Eversource 2002 Annual Report Download - page 50

balance sheets as derivative assets or liabilities. Changes in fair value
are recognized in operating revenues in the consolidated statements of
income in the period of change. The net fair value positions of the trading
portfolio at December 31, 2002 and 2001 were assets of $41 million and
$56.4 million, respectively.
The competitive energy subsidiaries trading portfolio includes New
York Mercantile Exchange (NYMEX) futures and options, the fair value
of which is based on closing exchange prices; over-the-counter forwards
and options, the fair value of which is based on the mid-point of bid
and ask quotes; and bilateral contracts for the purchase or sale of electricity
or natural gas, the fair value of which is modeled using available
information from external sources based on recent transactions and
validated with a gas forward curve and an estimated heat rate conversion.
The competitive energy subsidiaries trading portfolio also includes
transmission congestion contracts. The fair value of certain transmission
congestion contracts is based on market inputs. Market information for
other transmission congestion contracts is not available, and those contracts
cannot be reliably valued. Management believes the amounts paid for
these contracts are equal to their fair value and has established a valuation
reserve for changes in fair value in excess of cost.
Management conducted a thorough review of the contracts in the trading
portfolio in order to adopt EITF Issue No. 02-3 as of October 1, 2002.
Based on this review, 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 previously included in
the trading portfolio and valued at $33.9 million as of November 30,
2002 were determined to be nontrading and subsequently designated
as normal purchases and sales, as defined by SFAS No. 133, as of that
date. Management was able to make this designation based on the
high probability that these contracts will result in physical delivery.
The impact of the normal purchases and sales designation is that these
contracts were adjusted to fair value as of November 30, 2002 and
were not and will not be adjusted subsequently for changes in fair
value. The $33.9 million carrying value as of November 30, 2002 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, which extend to 2011.
Competitive Energy Subsidiaries Nontrading: Nontrading derivative contracts
are for delivery of energy related to the competitive energy subsidiaries’
retail and wholesale marketing activities. These contracts are not
entered into for trading purposes, but are subject to fair value accounting
because these contracts are derivatives that cannot be designated as
normal purchases or sales, as defined by SFAS No. 133. These contracts
cannot be designated as normal purchases or sales either because they
are included in the New York energy market that settles financially or
because the normal purchase and sale designation was not elected by
management. The fair value of nontrading derivatives was an asset of
$2.9 million at December 31, 2002. The competitive energy subsidiaries
held no nontrading derivatives at December 31, 2001.
Competitive Energy Subsidiaries Hedging: Select Energy utilizes derivative
financial and commodity instruments, including futures and forward
contracts, to reduce market risk associated with fluctuations in the price
of electricity and natural gas purchased to meet firm sales commitments
to certain customers. Select Energy also utilizes derivatives, including
price swap agreements, call and put option contracts, and futures and
forward contracts, to manage the market risk associated with a portion
of its anticipated retail supply requirements. These derivatives have
been designated as cash flow hedging instruments and are used to
reduce the market risk associated with fluctuations in the price of
electricity, natural gas, or oil. A derivative that hedges exposure to the
variable cash flows of a forecasted transaction (a cash flow hedge) is
initially recorded at fair value with changes in fair value recorded in
other comprehensive income. Hedges impact earnings when the
forecasted transaction being hedged occurs, when hedge ineffectiveness
is measured and recorded, when the forecasted transaction being
hedged is no longer probable of occurring, or when there is accumulated
other comprehensive loss and the hedge and the forecasted transaction
being hedged are in a loss position on a combined basis.
Select Energy maintains natural gas service agreements with certain
customers to supply gas at fixed prices for terms extending through 2004.
Select Energy has hedged its gas supply risk under these agreements
through NYMEX futures contracts. Under these contracts, which also
extend through 2004, the purchase price of a specified quantity of gas
is effectively fixed over the term of the gas service agreements. At
December 31, 2002 and 2001, the NYMEX futures contracts had notional
values of $30.9 million and $91.3 million, respectively, and were recorded
at fair value as a derivative asset of $12.2 million at December 31, 2002,
and as a derivative liability of $24.5 million at December 31, 2001.
During 2002, Select Energy determined that cash flow hedges related
to the CL&P standard offer service contract were ineffective. These
hedges were natural gas derivatives that were used to hedge off-peak
electricity purchases for CL&P standard offer sales. As a result of this
ineffectiveness, Select Energy transferred $3.9 million related to these
cash flow hedges from accumulated other comprehensive income to
fuel, purchased and net interchange power expense. Also in 2002,
Select Energy terminated these cash flow hedges and realized pre-tax
income of $5.6 million. In 2001, Select Energy had a liability related to
these standard offer contract hedges of $31.3 million with a corresponding
accumulated other comprehensive loss.
In the fourth quarter of 2002, Select Energy designated new hedges
with a derivative asset value of $5.6 million as hedging full requirements
contracts in the New York market.
Regulated Gas Utility Hedging: Yankee Gas maintains a master swap
agreement with a financial counterparty to purchase gas at fixed prices.
Under this master swap agreement, the purchase price of a specified
quantity of gas for two unaffiliated customers is effectively fixed over
the term of the gas service agreements with those customers for a period
of time not extending beyond 2005. At December 31, 2002 and 2001,
the commodity swap agreement had notional values of $10.7 million
and $16.9 million, respectively, and was recorded at fair value as a
derivative asset of $2.3 million at December 31, 2002, and as a derivative
liability of $2.3 million at December 31, 2001.
In 2001 Yankee Gas also held two interest rate swaps with a fair value
derivative asset amount of $0.2 million. These swaps were terminated
in 2002.
NU Parent Hedging: At December 31, 2001, NU Parent maintained a
treasury interest rate lock agreement, which was recorded as a fair
value liability of $0.1 million. This agreement was terminated in 2002.
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