Progress Energy 2007 Annual Report Download - page 50

MANAGEMENT’S DISCUSSION AND ANALYSIS
48
If the Annual Average Price fell between the Threshold
Price and the Phase-out Price for a year, the amount by
which Section 29/45K tax credits were reduced depended
on where the Annual Average Price fell in that continuum.
The Department of the Treasury calculates the Annual
Average Price based on the Domestic Crude Oil First
Purchases Prices published by the Energy Information
Agency (EIA). Because the EIA publishes its information
on a three-month lag, the secretary of the Treasury
finalizes the calculations three months after the year
in question ends. Thus, the Annual Average Price for
calendar year 2006 was published on April 4, 2007. Based
on the Annual Average Price for calendar year 2006 of
$59.68, our synthetic fuels tax credits generated during
2006 were reduced by 33 percent, or approximately
$35 million. The Annual Average Price for calendar year
2007 is expected to be published in early April 2008.
On September 14, 2007, we idled production of synthetic
fuels at our majority-owned synthetic fuels facilities.
As discussed below, the decision to idle production
was based on the high level of oil prices, and the
resumption of synthetic fuels production was dependent
upon a number of factors, including a reduction in oil
prices. On October 12, 2007, based upon the continued
high level of oil prices, unfavorable oil price projections
through the end of 2007, and the expiration of the
synthetic fuels tax credit program at the end of 2007, we
permanently ceased production of synthetic fuels at our
majority-owned facilities. The operation of synthetic fuels
facilities on behalf of third parties continued through late
2007. Because we have abandoned our majority-owned
facilities and our other synthetic fuels operations ceased
in late December 2007, we reclassified the operations of
our synthetic fuels businesses as discontinued operations
in the fourth quarter of 2007.
We estimate that the 2007 Threshold Price will be
approximately $57 per barrel and the Phase-out Price will
be approximately $71 per barrel, based on an estimated
inflation adjustment for 2007. The monthly Domestic Crude
Oil First Purchases Price published by the EIA has recently
averaged approximately $5 lower than the corresponding
daily New York Mercantile Exchange (NYMEX) prompt
month settlement price for light sweet crude oil. Through
December 31, 2007, the average NYMEX settlement price
for light sweet crude oil was $72.35 per barrel. Based
upon the estimated 2007 Threshold Price and Phase-
out Price and assuming that the $5 average differential
between the Domestic Crude Oil First Purchases Price
published by the EIA and the NYMEX settlement price
continued through December 31, 2007, we estimate
that the synthetic fuels tax credit amount for 2007 will
be reduced by approximately 70 percent. Therefore, we
reserved 70 percent or approximately $144 million of the
$205 million of tax credits generated during 2007. The
final calculations of any reductions in the value of the tax
credits will not be determined until April 2008 when final
2007 oil prices are published.
In January 2007, we entered into derivative contracts
to hedge economically a portion of our 2007 synthetic
fuels cash flow exposure to the risk of rising oil prices
over an average annual oil price range of $63 to $77 per
barrel on a NYMEX basis. The notional quantity of these
oil price hedge instruments was 25 million barrels and
provided protection for the equivalent of approximately
8 million tons of 2007 synthetic fuels production and was
marked-to-market with changes in fair value recorded
through earnings. The derivative contracts ended
on December 31, 2007, and were settled for cash on
January 8, 2008, with no material impact on 2008 earnings.
Approximately 34 percent of the notional quantity of
these contracts was entered into by Ceredo Synfuel LLC
(Ceredo). As discussed below in “Sales of Partnership
Interests” and in Notes 1C and 3J, we disposed of our
100 percent ownership interest in Ceredo in March 2007.
During the year ended December 31, 2007, we recorded
net pre-tax gains of $168 million related to these contracts,
including $57 million attributable to Ceredo, of which
$42 million was attributed to minority interest for the portion
of the gain subsequent to disposal. See Note 17A and
“Quantitative and Qualitative Disclosures About Market
Risk” and for a discussion of market risk and derivatives.
IMPAIRMENT OF SYNTHETIC FUELS AND OTHER
RELATED LONG-LIVED ASSETS
We monitor our long-lived assets for impairment as
warranted. With the idling of our synthetic fuels facilities
during the second quarter of 2006 due to the high level
of oil prices, we performed an impairment evaluation of
our synthetic fuels and other related operating long-lived
assets. The impairment test considered numerous factors,
including, among other things, continued high oil prices and
the then-current “idle” state of our synthetic fuels facilities.
Based on the results of the impairment test, we recorded
pre-tax impairment charges of $91 million ($55 million after-
tax) during the quarter ended June 30, 2006 (See Notes 8
and 9). These charges represent the entirety of the asset
carrying value of our synthetic fuels intangible assets and
manufacturing facilities, as well as a portion of the asset
carrying value associated with the river terminals at which
the synthetic fuels manufacturing facilities are located. As
discussed in Note 3B, these charges have been reclassified
to discontinued operations, net of tax on the Consolidated
Statements of Income.