Nature of Our Business
AGL Resources Inc. is a registered public utility holding company that manages its business in three operating segments and one nonoperating segment.
Distribution Operations Segment
The Distribution Operations segment includes the results of operations and financial condition of AGL Resources' three natural gas local distribution companies: AGLC, VNG and CGC. AGLC conducts its primary business, the distribution of natural gas, throughout most of Georgia. VNG distributes and sells natural gas in southeastern Virginia. CGC distributes and sells natural gas in the Chattanooga area of Tennessee. The GPSC regulates AGLC; the VSCC regulates VNG; and the TRA regulates CGC. The GPSC, the VSCC and the TRA regulate Distribution Operations with respect to rates, maintenance of accounting records and various other matters.
Wholesale Services Segment
The Wholesale Services segment includes the results of operations and financial condition of Sequent, AGL Resources' asset optimization, gas supply services, and wholesale marketing and risk management subsidiary. Asset optimization focuses on capturing the value from idle or underutilized assets, typically by participating in transactions that balance the needs of varying markets and time horizons.
Although Sequent is a nonregulated business, some of the assets that it manages are regulated. Under varying agreements and practices, Sequent acts as asset manager for AGL Resources' regulated utilities. In addition, Sequent procures from third parties storage and transportation rights on interstate pipelines to manage on its own behalf. The VSCC approved an asset management agreement, which provides for a sharing of profits between Sequent and VNG's customers. Sequent and CGC have an agreement whereby Sequent pays CGC's ratepayers an annual fee for the right to act as CGC's asset manager. Sequent also operates as asset manager for AGLC. By statute, profits earned by Sequent from AGLC asset transactions that constitute off-system sales or capacity release transactions are required to be shared with Georgia's Universal Service Fund. See "Regulatory Risk", contained in Item 3 of Part I under the caption "Quantitative and Qualitative Disclosure about Market Risk."
Energy Investments Segment
The Energy Investments segment includes AGL Resources' investments in SouthStar and US Propane and the results of operations and financial condition of AGL Networks.
SouthStar is a joint venture in which a subsidiary of AGL Resources is a 50% owner; a subsidiary of Dynegy Inc. is a 20% owner; and a subsidiary of Piedmont Natural Gas Company is a 30% owner (collectively the Owners). Although AGL Resources owns 50% of SouthStar, it does not have a controlling interest, as most matters of significance require the unanimous vote of the Owners' representatives to the governing board of SouthStar. SouthStar offers a combination of unregulated energy products and services to industrial, commercial and residential customers, principally in Georgia. SouthStar was formed and began marketing energy services in Georgia, under the trade name Georgia Natural Gas Services, in 1998, when that state became the only state in the Southeast to fully open to retail natural gas competition.
AGL Resources owns 22.36% of the limited partnership interests in US Propane and 22.36% of the limited liability company that serves as US Propane's general partner. The other limited partners of US Propane are subsidiaries of TECO Energy, Inc., Piedmont Natural Gas Company, and Atmos Energy Corporation. These companies are also the other owners of US Propane's general partner. US Propane owns all of the general partnership interest directly or indirectly and approximately 29% or 4,641,282 common units of the limited partnership interests in Heritage (NYSE: HPG), a marketer of propane through a nationwide retail distribution network. Heritage competes with electricity, natural gas and fuel oil, as well as with other companies in the retail propane distribution business. The propane business, like natural gas, is seasonal, with weather conditions significantly affecting the demand for propane.
AGL Networks seeks to serve the demand for high-speed network capacity in metropolitan areas within the United States. Under a certificate of authority from the GPSC, AGL Networks provides last-mile conduit and dark fiber infrastructure solutions to a variety of customers in metro Atlanta, including local, regional and national telecommunication companies, wireless service providers, educational institutions, and other commercial entities. Conduit and dark fiber is typically provided to these customers under a lease arrangement with term lengths that vary from 3 to 20 years. In addition to conduit and dark fiber leasing, AGL Networks provides turnkey telecommunications network construction services.
Corporate Segment
The Corporate segment includes the results of operations and financial condition of AGL Resources' nonoperating business units, including AGSC and AGL Capital. AGSC is a service company established in accordance with PUHCA. AGL Capital was established to finance the acquisition of VNG, refinance existing short-term debt, and provide for the ongoing financing needs of AGL Resources through a commercial paper program, the issuance of various debt and hybrid securities, and other financing mechanisms. All costs associated with AGSC, as well as financing costs associated with AGL Capital, are allocated to the operating segments in accordance with PUHCA. The corporate segment also includes intercompany eliminations for transactions between operating business segments.
Critical Accounting Policies
The selection and application of critical accounting policies is an important process that has progressed as AGL Resources' business activities and accounting rules have evolved. Accounting rules generally do not involve a selection among alternatives, but rather involve an implementation and interpretation of existing rules and the use of judgment as to the specific set of circumstances existing in our business. Each of the critical accounting policies involves complex situations requiring a high degree of judgment either in the application and interpretation of existing literature or in the development of estimates that impact AGL Resources' financial statements.
Regulatory Accounting
Transactions within Distribution Operations segment are accounted for according to the provisions of SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation". The application of this accounting policy allows Distribution Operations to defer expenses and income on the condensed consolidated balance sheet as regulatory assets and liabilities when it is probable that those expenses and income will be allowed in the rate setting process in a period different from the period in which they would have been reflected in the condensed statements of consolidated income of an unregulated company. These deferred regulatory assets and liabilities are then recognized in the condensed statement of consolidated income in the period in which the same amounts are reflected in rates.
If any portion of Distribution Operations ceased to continue to meet the criteria for application of regulatory accounting treatment for all or part of its operations, the regulatory assets and liabilities related to those portions ceasing to meet such criteria would be eliminated from the condensed statements of the consolidated balance sheet and included in the condensed statement of consolidated income for the period in which the discontinuance of regulatory accounting treatment occurred.
Pipeline replacement.AGLC has recorded a regulatory liability as of September 30, 2002 of $474.0 million that represents engineering estimates for remaining capital expenditure costs in the pipeline replacement program. The pipeline replacement program represents an approved settlement between AGLC and the staff of the GPSC that detailed a 10-year replacement of 2,300 miles of cast iron and bare steel pipe. The costs are recoverable through a combination of SFV rates and a pipeline replacement revenue rider.
Environmental Matters.AGLC has historically reported estimates of future remediation cost based on probabilistic models of potential costs. As cleanup options and plans continue to develop and cleanup contracts are entered into, AGLC is increasingly able to provide conventional engineering estimates of the likely costs of many elements of its MGP program. These estimates contain various engineering uncertainties, and AGLC continuously attempts to refine and update these engineering estimates. In addition, we continue to review technologies available for the cleanup of our two largest sites, Augusta and Savannah, which, if proven, could have the effect of reducing our total future expenditures by approximately $10 to $30 million. Until these reviews and updates are concluded, AGLC believes that the June 30, 2002 estimate of $137.0 million remains a reasonable engineering cost estimate of future action. For those remaining elements of the MGP program where AGLC still cannot perform engineering cost estimates, there remains considerable variability in available future cost estimates. For these elements AGLC believes that the June 30, 2002 estimate of the remaining cost of future actions at its MGP sites of $6.1 to $14.5 million remains reasonable. AGLC cannot at this time identify any single number within this range as a better estimate of its likely future costs. Consequently, as of September 30, 2002, AGLC has recorded the sum of $137.0 million plus the lower end of the remaining range, $6.1 million, less the cash payments made during the quarter of $4.5 million, or a total of $138.6 million, as a liability and a corresponding regulatory asset. This figure does not include other potential expenses, such as unasserted property damage, personal injury or natural resource damage claims, legal expenses, or other costs for which AGLC may be held liable, but with respect to which the amount cannot be reasonably forecast. This figure also does not include either the refinements to the cost estimates or the potential cost savings as described above. There is a corresponding regulatory asset of $219.4 million, which represents unrecovered investigation and cleanup costs.
Revenue Recognition
Unbilled revenue.VNG and CGC employ rate structures that include volumetric rate designs that allow recovery of costs through gas usage. VNG and CGC recognize revenues from sales of natural gas and transportation services in the same period in which they deliver the related volumes to customers. VNG and CGC bill and recognize sales revenues from residential and certain commercial and industrial customers on the basis of scheduled meter readings. In addition, VNG and CGC record revenues for estimated deliveries of gas, not yet billed to these customers, from the meter reading date to the end of the accounting period. AGL Resources includes these revenues in the condensed consolidated balance sheets as unbilled revenue. Included in the rates charged by CGC is a WNA factor, which offsets the impact of unusually cold or warm weather on operating margin. As of September 30, 2002, VNG's rates did not include such a factor, but beginning in November 2002, VNG's rates will include an expe rimental WNA program for two years. For wholesale and other commercial and industrial customers, VNG and CGC recognize revenues based upon actual deliveries during the accounting period.
Wholesale Services. AGL Resources accounts for transactions in connection with energy marketing and risk management activities under the mark-to-market method of accounting, in accordance with SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" and EITF Issue No. 98-10 (EITF 98-10), "Accounting for Contracts Involved in Energy Trading and Risk Management Activities." Under this method, AGL Resources records energy commodity contracts, including both physical transactions and financial instruments, at fair value. The market prices or fair values used in determining the value of these contracts are our best estimates utilizing information such as commodity exchange prices, over-the-counter quotes, volatility and time value, counterparty credit and the potential impact on market prices of liquidating positions in an orderly manner over a reasonable period of time under current market conditions. When the portfolio market value changes, primarily due to newly originated transactio ns and the effect of price changes, AGL Resources recognizes the change as a gain or loss in the period of change. When market prices are not readily available or determinable, AGL Resources values certain contracts at fair value using an alternate approach such as model pricing. The determination of market value can be complex and relies upon judgments concerning future prices and liquidity, among other things, particularly in the case of contracts that are longer in term. AGL Resources adjusts the modeling process as appropriate to account for uncertainties such as physical limitations of relevant pipeline systems, distribution requirements, and regulatory uncertainty. AGL Resources adopted EITF Issue No. 02-03 (EITF 02-03), "Accounting for Contracts Involved in Energy Trading and Risk Management Activities," in the third quarter of 2002. EITF 02-03 requires all energy-trading entities within the scope of EITF 98-10 to present gains and losses from energy-trading activities on a net basis and requires Se quent to disclose volumes of physically settled energy trading contracts. AGL Resources has restated prior periods' revenues and cost of sales in the comparative financial statements.
On October 25, 2002, the EITF voted to rescind EITF 98-10, effective December 15, 2002. AGL Resources has not yet determined the effect this rescission will have on its consolidated financial statements.
AGL Networks.Revenues attributable to leases of dark fiber pursuant to indefeasible rights-of-use (IRU) agreements are recognized as services are provided. Dark fiber IRU agreements generally require the customer to make a down payment upon execution of the agreement; however, in some cases AGL Networks receives up to the entire lease payment at inception of the lease and recognizes revenue ratably over the lease term. This results in deferred revenue being recorded on the Company's condensed consolidated balance sheet.
Accounting for contingencies
AGL Resources' accounting for contingencies policies cover a variety of business activities, including contingencies for potentially uncollectible receivables, rate matters and legal and environmental exposures. AGL Resources accrues for these contingencies when its assessments indicate that it is probable that a liability has been incurred or an asset will not be recovered, and an amount can be reasonably estimated in accordance with SFAS No. 5, "Accounting for Contingencies." AGL Resources' estimates for these liabilities are based on currently available facts and its estimates of the ultimate outcome or resolution of the liability in the future. Actual results may differ from estimates, and estimates can be, and often are, revised either negatively or positively, depending upon actual outcomes or expectations based on the facts surrounding each potential exposure.
Pension benefits
AGL Resources has a defined-benefit pension plan for the benefit of substantially all full-time employees. AGL Resources uses several statistical and other factors, which attempt to anticipate future events and to calculate the expense and liability related to the plan. These factors include assumptions about the discount rate, expected return on plan assets and rate of future compensation increases as determined by AGL Resources. In addition, the actuarial consultants also use subjective factors such as withdrawal and mortality rates to estimate the projected benefit obligation. The actuarial assumptions used may differ materially from actual results due to changing market and economic conditions, higher or lower withdrawal rates or longer or shorter life spans of participants. These differences may result in a significant impact on the amount of pension expense recorded in future periods.
The combination of poor market performance and historically low corporate bond rates has created a divergence in the potential value of the pension liability and the actual value of the pension assets. These conditions could result in an increase in AGL Resources' unfunded ABO and future pension expense. The primary assumptions that drive the value of the unfunded ABO are the discount rate and expected return on plan assets.
As reflected in AGL Resources' Form 10-K, the value of the pension asset and the ABO as of September 30, 2001 was $250.4 million and $250.0 million, respectively. As of September 30, 2002 the asset value was approximately $206.9 million. This decline is a result of the conditions mentioned above. A one-percentage point increase or decrease in the assumed discount rate could have approximately a negative or positive $38.0 million impact to the ABO. AGL Resources is currently unable to determine the impact of these changes until an updated actuarial valuation of the pension liability is performed, and asset value is determined, as of December 31, 2002. If we elect not to make a contribution to plan assets equal to the unfunded ABO, there could be an adjustment to other comprehensive income.
Results of Operations
Management evaluates segment performance based on EBIT, which includes the effects of corporate expense allocations. As an indicator of AGL Resources' operating performance or liquidity, EBIT should not be considered an alternative to, or more meaningful than, net income or cash flow as determined in accordance with GAAP. AGL Resources' EBIT may not be comparable to a similarly titled measure of another company.
Distribution Operations:
