| KEYSPAN CORP ITEM 1A RISK FACTORS |
| 28 ITEM 1A RISK FACTORS Certain statements contained in this Annual Report on Form 10-K concerning expectations, beliefs, plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements that are other than statements of historical facts, are "e forward-looking statements "e within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended |
| Without limiting the foregoing, all statements under the captions "e Item 7 |
| Managementapstas Discussion and Analysis of Financial Condition and Results of Operations "e and "e Item 7A Quantitative and Qualitative Disclosures About Market Risk "e relating to our future outlook, anticipated capital expenditures, future cash flows and borrowings, pursuit of potential acquisition opportunities and sources of funding, are forward-looking statements |
| Such forward-looking statements reflect numerous assumptions and involve a number of risks and uncertainties, and actual results may differ materially from those discussed in such statements |
| The risks, uncertainties and factors that could cause actual results to differ materially include but are not limited to the following: We are a Holding Company, and Our Subsidiaries are Subject to State Regulation Which Limits Their Ability to Pay Dividends and Make Distributions to Us We are a holding company with no business operations or sources of income of our own |
| We conduct all of our operations through our subsidiaries and depend on the earnings and cash flow of, and dividends or distributions from, our subsidiaries to provide the funds necessary to meet our debt and contractual obligations and to pay dividends on our common stock |
| 28 In addition, a substantial portion of our consolidated assets, earnings and cash flow is 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 by the utility regulatory commissions of New York, Massachusetts and New Hampshire |
| Pursuant to NYPSC orders, the ability of KEDNY and KEDLI to pay dividends to us is conditioned upon their maintenance of a utility capital structure with debt not exceeding 55prca and 58prca, respectively, of total utility capitalization |
| In addition, the level of dividends paid by both utilities may not be increased from current levels if a 40 basis point penalty is incurred under a customer service performance program |
| At the end of KEDNYapstas and KEDLIapstas rate years (September 30, 2005 and November 30, 2005, respectively), their ratios of debt to total utility capitalization were well in compliance with the ratios set forth above and we have incurred no penalties under the outstanding customer service performance program |
| Our Gas Distribution and Electric Services Businesses May Be Adversely Affected by Changes in Federal and State Regulation The regulatory environment applicable to our gas distribution and our electric services businesses has undergone substantial changes in recent years, on both the federal and state levels |
| These changes have significantly affected the nature of the gas and electric utility and power industries and the manner in which their participants conduct their businesses |
| Moreover, existing statutes and regulations may be revised or reinterpreted, new laws and regulations may be adopted or become applicable to us or our facilities and future changes in laws and regulations may affect our gas distribution and our electric services businesses in ways that we cannot predict |
| In addition, our operations are subject to extensive government regulation and require numerous permits, approvals and certificates from various federal, state and local governmental agencies |
| A significant portion of our revenues in our Gas Distribution and Electric Services segments are directly dependent on rates established by federal or state regulatory authorities, and any change in these rates and regulatory structure could significantly impact our financial results |
| Increases in utility costs other than gas, not otherwise offset by increases in revenues or reductions in other expenses, could have an adverse effect on earnings due to the time lag associated with obtaining regulatory approval to recover such increased costs and expenses in rates |
| Various rulemaking proposals and market design revisions related to the wholesale power market are being reviewed at the federal level |
| These proposals, as well as legislative and other attention to the electric power industry could have a material adverse effect on our strategies and results of operations for our electric services business and our financial condition |
| In particular, we sell capacity, energy and ancillary services from our Ravenswood Generating Station facility into the New York Independent System Operator, or NYISO, energy market at market-based rates, subject to mitigation measures approved by the FERC The pricing for capacity, energy sales and ancillary services in to the NYISO market is still evolving |
| and some of the FERCapstas price mitigation measures are subject to rehearing and possible judicial review, as well as revision in response to market participant complaints or NYISO requests |
| 29 Our Risk Mitigation Techniques Such as Hedging and Purchase of Insurance May Not Adequately Provide Protection To mitigate our financial exposure related to commodity price fluctuations, KeySpan routinely enters into contracts to hedge a portion of our purchase and sale commitments, weather fluctuations, electricity sales, natural gas supply and other commodities |
| However, we do not always cover the entire exposure of our assets or our positions to market price volatility and the coverage will vary over time |
| To the extent we have unhedged positions or our hedging procedures do not work as planned, fluctuating commodity prices could cause our sales and net income to be volatile |
| In addition, our business is subject to many hazards from which our insurance may not adequately provide coverage |
| An unexpected outage at our Ravenswood Generating Station, especially in the significant summer period, could materially impact our financial results |
| Damage to pipelines, equipment, properties and people caused by natural disasters, accidents, terrorism or other damage by third parties could exceed our insurance coverage |
| Although we do have insurance to protect against many of these contingent liabilities, this insurance is capped at certain levels, has self-insured retentions and does not provide coverage for all liabilities |
| SEC Rules for Exploration and Production Companies May Require Us to Recognize a Non-Cash Impairment Charge at the End of Our Reporting Periods Our investments in natural gas and oil consist of our ownership of KeySpan Exploration and Production and Seneca-Upshur |
| We use the full cost method for KeySpan Exploration and Production and Seneca-Upshur |
| Under the full cost method, all costs of acquisition, exploration and development of natural gas and oil reserves are capitalized into a full cost pool as incurred, and properties in the pool are depleted and charged to operations using the unit-of-production method based on production and proved reserve quantities |
| To the extent that these capitalized costs, net of accumulated depletion, less deferred taxes exceed the present value (using a 10prca discount rate) of estimated future net cash flows from proved natural gas and oil reserves and the lower of cost or fair value of unproved properties, those excess costs are charged to operations |
| If a write-down is required, it would result in a charge to earnings but would not have an impact on cash flows |
| Once incurred, an impairment of gas properties is not reversible at a later date, even if gas prices increase |
| Our Operating Results May Fluctuate on a Seasonal and Quarterly Basis Our gas distribution business is a seasonal business and is subject to weather conditions |
| We receive most of our gas distribution revenues in the first and fourth quarters, when demand for natural gas increases due to colder weather conditions |
| As a result, we are subject to seasonal variations in working capital because we purchase natural gas supplies for storage in the second and third quarters and must finance these purchases |
| Accordingly, our results of operations fluctuate substantially on a seasonal basis |
| In addition, our New England-based gas distribution subsidiaries do not have weather normalization tariffs, as we do in New York, and results from our Ravenswood Generating Station facility are directly correlated to the weather as the demand and price for the electricity it generates increases during extreme temperature conditions |
| As a result, fluctuations in weather between years may have a significant effect on our results of operations for these subsidiaries |
| We derive a substantial portion of our revenues in our electric services segment from a series of agreements with LIPA pursuant to which we manage LIPAapstas transmission and distribution system and supply the majority of LIPAapstas customers &apos electricity needs |
| On February 1, 2006, KeySpan and LIPA entered into amended and restated agreements whereby KeySpan will continue to operate and maintain the electric T&D System owned by LIPA on Long Island |
| As part of the amended agreements, the GPRA, pursuant to which LIPA had the option, through December 15, 2005, to acquire substantially all of the electric generating facilities owned by KeySpan on Long Island is replaced with the 2006 Option Agreement where LIPA only has the right to acquire two of our facilities, our Far Rockaway and/or EF Barrett Generating Stations during the period January 1, 2006 to December 31, 2006 |
| Additionally, the new agreements resolve many outstanding issues between the parties regarding the current LIPA Agreements and provide new pricing and extensions of the Agreements |
| There is a risk that these agreements will not receive the necessary governmental approvals, which are pending, and the effectiveness of each of the 2006 LIPA Agreements is conditioned upon all of the 2006 LIPA Agreements becoming effective |
| If the 2006 LIPA Agreements do not become effective, there is uncertainty as to whether LIPA will exercise their option under the GPRA and the status of the resolution of the various disputes between KeySpan and LIPA A Decline or an Otherwise Negative Change in the Ratings or Outlook on Our Securities Could Have a Materially Adverse Impact on Our Ability to Secure Additional Financing on Favorable Terms The credit rating agencies that rate our debt securities regularly review our financial condition and results of operations |
| We can provide no assurances that the ratings or outlook on our debt securities will not be reduced or otherwise negatively changed |
| A negative change in the ratings or outlook on our debt securities could have a materially adverse impact on our ability to secure additional financing on favorable terms |
| Our Costs of Compliance with Environmental Laws are Significant, and the Cost of Compliance with Future Environmental Laws Could Adversely Affect Us Our operations are subject to extensive federal, state and local environmental laws and regulations relating to air quality, water quality, waste management, natural resources and the health and safety of our employees |
| These environmental laws and regulations expose us to costs and liabilities relating to our operations and our current and formerly owned properties |
| Compliance with these legal requirements requires us to commit significant capital toward environmental monitoring, installation of pollution control equipment and permits at our facilities |
| Costs of compliance with environmental regulations, and in particular emission regulations, could have a material impact on our Electric Services segment and our results of operations and financial position, especially if emission limits are tightened, more extensive permitting requirements are imposed, additional substances become regulated or the number and type of electric generating plants we operate increase |
| In addition, we are responsible for the clean-up of contamination at certain MGP sites and at other sites and are aware of additional MGP sites where we may have responsibility for clean-up costs |
| While our gas utility subsidiaries &apos rate plans generally allow for the full recovery of the costs 31 of investigation and remediation of most of our MGP sites, these rate recovery mechanisms may change in the future |
| To the extent rate recovery mechanisms change in the future, or if additional environmental matters arise in the future at our currently or historically owned facilities, at sites we may acquire in the future or at third-party waste disposal sites, costs associated with investigating and remediating these sites could have a material adverse effect on our results of operations, financial condition and cash flows |
| Our Businesses are Subject to Competition and General Economic Conditions Impacting Demand for Services We recently expanded the Ravenswood Facility, our merchant generation plant, in our Electric Services segment with the Ravenswood Expansion, a 250 MW combined cycle generating unit |
| However, the Ravenswood Facility and Ravenswood Expansion continue to be subject to competition that could adversely impact the market price for the capacity, energy and ancillary services they sell |
| In addition, if new generation and/or transmission facilities are constructed, and/or the availability of our Ravenswood Generating Station deteriorates, then the quantities of capacity and energy sales could be adversely affected |
| In December 2005, NYPA completed construction of a nominal 500 MW generating facility in New York City, and it began selling its capacity and energy into the NYISO markets |
| In addition, another nominal 500 MW facility is expected to come on-line in 2006 |
| We cannot predict, however, when or if new power plants or transmission facilities in addition to the above-noted resources will be built or the nature of the future New York City capacity and energy requirements |
| Competition facing our unregulated Energy Services businesses, including but not limited to competition from other heating, ventilation and air conditioning, and engineering companies, as well as, other utilities and utility holding companies that are permitted to engage in such activities, could adversely impact our financial results and the value of those businesses, resulting in decreased earnings as well as write-downs of the carrying value of those businesses |
| Our Gas Distribution segment faces competition with distributors of alternative fuels and forms of energy, including fuel oil and propane |
| Our ability to continue to add new gas distribution customers may significantly impact financial results |
| The gas distribution industry has experienced a decrease in consumption per customer over time, partially due to increased efficiency of customers &apos appliances, economic factors and price elasticity |
| In addition, our Gas Distribution segmentapstas future growth is dependent upon the ability to add new customers to our system in a cost-effective manner |
| While our Long Island and New England utilities have significant growth potential, we cannot be sure new customers will continue to offset the decrease in consumption of our existing customer base |
| There are a number of factors outside of our control that impact customer conversions from an alternative fuel to gas, including general economic factors impacting customers &apos willingness to invest in new gas equipment |
| Risk Associated with our Financial Swap Agreement for In-City Unforced Capacity KeySpan believes that the New York City market represents a strong capacity market due to, among other things, its local reliability rules (which recently increased to 83prca from 80prca), increasing demand and the time required for new resources to be constructed |
| KeySpan anticipates that demand will increase and that the high cost to construct capacity in New York City will result in favorable In-City Unforced Capacity prices |
| Therefore, KeySpan entered into an ISDA Master Agreement for a fixed for floating unforced capacity financial swap for a notional quantity of 32 1cmam800cmam000kW at the Fixed Price is dlra7dtta57/kW-month |
| If the demand is less than KeySpanapstas estimates, additional resources enter the market, or costs are less than forecast, In-City Unforced Capacity prices could be on average less than the Fixed Price resulting in a loss to KeySpan, which under certain circumstances could be material |
| Labor Disruptions at Our Facilities Could Adversely Affect Our Results of Operations and Cash Flow Approximately 6cmam154 employees, or 63prca of our employees, are represented by unions through various collective bargaining agreements that expire between 2006 and 2009 |
| The bargaining agreements expiring in 2006 affect approximately 1cmam300 employees who primarily work for KEDNE and at our Ravenswood Generating Station |
| KeySpan is currently engaging in discussions with these unions for new collective bargaining agreements |
| It is possible that our employees may seek an increase in wages and benefits at the expiration of these agreements, and that we may be unable to negotiate new agreements without labor disruption |
| Counterparties to Our Transactions May Fail to Perform their Obligations, Which Could Harm Our Results of Operations Our operations are exposed to the risk that counterparties to our transactions that owe us money or supplies will not perform their obligations |
| Should the counterparties to arrangements with us fail to perform, we might be forced to enter into alternative hedging arrangements or honor our underlying commitment at then-current market prices that may exceed our contractual prices |
| In such event, we might incur additional losses to the extent of amounts, if any, already paid to counterparties |
| This risk is most significant where we have concentrations of receivables from natural gas and electric utilities and their affiliates, as well as industrial customers and marketers throughout the Northeastern United States |
| We Are Exposed to Risks That Are Beyond Our Control The cost of repairing damage to our operating subsidiaries &apos facilities and the potential disruption of their operations or supplier operations due to storms, natural disasters, wars, terrorist acts and other catastrophic events could be substantial |
| The occurrence or risk of occurrence of future terrorist attacks or related acts of war may lead to increased political, economic and financial market instability and volatility in prices for natural gas which could materially adversely affect us in ways we cannot predict at this time |
| A lower level of economic activity for these or other reasons could result in a decline in energy consumption, which could adversely affect our net revenues |
| The Long-Term Financial Condition of Our Gas Distribution Business Depends on the Continued Availability of Natural Gas Reserves The development of additional natural gas reserves requires significant capital expenditures by others for exploring, drilling and installing production, gathering, storage, transportation and other facilities that permit natural gas to be produced and delivered to our distribution systems |
| Low prices for natural gas, regulatory restrictions, or the lack of available capital for these projects could adversely affect the 33 development of additional natural gas reserves |
| Additional natural gas reserves may not be developed in sufficient amounts to fill the capacities of our distribution systems, thus limiting our prospects for long-term growth |
| Gathering, Processing and Transporting Activities Involve Numerous Risks that May Result in Accidents and Other Operating Risks and Costs Our gas distribution facilities pose a variety of hazards and operating risks, such as leaks, explosions and mechanical problems caused by natural disasters, accidents, terrorism or other damage by third parties, which could cause substantial financial losses |
| In addition to impairing our operations, these risks could also result in loss of human life and environmental pollution |
| In accordance with standard industry practice, we maintain insurance against some, but not all, of these potential risks and losses |
| The occurrence of any of these events not fully covered by insurance could have a material adverse effect on our financial position, results of operations and cash flows |
| Additional risks, uncertainties and factors that could cause actual results to differ materially include but are not limited to the following: - volatility of fuel prices used to generate electricity; - fluctuations in weather and in gas and electric prices; - our ability to successfully manage our cost structure and operate efficiently; - our ability to successfully contract for natural gas supplies required to meet the needs of our customers; - implementation of new accounting standards or changes in accounting standards or GAAP which may require adjustment to financial statements; - inflationary trends and interest rates; - the ability of KeySpan to identify and make complementary acquisitions, as well as the successful integration of such acquisitions; - retention of key personnel; - federal, state and local regulatory initiatives that threaten cost and investment recovery, and place limits on the type and manner in which we invest in new businesses and conduct operations; - the impact of federal, state and local utility regulatory policies and orders on our regulated and unregulated businesses; - the degree to which we develop unregulated business ventures, as well as federal and state regulatory policies affecting our ability to retain and operate such business ventures profitably; - a change in the fair market value of our investments that could cause a significant change in the carrying value of such investments or the carrying value of related goodwill; - timely receipts of payments from LIPA and the NYISO, our two largest customers; and - other risks detailed from time to time in other reports and other documents filed by KeySpan with the SEC 34 For any of these statements, KeySpan claims the protection of the safe harbor for forward-looking information contained in the Private Securities Litigation Reform Act of 1995, as amended |
| For additional discussion on these risks, uncertainties and assumptions, see Item 1 |
| "e Description of the Business, "e Item 2 |
| "e Properties, "e Item 7 |
| "e Managementapstas Discussion and Analysis of Financial Condition and Results of Operations "e and Item 7A "e Quantitative and Qualitative Disclosures About Market Risk "e contained herein |