UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2003
Commission File Number 1-14161
KEYSPAN CORPORATION
(Exact name of registrant as specified in its charter)
NEW YORK 11-3431358
(State or other jurisdiction (I.R.S. employer identification no.)
of 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. X Yes __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. X
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act) X Yes __No
As of June 30, 2003, the aggregate market value of the common stock held by
non-affiliates (157,824,519 shares) of the registrant was $5,594,879,198 based
on the closing price of the New York Stock Exchange on such date, of $35.45 per
share. For purposes of this computation, all officers and directors of the
registrant are deemed to be affiliates.
As of March 1, 2004, there were 159,844,530 shares of common stock, $.01 par
value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement dated on or about March 25, 2004 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...............................................................................................33
Item 3. Legal Proceedings........................................................................................34
Item 4. Submission of Matters to a Vote of Security Holders......................................................34
PART II
-------
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters....................................34
Item 6. Selected Financial Data..................................................................................36
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....................37
Item 7A. Quantitative and Qualitative Disclosures About Market Risk...............................................85
Item 8. Financial Statements and Supplementary Data..............................................................87
Notes to the Consolidated Financial Statements...............................................................................93
Note 1. Summary of Significant Accounting Policies...............................................................93
Note 2. Business Segments.......................................................................................111
Note 3. Income Tax..............................................................................................115
Note 4. Postretirement Benefits.................................................................................117
Note 5. Capital Stock...........................................................................................122
Note 6. Long-Term Debt..........................................................................................123
Note 7. Contractual Obligations, Financial Guarantees and Contingencies.........................................129
Note 8. Hedging, Derivative Financial Instruments and Fair Values...............................................139
Note 9. Discontinued Operations.................................................................................144
Note 10. Roy Kay Operations......................................................................................145
Note 11. Class Action Settlement.................................................................................146
Note 12. KeySpan Gas East Corporation Summary Financial Data.....................................................146
Note 13. Workforce Reduction Programs............................................................................152
Note 14. Shareholder Rights Plan.................................................................................152
Note 15. Subsequent Events.......................................................................................153
Note 16. Supplemental Gas and Oil Disclosures (Unaudited)........................................................153
Note 17. Summary of Quarterly Information (Unaudited)............................................................158
INDEPENDENT AUDITORS' REPORT................................................................................................159
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS....................................................................................161
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure....................162
Item 9A. Controls and Procedures.................................................................................162
PART III
Item 10. Directors and Executive Officers of the Registrant......................................................162
Item 11. Executive Compensation..................................................................................163
Item 12. Security Ownership of Certain Beneficial Owners and Management..........................................163
Item 13. Certain Relationships and Related Transactions..........................................................163
Item 14. Principal Accounting Fees and Services..................................................................163
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.........................................163
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, 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 generating capacity and, to the extent required,
energy conversion services for LIPA from our approximately 4,200 megawatts of
generating facilities located on Long Island; and manage fuel supplies for LIPA
to fuel our 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, as well as the 250 megawatt expansion unit at
Ravenswood expected to be completed within the next few months.
The Energy Services segment provides energy-related services to customers
primarily located within New York, New Jersey, Connecticut, Massachusetts, New
Hampshire, Rhode Island and Pennsylvania through various subsidiaries that
operate under the following principal two lines of business: (i) home energy
services; and (ii) business solutions.
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 pipeline
activities in the United Kingdom.
1
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 core businesses.
We also continue to explore the monetization of some or all of our non-core
assets in the Energy Investments segment.
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 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;
- - the resolution of certain disputes with LIPA concerning each party's rights
and obligations under various agreements;
- - retention of key personnel;
2
- - 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 and conduct operations;
- - 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
- - 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 the 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.
KeySpan has adopted a Code of Ethics applicable to its Chief Executive Officer
and Senior Financial Officers, and has revised its Ethical Business Conduct
Statement applicable to all directors, officers and employees of the Company in
each case as required by recently adopted rules and regulations.
KeySpan's Code of Ethics, Ethical Business Conduct Statement, Corporate
Governance Guidelines and Committee Charters can each be found on the Investor
Relations section of KeySpan's website (http://www.keyspanenergy.com) and
provide information on the framework and high standards set by the Company
relating to its corporate governance and business practices. Additionally, these
documents are available in print to any shareholder requesting a copy. The Code
of Ethics, Ethical Business Conduct Statement, Corporate Governance Guidelines
and Committee Charters have all been approved by the Board of Directors and are
vital to securing the confidence of KeySpan's shareholders, customers,
employees, governmental authorities and the investment community.
3
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 23,000 miles of gas mains and
distribution pipelines.
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.
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.
4
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 and
associated revenue taxes) 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. We utilize weather derivatives for KEDNE to mitigate
variations in firm net revenues due to fluctuations in weather.
For 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.
5
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 2,053 MDTH (one MDTH equals 1,000 DTH or 1 billion British Thermal
Units) of gas for a peak-day during the 2003/04 winter season and that the gas
available to us on such a peak-day amounts to approximately 2,076 MDTH. As of
January 20, 2004, the 2003/04 winter peak-day throughput to our New York
customers was 1,804 MDTH, which occurred on January 15, 2004 at an average
temperature of 7 degrees F, representing 87% of our peak-day capability. Our New
York firm gas peak-day capability is summarized in the following table:
Source MDTH per day % of Total
- ------------------------------------------- ------------------------- ------------------------
Pipeline 794 38%
Underground Storage 778 38%
Peaking Supplies 504 24%
--- ---
Total 2,076 100%
========================= ========================
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
2003/04 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 794 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, L.P. ("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 provided us with peak day capacity of
394 MDTH and winter season availability of 2,053 MDTH. The peaking supply
contracts with the five duel fuel power producers provided us with peak day
capacity of 110 MDTH and winter season availability of 3,349 MDTH.
6
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 which expires on March 31, 2006.
Gas Costs. 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 firm customers.
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 January 1, 2004, approximately 105,429 gas customers
on the New York Gas Distribution System are purchasing their gas from marketers.
However, net gas revenues are not significantly affected by customers opting to
purchase their gas supply from other sources since delivery rates charged to
transportation customers generally are the same as delivery rates charged to
sales service customers.
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, are available to
meet system requirements during the winter season.
Peak-Day Capability. The design criteria for our New England gas systems assumes
a level of 78 effective degree days for peak-day demand. Under such criteria,
KEDNE estimates that the requirements to supply their firm gas customers would
amount to approximately 1,281 MDTH of gas for a peak-day during the 2003/2004
winter season. The gas available to KEDNE on such peak-day amounts to 1,402
MDTH. KEDNE estimates an additional 105 MDTH of on-system throughput on behalf
of its transportation-only customers for a total peak day throughput estimate of
1,386 MDTH.
The highest daily throughput, which includes both firm sales and firm
transportation, to our New England customers was 1,421 MDTH, which occurred on
January 15, 2004 at a level of 80 effective degree days. The total throughput of
1,421 MDTH exceeded the design day throughput estimate by two and one half
percent (2.5%). KEDNE has sufficient gas supply available to meet the
requirements of their firm gas customers for the 2003/2004 winter season. The
firm gas supply peak day capability of KEDNE for its firm customers is
summarized in the following table:
7
MDTH per
Source day % of Total
- -------------------------------------------- ------------------------- -------------------------
Pipeline 486 35
- -------------------------------------------- ------------------------- -------------------------
Underground Storage 261 19
- -------------------------------------------- ------------------------- -------------------------
Peaking Supplies 655 47
--- --
- -------------------------------------------- ------------------------- -------------------------
Total 1402 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 747 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 23,280 MDTH and 261 MDTH per day of maximum deliverability.
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 2003/2004 winter season, on a
peak-day, KEDNE has access to 655 MDTH of peaking supplies, 47% of peak-day
supply.
Gas Supply Management. Since April 1, 2003 the New England based gas
distribution subsidiaries have been operating under a portfolio management
contract with Entergy Koch Trading, LP ("EKT"). EKT provides the majority of the
city gate supply requirements to the four New England gas distribution companies
(Boston Gas, Colonial Gas, Essex Gas and Energy North) at market prices and
manages upstream capacity, underground storage and supply contracts.
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.
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.
8
Electric Services Overview
We are the largest electric generator in New York State. Our subsidiaries own
and operate 5 large generating plants and 10 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 the
Ravenswood Generating Station located in Queens County, which is the largest
generating facility in New York City. Ravenswood is comprised of 3 large
steam-generating units and 17 gas turbine generators. A 250MW expansion at our
Ravenswood facility has been qualified to participate in the capicity market
adminstered by the New York Independent System Operator as of April 1, 2004 (the
"Ravenswood Expansion Project") and we operate and maintain a 55 MW gas turbine
unit in Greenport, Long Island under an agreement with Global Commons Greenport.
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 from the Long
Island units through a power supply agreement (the "PSA") and other long-term
agreements to provide LIPA with approximately two thirds of its customers energy
needs; 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").
We also purchase energy, capacity and ancillary services in the open market on
LIPA's behalf under 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."
Additional electric capacity and energy are supplied under power purchase
agreements with LIPA from four gas turbine units installed in 2002 at our
Glenwood and Port Jefferson sites. See Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operation - "Electric Services -
Revenue Mechanisms" for a further discussion of these matters.
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 a portion of 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 ("Master
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 instead conventional debt financing been employed. The initial term of the
Master Lease expires on June 20, 2004 and may be extended until June 20, 2009.
In June 2004, we have the right to: (i) either purchase the facility for the
original acquisition cost of $425 million, plus the present value of the lease
payments that would otherwise have been paid through June 2009; (ii) terminate
the Master Lease and dispose of the facility; or (iii) otherwise extend the
Master Lease to 2009. If the Master Lease is terminated in 2004, KeySpan has
guaranteed an amount generally equal to 83% of the residual value of the
9
original cost of the property, plus the present value of the lease payments that
would have otherwise been paid through June 20, 2009. KeySpan intends to extend
the Master Lease for the forseeable future. (See discussion concerning the
Financial Accounting Standards Board issued Interpretation No. 46 in Note 7 to
the Consolidated Financial Statements, "Contractual Obligations, Financial
Guarantees and Contingencies."
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. In addition,
KeySpan intends to enter into a sale/leaseback transaction to finance a
significant portion of the costs related to the Ravenswood Expansion Project.
For further details on this proposed transaction, see Note 15 to the
Consolidated Financial Statements - "Subsequent Events."
The New York State 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.
Forty-five of our seventy-seven generating units are dual fuel 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 MW, and we instituted a program to reduce
nitrogen oxides for improved environmental performance.
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 1,765
Northport, L.I. Steam Turbine Dual* 4 1,529
Port Jefferson, L.I. Steam Turbine Dual* 2 388
Glenwood, L.I. Steam Turbine Gas 2 232
Island Park, L.I. Steam Turbine Dual* 2 391
Far Rockaway, L.I. Steam Turbine Dual* 1 110
Long Island City GT Units Dual* 17 454
Throughout L.I. GT Units Gas 4 160
Throughout L.I. GT Units Dual* 12 311
Throughout L.I. GT Units Oil 30 1,093
-- -----
TOTAL 77 6,433
=========================================================================================================
*Dual - Oil (#2 oil, #6 residual oil) or kerosene, and natural gas.
10
In January 2002, we filed an application for approval with the New York State
Siting Board on Electric Generation and Environment ("Siting Board") for a 250
MW combined cycle plant in Melville, NY. 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, and
on May 8, 2003 the Siting Board issued the certificate. In 2003, we formed a
joint venture with American National Power, Inc. ("ANP") for the purpose of
jointly submitting a proposal in repsonse to a request for proposals by LIPA
for additional generating resources. The response proposed the construction of
two 250 MW plants, one at the Melville site and another at a site in the town of
Brookhaven in Long Island which also received a certificate from the Siting
Board. If successful in negotiating a power purchase agreement with LIPA, the
ANP joint venture will commence construction of the plant. Otherwise, we may
seek other opportunities to enter into a long-term agreement for the sale of
capacity, energy and ancillary services. In addition, as part of our growth
strategy, we continually evaluate the possible acquisition or development of
additional generating facilities in the Northeast. However, we are unable to
predict when or if such facilities will be acquired or constructed 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 (collectively, the "LIPA
Agreements"). Under the agreements and subsequent Power Purchase Agreements,
KeySpan provides: 4,214 MW of power generation capacity and energy conversion
services; operation, maintenance and capital improvement services for LIPA's
transmission and distribution system; and 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 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. A rate
filing reflecting the recalculated revenue requirement was submitted to FERC on
October 31, 2003 and on December 30, 2003, FERC issued an order accepting, in
part, the rates subject to refund pending settlement discussions and hearings.
We are unable to predict the outcome of those proceedings 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 2003, we earned
$4 million in incentives under the PSA.
11
The PSA runs for a term of 15 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 7 through 10 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 2003, we earned $7.2 million in
non-cost performance incentives.
12
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.
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
2003, 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 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 for the terminus of a transmission
cable under Long Island Sound and other generating facilities.
13
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 relates 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. In addition, costs incurred
by KeySpan for liabilities for asbestos exposure arising from the activities of
the generating facilities previously owned by LILCO are recoverable from LIPA
through the Power Supply Agreement between LIPA and KeySpan.
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
The Energy Services segment includes companies that provide energy-related
services to customers primarily located within the New York City metropolitan
area including New Jersey and Connecticut, as well as Rhode Island,
Pennsylvania, Massachusetts and New Hampshire through the following two lines of
business: (i) Home Energy Services, which provides residential customers with
installation, service and maintenance of energy systems and appliances, as well
as the retail marketing of electricity to commercial customers; and (ii)
Business Solutions, which provides plumbing, heating, ventilation, air
conditioning and mechanical services, as well as operation and maintenance,
design, engineering and consulting services to commercial and industrial
customers. On May 1, 2003, KeySpan's gas and electric marketing subsidiary,
KeySpan Energy Services, assigned a substantial portion of its retail natural
gas customers, consisting mostly of residential and small commercial customers,
to ECONnergy Energy Co., Inc. ("ECONnergy"). ECONnergy is one of the largest
deregulated energy service companies in the Northeast. KeySpan Energy Services
is continuing its electric marketing activities.
14
The Energy Services segment has more than 2,700 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, 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.
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 who,
among other things, have reviewed and continue to review and focus on our
overall strategy of these businesses.
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 pipeline
activities in the United Kingdom; and (v) certain other domestic energy-related
investments, such as the transportation by truck of liquid natural gas and new
fuel cell technologies.
Gas Exploration and Production
KeySpan is engaged in the exploration for 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 the current level
of approximately 55%. This reduction in our ownership interest is in line with
our strategy of monetizing or divesting certain non-core assets, which include
investment in oil and gas exploration and production assets. At March 1, 2004,
Houston Exploration's aggregate market capitalization was approximately $1.224
billion (based upon the closing price on the New York Stock Exchange on March 1,
2004 of $38.75 per share). At March 1, 2004, Houston Exploration had
approximately 31,587,637 shares of common stock, $0.01 par value, outstanding.
15
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.
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
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 2003. We have a total of 37 platforms
and production caissons 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,
16
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 412-mile pipeline that currently transports 1236
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. Applications for all necessary
regulatory authorizations were filed in 2000 and 2001. To date, Islander East
has received a final certificate from the Federal Energy Regulatory Commission
("FERC") and all necessary permits from the State of New York. However, the
State of Connecticut has denied Islander East's application for a coastal zone
management permit and a permit under Section 401 of the Clean Water Act.
Islander East has reinstated its appeal of the State of Connecticut's
determination on the coastal zone management issue to the United States
Department of Commerce and is evaluating its legal and other options with
respect to the Section 401 issue. Once in service, the pipeline is expected to
transport up to 260,000 DTH daily to the Long Island and New York City energy
markets, enough natural gas to heat 600,000 homes. The pipeline will also allow
KeySpan to diversify the geographic sources of its gas supply. However, we are
unable to predict when or if all regulatory approvals required to construct this
pipeline will be obtained. Various options for the financing of pipeline
construction are currently being evaluated. At December 31, 2003, total
expenditures associated with the siting and permitting of the Islander East
pipeline were $14.9 million.
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. 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 FERC. In a joint initiative
with BG LNG Services, KeySpan plans to upgrade the KeySpan LNG facility to
accept marine deliverables and to triple vaporization (or regasification
capacity). Pending regulatory approvals, the facility could be ready to accept
marine deliverables by late 2005.
17
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
and, therefore, we will continue to pursue these opportunities.
Midstream Natural Gas Processing Activities in Canada
During the year, we sold 39.09% of our interest in KeySpan Canada, a company
with natural gas processing plants and gathering facilities located in Western
Canada. In February 2004, we entered into an agreement to sell an additional
35.91% of our interest in KeySpan Canada. Following the closing of this
additional sale of our interest, currently scheduled for early April 2004, we
will own 25% of KeySpan Canada. The assets include interests in 14 processing
plants and associated gathering systems that can process approximately 1.5 BCFe
of natural gas daily, and provide associated natural gas liquids fractionation.
Additionally, we sold our 20% interest in Taylor NGL LP that owns and operates
two extraction plants also in Canada, one located in British Columbia, and one
in Alberta, Canada. We consider our Canadian operations to be non-core assets
and we continue to evaluate 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, 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. KeySpan considers this a non-core asset and is evaluating the possible
divestiture or monetization. In December, 2003, the company sold its interest in
Phoenix Natural Gas Limited, a gas distribution system serving the City of
Belfast, Northern Ireland.
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.
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 existing 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
18
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 in accordance with the terms of our rate recovery agreements for each
regulated subsidiary.
Air. The Federal Clean Air Act ("CAA") provides for the regulation of a variety
of air emissions from new and existing electric generating plants. Final permits
in accordance with the requirements of Title V of the 1990 amendments to the CAA
have been issued for all of our electric generating facilities, with the
exception of two 79 MW simple cycle gas turbine units which were constructed in
2002. These units currently are permitted under New York State Facility permits
and Title V permits have been timely applied for and are pending issuance by the
NYSDEC. Renewal applications have been submitted in a timely manner for 13
existing facilities whose initial permits will expire in 2004. The permits and
timely renewal applications 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 Transport 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, II, and
III of the OTC memorandum in a cost-effective manner. We have achieved and
expect to continue to achieve such emission reductions in a cost-effective
manner through the use of low NOX combustion control systems, the use of natural
gas fuel and/or the purchases of allowances when necessary. Capital expenditures
were incurred between $10 million and $15 million for combustion control systems
and natural gas fuel capability additions over the last several years enhance
compliance options.
In 2003, New York State promulgated regulations which will establish separate
NOX and SO2 emission reduction requirements on electric generating facilities in
New York State beginning in late 2004. KeySpan's facilities are expected to
comply with the NOX requirements without material additional expenditures
because of previously installed emissions control equipment. SO2 compliance is
expected to require a reduction in the sulfur content of the fuel oil used in
our Northport and Port Jefferson facilities. Based on current projections,
higher incremental fuel costs at these facilities will be approximately $10
million per year, and, contractually, are the obligation of LIPA in accordance
with the terms of the PPA.
In December 2003, the United States Environmental Protection Agency ("USEPA")
issued draft regulations that would require reductions of mercury and nickel as
well as further reductions of NOX and SO2 from electric generating facilities on
a national basis. The proposed mercury regulations would have no impact on
KeySpan facilities since their application is limited to coal-fired plants. The
proposed nickel, NOX and SO2 reduction requirements, if finalized as drafted,
could require additional expenditures for emission control systems or greater
use of natural gas in order to facilitate compliance. Until these regulations
are finalized, the nature and extent of the financial impact on KeySpan, if any,
cannot be determined.
19
In 2003, the Governor of New York initiated a Regional Greenhouse Gas Initiative
that seeks to establish a coordinated multistate plan to reduce greenhouse gas
emissions (primarily carbon dioxide) from electric generating emission sources
in the Northeast. Several congressional initiatives are also under consideration
that may also require greenhouse gas reductions from electric generating
facilities nationwide. At the present time, it is not possible to predict the
nature of the requirements, which ultimately will be imposed on KeySpan nor
what, if any, financial impact such requirements would have on KeySpan
facilities. However, our investments in emissions control technology and
conversions to natural gas capability have resulted in a 15% reduction in carbon
dioxide emissions over the last decade, while the electric generation industry
as a whole increased carbon dioxide emissions by 26%. The addition of the
efficient, combined cycle unit at Ravenswood will further reduce emission rates
when it commences commercial operations in 2004.
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 nature and cost of
equipment upgrades 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
even before Superfund was enacted 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 or its
predecessors and other potentially responsible parties were allegedly disposed.
Normally the costs associated with such claims are allocated among the
potentially responsible parties on a pro rata basis. The cost of these claims is
not presently determinable. Superfund does, however, provide for joint and
several liability against a single potentially responsible party. In the
unlikely event that Superfund claims were pursued against us on that basis, the
costs, 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."
20
Competition, Regulation and Rate Matters
Competition. Over the last several years, the natural gas and electric
industries 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 in 1998 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."
Ravenswood, the merchant plant in our Electric Services segment, is subject to
competitive and other risks that could adversely impact the market price for the
plant's output. Such risks include, but are not limited to, the construction of
new generation or transmission capacity serving the New York City market.
However, we cannot predict when or if new generation or transmission capacity
will be built.
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. Each of the federal and state
regulators also regulates certain transactions among our affiliates. 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.
21
State Utility Commissions. Our regulated utility subsidiaries are subject to
regulation by the NYPSC, DTE and NHPUC. The NYPSC regulates KEDNY and KEDLI.
Although KeySpan Corporation is not regulated by the NYPSC, it is impacted by
conditions that were included in the NYPSC order authorizing the 1998
KeySpan/LILCO transaction. Those conditions address, among other things, 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
electricity are also subject to regulation by the NYPSC. 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. 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. A rate filing reflecting a recalculated
revenue requirement was submitted to FERC on October 31, 2003. On December 30,
2003, FERC issued an order accepting, in part, the rates subject to refund
pending settlement discussions and hearings. We are unable to predict the
outcome of those proceedings at this time. Our Ravenswood facility's rates are
based on a market-based rate application approved by FERC. The rates that our
Ravenswood facility may charge 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 offers 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."
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 FERC. Our interests in Iroquois,
Honeoye, Steuben and KeySpan LNG are also fully regulated by FERC as natural gas
companies.
22
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 and to pay dividends to our
shareholders. 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.
In addition, in November 2000, KeySpan received authorization from the SEC to
operate three mutual service companies. Under this order, the SEC determined
that, in accordance with PUHCA, KeySpan Corporate Services LLC ("KCS"), KeySpan
Utility Services LLC ("KUS") and KeySpan Engineering & Survey, Inc. ("KENG") may
operate to provide various services to KeySpan subsidiaries, including regulated
utility companies, at cost fairly and equitably allocated among them.
Foreign Regulation. KeySpan's foreign operations in Northern Ireland, conducted
through Premier, 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).
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. 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
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 NYPSC
orders, the ability of KEDNY and 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
23
a customer service performance program. At the end of KEDNY's and KEDLI's
rate years (September 30, 2003 and November 30, 2003, respectively), their
ratios of debt to total utility capitalization were well in compliance with
the ratios set forth above.
PUHCA Also Limits Our Business Operations and Our Ability to Affiliate with
Other Utilities
In addition to limiting our financial activities, PUHCA 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 April 2003, the SEC determined that the companies that comprise our
Energy Services business are "energy-related companies" and therefore
retainable under existing SEC precedent. However, the SEC also required
that certain of those companies increase the percentage of their work that
is energy related.
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. A significant portion 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 in rates, and the uncertainty of whether regulatory
commissions will allow full recovery of and return on such increased costs
and expenses.
Various rulemaking proposals and market design revisions related to the
wholesale power market are being reviewed at the federal level. These
proposals, as well as 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, 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 FERC's price mitigation measures are subject to
rehearing and possible judicial review.
24
Our Risk Mitigation Techniques Such as Hedging and Purchase of Insurance May Not
Adequately Provide Protection
To mitigate our financial exposure related to commodity price fluctuations,
KeySpan routinely enters 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.
In addition, our business is subject to many hazards from which our
insurance may not adequately provide coverage. An 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 55%
equity interest in The Houston Exploration Company and our ownership of
KeySpan 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.
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 increases due to
colder weather conditions. As a result, we are subject to seasonal
variations in working capital because we purchase natural gas supplies for
storage in the second and third quarters and must 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
25
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 extreme temperature conditions. As a result,
fluctuations in weather between years may have a significant effect on our
results of operations for these subsidiaries. The construction activities
of our Energy Services subsidiaries are also affected by weather.
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 the GPRA, 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 (all Long Island units except for the 80MW facility
at Port Jefferson and the 80MW facility in Glenwood). 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 Assurance Can Be Made that These Arrangements Will Be Renewed at the End
of their Terms or that the Resolution of Certain Disputes Will Not Materially
Impact the Financial Condition of the Company
We derive a substantial portion of our revenues in our electric services
segment from a number 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, the terms and
conditions thereof. In addition, given the complexity of these
arrangements, disputes arise from time to time between the Company and LIPA
concerning the rights and obligations of each party to make and receive
payments as required pursuant to the terms of these agreements. As a
result, the Company is unable to determine what effect, if any, the
ultimate resolution of these disputes will have on its financial condition
or results of operations.
We Own Approximately 55% of Houston Exploration and Our Results of Operation are
Therefore Subject to the Risks Affecting its Business
We own approximately 55% of Houston Exploration. 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.
26
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.
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 credit rating agencies that rate our debt securities regularly review
our financial condition and results of operations. We can provide no
assurances that the ratings or outlook on our debt securities will not be
reduced or otherwise negatively changed. A negative change in the ratings
or outlook on our debt 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 utility subsidiaries' rate plans generally allow for
the full recovery of the costs of investigation and remediation of most of
27
our 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 quantities 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
write-downs of the carrying value of those businesses.
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.
Employee Matters
As of December 31, 2003, KeySpan and its wholly-owned subsidiaries had
approximately 11,300 employees. Of that total, approximately 5,800 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.
28
Prior to their expiration in February, KeySpan reached tentative agreements with
IBEW Locals 1049 and 1381 on new collective bargaining agreements. These Unions
represent KeySpan employees in physical and clerical positions respectively, and
serve our Long Island customers. The new four-year agreements are expected to be
ratified by each respective union before the end of March 2004.
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 67, 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.
Mr. Catell also serves on the Board of Directors for Houston Exploration.
Robert J. Fani
Mr. Fani, age 50, was elected President and Chief Operating Officer of KeySpan
in October 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 for Strategic Services in February
2000 and then to President of the KeySpan Energy Services and Supply Group in
2001. In January 2003, he was named President of KeySpan's Energy Assets and
Supply Group until assuming his current position in October 2003. Mr. Fani also
serves on the Board of Directors for Houston Exploration.
Wallace P. Parker Jr.
Mr. Parker, age 54, was elected President of the KeySpan Energy Delivery and
Customer Relations Group in January 2003. He also serves as Vice Chairman and
Chief Executive Officer of KeySpan Services, Inc. since October 2003. He had
previously served as President, KeySpan Energy Delivery, since June 2001, and
from February 2000 served as Executive Vice President of Gas Operations. 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.
29
Steven L. Zelkowitz
Mr. Zelkowitz, age 54, was elected President of KeySpan's Energy Assets and
Supply Group in October 2003. Prior to that, he served as Executive Vice
President & Chief Administrative Officer since January 2003. 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. In July
2001, Mr. Zelkowitz was promoted to Executive Vice President and General
Counsel, and in November 2002, he was named Executive Vice President,
Administration & Compliance, with responsibility for the offices of General
Counsel, Human Resources, Regulatory Affairs, Enterprise Risk Management and
administratively for Internal Auditing. Before joining the Company, Mr.
Zelkowitz practiced law with Cullen and Dykman LLP in Brooklyn, New York,
specializing in energy and utility law and had been a partner since 1984. He
served on the firm's Executive Committee and was head of its Corporate/Energy
Department.
John A. Caroselli
Mr. Caroselli, age 49, was elected Executive Vice President and Chief Strategy
Officer in January 2003. Mr. Caroselli is responsible for Brand Management,
Strategic Marketing, Strategic Planning, Strategic Performance, Human Resources,
and Information Technology. Mr. Caroselli came to KeySpan in 2001 and at that
time served as Executive Vice President of Strategic 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.
Gerald Luterman
Mr. Luterman, age 60, 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