Eversource 2001 Annual Report Download - page 48

Commodity Price Risk - Nontrading Activities: Select Energy
utilizes derivative financial and commodity instruments (deriva-
tives), including futures and forward contracts, to reduce market
risk associated with fluctuations in the price of electricity and nat-
ural gas sold under firm commitments with certain customers.
Select Energy also utilizes derivatives, including price swap agree-
ments, call and put option contracts, and futures and forward
contracts, to manage the market risk associated with a portion of
its anticipated supply requirements. These derivative instruments
have been designated as cash flow hedging instruments.
When conducting sensitivity analysis of the change in the fair
value of Select Energy’s electricity, natural gas and oil nontrading
portfolio, which would result from a hypothetical change in the
future market price of electricity, natural gas and oil, the fair value
of the contracts are determined from models which 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 quot-
ed prices on the futures exchange.
Select Energy has determined a hypothetical change in the fair
value for its nontrading electricity, natural gas and oil contracts,
assuming a 10 percent unfavorable change in forward market
prices. As of December 31, 2001, an unfavorable 10 percent
change in forward market price would have resulted in a decrease
in fair value of approximately $29 million.
The impact of a change in electricity, natural gas and oil prices
on Select Energy’s nontrading contracts on December 31, 2001, is
not necessarily representative of the results that will be realized
when these contracts are physically delivered.
Select Energy also 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 contracts. Under
these contracts, the purchase price of a specified quantity of gas is
effectively fixed over the term of the gas service agreements, which
extend through 2004. As of December 31, 2001, the NYMEX
contracts had a notional value of $91.3 million and a negative
after-tax mark-to-market position of $14.7 million.
Derivative Cash Flow Hedge Accounting: Derivative instru-
ments recorded which were effective cash flow hedges resulted in
an increase in other comprehensive income of $12.3 million, net
of tax, upon the adoption of SFAS No. 133. During 2001, a posi-
tive $4.5 million, net of tax, was reclassified from other compre-
hensive income upon the conclusion of these hedged transactions
and recognized in earnings. An additional $1.3 million, net of tax,
was recognized in earnings for those derivatives that were deter-
mined to be ineffective. Also, during 2001, new cash flow hedge
transactions were entered into which hedge cash flows through
2027. As a result of these new transactions and market value
changes since January 1, 2001, other comprehensive income
decreased by $53.7 million, net of tax. Accumulated other com-
prehensive income at December 31, 2001, was a negative $36.9
million, net of tax (decrease to equity), relating to hedged transac-
tions and it is estimated that $29.4 million, net of tax, will be
reclassified as a charge to earnings within the next twelve months.
Cash flows from the hedge contracts are reported in the same cat-
egory as cash flows from the hedged assets.
Credit Risk: NU serves a wide variety of customers and suppli-
ers that include independent power producers, industrial compa-
nies, gas and electric utilities, oil and gas producers, financial insti-
tutions, and other energy marketers. Margin accounts exist within
this diverse group, and NU realizes interest receipts and payments
related to balances outstanding in these accounts. This wide cus-
tomer and supplier mix generates a need for a variety of contractu-
al structures, products and terms. This multifaceted book of busi-
ness 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. Market risks are
monitored regularly by a Risk Oversight Council operating out-
side of the 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 accor-
dance with mark-to-market and other risk management method-
ologies that utilize forward price curves in the energy markets to
estimate the size and probability of future potential exposure.
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. New York Mercantile
Exchange (Exchange) traded futures and option contracts are
guaranteed by the Exchange and have a modest credit risk. NU
has established written credit policies with regard to its counter-
parties to minimize overall credit risk on all types of transactions.
These policies require an evaluation of potential counterparties’
financial conditions (including credit rating), collateral require-
ments under certain circumstances (including cash in advance,
letters of credit, and parent guarantees), and the use of standard-
ized agreements, which allow for the netting of positive and nega-
tive exposures associated with a single counterparty. This evalua-
tion 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.
Regulated Entities:
Interest Rate Risk - Nontrading Activities: NU manages its interest
rate risk exposure by maintaining a mix of fixed and variable rate
debt. In addition, Yankee has entered into an interest rate sensitive
derivative. Yankee uses swap instruments with financial institu-
tions to exchange fixed-rate interest obligations to a blend
between fixed and variable-rate obligations without exchanging
the underlying notional amounts. These instruments convert
fixed interest rate obligations to variable rates. The notional
amounts parallel the underlying debt levels and are used to mea-
sure interest to be paid or received and do not represent the expo-
sure to credit loss. As of December 31, 2001, Yankee had out-
standing agreements with a total notional value of $48 million
and a positive mark-to-market position of $0.2 million, which is
included within the $36.9 million reported for accumulated other
comprehensive income related to hedging activities.
Commodity Price Risk - Nontrading Activities: Yankee Gas
maintains a master swap agreement with one customer to supply
gas at fixed prices for a 10-year term extending through 2005.
Under this master swap agreement, the purchase price of a speci-
46
Return to First pageReturn to First pageReturn to HighlightsReturn to HighlightsReturn to Highlights