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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
OR
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from April 1, 1998 to December 31, 1998
Commission File Number 1-14161
MARKETSPAN CORPORATION
(Exact name of registrant as specified in its charter)
NEW YORK 11-3431358
(State or other jurisdiction of incorporation or (I.R.S. employer
organization) identification no.)
175 EAST OLD COUNTRY ROAD, HICKSVILLE, NEW YORK 11801
ONE METROTECH CENTER, BROOKLYN, NEW YORK 11201
(Address of principal executive offices) (Zip code)
(516) 755-6650 (HICKSVILLE)
(718) 403-1000 (BROOKLYN)
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
Title of each class Name of each exchange on which
registered
Common Stock, $.01 par value New York Stock Exchange
Pacific Stock Exchange
Series AA Preferred Stock, $25 par value New York Stock Exchange
Pacific Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
None
(Title of class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes. X No.
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |_|
As of March 22, 1999, the aggregate market value of the common stock
held by non-affiliates (139,173,954 shares) of the registrant was $3,601,126,073
(based on the closing price, on such date, of $25.88 per share).
As of March 22, 1999, there were 142,868,154 shares of common stock,
$.01 par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement dated on or about April 7, 1999 is incorporated by reference
into Part III hereof.
MARKETSPAN CORPORATION
D/B/A KEYSPAN ENERGY
INDEX TO FORM 10-K
Page
PART I
Item 1. Business................................................................ 1
Item 2. Properties.............................................................. 29
Item 3. Legal Proceedings....................................................... 29
Item 4. Submission of Matters to a Vote of Security Holders..................... 31
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters... 31
Item 6. Selected Financial Data................................................. 32
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 33
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.............. 53
Item 8. Financial Statements and Supplementary Data............................. 55
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.............................................................. 101
PART III
Item 10. Directors and Executive Officers of the Registrant...................... 101
Item 11. Executive Compensation.................................................. 101
Item 12. Security Ownership of Certain Beneficial Owners and Management.......... 101
Item 13. Certain Relationships and Related Transactions.......................... 101
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K......... 102
PART I
ITEM 1. BUSINESS
OVERVIEW
KeySpan Energy ("KeySpan" or the "Company") provides a range of
energy-related services through operations and investments in selected areas of
the energy industry. The Company is the fourth largest gas utility in the United
States with approximately 1.6 million customers in the New York City
metropolitan area. The Company competes in five principal lines of business,
including natural gas distribution, electric services, gas exploration and
production, energy-related investments, and energy-related services.
The Company was formed to facilitate the combination (the
"Combination"), completed on May 28, 1998, of KeySpan Energy Corporation ("KSE")
and its principal subsidiary The Brooklyn Union Gas Company ("Brooklyn Union")
and the non-nuclear electric generation and natural gas distribution businesses
of the Long Island Lighting Company ("LILCO"). To effect the Combination, all of
the assets used by LILCO in connection with its gas distribution business, its
non-nuclear electric generation business and the assets common to its prior
operations (the "Transferred Assets") were transferred to the Company. The Long
Island Power Authority ("LIPA") then acquired all of the common stock of LILCO
for approximately $2.5 billion in cash and the direct or indirect assumption of
certain liabilities. The Company sold to the former holders of LILCO common
stock, shares of the Company's common stock and then acquired KSE by merger with
a wholly-owned subsidiary of the Company in exchange for shares of the Company's
common stock. Upon completion of these transactions, former LILCO and KSE
shareholders owned approximately 68% and 32% of the Company's common stock,
respectively.
The assets of LILCO not transferred to the Company (the "Retained
Assets") were retained by LIPA and primarily consist of LILCO's electric
transmission and distribution system located on Long Island (the "T&D System"),
its 18% ownership interest in Nine Mile Point Nuclear Power Station, Unit 2
("NMP2"), located in upstate New York, and certain of LILCO's regulatory assets
and liabilities associated with its electric business.
The Company was organized under New York law in 1998. Brooklyn Union
was formed in 1895 through the consolidation of several existing companies, the
oldest of which commenced operations in 1849, providing gas distribution
services throughout the New York City boroughs of Brooklyn, Staten Island and
most of Queens, New York. LILCO was organized in 1910 to provide electric and
gas services in the Long Island counties of Nassau and Suffolk and the Rockaway
peninsula in the borough of Queens, all in New York.
As used herein, the "Company" or "KeySpan" refers to MarketSpan
Corporation d/b/a KeySpan Energy ("KeySpan Energy"), Brooklyn Union and KeySpan
Gas East Corporation d/b/a Brooklyn Union of Long Island ("Brooklyn Union of
Long Island"), its two principal gas distribution subsidiaries, and its other
subsidiaries, individually and in the aggregate. In 1998, the Company changed
its fiscal year end from March 31 to December 31. For financial reporting
purposes, financial statements included, or incorporated by reference, herein
for the period ending December 31, 1998 are for the nine months then ended and
have been prepared on the basis that LILCO is deemed to be the acquiring company
in the Combination for financial reporting purposes. Unless otherwise specified,
other information contained in Part I hereof has been compiled on a combined
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basis ("Combined Company Basis") to aggregate the information shown for both KSE
and LILCO and is presented for the twelve month periods ended December 31, 1998,
1997 and 1996, as indicated. Additional information about the Company's industry
segments is contained in "Note 10. Business Segments" of the Notes to the
Consolidated Financial Statements included herein and incorporated by reference
thereto.
Certain statements contained in this Annual Report on Form 10-K
concerning expectations, beliefs, plans, objectives, goals, strategies, future
events or performance and underlying assumptions and other statements which are
other than statements of historical facts, are "forward-looking statements"
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended. Without limiting the foregoing, all statements under the captions "Item
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Item 7A. Quantitative and Qualitative Disclosures About Risk"
relating to the Company's anticipated capital expenditures, future cash flows
and borrowings, pursuit of potential future acquisition opportunities and
sources of funding are forward-looking statements. Such forward-looking
statements reflect numerous assumptions and involve a number of risks and
uncertainties and actual results may differ materially from those discussed in
such statements. Among the factors that could cause actual results to differ
materially are: available sources and cost of fuel; federal and state regulatory
initiatives that increase competition, threaten cost and investment recovery,
and impact rate structures; the ability of the Company to successfully reduce
its cost structure; the successful integration of the Company's subsidiaries;
the degree to which the Company develops unregulated business ventures; the
ability of the Company to identify and make complementary acquisitions, as well
as the successful integration of such acquisitions; inflationary trends and
interest rates; the ability of the Company and its significant vendors to modify
their computer software, hardware and databases to accommodate the year 2000;
and other risks detailed from time to time in other reports and other documents
filed by the Company and its predecessors with the Securities and Exchange
Commission (the "SEC"). For any of these statements, the Company claims the
protection of the safe harbor for forward-looking information contained in the
Private Securities Litigation Reform Act of 1995, as amended. For additional
discussion on these risks, uncertainties and assumptions, see "Item 1.
Business," "Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations" and "Item 7A. Quantitative and Qualitative
Disclosures About Risk" contained in the Annual Report on Form 10-K.
The Company's principal executive offices are located at One
MetroTech Center, Brooklyn, New York 11201 and 175 East Old Country Road,
Hicksville, New York 11801 and its telephone numbers are (718) 403-1000
(Brooklyn) and (516) 755-6650 (Hicksville). Financial and other information is
also available through the World Wide Web at http://www.keyspanenergy.com.
INDUSTRY AND COMPETITION
The electric and natural gas sectors of the regulated energy industry
are undergoing significant changes, as market forces are replacing or
supplementing rate regulation as a means of controlling prices for natural gas
and electricity. The exposure of utilities to competition places pressures on
them to maintain market share and profits and manage the costs of providing
services as their customers gain access to lower cost supplies of natural gas
and electricity. Competition also presents utilities with greater opportunities
to manage the cost of their natural gas and electric supplies, to earn
unregulated profits on energy sales and to expand their business activities.
2
Historically, government regulation served both to control prices in
the natural gas and electric sectors of the energy industry and to substantially
shield industry participants from competition. The natural gas sector was
segmented into three regulated parts: production; interstate transportation; and
franchised retail sales and local distribution. The electric sector featured
vertically integrated utilities providing generation, transmission and
distribution services for their franchised service territories. Under
traditional rate regulation, utilities were provided the opportunity to earn a
fair, but regulated, return on invested capital in exchange for a commitment to
serve all customers within a franchised service territory. An extensive and
complex regime for the regulation of public utility companies and public utility
holding companies limited natural gas and electric utilities' opportunities for
geographic expansion and business diversification.
Between the 1930's and the late 1970's, federal and state energy
regulatory policies remained relatively stable, and the structure of the
regulated energy industry changed little. However, after the energy crises in
the 1970's, new legislation and changes in regulatory policy set in motion
competitive forces that are reshaping the energy industry, dramatically
increasing business opportunities for natural gas and electric companies.
Beginning in 1978 with federal legislation that authorized the phased
deregulation of wellhead natural gas prices and the establishment of unregulated
electric generation companies, competition has been increasingly introduced into
segments of the regulated energy industry. To foster competition, federal
regulators adopted "open access" rules which required interstate natural gas
pipelines and electric transmission systems to "unbundle" retail sales, I.E.,
the sale of gas or electricity, from transportation and transmission services.
Open access also required interstate gas pipelines and electric utilities, for
the first time, to provide transportation and transmission service on a
non-discriminatory basis to all qualified customers. Recent initiatives would
also permit market forces, rather than regulation, to establish rates charged
under short-term contracts for interstate natural gas transportation and to
determine the allocation of increased electricity costs that result when
electric transmission constraints prevent lower priced electricity from reaching
electric customers. By enabling natural gas producers and electric generators to
reach new markets, open access policies led to intensified competition in
wholesale markets and began to alter the geographic character of the industry.
No longer typified by isolated local companies, the natural gas and electric
sectors in many parts of the country today include a growing number of firms
with regional, national and international dimensions.
Parallel changes in the regulation of retail electric and gas markets
are being implemented by many state public utility commissions, including the
Public Service Commission of the State of New York ("NYPSC"). On a
state-by-state basis, initially in the Northeast, Mid-Atlantic and California,
and now spreading to other regions, local franchised utilities are being
required to separate their marketing and retail sales businesses from the
physical distribution of natural gas and electricity through pipes and wires.
Just as at the federal level, distribution services are increasingly required to
be unbundled from retail sales, and made available on a non-discriminatory open
access basis to all qualified retail customers. Retail natural gas and
electricity marketers are being permitted to compete for energy customers in
what were formerly exclusive service territories of electric and natural gas
utilities. However, natural gas and electric utilities are likely to remain
exclusive providers of unbundled distribution services through pipes and wires,
and may remain obligated to continue to sell natural gas or electricity to
customers who do not select other suppliers.
3
In New York State, large-volume retail customers have been able to
purchase natural gas supplies directly from non-utility vendors for more than
ten years, while direct sales to aggregations of small customers have been
permitted since 1996. New York regulators are commencing new initiatives to
further enhance retail competition in the state. Similarly, the NYPSC has been
encouraging the development of retail competition in the electric sector in New
York. In the past two years, electric utilities have begun to unbundle electric
sales from retail distribution services, open their franchised territories to
competitors, transfer control over their transmission systems to an independent
system operator, and divest many of their generating plants.
The introduction of competition for retail electricity sales may
threaten the ability of electric utilities to recover their past investments in
electric generating plants (and, in some cases, related transmission facilities)
to the extent that the cost of producing electricity from those generating
plants exceeds the competitive market price for electricity. In consideration
for opening franchise service territories to retail competition, many electric
utilities are being permitted to recover potentially "stranded" investments in
electric generation and associated transmission through charges to all customers
receiving distribution and transmission services. In many cases, the market
value of electric generating plants and the amount of stranded investment is
being determined through the divestiture of electric generating plants in
well-publicized auctions. The sale of generating plants and recovery of stranded
costs (to the extent they remain after divestiture) is providing electric
utilities with substantial cash infusions which, in some cases, are being used
to repurchase stock or to finance acquisition of other energy assets, often in
different regions of the country or internationally. Many utilities are
attempting to diversify their lines of business, while some are choosing to
concentrate on one or two industry segments, such as natural gas or electric
distribution or electric generation. Several New York investor-owned utilities
have commenced the sale of their non-nuclear generating plants. The Company's
pending purchase of the Ravenswood generating plant, as discussed below, results
from a plan under which Consolidated Edison Company of New York, Inc. ("Con
Edison") is divesting a substantial portion of its non-nuclear generating
capacity. See "The Company - Electric Services."
A significant number of natural gas and electric utilities have
reacted to the changing structure of the regulated energy industry by entering
into business combinations, with the goal of reducing common costs, gaining size
to better withstand competitive pressures and business cycles, and attaining
synergies from the combination of electric and natural gas operations. The
Combination and related transactions which resulted in the formation of the
Company shares many of these attributes.
The transformation of the energy industry is an ongoing process.
Larger regional, national and international companies are being formed through
acquisitions and mergers. The remaining legal barriers to interregional natural
gas and electric distribution companies, which have been relaxed as the result
of regulatory decisions, are the subject of legislative proposals calling for
repeal or substantial modifications. The advent of industry restructuring has
meant that regional, national and international companies are increasingly
offering energy consumers a wide array of choices as to the supply, type,
quality and cost of natural gas and electric services. For the Company, industry
restructuring means increased opportunities to enter new markets and pressures
to manage its costs of doing business.
4
BUSINESS STRATEGY
The Company seeks to become a premier energy company with operations
focused in the Northeastern United States, the Gulf of Mexico and Western
Canadian supply basins as well as selected international areas where the Company
identifies opportunities for growth in those energy-related lines of business in
which the Company has developed recognized expertise. The Company intends to
grow through acquisitions and selected energy-related investments; by expanding
its gas distribution business, particularly on Long Island; by emphasizing
superior customer service; and by taking advantage of the increasing trend
towards deregulation and competition to offer an expanded array of services to
its customers.
Key elements of the Company's business strategy include:
ENERGY-RELATED INVESTMENTS. In recent years, the Company has made
a number of acquisitions and energy-related investments designed to
enhance its presence in the Northeastern United States. The Combination
transformed the Company into the leading natural gas company in the
Northeast, with approximately 1.6 million gas customers in two
contiguous gas distribution service territories. The Combination also
gave the Company one of the largest power generation capabilities in the
region, with over 4,000 megawatts of generation capacity. Subsequent to
December 31, 1998, the Company entered into a definitive agreement,
subject to regulatory approvals, to acquire a 2,168 megawatt electric
generating facility in New York City from Con Edison. Upon consummation
of that transaction, the Company's power generation capacity will
approximate 6,200 megawatts. Consistent with the Company's long-standing
investment in the Iroquois pipeline, the Company recently acquired a 25%
interest in the proposed Cross Bay pipeline, which will transport gas
from interstate pipelines in New Jersey to New York and Long Island. In
addition, the Company has expanded the business of its unregulated
energy services operations, through the acquisition of Philip Fritze and
Sons, one of the largest heating, ventilation and air conditioning
contractors in New Jersey.
The Company has also made significant investments beyond its core
market area. In 1998, for example, the Company acquired a 50% interest
in certain midstream natural gas assets of Gulf Canada Resources
Limited, creating a partnership known as Gulf Midstream Services. The
Company also purchased an additional 25.5% interest in Premier Transco
Ltd. (resulting in an aggregate 50% interest), which transports natural
gas through an 84-mile pipeline from southwest Scotland to Northern
Ireland.
These acquisitions and investments reflect the Company's
commitment to enhancing its presence as an energy company focused
primarily on the Northeastern United States, with additional
complementary interests in the Gulf of Mexico and Western Canadian
supply basins, as well as Northern Ireland. The Company anticipates that
it will continue to target other acquisitions and investments that also
provide it with opportunities to increase its penetration of selected
energy markets in those core geographic areas.
5
EXPANDED GAS DISTRIBUTION SERVICES. The Company has achieved a
high degree of penetration in its Brooklyn Union service territory, with
approximately 79% of all one-and two-family homes currently using
natural gas for space heating. In contrast, only 30% of one-and
two-family homes in the Brooklyn Union of Long Island service territory
currently use natural gas for space heating. The Company believes there
is significant opportunity for increased penetration of the Long Island
service territory and intends to make capital expenditures to expand its
gas distribution infrastructure in order to support long-term growth. In
addition, the Company expects to focus marketing efforts throughout both
service territories. Examples of such marketing efforts include efforts
to convert customers from oil to gas heat and to target new
construction, small to medium commercial businesses and large volume
dual-fuel customers.
SUPERIOR CUSTOMER SERVICE. The Company's utility operations have
an outstanding reputation for customer service and have received
consistently excellent marks for customer loyalty and satisfaction, as
measured by independent customer-satisfaction specialists. In 1998, the
Company was the recipient of the Emergency Response Award of the Edison
Electric Institute, which honored the Company for restoring electric
power for LIPA after a severe thunderstorm on Long Island last
September. Similarly, Brooklyn Union was awarded the 1998 Brand Keys
Customer Loyalty Award as the U.S. energy provider that had achieved the
highest level of success in anticipating and exceeding customer
expectations. The Company intends to continue to emphasize superior
customer service, both to differentiate itself from competitors as
markets become increasingly deregulated and to take advantage of
cross-selling opportunities available in complementary energy-related
services such as appliance repair and energy system installation and
management.
EXPANDED SERVICES. With its strong market presence in the
metropolitan New York City area, the Company believes it is
well-positioned to provide customers with an expanding array of
energy-related services. In recent years, the Company has begun to offer
gas and electric marketing services throughout New York, Connecticut,
New Jersey, Maryland, Pennsylvania and Ohio and appliance repair and
related services and energy management services for residential,
commercial and industrial customers throughout the metropolitan New York
City area. The Company believes that continuing trends towards
deregulation and competition, coupled with growth in its customer base,
will afford it opportunities to expand those services both within and
outside its traditional service territories. The Company also owns a
250-mile fiber optic telecommunications network on Long Island and is
currently exploring various business opportunities to take commercial
advantage of that network.
THE COMPANY
GAS DISTRIBUTION
OVERVIEW
The Company sells, distributes and transports natural gas in two
separate, but contiguous service territories of approximately 1,417 square miles
in the aggregate in the New York City metropolitan area. The Company owns and
6
operates gas distribution, transmission and storage systems that consist of
approximately 10,036 miles of distribution pipelines, 578 miles of transmission
pipelines and two gas storage facilities. The Company serves approximately 1.6
million customers, of which approximately 1.5 million, or 94%, are residential.
Gas is offered for sale to residential customers on a "firm" basis, and to
commercial and industrial customers on a "firm" or "interruptible" basis. "Firm"
service is offered to customers under schedules or contracts which anticipate no
interruptions, whereas "interruptible" service is offered to customers under
schedules or contracts which anticipate and permit interruption on short notice,
generally in peak-load seasons. Gas is available at any time of the year on an
interruptible basis, if the supply is sufficient and the supply system is
adequate. The Company also participates in the interstate markets by releasing
pipeline capacity or bundling pipeline capacity with gas for "off-system" sales.
An "off-system" customer consumes gas at facilities located outside the
Company's service territories, by connecting to the Company's facilities or one
of its transporter's facilities, at a point of delivery agreed to by the Company
and the customer. The Company purchases its natural gas for sale to its
customers under long-term supply contracts and short-term spot contracts. Such
gas is transported under both firm and interruptible transportation contracts.
In addition, the Company has commitments for the provision of gas storage
capability and peaking supplies.
During 1998, on a Combined Company Basis, gas revenues were $1.760
billion, or 54% of the Company's revenues, and gas operating income was $218.8
million, excluding special charges related to the Combination.
The gas operations of the Company can be significantly affected by
seasonal weather conditions. Traditionally, annual revenues are substantially
realized during the heating season as a result of higher sales of gas due to
cold weather. Accordingly, operating results historically are most favorable in
the first and fourth calendar quarters. However, the Company's gas utility
tariffs contain weather normalization adjustments that provide for recovery from
or refund to firm customers of material shortfalls or excesses of firm net
revenues (revenues less applicable gas costs, if any) during a heating season
due to variations from normal weather. See "Regulation and Rate Matters."
SALES AND DISTRIBUTION
The Company is the fourth largest gas distribution company in the
United States, providing, through its gas distribution subsidiaries, natural gas
sales and transportation services to customers in the New York City boroughs of
Brooklyn, Queens and Staten Island and the Long Island counties of Nassau and
Suffolk.
7
Gas sales and revenues for 1998 on a Combined Company Basis by class
of customer are set forth below:
Sales Revenues Revenues
Customer (MDTH) (thousands of (% of Total)
$)
- --------------------------------------------- ----------- ---------------- ---------------
FIRM
Residential house heating................ 95,821 $ 971,987 55.22%
Residential (other than house heating)... 10,176 199,944 11.36
Temperature-Controlled heating........... 30,899 128,703 7.31
Commercial/Industrial.................... 28,434 245,005 13.92
----------- ---------------- ---------------
Total Firm........................... 165,330 1,545,639 87.80
FIRM TRANSPORTATION...................... 13,974 60,540 3.44
----------- ---------------- ---------------
Total Firm Gas Sales and Transportation 179,304 1,606,179 91.24
INTERRUPTIBLE............................ 11,861 40,276 2.29
OFF-SYSTEM SALES......................... 24,465 59,556 3.38
TRANSPORTATION........................... 29,156 18,289 1.04
----------- ---------------- ---------------
Total Gas Sales and Transportation.... 244,786 1,724,300 97.95
Other Retail Services.................... N/A 36,020 2.05
=========== ================ ===============
Total sales and revenues*............. 244,786 $1,760,320 100%
=========== ================ ===============
- -----------------------
*Excludes lost, unaccounted for and interdepartmental gas.
Set forth below is information, on a Combined Company Basis,
concerning certain operating statistics applicable to the Company's gas sales
and distribution business:
1998 1997 1996
-------------- -------------- -------------
Revenues ($000)........................... 1,760,320 1,991,793 2,073,851
Net Income ($000)......................... 133,685* 134,403 119,639
Firm Gas Sales and Transportation (MDTH).. 179,304 203,587 202,377
Other Deliveries (MDTH)................... 65,482 73,132 59,139
Heating customers......................... 665,465 657,433 651,750
Degree Days, % cooler (warmer) than normal (17.5) 0.2 4.8
Capital Expenditures...................... 181,700 178,651 190,403
- -----------------------
*Excludes special charges and tax benefits associated with the Combination.
The Company sells gas to its firm gas customers at the Company's cost
for such gas, plus a charge designed to recover the costs of distribution
(including a return of and a return on invested capital). The Company shares
with its firm gas customers net revenues (operating revenues less the cost of
gas purchased for resale) from off-system sales and, in addition, Brooklyn Union
of Long Island credits its firm gas customers all net revenues from
interruptible gas sales, thereby reducing its rates to these firm customers.
All of the Company's retail gas customers became eligible in 1996 to
purchase gas directly from suppliers other than the Company's gas utility
subsidiaries. At December 31, 1998, approximately 32,900 residential, commercial
and industrial customers, with annual requirements of approximately 19,500 MDTH,
or 10% of the Company's annual firm gas system requirements, purchased their gas
supply from sources other than the Company. If a customer decides to purchase
gas from another supplier, the supplier obtains the gas and transports it to the
Company's distribution system. The Company then delivers the gas to the
customer's premises through the Company's system of distribution mains and
service lines. In addition to delivering gas that customers purchase from other
suppliers, the Company has been providing metering, billing and other services
8
for aggregate rates that are comparable to the distribution charge reflected in
otherwise applicable sales rates to supply comparable customers.
On a Combined Company Basis, actual firm gas sales and transportation
quantities from gas distribution operations in 1998 were 179,304 MDTH compared
to 203,587 MDTH in 1997 and 202,377 MDTH in 1996. (An MDTH is 10,000 therms and
reflects the heating content of approximately one million cubic feet of gas. A
therm reflects the heating content of approximately 100 cubic feet of gas.)
These major variations in quantities are primarily due to weather. Measured in
annual degree days, weather was 17.5% warmer than normal in 1998, normal in 1997
and 4.8% colder than normal in 1996. After normalizing for weather, firm volumes
in 1998 were approximately the same as 1997.
On a Combined Company Basis, on-system interruptible volumes,
off-system sales (sales made to customers outside of the Company's service
territories) and related transportation in 1998 were 65,482 MDTH compared to
73,132 MDTH in 1997 and 59,139 MDTH in 1996. The decrease in total gas
throughput during 1998 reflects the effects of warmer weather and the fact that
Brooklyn Union discontinued its off-system sales program beginning April 1, 1998
and replaced it with a management agreement with Enron Capital and Trade
Resources Corp. and its parent company, Enron Corp. (collectively, "Enron"), in
which Enron pays the Company a fixed fee in exchange for the right granted Enron
to earn revenues based upon its management of Brooklyn Union's gas supply
requirements, storage arrangements, and off-system capacity.
During 1998, the Company continued to grow in its existing service
territories and to expand into new markets. In the Company's service area of the
New York City boroughs of Brooklyn, Queens and Staten Island, approximately 79%
of one- and two- family homes currently use gas for space heating, while
approximately 48% of the multi-family market and 63% of the commercial market
use gas for space heating. In these areas, the Company intends to seek growth
with an aggressive marketing effort designed to encourage conversions of
residential and multi-family homes and businesses from fuel oil to natural gas
heating. In the Company's service area of the Long Island counties of Nassau and
Suffolk and the Rockaway peninsula of Queens County, approximately 30% of one-
and two-family homes currently use natural gas for space heating, while
approximately 17% of the multi-family market and 57% of the commercial market
use gas for space heating. In these service areas, the Company will seek growth
through the expansion of its distribution system as well as through the
conversion of residential homes and the pursuit of opportunities to grow
multi-family, industrial and commercial markets. The Company also offers special
area development and incentive gas rates to multi-family, commercial and
industrial businesses that move to or expand operations in designated areas of
the Company's service territories.
SUPPLY AND STORAGE
The Company has contracts for the purchase of firm long-term
transportation and storage services. The Company's gas supplies are purchased
under long-term contracts and on the spot market and are transported by
interstate pipelines from domestic and Canadian sources. Storage and peaking
supplies are available to meet system requirements during winter periods.
Regulatory actions, economic factors and changes in customers and
their preferences continue to reshape the Company's gas operations markets. A
number of multi-family, commercial and industrial customers and a growing number
of residential customers currently purchase their gas supplies from natural gas
9
marketers and then contract with the Company for local transportation, balancing
and other unbundled services. Since these customers are no longer reliant on the
Company for sales service, the quantity of gas that the Company must obtain to
meet remaining sales customers' requirements has been reduced. This trend is
likely to continue as state regulators implement policies designed to encourage
customers to purchase their gas from suppliers other than the traditional gas
utilities.
PEAK-DAY CAPABILITY. The design criteria for the Company's gas system
assumes an average temperature of 0(0)F for peak-day demand. Under such
criteria, the Company estimates that the requirements to supply its firm gas
customers would amount to approximately 1,754 MDTH of gas for a peak-day during
the 1998/99 winter season and that the gas available to the Company on such a
peak-day amounts to approximately 2,033 MDTH. For the 1999/2000 winter season,
the Company estimates that the peak-day requirements would amount to
approximately 1,789 MDTH and that the gas available to the Company amounts to
approximately 2,033 MDTH. As of March 1, 1999, the 1998/99 winter peak-day
throughput to the Company's customers was 1,511 MDTH, which occurred on January
14, 1999, at an average temperature of 22(degree)F, representing 74% of the
Company's peak-day capability at that time. The Company expects that it will
have sufficient gas available to meet the projected requirements for firm gas
customers for the 1999/2000 winter season. The Company's firm gas peak-day
capability is summarized in the following table:
Source MDTH per day % of Total
- ------------------------------------------------------ ----------------- -----------------
Producers.......................................... 750 37
Underground Storage................................ 779 38
Peaking Supplies................................... 504 25
================= =================
Total.......................................... 2,033 100
================= =================
PRODUCERS. The Company purchases natural gas for sale to its
customers under contracts with suppliers located in domestic and Canadian supply
basins and arranges for its transportation to the Company's facilities under
firm long-term contracts with interstate pipeline companies. During 1998, about
78% of the Company's natural gas supply was available from domestic sources and
22% from Canadian sources. The Company has available under firm contract 750
MDTH per day of year-round and seasonal pipeline transportation capacity to its
facilities in the New York City metropolitan area. Major providers of interstate
pipeline capacity and related services to the Company include: Transcontinental
Gas Pipe Line Corporation, Texas Eastern Transmission Corporation, Iroquois Gas
Transmission System, Tennessee Gas Pipeline Company, CNG Transmission
Corporation and Texas Gas Transmission Company.
STORAGE. In order to meet higher winter demand, the Company also has
long-term contracts with Transcontinental Gas Pipe Line Corporation, Texas
Eastern Transmission Corporation, Tennessee Gas Pipeline Company, CNG
Transmission Corporation, Equitrans, Inc., Hattiesburg First Reserve and Honeoye
Storage Corporation, for underground storage capacity of 58,935 MDTH for the
winter season, with 779 MDTH per day maximum deliverability.
PEAKING SUPPLIES. In addition to the pipeline and storage supply, the
Company supplements its winter supply with peaking supplies which are available
on the coldest days of the year to enable the Company to meet the increased
requirements of its heating customers economically. The Company's peaking
supplies include gas provided by the Company's two liquefied natural gas ("LNG")
10
plants and under peaking supply contracts with four cogeneration
facilities/independent power producers located in its franchise area. For the
1998/99 winter season, the Company has the capability to provide a maximum
peak-day supply of 504 MDTH on excessively cold days. The LNG plants have a
storage capacity of approximately 2,053 MDTH and peak-day throughput capacity of
394 MDTH, or 19% of peak-day supply. The Company also has contract rights with
Trigen Services Corporation, Brooklyn Navy Cogeneration Partners, LP,
Nissequogue Cogen Partners and the New York Power Authority to purchase peaking
supplies with a maximum daily capacity of 110 MDTH and total available peaking
supplies during the winter season of 3,349 MDTH.
GAS SUPPLY MANAGEMENT. During 1998, the Company entered into a
one-year arrangement with Enron whereby Enron provides gas supply asset
management services for Brooklyn Union. Under the terms of this agreement, Enron
is responsible for managing certain aspects of Brooklyn Union's interstate
pipeline transportation, gas supply and storage. Enron also is responsible for
satisfying certain of the Company's gas supply requirements; however, the
Company remains contractually obligated to its gas suppliers and has not
terminated any of its supply and delivery contracts. Pursuant to this
arrangement, Enron paid the Company a fee in 1998, a portion of which was
credited to the Company's gas ratepayers, and obtained the right to earn
revenues based upon its management of the Company's gas supply requirements,
storage arrangements and off-system capacity.
In 1998, the Company entered into a one-year alliance with Coral
Energy Resources, L.P., a division of Shell Oil Company ("Coral"), whereby Coral
assists the Company in the origination, structuring, valuation and execution of
energy-related transactions relating to Brooklyn Union of Long Island and the
Company's energy-management services undertaken on behalf of LIPA. A sharing
agreement exists between the gas ratepayers and the Company for off-system gas
transactions and between the Company and LIPA for off-system electric
transactions. The Company's share of the profits on such transactions is then
shared with Coral. The Company also shares in revenues arising from certain
transactions initiated by Coral.
The arrangements with Enron and Coral are short-term agreements. The
Company will continue to evaluate the effectiveness of these arrangements and
ultimately determine the most effective management approach in light of the
Company's growth objectives. This approach could be an outsourcing of this
management function, entering into a strategic alliance with a third party to
jointly manage this activity, or internalizing the entire function.
GAS COSTS. On a Combined Company Basis, gas costs for 1998 were
$702.7 million and reflect warmer than normal weather during the year.
Variations in gas costs have little impact on operating results of the Company
since its current gas rate structures include gas adjustment clauses whereby
variations between actual gas costs and gas cost recoveries are deferred and
subsequently refunded to or collected from customers.
ELECTRIC SERVICES
OVERVIEW
The Company's electric services primarily consist of (i) the
ownership and operation of oil- and gas-fired generating facilities located on
Long Island and the delivery of the power generated by these facilities to LIPA;
(ii) the management and operation of LIPA's T&D System; and (iii) the management
of LIPA's fuel and electric energy purchases and any off-system sales.
11
As more fully described below, the Company (i) provides to LIPA all
operation, maintenance and construction services relating to the Retained Assets
through a Management Services Agreement (the "MSA"); (ii) supplies LIPA with
capacity and energy through a Power Supply Agreement (the "PSA") in order to
allow LIPA to provide electricity to its customers on Long Island; and (iii)
manages all aspects of the fuel supply for the Generating Facilities (as defined
below) as well as all aspects of the capacity and energy owned by or under
contract to LIPA through an Energy Management Agreement (the "EMA").
Collectively, the MSA, PSA and EMA are referred to herein as the "Operating
Agreements."
In addition, on January 28, 1999, the Company entered into a
definitive agreement with Con Edison to purchase, for approximately $597
million, subject to adjustment, the 2,168-megawatt Ravenswood electric
generating facilities located in Long Island City, Queens, New York.
Consummation of this transaction is subject to various regulatory approvals, the
timing of which cannot be determined.
During 1998, on a Combined Company Basis, electric revenues were
$1.294 billion or 40% of the Company's revenues and electric operating income
was $264.2 million, excluding special charges related to the Combination. For
the period following completion of the LIPA Transaction and ending December 31,
1998, electric revenues were $408.3 million and electric operating income was
$10.7 million, excluding special charges related to the Combination. On a
Combined Company Basis, electric revenues were $2.481 billion and $2.466 billion
for 1997 and 1996, respectively, and electric operating income was $645 million
and $642 million for 1997 and 1996, respectively.
GENERATION
GENERATING FACILITY OPERATIONS. The Company owns and operates an
aggregate of 53 electric generation units throughout Long Island (the
"Generating Facilities"), 20 of which can be powered either by oil or natural
gas at the Company's election. In recent years, the Company has reconfigured
several of its facilities to enable them to burn either oil or natural gas, thus
enabling the Company to switch periodically between fuel alternatives based upon
cost and seasonal environmental requirements.
The following table indicates the 1998 summer capacity of the
Company's steam generation facilities and internal combustion ("IC") Units as
reported to the New York Power Pool ("NYPP"):
---------------------- ---------------------- ---------------- ---------------- --------------
LOCATION OF UNITS DESCRIPTION FUEL UNITS MW
---------------------- ---------------------- ---------------- ---------------- --------------
Northport, L.I. Steam Turbine Dual* 3 1,156
Northport, L.I. Steam Turbine Oil 1 381
Port Jefferson, L.I. Steam Turbine Dual* 2 386
Glenwood, L.I. Steam Turbine Gas 2 228
Island Park, L.I. Steam Turbine Dual* 2 390
Far Rockaway, L.I. Steam Turbine Dual* 1 108
Throughout L.I. IC Units Dual* 12 291
Throughout L.I. IC Units Oil 30 1,078
====================== ====================== ================ ================ ==============
Total 53 4,018
====================== ====================== ================ ================ ==============
*Dual - Oil or natural gas.
12
The maximum demand on the T&D System was 4,208 megawatts ("MW") on
July 22, 1998, representing 84% of the total available capacity of 4,993 MW on
that day, which included 769 MW of firm capacity purchased from other sources.
By agreement with the NYPP, the Company is required to maintain, on a monthly
and annual basis, an installed and contracted firm power reserve generating
capacity equal to at least 18% of its actual peak demand. The Company expects
that it will be able to continue to meet this NYPP requirement. However, as
demand for capacity on Long Island increases, the Company anticipates that it
will seek to meet such demand through the acquisition or construction of
additional generation facilities.
POWER SUPPLY AGREEMENT. The PSA provides for the sale to LIPA by the
Company of all of the capacity and, to the extent LIPA requests, energy from the
Generating Facilities. Capacity refers to the ability to generate energy and,
pursuant to NYPP requirements, must be maintained at specified levels (including
reserves) regardless of the source and amount of energy consumption. By
contrast, energy refers to the electricity actually generated for consumption by
customers. Such sales of capacity and energy from the Generating Facilities are
made at cost-based wholesale rates regulated by the Federal Energy Regulatory
Commission ("FERC"). These rates may be modified in the future in accordance
with the terms of the PSA for (i) agreed upon labor and expense indices applied
to the base year; (ii) a return of and on the capital invested in the Generating
Facilities; and (iii) reasonably incurred expenses that are outside the control
of the Company.
The PSA provides incentives and penalties for the Company to maintain
the output capability of the Generating Facilities, as measured by annual
industry-standard tests of operating capability, and plant availability and
efficiency. These combined incentives and penalties may total as much as $4
million annually. In 1998 the Company earned approximately $3.3 million in
incentives under the PSA.
The PSA provides LIPA with all of the capacity from the Generating
Facilities. However, LIPA has no obligation to purchase energy from the
Generating Facilities and is able to purchase energy on a least-cost basis from
all available sources consistent with existing transmission interconnection
limitations of the T&D System. Under the terms of the PSA, LIPA is obligated to
pay for capacity at rates which reflect a large percentage of the overall fixed
cost of maintaining and operating the Generating Facilities. A variable
maintenance charge is imposed for each unit of energy actually acquired from the
Generating Facilities. The term of the PSA is 15 years and is renewable on
similar terms. However, the PSA provides LIPA the option of electing to reduce
or "ramp-down" the capacity it purchases from the Company beginning in year
seven of the PSA, in accordance with agreed-upon schedules. In years seven
through ten of the PSA, if LIPA elects to ramp-down, the Company is entitled to
receive payment for 100 percent of the present value of the capacity charges
otherwise payable over the remaining term of the PSA. If LIPA ramps-down the
generation capacity in years 11 through 15 of the PSA, the capacity charges
otherwise payable by LIPA will be reduced in accordance with a formula
established in the PSA. If LIPA exercises its ramp-down option, the Company may
use any capacity released by LIPA to bid on new LIPA capacity requirements or to
bid on LIPA's capacity requirements to replace other ramped-down capacity. If
the Company continues to operate the ramped-down capacity, the PSA requires it
to use reasonable efforts to market the capacity and energy from the ramped-down
capacity and to share any profits with LIPA. Capacity and energy sold by the
Company from ramped-down capacity must be transported over the T&D System, and
the Company will be required to pay LIPA's standard transmission (and, if
applicable, distribution) rates for the service. The PSA will be terminated in
13
the event that LIPA exercises its right to purchase, at fair market value, all
of the Generating Facilities in the twelve-month period beginning in May 2001.
The Company has an inventory of sulfur dioxide ("SO2") and nitrogen
oxide ("NOx") emission allowances that may be sold to third party purchasers.
The amount of allowances varies from year to year relative to the level of
emissions from the Generating Facilities, which is greatly dependent on the mix
of natural gas and fuel oil used for generation and the amount of purchased
power that is imported onto Long Island. In accordance with the PSA, 33% of
emission allowance sales revenue is kept by the Company and the other 67% is
credited to LIPA. LIPA also has a right of first refusal on any potential
emission allowance sales. Additionally, the Company is bound by a memorandum of
understanding with the New York State Department of Environmental Conservation
which prohibits the sale of SO2 allowances into certain states and requires the
purchaser to be bound by the same restriction, which may affect the allowances'
market value.
TRANSMISSION AND DISTRIBUTION MANAGEMENT
MANAGEMENT SERVICES AGREEMENT. Under the MSA, the Company performs
day-to-day operations and maintenance of the T&D System, including, among other
functions, transmission and distribution facility operations, customer service,
billing and collection, meter reading, planning, engineering, and construction,
all in accordance with policies and procedures adopted by LIPA. The Company
furnishes such services as an independent contractor and does not have any
ownership or leasehold interest in the T&D System.
In exchange for providing these services, the Company is entitled to earn
an annual management fee of $10 million and may also earn certain incentives, or
be responsible for certain penalties, based upon its performance. The incentives
provide for the Company to retain 100% of the first $5 million of cost
reductions and 50% of any additional cost reductions up to 15% of the total cost
budget. Thereafter all savings accrue to LIPA. The total cost budget for the
twelve month period ended December 31, 1998 was approximately $385.2 million.
The Company also is required to absorb any total cost budget overruns up to a
maximum of $15 million in each contract year.
In addition to the foregoing cost-based incentives and penalties, the
Company is eligible for incentives for performance above certain threshold
target levels and subject to disincentives for performance below certain other
threshold levels, with an intermediate band of performance in which neither
incentives nor disincentives will apply, for system reliability, worker safety,
and customer satisfaction.
The term of the MSA is eight years and requires that LIPA solicit
bids in the sixth year of the term for a new management services agreement
beginning after the eighth year. Generally, the Company is eligible to submit a
bid for such new management services agreement.
OTHER OPERATING AGREEMENTS
ENERGY MANAGEMENT AGREEMENT. Pursuant to the EMA, the Company (i)
procures and manages fuel supplies for LIPA to fuel the Generating Facilities,
(ii) performs off-system capacity and energy purchases on a least-cost basis to
meet LIPA's needs, and (iii) makes off-system sales of output from the
Generating Facilities and other power supplies either owned or under contract to
LIPA. LIPA is entitled to two-thirds of the profit from any off-system
14
electricity sales arranged by the Company. The term for the service provided in
(i) above is fifteen years, and the term for the service provided in (ii) and
(iii) above is eight years.
In exchange for these services, the Company earns an annual fee of
$1.5 million, plus an allowance for certain costs incurred in performing
services under the EMA. The EMA further provides incentives for control of the
cost of fuel and electricity purchased on behalf of LIPA by the Company. Fuel
and electricity purchase prices will be compared to regional price indices and
the Company will receive a payment from LIPA, or be obligated to make a payment
to LIPA, for fuel and/or purchased electricity costs which are below or above,
respectively, specified tolerance bands. The total fuel purchase incentive or
disincentive can be no greater than $5 million annually and the electricity
purchase incentive or disincentive can be no greater than $2 million annually.
For the period ended December 31, 1998, the Company earned an aggregate of $3.4
million in incentives under the EMA as well as revenue from off-system sales.
OTHER RIGHTS. Pursuant to other agreements between LIPA and the
Company, certain future rights have been granted to LIPA. Subject to certain
conditions, these rights include the right for 99 years to lease or purchase, at
fair market value, parcels of land and to acquire unlimited access to, as well
as appropriate easements at, the Generating Facilities for the purpose of
constructing new electric generating facilities to be owned by LIPA or its
designee. Subject to this right granted to LIPA, the Company will have the right
to sell or lease property on or adjoining the Generating Facilities to third
parties. In addition, LIPA has the right to acquire a parcel at the Shoreham
Nuclear Power Station site suitable as the terminus for a potential transmission
cable under Long Island Sound or the potential site of a new gas-fired combined
cycle generating facility.
The Company owns the common plant (such as administrative office buildings
and computer systems) formerly owned by LILCO and recovers LIPA's allocable
share of the carrying costs of such plant through the agreements described
above. The Company has agreed to provide LIPA, for a period of 99 years, the
right to enter into leases at fair market value for common plant or sub-contract
for common services which it may assign to a subsequent manager of the T&D
System. The Company has also agreed (i) for a period of 99 years not to compete
with LIPA as a provider of transmission or distribution service on Long Island;
(ii) that LIPA will share in synergy (I.E., efficiency) savings over a ten-year
period attributed to the Combination (estimated to be approximately $1 billion),
which savings are incorporated into the cost structure under the Operating
Agreements; and (iii) not to commence any tax certiorari case (until termination
of the PSA) challenging certain property tax assessments relating to the
Generating Facilities.
GUARANTEES AND INDEMNITIES. The Company and LIPA also have entered
into agreements providing for the guarantee of certain obligations,
indemnification against certain liabilities and allocation of responsibility and
liability for certain pre-existing obligations and liabilities. In general,
liabilities associated with the Transferred Assets have been assumed by the
Company and liabilities associated with the Retained Assets are borne by LIPA,
subject to certain specified exceptions. The Company has assumed all liabilities
arising from all manufactured gas plant ("MGP") operations of LILCO and its
predecessors and LIPA has assumed certain liabilities relating to the Generating
Facilities and all liabilities traceable to the business and operations
conducted by LIPA after completion of the Combination.
An agreement also provides for an allocation of liabilities that are
not traceable to either the business or operations to be conducted by LIPA or
15
the Company after completion of the Combination which relate to the assets that
were common to the operations of LILCO and/or shared services. LIPA bears 53.6%
of the costs associated therewith and the Company bears the remainder.
GAS EXPLORATION & PRODUCTION
Through its 64% equity interest in The Houston Exploration Company
("THEC"), an independent natural gas and oil company, the Company is engaged in
the exploration, development and acquisition of domestic natural gas and oil
properties. THEC's offshore properties are located in the Gulf of Mexico, and
its onshore properties are located in South Texas, South Louisiana, the Arkoma
Basin of Oklahoma and Arkansas, East Texas and West Virginia.
THEC was organized by the Company in 1985 to conduct natural gas and
oil exploration and production activities. It completed an initial public
offering in 1996 and its shares are currently traded on the New York Stock
Exchange under the symbol "THX." At March 22, 1999, its aggregate market
capitalization was approximately $451.0 million (based upon the closing price on
the New York Stock Exchange on that date of $18.875).
Information with respect to net proved reserves, production,
productive wells and acreage, undeveloped acreage, drilling activities, present
activities and drilling commitments is contained in "Note 14. Supplemental Gas
and Oil Disclosures" of the Notes to the Consolidated Financial Statements
included herein.
During 1998, on a Combined Company Basis, gas exploration and
production revenues were $127.1 million, and gas exploration and production
operating income was $15.3 million, excluding an impairment charge on its proved
gas reserves. Set forth below is certain selected information with respect to
THEC:
THEC Operating Statistics
- -------------------------
1998 1997 1996
----------- ----------- -----------
Net Proved Reserves (Mmcfe)...................... 480,347 337,063 327,260
Production of Natural Gas and Oil (MMcfe)........ 62,829 51,336 31,923
Average Realized Price of Natural Gas ($/per Mcf) 2.02 2.25 2.00
Average Unhedged Price of Natural Gas ($/per Mcf) 1.96 2.45 2.35
Capital Expenditures ($000)...................... 302,837 145,175 177,774
THEC has achieved significant growth in net proved reserves,
production and revenues over the past five years. It has increased net proved
reserves at a compound annual rate of 41% from 121 Bcfe at December 31, 1993 to
480 Bcfe at December 31, 1998. During this period, annual production increased
at a compound annual rate of 28% from 23 Bcfe in 1994 to 63 Bcfe in 1998. At the
close of 1998, daily production averaged 190 MMcfe per day. THEC's oil and gas
revenues have increased from $41.8 million in 1994 to $127.1 million in 1998.
THEC focuses its operations offshore in the Gulf of Mexico and
onshore in South Texas, South Louisiana, the Arkoma Basin, East Texas and West
Virginia. The geographic focus of its operations enables it to manage a
comparatively large asset base with relatively few employees and to add and
operate production at relatively low incremental costs. THEC seeks to balance
its offshore and onshore activities so that the lower risk and more stable
16
production typically associated with onshore properties complement the high
potential exploratory projects in the Gulf of Mexico by balancing risk and
reducing volatility. THEC's business strategy is to seek to continue to increase
reserves, production and cash flow by pursuing internally generated prospects,
primarily in the Gulf of Mexico, by conducting development and exploratory
drilling on its offshore and onshore properties and by making selective
opportune acquisitions.
OFFSHORE PROPERTIES. THEC holds interests in 86 lease blocks,
representing 439,896 gross (355,129 net) acres, in federal and state waters in
the Gulf of Mexico, of which 27 have current operations. THEC operates 21 of
these blocks, accounting for approximately 82% of THEC's offshore production.
Over the past five years, THEC has drilled 19 successful exploratory wells and
14 successful development wells in the Gulf of Mexico, representing a historical
success rate of 65%. During 1998, THEC drilled two successful exploratory wells
and one successful development well on its Gulf of Mexico properties. During the
same period, THEC drilled five exploratory wells and one development well that
were not successful. THEC plans to drill approximately 10 exploratory wells,
along with limited development drilling, in the Gulf of Mexico in 1999.
ONSHORE PROPERTIES. THEC owns onshore natural gas and oil properties
representing interests in 1,179 gross (764 net) wells, approximately 84% of
which THEC is the operator of record, and 174,513 gross (125,595 net) acres.
Over the past five years, THEC has drilled or participated in the drilling of 83
successful development wells and 7 successful exploratory wells onshore,
representing a historical success rate of 78%. During 1998, THEC drilled or
participated in the drilling of 23 successful development wells and one
successful exploratory well on its onshore properties. During the same period,
THEC drilled or participated in the drilling of four development wells that were
not successful.
THEC plans to drill approximately 25 wells onshore in 1999.
In November 1998, the Company extended a $150 million revolving
credit line to THEC (the "THEC Facility"). The THEC Facility matures January 1,
2000 and is convertible to equity if borrowings remain outstanding at maturity.
The THEC Facility is subordinated to THEC's bank credit facility and pari passu
to THEC's senior subordinated notes. As of December 31, 1998, THEC had $80
million outstanding under the THEC Facility.
On November 30, 1998, THEC acquired from Chevron U.S.A., Inc.
offshore producing properties and facilities in the Mustang Island area of the
Gulf of Mexico. The newly acquired properties are comprised of three adjacent
blocks, with nine producing wells and three platforms. The acquired properties
neighbor 19 undeveloped lease blocks and five producing blocks held by THEC. The
net purchase price of $84.9 million was paid in cash and financed by borrowings
under the THEC Facility. THEC plans both exploratory and development drilling in
1999 on those properties.
On March 15 1999, the Company and THEC entered into a joint
exploration agreement (the "THEC Joint Venture") to explore for natural gas and
oil over a term of three years expiring December 31, 2001. The THEC Joint
Venture may be terminated at the option of either party at the end of a given
year. Under the terms of this agreement, THEC will contribute all of its
currently undeveloped offshore leases to the THEC Joint Venture and the Company
will acquire 45% of THEC's working interest in all prospects to be drilled under
the THEC Joint Venture and will commit up to $100 million per calendar year to
explore and develop these leases. THEC will retain a 55% interest in the leases
and will commit its proportionate share of the funds per calendar year necessary
for such year's exploration and development drilling program. Revenues generated
17
from this joint program will be shared between the Company and THEC according to
the respective working interest ownership of each entity. THEC plans to drill
approximately 8-10 offshore exploratory wells under the terms of the THEC Joint
Venture during 1999.
The Company intends to continue to grow its exploration and
production investments in the Gulf region. KeySpan anticipates that THEC will
have capital expenditures of approximately $82 million in 1999. In addition, the
Company anticipates that it will invest approximately $45 million additionally
in exploration and production activities in 1999. Such amounts are expected to
consist primarily of contributions to the THEC Joint Venture.
ENERGY-RELATED INVESTMENTS
OVERVIEW
The Company has investments in energy-related businesses, including
natural gas pipelines, midstream natural gas processing and gathering facilities
and gas storage facilities in the Northeast region of the United States and in
Canada and the United Kingdom.
During 1998, on a Combined Company Basis, net after-tax loss from
energy-related investments was $6.1 million, and the Company's capital
expenditures in energy-related investments were $239.8 million, which was
significantly higher than past years primarily due to the Company's $189 million
investment in certain midstream natural gas assets, as discussed below.
The Company owns an approximately 20% interest in Iroquois Gas
Transmission System L.P. ("Iroquois"), the partnership that owns a 374-mile
pipeline which currently transports 892 MDTH of Canadian gas supply daily to
markets in the Northeastern United States. The Company is also a shipper on
Iroquois and currently transports up to 135 MDTH of gas per day on the pipeline.
The Company owns a 24.5% interest in Phoenix Natural Gas ("Phoenix")
in Belfast, Northern Ireland and, in December 1998, increased its interest in
The Premier Transco Pipeline ("Premier") from 24.5% to 50%. Phoenix is a newly
established gas distribution system serving the City of Belfast, which is in its
early stages of development pursuant to an eight-year program of capital
development and line extensions. Premier is an 84-mile pipeline to Northern
Ireland from southwest Scotland that currently transports approximately 300 MDTH
of gas supply daily to markets in Northern Ireland.
The Company has equity investments in two gas storage facilities in
the State of New York.
In August 1998, the Company acquired a 25% interest in a venture to
develop the Cross Bay pipeline. Upon completion, Cross Bay will transport gas
from interstate pipelines in New Jersey to New York City and Long Island,
including supplying customers served by the Company. The new system is scheduled
to begin operating in November 2000.
In December 1998, the Company acquired a 50% interest in certain
midstream natural gas assets owned by Gulf Canada Resources Limited ("Gulf
Canada") located in Western Canada. The purchased assets include interests in 14
processing plants and associated gathering systems which can process
18
approximately 1.4 Bcfe of natural gas daily, and associated natural gas liquids
fractionation, storage and transportation facilities. The Company paid Gulf
Canada $189 million for the equity interest and agreed to provide a three-year,
$65 million loan to Gulf Canada.
The Company's business strategy with respect to its energy-related
investments is to acquire and maintain interests in natural gas and natural gas
liquid gathering, processing, transmission and storage facilities near areas of
rapid reserve development or growing consumer markets. It is anticipated that
approximately $85 million will be invested in energy-related businesses in 1999,
a level of investment that could rise significantly in future years based on the
numerous potential domestic and international projects currently being pursued.
ENERGY-RELATED SERVICES
OVERVIEW
The Company has formed non-regulated subsidiaries to market and
manage natural gas, electricity, and consumer products and services to
residential, commercial and industrial customers, including those within the
Company's traditional service territories. These non-regulated subsidiaries
which are currently in the start-up phase, had revenues of $88.4 million and an
operating loss of $10.2 million in 1998, on a Combined Company Basis. The
Company expects to invest approximately $57 million in 1999 in these
non-regulated subsidiaries.
ENERGY MARKETING. The Company buys, sells and markets gas and
electricity and arranges for transportation and related services to over 30,000
customers throughout the northeastern United States, including those in the gas
service territories of the Company. In 1998, the Company established a joint
venture with Enron to market gas supply management services to gas distribution
companies throughout the Northeastern United States.
ENERGY MANAGEMENT. The Company owns, designs and/or operates energy
systems for commercial and industrial customers and provides energy-related
services to clients in the New York City metropolitan area. Revenues have been
enhanced through the continued integration of an engineering firm.
APPLIANCE SERVICES. The Company provides various technical and
maintenance services to customers throughout the New York City metropolitan
area, including maintaining and repairing heating equipment, water heaters,
central air conditioners and other appliances. With over 100,000 service
contracts, the Company is the largest provider of these services in the State of
New York. In November 1998, the Company purchased Philip Fritze and Sons, one of
the largest heating, ventilation and air conditioning contractors in the State
of New Jersey.
The Company's energy-related services businesses compete with the
marketing and management operations of both independent and major energy
companies in addition to electric utilities, independent power producers, local
distribution companies and various energy brokers. As a result of the continuing
efforts to deregulate both the natural gas and electric industries, the relative
energy cost differences among different forms of energy are expected to be
reduced in the future. Competition is based largely upon pricing, availability
and reliability of supply, technical and financial capabilities, regional
presence and experience. The Company's energy-related services subsidiaries are
expected to enable the Company to take advantage of emerging deregulated energy
markets for both gas and electricity and the Company anticipates that it will
19
continue to target other acquisitions which also provide it with opportunities
to expand those services both within and outside its traditional service
territories.
REGULATION AND RATE MATTERS
OVERVIEW
Gas and electric public utility companies, and corporations which own
gas and electric public utility companies (I.E., public utility holding
companies) may be subject to either or both state and federal regulation. In
general, state public service commissions, such as the NYPSC, regulate the
provision of retail services, including the distribution and sale of natural gas
and electricity to consumers. The Federal Energy Regulatory Commission ("FERC")
regulates interstate natural gas transportation and electric transmission, and
has jurisdiction over certain wholesale natural gas sales and wholesale electric
sales. Public utility holding companies, especially those with operations in
several states, are regulated by the SEC under the Public Utility Holding
Company Act of 1935 ("PUHCA") and, to some extent, by state commissions, through
the regulation of corporate, financial and affiliate activities of public
utilities.
PUBLIC UTILITY HOLDING COMPANY REGULATION. KeySpan Energy is a public
utility holding company, although it is exempt from most regulation under PUHCA
because of the predominately intrastate character of its public utility
subsidiaries. The only provision of PUHCA from which KeySpan Energy is not
exempt is the requirement that any person must obtain advance SEC approval for
the acquisition of 5% or more of voting securities issued by any public utility
company or public utility holding company. KeySpan Energy is also subject to
indirect regulation by the NYPSC in the form of conditions attached to NYPSC
orders authorizing the formation of the Company, among other matters. Those
conditions address the manner in which KeySpan Energy interacts with its two
NYPSC-regulated natural gas distribution subsidiaries, Brooklyn Union and
Brooklyn Union of Long Island.
NYPSC REGULATION
NATURAL GAS UTILITIES. The NYPSC is the principal agency in the State
of New York which regulates, as "gas corporations," companies that own, operate
or manage pipelines and other facilities used to distribute or sell natural gas.
The NYPSC regulates the construction, use and maintenance of intrastate natural
gas facilities, the retail rates, terms and conditions of service offered by gas
corporations, as well as matters relating to the quality, reliability and safety
of service. The NYPSC also regulates the corporate, financial and affiliate
activities of gas corporations. Both Brooklyn Union and Brooklyn Union of Long
Island are gas corporations subject to the full scope of NYPSC regulation.
Beginning in the mid-1980's, the NYPSC has taken a number of steps to
require the "unbundling" of natural gas sales and other services from the
distribution of natural gas through pipelines, in order to encourage competition
among gas sellers and energy service providers. In 1985, the NYPSC ordered the
major gas utilities in the state to offer transportation service for large
volume customers who choose to purchase natural gas from other suppliers.
Subsequently, the NYPSC required that transportation service be made available
to all customers beginning on May 1, 1996. Brooklyn Union of Long Island has
been providing a transportation service option to all its customers since April
1996. Brooklyn Union has been providing a transportation option to all its
customers since May 1996.
20
In April 1997, the NYPSC ordered gas utilities to cease providing
non-safety related appliance repair service by no later than May 1, 2000.
Brooklyn Union stopped providing these services in April 1998; Brooklyn Union of
Long Island will cease providing non-emergency appliance repair services on July
1, 1999. Utility affiliates can provide this service, and the Company does so
through a subsidiary.
In November 1998, the NYPSC issued a policy statement that
anticipated that natural gas utilities would cease sales of gas, and become
transportation-only providers, within three to seven years. Marketers which are
affiliated with the natural gas utilities are permitted to compete for retail
natural gas sales. The NYPSC's policy statement envisions proceedings to
restructure the operations of natural gas utilities in order to facilitate the
achievement of the objectives articulated in the policy statement. The Company
is evaluating the policy statement and anticipates making specific proposals to
the NYPSC in 1999.
Brooklyn Union of Long Island is currently operating under a
three-year rate plan. The rate plan applies to the period December 1, 1997
through November 30, 2000. Under the plan, if Brooklyn Union of Long Island's
earnings exceed 11.10%, it must credit back to certain customers 60% of earnings
up to 100 basis points above the 11.10% and 50% of any earnings in excess of a
12.10% return. Both a customer service and a safety and reliability incentive
performance program became effective on December 1, 1997, with maximum pre-tax
return on equity penalties of 40 and 12 basis points, respectively, if Brooklyn
Union of Long Island fails to achieve certain performance standards in these
areas.
Brooklyn Union is currently operating under a multi-year rate plan
that ends on September 30, 2002. Brooklyn Union, like Brooklyn Union of Long
Island, is subject to an earnings sharing provision, under which it will be
required to credit to certain customers 60% of any utility earnings up to 100
basis points above specified equity return levels (other than any earnings
associated with discrete incentives) and 50% of any utility earnings in excess
of 100 basis points above such threshold levels. The threshold levels are 13.75%
for fiscal year 1998, 13.50% for fiscal years 1999, 2000 and 2001; and 13.25%
for fiscal year 2002. A safety and reliability incentive mechanism provides a
maximum 12 basis point pre-tax penalty return on common equity if Brooklyn Union
fails to achieve certain safety and reliability performance standards, and a
customer service incentive performance program with a maximum 40 basis point
pre-tax penalty return on equity. With the exception of the simplification of
the customer service performance standards and the imposition of the earnings
sharing provisions, the Brooklyn Union rate plan approved by the NYPSC in 1996
remains unchanged.
As part of the settlement agreement approved by the NYPSC in
connection with its approval of the Combination (the "Stipulation"), Brooklyn
Union and Brooklyn Union of Long Island are subject to certain affiliate
transaction restrictions, cost allocation and financial integrity conditions and
a code of conduct governing affiliate relationships. These restrictions and
conditions eliminate or relax many restrictions previously applicable to
Brooklyn Union in such areas as affiliate transactions, use of the name and
reputation of Brooklyn Union by unregulated affiliates, common officers of the
Company, the utility subsidiaries and unregulated subsidiaries, dividend payment
restrictions, and the composition of the Board of Directors of Brooklyn Union.
The Stipulation provides that, in order to achieve forecasted synergy
savings resulting from the Combination, one or more shared services subsidiaries
of the Company may be formed to provide to both regulated and unregulated
operating subsidiaries, functions common to both utilities and their affiliates,
such as accounting, finance, human resources, legal and information systems and
technology.
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ELECTRIC UTILITIES. KeySpan Generation LLC ("KeySpan Generation"),
KeySpan's electric generation subsidiary, is not subject to NYPSC rate
regulation because its sales of electricity are made exclusively at wholesale;
however, KeySpan Generation is subject to NYPSC financial, reliability and
safety regulation. As a wholesale generator, KeySpan Generation qualifies for
"lightened" regulatory treatment, I.E. certain financial regulations are waived
or applied with less scrutiny than would be the case for fully-regulated
electric utilities.
FEDERAL REGULATION
NATURAL GAS COMPANIES. The FERC has jurisdiction to regulate certain
natural gas sales for resale in interstate commerce, the transportation of
natural gas in interstate commerce, and, unless an exemption applies, companies
engaged in such activities. The natural gas distribution activities of Brooklyn
Union and Brooklyn Union of Long Island and certain related intrastate gas
transportation functions are not subject to FERC jurisdiction. However, to the
extent that Brooklyn Union and Brooklyn Union of Long Island sell gas for resale
in interstate commerce, such sales are subject to FERC jurisdiction and have
been authorized by the FERC.
The Company also owns an approximately 20% interest in Iroquois, an
interstate natural gas pipeline extending from the Canadian border to Long
Island, and 52% and 18.6% of the Honeoye and Steuben gas storage facilities,
respectively. Iroquois, Honeoye and Steuben are fully regulated by the FERC as
natural gas companies.
ELECTRIC UTILITIES. The FERC regulates the sale of electricity at
wholesale and the transmission of electricity in interstate commerce, as well as
certain corporate and financial activities of companies that are engaged in such
activities.
KeySpan Generation is subject to FERC regulation based on its sales of
electricity at wholesale to LIPA under the PSA. On October 1, 1997, a rate
application was filed with the FERC which proposed rates that were designed for
KeySpan Generation to recover $327.6 million from LIPA for the first year of an
approximately five-year rate plan with various adjustments, and to set the rates
for the remainder of the multi-year rate period. In December 1997, KeySpan
Generation and LIPA agreed jointly to propose to FERC rates that would recover
$301.8 million in the first year of the multi-year rate period and adjustments
to set rates for the remaining years. LIPA, KeySpan Generation, and the Staff of
FERC eventually stipulated to setting rates designed to recover $300.5 million
in the first year with agreed-upon adjustments to set rates for the remainder of
the multi-year rate period. The only party opposed to this stipulation is the
County of Suffolk. Parties submitted initial briefs to a FERC Administrative Law
Judge ("ALJ") on December 8, 1998 and reply briefs on January 15, 1999. The
Company has not yet received the decision of the ALJ or a final decision of
FERC. Until such final decision, rates are in effect subject to adjustment and
refund. The FERC retains the ability in future proceedings, either on its own
motion or upon a complaint filed with the FERC, to modify KeySpan Generation's
rates, either upward or downward, if the FERC finds that the public interest
requires it to do so.
22
REGULATION IN OTHER COUNTRIES
The Company's operations in Northern Ireland, conducted through
Premier and Phoenix, are subject to licensing by the Northern Ireland Department
of Economic Development and regulation by the U.K. Department of Trade and
Industry (with respect to the subsea and on-land portions of the Premier
pipeline) and the Northern Ireland Director General, Office for the Regulation
of Electricity and Gas (with respect to the Northern Ireland portion of the
Premier pipeline and Phoenix's operations generally). The licenses establish
mechanisms for the establishment of rates for the conveyance and transportation
of natural gas, and generally may not be revoked except upon long term notice.
Charges for the supply of gas by Phoenix are largely unregulated unless a
determination is made of an absence of competition.
The Company's midstream natural gas processing facilities in Canada
are subject to regulation by Canadian provincial authorities. Such regulatory
authorities license the operations of the facilities and regulate safety matters
and certain changes in such facilities' operations.
ENVIRONMENTAL MATTERS
OVERVIEW
The Company's ordinary business operations subject it to various
federal, state and local laws, rules and regulations dealing with the
environment, including air, water, and hazardous waste, and its business
operations are regulated by various federal, regional, state and local
authorities, including the United States Environmental Protection Agency (the
"EPA") and the New York State Department of Environmental Conservation ("DEC").
These requirements govern both the normal, ongoing operations of the Company and
the remediation of contaminated properties historically used in utility
operations. Potential liabilities associated with the Company's historical
operations may be imposed without regard to fault, even if the activities were
lawful at the time they occurred.
Ensuring continuing compliance with environmental requirements may
require significant expenditures for capital improvements or modifications in
some areas. Total capital expenditures for environmental improvements and
related studies amounted to approximately $1.6 million for the year ended
December 31, 1998, and are expected to be $2.3 million for the year ending
December 31, 1999.
Except as set forth below, no material proceedings relating to
environmental matters have been commenced or, to the knowledge of the Company,
are contemplated by any federal, state or local agency against the Company, and
the Company is not a defendant in any material litigation with respect to any
matter relating to the protection of the environment. The Company believes that
its operations are in substantial compliance with environmental laws and that
requirements imposed by environmental laws are not likely to have a material
adverse impact upon the Company. The Company believes that all material costs
incurred with respect to environmental requirements will be recoverable from its
customers. The Company is pursuing claims against insurance carriers and
potentially responsible parties which seek the recovery of certain costs
associated with the investigation and remediation of contaminated properties.
AIR. Federal, state and local laws currently regulate a variety of
air emissions from new and existing electric generating plants, including SO2,
NOx, opacity and particulate matter and, in the future, may also regulate
emissions of fine particulate matter, hazardous air pollutants, and carbon
23
dioxide. The Company has submitted timely applications for permits in accordance
with the requirements of Title V of the 1990 amendments to the Federal Clean Air
Act ("CAA"). Final permits have been issued for all of the Company's electric
generating facilities with the exception of the Far Rockaway facility, which is
pending. The permits allow the Company's electric generating plants to continue
to operate without any additional significant expenditures, except as described
below.
The Company's generating facilities are located within a CAA severe
ozone non-attainment area, and are subject to the Phase I, II, and III NOx
reduction requirements established under the Ozone Transportation Commission
("OTC") memorandum of understanding. The Company's investments in boiler
combustion modifications and the use of natural gas firing at its steam electric
generating stations has enabled the Company to achieve the NOx emission
reductions required under Phase I and II in a cost-effective manner. In
addition, software and equipment upgrades of approximately $1 million for
continuous emissions monitors ("CEM") may be required in 1999-2000 to meet EPA
requirements for the NOx allowance tracking/trading program and certain other
regulatory changes affecting the operation of CEM systems. The Company currently
estimates that it may be required to spend between $10 million and $35 million
by the year 2003 for additional pollution control equipment to achieve the OTC
Phase III NOx reduction requirements and/or new requirements imposed under the
EPA NOx state implementation plan, depending on the actual level of NOx emission
reductions which are required when pending regulations are implemented by the
State of New York.
WATER. The Company possesses permits for its generating units which
authorize discharges from cooling water circulating systems and chemical
treatment systems. Several of these permits are being renewed; one or more of
the new permits are expected to require biological monitoring to determine if
the cooling water intake structures meet the best available technology
requirements of the Federal Clean Water Act ("CWA") for the protection of marine
life.
On behalf of LIPA, the Company provides management and operations
support for the LIPA-Connecticut Light and Power Company electric transmission
cable system located under the Long Island Sound (the "Sound Cable"). The
Connecticut Department of Environmental Protection ("DEP") and the DEC
separately have issued Administrative Consent Orders ("ACOs") in connection with
releases of insulating fluid from the Sound Cable. The ACOs require the
submission of a series of reports and studies describing cable system condition,
operation and repair practices, alternatives for cable improvements or
replacement, and environmental impacts associated with prior leaks of fluid into
the Long Island Sound. Compliance activities associated with the ACOs are
ongoing.
REMEDIATION OF CONTAMINATED PROPERTY
SUPERFUND SITES. Federal and New York State Superfund laws impose
liability, regardless of fault, upon generators of hazardous substances for
costs associated with remediating contaminated property. In the course of its
business operations, the Company generates materials which are subject to these
laws. From time to time, the Company has received notices under these laws
concerning possible claims with respect to sites at which hazardous substances
generated by the Company and other potentially responsible parties ("PRPs")
allegedly were disposed.
24
The DEC has notified the Company, pursuant to the State Superfund
program, that the Company may be responsible for the disposal of hazardous
substances at the Huntington/East Northport Site, a municipal landfill property.
The DEC investigation is in its preliminary stages, and the Company currently is
unable to estimate its share, if any, of the costs required to investigate and
remediate this site.
MANUFACTURED GAS PLANT SITES. The Company or its predecessor
entities, including Brooklyn Union and LILCO, historically owned or operated
several former MGP sites. Operations at these plants in the late 1800's and
early 1900's may have resulted in the release of hazardous substances. These
former sites have been identified to the DEC for inclusion on appropriate waste
site inventories. In certain circumstances, former MGP sites can give rise to
environmental cleanup responsibilities for the Company.
The Company has several former MGP sites that will require
investigation and/or remediation. In 1995, the Company executed an ACO with the
DEC which addressed the investigation and remediation of the Brooklyn Borough
Works site in Coney Island, Brooklyn. In 1998, the Company executed an ACO for
the investigation and remediation of the Clifton MGP site in Staten Island. Both
of these properties are owned by the Company. The City of New York has notified
the Company that a property now owned by the City which was formerly owned and
operated by a Brooklyn Union predecessor, the Citizen's Site, should be
investigated. The Company has submitted an investigation study plan and
requested cost sharing for this property with the City. The Company is awaiting
the City's response. Finally, the DEC notified the Company in 1998 that two MGP
sites previously owned by LILCO would require remediation under the State's
Superfund program; pending discussions with DEC on those and four additional
former LILCO sites are expected to result in the issuance of additional ACOs in
the near future.
The final end uses for these sites and acceptable remediation goals
have not been determined in the ACOs. In addition, investigation may be required
at other former MGP sites before determinations can be made regarding the need
for or scope of potential remediation at these locations. Based upon activities
conducted to date, the Company estimates the minimum cost of its MGP-related
environmental cleanup activities will be approximately $130 million; that amount
has been accrued by the Company as an environmental liability. The actual
MGP-related costs may be substantially higher, depending upon remediation
experience, selected end use for each site, and actual environmental conditions
encountered.
The NYPSC-approved rate plans for Brooklyn Union and Brooklyn Union
of Long Island provide for the recovery of such costs. The Brooklyn Union rate
plan provides, among other things, that if the total cost of investigation and
remediation varies from that which is specifically estimated for a site under
investigation and/or remediation, then Brooklyn Union will retain or absorb up
to 10% of the variation. Under prior rate orders, Brooklyn Union has already
recovered costs associated with certain MGP sites. The Brooklyn Union of Long
Island rate plan provides for the complete recovery of investigation and
remediation costs. At December 31, 1998, the Company has reflected a remaining
regulatory asset of $100 million of which $18 million is associated with
Brooklyn Union sites and $82 million is associated with Brooklyn Union of Long
Island sites. Expenditures incurred to date by Brooklyn Union and Brooklyn Union
of Long Island with respect to MGP-related activities total $8.7 million and $5
million, respectively.
25
Periodic discussions by the Company with insurance carriers and third
parties for reimbursement of some portion of MGP site investigation and
remediation costs continue. In December 1996, LILCO filed a complaint in the
United States District Court for the Southern District of New York against
fourteen insurance companies that issued general comprehensive liability
policies to LILCO. In January 1998, LILCO commenced a similar action against the
same and additional insurance companies in New York State Supreme Court, and the
federal court action subsequently was dismissed. The outcome of this proceeding
cannot yet be determined. In addition, Brooklyn Union is in discussions with
insurance carriers regarding the possible resolution of coverage claims related
to MGP site investigation and remediation activities.
EMPLOYEE MATTERS
On December 31, 1998, the Company had approximately 7,950 full-time
employees. Of that total, approximately 5,113 employees are covered under
collective bargaining agreements; 1,603 employees belong to Local 101, Utility
Division, of the Transport Workers Union of America, 175 employees belong to
Local 3 of the International Brotherhood of Electrical Workers (the "IBEW"),
2,119 employees belong to Local 1049 of the IBEW and 1,216 employees belong to
Local 1381 of the IBEW.
The Company maintains collective bargaining agreements covering each
of the four collective bargaining units detailed above, all of which expire in
2001. The Company has not experienced any work stoppage during the past five
years and considers its relationship with employees, including those covered by
collective bargaining agreements, to be good.
EXECUTIVE OFFICERS OF THE COMPANY
Certain information regarding the Company's Executive Officers, all
of whom serve at the will of the Board of Directors, is set forth below:
ROBERT B. CATELL
Mr. Catell, age 61, has been a Director of the Company since its creation in May
1998 and served as its President and Chief Operating Officer from May 1998-July
1998. He was elected Chairman of the Board and Chief Executive Officer in July
1998. Mr. Catell joined Brooklyn Union in 1958 and became an officer in 1974. He
was elected Vice President in 1977, Senior Vice President in 1981 and Executive
Vice President in 1984. He was elected Chief Operating Officer in 1986 and
President in 1990. Mr. Catell served as President and Chief Executive Officer
from 1991 to 1996, when he was elected Chairman and Chief Executive Officer. In
1997, Mr. Catell was elected Chairman, President and Chief Executive Officer of
KSE.
ANTHONY J. DIBRITA
Mr. DiBrita, age 58, has been Senior Vice President of Gas Operations for the
Company since its creation in May 1998. He joined Brooklyn Union in 1962. Since,
then he has held various engineering positions. In 1989, he was elected Vice
President in charge of Brooklyn Union's Gas Distribution, Materials Management,
and Research and Development Operations. From 1991 to 1992, he oversaw the Rate
Recovery, Budgeting and Forecasting, and Financial and Strategic Planning areas.
Mr. DiBrita was promoted to Senior Vice President of Brooklyn Union's
Engineering and Customer Field Services in 1994.
26
LAWRENCE S. DRYER
Mr. Dryer, age 39, was elected Vice President of Internal Audit for the Company
in September 1998. Mr. Dryer joined LILCO in 1992 as Director of Internal Audit
and has been responsible for providing independent appraisals and
recommendations to improve management controls and increase operational
efficiency.
ROBERT J. FANI
Mr. Fani, age 45, has been Senior Vice President of Gas Marketing and Sales for
the Company since its creation in May 1998. Mr. Fani joined Brooklyn Union in
1976, and held a variety of management positions in distribution, engineering,
planning, marketing, and business development. He was elected Vice President in
1992. In 1997, Mr. Fani was promoted to Senior Vice President of Marketing and
Sales for Brooklyn Union.
WILLIAM K. FERAUDO
Mr. Feraudo, age 48, has been Senior Vice President of the Company since its
creation in May 1998. He oversees the KeySpan Energy Marketing Group and is
responsible for the Company's four unregulated domestic subsidiaries providing
energy-related services. Mr. Feraudo began his career at Brooklyn Union in 1971
and rose through a succession of positions in Information Systems, Engineering,
Customer Operations, Sales, Marketing, and Product Development before being
named Senior Vice President of Brooklyn Union in 1994.
RONALD S. JENDRAS
Mr. Jendras, age 50, was named Vice President, Controller and Chief Accounting
Officer of the Company in August 1998. He joined Brooklyn Union in 1969 and held
a variety of positions in the Accounting Department before being named budget
director in 1973. In 1983, Mr. Jendras was promoted to manager of Brooklyn
Union's Rate and Regulatory Affairs area and, in 1997, was named general manager
of the Accounting Division.
FREDERICK M. LOWTHER
Mr. Lowther, age 55, was elected to the position of General Counsel in September
1998. He is also a partner in the law firm Dickstein Shapiro Morin & Oshinsky
LLP, Washington D.C., with which he has been associated since 1973. Mr. Lowther
has devoted his career principally to the development of large energy and
natural resource projects in the United States and abroad. He has served as
project counsel for a number of important U.S. energy projects, including the
Iroquois Gas Transmission System.
CRAIG G. MATTHEWS
Mr. Matthews, age 55, has been President and Chief Operating Officer of the
Company since January 1999. He has also been Chief Financial Officer of the
Company since May 1998. He served as Executive Vice President of the Company
from May 1998 to January 1999. Mr. Matthews joined Brooklyn Union in 1965 and
held various management positions in the corporate planning, financial,
marketing, and engineering areas. He has been an officer since 1977. He was
elected Vice President in 1981 and Senior Vice President in 1985. In 1991, Mr.
Matthews was named Executive Vice President with responsibilities for Brooklyn
Union's financial, gas supply, information systems, and strategic planning
functions, as well as Brooklyn Union's energy-related investments. In 1996, Mr.
Matthews was promoted to President and Chief Operating Officer of Brooklyn
Union.
27
ANTHONY NOZZOLILLO
Mr. Nozzolillo, age 50, became Senior Vice President of the Company's Electric
Business Unit in January 1999. He previously served as Senior Vice President of
Finance since the Company's creation in May 1998. He joined LILCO in 1972 and
held various positions, including Manager of Financial Planning and Manager of
Systems Planning. Mr. Nozzolillo served as LILCO's Treasurer from 1992 to 1994
and as Senior Vice President of Finance and Chief Financial Officer from 1994 to
1998.
WALLACE P. PARKER, JR.
Mr. Parker, age 49, has served as the Company's Senior Vice President of Human
Resources since August 1998. He joined Brooklyn Union 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.
DAVID L. PHILLIPS
Mr. Phillips, age 42, has served as the Company's Senior Vice President of
Strategic Planning & Corporate Development since the Company's creation in May
1998. Previously, he held the same position with Brooklyn Union. He joined
Brooklyn Union in 1996 and was a consultant to the merger process. Prior to
joining Brooklyn Union, Mr. Phillips had been a consultant to both the Bush and
Clinton Administrations. From the mid 1980s through late 1991, Mr. Phillips was
Vice President and General Counsel to the Houston-based Eastex Energy Inc., a
diversified energy company. From 1991 to 1995, he was an executive with
Equitable Resources, Inc., a diversified utility company operating in
Pittsburgh, Pennsylvania. Hired as General Counsel, he was promoted to president
of its unregulated companies, and in 1994, became a member of its Executive
Committee.
LENORE F. PULEO
Ms. Puleo, age 45, has served as the Company's Senior Vice President of Customer
Relations since its creation in May 1998. She joined Brooklyn Union in 1974 and
worked in management positions in Brooklyn Union's Accounting, Treasury,
Corporate Planning, and Human Resources areas. She was given responsibility for
the Human Resources Department in 1987 and was named a Vice President in 1990.
Ms. Puleo was promoted to Senior Vice President of Customer Relations in 1995
for Brooklyn Union.
CHERYL SMITH
Ms. Smith, age 47, joined the Company in November 1998 as Senior Vice President
and Chief Information Officer. She comes to the Company from Bell Atlantic where
she most recently served as Vice President of Strategic Billing and Corporate
Systems. Prior to Bell Atlantic, she worked at Honeywell Federal Systems Inc. as
the Director of MIS. Ms. Smith brings to the Company more than 25 years of
information systems technology experience.
MICHAEL J. TAUNTON
Mr. Taunton, age 43, has been the Company's Vice President of Investor Relations
since September 1998. He joined Brooklyn Union in 1975 and has worked in various
management positions in Marketing and Sales, Corporate Planning, Corporate
Finance and Accounting. Most recently he co-managed the day-to-day transition
process of the Combination on behalf of Brooklyn Union and LILCO. Before that,
Mr. Taunton was general manager of the Business Process Improvement for Brooklyn
Union.
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ROBERT R. WIECZOREK
Mr. Wieczorek, age 56, has been the Company's Vice President, Secretary and
Treasurer since August 1998. Mr. Wieczorek joined Brooklyn Union as the General
Auditor in 1976 and held a variety of financial-related positions. In 1981 he
was named Treasurer and, subsequently, Vice President, Secretary and Treasurer
responsible for all cash management activities and for overseeing pension fund
investments and retirement administration, pension manager evaluation, long-term
debt and equity financing, investor relations, and shareholder records.
STEVEN L. ZELKOWITZ
Mr. Zelkowitz, age 49, joined the Company as Senior Vice President and Deputy
General Counsel in October 1998. Before joining the Company, Mr. Zelkowitz
practiced law with Cullen and Dykman in Brooklyn, New York and had been a
partner since 1984. He served on the firm's Executive Committee and was head of
its Corporate/Energy Department. Mr. Zelkowitz specialized in energy and utility
law and represented investor-owned and municipal gas and electric utilities in
New York, New Jersey and Vermont.
ITEM 2. PROPERTIES
Information with respect to the Company's material properties used in
the conduct of its business is set forth in, or incorporated by reference in,
Item 1 hereof. Except where otherwise specified, all such properties are owned
or, in the case of certain rights of way used in the conduct of its gas
distribution business, held pursuant to municipal consents, easements or
long-term leases, and in the case of oil and gas properties, held under
long-term mineral leases. In addition to the information set forth therein with
respect to properties utilized by each business segment, the Company owns or
leases a variety of office space used for administrative operations of the
Company. In the case of leased office space, the Company anticipates no
significant difficulty in leasing alternative space at reasonable rates in the
event of the expiration, cancellation or termination of a lease relating to the
Company's leased properties.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company is subject to various legal
proceedings arising out of the ordinary course of its business. Except as
described below, the Company does not consider any of such proceedings to be
material to its business or likely to result in a material adverse effect on its
results of operations or financial condition.
Subsequent to the closing of the Combination, former shareholders of
LILCO commenced 13 class action lawsuits in the New York State Supreme Court,
Nassau County, against the Company and each of the former officers and directors
of LILCO. These actions were consolidated in August 1998. The consolidated
action alleges that, in connection with certain payments LILCO had determined
were payable in connection with the Combination to LILCO's chairman, and to
former officers of LILCO (the "Payments"): (i) the named defendants breached
their fiduciary duty owed to LILCO and KSE former and/or current Company
shareholders as a result of the Payments; (ii) the named defendants intended to
defraud such shareholders by means of manipulative, deceptive and wrongful
conduct, including materially inaccurate and incomplete news reports and filings
with the SEC; and (iii) the named defendants recklessly and/or negligently
failed to disclose material facts associated with the Payments.
29
In addition, three shareholder derivative actions have been commenced
pursuant to which such shareholders seek the return of the Payments or damages
resulting from among other things, an alleged breach of fiduciary duty on the
part of the former LILCO officers and directors. One action was brought on
behalf of LILCO in federal court. The Company moved to dismiss this action in
September 1998. The other two actions were brought on behalf of the Company in
New York State Supreme Court, Nassau County. In one of these state court
actions, the Company's directors and the recipients of the Payments are also
named as defendants.
Finally, two class action securities suits were filed in federal
court alleging that certain officers and directors of LILCO violated the federal
securities laws by failing to properly disclose that the Combination would
trigger the Payments. These actions were consolidated in October 1998.
On March 17, 1999, the Company signed a Memorandum of Understanding
to settle the above-referenced actions, except the federal court derivative
action, in exchange for (i) $7.9 million to be distributed (less plaintiffs'
attorneys fees) to former LILCO and KSE shareholders and (ii) the Company's
agreement to implement certain corporate governance and executive compensation
procedures. The entire $7.9 million settlement commitment will be funded from
insurance. The parties intend to submit the settlement to the Nassau County
Supreme Court for its review and approval. If that Court approves the
settlement, the parties will then make an application to the federal court for
an order and final judgment, dismissing the three federal court actions,
including the federal court derivative action, based, among other things, on the
binding effect of the state court judgment.
In addition to the above-mentioned actions, a class action lawsuit