Eversource 2003 Annual Report Download - page 28

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The second activity included in NU Enterprises’ merchant energy business
line is retail marketing, which also improved its financial performance in
2003 compared to 2002. Select Energy’s retail marketing activities had a
$25.9 million improvement in financial performance during 2003 compared
to 2002 with losses of $1.8 million and $27.7 million in 2003 and 2002,
respectively. The 2003 improved retail results are primarily due to improved
margins and growth in retail electric sales, along with improved management
of retail gas contracts. Over time, management expects that Select Energy’s
retail sales and financial performance will improve as more commercial
and industrial customers move from buying energy through their electric
distribution company to purchasing energy directly from suppliers such
as Select Energy. Select Energy does not sell electricity or natural gas to
residential customers, but actively markets energy to commercial and
industrial customers throughout the Northeast between Maine and
Maryland with the exception of Vermont. Vermont does not allow retail
customers to choose their electric suppliers.
NU Enterprises’ energy services business line, including SESI, NGS, and
Woods Network earned approximately $2.6 million in 2003 as compared
to 2002 when this business line was essentially breakeven. Financial
performance at SESI continues to benefit from an expanding level of
business with the United States Department of Defense, with net income
rising to $4.6 million in 2003 from $3 million in 2002. NGS, which
continues to be negatively affected by the lower level of electrical
contracting resulting from the slow economy in New England, lost $2.2
million in 2003, following a loss of $3.2 million in 2002. Woods Network
earned $0.2 million in both 2003 and 2002.
NU Enterprises parent costs totaled $0.4 million in 2003, compared to
$0.8 million in 2002.
In 2002, NU Enterprises concluded a study of the depreciable lives of
certain generation assets. The impact of this study was to lengthen the
useful lives of those generation assets by 32 years to an average of 70
years. In addition, the useful lives of certain software was revised and
shortened to reflect a remaining life of 1.5 years. As a result of these
studies, NU Enterprises’ operating expenses decreased by $8.6 million in
2003 and $5.1 million in 2002 as compared to 2001.
Intercompany Transactions: CL&P’s standard offer purchases from Select
Energy represented approximately $558 million of revenues in 2003,
compared with $501 million in 2002. CL&P’s TSO purchases from Select
Energy in 2004 are expected to total approximately $500 million. Other
transactions between CL&P and Select Energy totaled $130 million in
2003 and 2002. Additionally, WMECO’s purchases from Select Energy
represented approximately $143 million in 2003, compared with $14
million in 2002. All of these amounts are eliminated in consolidation.
The CL&P standard offer amounts have been reduced by the loss related
to the wholesale power contract settlement.
NU Enterprises’ Market and Other Risks
Overview: NU Enterprises is exposed to certain market risks inherent in
its business activities. The merchant energy business line enters into
contracts of varying lengths of time to buy and sell energy commodities,
including electricity, natural gas, and oil. Market risk represents the loss
that may affect Select Energy’s financial results due to adverse changes
in commodity market prices.
Risk management within Select Energy is organized to address the market,
credit and operational exposures arising from the merchant energy
business line including wholesale marketing activities (which include limited
energy trading for market and price discovery purposes) and retail
marketing activities. The framework and degree to which these risks are
managed and controlled is consistent with the limitations imposed by
NU’s Board of Trustees as established and communicated in NU’s risk
management policies and procedures. As a means to monitor and control
compliance with these policies and procedures, NU’s Risk Oversight
Council (ROC) monitors NU Enterprises’ risk management processes
independently from the business lines that create or manage risks. The
ROC ensures that the policies pertaining to these risks are followed and
makes recommendations to the Board of Trustees regarding periodic
adjustment to the metrics used in measuring and controlling portfolio
risk. The ROC also confirms methodologies employed to estimate
portfolio values.
Wholesale and Retail Marketing Activities: A significant portion of Select
Energy’s wholesale marketing activities is providing energy to full
requirements customers, primarily regulated distribution companies.
Under full requirements contract terms, Select Energy is required to
provide for the customers’ load at all times. Wholesale and retail marketing
transactions, including the full requirements contracts, are intended to
be part of Select Energy’s normal purchases and sales and are
recognized on the accrual basis of accounting.
An important component of Select Energy’s risk management strategy
focuses on managing the volume and price risks of full requirements
contracts. These risks include significant fluctuations in both supply and
demand due to numerous factors such as weather, plant availability,
transmission congestion, and potentially volatile price fluctuations. Select
Energy uses energy contracts to mitigate these risks. These contracts,
which are included in the wholesale and retail marketing portfolios and
are subject to accrual accounting, are important to Select Energy’s risk
management.
Select Energy manages its portfolio of wholesale and retail marketing
contracts and assets to maximize value while maintaining an acceptable
level of risk. At forward market prices in effect at December 31, 2003,
the wholesale marketing portfolio, which includes the CL&P TSO service
contract that extends through December 31, 2004 and other contracts
that extend to 2013, had a positive fair value. This positive fair value
indicates a positive impact on Select Energy’s gross margin in the future.
However, there may be significant volatility in the energy commodities
markets that may affect this position between now and when the
contracts are settled. Accordingly, there can be no assurances that Select
Energy will realize the gross margin corresponding to the present positive
fair value on its wholesale marketing portfolio.
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
purchases for firm sales commitments to certain customers. Select
Energy also utilizes derivatives, including financial swap agreements, call
and put option contracts, and futures and forward contracts, to manage
the market risk associated with a portion of its anticipated supply and
delivery requirements. These derivatives have been designated as cash
flow hedging instruments for accounting purposes and are used to
reduce the market risk associated with fluctuations in the price of electricity,