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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1997
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[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From to
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Commission File Number
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1-956
Duquesne Light Company
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(Exact name of registrant as specified in its charter)
Pennsylvania 25-0451600
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
411 Seventh Avenue
Pittsburgh, Pennsylvania 15219
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(Address of principal executive offices)(Zip Code)
Registrant's telephone number, including area code: (412) 393-6000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days. Yes X No
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DQE is the holder of all shares of outstanding common stock, $1 par value, of
Duquesne Light Company consisting of 10 shares as of February 28, 1998.
[X] Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K.
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Registrant Title of each class on which registered
---------- ------------------- ---------------------
Duquesne Light Preferred Stock New York Stock Exchange
Company
Involuntary
Series Liquidation Value
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3.75% $50 per share
4.00% $50 per share
4.10% $50 per share
4.15% $50 per share
4.20% $50 per share
$2.10 $50 per share
8.375% $25 per share (1)
Sinking Fund Debentures, due March 1, 2010 (5%) New York Stock Exchange
(1) Issued by Duquesne Capital, L.P., and the payments of dividends and
payments on liquidation or redemption are guaranteed by Duquesne
Light Company.
TABLE OF CONTENTS
Page
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GLOSSARY PART I
ITEM 1. BUSINESS
General 1
Property Plant & Equipment (PP&E) 2
Employees 3
Electric Utility Operations 3
Fossil Fuel 4
Nuclear Fuel 4
Nuclear Decommissioning 5
Nuclear Insurance 5
Spent Nuclear Fuel Disposal 5
Uranium Enrichment Obligations 6
Environmental Matters 6
Other 7
Executive Officers of the Registrant 9
ITEM 2. PROPERTIES 10
ITEM 3. LEGAL PROCEEDINGS 11
ITEM 4. SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS 11
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON
EQUITY AND RELATED SHAREHOLDER
MATTERS 11
ITEM 6. SELECTED FINANCIAL DATA 11
ITEM 7. MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Results of Operations 12
Liquidity and Capital Resources 15
Rate Matters 16
ITEM 7A. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK 19
ITEM 8. REPORT OF INDEPENDENT CERTIFIED
PUBLIC ACCOUNTANTS; CONSOLIDATED
FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA; SELECTED FINANCIAL DATA 20
Page
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PART III
ITEM 9. CHANGES IN AND DISAGREEMENTS
WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE 45
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
OF THE REGISTRANT 45
ITEM 11. EXECUTIVE COMPENSATION 45
ITEM 12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT 45
ITEM 13. CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS 46
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT
SCHEDULES AND REPORTS ON FORM 8-K 46
SCHEDULE II 58
SIGNATURES 59
Glossary of Terms
Competitive Generation Credit
Duquesne will provide a credit to a customer for the PUC-determined market
price of electric generation. Customers will experience savings to the extent
that they can purchase power at a lower price from an alternative electric
generation supplier than the amount of the credit.
CTC or Competitive Transition Charge
During the electric utility restructuring from the traditional regulatory
framework to customer choice, electric utilities will have the opportunity to
recover transition costs from customers through a surcharge, or competitive
transition charge.
Customer Choice
The Pennsylvania Electricity Generation Customer Choice and Competition Act (see
"Rate Matters" on page 16) will give consumers the right to contract for
electricity at market prices from PUC-approved electric generation suppliers.
Decommissioning Costs
Decommissioning costs are expenses to be incurred in connection with the
entombment, decontamination, dismantling, removal and disposal of structures,
systems and components of a power plant that has permanently ceased the
production of electric energy.
Deferred Energy Costs
In conjunction with the Energy Cost Rate Adjustment Clause, Duquesne records
deferred energy costs to offset differences between actual energy costs and the
level of energy costs currently recovered from its rate-regulated electric
utility customers.
Distribution/Transmission
Transmission is the flow of electricity from generating stations over high
voltage lines. Distribution is the flow of electricity over lower voltage
facilities to the ultimate customer--usually businesses and homes.
Divestiture
The selling of major assets (power plants, transmission equipment or
distribution lines).
Energy Cost Rate Adjustment Clause (ECR)
Duquesne recovers through the ECR, to the extent that such amounts are not
included in base rates, the cost of nuclear fuel, fossil fuel and purchased
power costs.
Federal Energy Regulatory Commission (FERC)
The FERC is an independent five-member commission within the United States
Department of Energy. Among its many responsibilities, the FERC sets rates and
charges for the wholesale transportation and sale of electricity.
Independent System Operator (ISO)
An organization formed by, but independent of, transmission-owning utilities
which is responsible for ensuring nondiscriminatory open transmission access and
the planning and security of the combined bulk transmission systems of utilities
within a given geographic region.
Market Power
When one company owns a sufficiently large percentage of generation,
transmission, or distribution capabilities in a region which allow it to set the
market price of electricity.
Obligation to Serve
Under traditional regulation, the duty of a regulated utility to provide service
to all customers in its service territory on a non-discriminatory basis.
Open Access
Gives all customers equal opportunity to access the transmission grid.
Peak Demand
Peak demand is the greatest amount of electricity demanded at any given time.
Pennsylvania Public Utility Commission (PUC)
The governmental body that regulates all utilities (electric, gas, telephone,
water, etc.) that do business in Pennsylvania.
Rate Base
The amount representing the value of assets approved by a regulatory agency for
inclusion in rates charged to rate-regulated customers.
Regulatory Assets
Historic ratemaking practices granted exclusive geographic franchises in
exchange for the obligation to serve all customers. Under this system, certain
prudently incurred costs were approved by the PUC and the FERC for deferral and
future recovery with a return from customers. These deferred costs are
capitalized as regulatory assets by the regulated utility.
Restructuring Plan
In contemplation of the merger with Allegheny Energy being consummated,
Duquesne has filed this plan incorporating the merger benefits into its
restructuring and recovery of transition costs under the Customer Choice Act.
Stand-Alone Plan
In the event the merger with Allegheny Energy is not consummated, Duquesne
has filed this plan for restructuring and recovery of transition costs under the
Customer Choice Act.
Tariff
Public schedules that detail a utility's rates, rules, service territory and
terms of service that are filed for official approval with a regulatory agency.
Transition or Stranded Costs
Transition costs, also known as stranded costs, are the net present value of a
utility's known or measurable costs related to electric generation that are
recoverable under the current regulatory framework, but which may not be
recoverable in a competitive generation market. They are costs which remain
unrecovered following mitigation efforts taken by the utility.
Unbundled Charges
Separate charges for each of the generation, transmission and distribution of
electricity in accordance with the deregulation of generation under the Customer
Choice Act.
Watt
A watt is the rate at which electricity is generated or consumed. A kilowatt
(KW) is equal to 1,000 watts. A kilowatt-hour (KWH) is a measure of the quantity
of electricity generated or consumed in one hour by one kilowatt of power. A
megawatt (MW) is 1,000 kilowatts or one million watts.
Part I
Item 1. Business.
General
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Part I of this Annual Report, Form 10-K (Report) should be read in conjunction
with Duquesne Light Company's audited consolidated financial statements, which
are set forth on pages 21 through 44 in Part IV of this Report. Explanations of
certain financial and operating terms used in this Report are set forth in a
GLOSSARY at the front of this Report.
Duquesne Light Company (Duquesne) is a wholly owned subsidiary of DQE, Inc.
(DQE), an energy services holding company. Duquesne is engaged in the
generation, transmission, distribution and sale of electric energy. Duquesne has
one wholly owned subsidiary, Monongahela Light and Power which currently holds
energy-related investments.
Proposed Merger
On August 7, 1997, the shareholders of Duquesne's parent, DQE, and Allegheny
Energy, Inc. (AYE), approved a proposed tax-free, stock-for-stock merger. Upon
consummation of the merger, DQE will be a wholly owned subsidiary of AYE.
Immediately following the merger, Duquesne will remain a wholly owned subsidiary
of DQE. The transaction is intended to be accounted for as a pooling of
interests. Under the pooling of interests method of accounting for a business
combination, the recorded assets, liabilities and equity of each of the
combining companies are carried forward to the combined corporation at their
recorded amounts. Accordingly, no goodwill, including the related future
earnings impact of goodwill amortization, results from a transaction accounted
for as a pooling of interests. In order to qualify for pooling treatment, many
requirements must be met by each of the combining companies for a period of time
before and after the combination occurs. Examples of the requirements prior to
the merger include limitations on: dividends paid on common stock, stock
repurchases, stock compensation plan activity and sales of significant assets.
DQE's management has focused and will continue to focus on meeting the pooling
requirements as they relate to DQE and its subsidiaries prior to the merger.
Under the terms of the transaction, DQE's shareholders will receive 1.12
shares of AYE common stock for each share of DQE's common stock and AYE's
dividend in effect at the time of the closing of the merger. The transaction is
expected to close in mid-1998, subject to approval of applicable regulatory
agencies, including the public utility commissions in Pennsylvania and Maryland,
the Securities and Exchange Commission (SEC), the Federal Energy Regulatory
Commission (FERC) and the Nuclear Regulatory Commission (NRC).
In September 1997, the City of Pittsburgh filed a federal antitrust suit
seeking to prevent the merger and asking for monetary damages. Although the
United States District Court for the District of Western Pennsylvania dismissed
the suit in January 1998, the City of Pittsburgh filed an appeal and asked for
expedited review. Duquesne anticipates a decision on whether the appeal has been
granted by late March 1998.
Unless otherwise indicated, all information presented in this Annual Report
relates to Duquesne only and does not take into account the proposed merger
between DQE and AYE.
Service Territory
Duquesne provides electric service to customers in Allegheny County, including
the City of Pittsburgh; Beaver County; and Westmoreland County. (See Item 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS "Rate Matters" on page 16.) This territory represents approximately
800 square miles in southwestern Pennsylvania, located within a 500-mile radius
of one-half of the population of the United States and Canada. The population of
the area served by Duquesne's electric utility operations, based on 1990 census
data, is approximately 1,510,000, of whom 370,000 reside in the City of
Pittsburgh. In addition to serving approximately 580,000 direct customers,
Duquesne's utility operations also sell electricity to other utilities.
Regulation
Duquesne is subject to the accounting and reporting requirements of the SEC.
In addition, Duquesne's electric utility operations are subject to regulation by
the Pennsylvania Public Utility Commission (PUC), including regulation under the
Pennsylvania Electricity Generation Customer Choice and Competition Act
(Customer Choice Act), and the FERC under the Federal Power Act with respect to
rates for interstate sales, transmission of electric power, accounting and other
matters. (See Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS "Rate Matters" on page 16.)
Duquesne is also subject to regulation by the NRC under the Atomic Energy Act
of 1954, as amended, with respect to the operation of its jointly owned/leased
nuclear power plants, Beaver Valley Unit 1 (BV Unit 1), Beaver Valley Unit 2 (BV
Unit 2) and Perry Unit 1.
1
Duquesne's consolidated financial statements report regulatory assets and
liabilities in accordance with Statement of Financial Accounting Standards
(SFAS) No. 71, Accounting for the Effects of Certain Types of Regulation (SFAS
No. 71), and reflect the effects of the current ratemaking process. In
accordance with SFAS No. 71, Duquesne's consolidated financial statements
reflect regulatory assets and liabilities consistent with cost-based,
pre-competition ratemaking regulations. The regulatory assets represent
probable future revenue to Duquesne because provisions for these costs are
currently included, or are expected to be included, in charges to electric
utility customers through the ratemaking process.
A company's electric utility operations, or a portion of such operations,
could cease to meet the SFAS No. 71 criteria for various reasons, including a
change in the FERC regulations or the competition-related changes in the PUC
regulations. (See Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS "Rate Matters" on page 16.) The Emerging
Issues Task Force of the Financial Accounting Standards Board (EITF) has
determined that once a transition plan has been approved, application of SFAS
No. 71 to the generation portion of a utility must be discontinued and replaced
by the application of SFAS No. 101, Regulated Enterprises - Accounting for the
Discontinuation of Application of FASB Statement No. 71 (SFAS No. 101). The
consensus reached by the EITF provides further guidance that the regulatory
assets and liabilities of the generation portion of a utility to which SFAS No.
101 is being applied should be determined on the basis of the source from which
the regulated cash flows to realize such regulatory assets and settle such
liabilities will be derived. Under the Customer Choice Act, Duquesne believes
that its generation-related regulatory assets will be recovered through a
competitive transition charge (CTC) collected in connection with providing
transmission and distribution services, and Duquesne will continue to apply SFAS
No. 71. Fixed assets related to the generation portion of a utility will be
evaluated including the cash flows provided by the CTC, in accordance with SFAS
No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of (SFAS No. 121). Duquesne believes that all of its
regulatory assets continue to satisfy the SFAS No. 71 criteria in light of the
transition to competitive generation under the Customer Choice Act and the
ability to recover these regulatory assets through a CTC. Once any portion of
Duquesne's electric utility operations is deemed to no longer meet the SFAS No.
71 criteria, or is not recovered through a CTC, Duquesne will be required to
write off assets (to the extent their net book value exceeds fair value), the
recovery of which is uncertain, and any regulatory assets or liabilities for
those operations that no longer meet these requirements. Any such write-off of
assets could be materially adverse to the financial position, results of
operations and cash flows of Duquesne.
Property, Plant and Equipment (PP&E)
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Investment in PP&E and Accumulated Depreciation
Duquesne's total investment in property, plant and equipment and the related
accumulated depreciation balances for major classes of property at December 31,
1997 and 1996, are as follows:
PP&E and Related Accumulated Depreciation at December 31
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(Amounts in Thousands of Dollars)
1997 1996
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Accumulated Net Accumulated Net
Investment Depreciation Investment Investment Depreciation Investment
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Electric Production $2,494,476 $1,175,516 $1,318,960 $2,467,786 $1,092,928 $1,374,858
Electric Transmission 298,614 119,895 178,719 299,895 114,406 185,489
Electric Distribution 1,206,546 390,103 816,443 1,176,738 374,180 802,558
Electric General 334,565 192,439 142,126 324,366 168,470 155,896
Property Held for Future Use (a) 3,980 66 3,914 190,821 82,737 108,084
Property Held Under Capital Leases 113,662 50,725 62,937 99,608 47,670 51,938
Other 58,895 19,075 39,820 49,559 10,909 38,650
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Total $4,510,738 $1,947,819 $2,562,919 $4,608,773 $1,891,300 $2,717,473
================================================================================================================
(a) See "Property Held for Future Use" discussion on page 3.
Joint Interests in Generating Units
Duquesne has various contracts with subsidiaries of FirstEnergy Corporation
(Ohio Edison Company, Pennsylvania Power Company, The Cleveland Electric
Illuminating Company (CEI) and The Toledo Edison Company), with respect to
several jointly owned/leased generating units, that include provisions for
coordinated maintenance responsibilities, limited and qualified mutual back-up
in the event of outages, and certain capacity and energy transactions.
In September 1995, Duquesne commenced arbitration against CEI, seeking
damages, termination of the Operating Agreement for Eastlake Unit 5 (Eastlake)
and partition of the parties' interests in Eastlake through a sale and division
of the proceeds. The arbitration demand alleged, among other things, the
improper allocation
2
by CEI of fuel and related costs; the mismanagement of the administration of
the Saginaw coal contract in connection with the closing of the Saginaw mine,
which historically supplied coal to Eastlake; and the concealment by CEI of
material information. In October 1995, CEI commenced an action against Duquesne
in the Court of Common Pleas, Lake County, Ohio seeking to prevent Duquesne from
taking any action to effect a partition on the basis of a waiver of partition
covenant contained in the deed to the land underlying Eastlake. CEI also seeks
monetary damages from Duquesne for alleged unpaid joint costs in connection with
the operation of Eastlake. Duquesne removed the action to the United States
District Court for the Northern District of Ohio, Eastern Division, where it is
now pending. Currently, the parties are engaged in settlement discussions.
Duquesne anticipates that a trial will commence late in 1998.
Joint Interests in Power Stations
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Nuclear Power Stations Beaver Valley
------------------ Perry
Unit 1 Unit 2 Unit 1
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Duquesne *47.50% *13.74% (a) 13.74%
FirstEnergy Corporation 52.50% 86.26% *86.26%
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Fossil Power Stations Bruce Mansfield
Sammis --------------------------- Eastlake
Unit 7 Unit 1 Unit 2 Unit 3 Unit 5
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Duquesne 31.20% 29.30% 8.00% 13.74% 31.20%
FirstEnergy Corporation *68.80% *70.70% *92.00% *86.26% * 68.80%
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*Denotes Operator
(a) In 1987, Duquesne sold and leased back its 13.74 percent interest in BV Unit
2. Duquesne leased back its interest in the unit for a term of 29.5 years.
The lease is accounted for as an operating lease.
Property Held for Future Use
In 1986, the PUC approved Duquesne's request to remove Phillips Power Station
(Phillips) and a portion of Brunot Island (BI) from service. These assets were
classified as property held for future use. In 1997, through its analysis of
customer choice in the Restructuring Plan and Stand-Alone Plan, Duquesne
determined that Phillips and a portion of BI would not be cost-effective in the
production of electricity in the face of a competitive marketplace. Based on
this analysis, Phillips and a portion of BI have been reclassified on the
balance sheet from property held for future use to a regulatory asset. In each
of the filings, Duquesne is seeking recovery of its investment and associated
costs of Phillips and BI through a CTC. (See Item 7. MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS "Rate Matters" on page
16.)
Employees
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At December 31, 1997, Duquesne had 3,352 employees, including 1,114 employees
at Beaver Valley Power Station (BVPS). Duquesne is party to a labor contract
expiring in September 2001 with the International Brotherhood of Electrical
Workers, which represents approximately 2,000 of Duquesne's employees. The
contract provides, among other things, employment security, income protection
and 3 percent annual wage increases through September 2000.
Electric Utility Operations
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Duquesne's fossil plants operated at an equivalent availability factor of 78
percent in 1997 and 76 percent in 1996. Duquesne's nuclear plants operated at an
equivalent availability factor of 67 percent in 1997 and 76 percent in 1996. BV
Unit 1 went off-line on September 27, 1997, for a scheduled refueling outage,
and returned to service on January 21, 1998. Perry Unit 1 completed a refueling
outage on October 23, 1997. This outage lasted 40 days, a record for Perry Unit
1. The next refueling outage for BV Unit 1 is currently scheduled to begin in
April 1999. The next refueling outages for BV Unit 2 and Perry Unit 1 are
currently scheduled to begin in September 1998 and March 1999, respectively. The
timing and duration of scheduled maintenance and refueling outages, as well as
the duration of forced outages, affect the availability of power stations.
Duquesne normally experiences its peak demand in the summer. The 1997 and all-
time customer system peak demand of 2,671 MW occurred on July 15, 1997.
BV Unit 1 went off-line January 30, 1998, due to an issue identified in a
technical review recently completed by Duquesne. BV Unit 2 went off-line
December 16, 1997, to repair the emergency air supply system to the control room
and has remained off-line due to other issues identified by a similar technical
review of BV Unit 2. These technical reviews are in response to a 1997
commitment made by Duquesne to the NRC. Duquesne is one of many utilities faced
with these technical issues, some of which date back to the original design of
BVPS.
3
Both BVPS units remain off-line for a revalidation of technical specification
surveillance testing requirements of various plant systems. Based on the current
status of the revalidation process, Duquesne currently anticipates that both
BVPS units will remain off-line through March 1998.
BVPS's two units are equipped with steam generators designed and built by
Westinghouse Electric Corporation (Westinghouse). Similar to other Westinghouse
nuclear plants, outside diameter stress corrosion cracking (ODSCC) has occurred
in the steam generator tubes of both units. The units continue to operate at 100
percent reactor power, although approximately 17 percent of BV Unit 1 and 2
percent of BV Unit 2 steam generator tubes have been removed from service.
Material acceleration in the rate of ODSCC could lead to a loss in plant
efficiency and significant repairs or replacement of BV Unit 1 steam generators.
The total replacement cost of the BV Unit 1 steam generators is estimated at
$125 million, $59 million of which would be Duquesne's responsibility. The
earliest that the BV Unit 1 steam generators could be replaced during a
scheduled refueling outage is the fall of 2000.
Fossil Fuel
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Duquesne believes that sufficient coal for its coal-fired generating units
will be available from various sources to satisfy its requirements for the
foreseeable future. During 1997, approximately 2.3 million tons of coal were
consumed at Duquesne's two wholly owned coal-fired stations, Cheswick Power
Station (Cheswick) and Elrama Power Station (Elrama).
Duquesne owns Warwick Mine, an underground mine located in southwestern
Pennsylvania. At December 31, 1997, Duquesne's net investment in the mine was
$10.7 million. Duquesne estimates that, at December 31, 1997, its economically
recoverable coal reserves at Warwick Mine were in excess of 1.5 million tons. An
unaffiliated contract operator at Warwick Mine encountered adverse geologic
conditions late in 1996 that resulted in a contract default. Commencing in 1997,
a new unaffiliated operator began producing approximately 360,000 tons of coal
per year for exclusive use at Elrama. Duquesne purchases the remaining coal for
use at Elrama on the open market. The current estimated liability for mine
closing, including final site reclamation, mine water treatment and certain
labor liabilities is $47.6 million, and Duquesne has recorded a liability on the
consolidated balance sheet of approximately $27.5 million toward these costs.
During 1997, 34 percent of Duquesne's coal supplies were provided by
contracts, including Warwick Mine, with the remainder satisfied through
purchases on the spot market. Duquesne had three long-term contracts in effect
at December 31, 1997 that, in combination with spot market purchases, are
expected to furnish an adequate future coal supply. Duquesne does not anticipate
any difficulty in replacing or renewing these contracts as they expire from 2000
through 2005. At December 31, 1997, Duquesne's wholly owned and jointly owned
generating units had on hand an average coal supply of 41 days.
Nuclear Fuel
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The cycle of production and utilization of nuclear fuel consists of (1) mining
and milling of uranium ore and processing the ore into uranium concentrates, (2)
converting uranium concentrates to uranium hexafluoride, (3) enriching the
uranium hexafluoride, (4) fabricating fuel assemblies, (5) utilizing the nuclear
fuel in the generating station reactor, and (6) storing and disposing of spent
fuel.
An adequate supply of uranium is under contract to meet Duquesne's
requirements for its jointly owned/leased nuclear units through 2000. An
adequate supply of conversion services through the year 2002 is also under
contract. Enrichment services for Duquesne's joint interests in BV Units 1 and 2
and Perry Unit 1 will be supplied through fiscal year 1999 under a United States
Enrichment Corporation's (USEC) Utility Services contract. Duquesne has
terminated, at zero cost, all of its enrichment services requirements under this
contract for the fiscal years 2000 through 2005 and is planning to secure
required enrichment services during this period from other suppliers. Duquesne
continues to review on an annual basis its alternatives for enrichment services
for the years 2006 through 2014 under the USEC contract and may terminate these
future years if it can arrange more cost-effective alternative enrichment
services. Fuel fabrication contracts are in place to supply reload requirements
through 2002 and 2003 respectively, for BV Unit 1 and BV Unit 2 and the life of
plant for Perry Unit 1. Duquesne will continue to make arrangements for future
uranium supply and related services, as required. (See Item 7. MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
"NUCLEAR FUEL LEASING" DISCUSSION ON PAGE 16.)
4
Nuclear Decommissioning
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Duquesne expects to decommission BV Unit 1, BV Unit 2 and Perry Unit 1 no
earlier than the expiration of each plant's operating license in 2016, 2027 and
2026. At the end of its operating life, BV Unit 1 may be placed in safe storage
until BV Unit 2 is ready to be decommissioned, at which time the units may be
decommissioned together.
Based on site-specific studies conducted in 1997 for BV Unit 1 and BV Unit 2,
and a 1997 update of the 1994 study for Perry Unit 1, Duquesne's approximate
share of the total estimated decommissioning costs, including removal and
decontamination costs, is $170 million, $55 million and $90 million,
respectively. The amount currently being used to determine Duquesne's cost of
service related to decommissioning all three nuclear units is $224 million.
Duquesne is seeking recovery of any potential shortfall in decommissioning
funding as part of either its Restructuring Plan or its Stand-Alone Plan. (See
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS "Rate Matters" on page 16.)
With respect to the transition to a competitive generation market, the
Customer Choice Act requires that utilities include a plan to mitigate any
shortfall in decommissioning trust fund payments for the life of the facility
with any future decommissioning filings. Consistent with this requirement, in
1997 Duquesne increased its annual contributions to the decommissioning trusts
by $5 million to approximately $9 million. Duquesne has received approval from
the Internal Revenue Service (IRS) for qualification of 100 percent of
additional nuclear decommissioning trust funding for BV Unit 2 and Perry Unit 1,
and 79 percent for BV Unit 1.
Funding for nuclear decommissioning costs is deposited in external, segregated
trust accounts and invested in a portfolio of corporate common stock and debt
securities, municipal bonds, certificates of deposit and United States
government securities. The market value of the aggregate trust fund balances at
December 31, 1997 totaled approximately $47.1 million.
Nuclear Insurance
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The Price-Anderson Amendments to the Atomic Energy Act of 1954 limit public
liability from a single incident at a nuclear plant to $8.9 billion. The maximum
available private primary insurance of $200 million has been purchased by
Duquesne. Additional protection of $8.7 billion would be provided by an
assessment of up to $79.3 million per incident on each nuclear unit in the
United States. Duquesne's maximum total possible assessment, $59.4 million,
which is based on its ownership or leasehold interests in three nuclear
generating units, would be limited to a maximum of $7.5 million per incident per
year. This assessment is subject to indexing for inflation and may be subject to
state premium taxes. If assessments from the nuclear industry prove insufficient
to pay claims, the United States Congress could impose other revenue-raising
measures on the industry.
Duquesne's share of insurance coverage for property damage, decommissioning
and decontamination liability is $1.2 billion. Duquesne would be responsible for
its share of any damages in excess of insurance coverage. In addition, if the
property damage reserves of Nuclear Electric Insurance Limited (NEIL), an
industry mutual insurance company that provides a portion of this coverage, are
inadequate to cover claims arising from an incident at any United States nuclear
site covered by that insurer, Duquesne could be assessed retrospective premiums
totaling a maximum of $5.8 million.
In addition, Duquesne participates in a NEIL program that provides insurance
for the increased cost of generation and/or purchased power resulting from an
accidental outage of a nuclear unit. Subject to the policy deductible, terms and
limit, the coverage provides for a weekly indemnity of the estimated incremental
costs during the three year period starting 21 weeks after an accident, with no
coverage thereafter. If NEIL's losses for this program ever exceed its reserves,
Duquesne could be assessed retrospective premiums totaling a maximum of $3.4
million.
Spent Nuclear Fuel Disposal
- --------------------------------------------------------------------------------
The Nuclear Waste Policy Act of 1982 established a federal policy for handling
and disposing of spent nuclear fuel and a policy requiring the establishment of
a final repository to accept spent nuclear fuel. Electric utility companies have
entered into contracts with the United States Department of Energy (DOE) for the
permanent disposal of spent nuclear fuel and high-level radioactive waste in
compliance with this legislation. The DOE has indicated that its repository
under these contracts will not be available for acceptance of spent nuclear fuel
before 2010. The DOE has not yet established an interim or permanent storage
facility, despite a ruling by the United States Court of Appeals for the
District of Columbia Circuit that the DOE was legally obligated to begin
acceptance of spent nuclear fuel for disposal by January 31, 1998. Existing on-
site spent nuclear fuel storage capacities at BV Unit 1, BV Unit 2 and Perry
Unit 1 are expected to be sufficient until 2017, 2011 and 2011, respectively.
5
In early 1997, Duquesne joined 35 other electric utilities and 46 states,
state agencies and regulatory commissions in filing suit in the United States
Court of Appeals for the District of Columbia Circuit against the DOE. The
parties requested the court to suspend the utilities' payments into the Nuclear
Waste Fund and to place future payments into an escrow account until the DOE
fulfills its obligation to accept spent nuclear fuel. The DOE had requested that
the court delay litigation while it pursued alternative dispute resolution under
the terms of its contracts with the utilities. The court ruling, issued November
14, 1997, was not entirely in favor of the DOE or the utilities. The court
permitted the DOE to pursue alternative dispute resolution, but prohibited it
from using its lack of a spent fuel repository as a defense. The DOE has
requested a rehearing on the matter, which has yet to be scheduled.
Uranium Enrichment Obligations
- --------------------------------------------------------------------------------
Nuclear reactor licensees in the United States are assessed annually for the
decontamination and decommissioning of DOE uranium enrichment facilities.
Assessments are based on the amount of uranium a utility had processed for
enrichment prior to enactment of the National Energy Policy Act of 1992 (NEPA)
and are to be paid by such utilities over a 15-year period. At December 31,
1997, Duquesne's liability for contributions was approximately $7.2 million
(subject to an inflation adjustment). (See Item 7. MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS "Rate Matters" on page
16.)
Environmental Matters
- --------------------------------------------------------------------------------
Various federal and state authorities regulate Duquesne with respect to air
and water quality and other environmental matters. Duquesne believes it is in
current compliance with all material applicable environmental regulations.
The Comprehensive Environmental Response, Compensation and Liability Act of
1980 and The Superfund Amendments and Reauthorization Act of 1986 (Superfund)
established a variety of informational and environmental action programs. The
Environmental Protection Agency (EPA) previously informed Duquesne of its
potential involvement in three hazardous waste sites. Duquesne reached
agreements to make de minimis financial settlements related to these sites in
order to resolve any associated liability.
As required by Title V of the Clean Air Act Amendments (Clean Air Act),
Duquesne filed comprehensive air operating permit applications for Cheswick,
Elrama, BI and Phillips during the last half of 1995. Approval is still pending
for these applications. Duquesne filed its Title IV Phase II Clean Air Act
compliance plan with the PUC on December 27, 1995. Duquesne also filed Title IV
Phase II permit applications for oxides of nitrogen (NO\\X\\) emissions from
Cheswick, Elrama and Phillips with the Allegheny County Health Department and
the Pennsylvania Department of Environmental Protection (DEP) on December 23,
1997.
Although Duquesne believes it has satisfied all of the Phase I Acid Rain
Program requirements of the Clean Air Act, the Phase II Acid Rain Program
requires significant additional reductions of sulfur dioxide (SO\\2\\) and
NO\\X\\ by the year 2000. Duquesne currently has 662 MW of nuclear capacity and
887 MW of coal capacity equipped with SO\\2\\ emission-reducing equipment
(excluding 300 MW of regulatory assets at Phillips). Through the year 2000,
Duquesne is considering a combination of compliance methods that include fuel
switching; increased use of, and improvements in, SO\\2\\ emission-reducing
equipment; low NO\\X\\ burner technology; and the purchase of emission
allowances for those remaining stations not in compliance.
Duquesne has developed, patented and installed low NO\\X\\ burner technology
for the Elrama boilers. These cost-effective NO\\X\\ reduction systems installed
on the Elrama roof-fired boilers were specified as the benchmark for the
industry for this class of boilers in the EPA's final Group II rulemaking.
Duquesne is also currently evaluating additional low-cost, developmental NO\\X\\
reduction technologies at Cheswick. In 1997, Duquesne tested combustion-related
NO\\X\\ controls at Cheswick, with positive results, and expects to install low-
cost modifications and a new flue gas conditioning system to maximize the
effects of such controls.
In addition to the Phase II Acid Rain Program requirements, Duquesne is
responsible for additional NO\\X\\ reduction requirements to meet the current
Ozone Ambient Air Quality Standards under Title I of the Clean Air Act.
Compliance with the current ozone standard is based on pre-1997 ozone data using
a one-hour average value approach. Flue gas conditioning and post-combustion
NO\\X\\ reduction technologies may be employed to meet the one-hour standard if
economically justified. Also, Duquesne is examining and developing innovative
emissions technologies designed to reduce costs. Duquesne also continues to work
with the operators of its jointly owned stations to implement cost-effective
compliance strategies to meet these requirements.
Duquesne is closely monitoring other future air quality programs and air
emission control requirements that could result from more stringent ambient air
quality and emission standards for SO\\2\\ and NO\\X\\ particulates and other
by-products of coal combustion. In 1997, the DEP finalized a regulation to
implement the additional NO\\X\\ control requirements that were recommended by
the Ozone Transport Commission. The estimated costs to
6
comply with this program have been included in Duquesne's capital cost
estimates through the year 2000. Duquesne currently estimates that additional
capital costs to comply with Clean Air Act requirements through the year 2000
will be approximately $20 million.
In July 1997, the EPA announced new national ambient air quality standards for
ozone and fine particulate matter. To allow each state time to determine what
areas may not meet the standards and to adopt control strategies to achieve
compliance, the ozone standards will not be implemented until 2004, and the fine
particulate matter standards will not be implemented until 2007 or later.
Because appropriate state ambient air monitoring and implementation plans have
not been developed, the costs of compliance with these new standards cannot be
determined by Duquesne at this time.
In December 1997, more than 160 nations reached a preliminary agreement
(Kyoto Protocol), under which, among other things, the United States would be
required to reduce its greenhouse gas emissions during the years 2008 through
2012. However, as the Kyoto Protocol has yet to be either signed or ratified,
and the related greenhouse gas reduction programs remain undeveloped, the costs
of compliance cannot be determined by Duquesne at this time.
In 1992, the DEP issued Residual Waste Management Regulations governing the
generation and management of non-hazardous residual waste, such as coal ash.
Duquesne is assessing the sites it utilizes and has developed compliance
strategies that are currently under review by the DEP. Capital costs of $2.8
million were incurred by Duquesne in 1997 to comply with these DEP regulations.
Based on information currently available, approximately $8 million will be spent
in 1998. The additional capital cost of compliance through the year 2000 is
estimated, based on current information, to be approximately $16 million. This
estimate is subject to the results of groundwater assessments and DEP final
approval of compliance plans.
Duquesne is involved in various other environmental matters. Duquesne believes
that such matters, in total, will not have a materially adverse effect on its
financial position, results of operations or cash flows.
Other
- ------------------------------------------------------------------------------
Customer Advanced Reliability System
The Customer Advanced Reliability System (CARS) is a communications service
that provides Duquesne with an electronic link to its customers, including the
ability to read customer meters. In September 1997, Duquesne amended its service
contract with Itron, Inc., with respect to CARS. The amendment extends by one
year, into 1998, the period during which Itron, Inc., will install and finalize
the system. As of December 31, 1997, more than 98 percent of customers' meters
had been adapted for CARS, and more than 450,000 meters were being read
automatically.
Year 2000
Many existing computer programs use only two digits to identify a year (for
example, "98" is used to represent "1998"). Such programs read "00" as the year
1900, and thus may not recognize dates beginning with the year 2000, or may
otherwise produce erroneous results or cease processing when dates after 1999
are encountered. Such failures could cause disruptions in normal business
operations.
In 1994, Duquesne inventoried and assessed the critical information systems
that impact operations and financial reporting (including systems with respect
to the general ledger, supply chain, billing, payroll, human resources,
financial reporting and certain types of data for plant maintenance) in order to
develop a strategy to address required computer software changes and upgrades
relating to such operations. By 1995, a plan to test and, as necessary, replace,
upgrade or repair these systems had been developed and implementation had begun,
with an anticipated completion date in 1999. Although implementation of the plan
has been accelerated in certain respects by Year 2000 issues, the planned
replacement, upgrade and repair of the systems is also generally required for
business purposes unrelated to the Year 2000 issue. Duquesne currently believes
that implementation of the plan will minimize its Year 2000 issues relating to
these systems. Replacement, upgrade and repair projects that have been completed
or are currently in progress include, without limitation, the replacement of an
integrated plant maintenance system at BVPS (including related computer
hardware), replacement of the supply chain (purchasing and inventory) system,
and release upgrades of packaged software for the corporate financial
recordkeeping system. The cost of all such projects is currently estimated to be
$35 million, approximately one-half of which had been incurred through 1997.
Duquesne has been expensing or capitalizing such costs in accordance with
appropriate accounting policies.
Duquesne has assembled a team to inventory and assess the Year 2000 issues
that impact it. The team is comprised of management representatives from all
functional areas of Duquesne. In addition to monitoring the information systems
plan described above, the goals of the team include an assessment of Duquesne's
exposure to Year 2000-related problems in devices and equipment containing
embedded microprocessors that may not correctly identify the year, as well as
potential problems that may originate with third parties outside Duquesne's
control. Duquesne also participates in the Electric Power Research Institute's
project to share information about technical issues regarding the Year 2000
problem with other entities in the electric utility industry.
7
Given the fact that Duquesne's assessment, as noted above, is currently in
progress, Duquesne cannot currently estimate the exact extent of any outstanding
Year 2000 systems and equipment issues, the specific time frame in which any
required corrections would need to be made and the costs to Duquesne in
correcting any possible related outstanding matters. Until Duquesne's assessment
is completed, it cannot determine whether Year 2000 issues and related costs
will be material to Duquesne's operations, financial condition and results of
operations.
Retirement Plan Measurement Assumptions
Duquesne decreased the discount rate used to determine the projected benefit
obligation on Duquesne's retirement plans at December 31, 1997 to 7.0 percent.
The assumed change in future compensation levels and assumed rate of return on
plan assets were also decreased to reflect current market and economic
conditions. The effects of these changes on Duquesne's retirement plan
obligations are reflected in the amounts shown in "Employee Benefits," Note M to
the consolidated financial statements, on page 41. The resulting change in
related expenses for subsequent years is not expected to be material.
Recent Accounting Pronouncements
SFAS No. 130, Reporting Comprehensive Income (SFAS No. 130) and SFAS No. 131,
Disclosures about Segments of an Enterprise and Related Information (SFAS No.
131), have been issued and are effective for fiscal years beginning after
December 15, 1997. SFAS No. 130 defines comprehensive income and outlines
certain reporting and disclosure requirements related to comprehensive income.
SFAS No. 131 requires certain disclosures about business segments of an
enterprise, if applicable. The adoption of SFAS No. 130 and SFAS No. 131 is not
expected to have a significant impact on Duquesne's financial statements or
disclosures.
------------------------------
Except for historical information contained herein, the matters discussed in
this Annual Report on Form 10-K are forward-looking statements which involve
risks and uncertainties including, but not limited to, economic, competitive,
governmental and technological factors affecting Duquesne's operations, markets,
products, services and prices and other factors discussed in Duquesne's filings
with the Securities and Exchange Commission.
8
Executive Officers of the Registrant
- ------------------------------------------------------------------------------
Set forth below are the names, ages as of March 1, 1998, positions and brief
accounts of the business experience during the past five years of the executive
officers of Duquesne.
Name Age Office
David D. Marshall 45 President and Chief Executive Officer since August 1996.
President and Chief Operating Officer from February
1995 to August 1996. Executive Vice President from
February 1992 to February 1995, Assistant to the
President from October 1990 to February 1992, and
Vice President - Corporate Development from August
1987 to February 1992.
Gary L. Schwass 52 Senior Vice President since February 1995 and Chief
Financial Officer since July 1989. Vice President -
Finance and Principal Financial Officer from May 1988
to February 1995; Vice President, Treasurer and
Principal Financial and Accounting Officer from
August 1987 to May 1988.
James E. Cross 51 President, Generation Group since September 1996.
Senior Vice President - Nuclear since February 1995.
Vice President - Nuclear from September 1994 to
February 1995. Formerly Vice President, Thermal
Operations, and Chief Nuclear Officer of Portland
General Electric from May 1993 to September 1994;
and Vice President and Chief Nuclear Officer of
Portland General Electric from December 1991 to
May 1993.
Gary R. Brandenberger 60 Vice President - Customer Operations since May 1997.
Vice President - Power Supply from August 1986 to
May 1997.
William J. DeLeo 47 Vice President - Marketing and Corporate
Performance since April 1995. Vice President -
Corporate Performance and Information Services
from January 1991 to April 1995.
Victor A. Roque 51 Vice President since April 1995 and General Counsel
since November 1994. Previously Vice President,
General Counsel and Secretary for Orange and
Rockland Utilities from April 1989 to November 1994.
Donald J. Clayton 43 Vice President since October 1997. Treasurer since
January 1995. Assistant Treasurer
from May 1990 to January 1995.
Morgan K. O'Brien 37 Vice President since October 1997. Controller and
Principal Accounting Officer since
October 1995. Assistant Controller from
December 1993 to October 1995. Manager,
Corporate Taxes, from September 1991 to
December 1993.
9
Item 2. Properties.
Duquesne's properties consist of electric generating stations, transmission
and distribution facilities, and supplemental properties and appurtenances,
comprising as a whole an integrated electric utility system, located in
Allegheny, Beaver and Westmoreland counties in southwestern Pennsylvania.
Duquesne owns all or a portion of the following generating units except Beaver
Valley Unit 2, which is leased.
Duquesne's
Share of Plant Output
Capacity Year Ended
(Megawatts) December 31, 1997
Name and Location Type Summer Winter (Megawatt-hours)
- ---------------------------- ------- -------- ------ ------------------
Cheswick Coal 562 570 3,475,197
Springdale, Pa.
Elrama Coal 474 487 2,097,700
Elrama, Pa.
Sammis Unit 7 (1) Coal 187 187 998,838
Stratton, Ohio
Eastlake Unit 5 (1) Coal 186 186 730,184
Eastlake, Ohio
Beaver Valley Unit 1 (1) Nuclear 385 385 1,925,121
Shippingport, Pa.
Beaver Valley Unit 2 (1) Nuclear 113 113 878,998
Shippingport, Pa.
Perry Unit 1 (1) Nuclear 161 164 1,117,806
North Perry, Ohio
Bruce Mansfield Unit 1 (1) Coal 228 228 1,397,484
Shippingport, Pa.
Bruce Mansfield Unit 2 (1) Coal 62 62 297,012
Shippingport, Pa.
Bruce Mansfield Unit 3 (1) Coal 110 110 511,924
Shippingport, Pa.
Brunot Island Oil 166 178 5,034
Brunot Island, Pa.
----- ----- ----------
Total 2,634 2,670 13,435,298
===== ===== ==========
(1) Amounts represent Duquesne's share of the unit which is owned by Duquesne in
common with one or more other electric utilities (or, in the case of Beaver
Valley Unit 2, leased by Duquesne).
Duquesne owns 24 transmission substations (including interests in common in
the step-up transformers at Sammis Unit 7; Eastlake Unit 5; Bruce Mansfield Unit
1; Beaver Valley Unit 1; Beaver Valley Unit 2; Perry Unit 1; Bruce Mansfield
Unit 2; and Bruce Mansfield Unit 3) and 562 distribution substations. Duquesne
has 714 circuit-miles of transmission lines, comprising 345,000, 138,000 and
69,000 volt lines. Street lighting and distribution circuits of 23,000 volts and
less include approximately 50,000 miles of lines and cable.
Duquesne owns the Warwick Mine, including 4,849 acres owned in fee of unmined
coal lands and mining rights, located on the Monongahela River in Greene County,
Pennsylvania. (See Item 1. BUSINESS. "Fossil Fuel" discussion on page 4.)
Additional information relating to Item 2. PROPERTIES, is set forth in Note C,
"Property, Plant and Equipment," of the consolidated financial statements for
year ended December 31, 1997, on page 28. The information is incorporated here
by reference.
10
Item 3. Legal Proceedings.
Rate-Related Legal Proceedings, Property, Plant and Equipment-Related Legal
Proceedings and Environmental Legal Proceedings
- ------------------------------------------------------------------------------
Eastlake Unit 5
In September 1995, Duquesne commenced arbitration against CEI, seeking
damages, termination of the Operating Agreement for Eastlake Unit 5 (Eastlake)
and partition of the parties' interests in Eastlake through a sale and division
of the proceeds. The arbitration demand alleged, among other things, the
improper allocation by CEI of fuel and related costs; the mismanagement of the
administration of the Saginaw coal contract in connection with the closing of
the Saginaw mine, which historically supplied coal to Eastlake; and the
concealment by CEI of material information. In October 1995, CEI commenced an
action against Duquesne in the Court of Common Pleas, Lake County, Ohio seeking
to prevent Duquesne from taking any action to effect a partition on the basis of
a waiver of partition covenant contained in the deed to the land underlying
Eastlake. CEI also seeks monetary damages from Duquesne for alleged unpaid joint
costs in connection with the operation of Eastlake. Duquesne removed the action
to the United States District Court for the Northern District of Ohio, Eastern
Division, where it is now pending. Currently, the parties are engaged in
settlement discussions. Duquesne anticipates that a trial will commence late in
1998.
Proposed Merger
In September 1997, the City of Pittsburgh filed a federal antitrust suit
seeking to prevent the merger of DQE and AYE and asking for monetary damages.
Although the United States District Court for the District of Western
Pennsylvania dismissed the suit in January 1998, the City filed an appeal and
asked for expedited review. Duquesne anticipates a decision on whether the
appeal has been granted by late March 1998.
Unless otherwise indicated, all information presented in this report relates
to Duquesne only and does not take into account the proposed merger between DQE
and AYE.
Proceedings involving Duquesne's rates are reported in Item 1. BUSINESS "Rate
Matters." Proceedings involving Property, Plant and Equipment are reported in
Item 1. BUSINESS "Property, Plant and Equipment." Proceedings involving
environmental matters are reported in Item 1. BUSINESS "Environmental Matters."
Item 4. Submission of Matters to a Vote Of Security Holders.
Not applicable.
Part II
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters.
Duquesne's common stock is not publicly traded. Effective July 7, 1989,
Duquesne became a wholly owned subsidiary of DQE, the holding company formed as
part of a shareholder-approved restructuring. As a result of the restructuring,
Duquesne's shareholders received DQE common stock in exchange for their shares
of Duquesne common stock, which were cancelled. DQE owns all of Duquesne's
outstanding common stock, which consists of 10 shares. As such, this item is not
applicable to Duquesne because all its common equity is held solely by DQE.
During 1997 and 1996, Duquesne declared quarterly dividends on its common stock
totaling $129 million and $276 million, respectively.
Item 6. Selected Financial Data.
Selected financial data for Duquesne for each of the six years in the period
ended December 31, 1997, are set forth on page 45. The financial data is
incorporated here by reference.
11
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Results of Operations
- ------------------------------------------------------------------------------
Duquesne's future financial condition and its future operating results are
substantially dependent upon the effects of the Restructuring Plan or Stand-
Alone Plan currently before the PUC. Duquesne expects to be given the
opportunity to fully recover its transition costs. However, to the extent
Duquesne does not ultimately recover its transition costs, a charge against
earnings would be recognized. Such charge could have a materially adverse effect
on Duquesne's financial position, results of operations and cash flows. (See
"Rate Matters" on page 16.)
Earnings
Duquesne's earnings for common stock decreased to $137.8 million in 1997
compared to $145.8 million in 1996. This $8.0 million decrease is the result of
increased depreciation and amortization related to Duquesne's continued
mitigation of fixed generation costs. Additionally, the milder 1997
temperatures impacted the weather-sensitive residential and commercial customer
kilowatt-hour sales. Partially offsetting these sales reductions was an
increase in sales to industrial customers, the result of sales to a new customer
and the expansion of an existing large customer's facilities. Other net income
reductions resulted from increased operating and maintenance expenses, primarily
as the result of approximately 21 percent more forced outage hours at nuclear
generating stations than in 1996, and a full year's dividend requirement on the
Monthly Income Preferred Securities (MIPS) issued in May 1996. Other earnings
increases resulted from increased long-term investment income, reduced interest
costs and reduced income tax expense.
Duquesne's earnings for common stock remained steady at $145.8 million in 1996
as compared to 1995. Although earnings for common stock did not change, there
were a variety of factors which impacted the statement of consolidated income
and offset one another. There was a decrease of approximately $25 million in
operating income, the result of increased depreciation and amortization related
to Duquesne's continued mitigation of fixed generation costs. Additionally, the
unseasonably warm summer temperatures in 1995 reflected a decrease in sales for
1996 by impacting the weather-sensitive residential and commercial customers.
Partially offsetting these reductions was an increase in other income in 1996 by
$23 million primarily due to income from long-term investments made during late
1995 and 1996. Duquesne achieved reductions in interest charges in 1996 offset
by the dividend requirement on the MIPS issued in May 1996. Other earnings
increases resulted from decreased income tax expense.
Revenues
Total operating revenues in 1997 decreased $11.9 million or 1.0 percent as
compared to 1996. Comparing 1996 and 1995 operating revenues, there was an
decrease of $3.0 million or 0.3 percent.
- ----------------------------------------------------------------------------------
Increase (Decrease) from Prior Year
(Revenues in Millions of Dollars) 1997 1996
- ----------------------------------------------------------------------------------
KWH Revenues KWH Revenues
Residential (1.6)% $ 0.5 (1.7)% $(8.9)
Commercial (0.7)% 5.1 0.1% (2.2)
Industrial 6.5% 8.0 1.5% 0.0
Less: Provision for Doubtful Accounts 0.4 (2.8)
- ----------------------------------------------------------------------------------
Sales to Electric Utility Customers 1.0% 13.2 0.0% (8.3)
- ----------------------------------------------------------------------------------
Sales to Other Utilities (56.4)% (33.4) 11.3% 2.3
Other Revenues 8.3 3.0
- ----------------------------------------------------------------------------------
Total (11.1)% $ (11.9) 2.2% $(3.0)
==================================================================================
Sales of Electricity to Customers
Operating revenues are primarily derived from Duquesne's sales of electricity.
Currently, the PUC authorizes rates for electricity sales which are cost-based
and are designed to recover Duquesne's operating expenses and investment in
electric utility assets and to provide a return on the investment. Customer
revenues fluctuate as a result of changes in sales volume and changes in fuel
and other energy costs, as these costs are generally recoverable from customers
through the Energy Cost Rate Adjustment Clause (ECR). Under fuel cost recovery
provisions, fuel revenues generally equal fuel expense, including the fuel
component of purchased power, and do not affect net income. As required under
the Customer Choice Act, Duquesne has filed with the PUC its plan addressing
its proposed restructuring to operate in a competitive environment including
unbundled charges for transmission, distribution, generation and a CTC. Duquesne
cannot predict what rates the PUC will authorize in connection with these
filings and the phase-in to competition. (See "Rate Matters" discussion on
page 16.)
Sales to residential and commercial customers are influenced by weather
conditions. Warmer summer and colder winter seasons lead to increased customer
use of electricity for cooling and heating. Commercial sales are also affected
by regional development. Sales to industrial customers are influenced by
national and global
12
economic conditions.
1997 Compared to 1996: In 1997, net customer revenues reflected on the
statement of consolidated income, increased $13.2 million or 1.2 percent from
1996. The variance can be attributed primarily to an increase in energy costs.
The total energy cost increase was $19.9 million. To a lesser extent, customer
revenues were favorably impacted by an increase of 6.5 percent in industrial
kilowatt (KWH) sales. Sales to a new customer, an industrial gas supplier,
represent 64 percent of the increase while the remaining increase is due to
expansion of one of Duquesne's largest customers' facilities. Residential and
commercial sales decreased 95,295 KWH when comparing 1997 and 1996 due to mild
1997 temperatures. Sales to Duquesne's 20 largest customers accounted for
approximately 14 percent of customer revenues in 1997, 1996, and 1995.
1996 Compared to 1995: Net customer revenues decreased $8.3 million or 0.8
percent in 1996 compared to 1995. The variance can be attributed primarily to
decreased residential customer KWH sales of 1.7 percent due to unseasonably warm
summer temperatures in 1995, as compared to 1996, resulting in decreased
revenues of $8.9 million. Industrial KWH sales volume in 1996 increased when
compared to the prior year because of a self-generation outage experienced in
1996 by one of Duquesne's large industrial customers.
Sales to Other Utilities
Short-term sales to other utilities are regulated by the FERC and are made at
market rates. Fluctuations in electricity sales to other utilities are related
to Duquesne's customer energy requirements, the energy market and transmission
conditions, and the availability of Duquesne's generating stations. Future
levels of short-term sales to other utilities will be affected by market rates.
1997 Compared to 1996: Duquesne's electricity sales to other utilities in
1997 were $33.4 million or 57.4 percent less than in 1996. The reduction is
due to reduced availability of generating capacity as a result of the sale of
Duquesne's 50 percent interest in the Ft. Martin Power Station (Ft. Martin) in
October 1996 and to a 9.1 percent increase in other generating stations' outage
hours when compared to 1996.
1996 Compared to 1995: In 1996, electricity sales to other utilities were
$2.3 million or 4.2 percent greater than in 1995 due to the timing of generating
station outages.
Other Operating Revenues
Duquesne's non-KWH revenues comprise other operating revenues in Duquesne's
statement of consolidated income. Other operating revenues are primarily
comprised of revenues from joint owners of BV Unit 1 and BV Unit 2 for their
shares of the administrative and general costs of operating these units. Other
operating revenues, therefore, fluctuate depending on the timing of scheduled
refueling and maintenance outages at BVPS when significant costs are incurred.
1997 Compared to 1996: The other operating revenue increase of $8.3 million
or 21.8 percent when comparing 1997 and 1996. The variance was due to the
21 percent increase in nuclear forced outage hours since 1996 and in part to a
pole attachment settlement in the second quarter of 1997.
1996 Compared to 1995: Both BV Unit 1 and BV Unit 2 underwent refueling
outages in 1996 and 1995. BV Unit 2 experienced an extended outage of 107 days
during 1996 due to unanticipated repairs to two residual heat removal pumps and
reactor head vent valves, resulting in a $3.0 million or 8.5 percent increase in
other operating revenues during 1996.
Operating Expenses
Fuel and Purchased Power Expense
Fluctuations in fuel and purchased power expense generally result from changes
in the cost of fuel, the mix between coal and nuclear generation, the total KWHs
sold, and generating station availability. Because of the ECR, changes in fuel
and purchased power costs did not impact earnings in 1997, 1996 and 1995. Under
Duquesne's mitigation plan approved by the PUC in June 1996, the level of energy
cost recovery is capped at 1.47 cents per KWH through May 2001. Pending the
outcome of Duquesne's Restructuring Plan or Stand-Alone Plan filing, Duquesne
may freeze the ECR and roll it into base rates. (See "Rate Matters" on page
16.)
1997 Compared to 1996: Fuel and purchased power expense decreased $13.5
million or 5.7 percent in 1997, as compared to 1996, as a result of an 11.1
percent reduction in energy volume supplied. The $26.7 million decrease due to
energy volume supplied was partially offset by increased energy costs of $13.2
million, primarily the result of purchased power prices. Reduced availability of
generating stations due to a 9.1 percent increase in outage hours forced
Duquesne to buy purchased power during high demand periods, resulting in
increased costs.
13
1996 Compared to 1995: The increase of $5.0 million or 2.1 percent in 1996
as compared to 1995 was the result of a 33 percent increase in purchased power
prices. This increase was partially offset by lower nuclear fuel costs.
Other Operating Expense
1997 Compared to 1996: The increase of $5.0 million or 2.0 percent in 1997 as
compared to 1996 resulted primarily from pension expense recorded in 1997 for an
early retirement plan offered to bargaining unit employees.
1996 Compared to 1995: Other operating expense increased $2.8 million or 1.1
percent when comparing 1996 and 1995. The increase was the result of a one-
time lease charge.
Maintenance Expense
1997 Compared to 1996: Maintenance expense increased $4.5 million or 5.7
percent. During 1997, there were approximately 21 percent more forced outage
hours at nuclear stations than in 1996.
1996 Compared to 1995: Maintenance expense decreased $3.1 million or 3.8
percent in 1996 from 1995. The decrease was primarily due to lower maintenance
outage costs as a result of fewer fossil station outages in 1996.
Depreciation and Amortization Expense
1997 Compared to 1996: During 1997, depreciation and amortization expense
increased $19.0 million or 8.8 percent from 1996. The May 1, 1996 increase
from 3.5 percent to 4.25 percent in Duquesne's composite depreciation rate
resulted in higher depreciation for the first four months of 1997; in addition
accelerated nuclear lease recovery, which began on May 1, 1997, resulted in
higher depreciation and amortization expense by $25 million. Offsetting the
increase by $8.5 million was the mid-1996 completion of the recovery of the
investment in Perry Unit 2, the construction of which was abandoned by Duquesne
in 1986. The remaining increase can be attributed to incremental depreciation
for 1997 fixed asset additions and an increased level of nuclear decommissioning
cost recognition.
1996 Compared to 1995: Depreciation and amortization expense increased $25.7
million or 13.5 percent in 1996 when compared to 1995 primarily due to the
increase in Duquesne's composite depreciation rate from 3.5 percent to 4.25
percent effective May 1, 1996. During the third quarter of 1996, Duquesne
completed recovery of its investment in Perry Unit 2, the construction of which
was abandoned by Duquesne in 1986. The resultant decrease in amortization
expense was offset by Duquesne's increase in depreciation, as well as $9 million
that was expensed related to the depreciation portion of deferred rate
synchronization costs in conjunction with Duquesne's 1996 PUC-approved
mitigation plan.
Taxes Other Than Income Taxes
Taxes other than income taxes decreased $3.6 million and $1.7 million in 1997
and 1996, respectively, from the prior year, primarily due to the reduced West
Virginia business and occupation taxes as a result of the sale of Ft. Martin in
the fourth quarter of 1996.
Income Taxes
Income taxes were lower in 1997 as compared to 1996 by $8.6 million and lower
in 1996 as compared to 1995 by $6.9 million. The variances result from
decreased taxable income.
Other Income and (Deductions)
Other income is primarily made up of income from long-term investments entered
into by the subsidiary of the utility and interest income from short-term
investments.
1997 Compared to 1996: Duquesne increased other income over the
1996 levels. An $8.3 million or 33.7 percent increase in other income and
deductions resulted from long-term investment income and interest and dividend
income from a higher level of short-term investments. The greater long-term
investment income of approximately $10 million was the result of investments
made late in 1996 and throughout 1997.
1996 Compared to 1995: The increase of $22.9 million in other income and
deductions, when comparing 1996 and 1995, was primarily the result of income
from long-term investments made during late 1995 and 1996.
14
Interest Charges
Duquesne achieved reductions of $3.0 million and $8.4 million in interest
charges in 1997 and 1996. Due to the maturity of $50.0 million of debt in the
second quarter of 1996 and $50.0 million of debt in the fourth quarter of 1997,
interest decreased in 1997. The decrease in 1996 was primarily due to the
retirement of long-term debt during 1995.
Monthly Income Preferred Securities Dividend Requirements
The Monthly Income Preferred Securities Dividend Requirements reflects the
payment of dividends related to preferred stock issued in May 1996. The
increase of $4.6 million in 1997 as compared with 1996, was the result of paying
a full year of dividends in 1997.
Dividends on Preferred and Preference Stock
The decrease of $1.3 million in 1996 in dividends on preferred and preference
stock was primarily due to the retirement of preferred stock in 1995.
Liquidity and Capital Resources
- --------------------------------------------------------------------------------
Duquesne's future liquidity and capital resources could be reduced as a result
of the Restructuring Plan or Stand-Alone Plan currently before the PUC. Duquesne
cannot predict the level of transition cost recovery that will be permitted, the
impact of any such recovery on Duquesne's capitalization and the continued
compliance with Duquesne's debt covenants or whether internally generated cash
will continue to meet or exceed Duquesne's capital requirements and dividend
payments. (See "Rate Matters" on page 16.)
Capital Expenditures
Duquesne spent approximately $93.7 million in 1997, $88.5 million in 1996 and
$78.7 million in 1995 for capital expenditures. Duquesne's capital expenditures
focus on improving and/or expanding electric utility generation, transmission
and distribution systems. Duquesne estimates that it will spend, excluding
allowance for funds used during construction (AFC) and nuclear fuel,
approximately $130 million during 1998 and $100 million during each of 1999 and
2000 for electric utility construction. Duquesne expects that funds generated
from operations will continue to be sufficient to fund a large part of its
capital needs. (See "Rate Matters" on page 16.)
Long-Term Investments
Duquesne's long-term investments consist of Duquesne's holdings of DQE common
stock, investments in affordable housing, lease investments, and nuclear
decommissioning trust funds. Investing activities in affordable housing included
approximately $4.0 million, $1.5 million and $5.4 million during 1997, 1996 and
1995, respectively. Duquesne invested approximately $11.4 million, $5.7 million
and $4.0 million in nuclear decommissioning trust funds during 1997, 1996 and
1995. Other investments in 1996 totaled $2.7 million. In addition, Duquesne
invested $57.5 million in lease investments during 1995.
Financing
Duquesne expects to meet its current obligations and debt maturities through
the year 2002 with funds generated from operations and through new financings.
At December 31, 1997, Duquesne was in compliance with all of its debt covenants.
Mortgage bonds in the amount of $35 million matured in February 1998 and were
retired using available cash. In February 1998, Duquesne issued a notice of
redemption of $100 million principal amount of its 8.75 percent mortgage bonds,
originally due in May 2022. The redemption date is March 1998, and the
redemption price is 106.5625 percent of the principal amount, plus interest
accrued until redemption. The redemption is to be partially financed with the
proceeds of the February 1998 issuance of $40 million principal amount of 6.45
percent mortgage bonds, due in February 2008. Duquesne anticipates additional
financing of the redemption through the further issuance of lower interest rate
mortgage bonds. Mortgage bonds in the amount of $35 million and $5 million will
mature in June and November 1998, respectively. Duquesne expects to retire these
bonds with available cash or to refinance the bonds. (See "Rate Matters" on page
16.)
In October 1997, a Duquesne subsidiary issued ten shares of preferred stock,
par value $100,000 per share. The holders of such shares are entitled to a 6.5%
annual dividend to be paid each September 30.
In May 1996, Duquesne Capital L.P. (Duquesne Capital), a special-purpose
limited partnership of which Duquesne is the sole general partner, issued $150.0
million principal amount of 8 3/8 percent MIPS with a stated liquidation value
of $25.00. The holders of MIPS are entitled to annual dividends of 8 3/8
percent, payable monthly. Such dividends are guaranteed by Duquesne.
15
Short-Term Borrowings
At December 31, 1997, Duquesne had a $150 million extendible revolving credit
arrangements expiring in October 1998. Interest rates can, in accordance with
the option selected at the time of the borrowing, be based on prime, Eurodollar
or certificate of deposit rates. Commitment fees are based on the unborrowed
amount of the commitments. The credit facility contains a two-year repayment
period for any amounts outstanding at the expiration of the revolving credit
periods. At December 31, 1997 and December 31, 1996, there were no short-term
borrowings outstanding.
Sale of Accounts Receivable
Duquesne and an unaffiliated corporation have an agreement that entitles
Duquesne to sell, and the corporation to purchase, on an ongoing basis, up to
$50 million of accounts receivable. Duquesne had no receivables sold at December
31, 1997 or December 31, 1996. The accounts receivable sales agreement, which
expires in June 1998, is one of many sources of funds available to Duquesne.
Duquesne may attempt to extend the agreement, replace it with a similar
facility, or eliminate it upon expiration.
Nuclear Fuel Leasing
Duquesne finances its acquisitions of nuclear fuel through a leasing
arrangement under which it may finance up to $75 million of nuclear fuel. As of
December 31, 1997, the amount of nuclear fuel financed by Duquesne under this
arrangement totaled approximately $46.2 million. The actual nuclear fuel costs
to be financed will be influenced by such factors as changes in interest rates;
lengths of the respective fuel cycles; reload cycle design; operations; and
changes in nuclear material costs and services, the prices and availability of
which are not known at this time. Such costs may also be influenced by other
events not presently foreseen. Duquesne plans to continue leasing nuclear fuel
to fulfill its requirements at least through September 1998, the remaining term
of the leasing arrangement. Duquesne may attempt to extend the arrangement,
replace it with a similar facility, or eliminate it upon expiration through the
purchase of the balance of the nuclear fuel.
Rate Matters
- --------------------------------------------------------------------------------
Competition and the Customer Choice Act
The electric utility industry continues to undergo fundamental change in
response to development of open transmission access and increased availability
of energy alternatives. Under historical ratemaking practice, regulated electric
utilities were granted exclusive geographic franchises to sell electricity in
exchange for making investments and incurring obligations to serve customers
under the then-existing regulatory framework. Through the ratemaking process,
those prudently incurred costs were recovered from customers along with a return
on the investment. Additionally, certain operating costs were approved for
deferral for future recovery from customers (regulatory assets). As a result of
this historical ratemaking process, utilities have assets recorded on their
balance sheets at above-market costs, thus creating transition costs.
In Pennsylvania, the Customer Choice Act went into effect January 1, 1997. The
Customer Choice Act enables Pennsylvania's electric utility customers to
purchase electricity at market prices from a variety of electric generation
suppliers (customer choice). Although the Customer Choice Act will give
customers their choice of electric generation suppliers, delivery of the
electricity from the generation supplier to the customer will remain the
responsibility of the existing franchised utility. The Customer Choice Act also
provides that the existing franchised utility may recover, through a CTC, an
amount of transition costs that are determined by the PUC to be just and
reasonable. Pennsylvania's electric utility restructuring is being accomplished
through a two-stage process consisting of an initial customer choice pilot
period (running through 1998) and a phase-in to competition period (beginning in
1999). For the first stage, Duquesne filed a pilot program with the PUC on
February 27, 1997. For the second stage, Duquesne filed on August 1, 1997 its
restructuring and merger plan (the Restructuring Plan) and its stand-alone
restructuring plan (the Stand-Alone Plan) with the PUC. (See the detailed
discussion of these plans on pages 18 and 19.)
Customer Choice Pilots
The pilot period gives utilities an opportunity to examine a wide range of
technical and administrative details related to competitive markets, including
metering, billing, and cost and design of unbundled electric services.
Duquesne's pilot filing proposed unbundling transmission, distribution,
generation and competitive transition charges and offered participating
customers the same options that were to be available in a competitive generation
market. The pilot was designed to comprise approximately 5 percent of Duquesne's
residential, commercial and industrial demand. The 28,000 customers
participating in the pilot may choose unbundled service, with their electricity
provided by an alternative generation supplier, and will be subject to unbundled
distribution and CTC charges approved by the PUC and unbundled transmission
charges pursuant to Duquesne's FERC-approved tariff. On May 9, 1997, the PUC
issued a Preliminary Opinion and Order approving Duquesne's filing in part, and
requiring certain revisions. Duquesne and other utilities objected to several
features of the PUC's Preliminary Opinion and Order. Hearings on several key
issues were held in July. The PUC issued its final order on August 29, 1997,
approving a revised pilot program for Duquesne. On September 8, 1997, Duquesne
appealed the determination of the market price of generation set forth in this
order to the Commonwealth Court of Pennsylvania. Duquesne expects a hearing to
be scheduled for mid-1998. Although this appeal is pending, Duquesne complied
with the PUC's order to implement the pilot program that began on November 3,
1997.
16
Financial Impact of Pilot Program Order
It is anticipated that the net financial impact of Duquesne's customers'
choosing alternative generation suppliers during the pilot period (through 1998)
will be a reduction of operating revenues of approximately $1 million per month.
(See "Forward-Looking Statements" discussion on page 19.) Duquesne is seeking in
its Restructuring Plan and its Stand-Alone Plan to maintain current rates under
Section 2804(4)(v) of the Customer Choice Act (Rate Cap Provision), which states
that in certain circumstances an electric distribution utility may roll its
energy cost rate into base rates without reducing its rates below the capped
level if the PUC determines that excess earnings are to be used for mitigation
of transition costs. Duquesne will reduce its accelerated nuclear lease
amortization to offset the shortfall, if any, in operating revenues between the
pilot program and the final approved rates.
Phase-In to Competition
The phase-in to competition begins on January 1, 1999, when 33 percent of
customers will have customer choice (including customers covered by the pilot
program); 66 percent of customers will have customer choice no later than
January 1, 2000; and all customers will have customer choice no later than
January 1, 2001. However, in its sole order to date (the PECO Order), the PUC
ordered the phase-in provisions of the Customer Choice Act to require the
acceleration of the second and third phases to January 2, 1999 and January 2,
2000, respectively. As they are phased-in, customers that have chosen an
electricity generation supplier other than Duquesne will pay that supplier for
generation charges, and will pay Duquesne a CTC (discussed below) and unbundled
charges for transmission and distribution. Customers that continue to buy their
generation from Duquesne will pay for their service at current regulated tariff
rates divided into unbundled generation, transmission and distribution charges.
The PECO Order concluded that under the Customer Choice Act, an electric
distribution company, such as Duquesne, is to remain a regulated utility and may
only offer PUC-approved, tariffed rates (including unbundled generation rates).
Delivery of electricity (including transmission, distribution and customer
service) will continue to be regulated in substantially the same manner as under
current regulation.
Rate Cap and Transition Cost Recovery
Before the phase-in to customer choice begins in 1999, the PUC expects
utilities to take vigorous steps to mitigate transition costs as much as
possible without increasing the rates they currently charge customers. Duquesne
has mitigated in excess of $350 million of transition costs during the past
three years through accelerated annual depreciation and a one-time write-down of
nuclear generating station costs, accelerated recognition of nuclear lease
costs, increased nuclear decommissioning funding, and amortization of various
regulatory assets. This relative level of transition cost reduction, while
holding rates constant, is unmatched within Pennsylvania.
The PUC will determine what portion of a utility's transition costs that
remain at January 1, 1999 will be recoverable through a CTC from customers. The
CTC recovery period could last through 2005, providing a utility a total of up
to nine years beginning January 1, 1997 to recover transition costs, unless this
period is extended as part of a utility's PUC-approved transition plan. An
overall four-and-one-half-year rate cap from January 1, 1997 will be imposed on
the transmission and distribution charges of electric utility companies.
Additionally, electric utility companies may not increase the generation price
component of rates as long as transition costs are being recovered, with certain
exceptions. Following is a summary of Duquesne's requested transition cost
recovery, net of deferred taxes, as of January 1, 1999; the related net balances
as of December 31, 1997; and the amounts mitigated during the past three years.
Transition Costs
- ---------------------------------------------------------------------------------------------
Mitigation Balance CTC Recovery
(Amounts in Millions of Dollars) 1/1/95 - 12/31/97 12/31/97 Requested 1/1/99
- ---------------------------------------------------------------------------------------------
Nuclear generation plant (a) $232 $ 968 $ 877
Fossil generation plant (a) -- 541 541
Generation-related regulatory assets (b) 103 382 357
Decommissioning costs (c) 18 133 124
- ---------------------------------------------------------------------------------------------
Total $353 $2,024 $1,899
=============================================================================================
(a) Nuclear and fossil generation plant represent a projection of the amount by
which the net book value, including materials and supplies inventories, and
fuel inventories, of the generating plants exceeds the market value for
these plants. "Nuclear generation plant" also includes the present value of
future above-market lease payments related to the sale/leaseback of BV Unit
2.
(b) Generation-related regulatory assets represent costs which under the
historical ratemaking process were deemed recoverable from customers through
future rates. These regulatory assets include, among other items, amounts
related to future federal income tax payments, premiums paid to reacquire
debt, initial operating costs of BV Unit 2 and Perry Unit 1, and energy
costs not recovered currently.
(c) Decommissioning costs represent the estimated present value of unfunded
fossil and nuclear generation plant decommissioning costs.
17
Financial Exposure to Transition Cost Recovery
Any estimate of the ultimate level of transition costs (including those set
forth in the table on page 17) depends on, among other things, the extent to
---
which such costs are deemed recoverable by the PUC; the ongoing level of
Duquesne's costs of operations; regional and national economic conditions; and
growth of Duquesne's sales. Duquesne believes that it is entitled to recover
substantially all of its transition costs, but cannot predict the outcome of
this regulatory process. (See "Forward-Looking Statements" discussion on page
19.) Indeed, the PECO Order provides for recovery by PECO Energy Company (PECO)
- ---
of 100 percent of transition costs determined to be just and reasonable by the
PUC. However, in determining transition costs, the PUC found the market value of
PECO's generating units to be significantly higher than the estimate of market
value sponsored by PECO. Thus, the total amount of transition costs requested by
PECO was significantly more than that allowed by the PUC in the PECO Order, as
the PUC-determined market value offset a larger portion of the transition costs.
The PUC-ordered recovery of PECO's transition costs through a CTC is permitted
over an eight-and-one-half-year period beginning January 1, 1999. However, PECO
is only permitted to earn a return on the unamortized balance of transition
costs at a rate equal to its long-term cost of debt. In the event that the PUC
rules that any or all of Duquesne's transition costs cannot be recovered through
a CTC mechanism, or Duquesne fails to satisfy the requirements of SFAS No. 71,
these costs will be written off. (See Item 1. BUSINESS "Regulation" on page 1.)
On January 26, 1998, PECO announced that it was reducing its dividend by 44
percent, and also that it was reporting a net loss for 1997 of $1.5 billion,
including an extraordinary charge of $3.1 billion ($1.8 billion net of taxes) in
the fourth quarter of 1997 to reflect the effects of the PECO Order. As Duquesne
has substantial exposure to transition costs relative to its size, significant
transition cost write-offs could have a materially adverse effect on Duquesne's
financial position, results of operations and cash flows. Various financial
covenants and restrictions could be violated if substantial write-off of assets
or recognition of liabilities occurs. Under such circumstances, Duquesne may
face constraints on its ability to pay dividends, issue new mortgage debt or
maintain access to bank lines of credit, thus negatively impacting its
operations.
Timetable for Restructuring Plan and Stand-Alone Plan Approval
On August 1, 1997, Duquesne filed the Restructuring Plan and the Stand-Alone
Plan with the PUC. Although the provisions of the Customer Choice Act require a
PUC decision nine months from the filing date (which would be April 30, 1998),
the Pennsylvania Attorney General's Office requested an extension in order to
conduct an investigation into certain competition issues relating to the
Restructuring Plan. Pursuant to an arrangement among Duquesne, the PUC and the
Attorney General, Duquesne anticipates a decision by the PUC (with respect to
the Restructuring Plan if the merger of DQE and AYE is approved, or with respect
to the Stand-Alone Plan if the merger is not approved) on or before May 29, 1998
or such later date as the parties may agree.
Stand-Alone Plan
In the event the merger of DQE with AYE is not consummated under the filed
Restructuring Plan, Duquesne has sought approval for restructuring and recovery
of its own transition costs through a CTC under the Stand-Alone Plan. Duquesne
proposed that any finding of market value for Duquesne's generating assets
should be based on market evidence and not on an administrative determination of
that value based on price forecasts (the PECO Order determined the market value
of PECO's generation based on the price forecast sponsored by the Pennsylvania
Office of Consumer Advocate). In addition, Duquesne proposed that such a final
market valuation be conducted in 2003, and that an annual competitive market
solicitation be used to set the CTC in the interim. The 2003 final market
valuation would be performed by an independent panel of experts using the best
available market evidence at that time. The Stand-Alone Plan filing also
provided for certain triggers that would accelerate the date of this final
market valuation. Prior to the final valuation, Duquesne would sell a
substantial amount of power to the highest bidder in an annual competitive
solicitation. The annual market price established by the solicitation would be
used to set competitive generation credits and determine the CTC as a residual
from the generation rate cap under the Rate Cap Provision. During the transition
period, Duquesne committed to accelerate amortization and depreciation of its
generation-related assets and cap its return on equity through a return on
equity spillover mechanism, in exchange for being allowed to charge existing
rates under the Rate Cap Provision. Duquesne committed to a minimum of $1.7
billion of amortization and depreciation of generation-related assets by the end
of 2005. Under the proposed return on equity spillover mechanism, additional
amortization and depreciation in excess of this minimum $1.7 billion commitment
would be recorded in order to comply with the return on equity cap. The
generation rate cap would apply to the sum of the CTC and the competitive
generation credit determined in the annual competitive solicitation. The Stand-
Alone Plan also proposed to redesign individual tariffs to encourage more
efficient consumption and further mitigate transition costs during the
transition period. Consistent with Duquesne's long-standing commitment to
economic development, the rate redesign provides for a significant reduction in
the cost of electricity for incremental consumption. Application of the rate
redesign to the CTC would also have the potential to maximize mitigation of
transition costs during the transition period.
As an alternative to a market-based valuation in 2003, if the PUC finds that a
determination of market value as of December 31, 1998 is required by the
Customer Choice Act, then Duquesne has agreed that the PUC may order an
immediate auction of Duquesne's generation at that time.
18
Restructuring Plan
The Restructuring Plan incorporates the benefits of the merger of DQE with
AYE, such as anticipated savings to Duquesne, on a nominal basis, of $365
million in generation-related costs over 20 years, and $9 million in
transmission-related costs and $173 million in distribution-related costs over
10 years. Duquesne plans to use the generation-related portion of its share of
net operating synergy savings to shorten the transition cost recovery period. In
addition, the anticipated cost savings are expected to permit Duquesne to
increase its minimum depreciation and amortization commitment by $160 million,
reduce distribution rates by $25 million in 2001, and freeze distribution rates
at this reduced level until 2005. The merger-related synergies are expected to
enable Duquesne to reduce its transition costs in 2005 by $200 million. (See
"Forward-Looking Statements" discussion on page 19.) The Restructuring Plan also
incorporates the market-based approach to determining transition costs proposed
by Duquesne in its Stand-Alone Plan. The 2003 final market valuation will be
performed by an independent panel of experts using the best available market
evidence at that time, including a potential sale of a portion of the combined
company's generating assets. Certain triggers will accelerate the date of this
final market valuation if market prices rise significantly or the minimum
amortization commitment is satisfied prior to 2003. The annual market price
established by Duquesne's solicitation would be used to set competitive
generation credits and to determine the CTC as a residual from the generation
rate cap under the Rate Cap Provision. Duquesne's minimum amortization
commitment of $1.7 billion in the proposed Stand-Alone Plan has been increased
under the Restructuring Plan. As in the Stand-Alone Plan, the determination of
transition costs in 2003 will compare the book value of generating assets in
2005 (after netting the increased minimum commitment to depreciation and
amortization and any return on equity spillover) with the market value of the
generating assets in 2005. The opposing parties believe that there should be a
one-time valuation of the generating assets performed at January 1, 1999. Any
merger-related synergies relating to generation would then be used to reduce
Duquesne's transition costs as of that date. These parties also believe that
Duquesne's proposed distribution rate decrease should be effective January 1,
1999, as well.
Additional Restructuring Plan Commitments
The Restructuring Plan also contains a number of commitments by the merged
DQE/AYE entity. First, the merged entity will open up its transmission system to
all parties on a reciprocal non-discriminatory basis and eliminate multiple rate
charges across the combined transmission system. Second, the merged entity will
join a recently proposed Midwest Independent System Operator (ISO) or other
then-existing ISO, or form its own ISO if no existing ISO offers acceptable
rules, including marginal cost transmission rates. Several utilities have
applications pending before the FERC to form ISOs. Third, the merged entity has
committed to make a report, 18 months after consummation of the merger, to the
PUC regarding its progress on the ISO commitment. The PUC may, at its option,
require the merged entity to relinquish control of 300 MW of generating capacity
to alleviate concerns over market power. The form of relinquishment would be at
the option of the merged entity; possible forms of relinquishment include an
energy swap, entering a power sale contract, divestiture of generating assets
and a bidding trust.
The Federal Filings
In addition to the PUC filings of the Restructuring Plan and the Stand-Alone
Plan, on August 1, 1997, DQE and AYE filed their joint merger application with
the FERC (the FERC Filing). Pursuant to the FERC Filing, DQE and AYE have
committed to forming or joining an ISO that meets the entity's requirements,
including marginal cost transmission pricing, following the merger. In addition,
DQE and AYE have stated in the FERC Filing that following the merger the
combined entity's market share will not violate the market power conditions and
requirements set by the FERC. On January 20, 1998, DQE and AYE filed merger
applications with the Antitrust Division of the Department of Justice and the
Federal Trade Commission. These applications are currently pending.
Forward-Looking Statements
The foregoing paragraphs contain forward-looking statements (within the
meaning of the Private Securities Litigation Reform Act of 1995) regarding the
financial impact, consequences and benefits of the Customer Choice Act, the
pilot program, the Stand-Alone Plan, the Restructuring Plan and the merger of
DQE with AYE. Such forward-looking statements involve known and unknown risks
and uncertainties that may cause the actual results and benefits to materially
differ from those implied by such statements. Such risks and uncertainties
include, but are not limited to, the substance of PUC approvals regarding the
Stand-Alone Plan or the Restructuring Plan, general economic and business
conditions, industry capacity, changes in technology, integration of the
operations of AYE and DQE, regulatory conditions to the merger, the loss of any
significant customers, and changes in business strategy or development plans.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Funding for nuclear decommissioning costs is deposited by Duquesne in
external, segregated trust accounts and invested in a portfolio of corporate
common stock and debt securities, municipal bonds, certificates of deposit and
United States government securities. The market value of the aggregate trust
fund balances at December 31, 1997 totaled approximately $47.1 million. The
amount funded into the trusts is based on estimated returns which, if not
achieved as projected, could require additional unanticipated funding
requirements.
19
Item 8. Consolidated Financial Statements and Supplementary Data.
Report of Independent Certified Public Accountants
To the Directors and Stockholder of Duquesne Light Company:
We have audited the accompanying consolidated balance sheet of Duquesne Light
Company (a wholly owned subsidiary of DQE, Inc.) and its subsidiaries as of
December 31, 1997 and 1996, and the related consolidated statements of income,
retained earnings, and cash flows for each of the three years in the period
ended December 31, 1997. Our audits also included the financial statement
schedule listed in the Index at Item 14. These financial statements and
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on the financial statements and
financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Duquesne Light Company and its
subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
Also, in our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Pittsburgh, Pennsylvania
January 27, 1998
20
Statement of Consolidated Income
- -------------------------------------------------------------------------------
(Thousands of Dollars)
----------------------------------------
Year Ended December 31,
- ---------------------------------------------------------------------------------------------------------------
1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------
Operating Revenues:
Sales of Electricity:
Residential $ 405,915 $ 405,392 $ 414,291
Commercial 500,070 494,919 497,187
Industrial 198,708 190,723 190,689
Provision for doubtful accounts (11,000) (10,582) (13,430)
- ---------------------------------------------------------------------------------------------------------------
Net customer revenues 1,093,693 1,080,452 1,088,737
Utilities 24,861 58,292 55,963
- ---------------------------------------------------------------------------------------------------------------
Total Sales of Electricity 1,118,554 1,138,744 1,144,700
Other 46,387 38,081 35,084
- ---------------------------------------------------------------------------------------------------------------
Total Operating Revenues 1,164,941 1,176,825 1,179,784
- ---------------------------------------------------------------------------------------------------------------
Operating Expenses:
Fuel 184,676 204,655 208,546
Purchased power 38,735 32,269 23,422
Other operating 258,063 253,109 250,322
Maintenance 82,869 78,386 81,516
Depreciation and amortization 235,381 216,338 190,679
Taxes other than income taxes 81,049 84,625 86,349
Income taxes 76,783 85,364 92,313
- ---------------------------------------------------------------------------------------------------------------
Total Operating Expenses 957,556 954,746 933,147
- ---------------------------------------------------------------------------------------------------------------
Operating Income 207,385 222,079 246,637
- ---------------------------------------------------------------------------------------------------------------
Other Income and (Deductions):
Interest and dividend income 16,014 12,216 7,923
Income taxes (2,945) 2,356 (581)
Allowance for equity funds used during construction -- -- 721
Other 19,761 9,991 (6,404)
- ---------------------------------------------------------------------------------------------------------------
Total Other Income 32,830 24,563 1,659
- ---------------------------------------------------------------------------------------------------------------
Income Before Interest and Other Charges 240,215 246,642 248,296
- ---------------------------------------------------------------------------------------------------------------
Interest Charges:
Interest on long-term debt 87,420 88,478 95,391
Other interest 752 1,632 2,599
Allowance for borrowed funds used during construction (2,339) (1,249) (764)
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Total Interest Charges 85,833 88,861 97,226
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Monthly Income Preferred Securities Dividend Requirements 12,562 7,921 --
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Net Income 141,820 149,860 151,070
Dividends on Preferred and Preference Stock 4,022 4,045 5,320
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Earnings for Common Stock $ 137,798 $ 145,815 $ 145,750
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See notes to consolidated financial statements.
21
Consolidated Balance Sheet
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(Thousands of Dollars)
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As of December 31,
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Assets 1997 1996
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Property, Plant and Equipment:
Electric plant in service $ 4,332,630 $ 4,272,623
Construction work in progress 56,471 45,059
Property held under capital leases 113,662 99,608
Property held for future use 3,980 190,821
Other 3,995 662
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Gross property, plant and equipment 4,510,738 4,608,773
Less: Accumulated depreciation and amortization (1,947,819) (1,891,300)
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Total Property, Plant and Equipment--Net 2,562,919 2,717,473
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