| Although we have tried to discuss key risk factors below, please be aware that other risks may prove to be important in the future |
| These factors include the following: We are subject to regulation by each state in which we operate that affect our operations and financial results |
| Our natural gas utility business is subject to various regulated returns on its rate base in each of the 12 states in which we operate |
| We monitor the allowed rates of return and our effectiveness in earning such rates and initiate rate proceedings or operating changes as we believe are needed |
| In addition, in the normal course of the regulatory environment, assets may be placed in service and historical test periods established before rate cases that could adjust our returns can be filed |
| Once rate cases are filed, regulatory bodies have the authority to suspend implementation of the new rates while studying the cases |
| Because of this process, we must suffer the negative financial effects of having placed assets in service without the benefit of rate relief, which is commonly referred to as “regulatory lag” |
| In addition, rate cases involve a risk of rate reduction, and once rates have been approved, they are still subject to challenge for their reasonableness by appropriate 23 _________________________________________________________________ [74]Table of Contents regulatory authorities |
| Our debt and equity financings are also subject to approval by regulatory bodies in several states which could limit our ability to take advantage of favorable market conditions |
| Our business could also be affected by deregulation initiatives, including the development of unbundling initiatives in the natural gas industry |
| Unbundling is the separation of the provision and pricing of local distribution gas services into discrete components |
| It typically focuses on the separation of the distribution and gas supply components and the resulting opening of the regulated components of sales services to alternative unregulated suppliers of those services |
| Although we believe that our enhanced technology and distribution system infrastructures have positively positioned us, we cannot provide assurance that there would be no significant adverse effect on our business should unbundling or further deregulation of the natural gas distribution service business occur |
| Our operations are weather sensitive |
| Our natural gas utility sales volumes and related revenues are correlated with heating requirements that result from cold winter weather |
| Although beginning in the 2006-2007 winter heating season, we will have weather-normalized rates for over 90 percent of our residential and commercial meters that should substantially eliminate the adverse effects of warmer-than-normal weather for meters in those service areas, our utility operating results will continue to vary with the temperatures during the winter heating season |
| In addition, sustained cold weather could adversely affect our natural gas marketing operations as we may be required to purchase gas at spot rates in a rising market to obtain sufficient volumes to fulfill some customer contracts |
| The concentration of our distribution, pipeline and storage operations in the State of Texas have increased the exposure of our operations and financial results to adverse weather, economic conditions or regulatory decisions in Texas |
| As a result of our acquisition of the distribution, pipeline and storage operations of TXU Gas in October 2004, over 50 percent of our natural gas distribution customers and most of our pipeline and storage assets and operations are now located in the State of Texas |
| This concentration of our business in Texas means that our operations and financial results are subject to greater impact than before from changes in the Texas economy in general as well as the weather in our service areas of the state during the winter heating season |
| Our financial results in fiscal 2006 were adversely affected by warm weather in Texas |
| In addition, the impact of any adverse rate or other regulatory decisions by state or local regulatory authorities in Texas will also be greater |
| The hearing in the Mid-Tex Division’s first rate case since the TXU Gas acquisition has just concluded |
| In the proceeding, we are seeking additional revenue and several rate design changes |
| A rate reduction or other significant, adverse decision by the Texas Railroad Commission in the proceeding could materially affect our financial results |
| We are subject to environmental regulation which could adversely affect our operations or financial results |
| We are subject to laws, regulations and other legal requirements enacted or adopted by federal, state and local governmental authorities relating to protection of the environment and health and safety matters, including those legal requirements that govern discharges of substances into the air and water, the management and disposal of hazardous substances and waste, the clean-up of contaminated sites, groundwater quality and availability, plant and wildlife protection, as well as work practices related to employee health and safety |
| Environmental legislation also requires that our facilities, sites and other properties associated with our operations be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities |
| Failure to comply with these laws, regulations, permits and licenses may expose us to fines, penalties or interruptions in our operations that could be significant to our financial results |
| In addition, existing environmental regulations may be revised or our operations may become subject to new regulations |
| Such revised or new regulations could result in increased compliance costs or additional operating restrictions which could adversely affect our business, financial condition and results of operations |
| 24 _________________________________________________________________ [75]Table of Contents Our operations are exposed to market risks that are beyond our control which could adversely affect our financial results |
| Our risk management operations are subject to market risks beyond our control including market liquidity, commodity price volatility and counterparty creditworthiness |
| Although we maintain a risk management policy, we may not be able to completely offset the price risk associated with volatile gas prices or the risk in our natural gas marketing and pipeline and storage segments which could lead to volatility in our earnings |
| Physical trading also introduces price risk on any net open positions at the end of each trading day, as well as volatility resulting from intra-day fluctuations of gas prices and the potential for daily price movements between the time natural gas is purchased or sold for future delivery and the time the related purchase or sale is hedged |
| Although we manage our business to maintain no open positions, there are times when limited net open positions related to our physical storage may occur on a short-term basis |
| The determination of our net open position as of any day requires us to make assumptions as to future circumstances, including the use of gas by our customers in relation to our anticipated storage and market positions |
| Because the price risk associated with any net open position at the end of each day may increase if the assumptions are not realized, we review these assumptions as part of our daily monitoring activities |
| Net open positions may increase volatility in our financial condition or results of operations if market prices move in a significantly favorable or unfavorable manner because the timing of the recognition of profits or losses on the hedges for financial accounting purposes does not always match up with the timing of the economic profits or losses on the item being hedged |
| This volatility may occur with a resulting increase or decrease in earnings or losses, even though the expected profit margin is essentially unchanged from the date the transactions were consummated |
| Further, if the local physical markets in which we trade do not move consistently with the NYMEX futures market, we could experience increased volatility in the financial results of our natural gas marketing and pipeline and storage segments |
| Our natural gas marketing and pipeline and storage segments manage margins and limit risk exposure on the sale of natural gas inventory or the offsetting fixed-price purchase or sale commitments for physical quantities of natural gas through the use of a variety of financial derivatives |
| However, contractual limitations could adversely affect our ability to withdraw gas from storage which could cause us to purchase gas at spot prices in a rising market to obtain sufficient volumes to fulfill customer contracts |
| We could also realize financial losses on our efforts to limit risk as a result of volatility in the market prices of the underlying commodities or if a counterparty fails to perform under a contract |
| In addition, adverse changes in the creditworthiness of our counterparties could limit the level of trading activities with these parties and increase the risk that these parties may not perform under a contract |
| We are also subject to interest rate risk on our commercial paper borrowings and floating rate debt |
| In the past few years, we have been operating in a relatively low interest-rate environment with both short and long-term interest rates being relatively low compared to past interest rates |
| However, in the past two years, the Federal Reserve has taken actions that have resulted in increases in short-term interest rates |
| Future increases in interest rates could adversely affect our future financial results |
| The execution of our business plan could be affected by an inability to access financial markets |
| We rely upon access to both short-term and long-term capital markets to satisfy our liquidity requirements |
| Adverse changes in the economy or these markets, the overall health of the industries in which we operate and changes to our credit ratings could limit access to these markets, increase our cost of capital or restrict the execution of our business plan |
| Our long-term debt is currently rated as “investment grade” by Standard & Poor’s Corporation (S&P), Moody’s Investors Services, Inc |
| (Moody’s) and Fitch Ratings, Ltd |
| There can be no assurance that these rating agencies will maintain investment grade ratings for our long-term debt |
| If we were to lose our investment-grade rating, the commercial paper markets and the commodity derivatives markets could become unavailable to us |
| This would increase our borrowing costs for working capital and reduce the borrowing capacity of our gas marketing affiliate |
| In addition, if our commercial paper ratings were lowered, it would increase the cost of commercial 25 _________________________________________________________________ [76]Table of Contents paper financing and could reduce or eliminate our ability to access the commercial paper markets |
| If we are unable to issue commercial paper, we intend to borrow under our bank credit facilities to meet our working capital needs |
| Inflation and increased gas costs could adversely impact our customer base and customer collections and increase our level of indebtedness |
| Inflation has caused increases in some of our operating expenses and has required assets to be replaced at higher costs |
| We have a process in place to continually review the adequacy of our utility gas rates in relation to the increasing cost of providing service and the inherent regulatory lag in adjusting those gas rates |
| Historically, we have been able to budget and control operating expenses and investments within the amounts authorized to be collected in rates and intend to continue to do so |
| Rapid increases in the price of purchased gas, which occurred recently and in some prior years, cause us to experience a significant increase in short-term debt because we must pay suppliers for gas when it is purchased, which can be significantly in advance of when these costs may be recovered through the collection of monthly customer bills for gas delivered |
| Increases in purchased gas costs also slow our utility collection efforts as customers are more likely to delay the payment of their gas bills, leading to higher than normal accounts receivable |
| Our operations are subject to increased competition |
| In the residential and commercial customer markets, our regulated utility operations compete with other energy products, such as electricity and propane |
| Our primary product competition is with electricity for heating, water heating and cooking |
| Increases in the price of natural gas could negatively impact our competitive position by decreasing the price benefits of natural gas to the consumer |
| This could adversely impact our business if as a result, our customer growth slows, resulting in reduced ability to make capital expenditures, or if our customers further conserve their use of gas, resulting in reduced gas purchases and customer billings |
| In the case of industrial customers, such as manufacturing plants, and agricultural customers, adverse economic conditions, including higher gas costs, could cause these customers to use alternative sources of energy, such as electricity, or bypass our systems in favor of special competitive contracts with lower per-unit costs |
| Our pipeline and storage operations currently face limited competition from other existing intrastate pipelines and gas marketers seeking to provide or arrange transportation, storage and other services for customers |
| However, competition may increase if new intrastate pipelines are constructed near our existing facilities |
| The cost of providing pension and postretirement health care benefits is subject to changes in pension fund values and changing demographics and may have a material adverse effect on our financial results |
| We provide a cash-balance pension plan for the benefit of eligible full-time employees as well as postretirement health care benefits to eligible full-time employees |
| Our costs of providing such benefits is subject to changes in the market value of our pension fund assets, changing demographics, including longer life expectancy of beneficiaries and an expected increase in the number of eligible former employees over the next five to ten years, and various actuarial calculations and assumptions |
| The actuarial assumptions used may differ materially from actual results due to changing market and economic conditions, higher or lower withdrawal rates and other factors |
| These differences may result in a significant impact on the amount of pension expense or other postretirement benefit costs recorded in future periods |
| 26 _________________________________________________________________ [77]Table of Contents Our growth in the future may be limited by the nature of our business, which requires extensive capital spending |
| We must continually build additional capacity in our natural gas distribution system to maintain the growth in the number of our customers |
| The cost of adding this capacity may be affected by a number of factors, including the general state of the economy and weather |
| Our cash flows from operations are generally not sufficient to supply funding for all our capital expenditures including the financing of the costs of this new construction along with capital expenditures necessary to maintain our existing natural gas system |
| As a result, we must fund at least a portion of these costs through borrowing funds from third party lenders, the cost of which is dependent on the interest rates at the time |
| This in turn may limit our ability to connect new customers to our system due to constraints on the amount of funds we can invest in our infrastructure |
| Distributing and storing natural gas involve risks that may result in accidents and additional operating costs |
| Our natural gas distribution business involves a number of hazards and operating risks that cannot be completely avoided, such as leaks, accidents and operational problems, which could cause loss of human life, as well as substantial financial losses resulting from property damage, damage to the environment and to our operations |
| We do have liability and property insurance coverage in place for many of these hazards and risks |
| However, because our pipeline, storage and distribution facilities are near or are in populated areas, any loss of human life or adverse financial results resulting from such events could be large |
| If these events were not fully covered by insurance, our financial position and results of operations could be adversely affected |
| Natural disasters and terrorist activities and other actions could adversely affect our operations or financial results |
| Natural disasters are always a threat to our assets and operations |
| In addition, the threat of terrorist activities could lead to increased economic instability and volatility in the price of natural gas that could affect our operations |
| Also, companies in our industry may face a heightened risk of exposure to actual acts of terrorism, which could subject our operations to increased risks |
| As a result, the availability of insurance covering such risks may be more limited, which could increase the risk that an event could adversely affect future financial results |