Item 7A. Quantitative and Qualitative
Disclosures About Market Risk
We are exposed to risks associated with natural gas prices, interest
rates and credit. Natural gas price risk is defined as the potential
loss that we may incur as a result of changes in the fair value of
natural gas. Interest rate risk results from our portfolio of debt and
equity instruments that we issue to provide financing and liquidity
for our business. Credit risk results from the extension of credit
throughout all aspects of our business but is particularly
concentrated at Atlanta Gas Light in distribution operations and in
wholesale services.
Our Risk Management Committee (RMC) is responsible for
establishing the overall risk management policies and monitoring
compliance with, and adherence to, the terms within these policies,
including approval and authorization levels and delegation of these
levels. Our RMC consists of members of senior management who
monitor open natural gas price risk positions and other types of risk,
corporate exposures, credit exposures and overall results of our risk
management activities. It is chaired by our chief risk officer, who is
responsible for ensuring that appropriate reporting mechanisms exist
for the RMC to perform its monitoring functions. Our risk
management activities and related accounting treatments are
described in further detail in Note 2.
Natural Gas Price Risk
Retail Energy Operations SouthStar’s use of derivative
instruments is governed by a risk management policy, approved and
monitored by its Finance and Risk Management Committee, which
prohibits the use of derivatives for speculative purposes.
Energy Marketing and Risk Management Activities SouthStar routinely utilizes various types of derivative financial
instruments to mitigate certain natural gas price and weather risk
inherent in the natural gas industry. This includes the active
management of storage positions through a variety of hedging
transactions for the purpose of managing exposures arising from
changing natural gas prices. SouthStar uses these hedging
instruments to lock in economic margins (as spreads between
wholesale and retail natural gas prices widen between periods) and
thereby minimize its exposure to declining operating margins.
We have designated a portion of SouthStar’s derivative
transactions as cash flow hedges in accordance with authoritative
guidance related to derivatives and hedging. We record derivative
gains or losses arising from cash flow hedges in OCI and reclassify
them into earnings as cost of gas in our consolidated statement of
income in the same period as the underlying hedged transaction
occurs and is recorded in earnings. We record any hedge
ineffectiveness, defined as when the gains or losses on the hedging
instrument do not offset and are greater than the losses or gains on
the hedged item, in cost of gas in our consolidated statement of
income in the period in which the ineffectiveness occurs. SouthStar
currently hasminimal hedge ineffectiveness.We have not designated
the remainder of SouthStar’s derivative instruments as hedges under
the guidance and, accordingly, we record changes in their fair value in
earnings as cost of gas in our consolidated statements of income in
the period of change.
SouthStar recorded a net unrealized gain related to changes in
the fair value of derivative instruments utilized in its energy marketing
and riskmanagement activities of $20million during 2009, unrealized
losses of $27 million during 2008 and $7 million during 2007. The
following tables illustrate the change in the net fair value of the
derivative financial instruments during 2009, 2008 and 2007 and
provide details of the net fair value of derivative financial instruments
outstanding as of December 31, 2009, 2008 and 2007.
| In millions | 2009 |
2008 |
2007 |
| Net fair value of derivative financial instruments outstanding at beginning of period |
$(17) |
$ 10 |
$ 17 |
| Derivative financial instruments realized or otherwise settled during period |
19 |
(10) |
(17) |
| Change in net fair value of derivative financial instruments |
1 |
(17) |
10 |
| Net fair value of derivative financial instruments outstanding at end of period(1) |
3 |
(17) |
10 |
| Netting of cash collateral | 18 |
31 |
3 |
| Cash collateral and net fair value of derivative financial instruments outstanding at end of period(1) |
$ 21 |
$ 14 |
$ 13 |
(1) Net fair value of derivative financial instruments outstanding includes $2 million premium and associated intrinsic value at December 31, 2009, $4 million at December 31, 2008 and $5 million at December 31, 2007 associated with weather derivatives.
The sources of SouthStar’s net fair value of its natural gasrelated
derivative financial instruments at December 31, 2009, are
as follows.
| In millions | Prices actively quoted (Level 1)(1) |
Significant other observable inputs (Level 2)(2) |
| Mature through 2010(3) | $1 |
$2 |
(1) Valued using NYMEX futures prices.
(2) Values primarily related to weather derivative transactions that are valued on an intrinsic basis in accordance with authoritative guidance related to financial instruments as based on heating degree days. Additionally, includes values associated with basis transactions that represent the commodity from NYMEX delivery point to the contract delivery point. These transactions are based on quotes obtained either through electronic trading platforms or directly from brokers.
(3) Excludes cash collateral amounts.
SouthStar routinely utilizes various types of financial and other
instruments to mitigate certain commodity price and weather risks
inherent in the natural gas industry. These instruments include a variety
of exchange-traded and OTC energy contracts, such as forward
contracts, futures contracts, options contracts and swap agreements.
The following tables include the fair values and average values
of SouthStar’s derivative instruments as of the dates indicated.
SouthStar bases the average values on monthly averages for the
12 months ended December 31, 2009 and 2008.
Derivative financial instruments average fair values at December 31, |
||
| In millions | 2009(1) |
2008(1) |
| Asset | $13 |
$17 |
| Liability | 19 |
12 |
(1) Excludes cash collateral amounts.
Derivative financial instruments fair values netted with cash collateral at December 31, |
|||
| In millions | 2009 |
2008 |
2007 |
| Asset | $21 |
$16 |
$13 |
| Liability | — |
2 |
— |
Value-at-risk A 95% confidence interval is used to evaluate
VaR exposure. A 95% confidence interval means that over the
holding period, an actual loss in portfolio value is not expected to
exceed the calculated VaR more than 5% of the time. We calculate
VaR based on the variance-covariance technique. This technique
requires several assumptions for the basis of the calculation, such
as price distribution, price volatility, confidence interval and holding
period. Our VaR may not be comparable to a similarly titled
measure of another company because, although VaR is a common
metric in the energy industry, there is no established industry
standard for calculating VaR or for the assumptions underlying such
calculations. SouthStar’s portfolio of positions for 2009, 2008 and
2007, had annual average 1-day holding period VaRs of less than
$100,000, and its high, low and period end 1-day holding period
VaR were immaterial.
Wholesale Services Sequent routinely uses various types of
derivative financial instruments to mitigate certain natural gas price
risks inherent in the natural gas industry. These instruments include
a variety of exchange-traded and OTC energy contracts, such as
forward contracts, futures contracts, options contracts and financial
swap agreements.
Energy Marketing and Risk Management Activities We
account for derivative transactions in connection with Sequent’s
energy marketing activities on a fair value basis in accordance with
authoritative guidance related to derivatives and hedging.We record
derivative energy commodity contracts (including both physical
transactions and financial instruments) at fair value, with unrealized
gains or losses from changes in fair value reflected in our earnings
in the period of change.
Sequent’s energy-trading contracts are recorded on an accrual
basis and its derivatives are recorded at fair value under authoritative
guidance related to derivatives and hedging.
Sequent experienced a $36 million increase in the net fair value
of its outstanding contracts during 2009 and $25 million during 2008
and a $62 million decrease in the net fair value of its outstanding
contracts during 2007, due to changes in the fair value of derivative
financial instruments utilized in its energy marketing and risk
management activities and contract settlements and new business
contracts acquired in 2009. The following tables illustrate the change
in the net fair value of Sequent’s derivative financial instruments
during 2009, 2008 and 2007 and provide details of the net fair value
of contracts outstanding as of December 31, 2009, 2008 and 2007.
| In millions | 2009 |
2008 |
2007 |
| Net fair value of derivative financial instruments outstanding at beginning of period |
$ 82 |
$ 57 |
$ 119 |
| Derivative financial instruments realized or otherwise settled during period |
(73) |
(49) |
(102) |
| Net fair value of derivative financial instruments acquired during period |
50 |
— |
— |
| Change in net fair value of derivative financial instruments |
59 |
74 |
40 |
| Net fair value of derivative financial instruments outstanding at end of period |
118 |
82 |
57 |
| Netting of cash collateral | 39 |
97 |
(9) |
| Cash collateral and net fair value of derivative financial instruments outstanding at end of period |
$157 |
$179 |
$ 48 |
The sources of Sequent’s net fair value at December 31, 2009,
are as follows.
| In millions | Prices actively quoted (Level 1) (1) |
Significant other observable inputs (Level 2) (2) |
| Mature through 2010 | $(4) |
$ 82 |
| Mature 2011 – 2012 | 2 |
25 |
| Mature 2013 – 2015 | 1 |
12 |
| Total derivative financial instruments (3) | $(1) |
$119 |
(1) Valued using NYMEX futures prices.
(2) Valued using basis transactions that represent the cost to transport natural gas from a NYMEX
delivery point to the contract delivery point. These transactions are based on quotes obtained
either through electronic trading platforms or directly from brokers.
(3) Excludes cash collateral amounts.
The following tables include the cash collateral fair values and
average values of Sequent’s energy marketing and risk management
assets and liabilities as of December 31, 2009 and 2008.
Sequent bases the average values on monthly averages for the
12 months ended December 31, 2009 and 2008.
Derivative financial
instruments average fair
values at December 31, |
||
| In millions | 2009(1) |
2008(1) |
| Asset | $170 |
$96 |
| Liability | 68 |
45 |
(1) Excludes cash collateral amounts.
Derivative financial instruments fair
values netted with cash collateral
at December 31, |
|||
| In millions | 2009 |
2008 |
2007 |
| Asset | $208 |
$206 |
$61 |
| Liability | 51 |
27 |
13 |
Value-at-risk Sequent’s open exposure is managed in
accordance with established policies that limit market risk and
require daily reporting of potential financial exposure to senior
management, including the chief risk officer. Because Sequent
generally manages physical gas assets and economically protects
its positions by hedging in the futures markets, its open exposure is
generally immaterial, permitting Sequent to operate within relatively
low VaR limits. Sequent employs daily risk testing, using both VaR
and stress testing, to evaluate the risks of its open positions.
Sequent’s management actively monitors open commodity
positions and the resulting VaR. Sequent continues to maintain a
relatively matched book, where its total buy volume is close to its sell
volume, with minimal open natural gas price risk. Based on a 95%
confidence interval and employing a 1-day holding period for all
positions, Sequent’s portfolio of positions for the 12 months ended
December 31, 2009, 2008 and 2007 had the following VaRs.
| In millions | 2009 |
2008 |
2007 |
| Period end | $2.4 |
$2.5 |
$1.2 |
| 12-month average | 1.8 |
1.8 |
1.3 |
| High | 3.3 |
3.1 |
2.3 |
| Low | 0.7 |
0.8 |
0.7 |
Energy Investments In 2009, Golden Triangle Storage began
using derivative financial instruments to reduce its exposure during
the construction of the storage caverns to the risk of changes with
the price of natural gas that will be purchased in future periods for
pad gas, which includes volumes of non-working natural gas used
to maintain the operational integrity of the caverns. As of
December 31, 2009, Golden Triangle Storage had locked-in the
price of approximately 68% of the required pad gas for the first
storage cavern or 2 Bcf and the associated fair value of the derivative
financial instruments was immaterial.
Interest Rate Risk
Interest rate fluctuations expose our variable-rate debt to changes
in interest expense and cash flows. Our policy is to manage interest
expense using a combination of fixed-rate and variable-rate debt.
Based on $762 million of variable-rate debt, which includes
$601 million of our variable-rate short-term debt and $161 million
of variable-rate gas facility revenue bonds outstanding at
December 31, 2009, a 100 basis point change in market interest
rates from 0.4%to 1.4%would have resulted in an increase in pretax
interest expense of $8 million on an annualized basis.
Credit Risk
Distribution Operations Atlanta Gas Light has a concentration of
credit risk as it bills nine certificated and active Marketers and one
regulated natural gas provider responsible for offering natural gas
to low-income customers and customers unable to get natural gas
service from other Marketers in Georgia for its services. The credit
risk exposure to Marketers varies with the time of the year, with
exposure at its lowest in the nonpeak summer months and highest
in the peak winter months. Marketers are responsible for the retail
sale of natural gas to end-use customers in Georgia. These retail
functions include customer service, billing, collections, and the
purchase and sale of the natural gas commodity. The provisions of
Atlanta Gas Light’s tariff allow Atlanta Gas Light to obtain security
support in an amount equal to a minimum of two times a Marketer’s
highest month’s estimated bill from Atlanta Gas Light. For 2009,
the four largest Marketers based on customer count, which
includes SouthStar, accounted for approximately 31% of our
consolidated operating margin and 44% of distribution operations’
operating margin.
Several factors are designed to mitigate our risks from the
increased concentration of credit that has resulted from deregulation.
In addition to the security support described above, Atlanta
Gas Light bills intrastate delivery service to Marketers in advance
rather than in arrears. We accept credit support in the form of cash
deposits, letters of credit/surety bonds from acceptable issuers and
corporate guarantees from investment-grade entities. The RMC
reviews on a monthly basis the adequacy of credit support
coverage, credit rating profiles of credit support providers and
payment status of each Marketer.We believe that adequate policies
and procedures have been put in place to properly quantify, manage
and report on Atlanta Gas Light’s credit risk exposure to Marketers.
Atlanta Gas Light also faces potential credit risk in connection
with assignments of interstate pipeline transportation and storage
capacity to Marketers. Although Atlanta Gas Light assigns this
capacity to Marketers, in the event that a Marketer fails to pay the
interstate pipelines for the capacity, the interstate pipelines would in
all likelihood seek repayment from Atlanta Gas Light.
Retail Energy Operations SouthStar obtains credit scores for its
firm residential and small commercial customers using a national
credit reporting agency, enrolling only those customers that meet or
exceed SouthStar’s credit threshold.
SouthStar considers potential interruptible and large commercial
customers based on a review of publicly available financial statements
and review of commercially available credit reports. Prior to entering
into a physical transaction, SouthStar also assigns physical wholesale
counterparties an internal credit rating and credit limit based on the
counterparties’ Moody’s, S&P and Fitch ratings, commercially available
credit reports and audited financial statements.
Wholesale Services Sequent has established credit policies to
determine and monitor the creditworthiness of counterparties, as
well as the quality of pledged collateral. Sequent also utilizes master
netting agreements whenever possible to mitigate exposure to
counterparty credit risk. When Sequent is engaged in more than
one outstanding derivative transaction with the same counterparty
and it also has a legally enforceable netting agreement with that
counterparty, the “net” mark-to-market exposure represents the
netting of the positive and negative exposures with that counterparty
and a reasonable measure of Sequent’s credit risk. Sequent also
uses other netting agreements with certain counterparties with
whom it conducts significant transactions. Master netting agreements
enable Sequent to net certain assets and liabilities by
counterparty. Sequent also nets across product lines and against
cash collateral provided the master netting and cash collateral
agreements include such provisions.
Additionally, Sequent may require counterparties to pledge
additional collateral when deemed necessary. Sequent conducts
credit evaluations and obtains appropriate internal approvals for its
counterparty’s line of credit before any transaction with the
counterparty is executed. Inmost cases, the counterpartymust have
an investment grade rating, which includes a minimum long-term
debt rating of Baa3 from Moody’s and BBB- from S&P. Generally,
Sequent requires credit enhancements by way of guaranty, cash
deposit or letter of credit for transaction counterparties that do not
have investment grade ratings.
Sequent, which provides services to retail marketers and utility
and industrial customers, also has a concentration of credit risk as
measured by its 30-day receivable exposure plus forward exposure.
As of December 31, 2009, Sequent’s top 20 counterparties
represented approximately 58% of the total counterparty exposure
of $534 million, derived by adding together the top 20 counterparties’
exposures and dividing by the total of Sequent’s
counterparties’ exposures.
As of December 31, 2009, Sequent’s counterparties, or the
counterparties’ guarantors, had a weighted average S&P equivalent
credit rating of A-, which is consistent with the prior year. The S&P
equivalent credit rating is determined by a process of converting the
lower of the S&P or Moody’s ratings to an internal rating ranging
from 9 to 1, with 9 being equivalent to AAA/Aaa by S&P and
Moody’s and 1 being D or Default by S&P and Moody’s. A
counterparty that does not have an external rating is assigned an
internal rating based on the strength of the financial ratios of that
counterparty. To arrive at the weighted average credit rating, each
counterparty is assigned an internal ratio, which is multiplied by their
credit exposure and summed for all counterparties. The sum is
divided by the aggregate total counterparties’ exposures, and this
numeric value is then converted to an S&P equivalent. There were
no credit defaults with Sequent’s counterparties. The following table
shows Sequent’s third-party natural gas contracts receivable and
payable positions.
As of December 31, Gross receivables |
||
| In millions | 2009 |
2008 |
| Netting agreements in place: | ||
Counterparty is investment grade |
$483 |
$398 |
Counterparty is non-investment grade |
12 |
15 |
Counterparty has no external rating |
106 |
129 |
| No netting agreements in place: | ||
Counterparty is investment grade |
14 |
7 |
Counterparty is non-investment grade |
— |
— |
Amount recorded on statements of financial position |
$615 |
$549 |
As of December 31, Gross payables |
||
| In millions | 2009 |
2008 |
| Netting agreements in place: | ||
Counterparty is investment grade |
$277 |
$266 |
Counterparty is non-investment grade |
34 |
41 |
Counterparty has no external rating |
207 |
228 |
| No netting agreements in place: | ||
Counterparty is investment grade |
6 |
4 |
Counterparty is non-investment grade |
— |
— |
Amount recorded on statements of financial position |
$524 |
$539 |
Sequent has certain trade and credit contracts that have
explicit minimum credit rating requirements. These credit rating
requirements typically give counterparties the right to suspend or
terminate credit if our credit ratings are downgraded to noninvestment
grade status. Under such circumstances, Sequent
would need to post collateral to continue transacting business with
some of its counterparties. If such collateral were not posted,
Sequent’s ability to continue transacting business with these
counterparties would be impaired. If our credit ratings had been
downgraded to non-investment grade status, the required amounts
to satisfy potential collateral demands under such agreements
between Sequent and its counterparties would have totaled
$25 million at December 31, 2009, which would not have a material
impact to our consolidated results of operations, cash flows or
financial condition.