of new proved reserves and can serve to reclassify proved undeveloped reserves to proved developed reserves. Proved reserve disclosures are provided annually, although changes to reserve classifications occur throughout the year. Accordingly, additions of new reserves from development activities can occur throughout the year and may result from numerous factors including, but not limited to, regulatory approvals for drilling unit downspacing that increase the number of available drilling locations; changes in the economic or operating environments that allow previously uneconomic locations to be added; technological advances that make reserve locations available for development; successful development of existing proved undeveloped reserve locations that reclassify adjacent probable locations to proved undeveloped reserve locations; increased knowledge of field geology and engineering parameters relative to oil and gas reservoirs; and changes in management’s intent to develop certain opportunities.
During the three years ended December 31, 2009, the Company’s development efforts have added 358 Bcfe of proved reserves from the drilling of 995 gross development and service wells (including 36 sidetrack wells) and 228 well recompletions and pay-adds. In 2009, Energen Resources’ successful development wells and other activities added approximately 106 Bcfe of proved reserves; the Company drilled 222 gross development and service wells (including 3 sidetrack wells), performed some 91 well recompletions and pay-adds, and conducted other operational enhancements. Energen Resources’ production totaled 111.2 Bcfe in 2009 and is estimated to total 114 Bcfe in 2010, including 110 Bcfe of estimated production from proved reserves owned at December 31, 2009.
Drilling Activity: The following table sets forth the total number of net productive and dry exploratory and development wells drilled:
As of December 31, 2009, the Company was participating in the drilling of 6 gross development and exploratory wells, with the Company’s interest equivalent to 5.1 wells. In addition to the development wells
Index to Financial Statements
drilled, the Company drilled 32.5, 84.1 and 99.8 net service wells during 2009, 2008 and 2007, respectively. As of December 31, 2009, the Company was not participating in the drilling of any gross service wells.
Productive Wells and Acreage: The following table sets forth the total gross and net productive gas and oil wells as of December 31, 2009, and developed and undeveloped acreage as of the latest practicable date prior to year-end:
There were 9 wells with multiple completions in 2009. All wells and acreage are located onshore in the United States, with the majority of the net undeveloped acreage located in Alabama.
Risk Management: Energen Resources attempts to lower the commodity price risk associated with its oil and natural gas business through the use of futures, swaps and options. Energen Resources does not hedge more than 80 percent of its estimated annual production and generally does not hedge more than two fiscal years forward. Energen Resources recognized all derivatives on the balance sheet and measures all derivatives at fair value. If a derivative is designated as a cash flow hedge, the effectiveness of the hedge, or the degree that the gain (loss) for the hedging instrument offsets the loss (gain) on the hedged item, is measured at each reporting period. The effective portion of the gain or loss on the derivative instrument is recognized in other comprehensive income as a component of equity and subsequently reclassified to operating revenues when the forecasted transaction affects earnings. The ineffective portion of a derivative’s change in fair value is required to be recognized in operating revenues immediately.
The Company may also enter into derivative transactions that do not qualify for cash flow hedge accounting but are considered by management to represent valid economic hedges and are accounted for as mark-to-market transactions. These economic hedges may include, but are not limited to, basis hedges without a corresponding New York Mercantile Exchange hedge and hedges on non-operated or other properties for which all of the necessary information to qualify for cash flow hedge accounting is either not readily available or subject to change. Derivatives that do not qualify for hedge treatment are recorded at fair value with gains or losses recognized in operating revenues in the period of change.
In the case of an acquisition, Energen Resources may hedge more than two years forward to protect targeted returns. Energen Resources prefers long-lived reserves and primarily uses the then-current oil and gas futures prices in its evaluation models, the prevailing swap curve and, for the longer-term, its own pricing assumptions.
See the Forward-Looking Statements in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 1A, Risk Factors, for further discussion with respect to price and other risks.
•
Natural Gas Distribution
General: Alagasco is the largest natural gas distribution utility in the state of Alabama. Alagasco purchases natural gas through interstate and intrastate suppliers and distributes the purchased gas through its distribution facilities for sale to residential, commercial and industrial customers and other end-users of natural gas. Alagasco also provides transportation services to industrial and commercial customers located on its distribution system. These transportation customers, using Alagasco as their agent or acting on their own, purchase gas directly from marketers or suppliers and arrange for delivery of the gas into the Alagasco distribution system. Alagasco charges a fee to transport such customer-owned gas through its distribution system to the customers’ facilities.
Alagasco’s service territory is located in central and parts of north Alabama and includes 180 cities and communities in 28 counties. The aggregate population of the counties served by Alagasco is estimated to be 2.4
Index to Financial Statements
million. Among the cities served by Alagasco are Birmingham, the center of the largest metropolitan area in Alabama, and Montgomery, the state capital. During 2009, Alagasco served an average of 409,214 residential customers and 33,264 commercial, industrial and transportation customers. The Alagasco distribution system includes approximately 10,400 miles of main and more than 11,950 miles of service lines, odorization and regulation facilities, and customer meters.
APSC Regulation: As an Alabama utility, Alagasco is subject to regulation by the Alabama Public Service Commission (APSC) which established the Rate Stabilization and Equalization (RSE) rate-setting process in 1983. RSE’s current extension is for a seven-year period through December 31, 2014. RSE will continue after December 31, 2014, unless, after notice to the Company and a hearing, the APSC votes to modify or discontinue the RSE methodology. Alagasco’s allowed range of return on average equity remains 13.15 percent to 13.65 percent throughout the term of the order. Alagasco is on a September 30 fiscal year for rate-setting purposes (rate year).
Under RSE, the APSC conducts quarterly reviews to determine, based on Alagasco’s projections and year-to-date performance, whether Alagasco’s return on average equity at the end of the rate year will be within the allowed range of return. Reductions in rates can be made quarterly to bring the projected return within the allowed range; increases, however, are allowed only once each rate year, effective December 1, and cannot exceed 4 percent of prior-year revenues. At September 30, 2009, RSE limited the utility’s equity upon which a return is permitted to 55 percent of total capitalization. Under the inflation-based Cost Control Measurement (CCM) established by the APSC, if the percentage change in O&M expense on an aggregate basis falls within a range of 0.75 points above or below the percentage change in the Consumer Price Index For All Urban Consumers (Index Range), no adjustment is required. If the change in O&M expense on an aggregate basis exceeds the Index Range, three-quarters of the difference is returned to customers. To the extent the change is less than the Index Range, the utility benefits by one-half of the difference through future rate adjustments. The O&M expense base for measurement purposes will be set at the prior year’s actual O&M expense amount unless the Company exceeds the top of the Index Range in two successive years, in which case the base for the following year will be set at the top of the Index Range. Certain items that fluctuate based on situations demonstrated to be beyond Alagasco’s control may be excluded for the CCM calculation.
Alagasco’s rate schedules for natural gas distribution charges contain a Gas Supply Adjustment (GSA) rider, established in 1993, which permits the pass-through to customers of changes in the cost of gas supply. Alagasco’s tariff provides a temperature adjustment mechanism, also included in the GSA, that is designed to moderate the impact of departures from normal temperatures on Alagasco’s earnings. The temperature adjustment applies primarily to residential, small commercial and small industrial customers. Other non-temperature weather related conditions that may affect customer usage are not included in the temperature adjustment.
The APSC approved an Enhanced Stability Reserve (ESR) beginning October 1997, with an approved maximum funding level of $4 million pre-tax, to which Alagasco may charge the full amount of: (1) extraordinary O&M expenses resulting from force majeure events when one or a combination of two such events results in more than $200,000 of additional O&M expense during a rate year; or (2) individual industrial and commercial customer revenue losses that exceed $250,000 during the rate year, if such losses cause Alagasco’s return on average equity to fall below 13.15 percent. Following a year in which a charge against the ESR is made, the APSC provides for accretions to the ESR of no more than $40,000 monthly until the maximum funding level is achieved. Under the terms of the current RSE extension, Alagasco will not have accretions against the ESR until December 31, 2010, unless Alagasco incurs a significant natural disaster during the three-year period ended December 31, 2010 and receives approval from the APSC to resume accretions under the ESR. Due to revenue losses from market-sensitive large commercial and industrial customers, Alagasco utilized the ESR of approximately $4.0 million pre-tax during the rate year ended September 30, 2008. Alagasco expects to utilize the ESR to recover certain manufactured gas plant site remediation costs through future rates and has recorded a corresponding amount to its Enhanced Stability Reserve regulatory account, as more fully described in Environmental Matters.
Index to Financial Statements Gas Supply: Alagasco’s distribution system is connected to two major interstate natural gas pipeline systems, Southern Natural Gas Company (Southern) and Transcontinental Gas Pipe Line Company (Transco). It is also connected to several intrastate natural gas pipeline systems and to Alagasco’s two liquified natural gas (LNG) facilities.
Alagasco purchases natural gas from various natural gas producers and marketers. Certain volumes are purchased under firm contractual commitments with other volumes purchased on a spot market basis. The purchased volumes are delivered to Alagasco’s system using a variety of firm transportation, interruptible transportation and storage capacity arrangements designed to meet the system’s varying levels of demand. Alagasco’s LNG facilities can provide the system with up to an additional 200,000 thousand cubic feet per day (Mcfd) of natural gas to meet peak day demand.
As of December 31, 2009, Alagasco had the following contracts in place for firm natural gas pipeline transportation and storage services:
Competition: The price of natural gas is a significant competitive factor in Alagasco’s service territory, particularly among large commercial and industrial transportation customers. Propane, coal and fuel oil are readily available, and many industrial customers have the capability to switch to alternate fuels and alternate sources of gas. In the residential and small commercial and industrial markets, electricity is the principal competitor. With the support of the APSC, Alagasco has implemented a variety of programs to help it compete for gas load in all market segments. The Company has been effective at utilizing these programs to avoid load loss to competitive fuels.
Alagasco’s Transportation Tariff allows the Company to transport gas for large commercial and industrial customers rather than buy and resell it to them and is based on Alagasco’s sales profit margin so that operating margins are unaffected. During 2009, substantially all of Alagasco’s large commercial and industrial customer deliveries involved the transportation of customer-owned gas.
Natural gas service available to Alagasco customers falls into two broad categories: interruptible and firm. Interruptible service contractually is subject to interruption by Alagasco for various reasons; the most common occurrence is curtailment during periods of peak core market heating demand. Customers who contract for interruptible service can generally adjust production schedules or switch to alternate fuels during periods of service interruption or curtailment. More expensive firm service, on the other hand, generally is not subject to interruption and is provided to residential and small commercial and industrial customers. These core market customers depend on natural gas primarily for space heating.
Growth: Customer growth presents a major challenge for Alagasco, given its mature, slow-growth service area. Over the past several years, a higher price commodity environment and reduced economic activity have resulted in a decline in the utility’s customer base of approximately 1 percent annually. Recent lower commodity prices have not yet reversed this adverse trend at the utility. In 2009, Alagasco’s average number of customers decreased almost 1 percent. Alagasco will continue to concentrate on maintaining its current penetration levels and increasing residential saturation levels for all end-use applications. Alagasco will also continue to explore opportunities to increase revenue in the small and large commercial and industrial market segments.
Seasonality: Alagasco’s gas distribution business is highly seasonal since a material portion of the utility’s total sales and delivery volumes relate to space heating customers. Alagasco’s rate Tariff includes a Temperature Adjustment Rider primarily for residential, small commercial and small industrial customers that moderates the impact of departures from normal temperatures on Alagasco’s earnings. The adjustments are made through the GSA.
Index to Financial Statements
•
Environmental Matters and Climate Change
Various federal, state and local environmental laws and regulations apply to the operations of Energen Resources and Alagasco. Historically, the cost of environmental compliance has not materially affected the Company’s financial position, results of operations or cash flows. New regulations, enforcement policies, claims for damages or other events could result in significant unanticipated costs. Remediation of the Huntsville, Alabama manufactured gas plant site, as discussed below, may also result in unanticipated costs.
Federal, state and local legislative bodies and agencies frequently exercise their respective authority to adopt new laws and regulations and to amend and interpret existing laws and regulations. Such law and regulation changes may occur with little prior notification, subject the Company to cost increases, and impose restrictions and limitations on the Company’s operations. Currently, there are various proposed law and regulatory changes with the potential to materially impact the Company. Such proposals include, but are not limited to, measures dealing with hydraulic fracturing, emission limits and reporting and the repeal of certain oil and gas tax incentives and deductions. Due to the nature of the political and regulatory processes and based on its consideration of existing proposals, the Company is unable to determine that such proposed laws and regulations are reasonably likely to occur or to determine that the potential impact would be material.
Existing federal, state and local environmental laws and regulations also have the potential to increase costs, reduce liquidity, delay operations and otherwise alter business operations. These existing laws and regulations include, but are not limited to, the Clean Air Act; the Clean Water Act; Oil Pollution Prevention: Spill Prevention Control and Countermeasure regulations; Toxic Substances Control Act; Resource Conservation and Recovery Act and the Federal Endangered Species Act. Compliance with these and other environmental laws and regulations is undertaken as part of the Company’s routine operations. The Company does not separately track costs associated with these routine compliance activities.
Climate change, whether arising through natural occurrences or through the impact of human activities, may have a significant impact upon the operations of Energen Resources and Alagasco. Volatile weather patterns and the resulting environmental impact may adversely impact the results of operations, financial position and cash flows of the Company. The Company is unable to predict the timing or manifestation of climate change or reliably estimate the impact to the Company. However, climate change could affect the operations of the Company as follows:
•
sustained increases or decreases to the supply and demand of oil, natural gas and natural gas liquids;
•
positive or negative changes to usage and customer count at Alagasco from prolonged increases or decreases in average temperature due to the geographic concentration of Alagasco’s customers in central and north Alabama;
•
potential disruption to third party facilities to which Energen Resources delivers to and from which Alagasco is served. Such facilities include third party oil and gas gathering, transportation, processing and storage facilities and are typically limited in number and geographically concentrated.
A discussion of certain litigation against Energen Resources in the state of Louisiana related to the restoration of oilfield properties is included in Item 3, Legal Proceedings of Part I in this Form 10-K.
Alagasco is in the chain of title of nine former manufactured gas plant sites (four of which it still owns) and five manufactured gas distribution sites (one of which it still owns). Subject to the following paragraph discussing the Huntsville, Alabama manufactured gas plant site, an investigation of the sites does not indicate the present need for remediation activities and management expects that, should remediation of any such sites be required in the future, Alagasco’s share, if any, of such costs will not materially affect the financial position of Alagasco.
Index to Financial Statements In June 2009, Alagasco received a General Notice Letter from the United States Environmental Protection Agency (EPA) identifying Alagasco as a responsible party for a former manufactured gas plant (MGP) site located in Huntsville, Alabama, and inviting Alagasco to enter an Administrative Settlement Agreement and Order on Consent to perform a removal action at that site. The Huntsville MGP, along with the Huntsville gas distribution system, was sold by Alagasco to the City of Huntsville in 1949. While Alagasco no longer owns the Huntsville site, the Company and the current site owner have agreed to enter into a Consent Order and develop an action plan for the site. Based on the limited information available at this time, Alagasco preliminarily estimates that it may incur costs associated with the site ranging from $3 million to $6.1 million. At the present time, the Company cannot conclude that any amount within this range is a better estimate than any other. During the year ended December 31, 2009, the Company incurred costs of $0.2 million associated with the site. As of December 31, 2009, the Company has accrued a contingent liability of $2.8 million in addition to the costs previously incurred. The estimate assumes an action plan for excavation of affected soil and sediment only. If it is determined that a greater scope of work is appropriate, then actual costs will likely exceed the preliminary estimate. Alagasco expects to recover such costs through insurance recovery and future rates and has recorded a corresponding amount to its Enhanced Stability Reserve regulatory asset account.
•
Employees
The Company has approximately 1,515 employees, of which Alagasco employs 1,100 and Energen Resources employs 415. The Company believes that its relations with employees are good.
Index to Financial Statements
ITEM 1A.
ITEM 1A. RISK FACTORS
The future success and continued viability of Energen and its businesses, like any venture, is subject to many recognized and unrecognized risks and uncertainties. Such risks and uncertainties could cause actual results to differ materially from those contained in forward-looking statements made in this report and presented elsewhere by management. The following list identifies and briefly summarizes certain risk factors, and should not be viewed as complete or comprehensive. The Company undertakes no obligation to correct or update such risk factors whether as a result of new information, future events or otherwise. These risk factors should be read in conjunction with the Company’s disclosure specific to Forward-Looking Statements made elsewhere in this report.
Commodity Prices: The Company and Alagasco are significantly influenced by commodity prices. Historical markets for natural gas, oil and natural gas liquids have been volatile. Energen Resources’ revenues, operating results, profitability and cash flows depend primarily upon the prices realized for its oil, gas and natural gas liquid production. Alagasco’s competitive position and customer demand is significantly influenced by prices for natural gas which are passed-through to customers.
Access to Credit Markets: The Company and its subsidiaries rely on access to credit markets. The availability and cost of credit market access is significantly influenced by market events and rating agency evaluations for both lenders and the Company. Recent market volatility and credit market disruption have demonstrated that credit availability and issuer credit ratings can change rapidly. Events negatively affecting credit ratings and credit market liquidity could increase borrowing costs or limit availability of funds to the Company.
Energen Resources’ Hedging: Although Energen Resources makes use of futures, swaps, options and fixed-price contracts to mitigate price risk, fluctuations in future oil, gas and natural gas liquids prices could materially affect the Company’s financial position, results of operations and cash flows; furthermore, such risk mitigation activities may cause the Company’s financial position and results of operations to be materially different from results that would have been obtained had such risk mitigation activities not occurred. The effectiveness of such risk mitigation assumes that counterparties maintain satisfactory credit quality. The effectiveness of such risk mitigation also assumes that actual sales volumes will generally meet or exceed the volumes subject to the futures, swaps, options and fixed- price contracts. A substantial failure to meet sales volume targets, whether caused by miscalculations, weather events, natural disaster, accident, mechanical failure, criminal act or otherwise, could leave Energen Resources financially exposed to its counterparties and result in material adverse financial consequences to Energen Resources and the Company. The adverse effect could be increased if the adverse event was widespread enough to move market prices against Energen Resources’ position.
Alagasco’s Hedging: Similarly, although Alagasco makes use of futures, swaps and fixed-price contracts to mitigate gas supply cost risk, fluctuations in future gas supply costs could materially affect its financial position and rates to customers. The effectiveness of Alagasco’s risk mitigation assumes that its counterparties in such activities maintain satisfactory credit quality. The effectiveness of such risk mitigation also assumes that Alagasco’s actual gas supply needs will generally meet or exceed the volumes subject to the futures, swaps and fixed-price contracts. A substantial failure to experience projected gas supply needs, whether caused by miscalculations, weather events, natural disaster, accident, mechanical failure, criminal act or otherwise, could leave Alagasco financially exposed to its counterparties and result in material adverse financial consequences to Alagasco and the Company. The adverse effect could be increased if the adverse event was widespread enough to move market prices against Alagasco’s position.
Energen Resources Customer Concentration: Revenues and related accounts receivable from oil and gas operations primarily are generated from the sale of produced oil, natural gas and natural gas liquids to a small number of energy marketing companies. Such sales are typically made on an unsecured credit basis with payment due the month following delivery. This concentration of sales to a limited number of customers in the energy marketing industry has the potential to affect the Company’s overall exposure to credit risk, either positively or negatively, based on changes in economic, industry or other conditions specific to a single customer or to the energy marketing industry generally. Energen Resources considers the credit quality of its customers and, in certain instances, may require credit assurances such as a deposit, letter of credit or parent guarantee. The three
Index to Financial Statements
largest oil, natural gas and natural gas liquids purchasers are expected to account for approximately 21 percent, 17 percent and 13 percent, respectively, of Energen Resources’ estimated 2010 production. Energen Resources’ other purchasers are each expected to purchase less than 8 percent of estimated 2010 production.
Third Party Facilities: Energen Resources delivers to and Alagasco is served by third party facilities. These facilities include third party oil and gas gathering, transportation, processing and storage facilities. Energen Resources relies upon such facilities for access to markets for its production. Alagasco relies upon such facilities for access to natural gas supplies. Such facilities are typically limited in number and geographically concentrated. An extended interruption of access to or service from these facilities, whether caused by weather events, natural disaster, accident, mechanical failure, criminal act or otherwise could result in material adverse financial consequences to Energen Resources, Alagasco and the Company.
Energen Resources’ Production and Drilling: There are numerous uncertainties inherent in estimating quantities of proved oil and gas reserves and in projecting future rates of production and timing of development expenditures. The total amount or timing of actual future production may vary significantly from reserve and production estimates. In the event Energen Resources is unable to fully invest its planned development, acquisition and exploratory expenditures, future operating revenues, production, and proved reserves could be negatively affected. The drilling of development and exploratory wells can involve significant risks, including those related to timing, success rates and cost overruns, and these risks can be affected by lease and rig availability, complex geology and other factors. Anticipated drilling plans and capital expenditures may also change due to weather, manpower and equipment availability, changing emphasis by management and a variety of other factors which could result in actual drilling and capital expenditures being substantially different than currently planned.
Operations: Inherent in the gas distribution activities of Alagasco and the oil and gas production activities of Energen Resources are a variety of hazards and operation risks, such as leaks, explosions and mechanical problems that could cause substantial financial losses. In addition, these risks could result in loss of human life, significant damage to property, environmental pollution, impairment of operations and substantial losses to the Company. In accordance with customary industry practices, the Company maintains insurance against some, but not all, of these risks and losses. Further, the Company’s insurance retention levels are such that significant events could adversely affect Energen Resources’, Alagasco’s and the Company’s financial position, results of operations and cash flows. The location of pipeline and storage facilities near populated areas, including residential areas, commercial business centers and industrial sites, could increase the level of damages resulting from these risks. The occurrence of any of these events could adversely affect Alagasco’s, Energen Resources’ and the Company’s financial position, results of operations and cash flows.
Alagasco’s Service Territory: Alagasco’s utility customers are geographically concentrated in central and north Alabama. Significant economic, weather, natural disaster, criminal act or other events that adversely affect this region could adversely affect Alagasco and the Company.
Federal, State and Local Laws and Regulations: Energen and Alagasco are subject to extensive federal, state and local regulation which significantly influences operations. Although the Company believes that operations generally comply with applicable laws and regulations, failure to comply could result in the suspension or termination of operations and subject the Company to administrative, civil and criminal penalties. Federal, state and local legislative bodies and agencies frequently exercise their respective authority to adopt new laws and regulations and to amend, modify and interpret existing laws and regulations. Such changes can subject the Company to significant tax or cost increases and can impose significant restrictions and limitations on the Company’s operations.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None
Index to Financial Statements
ITEM 2.
ITEM 2. PROPERTIES
The corporate headquarters of Energen, Energen Resources and Alagasco are located in leased office space in Birmingham, Alabama. See the discussion under Item 1, Business for further information related to Energen Resources’ and Alagasco’s business operations. Information concerning Energen Resources’ production and reserves is summarized in the table below and included in Note 17, Oil and Gas Operations (Unaudited), in the Notes to Financial Statements. See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations for a discussion of the future outlook and expectations for Energen Resources and Alagasco.
Oil and Gas Operations
Energen Resources focuses on increasing its production and proved reserves through the acquisition and development of onshore North American producing oil and gas properties. Energen Resources maintains offices in Arcadia, Louisiana; in Farmington, New Mexico; and in Midland, Texas. The Company also maintains offices in Lehman, Seminole, Westbrook and Penwell, Texas; and in Brookwood and Tuscaloosa, Alabama.
The major areas of operations include (1) the San Juan Basin, (2) the Permian Basin, (3) the Black Warrior Basin and (4) North Louisiana/East Texas as highlighted on the above map.
The following table sets forth the production volumes for the year ended December 31, 2009, and proved reserves and reserves-to-production ratio by area as of December 31, 2009:
Index to Financial Statements The following table sets forth proved reserves by area as of December 31, 2009:
The following table sets forth proved developed reserves by area as of December 31, 2009:
The following table sets forth proved undeveloped reserves by area as of December 31, 2009:
The following table sets forth the reconciliation of proved undeveloped reserves:
* Approximately $103 million in capital was spent in the year ended December 31, 2009 related to undeveloped reserves that were moved to developed
Energen Resources files Form EIA-23 with the Department of Energy which reports gross proved reserves, including the working interest share of other owners, for properties operated by the Company. The proved reserves reported in the table above represent our share of proved reserves for all properties, based on our ownership interest in each property. For properties operated by Energen Resources, the difference between the proved reserves reported on Form EIA-23 and the gross reserves associated with the Company-owned proved reserves reported in the table above does not exceed five percent. Estimated proved reserves as of December 31, 2009 are based upon studies for each of our properties prepared by Company engineers and audited by Ryder Scott Company, L.P. (Ryder Scott) and T. Scott Hickman and Associates, Inc. (T. Scott Hickman), independent oil and gas reservoir engineers. Calculations were prepared using standard geological and engineering methods generally accepted by the petroleum industry and in accordance with Securities and Exchange Commission (SEC) guidelines.
A Senior Vice President at Ryder Scott is the technical person primarily responsible for overseeing the audit of the reserves. The Senior Vice President has a Bachelor of Science degree in Mechanical Engineering and is a member of the Society of Petroleum Engineers and the Society of Petroleum Evaluation Engineers. He has been an employee of Ryder Scott since 1982 and also serves as chief technical advisor of unconventional reserves
Index to Financial Statements
evaluation. A Petroleum Consultant at T. Scott Hickman is the technical person primarily responsible for overseeing the audit of the reserves. He has a Bachelor of Science degree in Petroleum Engineering and is a member of the Society of Petroleum Engineers and the Society of Petroleum Evaluation Engineers. He has been employed by T. Scott Hickman since 1983. The General Manager of Acquisitions and Engineering is the technical person primarily responsible for overseeing reserves on behalf of Energen Resources. His background includes a Bachelor of Science degree in Mechanical Engineering and membership in the Society of Petroleum Engineers. He is a registered Professional Engineer in the State of Alabama with more than 30-years experience evaluating oil and natural gas properties and estimating reserves.
The Company relies upon certain internal controls when preparing its reserve estimations. These internal controls include review by the reservoir engineering managers to ensure the correct reserve methodology has been applied for each specific property and that the reserves are properly categorized in accordance with SEC guidelines. They also affirm the accuracy of the data used in the reserve and associated rate forecast, provide a review of the procedures used to input pricing data and a review of the working and net interest factors to ensure that factors are adequately reflected in the engineering analysis.
Net production forecasts are compared to historical sales volumes to check for reasonableness and operating costs and severance taxes calculated in the reserve report are compared to historical accounting data to ensure proper cost estimates are used. A reserve table is generated comparing previous years reserves to current year reserve estimates to determine variances. This table is reviewed by the General Manager of Engineering and Acquisitions and the Chief Operating Officer of Energen Resources. Revisions and additions are investigated and explained.
Reserve estimates of proved reserves are sent to independent reservoir engineers for audit and verification. For 2009, approximately 99 percent of all proved reserves were audited by the independent reservoir engineers which audit engineering procedures, check the reserve estimates for reasonableness and check that the reserves are properly classified.
The following table sets forth the standard pressure base in pounds-force per square inch absolute (psia) for each state in which Energen Resources has wells:
The following table sets forth the total net productive gas and oil wells by area as of December 31, 2009, and developed and undeveloped acreage as of the latest practicable date prior to year-end:
Energen Resources sells oil, natural gas, and natural gas liquids under a variety of contractual arrangements, some of which specify the delivery of a fixed and determinable quantity. Energen Resources is contractually committed to deliver approximately 53 Bcf (net) of natural gas through March 2011. The Company expects to fulfill delivery commitments through production of existing proved reserves.
Index to Financial Statements Natural Gas Distribution
The properties of Alagasco consist primarily of its gas distribution system, which includes approximately 10,400 miles of main and more than 11,950 miles of service lines, odorization and regulation facilities, and customer meters. Alagasco also has two LNG facilities, four division commercial offices, three division business centers, one district office, seven service centers, and other related property and equipment, some of which are leased by Alagasco.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Energen and its affiliates are, from time to time, parties to various pending or threatened legal proceedings. Certain of these lawsuits include claims for punitive damages in addition to other specific relief. Based upon information presently available, and in light of available legal and other defenses, contingent liabilities arising from threatened and pending litigation are not considered material in relation to the respective financial positions of Energen and its affiliates. It should be noted, however, that Energen and its affiliates conduct business in Alabama and other jurisdictions in which the magnitude and frequency of punitive or other damage awards may bear little or no relation to culpability or actual damages, thus making it difficult to predict litigation results.
Legacy Litigation
During recent years, numerous lawsuits have been filed against oil production companies in Louisiana for restoration of oilfield properties. These suits are referred to in the industry as “legacy litigation” because they usually involve operations that were conducted on the affected properties many years earlier. Energen Resources is or has been a party to several legacy litigation lawsuits, most of which result from the operations of predecessor companies. Based upon information presently available, and in light of available legal and other defenses, contingent liabilities arising from legacy litigation in excess of the Company’s accrued provision for estimated liability are not considered material to the Company’s financial position.
Other
Various other pending or threatened legal proceedings are in progress currently, and the Company has accrued a provision for the estimated liability.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of 2009.
Index to Financial Statements EXECUTIVE OFFICERS OF THE REGISTRANTS
Energen Corporation
Notes:
(1) All executive officers of Energen have been employed by Energen or a subsidiary for the past five years. Officers serve at the pleasure of the Board of Directors.
(2) Mr. McManus has been employed by the Company in various capacities since 1986. He was elected Executive Vice President and Chief Operating Officer of Energen Resources in October 1995 and President of Energen Resources in April 1997. He was elected President and Chief Operating Officer of Energen effective January 1, 2006 and Chief Executive Officer of Energen and each of its subsidiaries effective July 1, 2007. He was elected Chairman of the Board of Energen and each of its subsidiaries effective January 1, 2008. Mr. McManus serves as a Director of Energen and each of its subsidiaries.
(3) Mr. Porter has been employed by the Company in various financial capacities since 1989. He was elected Controller of Energen Resources in 1998. In 2001, he was elected Vice President - Finance of Energen Resources. He was elected Vice President, Chief Financial Officer and Treasurer of Energen and each of its subsidiaries effective January 1, 2007.
(4) Mr. Richardson has been employed by the Company in various capacities since 1985. He was elected Vice President - Acquisitions and Engineering of Energen Resources in 1997. He was elected Executive Vice President and Chief Operating Officer of Energen Resources effective January 1, 2006. He was elected President and Chief Operating Officer of Energen Resources effective January 23, 2008.
(5) Mr. Reynolds has been employed by the Company in various capacities since 1980. He was elected General Counsel and Secretary of Energen and each of its subsidiaries in April 1991. He was elected President and Chief Operating Officer of Alagasco effective January 1, 2003.
Index to Financial Statements
(6) Mr. Woodruff has been employed by the Company in various capacities since 1986. He was elected Vice President-Legal and Assistant Secretary of Energen and each of its subsidiaries in April 1991 and Vice President-Corporate Development of Energen in October 1995. He was elected General Counsel and Secretary of Energen and each of its subsidiaries effective January 1, 2003.
(7) Mr. Lynch has been employed by the Company in various capacities since 2001. He became Energen’s Manager of Financial Accounting and Treasury in 2004 and Director of Financial Accounting in 2007. He was elected Vice President and Controller of Energen effective January 1, 2009.
Index to Financial Statements PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Energen’s common stock is listed on the New York Stock Exchange under the symbol EGN. On February 16, 2010, there were 6,708 holders of record of Energen’s common stock. At the date of this filing, Energen Corporation owned all the issued and outstanding common stock of Alabama Gas Corporation. Energen expects to pay annual cash dividends of $0.52 per share on the Company’s common stock in 2010. The amount and timing of all dividend payments is subject to the discretion of the Board of Directors and is based upon business conditions, results of operations, financial conditions and other factors.
The following table summarizes information concerning securities authorized for issuance under equity compensation plans:
* These plans include 1,369,514 shares associated with the Company’s 1997 Stock Incentive Plan, 190,724 shares associated with the 1992 Energen Corporation Directors Stock Plan and 712,672 shares associated with the 1997 Deferred Compensation Plan.
The following table summarizes information concerning purchases of equity securities by the issuer:
* Acquired in connection with tax withholdings and payment of exercise price on stock compensation plans.
** By resolution adopted May 24, 1994, and supplemented by resolutions adopted April 26, 2000 and June 24, 2006, the Board of Directors authorized the Company to repurchase up to 12,564,400 shares of the Company’s common stock. The resolutions do not have an expiration date.
Index to Financial Statements PERFORMANCE GRAPH
Energen Corporation - Comparison of Five-Year Cumulative Shareholder Returns
This graph compares the total shareholder returns of Energen, the Standard & Poor’s Composite Stock Index (S&P 500), the Standard & Poor’s Supercomposite Oil & Gas Exploration & Production Index (S15OILP), and the Standard & Poor’s Supercomposite Gas Utilities Index (S15GASUX). The graph assumes $100 invested at the per-share closing price of the common stock on the New York Exchange Composite Tape on December 31, 2004, in the Company and each of the indices. Total shareholder return includes reinvested dividends.
Index to Financial Statements
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data as set forth below should be read in conjunction with the Consolidated Financial Statements and the Notes to Financial Statements included in this Form 10-K.
SELECTED FINANCIAL AND COMMON STOCK DATA
Energen Corporation
* Includes an after-tax gain of $34.5 million, or $0.47 per diluted share, on the sale of a 50 percent interest in Energen Resources’ acreage position in Alabama shales to Chesapeake Energy Corporation.
Index to Financial Statements SELECTED BUSINESS SEGMENT DATA
Energen Corporation
Index to Financial Statements
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Consolidated Net Income
Energen Corporation’s net income for the year ended December 31, 2009 totaled $256.3 million, or $3.57 per diluted share compared to the year ended December 31, 2008 net income of $321.9 million, or $4.47 per diluted share. This 20.1 percent decrease in earnings per diluted share (EPS) largely reflected the result of significantly lower prices for natural gas, oil and natural gas liquids, increased depreciation, depletion and amortization (DD&A) expense, increased administrative expense, a 2008 after-tax gain of $6.4 million on the sale of certain Permian Basin oil properties and higher lease operating expense. Positively affecting net income was the impact of an 8.9 billion cubic feet equivalent (Bcfe) increase in production volumes from Energen Resources Corporation, Energen’s oil and gas subsidiary, decreased production taxes and an after-tax gain of $3.1 million on the sale of certain oil properties in the Permian Basin. For the year ended December 31, 2009, Energen Resources earned $212.1 million, as compared with $282.7 million in the previous year. Alabama Gas Corporation (Alagasco), Energen’s utility subsidiary, generated net income of $45.4 million in the current year as compared with net income in the prior period of $40.2 million. For the year ended December 31, 2007, Energen reported net income of $309.2 million, or $4.28 per diluted share.
2009 vs 2008: Energen Resources’ net income totaled $212.1 million in 2009 as compared with $282.7 million in 2008 primarily due to decreased commodity prices of approximately $105 million after-tax, increased DD&A expense of approximately $28 million after-tax, increased administrative expense of approximately $7 million after-tax, the $6.4 million after-tax gain on the sale of certain Permian Basin oil properties in 2008 and higher lease operating expense of approximately $5 million after-tax. These increases were partially offset by the impact of increased production volumes of approximately $52 million after-tax, decreased production taxes of approximately $17 million after-tax and the after-tax gain of $3.1 million on the sale of certain oil properties in the Permian Basin.
Alagasco earnings increased to $45.4 million in 2009 from $40.2 million in 2008 which largely reflects the timing of revenue recovery associated with core-market sales as well as increased investment gains combined with the utility’s ability to earn on a higher level of equity. Alagasco achieved a return on average equity (ROE) of 14 percent in 2009 compared with 12.9 percent in 2008.
2008 vs 2007: For the year ended December 31, 2008, Energen Resources’ net income totaled $282.7 million and compared favorably to $273.2 million in the prior year. The primary factors positively influencing income included increased commodity prices of approximately $27 million after-tax, the impact of increased production volumes of approximately $22 million after-tax and a $6.4 million after-tax gain on the sale of certain Permian Basin oil properties. These increases were partially offset by higher lease operating expense of approximately $16 million after-tax, increased DD&A expense of approximately $15 million after-tax and the reduced benefit of the Section 199 Domestic Production Activities Deduction on qualified oil and gas production income of approximately $8 million after-tax.
Alagasco earned net income of $40.2 million in 2008 as compared with net income of $36.8 million in 2007. This increase in earnings largely reflected the utility’s ability to earn on a higher level of equity combined with timing differences associated with rate recovery of approximately $4.1 million after-tax, the $2.5 million after-tax utilization of the Enhanced Stability Reserve (ESR) to compensate for large industrial and commercial market sensitive load loss and the approximate $1.8 million after-tax benefit from the utility holding O&M expense to below the inflation-based Cost Control Measurement (CCM). Negatively affecting net income was a decrease in customer usage and other of approximately $5 million after-tax. Alagasco’s ROE was 12.9 percent in 2008 compared with 12.3 percent in 2007.
Operating Income
Consolidated operating income in 2009, 2008 and 2007 totaled $435.4 million, $562.1 million and $522 million, respectively. The decrease in operating income for 2009 is primarily due to significantly lower commodity prices partially offset by increased production at Energen Resources. Growth in operating income for 2008 and 2007 was
Index to Financial Statements
influenced by strong financial performance from Energen Resources arising from increased commodity prices and production. Alagasco’s operating income remained relatively flat in 2009. During 2008, Alagasco contributed to this growth in operating income consistent with an increase in the level of equity upon which it has been able to earn a return combined with timing differences associated with rate recovery, the utilization of the ESR and the benefit from the increase in O&M expense being below its CCM partially offset by lower customer usage.
Oil and Gas Operations: Revenues from oil and gas operations declined in the current year largely as a result of significantly lower commodity prices partially offset by the impact of increased production volumes. Production increased due to increased volumes related to the June 2009 purchase of certain Permian Basin oil properties, acquiring proved reserves of approximately 15.2 million barrels of oil equivalents along with additional development activities in the San Juan and Permian basins, partially offset by normal production declines and other. Revenue per unit of production for natural gas production declined 19.9 percent to $6.36 per thousand cubic feet (Mcf), oil revenue per unit of production fell 14.7 percent to $60.72 per barrel and natural gas liquids revenue per unit of production decreased 7.3 percent to $0.89 per gallon during 2009. Production rose 8.7 percent to 111.2 Bcfe during 2009. Natural gas production increased 7.1 percent to 72.3 billion cubic feet (Bcf) and oil volumes rose 14 percent to 4,690 thousand barrels (MBbl). Production of natural gas liquids increased 6.4 percent to 75.2 million gallons (MMgal).
In 2008, revenues from oil and gas operations rose primarily due to the impact of higher commodity prices along with increased production volumes. The primary factors affecting the increase in production were additional development activities in the San Juan and North Louisiana/East Texas basins partially offset by normal production declines. Revenue per unit of production for natural gas production rose 2.2 percent to $7.94 per Mcf, oil revenue per unit of production increased 9.8 percent to $71.20 per barrel and natural gas liquids revenue per unit of production increased 7.9 percent to $0.96 per gallon during 2008. Production rose 3.8 percent to 102.4 Bcfe during 2008. Natural gas production increased 5.1 percent to 67.6 Bcf and oil volumes increased 6.1 percent to 4,114 MBbl. Production of natural gas liquids decreased 8.4 percent to 70.7 MMgal due to normal production declines and severe winter weather in the San Juan Basin.
Coalbed methane operating fees are calculated as a percentage of net proceeds on certain properties, as defined by the related operating agreements, and vary with changes in natural gas prices, production volumes and operating expenses. Revenues from operating fees were $3.1 million, $8.6 million and $6.1 million in 2009, 2008 and 2007, respectively.
Index to Financial Statements Operations and maintenance (O&M) expense increased $19.1 million and $22.6 million in 2009 and 2008, respectively. Lease operating expense (excluding production taxes) in 2009 increased $7.7 million largely due to the June 2009 Permian Basin oil property acquisition (approximately $6.4 million), higher labor costs (approximately $1.6 million), increased marketing and transportation costs (approximately $0.7 million) and increased ad valorem taxes (approximately $0.5 million) partially offset by decreased electrical costs (approximately $1.3 million). In 2008, lease operating expense (excluding production taxes) increased $25.8 million largely due to higher workover expense, (approximately $10 million), increased transportation costs primarily related to increased San Juan production (approximately $5 million), additional compression costs (approximately $3 million), higher ad valorem taxes (approximately $2 million) and increased labor costs (approximately $2 million). Administrative expense rose $10.5 million in 2009 primarily due to increased benefit costs largely related to the Company’s performance-based compensation plans (approximately $8.9 million) and increased legal expenses (approximately $0.8 million). In 2008, administrative expense decreased $9.7 million largely due to lower benefit costs primarily related to the Company’s performance-based compensation plans. The year ended 2007 included settlement charges for the nonqualified supplemental retirement plans and the defined benefit pension plans of $2.3 million. In 2009, exploration expense increased $0.9 million. Exploration expense in 2009 includes the writeoff of two Chattanooga shale wells; the writeoff for one well was $5.6 million and the writeoff for the other well, originally drilled by Chesapeake for $0.9 million. In addition, exploration expense includes approximately $2.1 million of unproved leasehold impairments related to the Alabama shales. Exploration expense rose $6.4 million in 2008 largely due to the writeoff of two wells in the San Juan Basin where mechanical difficulties were encountered.
DD&A expense increased $44.6 million in 2009 and $25.3 million in 2008. The average DD&A rates were $1.63 per Mcfe in 2009, $1.33 per Mcfe in 2008 and $1.13 per Mcfe in 2007. The increase in the average 2009 DD&A rate, which contributed approximately $33.1 million, was primarily due to higher development costs along with the reserve revisions associated with 2008 and 2009 reserve prices. Higher development costs along with the impact in the 2008 fourth quarter of pricing year-end proved reserves resulted in an increase in the average 2008 DD&A rate of approximately $20.6 million. Increased production volumes also contributed approximately $11.3 million and $4.2 million to the increase in DD&A expense in 2009 and 2008, respectively.
Energen Resources’ expense for taxes other than income taxes primarily reflected production-related taxes. Energen Resources recorded severance taxes of $35.7 million, $62.6 million and $53.8 million for 2009, 2008 and 2007, respectively. Severance taxes decreased $26.9 million in 2009 over the prior year. Lower commodity market prices contributed approximately $32.3 million to the decrease in production-related taxes. Partially offsetting the decreases in production-related taxes were higher production volumes which contributed approximately $5.4 million. Higher severance taxes in 2008 resulted from increased commodity market prices and higher natural gas and oil production volumes. Higher commodity market prices and the impact of increased production volumes contributed approximately $13.7 million and $2 million, respectively. Partially offsetting the increase in severance taxes during 2008 was a $6.9 million adjustment related to 2005 through 2008 for reduced severance taxes in New Mexico. Commodity market prices exclude the effects of derivative instruments for purposes of determining severance taxes.
Natural Gas Distribution: As discussed more fully in Note 2, Regulatory Matters, in the Notes to Financial Statements, Alagasco is subject to regulation by the Alabama Public Service Commission (APSC) and is allowed to earn a range of return on equity of 13.15 percent to 13.65 percent. At September 30, 2009, RSE limited the utility’s equity upon which a return is permitted to 55 percent of total capitalization, subject to certain adjustments. Given existing economic conditions, Alagasco expects only modest growth in equity as annual dividends are typically paid by the utility.
Index to Financial Statements Under the inflation-based CCM established by the APSC, if the percentage change in O&M expense on an aggregate basis falls within a range of 0.75 points above or below the percentage change in the Consumer Price Index For All Urban Consumers (Index Range), no adjustment is required. If the change in O&M expense on an aggregate basis exceeds the Index Range, three-quarters of the difference is returned to customers. To the extent the change is less than the Index Range, the utility benefits by one-half of the difference through future rate adjustments. The O&M expense base for measurement purposes will be set at the prior year’s actual O&M expense amount unless the Company exceeds the top of the Index Range in two successive years, in which case the base for the following year will be set at the top of the Index Range. Certain items that fluctuate based on situations demonstrated to be beyond Alagasco’s control may be excluded from the cost control measurement calculation.
Alagasco generates revenues through the sale and transportation of natural gas. The transportation rate does not contain an amount representing the cost of gas, and Alagasco’s rate structure allows similar margins on transportation and sales gas. Weather can cause variations in space heating revenues; as such Alagasco’s tariff provides a temperature adjustment mechanism that is designed to moderate the impact of departures from normal temperatures on Alagasco’s earnings. The temperature adjustment applies primarily to residential, small commercial and small industrial customers and is adjusted through the Gas Supply Adjustment rider (GSA).
Alagasco’s natural gas and transportation sales revenues totaled $617.9 million, $654.8 million and $609.5 million in 2009, 2008 and 2007, respectively. Sales revenue in 2009 declined largely due to a decrease in gas costs of approximately $36 million and a decline in customer usage of approximately $9 million. The decline in revenues was also impacted by adjustments from the utility’s rate setting mechanisms. As of September 30, 2009, Alagasco had a $1.5 million pre-tax reduction in revenues to bring the return on average equity to midpoint within the allowed range of return. Alagasco charged approximately $4 million against the ESR during the third quarter of 2008 due to a decline in usage by certain market sensitive large commercial and industrial customers. At the end of the 2008 rate year, the increase in O&M expense was below its inflation-based cost control measure; as a result the utility benefited by a $2.9 million pre-tax increase in revenues. Weather was 4.7 percent warmer than in the prior year during 2009. Residential sales volumes declined 3.3 percent while commercial and industrial volumes decreased 9.1 percent. Transportation volumes fell 12.6 percent largely due to decreased large customer and industrial usage. In 2008, weather that was 13.3 percent colder than in the prior year contributed to a 4.7 percent increase in residential sales volumes while commercial and industrial volumes rose 3.2 percent. Transportation volumes declined 9.1 percent primarily due to decreased usage from construction industry related customers. In 2008, sales revenue increased primarily due to an increase in gas costs of approximately $22 million and a weather-driven increase in customer usage of approximately $11 million. Adjustments from the utility’s rate setting mechanisms also contributed to the increase in revenues as Alagasco charged approximately $4 million against the ESR during the third quarter of 2008 and benefited from the $2.9 million pre-tax adjustment as discussed above. At the end of the 2007 rate year, Alagasco had a $3.6 million pre-tax reduction in revenues to bring the return on average equity to midpoint in the allowed range of return. In 2009, lower gas costs along with decreased gas purchase volumes contributed to a 13 percent decrease in cost of gas. Higher gas costs combined with an increase in gas purchase volumes resulted in a 10.5 percent increase in cost of gas in 2008.
O&M expense at the utility increased 5.4 percent in 2009 primarily due to increased bad debt expense (approximately $4.2 million), higher labor-related costs (approximately $3.2 million) and increased marketing expenses (approximately $2.7 million) partially offset by lower distribution operation expenses (approximately $2.1 million) and net decreased consulting and technology costs (approximately $0.5 million). In 2008, O&M expense at the utility decreased 1.1 percent primarily due to lower labor-related costs (approximately $3.9 million) and decreased insurance costs (approximately $1.9 million) partially offset by increased consulting and technology fees (approximately $3.5 million) and higher bad debt expense (approximately $1 million). Settlement charges for the defined benefit pension plan of $0.7 million were included in the year ended December 31, 2008. The year ended December 31, 2007 included settlement charges for the nonqualified supplemental retirement plans and the defined benefit pension plans of $3.4 million. For the rate year ended September 30, 2008, the increase in O&M expense per customer was below the Index Range; as a result, the utility benefited by $2.9 million pre-tax with the related impact to rates effective December 1, 2008. Alagasco’s O&M expense fell within the Index Range for the rate year ended September 30, 2007.
Index to Financial Statements Depreciation expense rose 4.3 percent and 3.7 percent in 2009 and 2008, respectively, due to extension and replacement of the utility’s distribution and replacement of its support systems. Alagasco’s expense for taxes other than income primarily reflects various state and local business taxes as well as payroll-related taxes. State and local business taxes generally are based on gross receipts and fluctuate accordingly.
Non-Operating Items
Consolidated: Interest expense in 2009 fell $2.6 million largely due to lower borrowings at Energen Resources combined with lower interest rates on short-term debt. In 2008, interest expense declined $5.1 million largely due to the May 2007 voluntary call of the $100 million Floating Rate Senior Notes due November 15, 2007 along with lower interest rates on short term borrowings. The average daily outstanding balance under short-term credit facilities was $33.6 million in 2009. The average daily outstanding balance under short-term credit facilities was $89.2 million in 2008 as compared to $67.7 million in 2007. In 2009, other income increased largely due to increased investment gains. Increased investment losses affected other expense during 2008. In 2009 income tax expense decreased largely due to lower pre-tax income. Income tax expense increased in 2008 due to higher pre-tax income and the approximate $8 million reduction in the after-tax benefit of the Section 199 deduction.
FINANCIAL POSITION AND LIQUIDITY
The Company’s net cash from operating activities totaled $679.5 million, $569.2 million and $484.2 million in 2009, 2008 and 2007, respectively. Net income decreased for 2009 primarily due to lower realized commodity prices partially offset by higher production volumes at Energen Resources and lower production taxes. These decreases were more than offset by lower working capital requirements which were influenced primarily by accrued taxes along with the effect of lower commodity prices and the timing of payments. Operating cash flow in 2008 and 2007 benefited from higher realized commodity prices and production volumes at Energen Resources. Operating cash flows during 2008 were positively impacted by the tax effect of depreciation and basis differences. During 2007, operating cash flows were negatively affected by the tax effect of the depreciation and basis differences along with the 2006 utilization of minimum tax credit. During 2009, working capital needs at Alagasco were largely affected by decreased gas costs compared to the prior period, accrued taxes and storage gas inventory. Alagasco received a cash benefit in February 2009 from an approximate $26.2 million income tax refund claim from 2007 which resulted from an approved change by the Internal Revenue Service in a tax accounting method relating to the Company’s recovery of its gas distribution property. During 2008, working capital needs were primarily affected by increased gas costs and accrued taxes. Working capital needs at Alagasco were reduced by declining gas costs for 2007. Other working capital items, which primarily are the result of changes in throughput and the timing of payments, combined to create the remaining increases in 2008 and 2007.
During 2009, the Company made net investments of $519.1 million. Energen Resources invested $189.8 million in property acquisitions including approximately $5.1 million of unproved leaseholds, $237.9 million for development costs (includes approximately $23.8 million of accrued development cost) including approximately $138.8 million to drill 163 net development and service wells and $16.2 million for exploration. In June 2009, Energen Resources completed its purchase of oil properties located in the Permian Basin for a cash price of approximately $181 million. The acquisition added approximately 15.2 million barrels of oil equivalents in proved reserves. Energen
Index to Financial Statements
Resources had cash proceeds in 2009 of $7.9 million primarily from the sale of certain Permian Basin oil properties. Utility expenditures in 2009 totaled $77 million (includes approximately $0.5 million of accrued capital cost) and primarily represented expansion and replacement of its distribution system and support facilities, including the implementation of the Customer Care and Service (CCS) software system. During 2008, the Company made net investments of $464.6 million. Energen Resources invested $19 million in property acquisitions including approximately $18.1 million of unproved leaseholds (including approximately $13 million related to Alabama shales), $386.7 million for development costs (excludes approximately $26.2 million of accrued development cost) including approximately $262 million to drill 285 net development and service wells and $19.5 million for exploration. Energen Resources had cash proceeds in 2008 of $16.2 million from the sale of certain properties. Utility expenditures in 2008 totaled $62.6 million. During 2007, the Company made net investments of $431.9 million. Energen Resources invested $54.6 million in property acquisitions, including an $18 million acquisition in the Permian Basin and approximately $32 million of unproved leaseholds (including approximately $28 million related to Alabama shales), $313.2 million for development costs including approximately $202 million to drill 236 net development and service wells and $7.5 million for exploration. Utility expenditures in 2007 totaled $58.2 million.
During 2009, the Company added approximately 97 Bcfe of reserves primarily from the Permian Basin oil property acquisition. Also during 2009, Energen Resources added 106 Bcfe of reserves from discoveries and other additions, primarily the result of development drilling that increased the number of proved undeveloped locations in both the San Juan and Permian basins as well as continued downspacing in the Permian Basin. Energen Resources added approximately 126 Bcfe and 142 Bcfe of reserves in 2008 and 2007, respectively.
The Company used $97.7 million and $100.2 million for net financing activities in 2009 and 2008, respectively, primarily for the repayment of short-term debt borrowings. In addition, long-term debt was reduced by $1 million and $10.9 million for current maturities in 2009 and 2008, respectively. In 2007, net cash used for financing activities totaled $53.9 million primarily for the early redemption of $100 million Floating Rate Senior Notes, $34.4 million of 6.75% Notes, $10 million of Medium-Term Notes, Series A, with an annual interest rate of 8.09% and $10 million of 7.97% Medium-Term Notes. Partially offsetting these uses of cash was the January 2007 issuance by Alagasco of $45 million in long-term debt with an interest rate of 5.9%. For each of the years, net cash used in financing activities also reflected dividends paid to common stockholders.
Capital Expenditures
Oil and Gas Operations: Energen Resources spent a total of approximately $1.3 billion for capital projects during the years ended December 31, 2009, 2008 and 2007. Property acquisition expenditures totaled $265 million, development activities totaled $951.6 million, and exploratory expenditures totaled $43.2 million.
Natural Gas Distribution: During the years ended December 31, 2009, 2008 and 2007, Alagasco invested $200 million for capital projects: $146.8 million for expansion, replacements and support of its distribution system and $53.2 million for support facilities, including the development and implementation of information systems.
Index to Financial Statements FUTURE CAPITAL RESOURCES AND LIQUIDITY
Market Events
During 2008 and early 2009, capital and credit markets experienced significant volatility and disruption. Future economic disruptions could result in material adverse effects upon Energen’s financial position, results of operations and cash flows. Such events have the potential for a negative impact including, but not limited to, the following areas:
Risk Management: The Company utilizes derivative instruments to hedge its exposure to commodity price fluctuations. These derivative instruments are entered into with investment grade counterparties and are assessed each reporting period as to hedge effectiveness. Specifically, the Company considers the likelihood that the counterparty will be able to perform under the terms of the derivative instrument. If the Company is unable to conclude that it is probable that such counterparty will be able to perform under the terms of the derivative instrument, then the Company would be required to cease hedge accounting and recognize all gains and losses from that point forward in its results of operations. Further, the Company is at risk of nonperformance for any derivative contracts which are in a gain position. The Company’s current counterparties with active positions are Morgan Stanley Capital Group, Inc, J Aron & Company, Citibank, N.A., Bank of Montreal, Merrill Lynch Commodities, Inc., BP, Barclays Bank PLC, Wachovia Bank National Association and Shell Energy North America (US), L.P. Energen Resources was in a net gain position with six of its counterparties and a net loss with the remaining three at December 31, 2009.
Access to Capital: Energen and Alagasco rely upon excess cash flows supplemented by short-term credit facilities to fund working capital needs. During January 2010, the Company had two facilities that expired and were not renewed, RBC Bank (USA) for $35 million and Bank of New York Mellon for $25 million. The Company currently has available short-term credit facilities with seven financial institutions aggregating $465 million of which Energen has available $185 million, Alagasco has available $95 million and $185 million is available to either company. These short-term credit facilities are 364-day committed bilateral agreements. Energen and Alagasco are subject to the risk that these facilities will not be renewed or will be renewed at less favorable terms. However, the Company believes that its expected cash flows, the diversity of credit facilities and its ability to adjust future capital spending provides adequate support for its liquidity needs.
Oil and Gas Operations
The Company anticipates continued price volatility due to supply-and-demand factors, weather, natural disasters, changes in global economics and political unrest. Commodity price volatility will affect the Company’s revenue and associated cash flow available for investment.
The Company plans to continue investing significant capital in Energen Resources’ oil and gas production operations. For 2010, the Company expects its oil and gas capital spending to total approximately $310 million, including $288 million for existing properties. Included in this $288 million is approximately $125 million for the development of previously identified proved undeveloped reserves.
Capital expenditures by area during 2010 are planned as follows:
Index to Financial Statements Energen anticipates having the following drilling rigs and net wells by area during 2010. The drilling rigs presented below are operated while the net wells include operated and non-operated wells.
The Company also may allocate additional capital for other oil and gas activities such as property acquisitions, additional development of existing properties and the exploration and further development of potential shales acreage primarily in Alabama. Energen Resources may evaluate acquisition opportunities which arise in the marketplace and from time to time will pursue acquisitions that meet Energen’s acquisition criteria. Energen Resources’ ability to invest in property acquisitions is subject to market conditions and industry trends. Property acquisitions are not included in the aforementioned estimate of oil and gas investments and could result in capital expenditures different from those outlined above. To finance capital spending at Energen Resources, the Company primarily expects to use internally generated cash flow supplemented by its short-term credit facilities. The Company also may issue long-term debt and equity periodically to replace short-term obligations, enhance liquidity and provide for permanent financing. The Company currently has no plans for the issuance of equity.
Alabama Shales
During 2009 Energen Resources was unsuccessful in the completion of a Chattanooga shale well. The Company believes a casing leak rendered ineffective two small fracture simulations in the Chattanooga shale formation. The costs related to this well of approximately $5.6 million pretax were expensed during the fourth quarter of 2009. Also expensed during the fourth quarter, was approximately $1.2 million pretax of costs associated with a well originally drilled by Chesapeake in an area of the Chattanooga shale which the Company no longer intends to pursue. The Company recognized unproved leasehold impairments of $2.1 million associated with these wells. Approximately $13 million of the remaining $39 million of unproved leasehold costs for Alabama shales mentioned above are associated with the Chattanooga shale formation with the remainder associated with the Conasauga shale formation. In the event further efforts are unsuccessful and the Company concludes no further activity is warranted, Energen Resources would expect to record a loss associated with well costs and the non-cash write-off on capitalized unproved leasehold. Energen Resources plans to drill a well during the spring of 2010 in order to determine economic viability of the Chattanooga shale formation and an additional well during the latter half of 2010 to determine economic viability of Conasasuga shale formation.
Natural Gas Distribution
Alagasco’s use of commodity price hedges for a portion of its gas supply needs is reflected in the utility’s current rates. Alagasco’s rate schedules for natural gas distribution charges contain a GSA rider which permits the pass-through to customers for changes in the cost of gas supply. The GSA rider is designed to capture the Company’s cost of natural gas and provides for a pass-through of gas cost fluctuations to customers without markup; the cost of gas includes the commodity cost, pipeline capacity, transportation and fuel costs, and risk management gains and losses. Over the past several years, a higher price commodity environment and reduced economic activity has contributed to the decline in the utility’s customer base and in declines in usage volume per customer. While the commodity price environment has moderated, a return of natural gas prices to higher levels could result in a further decline in Alagasco’s customer base and usage and in increases in the utility’s GSA. Alagasco monitors the bad debt reserve and makes adjustments as required based on its evaluation of receivables which are impacted by natural gas prices and the underlying current and future economic conditions facing the utility’s customer base.
Alagasco maintains an investment in storage gas that is expected to average approximately $36 million in 2010 but will vary depending upon the price of natural gas. During 2010, Alagasco plans to invest approximately $80 million in utility capital expenditures for normal distribution and support systems. The utility anticipates funding these capital requirements through internally generated cash flow and the utilization of short-term credit facilities.
Index to Financial Statements Stock Repurchases
Energen periodically considers stock repurchases as a capital investment. Energen may buy shares on the open market or in negotiated purchases. The timing and amounts of any repurchases are subject to changes in market conditions. The Company did not repurchase shares of common stock for this program during 2009, 2008 and 2007. The Company expects any future stock repurchases to be funded through internally generated cash flows or through the utilization of short-term credit facilities. During 2009, the Company had noncash purchases of approximately $0.8 million of Company common stock in conjunction with tax withholdings on its non-qualified deferred compensation plan and other stock compensation plans. The Company utilized internally generated cash flows in payment of the related tax withholdings.
Short-Term Credit Facilities
Access to capital is an integral part of the Company’s business plan. While the Company expects to have ongoing access to its short-term credit facilities and the longer-term markets, continued access could be adversely affected by current and future economic and business conditions and credit rating downgrades. To help finance its growth plans and operating needs, the Company currently has available short-term credit facilities as follows:
Credit Ratings
In February 2009, Standard and Poor’s (S&P) removed from “CreditWatch with negative implications” the long-term debt ratings of Energen and Alagasco. The investment-grade, consolidated rating for Energen and Alagasco was downgraded from BBB+ to BBB; the outlook is “stable.” S&P said the one-notch downgrade primarily reflected a greater weighting of Energen’s exploration and production activities in S&P’s business risk assessment. In addition, S&P said the rating reflected Energen’s “solid credit measures, a favorable discretionary cash flow outlook for 2009, and some cash flow diversification provided by its regulated utility subsidiary.” The downgrade does not have a material impact on the consolidated financial statements or the results of operations. Future borrowing costs and terms may be negatively impacted.
Moody’s Investors Service (Moody’s) current debt rating for Energen is Baa3 senior unsecured. Energen’s debt rating of Baa3 is investment grade and reflects Moody’s assignment of increased risk exposure related to the growth of its oil and gas operations in contrast to its legacy natural gas distribution assets. Moody’s latest confirmation of Alagasco’s debt rating is A1 senior unsecured.
Dividends
Energen expects to pay annual cash dividends of $0.52 per share on the Company’s common stock in 2010. The amount and timing of all dividend payments is subject to the discretion of the Board of Directors and is based upon business conditions, results of operations, financial conditions and other factors.
Contractual Cash Obligations and Other Commitments
In the course of ordinary business activities, Energen enters into a variety of contractual cash obligations and other commitments. The following table summarizes the Company’s significant contractual cash obligations, other than hedging contracts, as of December 31, 2009:
(1) Long-term cash obligations include $0.7 million of unamortized debt discounts as of December 31, 2009.
Index to Financial Statements (2) Certain of the Company’s long-term contracts associated with the delivery and storage of natural gas include fixed charges of $204 million through September 2024. The Company also is committed to purchase minimum quantities of gas at market-related prices or to pay certain costs in the event the minimum quantities are not taken. These purchase commitments are approximately 107.6 Bcf through April 2015.
(3) Represents the estimated future asset retirement obligation on an undiscounted basis.
Energen Resources operates in certain instances through joint ventures under joint operating agreements. Typically, the operator under a joint operating agreement enters into contracts, such as drilling contracts, for the benefit of all joint venture partners. Through the joint operating agreement, the non-operators reimburse, and in some cases advance, the funds necessary to meet the contractual obligations entered into by the operator. These obligations are typically shared on a working interest basis as defined in the joint operating contractual agreement.
The Company has two defined non-contributory pension plans and provides certain postretirement healthcare and life insurance benefits. The Company anticipates required contributions of approximately $7 million during 2010 to the pension plans. The Company expects sufficient funding credits, as established under Internal Revenue Code Section 430(f), exist to meet the required funding. It is not anticipated that the funded status of the pension plans will fall below statutory thresholds requiring accelerated funding or constraints on benefit levels or plan administration. No additional discretionary contributions are currently expected to be made to the pension plans by the Company during 2010. The Company expects to make discretionary payments of approximately $7.8 million to postretirement benefit program assets during 2010. The contractual obligations reported above exclude any payments the Company expects to make to postretirement benefit program assets.
The contractual obligations reported above exclude the Company’s liability of $17.8 million related to the Company’s provision for uncertain tax positions. The Company cannot make a reasonably reliable estimate of the amount and period of related future payments for such liability.
OUTLOOK
Oil and Gas Operations: Energen Resources plans to continue to implement its growth strategy with capital spending in 2010. Production in 2010 is estimated to be 114 Bcfe, including approximately 110 Bcfe of estimated production from proved reserves owned at December 31, 2009. Production estimates do not include amounts for potential future acquisitions or Alabama shales.
Production volumes by area are expected to be as follows:
Index to Financial Statements During 2010, Energen Resources expects an annualized decline rate of approximately 7.5 percent for its proved developed producing properties owned at December 31, 2009. During the same period, total production from proved properties is expected to decrease approximately 1.3 percent and total production is expected to increase approximately 2.3 percent. The above proved developed producing properties decline rates are not necessarily indicative of the Company’s expectations for its terminal decline rate on a long term basis.
Various factors influence decline rates. For example, certain properties may have production curves that decline at faster rates in the early years of production and at slower rates in later years. Other properties, such as certain coalbed methane wells or waterflood projects, may experience inclining production during the early years followed by declining production. Further, production curves can be positively impacted by various enhanced recovery techniques. Accordingly, the decline rate for a single year is influenced by numerous factors, including but not limited to, the mix of types of wells, the mix of newer versus older wells, and the effect of enhanced recovery activities, but it is not necessarily indicative of future decline rates. Excluding the positive effects of more recent activities as discussed above, the longer term decline rates of properties typically flatten but continue to decline until a property reaches its economic limit and is then plugged and abandoned. Energen Resources expects a compound annual decline rate for proved producing properties owned at December 31, 2009 of approximately 9 percent for the 10 year period 2009 to 2019.
In the event Energen Resources is unable to fully invest in its capital investment opportunities, future operating revenues, production and proved reserves could be negatively affected. Energen Resources’ major market risk exposure is in the pricing applicable to its oil and gas production. Historically, prices received for oil and gas production have been volatile because of seasonal weather patterns, national supply and demand factors and general economic conditions. Crude oil prices also are affected by quality differentials, worldwide political developments and actions of the Organization of Petroleum Exporting Countries. Basis differentials, like the underlying commodity prices, can be volatile because of regional supply and demand factors, including seasonal variations and the availability and price of transportation to consuming areas.
Revenues and related accounts receivable from oil and gas operations primarily are generated from the sale of produced oil, natural gas and natural gas liquids to energy marketing companies. Such sales are typically made on an unsecured credit basis with payment due the month following delivery. This concentration of sales to the energy marketing industry has the potential to affect the Company’s overall exposure to credit risk, either positively or negatively, in that the Company’s oil and gas purchasers may be affected similarly by changes in economic, industry or other conditions. Energen Resources considers the credit quality of its customers and, in certain instances, may require credit assurances such as a deposit, letter of credit or parent guarantee. The three largest oil, natural gas and natural gas liquids purchasers are expected to account for approximately 21 percent, 17 percent and 13 percent, respectively, of Energen Resources’ estimated 2010 production. Energen Resources’ other purchasers are each expected to purchase less than 8 percent of production.
Derivative Commodity Instruments
Energen Resources periodically enters into derivative commodity instruments that qualify as cash flow hedges to hedge its price exposure to its estimated oil, natural gas and natural gas liquids production. Such instruments may include natural gas and crude oil over-the-counter (OTC) swaps, collars and basis hedges with major energy derivative product specialists. The counterparties to the commodity instruments are investment and commercial banks and energy-trading firms. At December 31, 2009, the counterparty agreements under which the Company had active positions did not include collateral posting requirements. Energen Resources was in a net gain position with six of its counterparties and a net loss with the remaining three at December 31, 2009. The Company is at risk for economic loss based upon the creditworthiness of its counterparties. Hedge transactions are pursuant to standing authorizations by the Board of Directors, which do not authorize speculative positions. Energen Resources does not hedge more than 80 percent of its estimated annual production and generally does not hedge this production more than two years forward. Production may be hedged for a longer period immediately following an acquisition in order to protect targeted returns.
Alagasco also enters into cash flow derivative commodity instruments to hedge its exposure to price fluctuations on its gas supply. Alagasco recognizes all derivatives at fair value as either assets or liabilities on the balance sheet.
Index to Financial Statements
Any gains or losses are passed through to customers using the mechanisms of the GSA in compliance with Alagasco’s APSC-approved tariff and are recognized as a regulatory asset or regulatory liability.
Energen Resources entered into the following transactions for 2010 and subsequent years:
Alagasco entered into the following natural gas transactions for 2010 and subsequent years:
Production
Period
Total Hedged
Volumes
Description
19.6 Bcf
NYMEX Swaps
10.7 Bcf
NYMEX Swaps
13.4 Bcf
NYMEX Swaps
Energen Resources has prepared a sensitivity analysis to evaluate the hypothetical effect that changes in the market value of crude oil, natural gas and natural gas liquids may have on the fair value of its derivative instruments. This analysis measured the impact on the commodity derivative instruments and, thereby, did not consider the underlying exposure related to the commodity. At December 31, 2009, Energen Resources was in a net gain position of $79.4 million for derivative contracts and estimates that a 10 percent increase or decrease in the commodities prices would have resulted in an approximate $124 million change in the fair value of open derivative contracts; however, gains and losses on derivative contracts are expected to be similarly offset by sales at the spot market price. The hypothetical change in fair value was calculated by multiplying the difference between the hypothetical price and the contractual price by the contractual volumes and did not include the impact of related taxes on actual cash prices.
All derivatives are recognized at fair value under the fair value hierarchy as discussed in Footnote 1, Summary of Significant Accounting Policies, in the Notes to Financial Statements. Over-the-counter derivatives are valued using market transactions and other market evidence whenever possible, including market-based inputs to models and broker or dealer quotations. These OTC derivative contracts trade in less liquid markets with limited pricing information as compared to markets with actively traded, unadjusted quoted prices; accordingly, the determination of fair value is inherently more difficult. OTC derivatives for which the Company is able to substantiate fair value through directly observable market prices are classified within Level 2 of the fair value hierarchy. These Level 2 fair values consist of swaps priced in reference to New York Mercantile Exchange (NYMEX) natural gas and oil futures. OTC derivatives valued using unobservable market prices have been classified within Level 3 of the fair value hierarchy. These Level 3 fair values include basin specific, basis and liquids swaps. All derivative commodity instruments in a gain position are valued on a discounted basis incorporating an estimate of
Index to Financial Statements
performance risk specific to each related counterparty. Derivative commodity instruments in a loss position are valued on a discounted basis incorporating an estimate of performance risk specific to Energen or Alagasco. As of the balance sheet date, the Company believes that these prices represent the best estimate of the exit price for these instruments and are representative of the prices for which the contract will ultimately settle or realize.
The following sets forth derivative assets and liabilities that were measured at fair value on a recurring basis:
* Amounts classified in accordance with accounting guidance which permits offsetting fair value of amounts recognized for multiple derivative instruments executed with the same counterparty under a master netting arrangement.
As of December 31, 2009, Alagasco has $25.8 million and $19 million of derivative instruments which are classified as Level 2 fair values and are included in the above table as current and noncurrent liabilities, respectively. As of December 31, 2008, Alagasco has $27.7 million and $8.8 million of derivative instruments which are classified as Level 2 fair values and are included in the above table as current and noncurrent liabilities, respectively. Alagasco has no derivative instruments classified as Level 3 fair values as of December 31, 2009 and 2008.
Level 3 assets as of December 31, 2009 represent approximately 2 percent of total assets and an immaterial amount of total liabilities. Changes in fair value primarily result from price changes in the underlying commodity. The Company has prepared a sensitivity analysis to evaluate the hypothetical effect that changes in the prices used to estimate fair value would have on the fair value of its derivative instruments. The Company estimates that a 10 percent increase or decrease in commodity prices would result in an approximate $38 million change in the fair value of open Level 3 derivative contracts. The resulting impact upon the results of operations for Level 3 derivatives would be immaterial due to the derivative instruments qualifying as cash flow hedges. Liquidity requirements to meet the obligation would not be significantly impacted as gains and losses on the derivative contracts would be similarly offset by sales at the spot market price.
Natural Gas Distribution: The extension of RSE in December 2007 provides Alagasco the opportunity to continue earning an allowed ROE between 13.15 percent and 13.65 percent through December 31, 2014. Under the terms of that extension, RSE will continue beyond that date, unless, after notice to the Company and a hearing, the APSC votes to modify or discontinue its operation. Alagasco’s rate schedules for natural gas distribution charges contain a Gas Supply Adjustment rider which permits the pass-through to customers for changes in the cost of gas supply. Also as discussed in Note 2, Regulatory Matters, in the Notes to Financial Statements, the utility’s CCM is based on the rate of inflation. Continued low inflation or the risk of deflation combined with a return to higher gas prices resulting in increased bad debt expense could impact the utility’s ability to manage its O&M expense sufficiently for the inflation-based cost control requirements of RSE and may result in an average return on equity lower than the allowed range of return. In addition, decreases in residential customers and declines in usage per customer in the residential and small commercial classes, as well as market sensitive load losses from large
Index to Financial Statements
industrial and commercial customers, will make it more difficult for the utility to earn within its allowed range of return on equity. The utility has developed a variety of programs to help it compete for gas load in all markets. The Company has been effective in utilizing these programs to deter load loss to competitive fuels.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. Management has identified the following critical accounting policies in the application of existing accounting standards or in the implementation of new standards that involve significant judgments and estimates by the Company. The application of these accounting policies necessarily requires management’s most subjective or complex judgments regarding estimates and projected outcomes of future events that could have a material impact on the financial statements.
Oil and Gas Operations
Accounting for Natural Gas and Oil Producing Activities and Related Reserves: The Company utilizes the successful efforts method of accounting for its natural gas and oil producing activities. Acquisition and development costs of proved properties are capitalized and amortized on a units-of-production basis over the remaining life of total proved and proved developed reserves. Proved oil and gas reserves are the estimated quantities of crude oil, natural gas and natural gas liquids that geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Accordingly, these estimates do not include probable or possible reserves. Estimated oil and gas reserves are based on currently available reservoir data and are subject to future revision. Estimates of physical quantities of oil and gas reserves have been determined by Company engineers. Independent oil and gas reservoir engineers have audited the estimates of proved reserves of natural gas, crude oil and natural gas liquids attributed to the Company’s net interests in oil and gas properties as of December 31, 2009. The independent reservoir engineers have issued reports covering approximately 99 percent of the Company’s ending proved reserves and in their judgment these estimates were reasonable in the aggregate. The Company’s production of undeveloped reserves requires the installation or completion of related infrastructure facilities such as pipelines and the drilling of development wells.
Changes in oil and gas prices, operating costs and expected performance from the properties can result in a revision to the amount of estimated reserves held by the Company. If reserves are revised upward, earnings could be affected due to lower depreciation and depletion expense per unit of production. Likewise, if reserves are revised downward, earnings could be affected due to higher depreciation and depletion expense or due to an immediate writedown of the property’s book value if an impairment is warranted. The table below reflects an estimated increase in 2010 depreciation, depletion and amortization expense associated with an assumed downward revision in the reported oil and gas reserve amounts at December 31, 2009:
Exploratory drilling costs are capitalized pending determination of proved reserves. If proved reserves are not discovered, the exploratory drilling costs are expensed. Other exploration costs, including geological and geophysical costs, are expensed as incurred.
Asset Impairments: Oil and gas proved properties periodically are assessed for possible impairment, generally on a field-by-field basis, using the estimated undiscounted future cash flows of each field. Impairment losses are recognized when the estimated undiscounted future cash flows are less than the current net book values of the properties in a field. The Company monitors its oil and gas properties as well as the market and business environments in which it operates and makes assessments about events that could result in potential impairment issues. Such potential events may include, but are not limited to, substantial commodity price declines, unanticipated increased operating costs, and lower-than-expected production performance. If a material event
Index to Financial Statements
occurs, Energen Resources makes an estimate of undiscounted future cash flows to determine whether the asset is impaired. If the asset is impaired, the Company will record an impairment loss for the difference between the net book value of the properties and the fair value of the properties. The fair value of the properties typically is estimated using discounted cash flows.
Cash flow and fair value estimates require Energen Resources to make projections and assumptions for pricing, demand, competition, operating costs, legal and regulatory issues, discount rates and other factors for many years into the future. These variables can, and often do, differ from the estimates and can have a positive or negative impact on the Company’s need for impairment or on the amount of impairment. In addition, further changes in the economic and business environment can impact the Company’s original and ongoing assessments of potential impairment.
Energen Resources recognizes any impairment of capitalized costs to unproved properties. The greatest portion of these costs generally relates to the acquisition of leasehold costs. The costs are capitalized and periodically evaluated as to recoverability, based on changes brought about by economic factors and potential shifts in business strategy employed by management. The Company considers a combination of geologic and engineering factors to evaluate the need for impairment of these costs.
Derivatives: Energen Resources periodically enters into commodity derivative contracts to manage its exposure to oil, natural gas and natural gas liquids price volatility. Energen Resources recognizes all derivates on the balance sheet and measures all derivatives at fair value. Realized gains and losses from derivatives designated as cash flow hedges are recognized in oil and gas production revenues when the forecasted transaction occurs. Energen Resources may also enter into derivative transactions that do not qualify for cash flow hedge accounting but are considered by management to be valid economic hedges. Gains and losses from the change in fair value of derivative instruments that do not qualify for hedge accounting are reported in current period operating revenues, rather than in the period in which the hedge transaction is settled. Energen Resources does not enter into derivatives or other financial instruments for trading purposes. The use of derivative contracts to mitigate price risk may cause the Company’s financial position, results of operations and cash flow to be materially different from results that would have been obtained had such risk mitigation activities not occurred.
Natural Gas Distribution
Regulated Operations: Alagasco capitalizes costs as regulatory assets that otherwise would be charged to expense if it is probable that the cost is recoverable in the future through regulated rates. Likewise, if current recovery is provided for a cost that will be incurred in the future, the cost would be recognized as a regulatory liability. The Company anticipates this accounting requirement will continue as the applicable accounting standard for its regulated operations. Alagasco’s rate setting methodology, Rate Stabilization and Equalization, has been in effect since 1983.
Consolidated
Employee Benefit Plans: An employer is required to recognize the net funded status of defined benefit pensions and other postretirement benefit plans (benefit plans) as an asset or liability in its statement of financial position and to recognize changes in the funded status through comprehensive income in the year in which the changes occur. The pension benefit obligation is the projected benefit obligation (PBO), a measurement of earned benefit obligations at expected retirement salary levels; for other postretirement plans, the benefit obligation is the accumulated postretirement benefit obligation (APBO), a measurement of earned postretirement benefit obligations expected to be paid to employees upon retirement. Alagasco established a regulatory asset for the portion of the total benefit obligation to be recovered through rates in future periods.
Actuarial assumptions attempt to anticipate future events and are used in calculating the expenses and liabilities related to these plans. The calculation of the liability related to the Company’s benefit plans includes assumptions regarding the appropriate weighted average discount rate, the expected long-term rate of return on the plans’ assets and the estimated weighted average rate of increase in the compensation level of its employee base for defined benefit pension plans. The key assumptions used in determining these calculations are disclosed in Note 5, Employee Benefit Plans, in the Notes to Financial Statements.
Index to Financial Statements In selecting the discount rate, consideration was given to Moody’s Aa corporate bond rates, along with a yield curve applied to payments the Company expects to make out of its retirement plans. The yield curve is comprised of a broad base of Aa bonds with maturities between zero and thirty years. The discount rate was developed as the level equivalent rate that would produce the same present value as that using spot rates aligned with the projected benefit payments; the discount rate used to determine net periodic costs was 6.50 percent for each of the plans for the year ended December 31, 2009. The assumed rate of return on assets is the weighted average of expected long-term asset assumptions; the return on assets used to determine net periodic expense was 8.25 percent for each of the applicable plans for the year ended December 31, 2009. The estimated weighted average rate of increase in the compensation level for pay related plans was 3.9 percent for the year ended December 31, 2009.
The selection and use of actuarial assumptions affects the amount of benefit expense recorded in the Company’s financial statements. The table below reflects a hypothetical 25 basis point change in assumed actuarial assumptions to pre-tax benefit expense for the year ended December 31, 2009:
The weighted average discount rate, return on plan assets and estimated rate of compensation increase used in the 2010 actuarial assumptions is 5.49 percent, 7.25 percent, and 3.95 percent, respectively.
Asset Retirement Obligation: The Company records the fair value of a liability for an asset retirement obligation (ARO) in the period in which it is incurred. Subsequent to initial measurement, liabilities are required to be accreted to their present value each period and capitalized costs are depreciated over the estimated useful life of the related assets. Upon settlement of the liability, the Company will settle the obligation for its recorded amount and recognize the resulting gain or loss. Energen Resources has an obligation to remove tangible equipment and restore land at the end of oil and gas production operations. Alagasco has certain removal cost obligations related to its gas distribution assets and a conditional asset retirement obligation to purge and cap its distribution and transmission lines upon abandonment. The estimate of future restoration and removal costs includes numerous assumptions and uncertainties, including but not limited to, inflation factors, discount rates, timing of settlement, and changes in contractual, regulatory, political, environmental, safety and public relations considerations.
Uncertain Tax Positions: The Company accounts for uncertain tax positions in accordance with accounting guidance which prescribes a recognition threshold and measurement attribute for financial statement recognition. The application of income tax law is inherently complex; laws and regulation in this area are voluminous and often ambiguous. As such, the Company is required to make many subjective assumptions and judgments regarding income tax exposures. Interpretations and guidance related to income tax laws and regulation change over time. It is possible that changes in the Company’s subjective assumptions and judgments could materially affect amounts recognized in the consolidated balance sheets and statements of income. Additional information related to the Company’s uncertain tax positions is provided in Note 4, Income Taxes, in the Notes to the Financial Statements.
FORWARD-LOOKING STATEMENTS
Certain statements in this report express expectations of future plans, objectives and performance of the Company and its subsidiaries and constitute forward-looking statements made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Except as otherwise disclosed, the Company’s forward-looking statements do not reflect the impact of possible or pending acquisitions, investments, divestitures or restructurings. The absence of errors in input data, calculations and formulas used in estimates, assumptions and forecasts cannot be guaranteed. Neither the Company nor Alagasco undertakes any obligation to correct or update any forward-looking statements whether as a result of new information, future events or otherwise.
Index to Financial Statements All statements based on future expectations rather than on historical facts are forward-looking statements that are dependent on certain events, risks and uncertainties that could cause actual results to differ materially from those anticipated. Some of these include, but are not limited to, economic and competitive conditions, inflation rates, legislative and regulatory changes, financial market conditions, the Company’s ability to access the capital markets, future business decisions, utility customer growth and retention and usage per customer, litigation results and other uncertainties, all of which are difficult to predict.
See Item 1A, Risk Factors, for a discussion of risk factors that may affect the Company and cause material variances from forward-looking statement expectations. The Item 1A, Risk Factors, discussion is incorporated by reference to this forward-looking statement disclosure.
RECENT PRONOUNCEMENTS OF THE FINANCIAL ACCOUNTING STANDARDS BOARD
See Note 15, Recently Issued Accounting Standards, in the Notes to Financial Statements for information regarding recently issued accounting standards.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item with respect to market risk is set forth in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations under the heading “Outlook” and in Note 8, Financial Instruments and Risk Management, in the Notes to Financial Statements.
Index to Financial Statements
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ENERGEN CORPORATION
ALABAMA GAS CORPORATION
AND FINANCIAL STATEMENT SCHEDULES
Schedules other than those listed above are omitted because they are not required, not applicable, or the required information is shown in the financial statements or notes thereto.
Index to Financial Statements REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Energen Corporation:
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Energen Corporation and its subsidiaries at December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report On Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
As discussed in Note 4, Income Taxes, in the Notes to Financial Statements, the Company adopted a new accounting standard related to the accounting for the uncertainty in income taxes effective January 1, 2007.
A company’s internal control over financial reporting is a process 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. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) 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 (iii) 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 its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. 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 compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
Birmingham, Alabama
February 25, 2010
Index to Financial Statements REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholder of Alabama Gas Corporation:
In our opinion, the financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Alabama Gas Corporation at December 31, 2009 and 2008, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report On Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our audits (which were integrated audits in 2009 and 2008). 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process 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. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) 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 (iii) 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 its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. 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 compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
Birmingham, Alabama
February 25, 2010
Index to Financial Statements CONSOLIDATED STATEMENTS OF INCOME
Energen Corporation
The accompanying Notes to Financial Statements are an integral part of these statements.
Index to Financial Statements CONSOLIDATED BALANCE SHEETS
Energen Corporation
The accompanying Notes to Financial Statements are an integral part of these statements.
Index to Financial Statements CONSOLIDATED BALANCE SHEETS
Energen Corporation
The accompanying Notes to Financial Statements are an integral part of these statements.
Index to Financial Statements CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
Energen Corporation
The accompanying Notes to Financial Statements are an integral part of these statements.
Index to Financial Statements CONSOLIDATED STATEMENTS OF CASH FLOWS
Energen Corporation
The accompanying Notes to Financial Statements are an integral part of these statements.
Index to Financial Statements STATEMENTS OF INCOME
Alabama Gas Corporation
The accompanying Notes to Financial Statements are an integral part of these statements.
Index to Financial Statements BALANCE SHEETS
Alabama Gas Corporation
The accompanying Notes to Financial Statements are an integral part of these statements.
Index to Financial Statements BALANCE SHEETS
Alabama Gas Corporation
The accompanying Notes to Financial Statements are an integral part of these statements.
Index to Financial Statements STATEMENTS OF SHAREHOLDER’S EQUITY
Alabama Gas Corporation
The accompanying Notes to Financial Statements are an integral part of these statements.
Index to Financial Statements STATEMENTS OF CASH FLOWS
Alabama Gas Corporation
The accompanying Notes to Financial Statements are an integral part of these statements.
Index to Financial Statements NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Energen Corporation (Energen or the Company) is a diversified energy holding company engaged primarily in the development, acquisition, exploration and production of oil and gas in the continental United States (oil and gas operations) and in the purchase, distribution, and sale of natural gas principally in central and north Alabama (natural gas distribution). The following is a description of the Company’s significant accounting policies and practices.
A. Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries, principally Energen Resources Corporation and Alabama Gas Corporation (Alagasco), after elimination of all significant intercompany transactions in consolidation. Certain reclassifications have been made to conform the prior years’ financial statements to the current-year presentation.
B. Oil and Gas Operations
Property and Related Depletion: Energen Resources follows the successful efforts method of accounting for costs incurred in the exploration and development of oil, gas and natural gas liquid reserves. Lease acquisition costs are capitalized initially, and unproved properties are reviewed periodically to determine if there has been impairment of the carrying value, with any such impairment charged to exploration expense currently. All development costs are capitalized. Exploratory drilling costs are capitalized pending determination of proved reserves. If proved reserves are not discovered, the exploratory drilling costs are expensed. Other exploration costs, including geological and geophysical costs, are expensed as incurred. Depreciation, depletion and amortization expense is determined on a field-by-field basis using the units-of-production method based on proved reserves. Anticipated abandonment and restoration costs are capitalized and depreciated using the units-of-production method based on proved developed reserves.
Operating Revenue: Energen Resources utilizes the sales method of accounting to recognize oil, gas and natural gas liquids production revenue. Under the sales method, revenues are based on actual sales volumes of commodities sold to purchasers. Over-production liabilities are established only when it is estimated that a property’s over-produced volumes exceed the net share of remaining reserves for such property. Energen Resources had no material production imbalances at December 31, 2009 and 2008.
Derivative Commodity Instruments: Energen Resources recognizes all derivatives on the balance sheet and measures all derivatives at fair value. If a derivative is designated as a cash flow hedge, the effectiveness of the hedge, or the degree that the gain (loss) for the hedging instrument offsets the loss (gain) on the hedged item, is measured at each reporting period. The effective portion of the gain or loss on the derivative instrument is recognized in other comprehensive income (OCI) as a component of shareholders’ equity and subsequently reclassified to operating revenues when the forecasted transaction affects earnings. The ineffective portion of a derivative’s change in fair value is recognized in operating revenues immediately. Derivatives that do not qualify for hedge treatment are recorded at fair value with gains or losses recognized in operating revenues in the period of change. All derivative transactions are included in operating activities on the consolidated statements of cash flows.
Energen Resources periodically enters into derivative commodity instruments to hedge its price exposure to its estimated oil, natural gas and natural gas liquids production. Such instruments may include natural gas and crude oil over-the-counter (OTC) swaps, collars and basis hedges with major energy derivative product specialists. The counterparties to the commodity instruments are investment and commercial banks and energy-trading firms. All derivative commodity instruments in a gain position are valued on a discounted basis incorporating an estimate of performance risk specific to each related counterparty. Derivative commodity instruments in a loss position are valued on a discounted basis incorporating an estimate of performance risk specific to Energen.
Index to Financial Statements The current policy of the Company is to not enter into agreements that require the posting of collateral. The Company has a few older agreements, none of which have active positions as of December 31, 2009, which include collateral posting requirements based on the amount of exposure and counterparty credit ratings. The majority of the Company’s counterparty agreements include provisions for net settlement of transactions payable on the same date and in the same currency. Most, but not all, of the agreements include various contractual set-off rights which may be exercised by the non-defaulting party in the event of an early termination due to a default.
Additionally, the Company may also enter into derivatives that do not qualify for cash flow hedge accounting but are considered by management to represent valid economic hedges and are accounted for as mark-to-market transactions. These economic hedges may include, but are not limited to, basis hedges without a corresponding New York Mercantile Exchange (NYMEX) hedge and hedges on non-operated or other properties for which all of the necessary information to qualify for cash flow hedge accounting is either not readily available or subject to change.
All hedge transactions are pursuant to standing authorizations by the Board of Directors, which do not permit speculative positions. The Company formally documents all relationships between hedging instruments and hedged items at the inception of the hedge, as well as its risk management objective and strategy for undertaking the hedge. This process includes specific identification of the hedging instrument and the hedge transaction, the nature of the risk being hedged and how the hedging instrument’s effectiveness in hedging the exposure to the hedged transaction’s variability in cash flows attributable to the hedged risk will be assessed. Both at the inception of the hedge and on an ongoing basis, the Company assesses whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows of hedged items. The Company discontinues hedge accounting if a derivative has ceased to be a highly effective hedge.
Long-Lived Assets and Discontinued Operations: The Company reports gains and losses on the sale of certain oil and gas properties and any impairments of properties held-for-sale as discontinued operations, with income or loss from operations of the associated properties reported as income or loss from discontinued operations. The results of operations for certain held-for-sale properties are reclassified and reported as discontinued operations for prior periods. Energen Resources may, in the ordinary course of business, be involved in the sale of developed or undeveloped properties. All assets held-for-sale are reported at the lower of the carrying amount or fair value.
C. Natural Gas Distribution
Regulatory Accounting: Alagasco is subject to regulation by the Alabama Public Service Commission (APSC) with respect to rates, accounting and various other matters. In general, Alagasco capitalizes or defers certain costs or revenues, based on the approvals received from the APSC, to be recovered from or refunded to customers in future periods. These costs or revenues are recorded as regulatory assets or liabilities.
Utility Plant and Depreciation: Property, plant and equipment are stated at cost. The cost of utility plant includes an allowance for funds used during construction. Maintenance is charged for the cost of normal repairs and the renewal or replacement of an item of property which is less than a retirement unit. When property which represents a retirement unit is replaced or removed, the cost of such property is credited to utility plant and is charged to the accumulated reserve for depreciation. The estimated net removal costs on certain gas distribution assets are charged through depreciation and recognized as a regulatory liability in accordance with regulatory accounting. Depreciation is provided on the straight-line method over the estimated useful lives of utility property at rates approved by the APSC. Approved depreciation rates averaged approximately 4.4 percent in the years ended December 31, 2009 and 2008, respectively, and 4.5 percent in the year ended December 31, 2007.
Index to Financial Statements Inventories: Inventories, which consist primarily of gas stored underground, are stated at average cost. Liquified natural gas is stated at base cost.
Operating Revenue and Gas Costs: Alagasco records natural gas distribution revenues in accordance with its tariff established by the APSC. The margin and gas costs on service delivered to cycle customers but not yet billed are recorded in current assets as accounts receivable with a corresponding regulatory liability. Gas imbalances are settled on a monthly basis. Alagasco had no material gas imbalances at December 31, 2009. Alagasco had gas imbalances of $1.6 million at December 31, 2008.
Derivative Commodity Instruments: Alagasco may enter into cash flow derivative commodity instruments to hedge its exposure to price fluctuations on its gas supply. Alagasco recognizes all derivatives as either assets or liabilities on the balance sheet at fair value. Any gains or losses are passed through to customers using the mechanisms of the Gas Supply Adjustment (GSA) rider in accordance with Alagasco’s APSC approved tariff and are recognized as a regulatory asset or regulatory liability. All derivative commodity instruments in a gain position are valued on a discounted basis incorporating an estimate of performance risk specific to each related counterparty. Derivative commodity instruments in a loss position are valued on a discounted basis incorporating an estimate of performance risk specific to Alagasco.
Taxes on revenues: Collections and payments of excise taxes are reported on a gross basis. These amounts are included in taxes other than income taxes on the consolidated statements of income as follows:
The collection and payment of utility gross receipts tax is presented on a net basis.
D. Fair Value Measurements
The carrying values of cash and cash equivalents, accounts payable and receivable, derivative commodity instruments, pension and postretirement plan assets and liabilities and other current assets and liabilities approximate fair value.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The fair value hierarchy that prioritizes the inputs used to measure fair value is defined as follows:
Level 1 -
Unadjusted quoted prices in active markets for identical assets or liabilities;
Level 2 -
Pricing inputs other than quoted prices in active markets included within Level 1, which are either directly or indirectly observable through correlation with market data as of the reporting date;
Level 3 -
Pricing that requires inputs that are both significant and unobservable to the calculation of the fair value measure. The fair value measure represents estimates of the assumptions that market participants would use in pricing the asset or liability.
Derivative commodity instruments are over-the-counter (OTC) derivatives valued using market transactions and other market evidence whenever possible, including market-based inputs to models and broker or dealer quotations. These OTC derivative contracts trade in less liquid markets with limited pricing information as compared to markets with actively traded, unadjusted quoted prices; accordingly, the determination of fair value is inherently more difficult. OTC derivatives for which the Company is able to substantiate fair value through directly observable market prices are classified within Level 2 of the fair value hierarchy. These Level 2 fair values consist of swaps priced in reference to New York Mercantile Exchange (NYMEX) natural gas and oil futures. OTC derivatives valued using unobservable market prices have been classified within Level 3 of the fair value hierarchy. These Level 3 fair values include basin specific, basis and liquids swaps.
Index to Financial Statements Pension and postretirement plan assets include mutual and comingled funds and a limited partnership. Plan assets were classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The determination and classification of fair value requires judgment and may affect the valuation of fair value assets and their placement within the fair value hierarchy. Level 1 and 2 fair values use market transactions and other market evidence whenever possible and consist primarily of equities, fixed income and mutual funds. Level 3 fair values used unobservable market prices primarily associated with certain alternative investments and a limited partnership.
E. Income Taxes
The Company uses the liability method of accounting for income taxes. Under this method, a deferred tax asset or liability is recognized for the estimated future tax effects attributable to temporary differences between the financial statement basis and the tax basis of assets and liabilities as well as tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period of the change. The Company and its subsidiaries file a consolidated federal income tax return. Consolidated federal income taxes are charged to appropriate subsidiaries using the separate return method.
F. Accounts Receivable and Allowance for Doubtful Accounts
Trade accounts receivable are recorded at the invoiced amounts and do not bear interest. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the existing accounts receivable. The Company determines the allowance based on historical experience and in consideration of current market conditions. Account balances are charged against the allowance when it is anticipated the receivable will not be recovered.
G. Cash Equivalents
The Company includes highly liquid marketable securities and debt instruments purchased with a maturity of three months or less in cash equivalents.
H. Earnings Per Share (EPS)
The Company’s basic earnings per share amounts have been computed based on the weighted-average number of common shares outstanding. Diluted earnings per share amounts reflect the assumed issuance of common shares for all potentially dilutive securities.
I. Stock-Based Compensation
The Company measures all share-based compensation awards at fair value at the date of grant and expenses the awards over the requisite vesting period. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if the actual forfeitures differ from those estimates.
The Company previously recognized all stock-based employee compensation expense over the stated vesting periods for each award. For awards granted prior to January 1, 2006, the Company recorded any unrecognized expense on the date of an employee’s retirement. For new awards granted to retirement eligible employees effective January 1, 2006, the Company began recognizing the entire compensation expense in the period of grant. If this method of expense recognition for retirement eligible employees had been applied to all awards, the impact to compensation expense would have been no change during 2009, an increase by approximately $1.2 million in 2008 and a reduction by approximately $1.1 million during 2007. The Company utilized the long-form method of calculating the available pool of windfall tax benefit. For 2009 and 2008, the Company recognized an excess tax benefit of $0.6 million and $17.1 million related to its stock-based compensation.
Index to Financial Statements
J. Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. The major estimates and assumptions identified by management include, but are not limited to, physical quantities of oil and gas reserves, periodic assessments of oil and gas properties for impairment, an assumption that regulatory accounting will continue as the applicable accounting standard for the Company’s regulated operations, the Company’s obligations under its employee pension plans, the valuation of derivative financial instruments, the allowance for doubtful accounts, tax contingency reserves, legal contingency reserves, asset retirement obligations, self insurance reserves and regulatory assets and liabilities. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may differ from the estimates.
K. Employee Benefit Plans
Energen has two defined benefit non-contributory qualified pension plans. These plans cover substantially all employees. Pension benefits for the majority of the Company’s employees are based on years of service and final earnings; one plan is based on years of service and flat dollar amounts. The Company’s policy is to use the projected unit credit actuarial method for financial reporting purposes. The Company also has nonqualified supplemental pension plans covering certain officers of the Company. In addition to providing pension benefits, the Company provides certain postretirement health care and life insurance benefits. Substantially all of the Company’s employees may become eligible for certain benefits if they reach normal retirement age while working for the Company. The projected unit credit actuarial method was used to determine the normal cost and actuarial liability.
For retirement plans and other postretirement plans, certain financial assumptions are used in determining the Company’s projected benefit obligation. These assumptions are examined periodically by the Company, and any required changes are reflected in the subsequent determination of projected benefit obligations.
Measurement: The Company calculates periodic expense for defined benefit pension plans and other post retirement benefit plans on an actuarial basis and the net funded status of benefit plans is recognized as an asset or liability in its statement of financial position with changes in the funded status recognized through comprehensive income. For pension plans, the benefit obligation is the projected benefit obligation; for other postretirement plans, the benefit obligation is the accumulated postretirement benefit obligation. Alagasco recognizes a regulatory asset for the portion of the obligation to be recovered in rates in future periods and a regulatory liability for the portion of the plan obligation to be provided through rates in the future. As of December 31, 2008, the Company measures the funded status of its employee benefit plans as of the date of its year-end statement of financial position. Previously, the Company used a September 30 valuation date for its benefit plans. During the fourth quarter of 2008, the Company changed the measurement date to December 31 using the alternative method. The Company recognized a one-time reduction to retained earnings of $1.8 million pre-tax and an increase to the current and noncurrent regulatory assets of Alagasco totaling approximately $0.1 million and $1.4 million pre-tax, respectively. The increase to regulatory assets which totaled $1.5 million will be recovered in rates over the average remaining service lives of each plan.
Discount Rate: In selecting the discount rate, consideration was given to Moody’s Aa corporate bond rates, along with a yield curve applied to payments the Company expects to make out of its retirement plans. The yield curve is comprised of a broad base of Aa bonds with maturities between zero and thirty years. The discount rate was developed as the level equivalent rate that would produce the same present value as that using spot rates aligned with the projected benefit payments; the discount rate used to determine net periodic costs was 6.50 percent for each of the plans for the year ended December 31, 2009.
Long-Term Rate of Return: The assumed rate of return on assets is the weighted average of expected long-term asset assumptions; the return on assets used to determine net periodic expense was 8.25 percent for each of the applicable plans for the year ended December 31, 2009. The Company based its expected return on long- term investment expectations. The Company considered past performance and current expectations for assets held by the plans as well as the expected long-term allocation of plan assets.
Index to Financial Statements Other Significant Assumptions: The estimated weighted average rate of increase in the compensation level for pay related plans was 3.9 percent for the year ended December 31, 2009.
L. Environmental Costs
Environmental compliance costs, including ongoing maintenance, monitoring and similar costs, are expensed as incurred. Environmental remediation costs are accrued when remedial efforts are probable and the cost can be reasonably estimated.
M. Subsequent Events
The Company has evaluated subsequent events until the time the consolidated financial statements were issued.
2. REGULATORY MATTERS
Alagasco is subject to regulation by the APSC which established the Rate Stabilization and Equalization (RSE) rate-setting process in 1983. RSE’s current extension is for a seven-year period through December 31, 2014. RSE will continue after December 31, 2014, unless, after notice to the Company and a hearing, the APSC votes to modify or discontinue the RSE methodology. Alagasco is on a September 30 fiscal year for rate-setting purposes (rate year) and reports on a calendar year for Securities and Exchange Commission reporting purposes.
Alagasco’s allowed range of return on average equity remains 13.15 percent to 13.65 percent throughout the term of the order. Under RSE the APSC conducts quarterly reviews to determine, based on Alagasco’s projections and year-to-date performance, whether Alagasco’s return on average equity at the end of the rate year will be within the allowed range of return. Reductions in rates can be made quarterly to bring the projected return within the allowed range; increases, however, are allowed only once each rate year, effective December 1, and cannot exceed 4 percent of prior-year revenues. As of September 30, 2009 and 2007, Alagasco had a $1.5 million pre-tax and a $3.6 million pre-tax, respectively, reduction in revenues to bring the return on average equity to midpoint within allowed range of return. Alagasco did not have a reduction in rates related to the return on average equity for the rate year ended 2008. Under the provisions of RSE, a $10.2 million, $24.7 million and $12 million annual increase in revenues became effective December 1, 2009, 2008, and 2007, respectively.
At September 30, 2009, RSE limited the utility’s equity upon which a return is permitted to 55 percent of total capitalization, subject to certain adjustments. Under the inflation-based Cost Control Measurement (CCM) established by the APSC, if the percentage change in operations and maintenance (O&M) expense on an aggregate basis falls within a range of 0.75 points above or below the percentage change in the Consumer Price Index For All Urban Consumers (Index Range), no adjustment is required. If the change in O&M expense on an aggregate basis exceeds the Index Range, three-quarters of the difference is returned to customers. To the extent the change is less than the Index Range, the utility benefits by one-half of the difference through future rate adjustments. The O&M expense base for measurement purposes will be set at the prior year’s actual O&M expense amount unless the Company exceeds the top of the Index Range in two successive years, in which case the base for the following year will be set at the top of the Index Range. Certain items that fluctuate based on situations demonstrated to be beyond Alagasco’s control may be excluded from the CCM calculation. In the rate year ended September 30, 2008, the increase in O&M expense was below the Index Range; as a result the utility benefited by $2.9 million pre-tax with the related impact to rates effective December 1, 2008. Alagasco’s O&M expense fell within the Index Range for the rate years ended September 30, 2009 and 2007.
Alagasco’s rate schedules for natural gas distribution charges contain a GSA rider, established in 1993, which permits the pass-through to customers of changes in the cost of gas supply. Alagasco’s tariff provides a temperature adjustment mechanism, also included in the GSA, that is designed to moderate the impact of departures from
Index to Financial Statements
normal temperatures on Alagasco’s earnings. The temperature adjustment applies primarily to residential, small commercial and small industrial customers. Other non-temperature weather related conditions that may affect customer usage are not included in the temperature adjustment.
The APSC has approved an Enhanced Stability Reserve (ESR), with a maximum funding level of $4 million, to which Alagasco may charge the full amount of: (1) extraordinary O&M expenses resulting from force majeure events when one or a combination of two such events results in more than $200,000 of additional O&M expense during a rate year; or (2) individual industrial and commercial customer revenue losses that exceed $250,000 during the rate year, if such losses cause Alagasco’s return on average equity to fall below 13.15 percent. Following a year in which a charge against the ESR is made, the APSC provides for accretions to the ESR of no more than $40,000 monthly until the maximum funding level is achieved. Under the terms of the current RSE extension, Alagasco will not have accretions against the ESR until December 31, 2010 unless the Company incurs a significant natural disaster during the three-year period ended December 31, 2010 and receives approval from the APSC to resume accretions under the ESR. Due to revenue losses from market sensitive large commercial and industrial customers, Alagasco utilized the entire ESR of approximately $4 million during the third quarter of 2008. In addition to the items mentioned above, Alagasco expects to utilize the ESR to recover certain manufactured gas plant site remediation costs through future rates and has recorded a corresponding amount to its Enhanced Stability Reserve regulatory account of $2.7 million as of December 31, 2009, as more fully described in Note 7, Commitments and Contingencies.
The excess of total acquisition costs over book value of net assets of acquired municipal gas distribution systems is included in utility plant and is being amortized through Alagasco’s rate-setting mechanism on a straight-line basis with a weighted average remaining life of approximately 5 years. At December 31, 2009 and 2008, the net acquisition adjustments were $5.9 million and $7 million, respectively.
3. LONG-TERM DEBT AND NOTES PAYABLE
Long-term debt consisted of the following:
The aggregate maturities of Energen’s long-term debt for the next five years are as follows:
Index to Financial Statements The aggregate maturities of Alagasco’s long-term debt for the next five years are as follows:
The Company’s various long-term debt and short-term debt agreements contain financial and nonfinancial covenants. Except as discussed below, debt covenants address routine matters such as timely payment of principal and interest, maintenance of corporate existence and restrictions on liens. The Company’s outstanding debt is subject to a cross default provision under Energen’s Indenture dated September 1, 1996 with The Bank of New York as Trustee. In the event Alagasco or Energen Resources had a debt default of more than $10 million it would also be considered an event of default by Energen under the 1996 Indenture. All of the Company’s debt is unsecured. No conditions exist under long-term debt agreements which could restrict the Company’s ability to pay dividends.
As of December 31, 2009, the Company had short-term credit lines and other credit facilities, with renewal terms at various dates during 2010, with various financial institutions aggregating $525 million of which Energen had available $230 million, Alagasco had available $110 million and $185 million was available to either Company for working capital needs. Alagasco has been authorized by the APSC to borrow up to $200 million at any one time under short-term lines of credit. Certain of the Company’s credit facilities in the aggregate amount of $190 million, including $150 million for Energen and $40 million for Alagasco, have a covenant that the ratio of consolidated debt to consolidated capitalization will not exceed 0.65:1. The following is a summary of information relating to notes payable to banks:
Energen’s total interest expense was $39,379,000, $41,981,000 and $47,100,000 for the years ended December 31, 2009, 2008 and 2007, respectively. Total interest expense for Alagasco was $13,714,000, $14,807,000 and $15,696,000 for the years ended December 31, 2009, 2008 and 2007, respectively.
4. INCOME TAXES
The components of Energen’s income taxes consisted of the following:
Index to Financial Statements For the years ended December 31, 2009 and 2008, Energen recorded no income tax expense related to income from discontinued operations. For the year ended December 31, 2007, Energen recorded current income tax expense of $12,000 related to income from discontinued operations.
The components of Alagasco’s income taxes consisted of the following:
Temporary differences and carryforwards which gave rise to Energen’s deferred tax assets and liabilities were as follows:
Index to Financial Statements Temporary differences and carryforwards which gave rise to Alagasco’s deferred tax assets and liabilities were as follows:
The Company files a consolidated federal income tax return with all of its subsidiaries. The Company has a current deferred tax asset of $702,000 relating to Alagasco’s $16.2 million state net operating loss carryforward which will expire beginning in 2023. Alagasco anticipates generating adequate future taxable income to fully realize this benefit. The Company has a full valuation allowance recorded against a noncurrent deferred tax asset of $2,729,000 arising from certain state net operating loss and charitable contribution carryforwards. The Company intends to fully reserve this asset until it is determined that it is more likely than not that the asset can be realized through future taxable income in the respective state taxing jurisdictions. No other valuation allowance with respect to deferred taxes is deemed necessary as both the Company and Alagasco anticipate generating adequate future taxable income to realize the benefits of all remaining deferred tax assets on the consolidated balance sheets.
Total income tax expense for the Company differed from the amount which would have been provided by applying the statutory federal income tax rate of 35 percent to earnings before taxes from continuing operations as illustrated below:
Total income tax expense for Alagasco differed from the amount which would have been provided by applying the statutory federal income tax rate of 35 percent to earnings before taxes from continuing operations as illustrated below:
Index to Financial Statements As of January 1, 2007, the Company adopted accounting guidance which prescribed a recognition threshold and measurement attribute for the financial statement recognition, measurement and disclosure of a tax position taken or expected to be taken in a tax return. A reconciliation of Energen’s beginning and ending amount of unrecognized tax benefits is as follows:
During 2009, there were no material changes to unrecognized tax benefits. The increase in the additions for tax positions of prior years in 2008 is primarily related to Alagasco’s tax accounting method change for the recovery of its gas distribution property that was approved by the Internal Revenue Service (IRS). The amount of unrecognized tax benefits at December 31, 2009 that would favorably impact the Company’s effective tax rate, if recognized, is $3.7 million. The Company recognizes potential accrued interest and penalties related to unrecognized tax benefits in income tax expense. During the years ended December 31, 2009, 2008, and 2007, the Company recognized approximately $91,000, $164,000 and $36,000 of expense for interest (net of tax benefit) and penalties, respectively. The Company had approximately $772,000 and $681,000 for the payment of interest (net of tax benefit) and penalties accrued at December 31, 2009 and 2008, respectively.
A reconciliation of Alagasco’s beginning and ending amount of unrecognized tax benefits is as follows:
During 2009, there were no material changes to Alagasco’s unrecognized tax benefits. The increase in the additions for tax positions of prior years in 2008 is primarily related to Alagasco’s tax accounting method change for the recovery of its gas distribution property discussed above. The amount of unrecognized tax benefits at December 31, 2009 that would favorably impact Alagasco’s effective tax rate, if recognized, is $210,000. Alagasco recognizes
Index to Financial Statements
potential accrued interest and penalties related to unrecognized tax benefits in income tax expense. During the years ended December 31, 2009, 2008, and 2007, Alagasco recognized approximately $146,000, $131,000, and $23,000 of expense for interest (net of tax benefit) and penalties, respectively. Alagasco had approximately $364,000 and $218,000 for the payment of interest (net of tax benefit) and penalties accrued at December 31, 2009 and 2008, respectively.
The Company and Alagasco’s tax returns for years 2006-2008, including the tax accounting method change noted above, remain open to examination by the IRS and major state taxing jurisdictions. The Company is currently under IRS examination of its federal consolidated income tax returns for 2006-2008. The Alabama Department of Revenue (ADOR) has also notified the Company and Alagasco of a forthcoming examination of its Alabama income tax returns for open years that will commence in 2010. The change in the unrecognized tax benefit expected within the next 12 months is not considered material to the financial statements.
5. EMPLOYEE BENEFIT PLANS
Pension Plans: The following table sets forth the combined funded status of the defined qualified and nonqualified supplemental benefit plans and their reconciliation with the related amounts in the Company’s consolidated financial statements:
Alagasco recognized a regulatory asset of $55.8 million and $54.7 million as of December 31, 2009 and 2008, respectively, for the portion of the obligation to be recovered through rates in future periods.
Index to Financial Statements The Company anticipates required contributions of approximately $7 million during 2010 to the pension plans. The Company expects sufficient funding credits, as established under Internal Revenue Code Section 430(f), exist to meet the required funding. It is not anticipated that the funded status of the pension plans will fall below statutory thresholds requiring accelerated funding or constraints on benefit levels or plan administration. No additional discretionary contributions are currently expected to be made to the pension plans by the Company during 2010. The Company expects to make benefit payments of approximately $2.2 million during 2010 to retirees with respect to the nonqualified supplemental retirement plans.
Other investment assets designated for payment of the nonqualified supplemental retirement plans were as follows:
While intended for payment of the nonqualified supplemental retirement plan benefits, these assets remain subject to the claims of the Company’s creditors and are not recognized in the funded status of the plan. The fair value of these assets was $18.3 million as of December 31, 2008. These assets are recorded at fair value and included in Deferred Charges and Other in the Consolidated Balance Sheets.
The following is a reconciliation of insurance contracts in Level 3 of the fair value hierarchy:
Other changes in pension plan assets and projected benefit obligations recognized in other comprehensive income were as follows:
Estimated amounts to be amortized from accumulated other comprehensive income into pension cost during 2010 are as follows:
Weighted average rate assumptions used to determine the projected benefit obligations at the measurement date:
Index to Financial Statements The components of net pension expense were:
Net retirement expense for Alagasco was $4,231,000, $5,595,000 and $6,812,000 for the years ended December 31, 2009, 2008 and 2007, respectively. In the second quarter of 2009, the Company recognized a termination benefit charge of $145,000 to provide for early retirement of certain non-highly compensated employees. The Company recognized settlement charges of $2.4 million in 2007 for the payment of lump sums from the nonqualified supplemental retirement plans. The Company also recognized settlement charges of $0.7 million in the fourth quarter of 2008 and $3.2 million in the third quarter of 2007 for the payment of lump sums from a defined benefit pension plan. These charges represented an acceleration of the unamortized actuarial losses.
Weighted average rate assumptions to determine net periodic benefit costs for the period ending:
Plan assets included in the funded status of the pension plans were as follows:
United States equities consist of mutual and commingled funds with varying strategies. Such strategies include stock investments across market capitalizations and investment styles. Global equities consist of mutual funds and a limited partnership that invest in United States and non-United States securities broadly diversified across mostly developed markets but with some tactical exposure to emerging markets. Fixed income securities consist of mutual funds and separate accounts. Fixed income securities are well diversified with allocations to investment grade and non-investment grade issues and issues that provide both intermediate and longer duration exposure. Alternative asset investments consist of limited partnerships and commingled and mutual funds with varying investment strategies. Alternative assets are meant to serve as a risk reducer at the total portfolio level as they provide asset class exposures not found elsewhere in the portfolio.
The following is a reconciliation of plan assets in Level 3 of the fair value hierarchy:
Index to Financial Statements Defined benefit pension plan payments, which reflect expected future service, are anticipated to be paid as follows:
Postretirement Health Care and Life Insurance Benefits: The status of the postretirement benefit programs was as follows:
Alagasco recognized a regulatory asset of $9.5 million and $16.4 million as of December 31, 2009 and 2008, respectively, for the portion of the obligation to be recovered through rates in future periods. The Company expects to make discretionary contributions of $7.8 million to postretirement benefit program assets during 2010.
Other changes in postretirement plan assets and projected benefit obligations recognized in other comprehensive income were as follows:
Index to Financial Statements Estimated amounts to be amortized from accumulated other comprehensive income into benefit cost during 2010 are as follows:
Weighted average rate assumptions used to determine postretirement benefit obligations at the measurement date:
Net periodic postretirement benefit expense included the following:
Net periodic postretirement benefit expense for Alagasco was $4,051,000, $1,457,000 and $300,000 for the years ended December 31, 2009, 2008 and 2007, respectively.
Weighted average rate assumptions to determine net periodic benefit costs for the years ending:
Assumed post-65 health care cost trend rates used to determine the postretirement benefit obligation at the measurement date:
Assumed health care cost trend rates used in determining the accumulated postretirement benefit obligation have an effect on the amounts reported. For example, revising the weighted average health care cost trend rate by 1 percentage point would have the following effects:
Plan assets included in the funded status of the postretirement benefit plans were as follows:
Index to Financial Statements The Company had no Level 3 postretirement benefit plan assets. United States equities consisted of mutual funds with varying strategies. These funds invest largely in medium to large capitalized companies with exposure blending growth, market-oriented and value styles. Additional fund investments include small capitalization companies, and certain of these funds utilize tax-sensitive management approaches. Global equities are mutual funds that invest in non-United States securities broadly diversified across most developed markets with exposure blending growth, market-oriented and value styles. Fixed income securities are high-quality short-duration securities including investment-grade market sectors with tactical investments in non-investment grade sectors.
The following postretirement benefit payments, which reflect expected future service, are anticipated to be paid:
The following benefits reflect the expected prescription drug subsidy related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (Act). The Act includes a prescription drug benefit under Medicare Part D as well as a federal subsidy which began in 2007:
The Company has a long-term disability plan covering most employees. The Company had expense for the years ended December 31, 2009, 2008 and 2007 of $458,000, $346,000 and $382,000, respectively.
Investment Strategy: The Company employs a total return investment approach whereby a mix of equities and fixed income investments are used to maximize the long-term return of plan assets with a prudent level of risk. Risk tolerance is established through consideration of plan liabilities, plan funded status, corporate financial condition, and market conditions.
The Company has developed an investment strategy that focuses on asset allocation, diversification and quality guidelines. The investment goals of the Company are to obtain an adequate level of return to meet future obligations of the plan by providing above average risk-adjusted returns with a risk exposure in the mid-range of comparable funds. Investment managers are retained by the Company to manage separate pools of assets. Funds are allocated to such managers in order to achieve an appropriate, diversified, and balanced asset mix. Comparative market and peer group benchmarks are utilized to ensure that investment managers are performing satisfactorily.
The Company seeks to maintain an appropriate level of diversification to minimize the risk of large losses in a single asset class. Accordingly, plan assets for the defined benefit pension plan and the postretirement benefit plan do not have a concentration of assets in a single entity, industry, country, commodity or class of investment fund.
The Company’s weighted-average defined benefit pension plan asset allocations by asset category were as follows:
Index to Financial Statements The Company’s weighted-average postretirement benefit program asset allocations by asset category were as follows:
6. COMMON STOCK PLANS
Energen Employee Savings Plan (ESP): A majority of Company employees are eligible to participate in the ESP by electing to contribute a portion of their compensation to the ESP. The Company may match a percentage of the contributions and make these contributions in Company common stock or in funds for the purchase of Company common stock. Employees may diversify 100 percent of their ESP Company stock account into other ESP investment options. The ESP also contains employee stock ownership plan provisions. At December 31, 2009, total shares reserved for issuance equaled 1,080,108. Expense associated with Company contributions to the ESP was $5,806,000, $5,559,000 and $5,237,000 for the years ended December 31, 2009, 2008 and 2007, respectively.
1997 Stock Incentive Plan and 1988 Stock Option Plan: The 1997 Stock Incentive Plan and the Energen 1988 Stock Option Plan provided for the grant of incentive stock options and non-qualified stock options to officers and key employees. The 1997 Stock Incentive Plan also provided for the grant of performance share awards and restricted stock. The Company has typically funded options, restricted stock obligations and performance share obligations through original issue shares. Under the 1997 Stock Incentive Plan, 5,600,000 shares of Company common stock were reserved for issuance with 1,369,514 remaining for issuance as of December 31, 2009. Under the 1988 Stock Option Plan, 1,080,000 shares of Company common stock reserved for issuance have been granted.
Performance Share Awards: The Energen 1997 Stock Incentive Plan provided for the grant of performance share awards, with each unit equal to the market value of one share of common stock, to eligible employees based on predetermined Company performance criteria at the end of a four-year award period. The 1997 Stock Incentive Plan provided that payment of earned performance share awards be made in the form of Company common stock.
1997 Stock Incentive Plan performance share awards granted or modified after January 1, 2006 have been valued using a Monte Carlo model. The Monte Carlo model uses historical volatility and other variables to estimate the probability of satisfying the market condition of the award. For performance share awards granted prior to January 1, 2006, the Company estimated fair value based on the quoted market price of the Company’s common stock and adjusted each period for the expected payout ratio.
No performance share awards were granted in 2009, 2008 or 2007. A summary of performance share award activity as of December 31, 2009, and transactions during the years ended December 31, 2009, 2008 and 2007 are presented below:
Index to Financial Statements The Company recorded expense of $502,000 and $4,254,000 for the years ended December 31, 2009 and 2007, respectively, for performance share awards with a related deferred income tax benefit of $190,000 and $1,608,000, respectively. The Company recorded income of $2,308,000 for the year ended December 31, 2008 for performance share awards with a related deferred income tax expense of $873,000.
Stock Options: The 1997 Stock Incentive Plan and the Energen 1988 Stock Option Plan provided for the grant of incentive stock options, non-qualified stock options, or a combination thereof to officers and key employees. Options granted under the 1997 Stock Incentive Plan provided for the purchase of Company common stock at not less than the fair market value on the date the option is granted. The sale or transfer of the shares is limited during certain periods. All outstanding options are incentive or non-qualified, vest within three years from date of grant, and expire 10 years from the grant date.
A summary of stock option activity as of December 31, 2009, and transactions during the years ended December 31, 2009, 2008 and 2007 are presented below:
The Company uses the Black-Scholes pricing model to calculate the fair values of the options awarded. For purposes of this valuation the following assumptions were used to derive the fair values:
The Company recorded stock option expense of $4,352,000, $3,080,000 and $3,124,000 during the years ended December 31, 2009, 2008 and 2007, respectively, with a related deferred tax benefit of $1,645,000, $1,165,000 and $1,181,000 respectively.
Index to Financial Statements The total intrinsic value of stock options exercised during the year ended December 31, 2009, was $1,586,000. During the year ended December 31, 2009, the total intrinsic value of stock appreciation rights exercised was $107,000. During the year ended December 31, 2009, the Company received cash of $892,000 from the exercise of stock options and paid $73,000 in settlement of stock appreciation rights. Total intrinsic value for outstanding options as of December 31, 2009, was $11,686,000 and $4,030,000 for exercisable options. The fair value of options vested for the year ended December 31, 2009 was $2,500,000. As of December 31, 2009, there was $1,745,000 of unrecognized compensation cost related to outstanding nonvested stock options.
The following table summarizes options outstanding as of December 31, 2009:
The weighted average remaining contractual life of currently exercisable stock options is 5.49 years as of December 31, 2009.
Restricted Stock: In addition, the 1997 Stock Incentive Plan provided for the grant of restricted stock which have been valued based on the quoted market price of the Company’s common stock at the date of grant. Restricted stock awards have a three to six year vesting period. A summary of restricted stock activity as of December 31, 2009, and transactions during the years ended December 31, 2009, 2008 and 2007 is presented below:
The Company recorded expense of $379,000, $596,000 and $908,000 for the years ended December 31, 2009, 2008 and 2007, respectively, related to restricted stock, with a related deferred income tax benefit of $143,000, $225,000 and $343,000, respectively. As of December 31, 2009, there was $384,000 of total unrecognized compensation cost related to nonvested restricted stock awards recorded in premium on capital stock. These awards have a remaining requisite service period of 0.75 years.
Stock Appreciation Rights Plan: The Energen 2004 Stock Appreciation Rights Plan provided for the payment of cash incentives measured by the long-term appreciation of Company stock. These awards are liability awards which settle in cash and are re-measured each reporting period until settlement. These awards have a three year requisite service period.
Index to Financial Statements The Company issued the following awards with stock appreciation rights. The Company uses the Black-Scholes pricing model to calculate the fair values of the options awarded. For purposes of this valuation the following assumptions were used to derive the fair values as of December 31, 2009:
Expense associated with stock appreciation rights of $4,608,000 and $1,933,000 was recorded for the years ended December 31, 2009 and 2007, respectively. Income associated with stock appreciation rights of $2,413,000 was recorded for the year ended December 31, 2008.
Petrotech Incentive Plan: The Energen Resources’ Petrotech Incentive Plan provided for the grant of stock equivalent units which may include market conditions. These awards are liability awards which settle in cash and are re-measured each reporting period until settlement. The fair value of the stock equivalent units with a market condition was calculated using a Monte Carlo approach. Stock equivalent units with service conditions were valued based on the Company’s stock price at the end of the period adjusted to remove the present value of future dividends.
In the first quarter of 2009, Energen Resources awarded 900 stock equivalent units with a two year vesting period and 2,911 stock equivalent units with a three year vesting period. During the third quarter of 2009, Energen Resources awarded 938 stock equivalent units with a three year vesting period. Energen Resources awarded 1,805 stock equivalent units with a two year vesting period and 1,014 stock equivalent units with a three year vesting period in 2008. During 2007, Energen Resources awarded 5,242 stock equivalent units with a three year vesting period. None of the awards issued included a market condition. Energen Resources recognized expense of $1,028,000 and $2,389,000 during 2009 and 2007, respectively, related to these units. Energen Resources recognized income of $2,042,000 during 2008 related to these units.
1997 Deferred Compensation Plan: The 1997 Deferred Compensation Plan allowed officers and non-employee directors to defer certain compensation. Amounts deferred by a participant under the 1997 Deferred Compensation Plan are credited to accounts maintained for a participant in either a stock account or an investment account. The stock account tracks the performance of the Company’s common stock, including reinvestment of dividends. The investment account tracks the performance of certain mutual funds. The Company has funded, and presently plans to continue funding, a trust in a manner that generally tracks participants’ accounts under the 1997 Deferred Compensation Plan. While intended for payment of benefits under the 1997 Deferred Compensation Plan, the trust’s assets remain subject to the claims of the Company’s creditors. Amounts earned under the Deferred Compensation Plan and invested in Company common stock held by the trust have been recorded as treasury stock, along with the related deferred compensation obligation in the consolidated statements of shareholders’ equity. As of December 31, 2009 there were 712,672 shares reserved for issuance from the 1997 Deferred Compensation Plan.
1992 Energen Corporation Directors Stock Plan: In 1992 the Company adopted the Energen Corporation 1992 Directors Stock Plan to pay a portion of the compensation of its non-employee directors in shares of Company common stock. Under the Plan, 12,000 shares, 11,218 shares and 11,503 shares were awarded during the years ended December 31, 2009, 2008 and 2007, respectively, leaving 190,724 shares reserved for issuance as of December 31, 2009.
Dividend Reinvestment and Direct Stock Purchase Plan: The Company’s Dividend Reinvestment and Direct Stock Purchase Plan included a direct stock purchase feature which allowed purchases by non-shareholders. As of December 31, 2009, 1,098,292 common shares were reserved under this Plan. Effective December 15, 2006, the Company suspended operations under the Plan and shareholders became eligible to reinvest dividends or make direct stock purchases using the Company’s stock transfer and dividend paying agent, The Bank of New York.
Index to Financial Statements Stock Repurchase Program: By resolution adopted May 25, 1994, and supplemented by a resolution adopted April 26, 2000 and June 24, 2006, the Board authorized the Company to repurchase up to 12,564,400 shares of the Company’s common stock. There were no shares repurchased pursuant to its repurchase authorization for the years ended December 31, 2009, 2008 and 2007. As of December 31, 2009, a total of 8,992,700 shares remain authorized for future repurchase. The Company also from time to time acquires shares in connection with participant elections under the Company’s stock compensation plans. For the years ended December 31, 2009, 2008 and 2007, the Company acquired 23,942 shares, 446,045 shares and 209,388 shares, respectively, in connection with its stock compensation plans.
7. COMMITMENTS AND CONTINGENCIES
Commitments and Agreements: Certain of Alagasco’s long-term contracts associated with the delivery and storage of natural gas include fixed charges of approximately $204 million through September 2024. During the years ended December 31, 2009, 2008 and 2007, Alagasco recognized approximately $49 million, $51 million and $48 million, respectively, of long term commitments through expense and its regulatory accounts in the accompanying financial statements. Alagasco also is committed to purchase minimum quantities of gas at market-related prices or to pay certain costs in the event the minimum quantities are not taken. These purchase commitments are approximately 107.6 Bcf through April 2015.
Environmental Matters: Various environmental laws and regulations apply to the operations of Energen Resources and Alagasco. Historically, the cost of environmental compliance has not materially affected the Company’s financial position, results of operations or cash flows. New regulations, enforcement policies, claims for damages or other events could result in significant unanticipated costs. Remediation of the Huntsville, Alabama manufactured gas plant site, as discussed below, may also result in unanticipated costs.
A discussion of certain litigation in the state of Louisiana related to the restoration of oilfield properties is included below under Legal Matters.
Alagasco is in the chain of title of nine former manufactured gas plant sites (four of which it still owns), and five manufactured gas distribution sites (one of which it still owns). Subject to the following paragraph discussing the Huntsville, Alabama manufactured gas plant site, an investigation of the sites does not indicate the present need for remediation activities and management expects that, should remediation of any such sites be required in the future, Alagasco’s share, if any, of such costs will not materially affect the financial position of Alagasco.
In June 2009, Alagasco received a General Notice Letter from the United States Environmental Protection Agency (EPA) identifying Alagasco as a responsible party for a former manufactured gas plant (MGP) site located in Huntsville, Alabama, and inviting Alagasco to enter an Administrative Settlement Agreement and Order on Consent to perform a removal action at that site. The Huntsville MGP, along with the Huntsville gas distribution system, was sold by Alagasco to the City of Huntsville in 1949. While Alagasco no longer owns the Huntsville site, the Company and the current site owner have entered into a Consent Order and agreed to develop an action plan for the site. Based on the limited information available at this time, Alagasco preliminarily estimates that it may incur costs associated with the site ranging from $3 million to $6.1 million. At the present time, the Company cannot conclude that any amount within this range is a better estimate than any other. During the year ended December 31, 2009, the Company incurred costs of $0.2 million associated with the site. As of December 31, 2009, the Company has accrued a contingent liability of $2.8 million in addition to the costs previously incurred. The estimate assumes an action plan for excavation of affected soil and sediment only. If it is determined that a greater scope of work is appropriate, then actual costs will likely exceed the preliminary estimate. Alagasco expects to recover such costs through insurance recovery and future rates and has recorded a corresponding amount to its Enhanced Stability Reserve regulatory asset account.
Legal Matters: Energen and its affiliates are, from time to time, parties to various pending or threatened legal proceedings. Certain of these lawsuits include claims for punitive damages in addition to other specified relief. Based upon information presently available, and in light of available legal and other defenses, contingent liabilities
Index to Financial Statements
arising from threatened and pending litigation are not considered material in relation to the respective financial positions of Energen and its affiliates. It should be noted, however, that Energen and its affiliates conduct business in jurisdictions in which the magnitude and frequency of punitive and other damage awards may bear little or no relation to culpability or actual damages, thus making it difficult to predict litigation results.
Legacy Litigation
During recent years, numerous lawsuits have been filed against oil production companies in Louisiana for restoration of oilfield properties. These suits are referred to in the industry as “legacy litigation” because they usually involve operations that were conducted on the affected properties many years earlier. Energen Resources is or has been a party to several legacy litigation lawsuits, most of which result from the operations of predecessor companies. Based upon information presently available, and in light of available legal and other defenses, contingent liabilities arising from legacy litigation in excess of the Company’s accrued provision for estimated liability are not considered material to the Company’s financial position.
Other
Various other pending or threatened legal proceedings are in progress currently, and the Company has accrued a provision for estimated liability.
Lease Obligations: Alagasco leases the Company’s headquarters building over a 25-year term and the related lease is accounted for as an operating lease. Under the terms of the lease, Alagasco has a renewal option; the lease does not contain a bargain purchase price or a residual value guarantee. Energen’s total lease payments related to leases included as operating lease expense were $21,529,000, $21,403,000 and $18,212,000 for the years ended December 31, 2009, 2008 and 2007, respectively. Minimum future rental payments required after 2009 under leases with initial or remaining noncancelable lease terms in excess of one year are as follows:
Alagasco’s total payments related to leases included as operating expense, net of approximately $1,025,000 of lease expense paid by Energen each year, were $2,150,000, $2,114,000 and $2,155,000 for the years ended December 31, 2009, 2008 and 2007, respectively. Minimum future rental payments required after 2009 under leases with initial or remaining noncancelable lease terms in excess of one year are as follows:
Included in the table above are approximately $14.4 million of payments associated with leasing of the Company’s headquarters, which are expected to be reimbursed to Alagasco by Energen through the remaining term of the related lease. Such amounts are subject to intercompany allocations but are not subject to contractual agreements.
8. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT
Financial Instruments: The stated value of cash and cash equivalents, trade receivables (net of allowance), and short-term debt approximates fair value due to the short maturity of the instruments. The fair value of Energen’s long-term debt, including the current portion, with a carrying value of $561,522,000 would be $567,848,000 at December 31, 2009. The fair value of Alagasco’s fixed-rate long-term debt, including the current portion, with a carrying value of $206,522,000 would be $199,121,000 at December 31, 2009. The fair values were based on market prices of similar issues having the same remaining maturities, redemption terms and credit rating.
Alagasco purchases gas as an agent for certain of its large commercial and industrial customers. Alagasco has in certain instances provided commodity-related guarantees to counterparties in order to facilitate these agency purchases. Liabilities existing for gas delivered to customers subject to these guarantees are included in the balance
Index to Financial Statements
sheet. In the event the customer for whom the guarantee was entered fails to take delivery of the gas, Alagasco can sell such gas for the customer, with the customer liable for any resulting loss. Although the substantial majority of purchases under these guarantees are for the customers’ current monthly consumption and are at current market prices, in some instances, the purchases are for an extended term at a fixed price. At December 31, 2009, the fixed price purchases under these guarantees had a maximum term outstanding through October 2010 with an aggregate purchase price of $4.3 million and a market value of $4.6 million.
Risk Management: At December 31, 2009, the counterparty agreements under which the Company had active positions did not include collateral posting requirements. Energen Resources was in a net gain position with six of its counterparties and a net loss with the remaining three at December 31, 2009. The Company is at risk for economic loss based upon the creditworthiness of its counterparties. The three largest counterparties, Morgan Stanley Capital Group, Inc., Merrill Lynch Commodities, Inc. and J Aron & Company, represented approximately 40 percent, 38 percent and 19 percent, respectively, of Energen Resources’ net gain on fair value of derivatives.
The following table details the fair values of commodity contracts by business segment on the balance sheets:
* Amounts classified in accordance with accounting guidance which permits offsetting fair value amounts recognized for multiple derivative instruments executed with the same counterparty under a master netting arrangement.
The Company had a net $30.3 million and a net $123.1 million deferred tax liability included in current and noncurrent deferred income taxes on the consolidated balance sheets related to derivative items included in other comprehensive income as of December 31, 2009 and 2008, respectively.
Index to Financial Statements The following table details the effect of derivative commodity instruments in cash flow hedging relationships on the financial statements:
The following table details the effect of derivative commodity instruments not designated as hedging instruments on the income statements:
As of December 31, 2009, $70.2 million of deferred net gains on derivative instruments recorded in accumulated other comprehensive income, net of tax, are expected to be reclassified and reported in earnings as operating revenues during the next twelve-month period. The actual amount that will be reclassified to earnings over the next year could vary materially from this amount due to changes in market conditions. As of December 31, 2009, the Company had 12 thousand barrels (MBbl) of oil hedges which expire during 2011 that did not meet the definition of a cash flow hedge but are considered by the Company to be economic hedges. During 2009, the Company discontinued hedge accounting and reclassified gains of $66,000 after-tax from other comprehensive income into operating revenues when Energen Resources determined it was probable certain forecasted volumes would not occur.
As of December 31, 2009, Energen Resources entered into the following transactions for 2010 and subsequent years:
Alagasco entered into the following natural gas transactions for 2010 and subsequent years:
Index to Financial Statements As of December 31, 2009, the maximum term over which Energen Resources and Alagasco has hedged exposures to the variability of cash flows is through December 31, 2013 and December 31, 2012, respectively.
The following sets forth derivative assets and liabilities that were measured at fair value on a recurring basis:
* Amounts classified in accordance with accounting guidance which permits offsetting fair value amounts recognized for multiple derivative instruments executed with the same counterparty under a master netting arrangement.
As of December 31, 2009, Alagasco had $25.8 million and $19 million of derivative instruments which are classified as Level 2 fair values and are included in the above table as current and noncurrent liabilities, respectively. As of December 31, 2008, Alagasco had $27.7 million and $8.8 million of derivative instruments which are classified as Level 2 fair values and are included in the above table as current and noncurrent liabilities, respectively. Alagasco had no derivative instruments classified as Level 3 fair values as of December 31, 2009 and 2008.
The table below sets forth a summary of changes in the fair value of the Company’s Level 3 derivative commodity instruments as follows:
Concentration of Credit Risk: Revenues and related accounts receivable from oil and gas operations primarily are generated from the sale of produced natural gas and oil to natural gas and oil marketing companies. Such sales are typically made on an unsecured credit basis with payment due the month following delivery. This concentration of sales to the energy marketing industry has the potential to affect the Company’s overall exposure to credit risk, either positively or negatively, in that the Company’s oil and gas purchasers may be affected similarly by changes in economic, industry or other conditions. Energen Resources considers the credit quality for its customers and, in certain instances, may require credit assurances such as a deposit, letter of credit or parent guarantee. The four largest oil and gas purchasers accounted for approximately 17 percent, 13 percent, 12 percent and 11 percent of Energen Resources’ accounts receivable for commodity sales as of December 31, 2009. Energen Resources’ other purchasers each accounted for less than 9 percent of this accounts receivable as of December 31, 2009. During the year ended December 31, 2009, there were no purchasers that accounted for more than 10 percent of the Company’s total operating revenues.
Index to Financial Statements Natural gas distribution operating revenues and related accounts receivable are generated from state-regulated utility natural gas sales and transportation to approximately 442,000 residential, commercial and industrial customers located in central and north Alabama. A change in economic conditions may affect the ability of customers to meet their obligations; however, the Company believes that its provision for possible losses on uncollectible accounts receivable is adequate for its credit loss exposure.
9. RECONCILIATION OF EARNINGS PER SHARE
For the year ended December 31, 2009, the Company had 969,487 options and 6,150 shares of non-vested restricted stock that were excluded from the computation of diluted EPS, as their effect was non-dilutive. The Company had no options or shares of non-vested restricted stock that were excluded from the computation of diluted EPS for the year ended December 31, 2008. For the year ended December 31, 2007, the Company had 239,545 options and no shares of non-vested restricted stock that were excluded from the computation of diluted EPS.
10. ASSET RETIREMENT OBLIGATIONS
The Company recognizes a liability for the fair value of asset retirement obligations (ARO) in the period incurred. Subsequent to initial measurement, liabilities are accreted to their present value and capitalized costs are depreciated over the estimated useful life of the related assets. Upon settlement of the liability, the Company may recognize a gain or loss for differences between estimated and actual settlement costs. The ARO fair value liability is recognized on a discounted basis incorporating an estimate of performance risk specific to the Company. Revisions in estimates to the ARO result from revisions to the estimated timing or amount of the underlying cash flows.
In 2009, 2008 and 2007, Energen Resources recognized amounts representing expected future costs associated with site reclamation, facilities dismantlement, and plug and abandonment of wells as follows:
Index to Financial Statements The Company recognizes conditional obligations if such obligations can be reasonably estimated and a legal requirement to perform an asset retirement activity exist. Included in the liabilities incurred for the year ended December 31, 2009, is $6,590,000 related to the acquisition of certain oil properties in the Permian Basin from Range Resources Corporation (Range Resources). Alagasco recorded a conditional asset retirement obligation on a discounted basis of $17.4 million and $17 million to purge and cap its gas pipelines upon abandonment as a regulatory liability as of December 31, 2009 and 2008, respectively. The costs associated with asset retirement obligations are currently either being recovered in rates or are probable of recovery in future rates.
Alagasco accrues removal costs on certain gas distribution assets over the useful lives of its property, plant and equipment through depreciation expense in accordance with rates approved by the APSC. The accumulated asset removal costs of $136.8 million and $129.6 million for December 31, 2009 and 2008, respectively, are included as regulatory liabilities in deferred credits and other liabilities on the consolidated balance sheets.
11. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental information concerning Energen’s cash flow activities was as follows:
The Company recorded a non-cash adjustment for accretion expense of $4.9 million, $4.3 million and $3.9 million during 2009, 2008 and 2007, respectively. In 2009, the Company issued treasury shares for $0.3 million.
Supplemental information concerning Alagasco’s cash flow activities was as follows:
12. ACQUISITION AND DISPOSITIONS OF OIL AND GAS PROPERTIES
In September 2009, Energen Resources recorded a $4.9 million pre-tax gain in other operating revenues from the sale of certain oil properties in the Permian Basin. The Company received approximately $6.5 million pre-tax in cash from the sale of this property.
On June 30, 2009, Energen completed the purchase of certain oil properties in the Permian Basin from Range Resources for a cash price of $182 million. This purchase had an effective date of May 1, 2009. Energen acquired proved reserves of approximately 15.2 million barrels of oil equivalents. Of the proved reserves acquired, an
Index to Financial Statements
estimated 24 percent are undeveloped. Approximately 76 percent of the proved reserves are oil, 16 percent are natural gas liquids and natural gas comprises the remaining 8 percent. Energen Resources used its short-term credit facilities and internally generated cash flows to finance the acquisition.
The acquisition qualifies as a business combination, and as such, the Company estimated the fair value of the assets acquired and liabilities assumed as of the June 30, 2009 acquisition date, the date on which the Company obtained control of the properties. The fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). Fair value measurements also utilize assumptions of market participants. The Company used a discounted cash flow model and made market assumptions as to future commodity prices, projections of estimated quantities of oil and natural gas reserves, expectations for timing and amount of future development and operating costs, projections of future rates of production, expected recovery rates and risk adjusted discount rates. These assumptions represent Level 3 inputs.
The Company estimates the fair value of these properties to be approximately $186.5 million, which the Company concludes approximates the fair value that would be paid by a typical market participant. This measurement resulted in no goodwill being recognized. The acquisition related costs have been expensed as incurred in operations and maintenance expense on the consolidated income statement.
The following table summarizes the consideration paid to Range Resources and the amounts of the assets acquired and liabilities assumed recognized as of June 30, 2009 (including the effects of closing adjustments).
Included in the Company’s consolidated results of operations for the year ended December 31, 2009, is $22.3 million of operating revenues and $8.9 million in operating income resulting from operation of the properties acquired from Range Resources.
Summarized below are the consolidated results of operations for the years ended December 30, 2009, 2008 and 2007, on an unaudited pro forma basis as if the acquisition had occurred at the beginning of each of the periods presented. The pro forma information is based on the Company’s consolidated results of operations for the years ended December 31, 2009, 2008 and 2007, and on the data provided by the seller. The pro forma financial information does not purport to be indicative of results of operations that would have occurred had the transaction occurred on the basis assumed above, nor are they indicative of results of the future operations of the combined enterprises.
During the year ended December 31, 2009, Energen Resources capitalized approximately $6.1 million of unproved leasehold costs, approximately $0.2 million of which was related to the Company’s acreage position in Alabama shales. Energen used its available cash and existing lines of credit to finance these unproved leasehold costs. During 2009 Energen Resources was unsuccessful in the completion of Chattanooga shale well. The costs related to this well of approximately $5.6 million pretax were expensed during the fourth quarter of 2009. Also expensed
Index to Financial Statements
during the fourth quarter, was approximately $1.2 million pretax of costs associated with a well originally drilled by Chesapeake in an area of the Chattanooga shale which the Company no longer intends to pursue. In addition, the Company recognized unproved leasehold impairments of approximately $2.1 million during 2009 related to the Alabama shales.
Energen Resources recorded a $10.3 million pre-tax gain in other operating revenues from the March 2008 property sale of certain Permian Basin oil properties. The Company received approximately $15.5 million pre-tax in cash from the sale of this property.
13. REGULATORY ASSETS AND LIABILITIES
The following table details regulatory assets and liabilities on the consolidated balance sheets:
As described in Note 2, Regulatory Matters, Alagasco’s rates are established under the RSE rate-setting process and are based on average equity for the period. Alagasco’s rates are not adjusted to exclude a return on its investment in regulatory assets during the recovery period.
14. TRANSACTIONS WITH RELATED PARTIES
The Company allocates certain corporate costs to Energen Resources and Alagasco based on the nature of the expense to be allocated using various factors including, but not limited to, total assets, earnings, or number of employees. The Company’s cash management program seeks to minimize borrowing from outside sources through inter-company lending. Under this program, Alagasco may borrow from but does not lend to affiliates. Alagasco had net payables to affiliates of $24,962,000 and $21,582,000 at December 31, 2009 and 2008, respectively. Interest income and expense between affiliates is calculated monthly based on the market weighted average interest rate. Alagasco had $0.3 million, $0.2 million and $0.7 million in affiliated company interest expense during the years ended December 31, 2009, 2008 and 2007. The weighted average interest rate during 2009 and 2008 was 1.02 percent and 2.82 percent, respectively.
15. RECENTLY ISSUED ACCOUNTING STANDARDS
As of January 1, 2008, the Company adopted new accounting guidance on fair value measurements for financial assets and liabilities. This new guidance defines fair value, establishes criteria to be considered when measuring fair value and expands disclosures about fair value measurements. As of January 1, 2009, the Company adopted
Index to Financial Statements
the guidance related to non-financial assets and liabilities with no impact to the Company’s consolidated financial statements or the results of operations.
On January 1, 2009, the Company adopted new accounting guidance which establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest, and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. This standard also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. This standard did not have an effect on the consolidated financial statements or the results of operations of the Company.
On January 1, 2009, the Company adopted revised accounting guidance for business combinations, which was issued to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects. Under this guidance, a company is required to recognize the assets acquired, liabilities assumed, contractual contingencies, and any contingent consideration measured at their fair value at the acquisition date. This guidance has been applied to an acquisition made during the second quarter of 2009 (see Note 12, Acquisition and Dispositions of Oil and Gas Properties).
On January 1, 2009, the Company adopted new accounting guidance expanding disclosure requirements about an entity’s derivative instruments and hedging activities. The additional disclosures for derivative instruments are included in Note 8, Financial Instruments and Risk Management.
On January 1, 2009, the Company adopted a newly issued accounting standard which addresses whether instruments granted in share-based payment transactions are participating securities. This accounting standard requires the Company to include all unvested stock awards which contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid, in the number of shares outstanding in basic and diluted EPS calculations. This standard did not have a material impact on the consolidated financial statements or the results of operations of the Company.
In 2009, the Company adopted a new accounting standard which provides additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased. This guidance did not have an effect on the consolidated financial statements or the results of operations of the Company.
In 2009, the Company adopted an accounting standard which establishes principles and requirements for subsequent events. The additional disclosure for subsequent events is included in Note 1, Summary of Significant Accounting Policies.
On December 31 2009, the Company adopted new accounting guidance for an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. This guidance requires additional disclosures to aid in the understanding of: (1) how investment allocation decisions are made, including the factors that are pertinent to an understanding of investment policies and strategies, (2) the major categories of plan assets, (3) the inputs and valuation techniques used to measure the fair value of plan assets, (4) the effect of fair value measurements using significant unobservable inputs (Level 3) on changes in plan assets for the period, and (5) significant concentrations of risk within plan assets. The additional disclosures for defined benefit pension and postretirement plans are included in Note 5, Employee Benefit Plans.
On December 31, 2008, the Securities and Exchange Commission (SEC) issued its final rule Modernization of Oil and Gas Reporting (Final Rule), which revises the disclosures required by oil and gas companies. In addition to changing the definition and disclosure requirements for oil and gas reserves, the Final Rule changes the requirements for determining quantities of oil and gas reserves. The revisions are intended to provide investors with a more meaningful and comprehensive understanding of oil and gas reserves, with a view to helping investors evaluate their investments in oil and gas companies. The amendments are designed to modernize the requirements for the determination of oil and gas reserves, aligning them with current practices and updating them for changes in technology. The Final Rule applies to annual reports on Forms 10-K for fiscal years ending on or after December 31, 2009. The revised disclosures required by the Final Rule are included in Note 17, Oil and Gas Operations.
Index to Financial Statements In June 2009, the Financial Accounting Standards Board (FASB) issued an accounting standard update to improve financial reporting by companies involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. This guidance is effective for fiscal years beginning after November 15, 2009. The Company is currently evaluating the impact of the standard.
In January 2010, the FASB issued Accounting Standard Update (ASU) No. 2010-03, Extractive Activities-Oil and Gas (Topic 932). ASU No. 2010-03 aligns the oil and gas reserve estimation and disclosure requirements of Extractive Activities-Oil and Gas with the requirements in the Final Rule. The amendments to Topic 932 are effective for annual reporting periods ending on or after December 31, 2009. The revised disclosures required by ASU No. 2010-03 are included in Note 17, Oil and Gas Operations. The impact of the adoption of ASU No. 2010-02 resulted in the use of the twelve-month average prices in the valuation of reserves versus the use of year-end prices. The Company determined that it was not practical to quantify the impact of the adoption of ASU 2010-03, due to the operational and technical challenges of preparing reserve information under multiple pricing scenarios.
In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures About Fair Value Measurements. These disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The effect of this standard is currently being evaluated.
16. SUMMARIZED QUARTERLY FINANCIAL DATA (Unaudited)
The Company’s business is seasonal in character. The following data summarizes quarterly operating results.
Index to Financial Statements 17. OIL AND GAS OPERATIONS (Unaudited)
The following schedules detail historical financial data of the Company’s oil and gas operations.
Capitalized Costs
Costs Incurred: The following table sets forth costs incurred in property acquisition, exploration and development activities and includes both capitalized costs and costs charged to expense during the year:
Results of Continuing Operations From Producing Activities: The following table sets forth results of the Company’s oil and gas continuing operations from producing activities:
Oil and Gas Operations: The calculation of proved reserves is made pursuant to rules prescribed by the SEC. Such rules, in part, require that proved categories of reserves be disclosed. Reserves and associated values were calculated using twelve-month average prices and current costs for the year ended December 31, 2009 and year-end prices and current costs for the years ended December 31, 2008 and 2007. Changes to prices and costs could have a significant effect on the disclosed amount of reserves and their associated values. In addition, the estimation of reserves inherently requires the use of geologic and engineering estimates which are subject to revision as reservoirs are produced and developed and as additional information is available. Accordingly, the amount of actual future production may vary significantly from the amount of reserves disclosed. The proved reserves are located onshore in the United States of America.
Estimates of physical quantities of oil and gas proved reserves were determined by Company engineers. Ryder Scott Company, L.P. (Ryder Scott) and T. Scott Hickman and Associates, Inc. (T. Scott Hickman), independent oil and gas reservoir engineers, have audited the estimates of proved reserves of natural gas, oil and natural gas liquids that the Company has attributed to its net interests in oil and gas properties as of December 31, 2009. Ryder Scott audited the reserve estimates for coalbed methane in the Black Warrior and San Juan basins and substantially all of the Permian Basin reserves. T. Scott Hickman audited the reserves for the North Louisiana and East Texas regions and the conventional reserves in the San Juan Basin. The independent reservoir engineers have issued reports covering approximately 99 percent of the Company’s ending proved reserves indicating that in their judgment the estimates are reasonable in the aggregate.
Index to Financial Statements Energen Resources had downward reserve revisions during 2009 which totaled 124.3 Bcfe. The Black Warrior Basin had downward reserve revisions totaling 45.6 Bcfe of which approximately 20.5 Bcfe related to changes in year-end pricing and approximately 12.9 Bcfe was caused by accelerated coal mining plans. In the San Juan Basin, downward reserve revisions of 73.9 Bcfe were largely due to 70.5 Bcfe of estimated price revisions and higher fuel usage. Upward reserve revisions of 6.4 Bcfe in the Permian Basin were due to 25.2 Bcfe of estimated positive price related revisions partially offset by lower than anticipated injection response in certain waterflood units.
Energen Resources purchased 97.2 Bcfe of reserves during 2009 primarily related to the acquisition of oil properties in the Permian Basin.
During 2009, Energen Resources had extensions and discoveries of 106.5 Bcfe of which 81 percent were proved undeveloped reserves and 19 percent were proved developed reserves. Extension drilling resulted in 105.9 Bcfe of discoveries with exploratory drilling providing 0.6 Bcfe of discoveries. The San Juan Basin added 38.2 Bcfe of reserves through the drilling or identification of 46 well locations; additionally, 10 sidetrack wells added 6.5 Bcfe of reserves. The Permian Basin added 56.8 Bcfe of reserves primarily through the drilling or identification of 130 well locations.
Energen Resources had downward reserve revisions during 2008 which totaled 188.1 Bcfe. The Black Warrior Basin had downward reserve revisions totaling 13.0 Bcfe of which approximately 3.1 Bcfe related to changes in year-end pricing and approximately 9.9 Bcfe was associated with high water production from several wells. In the San Juan Basin, downward reserve revisions of 72.7 Bcfe were largely due to 52 Bcfe of estimated price revisions
Index to Financial Statements
plus higher operating expense and fuel usage and partially offset by improved performance. Downward reserve revisions of 92.6 Bcfe in the Permian Basin were largely due to 61 Bcfe of estimated price related revisions and delayed waterflood responses estimated at 36 Bcfe partially offset by improved performance.
Energen Resources purchased 1.2 Bcfe of reserves during 2008 primarily related to the acquisition of gas properties in East Texas.
During 2008, Energen Resources had extensions and discoveries of 124.3 Bcfe of which 68 percent were proved undeveloped reserves and 32 percent were proved developed reserves. Extension drilling resulted in discoveries of 124 Bcfe with exploratory drilling providing 0.3 Bcfe of discoveries. The Black Warrior Basin added 9.5 Bcfe of reserves primarily through the drilling or identification of 57 well locations. The San Juan Basin added 43.7 Bcfe of reserves through the drilling or identification of 173 well locations; additionally, 12 sidetrack wells added 6.6 Bcfe of reserves. The Permian Basin added 38.8 Bcfe of reserves through the drilling or identification of 159 well locations.
Energen Resources had downward reserve revisions during 2007 which totaled 12.5 Bcfe. The Black Warrior Basin had downward reserve revisions totaling 3 Bcfe of which approximately 6.1 Bcfe related to changes in year-end pricing which accelerated reversions in ownership partially offset by an estimated 3.1 Bcfe of upward revisions associated with improved performance. In the San Juan Basin, upward reserve revisions of 9.2 Bcfe were largely due to 25 Bcfe of estimated price revisions partially offset by a 16 Bcfe decrease for the removal of proved undeveloped locations due to new reservoir interpretations. Downward reserve revisions of 21.4 Bcfe in the Permian Basin were largely a result of delayed waterflood responses estimated at 34.1 Bcfe partially offset by upward price revisions of approximately 12.7 Bcfe.
Energen Resources purchased 14.6 Bcfe of reserves during 2007 primarily related to the acquisition of oil properties in the Permian Basin.
During 2007, Energen Resources had extensions and discoveries of 127.4 Bcfe of which 65 percent were proved undeveloped reserves and 35 percent were proved developed reserves. Extension drilling resulted in discoveries of 109.7 Bcfe with exploratory drilling providing 17.7 Bcfe of discoveries. The Black Warrior Basin added 20.5 Bcfe of reserves primarily through the drilling or identification of 55 well locations. The San Juan Basin added 47.2 Bcfe of reserves through the drilling or identification of 92 well locations; additionally, 18 sidetrack wells added 12.9 Bcfe of reserves. The Permian Basin added 30.1 Bcfe of reserves through the drilling or identification of 128 well locations.
Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves: The standardized measure of discounted future net cash flows is not intended, nor should it be interpreted, to present the fair market value of the Company’s crude oil and natural gas reserves. An estimate of fair market value would take into consideration factors such as, but not limited to, the recovery of reserves not presently classified as proved reserves, 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. At December 31, 2009, 2008 and 2007, the Company had a deferred hedging gain of $79.7 million, a deferred hedging gain of $324 million, and a deferred hedging loss of $104.9 million, respectively, all of which are excluded from the calculation of standardized measure of future net cash flows.
Index to Financial Statements The following are the principal sources of changes in the standardized measure of discounted future net cash flows:
Index to Financial Statements 18. INDUSTRY SEGMENT INFORMATION
The Company is principally engaged in two business segments: the acquisition, development, exploration and production of oil and gas in the continental United States (oil and gas operations) and the purchase, distribution and sale of natural gas in central and north Alabama (natural gas distribution). The accounting policies of the segments are the same as those described in Note 1, Summary of Significant Accounting Policies.
Index to Financial Statements SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Energen Corporation
Index to Financial Statements
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Energen Corporation
a. Disclosure Controls and Procedures
Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives and, as of the end of the period covered by this report, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective at that reasonable assurance level.
b. Management’s Report On Internal Control Over Financial Reporting
Management of Energen Corporation is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Energen Corporation’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes those written policies and procedures that:
i pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of Energen Corporation;
ii provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of Energen Corporation are being made only in accordance with authorization of management and directors of Energen Corporation; and
iii provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. 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 compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of Energen Corporation’s internal control over financial reporting as of December 31, 2009. Management based this assessment on criteria for effective internal control over financial reporting described in “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management’s assessment included an evaluation of the design of Energen Corporation’s internal control over financial reporting and testing of the operational effectiveness of its internal control over financial reporting. Management reviewed the results of its assessment with the Audit Committee of our Board of Directors.
Based on this assessment, management determined that, as of December 31, 2009, Energen Corporation maintained effective internal control over financial reporting. The effectiveness of Energen Corporation’s internal control over financial reporting as of December 31, 2009 has been audited by PricewaterhouseCoopers, LLP, an independent registered public accounting firm, as stated in their report which appears herein.
February 25, 2010
Index to Financial Statements c. Changes in Internal Control Over Financial Reporting
Our chief executive officer and chief financial officer of Energen Corporation have concluded that during the most recent fiscal quarter covered by this report there were no changes in our internal control over financial reporting that materially affected or are reasonably likely to materially affect our internal control over financial reporting.
Alabama Gas Corporation
a. Disclosure Controls and Procedures
Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives and, as of the end of the period covered by this report, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective at that reasonable assurance level.
b. Management’s Report On Internal Control Over Financial Reporting
Management of Alabama Gas Corporation is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Alabama Gas Corporation’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes those written policies and procedures that:
i pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of Alabama Gas Corporation;
ii provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of Alabama Gas Corporation are being made only in accordance with authorization of management and directors of Alabama Gas Corporation; and
iii provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. 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 compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of Alabama Gas Corporation’s internal control over financial reporting as of December 31, 2009. Management based this assessment on criteria for effective internal control over financial reporting described in “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management’s assessment included an evaluation of the design of Alabama Gas Corporation’s internal control over financial reporting and testing of the operational effectiveness of its internal control over financial reporting. Management reviewed the results of its assessment with the Audit Committee of our Board of Directors.
Based on this assessment, management determined that, as of December 31, 2009, Alabama Gas Corporation maintained effective internal control over financial reporting. The effectiveness of Alabama Gas Corporation’s internal control over financial reporting as of December 31, 2009 has been audited by PricewaterhouseCoopers, LLP, an independent registered public accounting firm, as stated in their report which appears herein.
February 25, 2010
Index to Financial Statements c. Changes in Internal Control Over Financial Reporting
Our chief executive officer and chief financial officer of Alabama Gas Corporation have concluded that during the most recent fiscal quarter covered by this report there were no changes in our internal control over financial reporting that materially affected or are reasonably likely to materially affect our internal control over financial reporting.
Index to Financial Statements PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information regarding the executive officers of Energen is included in Part I. The other information required by Item 10 is incorporated herein by reference from Energen’s definitive proxy statement for the Annual Meeting of Shareholders to be held April 28, 2010. The definitive proxy statement will be filed on or about March 24, 2010.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information regarding executive compensation is incorporated herein by reference from Energen’s definitive proxy statement for the Annual Meeting of Shareholders to be held April 28, 2010.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
a. Security Ownership of Certain Beneficial Owners
The information regarding the security ownership of the beneficial owners of more than five percent of Energen’s common stock is incorporated herein by reference from Energen’s definitive proxy statement for the Annual Meeting of Shareholders to be held April 28, 2010.
b. Security Ownership of Management
The information regarding the security ownership of management is incorporated herein by reference from Energen’s definitive proxy statement for the Annual Meeting of Shareholders to be held April 28, 2010.
c. Securities Authorized for Issuance Under Equity Compensation Plans
The information regarding securities authorized for issuance under equity compensation plans is included in Part 2 under Item 4.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information regarding certain relationships and related transactions, and director independence is incorporated herein by reference from Energen’s definitive proxy statement for the Annual Meeting of Shareholders to be held April 28, 2010.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information regarding Principal Accountant Fees and Services is incorporated herein by reference from Energen’s definitive proxy statement for the Annual Meeting of Shareholders to be held April 28, 2010.
Index to Financial Statements PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
a. Documents Filed as Part of This Report
(1) Financial Statements
The consolidated financial statements of Energen and the financial statements of Alagasco are included in Item 8 of this Form 10-K
(2) Financial Statement Schedules
The financial statement schedules are included in Item 8 of this Form 10-K
(3) Exhibits
The exhibits listed on the accompanying Index to Exhibits are filed as part of this Form 10-K
Index to Financial Statements Energen Corporation
Alabama Gas Corporation
INDEX TO EXHIBITS
Item 14(a)(3)
Index to Financial Statements
Index to Financial Statements *Incorporated by reference
Index to Financial Statements SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrants have duly caused this report to be signed on their behalf by the undersigned thereunto duly authorized.
ENERGEN CORPORATION
(Registrant)
ALABAMA GAS CORPORATION
(Registrant)
February 25,
By
/s/ J.T. McManus, II
J.T. McManus, II
Chairman, Chief Executive Officer and President of Energen Corporation; Chairman and Chief Executive Officer of Alabama Gas Corporation
Index to Financial Statements SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrants and in the capacities and on the dates indicated: