Item 1. Distribution Operations
The distribution operations segment is the largest component of our business and includes six natural gas local distribution utilities. These utilities construct, manage and maintain intrastate natural gas pipelines and distribution facilities and include:
- Atlanta Gas Light
- Chattanooga Gas
- Elizabethtown Gas
- Elkton Gas
- Florida City Gas
- Virginia Natural Gas
Regulatory Environment Each utility operates subject to regulations of the state regulatory agency in its service territories with respect to rates charged to our customers and various service and safety matters. Rates charged to our customers vary according to customer class (residential, commercial or industrial) and rate jurisdiction. Rates are set at levels that allow recovery of all prudently incurred costs, including a return on rate base sufficient to pay interest on debt and provide a reasonable return on common equity. Rate base generally consists of the original cost of utility plant in service, working capital, inventories and certain other assets; less accumulated depreciation on utility plant in service and net deferred income tax liabilities, and may include certain other additions or deductions.
Atlanta Gas Light does not sell natural gas directly to its customers and does not need or utilize a PGA. All of our other utilities are authorized to use a PGA mechanism that allows them to adjust their rates to reflect changes in the wholesale cost of natural gas and to ensure they recover 100% of the costs incurred in purchasing gas for their customers. We continuously monitor the performance of our utilities to determine whether rates need to be further adjusted through the regulatory process. We have fixed rate settlements in three of our six jurisdictions in Georgia, New Jersey and Virginia.
Atlanta Gas Light's natural gas market was deregulated in 1997 with the Deregulation Act. Prior to this act, Atlanta Gas Light was the supplier and seller of natural gas to its customers. Today, Marketers sell natural gas to end-use customers in Georgia and handle customer billing functions. The Marketers file their rates monthly with the Georgia Commission. Atlanta Gas Light's role includes:
- distributing natural gas for Marketers
- constructing, operating and maintaining the gas system infrastructure, including responding to customer service calls and leaks
- reading meters and maintaining underlying customer premise information for Marketers
Atlanta Gas Light recognizes revenue under a straight-fixed-variable rate design whereby Atlanta Gas Light charges rates to its customers based primarily on monthly fixed charges. The Marketers bill these charges directly to their customers. This mechanism minimizes the seasonality of revenues since the monthly fixed charge is not volumetric or directly weather dependent. Weather indirectly influences the number of customers that have active accounts during the heating season, and this has a seasonal impact on Atlanta Gas Light's revenues since generally more customers are connected in periods of colder weather than in periods of warmer weather.
Regulatory Agreements In September 2007, the Georgia Commission approved our request to obtain an undivided interest in pipelines connecting our Georgia service territory to liquefied natural gas facilities at Elba Island, Georgia. We along with SNG have undertaken this pipeline project in an effort to diversify our sources of natural gas. We currently receive the majority of our natural gas supply from a production region in and around the Gulf of Mexico and generally, demand for this natural gas is growing faster than supply. This project is contingent upon FERC approval and therefore SNG and ourselves jointly filed an application with the FERC in October 2007. We anticipate that we will receive FERC approval in 2008. Construction is expected to begin in 2008 and to be completed in 2009.
In December 2007, the Florida Commission approved our request to include the amortization of certain components of the purchase price we paid for Florida City Gas in our calculation of return on equity. The costs will not be amortized for financial reporting purposes in accordance with GAAP but will be amortized over a period of 5 to 30 years for our regulatory reporting to the Florida Commission in connection with the Florida Commission's review of Florida City Gas' return on equity. Additionally and under the same order, the Florida Commission approved a five-year base rate stay-out beginning October 2007, whereby base rates will not be increased, except for certain unforeseen acts beyond our control. The five-year stay-out provision does not preclude the Florida Commission from initiating over earning or other proceedings.
A November 2004 agreement between Elizabethtown Gas and the New Jersey Commission approved our acquisition of NUI Corporation. This agreement included, among other things, a base rate freeze for Elizabethtown Gas for the five-year period from November 2004 to October 2009. Beginning with the annual measurement period in December 2007, 75% of Elizabethtown Gas' earnings in excess of an 11% return on equity would be shared with rate payers in the fourth and fifth years of the base rate stay-out period.
Weather Normalization Certain of our non-Georgia jurisdictions have various regulatory mechanisms that allow us to recover our costs in the event of unusual weather, but they are not direct offsets to the potential impacts of weather and customer consumption on earnings. The tariffs of Elizabethtown Gas, Virginia Natural Gas, and Chattanooga Gas contain WNA provisions that are designed to help stabilize operating results by increasing base rate amounts charged to customers when weather is warmer than normal and decreasing amounts charged when weather is colder than normal. The WNA is most effective in a reasonable temperature range relative to normal weather using historical averages. The following table provides certain regulatory information for our largest utilities.
Customer Demand All of our utilities face competition from other energy products. Our principal competition arises from electric utilities and oil and propane providers serving the residential and commercial markets throughout our service areas and the potential displacement or replacement of natural gas appliances with electric appliances. The primary competitive factors are the prices for competing sources of energy as compared to natural gas and the desirability of natural gas heating versus alternative heating sources.
Competition for space heating and general household and small commercial energy needs generally occurs at the initial installation phase when the customer or builder makes decisions as to which types of equipment to install. Customers generally continue to use the chosen energy source for the life of the equipment. Customer demand for natural gas could be affected by numerous factors, including:
- changes in the availability or price of natural gas and other forms of energy
- general economic conditions
- energy conservation
- legislation and regulations
- the capability to convert from natural gas to alternative fuels
- new housing starts
In some of our service areas, net growth continues to be slowed due to the number of customers who leave our systems because of higher natural gas prices, slower economic growth in some of our service areas and competition from alternative fuel sources, including incentives offered by the local electric utilities to switch to electric alternatives.
Through our targeted marketing and customer retention programs, we have improved the retention of our existing customers. Additionally, these activities have enabled us to obtain new customers, although at a lower rate than expected, due in part to downturns in the general economy and the housing and related mortgage markets. We expect these conditions to continue for an extended period of time and that such conditions could impact our net customer growth. Consequently, we will focus even more on our marketing and customer retention efforts.
These efforts include working to add residential customers, multifamily complexes and high-value commercial customers that use natural gas for purposes other than space heating. In addition, we partner with numerous entities to market the benefits of gas appliances and to identify potential retention options early in the process for those customers who might consider converting to alternative fuels.
Collective Bargaining Agreements In 2007, collective bargaining agreements, representing 55 employees at Atlanta Gas Light, Chattanooga Gas and Elizabethtown Gas were terminated as a result of the decertification of the respective unions. Accordingly, these 55 employees are no longer represented by a bargaining agreement and now fall under our standard human resources pay and benefit plans and policies. In January 2008, approximately 55 Florida City Gas employees filed for decertification of their union. The vote is expected to occur in February 2008.
The following table provides information about the collective bargaining agreements to which our natural gas local distribution utilities are parties. Additionally, we believe that our relations with our employees are good.