Eversource 2002 Annual Report Download - page 51

B. Market Risk Information
Select Energy utilizes the sensitivity analysis methodology to disclose
quantitative information for its commodity price risks. Sensitivity
analysis provides a presentation of the potential loss of future earnings,
fair values or cash flows from market risk-sensitive instruments over
a selected time period due to one or more hypothetical changes in
commodity prices, or other similar price changes. Under sensitivity
analysis, the fair value of the portfolio is a function of the underlying
commodity, contract prices and market prices represented by each
derivative commodity contract. For swaps, forward contracts and
options, fair value reflects management’s best estimates considering
over-the-counter quotations, time value and volatility factors of the
underlying commitments. Exchange-traded futures and options are
recorded at fair value based on closing exchange prices.
Competitive Energy Subsidiaries Trading Portfolio: At December 31, 2002,
Select Energy has calculated the market price resulting from a 10 percent
unfavorable change in forward market prices. That 10 percent change
would result in approximately a $2.6 million decline in the fair value
of the Select Energy trading portfolio. In the normal course of business,
Select Energy also faces risks that are either nonfinancial or non-
quantifiable. Such risks principally include credit risk, which is not
reflected in this sensitivity analysis.
Competitive Energy Subsidiaries Retail and Wholesale Marketing Portfolio:
When conducting sensitivity analyses of the change in the fair value of
Select Energy’s electricity, natural gas and oil nontrading derivatives
portfolio, which would result from a hypothetical change in the future
market price of electricity, natural gas and oil, the fair values of the
contracts are determined from models that take into account estimated
future market prices of electricity, natural gas and oil, the volatility of
the market prices in each period, as well as the time value factors of
the underlying commitments. In most instances, market prices and
volatility are determined from quoted prices on the futures exchange.
Select Energy has determined a hypothetical change in the fair value
for its retail and wholesale marketing portfolio, which includes cash
flow hedges and electricity, natural gas and oil contracts, assuming a 10
percent unfavorable change in forward market prices. At December 31,
2002, an unfavorable 10 percent change in market price would have
resulted in a decline in fair value of approximately $4.4 million.
The impact of a change in electricity, natural gas and oil prices on
Select Energy’s retail and wholesale marketing portfolio at December 31,
2002, is not necessarily representative of the results that will be realized
when these contracts are physically delivered.
C. Other Risk Management Activities
Interest Rate Risk Management: NU manages its interest rate risk exposure
by maintaining a mix of fixed and variable rate debt. At December 31,
2002, approximately 79 percent of NU’s long-term debt, including the
current portion and fees and interest due for spent nuclear fuel disposal
costs, is at a fixed interest rate. Fixed interest rate debt is subject to
interest rate risk in a falling interest rate environment. The remaining
long-term debt is variable-rate and is subject to interest rate risk that
could result in earnings volatility. Assuming a one percentage point
increase in NU’s variable interest rates, annual interest expense would
have increased by $4.9 million. At December 31, 2002, NU does not
have any derivative contracts outstanding to manage interest rate risk.
Credit Risk Management: Credit risk relates to the risk of loss that NU
would incur as a result of non-performance by counterparties pursuant
to the terms of their contractual obligations. NU serves a wide variety
of customers and suppliers that include independent power producers,
industrial companies, gas and electric utilities, oil and gas producers,
financial institutions, and other energy marketers. Margin accounts
exist within this diverse group, and NU realizes interest receipts and
payments related to balances outstanding in these margin accounts.
This wide customer and supplier mix generates a need for a variety of
contractual structures, products and terms which, in turn, requires NU
to manage the portfolio of market risk inherent in those transactions
in a manner consistent with the parameters established by NU’s risk
management process.
NU’s regulated utilities have a lower level of credit risk related to
providing electric and gas distribution service than NU’s competitive
energy subsidiaries.
Credit risks and market risks at the competitive energy subsidiaries are
monitored regularly by a Risk Oversight Council operating outside of
the business units that create or actively manage these risk exposures
to ensure compliance with NU’s stated risk management policies.
NU tracks and re-balances the risk in its portfolio in accordance with
fair value and other risk management methodologies that utilize forward
price curves in the energy markets to estimate the size and probability
of future potential exposure.
NYMEX traded futures and option contracts are guaranteed by the
NYMEX and have a lower credit risk. Select Energy has established
written credit policies with regard to its counterparties to minimize
overall credit risk on all types of transactions. These policies require an
evaluation of potential counterparties’ financial conditions (including
credit ratings), collateral requirements under certain circumstances
(including cash in advance, letters of credit, and parent guarantees),
and the use of standardized agreements, which allow for the netting
of positive and negative exposures associated with a single counterparty.
This evaluation results in establishing credit limits prior to NU entering
into trading activities. The appropriateness of these limits is subject to
continuing review. Concentrations among these counterparties may
impact NU’s overall exposure to credit risk, either positively or negatively,
in that the counterparties may be similarly affected by changes to
economic, regulatory or other conditions.
4. Employee Benefits
A. Pension Benefits and Postretirement Benefits Other Than Pensions
Pension Benefits: NU’s subsidiaries participate in a uniform noncontributory
defined benefit retirement plan (Plan) covering substantially all regular
NU employees. Benefits are based on years of service and the employees’
highest eligible compensation during 60 consecutive months of
employment. Pre-tax pension income, approximately 30 percent of
which was credited to utility plant, was $73.4 million in 2002, $101 million
in 2001, and $90.9 million in 2000. These amounts exclude pension
settlements, curtailments and net special termination income of $22.2
million in 2002, expense of $2.6 million in 2001, and income of $7
million in 2000.
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