= = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = =
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported) Not applicable
---------------
DUKE ENERGY CORPORATION
(Exact name of registrant as specified in its charter)
North Carolina 1-4928 56-0205520
(State or other jurisdiction (Commission File (IRS Employer
of incorporation) Number) Identification No.)
526 South Church Street
Charlotte, North Carolina 28201-1006
(Address of principal executive offices) (Zip Code)
(704) 594-6200
(Registrant's telephone number, including area code)
---------------
Not applicable
(Former name or address, if changed since last report)
= = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = = =
<PAGE>
Item 7. Financial Statements and Exhibits.
The registrant files this Form 8-K Current Report for the purpose of
filing the exhibits listed below. Exhibits 99(a) and 99(b) are expected to be
filed in identical form during March 1999, with the registrant's Form 10-K
Annual Report for the year ended December 31, 1998.
(c) Exhibits
23(a) Consent of Deloitte & Touche LLP
23(b) Consent of KPMG LLP
99(a) Consolidated Financial Statements:
Consolidated Statements of Income for the Years Ended
December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996
Consolidated Balance Sheets as of December 31, 1998
and 1997
Consolidated Statements of Common Stockholders' Equity
for the Years Ended December 31, 1998, 1997 and 1996
Notes to Consolidated Financial Statements
99(b) Management's Discussion and Analysis of Results of Operations
and Financial Condition
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
DUKE ENERGY CORPORATION
By:
Name: David L. Hauser
Title: Senior Vice President
and Treasurer
Dated: March 8, 1999
<PAGE>
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
23(a) Consent of Deloitte & Touche LLP
23(b) Consent of KPMG LLP
99(a) Consolidated Financial Statements:
Consolidated Statements of Income for the Years Ended
December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996
Consolidated Balance Sheets as of December 31, 1998
and 1997
Consolidated Statements of Common Stockholders' Equity
for the Years Ended December 31, 1998, 1997 and 1996
Notes to Consolidated Financial Statements
99(b) Management's Discussion and Analysis of Results of Operations
and Financial Condition
Exhibit No. 23(a)
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in Registration Statement Nos.
333-50543, 33-50617, 33-50715, 333-02571, 333-02575, 333-14209, 333-30263,
333-40679 and 333-59327 of Duke Energy Corporation on Form S-3 and Registration
Statement Nos. 333-29563, 333-29585, 333-29587, 333-34655, 333-12093, 333-50317
and 333-59279 of Duke Energy Corporation on Form S-8 of our report dated
February 12, 1999, appearing in this Form 8-K of Duke Energy Corporation.
Deloitte & Touche LLP
Charlotte, North Carolina
March 8, 1999
Exhibit No. 23(b)
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in Registration Statement Nos.
33-50543, 33-50617, 33-50715, 333-02571, 33-59926, 33-60314, 333-02575,
333-14209, and 333-30263 of Duke Energy Corporation on Form S-3 and Registration
Statements Nos. 333-29563, 333-29585, 333-29587, and 333-34655 of Duke Energy
Corporation on Form S-8 of our report on the consolidated financial statements
on PanEnergy Corp. as of and for the years ended December 31, 1996 and 1995,
dated January 16, 1997, appearing in this Form 8-K of Duke Energy Corporation.
/s/ KPMG LLP
Houston, Texas
March 8, 1999
Exhibit 99 (a)
Consolidated Financial Statements
DUKE ENERGY CORPORATION
Consolidated Statements of Income
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------
1998 1997 1996
------------- ------------ ----------
In millions, except per share amounts
<S> <C> <C> <C>
Operating Revenues
Sales, trading and marketing of natural gas and petroleum products
(Notes 1 and 4) ............................................................... $ 7,854 $ 8,151 $ 5,848
Transportation and storage of natural gas (Notes 1 and 4) ...................... 1,450 1,504 1,523
Generation, transmission and distribution of electricity (Notes 1 and 4) ....... 4,586 4,334 4,436
Trading and marketing of electricity (Notes 1 and 4) ........................... 2,788 1,665 78
Other (Note 8) ................................................................. 932 655 417
------- -------- -------
Total operating revenues ..................................................... 17,610 16,309 12,302
------- -------- -------
Operating Expenses
Natural gas and petroleum products purchased (Note 1) .......................... 7,497 7,705 5,414
Fuel used in electric generation (Notes 1 and 11) .............................. 767 743 758
Net interchange and purchased power (Notes 1, 4 and 5) ......................... 2,916 1,960 457
Other operation and maintenance (Notes 4, 11 and 14) ........................... 2,738 2,721 2,383
Depreciation and amortization (Notes 1 and 5) .................................. 909 841 789
Property and other taxes ....................................................... 350 369 342
------- -------- -------
Total operating expenses ..................................................... 15,177 14,339 10,143
------- -------- -------
Operating Income ................................................................. 2,433 1,970 2,159
------- -------- -------
Other Income and Expenses
Deferred returns and allowance for funds used during construction (Note 1) ..... 88 109 105
Other, net ..................................................................... 126 29 30
------- -------- -------
Total other income and expenses .............................................. 214 138 135
------- -------- -------
Earnings Before Interest and Taxes ............................................... 2,647 2,108 2,294
Interest Expense (Notes 7 and 10) ................................................ 514 472 499
Minority Interests (Notes 2 and 12) .............................................. 96 23 6
------- -------- -------
Earnings Before Income Taxes ..................................................... 2,037 1,613 1,789
Income Taxes (Notes 1 and 6) ..................................................... 777 639 698
------- -------- -------
Income Before Extraordinary Item ................................................. 1,260 974 1,091
Extraordinary Loss, net of tax ................................................... (8) -- (17)
--------- -------- -------
Net Income ....................................................................... 1,252 974 1,074
-------- -------- -------
Dividends and Premiums on Redemptions of Preferred and Preference Stock
(Note 13) ...................................................................... 21 72 44
-------- -------- -------
Earnings Available for Common Stockholders ....................................... $ 1,231 $ 902 $ 1,030
======== ======== =======
Common Stock Data (Note 1)
Weighted average shares outstanding ............................................ 361 360 361
Earnings per share (before extraordinary item)
Basic ......................................................................... $ 3.43 $ 2.51 $ 2.90
Dilutive ...................................................................... $ 3.42 $ 2.50 $ 2.88
Earnings per share
Basic ......................................................................... $ 3.41 $ 2.51 $ 2.85
Dilutive ...................................................................... $ 3.40 $ 2.50 $ 2.83
Dividends per share ............................................................ $ 2.20 $ 1.90 $ 1.57
</TABLE>
See Notes to Consolidated Financial Statements
<PAGE>
DUKE ENERGY CORPORATION
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
1998 1997 1996
------------- ------------- -------------
In millions
<S> <C> <C> <C>
Cash Flows from Operating Activities
Net Income ......................................................................... $ 1,252 $ 974 $ 1,074
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ...................................................... 1,055 983 965
Deferred income taxes .............................................................. (35) 99 94
Purchased capacity levelization .................................................... 88 56 73
Transition cost (payments) recoveries, net ......................................... (28) (36) 91
(Increase) decrease in .............................................................
Receivables ...................................................................... (18) (266) (646)
Inventory ........................................................................ (104) (7) 45
Other current assets ............................................................. (39) (18) 17
Increase (decrease) in .............................................................
Accounts payable ................................................................. 72 239 577
Taxes accrued .................................................................... (6) 50 (11)
Interest accrued ................................................................. (2) (13) (18)
Other current liabilities ........................................................ 84 15 (10)
Other, net ......................................................................... 12 64 84
--------- --------- -------
Net cash provided by operating activities ........................................ 2,331 2,140 2,335
--------- --------- -------
Cash Flows from Investing Activities
Capital expenditures ............................................................... (2,159) (1,323) (1,394)
Investment expenditures ............................................................ (341) (705) (156)
Decommissioning, retirements and other ............................................. 24 34 (18)
--------- --------- -------
Net cash used in investing activities ............................................ (2,476) (1,994) (1,568)
--------- --------- -------
Cash Flows from Financing Activities
Proceeds from the issuance of
Long-term debt ................................................................... 1,357 1,618 363
Guaranteed preferred beneficial interests in subordinated notes of Duke Energy
Corporation or subsidiaries ..................................................... 581 339 --
Common stock and stock options ................................................... 176 15 12
Payments for the redemption of
Long-term debt ................................................................... (698) (869) (527)
Common stock ..................................................................... -- (25) (159)
Preferred and preference stock ................................................... (180) (224) --
Net change in notes payable and commercial paper ................................... (350) (290) 159
Dividends paid ..................................................................... (814) (726) (609)
Other .............................................................................. 6 (41) (12)
--------- --------- -------
Net cash provided by (used in) financing activities .............................. 78 (203) (773)
--------- --------- -------
Net decrease in cash and cash equivalents .......................................... (67) (57) (6)
Cash received from business acquisitions ........................................... 38 -- --
Cash and cash equivalents at beginning of year ..................................... 109 166 172
--------- --------- ---------
Cash and cash equivalents at end of year ........................................... $ 80 $ 109 $ 166
========= ========= =========
Supplemental Disclosures
Cash paid for interest, net of amount capitalized .................................. $ 490 $ 476 $ 493
Cash paid for income taxes ......................................................... $ 733 $ 470 $ 550
</TABLE>
See Notes to Consolidated Financial Statements
<PAGE>
DUKE ENERGY CORPORATION
Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31,
-----------------------
1998 1997
----------- -----------
In millions
<S> <C> <C>
ASSETS
Current Assets (Note 1)
Cash and cash equivalents (Note 7) .................................. $ 80 $ 109
Receivables (Note 7) ................................................ 2,318 2,281
Inventory ........................................................... 543 440
Current portion of natural gas transition costs (Note 4) ............ 100 67
Current portion of purchased capacity costs (Note 5) ................ 99 76
Unrealized gains on mark to market transactions (Note 7) ............ 1,457 551
Other (Note 7) ...................................................... 228 161
-------- --------
Total current assets .............................................. 4,825 3,685
-------- --------
Investments and Other Assets
Investments in affiliates (Notes 8 and 14) .......................... 902 686
Nuclear decommissioning trust funds (Notes 7 and 11) ................ 580 471
Pre-funded pension costs (Note 17) .................................. 332 337
Goodwill, net (Notes 1, 2 and 6) .................................... 495 504
Notes receivable .................................................... 244 240
Unrealized gains on mark to market transactions (Notes 1 and 7) ..... 396 66
Other ............................................................... 283 144
-------- --------
Total investments and other assets ................................ 3,232 2,448
-------- --------
Property, Plant and Equipment (Notes 1, 5, 9, 10, 11 and 14)
Cost ................................................................ 27,128 25,448
Less accumulated depreciation and amortization ...................... 10,253 9,712
-------- --------
Net property, plant and equipment ................................. 16,875 15,736
-------- --------
Regulatory Assets and Deferred Debits (Note 1)
Purchased capacity costs (Note 5) ................................... 648 759
Debt expense ........................................................ 253 253
Regulatory asset related to income taxes ............................ 506 511
Natural gas transition costs (Note 4) ............................... 80 194
Environmental clean-up costs ........................................ 87 104
Other ............................................................... 300 339
-------- --------
Total regulatory assets and deferred debits ....................... 1,874 2,160
-------- --------
Total Assets ......................................................... $ 26,806 $ 24,029
======== ========
</TABLE>
See Notes to Consolidated Financial Statements
<PAGE>
DUKE ENERGY CORPORATION
Consolidated Balance Sheets -- Continued
<TABLE>
<CAPTION>
December 31,
---------------------
1998 1997
---------- ----------
In millions
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable ....................................................................... $ 1,754 $ 1,670
Notes payable and commercial paper (Notes 7 and 10) .................................... 209 170
Taxes accrued (Note 1) ................................................................. 119 125
Interest accrued ....................................................................... 109 111
Current maturities of long-term debt and preferred stock (Notes 10 and 13) ............. 707 77
Unrealized losses on mark to market transactions (Notes 1 and 7) ....................... 1,387 538
Other (Notes 1 and 14) ................................................................. 642 584
-------- --------
Total current liabilities ............................................................ 4,927 3,275
-------- --------
Long-term Debt (Notes 7 and 10) ......................................................... 6,272 6,530
-------- --------
Deferred Credits and Other Liabilities (Note 1)
Deferred income taxes (Note 6) ......................................................... 3,733 3,707
Investment tax credit (Note 6) ......................................................... 242 257
Nuclear decommissioning costs externally funded (Notes 7 and 11) ....................... 580 471
Natural gas transition liabilities (Note 4) ............................................ 4 78
Environmental clean-up liabilities (Note 14) ........................................... 148 158
Unrealized losses on mark to market transactions (Note 7) .............................. 362 50
Other .................................................................................. 903 967
-------- --------
Total deferred credits and other liabilities ......................................... 5,972 5,688
-------- --------
Minority Interests (Note 2) ............................................................. 253 168
-------- --------
Guaranteed Preferred Beneficial Interests in Subordinated
Notes of Duke Energy Corporation or Subsidiaries (Notes 7 and 12) ...................... 919 339
-------- --------
Preferred and Preference Stock (Notes 7 and 13)
Preferred and preference stock with sinking fund requirements .......................... 104 149
Preferred and preference stock without sinking fund requirements ....................... 209 340
-------- --------
Total preferred and preference stock ................................................. 313 489
-------- --------
Commitments and Contingencies (Notes 5, 11 and 14)
Common Stockholders' Equity (Notes 15 and 16)
Common stock, no par, 500 million shares authorized; 363.0 million and 359.8 million
shares outstanding at December 31, 1998 and 1997, respectively ....................... 4,449 4,284
Retained earnings ...................................................................... 3,701 3,256
-------- --------
Total common stockholders' equity .................................................... 8,150 7,540
-------- --------
Total Liabilities and Stockholders' Equity .............................................. $ 26,806 $ 24,029
======== ========
</TABLE>
See Notes to Consolidated Financial Statements
<PAGE>
DUKE ENERGY CORPORATION
Consolidated Statements of Common Stockholders' Equity
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------
1998 1997 1996
---------- ------------- ----------
In millions
<S> <C> <C> <C>
Common Stock
Balance at beginning of year ......................... $ 4,284 $ 4,289 $ 4,297
Stock repurchased (Note 15) .......................... -- -- (31)
Dividend reinvestment and employee benefits .......... 165 (9) 23
Other capital stock transactions, net ................ -- 4 --
------- -------- -------
Balance at end of year ............................. 4,449 4,284 4,289
------- -------- -------
Retained Earnings
Balance at beginning of year ......................... 3,256 3,052 2,716
Net income ........................................... 1,252 974 1,074
Common stock dividends ............................... (794) (682) (566)
Preferred and preference stock dividends and premiums
on redemptions (Note 13) ........................... (21) (72) (44)
Other capital stock transactions, net ................ 8 (16) (128)
------- -------- -------
Balance at end of year ............................. 3,701 3,256 3,052
------- -------- -------
Total Common Stockholders' Equity ..................... $ 8,150 $ 7,540 $ 7,341
======= ======== =======
</TABLE>
See Notes to Consolidated Financial Statements
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements
For the Years Ended December 31, 1998, 1997 and 1996
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidation. The consolidated financial statements include the accounts
of all of Duke Energy Corporation's majority-owned subsidiaries after the
elimination of significant intercompany transactions and balances. Investments
in other entities that are not controlled by Duke Energy Corporation, but where
it has significant influence over operations, are accounted for using the
equity method.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Although these estimates are based on management's
knowledge of current and expected future events, actual results could differ
from those estimates.
"Duke Energy" is used from time to time herein as a collective reference
to Duke Energy Corporation and its subsidiaries.
Cash and Cash Equivalents. All liquid investments with maturities at date
of purchase of three months or less are considered cash equivalents.
Inventory. Inventory consists primarily of materials and supplies, gas
held for transmission, processing and sales commitments and coal held for
electric generation. Inventory is recorded at the lower of cost or market,
primarily using the average cost method.
Commodity Derivatives. Duke Energy, primarily through its subsidiaries,
manages its exposure to risk from existing contractual commitments and provides
risk management services to its customers and suppliers through forward
contracts, futures, over-the-counter swap agreements and options.
Commodity derivatives and certain forward contracts utilized for trading
purposes are accounted for using the mark-to-market method. Under this
methodology, these instruments are adjusted to market value, and the gains and
losses are recognized in current period income and are included in the
Consolidated Statements of Income as Natural Gas and Petroleum Products
Purchased or Net Interchange and Purchased Power. Unrealized gains and losses
are recorded in the Consolidated Balance Sheets as Unrealized Gains or Losses
on Mark to Market Transactions.
Futures, over-the-counter swap agreements and options are also utilized
for non-trading purposes to hedge the impact of market fluctuations in the
price and transportation costs of natural gas, electricity and other
energy-related products. In order to qualify as a hedge, the price movements in
the commodity derivatives must be highly correlated with the underlying hedged
commodity. Under the deferral method of accounting, gains and losses related to
commodity derivatives which
qualify as hedges of commodity commitments are recognized in income when the
underlying hedged physical transaction closes and are included in the
Consolidated Statements of Income as Natural Gas and Petroleum Products
Purchased or Net Interchange and Purchased Power. Deferred gains and losses
related to such instruments are reported in the Consolidated Balance Sheets as
Current Assets or Liabilities until recognized in income. If the commodity
derivative is no longer sufficiently correlated to the underlying commodity, or
if the underlying commodity transaction closes earlier than anticipated, the
deferred gains or losses are recognized in income.
Derivative Financial Instruments. Duke Energy uses interest rate swaps,
accounted for under the accrual method, to manage the interest rate
characteristics associated with outstanding debt. Interest rate differentials
to be paid or received as interest rates change are accrued and recognized as
an adjustment to interest expense. The amount accrued as either a payable to or
receivable from counterparties is included in the Consolidated Balance Sheets
as Regulatory Assets and Deferred Debits.
Duke Energy also utilizes interest rate lock agreements to hedge interest
rate risk associated with new debt issuances. Under the deferral method of
accounting, gains or losses on such agreements, when settled, are deferred in
the Consolidated Balance Sheets as Long-term Debt and are amortized in the
Consolidated Statements of Income as an adjustment to interest expense.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued
Duke Energy enters into foreign currency swap agreements to manage foreign
currency risks associated with energy contracts denominated in foreign
currencies. These agreements are accounted for under the mark-to-market method.
See previous discussion of the mark-to-market method in the Commodity
Derivatives section.
Goodwill Amortization. Goodwill related to the purchases of Duke/Louis
Dreyfus, L.LC. (D/LD), Texas Eastern Corporation (TEC) and other natural gas
gathering, transmission and processing facilities and engineering consulting
businesses is amortized on a straight-line basis over 10 years, 40 years and 15
years, respectively. See Note 2 for a description of the D/LD acquisition.
Goodwill recorded as of December 31, 1998 and 1997 related to the 1989 TEC
acquisition was $245 million. Accumulated amortization of goodwill at December
31, 1998 and 1997 was $166 million and $124 million, respectively.
Property, Plant and Equipment. Property, plant and equipment are stated at
original cost. Duke Energy capitalizes all construction-related direct labor
and material costs, as well as indirect construction costs. Indirect costs
include general engineering, taxes and the cost of money. The cost of renewals
and betterments that extend the useful life of property, plant and equipment is
also capitalized. The cost of repairs and replacements is charged to expense as
incurred. Depreciation is generally computed using the straight-line method.
The composite weighted-average depreciation rates, excluding nuclear fuel, were
3.82%, 3.67% and 3.77% for 1998, 1997 and 1996, respectively.
When property, plant and equipment maintained by Duke Energy's regulated
operations are retired, the original cost plus the cost of retirement, less
salvage, is charged to accumulated depreciation and amortization. When entire
regulated operating units are sold or non-regulated properties are retired or
sold, the property and related accumulated depreciation and amortization
accounts are reduced, and any gain or loss is recorded in income, unless
otherwise required by the Federal Energy Regulatory Commission (FERC).
Impairment of Long-Lived Assets. The recoverability of long-lived assets
and intangible assets are reviewed whenever events or changes in circumstances
indicate that the carrying amount of the asset may not be recoverable. Such
evaluation is based on various analyses, including undiscounted cash flow
projections.
Unamortized Debt Premium, Discount and Expense. Premiums, discounts and
expenses incurred in connection with the issuance of presently outstanding
long-term debt are amortized over the terms of the respective issues. Any call
premiums or unamortized expenses associated with refinancing higher-cost debt
obligations used to finance regulated assets and operations are amortized
consistent with regulatory treatment of those items.
Environmental Expenditures. Environmental expenditures that relate to an
existing condition caused by past operations and do not contribute to current
or future revenue generation are expensed. Environmental expenditures relating
to current or future revenues are expensed or capitalized as appropriate.
Liabilities are recorded when environmental assessments and/or clean-ups are
probable and the costs can be reasonably estimated. Certain of these
environmental assessments and clean-up costs are expected to be recovered from
Natural Gas Transmission customers and have, therefore, been deferred and are
included in the Consolidated Balance Sheets as Environmental Clean-up Costs.
Cost-Based Regulation. Duke Energy's regulated operations are subject to
the provisions of Statement of Financial Accounting Standards (SFAS) No. 71,
"Accounting for the Effects of Certain Types of Regulation." Accordingly,
certain assets and liabilities that result from the regulated ratemaking
process are recorded that would not be recorded under generally accepted
accounting principles for non-regulated entities. These regulatory assets and
liabilities are classified in the Consolidated Balance Sheets as Regulatory
Assets and Deferred Debits and Deferred Credits and Other Liabilities,
respectively. The applicability of SFAS No. 71 is routinely evaluated, and
factors such as regulatory changes and the impact of competition are
considered. Discontinuing cost-based regulation or increasing competition might
require companies to reduce their asset balances to reflect a market basis less
than cost and to write off their associated regulatory assets. Management
cannot predict the potential impact, if any, of discontinuing cost-based
regulation or increasing competition on future financial position or results of
operations. However, Duke Energy continues to position itself to effectively
meet these challenges by maintaining competitive prices.
Common Stock Options. The intrinsic value method of accounting is used for
common stock options issued to employees.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued
Revenues. Revenues on sales of electricity and transportation and storage
of natural gas are recognized as service is provided. Revenues on sales of
natural gas and petroleum products are recognized in the period of delivery.
Receivables on the Consolidated Balance Sheets included $193 million and $232
million as of December 31, 1998 and 1997, respectively, for electric service
that has been provided but not yet billed to customers. When rate cases are
pending final approval, a portion of the revenues is subject to possible
refund. Reserves have been established where required for such cases.
Nuclear Fuel. Amortization of nuclear fuel is included in the Consolidated
Statements of Income as Fuel Used in Electric Generation. The amortization is
recorded using the units-of-production method.
Deferred Returns and Allowance for Funds Used During Construction (AFUDC).
Deferred returns represent the estimated financing costs associated with
funding certain regulatory assets. These regulatory assets primarily arose from
the funding of purchased capacity costs above levels collected in rates.
Deferred returns are non-cash items and are primarily recognized as an addition
to Purchased Capacity Costs with an offsetting credit to Other Income and
Expenses.
AFUDC represents the estimated debt and equity costs of capital funds
necessary to finance the construction of new regulated facilities. AFUDC is a
non-cash item and is recognized as a cost of Property, Plant and Equipment,
with offsetting credits to Other Income and Expenses and to Interest Expense.
After construction is completed, Duke Energy is permitted to recover these
costs, including a fair return, through their inclusion in rate base and in the
provision for depreciation.
Rates used for capitalization of deferred returns and AFUDC by Duke
Energy's regulated operations are calculated in compliance with FERC rules.
Income Taxes. Duke Energy and its subsidiaries file a consolidated federal
income tax return. Deferred income taxes have been provided for temporary
differences. Temporary differences occur when events and transactions
recognized for financial reporting result in taxable or tax-deductible amounts
in different periods. Investment tax credits have been deferred and are being
amortized over the estimated useful lives of the related properties.
Earnings Per Common Share. Basic earnings per share is based on a simple
weighted average of common shares outstanding. Dilutive earnings per share
reflects the potential dilution that could occur if securities or other
agreements to issue common stock, such as stock options, were exercised or
converted into common stock. The numerator for the calculation of basic and
dilutive earnings per share is earnings available for common stockholders.
Denominator for Earnings per Share
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ -----
In millions
<S> <C> <C> <C>
Denominator for basic earnings per share
(weighted average shares outstanding) .............. 361 360 361
Assumed exercise of dilutive stock options .......... 1 2 2
--- --- ---
Denominator for dilutive earnings per share ......... 362 362 363
=== === ===
</TABLE>
Extraordinary Items. In January 1998, TEPPCO Partners, L.P. (TEPPCO), in
which a subsidiary of Duke Energy has a 2% general partner interest and a 19.1%
limited partner interest, redeemed certain First Mortgage Notes. A non-cash
extraordinary loss of $8 million, net of income tax of $5 million, was recorded
related to costs of the early retirement of debt. Earnings per common share for
1998 were reduced by $0.02 as a result of this charge.
On October 1, 1996, Texas Eastern Transmission Corporation (TETCO), a
subsidiary of Duke Energy, redeemed $150 million, 10% debentures and $100
million, 10 1/8% debentures due 2011. TETCO recorded a non-cash extraordinary
item of $17 million, net of income tax of $10 million, related to the
unamortized discount on this early retirement of debt. Earnings per common
share for 1996 were reduced $0.05 as a result of this charge.
Reclassifications. Certain amounts have been reclassified in the
Consolidated Financial Statements to conform to the current presentation.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued
New Accounting Standard. In September 1998, SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," was issued. Duke Energy is
required to adopt this standard by January 1, 2000. SFAS No. 133 requires that
all derivatives be recognized as either assets or liabilities and measured at
fair value, and it defines the accounting for changes in the fair value of the
derivatives depending on the intended use of the derivative. Duke Energy is
currently reviewing the expected impact of SFAS No. 133 on consolidated results
of operations and financial position.
NOTE 2. BUSINESS COMBINATIONS
PanEnergy Corp (PanEnergy). On June 18, 1997, Duke Power Company (Duke
Power) changed its name to Duke Energy Corporation and completed a
stock-for-stock merger with PanEnergy (the merger). PanEnergy was involved in
the gathering, processing, transportation and storage of natural gas; the
production of natural gas liquids (NGL); and the marketing of natural gas,
electricity and other energy-related products. Pursuant to the merger
agreement, Duke Energy issued 158.3 million shares of its common stock in
exchange for all of the outstanding common stock of PanEnergy. Accordingly,
each share of PanEnergy common stock outstanding was converted into the right
to receive 1.0444 shares of Duke Energy's common stock. In addition, each
outstanding option to purchase PanEnergy common stock became an option to
purchase common stock of Duke Energy, adjusted accordingly. The merger was
accounted for as a pooling of interests; therefore, the Consolidated Financial
Statements and other financial information included in this Annual Report for
periods prior to the merger include the combined historical financial results
of Duke Power and PanEnergy.
Operating revenues and net income previously reported by the separate
companies and the combined amounts presented in the accompanying Consolidated
Statements of Income are as follows:
<TABLE>
<CAPTION>
Year Ended December 31, 1996
--------------------------------------------------
Duke Power PanEnergy Adjustments Combined
------------ ----------- ------------- -----------
In millions
<S> <C> <C> <C> <C>
Operating revenues ................... $ 4,758 $ 7,505 $ 39 $ 12,302
Income before extraordinary item ..... $ 730 $ 361 -- $ 1,091
Net income ........................... $ 730 $ 344 -- $ 1,074
</TABLE>
The adjustment to operating revenues is a reclassification of PanEnergy's
equity in earnings of unconsolidated affiliates from other income to revenues
to be consistent with Duke Energy's financial statement presentation.
Duke/Louis Dreyfus, L.L.C. On June 17, 1997, a wholly owned subsidiary of
Duke Energy acquired the remaining 50% ownership interest in D/LD from
affiliates of Louis Dreyfus Corp. for $247 million. D/LD markets electric
power, natural gas and energy-related services to utilities, municipalities and
other large energy users in North America. The acquisition was accounted for by
the purchase method, and the assets and liabilities and results of operations
of D/LD have been consolidated in Duke Energy's financial statements since the
date of purchase. The purchase price substantially represents goodwill.
Duke/UAE L.L.C. During December 1997, a wholly owned subsidiary of Duke
Energy formed a joint venture with UAE Ref-Fuel L.L.C. (UAE), a wholly owned
subsidiary of United American Energy Corp. Duke Energy owns a 65% interest in
the joint venture, with UAE owning a 35% minority interest. The joint venture
acquired a 50% ownership interest in American Ref-Fuel Company, a
waste-to-energy firm with operations primarily in New York and New Jersey.
Thus, Duke Energy has an indirect 32.5% ownership interest in American Ref-Fuel
Company and provided $237 million of investment and financing to the venture.
Duke Energy Trading and Marketing, L.L.C. On August 1, 1996, a wholly owned
subsidiary of Duke Energy formed a natural gas and power marketing joint venture
with Mobil Corporation affiliates. The marketing company conducts business as
Duke Energy Trading and Marketing, L.L.C. in the United States and as Duke
Energy Marketing L.P. in Canada. Duke Energy operates the joint venture and owns
a 60% interest, with Mobil Corporation owning a 40% minority interest.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 3. BUSINESS SEGMENTS
Duke Energy is an integrated energy and energy services provider with the
ability to offer physical delivery and management of both electricity and
natural gas throughout the United States and abroad. Duke Energy provides these
and other services through seven business segments:
o Electric Operations
o Natural Gas Transmission
o Field Services
o Trading and Marketing
o Global Asset Development
o Other Energy Services
o Real Estate Operations
These segments were defined as a result of Duke Energy adopting SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information."
Electric Operations generates, transmits, distributes and sells electric
energy in central and western North Carolina and the western portion of South
Carolina (doing business as Duke Power or Nantahala Power and Light). These
electric operations are subject to the rules and regulations of the FERC, the
North Carolina Utilities Commission (NCUC) and the Public Service Commission of
South Carolina (PSCSC).
Natural Gas Transmission, through its Northeast Pipelines, provides
interstate transportation and storage of natural gas for customers primarily in
the Mid-Atlantic and New England states. Until the expected sale of the Midwest
Pipelines in early 1999, Natural Gas Transmission also provides interstate
transportation and storage services in the midwest states. See further
discussion of the proposed sale of the Midwest Pipelines in Note 14 to the
Consolidated Financial Statements. The interstate natural gas transmission and
storage operations are also subject to the rules and regulations of the FERC.
Field Services gathers, processes, transports and markets natural gas and
produces and markets NGLs. Field Services operates gathering systems in ten
states that serve major gas-producing regions in the Rocky Mountain, Permian
Basin, Mid-Continent and Gulf Coast areas.
Trading and Marketing markets natural gas, electricity and other
energy-related products across North America. Duke Energy owns a 60% interest
in Trading and Marketing's operations, with Mobil Corporation owning a 40%
minority interest.
Global Asset Development develops, owns and operates energy-related
facilities worldwide. Global Asset Development conducts its operations
primarily through Duke Energy Power Services, LLC (Duke Energy Power Services)
and Duke Energy International, LLC (Duke Energy International).
Other Energy Services provides engineering, consulting, construction and
integrated energy solutions worldwide, primarily through Duke Engineering &
Services, Inc., Duke/Fluor Daniel and DukeSolutions, Inc.
Real Estate Operations conducts its business through Crescent Resources,
Inc., which develops high quality commercial and residential real estate
projects and manages forest holdings in the southeastern United States.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 3. BUSINESS SEGMENTS -- Continued
Business Segment Data
<TABLE>
<CAPTION>
Depreciation Capital and
Unaffiliated Intersegment Total and Invesment Segment
Revenues Revenues Revenues EBIT Amortization Expenditures Assets
-------------- -------------- ----------- ----------- -------------- -------------- -----------
In millions
<S> <C> <C> <C> <C> <C> <C> <C>
Year Ended December 31, 1998
Electric Operations ............ $ 4,626 $ -- $ 4,626 $ 1,513 $ 522 $ 586 $ 13,073
Natural Gas Transmission ....... 1,426 102 1,528 702 215 290 4,996
Field Services ................. 2,094 545 2,639 76 80 304 1,893
Trading and Marketing .......... 8,614 171 8,785 122 11 8 3,233
Global Asset Development ....... 237 82 319 80 31 1,027 2,061
Other Energy Services .......... 436 85 521 10 12 41 376
Real Estate Operations ......... 181 -- 181 142 6 217 724
Other Operations ............... (4) 26 22 2 32 27 848
Eliminations ................... -- (1,011) (1,011) -- -- -- (398)
--------- -------- -------- ------- ----- ------- --------
Total Consolidated ............. $ 17,610 $ -- $ 17,610 $ 2,647 $ 909 $ 2,500 $ 26,806
========= ======== ======== ======= ===== ======= ========
Year Ended December 31, 1997
Electric Operations ............ $ 4,401 $ -- $ 4,401 $ 1,282 $ 498 $ 743 $ 12,958
Natural Gas Transmission ....... 1,468 104 1,572 624 229 247 5,059
Field Services ................. 2,481 574 3,055 157 71 157 1,855
Trading and Marketing .......... 7,411 78 7,489 44 7 18 1,857
Global Asset Development ....... 109 14 123 5 9 348 988
Other Energy Services .......... 343 33 376 18 6 47 223
Real Estate Operations ......... 124 -- 124 98 4 223 594
Other Operations ............... (28) -- (28) (120) 17 245 941
Eliminations ................... -- (803) (803) -- -- -- (446)
--------- -------- -------- ------- ----- ------- --------
Total Consolidated ............. $ 16,309 $ -- $ 16,309 $ 2,108 $ 841 $ 2,028 $ 24,029
========= ======== ======== ======= ===== ======= ========
Year Ended December 31, 1996
Electric Operations ............ $ 4,498 $ -- $ 4,498 $ 1,419 $ 481 $ 610 $ 12,625
Natural Gas Transmission ....... 1,470 86 1,556 595 228 194 5,186
Field Services ................. 2,216 421 2,637 152 59 531 1,709
Trading and Marketing .......... 3,773 41 3,814 58 4 7 1,404
Global Asset Development ....... 65 7 72 -- 7 35 522
Other Energy Services .......... 183 21 204 20 3 39 130
Real Estate Operations ......... 114 -- 114 88 4 115 446
Other Operations ............... (17) -- (17) (38) 3 19 727
Eliminations ................... -- (576) (576) -- -- -- (383)
--------- -------- -------- ------- ----- ------- --------
Total Consolidated ............. $ 12,302 $ -- $ 12,302 $ 2,294 $ 789 $ 1,550 $ 22,366
========= ======== ======== ======= ===== ======= ========
</TABLE>
Duke Energy's reportable segments are strategic business units that offer
different products and services and are each managed separately. Management
evaluates segment performance based on earnings before interest and taxes
(EBIT). Segment earnings before interest and taxes, presented in the
accompanying table, includes intersegment sales accounted for at prices
representative of unaffiliated party transactions. Segment assets are provided
as additional information in the accompanying table and are net of intercompany
advances, intercompany notes receivable and investments in subsidiaries.
Other Operations primarily includes communication services, water services
and certain unallocated corporate costs.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 4. REGULATORY MATTERS
Electric Operations. The NCUC and the PSCSC approve rates for retail
electric sales within their respective states. The FERC approves Electric
Operations' rates for electric sales to wholesale customers. Electric sales to
the other joint owners of the Catawba Nuclear Station, which represent a
substantial majority of Electric Operations' electric wholesale revenues, are
set through contractual agreements.
In 1997, in conjunction with the merger, Duke Energy agreed to cap the
base electric rates for retail customers at existing levels through 2000, with
very limited exceptions. Duke Energy also agreed to freeze rates, except for
the market-based rates, for transmission and wholesale electric sales. In
addition, Duke Energy agreed to a cap on the rates charged to the other joint
owners of Catawba Nuclear Station under the interconnection agreements and on
the reimbursement of certain costs related to administration and general
expenses and general plant costs under operation and fuel agreements.
Management believes that these agreements will not have a material adverse
effect on consolidated results of operations or financial position.
Fuel costs are reviewed semiannually in the wholesale jurisdiction and
annually in the South Carolina retail jurisdiction, with provisions for
reviewing such costs in base rates. In the North Carolina retail jurisdiction,
a review of fuel costs in rates is required annually and during general rate
case proceedings. All jurisdictions allow Duke Energy to adjust electric rates
for past over- or under-recovery of fuel costs. Therefore, the difference
between actual fuel costs incurred for electric operations and fuel costs
recovered through rates is reflected in revenues. The stipulation agreements
related to the merger do not apply to the fuel cost adjustments.
The PSCSC, on May 7, 1996, ordered a rate reduction in the form of a
decrement rider of 0.432 cents per kilowatt-hour, or an average of
approximately 8%, affecting South Carolina retail customers. South Carolina
retail sales represent approximately 30% of Electric Operations' total
regulated electric sales. The rate reduction was reflected on bills rendered on
or after June 1, 1996. This net decrement rider reflects an interim true-up
decrement adjustment associated with the levelization of Catawba Nuclear
Station purchased capacity costs and an interim true-up increment associated
with amortization of the demand-side management deferral account. The rate
adjustment was made, in part, because cumulative levelized revenues associated
with the recovery of Catawba Nuclear Station purchased capacity costs had
exceeded purchased capacity payments and associated deferred returns.
Certain of Electric Operations' electric wholesale customers, excluding
the other Catawba Nuclear Station joint owners, initiated proceedings in 1995
before the FERC concerning rate related matters. Duke Energy and nine of its
eleven wholesale customers entered into a settlement in July 1996 which reduced
the customers' electric rates by approximately 9% and renewed their contracts
with Duke Energy through 2000. Both of the customers that did not enter into
the settlement signed agreements and began purchasing electricity from other
suppliers in 1997. Early in 1998, Duke Energy reached agreements, which were
approved by the FERC in September 1998, with both of these former customers to
recover the stranded costs incurred to serve these customers. Management
believes that these agreements will not have a material adverse impact on
consolidated results of operations or financial position.
In December 1997, Duke Energy filed applications with the FERC, NCUC and
PSCSC for authority to combine Nantahala Power and Light (a wholly owned
subsidiary) and Duke Power. Duke Energy received the necessary approvals in
June, April and February 1998, respectively. Nantahala Power and Light began
operations as a division of Duke Power effective August 3, 1998.
Natural Gas Transmission. Duke Energy's interstate natural gas pipelines
primarily provide transportation and storage services pursuant to FERC Order
636. Order 636 allows pipelines to recover eligible costs resulting from
implementation of the order (transition costs). In 1994, the FERC approved
TETCO's settlement resolving regulatory issues related primarily to Order 636
transition costs and a number of other issues related to services prior to
Order 636. Under the 1994 settlement, TETCO's liability for transition costs
was estimated based on the amount of producers' natural gas reserves and other
factors. This settlement provided for the recovery of certain of these
transition costs from customers through volumetric and reservation charges. In
1995, based upon producers' discoveries of additional natural gas reserves,
TETCO increased the estimated liabilities for transition costs by $126 million,
increased regulatory assets by $86 million for amounts expected to be collected
from customers and recognized a $40 million charge to operating expenses ($26
million after tax). In 1998, TETCO favorably resolved all remaining gas
purchase contracts, recognizing $39 million of income ($24 million after tax).
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 4. REGULATORY MATTERS -- Continued
On August 29, 1998, the FERC approved a settlement filed by TETCO, which
accelerates recovery of natural gas transition costs and reduces depreciation
expense to more appropriately reflect the estimated useful lives of its
facilities, principally interstate natural gas pipelines. Prior to the
settlement, Duke Energy reviewed the condition of its natural gas pipeline
facilities and current maintenance practices, and concluded that extension of
the useful lives was appropriate. These facilities have a book value of
approximately $1.8 billion, net of accumulated depreciation of $2.6 billion.
The new weighted average rate of depreciation for storage and transportation
plant is approximately 1.25%. Implementation of the settlement began October 1,
1998, and a rate moratorium will be in effect until 2004. The settlement
reduces customer rates as a result of the reduced depreciation expense offset
through 2001 by the accelerated recovery of natural gas transition costs. The
settlement is not expected to have a material effect on the net results of
operations or financial position of Duke Energy.
GLOBAL ASSET DEVELOPMENT. Two California electric generating plants, Moss
Landing and Oakland, sell electricity under the terms of Reliability Must Run
(RMR) Agreements with the California Independent System Operator (ISO), which
purchases electricity at FERC regulated rates. Duke Energy has not received
final approval from the FERC with respect to the electric rates charged by the
two plants, and, therefore, the rates are subject to partial refund. Management
believes that the final resolution of this matter will not have a material
adverse effect on consolidated results of operations or financial position.
NOTE 5. JOINT OWNERSHIP OF GENERATING FACILITIES
Joint Ownership of Catawba Nuclear Station
<TABLE>
<CAPTION>
Owner Ownership Interest
- -------------------------------------------------------------- -------------------
<S> <C>
North Carolina Municipal Power Agency Number 1 (NCMPA) ... 37.5 %
North Carolina Electric Membership Corporation (NCEMC) ... 28.125%
Duke Energy Corporation .................................. 12.5 %
Piedmont Municipal Power Agency (PMPA) ................... 12.5 %
Saluda River Electric Cooperative, Inc. (Saluda River) ... 9.375%
------
100%
</TABLE>
As of December 31, 1998, $516 million of Property, Plant and Equipment,
net of $219 million of accumulated depreciation and amortization, represented
Duke Energy's investment in Catawba Nuclear Station Units 1 and 2. Duke
Energy's share of operating costs is included in the Consolidated Statements of
Income.
Duke Energy entered into contractual interconnection agreements with the
other joint owners of Catawba Nuclear Station to purchase declining percentages
of the generating capacity and energy from the station. These purchased power
agreements were effective beginning with the commercial operation of each unit.
Units 1 and 2 began commercial operation in June 1985 and August 1986,
respectively. The purchased power agreements were established for fifteen years
for NCMPA and PMPA and ten years for NCEMC and Saluda River. While the
purchased power agreements with NCMPA and PMPA extend for fifteen years, a
significant decrease in the percentage of capacity and energy Duke Energy is
obligated to purchase occurs in the eleventh calendar year of operation for
each unit. This significant decrease occurred in 1995 for Unit 1 and 1996 for
Unit 2.
The interconnection agreements also provide for supplemental power sales
by Duke Energy to the other joint owners of Catawba Nuclear Station to satisfy
their capacity and energy needs beyond the capacity and energy which they
retain from the station or potentially acquire in the form of other resources.
The agreements further provide the other joint owners the ability to secure
such supplemental requirements outside of these contractual agreements
following an appropriate notice period. NCEMC and Saluda River have given such
appropriate notice effective January 1, 2001 and January 1, 2002, respectively.
In addition, as a result of the merger, the other joint owners have the right
to end their supplemental capacity requirements as of January 1, 2001 upon
notice to Duke Energy by December 31, 1999. As the other joint owners retain
more capacity and energy from the station, or obtain additional capacity and
energy from a third party, supplemental power sales are expected to decline.
Management believes this will not have a material adverse effect on
consolidated results of operations or financial position.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 5. JOINT OWNERSHIP OF GENERATING FACILITIES -- Continued
The interconnection agreements with the other joint owners include
provisions that Duke Energy will provide generating reserves to backstand the
other joint owners' retained capacity in the station at the system average cost
of installed capacity. Additionally, the agreements include certain reliability
exchanges designed to manage outage-related risks by exchanging energy
entitlements between the Catawba and McGuire Nuclear Stations, impacting Duke
Energy as well as all the other joint owners. The agreements also provide the
other joint owners the ability to terminate the interconnection agreements in
their entirety upon eight years written notice to Duke Energy. Such notice was
submitted by PMPA in December, 1997, and by Saluda River in May, 1998. Both
PMPA and Saluda River will provide the reserves associated with their
respective retained capacity. Management believes this will not have a material
adverse effect on consolidated results of operations or financial position.
Purchased energy cost payments are based on variable operating costs and
are a function of the generation output of the station. Purchased capacity
payments are based on the fixed costs of the station and include capital costs
and fixed operating and maintenance costs. Actual purchased capacity costs for
1998 and projected obligations through 2000, the last year of the purchase
buy-backs, are approximately $73 million, $53 million and $7 million,
respectively.
The portion of purchased capacity subject to levelization not currently
recovered in rates is being deferred, and a deferred return is recorded on the
accumulated balance. Duke Energy is recovering the accumulated balance,
including the deferred return, when the sum of the declining purchased capacity
payments and accrual of deferred returns for the current period drops below the
levelized revenues. Jurisdictional levelizations are intended to recover total
costs, including deferred returns, and are subject to adjustments, including
final true-ups. The costs of purchased energy and the non-levelized portion of
purchased capacity is recorded on a current basis.
The current levelized revenues approved in the last general rate
proceedings are approximately $211 million, $94 million and $7 million for
North Carolina retail, South Carolina retail and Other Wholesale (FERC),
respectively. Purchased power costs, subject to levelization, are deferred
based on allocation factors of approximately 62%, 26% and 2% for North Carolina
retail, South Carolina retail and Other Wholesale (FERC), respectively. The
PSCSC, on May 7, 1996, ordered a rate reduction in the form of a decrement
rider for an interim true-up adjustment. Deferred amounts related to two former
wholesale customers have been recovered separately and are no longer collected
through wholesale rates. An allocated amount of purchased power costs in the
pricing of supplemental sales made to the other joint owners is also recovered
on a current basis.
For the years ended December 31, 1998, 1997 and 1996, purchased capacity
and energy costs from the other joint owners was approximately $88 million,
$120 million and $151 million, respectively. These amounts, after adjustments
for the costs of capacity purchased not reflected in current rates, are
included in the Consolidated Statements of Income as Net Interchange and
Purchased Power. As of December 31, 1998 and 1997, $747 million and $836
million, respectively, associated with the cost of capacity purchased but not
reflected in current rates have been accumulated in the Consolidated Balance
Sheets as Purchased Capacity Costs and Current Portion of Purchased Capacity
Costs.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 6. INCOME TAXES
Income Tax Expense
<TABLE>
<CAPTION>
For the Years Ended December 31,
-----------------------------
1998 1997 1996
----------- -------- --------
In millions
<S> <C> <C> <C>
Current income taxes
Federal ................................ $ 673 $ 433 $ 514
State .................................. 138 100 109
----- ----- -----
Total current income taxes ............ 811 533 623
----- ----- -----
Deferred income taxes, net
Federal ................................ (15) 112 73
State .................................. (4) 9 13
------- ----- -----
Total deferred income taxes, net ...... (19) 121 86
------ ----- -----
Investment tax credit amortization ...... (15) (15) (11)
------ ----- -----
Total income tax expense ................ $ 777 $ 639 $ 698
====== ===== =====
</TABLE>
Income Tax Expense Reconciliation to Statutory Rate
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------
1998 1997 1996
--------- ---------- -----------
In millions
<S> <C> <C> <C>
Income tax, computed at the statutory rate of 35% .. $ 713 $ 565 $ 626
Adjustments resulting from:
State income tax, net of federal income tax effect 90 71 79
Other items, net .................................. (26) 3 (7)
------ ------- --------
Total income tax expense ........................... $ 777 $ 639 $ 698
====== ======= =======
Effective tax rate ................................. 38.1% 39.6% 39.0%
------ ------- -------
</TABLE>
Net Deferred Income Tax Liability Components
<TABLE>
<CAPTION>
December 31,
---------------------------
1998 1997
------------- -------------
In millions
<S> <C> <C>
Deferred credits and other liabilities ..................... $ 268 $ 409
Alternative minimum tax credit carryforward (a) ............ 30 30
Other ...................................................... 36 46
--------- ---------
Total deferred income tax assets ......................... 334 485
Valuation allowance ........................................ (52) (47)
--------- ---------
Net deferred income tax assets ........................... 282 438
--------- ---------
Investments and other assets ............................... (207) (263)
Property, plant and equipment .............................. (2,405) (2,358)
Regulatory assets and deferred debits ...................... (542) (623)
Regulatory asset related to restating to pre-tax basis ..... (435) (438)
Other ...................................................... (69) (99)
--------- ---------
Total deferred income tax liabilities .................... (3,658) (3,781)
--------- ---------
State deferred income tax, net of federal tax effect ....... (357) (364)
--------- ---------
Net deferred income tax liability .......................... $ (3,733) $ (3,707)
========= =========
</TABLE>
---------
(a) The alternative minimum tax credit carryforward can be carried
forward indefinitely.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 6. INCOME TAXES -- Continued
In 1990, PanEnergy established a provision for certain tax issues related
to the purchase of TEC, which resulted in an increase in goodwill and deferred
income tax liability. If tax benefits relating to the valuation allowance for
deferred income tax assets and other tax reserves are recognized subsequent to
December 31, 1998, approximately $29 million will be allocated as an adjustment
to goodwill.
NOTE 7. RISK MANAGEMENT AND FINANCIAL INSTRUMENTS
Duke Energy, primarily through Trading and Marketing, manages its exposure
to risk from existing contractual commitments and provides risk management
services to its customers through forward contracts, futures, over-the-counter
swap agreements and options (collectively, "commodity instruments"). Energy
commodity forward contracts involve physical delivery of an energy commodity.
Energy commodity futures involve the buying or selling of natural gas,
electricity or other energy-related commodities at a fixed price.
Over-the-counter swap agreements require Duke Energy to receive or make
payments based on the difference between a specified price and the actual price
of the underlying commodity. Energy commodity options held to mitigate price
risk provide the right, but not the requirement, to buy or sell energy-related
commodities at a fixed price.
Commodity Instruments -- Trading. Duke Energy engages in the trading of
commodity instruments, and therefore experiences net open positions. Duke
Energy manages open positions with strict policies which limit its exposure to
market risk and require daily reporting to management of potential financial
exposure. These policies include statistical risk tolerance limits using
historical price movements to calculate a daily earnings at risk measurement.
The weighted-average life of Duke Energy's commodity risk portfolio was
approximately 11 months at December 31, 1998. During 1998, 1997 and 1996, net
gains of $114 million, $34 million and $25 million, respectively, were
recognized from trading natural gas commodity derivatives. During 1998, net
gains of $14 million were recognized from trading electricity commodity
instruments. Net gains related to trading electricity commodity instruments
were not material during 1997 and 1996. As of December 31, 1998 and 1997, the
absolute notional contract quantity of natural gas commodity derivatives held
for trading purposes was 11,149 billion cubic feet (Bcf) and 5,408 Bcf,
respectively. As of December 31, 1998, the absolute notional contract quantity
of electricity commodity instruments held for trading purposes was 112,867
gigawatt hours (GWh). As of December 31, 1997, outstanding electricity
commodity instruments were not material. At December 31, 1998 and 1997, other
outstanding energy-related commodity derivatives held for trading purposes were
not material.
Commodity Instruments -- Trading
<TABLE>
<CAPTION>
1998 1997
------------------------ ---------------------
Assets Liabilities Assets Liabilities
---------- ------------- -------- ------------
In millions
<S> <C> <C> <C> <C>
Fair value at December 31 ........... $ 1,853 $ 1,749 $ 617 $ 588
Average fair value for the year ..... 685 646 384 369
</TABLE>
Commodity Derivatives -- Non-Trading. At December 31, 1998 and 1997, Duke
Energy held or issued several derivatives that reduce exposure to market
fluctuations relative to price and transportation costs of natural gas,
electricity and petroleum products. Duke Energy's market exposure arises from
natural gas storage inventory balances and fixed-price purchase and sale
commitments that extend for periods of up to eight years. Futures, swaps and
options are used to manage and hedge price and location risk related to these
market exposures. Futures and swaps are also used to manage margins on
underlying fixed-price purchase or sale commitments for physical quantities of
natural gas, electricity and other energy-related commodities. Options are
utilized to manage margins and to limit overall price risk exposure. The gains,
losses and costs related to those commodity derivatives that qualify as a hedge
are not recognized until the underlying physical transaction closes. At
December 31, 1998, Duke Energy had deferred net gains of $10 million related to
commodity derivative hedges. As of December 31, 1998, the absolute notional
contract quantity of commodity derivatives held for non-trading purposes was
218 Bcf of natural gas and 10,618 GWh of electricity. Commodity derivatives
held for non-trading purposes were not material at December 31, 1997.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 7. RISK MANAGEMENT AND FINANCIAL INSTRUMENTS -- Continued
Interest Rate Derivatives. In order to obtain variable rate financing at
an attractive cost, Duke Energy entered into interest rate swap agreements in
which $200 million of 8% Series B First and Refunding Mortgage Bonds were
effectively exchanged for floating rate debt at the three-month London
Interbank Offered Rate (LIBOR) plus a 0.074% margin and $100 million of 7.5%
Series B First and Refunding Mortgage Bonds were effectively exchanged for
floating rate debt at three-month LIBOR plus a 1.1272% margin. The interest
rate swaps expire in 1999 and 2000, respectively, and rates are reset
quarterly. As a result of the interest rate swap contracts, interest expense on
the Consolidated Statements of Income is recognized at the weighted average
LIBOR rate for the year plus the applicable margins.
Weighted Average Rates for Interest Rate Swaps
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
8% Series B Swap ........... 5.69% 5.78% 5.64%
7.5% Series B Swap ......... 6.74% 6.83% 6.69%
</TABLE>
The fair value of interest rate swaps was approximately $8 million and $10
million at December 31, 1998 and 1997, respectively. These amounts represent
estimated amounts that Duke Energy would have received if the swaps had been
settled at current market rates on the respective dates.
In connection with the January 1999 issuance of $200 million Senior Notes,
Duke Energy entered into Treasury Rate Lock Agreements in December 1998 to
hedge its interest rate risk. The agreements, with a notional principal amount
of $200 million, were settled on January 7, 1999, and resulted in a deferred
gain of approximately $2 million, which will be amortized to interest expense
over the life of the underlying debt issuance. The fair value of the lock
agreements was not material at December 31, 1998.
Foreign Currency Derivatives. Trading and Marketing enters into foreign
currency swap agreements to manage foreign currency risks associated with
energy contracts denominated in foreign currencies. The agreements, with a
notional contract amount of approximately $120 million, begin in the year 2000
and extend to the year 2005. The weighted average fixed exchange rate for the
agreements is 1.472 Canadian dollars to U.S. dollars. The fair value of these
agreements was not material at December 31, 1998.
Market and Credit Risk. New York Mercantile Exchange (Exchange) traded
futures and option contracts are guaranteed by the Exchange and have nominal
credit risk. On all other transactions previously described, Duke Energy is
exposed to credit risk in the event of nonperformance by the counterparties.
For each counterparty, Duke Energy analyzes the financial condition prior to
entering into an agreement, establishes credit limits and monitors the
appropriateness of these limits on an ongoing basis. The change in market value
of exchange-traded futures and options contracts requires daily cash settlement
in margin accounts with brokers. Swap contracts and most other over-the-counter
instruments are generally settled at the expiration of the contract term and
may be subject to margin requirements with the counterparty.
Financial Instruments. In 1996, TETCO received $99 million from the
financing of the right to collect certain Order 636 natural gas transition
costs, with limited recourse. At December 31, 1998 and 1997, $17 million and
$53 million, respectively, remained outstanding related to the transition cost
recovery rights and were included in the Consolidated Balance Sheets as Other
Current Liabilities and Deferred Credits and Other Liabilities. Management
believes the probability that Duke Energy will be required to perform under the
recourse provisions is remote.
The fair value of financial instruments is summarized below. Judgment is
required in interpreting market data to develop the estimates of fair value.
Accordingly, the estimates determined as of December 31, 1998 and 1997 are not
necessarily indicative of the amounts Duke Energy could have realized in
current market exchanges. The majority of the estimated fair value amounts were
obtained from independent parties.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 7. RISK MANAGEMENT AND FINANCIAL INSTRUMENTS -- Continued
Financial Instruments
<TABLE>
<CAPTION>
1998 1997
-------------------------- -------------------------
Approximate Approximate
Book Value Fair Value Book Value Fair Value
------------ ------------- ------------ ------------
In millions
<S> <C> <C> <C> <C>
Long-term debt (a) ................................................ $ 6,959 $ 7,240 $ 6,607 $ 6,843
Guaranteed preferred beneficial interests in subordinated notes
of Duke Energy or subsidiaries ................................... 919 937 339 356
Preferred stock (a) ............................................... 333 346 489 530
</TABLE>
---------
(a) Includes current maturities.
The fair value of cash and cash equivalents, notes receivable, notes
payable and commercial paper and nuclear decommissioning trust funds are not
materially different from their carrying amounts because of the short-term
nature of these instruments or because the stated rates approximate market
rates.
Guarantees made to affiliates or recourse provisions from affiliates and
the sales agreement for Order 636 natural gas transition cost recovery have no
book value associated with them, and there are no fair values readily
determinable since quoted market prices are not available.
NOTE 8. INVESTMENT IN AFFILIATES
Investments in domestic and international affiliates which are not
controlled by Duke Energy but where it has significant influence over
operations are accounted for by the equity method. These investments include
undistributed earnings of $5 million and $21 million in 1998 and 1997,
respectively. Duke Energy's share of net income from these affiliates are
reflected in the Consolidated Statements of Income as Other Operating Revenues.
Natural Gas Transmission. Investments primarily include ownership
interests in natural gas pipeline joint ventures which transport gas from
Canada to the United States. Investments include a 37.5% ownership interest in
Maritimes & Northeast Pipeline and a 9.8% ownership interest in Alliance
Pipeline.
Field Services. Investments primarily include a 37% interest in a
partnership which owns natural gas gathering systems in the Gulf of Mexico
(Dauphin Island Gathering Partners) and a 21.1% interest in TEPPCO.
Global Asset Development. Global Asset Development has investments in
various natural gas and electric generation and transmission facilities
worldwide. Significant investments include a 32.5% indirect interest in
American Ref-Fuel Company, a 9.76% indirect interest in Hidroelectrica Piedra
del Aguila S.A. and a 25% indirect interest in National Methanol Company, which
owns and operates a methanol and MTBE (methyl tertiary butyl ether) plant in
Jubail, Saudi Arabia.
Other Energy Services. Investments include the participation in various
construction and support activities for fossil-fueled generating plants.
Real Estate Operations. Investments include various real estate
development projects.
Other Operations. Investments include a 20% interest in the BellSouth PCS
L.P. joint venture, which provides wireless personal communication services.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 8. INVESTMENT IN AFFILIATES -- Continued
Investment in Affiliates
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
---------------------------------- ----------------------------------
Domestic International Total Domestic International Total
---------- --------------- ------- ---------- --------------- -------
In millions
<S> <C> <C> <C> <C> <C> <C>
Natural Gas Transmission ..... $ 104 $ 37 $ 141 $ 67 $ -- $ 67
Field Services ............... 303 -- 303 160 -- 160
Global Asset Development ..... 171 223 394 174 208 382
Other Energy Services ........ 19 23 42 16 10 26
Real Estate Operations ....... 5 -- 5 2 -- 2
Other Operations ............. 17 -- 17 36 13 49
----- ----- ----- ----- ----- -----
Total ........................ $ 619 $ 283 $ 902 $ 455 $ 231 $ 686
===== ===== ===== ===== ===== =====
<CAPTION>
December 31, 1996
-----------------------------------
Domestic International Total
---------- --------------- --------
In millions
<S> <C> <C> <C>
Natural Gas Transmission ..... $ 46 $ -- $ 46
Field Services ............... 130 -- 130
Global Asset Development ..... 14 184 198
Other Energy Services ........ 50 1 51
Real Estate Operations ....... 5 -- 5
Other Operations ............. 60 13 73
----- ----- -----
Total ........................ $ 305 $ 198 $ 503
===== ===== =====
</TABLE>
Equity in Earnings of Investment
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
---------------------------------- ----------------------------------
Domestic International Total Domestic International Total
---------- --------------- ------- ---------- --------------- -------
In millions
<S> <C> <C> <C> <C> <C> <C>
Natural Gas Transmission ..... $ 14 $ 3 $ 17 $ 8 $ -- $ 8
Field Services ............... 9 -- 9 19 -- 19
Global Asset Development ..... 50 18 68 8 21 29
Other Energy Services ........ 1 13 14 4 8 12
Real Estate Operations ....... -- -- -- -- -- --
Other Operations ............. (29) -- (29) (30) -- (30)
----- ---- ----- ------ ---- -----
Total ........................ $ 45 $ 34 $ 79 $ 9 $ 29 $ 38
===== ==== ===== ====== ==== =====
<CAPTION>
December 31, 1996
-----------------------------------
Domestic International Total
---------- --------------- --------
In millions
<S> <C> <C> <C>
Natural Gas Transmission ..... $ 5 $ -- $ 5
Field Services ............... 12 -- 12
Global Asset Development ..... 6 19 25
Other Energy Services ........ 19 2 21
Real Estate Operations ....... -- -- --
Other Operations ............. (31) 1 (30)
----- ---- -----
Total ........................ $ 11 $ 22 $ 33
===== ==== =====
</TABLE>
Summarized Combined Financial Information of Unconsolidated Subsidiaries
<TABLE>
<CAPTION>
December 31,
--------------------------------
1998 1997 1996
---------- ---------- ----------
In millions
<S> <C> <C> <C>
Balance Sheet
Current Assets ................. $ 848 $ 642 $ 1,025
Noncurrent Assets .............. 7,340 5,868 5,661
Current Liabilities ............ 1,084 758 879
Noncurrent Liabilities ......... 3,884 3,257 3,462
------- ------- -------
Net Assets ................... $ 3,220 $ 2,495 $ 2,345
======= ======= =======
Income Statement
Operating Revenues ............. $ 1,667 $ 905 $ 3,133
Operating Expenses ............. 1,166 703 2,494
Net Income ..................... 263 72 160
</TABLE>
Duke Energy had outstanding notes receivable from certain affiliates of
$80 million and $87 million at December 31, 1998 and 1997, respectively.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 9. PROPERTY, PLANT AND EQUIPMENT
<TABLE>
<CAPTION>
December 31,
---------------------
1998 1997
---------- ----------
In millions
<S> <C> <C>
Electric utility
Generation .............................. $ 7,670 $ 7,575
Transmission and distribution ........... 6,324 6,084
General plant ........................... 1,127 1,119
Nuclear fuel ............................ 554 644
Construction work in progress ........... 328 222
-------- --------
Total electric utility ................. 16,003 15,644
-------- --------
Natural gas transmission ................. 6,194 6,094
Gathering and processing ................. 1,409 1,315
Construction work in progress ............ 469 351
Other property and equipment ............. 3,053 2,044
-------- --------
Total Property, Plant and Equipment ..... $ 27,128 $ 25,448
======== ========
</TABLE>
Accumulated Depreciation
<TABLE>
<CAPTION>
December 31,
---------------------
1998 1997
---------- ----------
In millions
<S> <C> <C>
Electric utility (a) ................. $ 6,371 $ 6,068
Natural gas transmission ............. 2,585 2,459
Other ................................ 1,297 1,185
-------- -------
Total Accumulated Depreciation ...... $ 10,253 $ 9,712
======== =======
</TABLE>
---------
(a) Includes amortization of nuclear fuel: 1998 -- $325 million; 1997
-- $370 million.
On July, 1, 1998, a subsidiary of Duke Energy purchased three electric
generating stations in California for $501 million from Pacific Gas & Electric
Company. These stations have a combined capacity of 2,645 megawatts. Two of the
three plants, Moss Landing and Oakland, are subject to the terms of RMR
Agreements with the California ISO. The cost of these facilities is included
within "Other property and equipment" above.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 10. DEBT AND CREDIT FACILITIES
Long-term Debt
<TABLE>
<CAPTION>
December 31,
-----------------------
Year Due 1998 1997
------------- ----------- -----------
In millions
<S> <C> <C> <C>
Duke Energy (a)
First and refunding mortgage bonds:
5.76% - 8% ................................................................... 1999 $ 425 $ 425
7% ........................................................................... 2000 200 200
5 7/8% - 7.41% ............................................................... 2001 - 2004 500 600
6 3/8% - 7% .................................................................. 2005 - 2008 125 325
6 3/4% - 8.30% ............................................................... 2023 - 2025 678 878
7% - 8.95% ................................................................... 2027 - 2033 165 165
Mortgage bonds matured during 1998 ........................................... -- 50
Pollution control bonds, 3.85% -- 7.75% ........................................ 2012 - 2017 172 172
Notes:
6.9% - 9.21% ................................................................. 2011 - 2016 65 --
6% ........................................................................... 2028 300 --
Commercial paper, 5.28% and 5.9% weighted-average rate at December 31, 1998
and 1997, respectively ....................................................... 1,200 800
Other debt ..................................................................... 23 26
Duke Capital Corporation
Senior Notes:
6 1/4% ....................................................................... 2005 250 --
6 3/4% ....................................................................... 2018 150 --
Commercial paper, 5.73% and 6.03% weighted-average rate at December 31, 1998
and 1997, respectively ....................................................... 500 800
Other debt ..................................................................... 24 --
PanEnergy
Bonds:
7 3/4% ....................................................................... 2022 328 328
8 5/8% Debentures ............................................................ 2025 100 100
Notes:
9.55% - 9.9%, maturing serially ............................................. 1998 - 2003 59 73
7% - 8 5/8% .................................................................. 1999 - 2006 450 450
TETCO
Notes:
8% - 10 3/8% ................................................................... 2000 - 2004 500 500
Medium term, Series A, 7.64 - 9.07% .......................................... 1999 - 2012 100 100
Algonquin Gas Transmission Company
9.13% Notes .................................................................... 2003 100 100
Panhandle Eastern Pipe Line Company (PEPL)
7 7/8% Note .................................................................... 2004 100 100
7.2% - 7.95% Debentures ........................................................ 2023 - 2024 200 200
Crescent Resources, Inc. (b)
Construction and mortgage loans, 5.21% - 7.10% ................................. 1998 - 2011 69 117
Revolving credit facilities, 5.98% and 6.30% weighted-average rate at
December 31, 1998 and 1997, respectively ..................................... 2001 100 77
Global Asset Development
5.2% - 18% Notes ............................................................. 1999 - 2004 111 --
Other debt of subsidiaries ..................................................... 13 67
Unamortized debt discount and premium, net ..................................... (48) (46)
------- -------
Total long-term debt ........................................................... 6,959 6,607
Current maturities of long-term debt ........................................... (687) (77)
------- -------
Total long-term portion ........................................................ $ 6,272 $ 6,530
======= =======
</TABLE>
---------
(a) Substantially all of Duke Energy's electric plant was mortgaged.
(b) Substantial amounts of Crescent Resources' real estate development
projects, land and buildings were pledged as collateral.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 10. DEBT AND CREDIT FACILITIES -- Continued
The annual maturities of consolidated long-term debt at December 31, 1998
were $687 million, $413 million, $388 million, $133 million and $526 million
for 1999 through 2003, respectively. Such payments exclude $1,853 million of
long-term debt that matures after 2003 which have call options whereby Duke
Energy has the option to repay the debt early. Based on the years in which Duke
Energy may first exercise their redemption options, $820 million could
potentially be repaid in 1999, $178 million in 2000, $328 million in 2002, $427
million in 2003 and $100 million thereafter.
Credit Facilities
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------
1998 1997
-------------------------- -------------------------
Credit Credit
Facilities Outstanding Facilities Outstanding
------------ ------------- ------------ ------------
In millions
<S> <C> <C> <C> <C>
Annually renewable facilities .......... $ -- $ -- $ 54 $ 16
364-day facilities (a) ................. 600 -- 300 --
Two-year revolving facilities (b) ...... -- -- 40 --
Four-year revolving facilities ......... 125 100 125 77
Five-year revolving facilities (a) ..... 2,200 -- 2,200 --
------- ----- ------- ----
Total Consolidated .................... $ 2,925 $ 100 $ 2,719 $ 93
======= ===== ======= ====
</TABLE>
---------
(a) Supported commercial paper facilities.
(b) Supported pollution control bonds.
Notes Payable and Commercial Paper
<TABLE>
<CAPTION>
December 31,
-----------------------
1998 1997
----------- -----------
In millions
<S> <C> <C>
Credit facilities outstanding ................ $ 100 $ 93
Note payable ................................. 4 4
Commercial paper outstanding ................. 1,905 1,750
-------- --------
2,009 1,847
Less portion classified as long-term .........
Credit facilities ........................... (100) (77)
Commercial paper ............................ (1,700) (1,600)
-------- --------
Portion classified as short-term ............. $ 209 $ 170
======== ========
</TABLE>
The weighted average interest rate on outstanding short-term notes payable
and commercial paper at December 31, 1998 and 1997 was 5.23% and 6.04%,
respectively.
NOTE 11. NUCLEAR DECOMMISSIONING COSTS
Nuclear Decommissioning Costs. Estimated site-specific nuclear
decommissioning costs, including the cost of decommissioning plant components
not subject to radioactive contamination, total approximately $1.3 billion
stated in 1994 dollars based on decommissioning studies completed in 1994. This
amount includes Duke Energy's 12.5% ownership in the Catawba Nuclear Station.
The other joint owners of Catawba Nuclear Station are responsible for
decommissioning costs related to their ownership interests in the station. Both
the NCUC and the PSCSC have granted Duke Energy recovery of estimated
decommissioning costs through retail rates over the expected remaining service
periods of Duke Energy's nuclear stations. Such estimates presume each unit
will be decommissioned as soon as possible following the end of its license
life. Although subject to extension, the current operating licenses for Duke
Energy's nuclear units expire as follows: Oconee 1 and 2 - 2013, Oconee 3 -
2014; McGuire 1 - 2021, McGuire 2 - 2023; and Catawba 1 - 2024, Catawba 2 -
2026.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 11. NUCLEAR DECOMMISSIONING COSTS -- Continued
During 1998 and 1997, Duke Energy expensed approximately $57 million which
was contributed to the external funds for decommissioning costs and accrued an
additional $6 million and $3 million to the internal reserve in 1998 and 1997,
respectively. Nuclear units are depreciated at an annual rate of 4.7%, of which
1.61% is for decommissioning. The balance of the external funds as of December
31, 1998 and 1997, was $580 million and $471 million, respectively. The balance
of the internal reserve as of December 31, 1998 and 1997, was $217 million and
$211 million, respectively, and is reflected in the Consolidated Balance Sheets
as Accumulated Depreciation and Amortization. Management believes that the
decommissioning costs being recovered through rates, when coupled with assumed
after-tax fund earnings of 5.5% to 5.9%, are currently sufficient to provide
for the cost of decommissioning.
A provision in the Energy Policy Act of 1992 established a fund for the
decontamination and decommissioning of the Department of Energy's (DOE) uranium
enrichment plants. Licensees are subject to an annual assessment for 15 years
based on their pro rata share of past enrichment services. The annual
assessment is recorded in the Consolidated Statements of Income as Fuel Used in
Electric Generation. Duke Energy paid $10 million during 1998 and has paid $65
million cumulatively related to its ownership interests in nuclear plants. The
remaining liability and regulatory asset of $79 million and $87 million at
December 31, 1998 and 1997, respectively, is reflected in the Consolidated
Balance Sheets as Deferred Credits and Other Liabilities and Regulatory Assets
and Deferred Debits, respectively.
Spent Nuclear Fuel. Under provisions of the Nuclear Waste Policy Act of
1982, Duke Energy has entered into contracts with the DOE for the disposal of
spent nuclear fuel. The DOE failed to begin accepting the spent nuclear fuel on
January 31, 1998, the date provided by the Nuclear Waste Policy Act and by Duke
Energy's contract with the DOE. On June 8, 1998, Duke Energy filed with the
United States Court of Federal Claims a claim against the DOE for damages in
excess of $1 billion arising out of the DOE's failure to begin accepting
commercial spent nuclear fuel by January 31, 1998. Damages claimed in the suit
are intended to recover costs that Duke Energy is incurring and will continue
to incur as a result of the DOE's partial material breach of its contract with
Duke Energy, including costs associated with securing additional spent fuel
storage capacity. Duke Energy will continue to safely manage its spent nuclear
fuel until the DOE accepts it. Payments made to the DOE for disposal costs are
based on nuclear output and are included in the Consolidated Statements of
Income as Fuel Used in Electric Generation.
NOTE 12. GUARANTEED PREFERRED BENEFICIAL INTERESTS IN SUBORDINATED NOTES OF
DUKE ENERGY OR SUBSIDIARIES
Duke Energy and Duke Capital Corporation (Duke Capital) have each formed
business trusts for which they own all the respective common securities. The
trusts issue and sell preferred securities and invest the gross proceeds in
assets of the trusts. Substantially all the assets of each trust are junior
subordinated notes issued by the respective company.
Trust Preferred Securities
<TABLE>
<CAPTION>
December 31,
-----------------
Issued Rate 1998 1997 Junior Subordinated Notes
- ------------------------------------- --------- -------- -------- --------------------------
In millions
<S> <C> <C> <C> <C>
Duke Energy
1997 ............................. 7.2% $ 350 $ 350 7.2% Series A due 2037
Duke Capital
1998 ............................. 7 3/8% 250 -- 7 3/8% Series A due 2038
1998 ............................. 7 3/8% 350 -- 7 3/8% Series B due 2038
Unamortized debt discount ......... (31) (11)
----- -----
$ 919 $ 339
===== =====
</TABLE>
These trust preferred securities represent preferred undivided beneficial
interests in the assets of the respective trusts. Payment of distributions on
these preferred securities is guaranteed by the respective company, but only to
the extent the trusts have funds legally and immediately available to make such
distributions. Dividends of $44 million and $15 million related to the trust
preferred securities have been included in the Consolidated Statements of
Income as Minority Interests for the years ended December 31, 1998 and 1997,
respectively.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 13. PREFERRED AND PREFERENCE STOCK
Authorized Shares of Stock as of December 31, 1998 and 1997
<TABLE>
<CAPTION>
Shares
Par Value (in millions)
----------- --------------
<S> <C> <C>
Preferred Stock ........... $ 100 12.5
Preferred Stock A ......... $ 25 10.0
Preference Stock .......... $ 100 1.5
</TABLE>
As of December 31, 1998 and 1997, there were no shares of preference stock
outstanding.
Preferred Stock with Sinking Fund Requirements
<TABLE>
<CAPTION>
December 31,
Shares Outstanding ----------------
Rate/Series Year Issued at December 31, 1998 1998 1997
- --------------------------------- ------------- --------------------- -------- -------
Dollars in
millions
<S> <C> <C> <C> <C>
5.95% B (Preferred Stock A) 1992 800,000 $ 20 $ 20
6.10% C (Preferred Stock A) 1992 800,000 20 20
6.20% D (Preferred Stock A) 1992 800,000 20 20
6.20% T .................... 1992 130,000 13 13
6.30% U .................... 1992 130,000 13 13
6.40% V .................... 1992 130,000 13 13
6.75% X .................... 1993 250,000 25 50
----- -----
Total .................... $ 124 $ 149
===== =====
</TABLE>
The annual sinking fund requirements for 1999 through 2003 are $20
million, $33 million, $33 million, $13 million and $1 million, respectively.
Some additional redemptions are permitted at Duke Energy's option.
Preferred Stock without Sinking Fund Requirements
<TABLE>
<CAPTION>
December 31,
Shares Outstanding ----------------
Rate/Series Year Issued at December 31, 1998 1998 1997
- ----------------------------------- ------------- --------------------- -------- -------
Dollars in
millions
<S> <C> <C> <C> <C>
4.50% C ...................... 1964 175,000 $ 18 $ 35
7.85% S ...................... 1992 300,000 30 60
7.00% W ...................... 1993 249,989 25 50
7.04% Y ...................... 1993 299,995 30 60
6.375% (Preferred Stock A) ... 1993 1,257,185 31 60
Auction Series A ............. 1990 750,000 75 75
----- -----
Total ....................... $ 209 $ 340
===== =====
</TABLE>
The call provisions for the outstanding preferred stock specify various
redemption prices not exceeding 104% of par value, plus accumulated dividends
to the redemption date.
During December 1997, Duke Energy redeemed approximately three million
shares of preferred stock for $203 million. During February 1998, Duke Energy
purchased approximately two million shares of its preferred stock for $180
million. The premiums related to these redemptions were included in the
Consolidated Statements of Income as Dividends and Premiums on Redemptions of
Preferred and Preference Stock for 1997.
NOTE 14. COMMITMENTS AND CONTINGENCIES
Future Construction Costs. Duke Energy plans to maintain its regulated
electric operations facilities in the Carolinas and pursue business expansion
as opportunities arise. Projected 1999 capital and investment expenditures for
Electric Operations, including allowance for funds used during construction,
are approximately $900 million. These projections include
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 14. COMMITMENTS AND CONTINGENCIES -- Continued
expenditures for existing plants, including refurbishment and upgrades related
to the Oconee Nuclear Station's application for a 20-year renewal of its
operating license. The license renewal process could take three to five years
to complete. All projections are subject to periodic review and revisions.
Actual expenditures incurred may vary from such estimates due to various
factors, including industry restructuring, weather, economic growth, regulatory
constraints and environmental regulation.
Projected 1999 capital and investment expenditures for Natural Gas
Transmission, including allowance for funds used during construction, are
approximately $400 million and do not include projections related to the
Midwest Pipelines which are expected to be sold in early 1999. These
projections include the completion of the Maritimes & Northeast Pipeline
project, which will deliver natural gas to markets in the Canadian Maritimes
provinces and the northeastern United States from a supply basin offshore Nova
Scotia. These projections also include other market expansion projects and
costs relating to existing assets.
Duke Energy plans to continue to significantly grow several of its
business segments: Field Services, Global Asset Development, Trading and
Marketing and Other Energy Services. Expansion opportunities for Field Services
include the planned $1.35 billion acquisition of the natural gas gathering,
processing, fractionation and NGL pipeline business of Union Pacific Resources
along with its natural gas and NGL marketing activities. The transaction is
expected to close in the first half of 1999 and is contingent upon completion
of due diligence and receipt of clearances under the Hart-Scott-Rodino Act.
Expansion opportunities for Global Asset Development's international
division, Duke Energy International, include the $315 million purchase of power
generation and transmission assets in western Australia and New Zealand,
including an ownership interest in a pipeline in western Australia. This
acquisition also includes a development proposal for a cogeneration plant and a
portfolio of international and Australian-based projects. This transaction
closed on January 22, 1999.
Also, Duke Energy International recently purchased the rights to develop
and operate the 500-mile Eastern Gas Pipeline project in eastern Australia.
Construction of this $270 million pipeline project is scheduled to begin in
July 1999 and completion is expected by the middle of 2000.
Expansion opportunities for Global Asset Development's domestic division,
Duke Energy Power Services, include the continuation of greenfield projects,
such as the Bridgeport Energy project and Maine Independence Station, as well
as the Hidalgo project, a 510-megawatt power plant to be built in south Texas,
which is targeted to begin producing power in mid-2000. Other similar
initiatives in 1999 for both Duke Energy International and Duke Energy Power
Services will likely require significant capital and investment expenditures,
which will be subject to periodic review and revision and may vary
significantly depending on the value-added opportunities presented.
Projected 1999 capital and investment expenditures for Trading and
Marketing, Other Energy Services and Real Estate Operations are approximately
$30 million, $90 million and $300 million, respectively. These projected
capital and investment expenditures are subject to periodic review and revision
and may vary significantly depending on acquisition opportunities, market
volatility, economic trends and the value-added opportunities presented.
Nuclear Insurance. Duke Energy owns and operates the McGuire and Oconee
Nuclear Stations with two and three nuclear reactors, respectively, and
operates and has a partial ownership interest in the Catawba Nuclear Station
with two nuclear reactors. Nuclear insurance coverage is maintained in three
program areas: liability coverage; property, decontamination and
decommissioning coverage; and business interruption and/or extra expense
coverage. Certain expenses associated with nuclear insurance premiums paid by
Duke Energy are reimbursed by the other joint owners of the Catawba Nuclear
Station.
Pursuant to the Price-Anderson Act, Duke Energy is required to insure
against public liability claims resulting from nuclear incidents to the full
limit of liability of approximately $9.8 billion.
Primary Liability Insurance. The maximum required private primary
liability insurance of $200 million has been purchased along with a like amount
to cover certain worker tort claims.
Excess Liability Insurance. This policy currently provides approximately
$9.6 billion of coverage through the Price-Anderson Act's mandatory
industry-wide excess secondary insurance program of risk pooling. The $9.6
billion of coverage is the sum of the current potential cumulative
retrospective premium assessments of $88 million per licensed commercial
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 14. COMMITMENTS AND CONTINGENCIES -- Continued
nuclear reactor. This $9.6 billion will be increased by $88 million as each
additional commercial nuclear reactor is licensed, or reduced by $88 million
for certain nuclear reactors that are no longer operational and may be exempted
from the risk pooling insurance program. Under this program, licensees could be
assessed retrospective premiums to compensate for damages in the event of a
nuclear incident at any licensed facility in the nation. If such an incident
occurs and public liability damages exceed primary insurances, licensees may be
assessed up to $88 million for each of their licensed reactors, payable at a
rate not to exceed $10 million a year per licensed reactor for each incident.
The $88 million amount is subject to indexing for inflation and may be subject
to state premium taxes.
Duke Energy is a member of Nuclear Electric Insurance Limited (NEIL),
which provides property and business interruption insurance coverages for Duke
Energy's nuclear facilities under the following three policy programs:
Primary Property Insurance. This policy provides $500 million in primary
property damage coverage for each of Duke Energy's nuclear facilities.
Excess Property Insurance. This policy provides excess property,
decontamination and decommissioning liability insurance in the following
amounts: $2.25 billion for the Catawba Nuclear Station and $1.5 billion each
for the Oconee and McGuire Nuclear Stations.
Business Interruption Insurance. This policy provides business
interruption and/or extra expense coverage resulting from an accidental outage
of a nuclear unit. Each unit of the McGuire and Catawba Nuclear Stations is
insured for up to approximately $4 million per week and the Oconee Nuclear
Station units are insured for up to approximately $3 million per week. Coverage
amounts per unit decline if more than one unit is involved in an accidental
outage. Initial coverage begins after a 17-week deductible period and continues
at 100% for 52 weeks and 80% for the next 104 weeks.
If NEIL's losses ever exceed its reserves for any of the above three
programs, Duke Energy will be liable for assessments of up to five times its
annual premiums. The current potential maximum assessments are as follows:
Primary Property Insurance - $23 million; Excess Property Insurance - $23
million; Business Interruption Insurance - $20 million.
The other joint owners of the Catawba Nuclear Station are obligated to
assume their pro rata share of any liabilities for retrospective premiums and
other premium assessments resulting from the Price-Anderson Act's excess
secondary insurance program of risk pooling or the NEIL policies.
Environmental. Duke Energy is subject to international, federal, state and
local regulations regarding air and water quality, hazardous and solid waste
disposal and other environmental matters.
TETCO is currently conducting PCB (polychlorinated biphenyl) assessment
and clean-up programs at certain of its compressor station sites under
conditions stipulated by a U.S. Consent Decree. The programs include on- and
off-site assessment, installation of on-site source control equipment and
groundwater monitoring wells and on- and off-site clean-up work. TETCO
completed the soil clean-up programs during 1998, subject to regulatory
approval. Groundwater monitoring activities will continue at several sites
beyond 1999.
In 1987, the Commonwealth of Kentucky instituted a suit in state court
against TETCO, alleging improper disposal of PCBs at TETCO's three compressor
station sites in Kentucky. This suit is still pending. In 1996, TETCO completed
clean-up of these sites under the U.S. Consent Decree.
Duke Energy has also identified environmental contamination at certain
sites on the PEPL and Trunkline Gas Company (Trunkline) systems and has
undertaken clean-up programs at these sites. The contamination resulted from
the past use of lubricants containing PCBs and the prior use of wastewater
collection facilities and other on-site disposal areas. Soil and sediment
testing, to date, has detected no significant off-site contamination. Duke
Energy has communicated with the Environmental Protection Agency and
appropriate state regulatory agencies on these matters. Under the terms of the
agreement with CMS Energy Corporation discussed in Other Commitments and
Contingencies below, Duke Energy is obligated to complete the PEPL and
Trunkline clean-up programs at certain agreed-upon sites. These clean-up
programs are expected to continue until 2001.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 14. COMMITMENTS AND CONTINGENCIES -- Continued
At December 31, 1998 and 1997, remaining estimated clean-up costs on the
TETCO, PEPL and Trunkline systems have been accrued and are included in the
Consolidated Balance Sheets as Other Current Liabilities and Environmental
Clean-up Liabilities. These cost estimates represent gross clean-up costs
expected to be incurred, have not been discounted or reduced by customer
recoveries and generally do not include fines, penalties or third-party claims.
Costs to be recovered from customers are included in the Consolidated Balance
Sheets as of December 31, 1998 and 1997, as Environmental Clean-up Costs.
The federal and state clean-up programs are not expected to interrupt or
diminish Duke Energy's ability to deliver natural gas to customers. Based on
experience to date and costs incurred for clean-up operations, management
believes the resolution of matters relating to the environmental issues
discussed above will not have a material adverse effect on consolidated results
of operations or financial position.
Litigation. On April 25, 1997, a group of affiliated plaintiffs that own
and/or operate various pipeline and marketing companies and partnerships
primarily in Kansas filed suit against PEPL, a subsidiary of Duke Energy, in
the U.S. District Court for the Western District of Missouri. The plaintiffs
allege that PEPL has engaged in unlawful and anti-competitive conduct with
regard to requests for interconnects with the PEPL system for service to the
Kansas City area. Asserting that PEPL has violated the antitrust laws and
tortiously interfered with the plaintiffs' business expectancies, the
plaintiffs seek compensatory and punitive damages. Under the terms of the
agreement with CMS Energy Corporation discussed in Other Commitments and
Contingencies below, Duke Energy is retaining any liability associated with
this suit. Based on information currently available to Duke Energy, management
believes that the resolution of this matter will not have a material adverse
effect on consolidated results of operations or financial position.
Duke Energy and its subsidiaries are also involved in other legal, tax and
regulatory proceedings before various courts, regulatory commissions and
governmental agencies regarding matters arising in the ordinary course of
business, some of which involve substantial amounts. Where appropriate, Duke
Energy has made accruals in accordance with SFAS No. 5, "Accounting for
Contingencies," in order to provide for such matters. Management believes that
the final disposition of these proceedings will not have a material adverse
effect on consolidated results of operations or financial position.
Other Commitments and Contingencies. In January 1998, Duke Energy acquired
a 9.8% ownership in Alliance Pipeline. This pipeline is designed to transport
natural gas from western Canada to the Chicago-area market center for
distribution throughout North America. The pipeline is scheduled to begin
commercial operation in late 2000. In addition to buying an ownership interest
in the pipeline project, Duke Energy has a contractual commitment for 67.25
million cubic feet per day of capacity on the line over 15 years for an
estimated total of $315 million.
Periodically, Duke Energy may become involved in contractual disputes with
natural gas transmission customers involving potential or threatened abrogation
of contracts by the customers. If the customers are successful, Duke Energy may
not receive the full value of anticipated benefits under the contracts.
In the normal course of business, certain of Duke Energy's subsidiaries
and affiliates enter into various contracts for energy services which contain
certain schedule and performance requirements. Risk management techniques are
used to mitigate their exposure associated with such contracts. Certain
subsidiaries of Duke Energy have guaranteed performance under some of these
contracts. In addition, certain subsidiaries of Duke Energy have guaranteed
debt agreements of affiliates and have provided surety bonds and letters of
credit.
Management believes that these commitments and contingencies will not have
a material adverse effect on consolidated results of operations or financial
position.
Duke Energy, through its wholly owned subsidiaries, PanEnergy and TEC,
entered into an agreement to sell PEPL, Trunkline and additional storage
related to those systems (collectively, the PEPL Companies), which
substantially comprise the Midwest Pipelines, along with Trunkline LNG Company
(Trunkline LNG), to CMS Energy Corporation (CMSEnergy). The sales price of $2.2
billion involves cash proceeds of $1.9 billion and the assumption of existing
PEPL debt of approximately $300 million. Management believes that the retention
of certain assets and liabilities, such as the Houston office
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 14. COMMITMENTS AND CONTINGENCIES -- Continued
building, certain environmental, legal and tax liabilities, and substantially
all intercompany balances, will not have a material adverse effect on
consolidated results of operations or financial position. The sale will result
in an after-tax gain of approximately $700 million and is contingent upon
receipt of clearances under the Hart-Scott-Rodino Act. Closing is expected in
early 1999.
Total assets of the PEPL Companies and Trunkline LNG were $1.2 billion at
December 31, 1998.
Combined 1998 Operating Results of the PEPL Companies and Trunkline LNG (a)
<TABLE>
<CAPTION>
In millions
------------
<S> <C>
Operating Revenues ............................ $482
Operating Expenses ............................ 278
Other Income, Net ............................. 10
----
Earnings Before Interest and Taxes .......... $214
====
</TABLE>
---------
(a) Excludes intercompany building rental revenue, allocated corporate
expenses, building depreciation and certain other costs to be
retained by Duke Energy.
Leases. Duke Energy utilizes assets under operating leases in several
areas of operations. Consolidated rental expense amounted to $80 million, $92
million, and $84 million in 1998, 1997, and 1996, respectively. Future minimum
rental payments under Duke Energy's various operating leases for the years 1999
through 2003 are $85 million, $76 million, $65 million, $41 million, and $33
million, respectively.
NOTE 15. COMMON STOCK
The Board of Directors authorized Duke Energy to repurchase up to $1
billion of its common stock during the period beginning February 1996 and
ending February 2001. As a result of the merger, shares repurchased between
February 1996 and June 1999 were limited to 15 million shares. As of December
31, 1996, approximately three million shares had been repurchased for $159
million. No repurchases of common stock were made in 1997 or 1998, and none are
anticipated in the future.
NOTE 16. STOCK-BASED COMPENSATION
Under Duke Energy's 1998 Stock Incentive Plan, stock options for up to
fifteen million shares of common stock may be granted to key employees. Under
the plan, the exercise price of each option granted equals the market price of
Duke Energy's common stock on the date of grant. Vesting periods range from one
to five years with a maximum exercise term of ten years.
Effective with the merger, each share of PanEnergy common stock,
outstanding immediately prior to the merger, was converted into the right to
receive 1.0444 shares of Duke Energy common stock. Each option to purchase
PanEnergy common stock, outstanding prior to the merger, was assumed by Duke
Energy and became exercisable upon the same terms as under the applicable
PanEnergy stock option plan and option agreement, except that these options
became options to purchase shares of Duke Energy common stock, appropriately
adjusted.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 16. STOCK-BASED COMPENSATION -- Continued
Stock Option Grants
<TABLE>
<CAPTION>
Weighted
Options Average
(in thousands) Exercise Price
---------------- ---------------
<S> <C> <C>
Outstanding at December 31, 1995 ........ 3,559 $ 18
Granted ............................... 498 28
Exercised ............................. (712) 16
Forfeited ............................. (71) 22
-----
Outstanding at December 31, 1996 ........ 3,274 20
Granted ............................... 388 44
Exercised ............................. (873) 19
Forfeited ............................. (60) 27
-----
Outstanding at December 31, 1997 ........ 2,729 24
Granted ............................... 3,548 57
Exercised ............................. (948) 21
Forfeited ............................. (868) 57
-----
Outstanding at December 31, 1998 ........ 4,461 45
=====
</TABLE>
Stock Options at December 31, 1998
<TABLE>
<CAPTION>
Outstanding Exercisable
------------------------------------------ --------------------------
Weighted Weighted Weighted
Range of Average Average Average
Exercise Number Remaining Exercise Number Exercise
Prices (in thousands) Life (Years) Price (in thousands) Price
- ---------------------- ---------------- -------------- ---------- ---------------- ---------
<S> <C> <C> <C> <C> <C>
$10 to $14 ......... 57 2.3 $12 57 $12
$15 to $20 ......... 637 4.9 18 637 18
$21 to $25 ......... 556 4.9 21 556 21
$26 to $31 ......... 199 7.1 27 199 27
$42 to $50 ......... 240 8.1 44 87 44
$55 to $60 ......... 2,709 9.2 57 -- --
$66 to $67 ......... 63 9.7 67 7 67
----- -----
Total .............. 4,461 1,543 22
===== =====
</TABLE>
Duke Energy had two million options exercisable at both December 31, 1997
and 1996, with weighted average exercise prices of $21 and $19 per option,
respectively.
The weighted-average fair value of options granted was $9, $10 and $9 per
option during 1998, 1997 and 1996, respectively. The fair value of each option
grant was estimated on the date of grant using the Black-Scholes option-pricing
model.
Weighted-Average Assumptions for Option-Pricing
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Stock dividend yield ..................... 4.2% 3.5% 2.6%
Expected stock price volatility .......... 15.1% 20.7% 26.0%
Risk-free interest rates ................. 5.6% 6.5% 5.7%
Expected option lives .................... 7 years 7 years 7 years
</TABLE>
Had compensation expense for stock-based compensation been determined
based on the fair value at the grant dates, 1998 net income would have been
$1,250 million, or $3.40 per basic share; 1997 net income would have been $971
million, or $2.50 per basic share; and 1996 net income would have been $1,074
million, or $2.85 per basic share.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 17. EMPLOYEE BENEFIT PLANS
Retirement Plans. Duke Energy and its subsidiaries have maintained
multiple non-contributory defined benefit retirement plans covering most
employees with minimum service requirements. Effective January 1, 1997, the
Duke Power retirement plan was amended to base a plan participant's benefit on
a cash balance formula. Under a cash balance formula, a plan participant
accumulates a retirement benefit based upon a percentage, which may vary with
age and years of service, of current eligible earnings and current interest
credits. Prior to January 1, 1997, the Duke Power retirement plan benefits were
based on an age-related formula which took into account the participant's years
of benefit accrual service and highest average eligible earnings.
Through December 31, 1998, the PanEnergy plan provided retirement benefits
(i) for eligible employees of certain subsidiaries that are generally based on
an employee's years of benefit accrual service and highest average eligible
earnings, and (ii) for eligible employees of certain other subsidiaries under a
cash balance formula. In 1998, a significant amount of lump sum payouts was
made from the PanEnergy plan resulting in a settlement gain of $10 million.
Effective January 1, 1999, the benefit formula under the PanEnergy plan, for
all eligible employees, was changed to a cash balance formula.
In connection with the expected 1999 sale of the Midwest Pipelines to CMS
Energy, benefit accruals under the PanEnergy plan were frozen on December 31,
1998, for all participants who, as a result of the sale, will become employees
of CMS Energy and its subsidiaries. Once the transfer of benefit obligation and
related assets of the affected participants to CMS Energy is completed, the
PanEnergy plan will be merged into the Duke Energy Plan.
On December 31, 1998, all defined benefit retirement plans maintained by
Duke Energy, except for the PanEnergy plan, were merged to form the Duke Energy
Retirement Cash Balance Plan (Duke Energy Plan). The plan merger changed the
benefit for certain participants, from a formula based primarily on benefit
accrual service and highest average earnings, to a cash balance formula.
Duke Energy's policy is to fund amounts, as necessary, on an actuarial
basis to provide assets sufficient to meet benefits to be paid to plan
participants. On December 30, 1997, assets and related liabilities of $236
million and $204 million, respectively, for certain PanEnergy plan participants
were transferred to the Duke Power plan. As a result of this transfer, no
contributions to the Duke Power plan were necessary in 1998 or 1997.
In 1998, Duke Energy adopted SFAS No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits," which required the restatement of
prior year data. This restatement did not change the net periodic expense or
the funded status of the retirement or postretirement benefit plans.
Components of Net Periodic Pension Costs
<TABLE>
<CAPTION>
For the Years Ended December 31,
-----------------------------------
1998 1997 1996
----------- ----------- -----------
In millions
<S> <C> <C> <C>
Service cost benefit earned during the year ..... $ 63 $ 62 $ 63
Interest cost on projected benefit obligation ... 169 164 153
Expected return on plan assets .................. (218) (209) (192)
Amortization of prior service cost .............. (4) (5) (2)
Amortization of net transition asset ............ (4) (4) (5)
Recognized net actuarial loss ................... 10 17 13
Settlement gain ................................. (10) -- --
------- ------- -------
Net periodic pension costs .................... $ 6 $ 25 $ 30
======= ======= =======
</TABLE>
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 17. EMPLOYEE BENEFIT PLANS -- Continued
Reconciliation of Funded Status to Pre-funded Pension Costs
<TABLE>
<CAPTION>
December 31,
----------------------
1998 1997
----------- ----------
In millions
<S> <C> <C>
Change in Benefit Obligation
Benefit obligation at beginning of year ....... $ 2,372 $ 2,126
Service cost .................................. 63 62
Interest cost ................................. 169 164
Plan amendment ................................ 5 11
Actuarial loss ................................ 141 179
Special termination benefit ................... -- 2
Benefits paid ................................. (210) (172)
------- -------
Benefit obligation at end of year ............ $ 2,540 $ 2,372
======= =======
Change in Plan Assets
Fair value of plan assets at beginning of year (a) $ 2,725 $ 2,445
Actual return on plan assets .................. 406 451
Employer contributions ........................ 1 1
Benefits paid ................................. (210) (172)
------- -------
Fair value of plan assets at end of year (a) . $ 2,922 $ 2,725
======= =======
Funded status ................................. $ 382 $ 353
Unrecognized net experience loss .............. 2 81
Unrecognized prior service cost reduction ..... (27) (65)
Unrecognized net transition asset ............. (25) (32)
------- -------
Pre-funded pension costs ..................... $ 332 $ 337
======= =======
</TABLE>
---------
(a) Principally equity and fixed income securities.
Assumptions Used for Pension Benefits Accounting (a)
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
Percent
<S> <C> <C> <C>
Discount rate ..................................... 6.75 7.25 7.50
Salary increase ................................... 4.67 4.15 4.80
Expected long-term rate of return on plan assets... 9.25 9.25 9.18
</TABLE>
---------
(a) Reflects weighted averages across all plans.
Duke Energy also sponsors employee savings plans which cover substantially
all employees. Employer matching contributions of $53 million, $53 million and
$35 million were expensed in 1998, 1997 and 1996, respectively.
Other Postretirement Benefits. Duke Energy and most of its subsidiaries
provide certain health care and life insurance benefits for retired employees
on a contributory and non-contributory basis. Employees become eligible for
these benefits if they have met certain age and service requirements at
retirement, as defined in the plans. Under plan amendments effective late 1998
and early 1999, health care benefits for future retirees were changed to limit
employer contributions and medical coverage.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 17. EMPLOYEE BENEFIT PLANS -- Continued
Such benefit costs are accrued over the active service period of employees
to the date of full eligibility for the
benefits. The net unrecognized transition obligation, resulting from the
implementation of accrual accounting, is being amortized over approximately 20
years.
Duke Energy is using an investment account under section 401(h) of the
Internal Revenue Code, a retired lives reserve (RLR) and multiple voluntary
employees' beneficiary association (VEBA) trusts under section 501(c)(9) of the
Internal Revenue Code to partially fund postretirement benefits. The 401(h)
vehicle, which provides for tax deductions for contributions and tax-free
accumulation of investment income, partially funds postretirement health care
benefits. The RLR, which has tax attributes similar to 401(h) funding,
partially funds postretirement life insurance obligations. Certain subsidiaries
use the VEBA trusts to partially fund accrued postretirement health care
benefits and fund postretirement life insurance obligations.
Components of Net Periodic Postretirement Benefit Costs
<TABLE>
<CAPTION>
For the Years
Ended December 31,
----------------------------
1998 1997 1996
-------- ---------- --------
In millions
<S> <C> <C> <C>
Service cost benefit earned during the year ........................ $ 10 $ 10 $ 8
Interest cost on accumulated postretirement benefit obligation ..... 43 46 44
Expected return on plan assets ..................................... (18) (19) (16)
Amortization of prior service cost ................................. 7 6 1
Amortization of net transition obligation .......................... 16 16 18
Recognized net actuarial loss (gain) ............................... 1 (1) --
----- ------- -----
Net periodic postretirement benefit costs .......................... $ 59 $ 58 $ 55
===== ====== =====
</TABLE>
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 17. EMPLOYEE BENEFIT PLANS -- Continued
Reconciliation of Funded Status to Accrued Postretirement Benefit Costs
<TABLE>
<CAPTION>
December 31,
------------------------
1998 1997
------------- ----------
In millions
<S> <C> <C>
Change in Benefit Obligation
Accumulated postretirement benefit obligation at beginning of year ..... $7 $ 642
Service cost ........................................................... 10 10
Interest cost .......................................................... 43 46
Plan participants' contributions ....................................... 6 6
Amendments ............................................................. (49) 4
Actuarial (gain) loss .................................................. (6) 4
Benefits paid .......................................................... (46) (45)
-------- ------
Accumulated postretirement benefit obligation at end of year ........... $ 625 $ 667
======== ======
Change in Plan Assets
Fair value of plan assets at beginning of year (a) ..................... $ 266 $ 225
Actual return on plan assets ........................................... 34 45
Employer contributions ................................................. 45 40
Plan participants' contributions ....................................... 6 1
Benefits paid .......................................................... (46) (45)
-------- ------
Fair market value of plan assets at end of year (a) .................... $ 305 $ 266
-------- ------
Funded status .......................................................... $ (320) $ (401)
Unrecognized prior service cost ........................................ 9 64
Unrecognized net experience (gain) loss ................................ (23) 4
Unrecognized transition obligation ..................................... 239 256
-------- ------
Accrued postretirement benefit costs ................................... $ (95) $ (77)
======== ======
</TABLE>
---------
(a) Principally equity and fixed income securities.
Assumptions Used for Postretirement Benefits Accounting (a)
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
Percent
<S> <C> <C> <C>
Discount rate ..................................... 6.75 7.25 7.50
Salary increase ................................... 4.67 4.33 4.84
Expected long-term rate of return on 401(h) assets 9.25 9.25 9.00
Expected long-term rate of return on RLR assets ... 6.75 6.75 6.50
Expected long-term rate of return on VEBA assets .. 9.25 9.25 9.50
Assumed tax rate (b) .............................. 39.60 39.60 39.60
</TABLE>
---------
(a) Reflects weighted averages across all plans.
(b) Health care portion of postretirement benefits in VEBA trusts.
For measurement purposes, a 5% weighted average rate of increase in the
per capita cost of covered health care benefits was assumed for 1998. The rate
was assumed to decrease gradually to 4.75% for 2005 and remain at that level
thereafter. Assumed health care cost trend rates have a significant effect on
the amounts reported for the health care plans.
<PAGE>
DUKE ENERGY CORPORATION
Notes to Consolidated Financial Statements -- Continued
NOTE 17. EMPLOYEE BENEFIT PLANS -- Continued
Sensitivity to Changes in Assumed Health Care Cost Trend Rates
<TABLE>
<CAPTION>
1-Percentage- 1-Percentage-
Point Increase Point Decrease
---------------- ---------------
In millions
<S> <C> <C>
Effect on total of service and interest cost components .. $ 3 $ (2)
Effect on postretirement benefit obligation .............. 30 (28)
</TABLE>
NOTE 18. QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
First Quarter Second Quarter Third Quarter Fourth Quarter Total
--------------- ---------------- --------------- ---------------- -------------
In millions, except per share data
<S> <C> <C> <C> <C> <C>
1998
Operating revenues ........................... $ 4,115 $ 4,014 $ 5,298 $ 4,183 $ 17,610
Operating income ............................. 608 549 826 450 2,433
EBIT ......................................... 678 582 871 516 2,647
Income before extraordinary item ............. 328 279 429 224 1,260
Net income ................................... 320 279 429 224 1,252
Earnings per share (before extraordinary item)
Basic ....................................... $ 0.89 $ 0.76 $ 1.18 $ 0.60 $ 3.43
Dilutive .................................... $ 0.89 $ 0.76 $ 1.17 $ 0.60 $ 3.42
Earnings per share
Basic ....................................... $ 0.87 $ 0.76 $ 1.18 $ 0.60 $ 3.41
Dilutive .................................... $ 0.87 $ 0.76 $ 1.17 $ 0.60 $ 3.40
1997
Operating revenues............................ $ 3,786 $ 3,113 $ 4,820 $ 4,590 $ 16,309
Operating income ............................. 610 352 606 402 1,970
EBIT ......................................... 644 407 632 425 2,108
Net income ................................... 312 168 309 185 974
Earnings per share
Basic ....................................... $ 0.84 $ 0.43 $ 0.83 $ 0.41 $ 2.51
Dilutive .................................... $ 0.83 $ 0.43 $ 0.83 $ 0.40 $ 2.50
</TABLE>
NOTE 19. SUBSEQUENT EVENT (UNAUDITED)
On February 18, 1999, Duke Energy announced its intent to make a
concurrent cash tender offer in Chilean pesos in Chile and the United States
for 51% of the outstanding shares of Endesa-Chile. The estimated total cash
outlay is approximately $2.1 billion based on current exchange rates. The offer
will be contingent upon, among other things, certain Endesa-Chile shareholder
aprovals. If all approvals are obtained, the transactions are expected to be
completed during the second quarter of 1999. Endesa-Chile controls and operates
10,247 megawatts of generating capacity in Argentina, Brazil, Chile, Colombia
and Peru.
<PAGE>
Independent Auditors' Report
TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF DUKE ENERGY CORPORATION
We have audited the consolidated balance sheets of Duke Energy Corporation
and subsidiaries (Duke Energy) as of December 31, 1998 and 1997, and the
related consolidated statements of income, common stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1998.
These financial statements are the responsibility of Duke Energy's management.
Our responsibility is to express an opinion on the financial statements
based on our audits. The consolidated financial statements give retroactive
effect to the merger of Duke Power Company and PanEnergy Corp, which has been
accounted for as a pooling of interests as described in Note 2 to the
consolidated financial statements. We did not audit the statements of income,
common stockholders' equity, and cash flows of PanEnergy Corp and subsidiaries
for the year ended December 31, 1996, which statements reflect total operating
revenues of (in millions), $7,537 for the year ended December 31, 1996. Those
financial statements were audited by other auditors whose report has been
furnished to us, and our opinion, insofar as it relates to the amounts included
for PanEnergy Corp and subsidiaries for 1996, is based solely on the report of
such other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits and the report of the other
auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors,
the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Duke Energy as of December 31,
1998 and 1997, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 1998 in conformity with
generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
Deloitte & Touche LLP
Charlotte, North Carolina
February 12, 1999
<PAGE>
Responsibility for Financial Statements
The financial statements of Duke Energy Corporation (Duke Energy) are
prepared by management, which is responsible for their integrity and
objectivity. The statements are prepared in conformity with generally accepted
accounting principles appropriate in the circumstances to reflect in all
material respects the substance of events and transactions which should be
included. The other information in the annual report is consistent with the
financial statements. In preparing these statements, management makes informed
judgments and estimates of the expected effects of events and transactions that
are currently being reported.
Duke Energy's system of internal accounting control is designed to provide
reasonable assurance that assets are safeguarded and transactions are executed
according to management's authorization. Internal accounting controls also
provide reasonable assurance that transactions are recorded properly, so that
financial statements can be prepared according to generally accepted accounting
principles. In addition, accounting controls provide reasonable assurance that
errors or irregularities which could be material to the financial statements
are prevented or are detected by employees within a timely period as they
perform their assigned functions. Duke Energy's accounting controls are
continually reviewed for effectiveness. In addition, written policies,
standards and procedures, and a strong internal audit program augment Duke
Energy's accounting controls.
The Board of Directors pursues its oversight role for the financial
statements through the audit committee, which is composed entirely of directors
who are not employees of Duke Energy. The audit committee meets with management
and internal auditors periodically to review the work of each group and to
monitor each group's discharge of its responsibilities. The audit committee
also meets periodically with Duke Energy's independent auditors, Deloitte &
Touche LLP. The independent auditors have free access to the audit committee
and the Board of Directors to discuss internal accounting control, auditing and
financial reporting matters without the presence of management.
/s/ JEFFREY L. BOYER
Jeffrey L. Boyer
Vice President and Corporate Controller
Exhibit 99(b)
Management's Discussion and Analysis of Results of Operations and
Financial Condition
INTRODUCTION
Duke Energy Corporation (collectively with its subsidiaries, "Duke
Energy") is an integrated energy and energy services provider with the ability
to offer physical delivery and management of both electricity and natural gas
throughout the United States and abroad. Duke Energy provides these and other
services through seven business segments:
o Electric Operations
o Natural Gas Transmission
o Field Services
o Trading and Marketing
o Global Asset Development
o Other Energy Services
o Real Estate Operations
<PAGE>
These segments were defined as a result of Duke Energy adopting Statement
of Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information."
Electric Operations generates, transmits, distributes and sells electric
energy in central and western North Carolina and the western portion of South
Carolina (doing business as Duke Power or Nantahala Power and Light). These
electric operations are subject to the rules and regulations of the Federal
Energy Regulatory Commission (FERC), the North Carolina Utilities Commission
(NCUC) and the Public Service Commission of South Carolina (PSCSC).
Natural Gas Transmission, through its Northeast Pipelines, provides
interstate transportation and storage of natural gas for customers primarily in
the Mid-Atlantic and New England states. Until the expected sale of the Midwest
Pipelines in early 1999, Natural Gas Transmission also provides interstate
transportation and storage services in the midwest states. See further
discussion of the proposed sale of the Midwest Pipelines in the Liquidity and
Capital Resources section of Management's Discussion and Analysis. The
interstate natural gas transmission and storage operations are also subject to
the rules and regulations of the FERC.
Field Services gathers, processes, transports and markets natural gas and
produces and markets natural gas liquids (NGL). Field Services operates
gathering systems in ten states that serve major gas-producing regions in the
Rocky Mountain, Permian Basin, Mid-Continent and Gulf Coast areas.
Trading and Marketing markets natural gas, electricity and other
energy-related products across North America. Duke Energy owns a 60% interest
in Trading and Marketing's operations, with Mobil Corporation owning a 40%
minority interest.
Global Asset Development develops, owns and operates energy-related
facilities worldwide. Global Asset Development conducts its operations
primarily through Duke Energy Power Services, LLC (Duke Energy Power Services)
and Duke Energy International, LLC (Duke Energy International).
Other Energy Services provides engineering, consulting, construction and
integrated energy solutions worldwide, primarily through Duke Engineering &
Services, Inc. (Duke Engineering & Services), Duke/Fluor Daniel and
DukeSolutions, Inc. (DukeSolutions).
Real Estate Operations conducts its business through Crescent Resources,
Inc., which develops high quality commercial and residential real estate
projects and manages forest holdings in the southeastern United States.
The 1997 merger of Duke Power Company (Duke Power) and PanEnergy Corp
(PanEnergy) was accounted for as a pooling of interests; therefore, the
Consolidated Financial Statements and other financial information included in
this Annual Report for periods prior to the merger include the combined
historical financial results of Duke Power and PanEnergy. (See Note 2 to the
Consolidated Financial Statements.)
Management's Discussion and Analysis should be read in conjunction with
the Consolidated Financial Statements.
RESULTS OF OPERATIONS
In 1998, earnings available for common stockholders increased 36.5% over
1997, to $1,231 million, or $3.41 per basic share, net of an extraordinary loss
of $8 million, or $0.02 per basic share. The increase in earnings available for
common stockholders was primarily due to increased electric sales and energy
marketing activities, expansions and acquisitions, gains on sales of assets and
the absence of 1997 non-recurring merger costs. These increases were partially
offset by decreased NGL prices and increased interest expense and minority
interests.
Earnings available for common stockholders decreased 12.4% in 1997
compared to 1996, to $902 million or $2.51 per basic share in 1997 from $1,030
million or $2.85 per basic share in 1996. The decrease was due primarily to
non-recurring 1997 merger costs, 1997 severance costs, premiums associated with
the redemption and tender offer for ten issues of preferred stock and increased
nuclear expenses. Partially offsetting the decrease were lower expenses in 1997
as compared to 1996, when major storms affected Electric Operations'
distribution costs, and an extraordinary loss related to the early retirement
of debt in 1996.
Operating income for 1998 was $2,433 million compared to $1,970 million in
1997 and $2,159 million in 1996. Earnings before interest and taxes (EBIT) were
$2,647 million, $2,108 million and $2,294 million for 1998, 1997 and 1996,
respectively. Operating income and earnings before interest and taxes,
excluding the effect of gains on asset sales of $34 million by Field Services
in 1998, are affected by the same fluctuations for Duke Energy and each of its
business segments. Earnings before interest and taxes by business segment are
summarized below and are discussed by business segment thereafter.
<PAGE>
Earnings Before Interest and Taxes by Business Segment
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------
1998 1997 1996
--------- --------- ---------
In millions
<S> <C> <C> <C>
Electric Operations .............. $1,513 $1,282 $1,419
Natural Gas Transmission ......... 702 624 595
Field Services ................... 76 157 152
Trading and Marketing ............ 122 44 58
Global Asset Development ......... 80 5 --
Other Energy Services ............ 10 18 20
Real Estate Operations ........... 142 98 88
Other Operations ................. 2 (120) (38)
------ ------ ------
Consolidated EBIT ................ $2,647 $2,108 $2,294
====== ====== ======
</TABLE>
Other Operations primarily includes communication services, water services
and certain unallocated corporate costs. Included in the amounts discussed
below are intercompany transactions that are eliminated in the Consolidated
Financial Statements.
Electric Operations
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------
1998 1997 1996
--------- --------- ---------
Dollars in millions
<S> <C> <C> <C>
Operating Revenues .................... $4,626 $4,401 $4,498
Operating Expenses .................... 3,228 3,221 3,195
------ ------ ------
Operating Income ...................... 1,398 1,180 1,303
Other Income, Net of Expenses ......... 115 102 116
------ ------ ------
EBIT .................................. $1,513 $1,282 $1,419
====== ====== ======
Volumes, Sales -- GWh (a) ............. 82,011 77,935 77,547
</TABLE>
- ---------
(a) Gigawatt-hour
In 1998, earnings before interest and taxes for Electric Operations
increased 18.0% to $1,513 million from $1,282 million in 1997, primarily due to
a 5.2% increase in gigawatt-hour sales. The increase in earnings before
interest and taxes due to the absence of 1997 severance costs was substantially
offset by 1998 severance and other costs related to the shut-down of Electric
Operations' merchandising business.
Sales to weather-sensitive customers increased significantly in 1998
compared to 1997, which was a mild weather year, with sales to residential and
general service customers up 7.5% and 7.1%, respectively, primarily due to
warmer spring and summer weather conditions. On July 21, 1998, Electric
Operations customers set the third record demand of the summer, reaching a peak
of 15,812 megawatts. Sales to industrial customers increased slightly in 1998
over 1997, with sales to textile customers relatively flat. The number of
customers in the Electric Operations service territory increased 2.5% in 1998
over 1997 due to economic growth in the region.
In 1997, earnings before interest and taxes for Electric Operations
declined 9.7% as compared to 1996, primarily as a result of severance costs and
increased nuclear outage expenses. Also contributing to the decrease were lower
electric revenues, which were due primarily to mild weather and to the South
Carolina rate reduction, which was effective June 1, 1996. Partially offsetting
the decrease in earnings were lower expenses in 1997 as compared to 1996, when
major storms affected distribution costs.
<PAGE>
Natural Gas Transmission
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------
1998 1997 1996
--------- --------- ---------
Dollars in millions
<S> <C> <C> <C>
Operating Revenues ...................... $1,528 $1,572 $1,556
Operating Expenses ...................... 864 964 973
------ ------ ------
Operating Income ........................ 664 608 583
Other Income, Net of Expenses ........... 38 16 12
------ ------ ------
EBIT .................................... $ 702 $ 624 $ 595
====== ====== ======
Volumes, Throughput -- TBtu (a) ......... 2,593 2,862 2,939
</TABLE>
- ---------
(a) Trillion British thermal units
Earnings before interest and taxes for Natural Gas Transmission increased
$78 million in 1998 over 1997. Earnings before interest and taxes for Northeast
Pipelines increased $56 million to $476 million in 1998 compared to 1997,
primarily as a result of the favorable resolution of regulatory issues related
to gas supply realignment costs, favorable state property tax rulings and
increased market expansion projects. These increases were partially offset by a
decrease in throughput primarily as a result of mild winter weather.
In 1998, earnings before interest and taxes for Midwest Pipelines
increased 10.8% compared to 1997, primarily due to a gain on the sale of the
general partner interests in Northern Border Partners, L.P. and non-recurring
1997 litigation expenses. These increases were partially offset by the
favorable resolution of certain regulatory matters in 1997, which was reflected
as additional revenue and other income. See the Liquidity and Capital Resources
- -- Investing Cash Flows section of Management's Discussion and Analysis for a
discussion of the expected sale of the Midwest Pipelines in early 1999. (See
also Note 14 to the Consolidated Financial Statements.)
Earnings before interest and taxes for Natural Gas Transmission increased
4.9% in 1997 over 1996, with increases in earnings at Northeast Pipelines and
Midwest Pipelines of 5.3% and 4.0%, respectively. Earnings before interest and
taxes for the Northeast Pipelines increased primarily due to market-expansion
projects placed in service.
For the Midwest Pipelines, earnings before interest and taxes increased
primarily due to the favorable resolution of certain regulatory matters in 1997
in amounts in excess of those resolved in 1996, which was reflected as
additional revenue and other income. This increase was partially offset by 1997
litigation expenses.
Field Services
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------
1998 1997 1996
------------ ------------ ------------
Dollars in millions
<S> <C> <C> <C>
Operating Revenues ........................................ $ 2,639 $ 3,055 $ 2,637
Operating Expenses ........................................ 2,598 2,898 2,487
-------- -------- --------
Operating Income .......................................... 41 157 150
Other Income, Net of Expenses ............................. 35 -- 2
-------- -------- --------
EBIT ...................................................... $ 76 $ 157 $ 152
======== ======== ========
Volumes
Natural Gas Gathered and Processed/Transported, TBtu/d (a) 3.6 3.4 2.9
Natural Gas Marketed, TBtu/d .............................. 0.4 0.4 0.5
NGL Production, MBbl/d (b) ................................ 110.2 108.2 78.5
</TABLE>
- ---------
(a) Trillion British thermal units per day
(b) Thousand barrels per day
In 1998, earnings before interest and taxes for Field Services decreased
$81 million compared to 1997, primarily due to a decrease in average NGL prices
of approximately $0.09 per gallon, or 25.7%. The decrease in earnings before
interest and taxes was partially offset by $34 million of gains on sales of
assets which are included in other income.
<PAGE>
Earnings before interest and taxes for Field Services increased 3.3% in
1997 over 1996, primarily due to higher volumes as a result of acquisitions in
1996. Natural gas gathered and processed volumes increased 17.2%, and NGL
production increased 37.8% in 1997 compared to 1996. Partially offsetting these
increases were lower NGL prices of approximately $0.04 per gallon, or 8%, and
higher natural gas prices.
Trading and Marketing
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------
1998 1997 1996
----------- ----------- -----------
Dollars in millions
<S> <C> <C> <C>
Operating Revenues .................... $8,785 $7,489 $3,814
Operating Expenses .................... 8,665 7,446 3,758
------ ------ ------
Operating Income ...................... 120 43 56
Other Income, Net of Expenses ......... 2 1 2
------ ------ ------
EBIT .................................. $ 122 $ 44 $ 58
====== ====== ======
Volumes
Natural Gas Marketed, TBtu/d .......... 8.0 6.9 5.5
Electricity Marketed, GWh ............. 98,991 64,650 4,229
</TABLE>
In 1998, earnings before interest and taxes for Trading and Marketing
increased $78 million over 1997. The increase resulted primarily from increased
financial trading margins and electricity margins, partially offset by
increased expenses due to business growth. Electricity volumes marketed
increased primarily as a result of acquiring the remaining 50% ownership
interest in the Duke/Louis Dreyfus, L.L.C. (D/LD) joint venture in June 1997.
Earnings before interest and taxes for Trading and Marketing decreased $14
million in 1997 compared to 1996. The acquisition of the remaining 50%
ownership interest in the D/LD joint venture in 1997, coupled with a full year
of operations of the joint venture with Mobil Corporation formed in August
1996, accounted for the significant increases in Trading and Marketing
revenues, related operating expenses (including increased purchased power
expense) and volumes in 1997 over 1996. Increased natural gas volumes marketed
of 25.5% in 1997, in addition to increased natural gas margins from trading
activities, were largely offset by the emerging electric power trading and
marketing activities. Higher operating expenses, due primarily to increased
personnel levels and system development costs to provide the necessary
infrastructure for growth in the trading and marketing business, resulted in a
decrease in earnings before interest and taxes in 1997 as compared to 1996.
Global Asset Development
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------
1998 1997 1996
-------- ----------- ----------
In millions
<S> <C> <C> <C>
Operating Revenues .................... $ 319 $ 123 $ 72
Operating Expenses .................... 261 129 73
----- ----- ----
Operating Income ...................... 58 (6) (1)
Other Income, Net of Expenses ......... 22 11 1
----- ----- -----
EBIT .................................. $ 80 $ 5 $ --
===== ===== =====
</TABLE>
In 1998, earnings before interest and taxes for Global Asset Development
increased $75 million over 1997. The increase results primarily from business
expansion and acquisitions, including Duke Energy Power Services' July 1, 1998
acquisition of three electric generating stations in California from Pacific
Gas & Electric Company (PG&E) and December 1997 acquisition of an indirect
32.5% ownership interest in American Ref-Fuel Company. Duke Energy
International also contributed to the increase in earnings before interest and
taxes in 1998 compared to 1997 through an expansion to the PT Puncakjaya power
generation facility in Indonesia. This increase was partially offset by
decreased earnings resulting from lower prices at National Methanol, a methanol
and MTBE (methyl tertiary butyl ether) plant in Saudi Arabia.
In 1997, earnings before interest and taxes increased slightly compared to
1996, due primarily to business expansion and acquisitions, including the
December 1997 acquisition of an ownership interest in American Ref-Fuel
Company, and a gain on the sale of an investment. These increases were
partially offset by increased expenses due to business growth.
<PAGE>
Other Energy Services
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------
1998 1997 1996
-------- ----------- --------
In millions
<S> <C> <C> <C>
Operating Revenues .................... $ 521 $ 376 $ 204
Operating Expenses .................... 511 353 184
----- ----- -----
Operating Income ...................... 10 23 20
Other Income, Net of Expenses ......... -- (5) --
----- ----- -----
EBIT .................................. $ 10 $ 18 $ 20
===== ===== =====
</TABLE>
In 1998, earnings before interest and taxes for Other Energy Services
decreased $8 million compared to 1997, primarily due to decreased earnings of
Duke Engineering & Services. Earnings before interest and taxes for Other
Energy Services decreased $2 million in 1997 compared to 1996, primarily as a
result of start-up expenses of DukeSolutions partially offset by increased
earnings of Duke Engineering & Services due to growth.
Real Estate Operations
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------
1998 1997 1996
-------- -------- --------
In millions
<S> <C> <C> <C>
Operating Revenues .................... $ 181 $ 124 $ 114
Operating Expenses .................... 39 26 26
----- ----- -----
Operating Income ...................... 142 98 88
Other Income, Net of Expenses ......... -- -- --
----- ----- -----
EBIT .................................. $ 142 $ 98 $ 88
===== ===== =====
</TABLE>
In 1998, earnings before interest and taxes for Real Estate Operations
increased 44.9% compared to 1997, primarily as a result of increased project
and lake lot sales and a gain on land sales in the Jocassee Gorges region of
South Carolina. Earnings before interest and taxes for Real Estate Operations
increased 11.4% in 1997 over 1996, primarily due to gains associated with bulk
land sales in 1997.
Other Operations
Earnings before interest and taxes for Other Operations increased in 1998
compared to 1997, primarily as a result of the absence of $71 million of
non-recurring 1997 merger-related costs and the favorable resolution of certain
contingent items in 1998. The increase in earnings before interest and taxes
was partially offset by a 1997 gain on the sale of the ownership interest in
the Midland Cogeneration Venture.
Earnings before interest and taxes for Other Operations declined $82
million in 1997 compared to 1996. Contributing to the decrease were increased
merger-related expenses of $57 million in 1997 compared to 1996 and the 1997
amortization of goodwill associated with the purchase of the remaining 50%
ownership interest in the D/LD joint venture. This decline was partially offset
by the sale of the ownership interest in the Midland Cogeneration Venture in
1997.
Other Impacts on Earnings Available for Common Stockholders
Interest expense increased 8.9% in 1998 over 1997 due to higher average
debt balances outstanding. In 1997, interest expense decreased $27 million, or
5.4%, as compared to 1996 as a result of lower interest rates.
In 1998, minority interests increased $73 million compared to 1997. This
increase includes 1998 dividends for trust preferred securities, of which $350
million were issued in December 1997 and $600 million were issued in 1998. See
further discussion of the 1998 issuances of trust preferred securities in the
Liquidity and Capital Resources section of Management's Discussion and
Analysis. Excluding these dividends, minority interests relate primarily to the
trading and marketing joint venture with Mobil Corporation formed in August
1996.
In January 1998, TEPPCO Partners, L.P., in which a subsidiary of Duke
Energy has a 2% general partner interest and a 19.1% limited partner interest,
redeemed certain First Mortgage Notes. A non-cash extraordinary loss of $8
million, net of income tax of $5 million, was recorded related to costs of the
early retirement of that debt.
<PAGE>
On October 1, 1996, a subsidiary of Duke Energy redeemed its $150 million,
10% debentures and its $100 million, 10 1/8% debentures, both due 2011. A
non-cash extraordinary loss of $17 million, net of income tax of $10 million,
was recorded related to the unamortized discount on this early retirement of
debt.
In December 1997, Duke Energy redeemed four issues of preferred stock and
commenced a tender offer to purchase a portion of an additional six issues of
preferred stock. Premiums related to these redemptions were included in the
Consolidated Statements of Income in 1997 as Dividends and Premiums on
Redemptions of Preferred and Preference Stock.
LIQUIDITY AND CAPITAL RESOURCES
Operating Cash Flows. Assets and liabilities recorded in the Consolidated
Balance Sheets related to purchased capacity levelization and natural gas
transition cost recoveries and the related cash flow impacts are affected by
state and federal regulatory initiatives and specific agreements. For more
information on the purchased capacity levelization and the natural gas
transition cost recoveries, see Notes 5 and 4, respectively, to the
Consolidated Financial Statements.
On August 29, 1998, the FERC approved a settlement from Texas Eastern
Transmission Corporation (TETCO), a subsidiary of Duke Energy, which will
accelerate recovery of natural gas transition costs and reduce depreciation
expense to more appropriately reflect the estimated useful lives of its
facilities, principally interstate natural gas pipelines. The order was
effective October 1, 1998 and includes a rate moratorium until 2004. Cash flows
from operations are not expected to change for the first two years after
implementation due to the offsetting effect on customer rates of the reduced
depreciation expense and increased recovery of natural gas transition costs.
When the natural gas transition costs are fully recovered, cash flows from
operations are expected to decrease during 2001 through 2003 by an estimated
total of $270 million. For more information concerning the settlement, see Note
4 to the Consolidated Financial Statements.
Investing Cash Flows. Capital and investment expenditures were
approximately $2.5 billion in 1998 compared to approximately $2.0 billion in
1997. This increase was primarily due to business expansion by Global Asset
Development, which included Duke Energy Power Services' $501 million purchase
of three electric generating stations in California from PG&E and the
completion of the first phase of Bridgeport Energy, a $265 million,
520-megawatt combined cycle natural gas-fired merchant generation plant.
Business expansion for Natural Gas Transmission and Field Services also
contributed to the increase in capital and investment expenditures. The
increase was partially offset by decreased expenditures for Electric
Operations, primarily as a result of steam generator replacements at certain of
its nuclear plants in 1997, and by the acquisition of the remaining 50%
ownership of the D/LD joint venture in June 1997.
Capital and investment expenditures in 1997 included the acquisition of
the remaining 50% ownership interest in the D/LD joint venture for $247
million, which substantially represented goodwill, and Global Asset
Development's acquisition of an ownership interest in American Ref-Fuel Company
for $237 million. The increase in capital and investment expenditures in 1997
over 1996 also included increased Electric Operations construction costs,
primarily due to steam generator replacements at certain of its nuclear plants
and increased distribution line construction, and business expansion for the
Natural Gas Transmission segment. These increases were partially offset by the
1996 acquisition of certain assets from Mobil Corporation.
Duke Energy plans to maintain its regulated electric operations facilities
in the Carolinas and pursue business expansion as opportunities arise.
Projected 1999 capital and investment expenditures for Electric Operations,
including allowance for funds used during construction, are approximately $900
million. These projections include expenditures for existing plants, including
refurbishment and upgrades related to the Oconee Nuclear Station's application
for a 20-year renewal of its operating license. The license renewal process
could take three to five years to complete. All projections are subject to
periodic review and revisions. Actual expenditures incurred may vary from such
estimates due to various factors, including industry restructuring, weather,
economic growth, regulatory constraints and environmental regulation.
Projected 1999 capital and investment expenditures for Natural Gas
Transmission, including allowance for funds used during construction, are
approximately $400 million which do not include projections related to the
Midwest Pipelines which are expected to be sold in early 1999. These
projections include the completion of the Maritimes & Northeast Pipeline
project, which will deliver natural gas to markets in the Canadian Maritimes
provinces and the northeastern United States from a supply basin offshore Nova
Scotia. These projections also include other market expansion projects and
costs relating to existing assets.
Duke Energy plans to continue to significantly grow several of its
business segments: Field Services, Global Asset Development, Trading and
Marketing and Other Energy Services. Expansion opportunities for Field Services
include the planned $1.35 billion acquisition of the natural gas gathering,
processing, fractionation and NGL pipeline business of Union
<PAGE>
Pacific Resources along with its natural gas and NGL marketing activities. The
transaction is expected to close in the first half of 1999 and is contingent
upon completion of due diligence and receipt of clearances under the
Hart-Scott-Rodino Act.
Expansion opportunities for Global Asset Development's international
division, Duke Energy International, include the $315 million purchase of power
generation and transmission assets in western Australia and New Zealand,
including an ownership interest in a pipeline in western Australia. This
acquisition also includes a development proposal for a cogeneration plant and a
portfolio of international and Australian-based projects. This transaction
closed on January 22, 1999.
Also, Duke Energy International recently purchased the rights to develop
and operate the 500-mile Eastern Gas Pipeline project in eastern Australia.
Construction of this $270 million pipeline project is scheduled to begin in
July 1999 and completion is expected by the middle of 2000.
Expansion opportunities for Global Asset Development's domestic division,
Duke Energy Power Services, include the continuation of greenfield projects,
such as the Bridgeport Energy project and the Maine Independence Station, a
520-megawatt combined cycle natural gas-fired merchant generation plant in
Maine which is scheduled to begin producing power in the summer of 2000. Other
expansion opportunities include the Hidalgo project, a 510-megawatt power plant
to be built in south Texas, which is targeted to begin producing power in
mid-2000. Other similar initiatives in 1999 for both Duke Energy International
and Duke Energy Power Services will likely require significant capital and
investment expenditures, which will be subject to periodic review and revision
and may vary significantly depending on the value-added opportunities
presented.
Projected 1999 capital and investment expenditures for Trading and
Marketing, Other Energy Services and Real Estate Operations are approximately
$30 million, $90 million and $300 million, respectively. All projected capital
and investment expenditures are subject to periodic review and revision and may
vary significantly depending on acquisition opportunities, market volatility,
economic trends and the value-added opportunities presented.
In October 1998, Duke Energy, through its wholly owned subsidiaries,
PanEnergy and Texas Eastern Corporation, entered into an agreement to sell
Panhandle Eastern Pipe Line Company (PEPL), Trunkline Gas Company (Trunkline)
and additional storage related to those systems, which substantially comprise
the Midwest Pipelines, along with Trunkline LNG Company, to CMS Energy
Corporation. The sales price of $2.2 billion involves cash proceeds of $1.9
billion and the assumption of existing PEPL debt of approximately $300 million.
The sale is expected to close in early 1999 and will result in an after-tax
gain of approximately $700 million. The sale is contingent upon receipt of
clearances under the Hart-Scott-Rodino Act.
Financing Cash Flows. Duke Energy's consolidated capital structure at
December 31, 1998, including short-term debt, was 43.3% debt, 5.5% trust
preferred securities, 2.0% preferred stock and 49.2% common equity. Fixed
charges coverage, calculated using the Securities and Exchange Commission
method, was 4.7 times, 4.1 times and 4.3 times for 1998, 1997 and 1996,
respectively.
Duke Energy plans to continue to significantly grow several of its
business segments: Field Services, Trading and Marketing, Global Asset
Development and Other Energy Services. These growth opportunities, along with
dividends, debt repayments and operating and investing requirements, are
expected to be funded by cash from operations, external debt financing and the
proceeds from the sale of the Midwest Pipelines.
Securities Ratings
<TABLE>
<CAPTION>
Duke Energy Corporation S&P Moody's Fitch Duff & Phelps
<S> <C> <C> <C> <C>
First and Refunding Mortgage Bonds AA- Aa3 AA- AA
Senior Unsecured A A1 A+ AA-
Preferred Stock A a1 A+ A+
Trust Preferred Securities A a1 A+ A+
Commercial Paper A-1 P-1 F-1+ D-1+
</TABLE>
To maintain financial flexibility and reduce the amount of financing
needed for growth opportunities, Duke Energy's Board of Directors adopted a
dividend policy in June 1998 that targets 50% of earnings paid out in dividends
on common stock. Prior to the adoption of the policy, approximately 65% of
earnings were paid out in dividends. The Board of Directors intends to maintain
dividends at the current quarterly rate of $0.55 per share until the target
payout ratio is reached.
<PAGE>
In February 1998, Duke Energy completed its tender offer for a maximum of
50% of the outstanding shares of six of its preferred stock issues, purchasing
two million shares of its preferred stock for $180 million.
Duke Capital Corporation (Duke Capital) is a wholly owned subsidiary of
Duke Energy and serves as the parent for Duke Energy's business segments except
Electric Operations and certain other operations. In July 1998, Duke Capital
issued $400 million of Senior Unsecured Notes. Also, during 1998, Duke
Capital's business trusts, which are treated as indirect wholly owned
subsidiaries of Duke Energy for financial reporting purposes, issued $600
million of trust preferred securities. (See Note 12 to the Consolidated
Financial Statements.)
In December 1998, Duke Energy issued $300 million of Senior Unsecured
Notes. The proceeds, along with $200 million in commercial paper, were used to
redeem $500 million of First and Refunding Mortgage Bonds, which were called on
December 31, 1998. In January 1999, Duke Energy issued $200 million of Senior
Notes.
Under its commercial paper facilities, Duke Energy had the ability to
borrow up to $2.8 billion and $2.5 billion as of December 31, 1998 and 1997,
respectively. At December 31, 1998, the commercial paper facilities consisted
of $1.25 billion for Duke Energy and $1.55 billion for Duke Capital. At
December 31, 1997, the commercial paper facilities consisted of $1.25 billion
each for Duke Energy and Duke Capital. At December 31, 1998 and 1997, Duke
Energy's various bank credit facilities totaled approximately $2.9 billion and
$2.7 billion, respectively. At December 31, 1998, $1.9 billion was outstanding
under the commercial paper facilities and $100 million was outstanding under
the bank credit facilities.
As of December 31, 1998, Duke Energy and its subsidiaries, excluding PEPL,
had authority to issue up to $1.2 billion aggregate principal amount of debt
and other securities under shelf registrations filed with the Securities and
Exchange Commission. Such securities may be issued as First and Refunding
Mortgage Bonds, Senior Notes, Subordinated Notes or Preferred Stock. On January
27, 1999, Duke Capital filed a $1 billion shelf registration statement, which
was declared effective by the Securities and Exchange Commission on February
10, 1999.
Duke Energy used authorized but unissued shares of its common stock to
meet 1998 employee benefit plan contribution requirements instead of purchasing
shares on the open market. This practice is expected to be continued in 1999.
QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
Risk Policies. Duke Energy is exposed to market risks associated with
commodity prices, interest rates, equity prices and foreign exchange rates.
Comprehensive risk management policies have been established by the Corporate
Risk Management Committee (CRMC) to monitor and control these market risks. The
CRMC is chaired by the Chief Financial Officer and primarily comprises senior
executives. The CRMC has responsibility for overseeing all corporate energy
risk management and recommending energy financial exposure limits, as well as
responsibility for oversight of interest rate risk, foreign currency risk and
credit risk.
Interest Rate Risk. Duke Energy is exposed to risk resulting from changes
in interest rates as a result of its issuance of variable-rate debt, fixed-rate
debt and trust preferred securities, commercial paper and auction market
preferred stock, as well as fixed-to-floating interest rate swaps and interest
rate lock agreements. Duke Energy manages its interest rate exposure by
limiting its variable-rate and fixed-rate exposure to a certain percentage of
total capitalization, as set by policy, and by monitoring the effects of market
changes in interest rates. (See Notes 1, 7, 10, 12 and 13 to the Consolidated
Financial Statements.)
If market interest rates average 1% higher (lower) in 1999 than in 1998,
interest expense would increase (decrease), and earnings before income taxes
would decrease (increase) by approximately $23 million. Comparatively, had
interest rates averaged 1% higher (lower) in 1998 than in 1997, interest
expense would have increased (decreased), and earnings before income taxes
would have decreased (increased) by approximately $24 million. These amounts
were determined by considering the impact of the hypothetical interest rates on
the variable-rate securities outstanding as of December 31, 1998 and 1997. In
the event of a significant change in interest rates, management would likely
take actions to manage its exposure to the change. However, due to the
uncertainty of the specific actions that would be taken and their possible
effects, the sensitivity analysis assumes no changes in Duke Energy's financial
structure.
Commodity Price Risk. Duke Energy, substantially through its subsidiaries,
is exposed to the impact of market fluctuations in the price and transportation
costs of natural gas, electricity and petroleum products marketed. Duke Energy
employs established policies and procedures to manage its risks associated with
these market fluctuations using various commodity derivatives, including
futures, swaps and options. (See Notes 1 and 7 to the Consolidated Financial
Statements.) The risk in the commodity trading portfolio is measured on a daily
basis utilizing a Value-at-Risk model to determine the maximum potential
one-day favorable or unfavorable Daily Earnings at Risk (DER). The DER is
monitored in comparison
<PAGE>
to established thresholds. Other measures are also utilized to monitor the risk
in the commodity trading portfolio on a monthly and annual basis.
The DER computations are based on a historical simulation, which utilizes
price movements over a specified period to simulate forward price curves in the
energy markets to estimate the favorable or unfavorable impact of one-day's
price movement on the existing portfolio. The historical simulation emphasizes
the most recent market activity, which is considered the most relevant
predictor of future market movements for natural gas, electricity and petroleum
products. The DER computations utilize several key assumptions, including a 95%
confidence level for the resultant price movement and the holding period
specified for the calculation. Duke Energy's calculation includes commodity
derivative instruments and forwards held for trading purposes and excludes the
effects of embedded physical options in the trading portfolio. At December 31,
1998 and 1997, the estimated potential one-day favorable or unfavorable impact
on earnings before income taxes related to commodity instruments held for
trading purposes was approximately $10 million and $2 million, respectively.
During 1998, the average estimated potential one-day favorable or unfavorable
impact on earnings before income taxes related to commodity instruments held
for trading purposes was approximately $5 million. The increase in 1998
compared to 1997 is a result of an increase in the authorized energy financial
exposure limit, which was approved by the CRMC. Changes in markets inconsistent
with historical trends could cause actual results to exceed predicted limits.
Market risks associated with commodity derivatives held for purposes other than
trading were not material at December 31, 1998 and 1997.
Subsidiaries of Duke Energy are also exposed to market fluctuations in the
prices of NGLs related to their ongoing gathering and processing operating
activities. Duke Energy closely monitors the risks associated with NGL price
changes on its future operations, and where appropriate, uses crude oil and
natural gas commodity instruments to hedge NGL prices. If NGL prices averaged
one cent per gallon less in 1998, earnings before income taxes would have
decreased by approximately $8 million. Duke Energy generally does not maintain
a material inventory of NGLs or actively trade commodity derivatives related to
NGLs.
Equity Price Risk. Duke Energy maintains trust funds, as required by the
Nuclear Regulatory Commission, to fund certain costs of nuclear
decommissioning. (See Note 11 to the Consolidated Financial Statements.) As of
December 31, 1998 and 1997, these funds were invested primarily in domestic and
international equity securities, fixed-rate, fixed-income securities and cash
and cash equivalents. Management believes that its exposure to fluctuations in
equity prices or interest rates will not affect consolidated results of
operations. See further discussion in the Current Issues, Nuclear
Decommissioning Costs section of Management's Discussion and Analysis.
Foreign Operations Risk. Duke Energy is exposed to foreign currency risk,
sovereign risk and other foreign operations risks arising from equity
investments in international affiliates and businesses owned and operated in
foreign countries. At December 31, 1998 Duke Energy had more than $100 million
invested in Australia. Investments in other foreign countries were not material
at December 31, 1998 or 1997. In order to mitigate risks associated with
foreign currency fluctuations, the majority of contracts entered into by Duke
Energy or its affiliates are denominated in or indexed to the U.S. dollar or
may be hedged through issuance of debt denominated in the foreign currency.
Duke Energy also uses foreign currency swaps, where appropriate, to manage its
risk related to foreign currency fluctuations. Other exposures to foreign
currency risk, sovereign risk or other foreign operations risk are periodically
reviewed by management and were not material to consolidated results of
operations or financial position during 1998 or 1997.
CURRENT ISSUES
Operations Outlook. Duke Energy's business strategy is to develop regional
centers of energy assets involving gas, electric generation and marketing in
the United States and internationally. In the United States, Duke Energy is
aggressively investing in new pipelines and power plants in the Northeast, Gulf
Coast and West. Internationally, Duke Energy is focusing on opportunities in
Asia Pacific, South America and Europe.
Electric Operations is expected to grow moderately, consistent with
historical trends. Expansion will primarily result from continued economic
growth in its service territory. In 1997, as a result of the merger with
PanEnergy, Duke Energy signed various agreements with the NCUC, PSCSC and the
FERC capping base rates to retail and wholesale electric customers at existing
levels through 2000. In addition, Duke Energy signed agreements with the other
joint owners of the Catawba Nuclear Station providing for a cap on certain
rates charged under interconnection agreements. In response to these rate
agreements and competitive pressures, Electric Operations continues to strive
to maintain low costs and competitive
<PAGE>
rates for its customers and to provide high quality customer service. Duke
Energy does not expect a negative impact as a result of such agreements on its
results of operations or financial position. (See further discussion in the
Electric Competition section below.)
The Northeast Pipelines are an essential part of Natural Gas
Transmission's strategy to advance projects that provide expanded services to
meet the specific needs of customers. The proposed sale of the Midwest
Pipelines allows Natural Gas Transmission to focus on regions, such as the
northeastern U.S., with increasing demand for gas. Northeast pipeline projects
will provide transportation from new supplies in both eastern and western
Canada in addition to traditional domestic supply basins.
Duke Energy plans to significantly grow several of its business segments:
Field Services, Trading and Marketing, Global Asset Development and Other
Energy Services. Deregulation of energy markets in the United States and abroad
is providing substantial opportunities for these segments to capitalize on
their broad capabilities. Field Services will expand through the purchase of
the natural gas gathering, processing, fractionation and NGL pipeline business
from Union Pacific Resources along with its natural gas and NGL marketing
activities.
Global Asset Development expects to continue strong growth through
acquisitions, construction of greenfield projects and expansion of existing
facilities as value-added opportunities present themselves. Duke Energy's
combination of assets and capabilities that span the energy value chain have
contributed to Global Asset Development's successful combination of natural gas
pipeline capabilities, power generation, energy marketing and other services.
This demonstrated domestic strategy is now being deployed internationally in
the Asia Pacific area and in South America. Other Energy Services seeks to grow
with types of services including comprehensive energy efficiencies in food,
textile and government facilities.
The strong real estate market in the Southeast continues to present
substantial growth opportunities for Real Estate Operations. In 1998, Real
Estate Operations initiated development of significant office and industrial
facilities in each of its established markets to capitalize on market
conditions.
While the proposed sale of the Midwest Pipelines will provide an
opportunity to deploy capital into areas of higher growth, Duke Energy expects
to experience some near-term earnings pressure as a result of the sale. Duke
Energy believes that its strategy of developing regional centers of energy
assets will return long-term growth and increase shareholder value. Duke Energy
continues to target long-term annual growth in earnings per share of eight to
ten percent.
Electric Competition. Wholesale Competition. The Energy Policy Act of 1992
(EPACT) and the FERC's subsequent rulemaking activities have established the
regulatory framework to open the wholesale energy market to competition. EPACT
amended provisions of the Public Utility Holding Company Act of 1935 and the
Federal Power Act to remove certain barriers to a competitive wholesale market.
EPACT permits utilities to participate in the development of independent
electric generating plants for sales to wholesale customers, and also permits
the FERC to order transmission access for third parties to transmission
facilities owned by another entity. It does not, however, permit the FERC to
issue an order requiring transmission access to retail customers. The FERC,
responsible in large measure for implementation of the EPACT, has moved
vigorously to implement its mandate, interpreting the statute broadly and
issuing orders for third-party transmission service and a number of rules of
general applicability, including Orders 888 and 889.
Open-access transmission for wholesale customers as defined by the FERC's
final rules provides energy suppliers, including Duke Energy, with
opportunities to sell and deliver capacity and energy at market-based prices.
Duke Energy and several of its non-regulated subsidiaries were granted
authority by the FERC to act as power marketers in 1995. In 1998, an additional
non-regulated subsidiary was granted power marketer authority. Electric
Operations obtained from the FERC open-access rule the rights to sell capacity
and energy at market-based rates from its own assets. Open access provides
another supply option through which Electric Operations can purchase at
attractive rates a portion of capacity and energy requirements resulting in
lower overall costs to customers. Open access also provides Electric
Operations' existing wholesale customers with competitive opportunities to seek
other suppliers for their capacity and energy requirements.
Wholesale sales represented approximately 11.3% of total gigawatt-hour
sales for Electric Operations in 1998. Supplemental power sales to the other
joint owners of Catawba Nuclear Station comprised the majority of wholesale
sales. Such supplemental power sales will continue to decline in 1999 as the
joint owners retain more capacity and energy from Catawba Nuclear Station or
purchase from a third party. (See Note 5 to the Consolidated Financial
Statements.)
Retail Competition. Currently, Electric Operations operates as a
vertically integrated, investor-owned utility with exclusive rights to supply
electricity in a franchised service territory -- a 20,000-square-mile service
territory in the Carolinas. In its retail business, the NCUC and the PSCSC
regulate Electric Operations' service and rates.
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Electric industry restructuring is being addressed in all 50 states and in
the District of Columbia which is resulting in changes in the industry. These
changes will likely impact all entities owning electric generating assets. The
NCUC and the PSCSC are studying the merits of restructuring the electric
utility industry in the Carolinas. Although the North Carolina and South
Carolina legislatures have not made a final decision on this matter,
initiatives are underway to determine whether it is in the best interests of
all parties to deregulate the electric industry.
In May 1997, North Carolina passed a bill that established a study
commission to examine whether competition should be implemented in the state.
The commission's report to the state General Assembly is expected to be
completed by early 2000. Duke Energy is a member of the study commission along
with other utility representatives, legislators, customers and a member of an
environmental group.
On February 3, 1998, the PSCSC presented its report to the South Carolina
House of Representatives on how to deregulate the electric industry. The report
leaves the final decisions to the General Assembly of South Carolina. The
Public Utility Subcommittee of the House of Representatives Committee on Labor,
Commerce and Industry has been conducting hearings regarding electric industry
restructuring during the past year.
Late in 1998, a task force was formed by the South Carolina Senate to
examine issues related to deregulation of the state's electric utility
business. This task force will prepare a report for review, discussion and
possible legislative action by the Senate Judiciary Committee and the General
Assembly as a whole.
Currently, the electric utility industry is predominantly regulated on a
basis designed to recover the cost of providing electric power to customers. If
cost-based regulation were to be discontinued in the industry for any reason,
including competitive pressure on the cost-based prices of electricity, profits
could be reduced and electric utilities might be required to reduce their asset
balances to reflect a market basis less than cost. Discontinuance of cost-based
regulation would also require affected utilities to write off their associated
regulatory assets. Duke Energy's regulatory assets are included in the
Consolidated Balance Sheets. The portion of these regulatory assets related to
Electric Operations is approximately $1.5 billion, including primarily
purchased capacity costs, debt expense and deferred taxes related to regulatory
assets. Currently, Duke Energy is recovering substantially all of these
regulatory assets through its wholesale and retail electric rates and would
attempt to continue to recover these assets during a transition to competition.
In addition, Duke Energy would seek to recover the costs of its electric
generating facilities in excess of the market price of power at the time of
transition.
Duke Energy supports a properly managed and orderly transition to
competitive generation and retail services in the electric industry. However,
transforming the current regulated industry into efficient, competitive
generation and retail electric markets is a complex undertaking, which will
require a carefully considered transition to a restructured electric industry.
The key to effective retail competition is fairness among customers, service
providers and investors. Duke Energy intends to work with customers,
legislators and regulators to address all the important issues. Management
cannot predict the potential impact, if any, of these competitive forces on
future consolidated results of operations or financial position.
Natural Gas Competition. Wholesale Competition. On July 29, 1998, the FERC
issued a Notice of Proposed Rulemaking (NOPR) on short-term natural gas
transportation services, which proposed an integrated package of revisions to
its regulations governing interstate natural gas pipelines. "Short term" has
been defined in the NOPR as all transactions of less than one year. Under the
proposed approach, cost-based regulation would be eliminated for short-term
transportation and replaced by regulatory policies intended to maximize
competition in the short-term transportation market, mitigate the ability of
companies to exercise residual monopoly power and provide opportunities for
greater flexibility providing pipeline services. The proposed changes include
initiatives to revise pipeline scheduling procedures, receipt and delivery
point policies and penalty policies, and require pipelines to auction
short-term capacity. Other proposed changes would improve the FERC's reporting
requirements, permit pipelines to negotiate rates and terms of services, and
revise certain rate and certificate policies that affect competition.
In conjunction with the NOPR, the FERC also issued a Notice of Inquiry
(NOI) on its pricing policies in the existing long-term market and pricing
policies for new capacity. The FERC seeks comments on whether its policies are
biased toward either short-term or long-term service, provide accurate price
signals and the right incentives for pipelines to provide optimal
transportation services and construct facilities that meet future demand and do
not result in over building and excess capacity. Comments on the NOPR and NOI
are due in April, 1999.
Because these notices are at a very early stage and ultimate resolution is
unknown, management cannot estimate the effects of these matters on future
consolidated results of operations or financial position.
Retail Competition. Duke Energy currently does not provide retail natural
gas service, but changes in regulation to allow retail competition could affect
Duke Energy's natural gas transportation contracts with local distribution
companies.
<PAGE>
Natural gas retail deregulation is in the very early stages of development and
management cannot estimate the effects of this matter on future consolidated
results of operations or financial position.
Nuclear Decommissioning Costs. Duke Energy's estimated site-specific
nuclear decommissioning costs total approximately $1.3 billion stated in 1994
dollars based on decommissioning studies completed in 1994. This estimate
includes the cost of decommissioning plant components not subject to
radioactive contamination. Duke Energy contributes to an external
decommissioning trust fund and maintains an internal reserve to fund these
costs.
The balance of the external funds as of December 31, 1998 and 1997, was
$580 million and $471 million, respectively. The balance of the internal
reserve as of December 31, 1998 and 1997, was $217 million and $211 million,
respectively, and is reflected in the Consolidated Balance Sheets as
Accumulated Depreciation and Amortization.
Both the NCUC and the PSCSC have granted Duke Energy recovery of estimated
decommissioning costs through retail rates over the expected remaining service
periods of its nuclear plants. Management believes that funding of the
decommissioning costs will not have a material adverse effect on consolidated
results of operations or financial position. (See Note 11 to the Consolidated
Financial Statements.)
As of December 31, 1998 and 1997, the external decommissioning trust fund
was invested primarily in domestic and international equity securities,
fixed-rate, fixed-income securities and cash and cash equivalents. Maintaining
a portfolio that includes long-term equity investments maximizes the returns to
be utilized to fund nuclear decommissioning, which in the long-term will better
correlate to inflationary increases in decommissioning costs. However, the
equity securities included in Duke Energy's portfolio are exposed to price
fluctuations in equity markets, and the fixed-rate, fixed-income securities are
exposed to changes in interest rates.
Duke Energy actively monitors its portfolio by benchmarking the
performance of its investments against certain indexes and by maintaining, and
periodically reviewing, established target allocation percentages of the assets
in its trusts. Because the accounting for nuclear decommissioning recognizes
that costs are recovered through the Electric Operations segment's rates,
fluctuations in equity prices or interest rates do not affect consolidated
results of operations.
Environmental. Duke Energy is subject to international, federal, state and
local regulations regarding air and water quality, hazardous and solid waste
disposal and other environmental matters.
Manufactured Gas Plants and Superfund Sites. Duke Energy was an operator
of manufactured gas plants until the early 1950s and has entered into a
cooperative effort with the State of North Carolina and other owners of certain
former manufactured gas plant sites to investigate and, where necessary,
remediate these contaminated sites. The State of South Carolina has expressed
interest in entering into a similar arrangement. Duke Energy is considered by
regulators to be a potentially responsible party and may be subject to future
liability at seven federal Superfund sites and three state Superfund sites.
While the cost of remediation of the remaining sites may be substantial, Duke
Energy will share in any liability associated with remediation of contamination
at such sites with other potentially responsible parties. Management believes
that resolution of these matters will not have a material adverse effect on
consolidated results of operations or financial position.
PCB (Polychlorinated Biphenyl) Assessment and Clean-up Programs. TETCO, a
wholly owned subsidiary of Duke Energy, is currently conducting PCB assessment
and clean-up programs at certain of its compressor station sites under
conditions stipulated by a U.S. Consent Decree. The programs include on- and
off-site assessment, installation of on-site source control equipment and
groundwater monitoring wells, and on- and off-site clean-up work. TETCO
completed the soil clean-up programs during 1998, subject to regulatory
approval. Groundwater monitoring activities will continue at several sites
beyond 1999.
In 1987, the Commonwealth of Kentucky instituted a suit in state court
against TETCO, alleging improper disposal of PCBs at TETCO's three compressor
station sites in Kentucky. This suit is still pending. In 1996, TETCO completed
clean-up of these sites under the U.S. Consent Decree.
Duke Energy has also identified environmental contamination at certain
sites on the PEPL and Trunkline systems and has undertaken clean-up programs at
these sites. The contamination resulted from the past use of lubricants
containing PCBs and the prior use of wastewater collection facilities and other
on-site disposal areas. Soil and sediment testing, to date, has detected no
significant off-site contamination. Duke Energy has communicated with the
Environmental Protection Agency (EPA) and appropriate state regulatory agencies
on these matters. Under the terms of the agreement with CMS Energy Corporation,
Duke Energy is obligated to complete the PEPL and Trunkline clean-up programs
at certain agreed-upon sites. These clean-up programs are expected to continue
until 2001.
<PAGE>
At December 31, 1998 and 1997, remaining estimated clean-up costs on the
TETCO, PEPL and Trunkline systems were accrued and included in the Consolidated
Balance Sheets as Environmental Clean-up Liabilities. These cost estimates
represent gross clean-up costs expected to be incurred, have not been
discounted or reduced by customer recoveries and generally do not include
fines, penalties or third-party claims. Costs expected to be recovered from
customers have been deferred and are included in the Consolidated Balance
Sheets as Environmental Clean-up Costs.
The federal and state clean-up programs are not expected to interrupt or
diminish Duke Energy's ability to deliver natural gas to customers. Based on
Duke Energy's experience to date and costs incurred for clean-up operations,
management believes the resolution of matters relating to the environmental
issues discussed above will not have a material adverse effect on consolidated
results of operations or financial position.
Air Quality Control. The Clean Air Act Amendments of 1990 require a
two-phase reduction by electric utilities in aggregate annual emissions of
sulfur dioxide and nitrogen oxide by 2000. Duke Energy currently meets all
requirements of Phase I. Duke Energy supports the national objective of
protecting air quality in the most cost-effective manner, and has already
reduced emissions by operating plants efficiently, using nuclear and
hydroelectric generation and implementing various compliance strategies. To
meet Phase II requirements by 2000, Duke Energy's current strategy includes
using low-sulfur coal, purchasing sulfur dioxide emission allowances and
installing low-nitrogen oxide burners and emission monitoring equipment.
Construction activities needed to comply with Phase II requirements are
substantially complete. Additional annual operating expenses of approximately
$25 million for low-sulfur coal premiums, emission allowance purchases and
other compliance activities will occur after 2000. This strategy is contingent
upon developments in future markets for emission allowances, low-sulfur coal,
future regulatory and legislative actions and advances in clean air
technologies.
In October 1998, the EPA issued a final ruling on regional ozone control
which requires revised State Implementation Plans for 22 eastern states and the
District of Columbia. This EPA ruling is being challenged in court by various
states, industry and other interests, including the states of North Carolina
and South Carolina and Duke Energy. Depending on the resolution of this matter,
costs to Duke Energy may range from approximately $100 million to $500 million.
In December 1997, the United Nations held negotiations in Kyoto, Japan to
determine how to achieve worldwide stabilization of greenhouse gas emissions,
including carbon dioxide emissions from fossil-fired generating facilities and
methane from natural gas operations. Further negotiations in November 1998 in
Buenos Aires, Argentina, resulted in a work plan to complete the operational
details of the Kyoto agreement by late 2000. Duke Energy is taking steps to
prepare for possible action on greenhouse gas emissions and has completed a
greenhouse gas emissions inventory. Implications of greenhouse gas emissions
are being integrated into planning processes. Because this matter is in the
early stages of discussion, management cannot estimate the effects on future
consolidated results of operations or financial position.
Litigation and Contingencies. For information concerning litigation and
other commitments and contingencies, see Note 14 to the Consolidated Financial
Statements.
Year 2000 Readiness Program. State of Readiness. Duke Energy initiated its
Year 2000 Readiness Program in 1996 and began a formal review of computer-based
systems and devices that are used in its business operations both domestically
and internationally. These systems and devices include customer information,
financial, materials management and personnel systems; as well as components of
natural gas production, gathering, processing and transmission, and electric
generation, distribution and transmission.
Duke Energy is using a three-phase approach to address year 2000 issues:
1) inventory and preliminary assessment of computer systems, equipment and
devices; 2) detailed assessment and remediation planning; and 3) conversion,
testing and contingency planning. Duke Energy is employing a combination of
systems repair and planned systems replacement activities to achieve year 2000
readiness for its business and process control systems, equipment and devices.
Duke Energy has substantially completed the first two phases throughout its
business operations, and is in various stages of the third and final phase.
Duke Energy's goal is to have its critical systems, equipment and devices year
2000 ready by mid-1999. Business acquisitions routinely involve an analysis of
year 2000 readiness and are incorporated into the overall program as necessary.
Duke Energy is actively evaluating and tracking year 2000 readiness of
external third parties with which it has a material relationship. Such third
parties include vendors, customers, U.S. governmental agencies, foreign
governments and agencies, and other business associates. While the year 2000
readiness of third parties cannot be controlled, Duke Energy is attempting to
assess the readiness of third parties and any potential implications to its
operations. Alternate suppliers of critical products, goods and services are
being identified, where necessary.
Costs. Management believes it is devoting the resources necessary to
achieve year 2000 readiness in a timely manner. Current estimates for total
costs of the program, including internal labor as well as incremental costs
such as consulting and
<PAGE>
contract costs, are approximately $65 million, of which approximately $41
million had been incurred as of December 31, 1998. These costs exclude
replacement systems that, in addition to being year 2000 ready, provide
significantly enhanced capabilities which will benefit operations in future
periods.
Risks. Management believes it has an effective program in place to manage
the risks associated with the year 2000 issue in a timely manner. Nevertheless,
since it is not possible to anticipate all future outcomes, especially when
third parties are involved, there could be circumstances in which Duke Energy
would temporarily be unable to deliver energy or energy services to its
customers. Management believes that the most reasonably likely worst case
scenario would be small, localized interruptions of service, which likely would
be rapidly restored. In addition, there could be a temporary reduction in
energy needs of customers due to their own year 2000 problems. In the event
that such a scenario occurs, it is not expected to have a material adverse
impact on consolidated results of operations or financial position.
Contingency Plans. Year 2000 contingency planning is currently underway to
assure continuity of business operations for all periods during which year 2000
impacts may occur. Duke Energy is participating in multiple industry efforts to
assure effective year 2000 contingency plans, and intends to complete its own
year 2000 contingency plans by mid-1999. These plans address various year 2000
risk scenarios that cross departmental, business unit and industry lines as
well as specific risks from various internal and external sources, including
supplier readiness.
Based on assessments completed to date and compliance plans in process,
management believes that year 2000 issues, including the cost of making
critical systems, equipment and devices ready, will not have a material adverse
effect on Duke Energy's business operation or consolidated results of
operations or financial position. Nevertheless, achieving year 2000 readiness
is subject to risks and uncertainties, including those described above. While
management believes the possibility is remote, if Duke Energy's internal
systems, or the internal systems of external parties, fail to achieve year 2000
readiness in a timely manner, Duke Energy's business, consolidated results of
operations or financial condition could be adversely affected.
New Accounting Standard. In September 1998, Statement of Financial
Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and
Hedging Activities," was issued. Duke Energy is required to adopt this standard
by January 1, 2000. SFAS No. 133 requires that all derivatives be recognized as
either assets or liabilities and measured at fair value, and it defines the
accounting for changes in the fair value of the derivatives depending on the
intended use of the derviative. Duke Energy is currently reviewing the expected
impact of SFAS No. 133 on consolidated results of operations and financial
position.
Subsequent Event. On February 18, 1999, Duke Energy announced its intent
to make a concurrent cash tender offer in Chilean pesos in Chile and the United
States for 51% of the outstanding shares of Endesa-Chile. The estimated total
cash outlay is approximately $2.1 billion based on current exchange rates. The
offer will be contingent upon, among other things, certain Endesa-Chile
shareholder approvals. If all approvals are obtained, the transactions are
expected to be completed during the second quarter of 1999. Endesa-Chile
controls and operates 10,247 megawatts of generating capacity in Argentina,
Brazil, Chile, Colombia and Peru.
Forward-Looking Statements. From time to time, Duke Energy may make
statements regarding its assumptions, projections, expectations, intentions or
beliefs about future events. These statements are intended as "forward-looking
statements" under the Private Securities Litigation Reform Act of 1995. Duke
Energy cautions that assumptions, projections, expectations, intentions or
beliefs about future events may and often do vary from actual results and the
differences between assumptions, projections, expectations, intentions or
beliefs and actual results can be material. Accordingly, there can be no
assurance that actual results will not differ materially from those expressed
or implied by the forward-looking statements. Factors that could cause actual
achievements and events to differ materially from those expressed or implied in
such forward-looking statements include state and federal legislative and
regulatory initiatives that affect cost and investment recovery, have an impact
on rate structures and affect the speed and degree to which competition enters
the electric and natural gas industries; industrial, commercial and residential
growth in the service territories of Duke Energy and its subsidiaries; the
weather and other natural phenomena; the timing and extent of changes in
commodity prices and interest rates; changes in environmental and other laws
and regulations to which Duke Energy and its subsidiaries are subject or other
external factors over which Duke Energy has no control; the results of
financing efforts; growth in opportunities for Duke Energy's business units;
achievement of year 2000 readiness; and the effect of accounting policies
issued periodically by accounting standard-setting bodies.
