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, 2002 to December 31, 2002
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 (I.R.S. employer identification no.)
incorporation or organization)
One MetroTech Center, Brooklyn, New York 11201
175 East Old Country Road, Hicksville, New York 11801
(Address of principal executive offices) (Zip code)
(718) 403-1000 (Brooklyn)
(516) 755-6650 (Hicksville)
(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, 2003, the aggregate market value of the common stock held by
non-affiliates (156,910,326 shares) of the registrant was $5,016,423,122.22
based on the closing price, on such date, of $31.97 per share.
As of March 1, 2003, there were 172,737,654 shares of common stock, $.01
par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement dated on or about March 31, 2003 is incorporated by reference
into Part III hereof.
KEYSPAN CORPORATION
INDEX TO FORM 10-K
Page
----
Part I
Item 1. Description of the Business.................................................................................1
Item 2. Properties.................................................................................................26
Item 3. Legal Proceedings..........................................................................................27
Item 4. Submission of Matters to a Vote of Security Holders........................................................27
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters......................................27
Item 6. Selected Financial Data....................................................................................29
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................................................30
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ................................................73
Item 8. Financial Statements and Supplementary Data ...............................................................79
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure..................................................................................149
Part III
Item 10. Directors and Executive Officers of the Registrant.........................................................149
Item 11. Executive Compensation.....................................................................................149
Item 12. Security Ownership of Certain Beneficial Owners and Management.............................................149
Item 13. Certain Relationships and Related Transactions.............................................................150
Item 14. Controls and Procedures....................................................................................150
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K............................................150
PART I
Item 1. Description of the Business
Corporate Overview
KeySpan Corporation ("KeySpan"), a New York corporation, is a member of the
Standard and Poor's 500 Index and a registered holding company under the Public
Utility Holding Company Act of 1935, as amended ("PUHCA"). KeySpan was formed in
May 1998, as a result of the business combination of KeySpan Energy Corporation,
the parent of The Brooklyn Union Gas Company, and certain businesses of the Long
Island Lighting Company ("LILCO"). On November 8, 2000, we acquired Eastern
Enterprises ("Eastern"), now known as KeySpan New England, LLC ("KNE"), a
Massachusetts limited liability company[1], which primarily owns Boston Gas
Company ("Boston Gas"), Colonial Gas Company ("Colonial Gas") and Essex Gas
Company ("Essex Gas"), gas utilities operating in Massachusetts, as well as
EnergyNorth Natural Gas, Inc. ("EnergyNorth"), a gas utility operating
principally in central New Hampshire. As used herein, "KeySpan," "we," "us" and
"our" refers to KeySpan, its six principal gas distribution subsidiaries, and
its other regulated and unregulated subsidiaries, individually and in the
aggregate.
Under our holding company structure, we have no independent operations and
conduct substantially all of our operations through our subsidiaries. Our
subsidiaries operate in the following four businesses: Gas Distribution,
Electric Services, Energy Services and Energy Investments.
The Gas Distribution segment consists of our six regulated gas distribution
subsidiaries, which operate in New York, Massachusetts and New Hampshire and
serve approximately 2.5 million customers.
The Electric Services segment consists of subsidiaries that manage the electric
transmission and distribution ("T&D") system owned by the Long Island Power
Authority ("LIPA"); provide energy conversion services for LIPA from our
generating facilities located on Long Island; and manage fuel supplies for LIPA
to fuel our approximate 4,200 megawatts of Long Island generating facilities.
The electric services segment also includes subsidiaries that own, lease and
operate the 2,200 megawatt Ravenswood electric generation facility (the
"Ravenswood facility"), located in Queens County in New York City.
The Energy Services segment provides energy-related services to customers
primarily located within New York, New Jersey, Massachusetts, New Hampshire,
Rhode Island and Pennsylvania through various subsidiaries that operate under
the following principal three lines of business: (i) home energy services; (ii)
business solutions; and (iii) fiber optic services.
The Energy Investments segment includes: (i) gas exploration and production
activities; (ii) domestic pipelines and gas storage facilities; (iii) midstream
natural gas processing activities in Canada; and (iv) natural gas distribution
and pipeline activities in the United Kingdom.
KeySpan's vision is to be the premier energy company in the Northeastern United
States. Following the acquisition of Eastern and EnergyNorth in November 2000,
KeySpan became the largest gas distribution company in the Northeast and the
fifth largest in the United States. KeySpan's increased size and scope is
enabling us to provide enhanced cost-effective customer service; to offer our
existing customers other services and products by building upon our existing
customer relationships; and to capitalize on the above-average growth
opportunities for natural gas expansion in the Northeast by expanding our
infrastructure, primarily on Long Island and in New England. The key element of
our business strategy is the continued focus and growth of our Gas Distribution,
Electric Services and Energy Services businesses. We also continue to explore
the monetization of some or all of our non-core assets in the Energy Investments
segment.
- --------
1 Pursuant to an application on Form U-1 filed with the Securities and Exchange
Commission on May 28, 2002, Eastern Enterprises, a Massachusetts business trust,
was reorganized as KNE. The transaction involved the formation of KNE as well as
another new subsidiary named KSNE, LLC ("KSNE"), a Delaware limited liability
company, that is a wholly-owned subsidiary of KeySpan. KNE is 99% owned by
KeySpan and 1% owned by KSNE.
1
Certain statements contained in this Annual Report on Form 10-K concerning
expectations, beliefs, plans, objectives, goals, strategies, future events or
performance and underlying assumptions and other statements that are other than
statements of historical facts, are "forward-looking statements" within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended.
Without limiting the foregoing, all statements under the captions "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Item 7A. Quantitative and Qualitative Disclosures About Market
Risk" relating to our future outlook, anticipated capital expenditures, future
cash flows and borrowings, pursuit of potential 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:
- volatility of energy prices of fuel used to generate electricity;
- fluctuations in weather and in gas and electric prices;
- general economic conditions, especially in the Northeast United
States;
- our ability to successfully reduce our cost structure and operate
efficiently;
- our ability to successfully contract for natural gas supplies required
to meet the needs of our firm customers;
- implementation of new accounting standards;
- inflationary trends and interest rates;
- the ability of KeySpan to identify and make complementary
acquisitions, as well as the successful integration of recent and
future acquisitions;
- available sources and cost of fuel;
- creditworthiness of counter-parties to derivative instruments and
commodity contracts;
- retention of key personnel;
- federal and state regulatory initiatives that increase competition,
threaten cost and investment recovery, and place limits on the type
and manner in which we invest in new businesses;
- the impact of federal and state utility regulatory policies and orders
on our regulated and unregulated businesses;
- potential write-down of our investment in natural gas properties when
natural gas prices are depressed or if we have significant downward
revisions in our estimated proved gas reserves;
- competition in general facing our unregulated Energy Services
businesses, including but not limited to competition from other
mechanical, plumbing, heating, ventilation and air conditioning, and
engineering companies, as well as, other utilities and utility holding
companies that are permitted to engage in such activities;
- the degree to which we develop unregulated business ventures, as well
as federal and state regulatory policies affecting our ability to
retain and operate such business ventures profitably; and
2
- other risks detailed from time to time in other reports and other
documents filed by KeySpan with the Securities and Exchange Commission
("SEC").
For any of these statements, KeySpan claims the protection of the safe harbor
for forward-looking information contained in the Private Securities Litigation
Reform Act of 1995, as amended. For additional discussion on these risks,
uncertainties and assumptions, see "Item 1. Description of Business," "Item 2.
Properties," "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Item 7A. Quantitative and Qualitative
Disclosures About Market Risk" contained herein.
KeySpan's principal executive offices are located at One MetroTech Center,
Brooklyn, New York 11201 and 175 East Old Country Road, Hicksville, New York
11801 and its telephone numbers are (718) 403-1000 (Brooklyn) and (516) 755-6650
(Hicksville). KeySpan makes available free of charge on or through its website,
http://www.keyspanenergy.com (Investor Relations section), its annual report on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all
amendments to those reports as soon as reasonably practicable after such
material is electronically filed with or furnished to the SEC.
Gas Distribution Overview
Our gas distribution activities are conducted by our six regulated gas
distribution subsidiaries, which operate in three states in the Northeast: New
York, Massachusetts and New Hampshire. We are the fifth largest gas distribution
company in the United States and the largest in the Northeast, with
approximately 2.5 million customers served within an aggregate service area
covering 4,273 square miles. In New York, The Brooklyn Union Gas Company, doing
business as KeySpan Energy Delivery New York ("KEDNY") provides gas distribution
services to customers in the New York City Boroughs of Brooklyn, Queens and
Staten Island; and KeySpan Gas East Corporation doing business as KeySpan Energy
Delivery Long Island ("KEDLI") provides gas distribution services to customers
in the Long Island Counties of Nassau and Suffolk and the Rockaway Peninsula of
Queens County. In Massachusetts, Boston Gas provides gas distribution services
in eastern and central Massachusetts; Colonial Gas provides gas distribution
services on Cape Cod and in eastern Massachusetts; and Essex Gas provides gas
distribution services in eastern Massachusetts. In New Hampshire, EnergyNorth
provides gas distribution services to customers principally located in central
New Hampshire. Our New England gas companies all do business as KeySpan Energy
Delivery New England ("KEDNE").
In New York, there are two separate, but contiguous service territories served
by KEDNY and KEDLI, comprising approximately 1,417 square miles, and 1.66
million customers. In Massachusetts, Boston Gas, Colonial Gas and Essex Gas
serve three contiguous service territories consisting of 1,934 square miles and
approximately 768,000 customers. In New Hampshire, EnergyNorth has a service
territory that is contiguous to Colonial Gas' and ranges from within 30 to 85
miles of the greater Boston area. EnergyNorth provides service to approximately
75,000 customers over a service area of approximately 922 square miles.
Collectively, KeySpan owns and operates gas distribution, transmission and
storage systems that consist of approximately 21,000 miles of gas mains and
distribution pipelines and 576 miles of transmission pipelines, as well as six
major gas storage facilities.
Natural gas is offered for sale to residential and small commercial customers on
a "firm" basis, and to most large commercial and industrial customers on a
"firm" or "interruptible" basis. "Firm" service is offered to customers under
tariffed schedules or contracts that anticipate no interruptions, whereas
"interruptible" service is offered to customers under tariffed schedules or
contracts that anticipate and permit interruption on short notice, generally in
peak-load seasons or for system reliability reasons. We have restructured our
gas supply and capacity contracts to reduce fixed costs and to minimize the risk
of stranded costs. We maintain sufficient gas supply and capacity contracts to
serve our customers, maintain system reliability and system operations, and to
meet our obligation to serve. Over the long term, we intend to minimize our
fixed costs by increasing the amount of gas purchased at points within or in
close proximity to our market area, which allow us to contract for firm
short-haul transportation capacity from these points rather than long-haul
transportation capacity from production areas. We also engage in the use of
derivative financial instruments from time to time to reduce the cash flow
volatility associated with the purchase price for a portion of future natural
gas purchases.
3
Natural gas is available at any time of the year on an interruptible basis, if
supply is sufficient and the gas delivery system is operationally adequate.
KeySpan actively promotes a competitive retail gas market by making capacity
available to retail marketers that are unable to obtain their own capacity and
are otherwise not participants of a mandatory capacity assignment program.
KeySpan also participates in interstate markets by releasing pipeline capacity
or by bundling gas supply and pipeline capacity for "off-system" sales. An
"off-system" customer consumes gas at facilities located outside of our service
territories by connecting to our facilities or another transporter's facilities
at a point of delivery agreed to by us and the customer.
KeySpan purchases natural gas for sale to customers under both long-and
short-term supply contracts, as well as on the spot market, and utilizes its
firm transportation contracts to transport the gas. KeySpan also contracts for
firm capacity in natural gas underground storage facilities, in addition to
winter peaking supplies.
KeySpan sells gas to firm gas customers at its cost for such gas, plus a charge
designed to recover the costs of distribution (including a return of and a
return on capital invested in our distribution facilities). We share with our
firm gas customers net revenues (operating revenues less the cost of gas) from
off-system sales and capacity release transactions. Further, net revenues from
tariff gas balancing services and certain interruptible on-system sales are
refunded, for most of our subsidiaries, to firm customers subject to certain
sharing provisions.
Our gas operations can be significantly affected by seasonal weather conditions.
Annual revenues are substantially realized during the heating season as a result
of higher sales of gas due to cold weather. Accordingly, operating results
historically are most favorable in the first and fourth calendar quarters. KEDNY
and KEDLI each operate under utility tariffs that contain a weather
normalization adjustment that significantly offsets variations in firm net
revenues due to fluctuations in weather. However, the tariffs for our four KEDNE
gas distribution companies do not contain such a weather normalization
adjustment and, therefore, fluctuations in seasonal weather conditions between
years may have a significant effect on results of operations and cash flows for
these four subsidiaries.
Further information and statistics regarding our Gas Distribution segment see
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations, "Gas Distribution."
New York Gas Distribution System - KEDNY and KEDLI
Supply and Storage
KEDNY and KEDLI have firm long-term contracts for the purchase of transportation
and underground storage services. Gas supplies are purchased under long and
short-term firm contracts, as well as on the spot market. Gas supplies are
transported by interstate pipelines from domestic and Canadian supply basins.
Peaking supplies are available to meet system requirements on the coldest days
of the winter season.
Peak-Day Capability. The design criteria for the New York gas system assumes an
average temperature of 0(0)F for peak-day demand. Under such criteria, we
estimate that the requirements to supply our firm gas customers would amount to
approximately 2,025 MDTH of gas for a peak-day during the 2002/03 winter season
and that the gas available to us on such a peak-day amounts to approximately
2,026 MDTH. For the 2003/04 winter season, we estimate the peak-day requirements
will amount to 2,088 MDTH and that the gas supplies available to us on such a
peak-day will amount to approximately 2,001 MDTH; we have plans for additional
purchases to offset the peak-day supply deficit. The 2002/03 winter peak-day
throughput to our New York customers was 1,754 MDTH, which occurred on January
23, 2003 at an average temperature of 14 degrees F, representing 87% of our peak
day capability. Our New York firm gas peak-day capability is summarized in the
following table:
4
Source MDTH per day % of Total
- --------------------------------------------------------------- --------------------- ---------------------
Pipeline 744 37%
Underground Storage 778 38%
Peaking Supplies 504 25%
--- ---
Total 2,026 100%
===================== =====================
Pipelines. Our New York based gas distribution utilities purchase natural gas
for sale under contracts with suppliers with natural gas located in domestic and
Canadian supply basins and arrange for its transportation to our facilities
under firm long-term contracts with interstate pipeline companies. For the
2002/03 winter, approximately 75% of our New York natural gas supply was
available from domestic sources and 25% from Canadian sources. We have available
under firm contract 744 MDTH per day of year-round and seasonal pipeline
transportation capacity. Major providers of interstate pipeline capacity and
related services to us include: Transcontinental Gas Pipe Line Corporation
("Transco"), Texas Eastern Transmission Corporation ("Tetco"), Iroquois Gas
Transmission System ("Iroquois"), Tennessee Gas Pipeline Company ("Tennessee"),
Dominion Transmission Incorporated ("Dominion"), and Texas Gas Transmission
Company.
Underground Storage. In order to meet winter demand in our New York service
territories, we also have long-term contracts with Transco, Tetco, Tennessee,
Dominion, Equitrans, Inc., and Honeoye Storage Corporation ("Honeoye"), for
underground storage capacity of 59,058 MDTH and 778 MDTH per day of maximum
deliverability.
Peaking Supplies. In addition to the pipeline and underground storage supply, we
supplement our winter supply portfolio with peaking supplies that are available
on the coldest days of the year to economically meet the increased requirements
of our heating customers. Our peaking supplies include: (i) two liquefied
natural gas ("LNG") plants; and (ii) peaking supply contracts with five dual
fuel power producers located in our franchise areas. For the 2002/03 winter
season, we had the capability to provide a maximum peak-day supply of 504 MDTH
on excessively cold days. The LNG plants have a storage capacity of
approximately 2,053 MDTH and peak-day throughput capacity of 394.5 MDTH, or 19%
of peak-day supply. We also have contract rights with Trigen Services
Corporation, Brooklyn Navy Cogeneration Partners, LP, Nissequogue Cogen
Partners, TBG Cogen Partners, and NYPA 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.
Gas Supply Management.
We have an agreement with Coral Resources, L.P. ("Coral"), a subsidiary of Shell
Oil Company, under which Coral assists in the origination, structuring,
valuation and execution of energy-related transactions on behalf of KEDNY and
KEDLI. The agreement with Coral expires on March 31, 2003. In anticipation of
the expiration of the existing agreement, a request for proposal was sent to
various portfolio managers. Upon evaluation of the bids, KeySpan will negotiate
an agreement for its gas distribution subsidiaries. It is anticipated that such
agreement will become effective April 1, 2003.
Gas Costs. Fluctuations in gas costs have little direct impact on the financial
results of KEDNY and KEDLI, since the current gas rate structure of each of
these companies includes a gas adjustment clause pursuant to which variations
between actual gas costs incurred and gas costs billed are deferred and
subsequently refunded to or collected from customers.
5
Deregulation. Regulatory actions, economic factors and changes in customers and
their preferences continue to reshape our gas operations. A number of customers
currently purchase their gas supplies from natural gas marketers and then
contract with us for local transportation, balancing and other unbundled
services. In addition, our New York gas distribution companies release firm
capacity on our interstate pipeline transportation contracts to natural gas
marketers to ensure the marketers' gas supply is delivered on a firm basis and
in a reliable manner. As of February 1, 2003, approximately 119,776 gas
customers have opted to purchase their gas from marketers.
New England Gas Distribution Systems
Supply and Storage
KEDNE has firm long-term contracts for the purchase of transportation and
underground storage services. Gas supplies are purchased under long and
short-term firm contracts, as well as on the spot market. Gas supplies are
transported by interstate pipelines from domestic and Canadian supply basins. In
addition, peaking supplies, principally liquefied natural gas ("LNG"), are
available to meet system requirements during the winter season.
Peak-Day Capability. The design criteria for our New England gas systems assumes
an average temperature of -6(0)F for peak-day demand. Under such criteria, KEDNE
estimates that the requirements to supply their firm gas customers would amount
to approximately 1,231 MDTH of gas for a peak-day during the 2002/2003 winter
season and that the gas available to KEDNE on such a peak-day amounts to
approximately 1,347 MDTH. For the 2003/2004 winter season, KEDNE estimates that
the peak-day requirements will amount to 1,266 MDTH and that the gas supplies
available on such a peak-day will amount to approximately 1,412 MDTH.
As of March 1, 2003, the highest daily throughput to our New England customers
was 1,203 MDTH, which occurred on January 22, 2003 at an average temperature of
9'F. KEDNE has sufficient gas available to meet the requirements of their
firm gas customers for the 2002/2003 winter gas season. The firm gas peak day
capability of KEDNE is summarized in the following table:
Source MDTH per day % of Total
- --------------------------------------------------------------------- --------------------- ----------------------
Pipeline 412 31
Underground Storage 270 20
Peaking Supplies 665 49
Total 1347 100
===================== ======================
Pipelines. Our New England based gas distribution utilities purchase natural gas
for sale under contracts with suppliers with natural gas located in domestic and
Canadian supply basins and arrange for transportation to their facilities under
firm long-term contracts with interstate pipeline companies. Major providers of
interstate pipeline capacity and related services to the KEDNE companies
include: Tetco, Iroquois, Maritimes and Northeast Pipelines, Tennessee,
Algonquin Gas Transmission Company and Portland Natural Gas Transmission System.
Underground Storage. KEDNE has available under firm contract 682 MDTH per day of
year-round and seasonal transportation and underground storage capacity to their
facilities in New England. KEDNE has long-term contracts with Tetco, Tennessee,
Dominion, National Fuel Gas Supply Corporation and Honeoye for underground
storage capacity of 23,279 MDTH and 270 MDTH per day of maximum deliverability.
6
Peaking Supplies. The KEDNE gas supply portfolio is supplemented with peaking
supplies that are available on the coldest days throughout the winter season in
order to economically meet the increased requirements of our heating customers.
Peaking supplies include gas provided by both LNG and propane air plants located
within the distribution system, as well as two leased facilities located in
Providence, Rhode Island and Everett, MA. For the 2002/2003 winter season, on a
peak-day, KEDNE has access to 665 MDTH of peaking supplies, 49% of peak-day
supply.
Gas Supply Management. From November 1, 1999 through October 31, 2002, the New
England based gas distribution subsidiaries operated under a portfolio
management contract with El Paso Merchant Energy ("El Paso"). El Paso provided
the majority of the city gate supply requirements to the four New England gas
distribution companies (Boston Gas, Colonial Gas, Essex Gas and EnergyNorth) at
market prices and managed upstream capacity, underground storage and term supply
contracts. We negotiated a new agreement with Entergy-Koch that replaced the
expired El Paso agreement. The new agreement with Entergy-Koch commenced on
November 1, 2002 and extends through March 31, 2003. In anticipation of the
expiration of the existing agreement, a request for proposal was sent to various
portfolio managers. Upon evaluation of the bids, KeySpan will negotiate an
agreement for its gas distribution subsidiaries. It is anticipated that such
agreement will become effective April 1, 2003.
Gas Costs. Fluctuations in gas costs have little impact on the operating results
of the KEDNE companies since the current gas rate structure for each of the
companies include gas adjustment clauses pursuant to which variations between
actual gas costs incurred and gas costs billed are deferred and subsequently
refunded to or collected from customers. The KEDNE companies do not have a
weather normalization adjustment clause and as a result, fluctuations from
normal weather may have a positive or negative impact on their results. To
lessen to some extent the effect of flucuations in normal weather patterns on
KEDNE's results of operations and cash flows, weather derivatives are in place
for the 2002/2003 winter heating season.
For additional information concerning the gas distribution segment, see the
discussion in "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Gas Distribution" contained herein.
Electric Services Overview
We are the largest investor owned electric generator in New York State. Our
subsidiaries own and operate 5 large generating plants and 8 smaller facilities
which are comprised of 57 generating units in Nassau and Suffolk Counties on
Long Island and the Rockaway Peninsula in Queens. In addition, we own, lease and
operate a major generating facility in Queens County in New York City, the
Ravenswood facility, which is comprised of 3 large steam-generating units and 17
gas turbine generators.
As more fully described below, we: (i) provide to LIPA all operation,
maintenance and construction services and significant administrative services
relating to the Long Island electric transmission and distribution ("T&D")
system through a management services agreement (the "MSA"); (ii) supply LIPA
with generating 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) manage all aspects of the fuel supply for
our Long Island generating facilities, as well as all aspects of the capacity
and energy owned by or under contract to LIPA 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."
7
Generating Facility Operations
In June 1999, we acquired the 2,200 megawatt Ravenswood facility located in New
York City from Consolidated Edison Company of New York, Inc. ("Consolidated
Edison") for approximately $597 million. In order to reduce our initial cash
requirements to finance this acquisition, we entered into an arrangement with an
unaffiliated variable interest entity through which we lease the Ravenswood
facility. Under the arrangement, the variable interest entity acquired a portion
of the facility directly from Consolidated Edison and leased it to our wholly
owned subsidiary. We have guaranteed all payment and performance obligations of
our subsidiary under the lease. The lease relates to approximately $425 million
of the acquisition cost of the facility, which is the amount of debt that would
have been recorded on our Consolidated Balance Sheet had the variable interest
entity not been utilized and conventional debt financing been employed. Further,
we would have recorded an asset in the same amount. Monthly lease payments are
for interest only. The lease qualifies as an operating lease for financial
reporting purposes while preserving our ownership of the facility for federal
and state income tax purposes. We believe that the fair market value of the
Ravenswood facility, including the leased facilities, is in excess of its
acquisition cost (see discussion concerning the Financial Accounting Standards
Board issued Interpretation No. 46 in "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations").
The Ravenswood facility sells capacity, energy and ancillary services into the
New York Independent System Operator ("NYISO") energy market at market-based
rates, subject to mitigation. The plant has the ability to provide approximately
25% of New York City's capacity requirements and is a strategic asset that is
available to serve residents and businesses in New York City. Reliability
improvement investments at our Ravenswood facility reduced the forced outage
rate for that facility from 35% in 1999 to under 6% in 2000, 2001 and 2002.
Decreasing the amount of time our generating units are offline for repair allows
us to increase sales. We are also in the process of expanding our Ravenswood
facility by adding a 250-megawatt state-of-the-art gas-fired combined-cycle
unit. On September 5, 2001, we received approval for the expansion from New York
State's Siting Board on Electric Generation and the Environment ("Siting Board")
and construction is underway. We anticipate that the new unit will be
operational in late 2003. Further, two 79.9 megawatt generating facilities
located on Long Island were placed into service in June and July 2002. The
capacity of and energy from these facilities are dedicated to LIPA under 25 year
contracts.
The competitive wholesale market for capacity, energy and ancillary services
administered by the NYISO is still evolving and the Federal Energy Regulatory
Commission ("FERC") has adopted several price mitigation measures which are
subject to rehearing and possible judicial review. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of
Operation-Regulatory Issues and Competitive Environment" for a further
discussion of these matters.
Natural gas or oil can be used to power 45 of our 77 generating units. In recent
years, we have reconfigured several of our facilities to enable them to burn
either natural gas or oil, thus enabling us to switch periodically between fuel
alternatives based upon cost and seasonal environmental requirements. Through
other innovative technological approaches, we increased installed capacity in
our generating facilities by 80 megawatts, and we instituted a program to reduce
nitrogen oxides for improved environmental performance.
8
The following table indicates the 2003 summer capacity of all of our steam
generation facilities and gas turbine ("GT") units as reported to the NYISO:
- ----------------------------------------------------------------------------------------------------------------------------
Location of Units Description Fuel Units MW
- ----------------------------------------------------------------------------------------------------------------------------
Long Island City Steam Turbine Dual* 3 1,755
Northport, L.I. Steam Turbine Dual* 4 1,520
Port Jefferson, L.I. Steam Turbine Dual* 2 385
Glenwood, L.I. Steam Turbine Gas 2 229
Island Park, L.I. Steam Turbine Dual* 2 389
Far Rockaway, L.I. Steam Turbine Dual* 1 110
Long Island City GT Units Dual* 17 455
Throughout L.I. GT Units Dual* 16 471
Throughout L.I. GT Units Oil 30 1,093
TOTAL 77 6,407
============================================================================================================================
*Dual - Oil (#2 oil, #6 residual oil) or kerosene, and natural gas
In addition to the 250 MW expansion of the Ravenswood facility, we plan to
construct another 250 MW combined cycle plant in Melville, Long Island. In
January 2002, we filed an application for approval with the Siting Board for
this project, and in February 2003, the Presiding Examiners issued a Recommended
Decision recommending that the Siting Board issue a Certificate of Environmental
Capability and Public Need for the project. Action by the Siting Board is
expected in March 2003. In addition, as part of our growth strategy, we
continually evaluate the possible acquisition of additional generating
facilities in the Northeast. However, we are unable to predict when or if such
facilities will be acquired and the effect any such acquired facilities will
have on our financial condition, results of operations or cash flows.
LIPA Agreements
LIPA is a corporate municipal instrumentality and a political subdivision of the
State of New York. On May 28, 1998, certain of LILCO's business units were
merged with KeySpan and LILCO's common stock and remaining assets were acquired
by LIPA. At the time of this transaction, three major long-term service
agreements were also executed between KeySpan and LIPA that provide for KeySpan
to provide 4,037 MW of power generation capacity and energy conversion services;
operation, maintenance and capital improvement services for LIPA's transmission
and distribution system; and the performance of energy management services.
Power Supply Agreement. A KeySpan subsidiary sells to LIPA all of the capacity
and, to the extent requested, energy conversion services from our existing Long
Island based oil and gas-fired generating plants. Sales of capacity and energy
conversion services are made under rates approved by the FERC. Under the terms
of the PSA, rates will be reestablished for the contract year commencing January
1, 2004 by recalculating the revenue requirement underlying those rates. We
anticipate submitting to the FERC a rate filing reflecting the recalculated
revenue requirement in the Fall of 2003. We are unable to predict the outcome of
that proceeding at this time. Rates charged to LIPA include a fixed and variable
component. The variable component is billed to LIPA on a monthly basis and is
dependent on the number of megawatt hours dispatched. LIPA has no obligation to
purchase energy conversion services from us and is able to purchase energy or
energy conversion services on a least-cost basis from all available sources
consistent with existing interconnection limitations of the T&D system. The PSA
provides incentives and penalties that can total $4 million annually for the
maintenance of the output capability and the efficiency of the generating
facilities. In 2002, we earned $4 million in incentives under the PSA.
9
The PSA runs for a term of fifteen years. The PSA is renewable for an additional
15 years on similar terms at LIPA's option. However, the PSA provides LIPA the
option of electing to reduce or "ramp-down" the capacity it purchases from us in
accordance with agreed-upon schedules. In years seven through ten of the PSA, if
LIPA elects to ramp-down, we are entitled to receive payment for 100% of the
present value of the capacity charges otherwise payable over the remaining term
of the 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, KeySpan may use any capacity released by LIPA to bid on new
LIPA capacity requirements or to replace other ramped-down capacity. If we
continue to operate the ramped-down capacity, the PSA requires us to use
reasonable efforts to market the capacity and energy from the ramped-down
capacity and to share any profits with LIPA. The PSA will be terminated in the
event that LIPA exercises its right to purchase, at fair market value, all of
the Long Island generating facilities pursuant to the Generation Purchase Rights
Agreement discussed in greater detail below.
We also have an inventory of sulfur dioxide ("SO2") and nitrogen oxide ("NOx")
emission allowances that may be sold to third party purchasers. The amount of
allowances varies from year to year relative to the level of emissions from the
Long Island generating facilities, which is greatly dependent on the mix of
natural gas and fuel oil used for generation and the amount of purchased power
that is imported onto Long Island. In accordance with the PSA, 33% of emission
allowance sales revenues attributable to the Long Island generating facilities
is retained by KeySpan and the other 67% is credited to LIPA. LIPA also has a
right of first refusal on any potential emission allowance sales of the Long
Island generating facilities. Additionally, KeySpan voluntarily entered into a
memorandum of understanding with the New York State Department of Environmental
Conservation ("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 marginally affect the market value of the allowances.
Management Services Agreement. Under the MSA, we perform day-to-day operation
and maintenance services and capital improvements for LIPA's transmission and
distribution system, including, among other functions, transmission and
distribution facility operations, customer service, billing and collection,
meter reading, planning, engineering, and construction, all in accordance with
policies and procedures adopted by LIPA. KeySpan furnishes such services as an
independent contractor and does not have any ownership or leasehold interest in
the transmission and distribution system.
In exchange for providing these services, we are reimbursed for our budgeted
costs and entitled to earn an annual management fee of $10 million and may also
earn certain cost-based incentives, or be responsible for certain cost-based
penalties. The incentives provide for us to retain 100% of the first $5 million
of budget underruns and 50% of any additional budget underruns up to 15% of the
total cost budget. Thereafter, all savings accrue to LIPA. The penalties require
us to absorb any total cost budget overruns up to a maximum of $15 million in
any contract year.
In addition to the foregoing cost-based incentives and penalties, we are
eligible for performance-based incentives for performance above certain
threshold target levels and subject to disincentives for performance below
certain other threshold levels, with an intermediate band of performance in
which neither incentives nor disincentives will apply, for system reliability,
worker safety, and customer satisfaction. In 2002, we earned $7 million in
non-cost performance incentives.
The MSA was originally set to expire on May 28, 2006, but was extended through
December 31, 2008. The MSA was extended in exchange for an extension of the
option period under the Generation Purchase Rights Agreement as more fully
described in the discussion on "Generation Purchase Rights Agreement" below.
Energy Management Agreement. Pursuant to the EMA, KeySpan (i) procures and
manages fuel supplies for LIPA to fuel our Long Island generating facilities
acquired from LILCO in 1998, (ii) performs off-system capacity and energy
purchases on a least-cost basis to meet LIPA's needs, and (iii) makes off-system
sales of output from the Long Island generating facilities and other power
supplies either owned or under contract to LIPA. LIPA is entitled to two-thirds
of the profit from any off-system electricity sales arranged by us. The term for
the fuel supply service provided in (i) above is fifteen years, expiring May 28,
2013, and the term for the off-system purchases and sales services provided in
(ii) and (iii) above is eight years, expiring May 28, 2006.
10
In exchange for these services, we earn an annual fee of $1.5 million, plus an
allowance for certain costs incurred in performing services under the EMA. The
EMA further provides incentives and disincentives up to $5 million annually for
control of the cost of fuel and electricity purchased on behalf of LIPA. In
2002, we earned EMA incentives in an aggregate of $5 million.
Generation Purchase Rights Agreement. Under the Generation Purchase Rights
Agreement ("GPRA"), LIPA had the right for a one-year period, beginning May 28,
2001, to acquire all of our Long Island based generating assets formerly owned
by LILCO at fair market value at the time of the exercise of such right. By
agreement dated March 29, 2002, LIPA and KeySpan amended the GPRA to provide for
a new six-month option period ending on May 28, 2005. The other terms of the
option reflected in the GPRA remain unchanged.
The GPRA and MSA extensions were the result of an initiative established by LIPA
to work with KeySpan and others to review Long Island's long-term energy needs.
We will work with LIPA to jointly analyze new energy supply options including
re-powering existing plants, renewable energy technologies, distributed
generation, conservation initiatives and retail competition. The extension also
allows both LIPA and us to explore alternatives to the GPRA including the sale
of some, or all of our currently existing Long Island generation plants to LIPA,
or the sale of some or all of these plants to other private operators.
Other Rights. Pursuant to other agreements between LIPA and us, 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 Long Island generating facilities for the purpose of
constructing new electric generating facilities to be owned by LIPA or its
designee. Subject to this right granted to LIPA, KeySpan has the right to sell
or lease property on or adjoining the Long Island generating facilities to third
parties. In addition, LIPA has acquired a parcel of land at the site of the
former 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.
We own the common plant (such as administrative office buildings and computer
systems) formerly owned by LILCO and recover an allocable share of the carrying
costs of such plant through the MSA. KeySpan 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 transmission and distribution system. We have 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
May 28, 1998 transaction which resulted in the formation of KeySpan (estimated
to be approximately $1 billion), which savings are incorporated into the cost
structure under the LIPA Agreements; and (iii) generally not to commence any tax
certiorari case (until termination of the PSA) challenging certain property tax
assessments relating to the former LILCO Long Island generating facilities.
Guarantees and Indemnities. We have entered into agreements with LIPA to provide
for the guarantee of certain obligations, indemnification against certain
liabilities and allocation of responsibility and liability for certain
pre-existing obligations and liabilities. In general, liabilities associated
with the LILCO assets transferred to KeySpan, have been assumed by KeySpan; and
liabilities associated with the assets acquired by LIPA, are borne by LIPA,
subject to certain specified exceptions. We have assumed all liabilities arising
from all manufactured gas plant ("MGP") operations of LILCO and its
predecessors, and LIPA has assumed certain liabilities relating to the former
LILCO Long Island generating facilities and all liabilities traceable to the
business and operations conducted by LIPA after completion of the 1998
KeySpan/LILCO transaction. An agreement also provides for an allocation of
liabilities which 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 KeySpan.
Other. In late 2002, LIPA announced, and we acknowledged, that during 2001 and
2002 we had made an error in reporting LIPA's electric system requirements,
resulting in an overestimation of LIPA's unbilled revenue. LIPA and KeySpan have
continued to review and audit the reporting electric system requirements for
2002 and earlier periods, and have determined that, in addition to the 2001 and
2002 overestimation, unbilled revenues for prior periods back to May 1998 were
slightly underestimated. Based on the review, the total overestimation in
unbilled revenue was approximately $65 million. The LIPA revenue estimation
error did not have an impact on LIPA's electric rates charged to its customers
or to its cash balances. We do not believe that the LIPA revenue estimation
error will have any material adverse impact on the various agreements with LIPA
or on our financial or operating performance.
11
For additional information concerning the Electric services segment, see the
discussion in "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Electric Services" contained herein.
Energy Services Overview
Our Energy Services segment provides services to customers located primarily
within New York, New Jersey, Massachusetts, New Hampshire, Rhode Island and
Pennsylvania through various subsidiaries which operate under the following
three principal lines of business: (i) home energy services, which provides
residential and small commercial customers with service and maintenance of
energy systems and appliances, as well as the competitive retail supply of
natural gas and electricity; (ii) business solutions, which provides
engineering, consulting and construction services, related to the design,
construction, installation, operation, maintenance and management of heating,
cooling and power production equipment and systems for commercial and industrial
customers, as well as the competitive retail supply of natural gas and
electricity to large commercial, institutional and industrial customers (certain
subsidiaries within this line of business also engage or may engage in the
financing and ownership of cogeneration, small power production, thermal energy,
chilled water and related equipment and facilities); and (iii) fiber optic
services in which we construct fiber optic systems and facilities and own and
lease fiber optic cable to local, long distance, and trans-Atlantic carriers, as
well as internet service providers.
The Energy Services segment has more than 3,000 employees and 200,000 service
contracts, and is the number one oil to gas conversion contractor in New York
and New England.
KeySpan's Energy Services subsidiaries compete with local, regional and national
mechanical contracting, HVAC, plumbing, engineering, wholesale fiber optics
carriers, and independent energy companies, in addition to electric utilities,
independent power producers and local distribution companies.
Competition is based largely upon pricing, availability and reliability of
supply, technical and financial capabilities, regional presence, experience and
customer service. With our strong market presence in the Northeast centered on
our Gas Distribution and Electric Services operations and the long-term trend
towards further deregulation, we believe that we are well positioned to provide
our customers with an expanded array of energy products and services through our
unregulated energy service companies.
In 2001, we discontinued the general contracting activities related to the
former Roy Kay companies with the exception of work to be completed on existing
contracts, based upon our view that the general contracting business was not a
core competency of these companies. As a result of our evaluation of the Energy
Services business undertaken during 2001, we decided to set certain limitations
on the types of new general contracting activities in which our contracting
subsidiaries may engage. We also installed senior management personnel whom,
among other things, have reviewed and continue to review and focus on our
overall strategy of these businesses. We are currently engaged in litigation
concerning the Roy Kay companies. For further information, See Note 10 to the
Consolidated Financial Statements, "Roy Kay Operations" and Note 7 "Contractual
Obligations and Contingencies - Legal Matters for a further discussion.
Although the Roy Kay companies are exiting the non-energy related general
contracting business, KeySpan Services, Inc. ("KSI"), through its subsidiaries,
may engage in general contracting where such activities involve contracts for
construction activities that management is satisfied such subsidiary, either by
itself or through one or more contracts with other KSI subsidiaries and/or third
parties, has the necessary resources to perform and which are primarily energy
related as determined by SEC rule or precedent under PUHCA (e.g., involving
projects such as the construction of HVAC, thermal, chilled water and other HVAC
12
facilities, renewable energy, cogeneration and other types of power production
facilities and waste water treatment facilities). KSI and its subsidiaries will
not, however, enter into new contracts to provide general contracting services
involving the construction of primarily non-energy related facilities, as
determined by SEC rule or precedent under PUHCA.
In its order approving the acquisition by KeySpan of Eastern, the SEC reserved
jurisdiction on its determination of whether the Energy Services companies were
retainable and required KeySpan to file a post-effective amendment regarding the
retention of these Energy Services companies. On June 27, 2001, we filed such a
post-effective amendment. The SEC has not made a determination, but we believe
that the SEC may find ample bases to approve of KeySpan's continued operations
in the Energy Services business, especially in light of the fact that other
registered holding companies have been permitted to retain their energy-service
operations.
For additional information concerning the Energy Services segment, see the
discussion in "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Energy Services" contained herein.
Energy Investments Overview
We are also engaged in Energy Investments which include: (i) gas exploration and
production activities; (ii) domestic pipelines and gas storage facilities; (iii)
midstream natural gas processing activities in Canada; (iv) natural gas
distribution and pipeline activities in the United Kingdom; and (v) certain
other domestic energy-related investments, such as providing meter reading
equipment and services to municipal utilities, the transportation by truck of
liquid natural gas, new fuel cell technologies and certain internet related
activities.
Gas Exploration and Production
KeySpan is engaged in the exploration and production of domestic natural gas and
oil through our equity interest in The Houston Exploration Company ("Houston
Exploration") and through our wholly owned subsidiary, KeySpan Exploration and
Production, LLC ("KeySpan Exploration"). Houston Exploration was organized by
KEDNY 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." On
February 26, 2003, Houston Exploration issued 3 million shares of its common
stock, the net proceeds of which were used to repurchase 3 million shares of
common stock owned by us. As a result of the repurchase, our ownership interest
in Houston Exploration was reduced from approximately 66% to approximately 56%.
Additionally, there is an over-allotment option for 300,000 shares, which if
exercised would further reduce our ownership in Houston Exploration to 55%. At
March 1, 2003, Houston Exploration's aggregate market capitalization was
approximately $842.2 million (based upon the closing price on the New York Stock
Exchange on February 28, 2003 of $27.20). At March 1, 2003, Houston Exploration
had approximately 30,961,618 shares of common stock, $.01 par value,
outstanding.
KeySpan Exploration is engaged in a joint venture with Houston Exploration to
explore for natural gas and oil. Houston Exploration contributed all of its
undeveloped offshore leases to the joint venture for a 55% working interest and
KeySpan Exploration, acquired a 45% working interest in all prospects to be
drilled by the joint venture. Effective 2001, the joint venture was modified to
reflect that KeySpan Exploration would only participate in the development of
wells that had previously been drilled and not participate in future exploration
prospects.
In line with our stated strategy of exploring the monetization or divestiture of
certain non-core assets, in October 2002, we sold a portion of our assets in the
joint venture drilling program to Houston Exploration. We received $26.5 million
in cash for our working interests in producing properties with an estimated 18.6
Bcfe of proved and provable reserves.
Our gas exploration and production subsidiaries focus their 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 these operations
enables our subsidiaries to manage a comparatively large asset base with
relatively few employees and to add and operate production at relatively low
incremental costs. Our gas exploration and production subsidiaries seek to
balance their 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
13
reducing volatility. Houston Exploration'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 our offshore and onshore properties and by making
selective opportune acquisitions.
Offshore Properties. Our interests in offshore properties are located in the
shallow waters of the Outer Continental Shelf of the Gulf of Mexico. Our
interests in key producing properties are located in the western and central
Gulf of Mexico and include the Mustang Island, High Island, East Cameron,
Vermilion and South Timbalier areas. We hold interests in 86 blocks in federal
and state waters, of which 42 are developed. Through our subsidiaries, we
operate 29 of our developed blocks, which accounted for approximately 75% of our
interests in offshore production during 2002. We have a total of 37 platforms
and production cassions of which we operate 27. Since its inception in 1999, the
joint venture participated in 28 wells, 23 of which were successful-- 17
exploratory and six development. During 2002, we drilled ten offshore wells,
nine of which were successful, representing a success rate of 90%. Of the
successful wells drilled, six were exploratory and three were development. The
joint venture participated in four of the 2002 wells, two exploratory and two
development, all of which were successful.
Onshore Properties. Our interests in South Texas properties are concentrated in
the Charco, Haynes and South Trevino Fields of Zapata County; the Alexander,
Hubbard and South Laredo Fields of Webb County; and the North East Thompsonville
Field in Jim Hogg County. We own interests in 562 producing wells, 450 of which
are operated by our subsidiaries. Our interests in Arkoma Basin properties are
located in two primary areas: the Chismville/Massard Field located in Logan and
Sebastian Counties of Arkansas and the Wilburton and Panola Fields located in
Latimer County, Oklahoma. We own working interests in 252 producing natural gas
wells, of which we operate 131. Other Onshore properties are concentrated in
three areas: South Louisiana, West Virginia and East Texas. On a combined basis,
we own working interests in 708 producing wells, 653 of which we operate. During
2002, we drilled 87 onshore wells, 75 of which were successful, representing a
success rate of 86%. Of the successful wells drilled, 54 were drilled in South
Texas and 21 were drilled in the Arkoma Basin. Of the 75 successful wells
drilled, 73 were development and two were exploratory.
For additional information concerning the gas exploration and production
segment, see the discussion on "Gas Exploration and Production" in "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and for information with respect to net proved reserves, production,
productive wells and acreage, undeveloped acreage, drilling activities, present
activities and drilling commitments see "Note 17 to the Consolidated Financial
Statements, Supplemental Gas and Oil Disclosures," included herein.
Domestic Pipelines and Gas Storage Facilities
We also own an approximate 20% interest in Iroquois Gas Transmission System LP,
the partnership that owns a 375-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. KeySpan is also a shipper on Iroquois and currently
transports up to 137 MDTH of gas per day.
We are also participating in the Islander East Pipeline Company LLC ("Islander
East"), an interstate pipeline joint venture with Duke Energy Corporation. The
joint venture involves the construction, ownership and operation of a 50 mile
natural gas pipeline that will transport 260 MDTH of gas supply daily from Nova
Scotia, Canada to growing markets in Connecticut, New York City and Long Island,
New York. Increasing gas transmission capacity is necessary to meet the
increased demand for natural gas in the Northeast, which coincides with the
growth strategy of our Gas Distribution business. The project received a
certificate of public convenience and necessity from the FERC authorizing the
construction, operation and maintenance of the interstate natural gas pipeline
facilities in Connecticut and Long Island, N.Y. Islander East has obtained all
required permits in New York State for the construction of the facility.
However, the State of Connecticut has issued a moratorium on the issuance of
permits relating to the construction of energy projects until June 2003.
Islander East has therefore been unable to obtain the necessary permits from the
State of Connecticut at this time. Islander East has also appealed a denial by
the State of Connecticut of the coastal zone management permit to the U.S.
Department of Commerce and such appeal is currently pending. Islander East is
projected to be in service by year end 2004.
14
We also have equity investments in two gas storage facilities in the State of
New York: Honeoye Storage Corporation and Steuben Gas Storage Company. We own a
52% interest in Honeoye, an underground gas storage facility which provides up
to 4.8 billion cubic feet of storage service to New York and New England.
Additionally, we own 34% of a partnership that has a 50% interest in the Steuben
facility that provides up to 6.2 billion cubic feet of storage service to New
Jersey and Massachusetts.
On December 12, 2002, we acquired Algonquin LNG, LP, the owner and operator of a
600,000 barrel liquefied natural gas ("LNG") storage and receiving facility
located in Providence, Rhode Island, from Duke Energy for approximately $28
million. Boston Gas Company is the facility's largest customer and contracts for
more than half of its storage. The facility, renamed KeySpan LNG, LP, is
regulated by the FERC.
Our investments in domestic pipelines and gas storage facilities are
complimentary to our Gas Distribution and Electric Services businesses in that
they provide energy infrastructure to support the growth of these businesses. To
the extent that opportunities become available for expanding our investments in
these types of Energy Investments, KeySpan will continue to consider such
investments as strategic.
Midstream Natural Gas Processing Activities in Canada
We also own 100% of KeySpan Canada, a company with natural gas processing plants
and gathering facilities located in Western Canada. In October 2000, we
purchased the remaining 50% interest in KeySpan Canada from our former partner,
Gulf Canada Resources Limited. The assets include interests in 14 processing
plants and associated gathering systems that can process approximately 1.5 BCFe
of natural gas daily, and provide associated natural gas liquids fractionation.
Additionally, KeySpan owns an approximate 20% interest in Taylor NGL LP which
owns and operates two extraction plants, one located in British Columbia, and
one in Alberta, Canada. We also consider our Canadian operations to be non-core
assets and are also evaluating strategies to divest or monetize these assets.
Natural Gas Distribution and Pipeline Activities in the United Kingdom
We own a 50% interest in Premier Transmission Limited and a 24.5% interest in
Phoenix Natural Gas Limited both in Northern Ireland. 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. Phoenix is a gas distribution system serving the City of
Belfast, Northern Ireland. KeySpan also considers these assets non-core and is
evaluating the possible divestiture or monetization of these assets.
Marine Transportation Activities - Discontinued Operations
Our marine transportation subsidiary, Midland Enterprises, Inc. ("Midland") that
was acquired as part of the Eastern acquisition was divested and its operations
discontinued. We were required by the SEC to divest this subsidiary by November
8, 2003, as its operations were determined not to be functionally related to our
core utility operations as required by PUHCA. On July 2, 2002, we announced that
we closed the sale of Midland to a subsidiary of Ingram Industries Inc.
("Ingram") and we received net proceeds of approximately $175 million from the
sale. See Note 9 "Discontinued Operations," for further information on the sale
of our marine transportation business.
For additional information concerning the Energy Investments segment, see the
discussion on "Energy Investments" in "Item 7, Management's Discussion and
Analysis of Financial Condition and Results of Operations" contained herein.
Environmental Matters Overview
KeySpan's ordinary business operations subject it to regulation in accordance
with various federal, state and local laws, rules and regulations dealing with
the environment, including air, water, and hazardous substances. These
requirements govern both our normal, ongoing operations and the remediation of
impacted properties historically used in utility operations. Potential liability
associated with our historical operations may be imposed without regard to
fault, even if the activities were lawful at the time they occurred.
15
Except as set forth below, or in Note 7 to the Consolidated Financial Statements
"Contractual Obligations and Contingencies - Environmental Matters," no material
proceedings relating to environmental matters have been commenced or, to our
knowledge, are contemplated by any federal, state or local agency against
KeySpan, and we are not a defendant in any material litigation with respect to
any matter relating to the protection of the environment. We believe that our
operations are in substantial compliance with environmental laws and that
requirements imposed by environmental laws are not likely to have a material
adverse impact upon us. We are also pursuing claims against insurance carriers
and potentially responsible parties which seek the recovery of certain
environmental costs associated with the investigation and remediation of
contaminated properties. We believe that investigation and remediation costs
prudently incurred at facilities associated with utility operations, not
recoverable through insurance or some other means, will be recoverable from our
customers.
Air. The Federal Clean Air Act ("CAA") provides for the regulation of a variety
of air emissions from new and existing electric generating plants. We have
submitted timely applications for permits in accordance with the requirements of
Title V of the 1990 amendments to the CAA. Final permits have been issued for
all of our electric generating facilities. The permits allow our electric
generating plants to continue to operate without any additional significant
expenditures, except as described below.
Our generating facilities are located within a CAA severe ozone non-attainment
area, and are subject to Phase I, II and III NOx reduction requirements
established under the Ozone Transportation Commission ("OTC") memorandum of
understanding. Our investments in boiler combustion modifications and the use of
natural gas firing systems at our steam electric generating stations have
enabled us to achieve the emission reductions required under Phase I and II of
the OTC memorandum in a cost-effective manner. We are required to be in
compliance with the Phase III reduction requirements of the OTC memorandum
effective May 1, 2003. We expect to achieve such emission reductions in a
cost-effective manner through the completion of low NOx combustion control
systems, the use of natural gas fuel and the purchases of allowances when
necessary. Expenditures for combustion control systems and natural gas fuel
capability additions to address NOx emission reductions begun in 2002 and ending
in 2003 are expected to be between $10 million and $15 million.
Water. The Federal Clean Water Act provides for effluent limitations, to be
implemented by a permit system, to regulate the discharge of pollutants into
United States waters. We possess permits for our generating units which
authorize discharges from cooling water circulating systems and chemical
treatment systems. These permits are renewed from time to time, as required by
regulation. Additional capital expenditures associated with the renewal of the
surface water discharge permits for our power plants may be required by the DEC.
We are currently monitoring impacts of our discharges on aquatic resources, in
consultation with the DEC. Until our monitoring obligations are completed and
proposed changes to the Environmental Protection Agency regulations under
Section 316 of the Clean Water Act are finalized, the need for and the cost of
equipment upgrades, if any, cannot be determined.
Land. The Federal Comprehensive Environmental Response, Compensation and
Liability Act of 1980 and certain similar state laws (collectively "Superfund")
impose liability, regardless of fault, upon generators of hazardous substances
for costs associated with remediating contaminated property. In the course of
our business operations, we generate materials which, after disposal, may become
subject to Superfund. From time to time, we have received notices under
Superfund concerning possible claims with respect to sites where hazardous
substances generated by KeySpan and other potentially responsible parties were
allegedly disposed. The cost of these claims is not presently determinable but,
if actually imposed on us, may be material to our financial condition, results
of operations or cash flows.
KeySpan has identified certain manufactured gas plant ("MGP") sites which were
historically owned or operated by its subsidiaries (or such companies'
predecessors). Operations at these sites between the mid 1800s to mid 1900s may
have resulted in the release of hazardous substances. For a discussion on our
MGP sites and further information concerning environmental matters, see Note 7
to the Consolidated Financial Statements, "Contractual Obligations and
Contingencies - Environmental Matters."
16
Competition, Regulation and Rate Matters
Competition
Over the last several years, the natural gas and electric sectors of the
regulated energy industry have undergone significant change as market forces
moved towards replacing or supplementing rate regulation through the
introduction of competition. A significant number of natural gas and electric
utilities reacted to the changing structure of the energy industry by entering
into business combinations, with the goal of reducing common costs, gaining size
to better withstand competitive pressures and business cycles, and attaining
synergies from the combination of operations. We engaged in two such
combinations, the KeySpan/LILCO transaction in1998 and our November 2000
acquisition of Eastern and EnergyNorth. For further information regarding the
gas and electric industry, see "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operation-Regulatory Issues and Competitive
Environment."
Additionally, our non-utility subsidiaries engaged in the Energy Services
business compete with other mechanical, HVAC, and engineering companies, and in
New Jersey are faced with competition from the regulated utilities that are
still able to offer appliance repair and protection services.
Regulation
Public utility holding companies, like KeySpan, 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. Our utility
subsidiaries are subject to extensive federal and state regulation by state
utility commissions, FERC and the SEC. Our gas and electric public utility
companies are subject to either or both state and federal regulation. In
general, state public utility commissions, such as the New York Public Service
Commission ("NYPSC"), the Massachusetts Department of Telecommunications and
Energy ("DTE") and the New Hampshire Public Utilities Commission ("NHPUC")
regulate the provision of retail services, including the distribution and sale
of natural gas and electricity to consumers. The FERC regulates interstate
natural gas transportation and electric transmission, and has jurisdiction over
certain wholesale natural gas sales and wholesale electric sales.
In addition, our non-utility subsidiaries are subject to a wide variety of
federal, state and local laws, rules and regulations with respect to their
business activities, including but not limited to those affecting public sector
projects, environmental and labor laws and regulations, state licensing
requirements, as well as state laws and regulations concerning the competitive
retail commodity supply.
State Utility Commissions
Our regulated utility subsidiaries are subject to regulation by the NYPSC, DTE
and NHPUC. The NYPSC regulates KEDNY and KEDLI, and indirectly KeySpan itself,
through conditions that were included in the NYPSC order authorizing the 1998
KeySpan/LILCO transaction. Those conditions address the manner in which KeySpan,
its service company subsidiaries and its unregulated subsidiaries may interact
with KEDNY and KEDLI. The NYPSC also regulates the safety, reliability and
certain financial transactions of our Long Island generating facilities and our
Ravenswood generating facility under a lightened regulatory standard. Our KEDNE
subsidiaries are subject to regulation by the DTE and NHPUC. Our Energy Services
subsidiaries which engage in the retail sale of gas and electricity are also
subject to regulation by the NYPSC and the New Jersey Board of Public Utilities.
For further information regarding the state regulatory commissions, see the
discussion in "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Regulation and Rate Matters."
Federal Energy Regulatory Commission
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 Long Island
generating facilities and the Ravenswood facility are subject to FERC regulation
based on their wholesale energy transactions. In 1998, LIPA, KeySpan and the
Staff of FERC stipulated to a five-year rate plan for the Long Island generating
facilities with agreed-upon yearly adjustments, which have been approved by
FERC. Our Ravenswood facility's rates are based on a market-based rate
application approved by FERC. The rates that our Ravenswood facility may charge
17
are subject to mitigation measures due to market power concerns of FERC. The
mitigation measures are administered by the NYISO. FERC retains the ability in
future proceedings, either on its own motion or upon a complaint filed with
FERC, to modify the Ravenswood facility's rates, as well as the mitigation
measures, if FERC concludes that it is in the public interest to do so.
KeySpan currently bids and sells the energy, capacity and ancillary services
from the Ravenswood facility through the energy market operated by the NYISO.
For information concerning the NYISO, see "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operation-Regulatory Issues and
Competitive Environment."
The FERC also has jurisdiction to regulate certain natural gas sales for resale
in interstate commerce, the transportation of natural gas in interstate
commerce, and, unless an exemption applies, companies engaged in such
activities. The natural gas distribution activities of KEDNY, KEDLI, KEDNE and
certain related intrastate gas transportation functions are not subject to FERC
jurisdiction. However, to the extent that KEDNY, KEDLI or KEDNE purchase or sell
gas for resale in interstate commerce, such transactions are subject to FERC
jurisdiction and have been authorized by the FERC. Our interests in Iroquois,
Honeoye, Steuben and Algonquin LNG are also fully regulated by FERC as natural
gas companies.
Securities and Exchange Commission
As a result of the acquisition of Eastern and EnergyNorth, we became a
registered holding company under PUHCA. Therefore, our corporate and financial
activities and those of our subsidiaries, including their ability to pay
dividends to us, are subject to regulation by the SEC. Under our holding company
structure, we have no independent operations or source of income of our own and
conduct substantially all of our operations through our subsidiaries and, as a
result, we depend on the earnings and cash flow of, and dividends or
distributions from, our subsidiaries to provide the funds necessary to meet our
debt and contractual obligations. Furthermore, a substantial portion of our
consolidated assets, earnings and cash flow is derived from the operations of
our regulated utility subsidiaries, whose legal authority to pay dividends or
make other distributions to us is subject to regulation by state regulatory
authorities. For additional information concerning regulation by the SEC under
PUHCA see the discussion under the heading "Securities and Exchange Commission
Regulation" contained in "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations" contained herein.
Foreign Regulation
KeySpan's foreign 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.
KeySpan's assets in Canada are subject to regulation by Canadian federal and
provincial authorities. Such regulatory authorities license various aspects of
the facilities and pipeline systems as well as regulate safety, operational and
environmental matters and certain changes in such facilities' and pipelines'
capacities and operations.
Risks Related To Our Business
We are a Holding Company, and We and Our Subsidiaries are Subject to Federal
and/or State Regulation Which Limits Our Financial Activities, Including the
Ability of Our Subsidiaries to Pay Dividends and Make Distributions to Us
18
We are a holding company registered under PUHCA with no business operations or
sources of income of our own. We conduct all of our operations through our
subsidiaries and depend on the earnings and cash flow of, and dividends or
distributions from, our subsidiaries to provide the funds necessary to meet our
debt and contractual obligations and to pay dividends on our common stock.
Because we are a registered holding company, our corporate and financial
activities and those of our subsidiaries, including their ability to pay
dividends to us from unearned surplus, are subject to PUHCA and regulation by
the SEC.
In addition, a substantial portion of our consolidated assets, earnings and cash
flow is derived from the operation of our regulated utility subsidiaries, whose
legal authority to pay dividends or make other distributions to us is subject to
regulation by the utility regulatory commissions of New York, Massachusetts and
New Hampshire. Pursuant to New York Public Service Commission orders, the
ability of KeySpan Energy Delivery New York, or KEDNY, and KeySpan Energy
Delivery Long Island, or KEDLI, to pay dividends to us is conditioned upon their
maintenance of a utility capital structure with debt not exceeding 55% and 58%,
respectively, of total utility capitalization. In addition, the level of
dividends paid by both utilities may not be increased from current levels if a
40 basis point penalty is incurred under a customer service performance program.
At the end of KEDNY's and KEDLI's rate years (September 30, 2002 and November
30, 2002, respectively), their ratios of debt to total utility capitalization
were in compliance with the ratios set forth above.
PUHCA Also Limits Our Business Operations and Our Ability to Affiliate with
Other Utilities
PUHCA, in addition to limiting our financial activities, also limits our
operations to a single integrated utility system, plus additional energy related
businesses, regulates transactions between us and our subsidiaries and requires
SEC approval for specified utility mergers and acquisitions. In its order
approving our acquisition of Eastern Enterprises and EnergyNorth, Inc., the SEC
reserved jurisdiction on its determination of whether the companies that
comprise our energy services business can be classified as 'energy-related
companies' and therefore retainable under existing SEC precedent. We are unable
to predict whether the SEC will authorize the retention of all or some of these
companies or the impact its determination will have on our financial condition
or results of operations.
The SEC is currently conducting a routine audit of our operations to determine
compliance with PUHCA, and while no issues have been brought to our attention
that we believe to be material, we can provide no assurances as to the ultimate
findings of the audit or their potential impact on our operations.
Our Gas Distribution and Electric Services Businesses May Be Adversely Affected
by Changes in Federal and State Regulation
The regulatory environment applicable to our gas distribution and our electric
services businesses has undergone substantial changes in recent years, on both
the federal and state levels. These changes have significantly affected the
nature of the gas and electric utility and power industries and the manner in
which their participants conduct their businesses. Moreover, existing statutes
and regulations may be revised or reinterpreted, new laws and regulations may be
adopted or become applicable to us or our facilities, and future changes in laws
and regulations may affect our gas distribution and our electric services
businesses in ways that we cannot predict.
In addition, our operations are subject to extensive government regulation and
require numerous permits, approvals and certificates from various federal, state
and local governmental agencies. Some of our revenues in our Gas Distribution
and Electric Services segments are directly dependent on rates established by
federal or state regulatory authorities, and any change in these rates and
regulatory structure could significantly impact our financial results. Increases
in utility costs other than gas, not otherwise offset by increases in revenues
or reductions in other expenses, could have an adverse effect on earnings due to
the time lag associated with obtaining regulatory approval to recover such
increased costs and expenses, and the uncertainty of whether regulatory
commissions will allow full recovery of and return on such increased costs and
expenses.
Proposals to re-regulate the wholesale power market have been made at the
federal level. These proposals, and legislative and other attention to the
electric power industry could have a material adverse effect on our strategies
and results of operations for our electric services business and our financial
condition. In particular, we sell power and energy from our Ravenswood
generating facility into the New York Independent System Operator, or NYISO,
19
energy market at market based rates, subject to mitigation measures approved by
the Federal Energy Regulatory Commission, or FERC. The pricing for both energy
sales and services to the NYISO energy market is still evolving and some of the
FERC's price mitigation measures are subject to rehearing and possible judicial
review.
Our Risk Mitigation Techniques Such as Hedging and Purchase of Insurance May Not
Adequately Provide Protection
To lower our financial exposure related to commodity price fluctuations, our
marketing, trading and risk management operations routinely enter into contracts
to hedge a portion of our purchase and sale commitments, weather fluctuations,
electricity sales, natural gas supply and other commodities. However, we do not
always cover the entire exposure of our assets or our positions to market price
volatility and the coverage will vary over time. To the extent we have unhedged
positions or our hedging procedures do not work as planned, fluctuating
commodity prices could cause our sales and net income to be volatile.
Our business is subject to many hazards from which our insurance may not
adequately provide coverage. Therefore it is possible that our insurance may not
be adequate to cover all losses or liabilities that we might incur in our
operations. Unexpected outage of Ravenswood, especially in the significant
summer period, could materially impact our financial results. Damage to
pipelines, equipment, properties and people caused by natural disasters,
accidents, terrorism or other damage by third parties could exceed our insurance
coverage. Although we do have insurance to protect against many of these
contingent liabilities, this insurance is capped at certain levels, has
self-insured retentions and does not provide coverage for all liabilities.
SEC Rules for Exploration and Production Companies May Require Us to Recognize a
Non-Cash Impairment Charge at the End of Our Reporting Periods
We use the full cost method of accounting for our investments in natural gas and
oil properties. These investments consist of our approximately 56% equity
interest in The Houston Exploration Company, an independent natural gas and oil
exploration company, as well as KeySpan Exploration and Production, LLC, our
wholly owned subsidiary engaged in a joint venture with Houston Exploration.
Under the full cost method, all costs of acquisition, exploration and
development of natural gas and oil reserves are capitalized into a 'full cost
pool' as incurred, and properties in the pool are depleted and charged to
operations using the unit-of-production method based on production and proved
reserve quantities. To the extent that these capitalized costs, net of
accumulated depletion, less deferred taxes exceed the present value (using a 10%
discount rate) of estimated future net cash flows from proved natural gas and
oil reserves and the lower of cost or fair value of unproved properties, those
excess costs are charged to operations. If a write-down is required, it would
result in a charge to earnings but would not have an impact on cash flows. Once
incurred, an impairment of gas properties is not reversible at a later date,
even if gas prices increase.
You May Not Be Able to Seek Remedies Against Arthur Andersen LLP, Our Former
Independent Accountant, with Respect to Our Financial Statements that were
Audited by Arthur Andersen
On June 15, 2002, Arthur Andersen LLP, our former independent certified public
accountant, was convicted of federal obstruction of justice arising from the
government's investigation of Enron Corp. On April 5, 2002, we dismissed Arthur
Andersen and appointed Deloitte & Touche LLP to serve as our independent
certified public accountant for fiscal year 2002. Arthur Andersen had audited
our financial statements for the fiscal years ended December 31, 2000 and
December 31, 2001. Holders of our common stock may have no effective remedy
against Arthur Andersen in connection with a material misstatement or omission
in those financial statements, particularly in the event that Arthur Andersen
ceases to exist or becomes insolvent as a result of the conviction or other
proceedings against it.
Our Operating Results May Fluctuate on a Seasonal and Quarterly Basis
Our gas distribution business is a seasonal business and is subject to weather
conditions. We receive most of our gas distribution revenues in the first and
fourth quarters when demand for natural gas usually increases due to colder
weather conditions. As a result, we are subject to seasonal variations in
working capital because we purchase most of our natural gas supplies in the
20
second and third quarters and must increase our borrowings in these periods to
finance these purchases. Accordingly, our results of operations in the future
will fluctuate substantially on a seasonal basis. In addition, our New
England-based gas distribution subsidiaries do not benefit from weather
normalization tariffs, and results from our Ravenswood generating facility are
directly correlated to the weather as the demand and price for the electricity
it generates increases during the summer. As a result, fluctuations in weather
between years may have a significant effect on our results of operations for
these subsidiaries.
We Cannot Predict Whether LIPA will Exercise its Option to Purchase Our Long
Island Generating Assets and the Effect of that Purchase on Us
Under a Generation Purchase Right Agreement, as amended, entered into with the
Long Island Power Authority, LIPA has the right to purchase, at fair market
value, during the six month period beginning November 29, 2004, all of our Long
Island based generating assets that had been previously owned by the Long Island
Lighting Company. At this point in time, we cannot predict whether LIPA will
exercise its right to purchase the assets, nor can we estimate the effect on our
financial condition or results of operations if LIPA were to exercise its
option.
A Substantial Portion of Our Revenues are Derived from Our Agreements with LIPA,
and No Assurances Can Be Made that These Arrangements Will Not Be Discontinued
at Some Point in the Future
We derive a substantial portion of our revenues in our electric services segment
from a series of agreements with LIPA pursuant to which we manage LIPA's
transmission and distribution system and supply the majority of LIPA's
customers' electricity needs. The agreements terminate at various dates between
May 28, 2006 and May 28, 2013 and at this time we can provide no assurance that
any of the agreements will be renewed or extended or, if they were to be renewed
or extended, as to the terms and conditions thereof.
We Own Approximately 56% of The Houston Exploration Company, and Our Results of
Operation are Therefore Subject to the Risks Affecting its Business
We own approximately 56% of The Houston Exploration Company, an independent
natural gas and oil producer. Therefore, our results of operations in our energy
investments segment are subject to the same risks and uncertainties that affect
the operations of Houston Exploration. In addition to the risks set forth under
the caption ' -- SEC rules for exploration and production companies may require
us to recognize a non-cash impairment charge at the end of our reporting
periods,' these risks and uncertainties include:
The volatility of natural gas and oil prices. If natural gas and oil
prices decline, the amount of natural gas and oil Houston Exploration can
economically produce may be reduced, which may result in a material decline
in its revenue.
The potential inability of Houston Exploration to meet its capital
requirements. If Houston Exploration is unable to meet its capital
requirements to fund, develop, acquire and produce natural gas and oil
reserves, its oil and gas reserves will decline.
Substantial indebtedness. Houston Exploration's outstanding
indebtedness under its bank credit facility and the indenture governing its
senior subordinated notes contain covenants that require a substantial
portion of its cash flow from operations to be dedicated to its debt
service obligations and impose other restrictions that limit its ability to
borrow additional funds or dispose of assets. These restrictions may affect
its flexibility in planning for, and reacting to, changes in business
conditions.
Estimates of proved reserves and future net revenue may change. Any
significant variance from the assumptions used to estimate proved reserves
or natural gas could result in the actual quantity of Houston Exploration's
reserves and future net cash flow being materially different from the
estimates in its reserve report.
21
A Decline or an Otherwise Negative Change in the Ratings or Outlook on Our
Securities Could Have a Materially Adverse Impact on Our Ability to Secure
Additional Financing on Favorable Terms
The rating agencies that rate our securities regularly review our financial
condition and results of operations. We can provide no assurances that the
ratings or outlook on our securities will not be reduced or otherwise negatively
changed. A negative change in the ratings or outlook on our securities could
have a materially adverse impact on our ability to secure additional financing
on favorable terms.
Our Costs of Compliance with Environmental Laws are Significant, and the Cost of
Compliance with Future Environmental Laws Could Adversely Affect Us
Our operations are subject to extensive federal, state and local environmental
laws and regulations relating to air quality, water quality, waste management,
natural resources and the health and safety of our employees. These
environmental laws and regulations expose us to costs and liabilities relating
to our operations and our current and formerly owned properties. Compliance with
these legal requirements requires us to commit significant capital toward
environmental monitoring, installation of pollution control equipment and
permits at our facilities. Costs of compliance with environmental regulations,
and in particular emission regulations, could have a material impact on our
electric services business and our results of operations and financial position,
especially if emission limits are tightened, more extensive permitting
requirements are imposed, additional substances become regulated or the number
and type of electric generating plants we operate increase.
In addition, we are responsible for the clean-up of contamination at certain
manufactured gas plant ('MGP') sites and at other sites and are aware of
additional MGP sites where we may have responsibility for clean up costs. While
our gas rate plans generally allow for the full recovery of the costs of
investigation and remediation of MGP sites, these rate recovery mechanisms may
change in the future. To the extent rate recovery mechanisms change in the
future, or if additional environmental matters arise in the future at our
currently or historically owned facilities, at sites we may acquire in the
future or at third party waste disposal sites, costs associated with
investigating and remediating these sites could have a material adverse effect
on our results of operations and financial condition.
Our Businesses are Subject to Competition and General Economic Conditions
Impacting Demand for Services
Ravenswood, our merchant generation plant, in our Electric Services segment, is
subject to competition that could adversely impact the market price for the
electricity it produces. Construction of new transmission facilities could also
cause significant changes to the market. If generation and/or transmission
facilities are constructed, and/or the availability of our Ravenswood facility
deteriorates, then the capacity and energy sales volumes could be adversely
affected. We cannot predict, however, when or if new power plants or
transmission facilities will be built or the nature of the future New York City
energy requirements.
Competition facing our unregulated Energy Services businesses, including but not
limited to competition from other mechanical, plumbing, heating, ventilation and
air conditioning, and engineering companies, as well as, other utilities and
utility holding companies that are permitted to engage in such activities, could
adversely impact our financial results and the value of those businesses,
resulting in decreased earnings as well as writedowns of the carrying value of
those businesses. In addition, competition in the fiber optics business could
negatively impact the value of this business.
Our Gas Distribution segment faces competition with distributors of alternative
fuels and forms of energy, including fuel oil and propane. Our ability to
continue to add new gas distribution customers may significantly impact
financial results. The gas distribution industry has experienced a decrease in
consumption per customer over time partially due to increased efficiency of
customers' appliances. Our Gas Distribution segment is dependent upon the
ability to add new customers to our system in a cost-effective manner. While our
Long Island and New England utilities have significant growth potential, we
cannot be sure new customers will continue to offset the decrease in consumption
of our existing customer base. There are a number of factors outside of our
control that impact whether a potential customer converts from an alternative
fuel to gas, including general economic factors impacting customers willingness
to invest in new gas equipment.
22
Employee Matters
As of December 31, 2002, KeySpan and its wholly owned subsidiaries had
approximately 13,000 employees. Of that total, approximately 5,850 employees in
our regulated companies are covered under collective bargaining agreements.
KeySpan has not experienced any work stoppage during the past five years and
considers its relationship with employees, including those covered by collective
bargaining agreements, to be good.
Executive Officers of the Company
Certain information regarding executive officers of KeySpan and certain of its
subsidiaries is set forth below:
Robert B. Catell
Mr. Catell, age 66, has been a Director of KeySpan since its creation in May
1998. He was elected Chairman of the Board and Chief Executive Officer in July
1998. He served as its President and Chief Operating Officer from May 1998
through July 1998. Mr. Catell joined KEDNY in 1958 and became an officer in
1974. He was elected Vice President in 1977, Senior Vice President in 1981 and
Executive Vice President in 1984. He was elected Chief Operating Officer in 1986
and President in 1990. Mr. Catell continued to serve as President and Chief
Executive Officer of KEDNY from 1991 through 1996, when he was elected Chairman
and Chief Executive Officer. In 1997, Mr. Catell was elected Chairman, President
and Chief Executive Officer of KEDNY and its parent KeySpan Energy Corporation.
Robert J. Fani
Mr. Fani, age 49, was elected President, KeySpan Energy Assets and Supply Group
in January 2003. Mr. Fani joined KEDNY 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 for KEDNY. In 1998, he
assumed the position of Senior Vice President of Marketing and Sales for
KeySpan. In September 1999, he became Senior Vice President for Gas Operations
and was promoted to Executive Vice President in February 2000 and then President
of Energy Services and Supply until assuming his current position in February
2003.
Wallace P. Parker Jr.
Mr. Parker, age 53, was elected President, Energy Delivery and Customer
Relations Group, in January 2003. He had previously served as President, KeySpan
Energy Delivery, since June 2001, and before that served as Executive Vice
President of Gas Operations from February 2000. He joined KEDNY in 1971 and
served in a wide variety of management positions. In 1987 he was named Assistant
Vice President for marketing and advertising and was elected Vice President in
1990. In 1994, Mr. Parker was promoted to Senior Vice President of Human
Resources and in August 1998 was promoted to Senior Vice President of Human
Resources of KeySpan.
John A. Caroselli
Mr. Caroselli, age 48, was elected Executive Vice President of Strategic
Services in October 2001 and is responsible for Brand Management, Strategic
Marketing, Strategic Planning, Strategic Performance, and E-business. Mr.
Caroselli came to KeySpan in 2001 and served at that time as Executive Vice
President of Corporate Development. Before joining KeySpan, Mr. Caroselli held
the position of Executive Vice President of Corporate Development at AXA
Financial. Prior to that, he held senior officer positions with Chase Manhattan,
Chemical Bank and Manufacturers Hanover Trust. He has extensive experience in
brand management, marketing, communications, human resources, facilities
management, e-business and change management.
23
Gerald Luterman
Mr. Luterman, age 59 was elected Executive Vice President and Chief Financial
Officer in February 2002. He previously served as Senior Vice President and
Chief Financial Officer since joining KeySpan in July 1999. He formerly served
as Chief Financial Officer of barnesandnoble.com and Senior Vice President and
Chief Financial Officer of Arrow Electronics, Inc. Prior to that, from 1985
through 1996, he held executive positions with American Express, including
Executive Vice President and Chief Financial Officer of the Consumer Card
Division from 1991-1996. Mr. Luterman has served on the Board of Directors of
The Houston Exploration Company since May 2000.
Anthony Nozzolillo
Mr. Nozzolillo, age 54, was elected Executive Vice President of Electric
Operations in February 2000. He previously served as Senior Vice President of
KeySpan's Electric Business Unit from December 1998 to January 2000. He joined
LILCO in 1972 and held various positions, including Manager of Financial
Planning and Manager of Systems Planning. Mr. Nozzolillo served as LILCO's
Treasurer from 1992 to 1994 and as Senior Vice President of Finance and Chief
Financial Officer from 1994 to 1998.
Lenore F. Puleo
Ms. Puleo, age 49, was elected Executive Vice President of Client Services in
June 2000. She previously served as Senior Vice President of Customer Relations
for KEDNY from May 1994 to May 1998, and for KeySpan from May 1998 to January
2000. She joined KEDNY in 1974 and worked in management positions in KEDNY's
Accounting, Treasury, Corporate Planning, and Human Resources areas. She was
given responsibility for the Human Resources Department in 1987 and was named a
Vice President in 1990. Ms. Puleo was promoted to Senior Vice President of
KEDNY's Customer Relations in 1994.
Nickolas Stavropoulos
Mr. Stavropoulos, age 44, was elected Executive Vice President, KeySpan
Corporation, and President, KeySpan Energy Delivery New England, in April 2002;
prior to this he was Senior Vice President of sales and marketing in New England
since 2000. Prior to joining KeySpan, Mr. Stavropoulos was Senior Vice President
of marketing and gas resources for Boston Gas. Before joining Boston Gas, he was
Executive Vice President and Chief Financial Officer for Colonial Gas. In 1995,
Mr. Stavropoulos was elected Executive Vice President - Finance, Marketing and
CFO, and assumed responsibility for all of Colonial's financial, marketing,
information technology and customer service functions.
Steven L. Zelkowitz
Mr. Zelkowitz, age 53, Executive Vice President, was named Chief Administrative
Officer, with responsibility for the offices of General Counsel, Human
Resources, Regulatory Affairs, Enterprise Risk Management, and administratively
for Internal Auditing, in January 2003. Prior to that he served as Executive
Vice President-Administration and Compliance since November 2002, and Executive
Vice President and General Counsel of KeySpan since July 2001. He joined KeySpan
as Senior Vice President and Deputy General Counsel in October 1998, and was
elected Senior Vice President and General Counsel in February 2000. Before
joining the Company, Mr. Zelkowitz practiced law with Cullen and Dykman in
Brooklyn, New York specializing in energy and utlity law and had been a partner
since 1984. He served on the firm's Executive Committee and was head of its
Corporate/Energy Department.
24
John J. Bishar, Jr.
Mr. Bishar, age 52, became Senior Vice President and General Counsel on November
1, 2002, with responsibility for the Legal Services Business Unit and the
Corporate Secretary's Office. Before joining KeySpan, Mr. Bishar practiced law
with Cullen and Dykman LLP. He was the Managing Partner from 1993 through 2002
and was a member of the firm's Executive Committee. From 1980 to 1987, Mr.
Bishar was Vice President, General Counsel and Corporate Secretary of LITCO
Bancorporation of New York, Inc. In 1987, Mr. Bishar returned to Cullen and
Dykman LLP as a partner responsible for the firm's commercial lending and
commercial real estate lending activities for a variety of financial
institutions.
Joseph F. Bodanza
Mr. Bodanza, age 55, was elected Senior Vice President of Finance Operations and
Regulatory Affairs in August 2001, and Chief Accounting Officer effective April
1, 2003. Prior to his appointment he was Senior Vice President and Chief
Financial Officer of KEDNE. Mr. Bodanza previously served as Senior Vice
President of Finance and Management Information Systems and Treasurer of Eastern
Enterprise's Gas Distribution Operations. Mr. Bodanza joined Boston Gas in 1972
and held a variety of positions in the financial and regulatory areas before
becoming Treasurer in 1984. He was elected Vice President and Treasurer in 1988.
John F. Haran
Mr. Haran, age 52, was elected Senior Vice President of gas operations for KEDNY
and KEDLI in April 2002. Mr. Haran joined The Brooklyn Union Gas Company in 1972
and has held management positions in operations, engineering, and marketing and
sales. He was named Vice President of KEDNY gas operations in 1996 and in 2000
moved to the position of Vice President of KEDLI gas operations.
David J. Manning
Mr. Manning, age 52, was elected Senior Vice President of KeySpan's Corporate
Affairs group in April 1999. Before joining KeySpan, Mr. Manning had been
President of the Canadian Association of Petroleum Producers since 1995. From
1993 to 1995, he was Deputy Minister of Energy for the Province of Alberta,
Canada. From 1988 to 1993, he was Senior International Trade Counsel for the
Government of Alberta, based in New York City. Previously he was in the private
practice of law in Canada.
H. Neil Nichols
Mr. Nichols, age 65, was elected Senior Vice President of KeySpan's Corporate
Development and Asset Management division in March 1999. He also serves as
President of KeySpan Energy Development Corporation ("KEDC"), a position to
which he was elected in March 1998. KEDC is a wholly owned subsidiary of KeySpan
responsible for our Energy Investments segment. Since February 1999, Mr. Nichols
also has responsibility for KeySpan Energy Trading Services, LLC, which provides
fuel-procurement management and energy-trading services as agent for LIPA. Mr.
Nichols joined KeySpan in 1997 as a broad-based negotiator and business
strategist with comprehensive finance and treasury experience in domestic and
international markets. Prior to joining KeySpan, Mr. Nichols was an owner and
president of Corrosion Interventions, Ltd. in Toronto, Canada. He also served as
Chief Financial Officer and Executive Vice President with TransCanada PipeLines.
Colin P. Watson
Mr. Watson, age 51, was named Senior Vice President of KeySpan's Strategic
Marketing and E-Business division effective March 1, 2000. He previously served
as Vice President of Strategic Marketing from May 1998 until his promotion to
Senior Vice President. Mr. Watson joined KEDNY in 1997 as Vice President of
Strategic Marketing. From 1973 to 1997, he held several positions at NYNEX,
including Vice President of General Business Sales and Managing Director of
worldwide operations.
25