Eversource 2002 Annual Report Download - page 23

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determine the fair value of energy trading contracts are identified and
segregated in the table of fair value of contracts at December 31, 2002
and 2001 below. A description of each method is as follows: 1) prices
actively quoted primarily represent New York Mercantile Exchange
futures and options that are marked to closing exchange prices; 2)
prices provided by external sources primarily include over-the-counter
forwards and options, including bilateral contracts for the purchase or
sale of electricity or natural gas, and are marked to the mid-point of bid
and ask quotes; and 3) prices based on models or other valuation methods
primarily include forwards and options and other transactions for
which specific quotes are not available. These transactions are modeled
using recognized option pricing models. The option component of a
forward electricity purchase contract had a fair value of $4.5 million at
December 31, 2002, and is the only amount included in this method of
determining fair value. The fair value of this contract component at
December 31, 2001 was not material. Broker quotes for electricity are
available through the year 2005, and models are generally used for the
years 2006 and thereafter. Select Energy has procured sourcing for the
contracts with maturities in excess of four years. Accordingly, the value
of these contracts and the related power supply contracts do not need
to be determined with a model. Broker quotes for natural gas are available
through 2013. The decrease in the number of counterparties participating
in the market for long-term energy contracts continues to impact Select
Energy’s ability to determine the estimated fair value of its long-term
energy contracts.
Generally, valuations of short-term contracts derived from quotes or
other external sources are more reliable should there be a need to liquidate
the contracts, while valuations based on models or other methods for
longer-term contracts are less certain. Accordingly, there is a risk that
contracts will not be realized at the amounts recorded.
As of and for the years ended December 31, 2002 and 2001, respectively,
the sources of the fair value of trading contracts and the changes in fair
value of these trading contracts are included in the following tables.
Intercompany transactions are eliminated and not reflected in the
amounts below.
(Millions of Dollars) Fair Value of Trading Contracts at December 31, 2002
Maturity Maturity Maturity
Less Than of One to in Excess of Total
Sources of Fair Value One Year Four Years Four Years Fair Value
Prices actively quoted $(1.2) $ 0.1 $ — $ (1.1)
Prices provided by
external sources 2.8 20.2 14.6 37.6
Prices based on models
or other valuation methods —4.5 — 4.5
Totals $1.6 $24.8 $14.6 $41.0
(Millions of Dollars) Fair Value of Trading Contracts at December 31, 2001
Maturity Maturity Maturity
Less Than of One to in Excess of Total
Sources of Fair Value One Year Four Years Four Years Fair Value
Prices actively quoted $ 6.5 $ 6.8 $ — $13.3
Prices provided by
external sources 6.5 15.8 20.8 43.1
Prices based on models
or other valuation methods — — — —
Totals $13.0 $22.6 $20.8 $56.4
As indicated in the tables, the fair value of energy trading contracts
decreased $15.4 million from $56.4 million at December 31, 2001 to $41
million at December 31, 2002. This decrease, combined with the realized
losses on positions taken and closed in 2002, is included in Select
Energy’s gross margin and, after it is tax affected, is reflected in the $24
million that Select Energy’s trading business lost in 2002.
Years Ended December 31,
2002 2001
(Millions of Dollars) Total Fair Value
Fair value of trading contracts
outstanding at the beginning of the period $56.4 $13.8
Acquisition of SENY —10.9
Contracts realized or otherwise settled
during the period (4.0) (9.4)
Fair value of new contracts when entered
into during the period 13.7 58.6
Changes in fair values attributable to changes
in valuation techniques and assumptions (39.9) —
Changes in fair value of contracts 14.8 (17.5)
Fair value of trading contracts outstanding
at the end of the period $41.0 $56.4
During the first quarter of 2002, Select Energy terminated certain long-
term energy contracts. Coincident with these contract terminations,
new contracts were entered into with different terms and conditions.
Select Energy also entered into several new contracts with existing
counterparties. These new energy trading contracts are trading derivatives,
and collectively they had a positive fair value of $13.7 million when
entered into. In 2001, Select Energy entered into certain contracts with
a fair value of $58.6 million when entered into.
Effective October 1, 2002, Select Energy adopted a consensus reached
by the Emerging Issues Task Force (EITF) on October 25, 2002 in Issue
No. 02-3,“Accounting for Contracts Involved in Energy Trading and
Risk Management Activities.”Adopting this consensus required
management to conduct a thorough review of contracts in the trading
portfolio to determine if there were any contracts in the trading portfolio
that were not derivatives, as defined. Management determined that
there were no nonderivative contracts in the energy trading portfolio,
and as such, there was no cumulative effect of an accounting change
as of October 1, 2002.
In connection with management’s review of the contracts in the trading
portfolio, the significant changes in the energy trading market and the
change in the focus of the energy trading business, certain long-term
derivative energy contracts that were included in the trading portfolio
and valued at $33.9 million at November 30, 2002, were designated as
normal purchases and sales. The impact of this designation is that the
contracts were adjusted to fair value at November 30, 2002 and were
not and will not be adjusted subsequently for changes in fair value.
The $33.9 million carrying value of these contracts was reclassified
from trading derivative assets to other long-term assets and will be
amortized on a straight-line basis to fuel, purchased and net interchange
power expense over the remaining terms of the contracts, some of
which extend to 2011. This amount is included in changes in fair values
attributable to changes in valuation techniques and assumptions.