If Sequent’s storage withdrawals associated with existing inventory positions are executed as planned, it expects operating revenues from storage withdrawals of approximately $11 million during the next twelve months. This will change as Sequent adjusts its daily injection and withdrawal plans in response to changes in market conditions in future months and as forward NYMEX prices fluctuate. In addition, inventory balances are usually near their lowest point at the end of the first quarter just prior to the start of the inventory injection season as inventories are built for the next heating season.
In March 2011, the New Jersey BPU authorized the renewal of the asset management agreement between Elizabethtown Gas and Sequent. Expiring in March 2014, the renewed agreement requires Sequent to pay minimum annual fees of $5 million to Elizabethtown Gas and includes overall margin sharing levels of 30% to Sequent and 70% to Elizabethtown Gas.
We evaluate segment performance using the measures of operating margin and EBIT, which include the effects of corporate expense allocations. Operating margin is a non-GAAP measure that is calculated as operating revenues minus cost of gas, which excludes operation and maintenance expense, depreciation and amortization, taxes other than income taxes, and the gain or loss on the sale of our assets. These items are included in our calculation of operating income as reflected in our Condensed Consolidated Statements of Income. EBIT is also a non-GAAP measure that includes operating income, other income and expenses. Items that we do not include in EBIT are financing costs, including interest and debt expense and income taxes, each of which we evaluate on a consolidated level.
We believe operating margin is a better indicator than operating revenues for the contribution resulting from customer growth in our distribution operations segment since the cost of gas can vary significantly and is generally billed directly to our customers. We also consider operating margin to be a better indicator in our retail energy operations, wholesale services and energy investments segments since it is a direct measure of operating margin before overhead costs. We believe EBIT is a useful measurement of our operating segments’ performance because it provides information that can be used to evaluate the effectiveness of our businesses from an operational perspective, exclusive of the costs to finance those activities and exclusive of income taxes, neither of which is directly relevant to the efficiency of those operations.
You should not consider operating margin or EBIT an alternative to, or a more meaningful indicator of, our operating performance than operating income, or net income attributable to AGL Resources Inc. as determined in accordance with GAAP. In addition, our operating margin or EBIT measures may not be comparable to similarly titled measures from other companies.
The following table sets forth a reconciliation of our operating margin to operating income and EBIT to our earnings before income taxes and net income, together with other consolidated financial information for the three months ended March 31, 2011 and 2010.
For the first quarter of 2011, net income attributable to AGL Resources Inc. decreased by $10 million or 7% compared to the same period last year. The decrease was primarily the result of reduced operating margins at wholesale services, retail energy operations and energy investments, as well as higher operating expenses primarily at distribution operations. This decrease was partially offset by higher operating margins at distribution operations and decreased income taxes as a result of lower earnings. Additionally, during the three months ended March 31, 2011, we recorded approximately $5 million ($3 million net of tax) of non-recurring transaction expenses associated with the proposed merger with Nicor. These costs are expensed as incurred. The variances for each operating segment are contained within the first quarter 2011 compared to first quarter 2010 discussion on the following pages.
Our income tax expense decreased by $6 million or 7% for the first quarter of 2011 compared to the first quarter of 2010. This was primarily due to lower consolidated earnings. Our income tax expense is determined from earnings before income taxes less net income attributable to the noncontrolling interest.
Selected weather, customer and volume metrics, which we consider to be some of the key performance indicators for our operating segments, for the three months ended March 31, 2011 and 2010, are presented in the following tables. We measure the effects of weather on our business through Heating Degree Days. Generally, increased Heating Degree Days result in greater demand for gas on our distribution systems. However, extended and unusually mild weather during the Heating Season can have a significant negative impact on demand for natural gas. Our customer metrics highlight the average number of customers to which we provide services. This number of customers can be impacted by natural gas prices, economic conditions and competition from alternative fuels.
Volume metrics for distribution operations and retail energy operations present the effects of weather and our customers’ demand for natural gas. Wholesale services’ daily physical sales represent the daily average natural gas volumes sold to its customers. Within our energy investments segment, our natural gas storage businesses seek to have a significant percentage of their working natural gas capacity under firm subscription, but also take into account current and expected market conditions. This allows our natural gas storage business to generate additional revenue during times of peak market demand for natural gas storage services, but retain some consistency with their earnings and maximize the value of the investments.
Operating margin, operating expenses and EBIT information for each of our segments are contained in the following table for the three months ended March 31, 2011 and 2010.
Distribution operations’ EBIT increased by $5 million or 4% compared to last year as shown in the following table.
Retail energy operations’ EBIT decreased by $6 million or 8% compared to last year as shown in the following table.
Wholesale services’ EBIT decreased by $10 million or 23% compared to last year as shown in the following table.
The following table indicates the components of wholesale services’ operating margin for the three months ended March 31, 2011 and 2010.
Energy investments’ EBIT decreased by $2 million compared to last year as shown in the following table.
Overview The acquisition of natural gas, pipeline capacity, payment of dividends and working capital requirements are our most significant short-term financing requirements. The need for long-term capital is driven primarily by capital expenditures and maturities of long-term debt. Additionally, we anticipate incurring indebtedness in connection with financing the consideration for the proposed Nicor merger.
The liquidity required to fund our working capital, capital expenditures and other cash needs is primarily provided by our operating activities. Our short-term cash requirements not met by cash from operations are primarily satisfied with short-term borrowings under our commercial paper program, which is supported by our Credit Facility. Periodically, we raise funds supporting our long-term cash needs from the issuance of long-term debt or equity securities. We regularly evaluate our funding strategy and profile to ensure that we have sufficient liquidity for our short-term and long-term needs in a cost-effective manner.
Our capital market strategy has continued to focus on maintaining a strong Consolidated Statement of Financial Position, ensuring ample cash resources and daily liquidity, accessing capital markets at favorable times as necessary, managing critical business risks and maintaining a balanced capital structure through the appropriate balance of equity or long-term debt securities.
Our issuance of various securities, including long-term and short-term debt and equity, is subject to customary approval or review by state and federal regulatory bodies including the various public service commissions of the states in which we conduct business, the SEC and the FERC. Furthermore, a substantial portion of our consolidated assets, earnings and cash flow are derived from the operation of our regulated utility subsidiaries, whose legal authority to pay dividends or make other distributions to us is subject to regulation.
We believe the amounts available to us under our senior notes, Credit Facility and Bridge Facility, through the issuance of debt and equity securities, combined with cash provided by operating activities, will continue to allow us to meet our needs for working capital, pension contributions, construction expenditures, anticipated debt redemptions, interest payments on debt obligations, dividend payments, common share repurchases, financing requirements for the proposed Nicor merger and other cash needs through the next several years. Nevertheless, our ability to satisfy our working capital requirements and debt service obligations, or fund planned capital expenditures, will substantially depend upon our future operating performance (which will be affected by prevailing economic conditions), and financial, business and other factors, some of which we are unable to control. These factors include, among others, regulatory changes, the price of natural gas, the demand for natural gas and operational risks.
We will continue to evaluate our need to increase available liquidity based on our view of working capital requirements, including the impact of changes in natural gas prices, liquidity requirements established by rating agencies, the proposed merger with Nicor and other factors. See Item 1A, “Risk Factors,” of our Annual Report on Form 10-K for the year ended December 31, 2010, for additional information on items that could impact our liquidity and capital resource requirements.
Cash Flows
The following table provides a summary of our operating, investing and financing cash flows for the three months ended March 31, 2011 and 2010.
| | | Three months ended March 31, | |
| In millions | | 2011 | | | 2010 | |
| Net cash provided by (used in): | | | | | | |
| Operating activities | | $ | 718 | | | $ | 673 | |
| Investing activities | | | (94 | ) | | | (117 | ) |
| Financing activities | | | (563 | ) | | | (563 | ) |
| Net increase (decrease) in cash and cash equivalents | | $ | 61 | | | $ | (7 | ) |
Cash Flow from Operating Activities In the first three months of 2011, our net cash flow provided from operating activities was $718 million, an increase of $45 million or 7% from the same period in 2010. This increase was primarily a result of the recovery of $76 million in working capital in 2011 as a result of colder weather in December 2010 as compared to last year. We also had an increase in cash of $23 million from deferred natural gas costs as a result of fluctuations in natural gas prices as well as an increase in cash of $17 million in trade payables primarily due to the timing differences of wire transfer payments and receipts. These increases were offset by an increase in working capital requirements for Sequent’s energy marketing activities of $41 million during the current year, which was primarily driven by the effects of the timing of payments for gas purchases relative to collections of accounts receivable. Additionally, we had a $24 million decrease in cash from inventories, which was mainly driven by reduced storage volumes at Sequent and Golden Triangle Storage, partially offset by higher storage volumes at SouthStar.
Cash Flow from Investing Activities Our investing activities consisted of PP&E expenditures of $94 million for the three months ended March 31, 2011 compared to $117 million for the same period in 2010. The decrease of $23 million or 20% in PP&E expenditures was primarily due to a $33 million decrease in expenditures for the construction of the Golden Triangle Storage natural gas storage facility, a $7 million decrease in expenditures for system preservation and upgrades to automate meter readings and a $5 million reduction in expenditures for AGL Networks projects. This was offset by increased expenditures of $25 million for STRIDE and other capital projects in distribution operations.
Cash Flow from Financing Activities Our cash used in financing activities was $563 million for the three months ended March 31, 2011, which is in line with the cash used in financing activities for the same period in 2010. Our cash increased by $500 million due to our senior note offering in March 2011. Our prior year purchase of an additional 15% ownership interest in SouthStar resulted in an increase in cash of $58 million compared to the same period in 2010. Offsetting these amounts was our $300 million payment for our senior notes that matured in January 2011. Additionally, net payments on short-term debt increased by $259 million when compared to the same period in 2010 as we paid down our commercial paper borrowings with the remaining proceeds from our senior note offering and cash on hand.
Our capitalization and financing strategy is intended to ensure that we are properly capitalized with the appropriate mix of equity and debt securities. This strategy includes active management of the percentage of total debt relative to total capitalization, appropriate mix of debt with fixed to floating interest rates (our variable-rate debt target is 20% to 45% of total debt), as well as the term and interest rate profile of our debt securities. As of March 31, 2011, our variable-rate debt was 8% of our total debt, compared to 15% as of March 31, 2010. The decrease in our variable-rate debt at March 31, 2011 compared to the same period last year was primarily due to an increase of $200 million in fixed-rate debt resulting from our $500 million senior note offering, which was offset by the January 2011 maturity of $300 million in senior notes. Additionally, our commercial paper borrowings decreased $128 million as a portion of the proceeds from the senior note offering in March 2011 and cash on hand was used to pay down our commercial paper borrowings.
Credit Ratings Our borrowing costs and ability to obtain adequate and cost effective financing are directly impacted by our credit ratings as well as the availability of financial markets. In addition, credit ratings are important to counterparties when we engage in certain transactions including over-the-counter derivatives. It is our long-term objective to maintain or improve our credit ratings on our debt in order to manage our existing financing costs and enhance our ability to raise additional capital on favorable terms.
Credit ratings and outlooks are opinions subject to ongoing review by the rating agencies and may periodically change. Each rating should be evaluated independently of any other rating. The rating agencies regularly review our performance, prospects and financial condition and reevaluate their ratings of our long-term debt and short-term borrowings, including our corporate ratings.
There is no guarantee that a rating will remain in effect for any given period of time or that a rating will not be lowered or withdrawn entirely by a rating agency if, in its judgment, circumstances so warrant. A credit rating is not a recommendation to buy, sell or hold securities.
Factors we consider important in assessing our credit ratings include our Statements of Financial Position leverage, capital spending, earnings, cash flow generation, available liquidity and overall business risks. We do not have any trigger events in our debt instruments that are tied to changes in our specified credit ratings or our stock price and have not entered into any agreements that would require us to issue equity based on credit ratings or other trigger events.
The following table summarizes our credit ratings as of March 31, 2011, and reflects no change from December 31, 2010.
| | | S&P | | Moody’s | | Fitch | |
| Corporate rating | | A- | | | | A- | |
| Commercial paper | | A-2 | | P-2 | | F2 | |
| Senior unsecured | | BBB+ | | Baa1 | | A- | |
| Ratings outlook | | Negative | | Stable | | Stable | |
Subsequent to the announcement of our proposed merger with Nicor, S&P placed our long-term debt ratings and our corporate credit ratings on credit watch with negative implications. The primary reason for this change is the increased leverage we will assume to complete the proposed merger and the uncertainties that exist with the proposed merger.
Our credit ratings depend largely on our financial performance, and a downgrade in our current ratings, particularly below investment grade, could adversely affect our borrowing costs and significantly limit our access to the commercial paper market. In addition, we would likely be required to pay a higher interest rate in future financings, and our potential pool of investors and funding sources would decrease.
Default provisions As of March 31, 2011, December 31, 2010 and March 31, 2010, we were in compliance with all of our existing debt provisions and covenants, both financial and non-financial. Additionally, our Bridge Facility contains the same financial covenant and similar non-financial covenants and default provisions as contained in our Credit Facility; however, most of these are not in effect until we draw under the facility.
Our ratio, on a consolidated basis, of total debt to total capitalization is typically greater at the beginning of the Heating Season as we make additional short-term borrowings to fund our natural gas purchases and meet our working capital requirements. We intend to maintain our capitalization ratio in a target range of 50% to 60%. Accomplishing this capital structure objective and maintaining sufficient cash flow are necessary to maintain attractive credit ratings. For more information on our default provisions see Note 7. The components of our capital structure, as calculated from our Condensed Consolidated Statements of Financial Position, as of the dates indicated, are provided in the following table.
| | | Mar. 31, 2011 | | | Dec. 31, 2010 | | | Mar. 31, 2010 | |
| Short-term debt | | 1 | % | | 23 | % | | 11 | % |
| Long-term debt | | 53 | | | 37 | | | 42 | |
| Total debt | | 54 | | | 60 | | | 53 | |
| Equity | | 46 | | | 40 | | | 47 | |
| Total capitalization | | 100 | % | | 100 | % | | 100 | % |
Short-term debt Our short-term debt during the quarter was composed of borrowings and payments under our Credit Facility and commercial paper program, Term Loan Facility, the current portion of our capital leases and our senior notes maturing in less than one year.
| | | Period end balance outstanding | | Daily average balance outstanding | | Largest balance outstanding | |
| In millions | | | (1) | | | (2) | | | (2) | |
| Commercial paper | | $ | 25 | | $ | 623 | | $ | 835 | |
| Capital leases | | | 1 | | | 1 | | | 1 | |
| Current portion of long-term debt | | | - | | | 47 | | | 300 | |
| Term loan facility | | | - | | | 50 | | | 150 | |
| (1) | As of March 31, 2011. |
| (2) | For the three months ended March 31, 2011. |
The largest amounts borrowed on our commercial paper borrowings are important when assessing the intra-period fluctuation of our short-term borrowings and any potential liquidity risk. Our short-term debt financing generally increases between June and December as we purchase natural gas in advance of the Heating Season. The variation of when we pay our suppliers for natural gas purchases and when we recover our costs from our customers through their monthly bills can significantly affect our short-term cash requirements. Our short-term debt balances are typically reduced during the Heating Season because a significant portion of our current assets, primarily natural gas inventories, are converted into cash.
During the first quarter of 2011, our short-term debt balances were also impacted by our $300 million senior notes, which were current at December 31, 2010 and matured in January 2011. These senior notes were initially repaid with a $150 million funding under our Term Loan Facility and borrowings under our commercial paper program.
In February 2011, the Term Loan Facility was repaid through additional commercial paper borrowings at which time the Term Loan Facility expired. In March 2011, we completed a new $500 million senior note offering, using a portion of the proceeds to reduce outstanding commercial paper to $25 million at March 31, 2011, as compared to $732 million at December 31, 2010 and $153 million at March 31, 2010.
The timing of natural gas withdrawals is dependent on the weather and natural gas market conditions, both of which impact the price of natural gas. Increasing natural gas commodity prices can have a significant impact on our commercial paper borrowings. Based on current natural gas prices and our expected purchases during the upcoming injection season, a $1 increase per Mcf in natural gas prices could result in an additional $60 to $70 million of working capital requirements during the peak of the Heating Season based upon our current injection plan. This range is sensitive to the timing of storage injections and withdrawals, collateral requirements and our portfolio position.
The lenders under our Credit Facility and Bridge Facility are all major financial institutions with approximately $2.1 billion of committed balances and all have investment grade credit ratings as of March 31, 2011. It is possible that one or more lending commitments could be unavailable to us if the lender defaulted due to lack of funds or insolvency. However, based on our current assessment of our lenders’ creditworthiness, we believe the risk of lender default is minimal. As of March 31, 2011 and 2010, we had no outstanding borrowings on our Credit Facility or Bridge Facility.
Long-term debt Our long-term debt matures more than one year from the date of our Statements of Financial Position and consists of medium-term notes, senior notes, gas facility revenue bonds and capital leases.
In March 2011, we completed a public offering of $500 million senior notes that mature in 2041 with an interest rate of 5.875%. A portion of the net proceeds of this offering was used to pay down the commercial paper borrowings that were used to repay the $300 million of senior notes that matured in January 2011. The remaining proceeds are expected to be used to pay a portion of the cash consideration and expenses incurred in connection with the proposed merger with Nicor, if completed, or for other general corporate purposes. In connection with our issuance of these senior notes, and in accordance with the terms of the Bridge Facility, the principal amount of the Bridge Facility has been reduced from $1.05 billion to $852 million. For more information on our senior notes see Note 7.
Noncontrolling Interest In We recorded cash distribution for SouthStar’s dividends paid to Piedmont of $16 million for the three months ended March 31, 2011 and $27 million for the three months ended March 31, 2010.
Dividends on Common Stock Our common stock dividend payments were $34 million for the three months ended March 31, 2011 and $33 million for the three months ended March 31, 2010. The increase was generally the result of annual dividend increases of $0.04 per share for each of the last two years. For information about restrictions on our ability to pay dividends on our common stock, see Note 2.
Contractual Obligations and Commitments We have incurred various contractual obligations and financial commitments in the normal course of our operating and financing activities that are reasonably likely to have a material effect on liquidity or the availability of requirements for capital resources. Contractual obligations include future cash payments required under existing contractual arrangements, such as debt and lease agreements. These obligations may result from both general financing activities and from commercial arrangements that are directly supported by related revenue-producing activities. Contingent financial commitments represent obligations that become payable only if certain predefined events occur, such as financial guarantees, and include the nature of the guarantee and the maximum potential amount of future payments that could be required of us as the guarantor.
Pension Contributions In the first three months of 2011 we contributed $38 million to our qualified pension plans and an additional $6 million in April 2011 for a total of $44 million during 2011. We plan to make additional contributions up to $12 million, for a total of up to $56 million during 2011. Based on the funding status of the plans as of December 31, 2010, we were required to make a minimum contribution to the plans of $30 million in 2011. In the three months ended March 31, 2010, we contributed $17 million to our pension plans and through April 2010, we contributed $21 million.
During the three months ended March 31, 2011, we recorded net periodic benefit costs of $5 million related to our defined pension and postretirement benefit plans compared to $4 million during the same period last year. We estimate that during the remainder of 2011, we will record net periodic pension and other postretirement benefit costs in the range of $14 million to $16 million, a $2 million increase compared to 2010. In determining our estimated expenses for 2011, our actuarial consultant assumed an 8.50% expected return on plan assets and a discount rate of 5.40% for the AGL Retirement Plan and 5.20% for the NUI Retirement Plan and for our postretirement plan.
The following table illustrates our expected future contractual obligation payments such as debt and lease agreements, and commitments and contingencies as of March 31, 2011.
| | | | | | | | | 2012 & | | | 2014 & | | | 2016 & | |
| In millions | | Total | | | 2011 | | | 2013 | | | 2015 | | | thereafter | |
| Recorded contractual obligations: | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Long-term debt | | $ | 2,173 | | | $ | - | | | $ | 242 | | | $ | 200 | | | $ | 1,731 | |
Regulatory infrastructure program costs (1) | | | 212 | | | | 47 | | | | 165 | | | | - | | | | - | |
Environmental remediation liabilities (1) | | | 141 | | | | 11 | | | | 63 | | | | 53 | | | | 14 | |
| Short-term debt | | | 26 | | | | 26 | | | | - | | | | - | | | | - | |
| Total | | $ | 2,552 | | | $ | 84 | | | $ | 470 | | | $ | 253 | | | $ | 1,745 | |
Unrecorded contractual obligations and commitments (2) (7): | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Pipeline charges, storage capacity and gas supply (3) | | $ | 1,909 | | | $ | 446 | | | $ | 704 | | | $ | 290 | | | $ | 469 | |
Interest charges (4) | | | 1,740 | | | | 88 | | | | 224 | | | | 201 | | | | 1,227 | |
Operating leases (5) | | | 111 | | | | 20 | | | | 40 | | | | 20 | | | | 31 | |
Asset management agreements (6) | | | 26 | | | | 10 | | | | 14 | | | | 2 | | | | - | |
| Standby letters of credit, performance / surety bonds | | | 16 | | | | 12 | | | | 4 | | | | - | | | | - | |
| Total | | $ | 3,802 | | | $ | 576 | | | $ | 986 | | | $ | 513 | | | $ | 1,727 | |
| (1) | Includes charges recoverable through rate rider mechanisms. |
| (2) | In accordance with GAAP, these items are not reflected in our Condensed Consolidated Statements of Financial Position. |
| (3) | Charges recoverable through a natural gas cost recovery mechanism or alternatively billed to Marketers, and includes demand charges associated with Sequent. Also includes SouthStar’s natural gas purchase commitments of 23 Bcf at floating gas prices calculated using forward natural gas prices as of March 31, 2011, and are valued at $97 million. |
| (4) | Floating rate debt is based on the interest rate as of March 31, 2011, and the maturity of the underlying debt instrument. As of March 31, 2011, we have $30 million of accrued interest on our Condensed Consolidated Statements of Financial Position that will be paid over the next 12 months. |
| (5) | We have certain operating leases with provisions for step rent or escalation payments and certain lease concessions. We account for these leases by recognizing the future minimum lease payments on a straight-line basis over the respective minimum lease terms, in accordance with authoritative guidance related to leases. However, this lease accounting treatment does not affect the future annual operating lease cash obligations as shown herein. Additionally, minimum payments have not been reduced by minimum sublease rentals of $15 million due in the future under noncancelable subleases. |
| (6) | Represent fixed-fee minimum payments for Sequent’s asset management agreements. |
| (7) | The Merger Agreement with Nicor contains termination rights for both us and Nicor and provides that, if we terminate the agreement under specified circumstances, we may be required to pay a termination fee of $67 million. In addition, if we terminate the agreement due to a failure to obtain the necessary financing for the transaction, we may also be required to pay Nicor $115 million. |
The preparation of our financial statements in conformity with GAAP requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the related disclosures of contingent assets and liabilities. We based our estimates on historical experience, where applicable, and various other assumptions that we believe to be reasonable under the circumstances. We evaluate our estimates on an ongoing basis, and our actual results may differ from these estimates. Our critical accounting estimates used in the preparation of our Condensed Consolidated Financial Statements include the following:
| · | Regulatory Infrastructure Program Liabilities |
| · | Environmental Remediation Liabilities |
| · | Derivatives and Hedging Activities |
| · | Pension and Other Postretirement Plans |
Each of our critical accounting estimates 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 our financial statements. There have been no significant changes to our critical accounting estimates from those disclosed in our Management’s Discussion and Analysis of Financial Condition and Results of Operation as filed on Form 10-K with the SEC on February 9, 2011.
We are exposed to risks associated with natural gas prices, interest rates and credit. Natural gas price risk is defined as the potential loss that we may incur as a result of changes in the fair value of natural gas. Interest rate risk results from our portfolio of debt and equity instruments that we issue to provide financing and liquidity for our business. Credit risk results from the extension of credit throughout all aspects of our business, but is particularly concentrated at Atlanta Gas Light in distribution operations and in wholesale services.
Our Risk Management Committee (RMC) is responsible for establishing the overall risk management policies and monitoring compliance with, and adherence to, the terms within these policies, including approval and authorization levels and delegation of these levels. Our RMC consists of members of senior management who monitor open natural gas price risk positions and other types of risk, corporate exposures, credit exposures and overall results of our risk management activities. It is chaired by our chief risk officer, who is responsible for ensuring that appropriate reporting mechanisms exist for the RMC to perform its monitoring functions. Our risk management activities and related accounting treatment for our derivative financial instruments are described in further detail in Note 5.
Natural Gas Price Risk
The following tables include the fair value and average values of our consolidated derivative financial instruments as of the dates indicated. We base the average values on monthly averages for the three months ended March 31, 2011 and 2010.
| | | Derivative financial instruments average values (1) at March 31, | |
| In millions | | 2011 | | | 2010 | |
| Asset | | $ | 210 | | | $ | 209 | |
| Liability | | | 47 | | | | 7 | |
| (1) | Excludes cash collateral amounts. |
| | | Derivative financial instruments fair values netted with cash collateral at | |
| In millions | | Mar. 31, 2011 | | | Dec. 31, 2010 | | | Mar. 31, 2010 | |
| Asset | | $ | 153 | | | $ | 228 | | | $ | 261 | |
| Liability | | | 28 | | | | 48 | | | | 82 | |
The following tables illustrate the change in the net fair value of our derivative financial instruments during the three months ended March 31, 2011 and 2010, and provide details of the net fair value of contracts outstanding as of March 31, 2011 and 2010.
| | | Three months ended March 31, | |
| In millions | | 2011 | | | 2010 | |
| Net fair value of derivative financial instruments outstanding at beginning of period | | $ | 75 | | | $ | 121 | |
| Derivative financial instruments realized or otherwise settled during period | | | (55 | ) | | | (64 | ) |
| Change in net fair value of derivative financial instruments | | | 17 | | | | 16 | |
| Net fair value of derivative financial instruments outstanding at end of period | | | 37 | | | | 73 | |
| Netting of cash collateral | | | 88 | | | | 105 | |
| Cash collateral and net fair value of derivative financial instruments outstanding at end of period | | $ | 125 | | | $ | 178 | |
The sources of net fair value of our natural gas-related derivative financial instruments at March 31, 2011, are as follows:
| In millions | | | Prices actively quoted (Level 1) (1) | | | Significant other observable inputs (Level 2) (2) | |
| Mature through | | | | | | | |
2011 | | | $ | (32 | ) | | $ | 43 | |
| 2012 – 2013 | | | (17 | ) | | | 41 | |
| 2014 – 2016 | | | | - | | | | 2 | |
Total derivative financial instruments (3) | | | $ | (49 | ) | | $ | 86 | |
| (1) | Valued using NYMEX futures prices and other quoted sources. |
| (2) | Values primarily related to basis transactions that represent the cost to transport natural gas from a NYMEX delivery point to the contract delivery point. These transactions are based on quotes obtained either through electronic trading platforms or directly from brokers. |
| (3) | Excludes cash collateral amounts. |
Value at Risk Our open exposure is managed in accordance with established policies that limit market risk and require daily reporting of potential financial exposure to senior management, including the chief risk officer. Because we generally manage physical gas assets and economically protect our positions by hedging in the futures markets, our open exposure is generally immaterial, permitting us to operate within relatively low VaR limits. We employ daily risk testing, using both VaR and stress testing, to evaluate the risks of its open positions.
Management actively monitors open natural gas positions and the resulting VaR. We continue to maintain a relatively matched book, where our total buy volume is close to sell volume with minimal open natural gas price risk. Based on a 95% confidence interval and employing a 1-day holding period for all positions, our portfolio of positions for the three months ended March 31, 2011 and 2010 had the following VaRs.
| | | Three months ended March 31, | |
| In millions | | 2011 | | | 2010 | |
| Period end | | $ | 1.8 | | | $ | 0.7 | |
| Average | | | 1.4 | | | | 1.4 | |
| High | | | 1.8 | | | | 3.0 | |
| Low | | | 0.9 | | | | 0.7 | |
Interest Rate Risk
Interest rate fluctuations expose our variable-rate debt to changes in interest expense and cash flows. Our policy is to manage interest expense using a combination of fixed-rate and variable-rate debt. Based on $185 million of variable-rate debt outstanding at March 31, 2011, a 100 basis point change in average market interest rates from 0.26% to 1.26% would have resulted in an increase in pretax interest expense of $2 million on an annualized basis.
Credit Risk
Wholesale Services Sequent has established credit policies to determine and monitor the creditworthiness of counterparties, as well as the quality of pledged collateral. Sequent also utilizes master netting agreements whenever possible to mitigate exposure to counterparty credit risk. When Sequent is engaged in more than one outstanding derivative transaction with the same counterparty and it has a legally enforceable netting agreement with that counterparty, the “net” mark-to-market exposure represents the netting of the positive and negative exposures with that counterparty and a reasonable measure of Sequent’s credit risk. Sequent also uses other netting agreements with certain counterparties with whom it conducts significant transactions. Master netting agreements enable Sequent to net certain assets and liabilities by counterparty. Sequent also nets across product lines and against cash collateral provided the master netting and cash collateral agreements include such provisions.
Additionally, Sequent may require counterparties to pledge additional collateral when deemed necessary. Sequent conducts credit evaluations and obtains appropriate internal approvals for its counterparty’s line of credit before any transaction with the counterparty is executed. In most cases, the counterparty must have an investment grade rating, which includes a minimum long-term debt rating of Baa3 from Moody’s and BBB- from S&P. Generally, Sequent requires credit enhancements by way of guaranty, cash deposit or letter of credit for counterparties that do not have investment grade ratings.
Sequent, which provides services to marketers and utility and industrial customers, also has a concentration of credit risk as measured by its 30-day receivable exposure plus forward exposure. As of March 31, 2011, Sequent’s top 20 counterparties represented approximately 56% of the total counterparty exposure of $395 million, derived by adding together the top 20 counterparties’ exposures and dividing by the total of Sequent’s counterparties’ exposures. Sequent’s counterparties, or the counterparties’ guarantors, had a weighted-average S&P equivalent credit rating of BBB+ at March 31, 2011 and December 31, 2010 and A- at March 31, 2010. The S&P equivalent credit rating is determined by a process of converting the lower of the S&P and Moody’s ratings to an internal rating ranging from 9 to 1, with 9 being the equivalent to AAA/Aaa by S&P and Moody’s and 1 being D or Default by S&P and Moody’s.
A counterparty that does not have an external rating is assigned an internal rating based on the strength of the financial ratios for that counterparty. To arrive at the weighted-average credit rating, each counterparty is assigned an internal ratio, which is multiplied by their credit exposure and summed for all counterparties. The sum is divided by the aggregate total counterparties’ exposures, and this numeric value is then converted to an S&P equivalent. There were no credit defaults with Sequent’s counterparties in the quarter ended March 31, 2011.
The following table shows Sequent’s third-party natural gas contracts receivable and payable positions as of March 31, 2011 and 2010 and December 31, 2010.
| | | Gross receivables | | | Gross payables | |
| | | Mar. 31, | | | Dec. 31, | | | Mar. 31, | | | Mar. 31, | | | Dec. 31, | | | Mar. 31, | |
| In millions | | 2011 | | | 2010 | | | 2010 | | | 2011 | | | 2010 | | | 2010 | |
| Netting agreements in place: | | | | | | | | | | | | | | | | | | |
| Counterparty is investment grade | | $ | 337 | | | $ | 515 | | | $ | 449 | | | $ | 255 | | | $ | 341 | | | $ | 328 | |
| Counterparty is non-investment grade | | | 8 | | | | 11 | | | | 3 | | | | 37 | | | | 40 | | | | 19 | |
| Counterparty has no external rating | | | 208 | | | | 260 | | | | 101 | | | | 317 | | | | 363 | | | | 265 | |
| No netting agreements in place: | | | | | | | | | | | | | | | | | | | | | | | | |
| Counterparty is investment grade | | | 9 | | | | 2 | | | | 10 | | | | 14 | | | | - | | | | 8 | |
| Counterparty has no external rating | | | 2 | | | | - | | | | - | | | | 2 | | | | - | | | | - | |
| Amount recorded on statements of financial position | | $ | 564 | | | $ | 788 | | | $ | 563 | | | $ | 625 | | | $ | 744 | | | $ | 620 | |
Sequent has certain trade and credit contracts that have explicit minimum credit rating requirements. These credit rating requirements typically give counterparties the right to suspend or terminate credit if our credit ratings are downgraded to non-investment grade status. Under such circumstances, Sequent would need to post collateral to continue transacting business with some of its counterparties. If such collateral were not posted, Sequent’s ability to continue transacting business with these counterparties would be negatively impacted. If our credit ratings had been downgraded to non-investment grade status, the required amounts to satisfy potential collateral demands under such agreements between Sequent and its counterparties would have totaled $28 million at March 31, 2011, which would not have a material impact to our condensed consolidated results of operations, cash flows or financial condition.
There have been no other significant changes to our credit risk related to our other segments, as described in Item 7A ”Quantitative and Qualitative Disclosures about Market Risk” of our Annual Report on Form 10-K for the year ended December 31, 2010.
(a) Evaluation of disclosure controls and procedures. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act), as of March 31, 2011, the end of the period covered by this report. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of March 31, 2011, in providing a reasonable level of assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods in SEC rules and forms, including a reasonable level of assurance that information required to be disclosed by us in such reports is accumulated and communicated to our management, including our principal executive officer and our principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
(b) Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting that occurred during the first quarter ended March 31, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 1. Legal Proceedings
The nature of our business ordinarily results in periodic regulatory proceedings before various state and federal authorities and litigation incidental to the business. For information regarding pending federal and state regulatory matters see “Note 9 - Commitments and Contingencies” contained in Item 1 of Part I under the caption “Notes to Condensed Consolidated Financial Statements (Unaudited).”
With regard to legal proceedings, we are a party, as both plaintiff and defendant, to a number of other suits, claims and counterclaims on an ongoing basis. Management believes that the outcome of all such other litigation in which it is involved has not had and will not have a material adverse effect on our Consolidated Financial Statements.
The following table sets forth information about purchases of our common stock by us and any affiliated purchasers during the three months ended March 31, 2011. Stock repurchases may be made in the open market or in private transactions at times and in amounts that we deem appropriate. However, there is no guarantee as to the exact number of additional shares that may be repurchased, and we may terminate or limit the stock repurchase program at any time. We currently anticipate holding the repurchased shares as treasury shares.
| Period | | Total number of shares purchased (1) (2) | | | Average price paid per share | | | Total number of shares purchased as part of publicly announced plans or programs (2) | | | Maximum number of shares that may yet be purchased under the publicly announced plans or programs (2) | |
| January 2011 | | | 54,450 | | | $ | 36.22 | | | | 54,450 | | | | 4,707,051 | |
| February 2011 | | | 10,800 | | | | 36.38 | | | | 10,800 | | | | 4,696,251 | |
| March 2011 | | | 30,000 | | | | 21.91 | | | | - | | | | 4,696,251 | |
| Total first quarter | | | 95,250 | | | $ | 31.73 | | | | 65,250 | | | | | |
| (1) | On March 20, 2001, our Board of Directors approved the purchase of up to 600,000 shares of our common stock in the open market to be used for issuances under the Officer Incentive Plan (Officer Plan). We purchased 30,000 shares for such purposes in the first quarter of 2011. As of March 31, 2011, we had purchased a total of 377,153 of the 600,000 shares authorized for purchase, leaving 222,847 shares available for purchase under this program. |
| (2) | On February 3, 2006, we announced that our Board of Directors had authorized a plan to repurchase up to a total of 8 million shares of our common stock, excluding the shares remaining available for purchase in connection with the Officer Plan as described in note (1) above, over a five-year period. This plan expired January 31, 2011 and 10,800 shares that were purchased in January 2011 settled in February 2011. |
| 12 | Statement of Computation of Ratio of Earnings to Fixed Charges. |
| 31.1 | Certification of John W. Somerhalder II pursuant to Rule 13a - 14(a). |
| 31.2 | Certification of Andrew W. Evans pursuant to Rule 13a - 14(a). |
| 32.1 | Certification of John W. Somerhalder II pursuant to 18 U.S.C. Section 1350. |
| 32.2 | Certification of Andrew W. Evans pursuant to 18 U.S.C. Section 1350. |
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Attached as Exhibit 101 to this Quarterly Report are the following documents formatted in extensible business reporting language (XBRL): (i) Document and Entity Information; (ii) Condensed Consolidated Statements of Financial Position at March 31, 2011, December 31, 2010 and March 31, 2010; (iii) Condensed Consolidated Statements of Income for the three months ended March 31, 2011 and 2010; (iv) Condensed Consolidated Statements of Equity for the three months ended March 31, 2011 and 2010; (v) Condensed Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2011 and 2010; (vi) Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2011 and 2010; and (vii) Notes to Condensed Consolidated Financial Statements. Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability. We also make available on our web site the Interactive Data Files submitted as Exhibit 101 to this Quarterly Report. | |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
AGL RESOURCES INC.
(Registrant)
Date: May 3, 2011 /s/ Andrew W. Evans
Executive Vice President and Chief Financial Officer
