KeySpan Corporation ("KeySpan") is a member of the Standard and Poor's 500 Index. KeySpan is a New York corporation and a holding company under the Public Utility Holding Company Act of 2005 ("PUHCA 2005"). KeySpan was formed in May 1998, as a result of the business combination of KeySpan Energy Corporation, the parent of The Brooklyn Union Gas Company, and certain businesses of the Long Island Lighting Company ("LILCO"). On November 8, 2000, KeySpan acquired Eastern Enterprises ("Eastern"), now known as KeySpan New England, LLC ("KNE"), a Massachusetts limited liability company, which primarily owns Boston Gas Company ("Boston Gas"), Colonial Gas Company ("Colonial Gas") and Essex Gas Company ("Essex Gas"), gas utilities operating in Massachusetts, as well as EnergyNorth Natural Gas, Inc. ("EnergyNorth"), a gas utility operating principally in central New Hampshire. KeySpan operates six regulated utilities that distribute natural gas to approximately 2.6 million customers in New York City, Long Island, Massachusetts and New Hampshire, making KeySpan the fifth largest gas distribution company in the United States and the largest in the Northeast. KeySpan also owns, leases and operates electric generating plants in Nassau and Suffolk Counties on Long Island and in Queens County in New York City and is the largest electric generation operator in New York State.
Under contractual arrangements, KeySpan provides power, electric transmission and distribution services, billing and other customer services for approximately 1.1 million electric customers of the Long Island Power Authority ("LIPA"). KeySpan's other operating subsidiaries are primarily involved in gas production and development; underground gas storage; liquefied natural gas ("LNG") storage; retail electric marketing; large energy-system ownership, installation and management; service and maintenance of energy systems; and engineering and consulting services. KeySpan also invests and participates in the development of natural gas pipelines, electric generation and other energy-related projects. As used herein, "KeySpan," "we," "us" and "our" refers to KeySpan Corporation, its six principal gas distribution subsidiaries and its other regulated and unregulated subsidiaries, individually and in the aggregate.
On February 25, 2006, KeySpan entered into an Agreement and Plan of Merger (the "Merger Agreement"), with National Grid plc, a public limited company incorporated under the laws of England and Wales ("Parent") and National Grid US8, Inc., a New York Corporation ("Merger Sub"), pursuant to which Merger Sub will merge with and into KeySpan (the "Merger"), with KeySpan continuing as the surviving company and thereby becoming an indirect wholly-owned subsidiary of the Parent. Pursuant to the Merger Agreement, at the effective time of the Merger, each outstanding share of KeySpan common stock, par value $0.01 per share (the "Shares"), other than treasury shares and shares held by the Parent and its subsidiaries, shall be canceled and shall be converted into the right to receive $42.00 in cash, without interest.
Consummation of the Merger is subject to various closing conditions, including but not limited to the receipt of requisite regulatory approvals from certain United States federal and state public utility, antitrust and other regulatory authorities, all of which have been filed and many of which have been obtained. Specifically, we filed our application for approval of the Merger pursuant to the Federal Power Act in May 2006 and in October the requisite approval was obtained from the Federal Energy Regulatory Commission ("FERC"). In early July 2006, we cleared review by the Federal Trade Commission under the Hart-Scott-Rodino Antitrust Improvement Act and received notification that the Committee on Foreign Investment in the U.S. has determined that there are no issues of national security sufficient to warrant an investigation of the transaction.
On July 20, 2006 we filed an application for approval of the transaction with the New York Public Service Commission ("NYPSC"). KeySpan has also sought approval of the merger from the New Hampshire Public Utility Commission. In October 2006, the State of New Jersey Board of Public Utilities approved a change of control of KeySpan Communication Corp., which provides telecommunications services in New Jersey. In addition, the Merger was approved by our shareholders at our Annual Meeting on August 17, 2006. Shareholders of National Grid plc approved the Merger at a meeting held on July 31, 2006.
In addition to seeking approval of the Merger, the application filed with the NYPSC also contained proposed ten-year rate plans for KeySpan Energy Delivery of New York ("KEDNY") and KeySpan Energy Delivery of Long Island ("KEDLI"), as well as proposals concerning corporate structure and affiliate rules, the rate treatment for synergy savings and for low income and energy efficiency programs, among others. Specifically, the rate plan proposals provide for, among other things, a freeze of base delivery rates for KEDNY and KEDLI for 18 months. Thereafter, KEDNY's and KEDLI's gas adjustment clauses would be increased to recover, on a prospective basis, estimated gas commodity-related costs of $68.6 million for KEDNY and $28.7 million for KEDLI that would no longer be included in base rates.
In addition, KEDNY and KEDLI base delivery rates would be increased by an average of 2.5% ($62.4 million) and 2.3% ($39.4 million), respectively in years 3, 5, 7 and 9 of the rate plans. The proposed rate plans contemplate an allowed return on equity of 11.0% for each entity. Cumulative earnings above 11.75% would be shared between gas sales customers and KeySpan over the rate plan period. On October 3, 2006 National Grid plc filed testimony and exhibits with the NYPSC that further explains the exhibits and attachments that were previously submitted as part of the July 20, 2006 petition.
Separately from the merger application, on October 3, 2006, KEDNY and KEDLI filed with the NYPSC individual applications for proposed annual increases in revenues, which applications assumed that KEDNY and KEDLI remained as stand-alone companies. The proposed revenue increases are for approximately 9.1% and 10.9% for KEDNY and KEDLI, respectively. KEDNY's last base rate increase took effect October 1, 1993 and since then base rates have been reduced twice - once in 1996 and again in 1998. KEDLI's last base rate increase took effect December 1, 1995. Since that time, KEDLI's base rates were reduced twice in 1998. The principal factors creating the need for rate relief are increases in operating and maintenance expenses, increases in rate base, increased property taxes and depreciation expense, and the need to commence recovery of previously deferred costs such as pension and post retirement benefits, environmental expenditures and property taxes.
The total projected increase in revenues is comprised of two components; (i) an increase in base rates of $180.7 million for KEDNY and $145 million for KEDLI; and (ii) projected increases of $32.8 million and $13.6 million for KEDNY and KEDLI, respectively, for gas-related expenses that will be recovered through the Gas Adjustment Clause ("GAC") and/or the Transportation Adjustment Clause ("TAC"). The proposed rate of return on equity is 11.0% for both KEDNY and KEDLI.
The NYPSC may suspend the implementation of the proposed tariff changes for up to eleven months, which would mean, absent other intervening events, an effective date of September 3, 2007 for new rates. Although KEDNY and KEDLI proposed the new rates described above in these tariff filings, it will not be necessary to implement the rate increases proposed therein if the NYPSC approves the Merger between National Grid plc and KeySpan and approves the related ten-year rate plan previously noted, or some variation thereof.
On February 20, 2007, NYPSC Staff filed its direct testimony in the merger proceeding. NYSPSC Staff opposed the current terms of the Merger on policy grounds, but suggested that it could support the Merger under certain circumstances. KeySpan and National Grid intend to file testimony responding to the positions taken by Staff. In addition, on January 29, 2007, Staff filed its direct testimony in the rate case proceedings and our rebuttal testimony was filed on February 21, 2007. In connection with each of these proceedings, hearings before an administrative law judge (ALJ) are scheduled to begin in late March. Unless a settlement among the parties is otherwise reached, the ALJ will issue its recommended decision to the NYPSC following such hearings. Ultimately, the NYPSC may accept, reject, or modify all or any part of the ALJ's recommended decision.
KeySpan and National Grid will continue to pursue all required approvals and continue to anticipate that the Merger will be consummated in mid-2007. However, we are unable to predict the outcome of these regulatory proceedings and no assurance can be given that the Merger will occur or the timing of its completion. Accordingly, any statements contained herein concerning expectations, beliefs, plans, objectives, goals, strategies, future events or performance and underlying assumptions are "forward-looking statements" and do not take into account the occurrence or impact of any potential strategic transaction on the future operations, financial condition and cash flows of KeySpan.
KeySpan is a holding company under the Public Utility Holding Company Act of 2005, as amended ("PUHCA 2005"). In August 2005, the Energy Policy Act of 2005 (the "Energy Act") was enacted. The Energy Act is a broad energy bill that places an increased emphasis on the production of energy and promotes the development of new technologies and alternative energy sources and provides tax credits to companies that produce natural gas, oil, coal, electricity and renewable energy. For KeySpan, one of the more significant provisions of the Energy Act was the repeal of the Public Utility Holding Company Act of 1935, as amended ("PUHCA 1935"), which became effective on February 8, 2006. Since that time, the jurisdiction of the Securities and Exchange Commission ("SEC") over certain holding company activities, including the regulation of our affiliate transactions and service companies, has been transferred to the jurisdiction of the Federal Energy Regulatory Commission ("FERC") pursuant to PUHCA 2005. See "Regulation and Rate Matters" for additional information on the Energy Act and PUHCA 2005.
Under our holding company structure, we have no independent operations and conduct substantially all of our operations through our subsidiaries. Our subsidiaries operate in the following four business segments: Gas Distribution, Electric Services, Energy Services and Energy Investments.
The Gas Distribution segment consists of our six regulated gas distribution subsidiaries, which operate in New York, Massachusetts and New Hampshire and serve approximately 2.6 million customers.
The Electric Services segment consists of subsidiaries that manage the electric transmission and distribution system ("T&D System") owned by LIPA; provide generating capacity and, to the extent required, energy conversion services for LIPA from our approximately 4,200 megawatts ("MW") of generating facilities
located on Long Island; and manage fuel supplies for LIPA to fuel our Long Island generating facilities. The Electric Services segment also includes subsidiaries that own, lease and operate the 2,200 MW Ravenswood electric generation facility (the "Ravenswood Facility"), located in Queens County in New York City, and the 250 MW combined cycle generating unit (the "Ravenswood Expansion") which began full commercial operation in May 2004 (collectively, the Ravenswood Facility and the Ravenswood Expansion are referred to herein as the "Ravenswood Generating Station" and have a total electric capacity of 2,450 MW). Moreover, subsidiaries in this segment also provide retail marketing of electricity to commercial customers.
The Energy Services segment provides energy-related services to customers primarily located within the Northeastern United States, with concentrations in the New York City and Boston metropolitan areas.
The Energy Investments segment includes our gas production and development activities, domestic pipelines, gas storage facilities and LNG facilities and operations.
KeySpan's principal executive offices are located at One MetroTech Center, Brooklyn, New York 11201 and 175 East Old Country Road, Hicksville, New York 11801, and its telephone numbers are (718) 403-1000 (Brooklyn) and (516) 755-6650 (Hicksville).
GAS DISTRIBUTION OVERVIEW
Our gas distribution activities are conducted by our six regulated gas distribution subsidiaries, which operate in three states in the Northeast: New York, Massachusetts and New Hampshire. We are the fifth largest gas distribution company in the United States and the largest in the Northeast, with approximately 2.6 million customers served within an aggregate service area covering 4,273 square miles. In New York, The Brooklyn Union Gas Company, doing business as KeySpan Energy Delivery New York ("KEDNY"), provides gas distribution services to customers in the New York City Boroughs of Brooklyn, Queens and Staten Island; and KeySpan Gas East Corporation, doing business as KeySpan Energy Delivery Long Island ("KEDLI"), provides gas distribution services to customers in the Long Island Counties of Nassau and Suffolk and the Rockaway Peninsula of Queens County. In Massachusetts, Boston Gas provides gas distribution services in eastern and central Massachusetts; Colonial Gas provides gas distribution services on Cape Cod and in eastern Massachusetts; and Essex Gas provides gas distribution services in eastern Massachusetts. In New Hampshire, EnergyNorth provides gas distribution services to customers principally located in central New Hampshire. Our New England gas companies all do business as KeySpan Energy Delivery New England ("KEDNE").
In New York, there are two separate, but contiguous service territories served by KEDNY and KEDLI, comprising approximately 1,417 square miles and 1.68 million customers. In Massachusetts, Boston Gas, Colonial Gas and Essex Gas serve three service territories consisting of 1,934 square miles and approximately 792,000 customers. In New Hampshire, EnergyNorth has a service territory that is contiguous to Colonial Gas' and ranges from within 30 to 85 miles of the greater Boston area. EnergyNorth provides service to approximately 80,000 customers over a service area of approximately 922 square miles. Collectively, KeySpan owns and operates gas distribution, transmission and storage systems that consist of approximately 23,336 miles of gas mains and distribution pipelines.
Natural gas is offered for sale to residential and small commercial customers on a "firm" basis, and to most large commercial and industrial customers on either a "firm" or "interruptible" basis. "Firm" service is offered to customers under tariffed schedules or contracts that anticipate no interruptions, whereas "interruptible" service is offered to customers under tariffed schedules or contracts that anticipate and permit interruption on short notice, generally in peak-load seasons or for system reliability reasons. We maintain a diverse portfolio of firm gas supply, storage and pipeline transportation capacity contracts to adequately serve the requirements of our gas sales customers, to maintain system reliability and system operations, and to meet our obligation to serve our customers. We also engage in the use of derivative financial instruments from time to time to reduce the cash flow volatility associated with the purchase price for a portion of future natural gas purchases.
KeySpan actively promotes a competitive retail gas market by offering tariff firm transportation services to firm gas customers who elect to purchase their gas supplies from natural gas marketers rather than from the utility. In New York, KeySpan further facilitates competition by releasing its pipeline transportation capacity and offering bundled gas supply to natural gas marketers that would otherwise not be able to obtain their own capacity. In Massachusetts and New Hampshire, there are mandatory capacity assignment programs in place whereby capacity is released to natural gas marketers on behalf of customers they serve. However, net gas revenues are not significantly affected by customers opting to purchase their gas supply from other sources since delivery rates charged to transportation customers generally are the same as delivery rates charged to sales service customers.
KeySpan also participates in interstate markets by releasing pipeline capacity and by selling bundled gas services to customers located outside of our service territory ("off-system" customers).
KeySpan purchases natural gas for firm gas customers under both long and short-term supply contracts, as well as on the spot market, and utilizes its firm pipeline transportation contracts to transport the gas from the point of purchase to the market. KeySpan also contracts for firm capacity in natural gas underground storage facilities to store gas during the summer for later withdrawal during the winter heating season when gas customer demand is higher. KeySpan also contracts for firm winter peaking supplies to meet firm gas customer demand on the coldest days of the year.
KeySpan sells gas to firm gas customers at its cost for such gas, plus a charge designed to recover the costs of distribution (including a return of and a return on capital invested in our distribution facilities). We share with our firm gas customers net revenues (operating revenues less the cost of gas and associated revenue taxes) from off-system sales and capacity release transactions. Further, net revenues from tariff gas balancing services and certain interruptible on-system sales are refunded, for most of our subsidiaries, to firm customers subject to certain sharing provisions.
Our gas operations can be significantly affected by seasonal weather conditions. Annual revenues are substantially realized during the heating season as a result of higher sales of gas due to cold weather. Accordingly, operating results historically are most favorable in the first and fourth calendar quarters. KEDNY and KEDLI each operate under a utility tariff that contains a weather normalization adjustment that largely offsets variations in firm net revenues due to fluctuations in normal weather. However, the tariffs for our four KEDNE gas distribution companies do not contain such a weather normalization adjustment and, therefore, fluctuations in seasonal weather conditions between years may have a significant effect on results of operations and cash flows for these four subsidiaries. We utilize weather derivatives for KEDNE to mitigate variations in firm net revenues due to warmer-than-normal weather during the heating season.
New York Gas Distribution Systems - KEDNY and KEDLY Supply and Storage
KEDNY and KEDLI have firm long-term contracts for the purchase of transportation and underground storage services. Gas supplies are purchased under long and short-term firm contracts, as well as on the spot market. Gas supplies are transported by interstate pipelines from domestic and Canadian supply basins. Peaking supplies are available to meet system requirements on the coldest days of the winter season.
Peak-Day Capability. The design criteria for the New York gas system assumes an average temperature of 0(0)F for peak-day demand. Under such criteria, we estimate that the requirements to supply our firm gas customers would amount to approximately 2,129 MDTH (one MDTH equals 1,000 DTH or 1 billion British Thermal Units) of gas for a peak-day during the 2006/07 winter season and that the gas available to us on such a peak-day amounts to approximately 2,235 MDTH.