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EX-23 - EXHIBIT 23 - SOUTH JERSEY GAS Coex23.htm
EX-3.B - EXHIBIT 3(B) - SOUTH JERSEY GAS Coex3b.htm
EX-21 - EXHIBIT 21 - SOUTH JERSEY GAS Coex21.htm
EX-12 - EXHIBIT 12 - SOUTH JERSEY GAS Coex12.htm
EX-32.1 - EXHIBIT 32.1 - SOUTH JERSEY GAS Coex32_1.htm
EX-31.1 - EXHIBIT 31.1 - SOUTH JERSEY GAS Coex31_1.htm
EX-31.2 - EXHIBIT 31.2 - SOUTH JERSEY GAS Coex31_2.htm
EX-32.2 - EXHIBIT 32.2 - SOUTH JERSEY GAS Coex32_2.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

FORM 10-K

x
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2010

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________to ______________.

Commission File Number: 000-22211

SOUTH JERSEY GAS COMPANY
(Exact name of registrant as specified in its charter)

New Jersey
21-0398330
(State of incorporation)
(IRS employer identification no.)

1 South Jersey Plaza, Folsom, New Jersey 08037
(Address of principal executive offices, including zip code)

(609) 561-9000
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act:     Yes o      No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Act:     Yes o      No x

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 o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).       o Yes      o    No
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer    o
 
Accelerated filer     o
Non-accelerated filer      x (Do not check if a smaller reporting company)
 
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).      Yes o           No x

All of the equity securities of the registrant are owned by South Jersey Industries, Inc., its parent company, a 1934 Act reporting company named in the registrants description of its business, which has itself fulfilled its 1934 Act filing requirements.
 
The registrant meets all of the conditions set forth in General Instruction I 1(a) and (b) of Form 10-K and is therefore filing this form with the reduced disclosure format.

Documents Incorporated by Reference:   None
 


 
 

 
 
TABLE OF CONTENTS

 
Page No.
   
3
     
 
PART I
 
     
Item 1.
3
Item 1A.
7
Item 1B.
8
Item 2.
8
Item 3.
9
Item 4.
9
     
 
PART II
 
     
Item 5.
9
Item 6.
10
Item 7.
11
Item 7A.
24
Item 8.
25
Item 9.
57
Item 9A.
58
Item 9B.
58
     
 
PART III
 
     
Item 10.
58
Item 11.
58
Item 12.
58
Item 13.
58
Item 14.
59
     
 
PART IV
 
     
Item 15.
59
     
63
65
 

Forward Looking Statements

Certain statements contained in this Annual Report on form 10-K may qualify as “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical fact included in this Report should be considered forward-looking statements made in good faith by the Company and are intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. When used in this Report, or any other of the Company’s documents or oral presentations, words such as “anticipate,” “believe,” “expect,” “estimate,” “forecast,” “goal,” “intend,” “objective,” “plan,” “project,” “seek,” “strategy” and similar expressions are intended to identify forward-looking statements. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the statements. These risks and uncertainties include, but are not limited to the risks set forth under “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K and elsewhere throughout this Report. These cautionary statements should not be construed by you to be exhaustive and they are made only as of the date of this Report. While South Jersey Gas Company, Inc. (SJG or the Company) believes these forward-looking statements to be reasonable, there can be no assurance that they will approximate actual experience or that the expectations derived from them will be realized. Further, SJG undertakes no obligation to update or revise any of its forward-looking statements whether as a result of new information, future events or otherwise.

Available Information - Information regarding SJG can be found at the South Jersey Industries, Inc. (SJI) internet address, www.sjindustries.com. We make available free of charge on or through our website SJG’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (SEC). The SEC maintains an Internet site that contains these reports at http://www.sec.gov. The content on any web site referred to in this filing is not incorporated by reference into this filing unless expressly noted otherwise.

PART I
Item 1. Business

Units of Measurement
 
For Natural Gas:
1 dt
= One decatherm
1 MMdt
= One million decatherms
Dts/d
= Decatherms per day
MDWQ
= Maximum daily withdrawal quantity

Description of Business

South Jersey Gas Company (SJG) is a regulated natural gas utility. SJG distributes natural gas in the seven southernmost counties of New Jersey.

Additional information on the nature of our business is incorporated by reference to “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Market Risk” and Note 3, “Rates and Regulatory Actions”.
 
Financial Information About Reportable Segments

Not applicable.
 
Rates and Regulation

Information on our rates and regulatory affairs is incorporated by reference to “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Note 3, “Rates and Regulatory Actions”.


Sources and Availability of Raw Materials

Transportation and Storage Agreements
 
SJG has direct connections to the interstate pipeline systems of both Transcontinental Gas Pipe Line Company, LLC (Transco) and Columbia Gas Transmission, LLC (Columbia). During 2010, SJG purchased and had delivered approximately 35.4 million decatherms (MMdts) of natural gas for distribution to both on-system and off-system customers. Of this total, 24.2 MMdts were transported on the Transco pipeline system while 11.2 MMdts were transported on the Columbia pipeline system. SJG also secures firm transportation and other long term services from one additional pipeline upstream of the Transco and Columbia systems. This upstream pipeline is owned by Dominion Transmission, Inc. (Dominion). Services provided by Dominion are utilized to deliver gas into either the Transco or Columbia systems for ultimate delivery to SJG. Services provided by all of the above-mentioned pipelines are subject to the jurisdiction of the Federal Energy Regulatory Commission (FERC).  Unless otherwise indicated, our intentions are to renew or extend these service agreements before they expire.

Transco:

Transco is SJG’s largest supplier of long-term gas transmission services which includes both year-round and seasonal firm transportation (FT) service arrangements. When combined, these FT services enable SJG to purchase gas from third parties and have delivered to its city gate stations by Transco a total of 280,525 dts per day (dts/d). Of this total, 133,917 dts/d is long-haul FT (where gas can be transported from the production areas of the Southwest to the market areas of the Northeast) while 146,608 dts/d is market area FT. The terms of SJG’s year-round agreements extend for various periods through 2025. The terms of its seasonal agreements vary in length with the longest extending into 2012.

Of the 280,525 dts/d of Transco services mentioned above, SJG has released a total of 39,800 dts/d of its long-haul FT and 25,565 dts/d of its market area FT service. These releases were made in association with SJG’s Conservation Incentive Program (CIP) discussed further under Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.  In addition, SJG released 90,000 dts/d of its market area FT service to South Jersey Resources Group (SJRG) as part of an Asset Management Agreement discussed further in this section under “Gas Supplies.”

SJG currently has seven long-term gas storage service agreements with Transco that, when combined, are capable of storing approximately 6.3 MMdts. Through these agreements, SJG can inject gas into market and production area storages during periods of low demand and extract gas at a Maximum Daily Withdrawal Quantity (MDWQ) of up to 124,840 dts during periods of high demand. The terms of these storage service agreements extend for various periods from 2010 to 2013.  During 2010 SJG released 17,433 dts/d of Transco SS-1 storage demand and 1,307,475 dts of its SS-1 storage capacity (both represent 100 percent of this service) thereby reducing its Transco MDWQ to 107,407 dts/d, and its storage capacity to approximately 5.0 MMdts.  Also released was 17,433 dts/d of winter season firm transportation service associated with SS-1 storage service.

Dominion:

SJG had previously subscribed to a single firm transportation service from Dominion under Rate Schedule FTNN.  This service facilitated the transportation of up to 5,545 dts/d from various Appalachian aggregation points to Transco’s Leidy Line for ultimate delivery to SJG city gate stations during the winter season (November through March) each year.  During 2010, this agreement and service were allowed to expire by their terms.

SJG also subscribes to a firm storage service from Dominion, under its Rate Schedule GSS.  This storage has a MDWQ of 10,000 dts during the period between November 16 and March 31 of each winter season, with an associated total storage capacity of 423,000 dts.  Gas withdrawn from Dominion GSS storage is delivered through both the Dominion and Transco (Leidy Line) pipeline systems for delivery to SJG service territory.  The primary term of this agreement extends through March 31, 2015.

 
Columbia:

SJG has two firm transportation agreements with Columbia which, when combined, provide for 45,022 dts/d of firm deliverability and extend through October 31, 2019.   SJG had previously released 14,714 dts/d of this amount to SJRG in conjunction with its CIP thereby reducing the combined availability of firm transportation on the Columbia system to 30,308 dts/d.

SJG also subscribes to a firm storage service (FSS) with Columbia under its Rate Schedule FSS along with a firm transportation service under Rate Schedule SST.  Prior to 2010, these services were each rendered under three separate agreements.  In order to reduce both administrative and scheduling burdens associated with multiple contracts, SJG and Columbia agreed to merge the three agreements for each rate schedule into one agreement for each service effective May 1, 2010 and extended both agreements through October 31, 2019.  This was accomplished while preserving the Company’s total FSS MDWQ of 52,891 dts and related 3,473,022 dts of storage capacity.  Moreover, during 2010, SJG released to SJRG 19,029 dts per day of its FSS MDWQ along with 1,249,485 dts of its FSS storage capacity.  Additionally, SJG also released to SJRG 19,029 dts per day of its associated Columbia SST transportation service.  Both releases made by SJG were in connection with its CIP and extend through September 30, 2014.

Gas Supplies

SJG has an Asset Management Agreement (AMA) with SJRG that extends through November 30, 2013.  Under this agreement SJG has released to SJRG its firm transportation rights equal to 90,000 dth/d of transportation capacity on Transco.  SJRG will manage this capacity and provide SJG with up to 90,000 dth/d of firm deliverability in the summer season and up to 90,000 dth/d of interruptible deliverability in the winter season.  SJRG will seek to optimize the capacity released under this AMA and will pay SJG a fee based on a sharing formula in the agreement.  Due to increased liquidity in the market place, all other gas supply agreements with third party producer suppliers are short-term agreements and SJG uses financial contracts secured through SJRG to hedge against forward price risk.  Short-term agreements typically extend between one day and several months in duration.

Supplemental Gas Supplies

During 2010, SJG entered into two seasonal Liquefied Natural Gas (LNG) sales agreements with a separate third party supplier. The term of the first agreement, which was used during the 2010 summer season to refill SJG’s storage tank, extended through October 31, 2010, and had an associated contract quantity of 250,000 dts. The second agreement was acquired to replenish LNG in storage during the 2010-2011 winter season.  This agreement extends through March 31, 2011 and also provides SJG with up to 250,000 dts of LNG.

SJG operates peaking facilities which can store and vaporize LNG for injection into its distribution system. SJG’s LNG facility has a storage capacity equivalent to 434,300 dts of natural gas and has an installed capacity to vaporize up to 96,750 dts of LNG per day for injection into its distribution system.

Peak-Day Supply

SJG plans for a winter season peak-day demand on the basis of an average daily temperature of 2 degrees Fahrenheit (F). Gas demand on such a design day for the 2010-2011 winter season is estimated to be 466,995 dts. SJG projects that it has adequate supplies and interstate pipeline entitlements to meet its design requirements. SJG experienced its highest peak-day demand for calendar year 2010 of 401,761 dts on January 30th while experiencing an average temperature of 16.5 degrees F that day.

Natural Gas Prices

SJG’s average cost of natural gas purchased and delivered in 2010, 2009 and 2008, including demand charges, was $6.64 per dt, $8.38 per dt and $9.90 per dt, respectively.

Patents and Franchises
 
SJG holds nonexclusive franchises granted by municipalities in the seven-county area of southern New Jersey that it serves. No other natural gas public utility presently serves the territory covered by SJG’s franchises. Otherwise, patents, trademarks, licenses, franchises and concessions are not material to the business of SJG.


Seasonal Aspects

SJG experiences seasonal fluctuations in sales when selling natural gas for heating purposes. SJG meets this seasonal fluctuation in demand from its firm customers by buying and storing gas during the summer months, and by drawing from storage and purchasing supplemental supplies during the heating season. As a result of this seasonality, SJG’s revenues and net income are significantly higher during the first and fourth quarters than during the second and third quarters of the year.

Working Capital Practices

Reference is made to “Liquidity and Capital Resources” included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, of this report.

Customers

No material part of SJG’s business is dependent upon a single customer or a few customers, the loss of which would have a material adverse effect on SJG’s business. See Item 1, “Description of Business.”

Backlog

Backlog is not material to an understanding of SJG’s business.

Government Contracts

No material portion of SJG’s business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of any government.

Competition

Information on competition is incorporated by reference to “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, of this report.

Research

During the last three fiscal years, SJG did not engage in research activities to any material extent.

Environmental Matters

Information on environmental matters can be found in Note 12 of the financial statements included under Item 8 of this report.

Employees

SJG had a total of 407 employees as of December 31, 2010. Of that total, 264 employees are unionized. There are 37 unionized employees represented by the International Brotherhood of Electrical Workers (IBEW) that operate under a collective bargaining agreement that runs through February 2013, with the option to extend until February 2014 at the union's election. The remaining unionized employees are represented by the International Association of Machinists and Aerospace Workers (IAM).    Employees represented by the IAM operate under a new collective bargaining agreement that expires in August 2014.



Financial Information About Foreign and Domestic Operations and Export Sales

SJG has no foreign operations and export sales are not a part of its business.

Item 1A. Risk Factors
 
SJG operates in an environment that involves risks, many of which are beyond our control. The Company has identified the following risk factors that could cause the Company’s operating results and financial condition to be materially adversely affected. Security Holders should carefully consider these risk factors and should also be aware that this list is not all-inclusive of existing risks. In addition, new risks may emerge at any time, and the Company cannot predict those risks or the extent to which they may affect the Company’s businesses or financial performance.

 
SJG’s business activities are concentrated in southern New Jersey. Changes in the economies of southern New Jersey and surrounding regions could negatively impact the growth opportunities available to SJG and the financial condition of customers and prospects of SJG.
 
Changes in the regulatory environment or unfavorable rate regulation may have an unfavorable impact on SJG’s financial performance or condition.  SJG’s business is regulated by the New Jersey Board of Public Utilities which has authority over many of the activities of the business including, but not limited to, the rates it charges to its customers, the amount and type of securities it can issue, the nature of investments it can make, the nature and quality of services it provides, safety standards and other matters. The extent to which the actions of regulatory commissions restrict or delay SJG’s ability to earn a reasonable rate of return on invested capital and/or fully recover operating costs may adversely affect its results of operations, financial condition and cash flows.
 
SJG may not be able to respond effectively to competition, which may negatively impact SJG’s financial performance or condition. Regulatory initiatives may provide or enhance opportunities for competitors that could reduce utility income obtained from existing or prospective customers. Also, competitors may be able to provide superior or less costly products or services based upon currently available or newly developed technologies.
 
Warm weather, high commodity costs, or customer conservation initiatives could result in reduced demand for natural gas. While SJG currently has a conservation incentive program clause that protects its revenues and gross margin against usage that is lower than a set level, the clause is currently approved as a pilot program through 2013. Should this clause expire without replacement, lower customer energy utilization levels would likely reduce SJG’s net income.
 
High natural gas prices could cause more of SJG’s receivables to be uncollectible. Higher levels of uncollectibles from utility customers would negatively impact SJG’s income and could result in higher working capital requirements.
 
SJG’s net income could decrease if it is required to incur additional costs to comply with new governmental safety, health or environmental legislation. SJG is subject to extensive and changing federal and state laws and regulations that impact many aspects of its business; including the storage, transportation and distribution of natural gas, as well as the remediation of environmental contamination at former manufactured gas plant facilities.
 
Increasing interest rates would negatively impact the net income of SJG. SJG is capital intensive, resulting in the incurrence of significant amounts of debt financing. SJG has issued all long-term debt either at fixed rates or has utilized interest rate swaps to mitigate changes in floating rates. However, new issues of long-term debt and all variable rate short-term debt are exposed to the impact of rising interest rates. 
 
The inability to obtain capital, particularly short-term capital from commercial banks, could negatively impact the daily operations and financial performance of SJG. SJG uses short-term borrowings under committed and uncommitted credit facilities provided by commercial banks to supplement cash provided by operations, to support working capital needs, and to finance capital expenditures, as incurred. If the customary sources of short-term capital were no longer available due to market conditions, SJG may not be able to meet its working capital and capital expenditure requirements and borrowing costs could increase.

 
 
A downgrade in SJG’s credit rating could negatively affect its ability to access adequate and cost effective capital. SJG’s ability to obtain adequate and cost effective capital depends largely on its credit ratings, which are greatly influenced by financial condition and results of operations. If the rating agencies downgrade SJG’s credit ratings, particularly below investment grade, SJG’s borrowing costs would increase. In addition, SJG would likely be required to pay higher interest rates in future financings and potential funding sources would likely decrease. 
 
The inability to obtain natural gas would negatively impact the financial performance of SJG.  SJG’s business is based upon the ability to deliver natural gas to customers. Disruption in the production of natural gas or transportation of that gas to SJG from its suppliers could prevent SJG from completing sales to its customers.
 
Transporting and storing natural gas involves numerous risks that may result in accidents and other operating risks and costs. SJG’s gas distribution activities involve a variety of inherent hazards and operating risks, such as leaks, accidents and mechanical problems, which could cause substantial financial losses. In addition, these risks could result in loss of human life, significant damage to property, environmental pollution and impairment of operations, which in turn could lead to substantial losses. In accordance with customary industry practice, SJG maintains insurance against some, but not all, of these risks and losses. The occurrence of any of these events not fully covered by insurance could adversely affect SJG’s financial position, results of operations and cash flow.
 
Adverse results in legal proceedings could be detrimental to the financial condition of SJG. The outcomes of legal proceedings can be unpredictable and can result in adverse judgments.
 
Proposed climate change legislation could impact SJG’s financial performance and condition.  Climate change is receiving ever increasing attention from scientists and legislators alike.  The debate is ongoing as to the extent to which our climate is changing, the potential causes of this change and its potential impacts.  Some attribute global warming to increased levels of greenhouse gases, which has led to significant legislative and regulatory efforts to limit greenhouse gas emissions.  The outcome of proposed federal and state actions to address global climate change could result in a variety of regulatory programs including additional charges to fund energy efficiency activities or other regulatory actions.  These actions could affect the demand for natural gas and electricity, result in increased costs to our business and impact the prices we charge our customers.  Because natural gas is a fossil fuel with low carbon content, it is possible that future carbon constraints could create additional demands for natural gas, both for production of electricity and direct use in homes and businesses.  Any adoption by federal or state governments mandating a substantial reduction in greenhouse gas emissions could have far-reaching and significant impacts on the energy industry.  We cannot predict the potential impact of such laws or regulations on our future financial condition, results of operations or cash flows.

Item 1B. Unresolved Staff Comments

None.
Item 2. Properties

The principal property of SJG consists of its gas transmission and distribution systems that include mains, service connections and meters. The transmission facilities carry the gas from the connections with Transco and Columbia to SJG’s distribution systems for delivery to customers. As of December 31, 2010, there were approximately 121.9 miles of mains in the transmission systems and 5,939 miles of mains in the distribution systems.

 
SJG owns 154 acres of land in Folsom, New Jersey, which is the site of its corporate headquarters. Approximately 140 acres of this property is deed restricted.  SJG also has office and service buildings at six other locations in the territory. There is a liquefied natural gas storage and vaporization facility at one of these locations.

As of December 31, 2010, SJG’s utility plant had a gross book value of $1.4 billion and a net book value, after accumulated depreciation, of $1.0 billion.  In 2010, $115.5 million was spent on additions to utility plant and there were retirements of property having an aggregate gross book cost of $6.4 million.
 
Virtually all of SJG’s transmission pipeline, distribution mains and service connections are under streets or highways or on the property of others. The transmission and distribution systems are maintained under franchises or permits or rights-of-way, many of which are perpetual. SJG’s properties (other than property specifically excluded) are subject to a lien of mortgage under which its first mortgage bonds are outstanding. We believe these properties are well maintained and in good operating condition.

Item 3. Legal Proceedings

SJG is subject to claims which arise in the ordinary course of business and other legal proceedings. We accrue liabilities related to these claims when we can reasonably estimate the amount or range of amounts of probable settlement costs or other charges for these claims.  Management does not currently anticipate the disposition of any known claims to have a material adverse affect on SJG’s financial position, results of operations or liquidity.
 
Item 4. (Removed and Reserved)

PART II

Item 5. Market for the Registrant’s Common Equity
Related Stockholder Matters, and Issuer Purchases of Equity Securities
 
Common equity securities of SJG, owned by its parent company, South Jersey Industries, Inc., are not traded on any stock exchange. SJG no longer has any preferred stock outstanding.
 
SJG is restricted under its First Mortgage Indenture, as supplemented, as to the amount of cash dividends or other distributions that may be paid on its common stock. As of December 31, 2010, these restrictions did not affect the amount that may be distributed from SJG’s retained earnings. Dividends of $45.9 million were declared and paid on SJG’s common stock in 2010 and $10.0 million were declared and paid in 2009.

 
Item 6. Selected Financial Data

The following financial data has been obtained from SJG’s audited financial statements (In thousands, except for Ratio Data and Customers):
 
 
Year Ended December 31,
 
   
2010
   
2009
   
2008
   
2007
   
2006
 
                               
Operating Revenues
 
$
475,982
   
$
484,376
   
$
568,046
   
$
630,547
   
$
642,671
 
                                         
Operating Income
 
$
90,701
   
$
81,439
   
$
84,417
   
$
83,989
   
$
81,209
 
                                         
Net Income Applicable to Common Stock
 
$
43,925
   
$
39,195
   
$
39,431
   
$
38,025
   
$
35,779
 
                                         
Average Shares of Common Stock Outstanding
   
2,339
     
2,339
     
2,339
     
2,339
     
2,339
 
                                         
Ratio of Earnings to Fixed Charges (1)
   
5.1
   
4.9
x
   
4.4
x
   
4.1
x
   
3.7
x

 
As of December 31,
   
2010
   
2009
   
2008
   
2007
   
2006
 
                                         
Property, Plant and Equipment, Net
 
$
1,046,804
   
$
961,165
   
$
876,582
   
$
847,691
   
$
821,833
 
                                         
Total Assets
 
$
1,468,635
   
$
1,357,062
   
$
1,354,015
   
$
1,227,162
   
$
1,228,076
 
                                         
Capitalization:
                                       
Common Equity
 
$
426,885
   
$
431,530
   
$
401,739
   
$
378,348
   
$
360,353
 
Long-Term Debt
   
340,000
     
250,000
     
269,873
     
294,873
     
294,893
 
Total Capitalization
 
$
766,885
   
$
681,530
   
$
671,612
   
$
673,221
   
$
655,246
 
Total Customers
   
347,725
     
343,566
     
340,136
     
335,663
     
330,049
 

(1) The ratio of earnings to fixed charges represents, on a pre-tax basis, the number of times earnings cover fixed charges. Earnings consist of net income, to which has been added fixed charges and taxes based on income of the company. Fixed charges consist of interest charges.

 
Item 7. Management’s Discussion and Analysis of Financial Condition
and Results of Operations

OVERVIEW:

Organization - We are an operating public utility company engaged in the purchase, transmission and sale of natural gas for residential, commercial and industrial use. We also sell natural gas and pipeline transportation capacity (off-system sales) on a wholesale basis to various customers on the interstate pipeline system and transport natural gas purchased directly from producers or suppliers to their customers.

Our service territory covers approximately 2,500 square miles in the southern part of New Jersey. It includes 112 municipalities throughout Atlantic, Cape May, Cumberland and Salem Counties and portions of Burlington, Camden and Gloucester Counties, with an estimated permanent population of 1.2 million. We benefit from our proximity to Philadelphia, PA and Wilmington, DE on the western side of our service territory and Atlantic City, NJ and the popular shore communities on the eastern side. Economic development and housing growth have been long driven by the development of the Philadelphia metropolitan area.   The gradual extension of our infrastructure, particularly in the eastern portion of our service territory, has contributed to our annual customer growth.  In the past, economic growth in Atlantic City and the surrounding region has been primarily driven by new and proposed gaming and non-gaming investments that emphasize destination style attractions. While many of these new projects were suspended or postponed due to the current economic environment, the casino industry is expected to remain a significant source of regional economic development going forward.  Over the years, the ripple effect from Atlantic City has produced new housing and commercial construction.  Combining with the gaming industry catalyst is the ongoing transition of southern New Jersey’s oceanfront communities from seasonal resorts to year round economies.  New and expanded hospitals, schools and large scale retail developments throughout the service territory have contributed to our growth. Presently, we serve approximately 66% of households within our territory with natural gas.   We also serve southern New Jersey’s diversified industrial base that includes processors of petroleum and agricultural products; chemical, glass and consumer goods manufacturers; and high technology parks.

As of December 31, 2010, we served 347,725 residential, commercial and industrial customers in southern New Jersey, compared with 343,566 customers at December 31, 2009.  No material part of our business is dependent upon a single customer or a few customers. Gas sales, transportation and capacity release for 2010 amounted to 110.8 MMdts (million dekatherms), of which 56.6 MMdts were firm sales and transportation, 1.9 MMdts were interruptible sales and transportation and 52.3 MMdts were off-system sales and capacity release. The breakdown of firm sales and transportation includes 44.3% residential, 21.1% commercial, 22.8% industrial, and 11.8% cogeneration and electric generation. At year-end 2010, we served 324,246 residential customers, 23,010 commercial customers and 469 industrial customers.  This includes 2010 net additions of 3,956 residential customers and 208 commercial customers.

We make wholesale gas sales to gas marketers for resale and ultimate delivery to end users. These “off-system” sales are made possible through the issuance of the Federal Energy Regulatory Commission (FERC) Orders No. 547 and 636. Order No. 547 issued a blanket certificate of public convenience and necessity authorizing all parties, which are not interstate pipelines, to make FERC jurisdictional gas sales for resale at negotiated rates, while Order No. 636 allowed us to deliver gas at delivery points on the interstate pipeline system other than our own city gate stations and release excess pipeline capacity to third parties. During 2010, off-system sales amounted to 6.0 MMdts and capacity release amounted to 46.3 MMdts.

Supplies of natural gas available to us that are in excess of the quantity required by those customers who use gas as their sole source of fuel (firm customers) make possible the sale and transportation of gas on an interruptible basis to commercial and industrial customers whose equipment is capable of using natural gas or other fuels, such as fuel oil and propane. The term “interruptible” is used in the sense that deliveries of natural gas may be terminated by us at any time if this action is necessary to meet the needs of higher priority customers as described in our tariffs. In 2010 usage by interruptible customers, excluding off-system customers, amounted to 1.9 MMdts, approximately 1.7% of the total throughput.

Our primary goals are to: 1) provide safe, reliable natural gas service at the lowest cost possible; 2) promote natural gas as the fuel of choice for residential, commercial and industrial customers; and 3) aid our customers in becoming more energy efficient.

 
The following is a summary of the primary factors we expect to have the greatest impact on our performance and our ability to achieve our goals going forward:

Business Model - We are the primary focus of our parent, SJI, and will continue to account for the majority of SJI’s net income by maximizing the growth potential of our service territory.

Customer Growth —    Southern New Jersey, our primary area of operations, has not been immune to the issues impacting the new housing market nationally.  However, net customers for SJG still grew 1.2% as we increased our focus on customer conversions.  In 2010, the 3,271 consumers converting their homes and businesses from other heating fuels, such as electric, propane or oil represented over 54% of the total new customer acquisitions for the year.  In comparison, conversions over the past five years averaged 2,697 annually.  Customers in our service territory typically base their decisions to convert on comparisons of fuel costs, environmental considerations and efficiencies.  As such, SJG began a comprehensive partnership with the State’s Office of Clean Energy to educate consumers on energy efficiency and to promote the rebates and incentives available to natural gas users.

Regulatory Environment - We are primarily regulated by the New Jersey Board of Public Utilities (BPU). The BPU sets the rates that we charge our rate-regulated customers for services provided and establishes the terms of service under which we operate. We expect the BPU to continue to set rates and establish terms of service that will enable us to obtain a fair and reasonable return on capital invested. The BPU approved a Conservation Incentive Program (CIP) effective October 1, 2006, discussed in greater detail under “Results of Operations,” that protects our net income from reductions in gas used by our residential, commercial, and small industrial customers.  In addition, in April 2009, the BPU approved the Capital Investment Recovery Tracker (CIRT), an accelerated infrastructure investment program and an associated rate tracker, which allows SJG to accelerate $103.0 million of capital spending into 2009 and 2010.  The CIRT allows SJG to earn a return of, and return on, investment as the capital is spent.

Weather Conditions and Customer Usage Patterns - Usage patterns can be affected by a number of factors, such as wind, precipitation, temperature extremes and customer conservation. Our earnings are largely protected from fluctuations in temperatures by the CIP. The CIP has a stabilizing effect on earnings as we adjust revenues when actual usage per customer experienced during an annual period varies from an established baseline usage per customer.

Changes in Natural Gas Prices -   Gas costs are passed on directly to customers without any profit margin added. For the vast majority of our customers, the price for natural gas is set annually, with a regulatory mechanism in place to make limited adjustments to that price during the course of a year. In the event that gas cost increases would justify customer price increases greater than those permitted under the regulatory mechanism, we can petition the BPU for an incremental rate increase. High prices can make it more difficult for our customers to pay their bills and may result in elevated levels of bad-debt expense.

Changes in Interest Rates - We have operated in a relatively low interest rate environment over the past several years. Rising interest rates would raise the expense associated with all issuances of new debt. We have sought to mitigate the impact of a potential rising rate environment by directly issuing fixed-rate debt, or by entering into derivative transactions to hedge against rising interest rates.

Labor and Benefit Costs - Labor and benefit costs have a significant impact on our profitability. Benefit costs, especially those related to pension and health care, have risen in recent years. We sought to manage these costs by revising health care plans offered to existing employees, capping postretirement health care benefits, and changing health care and pension packages offered to new hires.  We expect savings from these changes to gradually increase as new hires replace retiring employees. In an effort to accelerate the realization of those benefits, we had offered a voluntary separation program at the beginning of 2010 to our unionized employees. Our workforce totaled 407 employees at the end of 2010, with 65% of that total covered under collective bargaining agreements.

Balance Sheet Strength - Our goal is to maintain a strong balance sheet with an average annual equity-to-capitalization ratio of 46% to 50%. Our equity-to-capitalization ratio, inclusive of short-term debt, was 48.8% and 52.2% at the end of 2010 and 2009, respectively. A strong balance sheet permits us the financial flexibility necessary to address volatile economic and commodity markets while maintaining a low-risk platform.


Critical Accounting Policies - Estimates and Assumptions - As described in the notes to our financial statements, management must make estimates and assumptions that affect the amounts reported in the financial statements and related disclosures. Actual results could differ from those estimates. Five types of transactions presented in our financial statements require a significant amount of judgment and estimation. These relate to regulatory accounting, derivatives, environmental remediation costs, pension and other postretirement benefit costs, and revenue recognition.

Regulatory Accounting- We maintain our accounts according to the Uniform System of Accounts as prescribed by the New Jersey Board of Public Utilities (BPU). As a result of the ratemaking process, we are required to follow Financial Accounting Standards Board (FASB) ASC Topic 980 – “Regulated Operations.”  We are required under Topic 980 to recognize the impact of regulatory decisions on our financial statements. We are required under our Basic Gas Supply Service (BGSS) clause to forecast our natural gas costs and customer consumption in setting our rates. Subject to BPU approval, we are able to recover or return the difference between gas cost recoveries and the actual costs of gas through a BGSS charge to customers. We record any over/under recoveries as a regulatory asset or liability on the balance sheets and reflect it in the BGSS charge to customers in subsequent years. We also enter into derivatives that are used to hedge natural gas purchases. The offset of the resulting derivative assets or liabilities is also recorded as a regulatory asset or liability on the balance sheets.

The Conservation Incentive Program (CIP) is a BPU approved pilot program that is designed to eliminate the link between our profits and the quantity of natural gas we sell, and foster conservation efforts.  With the CIP, our profits are tied to the number of customers we serve and how efficiently we serve them, thus allowing us to focus on encouraging conservation and energy efficiency among our customers without negatively impacting our net income.  The CIP tracking mechanism adjusts earnings based on weather and also adjusts our earnings where actual usage per customer experienced during an annual period varies from an established baseline usage per customer.  Utility earnings are recognized during current periods based upon the application of the CIP.  The cash impact of variations in customer usage will result in cash being collected from, or returned to, customers during the subsequent CIP year, which runs from October 1 to September 30.

In addition to the BGSS and the CIP, other regulatory assets consist primarily of remediation costs associated with manufactured gas plant sites (discussed below under “Environmental Remediation Costs,” deferred pension and other postretirement benefit cost, and several other assets as detailed in Note 4 to the financial statements. If there are changes in future regulatory positions that indicate the recovery of such regulatory assets is not probable, we would charge the related cost to earnings. Currently, there are no such anticipated changes at the BPU.

Derivatives - We recognize assets or liabilities for contracts that qualify as derivatives when contracts are executed. We record contracts at their fair value in accordance with FASB ASC Topic 815 – “Derivatives and Hedging.” We record changes in the fair value of the effective portion of derivatives qualifying as cash flow hedges, net of tax, in Accumulated Other Comprehensive Loss and recognize such changes in the income statement when the hedged item affects earnings. Changes in the fair value of derivatives not designated as hedges are recorded in earnings in the current period. Currently, we do not designate energy-related derivative instruments as cash flow hedges. Certain derivatives that result in the physical delivery of the commodity may meet the criteria to be accounted for as normal purchases and normal sales, if so designated, in which case the contract is not marked-to-market, but rather is accounted for when the commodity is delivered. Due to the application of regulatory accounting principles under GAAP, derivatives related to gas purchases that are marked-to-market are recorded through our BGSS.  We periodically enter into financial derivatives to hedge against forward price risk. These derivatives are recorded at fair value with an offset to regulatory assets and liabilities through our BGSS, subject to BPU approval (See Notes 3 and 4 to the financial statements). We adjust the fair value of the contracts each reporting period for changes in the market.

 
As discussed in Notes 13 and 14 of the financial statements, energy-related derivative instruments are traded in both exchange-based and non-exchange-based markets. Exchange-based contracts are valued using unadjusted quoted market sources in active markets and are categorized in Level 1 in the fair value hierarchy established by FASB ASC Topic 820 – “Fair Value Measurements and Disclosures.” Certain non-exchange-based contracts are valued using indicative non-binding price quotations available through brokers or from over-the-counter, on-line exchanges and are categorized in Level 2. These price quotations reflect the average of the bid-ask mid-point prices and are obtained from sources that management believes provide the most liquid market. Management reviews and corroborates the price quotations with at least one additional source to ensure the prices are observable market information, which includes consideration of actual transaction volumes, market delivery points, bid-ask spreads and contract duration. Derivative instruments that are used to limit our exposure to changes in interest rates on variable-rate, long-term debt are valued using quoted prices on commonly quoted intervals, which are interpolated for periods different than the quoted intervals, as inputs to a market valuation model. Market inputs can generally be verified and model selection does not involve significant management judgment, as a result, these instruments are categorized in Level 2 in the fair value hierarchy.  For non-exchange-based derivatives that trade in less liquid markets with limited pricing information, model inputs generally would include both observable and unobservable inputs.  In instances where observable data is unavailable, management considers the assumptions that market participants would use in valuing the asset or liability.  This includes assumptions about market risks such as liquidity, volatility and contract duration.  Such instruments are categorized in Level 3 in the fair value hierarchy as the model inputs generally are not observable.  Counterparty credit risk, and the credit risk of SJG, is incorporated and considered in the valuation of all derivative instruments as appropriate. The effect of counterparty credit risk and the credit risk of SJG on the derivative valuations is not significant.

Environmental Remediation Costs - We estimate future costs based on projected investigation and work plans using existing technologies.  In preparing financial statements, we record liabilities for future costs using the lower end of the range because a single reliable estimation point is not feasible due to the amount of uncertainty involved in the nature of projected remediation efforts and the long period over which remediation efforts will continue. We update estimates each year to take into account past efforts, changes in work plans, remediation technologies, government regulations and site specific requirements (See Note 12 to the financial statements).

Pension and Other Postretirement Benefit Costs - The costs of providing pension and other postretirement employee benefits are impacted by actual plan experience as well as assumptions of future experience. Employee demographics, plan contributions, investment performance, and assumptions concerning mortality, return on plan assets, discount rates and health care cost trends all have a significant impact on determining our projected benefit obligations. We evaluate these assumptions annually and adjust them accordingly. These adjustments could result in significant changes to the net periodic benefit costs of providing such benefits and the related liabilities recognized by us.    While the discount rate and expected return on plan assets both decreased slightly in the determination of the 2009 benefit costs, the primary cost driver in 2009 was the erosion of plan assets during 2008.   The declines in the equity markets during 2008 resulted in significant unrealized losses in the assets of the plans, causing the 2009 cost of providing such benefits to more than double.

The recognition of the unrealized losses originating in 2008 over the average remaining service period of active plan participants continued to cause the cost of providing such plans to remain relatively high in 2010.  However, additional pension contributions during both 2009 and 2010 and improvements in equity markets further reduced the cost of providing such benefits in 2010, despite a 50 basis point decrease in the expected return on plan assets.

Revenue Recognition - Gas revenues are recognized in the period the commodity is delivered to customers. We bill customers monthly at rates approved by the BPU. A majority of our customers have their meters read on a cycle basis throughout the month. As a result, recognized revenues include estimates. For customers that are not billed at the end of each month, we record an estimate to recognize unbilled revenues for gas delivered from the date of the last meter reading to the end of the month. Our unbilled revenue is estimated each month based on natural gas delivered monthly into the system; unaccounted for natural gas based on historical results; customer-specific use factors, when available; actual temperatures during the period; and applicable customer rates.

 
The BPU allows us to recover gas costs in rates through the Basic Gas Supply Service (BGSS) price structure. We defer over/under recoveries of gas costs and include them in subsequent adjustments to the BGSS rate. These adjustments result in over/under recoveries of gas costs being included in rates during future periods. As a result of these deferrals, utility revenue recognition does not directly translate to profitability. While we realize profits on gas sales during the month of providing the utility service, significant shifts in revenue recognition may result from the various recovery clauses approved by the BPU. This revenue recognition process does not shift earnings between periods, as these clauses only provide for cost recovery on a dollar-for-dollar basis (See Notes 3 and 4 to the financial statements).

In January 2010, the BPU approved an extension of the Conservation Incentive Program (CIP) through 2013.  Each CIP year begins October 1 and ends September 30 of the subsequent year.  On a monthly basis during the CIP year, we record adjustments to earnings based on weather and customer usage factors, as incurred.  Subsequent to each year, we make filings with the BPU to review and approve amounts recorded under the CIP.  BPU approved cash inflows or outflows generally will not begin until the next CIP year and have no impact on earnings at that time.

New Accounting Pronouncements - See detailed discussions concerning New Accounting Pronouncements and their impact in Note 1 to the financial statements.

Rates and Regulation - As a public utility, we are subject to regulation by the New Jersey Board of Public Utilities (BPU). Additionally, the Natural Gas Policy Act, which was enacted in November 1978, contains provisions for Federal regulation of certain aspects of our business. We are affected by Federal regulation with respect to transportation and pricing policies applicable to pipeline capacity from Transcontinental Gas Pipeline Corporation (our major supplier), Columbia Gas Transmission Corporation and Dominion Transmission, Inc., since such services are provided under rates and terms established under the jurisdiction of the FERC. Our retail sales are made under rate schedules within a tariff filed with, and subject to the jurisdiction of, the BPU. These rate schedules provide primarily for either block rates or demand/commodity rate structures. Our primary rate mechanisms include base rates, the Basic Gas Supply Service Clause, Capital Investment Recovery Tracker, Energy Efficiency Tracker and the Conservation Incentive Program.

Effective September 17, 2010, the BPU granted SJG a base rate increase of $42.1 million, which was predicated, in part, upon a 8.21% rate of return on rate base that included a 10.3% return on common equity.  The $42.1 million includes $16.6 million of revenue previously recovered through the Conservation Incentive Program (CIP) and $6.8 million of revenues previously recovered through the Capital Investment Recovery Tracker (CIRT), resulting in incremental revenue of $18.7 million.  SJG was permitted to recover regulatory assets contained in its petition and is allowed to defer certain federally mandated pipeline integrity management program costs for recovery in its next base rate case.  In addition, annual depreciation expense will be reduced by $1.2 million as a result of the amortization of excess cost of removal recoveries.  The BPU also authorized a Phase II of the rate proceeding to address the recovery of investment in CIRT not rolled into rate base in this case.

Basic Gas Supply Service Clause (BGSS) - In December 2002, the BPU approved the BGSS price structure which gave customers the ability to make more informed decisions regarding their choices of an alternate supplier by having a utility price structure that is more consistent with market conditions. The cost of gas purchased from the utility by our periodic consumers is set annually by the BPU through a BGSS clause within our tariff. When actual gas costs experienced are less than those charged to customers under the BGSS, customer bills in the subsequent BGSS period(s) are reduced by returning the overrecovery with interest. When actual gas costs are more than is recovered through rates, we are permitted to charge customers more for gas in future periods to recover the shortfall.

Capital Investment Recovery Tracker (CIRT) – In April 2009, the BPU approved an accelerated infrastructure investment program and an associated rate tracker, which allowed SJG to accelerate $103.0 million of capital spending into 2009 and 2010.  As stated above, the BPU authorized a Phase II of its rate case proceeding to address the recovery of investments in CIRT not rolled into rate base in its September 2010 rate case settlement. The CIRT allows SJG to earn a return of, and return on, investment as the capital is spent.

Energy Efficiency Tracker (EET) – In July 2009, the BPU approved an energy efficiency program to invest $17.0 million over two years in energy efficiency programs for residential, commercial and industrial customers.  Under this program SJG can recover incremental operating and maintenance expenses and earn a return of, and return on, program investments.

 
Conservation Incentive Program (CIP) - The CIP is a BPU approved pilot program that is designed to eliminate the link between our profits and the quantity of natural gas we sell, and to foster conservation efforts. With the CIP, our profits are tied to the number of customers we serve and how efficiently we serve them, thus allowing us to focus on encouraging conservation and energy efficiency among our customers without negatively impacting our net income.  The CIP tracking mechanism adjusts earnings based on weather, and also adjusts our earnings when actual usage per customer experienced during an annual period varies from an established baseline usage per customer.  In January 2010, the BPU approved an extension of the CIP through September 2013. Under the terms of the settlement, the CIP may be extended for a one year period in the absence of a Board order taking any affirmative action to the contrary with regard to the pilot program.

Utility earnings are recognized during current periods based upon the application of the CIP. The cash impact of variations in customer usage will result in cash being collected from, or returned to, customers during the subsequent CIP year, which runs from October 1 to September 30.

The effects of the CIP on our net income for the last three years and the associated weather comparisons were as follows ($’s in millions):

   
2010
   
2009
   
2008
 
Net Income Benefit:
                 
CIP – Weather Related
   
1.1
     
0.8
     
1.6
 
CIP – Usage Related
   
5.5
     
8.5
     
9.2
 
Total Net Income Benefit
 
$
6.6
   
$
9.3
   
$
10.8
 
                         
Weather Compared to 20-Year Average
 
2.2% warmer
   
1.1% warmer
   
4.7% warmer
 
Weather Compared to Prior Year
 
0.1% warmer
   
3.9% colder
   
1.6% warmer
 

As part of the CIP, we are required to implement additional conservation programs including customized customer communication and outreach efforts, targeted upgrade furnace efficiency packages, financing offers, and an outreach program to speak to local and state institutional constituents. We are also required to reduce gas supply and storage assets and their associated fees. Note that changes in fees associated with supply and storage assets have no effect on our net income as these costs are passed through directly to customers on a dollar-for-dollar basis.

Earnings accrued and payments received under the CIP are limited to a level that will not cause our return on equity to exceed 10.3% (excluding earnings from off-system gas sales and certain other tariff clauses) and the annualized savings attained from reducing gas supply and storage assets.

Other Rate Mechanisms - Our tariff also contains provisions permitting the recovery of environmental remediation costs associated with former manufactured gas plant sites, energy efficiency and renewable energy program costs, consumer education program costs and low-income program costs. These costs are recovered from customers through our Societal Benefits Clause.

See additional detailed discussions on Rates and Regulatory Actions in Note 3 to the financial statements.

Environmental Remediation - See detailed discussion concerning Environment Remediation in Note 12 to the financial statements.


Competition - Our franchises are non-exclusive. Currently, no other utility provides retail gas distribution services within our territory. We do not expect any other utilities to do so in the foreseeable future because of the extensive investment required for utility plant and related costs. We compete with oil, propane and electricity suppliers for residential, commercial and industrial users, with alternative fuel source providers (wind, solar and fuel cells) based upon price, convenience and environmental factors, and with other marketers/brokers in the selling of wholesale natural gas services. The market for natural gas commodity sales is subject to competition due to deregulation. We enhanced our competitive position while maintaining margins by using an unbundled tariff. This tariff allows full cost-of-service recovery, when transporting gas for our customers. Under this tariff, we profit from transporting, rather than selling, the commodity. Our residential, commercial and industrial customers can choose their supplier while we recover the cost of service through transportation service (see Customer Choice Legislation below).

Customer Choice Legislation - All residential natural gas customers in New Jersey can choose their natural gas commodity supplier under the terms of the “Electric Discount and Energy Competition Act of 1999.” This bill created the framework and necessary time schedules for the restructuring of the state’s electric and natural gas utilities. The Act established unbundling, where redesigned utility rate structures allow natural gas and electric consumers to choose their energy supplier. It also established time frames for instituting competitive services for customer account functions and for determining whether basic gas supply services should become competitive. Customers purchasing natural gas from a provider other than the local utility (marketer) are charged for the gas costs by the marketer and charged for the transportation costs by the utility.  The number of customers purchasing their natural gas from marketers averaged 30,152, 28,379, and 28,637 during 2010, 2009 and 2008, respectively.  

 
RESULTS OF OPERATIONS

The following table summarizes the composition of selected gas utility data for the three years ended December 31 (in thousands, except for customer and degree day data):

   
2010
   
2009
   
2008
 
Utility Throughput – dth:
                                   
Firm Sales -
                                   
Residential
   
22,962
     
21
%
   
22,736
     
23
%
   
21,530
     
15
%
Commercial
   
5,884
     
5
%
   
6,063
     
6
%
   
6,127
     
4
%
Industrial
   
292
     
-
     
331
     
1
%
   
188
     
-
 
Cogeneration and electric generation
   
1,167
     
1
 %
   
322
     
-
     
561
     
-
 
Firm Transportation -
                                               
Residential
   
2,136
     
2
%
   
2,005
     
2
%
   
1,988
     
1
%
Commercial
   
6,043
     
6
%
   
5,930
     
6
%
   
5,687
     
4
%
Industrial
   
12,625
     
11
%
   
12,002
     
12
%
   
12,661
     
9
%
Cogeneration and electric generation
   
5,500
     
5
%
   
2,290
     
2
%
   
2,536
     
2
%
                                                 
Total Firm Throughput
   
56,609
     
51
%
   
51,679
     
52
%
   
51,278
     
35
%
                                                 
Interruptible Sales
   
52
     
-
     
5
     
-
     
35
     
-
 
Interruptible Transportation
   
1,842
     
2
%
   
2,314
     
2
%
   
2,716
     
2
%
Off-System
   
6,034
     
5
%
   
6,282
     
7
%
   
9,632
     
7
%
Capacity Release
   
46,278
     
42
%
   
38,387
     
39
%
   
80,665
     
56
%
                                                 
Total Utility Throughput
   
110,815
     
100
%
   
98,667
     
100
%
   
144,326
     
100
%
                                     
Utility Operating Revenues:
                                   
Firm Sales-
                                   
Residential
 
$
302,824
     
64
%
 
$
318,143
     
66
%
 
$
320,401
     
57
%
Commercial
   
67,967
     
14
%
   
71,669
     
15
%
   
81,914
     
15
%
Industrial
   
3,573
     
1
%
   
3,824
     
1
%
   
5,434
     
1
%
Cogeneration and electric generation
   
7,774
     
2
%
   
2,709
     
1
%
   
7,940
     
1
%
Firm Transportation -
                                               
Residential
   
11,908
     
2
%
   
10,491
     
2
%
   
10,408
     
2
%
Commercial
   
21,989
     
5
%
   
19,722
     
4
%
   
18,286
     
3
%
Industrial
   
16,613
     
3
%
   
14,751
     
3
%
   
12,504
     
2
%
Cogeneration and electric generation
   
4,598
     
1
%
   
2,272
     
-
     
1,682
     
-
 
                                                 
Total Firm Revenues
   
437,246
     
92
%
   
443,581
     
92
%
   
458,569
     
81
%
                                                 
Interruptible Sales
   
770
     
-
     
89
     
  -
     
403
     
-
 
Interruptible Transportation
   
1,842
     
-
     
2,122
     
  -
     
1,786
     
-
 
Off-System
   
30,757
     
7
%
   
32,978
     
7
%
   
90,430
     
16
%
Capacity Release
   
4,156
     
1
%
   
4,282
     
1
%
   
15,549
     
3
%
Other
   
1,211
     
-
     
1,324
     
  -
     
1,309
     
-
 
                                                 
Total Utility Operating Revenues
   
475,982
     
100
%
   
484,376
     
100
%
   
568,046
     
100
%
                                                 
Less:
                                               
Cost of sales
   
266,382
             
293,852
             
383,403
         
Conservation recoveries *
   
6,910
             
7,718
             
7,741
         
RAC recoveries *
   
6,863
             
5,189
             
3,079
         
EET Recoveries *
   
1,433
             
190
             
-
         
Revenue taxes
   
8,607
             
8,836
             
8,656
         
Utility Margin
 
$
185,787
           
$
168,591
           
$
165,167
         
                                                 
Utility Margin:
                                               
Residential
 
$
115,697
     
62
%
 
$
104,373
     
62
%
 
$
99,862
     
61
%
Commercial and industrial
   
44,705
     
24
%
   
39,853
     
24
%
   
38,995
     
24
%
Cogeneration and electric generation
   
2,957
     
2
%
   
2,251
     
1
%
   
1,997
     
1
%
Interruptible
   
177
     
-
     
144
     
-
     
143
     
-
 
Off-system & capacity release
   
1,258
     
1
%
   
1,416
     
1
%
   
3,349
     
2
%
Other revenues
   
2,158
     
1
%
   
2,511
     
1
%
   
2,440
     
1
%
Margin before weather normalization & decoupling
   
166,952
     
90
%
   
150,548
     
89
%
   
146,786
     
89
%
CIRT mechanism
   
7,523
     
4
%
   
2,198
     
1
%
   
-
     
-
 
CIP mechanism
   
11,139
     
6
%
   
15,809
     
10
%
   
18,381
     
11
EET mechanism
   
173
     
-
     
36
     
-
     
-
     
-
 
Utility Margin
 
$
185,787
     
100
%
 
$
168,591
     
100
%
 
$
165,167
     
100
%
                                                 
Number of Customers at Year End:
                                               
Residential
   
324,246
     
93
%
   
320,290
     
93
%
   
317,026
     
93
%
Commercial
   
23,010
     
7
%
   
22,802
     
7
%
   
22,636
     
7
%
Industrial
   
469
     
-
     
474
     
-
     
474
     
-
 
Total Customers
   
347,725
     
100
%
   
343,566
     
100
%
   
340,136
     
100
%
                                                 
Annual Degree Days:
   
4,582
             
4,588
             
4,417
         

* Represents expenses for which there is a corresponding credit in operating revenues. Therefore, such recoveries have no impact on our financial results.

Throughput - Total gas throughput increased 12.1 MMdts, or 12.3%, from 2009 to 2010,  The majority of the increase is attributable to higher capacity release, which increased by 7.9 MMdts over the prior year, as reflected in the table above.  More capacity became available during 2010 as capacity previously transferred out of SJG under the provisions of the Conservation Incentive Program (CIP) were returned to the utility. See additional discussion of the CIP under “Rates and Regulation.” In addition, cogeneration and electric generation sales and transportation throughput increased in 2010.  As the summer of 2010 was one of the hottest on record, higher electric consumption for air conditioning drove the demand for greater natural gas consumption by the region’s electric utility.  In the cogeneration market, a significant increase in transportation throughput was realized as a single customer increased its contract significantly to shift supply from its alternate pipeline supplier to SJG. Firm throughput also increased moderately due to the addition of 3,956 residential customers in 2010.


Total gas throughput decreased 45.7 MMdts, or 31.6%, from 2008 to 2009.  Off-System sales (OSS) and capacity release volume decreased substantially as SJG’s portfolio of assets available for such activities had been reduced in prior years under the CIP.  As the majority of profits from OSS and capacity release are returned to the ratepayers via a BPU-approved sharing formula, the resulting impact of such activity on SJG earnings is greatly mitigated, as reflected in the margin table above.  Firm throughput increased in the residential market as a result of 3.9% colder weather and the addition of 3,264 residential customers during 2009 as compared with 2008.   Changes in throughput in other customer categories were not significant.

Operating Revenues – Revenues decreased $8.4 million, or 1.7%, during 2010 compared with 2009.  Firm revenues decreased $6.3 million, or 1.4%, primarily as a result of a lower BGSS rate in effect during 2010.  While changes in gas costs and BGSS recoveries may fluctuate from period to period, SJG does not profit from the sale of the commodity.  Therefore, corresponding fluctuations in Operating Revenue or Cost of Sales have no impact on Company profitability, as further discussed under “Margin.”  There was also a $2.2 million decrease in OSS during 2010 versus 2009.  This decrease was primarily related to more volume being marketed as capacity release compared with 2009. As reflected in the Margin table above, the impact of lower OSS did not have a material impact on the earnings of the Company, as SJG is required to share 85% of the profits of such activity with the ratepayers.

Revenues decreased $83.7 million, or 14.7%, during 2009 compared with 2008.  This was the result of a substantial decrease in Off-System Sales (OSS) and Capacity Release revenue, which decreased by $57.5 million and $11.3 million, respectively, during 2009 compared with 2008.  These decreases were primarily related to continued reductions in SJG’s portfolio of assets available for such activities under the provisions of the CIP, as noted above under “Throughput,” and a significant decrease in the average cost per unit sold during 2009.  The cost of natural gas had declined so dramatically during 2009 that OSS unit sales prices declined from an average of $9.39 per decatherm (Dt) during 2008 to only $5.25 per Dt during 2009.  As previously stated, the impact of lower OSS and Capacity Release did not have a material impact on the earnings of the Company.  Firm sales revenue decreased approximately $15.0 million as a result of significantly lower natural gas prices during 2009.  The average cost of natural gas purchased during 2009 was $7.52 per Dt, representing a 27.5% decrease relative to the average cost of $10.38 per Dt in 2008.  This decrease in natural gas costs precipitated a customer refund of over recovered gas costs through the BPU-approved Basic Gas Supply Service (BGSS) in October 2009 totaling approximately $20.4 million. As previously stated, SJG does not profit from the sale of the commodity.  Therefore, corresponding fluctuations in Operating Revenue or Cost of Sales have no impact on Company profitability, as further discussed under “Margin.”

Margin - Our margin is defined as natural gas revenues less natural gas costs; volumetric and revenue based energy taxes; and regulatory rider expenses. We believe that margin provides a more meaningful basis for evaluating utility operations than revenues since natural gas costs, energy taxes and regulatory rider expenses are passed through to customers, and therefore, have no effect on our profitability. Natural gas costs are charged to operating expenses on the basis of therm sales at the prices approved by the New Jersey Board of Public Utilities through our BGSS tariff.

Total margin in 2010 increased $17.2 million, or 10.2%, from 2009 primarily due to the rate case settlement discussed above under “Rates and Regulation,” a full year of the Capital Investment Recovery Tracker (CIRT) and customer additions.  The CIRT allows SJG to earn a return on approved infrastructure investments made under this program.

The CIP protected $11.1 million of pre-tax margin in 2010 that would have been lost due to lower customer usage, compared to $15.8 million in 2009.  Of these amounts, $1.9 million and $1.4 million were related to weather variations and $9.2 million and $14.4 million were related to other customer usage variations in 2010 and 2009, respectively.

Total margin in 2009 increased $3.4 million, or 2.1%, from 2008 primarily due to customer additions of 3,430 and approval in 2009 of SJG’s CIRT, as discussed above.  Partially offsetting these increases was a decrease in off-system sales and capacity release margins due to continued reductions in SJG’s portfolio of assets available for such activities as discussed above.

The CIP protected $15.8 million of pre-tax margin in 2009 that would have been lost due to lower customer usage, compared with $18.4 million in 2008.  Of these amounts, $1.4 million and $2.7 million were related to weather variations and $14.4 million and $15.7 million were related to other customer usage variations in 2009 and 2008, respectively.

 
Operating Expenses - A summary of changes in other operating expenses (in thousands):

   
2010 vs. 2009
   
2009 vs. 2008
 
             
Operations
 
$
4,728
   
$
6,422
 
Maintenance
 
$
2,681
   
$
970
 
Depreciation
 
$
2,463
   
$
1,267
 
Energy and Other Taxes
 
$
(58
)
 
$
200
 

Operations – Operations expense increased $4.7 million during 2010, as compared with 2009.  The increases are primarily comprised of the following:

First, expense associated with the write-off of uncollectible customer accounts receivable increased $1.1 million in 2010, as compared with 2009.  This increase in write-offs resulted from an increase in the aging of receivables.  SJG also increased its reserve for uncollectible accounts, resulting in $0.4 million of additional expense in 2010, as compared to 2009.  Changes in the uncollectible reserve are the result of fluctuations in levels of customer accounts receivable balances, which are higher as of December 31, 2010 due to a colder winter season.  Higher bank fees required to support credit availability and the Company’s variable-rate debt contributed an incremental $0.7 million of additional cost in 2010.  Payroll expense increased $1.1 million for 2010, as compared with 2009. This was the result of annual compensation increases, additional overtime required to address the impact of unusually inclement weather on the Company’s distribution system, and a voluntary separation program offered in the early part of 2010 to our unionized workforce in an effort to reduce future labor costs. SJG also experienced a $0.7 million increase in expense associated with corporate support, governance and compliance costs, primarily attributable to our parent, SJI, in 2010.  Finally, spending under the New Jersey Clean Energy Program and Energy Efficiency Programs experienced a net increase $0.4 million in 2010, as compared to 2009.  Such costs are recovered on a dollar-for-dollar basis; therefore, SJG experienced offsetting changes in revenues during the periods.

Operations expense increased $6.4 million during 2009, as compared with 2008.  The increases are primarily comprised of the following factors.

First, the cost of providing pension and other postretirement benefit plans increased by $2.9 million and $1.0 million, respectively, as compared with 2008.  This was the result of significant losses in the assets of those plans during 2008.  Additional information regarding these benefit plans can be found in Note 11 of the Notes to Financial Statements.  Second, corporate support, governance and compliance costs, primarily attributable to our parent, SJI, also rose $1.1 million in 2009 as compared with 2008.  Third, our spending under the newly approved Energy Efficiency Tracker (EET) was $0.2 million in 2009.  Such costs are recovered on a dollar-for-dollar basis; therefore, SJG experienced an offsetting increase in revenues during 2009.  The BPU-approved EET allows for full recovery of costs, including carrying costs when applicable.  As a result, this new item of expense had no impact on our net income. Finally, SJG experienced increases in various other areas including general compensation increases; higher bank fees to support higher lines of credit available to the Company; and higher insurance costs.

Maintenance – Maintenance expense increased $2.7 million during 2010, compared with 2009, primarily due to a $1.7 million increase in Remediation Adjustment Clause (RAC) expense amortization.   As discussed in Notes 3 and 4 to the Financial Statements, these costs are recovered from ratepayers; therefore, SJG experienced an offsetting increase in revenue during 2010.  The majority of the difference is associated with regulatory deferrals and amortizations of costs approved in SJG’s recent rate case settlement.  As with the RAC, SJG experienced an increase in revenue to offset the BPU-approved amortizations of expense.

Maintenance expense increased $1.0 million during 2009, compared with 2008, primarily due to an  increase in RAC expense amortization.
 
Depreciation - Depreciation expense increased $2.5 million and $1.3 million in 2010 and 2009, respectively, due mainly to our continuing investment in utility plant. SJG’s investment in utility plant during 2010, 2009 and 2008 was $115.5 million, $98.7 million and $52.6 million, respectively.  The increased spending in 2010 and 2009 was a direct result of the State’s stimulus efforts, which included the approval of SJG’s Capital Investment Recovery Tracker, as discussed under “Rates and Regulation”.


Energy and Other Taxes – Energy and Other Taxes decreased $0.1 million during 2010, compared with 2009, primarily due to lower taxable firm throughput in 2010.  While total throughput increased, as previously discussed under “Throughput,” each market experiencing a significant increase in throughput is exempt from utility energy taxes.  Therefore, a corresponding increase in energy and other taxes did not result.

Energy and Other Taxes increased in 2009, compared with 2008, primarily due to higher taxable firm throughput in 2009.  Higher taxable firm throughput in 2009 resulted from colder weather and customer growth in 2009.  This was partially offset by lower revenue-based taxes as revenues decreased substantially during 2009.

Other Income and Expense - Other income and expense was lower in 2010, when compared with 2009, primarily due to an agreement reached with the FERC to resolve an outstanding dispute.  SJG’s portion of this settlement approximated $0.7 million.  Additional details concerning this settlement can be found in Item 8.01, Other Events, of SJI’s Form 8-K filed on September 28, 2010.    In addition, the Company recognized an impairment loss of $0.7 million during 2008 due to the poor earnings performance of our available-for-sale securities resulting from declines in the equity markets in 2008.  No impairment losses were recognized in either 2010 or 2009. These securities represent assets held in trusts for the payment of postretirement healthcare costs.  

Interest Charges – Interest charges increased $1.2 million in 2010, compared with 2009.  The effect of lower average levels of short-term debt and lower average short-term debt interest rates was offset by the issuance of $115.0 million aggregate principal long-term debt issued during 2010.

Interest charges decreased by $2.5 million in 2009, compared with 2008, due primarily to significantly lower average short-term interest rates, partially offset by higher debt levels during 2009.

LIQUIDITY AND CAPITAL RESOURCES:

Liquidity needs are driven by factors that include natural gas commodity prices; the impact of weather on customer bills; lags in fully collecting gas costs from customers under the Basic Gas Supply Service charge; the timing of construction and remediation expenditures and related permanent financings; mandated tax payment dates; both discretionary and required repayments of long-term debt; and the amounts and timing of dividend payments.

Cash Flows from Operating Activities - Cash generated from operating activities constitutes our primary source of liquidity and varies from year-to-year due to the impact of weather on customer demand and related gas purchases, customer usage factors related to conservation efforts and the price of the natural gas commodity, inventory utilization and recoveries provided through our various rate mechanisms. Net cash provided by operating activities was $112.6 million in 2010, $122.9 million in 2009 and $30.3 million in 2008.

Cash provided by operating activities declined in 2010 as compared with 2009 due to higher accounts receivable balances at the end of 2010 caused by the impact of cold weather on natural gas demand; higher prepaid taxes due to a late year tax law change; higher planned environmental remediation costs in 2010; and high levels of cash produced in 2009 from the liquidation of high priced natural gas in inventory was not repeated in 2010.  These factors more than offset an improved recovery of gas costs from customers under our BGSS clause and higher accounts payable due to gas costs associated with the increased weather related demand at year end 2010.

Cash provided from operating activities increased in 2009, as compared with 2008, primarily as a result of lower unit gas costs and the impact of those costs on natural gas inventory balances.  The Company also incurred lower environmental remediation costs in 2009 as compared with 2008.  The lower environmental remediation costs include a decrease in remediation expenditures as well as increased insurance recoveries during 2009.

Cash Flows from Investing Activities - We have a continuing need for cash resources for capital purchases, primarily to invest in new and replacement facilities and equipment. Cash used for capital expenditures was $115.5 million, $98.7 million and $52.6 million in 2010, 2009 and 2008, respectively, primarily due to infrastructure improvements that continue to support SJG’s growth.  The increases in the 2010 and 2009 capital expenditures were the direct result of the Company’s CIRT program which began in 2009.  See additional details under “Rates and Regulation.”

 
For capital expenditures, including those under the CIRT, SJG will use short-term borrowings under lines of credit from commercial banks to finance capital expenditures as incurred.  From time to time, the Company will refinance the short-term debt incurred to support capital expenditures with long-term debt.

Cash Flows from Financing Activities - We use short-term borrowings under lines of credit from commercial banks to supplement cash from operations, to support working capital needs and to finance capital expenditures as incurred. From time to time, we refinance short-term debt incurred to finance capital expenditures with long-term debt. Debt is incurred primarily to expand and upgrade our gas transmission and distribution system and to support seasonal working capital needs related to inventories and customer receivables.   

Credit facilities and available liquidity as of December 31, 2010 were as follows (in thousands):

   
Total Facility
   
Usage
   
Available Liquidity
 
Expiration Date
                     
Revolving Credit Facility
 
$
100,000
   
$
50,000
   
$
50,000
 
August 2011(A)
Line of Credit
   
40,000
     
-
     
40,000
 
August 2011 (A)
Uncommitted Bank Lines
   
   40,000
     
8,900
     
31,100
 
Various
                           
Total
 
$
180,000
   
$
58,900
   
$
121,100
   

(A)  SJG anticipates extending these lines of credit during the second quarter of 2011.  Based upon the existing credit facilities and a regular dialogue with our banks, we believe there will continue to be sufficient credit available to meet our future liquidity needs.

SJG supplements its operating cash flow and credit lines with both debt and equity capital.  Over the years, the Company has used long-term debt, primarily in the form of First Mortgage Bonds and Medium Term Notes (MTN), secured by the same pool of utility assets, to finance our long-term borrowing needs.  These needs are primarily capital expenditures for property, plant and equipment.  In September 2009, SJG received approval from the New Jersey Board of Public Utilities to issue up to $150.0 million in long-term debt by September 2011.  In March, June and December 2010, SJG issued $15.0 million, $45.0 million and $55.0 million aggregate principal amounts, respectively, of its MTNs under private placements.  In November 2009, SJG completed an early redemption of $9.9 million of 6.5% bonds due in 2016.  We redeemed this debt early to achieve significant interest expense savings due to the low interest rates available to SJG.

In June 2008, SJG repurchased $25.0 million of its auction-rate securities at par by drawing under its lines of credit.  That action resulted in a $25.0 million reduction in long-term debt on SJG’s balance sheet.  SJG converted these repurchased auction-rate securities to variable-rate demand bonds and remarketed them to the public during the third quarter of 2008.    We repaid long-term debt totaling $10.0 million, $9.9 million and $25.0 million in 2010, 2009 and 2008, respectively.

SJI contributed no capital to us in 2010, 2009 or 2008. 

As of December 31, our capital structure was as follows:

   
2010
   
2009
 
             
Common Equity
   
48.8
%
   
52.2
%
Long-Term Debt
   
44.5
%
   
30.3
%
Short-Term Debt
   
6.7
%
   
17.5
%
                 
Total
   
100.0
%
   
100.0
%
 

COMMITMENTS AND CONTINGENCIES:

SJG has a continuing need for cash resources and capital, primarily to invest in new and replacement facilities and equipment, working capital, and for environmental remediation costs. Cash outflows for capital expenditures for the year of 2010 amounted to $115.5 million. Management estimates net cash outflows for construction projects for 2011, 2012 and 2013, to be approximately $131.5 million, $113.0 million and $106.0 million, respectively.  Costs for remediation projects, net of insurance reimbursements, for the year of 2010 amounted to net cash outflows of $3.5 million.  Total cash outflows for remediation projects are expected to be $22.3 million, $10.4 million and $8.0 million for 2011, 2012, and 2013, respectively.  As discussed in Notes 3 and 12 to the Financial Statements in Item 8, environmental remediation costs are subject to recovery from insurance carriers and ratepayers.

STANDBY LETTER OF CREDIT - SJG provided a $25.2 million letter of credit, under a separate credit facility from those it borrows under to provide liquidity support for the remarketing of variable-rate demand bonds issued through the NJEDA. The bonds were used to finance the expansion of SJG’s natural gas distribution system as discussed in Note 7 to the financial statements.  This letter of credit expires in August 2011.

We have certain commitments for both pipeline capacity and gas supply for which we pay fees regardless of usage. Those commitments as of December 31, 2010, average $44.0 million annually and total $181.0 million over the contracts’ lives. Approximately 20% of the financial commitments under these contracts expire during the next five years. We expect to renew each of these contracts under renewal provisions as provided in each contract. We recover all prudently incurred fees through rates via the Basic Gas Supply Service clause.

The following table summarizes our contractual cash obligations and their applicable payment due dates as of December 31, 2010 (in thousands):

Contractual Cash Obligations
 
Total
   
Up to
1 Year
   
Years
2 & 3
   
Years
4 & 5
   
More than
5 Years
 
                               
Principal Payments on Long-Term Debt
 
$
390,000
   
$
50,000
   
$
29,375
   
$
36,284
   
$
274,341
 
Interest on Long-Term Debt
   
245,047
     
20,825
     
37,995
     
33,918
     
152,309
 
Operating Leases
   
175
     
70
     
65
     
40
     
-
 
Construction Obligations
   
3,259
     
3,259
     
-
     
-
     
-
 
Commodity Supply Purchase Obligations
   
181,018
     
43,898
     
32,406
     
26,816
     
77,898
 
New Jersey Clean Energy Program (Note 3)
   
24,031
     
11,053
     
12,978
     
-
     
-
 
Other Purchase Obligations
   
608
     
608
     
-
     
-
     
-
 
                                         
Total Contractual Cash Obligations
 
$
844,138
   
$
129,713
   
$
112,819
   
$
97,058
   
$
504,548
 

As discussed in Note 7 to the financial statements, SJG’s variable-rate debt of $25.0 million has been included in the current portion of long-term debt above.  However, interest on long-term debt in the table above includes the related interest obligations through maturity, as well as the impact of the related interest rate swap agreements on this variable-rate debt.

Expected environmental remediation costs, asset retirement obligations and the liability for unrecognized tax benefits are not included in the table above as the total obligation cannot be calculated due to the subjective nature of these costs and timing of anticipated payments. SJG has no obligation to make a contribution to its employee pension plans in 2011.  Furthermore, future pension contributions beyond 2011 cannot be determined at this time. Our regulatory obligation to contribute $3.6 million annually to our postretirement benefit plans’ trusts, as discussed in Note 11 to the financial statements, is also not included as its duration is indefinite.

Off-Balance Sheet Arrangements - We have no off-balance sheet financing arrangements.
 
Pending Litigation - We are subject to claims arising in the ordinary course of business and other legal proceedings. We accrue liabilities related to claims when we can reasonably estimate the amount or range of amounts of probable settlement costs or other charges.  Management does not currently anticipate the disposition of any known claims to have a material adverse effect on our financial position, results of operations or liquidity.

 
Item 7a. Quantitative and Qualitative Disclosures about Market Risks

MARKET RISKS:

Commodity Market Risks - We are involved in buying, selling, transporting and storing natural gas and are subject to market risk due to price fluctuations. To hedge against this risk, we enter into a variety of physical and financial transactions including forward contracts, futures and options agreements. To manage these transactions, we have a well-defined risk management policy approved by our Board of Directors that includes volumetric and monetary limits. Management reviews reports detailing activity daily. Generally, the derivative activities described above are entered into for risk management purposes.

We transact commodities on a physical basis and typically do not enter into financial derivative positions directly. South Jersey Resources Group, LLC, (SJRG) an affiliate by common ownership, manages our risk by entering into the types of transactions noted above. As part of our gas purchasing strategy, we use financial contracts to hedge against forward price risk. These contracts are recoverable through our BGSS, subject to BPU approval. It is management’s policy, to the extent practical, within predetermined risk management policy guidelines, to have limited unmatched positions on a deal or portfolio basis while conducting these activities. As a result of holding open positions to a minimal level, the economic impact of changes in value of a particular transaction is substantially offset by an opposite change in the related hedge transaction. The majority of our contracts are typically less than 12-months long. The fair value and maturity of all these energy trading and hedging contracts determined using mark-to-market accounting as of December 31, 2010 is as follows (in thousands):
 
Assets:
   
Maturity
   
Maturity
       
 
Source of Fair Value
 
<1 Year
   
1 - 3 Years
   
Total
 
                     
Prices Actively Quoted
NYMEX
 
$
623
   
$
161
   
$
784
 
Other External Sources
Basis
   
5,241
     
844
     
6,085
 
Total
   
$
5,864
   
$
1,005
   
$
6,869
 
                           
Liabilities:
   
Maturity
   
Maturity
         
 
Source of Fair Value
 
<1 Year
   
1 - 3 Years
   
Total
 
                           
Prices Actively Quoted
NYMEX
 
$
10,282
   
$
332
   
$
10,614
 
Other External Sources
Basis
   
1,124
     
98
     
1,222
 
Total
   
$
11,406
   
$
430
   
$
11,836
 

NYMEX (New York Mercantile Exchange) is the primary national commodities exchange on which natural gas is traded. Basis represents the price of a NYMEX natural gas futures contract adjusted for the difference in price for delivering the gas at another location. Contracted volumes of our NYMEX contracts are 12.8 MMdts with a weighted-average settlement price of $5.40 per dt.  Contracted volumes of our Basis contracts are 10.1 MMdts with a weighted-average settlement price of $0.85 per dt.

A reconciliation of our estimated net fair value of energy-related derivatives, including energy trading and hedging contracts follows (in thousands):

Net Derivatives — Energy Related Liability, January 1, 2010
 
$
(9,173
Contracts Settled During 2010, Net
   
9,002
 
Other Changes in Fair Value from Continuing and New Contracts, Net
   
(4,796
)
Net Derivatives — Energy Related Liability, December 31, 2010
 
$
(4,967
)

The change in our derivative position from a $9.2 million liability at December 31, 2009 to a $5.0 million liability at December 31, 2010 is primarily due to the change in value of our financial positions held with SJRG.  As of December 31, 2010 the average future price was approximately $4.79 per dt vs. $5.80 per dt as of December 31, 2009.  

 
Interest Rate Risk - Our exposure to interest rate risk relates primarily to short-term, variable-rate borrowings. Short-term, variable-rate debt outstanding at December 31, 2010, was $58.9 million and averaged $89.3 million during 2010. The months where average outstanding variable-rate debt was at its highest and lowest levels were November, at $130.9 million, and March, at $50.0 million. A hypothetical 100 basis point (1%) increase in interest rates on our average variable-rate debt outstanding would result in a $536,000 increase in our annual interest expense, net of tax. The 100 basis point increase was chosen for illustrative purposes, as it provides a simple basis for calculating the impact of interest rate changes under a variety of interest rate scenarios. Over the past five years, the change in basis points (b.p.) of our average monthly interest rates from the beginning to end of each year was as follows: 2010 – 5 b.p. increase; 2009 – 29 b.p. decrease; 2008 - 317 b.p. decrease; 2007 – 36 b.p. decrease; and 2006 - 72 b.p. increase.  As of December 31, 2010, our average borrowing cost, which changes daily, was 0.71%.

We issue long-term debt either at fixed rates or use interest rate derivatives to limit our exposure to changes in interest rates on variable-rate, long-term debt. As of December 31, 2010, the interest costs on all of our long-term debt was either at a fixed-rate or hedged via an interest rate derivative. Consequently, interest expense on existing long-term debt is not significantly impacted by changes in market interest rates. However, due to general market conditions during 2008, the demand for auction-rate securities was disrupted resulting in increased interest rate volatility for tax-exempt auction-rate debt.   As a result, the $25.0 million of tax-exempt auction-rate debt issued by the Company (and repurchased in June 2008) was exposed to changes in interest rates that were not completely mitigated by the related interest rate derivatives. The auction-rate debt was converted to another form of variable- rate debt and resold in the public market in August 2008. The original interest rate derivatives remain in place and are expected to substantially offset changes in interest rates on the security.

Item 8. Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholder of
South Jersey Gas Company
Folsom, New Jersey

We have audited the accompanying balance sheets of South Jersey Gas Company (the "Company") as of December 31, 2010 and 2009, and the related statements of income, cash flows, changes in common equity and comprehensive income for each of the three years in the period ended December 31, 2010.  Our audits also included the financial statement schedule listed in the Index at Item 15(a)2.  These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such financial statements present fairly, in all material respects, the financial position of South Jersey Gas Company as of December 31, 2010 and 2009, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

/s/ Deloitte & Touche LLP
Philadelphia, Pennsylvania
February 28, 2011

 
SOUTH JERSEY GAS COMPANY
STATEMENTS OF INCOME
(In Thousands)

   
Year Ended December 31,
 
   
2010
   
2009
   
2008
 
                   
Operating Revenues
 
$
475,982
   
$
484,376
   
$
568,046
 
                         
Operating Expenses:
                       
Cost of Sales (Excluding depreciation)
   
266,382
     
293,852
     
383,403
 
Operations
   
67,261
     
62,533
     
56,111
 
Maintenance
   
11,550
     
8,869
     
7,899
 
Depreciation
   
29,319
     
26,856
     
25,589
 
Energy and Other Taxes
   
10,769
     
10,827
     
10,627
 
                         
Total Operating Expenses
   
385,281
     
402,937
     
483,629
 
                         
Operating Income
   
90,701
     
81,439
     
84,417
 
                         
Other Income and Expense
   
543
     
1,302
     
459
 
                         
Interest Charges
   
(17,641
)
   
(16,442
)
   
(18,937
)
                         
Income Before Income Taxes
   
73,603
     
66,299
     
65,939
 
                         
Income Taxes
   
(29,678
)
   
(27,104
)
   
(26,508
)
                         
Net Income
 
$
43,925
   
$
39,195
   
$
39,431
 

The accompanying notes are an integral part of the financial statements.

 
SOUTH JERSEY GAS COMPANY
STATEMENTS OF CASH FLOWS
(In Thousands)

   
Year Ended December 31,
 
   
2010
   
2009
   
2008
 
                   
Cash Flows from Operating Activities:
                 
Net Income
 
$
43,925
   
$
39,195
   
$
39,431
 
Provided by Operating Activities:
                       
Depreciation and Amortization
   
39,502
     
34,507
     
31,506
 
Provision for Losses on Accounts Receivable
   
3,741
     
2,418
     
2,281
 
CIP Receivable
   
4,381
     
5,376
     
2,641
 
Deferred Gas Costs - Net of Recoveries
   
22,492
     
(7,910
   
5,885
 
Deferred SBC Costs - Net of Recoveries
   
(2,344
)
   
(119
   
1,199
 
Environmental Remediation Costs - Net of Recoveries
   
(3,530
)
   
(444
)
   
(26,177
)
Deferred and Noncurrent Income Taxes and Credits - Net
   
24,540
     
22,104
     
21,378
 
Gas Plant Cost of Removal
   
(1,596
)
   
(1,678
)
   
(1,463
)
Changes in:
                       
Accounts Receivable
   
(13,262
)
   
3,526
     
(4,531
)
Inventories
   
5,945
     
47,934
     
(18,659
Prepaid and Accrued Taxes - Net
   
(8,744
)
   
4,321
     
(1,657
)
Other Prepayments and Current Assets
   
(105
)
   
168
     
(138
)
Gas Purchases Payable
   
7,285
     
(16,957
   
1,717
 
Accounts Payable and Other Accrued Liabilities
   
(4,017
)
   
(5,856
)
   
(13,857
Other Assets
   
(5,886
)
   
(2,132
)
   
(375
)
Other Liabilities
   
252
     
(1,534
)
   
(8,920
)
                         
Net Cash Provided by Operating Activities
   
112,579
     
122,919
     
30,261
 
                         
Cash Flows from Investing Activities:
                       
Capital Expenditures
   
(115,466
)
   
(98,673
)
   
(52,580
)
Investment in Long-Term Receivables
   
(3,313
)
   
(4,730
)
   
(5,558
)
Proceeds from Long-Term Receivables
   
2,901
     
5,399
     
3,399
 
Purchase of Restricted Investment with Escrowed Loan Proceeds
   
-
     
-
     
(39
)
Restricted Investment - Escrowed Loan Proceeds
   
-
     
-
     
2,146
 
    Net Purchase of Restricted Investment in Margin Account
   
(4,169
)
   
-
     
-
 
                         
 Net Cash Used in Investing Activities
   
(120,047
)
   
(98,004
)
   
(52,632
)
                         
Cash Flows from Financing Activities:
                       
Net (Repayments of) Borrowing from Lines of Credit
   
(50,500
)
   
(5,150
   
36,210
 
Proceeds from Issuance of Long-Term Debt
   
115,000
     
-
     
25,000
 
Principal Repayments of Long-Term Debt
   
(10,000
)
   
(9,873
)
   
(25,000
)
Payments for Issuance of Long-Term Debt
   
(1,215
)
   
(178
)
   
(320
Dividends on Common Stock
   
(45,905
)
   
(10,002
)
   
(14,867
)
Excess Tax Benefit from Restricted Stock Plan
   
125
     
53
     
346
 
                         
Net Cash Provided by (Used in) Financing Activities
   
7,505
     
(25,150
   
21,369
 
                         
Net Increase (Decrease) in Cash and Cash Equivalents
   
37
     
(235
)
   
(1,002
Cash and Cash Equivalents at Beginning of Period
   
1,993
     
2,228
     
3,230
 
                         
Cash and Cash Equivalents at End of Period
 
$
2,030
   
$
1,993
   
$
2,228
 
                         
Supplemental Disclosures of Cash Flow Information
                       
Interest (Net of Amounts Applicable to Gas Cost Overcollections and Amounts Capitalized)
 
$
17,611
   
$
17,926
   
$
19,550
 
Income Taxes (Net of Refunds)
 
$
14,816
   
$
(4,308
 
$
7,315
 
                         
Supplemental Disclosures of Noncash Investing Activities
                       
Capital property and equipment acquired on account but not paid at year-end
 
$
14,906
   
$
19,166
   
$
7,590
 
 
The accompanying notes are an integral part of the financial statements.

 
SOUTH JERSEY GAS COMPANY
BALANCE SHEETS
(In Thousands)

   
December 31,
 
   
2010
   
2009
 
Assets
           
             
Property, Plant and Equipment:
           
Utility Plant, at original cost
 
$
1,384,797
   
$
1,275,792
 
Accumulated Depreciation
   
(337,993
)
   
(314,627
)
                 
Property, Plant and Equipment – Net
   
1,046,804
     
961,165
 
                 
Investments:
               
Available-for-Sale Securities
   
6,700
     
5,941
 
Restricted Investments
   
4,301
     
132
 
                 
Total Investments
   
11,001
     
6,073
 
                 
Current Assets:
               
Cash and Cash Equivalents
   
2,030
     
1,993
 
Accounts Receivable
   
37,619
     
41,392
 
Accounts Receivable - Related Parties
   
4,885
     
974
 
Unbilled Revenues
   
58,197
     
47,333
 
Provision for Uncollectibles
   
(4,577
)
   
(3,915
)
Natural Gas in Storage, average cost
   
20,109
     
23,711
 
Materials and Supplies, average cost
   
2,511
     
4,854
 
Prepaid Taxes
   
15,907
     
13,796
 
Derivatives - Energy Related Assets
   
5,864
     
797
 
Other Prepayments and Current Assets
   
2,353
     
2,248
 
                 
Total Current Assets
   
144,898
     
133,183
 
                 
Regulatory and Other Noncurrent Assets:
               
Regulatory Assets
   
248,413
     
240,462
 
Unamortized Debt Issuance Costs
   
6,718
     
5,829
 
Long-Term Receivables
   
7,285
     
7,693
 
Derivatives - Energy Related Assets
   
1,005
     
333
 
Other
   
2,511
     
2,324
 
                 
Total Regulatory and Other Noncurrent Assets
   
265,932
     
256,641
 
                 
Total Assets
 
$
1,468,635
   
$
1,357,062
 
 
The accompanying notes are an integral part of the financial statements.

 
SOUTH JERSEY GAS COMPANY
BALANCE SHEETS
(In Thousands, except for share data)

   
December 31,
 
   
2010
   
2009
 
             
Capitalization and Liabilities
           
             
Common Equity:
           
Common Stock, Par Value $2.50 per share:
           
Authorized - 4,000,000 shares
           
Outstanding - 2,339,139 shares
 
$
5,848
   
$
5,848
 
Other Paid-In Capital and Premium on Common Stock
   
200,841
     
200,716
 
Accumulated Other Comprehensive Loss
   
(9,120
)
   
(6,330
)
Retained Earnings
   
229,316
     
231,296
 
                 
Total Common Equity