FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934

DUKE ENERGY FIELD SERVICES, LLC

370 17th Street, Suite 2500
Denver, Colorado 80202
(Address of principal executive offices)
(Zip Code)

303-595-3331
(Registrant’s telephone number, including area code)

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 o

Indicate by check mark whether the registrant is an accelerated filer as defined by Rule 12b-2 of the Act. Yes o   No x

DUKE ENERGY FIELD SERVICES, LLC
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2004

INDEX

CAUTIONARY STATEMENT ABOUT FORWARD-LOOKING STATEMENTS

     Our reports, filings and other public announcements may from time to time contain statements that do not directly or exclusively relate to historical facts. Such statements are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. You can typically identify forward-looking statements by the use of forward-looking words, such as “may,” “could,” “project,” “believe,” “anticipate,” “expect,” “estimate,” “potential,” “plan,” “forecast” and other similar words.

     All statements that are not statements of historical facts, including statements regarding our future financial position, business strategy, budgets, projected costs and plans and objectives of management for future operations, are forward-looking statements.

     These forward-looking statements reflect our intentions, plans, expectations, assumptions and beliefs about future events and are subject to risks, uncertainties and other factors, many of which are outside our control. Important factors that could cause actual results to differ materially from the expectations expressed or implied in the forward-looking statements include known and unknown risks. Known risks include, but are not limited to, the following:

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our ability to access the capital and bank markets, which will depend on general market conditions and the credit ratings for our debt obligations;

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our use of derivative financial instruments to hedge commodity and interest rate risks;

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the level of creditworthiness of counterparties to transactions;

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the amount of collateral required to be posted from time to time in our transactions;

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changes in laws and regulations, particularly with regard to taxes, safety and protection of the environment or the increased regulation of the gathering and processing industry;

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the timing and extent of changes in commodity prices, interest rates, foreign currency exchange rates and demand for our services;

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weather and other natural phenomena;

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industry changes, including the impact of consolidations, and changes in competition;

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our ability to obtain required approvals for construction or modernization of gathering and processing facilities, and the timing of production from such facilities, which are dependent on the issuance by federal, state and municipal governments, or agencies thereof, of building, environmental and other permits, the availability of specialized contractors and work force and prices of and demand for products;

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the extent of success in connecting natural gas supplies to gathering and processing systems;

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general economic conditions, including any potential effects arising from terrorist attacks and any consequential hostilities or other hostilities; and

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The effect of accounting pronouncements issued periodically by accounting standard-setting bodies.

     In light of these risks, uncertainties and assumptions, the events described in the forward-looking statements might not occur or might occur to a different extent or at a different time than we have described. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

DUKE ENERGY FIELD SERVICES, LLC

See Condensed Notes to Consolidated Financial Statements.

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DUKE ENERGY FIELD SERVICES, LLC

See Condensed Notes to Consolidated Financial Statements.

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DUKE ENERGY FIELD SERVICES, LLC

See Condensed Notes to Consolidated Financial Statements.

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DUKE ENERGY FIELD SERVICES, LLC

See Condensed Notes to Consolidated Financial Statements.

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DUKE ENERGY FIELD SERVICES, LLC

1. General

     Duke Energy Field Services, LLC (with its consolidated subsidiaries, “us”, “we”, “our” or the “Company”) operates in the two principal segments of the midstream natural gas industry of (1) natural gas gathering, compression, treatment, processing, transportation, trading and marketing and storage; and (2) natural gas liquids (“NGL”), fractionation, transportation, and trading and marketing. Duke Energy Corporation (“Duke Energy”) owns 69.7% of the Company’s outstanding member interests and ConocoPhillips owns the remaining 30.3%.

These Consolidated Financial Statements reflect all normal recurring adjustments that are, in the opinion of management, necessary to present fairly the financial position and results of operations for the respective interim periods. These consolidated financial statements and other information included in this quarterly report on Form 10-Q should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes thereto included in our annual report on Form 10-K for the fiscal year ended December 31, 2003.

2. Summary of Significant Accounting Policies

     Consolidation — The Consolidated Financial Statements include the accounts of the Company and all majority-owned subsidiaries, after eliminating intercompany transactions and balances, and variable interest entities where we are the primary beneficiary. Investments in 20% to 50% owned affiliates, and investments in less than 20% owned affiliates where we have the ability to exercise significant influence, are accounted for using the equity method. Investments greater than 50% are consolidated unless we do not have the ability to exercise control, in which case, they are accounted for using the equity method.

     Use of Estimates — Conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and notes. Although these estimates are based on management’s best available knowledge of current and expected future events, actual results could be different from those estimates.

     Accounting for Hedges and Commodity Trading and Marketing Activities — Each derivative not qualifying for the normal purchases and sales exception under Statement of Financial Accounting Standards (“SFAS”) No. 133 (“SFAS 133”), “Accounting for Derivative Instruments and Hedging Activities,” as amended, is recorded on a gross basis in the Consolidated Balance Sheets at its fair value as Unrealized gains or Unrealized losses on mark-to-market and hedging transactions. Derivative assets and liabilities remain classified in the Consolidated Balance Sheets as Unrealized gains or Unrealized losses on mark-to-market or hedging transactions at fair value until the contractual delivery period occurs.

     Effective January 1, 2003, we designate each energy commodity derivative as either trading or non-trading. For each of our derivatives, the accounting method and presentation of gains and losses or revenue and expense in the Consolidated Statements of Operations are as follows:

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^a Mark-to-market- An accounting method whereby the change in the fair value of the asset or liability is recognized in the Consolidated Statements of Operations in Trading and marketing net margin during the current period.

^b Hedge method- An accounting method whereby the change in the fair value of the asset or liability is recorded in the Consolidated Balance Sheets and there is no recognition in the Consolidated Statements of Operations for the effective portion until the hedged transaction occurs.

^c Accrual method- An accounting method whereby there is no recognition in the Consolidated Statements of Operations for changes in fair value of a contract until the service is provided or the associated delivery of product occurs.

     For derivatives designated as a cash flow hedge or a fair value hedge, we formally assess, both at the inception of the hedge and on an ongoing basis, whether the hedge contract is highly effective in offsetting changes in fair values or cash flows of hedged items. We exclude the time value of the options when assessing hedge effectiveness.

     When available, quoted market prices or prices obtained through external sources are used to verify a contract’s fair value. For contracts with a delivery location or duration for which quoted market prices are not available, fair value is determined based on pricing models developed primarily from historical and expected correlations with quoted market prices.

     Values are adjusted to reflect the credit risk inherent in the transaction as well as the potential impact of liquidating the open positions in an orderly manner over a reasonable time period under current conditions. Changes in market prices and management estimates directly affect the estimated fair value of these contracts. Accordingly, it is reasonably possible that such estimates may change in the near term.

     Commodity Trading and Marketing — A favorable or unfavorable price movement of any derivative contract held for trading and marketing purposes is reported as Trading and marketing net margin in the Consolidated Statements of Operations. An offsetting amount is recorded in the Consolidated Balance Sheets as Unrealized gains or Unrealized losses on mark-to-market and hedging transactions. When the contractual delivery period occurs, the realized gain or loss is reclassified to an account receivable or payable.

     Commodity Cash Flow Hedges — The fair value of a derivative designated as a cash flow hedge is recorded in the Consolidated Balance Sheets as Unrealized gains or Unrealized losses on mark-to-market and hedging transactions. The effective portion of the change in fair value of a derivative designated as a cash flow hedge is recorded in the Consolidated Balance Sheets as Accumulated other comprehensive income (“AOCI”) and the ineffective portion is recorded in the Consolidated Statements of Operations. During the period in which the hedged transaction occurs, amounts in AOCI associated with the hedged transaction are reclassified to the Consolidated Statements of Operations in the same accounts as the item being hedged. We discontinue hedge accounting prospectively when it is determined that the derivative no longer qualifies as an effective hedge, or when it is no longer probable that the hedged transaction will occur. When hedge accounting is discontinued because the derivative no longer qualifies as an effective hedge, the derivative continues to be carried on the Consolidated Balance Sheets at its fair value; however, subsequent changes in its fair value are recognized in current period earnings. Gains and losses related to discontinued hedges that were previously accumulated in AOCI will remain in AOCI until the hedged transaction occurs, unless it is no longer probable that the hedged transaction will occur, in which case, the gains and losses that were previously deferred in AOCI will be immediately recognized in current

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period earnings. At June 30, 2004 and December 31, 2003, $16 million and $29 million, respectively, of losses related to cash flow hedges were deferred in AOCI.

     Commodity Fair Value Hedges — Changes in the fair value of a derivative that is designated and qualifies as a fair value hedge are included in the Consolidated Statements of Operations as Sales of natural gas and petroleum products and Purchases of natural gas and petroleum products, as appropriate, and are included in the Consolidated Balance Sheets as Unrealized gains or Unrealized losses on mark-to-market and hedging transactions. Changes in the fair value of the physical portion of a fair value hedge (i.e., the hedged item) are recorded in the Consolidated Statements of Operations in the same accounts as the changes in the fair value of the derivative, with offsetting amounts in the Consolidated Balance Sheets as Other current assets, Other noncurrent assets, Other current liabilities or Other long term liabilities, as appropriate.

     Interest Rate Fair Value Hedges — We periodically enter into interest rate swaps to convert some of our fixed-rate long term debt to floating-rate long term debt. Hedged items in fair value hedges are marked-to-market with the respective derivative instruments. Accordingly, our hedged fixed-rate debt is carried at fair value. The terms of the outstanding swaps match those of the associated debt which permits the assumption of no ineffectiveness, as defined by SFAS 133. As such, for the life of the swaps, no ineffectiveness will be recognized.

     Distributions – Under the terms of our Limited Liability Company Agreement (the “LLC Agreement”), we are required to make quarterly distributions to Duke Energy and ConocoPhillips based on allocated taxable income. The LLC Agreement, as amended, provides for taxable income to be allocated in accordance with Internal Revenue Code Section 704(c). This Code Section accounts for the variation between the adjusted tax basis and the fair market value of assets contributed to the joint venture. The distribution is based on the highest taxable income allocated to either member, with the other member receiving a proportionate amount to maintain the ownership capital accounts at 69.7% for Duke Energy and 30.3% for ConocoPhillips. During the six months ended June 30, 2004, we paid distributions of $11 million based on estimated annual taxable income allocated to the members according to their respective ownership percentages. As of June 30, 2004, additional distributions payable of $5 million were included in Other current liabilities in the Consolidated Balance Sheets.

     In 2003, our board of directors approved a plan to consider the payment of a quarterly dividend to Duke Energy and ConocoPhillips. The board of directors may consider net income, cash flow or any other criteria deemed appropriate for determining the amount of the quarterly dividend to be paid. The LLC Agreement restricts making distributions, which would include these dividends, except with the approval of both members. During the six months ended June 30, 2004, with the approval of both members, we paid a total dividend of $137 million to the members, allocated in accordance with their respective ownership percentages.

     Stock-Based Compensation — Under Duke Energy’s 1998 Long Term Incentive Plan, stock options for Duke Energy’s common stock may be granted to our key employees. We account for stock-based compensation using the intrinsic value recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and FASB Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation (an Interpretation of APB Opinion No. 25).” Under this method, any compensation cost is measured as the quoted market price of stock at the date of the grant less the amount an employee must pay to acquire the stock. Since the exercise price for all options granted under the plan was equal to the market value of the underlying common stock on the date of grant, no compensation cost is recognized in the accompanying Consolidated Statements of Operations. Restricted stock grants and phantom stock awards are recorded as compensation cost over the required vesting period, based on the fair value on the date of grant. Performance awards are recorded as compensation cost over the required vesting period, based on the fair value of the awards at the balance sheet date.

     The following table shows what earnings available for members’ interest would have been if we had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” to stock options and reflects the provisions of SFAS No. 148 “Accounting for Stock-Based Compensation — Transition and Disclosure — an amendment of FASB Statement No. 123.”

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Pro Forma Stock-Based Compensation

     Accumulated Other Comprehensive Income — The components of and changes in accumulated other comprehensive income are as follows:

Accumulated Other Comprehensive Income

     Cumulative Effect of Change in Accounting Principles — We adopted the provisions of EITF Issue 02-03 (“EITF 02-03”), “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and for Contracts Involved in Energy Trading and Risk Management Activities,” that required new non-derivative energy trading contracts entered into after October 25, 2002 to be accounted for under the accrual accounting basis. Non-derivative energy trading contracts recorded in the Consolidated Balance Sheet as of January 1, 2003 that existed at October 25, 2002 and inventories that were recorded at fair value were adjusted to historical cost via a cumulative effect adjustment of $5 million as a reduction to earnings in the first quarter of 2003.

     We adopted the provisions of SFAS No. 143 (“SFAS 143”), “Accounting for Asset Retirement Obligations,” as of January 1, 2003 which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. In accordance with the transition provisions of SFAS 143, we recorded a cumulative effect adjustment of $18 million as a reduction to earnings in the first quarter of 2003.

     New Accounting Standards — In May 2003, the FASB issued SFAS No. 150 (“SFAS 150”), “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” including the deferral of certain effective dates as a result of the provisions of FASB Staff Position 150-3, “Effective Date, Disclosures, and Transition for Mandatorily Redeemable Noncontrolling Interests Under FASB Statement No. 150, ‘Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity’.” SFAS 150 requires that certain financial instruments that could previously be accounted for as equity, be classified as liabilities in the consolidated balance sheets and initially recorded at fair value. In addition to its requirements for the classification and measurement of financial instruments in its scope, SFAS 150 also requires disclosures about the nature and terms of the financial instruments and about alternative ways of settling the instruments. Upon adoption on July 1, 2003, we reclassified our preferred members’ interest, which were mandatorily redeemable, of $200 million from mezzanine equity to long term debt and prospectively classified accrued or paid distributions on these securities, which had previously been classified as dividends, as interest expense. During 2003, we redeemed the remaining $200 million of these securities in cash.

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     In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities” which requires the primary beneficiary of a variable interest entity’s activities to consolidate the variable interest entity. We adopted the provisions of FIN 46 and its related interpretations (“FIN 46R”) in the first quarter of 2004. As a result, we consolidated one entity, previously accounted for under the equity method of accounting, on January 1, 2004. This entity, which is a substantive entity, had total assets of approximately $92 million as of January 1, 2004. Adoption of FIN 46R had no material effect on our consolidated results of operations, cash flows or financial position.

     In July 2003, the EITF reached consensus in EITF Issue No. 03-11 (“EITF 03-11”), “Reporting Realized Gains and Losses on Derivative Instruments that are Subject to FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, and Not Held for Trading Purposes,” that determining whether realized gains and losses on derivative contracts not held for trading purposes should be reported on a net or gross basis is a matter of judgment that depends on the relevant facts and circumstances. In analyzing the facts and circumstances, EITF 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent” and Opinion No. 29, “Accounting for Nonmonetary Transactions,” should be considered. EITF 03-11 is effective for transactions or arrangements entered into after September 30, 2003. The adoption of EITF 03-11 had no material effect on our consolidated results of operations, cash flows or financial position.

     In May 2003, the EITF reached consensus in EITF Issue No. 01-08 (“EITF 01-08”), “Determining Whether an Arrangement Contains a Lease,” to clarify the requirements of identifying whether an arrangement should be accounted for as a lease at its inception. The guidance in the consensus is designed to mandate reporting revenue as rental or leasing income that otherwise would be reported as part of product sales or service revenue. EITF 01-08 requires both parties to an arrangement to determine whether a service contract or similar arrangement is or includes a lease within the scope of SFAS No. 13, “Accounting for Leases.” The consensus is to be applied prospectively to arrangements agreed to, modified, or acquired in business combinations in fiscal periods beginning on July 1, 2003. The adoption of EITF 01-08 had no material effect on our consolidated results of operations, cash flows or financial position.

     Reclassifications — Certain prior period amounts have been reclassified in the Consolidated Financial Statements to conform to the current period presentation. Included in the reclassified amounts are increases in both Sales of natural gas and petroleum products and in Purchases of natural gas and petroleum products in the amount of approximately $223 million and $459 million, respectively, for the three and six months ended June 30, 2003. This reclassification resulted from intersegment trading activities being eliminated twice from the Consolidated Statements of Operations during the six months ended June 30, 2003. Management has concluded that these reclassifications are not material to the fair presentation of our financial statements.

3. Acquisitions and Dispositions

     On March 10, 2004, we entered into an agreement to acquire gathering, processing and transmission assets in Southeast New Mexico from ConocoPhillips, a related party, for a total purchase price of approximately $80 million, consisting of $74 million in cash and the assumption of approximately $6 million of liabilities. The transaction closed during the second quarter of 2004.

     In February 2004, we sold gas gathering and processing plant assets in West Texas to a third party purchaser for a sales price of approximately $62 million. These assets comprised a component of the Company for purposes of reporting discontinued operations. All prior period operations have been revised to reflect these assets as discontinued operations.

     During the six months ended June 30, 2003, we sold gathering, transmission and processing assets to two separate buyers for a combined sales price of approximately $90 million. These assets comprised a component of the Company for purposes of reporting discontinued operations. All prior period operations have been revised to reflect these assets as discontinued operations.

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     The following table sets forth selected financial information associated with the assets discussed above which are accounted for as discontinued operations:

4. Derivative Instruments, Hedging Activities and Credit Risk

     Commodity cash flow hedges — We may, from time to time, use cash flow hedges, as specifically defined by SFAS 133, to reduce the potential negative impact that commodity price changes could have on our earnings and ability to adequately plan for cash needed for debt service, capital expenditures and tax distributions.

     We use natural gas, crude oil and NGL swaps to hedge the impact of market fluctuations in the prices of NGL, natural gas and other energy-related products. For the three and six months ended June 30, 2004, the recognition in the Consolidated Statements of Operations of the cumulative changes in the fair value of these hedge instruments reduced revenues by $23 million and $41 million, respectively, compared to $24 million and $63 million, respectively, in the same periods of 2003. The above changes in the fair value of these hedge instruments include the effects of any ineffectiveness, which for the six months ended June 30, 2004 and 2003, were a $1 million gain and a $3 million loss, respectively. No derivative gains or losses were reclassified from AOCI to current period earnings as a result of the discontinuance of cash flow hedges related to any forecasted transactions that are not probable of occurring.

     Gains and losses on derivative contracts that are reclassified from AOCI to current period earnings are included in the line item in which the hedged item is recorded. As of June 30, 2004, $16 million of the remaining deferred net losses on derivative instruments in AOCI are expected to be reclassified into earnings within the next 12 months as the hedged transactions occur; however, due to the volatility of the commodities markets,