<PAGE 1>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549-1004
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1996
OR
[ ] 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 1-7316
COMMONWEALTH ENERGY SYSTEM
(Exact name of registrant as specified in its Declaration of Trust)
Massachusetts 04-1662010
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Main Street, Cambridge, Massachusetts 02142-9150
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (617) 225-4000
(Former name, address and fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES X NO
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Outstanding at
Class of Common Stock August 1, 1996
Common Shares of Beneficial
Interest, $2 par value 21,529,676 shares
<PAGE 2>
PART I. - FINANCIAL INFORMATION
Item 1. Financial Statements
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
CONDENSED BALANCE SHEETS
JUNE 30, 1996 AND DECEMBER 31, 1995
ASSETS
(Dollars in thousands)
June 30, December 31,
1996 1995
(Unaudited)
PROPERTY, PLANT AND EQUIPMENT, at original cost
Electric $1 116 039 $1 105 502
Gas 349 818 346 990
Other 63 300 63 132
1 529 157 1 515 624
Less - Accumulated depreciation and
amortization 521 112 497 627
1 008 045 1 017 997
Add - Construction work in progress
and nuclear fuel in process 17 599 10 276
1 025 644 1 028 273
LEASED PROPERTY, net 14 387 14 931
EQUITY IN CORPORATE JOINT VENTURES
Nuclear electric power companies (2.5%
to 4.5%) 10 123 9 814
Other investments 3 458 3 400
13 581 13 214
CURRENT ASSETS
Cash 2 983 4 319
Accounts receivable 98 918 105 377
Unbilled revenues 14 596 31 642
Inventories, at average cost 23 759 25 538
Prepaid taxes and other 6 637 15 843
146 893 182 719
DEFERRED CHARGES 151 029 150 964
$1 351 534 $1 390 101
See accompanying notes.
<PAGE 3>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
CONDENSED BALANCE SHEETS
JUNE 30, 1996 AND DECEMBER 31, 1995
CAPITALIZATION AND LIABILITIES
(Dollars in thousands)
June 30, December 31,
1996 1995
(Unaudited)
CAPITALIZATION
Common share investment -
Common shares, $2 par value -
Authorized - 50,000,000 shares
Outstanding - 21,529,676 in 1996 and
21,528,268 in 1995 $ 43 059 $ 43 056
Amounts paid in excess of par value 111 778 111 749
Retained earnings 256 238 235 980
411 075 390 785
Redeemable preferred shares, less current
sinking fund requirements 13 590 13 840
Long-term debt, including premiums, less current
sinking fund requirements and maturing debt 361 786 377 181
786 451 781 806
CAPITAL LEASE OBLIGATIONS 12 747 13 291
CURRENT LIABILITIES
Interim Financing -
Notes payable to banks 59 750 55 600
Maturing long-term debt 24 260 33 230
84 010 88 830
Other Current Liabilities -
Current sinking fund requirements 8 473 9 103
Accounts payable 114 036 134 908
Accrued taxes 17 425 31 587
Other 35 446 35 407
175 380 211 005
259 390 299 835
DEFERRED CREDITS
Accumulated deferred income taxes 172 224 170 182
Unamortized investment tax credits
and other 120 722 124 987
292 946 295 169
COMMITMENTS AND CONTINGENCIES
$1 351 534 $1 390 101
See accompanying notes.
<PAGE 4>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
CONDENSED STATEMENTS OF INCOME
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1996 AND 1995
(Dollars in thousands, except per share amounts)
(Unaudited)
Three Months Ended Six Months Ended
1996 1995 1996 1995
OPERATING REVENUES
Electric $151 185 $138 643 $318 953 $290 546
Gas 68 033 67 072 191 756 175 050
Steam and other 3 884 3 539 11 097 9 272
223 102 209 254 521 806 474 868
OPERATING EXPENSES
Fuel and purchased power 77 750 76 252 176 769 163 468
Cost of gas sold 38 193 39 419 99 806 90 555
Other operation and maintenance 64 915 62 800 126 168 124 691
Depreciation 11 844 11 244 26 511 24 995
Taxes -
Federal and state income 5 853 (4 040) 22 901 8 817
Local property and other 5 504 5 864 14 387 14 227
204 059 191 539 466 542 426 753
OPERATING INCOME 19 043 17 715 55 264 48 115
OTHER INCOME 820 23 3 221 1 536
INCOME BEFORE INTEREST CHARGES 19 863 17 738 58 485 49 651
INTEREST CHARGES
Long-term debt 8 858 9 772 18 230 19 571
Other interest charges 1 618 1 884 3 066 3 317
Allowance for borrowed funds
used during construction (76) (348) (181) (600)
10 400 11 308 21 115 22 288
NET INCOME 9 463 6 430 37 370 27 363
Dividends on preferred shares 267 282 534 564
EARNINGS APPLICABLE TO
COMMON SHARES $ 9 196 $ 6 148 $ 36 836 $ 26 799
AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING (a) 21 529 676 21 249 624 21 529 676 21 191 128
EARNINGS PER COMMON SHARE (a) $ .43 $ .29 $1.71 $1.26
DIVIDENDS DECLARED PER
COMMON SHARE (a) $.385 $.375 $ .77 $ .75
(a) Prior period amounts have been restated to reflect a two-for-one stock
split that became effective June 5, 1996.
See accompanying notes.
<PAGE 5>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
CONDENSED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1996 AND 1995
(Dollars in thousands)
(Unaudited)
1996 1995
OPERATING ACTIVITIES
Net income $ 37 370 $ 27 363
Effects of noncash items -
Depreciation and amortization 32 225 30 987
Deferred income taxes and investment
tax credits, net 190 (577)
Earnings from corporate joint ventures (892) (763)
Dividends from corporate joint ventures 525 867
Change in working capital, exclusive of cash
and interim financing (1 135) 38 086
All other operating items (9 284) (20 887)
Net cash provided by operating activities 58 999 75 076
INVESTING ACTIVITIES
Additions to property, plant and equipment
(exclusive of AFUDC) -
Electric (19 123) (26 927)
Gas (3 233) (6 150)
Other (253) (522)
Allowance for borrowed funds used during
construction (181) (600)
Net cash used for investing activities (22 790) (34 199)
FINANCING ACTIVITIES
Sale of common shares 32 4 798
Payment of dividends (17 112) (16 490)
Proceeds from (payment of) short-term borrowings 4 150 (21 700)
Long-term debt issues refunded (23 230) (10 000)
Sinking funds payments (1 385) (1 825)
Net cash used for financing activities (37 545) (45 217)
Net decrease in cash (1 336) (4 340)
Cash at beginning of period 4 319 7 722
Cash at end of period $ 2 983 $ 3 382
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest (net of capitalized amounts) $ 19 785 $ 20 884
Income taxes $ 17 173 $ 4 545
See accompanying notes.
<PAGE 6>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
NOTES TO CONDENSED FINANCIAL STATEMENTS
(1) General Information
Commonwealth Energy System, the parent company, is referred to in this
report as the "System" and, together with its subsidiaries, is collec-
tively referred to as "the system." The System is an exempt public
utility holding company under the provisions of the Public Utility Holding
Company Act of 1935 with investments in four operating public utility
companies located in central, eastern and southeastern Massachusetts. In
addition, the System has interests in other utility and several non-
regulated companies.
The system has 2,044 regular employees including 1,209 (59%)
represented by various collective bargaining units. Negotiations to
resolve a labor dispute with one collective bargaining unit that
represents approximately 17% of regular employees are ongoing. The
agreement that covered this bargaining unit expired on March 31, 1996 and
work performed by these employees has been disrupted since that time. A
workforce of management personnel and experienced contractors are
performing all essential tasks. Management is unable to predict the
ultimate outcome of these negotiations. New agreements were reached
earlier this year with two other bargaining units (representing
approximately 23% of regular employees) that were scheduled to expire on
October 1, 1996 and November 1, 1997. These new agreements will remain in
effect until 2002 and 2001, respectively.
(2) Significant Accounting Policies
(a) Principles of Accounting
The system's significant accounting policies are described in Note 1
of Notes to Consolidated Financial Statements included in its 1995 Annual
Report on Form 10-K filed with the Securities and Exchange Commission.
For interim reporting purposes, the system follows these same basic
accounting policies but considers each interim period as an integral part
of an annual period and makes allocations of certain expenses to interim
periods based upon estimates of such expenses for the year.
Generally, expenses which relate to more than one interim period are
allocated to other periods to more appropriately match revenues and
expenses. Principal items of expense which are allocated other than on
the basis of passage of time are depreciation and property taxes of the
gas subsidiary, Commonwealth Gas Company (Commonwealth Gas). These
expenses are recorded for interim reporting purposes based upon projected
gas revenue. Income tax expense is recorded using the statutory rates in
effect applied to book income subject to tax for each interim period.
The unaudited financial statements for the periods ended June 30, 1996
and 1995, reflect, in the opinion of the System, all adjustments (consist-
ing of only normal recurring accruals) necessary to summarize fairly the
results for such periods. In addition, certain prior period amounts are
reclassified from time to time to conform with the presentation used in
the current period's financial statements.
<PAGE 7>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
The results for interim periods are not necessarily indicative of
results for the entire year because of seasonal variations in the
consumption of energy and Commonwealth Gas' seasonal rate structure.
(b) Regulatory Assets and Liabilities
Regulated subsidiaries of the System have established various
regulatory assets in cases where the Massachusetts Department of Public
Utilities (DPU) and/or the Federal Energy Regulatory Commission (FERC)
have permitted or are expected to permit recovery of specific costs over
time. Similarly, the regulatory liabilities established by the system are
required to be refunded to customers over time.
Based on the current regulatory framework, the system accounts for the
economic effects of regulation in accordance with the provisions of
Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for
the Effects of Certain Types of Regulation." On January 1, 1996, the
system adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of." SFAS No. 121 imposes
stricter criteria for regulatory assets by requiring that such assets be
probable of future recovery at each balance sheet date. As of June 30,
1996, SFAS No. 121 did not have an impact on its financial position or
results of operations. However, this result may change as modifications
are made in the current regulatory framework pursuant to electric utility
restructuring orders issued by the DPU including a final order that is
expected to be issued by the end of 1996. For additional discussion of
electric industry restructuring activities, see Management's Discussion
and Analysis of Financial Condition and Results of Operations in Item 2 of
this report.
The principal regulatory assets included in deferred charges were as
follows:
June 30, December 31,
1996 1995
(Dollars in thousands)
Postretirement benefit costs including
pensions $ 24 701 $ 24 608
Power contract buy-out 22 460 23 838
Fuel charge stabilization 21 975 22 063
Deferred income taxes 14 188 14 106
FERC Order 636 transition costs 10 726 11 711
Yankee Atomic unrecovered plant
and decommissioning costs 9 001 10 135
Seabrook related costs 7 891 9 511
Other 14 083 14 700
$125 025 $130 672
The principal regulatory liabilities, reflected in the accompanying
condensed balance sheets and related to deferred income taxes, were $19
million and $20.6 million at June 30, 1996 and December 31, 1995,
respectively.
<PAGE 8>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
(3) Commitments and Contingencies
Construction Program
The system is engaged in a continuous construction program presently
estimated at $293 million for the five-year period 1996 through 2000. Of
that amount, $69.3 million is estimated for 1996. The program is subject
to periodic review and revision.
(4) Common Shares
On June 5, 1996, the System effected a two-for-one stock split of its
outstanding common shares which was proposed by the System's Board of
Trustees on March 28, 1996 and subsequently approved by the System's
shareholders on May 2, 1996. The record date for the stock split was May
15, 1996. The split resulted in the issuance of an additional 10.8
million common shares and accompanied an increase in the number of
authorized common shares from 18 million to 50 million and a change in the
par value from four dollars to two dollars per common share. Prior period
amounts for the average number of common shares outstanding, earnings per
common share, dividends declared per common share and common share
investment information in the accompanying condensed financial statements
have been restated to reflect the stock split.
<PAGE 9>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Financial Condition
Capital resources of the System and its subsidiaries are derived
principally from retained earnings and equity funds provided through the
System's Dividend Reinvestment and Common Share Purchase Plan (DRP).
However, effective February 1, 1996, the System's DRP common share
requirement is being fulfilled through open market purchases rather than
the direct issue of common shares. This change was prompted by the
System's improving financial condition and reduced need for equity
capital. Supplemental interim funds are borrowed on a short-term basis
and, when necessary, replaced with new equity and/or debt issues through
permanent financing secured on an individual company basis. The System
purchases 100% of all subsidiary common stock issues and provides, to the
extent possible, a portion of the subsidiaries' short-term financing
needs. These capital resources provide the funds required for the
subsidiary companies' construction programs, current operations, debt
service and other capital requirements.
During the first half of 1996, cash flows from operating activities
amounted to approximately $59 million and reflect net income of $37.4
million and noncash items including depreciation of $26.5 million and $5.7
million in amortization and deferred income taxes. Working capital since
December 31, 1995, exclusive of cash and interim financing, decreased
$1.1 million reflecting lower levels of accounts payable ($20.9 million)
and accrued taxes ($14.2 million) offset, in part, by a decrease in
unbilled revenues ($17 million), prepaid taxes ($9 million), accounts
receivable ($6.5 million) and inventories ($1.8 million).
Construction expenditures for the first half of 1996 were approxi-
mately $22.8 million, including an allowance for funds used during
construction (AFUDC) and nuclear fuel. Construction expenditures,
preferred and common dividend requirements of the System ($17.1 million)
and the refunding of long-term debt ($23.2 million) were funded almost
entirely with internally-generated funds. Proceeds from short-term
borrowings of $4.2 million helped to meet the cash requirements for the
current six-month period.
Results of Operations
The following is a discussion of certain significant factors that have
affected operating revenues, expenses and net income during the periods
included in the accompanying condensed statements of income. This
discussion should be read in conjunction with the Notes to Condensed
Financial Statements appearing elsewhere in this report.
<PAGE 10>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
A summary of the period to period changes in the principal items
included in the accompanying condensed statements of income for the three
and six-month periods ended June 30, 1996 and 1995 and unit sales for
these periods is shown below:
Three Months Six Months
Ended June 30, Ended June 30,
1996 and 1995 1996 and 1995
Increase (Decrease)
(Dollars in thousands)
Operating Revenues -
Electric $12 542 9.0% $28 407 9.8%
Gas 961 1.4 16 706 9.5
Steam and other 345 9.7 1 825 19.7
13 848 6.6 46 938 9.9
Operating Expenses -
Fuel and purchased power 1 498 2.0 13 301 8.1
Cost of gas sold (1 226) (3.1) 9 251 10.2
Other operation and maintenance 2 115 3.4 1 477 1.2
Depreciation 600 5.3 1 516 6.1
Taxes -
Federal and state income 9 544 236.2 14 084 159.7
Local property and other (11) (0.2) 160 1.1
12 520 6.5 39 789 9.3
Operating Income 1 328 7.5 7 149 14.9
Other Income 797 3465.2 1 685 109.7
Income Before Interest Charges 2 125 12.0 8 834 17.8
Interest Charges (908) (8.0) (1 173) (5.3)
Net Income 3 033 47.2 10 007 36.6
Dividends on preferred shares (15) (5.3) (30) (5.3)
Earnings Applicable to Common Shares $ 3 048 49.6 $ 10 037 37.5
Unit Sales
Electric - Megawatthours (MWH)
Retail 33 610 3.1 56 815 2.5
Wholesale 323 149 122.5 679 140 103.5
356 759 26.3 735 955 25.4
Gas - Billions of British Thermal
Units (BBTU)
Firm 648 10.4 2 731 12.2
Interruptible and other (276) (14.8) (1 446) (38.3)
372 4.6 1 285 4.9
<PAGE 11>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
The following is a summary of electric and gas unit sales for the three
and six-month periods ended June 30, 1996 and 1995:
Three Months Ended Six Months Ended
June 30, June 30,
1996 1995 1996 1995
Electric Sales - MWH
Residential 417 715 392 619 903 739 850 110
Commercial 596 162 590 913 1 179 886 1 177 610
Industrial 109 225 105 941 203 276 202 250
Other 5 108 5 127 11 569 11 685
Total retail sales 1 128 210 1 094 600 2 298 470 2 241 655
Wholesale sales 587 002 263 853 1 335 450 656 310
Total 1 715 212 1 358 453 3 633 920 2 897 965
Gas Sales - BBTU
Residential 3 719 3 459 14 143 12 863
Commercial 1 942 1 731 7 072 6 163
Industrial 857 765 2 531 2 239
Other 384 299 1 350 1 100
Total firm sales 6 902 6 254 25 096 22 365
Off-system sales 704 967 953 2 380
Quasi-firm sales 361 520 485 870
Interruptible sales 520 374 893 527
Total 8 487 8 115 27 427 26 142
Electric Operating Revenues, Fuel and Purchased Power Costs
Electric operating revenues increased $12.5 million (9%) and $28.4
million (9.8%) during the current quarter and first half of 1996 due mainly
to higher total unit sales reflecting an increase in retail unit sales of
3.1% and 2.5% and higher wholesale revenues of $8.5 million and $20.7
million that resulted from the changing capacity needs of non-affiliated
utilities and NEPOOL. However, changes in wholesale electric sales have
little, if any, impact on net income. The increase in revenues in both
current periods was also attributed to the absence of a $7.5 million refund
to customers during the second quarter of 1995 that related to settlement
agreements reached with the Massachusetts Department of Public Utilities
(DPU). The increase in retail unit sales, particularly in the residential
sector, during the current quarter and first half of 1996 was attributed
mainly to more favorable weather and a slight increase in customers.
Fuel and purchased power increased approximately $1.5 million (2%) and
$13.3 million (8.1%) during the current three and six-month periods
reflecting higher unit sales and greater fuel costs at Canal (a major
supplier of electricity to the system) resulting from the absence of
scheduled maintenance to Canal Unit 1 that occurred in 1995 offset, to a
great degree, by a decline in purchases from independent power producers.
<PAGE 12>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
Gas Operating Revenues and Cost of Gas Sold
During the current quarter, gas operating revenues increased nearly $1
million (1.4%) due mainly to higher firm unit sales offset, in part, by a
lower level of cost of gas sold ($1.2 million), which reflected a decline
in the price of gas and lower off-system and quasi-firm sales. Gas
operating revenues for the first half of 1996 increased approximately $16.7
million (9.5%) due mainly to a $9.3 million increase in the cost of gas
sold that reflected higher firm and interruptible unit sales. These
increases were somewhat offset by a decline in off-system sales and quasi-
firm sales and a lower level of C&LM costs ($1.2 million). Fluctuations in
interruptible unit sales during both the current quarter and first half of
1996 had no impact on net income.
The increase in unit sales to firm customers during the current quarter
(10.4%) and first half of 1996 (12.2%) reflects significant weather-related
improvements for all customer segments due to the colder than normal
weather experienced throughout the region, particularly during the first
quarter as compared to milder weather last year. A growing customer base
also contributed to the increase in firm unit sales during both current
periods. Heating degree days were nearly 4% and 11% higher in the current
quarter and first half of 1996 as compared to the same periods in 1995.
The decreases in off-system and quasi-firm sales had no impact on net
income during the current quarter and first half of 1996. A portion of the
margin realized on these sales reduces the cost of gas sold to firm
customers and the remaining amount is deferred pending approval of the
Company's margin sharing proposals. The proposal related to quasi-firm
sales was filed in December 1995 and a ruling is expected from the DPU
later this year. The proposal for off-system sales is expected to be filed
by the end of this year.
Other Operation and Maintenance
For the current quarter and first half of 1996, other operation and
maintenance increased approximately $2.1 million (3.4%) and $1.5 million
(1.2%) reflecting higher postretirement benefit costs ($1.7 million and
$3.3 million) and the net impact of a labor dispute discussed in Note 1 of
Notes to Condensed Financial Statements in Item 1 of this report. These
increases were partially offset by an $851,000 and $1.7 million reduction
in maintenance costs, primarily associated with Canal Unit 1, for the three
and six-month periods, lower insurance costs and a decline in the provision
for bad debts.
Depreciation and Taxes
Depreciation expense increased $600,000 (5.3%) and $1.5 million (6.1%)
during the current three and six-month periods due primarily to a higher
level of depreciable plant, particularly Canal Unit 1. Federal and state
income taxes increased significantly during the current periods due mainly
to the impact of the settlement agreements previously discussed and a
greater level of taxable income. Local property and other taxes were
virtually unchanged as compared to the same periods in 1995.
<PAGE 13>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
Other Income and Interest Charges
During the current quarter and first half of 1996, other income
increased $797,000 and $1.7 million as compared to the same periods in 1995
due mainly to a gain recognized on the sale of a parcel of non-utility
land. The change in the current six-month period also reflects the
recording of a regulatory asset by Canal for costs associated with
postretirement benefits that are now being recovered in wholesale rates.
The decline in total interest charges for the current three and six-
month periods mainly reflects scheduled sinking fund payments and maturing
long-term debt.
Electric Industry Restructuring
On August 16, 1995, the DPU issued an order calling for the restructur-
ing of the electric utility industry in Massachusetts. The DPU's intent is
to reduce electric costs to consumers by providing customers with the
opportunity to choose their electric power provider while companies such as
the System's retail electric subsidiaries continue to provide transmission
and distribution services. On May 1, 1996, the DPU issued an order
containing proposed rules for implementing electric industry restructuring.
The proposed rules, which were the subject of public comment and
hearings during June and July 1996, provide for:
(1) the establishment of an independent system operator to operate the
regional transmission system;
(2) a power exchange to manage a competitive bidding pool for short-term
power sales;
(3) functional separation of electric companies into generation,
transmission and distribution corporate entities;
(4) preservation of discounts for low-income customers, shut-off
protections and provision of service to all customers;
(5) registration requirements for generation suppliers;
(6) options for phased incentives for electric companies to divest their
generation assets;
(7) promotion of environmental goals;
(8) support for energy efficiency and renewable energy resources;
(9) a price cap system of incentive regulation for the remaining
distribution and transmission functions;
(10) unbundling of rates on bills into separate components of
transmission, distribution and energy, and implementation of a
competitive generation market by January 1, 1998; and
(11) a reasonable opportunity for recovery of stranded cost.
On August 9, 1996, the DPU issued an order delaying the issuance of final
rules until the end of 1996. The DPU also stated that it will soon issue a
revised schedule for electric companies to make company-specific unbundled
rate filings.
<PAGE 14>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
Although the DPU has not yet issued its revised rate filing schedule,
Commonwealth Electric Company and Cambridge Electric Light Company (the
Companies) anticipate filing their revenue-neutral, unbundled rates in
early 1997 after the issuance of the DPU's final rules. Also, during 1997,
the Companies will file their comprehensive restructuring plan. One
element of the Companies' plan (announced on February 15, 1996) calls for
the auctioning, in a competitive market, of their capacity entitlement
(1,140 MW) in all twenty-one power contracts in an effort to develop a
competitive market whereby customers would have the flexibility to choose
their electric supplier. These entitlements include contracts for power
from Canal Units 1 and 2 and Seabrook 1, which are owned or jointly owned
by the System's generating subsidiary Canal Electric Company. The
Companies' plan provides for total recovery of the difference between the
current market value of the Companies' power contracts and their
unavoidable costs. Under the Companies' plan, this difference, a component
of what is often referred to as stranded cost, would be recovered through a
non-bypassable access charge paid over an appropriate time period by all
customers in the Companies' service areas.
The DPU's May 1 order reaffirmed that one of its transition principles
is to seek near-term rate relief for electric customers. Also, the DPU's
proposed rules would limit the period for recovery of net, non-mitigable
stranded cost to a ten-year period (January 1, 1998 through December 31,
2007). Recovery of stranded cost depends upon the timing, nature, and
degree of competition that may result from future changes in regulatory
policies governing the Companies' activities and prices, as well as future
power costs and market prices of power. The Companies' single largest
component of stranded cost relates to their purchased power contracts with
non-utility generators. Based on their analyses of the DPU's proposal, the
Companies would be unable to recover a substantial portion of their
stranded cost within the ten-year period without rate increases.
Generally accepted accounting principles require that losses be accrued
in full when costs to complete a contract are expected to exceed related
revenues expected to be realized. To the extent that the Companies
determine that they will be unable to recover costs associated with their
purchased power contracts, the Companies would be required to take an
immediate charge against earnings when such a loss is probable and
estimable. Statement of Financial Accounting Standards No. 121 -
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of" (SFAS No. 121) which became effective for 1996,
requires impairment losses on long-lived assets to be recognized when the
book value of an asset exceeds its expected future cash flows. This
standard also imposes stricter criteria for the retention of regulatory-
created assets by requiring that such assets be probable of future recovery
at each balance sheet date. To the extent such recovery is not probable at
the balance sheet date, the Companies would be required to take a charge
against earnings in that period.
The Companies currently account for the economic effects of regulation
in accordance with the provisions of Statement of Financial Accounting
Standards No. 71, "Accounting for the Effects of Certain Types of
Regulation" (SFAS No. 71) based on the cost-of-service regulatory
<PAGE 15>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
framework in which they operate. The DPU has proposed that the
distribution and transmission functions of their businesses be regulated
under a form of price capped incentive regulation.
In the event that recovery of specific costs through rates becomes
unlikely or uncertain for all or a portion of the Companies' utility
operations, whether resulting from the expanding effects of competition or
specific regulatory actions which move the Companies away from cost-of-
service ratemaking, SFAS No. 71 would no longer apply. While the Companies
are unable to predict the final rules which may be adopted by the DPU in
its restructuring effort, the Companies could be required to discontinue
the application of SFAS No. 71. Discontinuance of SFAS No. 71 would cause
the write-off of the applicable portions of their regulatory assets which
would have an adverse impact on the Companies' financial position and
results of operations. The Companies will challenge any order that would
have a significant adverse impact on them, including attempts to limit
their recovery of stranded cost.
Environmental Matters
Commonwealth Gas is participating in the assessment of a number of
former manufactured gas plant (MGP) sites and alleged MGP waste disposal
locations to determine if and to what extent such sites have been
contaminated and whether Commonwealth Gas may be responsible for remedial
actions. Commonwealth Gas and certain other subsidiaries are also involved
in other known or potentially contaminated sites where the associated costs
may not be recoverable in rates. There were no significant new
developments that occurred during the first half of 1996. For further
information on these matters, refer to the System's 1995 Annual Report on
Form 10-K.
<PAGE 16>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
Item 1. Legal Proceedings
The System is subject to legal claims and matters arising from its
course of business including Cambridge Electric's involvement in two
court actions filed by the Massachusetts Institute of Technology (MIT)
relating to a September 1995 decision of the DPU approving Cambridge
Electric's customer transition charge (CTC) for the recovery of
stranded cost. The first proceeding is an appeal by MIT of the DPU
decision to the Massachusetts Supreme Judicial Court (SJC). Cambridge
Electric is an intervenor in this proceeding. The SJC has not yet
established a schedule for submitting briefs. This issue is discussed
more fully in the System's 1995 Annual Report on Form 10-K. At this
time, management is unable to predict the outcome of this proceeding.
The second proceeding involves a complaint filed by MIT in May 1996
with the United States District Court alleging that the CTC is
inconsistent with the provisions of the Public Utility Regulatory
Policies Act of 1978 (PURPA), discriminates against qualifying
facilities, and is inconsistent with the policies of the Federal
Energy Regulatory Commission (FERC) regarding stranded cost recovery.
MIT named both the DPU and Cambridge Electric as parties to the
complaint. In June 1996, Cambridge Electric filed a Motion to Dismiss
MIT's complaint arguing that the Court lacks jurisdiction over the
matter, the CTC is wholly consistent with PURPA, and, in the
alternative, the Court must abstain from considering the case to avoid
interfering with the SJC proceeding. Cambridge Electric also noted
that MIT's complaint is virtually identical to a complaint filed
earlier by MIT at the FERC that the FERC dismissed. A hearing on the
Motion to Dismiss was held in July 1996. The Court has taken the
matter under advisement, and, at this time, management is unable to
predict the outcome of this proceeding.
Item 2. Changes in the Rights of the Company's Security Holders
None
Item 3. Defaults by the Company on its Senior Securities
None
Item 4. Results of Votes of Security Holders
None
Item 5. Other Information
None
<PAGE 17>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 27 - Financial Data Schedule
Filed herewith as Exhibit 1 is the Financial Data Schedule for
the six months ended June 30, 1996.
Filed herewith as Exhibit 2 is the restated Financial Data
Schedule for the six months ended June 30, 1995.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the three months ended
June 30, 1996.
<PAGE 18>
COMMONWEALTH ENERGY SYSTEM
SIGNATURES
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.
COMMONWEALTH ENERGY SYSTEM
(Registrant)
Principal Financial and
Accounting Officer
JAMES D. RAPPOLI
James D. Rappoli,
Financial Vice President
and Treasurer
Date: August 14, 1996