(As filed with the Securities and Exchange Commission on October 9, 2001)
File No. 70-[ ]
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM U-1
APPLICATION/DECLARATION
UNDER THE
PUBLIC UTILITY HOLDING COMPANY ACT OF 1935
NATIONAL FUEL GAS COMPANY
10 Lafayette Square
Buffalo, New York 14203
(Name of company filing this statement
and address of principal executive offices)
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NATIONAL FUEL GAS COMPANY
(Name of top registered holding company parent)
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Philip C. Ackerman,
President and Chief Executive Officer
National Fuel Gas Company
10 Lafayette Square
Buffalo, New York 14203
(Name and address of agent for service)
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The Commission is requested to mail copies of all
orders, notices and other communications to:
James R. Peterson, Michael F. Fitzpatrick, Jr., Esq.
Assistant Secretary Thelen Reid & Priest LLP
National Fuel Gas Company 40 West 57th Street
10 Lafayette Square New York, New York 10019
Buffalo, New York 14203
TABLE OF CONTENTS
Page
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ITEM 1. DESCRIPTION OF PROPOSED TRANSACTION 4
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A. BACKGROUND: NATIONAL'S CURRENT FINANCING AUTHORITY 4
B. PROPOSED INCREASE IN AGGREGATE INVESTMENT LIMIT 5
C. DESCRIPTION OF NATIONAL'S CURRENT PORTFOLIO OF EXEMPT PROJECTS 6
1. FUCOs 6
c. UNITED ENERGY, a.s. 6
b. TEPLARNA LIBEREC a.s. 6
d. TEPLARNA KROMERIZ, a.s. 7
2. EWGS 7
D. RISK PROFILE OF NATIONAL'S INVESTMENTS IN EXEMPT PROJECTS 7
1. THE PROJECT REVIEW PROCESS 7
2. RISK MITIGATION MEASURES 9
a. OPERATING RISKS 9
b. CONSTRUCTION RISKS 9
c. COMMERCIAL RISKS 10
d. FINANCIAL RISKS 10
e. INTEREST RATE RISK 11
f. FOREIGN CURRENCY EXCHANGE RISK 11
g. LEGAL RISKS 11
h. COUNTRY RISKS 12
i. PORTFOLIO DIVERSIFICATION 12
j. EARNINGS FROM EXEMPT PROJECTS 13
k. EFFECT OF REGULATORY CHANGE 13
ITEM 2. FEES, COMMISSIONS, AND EXPENSES 14
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ITEM 3. APPLICABLE STATUTORY PROVISIONS 14
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A. GENERAL PROVISIONS 14
B. COMPLIANCE WITH RULE 53(c) 15
1. THE PROPOSED TRANSACTIONS WILL NOT HAVE A SUBSTANTIAL ADVERSE
IMPACT UPON THE FINANCIAL INTEGRITY OF THE NATIONAL SYSTEM 17
a. KEY FINANCIAL RATIOS/BENCHMARKS 17
i. CAPITALIZATION RATIOS 17
ii. NATIONAL SECURITY RATINGS 18
iii. CONSOLIDATED RETAINED EARNINGS 18
iv. NATIONAL'S DEBT LIMITATIONS 18
v. RULE 53(B) FACTORS 19
vi. OTHER INDICATORS 19
b. MARKET ASSESSMENT OF NATIONAL 19
i. ASSESSMENT OF GROWTH AND EARNINGS 19
ii. DIVIDEND PAYOUT RATIO 20
2
2. THE PROPOSED TRANSACTIONS WILL NOT HAVE AN ADVERSE IMPACT ON
DISTRIBUTION OR ITS CUSTOMERS, OR ON THE ABILITY OF DISTRIBUTION'S
STATE PUBLIC UTILITY COMMISSIONS TO PROTECT SUCH CUSTOMERS 20
a. INSULATION FROM RISK 20
b. DISTRIBUTION'S FINANCIAL INTEGRITY 21
c. ADEQUACY OF STATE COMMISSION OVERSIGHT 22
C. COMPLIANCE WITH RULE 54 22
ITEM 4. REGULATORY APPROVAL 23
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ITEM 5. PROCEDURE 24
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ITEM 6. EXHIBITS AND FINANCIAL STATEMENTS 24
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ITEM 7. INFORMATION AS TO ENVIRONMENTAL EFFECTS 24
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3
ITEM 1. DESCRIPTION OF PROPOSED TRANSACTION
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National Fuel Gas Company ("National") is a registered holding company
under the Public Utility Holding Company Act of 1935, as amended (the "Act").
Through its subsidiaries, National engages in a diversified energy business that
is organized into six major business segments, namely: Utility; Exploration and
Production; Pipeline and Storage; Timber; International; and Energy Marketing.
The Utility segment (National Fuel Gas Distribution Company) sells or transports
natural gas to approximately 735,000 customers through a local distribution
system located in western New York and northwestern Pennsylvania; the
Exploration and Production segment (Seneca Resources Corporation) explores for,
develops and purchases natural gas and oil reserves in the Gulf Coast region of
Texas and Louisiana, California, Wyoming, and the Appalachian region of the
United States, and in the western Canadian provinces (Manitoba, Alberta and
Saskatchewan); the Pipeline and Storage segment (National Fuel Gas Supply
Corporation) provides interstate natural gas transportation and storage services
for affiliated and nonaffiliated companies through an integrated regional gas
pipeline system that extends 3,065 miles from southwestern Pennsylvania to the
New York-Canadian border and 29 underground storage areas; the Timber segment
(Highland Forest Resources, Inc. and Seneca Resources Corporation, Northeast
Division) operates sawmills in northwestern Pennsylvania and markets timber from
National's New York and Pennsylvania land holdings; the International segment
(Horizon Energy Development, Inc. and Horizon Power, Inc.) invests in and
manages foreign energy projects, primarily in the Czech Republic, as well as
projects in the United States; and the Energy Marketing segment (National Fuel
Resources, Inc.) markets and brokers natural gas and electricity and the
provides energy management services for industrial, commercial, public authority
and residential end-users throughout the northeast United States. National and
its subsidiaries are hereinafter referred to collectively as the National
System.
For the fiscal year ended September 30, 2000, National reported
consolidated revenues of $1.4 billion and net income of $127.2 million. National
Fuel Gas Distribution Company ("Distribution") contributed approximately 45.3%
of National's net income, while National's principal non-utility subsidiaries,
National Fuel Gas Supply Corporation and Seneca Resources Corporation,
contributed 24.9% and 27.4%, respectively, of National's net income.
A. BACKGROUND: NATIONAL'S CURRENT FINANCING AUTHORITY
By order dated March 20, 1998,1 as modified by order dated April 21,
2000 2 (as modified, the "1998 Order"), National and its subsidiaries are
authorized to engage in a program of external financing, intrasystem financing
and other related transactions for the period through December 31, 2002. Among
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1 National Fuel Gas Company, et al., Holding Co. Act Release No. 26847.
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2 National Fuel Gas Company, et al., Holding Co. Act Release No. 27170.
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other approvals granted, the Commission authorized National to (i) issue and
sell from time to time additional long-term debt and equity securities
outstanding at any one time not to exceed $2 billion, (ii) issue and sell from
time to time up to $750 million principal amount of short-term debt in the form
of commercial paper and borrowings under credit facilities having maturities of
up to 270 days, and (iii) guarantee securities of its subsidiaries and provide
other forms of credit support with respect to obligations of its subsidiaries as
may be necessary or appropriate to enable such subsidiaries to carry on in the
ordinary course of business in an aggregate amount not to exceed $2 billion
outstanding at any one time. Under the terms of the 1998 Order, National is
authorized to use the proceeds of authorized financing to invest in and enter
into guarantees with respect to the obligations of "exempt wholesale generators"
("EWGs") and "foreign utility companies" ("FUCOs"),3 provided that its
"aggregate investment" (as defined under Rule 53) in EWGs and FUCOs does not
exceed 50% of its "consolidated retained earnings" (also as defined in Rule 53),
except for short-term borrowings by National to provide funds to the National
System Money Pool, which may not be used to finance the acquisition of any
interest in a FUCO or EWG. As of August 31, 2001, National's aggregate
investment in EWGs and FUCOs was approximately $130,074,000, or 22.3% of
National's average consolidated retained earnings for the four quarters ended
June 30, 2001 ($583,737,000).
B. PROPOSED INCREASE IN AGGREGATE INVEST LIMIT
National is now requesting, pursuant to Rule 53(c), authority to
increase its "aggregate investment" in EWGs and FUCOs (hereafter referred to
collectively as "Exempt Projects") to $750,000,000 (the "EWG/FUCO Investment
Limit"), which is equal to approximately 128% of National's average consolidated
retained earnings for the four quarters ended June 30, 2001.
National believes that, at this stage of the restructuring of the
utility industry both in this country and abroad, it is critical that it have
the flexibility to increase its investment in Exempt Projects in order to create
maximum shareholder value. As described below, National has already made
substantial investments in electric generation and thermal energy systems in the
Czech Republic and is investigating potential investments in other similar
facilities in eastern Europe and elsewhere. Domestically, National has made
relatively modest investments in EWG facilities in New York that utilize
landfill gas (methane) and natural gas as a fuel. National has explored possible
investments in other similar domestic generation facilities as well as in
existing generating plants that are being sold by electric utility companies
under State restructuring initiatives.
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3 The terms "exempt wholesale generator" and "foreign utility company" are
defined, respectively, in Sections 32(a) and 33(a) of the Act.
5
For the reasons discussed in greater detail below, National believes
that it has the capacity to fund from external sources investments in Exempt
Projects in amounts significantly greater than 50% of its average consolidated
retained earnings without impairing the financial condition of the National
System or the ability of National to provide necessary capital to its domestic
public utility operations. Accordingly, National requests that the Commission
issue an order pursuant to Rule 53(c) under the Act modifying the 1998 Order in
order to allow National to utilize the proceeds of financing and to issue
guarantees, within the limits specified under the 1998 Order (or any order or
orders hereafter issued that extend or renew National's authorization under the
1998 Order), to finance investments in Exempt Projects in an amount up to the
proposed EWG/FUCO Investment Limit. As demonstrated in Item 3 of this
Application/Declaration, National satisfies the applicable standards under Rule
53(c).
C. DESCRIPTION OF NATIONAL'S CURRENT PORTFOLIO OF EXEMPT PROJECTS
1. FUCOs
a. UNITED ENERGY, a.s.
National, through Horizon Energy Development, B.V.("Horizon B.V."),
owns an 84.76% interest in United Energy, a.s. ("UE"), which owns and operates
wholesale power and heating facilities located in the northern Bohemian region
of the Czech Republic. UE's revenues are derived from the sale of both electric
energy and thermal energy produced from its generation facilities. UE also
purchases heat for resale. UE's generating facilities have a capacity of 236
megawatts electric (MWe) and 1,253 megawatts thermal (MWt). UE sells the
electricity it produces at wholesale to the local electric utility. Thermal
energy is ultimately sold to residential, commercial and industrial customers.
In calendar year 2000, UE had approximately 7,878 terajoules (TJ) of heat sales
and approximately 1,114 gigawatthours (GWh) of electric sales.
b. TEPLARNA LIBEREC a.s.
National, through UE, owns a 70% interest in Teplarna Liberec a.s.
("Liberec"), which owns and operates wholesale power and district heating
facilities located in the city of Liberec in the Czech Republic. Liberec's
facilities include a 12 MWe back pressure steam turbine generator. In calendar
year 2000, Liberec made heat sales totaling 1,549 TJ and wholesale sales of
electricity totaling 45 GWh. Electric power was sold at wholesale to the local
electric utility.
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c. TEPLARNA KROMERIZ, a.s.
National, through Horizon B.V., owns 100% of Teplarna Kromeriz, a.s.
("Kromeriz"), which owns and operates a district heating system in the town of
Kromeriz in the Czech Republic. Kromeriz made heat sales of 168 TJ in calendar
year 2000.
2. EWGS.
a. SENECA ENERGY II, LLC
National indirectly owns a 50% membership interest in Seneca Energy
II, LLC, an EWG that generates approximately 11 MW of electricity from methane
gas obtained from a landfill located in Waterloo, New York.
b. MODEL CITY ENERGY, LLC
National indirectly owns a 50% membership interest in Model City
Energy, LLC, an EWG that generates approximately 5.5 MW of electricity from
methane gas obtained from a landfill located in Model City, New York.
c. ENERGY SYSTEMS NORTH EAST, LLC
National indirectly owns a 50% membership interest in Energy Systems
North East, LLC, an EWG, which owns and operates an approximately 80 MW
gas-fired generating facility in North East, Pennsylvania. The facility supplies
thermal energy to Welch Foods, Inc. and markets the electric energy produced
under a tolling arrangement.
D. RISK PROFILE OF NATIONAL'S INVESTMENTS IN EXEMPT PROJECTS
Investments in EWGs and FUCOs may involve a variety of risks that
historically have not been present in the traditional, regulated, electric and
gas utility industries in this country. The review process (the "Review
Process") employed by National in evaluating and assessing the benefits and
risks in any investment in an EWG or FUCO identifies and addresses (i.e., limits
and/or mitigates) these risks as they relate to both domestic and, more
significantly, foreign projects. The following is a discussion of these
procedures and risks.
1. THE PROJECT REVIEW PROCESS
Every potential EWG and FUCO investment and acquisition opportunity
(both domestic and foreign) considered by National is subjected to several
stages of formal review to ensure both the alignment of the project with
strategic objectives of National and the appropriate assessment of both the
risks and rewards for the project. This review process applies to all new
business opportunities, not simply Exempt Projects. The Review Process includes
a detailed framework for each phase of the project development cycle.
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Initially, at the conceptual stage in the assessment of a proposed
project or acquisition, National's Development Team must make a preliminary
determination as to whether the project is consistent with National's strategic
objectives and whether the project's risk and rewards ratio will be acceptable.
National's Development Team consists of specialists in accounting, legal
affairs, engineering, finance and operations. If deemed to be consistent with
National's strategic objectives and the initial evaluation of the project's
risks and rewards ratio is acceptable, then the Development Team is responsible
for the preparation of a business concept document ("Pro Forma") for the
project. The Pro Forma must address at a minimum the description of the
business, an analysis of potential partnerships, a preliminary market
assessment, a technical analysis, initial financial analysis, critical success
factors, risks, estimated development costs, and exit strategies. Upon the
completion of the Pro Forma, the Development Team and Management, must review it
and make a determination that the project is consistent with National's
corporate strategic objectives, and, given the identified risks, has the
requisite earnings potential to merit further review through detailed due
diligence.
National's Development Team will perform detailed project due
diligence and risk assessment using in-country advisors, engineers,
environmental auditors, accountants, tax advisors, attorneys, and investment
bankers to evaluate the project. The Pro Forma will be updated and a business
case will be developed. This business case, along with the results of the due
diligence and risk assessment process performed in connection with the
development of the business case, is to form the basis upon which the National
Executives and the National Board of Directors will approve of the proposed
investment in the project. The business case is to be a comprehensive
identification and analysis of the strategic, market, operational, and financial
components of the project. In addition to an assessment of the project, it will
also include the identification of an exit strategy and identify initial project
implementation steps. Its scope will be driven by the size, complexity, and risk
associated with the project.
Upon completion of the Pro Forma and business case, a summary of the
findings as well as a recommendation on whether, and if so, how, to proceed will
be presented to the National Executives. Upon approval by the National
Executives, the investment will be assessed against pre-approved Board
investment criteria to determine the level of additional approvals, if any, that
may be required. Depending on the magnitude of the investment in a project, full
Board approval may be necessary.
As indicated, the above internal review process applies to all new
National businesses, including Exempt Projects. Due to the --- special risks
associated with foreign Exempt Projects, however, additional factors are
considered. Before National makes any investment in a foreign country, the
business case must include an analysis of country risk, which will be presented
to and reviewed by National's Board of Directors. The analysis includes a review
of the political and economic stability of the particular country, the
government's commitment to private power, the extent to which there is a free
market economy, the extent to which there is a developed local banking system,
the legal and regulatory framework for private investment in electric or gas
facilities, the local business support for long-term investment of private
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capital, currency conversion and repatriation, and the potential for future
partial sales of the investment interest to other investors.
2. RISK MITIGATION MEASURES
As National expands its energy business in the future, National will
carefully and systematically evaluate the potential risks of a project in
connection with the development of the business case before National funds are
committed. The risks evaluated include those discussed below.
a. OPERATING RISKS
National's experience in competing in a non-regulated environment
through its non-utility subsidiaries (particularly the Pipeline and Storage,
Exploration and Production, and International segments) enables National to
anticipate and consequently mitigate risks associated with Exempt Projects. As
indicated, National's non-utility subsidiaries contributed more than half of
National's net income from operations for the fiscal year ended September 30,
2000, and that percentage is expected to grow over time.
Due diligence review of operating assumptions relating to any project
include an analysis of fuel supply and environmental effects by appropriate
personnel with experience in the technology being evaluated, supplemented as
appropriate by the use of outside technical consultants. Other operating risks
may, as appropriate, be mitigated by equipment warranties and by casualty,
business interruption, and other forms of insurance. Further, operating risk may
be mitigated in some instances by a subsidiary's direct participation in the
administration and operation of a project; such direct involvement may enhance
National's ability to identify and address developing and existing problems on a
timely basis.
b. CONSTRUCTION RISKS
Another element of National's risk mitigation policy is to achieve a
balance between so-called "greenfield" projects and acquisitions of existing
facilities and power systems. Greenfield projects are those that involve
completely new development and construction of facilities, principally
generating stations. Greenfield projects involve a higher degree of risk because
they entail a lengthy process of development and construction. Funds are
expended during the early years of such projects; and return on investment is
not earned until the project is in operation. Nevertheless, while greenfield
projects have higher levels of risk and deferred returns, they are important to
National because they generally produce higher rates of return on investment
than investments in existing assets and lay the foundation for continued
earnings growth.
To the extent issues regarding construction risks arise, such risks
are commonly mitigated by fixed-price contracts with milestones and performance
guarantees (e.g., guaranteed rates and availability factors), backed by
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appropriate levels of liquidated damages. The creditworthiness and track record
of the construction contractor is an important consideration in this regard. In
those cases where a subsidiary of National may serve as its own general
construction contractor, it will look to pre-negotiated cost and damage
provisions from sub-contractors, including, without limitation, equipment
vendors, to protect against performance shortfalls, cost overruns and schedule
delays.
c. COMMERCIAL RISKS
In a competitive market, prices are determined by the economic laws of
supply and demand. Accordingly, National System personnel will conduct extensive
investigations of the foreign or domestic markets in which a particular project
will operate. With respect to an EWG, a National System company will seek to
ensure that the EWG will be capable of producing electricity at competitive
rates in a non-regulated environment. National System personnel will also assess
the underlying economic parameters in specific markets to assure that there will
be sufficient demand for the output of the EWG.
d. FINANCIAL RISKS
National takes various issues into consideration in mitigating the
financial risk associated with a proposed project. The Pro Forma analysis
prepared for a proposed investment in a project by National will include an
evaluation of whether the project cash flows will be able to support National's
anticipated investment financing based on the traditional debt and equity
financial structure that National attempts to maintain on a consolidated basis.
The Pro Forma analysis will also evaluate whether the project can
support additional financial risk from debt financing at the project level. This
evaluation will consider whether the project is of a sufficient size to enable
permanent debt financing to be obtained at a reasonable cost and on a
non-recourse basis to National. The use of non-recourse project debt means that
this debt will be secured solely by the project's assets and revenues, and
creditors have no ability to seek repayment upon default from National. This
method of financing ensures that National's exposure to any project is limited
to the amount of National's equity investment in the project.
In determining the amount any non-recourse debt financing and
associated financial risk for a particular project, National will also take into
consideration the economic characteristics of the project. For example, if a
project is supported by a long-term, fixed-price, "off-take" agreement with a
third party, the project debt may be designed to be of a similar term, with
scheduled debt payments covered by fixed charges. On the other hand, where there
is no long-term, fixed source of revenue, the amount of non-recourse debt
financing by the project would normally be smaller, so that undue financial risk
is not incurred through excessive debt levels.
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e. INTEREST RATE RISK
A specific financing risk is the potential variability of interest
rates. Interest rate variability can be addressed, in part, by borrowing on a
fixed-rate basis or by purchasing financial instruments that fix or cap variable
interest rates. The effects of interest rate volatility can be mitigated
principally through two strategies: hedging and diversifying. Hedging techniques
that National may utilize would limit the impact that rising interest rates have
on floating rate debt instruments.4 Diversification implies that liabilities
will be spread among short- and long-term debt instruments, as well as fixed and
floating interest obligations.
As an example, National, through UE, has entered into an interest rate
swap to eliminate interest rate fluctuations on a CZK (Czech koruna) denominated
term loan having a variable interest rate equal to six month Prague Interbank
Offered Rate (PRIBOR), plus 0.475%. Under the terms of the interest rate swap,
which extends until 2002, National pays a fixed rate of 8.31% and receives a
floating rate of six month PRIBOR.
f. FOREIGN CURRENCY EXCHANGE RISK
There are several ways in which National may address the foreign
currency exchange risk element, depending on the status of the target country.
Initially, National will seek to develop or acquire projects where there is free
convertibility of the local currency into U.S. dollars. In countries that do not
have a history of stability in the management of their exchange policy, National
may require that part or all of the revenue from a project be payable in or
indexed to hard currency (almost invariably U.S. dollars). Back-up guarantees or
other undertakings by the central government may be available to ensure that the
U.S. dollar payments due under a power purchase agreement are actually made
available by the central bank or ministry of finance.
In other cases, some or all of the non-recourse project debt may be
borrowed in the same currency as the project's revenues, thereby ensuring a
match between debt service obligations and operating income. Where available,
long-term currency swaps would provide a further hedging option for the equity
component of the investment.
g. LEGAL RISKS
Legal risks will be addressed by careful review of any investment by
legal counsel, including local and international counsel where foreign projects
are concerned. Such legal reviews address regulatory and permitting risks,
environmental risks, the adequacy and enforceability of guarantees or other
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4 Under the terms of the 1998 Order, National is authorized to enter into
interest rate hedging transactions to mitigate interest rate risk.
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contractual undertakings of third parties, the status of title to utility
property, and the obligations inherent in the financing arrangements.
h. COUNTRY RISKS
In addition to the specific risks mentioned above, investment outside
the United States can entail country-specific risks related to political or
economic performance. As indicated above, National thoroughly evaluates country
risk before committing to invest in any foreign project, and attempts to
mitigate this risk through a number of measures. Most important, the country
review process described above ensures that the political and economic stability
of any country has been reviewed at several levels up to and, depending on the
level of investment, including National's Board of Directors before any
investment occurs. The country analysis also focuses specifically on the
country's energy sector and on the government's support for private ownership in
that sector.
In some instances, in order to mitigate risk, National has acquired
interests in Exempt Projects that that are partly owned by local entities that
are experienced in doing business in the host country. Having local
participation in the ownership of an Exempt Project can in most cases greatly
reduce the risk of future expropriation or unfair regulatory treatment in the
host country. Another mitigating factor is the participation of official or
multilateral agencies in an Exempt Project. When funds for the project are
supplied by government-sponsored export credit agencies or other governments or
institutions such as the World Bank through its International Finance
Corporation affiliate, the host country has strong incentives not to take
actions which would harm the project's viability.
Political risk may be addressed through political risk insurance
obtained from the Overseas Private Investment Corporation, a United States
agency, or the Multilateral Investment Guaranty Agency, a World Bank affiliate,
or in the commercial insurance market. Political risk insurance is available to
insure the project debt or the return of an investor's equity. One can also
insure against outright expropriation, acts of civil violence, or even
"creeping" nationalization brought about by punitive regulation. National will
analyze the perceived risk and its costs and compare that with the cost of
obtaining such insurance and, when such costs associated with such risks exceed
the costs of insurance coverage, National will attempt to procure such
insurance.
i. PORTFOLIO DIVERSIFICATION
National recognizes that the risk inherent in any investment cannot be
eliminated entirely, even by the most careful approach to project development.
However, National believes that diversification of both the type and location of
projects can mitigate risk. Accordingly, National will evaluate opportunities
across countries and regions of the world. On the other hand, National may
balance its diversification strategy with another goal--i.e., to develop
regional expertise.
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In the domestic sector, several electric utilities operating in the
States in which Distribution operates (New York and Pennsylvania) and
neighboring States have either sold or announced their intention to sell their
electric generating properties as part of State-sponsored electric utility
industry restructuring initiatives. National is actively considering acquiring
existing electric generating assets in this region through affiliated EWGs.
National believes that ownership of operating power plants, especially in its
service territory, would present unique opportunities to leverage its existing
experience and core competencies in such areas as customer relations, fuel
management and supply, regulatory relations, and others. The acquisition of
existing power plants would reduce the risk of National's overall business by
producing near-term earnings without significant development or construction
risk. Moreover, National believes that it can, through the expertise and
resources of the National System companies, improve the operations of many
existing generating projects that are available.
In the foreign sphere, National will continue to investigate
opportunities to invest in "greenfield" power projects as well as utility
systems that are the subject of privatization initiatives. Although National has
not committed to invest in any particular foreign project (other than those
described above), it is currently engaged in preliminary development activities
in Europe.
j. EARNINGS FROM EXEMPT PROJECTS
National's investments in Exempt Projects have contributed positively
to earnings in each of the past three fiscal years. For example, for the fiscal
year ended September 30, 2000, National's investments in FUCOs have increased
consolidated net income by approximately $7.7 million. National expects that its
investments in Exempt Projects will continue to generate positive earnings and
contribute to consolidated earnings growth in the future.
k. EFFECT OF REGULATORY CHANGE
Regulatory change in the United States has served both to mitigate the
risk of investing in EWGs and to increase the opportunities for investment in
EWGs. Global regulatory changes and privatization have increased the
opportunities to invest in FUCOs. In this environment, National can best enhance
its future earnings growth, and thereby lower its overall cost of capital,
through a broadly diversified program of developing and investing in Exempt
Projects.
In the past several years, the United States (and North American)
energy market has evolved into a competitive and liquid market, with open
transmission access in the United States and substantial markets available
through federal and state sponsored restructuring. This market has evolved since
the passage of the Energy Policy Act of 1992 and particularly in the wake of the
transmission access required by FERC Order 888 and the formation of independent
regional transmission organizations, as envisioned by FERC Order 2000. The
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Commission recognized the transfiguration of the energy market in the United
States in its order adopting Rule 58:
As a result of Congressional action [i.e. the Energy Policy Act], combined
with initiatives of the Federal Energy Regulatory Commission ("FERC") and
the state and local ratemaking authorities, the pace of change in the gas
and electric utility industry is accelerating. Today, the gas industry is
largely deregulated and the electric industry is undergoing a similar
process. In addition to increasing competition at the wholesale level,
retail electric competition is developing more rapidly than anticipated,
due to state efforts. Utilities and the suppliers of energy appear poised
to compete in retail markets. As a result of these developments the
contemporary gas and electric industries no longer focus solely upon the
traditional production and distribution functions of a regulated utility,
but are instead evolving toward a broadly based, competitive, energy
services business.5
In addition, partially as a result of the Energy Policy Act, partially
as a result of foreign nations opening government utility systems to private
investment activity, and partially through utility restructuring, the global
energy market has evolved to allow a much greater level of competition and
outside investment. Participants in this market who seek to own or operate power
generation must utilize a portfolio approach to investment and maintain
investment levels sufficient to achieve the benefits of scale economies.
National has successfully participated in this global market through investments
in the Czech Republic. Continued success will require continued investment and
growth.
ITEM 2. FEES, COMMISSIONS, AND EXPENSES
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The fees, commissions, and expenses incurred or to be incurred in
connection with this Application/Declaration are estimated to be $20,000 (for
legal fees and expenses).
ITEM 3. APPLICABLE STATUTORY PROVISIONS
-------------------------------
A. GENERAL PROVISIONS
Sections 32 and 33 of the Act and Rule 53 of the Commission's rules
thereunder are or may be applicable to the proposed transactions.
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5 Holding Company Act Release No. 26667 (February 20, 1997), text at
footnotes 19-21. See also The Regulation of Public-Utility Holding
--------
Companies, Report of the Division of Investment Management, Securities and
Exchange Commission (June 1995), at 19-22, 26-27.
14
Rule 53 provides that, if each of the conditions of paragraph (a)
thereof is met, and none of the conditions of paragraph (b) thereof is
applicable, then the Commission may not make certain adverse findings under
Sections 7 and 12 of the Act in determining whether to approve a proposal by a
registered holding company to issue securities in order to finance an investment
in any EWG or to guarantee the securities of any EWG. The Commission has applied
these same criteria to financing of investments in FUCOs. Giving effect to the
proposals contained herein, National will satisfy all of the conditions of Rule
53(a) except for clause (1) thereof, since National is proposing herein to
increase its aggregate investment in EWGs and FUCOs to more than 50% of
National's consolidated retained earnings. None of the conditions specified in
Rule 53(b) is applicable.
B. COMPLIANCE WITH RULE 53(c)
Rule 53(c) states that, in connection with a proposal to issue and
sell securities to finance an investment in any EWG, or to guarantee the
securities of any EWG, a registered holding company that is unable to satisfy
the requirements of paragraph (a) or (b) of Rule 53 must "affirmatively
demonstrate" that such proposal:
- will not have a substantial adverse impact upon the financial
integrity of the registered holding company system; and
- will not have an adverse impact on any utility subsidiary of the
registered holding company, or its customers, or on the ability
of State commissions to protect such subsidiary or customers.
In the past, the Commission has routinely issued orders under Rule
53(c) permitting other registered holding companies to finance investments in
EWGs and FUCOs in amounts up to 100% of consolidated retained earnings.6 More
recently, the Commission has authorized aggregate investment limits that are
well above 100% of consolidated retained earnings. National Grid Group, plc
("National Grid"), for example, was authorized in early 2000 as part of its
acquisition of New England Electric System to make additional investments in
EWGs and FUCOs that would increase its aggregate investment to approximately
252% of its pro forma consolidated retained earnings.7 In late 2000, also as
------------------------
6 See The Southern Company, Holding Co. Act Release No. 26501 (Apr. 1, 1996),
--- --------------------
Central and South West Corporation, Holding Co. Act Release No. 26653 (Jan.
----------------------------------
24, 1997), GPU, Inc., Holding Co. Act Release No. 26779 (Nov. 17, 1997),
---------
Cinergy Corporation, Holding Co. Act Release No. 26848 (Mar. 23, 1998),
-------------------
American Electric Power Company, Inc., Holding Co. Act Release No. 26864
-------------------------------------
(Apr. 27, 1998), New Century Energies, Inc., Holding Co. Act Release No.
--------------------------
26892 (Feb. 26, 1999), and Entergy Corporation, Holding Co. Act Release No.
-------------------
27184 (Mar. 15, 2000).
7 See The National Grid Group plc, Holding Co. Act Release No. 27154 (Mar.
--- ---------------------------
15, 2000).
15
part of a merger approval, the Commission authorized KeySpan Corporation
("KeySpan") to invest up to 250% of its pro forma consolidated retained earnings
in EWGs and FUCOs.8 That was followed by an order issued to Cinergy Corp.
("Cinergy") in which the Commission authorized an increase in Cinergy's
aggregate investment limit to an amount that is equal to the sum of its
aggregate investment in EWGs and FUCOs at that time plus $1 billion, or about
154% of Cinergy's consolidated retained earnings.9 Subsequently, Cinergy
obtained a supplemental order authorizing it to have an aggregate investment
equal to 100% of its consolidated retained earnings plus $2 billion, or an
amount that would equal about 274% of Cinergy's current consolidated retained
earnings.10 Exelon Corp. ("Exelon"), which has no history of investments in
EWGs or FUCOs, was authorized in November 2000 to invest up to $2 billion in
EWGs and FUCOs, which was equivalent to about 264% of Exelon's "reclassified"
pro forma consolidated retained earnings, an amount that was subsequently
increased to $4 billion.11 Dominion Resources has filed an application
requesting approval for an aggregate investment limit equal to 100% of
consolidated retained earnings plus $8 billion, which appears to be several
times higher than Dominion's consolidated retained earnings.12
In each of these cases, the applicants compared the amount of the proposed
aggregate investment limit to other relevant financial statistics, such as
consolidated capitalization, consolidated net utility plant, total consolidated
capitalization and the total market value of the applicant's common stock.
As previously indicated, an aggregate investment in Exempt Projects of
$750,000,000 would be equal to about 128% of National's average consolidated
retained earnings for the four quarters ended June 30, 2001, which is
substantially lower than the percentages found acceptable in National Grid,
-------------
KeySpan, Exelon and Cinergy orders.
------- ------ -------
------------------------
8 See KeySpan Corporation, et al., Holding Co. Act Release No. 27272 (Nov. 8,
--- ---------------------------
2000).
9 See Cinergy Corporation, Holding Co. Act Release No. 27190 (June 23, 2000).
--- -------------------
10 See Cinergy Corporation, Holding Co. Act Release No. 27400 (May 18, 2001).
--- -------------------
11 See Exelon Corporation, Holding Co. Act Release No. 27266 (Nov. 2, 2000)
--- ------------------
(authorizing aggregate investment limit of $2 billion); and Exelon
------
Corporation, Holding Co. Act Release No. 27296 (Dec. 8, 2000) (authorizing
-----------
aggregate investment limit of $4 billion).
12 File No. 70-9555. Dominion explains in its application that, due to the
application of purchase method accounting in connection with its
acquisition of Consolidated Natural Gas Company, its consolidated retained
earnings do not reflect the retained earnings of Consolidated before the
acquisition.
16
1. THE PROPOSED TRANSACTIONS WILL NOT HAVE A SUBSTANTIAL ADVERSE
IMPACT UPON THE FINANCIAL INTEGRITY OF THE NATIONAL SYSTEM
The lack of any "substantial adverse impact" on National's financial
integrity as a result of increased levels of investments in EWGs and FUCOs can
be demonstrated in several ways, including the analysis of historic trends in
National's consolidated capitalization ratios and retained earnings and the
market view of National's securities. Consideration of these and other relevant
factors supports the conclusion that the issuance of securities and guarantees
by National to finance investments in EWGs and FUCOs exceeding the 50%
consolidated retained earnings limitation in Rule 53(a)(1) will not have any
"substantial adverse impact" on the financial integrity of the National System.
a. KEY FINANCIAL RATIOS/BENCHMARKS
i. CAPITALIZATION RATIOS
An aggregate investment in Exempt Projects of $750,000,000 would
represent a relatively small commitment of National's capital for a company the
size of National, based on various key financial ratios at September 30, 2000.
For example, investments of this amount would be equal to only 38.6% of
National's total consolidated capitalization ($1.941 billion), 53% of net
utility plant ($1.414 billion 13), 23.2% of total consolidated assets ($3.237
billion), and 35.4% of the market value of National's outstanding common stock
($2.121 billion) as of September 30, 2000. The following table shows how these
percentages would compare to the comparable percentages for KeySpan, Exelon,
Cinergy, Dominion, and Alliant Energy Corporation,14 as reflected in each
company's Rule 53(c) application and/or as calculated based on financial
information available for the year ended December 31, 2000 (except as otherwise
indicated).
------------------------
13 Includes gas distribution, pipeline and storage plant.
14 See Alliant Energy Corporation, File No. 70-9891.
17
Proposed Investments in EWGs and FUCOs
as a percentage of:
------------------------------------------------------------------------------------
Consolidated Consolidated Net Total Consolidated Market Value of Outstanding
Company Capitalization Utility Plant Assets Common Stock
------------------------ ---------------- ---------------- ------------------ ----------------------------
KeySpan (6/30/00) 16.6% 20.9% 11.5% 29.2%
Exelon Corp. 18.9% 23.3% 11.1% 28.2%
Cinergy Corp. 46% 47.5% 25.6% 56%
Dominion (pending) 42.0% 60.8% 30.7% 54.6%
Alliant Energy (pending) 37.7% 55.7% 26.0% 69.6%
National (9/30/00) 38.6% 53% 23.2% 35.4%
ii. NATIONAL SECURITY RATINGS
National's long-term debt has been rated by Standard & Poor's
Corporation ("S&P"), Moody's Investor Service ("Moody's"), and Fitch Investor
Service ("Fitch") as follows:
----------------------------------------------------------------------
NATIONAL'S LONG-TERM DEBT RATINGS (AS OF 9/30)
----------------------------------------------------------------------
1998 1999 2000 CURRENT
-------------------- ----------- ----------- ----------- -----------
S&P A- A- A- A-
-------------------- ----------- ----------- ----------- -----------
Moody's A-2 A-2 A-2 A-2
-------------------- ----------- ----------- ----------- -----------
Fitch A A A A
----------------------------------------------------------------------
iii. CONSOLIDATED RETAINED EARNINGS
Excluding the effects of accounting changes relating to National's oil
and gas exploration and production operations, National's consolidated retained
earnings have grown on average approximately 10% per year over the five years
ended September 30, 2000, which is within the range of growth rates for other
integrated gas companies, as well as other registered holding company systems
that have obtained relief under Rule 53(c).
iv. NATIONAL'S DEBT LIMITATIONS
Currently, National is restricted under the terms of its 1974
indenture in the amount of additional long-term debt (funded debt) that it may
issue. Generally, National may not issue additional long-term debt unless, after
giving effect to each issuance, (i) outstanding long-term debt does not exceed
60% of the consolidated assets of National, and (ii) income available for
18
interest and subsidiary preferred stock dividends for any 12 consecutive months
within the preceding 15 months has been at least two times the sum of annual
interest charges and subsidiary dividend requirements.15 For the twelve-month
periods ended September 30, 1999 and 2000, these coverage ratios were 4.25 times
and 4.48 times, respectively.
v. RULE 53(B) FACTORS
As previously indicated, none of the circumstances described under
Rule 53(b) has occurred. National undertakes to notify the Commission by filing
a post-effective amendment in this proceeding in the event of the occurrence of
any of these circumstances.
vi. OTHER INDICATORS
Other financial indicators show the financial strength of National.
For example, National's diluted earnings per share and return on average equity
were $2.95 and 12.6%, respectively, for the fiscal year ended September 30, 1999
and $3.21 and 13.2%, respectively, for the fiscal year ended September 30, 2000.
For comparison purposes, the following table lists diluted earnings per share
and return on average equity for other "peer group" utilities for the year ended
December 31, 2000:
Company Earnings Per Share Return on Equity
------- ------------------ ----------------
KeySpan Corp. $2.10 10.1%
Equitable Resources, Inc. 1.60 13.4
Kinder Morgan, Inc. 1.32 7.5
Oneok, Inc. 1.11 12.3
Questar Corporation 1.94 16.2
NiSource Inc. 1.15 6.6
National (Sept. 30, 2000) 3.21 13.2
b. MARKET ASSESSMENT OF NATIONAL
i. ASSESSMENT OF GROWTH AND EARNINGS
The market's assessment of National's future growth and earnings can
also be shown by comparison of National to the same "peer group" utilities based
on price-earnings ratio and market-to-book ratio for 2000. These measures
indicate investor confidence in National and have been cited as favorable
indicators in other orders the Commission has issued under Rule 53(c).
------------------------
15 National's subsidiaries do not currently have any preferred stock
outstanding.
19
Company P/E Ratio Market to Book Ratio
KeySpan Corp. 20.2 2.05
Equitable Resources, Inc. 20.9 3.13
Kinder Morgan, Inc. 39.5 3.32
Oneok, Inc. 16.3 1.16
Questar Corporation 15.5 2.45
NiSource Inc. 26.7 1.86
National (Sept. 30, 2000) 17.2 2.23
ii. DIVIDEND PAYOUT RATIO
National's indicated dividend rate at September 30, 2000 was $1.92 per
share. National's payout ratio (60%) is lower than the utility industry average
of 82%.16
2. THE PROPOSED TRANSACTIONS WILL NOT HAVE AN ADVERSE IMPACT ON
DISTRIBUTION OR ITS CUSTOMERS, OR ON THE ABILITY OF DISTRIBITION'S
STATE PUBLIC UTILITY COMMISSIONS TO PROTECT SUCH CUSTOMERS
National's request to increase its aggregate investment in Exempt
Projects to $750,000,000 will not have an "adverse impact" on Distribution, its
customers, or on the ability of the two State commissions having jurisdiction
over Distribution to protect Distribution or such customers.
The conclusion that Distribution and its customers will not be
adversely impacted by increased levels of investment by National in Exempt
Projects is well supported by (i) the insulation of Distribution and its
customers from potential direct adverse effects of investments in Exempt
Projects; (ii) analyses of Distribution financial integrity; and (iii) the
proven effectiveness of state commission oversight to protect ratepayers in
their respective states from any adverse impact.
a. INSULATION FROM RISK
All of National's investments in Exempt Projects are, and in the
future will remain, segregated from Distribution. Thus, Distribution is, and is
currently expected in the future to remain, insulated from the direct effects of
investments by National in Exempt Projects. Any losses that may be incurred by
such Exempt Projects would have no effect on domestic rates of Distribution.
National represents that it will not seek recovery through higher rates to
------------------------
16 Source: Standard & Poor's Corporate Ratings Criteria 2001.
20
Distribution's utility customers in order to compensate National for any
possible losses that it or any National System company may sustain on
investments in Exempt Projects or for any inadequate returns on such
investments.
National has complied and will continue to comply with the
requirements of Rule 53(a)(3) regarding the limitation on the use of
Distribution's employees in connection with providing services to EWGs and
FUCOs. Increased levels of investment in EWGs and FUCOs are not anticipated to
have any impact on utilization of Distribution employees. Distribution has not
and will not increase staffing levels to support the operations of EWGs and
FUCOs. National expects that project development, management, and home office
support functions for EWGs and FUCOs will largely be performed by outside
consultants (e.g., engineers, investment advisors, accountants, and attorneys)
engaged by Horizon or other non-utility subsidiaries. Accordingly, National's
need for the support of personnel provided by Distribution has been, and is
expected to continue to be, limited to corporate governance services.
Finally, National has complied and will continue to comply with the
other conditions of Rule 53(a) providing specific protections to customers of
Distribution and its state commissions, in particular, the requirements of Rule
53(a)(1) regarding the preparation and making available of books and records and
financial reports regarding EWGs and FUCOs, and the requirements of Rule
53(a)(4) regarding filing of copies of applications and reports with other
regulatory commissions.
b. DISTRIBUTION'S FINANCIAL INTEGRITY
Distribution is in excellent financial health, as indicated by such
factors as its debt/equity ratio. At September 30, 2000, debt (including
short-term debt) as a percentage of Distribution's consolidated capitalization
was equal to 44%, compared to 50.5%, the current industry median for U.S.
utilities.17 Moreover, additional investments in EWGs and FUCOs by National will
not have any negative impact on Distribution's ability to fund operations and
growth. As shown in the table below, present projections indicate that
Distribution will continue to fund its operations and its construction
expenditures from internal sources of cash for at least the next 5 years.
Distribution does not project the need for any increased amount of capital from
National.
------------------------
17 Source: Standard & Poor's Corporate Ratings Criteria 2001.
21
DISTRIBUTION - CONSTRUCTION EXPENDITURES: ACTUAL (FY 1998-2000) AND
PROJECTED (FY 2001 - 2005) EXPENDITURES, INCLUDING ALLOWANCE FOR FUNDS
USED DURING CONSTRUCTION AND PERCENTAGE INTERNALLY GENERATED
--------------- -------------------- ----------------------------
Year Budget ($ million) % Internally Generated
--------------- -------------------- ----------------------------
1998 50.680 91
--------------- -------------------- ----------------------------
1999 46.974 181
--------------- -------------------- ----------------------------
2000 55.799 67
--------------- -------------------- ----------------------------
2001 49.541 197
--------------- -------------------- ----------------------------
2002 48.100 132
--------------- -------------------- ----------------------------
2003 47.100 131
--------------- -------------------- ----------------------------
2004 46.600 127
--------------- -------------------- ----------------------------
2005 46.100 126
--------------- -------------------- ----------------------------
c. ADEQUACY OF STATE COMMISSION OVERSIGHT
National believes that the New York State Public Service Commission
and the Pennsylvania Public Utility Commission (the "State Commissions") have
the authority and resources available under applicable public utility codes to
protect Distribution's utility customers from any adverse impacts associated
with National's investments in Exempt Projects. Significantly, the State
Commissions have not raised objections to National's current investments in EWGs
or FUCOs.18 Moreover, other registered holding companies with subsidiaries
subject to the jurisdiction of one or the other of the State Commissions (e.g.,
GPU, Exelon, KeySpan) have been permitted to increase their aggregate investment
in EWGs and FUCOs over the 50% consolidated retained earnings limit of Rule
53(a).
C. COMPLIANCE WITH RULE 54
Rule 54 provides that the Commission, in determining whether to
approve the issue or sale of a security by a registered holding company for
purposes other than the acquisition of an EWG or FUCO, or other transactions by
such registered holding company or its subsidiary other than with respect to
EWGs and FUCOs, shall not consider the effect of the capitalization or earnings
of any subsidiary which is an EWG or FUCO upon the registered holding company
system if the provisions of Rule 53(a), (b) and (c) are satisfied. If the
transactions contemplated hereby are consummated and National's aggregate
investment in EWGs and FUCOs exceeds 50% of its consolidated retained earnings,
the provisions of Rule 53(a) will not be satisfied. However, to enable the
------------------------
18 Section 33(c)(2) provides that the State commissions may make
recommendations to the Commission regarding a registered holding company's
relationship to FUCOs, and that the Commission shall "reasonably and fully
consider" such recommendations.
22
Commission to monitor the impact of the transactions for which authority is
sought hereby, National proposes to report the following additional information
in the quarterly Rule 24 certificates it is filing in accordance with the 1998
Order:
1. A Rule 53(a) computation--that is a calculation of the ratio of
National's aggregate investment in EWGs and FUCOs to National's average
consolidated retained earnings (both as determined in accordance with Rule
53(a));
2. A statement of aggregate investment as a percentage of the
following: total capitalization, net utility plant, total consolidated assets,
and market value of common equity, all as of the end of that quarter;
3. Consolidated capitalization ratios as of the end of that quarter;
4. The market-to-book ratio of National's common stock at the end of
that quarter;
5. An analysis of the growth in consolidated retained earnings, which
segregates total earnings growth attributable to EWGs and FUCOs from that
attributable to other National subsidiaries; and
6. A statement of revenues and net income of each material National
System company for the twelve months ended as of the end of that quarter.
This information is the same as that required by the Commission with
respect to the other registered systems that have obtained relief under Rule
53(c). National believes that such reporting requirements will assist the
Commission in its determinations concerning the effect of investments in Exempt
Projects on other transactions for which National and other National System
companies will require Commission authorization.
ITEM 4. REGULATORY APPROVAL
-------------------
The issuance and sale of securities by National and the use of the
proceeds thereof to acquire or guarantee the securities of any EWG or FUCO are
not subject to the jurisdiction of any state commission or of any federal
commission other than the Commission. National will comply with the requirements
of Rule 53(a)(4) by submitting a copy of this Application/Declaration to each of
the State Commissions.
23
ITEM 5. PROCEDURE
---------
National requests, pursuant to Rule 23(c) of the Rules and Regulations
of the Commission, that the Commission's order granting, and permitting this
Application/Declaration to become effective be issued forthwith. National waives
any recommended decision by a hearing officer or other responsible officer of
the Commission and waives the 30-day waiting period between the issuance of the
Commission's order and the date it is to become effective, since National
desires that the Commission's order, when issued, become effective immediately.
National consents to the Division of Investment Management assisting in the
preparation of the Commission's decision and/or order in this matter, unless
such Division opposes the matters covered by this Application/Declaration.
ITEM 6. EXHIBITS AND FINANCIAL STATEMENTS
---------------------------------
(a) Exhibits
--------
F Opinion of Counsel (to be filed by amendment)
G Proposed Form of Federal Register Notice
(b) Financial Statements
--------------------
FS-1 National Consolidated Financial Statements as of September
30, 2000 (incorporated by reference to the Annual Report on
Form 10-K of National for the fiscal year ended September
30, 2000 (File No. 1-3880)).
FS-2 National Consolidated Financial Statements as of June 30,
2001 (incorporated by reference to the Quarterly Report on
Form 10-Q of National for the quarter ended September 30,
2001 (File No. 1-3880)).
ITEM 7. INFORMATION AS TO ENVIRONMENTAL EFFECTS
---------------------------------------
None of the matters that are the subject of the
Application/Declaration involve a "major federal action" nor do they
"significantly affect the quality of the human environment" as those terms are
used in section 102(2)(C) of the National Environmental Policy Act. The
transaction that is the subject of this Application/Declaration will not result
in changes in the operation of National or its subsidiaries that will have an
impact on the environment. National is not aware of any federal agency that has
prepared or is preparing an environmental impact statement with respect to the
transactions that are the subject of this Application/Declaration.
24
SIGNATURE
Pursuant to the requirements of the Public Utility Holding Company Act
of 1935, as amended, the undersigned company has duly caused this
Application/Declaration to be signed on its behalf by the undersigned thereunto
duly authorized.
NATIONAL FUEL GAS COMPANY
By: /s/ James R. Peterson
-----------------
Name: James R. Peterson
Title: Assistant Secretary
Date: October 9, 2001
25