Eversource 2003 Annual Report Download - page 64

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Other hedging derivative liabilities, which are valued at the mid-point
of bid and ask market prices, include forwards, options and swaps to
hedge Select Energy’s basic generation service contracts in the PJM
region and were recorded at fair value as derivative liabilities of $5.8
million at December 31, 2003 and derivative assets of $1.1 million at
December 31, 2002.
Select Energy New York, Inc. maintains financial power swaps to hedge
its retail sales portfolio through 2004, which were also valued at the
mid-point of bid and ask market prices. These contracts were recorded
at fair value as derivative assets of $6.9 million and $5.6 million at
December 31, 2003 and 2002, respectively.
Utility Group — Gas — Non-trading: Yankee Gas’ non-trading derivatives
consist of peaking supply arrangements to serve winter load obligations
and firm sales contracts with options to curtail delivery. These contracts
are subject to fair value accounting because these contracts are derivatives
that cannot be designated as normal purchases or sales, as defined,
because of the optionality in their contract terms. The net fair values of
non-trading derivatives at December 31, 2003 were liabilities of $24
thousand. Yankee Gas held no contracts accounted for as non-trading
derivatives at December 31, 2002.
Utility Group — Gas — 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 an unaffiliated customer is effectively fixed over the
term of the gas service agreements with those customers for a period not
extending beyond 2005. At December 31, 2003 and 2002, the commodity
swap agreement had notional values of $6.3 million and $10.7 million,
respectively, and was recorded at fair value as derivative assets at
December 31, 2003 and 2002 of $2.8 million and $2.3 million, respectively.
Utility Group — Electric — Non-trading: CL&P has two IPP contracts to
purchase power that contain pricing provisions that are not clearly and
closely related to the price of power. Because of a clarification in the
definition of “clearly and closely related” in Issue No. C-20, these contracts
no longer qualify for the normal purchases and sales exception to SFAS
No. 133, as amended. The fair values of these IPP non-trading derivatives
at December 31, 2003 include a derivative asset with a fair value of
$112.4 million and a derivative liability with a fair value of $54.6 million.
To mitigate the risk associated with certain supply contracts, CL&P
purchased FTRs. FTRs are derivatives that cannot qualify for the normal
purchases and sales exception. The fair value of these FTR non-trading
derivatives at December 31, 2003 was an asset of $3 million. CL&P had
no non-trading derivatives at December 31, 2002 that were required to
be recorded at fair value.
NU Parent — Hedging: In March of 2003, NU parent entered into a fixed
to floating interest rate swap on its $263 million, 7.25 percent fixed-rate
note that matures on April 1, 2012. As a matched-terms fair value
hedge, the changes in fair value of the swap and the hedged debt
instrument are recorded on the consolidated balance sheets but are
equal and offsetting in the consolidated statements of income. The
cumulative change in the fair value of the hedged debt of $3.6 million
is included as long-term debt on the consolidated balance sheets. The
resulting changes in interest payments made are recorded as adjustments
to interest expense.
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 val-
ues 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.
NU Enterprises — Wholesale and Retail Marketing Portfolio: When
conducting sensitivity analyses of the change in the fair value of Select
Energy’s electricity, natural gas and oil on the wholesale and retail marketing
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 consideration
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 wholesale and retail marketing portfolio, which includes cash flow
hedges and electricity, natural gas and oil contracts, assuming a 10 percent
change in forward market prices. At December 31, 2003, a 10 percent
change in market price would have resulted in an increase or decrease in
fair value of $3.7 million.
The impact of a change in electricity, natural gas and oil prices on Select
Energy’s wholesale and retail marketing portfolio at December 31, 2003,
is not necessarily representative of the results that will be realized when
these contracts are physically delivered.
NU Enterprises — Trading Contracts: At December 31, 2003, Select
Energy has calculated the market price resulting from a 10 percent
change in forward market prices. That 10 percent change would result in
a $0.4 million increase or decrease in the fair value of the Select Energy
trading portfolio. In the normal course of business, Select Energy also
faces risks that are either non-financial or non-quantifiable. These risks
principally include credit risk, which is not reflected in this sensitivity
analysis.
C. Other Risk Management Activities
Interest Rate Risk Management: NU manages its interest rate risk exposure
in accordance with written policies and procedures by maintaining a mix
of fixed and variable rate debt. At December 31, 2003, approximately
82 percent (72 percent including the debt subject to the fixed-to-floating
interest rate swap in variable rate debt), of NU’s long-term debt, including
fees and interest due for spent nuclear fuel disposal costs, is at a fixed
interest rate. 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, including the rate
on debt subject to the fixed-to-floating interest rate swap, annual interest
expense would have increased by $4.3 million. At December 31, 2003,
NU parent maintained a fixed to floating interest rate swap to manage
the interest rate risk associated with its $263 million of fixed-rate debt.