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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
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the period from January 1, 1999 to December 31, 1999
Commission File Number 1-14161
KEYSPAN CORPORATION
(Exact name of registrant as specified in its charter)
NEW YORK 11-3431358
(State or other jurisdiction of incorporation (I.R.S.)employer
or organization identification no.)
175 EAST OLD COUNTRY ROAD, HICKSVILLE, NEW YORK 11801
ONE METROTECH CENTER, BROOKLYN, NEW YORK 11201
(Address of principal executive offices) (Zip code)
(516) 755-6650 (HICKSVILLE)
(718) 403-1000 (BROOKLYN)
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
Common Stock, $.01 par value New York Stock Exchange
Pacific Stock Exchange
Series AA Preferred Stock, $25 par value New York Stock Exchange
Pacific Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
None
(Title of class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes. X No.
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |_|
As of March 1, 2000, the aggregate market value of the common stock held
by non-affiliates (129,408,442 shares) of the registrant was 2,628,608,978
(based on the closing price, on such date, of $20.3125 per share).
As of March 1, 2000, there were 133,876,426 shares of common stock, $.01
par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement dated on or about March 27, 2000 is incorporated by reference
into Part III hereof.
1
KEYSPAN CORPORATION D/B/A KEYSPAN ENERGY
INDEX TO FORM 10-K
Page
PART I
Item 1. Business................................................................
Item 2. Properties..............................................................
Item 3. Legal Proceedings.......................................................
Item 4. Submission of Matters to a Vote of Security Holders.....................
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Item 6. Selected Financial Data.................................................
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations...........................................................
Item 7A. Quantitative and Qualitative Disclosures About Market Risk..............
Item 8. Financial Statements and Supplementary Data.............................
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure....................................................
PART III
Item 10. Directors and Executive Officers of the Registrant......................
Item 11. Executive Compensation..................................................
Item 12. Security Ownership of Certain Beneficial Owners and Management
Item 13. Certain Relationships and Related Transactions..........................
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.........
2
PART I
ITEM 1. BUSINESS
OVERVIEW
KeySpan Corporation d/b/a KeySpan Energy (the "Company" or "KeySpan Energy")
provides a range of energy-related services through operations and investments
in selected areas of the energy industry. The Company is the fourth largest gas
utility in the United States with approximately 1.6 million customers in New
York City and Long Island. The Company engages in three core downstream
businesses: natural gas distribution, electric services and energy-related
services. It also competes in two additional lines of business: gas exploration
and production and select energy- related investments.
The Company was formed to facilitate the combination (the "Combination"),
completed on May 28, 1998, of KeySpan Energy Corporation ("KSE") and its
principal subsidiary, The Brooklyn Union Gas Company ("Brooklyn Union") and the
non-nuclear electric generation and natural gas distribution businesses of the
Long Island Lighting Company ("LILCO"). To effect the Combination, all of the
assets used by LILCO in connection with its gas distribution business, its
non-nuclear electric generation business and the assets common to its prior
operations (the "Transferred Assets") were transferred to the Company. The Long
Island Power Authority ("LIPA") then acquired all of the common stock of LILCO
for approximately $2.5 billion in cash and the direct or indirect assumption of
certain liabilities. The Company sold to the former holders of LILCO common
stock, shares of the Company's common stock and then acquired KSE by merger with
a wholly-owned subsidiary of the Company in exchange for shares of the Company's
common stock.
The assets of LILCO not transferred to the Company (the "Retained Assets") were
retained by LIPA and primarily consist of LILCO's electric transmission and
distribution ("T&D") system located on Long Island, its 18% ownership interest
in Nine Mile Point Nuclear Power Station, Unit 2 ("NMP2"), located in upstate
New York, and certain of LILCO's regulatory assets and liabilities associated
with its electric business.
The Company was organized as a corporation under New York law in 1998. Brooklyn
Union was formed in 1895 through the consolidation of several existing
companies, the oldest of which commenced operations in 1849, providing gas
distribution services throughout the New York City Boroughs of Brooklyn, Staten
Island and most of Queens, New York. LILCO was organized in 1910 to provide
electric and gas services in the Long Island counties of Nassau and Suffolk and
the Rockaway peninsula in the Borough of Queens, all in New York.
In November 1999, the Company and Eastern Enterprises ("Eastern") announced that
they had signed a definitive merger agreement under which the Company will
acquire all of the common stock of Eastern for $64.00 per share in cash (the
"K/E Transaction"). Through its subsidiaries, Eastern is the largest gas utility
in New England. It owns and operates Boston Gas Company, Colonial Gas
3
Company and Essex Gas Company, all of which are natural gas distribution
companies operating in Massachusetts.
Boston Gas Company is a regulated utility that distributes natural gas in
eastern and central Massachusetts, and also sells natural gas for resale in
Massachusetts. Boston Gas has been wholly- owned by Eastern since 1929 and has
been in business for 177 years, making it the second oldest gas company in the
United States. Colonial Gas Company also is a regulated utility that distributes
natural gas in Cape Cod and eastern Massachusetts. Colonial Gas has been in
business for 150 years and was acquired by eastern in August 1999. Essex Gas
Company also is a regulated utility that distributes natural gas in eastern
Massachusetts. Essex Gas has been in business for 146 years and was acquired by
Eastern in September 1998.
Eastern also owns Midland Enterprises Inc., the second largest independent
operator of tow boats and barges on the nations inland river system; Transgas
Inc., an unregulated energy trucking company and ServicEdge Partners, Inc.,
which is engaged in heating, ventilation and air conditioning ("HVAC")
installation and maintenance. At December 31, 1999, Eastern had total assets of
$2.0 billion; long-term debt and preferred stock of $515.2 million; common
shareholders equity of $754.6 million; gross revenues of $978.7 million of which
$690.8 million (or approximately 71%) were derived from regulated gas sales and
gas transportation; operating earnings of $113.4 million; and earnings before
extraordinary items of $55.1 million.
In July 1999, Eastern announced that it had entered into an agreement to acquire
EnergyNorth Inc., owner of New Hampshire's largest natural gas distributor,
Energy North Natural Gas, Inc. ("Energy North"). Energy North is located across
the border from, but contiguous to, areas served by Eastern's gas distribution
subsidiaries. In connection with the Company's acquisition of Eastern, Eastern
has amended its agreement with EnergyNorth Inc. to provide for an all cash
acquisition of EnergyNorth Inc. shares at a price per share of $61.13. The
restructured EnergyNorth Inc. merger is expected to close contemporaneously with
the K/E Transaction (collectively, the K/E Transaction and the restructured
EnergyNorth Inc.'s merger are referred to as the "Eastern Transaction").
The Eastern Transaction is conditioned upon, among other things, the approval of
Eastern's shareholders, the Securities and Exchange Commission (the "SEC") and
the New Hampshire Public Utility Commission. The Company anticipates that the
transaction will be completed in the third or fourth quarter of 2000, but is
unable to determine when or whether all of the required approvals will be
obtained.
The Eastern transaction has a total value of approximately $2.5 billion ($1.7
billion in equity and $0.8 billion in assumed debt and preferred stock).
With the consummation of the Eastern Transaction, the Company will become a
registered holding company under the Public Utility Holding Company Act of 1935,
as amended ("PUHCA"). As such, the corporate and financial activities of the
Company and its subsidiaries, including the ability of each such entity to pay
dividends, will be subject to regulation of the SEC.
The increased size and scope of the combined organization should enable the
combined company to: provide enhanced, cost-effective customer service;
capitalize on the above-average growth
4
opportunities for natural gas in the Northeast; and provide additional resources
to the Company's unregulated businesses. The combined company will serve
approximately 2.4 million customers and will be the largest gas distributor in
the Northeast.
As used herein, the "Company" or "KeySpan Energy" refers to KeySpan Corporation
d/b/a KeySpan Energy, Brooklyn Union and KeySpan Gas East Corporation d/b/a
Brooklyn Union of Long Island ("Brooklyn Union of Long Island"), its two
principal gas distribution subsidiaries, and its other subsidiaries,
individually and in the aggregate. In 1998, the Company changed its fiscal year
end from March 31 to December 31. For financial reporting purposes, financial
statements included, or incorporated by reference, herein for the period ending
December 31, 1998 are for the nine months then ended and have been prepared on
the basis that LILCO was deemed the acquiring company in the Combination for
financial reporting purposes. Unless otherwise specified, other information
contained in Part I hereof, for the twelve month periods ended December 31, 1998
and 1997, has been compiled on a combined basis ("Combined Company Basis") to
aggregate the information shown for both KSE and LILCO. Additional information
about the Company's industry segments is contained in Note 2 to the Consolidated
Financial Statements, "Business Segments" included herein and incorporated by
reference thereto.
Certain statements contained in this Annual Report on Form 10-K concerning
expectations, beliefs, plans, objectives, goals, strategies, future events or
performance and underlying assumptions and other statements which are other than
statements of historical facts, are "forward-looking statements" within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended.
Without limiting the foregoing, all statements under the captions "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Item 7A. Quantitative and Qualitative Disclosures About Market
Risk" relating to the Company's future outlook, anticipated capital
expenditures, future cash flows and borrowings, pursuit of potential future
acquisition opportunities and sources of funding are forward-looking statements.
Such forward-looking statements reflect numerous assumptions and involve a
number of risks and uncertainties and actual results may differ materially from
those discussed in such statements. Among the factors that could cause actual
results to differ materially are: available sources and cost of fuel; federal
and state regulatory initiatives that increase competition, threaten cost and
investment recovery, and impact rate structures; the ability of the Company to
successfully reduce its cost structure; the successful integration of the
Company's subsidiaries, including the Eastern Transaction companies; the degree
to which the Company develops unregulated business ventures; the ability of the
Company to identify and make complementary acquisitions, as well as the
successful integration of such acquisitions; inflationary trends and interest
rates; and other risks detailed from time to time in other reports and other
documents filed by the Company with the SEC. For any of these statements, the
Company claims the protection of the safe harbor for forward-looking information
contained in the Private Securities Litigation Reform Act of 1995, as amended.
For additional discussion on these risks, uncertainties and assumptions, see
"Item 1. Business," "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Item 7A. Quantitative and Qualitative
Disclosures About Market Risk" contained herein.
The Company's principal executive offices are located at One MetroTech Center,
Brooklyn, New York 11201 and 175 East Old Country Road, Hicksville, New York
11801 and its telephone
5
numbers are (718) 403-1000 (Brooklyn) and (516) 755-6650 (Hicksville). Financial
and other information is also available through the World Wide Web at
http://www.keyspanenergy.com.
BUSINESS STRATEGY
The Company seeks to become the premier energy and services company in the
Northeastern United States, delivering energy, products and services to people
at their homes and businesses. The Company engages in three core downstream
businesses: natural gas distribution, electric services and energy-related
services primarily focused in the Northeast. It also competes in two additional
lines of business: gas exploration and production and select energy-related
investments, which include investments in select energy markets or regions,
including the Gulf of Mexico, Western Canada and Northern Ireland. The Company
intends to grow through investments in its core businesses and other
energy-related activities; by expanding its gas distribution business through
the completion of the Eastern Transaction and the continued penetration of the
Long Island gas market; by emphasizing superior customer service; and by taking
advantage of the increasing trend towards deregulation and competition to offer
an expanded array of energy services to its customers.
Key elements of the Company's business strategy include:
INVESTMENTS IN CORE BUSINESSES AND ENERGY-RELATED ACTIVITIES. In recent years,
the Company has made a number of acquisitions and energy-related investments
designed to enhance its presence in the Northeastern United States. On June 18,
1999, the Company acquired the 2,168 megawatt Ravenswood electric generating
plant (the "Ravenswood Facility") located in Long Island City, Queens, New York
City. The Company's total power generation capacity, including its Long Island
generation, now approximates 6,200 megawatts, making it one of the largest power
generators in the region.
As previously noted, on November 4, 1999, the Company entered into a definitive
merger agreement with Eastern to acquire all of its common stock. The Eastern
Transaction will increase the number of gas distribution utilities owned by the
Company, to include Boston Gas Company, Colonial Gas Company, Essex Gas Company
and EnergyNorth, resulting in the Company being the largest gas distributor in
the Northeast serving approximately 2.4 million customers.
The Company has also expanded its unregulated energy services operations in the
Northeast, through several significant acquisitions, including one of the
largest heating, ventilation and air conditioning ("HVAC") contractors in the
state of Rhode Island and a New Jersey based HVAC contractor. Further, in
February 2000, the Company acquired additional companies. For information
concerning these acquisitions, see Note 2 to the Consolidated Financial
Statements, "Business Segment."
Consistent with the Company's strategy to make investments in certain select
markets outside of the Northeast, the Company made two additional investments in
Western Canada. In September 1999, the Company acquired a 37% interest in the
Paddle River gas processing plant and associated gathering systems ("Paddle
River"); and in December 1999, the Company acquired certain oil properties in
Alberta, Canada.
6
These acquisitions and energy-related investments reflect the Company's
commitment to enhancing its presence as an energy and service company focused
primarily on the customer-oriented segment of the energy market in the
Northeastern United States, with additional complementary interests in the Gulf
of Mexico and Western Canadian supply basins, as well as Northern Ireland.
EXPANDED GAS DISTRIBUTION SERVICES. The Company has achieved a high degree of
penetration in its Brooklyn Union service territory, with approximately 79% of
all one and two family homes currently using natural gas for space heating. In
contrast, only 28% of one and two family homes in Brooklyn Union of Long
Island's service territory currently use natural gas for space heating. The
Company believes that there remains a significant opportunity for increased gas
heating penetration of the Long Island service territory and continues to make
capital expenditures to expand its gas distribution infrastructure in this area
in order to maximize long-term growth objectives while enhancing shareholder
value. In addition, the Company expects to provide a focused marketing effort in
both service territories, in an attempt to capitalize on the current substantial
price advantage that natural gas enjoys over competing fuel oil in residential
and small commercial markets in the metropolitan New York City - Long Island
area. Examples of focused marketing programs include concentrated efforts to
convert current non-heating natural gas customers, which would require little or
minimal capital investment; continued targeting of the new construction segments
where natural gas heating is the preferred choice; and conversion to gas of
small to medium size commercial businesses and large volume dual-fuel customers.
SUPERIOR CUSTOMER SERVICE. The Company's utility operations have an outstanding
reputation for customer service and have consistently received excellent marks
for customer loyalty and satisfaction, as measured by independent
customer-satisfaction specialists. In 1999, for the second consecutive year,
Brooklyn Union was awarded the Brand Keys Customer Loyalty Award, as the United
States energy provider that had achieved the highest level of success in
anticipating and exceeding customer expectations.
The Company was also recognized for its outstanding commitment to the community.
In 1999, Brooklyn Union was honored by the New York City Council on the 30th
Anniversary of its Cinderella Program, which has contributed to the development
of more than 10,000 units of residential housing as well as the revitalization
of commercial facilities in Brooklyn, Queens, and Staten Island.
During 1999, Chairman and Chief Executive Officer, Robert B. Catell, received
the American Gas Association's Distinguished Service Award, the association's
highest honor. In addition, in its Century of Power edition, Energy Markets
Magazine honored Chairman and CEO Robert B. Catell as one of the 20th Century's
100 most influential people in gas and electricity. Mr. Catell was cited for his
role in helping to integrate U.S. and Canadian gas lines to supply natural gas
in the Northeast through the Iroquois Transmission System.
The Company intends to continue to emphasize superior customer service, both to
differentiate itself from competitors as markets become increasingly deregulated
and to take advantage of selling opportunities available for complementary
energy-related services such as appliance repair and energy system installation
and management.
7
EXPANDED SERVICES. With its strong market presence in the metropolitan New York
City -Long Island area, the Company believes it is well-positioned to provide
customers with an expanded array of energy-related services. In recent years,
the Company offered gas and electric marketing services throughout New York,
Connecticut, New Jersey, Maryland, Delaware, Pennsylvania and Ohio and appliance
repair, energy management, and related services for residential, commercial and
industrial customers throughout the metropolitan New York City - Long Island
area, as well as in Rhode Island. The Company owns a fiber optic
telecommunications network consisting in excess of 350 miles of fiber optics on
Long Island and, in addition to use in its operations, it provides use of the
network to local carriers. The Company also has become the exclusive provider of
residential fuel cell units distributed on behalf of a joint venture between GE
MicroGen, a subsidiary of General Electric Power Systems and Plug Power in New
York City and Long Island and is the authorized service provider for PC25(TM)
natural-gas-powered fuel cells manufactured by International Fuel Cells
(IFC)/ONSI(R) Corporation, subsidiaries of United Technologies, in the New York
metropolitan area. The Company believes that its investments in the fiber optic
network and fuel cells provide increased growth opportunities for the Company in
new and developing technologies.
INDUSTRY AND COMPETITION
The electric and natural gas sectors of the regulated energy industry are
undergoing significant change, as market forces are moving towards replacing or
supplementing rate regulation as a means of controlling prices for natural gas
and electricity. Competition also presents utilities with greater opportunities
to manage the cost of their natural gas and electric supplies, and through
unregulated affiliates, to earn profits on energy sales and to expand their
business activities.
Historically, government regulation served both to control prices in the natural
gas and electric sectors of the energy industry and to substantially shield
industry participants from competition. The natural gas sector was segmented
into three regulated parts: production; interstate transportation; and
franchised retail sales and local distribution. The electric sector featured
vertically integrated utilities providing generation, transmission and
distribution services for their franchised service territories. Under
traditional rate regulation, utilities were provided the opportunity to earn a
fair, but regulated, return on invested capital in exchange for a commitment to
serve all customers within a franchised service territory. An extensive and
complex regime for the regulation of public utility companies and public utility
holding companies limited natural gas and electric utilities' opportunities for
geographic expansion and business diversification.
Between the 1930's and the late 1970's, federal and state energy regulatory
policies remained relatively stable, and the structure of the regulated energy
industry changed little. However, after the energy crises in the 1970's, new
legislation and changes in regulatory policy set in motion competitive forces
that are continuing to reshape the energy industry.
Beginning in 1978 with federal legislation that authorized the phased
deregulation of wellhead natural gas prices and the establishment of unregulated
electric generation companies, competition has been increasingly introduced into
segments of the regulated energy industry. To foster competition, federal
regulators adopted "open access" rules which required interstate natural gas
pipelines and electric transmission systems to "unbundle" wholesale sales, I.E.,
the sale of gas or electricity for resale, from transportation and transmission
services. Open access also required
8
interstate gas pipelines and electric utilities, for the first time, to provide
transportation and transmission service on a non-discriminatory basis to all
qualified customers. Recent initiatives also permit market forces, rather than
regulation, to establish rates charged under short-term contracts for interstate
natural gas transportation and to determine the allocation of increased
electricity costs that result when electric transmission constraints prevent
lower priced electricity from reaching electric customers. By enabling natural
gas producers and electric generators to reach new markets, open access policies
have led to intensified competition in wholesale markets and are altering the
geographic character of the industry. No longer typified by isolated local
companies, the natural gas and electric sectors in many parts of the country
include a growing number of firms with regional, national and international
dimensions.
Parallel changes in the regulation of retail electric and gas markets are being
implemented by many state public utility commissions, including the Public
Service Commission of the State of New York ("NYPSC"). On a state-by-state
basis, initially in the Northeast, Mid-Atlantic and California, and now
spreading to other regions, local franchised utilities are being required to
separate their marketing and retail sales businesses from the physical
distribution of natural gas and electricity through pipes and wires. Just as at
the federal level, distribution services are increasingly required to be
unbundled from retail sales, and made available on a non-discriminatory open
access basis to all qualified retail customers. Retail natural gas and
electricity marketers are being permitted to compete for energy customers in
what were formerly exclusive service territories of electric and natural gas
utilities. However, natural gas and electric utilities are likely to remain
exclusive providers of unbundled distribution services through pipes and wires,
and may remain obligated to continue to sell natural gas or electricity to
customers who do not select other suppliers.
In New York State, large-volume retail customers have been able to purchase
natural gas supplies directly from non-utility vendors for about 15 years, while
direct sales to aggregations of small customers have been permitted since 1996.
New York regulators have commenced initiatives to further enhance retail
competition in the state. In November 1998, the NYPSC issued a policy statement
setting forth its vision for furthering competition in the natural gas industry
and requesting that each of the gas utility subsidiaries file a restructuring
proposal. In response, the Company's two gas distribution utility subsidiaries
filed their restructuring proposal with the NYPSC in October 1999. For
additional discussion on gas deregulation, see "NYPSC Regulation."
Similarly, the NYPSC has been encouraging the development of retail competition
in the electric sector in New York. In the past three years, electric utilities
have begun to unbundle electric sales from retail distribution services, open
their franchised territories to competitors, transfer control over their
transmission systems to an independent system operator, and divest many of their
generating plants. Several New York investor-owned utilities have divested their
non-nuclear generating plants, including Consolidated Edison Company of New
York, Inc. ("Con Edison"). In response to a divestiture plan by Con Edison, in
June 1999, the Company completed the acquisition of the Ravenswood Facility from
Con Edison, as discussed under the heading "The Company - Electric Services."
The Company's electric operations on Long Island are governed by a service
agreement with LIPA, discussed in greater detail below, and FERC. This agreement
generally provides for recovery of all costs of production, operation and
maintenance, and capital improvements, subject to certain
9
incentive provisions. Also, since Long Island is considered a "load pocket,"
I.E., there are insufficient transmission ties to permit a significant amount of
energy to be transported into Long Island, at this time, the Company faces
minimal competitive pressures associated with its electric operations on Long
Island.
As indicated, the Company also has electric operations in New York City. The
Company currently bids and sells the energy produced by the Ravenswood Facility
through bidding it into the energy market operated by the New York Independent
System Operator ("NYISO"). Further, the Company has a capacity contract with Con
Edison, which provides Con Edison with 100% of the available capacity of the
Ravenswood Facility. The Company anticipates that this contract will expire on
April 30, 2000, at which time the available capacity of the Ravenswood Facility
will be bid into the capacity auction conducted by the NYISO. New York City
local reliability rules currently require that 80% of the electric capacity
needs of New York City is to be provided by "in-city" generators. The Company
expects that the current New York City reliability rules will remain in effect
through at least 2000. However, in the future, should new, more efficient
electric power plants be built in New York City and/or the in-city capacity
requirements be modified, the capacity and energy sales quantities of the
Ravenswood Facility could be adversely affected. The Company can not predict,
however, when or if new power plants will be built or the nature of future New
York City requirements.
A significant number of natural gas and electric utilities have reacted to the
changing structure of the regulated energy industry by entering into business
combinations, with the goal of reducing common costs, gaining size to better
withstand competitive pressures and business cycles, and attaining synergies
from the combination of electric and natural gas operations. The Combination and
related transactions which resulted in the formation of the Company, as well as
the pending Eastern Transaction, illustrate these attributes.
The transformation of the energy industry is an ongoing process. Larger
regional, national and international companies are being formed through
acquisitions and mergers. The remaining legal barriers to interregional natural
gas and electric distribution companies, which have been relaxed as the result
of regulatory decisions, are the subject of legislative proposals calling for
repeal or substantial modifications. The advent of industry restructuring has
meant that regional, national and international companies are increasingly
offering energy consumers a wide array of choices as to the supply, type,
quality and cost of natural gas and electric services as well as other services,
such as telecommunications and cable. For the Company, industry restructuring
means increased opportunities to enter new markets and pressures to manage its
costs of doing business.
THE COMPANY
GAS DISTRIBUTION
OVERVIEW
The Company sells, distributes and transports natural gas in two separate, but
contiguous service territories of approximately 1,417 square miles in the
aggregate in the New York City - Long Island metropolitan area. The Company owns
and operates gas distribution, transmission and storage
10
systems that consist of approximately 10,146 miles of distribution pipelines,
576 miles of transmission pipelines and two gas storage facilities. The Company
serves approximately 1.6 million customers, of which approximately 1.5 million,
or 94%, are residential. Gas is offered for sale to residential customers on a
"firm" basis, and to commercial and industrial customers on a "firm" or
"interruptible" basis. "Firm" service is offered to customers under schedules or
contracts which anticipate no interruptions, whereas "interruptible" service is
offered to customers under schedules or contracts which anticipate and permit
interruption on short notice, generally in peak- load seasons. Gas is available
at any time of the year on an interruptible basis, if the supply is sufficient
and the supply system is adequate. The Company also participates in the
interstate markets by releasing pipeline capacity or bundling pipeline capacity
with gas for "off-system" sales. An "off- system" customer consumes gas at
facilities located outside the Company's service territories, by connecting to
the Company's facilities or one of its transporter's facilities, at a point of
delivery agreed to by the Company and the customer. The Company purchases its
natural gas for sale to its customers under long-term supply contracts and
short-term spot contracts. Such gas is transported under both firm and
interruptible transportation contracts. In addition, the Company has commitments
for the provision of gas storage capability and peaking supplies.
For the year ended December 31, 1999, gas revenues were $1.753 billion, or 59%
of the Company's revenues, and gas operating income was $308.4 million.
The gas operations of the Company can be significantly affected by seasonal
weather conditions. Traditionally, annual revenues are substantially realized
during the heating season as a result of higher sales of gas due to cold
weather. Accordingly, operating results historically are most favorable in the
first and fourth calendar quarters. However, the Company's gas utility tariffs
contain weather normalization adjustments that provide for recovery from or
refund to firm customers of material shortfalls or excesses of firm net revenues
(revenues less applicable gas costs, if any) during a heating season due to
variations from normal weather. For additional discussion, see "Regulation and
Rate Matters" below.
SALES AND DISTRIBUTION
The Company is the fourth largest gas distribution company in the United States,
providing, through its gas distribution subsidiaries, natural gas sales and
transportation services to customers in the New York City Boroughs of Brooklyn,
Queens and Staten Island and the Long Island counties of Nassau and Suffolk.
11
Gas sales and revenues for 1999 by class of customer are set forth below:
Revenues
Sales Revenues (% of
Customer (MDTH) (thousands of $) Total)
- -------------------------------------------- ----------- ----------------- ---------------
FIRM
Residential Heating......................... 102,135 976,193 55.68
Residential Non-Heating..................... 9,916 192,810 11.00
Temperature-Controlled heating.............. 31,112 137,422 1.84
Commercial/Industrial....................... 28,856 226,675 12.93
----------- ----------------- ---------------
Total Firm.................................. 172,019 1,533,100 87.45
----------- ----------------- ---------------
Firm Transportation......................... 21,249 88,168 5.03
Transportation - Electric Generation........ 82,503 15,150 0.86
----------- ----------------- ---------------
Total Firm Transportation................... 103,752 103,318 5.89
----------- ----------------- ---------------
Total Firm Gas Sales and Transportation... 275,771 1,636,418 93.34
INTERRUPTIBLE............................... 10,903 32,825 1.87
OFF-SYSTEM SALES............................ 14,323 32,006 1.83
TRANSPORTATION.............................. 29,435 11,492 .66
----------- ----------------- ---------------
Total Gas Sales and Transportation........ 330,432 1,712,741 97.70
OTHER RETAIL SERVICES....................... N/A 40,391 2.30
Total Sales and Revenues*................. 330,432 1,753,132 100.00
<
=========== ================= ===============
- -----------------------
*Excludes lost and unaccounted for gas.
Set forth below is information, on a Combined Company Basis, concerning certain
operating statistics applicable to the Company's gas distribution business:
1999 1998 1997
-------------- -------------- --------------
Revenues ($000)............................. 1,753,132 1,766,949 1,991,793
Net Income ($000)........................... 151,217 133,685 * 134,403
Firm Gas Sales and Transportation (MDTH).... 193,268 179,305 203,587
Transportation - Electric Generation (MDTH). 82,503 40,614 --
Other Deliveries (MDTH)..................... 54,661 65,482 73,132
Heating customers........................... 677,000 665,000 657,000
Degree Days, Cooler (Warmer) than Normal %.. (10.0) (17.5) 0.2
Capital Expenditures ($000)................. 213,845 181,700 178,651
- -----------------------
*Excludes non-recurring and special charges associated with the Combination.
-An MDTH is 10,000 therms (British Thermal Units) and reflects the heating
content of approximately one million cubic feet of gas. A therm reflects the
heating content of approximately 100 cubic feet of gas.
The Company sells gas to its firm gas customers at the Company's cost for such
gas, plus a charge designed to recover the costs of distribution (including a
return of and a return on invested capital). The Company shares with its firm
gas customers net revenues (operating revenues less the cost of gas purchased
for resale) from off-system sales and, in addition, Brooklyn Union of Long
Island credits its firm gas customers net revenues from on-system interruptible
gas sales, thereby reducing its rates to these firm customers.
12
The yearly variations in firm gas sales and transportation quantities is due,
primarily, to variations in weather between the periods presented. Measured in
annual degree days, weather was 10% warmer than normal in 1999, 17.5% warmer
than normal in 1998 and 0.2% colder than normal in 1997. After normalizing for
weather, firm sales volumes increased by 2.4% in 1999, as compared to 1998. Firm
sales quantities, after normalizing for weather, were approximately the same in
1998 as compared to 1997.
Transportation volumes related to electric generation, reflect the
transportation of gas to the Company's electric generating facilities located on
Long Island. The Company has been reporting these quantities since the
Combination.
The decrease in other deliveries in all periods is primarily due to the
discontinuance by Brooklyn Union of its off-system sales program in April 1998.
The program was replaced by a management agreement with Enron Capital and Trade
Resources Corp. For a further discussion and additional information on this
agreement, see "Supply and Storage."
For additional details on gas revenues, gas sales quantities and market
saturation, see Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.
SUPPLY AND STORAGE
The Company has contracts for the purchase of firm long-term transportation and
storage services. The Company's gas supplies are purchased under long-term
contracts and on the spot market and are transported by interstate pipelines
from domestic and Canadian sources. Storage and peaking supplies are available
to meet system requirements during winter periods.
Regulatory actions, economic factors and changes in customers and their
preferences continue to reshape the Company's gas operations markets. A number
of multi-family, commercial and industrial customers and a growing number of
residential customers currently purchase their gas supplies from natural gas
marketers and then contract with the Company for local transportation, balancing
and other unbundled services. Since these customers are no longer reliant on the
Company for sales service, the quantity of gas that the Company must obtain to
meet remaining sales customers' requirements has been reduced. This trend is
likely to continue as state regulators continue to implement policies designed
to encourage customers to purchase their gas from suppliers other than the
traditional gas utilities. In October 1999, the Company filed a proposal with
the NYPSC consistent with the NYPSC's policy objective of local distribution
companies ending their role as providers of merchant sales service for the
natural gas commodity. For further information, see "NYPSC Regulation" below.
PEAK-DAY CAPABILITY. The design criteria for the Company's gas system assumes an
average temperature of 0(0)F for peak-day demand. Under such criteria, the
Company estimates that the requirements to supply its firm gas customers would
amount to approximately 1,863 MDTH of gas for a peak-day during the 1999/2000
winter season and that the gas supplies available to the Company on such a
peak-day amounts to approximately 2,033 MDTH. For the 2000/2001 winter season,
the Company estimates that the peak-day requirements would amount to
approximately 1,904 MDTH and that the gas supplies available to the Company on
such a peak day amounts to
13
approximately 2,033 MDTH. The 1999/2000 winter peak-day throughput to the
Company's customers was 1,721 MDTH, which occurred on January 17, 2000, at an
average temperature of 9 degrees Fahrenheit, representing 85% of the Company's
per day capability at that time. The Company had sufficient gas available to
meet the requirements of firm gas customers for the 1999/2000 winter season, and
projects that it also will have sufficient gas supply available to meet such
requirements for the 2000/2001 winter season. The Company's firm gas peak-day
capability is summarized in the following table:
Source MDTH per day % of Total
Pipeline.................... 750 37
Underground Storage......... 779 38
Peaking Supplies............ 504 25
Total................... 2,033 100
=============== ===============
PIPELINES. The Company purchases natural gas for sale to its customers under
contracts with suppliers located in domestic and Canadian supply basins and
arranges for its transportation to the Company's facilities under firm long-term
contracts with interstate pipeline companies. For the 1999/2000 winter,
approximately 78% of the Company's natural gas supply was available from
domestic sources and 22% from Canadian sources. The Company has available under
firm contract 750 MDTH per day of year-round and seasonal pipeline
transportation capacity to its facilities in the New York City metropolitan
area. Major providers of interstate pipeline capacity and related services to
the Company include: Transcontinental Gas Pipe Line Corporation ("Transco"),
Texas Eastern Transmission Corporation ("Texas Eastern"), Iroquois Gas
Transmission System ("Iroquois"), Tennessee Gas Pipeline Company ("Tennessee"),
CNG Transmission Corporation ("CNG") and Texas Gas Transmission Company ("Texas
Gas").
STORAGE. In order to meet higher winter demand, the Company also has long-term
contracts with Transco, Texas Eastern, Tennessee, CNG, Equitrans, Inc.,
Hattiesburg First Reserve and Honeoye Storage Corporation, for underground
storage capacity of 58,935 MDTH for the winter season, with 779 MDTH per day,
maximum deliverability.
PEAKING SUPPLIES. In addition to the pipeline and storage supply, the Company
supplements its winter supply with peaking supplies which are available on the
coldest days of the year to enable the Company to economically meet the
increased requirements of its heating customers. The Company's peaking supplies
include gas provided by the Company's two liquefied natural gas ("LNG") plants
and under peaking supply contracts with four cogeneration facilities/independent
power producers located in its franchise areas. For the 1999/2000 winter season,
the Company has the capability to provide a maximum peak-day supply of 504 MDTH
on extremely cold days. The LNG plants have a storage capacity of approximately
2,053 MDTH and peak-day throughput capacity of 395 MDTH, or 19% of peak-day
supply. The Company has contract rights with Trigen Services Corporation,
Brooklyn Navy Cogeneration Partners, LP, Nissequogue Cogen Partners and the New
York Power Authority to purchase peaking supplies with a maximum daily capacity
of 110 MDTH and total available peaking supplies during the winter season of
3,349 MDTH.
14
GAS SUPPLY MANAGEMENT. Enron Capital and Trade Resources Corp., a subsidiary of
Enron Corp. ("Enron"), provides gas supply asset management services to Brooklyn
Union. Under the terms of this agreement, which has been in effect since April
1, 1998 and expires on March 31, 2000, Enron is responsible for managing certain
aspects of Brooklyn Union's interstate pipeline transportation, gas supply and
storage. Enron is also responsible for satisfying certain of the Company's gas
supply requirements; however, the Company remains contractually obligated to its
gas suppliers and has not terminated any of its supply and delivery contracts.
Pursuant to this agreement, Enron paid the Company a fee in 1999, a portion of
which was credited to the Company's gas ratepayers, and obtained the right to
earn revenues based upon its management of the Company's gas supply
requirements, storage arrangements and off-system capacity.
The Company also has an arrangement with Coral Energy Resources, L.P., a
subsidiary of Shell Oil Company ("Coral"), whereby Coral assists the Company in
the origination, structuring, valuation and execution of energy-related
transactions relating to Brooklyn Union of Long Island and the Company's
energy-management services undertaken on behalf of LIPA. A sharing agreement
exists between the gas ratepayers and the Company for off-system gas
transactions and between the Company and LIPA for off-system electric
transactions. The Company's share of the profits on such transactions is then
shared with Coral. The Company also shares in revenues arising from certain
transactions initiated by Coral. This agreement also expires on March 31, 2000.
The Company currently is in negotiations with a large energy corporation to
provide energy supply management services to both Brooklyn Union and Brooklyn
Union of Long Island beginning on April 1, 2000.
GAS COSTS. Gas costs for 1999 were $702.0 million and reflect warmer than normal
weather during the year. Variations in gas costs have little impact on operating
results of the Company since its current gas rate structures include gas
adjustment clauses whereby variations between actual gas costs and gas cost
recoveries are deferred and subsequently refunded to or collected from
customers.
ELECTRIC SERVICES
OVERVIEW
The Company's electric services primarily consist of (i) the ownership and
operation of oil and gas fired generating facilities located on Long Island and
New York and the delivery of the power generated by the Long Island facilities
to LIPA; (ii) the management and operation of LIPA's T&D System; and (iii) the
management of LIPA's fuel and electric energy purchases and off-system sales.
As more fully described below, the Company (i) provides to LIPA all operation,
maintenance and construction services relating to the Retained Assets through a
Management Services Agreement (the "MSA"); (ii) supplies LIPA with capacity,
energy conversion and ancillary services through a Power Supply Agreement (the
"PSA") to allow LIPA to provide electricity to its customers on Long Island; and
(iii) manages all aspects of the fuel supply for the Generating Facilities (as
defined below) as well as all aspects of the capacity and energy owned by or
under contract to LIPA through an Energy Management Agreement (the "EMA"). Each
of the MSA, PSA and EMA became effective on May 28, 1998 and are collectively
referred to herein as the "LIPA Agreements."
15
On June 18, 1999, the Company completed its acquisition of the 2,168 megawatt
Ravenswood Facility located in New York City from Con Edison for approximately
$597 million. As a means of financing this acquisition, the Company entered into
a lease agreement with a special purpose, unaffiliated financing entity that
acquired a portion of the Ravenswood Facility directly from Con Edison and
leased it to a subsidiary of the Company under a ten year lease. The Company has
guaranteed all payment and performance obligations of its subsidiary under the
lease. Another subsidiary of the Company provides all operating, maintenance and
construction services for the facility. The lease program was established in
order to reduce the Company's cash requirements by $425 million. The lease
qualifies as an operating lease for financial reporting purposes while
preserving the Company's ownership of the facility for federal and state income
tax purposes. The balance of the funds needed to acquire the facility were
provided from cash on hand. The Company has recorded an asset of approximately
$200 million, representing its ownership interest in the assets acquired.
The Company currently sells the energy produced by the Ravenswood Facility
through daily and/or hourly bidding into the energy market conducted by the
NYISO. Revenues are recorded when the energy is sold to the NYISO. Further, the
Company has an interim capacity contract with Con Edison which provides Con
Edison with 100% of the available capacity of the Ravenswood Facility under the
capacity contract. Capacity charges are billed to Con Edison on a monthly
fixed-fee basis. The Company anticipates that this contract will expire on April
30, 2000, at which time the available capacity of the Ravenswood Facility will
be bid into an auction process conducted by the NYISO.
For the year ended December 31, 1999, electric revenues were $861.6 million or
29% of the Company's revenues and electric operating income was $139.9 million.
GENERATING FACILITY OPERATIONS.
The Company owns and operates an aggregate of 73 electric generation units
throughout Long Island and Queens (the Long Island electric generation units are
referred to as the "Generating Facilities"), 40 of which can be powered either
by oil or natural gas at the Company's election. In recent years, the Company
has reconfigured several of its facilities to enable them to burn either oil or
natural gas, thus enabling the Company to switch periodically between fuel
alternatives based upon cost and seasonal environmental requirements.
The following table indicates the 1999 summer capacity of the Company's steam
generation facilities and internal combustion ("IC") Units as reported to the
NYISO:
16
LOCATION OF UNITS Description Fuel Units MW
- ---------------------- ---------------------- -------------------------- -----
Long Island City Steam Turbine Dual* 3 1,743
Northport, L.I. Steam Turbine Dual* 3 1,167
Northport, L.I. Steam Turbine Oil 1 381
Port Jefferson, L.I. Steam Turbine Dual* 2 387
Glenwood, L.I. Steam Turbine Gas 2 228
Island Park, L.I. Steam Turbine Dual* 2 390
Far Rockaway, L.I. Steam Turbine Dual* 1 108
Long Island City IC Units Dual* 17 425
Throughout L.I. IC Units Dual* 12 296
Throughout L.I. IC Units Oil 30 1,075
Total 73 6,200
====================== ====================== =================================
*Dual - Oil or natural gas.
LIPA AGREEMENTS
POWER SUPPLY AGREEMENT. The PSA provides for the sale to LIPA by the Company of
all of the capacity and, to the extent LIPA requests, energy from the Generating
Facilities. Capacity refers to the ability to generate energy and, pursuant to
NYISO requirements, must be maintained at specified levels (including reserves)
regardless of the source and amount of energy consumption. By contrast, energy
refers to the electricity actually generated for consumption by consumers. Such
sales of capacity and energy from the Generating Facilities are made at
cost-based wholesale rates regulated by FERC. These rates may be modified in the
future in accordance with the terms of the PSA for (i) agreed upon labor and
expense indices applied to the base year; (ii) a return of and on the capital
invested in the Generating Facilities; and (iii) reasonably incurred expenses
that are outside the control of the Company.
The PSA provides incentives and penalties for the Company to maintain the output
capability of the Generating Facilities, as measured by annual industry-standard
tests of operating capability, and plant availability and efficiency. These
combined incentives and penalties may total as much as $4 million annually. In
1999, the Company earned approximately $3.3 million in incentives under the PSA.
The PSA provides LIPA with all of the capacity from the Generating Facilities.
However, LIPA has no obligation to purchase energy conversion services from the
Generating Facilities and is able to purchase energy on a least-cost basis from
all available sources consistent with existing transmission interconnection
limitations of the T&D system. Under the terms of the PSA, LIPA is obligated to
pay for capacity at rates which reflect a large percentage of the overall fixed
cost of maintaining and operating the Generating Facilities. A variable
maintenance charge is imposed for each unit of energy actually generated by the
Generating Facilities. The PSA expires on May 28, 2013 and is renewable on
similar terms. However, the PSA provides LIPA the option of electing to reduce
or "ramp-down" the capacity it purchases from the Company in accordance with
agreed-upon schedules. In years 7 through 10 of the PSA, if LIPA elects to
ramp-down, the Company is entitled to receive payment for 100 percent of the
present value of the capacity charges otherwise payable
17
over the remaining term of the PSA. If LIPA ramps-down the generation capacity
in years 11 through 15 of the PSA, the capacity charges otherwise payable by
LIPA will be reduced in accordance with a formula established in the PSA. If
LIPA exercises its ramp-down option, the Company may use any capacity released
by LIPA to bid on new LIPA capacity requirements or to bid on LIPA's capacity
requirements to replace other ramped-down capacity. If the Company continues to
operate the ramped-down capacity, the PSA requires it to use reasonable efforts
to market the capacity and energy from the ramped-down capacity and to share any
profits with LIPA. Capacity and energy sold by the Company from ramped-down
capacity must be transported over the T&D system, and the Company will be
required to pay LIPA's standard transmission (and, if applicable, distribution)
rates for the service. The PSA will be terminated in the event that LIPA
exercises its right to purchase, at fair market value, all of the Generating
Facilities in the twelve- month period beginning on May 28, 2001.
The Company has an inventory of sulfur dioxide ("SO2") and nitrogen oxide
("NOx") emission allowances that may be sold to third party purchasers. The
amount of allowances varies from year to year relative to the level of emissions
from the Generating Facilities which is greatly dependent on the mix of natural
gas and fuel oil used for generation and the amount of purchased power that is
imported onto Long Island. In accordance with the PSA, 33% of emission allowance
sales revenues attributable to the Generating Facilities is kept by the Company
and the other 67% is credited to LIPA. LIPA also has a right of first refusal on
any potential emission allowance sales of the Generating Facilities.
Additionally, the Company is bound by a memorandum of understanding with the New
York State Department of Environmental Conservation ("DEC"), which memorandum
prohibits the sale of SO2 allowances into certain states and requires the
purchaser to be bound by the same restriction, which may affect the market value
of the allowances.
MANAGEMENT SERVICES AGREEMENT. Under the MSA, the Company performs day-to-day
operation and maintenance services and capital improvements for the T&D system,
including, among other functions, transmission and distribution facility
operations, customer service, billing and collection, meter reading, planning,
engineering, and construction, all in accordance with policies and procedures
adopted by LIPA. The Company furnishes such services as an independent
contractor and does not have any ownership or leasehold interest in the T&D
system.
In exchange for providing these services, the Company is entitled to earn an
annual management fee of $10 million and may also earn certain incentives, or be
responsible for certain penalties, based upon its performance. The incentives
provide for the Company to retain 100% of the first $5 million of cost
reductions and 50% of any additional cost reductions up to 15% of the total cost
budget. Thereafter, all savings accrue to LIPA. The Company also is required to
absorb any total cost budget overruns up to a maximum of $15 million in each
contract year.
In addition to the foregoing cost-based incentives and penalties, the Company is
eligible for incentives for performance above certain threshold target levels
and subject to disincentives for performance below certain other threshold
levels, with an intermediate band of performance in which neither incentives nor
disincentives will apply, for system reliability, worker safety, and customer
satisfaction. In 1999, the Company earned $7.2 million in non-cost performance
incentives.
18
The MSA shall continue in effect until May 28, 2006. Thereafter, LIPA will
commence a competitive process to solicit a new management services agreement.
Generally, the Company is eligible to submit a bid for such new management
services agreement.
ENERGY MANAGEMENT AGREEMENT. Pursuant to the EMA, the Company (i) procures and
manages fuel supplies for LIPA to fuel the Generating Facilities, (ii) performs
off-system capacity and energy purchases on a least-cost basis to meet LIPA's
needs, and (iii) makes off-system sales of output from the Generating Facilities
and other power supplies either owned or under contract to LIPA. LIPA is
entitled to two-thirds of the profit from any off-system electricity sales
arranged by the Company. The term for the service provided in (i) above is
fifteen years, and the term for the service provided in (ii) and (iii) above is
eight years.
In exchange for these services, the Company earns an annual fee of $1.5 million,
plus an allowance for certain costs incurred in performing services under the
EMA. The EMA further provides incentives for control of the cost of fuel and
electricity purchased on behalf of LIPA by the Company. Fuel and electricity
purchase prices will be compared to regional price indices and the Company will
receive a payment from LIPA, or be obligated to make a payment to LIPA, for fuel
and/or purchased electricity costs which are below or above, respectively,
specified tolerance bands. The total fuel purchase incentive or disincentive can
be no greater than $5 million annually and the electricity purchase incentive or
disincentive can be no greater than $2 million annually. For the year ended
December 31, 1999, the Company earned an aggregate of $5.3 million in incentives
under the EMA.
OTHER RIGHTS. Pursuant to other agreements between LIPA and the Company, certain
future rights have been granted to LIPA. Subject to certain conditions, these
rights include the right for 99 years to lease or purchase, at fair market
value, parcels of land and to acquire unlimited access to, as well as
appropriate easements at, the Generating Facilities for the purpose of
constructing new electric generating facilities to be owned by LIPA or its
designee. Subject to this right granted to LIPA, the Company has the right to
sell or lease property on or adjoining the Generating Facilities to third
parties. In addition, LIPA has the right to acquire a parcel at the Shoreham
Nuclear Power Station site suitable as the terminus for a potential transmission
cable under Long Island Sound or the potential site of a new gas-fired combined
cycle generating facility.
The Company owns the common plant (such as administrative office buildings and
computer systems) formerly owned by LILCO and recovers LIPA's allocable share of
the carrying costs of such plant through the MSA. The Company has agreed to
provide LIPA, for a period of 99 years, the right to enter into leases at fair
market value for common plant or sub-contract for common services which it may
assign to a subsequent manager of the T&D system. The Company has also agreed
(i) for a period of 99 years not to compete with LIPA as a provider of
transmission or distribution service on Long Island; (ii) that LIPA will share
in synergy (I.E., efficiency) savings over a 10-year period attributed to the
Combination (estimated to be approximately $1 billion), which savings are
incorporated into the cost structure under the LIPA Agreements; and (iii) not to
commence any tax certiorari case (until termination of the PSA) challenging
certain property tax assessments relating to the Generating Facilities.
19
GUARANTEES AND INDEMNITIES. The Company and LIPA also have entered into
agreements providing for the guarantee of certain obligations, indemnification
against certain liabilities and allocation of responsibility and liability for
certain pre-existing obligations and liabilities. In general, liabilities
associated with the Transferred Assets have been assumed by the Company and
liabilities associated with the Retained Assets are borne by LIPA, subject to
certain specified exceptions. The Company has assumed all liabilities arising
from all manufactured gas plant ("MGP") operations of LILCO and its predecessors
and LIPA has assumed certain liabilities relating to the Generating Facilities
and all liabilities traceable to the business and operations conducted by LIPA
after completion of the Combination.
An agreement also provides for an allocation of liabilities which relate to the
assets that were common to the operations of LILCO and/or shared services and
are not traceable directly to either the business or operations conducted by
LIPA or the Company. LIPA bears 53.6% of the costs associated therewith and the
Company bears the remainder.
In addition, the Company has assumed environmental obligations relating to the
Ravenswood Facility operations, but not including liabilities arising from
pre-closing disposal of waste at off-site locations and any monetary fines
arising from Con Edison's pre-closing conduct. For additional discussion, see
"Remediation of Contaminated Property."
20
GAS EXPLORATION & PRODUCTION
The Company is also engaged in the exploration and production of domestic gas
and oil, through its 64% equity interest in The Houston Exploration Company
("THEC"), an independent natural gas and oil company, and its wholly owned
subsidiary, KeySpan Exploration and Production, LLC "KeySpan Exploration."
THEC was organized by the Company in 1985 to conduct natural gas and oil
exploration and production activities. It completed an initial public offering
in 1996 and its shares are currently traded on the New York Stock Exchange under
the symbol "THX." At March 1, 2000, its aggregate market capitalization was
approximately $372.3 million (based upon the closing price on the New York Stock
Exchange on that date of $15.5625. THEC has approximately 23,923,020 shares of
common stock, $.01 par value, outstanding. More detailed information concerning
the operations of THEC is contained in the annual, quarterly and periodic
reports filed by THEC with the SEC.
KeySpan Exploration was organized in 1999, as a Delaware corporation,
principally to form a joint venture with THEC. On March 15, 1999, KeySpan
Exploration and THEC entered into a joint exploration agreement (the "THEC Joint
Venture") to explore for natural gas and oil over a term of three years and
expiring on December 31, 2001, subject to earlier termination, at the option of
either party, upon proper notice to the other party. THEC contributed all of its
then undeveloped offshore leases to the THEC Joint Venture, and KeySpan
Exploration and Production, LLC acquired a 45% working interest in all prospects
to be drilled under the THEC Joint Venture . THEC retained a 55% interest in the
leases, and the revenues generated from this joint program are shared between
the Company and THEC on a 45% and 55% basis, respectively. The Company commit
approximately $25 million for exploration and development activities, and will
reimburse THEC for certain general and administrative expenses relating to the
THEC Joint Venture during 2000.
Information with respect to net proved reserves, production, productive wells
and acreage, undeveloped acreage, drilling activities, present activities and
drilling commitments is contained in Note 16 to the Consolidated Financial
Statements, "Supplemental Gas and Oil Disclosures," included herein.
During 1999, the Company's revenues attributable to gas exploration and
production were $150.6 million, and gas exploration and production operating
income was $48.5 million. Set forth below is certain selected information with
respect to the Company's gas exploration and production activities:
1999* 1998 1997
---------- ----------- ---------
Net Proved Reserves (BCFe)....................... 553.0 480.3 337.1
Production of Natural Gas and Oil (BCFe)......... 71.2 62.8 51.3
Average Realized Price of Natural Gas ($/per MCF) 2.10 2.02 2.25
Average Unhedged Price of Natural Gas ($/per MCF) 2.14 1.96 2.45
Capital Expenditures ($000)...................... 183,322 302,837 145,175
*1999 is the first year which includes KeySpan Exploration's activities.
- One billion cubic feet (BCFe) of gas equals 1,000 MDTH. Gas reserves and
production are stated in BCFe and MCFe, which includes equivalent oil
reserves.
21
The Company's interests in exploration and production have achieved significant
growth in net proved reserves, production and revenues over the past five years.
The Company, primarily through its interests in THEC, has increased net proved
reserves from 150 BCFe at December 31, 1994 to 553 BCFe at December 31, 1999.
During this period, annual production increased from 22 BCFe in 1994 to 71 BCFe
in 1999. At the close of 1999, daily production averaged 195 MMcfe per day. The
Company's oil and gas revenues from its interests in exploration and production
activities have increased from $42 million in 1994 to $150.6 million in 1999.
In September 1999, the Company and THEC jointly announced their intention to
begin a process to review strategic alternatives for THEC. The process included
an assessment of the role of THEC within the Company's strategic plans,
including the sale of all or a portion of THEC by the Company. After completing
the review of strategic alternatives for THEC, the Company concluded that it
would retain its equity interest in THEC.
In November 1998, the Company extended a $150 million revolving credit line to
THEC (the "THEC Facility"). The THEC Facility matures on March 31, 2000 and is
convertible to equity, if borrowings remain outstanding at maturity. Currently,
there is approximately $80 million outstanding and it is anticipated that such
debt will convert into additional common equity on April 1, 2000, increasing the
Company's equity ownership interest in THEC to approximately 70%.
THEC focuses its operations offshore in the Gulf of Mexico and onshore in South
Texas, South Louisiana, the Arkoma Basin, East Texas and West Virginia. The
geographic focus of its operations enables it to manage a comparatively large
asset base with relatively few employees and to add and operate production at
relatively low incremental costs. THEC seeks to balance its offshore and onshore
activities so that the lower risk and more stable production typically
associated with onshore properties complement the high potential exploratory
projects in the Gulf of Mexico by balancing risk and reducing volatility. THEC's
business strategy is to seek to continue to increase reserves, production and
cash flow by pursuing internally generated prospects, primarily in the Gulf of
Mexico, by conducting development and exploratory drilling on its offshore and
onshore properties and by making selective opportune acquisitions.
OFFSHORE PROPERTIES. THEC holds interests in 86 lease blocks, representing
527,279 gross (286,953 net) acres, in federal and state waters in the Gulf of
Mexico, of which 28 have current operations. THEC operates 22 of these blocks,
accounting for approximately 79% of THEC's offshore production. Over the past
five years, THEC has drilled 21 successful exploratory wells and 18 successful
development wells in the Gulf of Mexico, representing a historical success rate
of 71%. During 1999, THEC drilled 6 successful exploratory wells and 8
successful development wells on its Gulf of Mexico properties.
ONSHORE PROPERTIES. THEC owns onshore natural gas and oil properties
representing interests in 1,179 gross (779 net) wells, approximately 86% of
which THEC is the operator of record, and 166,450 gross (116,639 net) acres.
Over the past five years, THEC has drilled or participated in the drilling of
108 successful development wells and 9 successful exploratory wells onshore,
representing a historical success rate of 80%. During 1999, THEC drilled 31
successful development wells and 2 successful exploratory wells on its onshore
properties. During the same period, THEC drilled or participated in the drilling
of 6 development wells that were not successful.
22
Effective October 1, 1999, THEC acquired from a private undisclosed party an
interest in offshore producing properties in the West Cameron 587 field of the
Gulf of Mexico. The newly acquired properties are comprised of 21 BCFe of proved
reserves and 6 BCFe of probable reserves. The net purchase price of $21.0
million was paid in cash and financed by borrowings under the THEC Facility.
THEC plans to drill 2 additional wells and install a minimal structure with test
facilities to commence production in 2000.
JOINT VENTURE
During 1999, THEC completed the drilling of eight wells, six of which were
successful. At December 31, 1999, two additional joint venture wells were
drilled, and subsequently, in January and February 2000, three new wells were
spud. During 2000, the THEC Joint Venture plans to drill approximately five to
eight offshore exploratory wells and to complete the development and facility
installation of the successful exploratory wells drilled in 1999.
23
ENERGY-RELATED SERVICES
As part of its business strategy, the Company is focusing on continuing to
develop and grow its energy services through non-regulated subsidiaries that
market and manage natural gas, electricity, and consumer products and services
to residential, commercial and industrial customers, including those within the
Company's traditional utility service territories. These non-regulated
subsidiaries, some of which are currently in the start-up phase, had revenues of
$188.6 million and an operating loss of $3.4 million in 1999.
ENERGY MARKETING. The Company buys, sells and markets gas and electricity and
arranges for transportation and related services to over 100,000 customers
throughout the Northeastern United States, including those in the gas service
territories of the Company.
ENERGY MANAGEMENT. The Company owns, designs, constructs and/or operates energy
systems for commercial and industrial customers and provides energy-related
services to clients in the metropolitan New York City - Long Island area and in
New England.
APPLIANCE SERVICES. The Company provides various technical and maintenance
services to customers throughout the metropolitan New York City - Long Island
area, including the installation, maintenance and repair of heating equipment,
water heaters, central air conditioners and other appliances. With over 125,000
service contracts, the Company is the largest provider of these services in the
State of New York.
TELECOMMUNICATIONS. The Company owns a fiber optic network in excess of 350
miles on Long Island. The fiber optic network serves the telecommunication needs
of the Company on Long Island and also serves several carriers under short and
long-term agreements.
FUEL CELLS. The Company has also become the exclusive provider of residential
fuel cell units distributed on behalf of a joint venture between GE MicroGen, a
subsidiary of GE Power Systems and Plug Power in New York City and Long Island
and is the authorized service provider for PC25(TM) natural-gas-powered fuel
cells manufactured by International Fuel Cells (IFC)/ONSI(R) Corporation,
subsidiaries of United Technologies, in the metropolitan New York - Long Island
area.
As previously stated, during 1999 and in February 2000, the Company made several
acquisitions to expand its energy services operations in the metropolitan New
York City - Long Island area and in New England.
The Company's energy-related services operations compete with the marketing and
management operations of both independent and major energy companies in addition
to electric utilities, independent power producers, local distribution companies
and various energy brokers. As a result of the continuing efforts to deregulate
both the natural gas and electric industries, the relative energy cost
differences among different forms of energy are expected to be reduced in the
future. Competition is based largely upon pricing, availability and reliability
of supply, technical and financial capabilities, regional presence and
experience. The Company's energy-related services subsidiaries are expected to
enable the Company to take advantage of emerging deregulated energy markets for
both gas and electricity and the Company anticipates that it will continue to
target other
24
acquisitions which also provide it with opportunities to expand those services
both within and outside its traditional service territories.
25
ENERGY-RELATED INVESTMENTS
As one of its complementary lines of business, the Company has investments in
energy-related businesses, including natural gas pipelines, midstream natural
gas processing and gathering facilities and gas storage facilities in the
Northeast region of the United States and in Canada and the United Kingdom.
During 1999, net income from energy-related investments was $7.8 million, and
the Company's capital expenditures in this segment were $49.4 million, which
represents the Company's acquisition of a 37% interest in Paddle River, its
purchase of certain oil properties in Canada, as well as its share of capital
expenditures in the midstream natural gas assets owned jointly with Gulf Canada
Resources Limited ("Gulf Canada") and its capital expenditures related to its
investment in the gas distribution system in Northern Ireland, as discussed
below.
The Company owns a 20% interest in Iroquois, the partnership that owns a
374-mile pipeline that currently transports 946 MDTH of Canadian gas supply
daily from the New York-Canadian border to markets in the Northeastern United
States. The Company is also a shipper on Iroquois and currently transports up to
137 MDTH of gas per day on the pipeline.
The Company owns a 24.5% interest in Phoenix Natural Gas ("Phoenix") and a 50%
interest in Premier Transco Pipeline ("Premier") in Northern Ireland. Phoenix is
a gas distribution system serving the City of Belfast, Northern Ireland, which
is in its early stages of development pursuant to an eight-year program of
capital development and line extensions. Premier is an 84-mile pipeline to
Northern Ireland from southwest Scotland that has planned transportation
capacity of approximately 300 MDTH of gas supply daily to markets in Northern
Ireland.
The Company has equity investments in two gas storage facilities in the State of
New York, Honeoye Storage Corporation and Steuben Gas Storage Company.
The Company also has a 50% interest in midstream natural gas assets located in
Western Canada owned jointly with Gulf Canada. The assets include interests in
14 processing plants and associated gathering systems that can process
approximately 1.5 BCFe of natural gas daily, and associated natural gas liquids
fractionation. Additionally, as previously discussed, a 37% interest in Paddle
River was acquired by the Company in September 1999 and in December 1999, the
Company acquired the Nipisi oil property all in Western Canada.
26
REGULATION AND RATE MATTERS
Gas and electric public utility companies, and corporations which own gas and
electric public utility companies (I.E., public utility holding companies) may
be subject to either or both state and federal regulation. In general, state
public utility commissions, such as the NYPSC, regulate the provision of retail
services, including the distribution and sale of natural gas and electricity to
consumers. FERC regulates interstate natural gas transportation and electric
transmission, and has jurisdiction over certain wholesale natural gas sales and
wholesale electric sales. Public utility holding companies, especially those
with operations in several states, are regulated by the SEC under PUHCA, and to
some extent by state utility commissions through the regulation of corporate,
financial and affiliate activities of public utilities.
PUBLIC UTILITY HOLDING COMPANY REGULATION. KeySpan Energy is a public utility
holding company, although it is currently exempt from most regulation under
PUHCA because of the predominately intrastate character of its public utility
subsidiaries. The only provision of PUHCA from which KeySpan Energy is not
currently exempt is the requirement that any person must obtain advance SEC
approval for the acquisition of 5% or more of voting securities issued by any
public utility company or public utility holding company. However, following the
consummation of the Eastern Transaction, the Company will become a "registered"
holding company under PUHCA. As such, the corporate and financial activities of
the Company and its subsidiaries, including the ability of each entity to pay
dividends will be subject to regulation of the SEC. On March 6, 2000, the
Company filed its application with the SEC to become a registered holding
company under PUHCA.
KeySpan Energy also is subject to indirect regulation by the NYPSC in the form
of conditions attached to NYPSC orders authorizing the formation of the Company
and approving the Combination, among other matters. Those conditions address the
manner in which KeySpan Energy and its subsidiaries interact with their two
NYPSC-regulated natural gas distribution subsidiaries, Brooklyn Union and
Brooklyn Union of Long Island.
NYPSC REGULATION
NATURAL GAS UTILITIES. The NYPSC is the principal agency in the State of New
York which regulates, as "gas corporations" - companies that own, operate or
manage pipelines and other facilities used to distribute or sell natural gas.
The NYPSC regulates the construction, use and maintenance of intrastate natural
gas facilities, the retail rates, terms and conditions of service offered by gas
corporations, as well as matters relating to the quality, reliability and safety
of service. The NYPSC also regulates the corporate, financial and affiliate
activities of gas corporations. Both Brooklyn Union and Brooklyn Union of Long
Island are gas corporations subject to the full scope of NYPSC regulation.
Beginning in the mid-1980's, the NYPSC has taken a number of steps to require
the "unbundling" of natural gas sales and other services from the distribution
of natural gas through pipelines in order to encourage competition among gas
sellers and energy service providers. In 1985, the NYPSC ordered the major gas
utilities in the state to offer transportation service for large volume
customers who choose to purchase natural gas from other suppliers. Subsequently,
the NYPSC required that transportation service be made available to all
customers beginning on May 1, 1996. Brooklyn
27
Union and Brooklyn Union of Long Island have been providing a transportation
service option to all their customers in compliance with that NYPSC requirement.
In April 1997, the NYPSC ordered gas utilities to cease providing non-safety
related appliance repair service by no later than May 1, 2000. Brooklyn Union
stopped providing these services in April 1998, and Brooklyn Union of Long
Island ceased providing non-emergency appliance repair services on July 1, 1999.
During a transition period from September 22, 1999 through April 30, 2000,
Brooklyn Union of Long Island is implementing a transition program to assist
customers in their change to new non-emergency appliance service providers.
In November 1998, the NYPSC issued a policy statement that anticipated that
natural gas utilities would cease sales of gas, and become transportation-only
providers, within three to seven years. Marketers, including those that are
affiliated with the natural gas utilities, are permitted to compete for retail
natural gas sales. The NYPSC's policy statement envisions proceedings to
restructure the operations of natural gas utilities in order to facilitate the
achievement of the objectives articulated in the policy statement.
On October 18, 1999, Brooklyn Union and Brooklyn Union of Long Island (the "Gas
Companies") filed a Joint Restructuring Proposal (the "Proposal") with the
NYPSC. The Proposal outlines how the Gas Companies would restructure their
operations by encouraging all gas consumers to migrate to transportation-only
service. The Proposal is designed to (i) provide significant impetus towards the
Gas Companies exiting the gas supply business and (ii) present opportunities for
the development of a competitive unbundled gas supply market for all customers.
Settlement discussions with the Staff of the NYPSC and other interested parties
have been held regarding the Gas Companies' restructuring proposals. The Company
is unable to predict the outcome of this matter. For more information on gas
deregulation, see Item 7A, Quantitative and Qualitative Disclosures About Market
Risk.
Brooklyn Union currently is operating under a six-year rate plan that ends on
September 30, 2002. Brooklyn Union is subject to an earnings sharing provision
under which it will be required to credit to certain customers 60% of any
utility earnings up to 100 basis points above specified common equity return
levels (other than any earnings associated with discrete incentives) and 50% of
any utility earnings in excess of 100 basis points above such threshold levels.
The threshold levels are13.50% for rate years, September 30 1999, 2000 and 2001;
and 13.25% for rate year 2002. A safety and reliability incentive mechanism
provides a maximum 12 basis point pre-tax penalty return on common equity if
Brooklyn Union fails to achieve certain safety and reliability performance
standards, and a customer service incentive performance program with a maximum
40 basis point pre-tax penalty return on equity. With the exception of the
simplification of the customer service performance standards and the imposition
of the earnings sharing provisions, the Brooklyn Union rate plan approved by the
NYPSC in 1996 remains unchanged.
Brooklyn Union of Long Island currently is operating under a three-year rate
plan. The rate plan applies to the period December 1, 1997 through November 30,
2000. Under the plan, if Brooklyn Union of Long Island's earned return on common
equity devoted to its operations exceeds 11.10%, it must credit back to certain
customers 60% of earnings up to 100 basis points above the 11.10% and 50% of any
earnings in excess of a 12.10% return. Both a customer service and a safety and
28
reliability incentive performance program became effective on December 1, 1997,
with maximum pre-tax return on equity penalties of 40 and 12 basis points,
respectively, if Brooklyn Union of Long Island fails to achieve certain
performance standards in these areas. At the conclusion of the Brooklyn Union of
Long Island rate plan on November 30, 2000, Brooklyn Union of Long Island or the
NYPSC on its own motion, may initiate a proceeding to revise the rates and
charges of that company.
As part of the settlement agreement approved by the NYPSC in connection with its
approval of the Combination (the "Stipulation"), Brooklyn Union and Brooklyn
Union of Long Island are subject to certain affiliate transaction restrictions,
cost allocation and financial integrity conditions and a code of conduct
governing affiliate relationships. These restrictions and conditions eliminate
or relax many restrictions previously applicable to Brooklyn Union in such areas
as affiliate transactions, use of the name and reputation of Brooklyn Union by
unregulated affiliates, common officers of the Company, the utility subsidiaries
and unregulated subsidiaries, dividend payment restrictions, and the composition
of the Board of Directors of Brooklyn Union.
ELECTRIC SUPPLIERS. KeySpan Generation LLC ("KeySpan Generation") and KeySpan
Ravenswood, Inc. ("KeySpan Ravenswood"), KeySpan Energy's electric generation
subsidiaries, are not subject to NYPSC rate regulation because their energy
transactions are made exclusively at wholesale; however, KeySpan Generation and
KeySpan Ravenswood are subject to NYPSC financial, reliability and safety
regulation. As wholesale generators, KeySpan Generation and KeySpan Ravenswood
qualify for "lightened" regulatory treatment, I.E. certain discretionary
regulations are waived and others are applied with less scrutiny than would be
the case for fully-regulated electric utilities.
FEDERAL REGULATION
NATURAL GAS COMPANIES. The FERC has jurisdiction to regulate certain natural gas
sales for resale in interstate commerce, the transportation of natural gas in
interstate commerce, and, unless an exemption applies, companies engaged in such
activities. The natural gas distribution activities of Brooklyn Union and
Brooklyn Union of Long Island and certain related intrastate gas transportation
functions are not subject to FERC jurisdiction. However, to the extent that
Brooklyn Union and Brooklyn Union of Long Island sell gas for resale in
interstate commerce, such sales are subject to FERC jurisdiction and have been
authorized by the FERC.
The Company also owns an approximate 20% interest in Iroquois and 52% and 18.6%
interests in the Honeoye and Steuben gas storage facilities, respectively.
Iroquois, Honeoye and Steuben are fully regulated by the FERC as natural gas
companies.
ELECTRIC SUPPLIERS. The FERC regulates the sale of electricity at wholesale and
the transmission of electricity in interstate commerce as well as certain
corporate and financial activities of companies that are engaged in such
activities.
The Generating Facilities and the Ravenswood Facility are subject to FERC
regulation based on their wholesale energy transactions. LIPA, KeySpan
Generation, and the Staff of FERC stipulated to setting rates designed to
recover $300.5 million in the first year with agreed-upon adjustments to set
rates for the remainder of the five-year rate period. The only party opposed to
this stipulation is the
29
County of Suffolk. Parties submitted initial briefs to a FERC Administrative Law
Judge ("ALJ") on December 8, 1998 and reply briefs on January 15, 1999. On April
15, 1999, the presiding ALJ issued an Initial Decision which ordered, subject to
review of the Commission on exceptions or on its own motion, that the rates and
terms contained in the PSA, as modified by the June 30, 1998 Stipulation and
Agreement, are just and reasonable. On June 17, 1999, this initial decision was
made a final order of the FERC. The FERC retains the ability in future
proceedings, either on its own motion or upon a complaint filed with the FERC,
to modify KeySpan Generation's rates, either upward or downward, if the FERC
finds that the public interest requires it to do so.
KeySpan Ravenswood's rates are based on its market based rate application
approved by FERC. The rates that KeySpan Ravenswood may charge are subject to
mitigation measures due to market power concerns of the FERC. As is the case
with KeySpan Generation, the FERC retains the ability in future proceedings,
either on its own motion or upon a complaint filed with the FERC, to modify
KeySpan Ravenswood's rates, either upward or downward, if the FERC concludes
that it is in the public interest to do so.
REGULATION IN OTHER COUNTRIES
The Company's operations in Northern Ireland, conducted through Premier and
Phoenix, are subject to licensing by the Northern Ireland Department of Economic
Development and regulation by the U.K. Department of Trade and Industry (with
respect to the subsea and on-land portions of the Premier pipeline) and the
Northern Ireland Director General, Office for the Regulation of Electricity and
Gas (with respect to the Northern Ireland portion of the Premier pipeline and
Phoenix's operations generally). The licenses establish mechanisms for the
establishment of rates for the conveyance and transportation of natural gas, and
generally may not be revoked except upon long- term notice. Charges for the
supply of gas by Phoenix are largely unregulated unless a determination is made
of an absence of competition.
The Company's assets in Canada are subject to regulation by Canadian provincial
authorities. Such regulatory authorities license the operations of the
facilities and regulate safety matters and certain changes in such facilities'
operations.
ENVIRONMENTAL MATTERS
OVERVIEW
The Company's ordinary business operations subject it to various federal, state
and local laws, rules and regulations dealing with the environment, including
air, water, and hazardous waste, and its business operations are regulated by
various federal, regional, state and local authorities, including the United
States Environmental Protection Agency (the "EPA"), the DEC, the New York City
Department of Environmental Protection (NYC DEP) and the Nassau and Suffolk
County Departments of Health. These requirements govern both the normal, ongoing
operations of the Company and the remediation of contaminated properties
historically used in utility operations. Potential liability associated with the
Company's historical operations may be imposed without regard to fault, even if
the activities were lawful at the time they occurred.
30
Ensuring continuing compliance with environmental requirements may require
significant expenditures for capital improvements or modifications in some
areas. Total capital expenditures for environmental improvements and related
studies, for other than MGP matters, amounted to approximately $1.7 million for
the year ended December 31, 1999, and are expected to be in the $1 to $2 million
range for the year ending December 31, 2000.
Except as set forth below, no material proceedings relating to environmental
matters have been commenced or, to the knowledge of the Company, are
contemplated by any federal, state or local agency against the Company, and the
Company is not a defendant in any material litigation with respect to any matter
relating to the protection of the environment. The Company believes that its
operations are in substantial compliance with environmental laws and that
requirements imposed by environmental laws are not likely to have a material
adverse impact upon the Company. The Company believes that all prudently
incurred costs not recoverable through insurance or some other means with
respect to environmental requirements will be recoverable from its customers.
The Company also is pursuing claims against insurance carriers and potentially
responsible parties which seek the recovery of certain costs associated with the
investigation and remediation of contaminated properties.
AIR. Federal, state and local laws currently regulate a variety of air emissions
from new and existing electric generating plants, including SO2, NOx, opacity
and particulate matter and, in the future, may also regulate emissions of fine
particulate matter, hazardous air pollutants, and carbon dioxide. The Company
has submitted timely applications for permits in accordance with the
requirements of Title V of the 1990 amendments to the Federal Clean Air Act
("CAA"). Final permits have been issued for all of the Company's electric
generating facilities with the exception of the Far Rockaway and KeySpan
Ravenswood facilities, which are pending. The permits allow the Company's
electric generating plants to continue to operate without any additional
significant expenditures, except as described below.
The Company's generating facilities are located within a CAA severe ozone
non-attainment area, and are subject to the Phase I, II, and III NOx reduction
requirements established under the Ozone Transportation Commission ("OTC")
memorandum of understanding. The Company's investments in boiler combustion
modifications and the use of natural gas firing at its steam electric generating
stations has enabled the Company to achieve the NOx emission reductions required
under Phase I and II in a cost-effective manner. In addition, software and
equipment upgrades of approximately $1 million for continuous emissions monitors
("CEM") may be required in 2000 to meet EPA requirements for the NOx allowance
tracking/trading program and certain other regulatory changes affecting the
operation of CEM systems. The Company currently estimates that it may be
required to spend between $5 million and $25 million by the year 2003 for
additional pollution control equipment to achieve the OTC Phase III NOx
reduction requirements and/or new requirements imposed under the EPA NOx state
implementation plan, depending on the actual level of NOx emission reductions
which are required when pending regulations are implemented by the State of New
York.
WATER. The Company possesses permits for its generating units which authorize
discharges from cooling water circulating systems and chemical treatment
systems. These permits are renewed from
31
time to time, as required by regulation. The Company does not foresee any new,
material obligations arising from these permit renewals.
On behalf of LIPA, the Company provides management and operations support for
the LIPA- Connecticut Light and Power Company electric transmission cable system
located under the Long Island Sound (the "Sound Cable"). The Connecticut
Department of Environmental Protection and the DEC separately have issued
Administrative Consent Orders ("ACOs") in connection with releases of insulating
fluid from the Sound Cable. The ACOs require the submission of a series of
reports and studies describing cable system condition, operation and repair
practices, alternatives for cable improvements or replacement, and environmental
impacts associated with prior leaks of fluid into the Long Island Sound.
Compliance activities associated with the ACOs are ongoing and are recoverable
from LIPA under the MSA.
REMEDIATION OF CONTAMINATED PROPERTY
SUPERFUND SITES. Federal and New York State Superfund laws impose liability,
regardless of fault, upon generators of hazardous substances for costs
associated with remediating contaminated property. In the course of its business
operations, the Company generates materials which are subject to these laws.
From time to time, the Company has received notices under these laws concerning
possible claims with respect to sites at which hazardous substances generated by
the Company and other potentially responsible parties ("PRPs") allegedly were
disposed.
The DEC has notified the Company, pursuant to the State Superfund program, that
the Company may be responsible for the disposal of hazardous substances at the
Huntington/East Northport Site, a municipal landfill property. The DEC
investigation is in its preliminary stages, and the Company currently is unable
to estimate its share, if any, of the costs required to investigate and
remediate this site.
MANUFACTURED GAS PLANT SITES. The Company has identified twenty-six MGP sites
which were historically owned or operated by Brooklyn Union or Brooklyn Union of
Long Island (or such companies' predecessors). Operations at these plants in the
late 1800's and early 1900's may have resulted in the release of hazardous
substances. These former sites, some of which are no longer owned by the
Company, have been identified to both the DEC for inclusion on appropriate waste
site inventories and the PSC. The currently-known conditions of fourteen of
these former MGP sites, their period and magnitude of operation, generally
observed cleanup requirements and costs in the industry, current land use and
ownership, and possible reuse have been considered in establishing contingency
reserves that are discussed below.
In 1995, Brooklyn Union executed an ACO with the DEC which addressed the
investigation and remediation of a site in Coney Island, Brooklyn. In 1998,
Brooklyn Union executed an ACO for the investigation and remediation of the
Clifton MGP site in Staten Island. At the initiative of DEC, the City of New
York and the Company are in negotiations on a cost sharing arrangement to
conduct investigations in 2000 at the Citizen's MGP site in Brooklyn, which is
now primarily owned by the City, but was formerly owned and operated by a
Brooklyn Union predecessor. The DEC notified the Company in 1998 that the Sag
Harbor and Rockaway Park MGP sites owned by Brooklyn Union of Long Island would
require remediation under the State's Superfund program. Accordingly, the
32
Sag Harbor and Rockaway Park sites; as well as the Bay Shore, Glen Cove,
Halesite and Hempstead MGP sites; are the subject of two separate ACOs, which
the Company executed with the DEC in March and September 1999, respectively.
Field investigations and, in some cases, interim remedial measures, are underway
or scheduled to occur at each of these sites under the supervision of the DEC
and the New York State Department of Health.
The Company was also requested by the DEC to perform preliminary site
assessments at the Patchogue, Babylon, Far Rockaway, Garden City and Hempstead
(Clinton St.) MGP sites, each of which were formerly owned by LILCO, under a
separate ACO entered into in September 1999. Initial studies based on existing,
available documentation have been completed for each such site and the DEC has
requested that the Company collect additional samples at each of the subject
properties.
With the exception of the Coney Island site, which will be redeveloped for
commercial or industrial use, the final end uses for the sites identified above
and, therefore, acceptable remediation goals have not yet been determined. The
Company is required to prepare a feasibility study for the remediation of each
such site, based on cleanup levels derived from risk analyses associated with
the proposed or anticipated future use of the properties. The schedule for
completing this phase of the work under the ACOs for the identified sites
discussed above extends through 2001.
Thus, thirteen sites identified above are currently the subject of ACOs with the
DEC and one is subject to the negotiation of such an agreement. The Company's
remaining MGP sites may not become subject to ACOs in the future, and
accordingly no liability has been accrued for these sites. It is possible, based
on future investigation, that the Company may be required to undertake
investigation and potential remediation efforts at these, or other currently
unknown former MGP sites. However, the Company is currently unable to determine
whether or to what extent such additional costs may be incurred.
The Company believes that in the aggregate, the accrued liability for
investigation and remediation of the MGP sites identified above are reasonable
estimates of likely cost within a range of reasonable, foreseeable costs.
Accordingly, the Company presently estimates the cost of its MGP- related
environmental cleanup activities will be $123 million; which amount has been
accrued by the Company as its current best estimate of its aggregate
environmental liability for known sites. As previously indicated, the total
MGP-related costs may be substantially higher, depending upon remediation
experience, selected end use for each site, and actual environmental conditions
encountered.
The NYPSC approved rate plans for Brooklyn Union and Brooklyn Union of Long
Island provide for the recovery of such investigation and remediation costs. The
Brooklyn Union rate plan provides, among other things, that if the total cost of
investigation and remediation varies from that which is specifically estimated
for a site under investigation and/or remediation, then Brooklyn Union will
retain or absorb up to 10% of the variation. The Brooklyn Union of Long Island
rate plan also provides for the recovery of investigation and remediation costs
but with no consideration of the difference between estimated and actual costs.
Under prior rate orders, Brooklyn Union has offset certain moneys due to
ratepayers against its estimated environmental cleanup costs for MGP sites. At
December 31, 1999, the Company has reflected a regulatory asset of $95.6
million.
33
Expenditures incurred to date by the Company with respect to MGP-related
activities total $15.9 million.
Periodic discussions by the Company with insurance carriers and third parties
for reimbursement of some portion of MGP site investigation and remediation
costs continue. In December 1996, LILCO filed a complaint in the United States
District Court for the Southern District of New York against fourteen insurance
companies that issued general comprehensive liability policies to LILCO. In
January 1998, LILCO commenced a similar action against the same, and additional,
insurance companies in New York State Supreme Court, and the federal court
action subsequently was dismissed. The state court action is being conducted by
the Company on behalf of Brooklyn Union of Long Island. The outcome of this
proceeding cannot yet be determined. In addition, Brooklyn Union is in
discussions with insurance carriers regarding the possible resolution of
coverage claims related to its MGP site investigation and remediation activities
without litigation. The Company is not able to predict the outcome of these
discussions.
RAVENSWOOD FACILITY. In connection with the Company's acquisition of the
Ravenswood Facility, the Company assumed all of Con Edison's historical
contingent environmental obligations relating to facility operations other than
liabilities arising from pre-closing disposal of waste at off-site locations and
any monetary fines arising from Con Edison's pre-closing conduct. These
environmental exposures are generally divided between (i) future capital
expenditures, in the nature of property and leasehold improvements, necessary to
address compliance obligations and (ii) expenditures to investigate and, as
necessary, remediate certain on-site contamination which may or may not result
in leasehold improvements.
Presently, there are four ACOs issued to Con Edison by the DEC. The Company has
contractually agreed to assume Con Edison's remaining obligations at the
Ravenswood Facility under these ACOs. Generally, the Company's derivative
obligations are expected to include investigation and remediation of certain
petroleum releases, inspection and any necessary corrective action for certain
aboveground storage tanks and underground piping, potential upgrades to existing
cooling water intake structures, and implementation of an air emissions opacity
reduction program. The Company is currently negotiating a consolidated ACO with
the DEC that will clarify the scope and timing of these activities.
The Company has identified certain capital expenditures for environmental
compliance purposes at the Ravenswood Facility that are reasonably likely to
occur. To address an anticipated shortfall of NOx emissions allowances beginning
in May 2003, the Company may incur capital costs for additional air pollution
control equipment. Alternatively, the Company may elect to purchase additional
NOx allowances. The Company may be required to upgrade the Ravenswood Facility
cooling intake structures in order to meet the best available technology
requirements of the Federal Clean Water Act. The extent and cost of any upgrades
are uncertain and will depend upon the analysis and interpretation of certain
studies submitted by the Company to the DEC and subsequently agreed upon between
the DEC and the Company.
Pursuant to its derivative ACO obligations, the Company will complete the
investigation and remediation of certain petroleum and other hazardous material
releases at the Ravenswood Facility, as necessary. The Company will also address
similar releases not covered by the ACO's. The
34
Ravenswood Facility is located on a former MGP site. The Company has no current
obligation to investigate or remediate the property for contamination resulting
from historical MGP operations, although there may be a need to perform certain
site remediation as part of an overall improvement of property related to the
installation of new generation capacity. Based on information currently
available for environmental contingencies related to the Ravenswood acquisition,
the Company has accrued $5 million as the minimum liability to be incurred.
EMPLOYEE MATTERS
On December 31, 1999, the Company had approximately 7,723 full-time employees.
Of that total, approximately 4,946 employees are covered under collective
bargaining agreements; 1,726 employees are represented by Local 101, Utility
Division, of the Transport Workers Union of America, 205 employees are
represented by Local 3 of the International Brotherhood of Electrical Workers
(the "IBEW"), 1,882 employees are represented by Local 1049 of the IBEW and
1,133 employees are represented by Local 1381 of the IBEW.
The Company maintains collective bargaining agreements covering each of the four
collective bargaining units detailed above, all of which expire in 2001. The
Company has not experienced any work stoppage during the past five years and
considers its relationship with employees, including those covered by collective
bargaining agreements, to be good.
EXECUTIVE OFFICERS OF THE COMPANY
Certain information regarding the Company's Executive Officers, all of whom
serve at the will of the Board of Directors, is set forth below:
ROBERT B. CATELL
Mr. Catell, age 62, has been a Director of the Company since its creation in May
1998 and served as its President and Chief Operating Officer from May 1998-July
1998. He was elected Chairman of the Board and Chief Executive Officer in July
1998. Mr. Catell joined Brooklyn Union in 1958 and became an officer in 1974. He
was elected Vice President in 1977, Senior Vice President in 1981 and Executive
Vice President in 1984. He was elected Chief Operating Officer in 1986 and
President in 1990. Mr. Catell served as President and Chief Executive Officer
from 1991 to 1996, when he was elected Chairman and Chief Executive Officer. In
1997, Mr. Catell was elected Chairman, President and Chief Executive Officer of
the Company.
LAWRENCE S. DRYER
Mr. Dryer, age 40, was elected Vice President of Internal Audit for the Company
in September 1998. Mr. Dryer had been with the Long Island Lighting Company
(LILCO) since 1992 as Director of Internal Audit and was responsible for
providing independent appraisals and recommendations to improve management
controls and increase operational efficiency. Prior to joining LILCO, Mr. Dryer
was an Audit Manager with Coopers & Lybrand.
35
ROBERT J. FANI
Mr. Fani, age 46, was elected Executive Vice President of Strategic Services in
February 2000. Mr. Fani joined Brooklyn Union in 1976, and held a variety of
management positions in distribution, engineering, planning, marketing, and
business development. He was elected Vice President in 1992. In 1997, Mr. Fani
was promoted to Senior Vice President of Marketing and Sales. In 1998, he
assumed that position with the Company and, as of September 1, 1999, assumed
responsibility for Gas Operations.
WILLIAM K. FERAUDO
Mr. Feraudo, age 49, was elected Executive Vice President of KeySpan Services
Group in February 2000. KeySpan Services Group, is the group of non-regulated
energy service companies focusing on gas marketing, energy management and
telecommunications. Since its founding in 1996, the group has grown to more than
2,000 employees, serving customers in the Northeast. Mr. Feraudo began his
career at Brooklyn Union in 1971 and rose through a succession of positions in
Information Systems, Engineering, Customer Operations, Sales, Marketing, and
Product Development before being named Senior Vice President in 1994. He served
as Senior Vice President of Energy Services for the Company prior to his
promotion to Executive Vice President.
RONALD S. JENDRAS
Mr. Jendras, age 52, was named Vice President, Controller and Chief Accounting
Officer of the Company in August 1998. He joined Brooklyn Union in 1969 and held
a variety of positions in the Accounting Department before being named budget
director in 1973. In 1983, Mr. Jendras was promoted to manager of Brooklyn
Union's Rate and Regulatory Affairs area, and in 1997, was named general manager
of the Accounting Division.
GERALD LUTERMAN
Mr Luterman, age 56, has s