Item 1. Business.
General - -------------------------------------------------------------------------------
Part I of this Annual Report, Form 10-K (Report) should be read in conjunction with Duquesne Light Company's audited consolidated financial statements, which are set forth on pages 35 through 58 in Part IV of this Report. Explanations of certain financial and operating terms used in this Report are set forth in a GLOSSARY on page 60 of this Report.
Duquesne Light Company (Duquesne) is a wholly owned subsidiary of DQE, an energy services holding company. Duquesne is engaged in the production, transmission, distribution and sale of electric energy. Duquesne has one wholly owned subsidiary, Monongahela Light and Power which currently holds energy- related lease investments.
Service Territory
Duquesne provides electric service to customers in Allegheny County, including the City of Pittsburgh, Beaver County and Westmoreland County. This represents approximately 800 square miles in southwestern Pennsylvania, located within a 500-mile radius of one-half of the population of the United States and Canada. The population of the area served by Duquesne, based on 1990 census data, is approximately 1,510,000, of whom 370,000 reside in the City of Pittsburgh. In addition to serving approximately 580,000 direct customers, Duquesne also sells electricity to other utilities.
Regulation
Duquesne is subject to the accounting and reporting requirements of the United States Securities and Exchange Commission (SEC). In addition, Duquesne's operations are subject to regulation by the Pennsylvania Public Utility Commission (PUC) and the Federal Energy Regulatory Commission (FERC) under the Federal Power Act with respect to rates for interstate sales, transmission of electric power, accounting and other matters.
The Electricity Generation Customer Choice and Competition Act (Customer Choice Act) went into effect in Pennsylvania on January 1, 1997. This legislation provides for a gradual deregulation of the generation of electricity, while maintaining regulation of the transmission and distribution of electricity and related services to customers. (See "Rate Matters" and "Competition" discussions on pages 5 and 13.)
Duquesne's operations are also subject to regulation by the Nuclear Regulatory Commission (NRC) under the Atomic Energy Act of 1954, as amended, with respect to the operation of its jointly owned/leased nuclear power plants, Beaver Valley Unit 1 (BV Unit 1), Beaver Valley Unit 2 (BV Unit 2) and Perry Unit 1.
Duquesne's consolidated financial statements report regulatory assets and liabilities in accordance with Statement of Financial Accounting Standards No. 71, Accounting for the Effects of Certain Types of Regulation (SFAS No. 71), and reflect the effects of the current ratemaking process. In accordance with SFAS No. 71, Duquesne's consolidated financial statements reflect regulatory assets and liabilities consistent with cost-based, pre-competition ratemaking regulations. The regulatory assets represent probable future revenue to Duquesne because provisions for these costs are currently included, or are expected to be included, in charges to electric utility customers through the ratemaking process.
Duquesne's operations or a portion of such operations could cease to meet the SFAS No. 71 criteria for various reasons, including a change in the FERC regulations or the competition-related changes in the PUC regulations described above. (See "Rate Matters" and "Competition" discussions on pages 5 and 13.) Duquesne believes its electricity generating assets and related regulatory assets continue to satisfy these criteria in light of the transition to competitive generation under the Customer Choice Act. Should any portion of Duquesne's operations be deemed to no longer meet the SFAS No. 71 criteria, Duquesne may be required to write off any above-market cost assets, the recovery of which is uncertain, and any regulatory assets or liabilities for those operations that no longer meet these requirements.
Results of Operations - -------------------------------------------------------------------------------
Sales of Electricity to Customers
The decrease in 1996 total operating revenues was $3.0 million, as compared to 1995. Comparing 1995 total operating revenues to 1994, there was an increase of $11.2 million. Operating revenues are derived from Duquesne's sales of electricity. The PUC authorizes rates for electricity sales which are cost- based and are designed to recover Duquesne's operating expenses and investment in electric utility assets and to provide a return on the investment. (See "Rate Matters" and "Competition" discussions on pages 5 and 13.)
Electric Utility Sales by Customer Class (Kilowatt-Hours in Millions): - ---------------------------------------------------------------------
Sales to residential and commercial customers are strongly influenced by weather conditions. Warmer summer and colder winter seasons lead to increased customer use of electricity for cooling and heating. Commercial sales are also affected by regional economic development. Sales to industrial customers are influenced by national and global economic conditions. Customer revenues fluctuate as a result of changes in sales volume and changes in fuel and other energy costs.
Net Customer Revenues
Net customer revenues, reflected on the statement of consolidated income, decreased $8.3 million or 0.8 percent in 1996 compared to 1995. The variance can be attributed primarily to decreased residential customer kilowatt- hour (KWH) sales of 1.7 percent due to unseasonably warm summer temperatures in 1995, as compared to 1996, resulting in decreased revenues of $8.9 million. Industrial KWH sales volume in 1996 increased when compared to the prior year because of a self-generation outage experienced in 1996 by one of Duquesne's large industrial customers. Sales to Duquesne's 20 largest customers accounted for approximately 14 percent of customer revenues in 1996, 1995 and 1994.
In 1995 as compared to 1994, net customer revenues increased by $7.8 million, or 0.7 percent. The increase is the net result of higher KWH sales to residential customers by 4.9 percent in response to extreme 1995 summer temperatures, partially offset by lower fuel and other energy costs per KWH, the benefits of which are passed through to the customers in the form of lower rates. Revenues from electric sales to residential customers in 1995 exceeded 1994 residential revenues by $13.0 million.
Sales to Other Utilities
Short-term sales to other utilities are regulated by the FERC and are made at market rates. Fluctuations in electricity sales to other utilities are related to Duquesne's customer energy requirements, the energy market and transmission conditions, and the availability of Duquesne's generating stations. Duquesne's electricity sales to other utilities in 1995 were less than 1996 and 1994 due to the timing of generating station outages and the fluctuating level of sales to Duquesne's electric utility customers. Future levels of short-term sales to other utilities will be affected by Duquesne's sale of its ownership interest in the Ft. Martin Power Station (Ft. Martin), the possible sale of other generating stations, market rates, and by the outcome of Duquesne's FERC filings requesting firm transmission access. (See "Mitigation Plan" and "Transmission Access" discussions on pages 5 and 15.)
Other Operating Revenues
Duquesne's non-KWH revenues comprise other operating revenues in Duquesne's statement of consolidated income. Other operating revenues are primarily comprised of revenues from joint owners of BV Unit 1 and BV Unit 2 for their shares of the administrative and general costs of operating these units. Other operating revenues, therefore, fluctuate depending on the timing of scheduled refueling and maintenance outages at Beaver Valley Power Station (BVPS) when significant costs are incurred. Both BV Unit 1 and BV Unit 2 underwent refueling outages in 1996 and 1995. BV Unit 2 experienced an extended outage of 107 days during 1996 due to unanticipated repairs to two residual heat removal pumps and reactor head vent valves, resulting in a $3.0 million increase in other operating revenues during 1996. There were no refueling outages in 1994; accordingly, other operating revenues increased $5.7 million in 1995 when compared to 1994.
Operating Expenses
Fuel and purchased power expense fluctuations generally result from changes in the cost of fuel, the mix between coal and nuclear generation, the total KWHs sold, and generating station availability. Because of the Energy Cost Rate Adjustment Clause (ECR), changes in fuel and purchased power costs did not impact earnings in 1996, 1995 and 1994.
Fuel and purchased power expense increased in 1996 compared to 1995 as a result of a 33 percent increase in purchased power prices. This increase was partially offset by lower nuclear fuel costs. Fuel and purchased power expense decreased in 1995 compared to 1994 due to lower nuclear fuel costs, a more favorable generation mix and a 2.7 percent decline in KWH generation.
Other operating expense increased $2.8 million when comparing 1996 to 1995. The increase was the result of a one-time lease charge. In 1995, other operating expense decreased $18.7 million when compared to 1994. This 1995 reduction reflects ongoing cost savings efforts.
Depreciation and amortization expense increased $25.7 million in 1996 when compared to 1995 primarily due to the increase in Duquesne's composite depreciation rate from 3.5 percent to 4.25 percent effective May 1, 1996. During the third quarter of 1996, Duquesne completed recovery of its investment in Perry Unit 2, the construction of which was abandoned by Duquesne in 1986. The resultant decrease in amortization expense was offset by Duquesne's increase in depreciation, as well as $9 million that was expensed related to the depreciation portion of deferred rate synchronization costs in conjunction with Duquesne's Mitigation Plan. Depreciation and amortization expense increased $27.6 million in 1995, primarily due to the change in Duquesne's composite depreciation rate from 3.0 percent to 3.5 percent effective January 1, 1995. Duquesne did not seek a rate increase to recover the additional costs. (See "Mitigation Plan" discussion on page 5.)
Income taxes decreased in 1996 when compared to 1995 by $6.9 million, primarily due to reduced taxable income. In 1995, taxable income was greater than in 1994, resulting in increased income taxes of $1.8 million.
Other Income and (Deductions)
The increase of $22.9 million in other income and deductions, when comparing 1996 to 1995, was primarily the result of income from long-term investments made during late 1995 and 1996. Other income and deductions decreased $10.3 million in 1995 when compared to 1994 primarily due to increases in income taxes related to other income.
Interest Charges
Duquesne achieved reductions of $8.4 million and $3.8 million in interest charges in 1996 and 1995, respectively. The decreases were primarily due to the retirement of long-term debt during 1995. Interest expense in 1997 will be influenced by fluctuations in short-term rates and any new financing.
Monthly Income Preferred Securities Dividend Requirements
The Monthly Income Preferred Securities Dividend Requirements reflect the payment of $7.9 million in dividends in 1996 related to preferred stock issued in May 1996.
Dividends on Preferred and Preference Stock
The decreases of $1.3 million and $0.7 million in 1996 and 1995 in dividends on preferred and preference stock were primarily due to the retirement of preferred stock in 1995.
Liquidity and Capital Resources - -------------------------------------------------------------------------------
Capital Expenditures
Duquesne spent approximately $88.5 million in 1996, $78.7 million in 1995 and $94.3 million in 1994 for construction. Duquesne's capital expenditures for construction focus on improving and/or expanding electric production, transmission and distribution systems. Duquesne estimates that it will spend, excluding allowance for funds used during construction (AFC) and nuclear fuel, approximately $110 million, $110 million and $95 million for construction during 1997, 1998 and 1999. These estimates also exclude any potential expenditures for reliability enhancements to the Brunot Island (BI) Unit 3 combustion turbine. (See "Mitigation Plan" discussion on page 5.) Duquesne expects that funds generated from operations will continue to be sufficient to fund a large part of its capital needs.
Long-Term Investments
Duquesne's long-term investments consist of Duquesne's holdings of DQE common stock, investments in affordable housing, lease investments, and Duquesne's nuclear decommissioning trusts. Investing activities decreased in 1996, after increasing in 1995, when compared to 1994. Duquesne invested $1.5 million and $5.4 million in affordable housing funds during 1996 and 1995. Other investments in 1996 totaled approximately $2.7 million. In addition, Duquesne invested $57.5 million in lease investments during 1995.
Financing
Duquesne expects to meet its current obligations and debt maturities through the year 2001 with funds generated from operations and through new financings. At December 31, 1996, Duquesne was in compliance with all of its debt covenants.
On May 14, 1996, Duquesne Capital L.P., a Delaware special-purpose limited partnership the sole general partner of which is Duquesne, issued $150 million principal amount of 8-3/8 percent Cumulative Monthly Income Preferred Securities (MIPS), Series A, with a stated liquidation value of $25.00. A portion of the proceeds was used to retire $50 million of long-term debt maturing May 15, 1996. Duquesne intends to continue to apply the remaining proceeds to the purchase or redemption of outstanding securities and for general corporate purposes.
In November 1997, $50 million of mortgage bonds will mature. Duquesne expects to retire these bonds with available cash or to refinance the bonds.
Short-Term Borrowings
At December 31, 1996, Duquesne had a $150 million extendible revolving credit arrangement expiring in October 1997. Interest rates can, in accordance with the option selected at the time of the borrowing, be based on prime, Eurodollar or certificate of deposit rates. Commitment fees are based on the unborrowed amount of the commitment. The credit facility contains a two-year repayment period for any amount outstanding at the expiration of the revolving credit period. At December 31, 1996 and 1995, there were no short-term borrowings outstanding.
Sale of Accounts Receivable
Duquesne and an unaffiliated corporation have an agreement that entitles Duquesne to sell, and the corporation to purchase, on an ongoing basis, up to $50 million of accounts receivable. Duquesne had no receivables sold at December 31, 1996. At December 31, 1995, Duquesne had sold $7 million of receivables to the unaffiliated corporation. The accounts receivable sales agreement, which expires in June 1997, is one of many sources of funds available to Duquesne. Duquesne has not determined, but may attempt to extend the agreement or to replace the facility with a similar arrangement or to eliminate it upon expiration.
Nuclear Fuel Leasing
Duquesne finances its acquisitions of nuclear fuel through a leasing arrangement under which it may finance up to $75 million of nuclear fuel. As of December 31, 1996, the amount of nuclear fuel financed by Duquesne under this arrangement totaled approximately $35 million. Duquesne plans to continue leasing nuclear fuel to fulfill its requirements at least through September 1998, the remaining term of the leasing arrangement.
Rate Matters - -------------------------------------------------------------------------------
Customer Choice Act
Under the Customer Choice Act, which went into effect on January 1, 1997, Pennsylvania has become a leader in customer choice. The Customer Choice Act will enable Pennsylvania's electric utility customers to purchase electricity at market prices from a variety of electric generation suppliers (customer choice). Electric utility restructuring will be accomplished through a two-stage process consisting of a pilot period (running through 1998) and a phase-in period (1999 through 2001). The pilot period will give utilities an opportunity to examine a wide range of technical and administrative details related to competitive markets, including metering, billing, and cost and design of unbundled electric services. Duquesne filed a pilot program with the PUC on February 27, 1997, which proposes unbundling transmission, distribution, electricity and competitive transition charges and offers participating customers the same options that will be available in a competitive generation market.
The pilot program will comprise approximately 5 percent of Duquesne's residential, commercial and industrial demand beginning September 1, 1997. Customers participating in the pilot will have two basic options. First, customers can choose to continue taking bundled service from Duquesne under approved tariffs. Second, customers can choose unbundled service with their electricity provided by an alternative electric generation supplier. All customers that choose unbundled electric service will be subject to unbundled distribution charges approved by the PUC and unbundled transmission charges pursuant to Duquesne's FERC-approved tariff. Each customer that elects unbundled service also will be required to pay a non-bypassable access fee (competitive transition charge) that provides Duquesne with a reasonable opportunity to recover transition costs.
Duquesne must file a restructuring plan with the PUC by August 1, 1997 setting forth its proposals for the transition to customer choice and the recovery of transition costs. (See "Competition" discussion on page 13.) The phase-in to competition begins on January 1, 1999 when 33 percent of consumers will have customer choice (including consumers covered by the pilot program); 66 percent of consumers will have customer choice by January 1, 2000; and all consumers will have customer choice by January 1, 2001. Although the Customer Choice Act will give customers their choice of electric generation suppliers, delivery of the electricity from the generation supplier to the customer will remain the responsibility of the existing franchised utility. Delivery of electricity (including transmission, distribution and customer service) will continue to be regulated in substantially the current manner.
Mitigation Plan
Duquesne has taken a number of steps to mitigate its potential transition costs. (See "Competition" discussion on page 13.) In addition to the steps taken during the last 10 years to prepare for competition, effective January 1, 1995, Duquesne accelerated its rate of depreciation on its fixed nuclear assets without seeking a rate increase to recover the additional costs. On October 31, 1996, the sale of Duquesne's ownership interest in
Ft. Martin was completed. Ft. Martin Unit 1 was owned 50 percent by Duquesne and 50 percent by its operator, Allegheny Power System (APS). The sale and a plan, to be funded in part by the proceeds of the Ft. Martin transaction, were approved by the PUC on May 23, 1996. Under the approved plan, Duquesne will not increase its base rates for a period of five years through May 2001. In addition, Duquesne recorded in October 1996 a one-time reduction of approximately $130 million in the book value of Duquesne's nuclear plant investment. The proceeds from the sale are expected to be used to fund reliability enhancements to the BI Unit 3 combustion turbine and to reduce Duquesne's capitalization. The approved plan also provides for incremental increases of $25 million in depreciation and amortization expense in 1996, 1997 and 1998 related to Duquesne's nuclear investment, as well as additional annual contributions to its nuclear plant decommissioning funds of $5 million, without any increase in existing electric rates. Also, Duquesne will record an annual $5 million credit to the ECR during the plan period to compensate Duquesne's customers for lost profits from any short-term power sales foregone by the sale of its ownership interest in Ft. Martin. In addition, Duquesne will cap energy costs, beginning April 1, 1997 through the remainder of the plan period, at a historical five-year average of 1.47 cents per KWH. In accordance with the approved plan, Duquesne has expensed $9 million related to the depreciation portion of the deferred rate synchronization costs associated with BV Unit 2 and Perry Unit 1. Duquesne's approved plan provides for the amortization of the remaining deferred rate synchronization costs over a 10-year period. At December 31, 1996, the unamortized portion of these costs totaled $41.4 million, net of deferred fuel savings related to the two units. (See "Deferred Rate Synchronization Costs" below.) Finally, Duquesne's approved plan also provides for annual assistance of $0.5 million to low-income customers.
Deferred Rate Synchronization Costs
In 1987, the PUC approved Duquesne's petition to defer initial operating and other costs of BV Unit 2 and Perry Unit 1. Duquesne deferred the costs incurred from November 1987, when the units went into commercial operation, until March 1988, when a rate order was issued. In its rate order, the PUC postponed ruling on whether these costs would be recoverable from Duquesne's electric utility customers. Duquesne is not earning a return on the deferred costs. (See "Mitigation Plan" discussion on page 5.)
Energy Cost Rate Adjustment Clause (ECR)
Through the ECR, Duquesne recovers (to the extent that such amounts are not included in base rates) nuclear fuel, fossil fuel and purchased power expenses and, also through the ECR, passes to its customers the profits from short-term power sales to other utilities (collectively, ECR energy costs).
On Duquesne's statement of consolidated income, these ECR revenues are included as a component of operating revenues. For ECR purposes, Duquesne defers fuel and other energy expenses for recovery, or refunding, in subsequent years. The deferrals reflect the difference between the amount that Duquesne is currently collecting from customers and its actual ECR energy costs. The PUC annually reviews Duquesne's ECR energy costs for the fiscal year April through March, compares them to previously projected ECR energy costs, and adjusts the ECR for over- or under-recoveries and for two PUC-established coal cost standards. (See "Fossil Fuel" discussion on page 9.)
Under the Customer Choice Act, Duquesne may replace the ECR effective April 1, 1997 by rolling its ECR energy costs into its base rates. The effect of this change would be to provide to Duquesne an opportunity to further mitigate its deferred energy costs based upon its ability to manage its energy costs. Under Duquesne's PUC-approved Mitigation Plan, the level of energy cost recovery is capped at 1.47 cents per KWH through May 2001. To the extent that projections do not support recovery of previously deferred costs through this pricing mechanism, these costs would become transition costs subject to recovery through a competitive transition charge (CTC). (See "Competition" discussion on page 13.)
Property, Plant and Equipment (PP&E) - -------------------------------------------------------------------------------
Investment in PP&E and Accumulated Depreciation
Duquesne's total investment in property, plant and equipment and the related accumulated depreciation balances for major classes of property at December 31, 1996 and 1995, are as follows:
PP&E and Related Accumulated Depreciation at December 31 - -------------------------------------------------------------------------------
Joint Interests in Generating Units
Duquesne has various contracts with Ohio Edison Company, Pennsylvania Power Company, The Cleveland Electric Illuminating Company (CEI) and The Toledo Edison Company, with respect to several jointly owned/leased generating units, that include provisions for coordinated maintenance responsibilities, limited and qualified mutual back-up in the event of outages, and certain capacity and energy transactions.
In September 1995, Duquesne commenced arbitration against CEI, seeking damages, termination of the Operating Agreement for Eastlake Unit 5 (Eastlake) and partition of the parties' interests in Eastlake through a sale and division of the proceeds. The arbitration demand alleged, among other things, the improper allocation by CEI of fuel and related costs; the mismanagement of the administration of the Saginaw coal contract in connection with the closing of the Saginaw mine, which historically supplied coal to Eastlake; and the concealment by CEI of material information. In October 1995, CEI commenced an action against Duquesne in the Court of Common Pleas, Lake County, Ohio seeking to enjoin Duquesne from taking any action to effect a partition on the basis of a waiver of partition covenant contained in the deed to the land underlying Eastlake. CEI also seeks monetary damages from Duquesne for alleged unpaid joint costs in connection with the operation of Eastlake. Duquesne removed the action to the United States District Court for the Northern District of Ohio, Eastern Division, where it is now pending. Currently, the parties are engaged in settlement discussions. To provide the parties with the opportunity to settle their claims, the court has postponed litigation proceedings until April 1, 1997.
Joint Interests in Nuclear Power Stations
(a) Subsidiary of Ohio Edison Company (b) Subsidiary of Centerior Energy Corporation (c) In 1987, Duquesne sold and leased back its 13.74 percent interest in BV Unit 2; the sale was exclusive of transmission and common facilities. The total sales price of $537.9 million was the appraised value of Duquesne's interest in the property. Duquesne subsequently leased back its interest in the unit for a term of 29.5 years. The lease provides for semi-annual payments and is accounted for as an operating lease. Duquesne is responsible under the terms of the lease for all costs related to its interest in the unit.
Joint Interests in Fossil Power Stations
*Denotes Operator (a) Subsidiary of Ohio Edison Company (b) Subsidiary of Centerior Energy Corporation
On September 13, 1996, Ohio Edison Company and Centerior Energy Corporation entered into an agreement and plan of merger to form First Energy Corporation. The regulatory approval process for the proposed merger is expected to take approximately 12 to 18 months.
Property Held for Future Use
In 1986, the PUC approved Duquesne's request to remove Phillips Power Station (Phillips) and a portion of BI from service and from rate base. In accordance with Duquesne's Mitigation Plan, 112 MWs related to BI Units 2a and 2b were moved from property held for future use to electric plant in service in 1996. Duquesne expects to recover its investment in BI Units 3 and 4, which remain in property held for future use through future electricity sales. Duquesne believes its investment in BI will be necessary in order to meet future business needs. A portion of the proceeds of the sale of Ft. Martin is expected to be used to fund reliability enhancements to the BI Unit 3 combustion turbine. The reliability enhancements are contingent upon the projects meeting a least- cost test versus other potential sources of peaking capacity. (See "Mitigation Plan" discussion on page 5.) Duquesne is analyzing the effects of customer choice on its future generating requirements. Duquesne is planning to seek recovery of its investment and associated costs of Phillips through a CTC. (See "Competition" discussion on page 13.) In the event that market demand, transmission access or rate recovery do not support the utilization of these plants, Duquesne may have to write off part or all of these investments and associated costs. At December 31, 1996, Duquesne's net of tax investment in Phillips and BI held for future use was $53.6 million and $17.2 million.
Employees - -------------------------------------------------------------------------------
At December 31, 1996, Duquesne had 3,413 employees, including 1,157 employees at the Duquesne-operated BVPS. In November 1996, Duquesne reached an agreement on a three-year contract extension through September 30, 2001 with the International Brotherhood of Electrical Workers, which represents approximately 2,000 of Duquesne's employees.
Electric Utility Operations - -------------------------------------------------------------------------------
Duquesne's fossil plants operated at 76 percent availability in 1996 and 1995. Duquesne's nuclear plants operated at 76 percent availability in 1996 and 83 percent in 1995. The timing and duration of scheduled maintenance and refueling outages, as well as the duration of forced outages, affect the availability of power stations. Duquesne normally experiences its peak demand in the summer. The 1996 customer system peak demand of 2,463 MW occurred on August 7, 1996.
Duquesne's plan for optimizing generation resources is designed to reduce under-utilized generating capacity and employ cost-effective sources of peaking capacity. The sale of Duquesne's ownership interest in Ft. Martin reduced in-service capacity by 276 MW. In conjunction with the sale, Duquesne returned 112 MW of peaking capacity at BI to electric plant in service. Additionally, through potential reliability enhancements to the BI Unit 3 combustion turbine, Duquesne could return to service another 56 MW of oil-fired peaking capacity. (See "Property Held for Future Use" discussion above.)
Duquesne has a 13.74 percent ownership interest in Perry Unit 1, a nuclear generating unit located in Ohio and operated by CEI. CEI management has advised Duquesne that the Perry Course of Action (PCA), an action plan submitted to the NRC in 1993, was completed at the end of the unit's fifth refueling outage in the spring of 1996. Perry Unit 1 has followed the PCA with the Perry Plan for Excellence, which is the long-term phase of the unit's performance improvement program. Duquesne will continue to monitor closely the status of the performance improvement program.
Fossil Fuel - -------------------------------------------------------------------------------
Duquesne believes that sufficient coal for its coal-fired generating units will be available from various sources to satisfy its requirements for the foreseeable future. During 1996, approximately 2.4 million tons of coal were consumed at Duquesne's two wholly owned coal-fired stations, Cheswick Power Station (Cheswick) and Elrama Power Station (Elrama).
Duquesne owns Warwick Mine, an underground mine located approximately 83 river miles from Pittsburgh. At December 31, 1996, Duquesne's net investment in the mine was $11.4 million. Duquesne estimates that, at December 31, 1996, its economically recoverable coal reserves at Warwick Mine were in excess of 1.5 million tons. The unaffiliated contract operator at Warwick Mine notified Duquesne that its financial circumstances and geologic conditions caused it to cease operations late in 1996. Therefore, Duquesne is pursuing its remedies and is currently negotiating to retain an operator for the mine as a smaller sized operation. Additionally, Duquesne will continue to purchase coal on the open market. This change should not impact Duquesne's ability to recover all of its investment in Warwick Mine, the $2.6 million of unrecovered system-wide cost of coal which excludes the Bruce Mansfield Power Station (Bruce Mansfield), or to accrue funds for future liabilities. It is anticipated that this effort will be successfully completed by March 31, 2000 when the system-wide coal cost cap expires. The current estimated liability for mine closing, including final site reclamation, mine water treatment and certain labor liabilities is $47.6 million, and Duquesne has recorded a liability on the consolidated balance sheet of approximately $20.2 million toward these costs.
During 1996, 69 percent of Duquesne's coal supplies were provided by contracts including Warwick Mine, with the remainder satisfied through purchases on the spot market. Duquesne had four long-term contracts in effect at December 31, 1996 that, in combination with spot market purchases, are expected to furnish an adequate future coal supply. Duquesne does not anticipate any difficulty in replacing or renewing these contracts as they expire from 1997 through 2002. At December 31, 1996, Duquesne's wholly owned and jointly owned generating units had on hand an average coal supply of 45 days.
The PUC has established two market price coal cost standards for Duquesne. One applies only to coal delivered at Bruce Mansfield. The other, the system-wide coal cost standard, applies to coal delivered to the remainder of Duquesne's system. Both standards are updated monthly to reflect prevailing market prices of similar coal. The PUC has directed Duquesne to defer recovery of the delivered cost of coal to the extent that such cost exceeds generally prevailing market prices for similar coal, as determined by the PUC. The PUC allows deferred amounts to be recovered from customers when the delivered costs of coal fall below such PUC-determined prevailing market prices. Duquesne's obligations to pay certain debt service costs associated with the Bruce Mansfield coal supply will end on January 1, 2000. The Bruce Mansfield coal cost-capping mechanism does not expire until the recovery of all deferrals has been resolved. Duquesne believes that Bruce Mansfield deferrals may increase through the end of this decade and then be reduced to zero by the end of the year 2002. The unrecovered cost of Bruce Mansfield coal was $9.6 million and the unrecovered cost of the remainder of the system-wide coal was $2.6 million at December 31, 1996. Duquesne believes that all deferred coal costs will be recovered.
Nuclear Fuel - -------------------------------------------------------------------------------
The cycle of production and utilization of nuclear fuel consists of (1) mining and milling of uranium ore and processing the ore into uranium concentrates, (2) converting uranium concentrates to uranium hexafluoride, (3) enriching the uranium hexafluoride, (4) fabricating fuel assemblies, (5) utilizing the nuclear fuel in the generating station reactor and (6) storing and disposing of spent fuel.
Adequate supplies of uranium and conversion services are under contract for Duquesne's requirements for its jointly owned/leased nuclear units through June and December 1997, respectively. Enrichment services are supplied under a 1984 United States Enrichment Corporation Utility Services Contract entered into for a period of 30 years by Duquesne for joint interests in Perry Unit 1, BV Unit 1 and BV Unit 2. Under the terms and conditions of this contract, Duquesne is committed to 100 percent of its enrichment needs through 1999; Duquesne has terminated, at zero cost, all of its enrichment services requirements for fiscal years 2000 through 2005. Duquesne continues to review the need for further enrichment services for the years 2006 through 2014 and may terminate these future years' services under the contract. Fuel fabrication contracts are in place to supply reload requirements for the next 18-month cycle for BV Unit 1 and BV Unit 2 and the next fifteen 18-month cycles for Perry Unit 1. Duquesne will make arrangements for future uranium supply and related services, as required.
Each utility company is responsible for financing its proportionate share of the costs of nuclear fuel for each nuclear unit in which it has an ownership or leasehold interest. Duquesne's nuclear fuel costs, which are amortized to reflect fuel consumed, are charged to fuel expense and are currently recovered through rates. Duquesne estimates that, over the next three years, the expenditures for new fuel will exceed the amortization of nuclear fuel consumed by approximately $4.4 million. The actual nuclear fuel costs to be financed and amortized will be influenced by such factors as changes in interest rates; lengths of the respective fuel cycles; reload cycle design; and changes in nuclear material costs and services, the prices and availability of which are not known at this time. Such costs may also be influenced by other events not presently foreseen.
Nuclear Decommissioning - -------------------------------------------------------------------------------
The PUC ruled that recovery of the decommissioning costs for BV Unit 1 could begin in 1977, and that recovery for BV Unit 2 and Perry Unit 1 could begin in 1988. Duquesne expects to decommission BV Unit 1, BV Unit 2 and Perry Unit 1 no earlier than the expiration of each plant's operating license in 2016, 2027 and 2026. At the end of its operating life, BV Unit 1 may be placed in safe storage until BV Unit 2 is ready to be decommissioned, at which time the units may be decommissioned together.
Based on site-specific studies finalized in 1992 for BV Unit 2, and in 1994 for BV Unit 1 and Perry Unit 1, Duquesne's share of the total estimated decommissioning costs, including removal and decontamination costs, currently being used to determine Duquesne's cost of service, is $122 million for BV Unit 1, $35 million for BV Unit 2, and $67 million for Perry Unit 1. A study will be performed in 1997 to update Duquesne's estimated decommissioning costs of BV Unit 1 and BV Unit 2.
On July 18, 1996, the PUC issued a Proposed Policy Statement Regarding Nuclear Decommissioning Cost Estimation and Cost Recovery for the purpose of obtaining comments from the public. The proposed policy includes guidelines for a site-specific study to estimate the cost of decommissioning. Guidelines require that studies be performed at least every five years, address radiological and non-radiological costs, and include a contingency factor of not more than 10 percent. Under the proposed policy, annual decommissioning funding levels are based on an annuity calculation recognizing inflation in the cost estimates and earnings on fund assets. With respect to the transition to a competitive generation market, the Customer Choice Act requires that utilities include a plan to mitigate any shortfall in decommissioning trust fund payments for the life of the facility with any future decommissioning filings. Consistent with this requirement, Duquesne has increased its nuclear decommissioning funding by $5 million under the PUC-approved plan for the sale of Duquesne's ownership interest in Ft. Martin. (See "Mitigation Plan" discussion on page 5.) These additional annual contributions bring the total annual funding to approximately $9 million. Also, on October 17, 1996, the PUC adopted an Accounting Order filed by Duquesne to recognize the increased funding as part of Duquesne's cost of service. Duquesne expects to receive approval from the Internal Revenue Service (IRS) for qualification of 100 percent of additional nuclear decommissioning trust funding for BV Unit 2 and Perry Unit 1, and 79 percent for BV Unit 1.
Duquesne records nuclear decommissioning expense under the category of depreciation and amortization expense and accrues a liability, equal to that amount, for nuclear decommissioning costs. Funding for nuclear decommissioning costs is deposited in external, segregated trust accounts and may be invested in a portfolio of corporate common stock and debt securities, municipal bonds, certificates of deposit and United States government securities. Trust fund earnings increase the fund balance and the recorded liability. The market value of the aggregate trust fund balances at December 31, 1996 totaled approximately $33.7 million. On Duquesne's consolidated balance sheet, the decommissioning trusts have been reflected in other long-term investments, and the related liability has been recorded as other non-current liabilities.
Nuclear Insurance - -------------------------------------------------------------------------------
The Price-Anderson Amendments to the Atomic Energy Act of 1954 limit public liability from a single incident at a nuclear plant to $8.9 billion. The maximum available private primary insurance of $200 million has been purchased by Duquesne. Additional protection of $8.7 billion would be provided by an assessment of up to $79.3 million per incident on each nuclear unit in the United States. Duquesne's maximum total possible assessment, $59.4 million, which is based on its ownership or leasehold interests in three nuclear generating units, would be limited to a maximum of $7.5 million per incident per year. This assessment is subject to indexing for inflation and may be subject to state premium taxes. If funds prove insufficient to pay claims, the United States Congress could impose other revenue-raising measures on the nuclear industry.
Duquesne's share of insurance coverage for property damage, decommissioning and decontamination liability is $1.2 billion. Duquesne would be responsible for its share of any damages in excess of insurance coverage. In addition, if the property damage reserves of Nuclear Electric Insurance Limited (NEIL), an industry mutual insurance company that provides a portion of this coverage, are inadequate to cover claims arising from an incident at any United States nuclear site covered by that insurer, Duquesne could be assessed retrospective premiums totaling a maximum of $7.3 million.
In addition, Duquesne participates in a NEIL program that provides insurance for the increased cost of generation and/or purchased power resulting from an accidental outage of a nuclear unit. Subject to the policy limit, the coverage provides for 100 percent of the estimated incremental costs per week during the 52-week period starting 21 weeks after an accident and 80 percent of such estimate per week for the following 104 weeks, with no coverage thereafter. If NEIL's losses for this program ever exceed its reserves, Duquesne could be assessed retrospective premiums totaling a maximum of $3.5 million.
Spent Nuclear Fuel Disposal - -------------------------------------------------------------------------------
The Nuclear Waste Policy Act of 1982 established a policy for handling and disposing of spent nuclear fuel and a policy requiring the establishment of a final repository to accept spent nuclear fuel. Electric utility companies have entered into contracts with the United States Department of Energy (DOE) for the permanent disposal of spent nuclear fuel and high-level radioactive waste in compliance with this legislation. The DOE has indicated that its repository under these contracts will not be available for acceptance of spent nuclear fuel before 2010. On July 23, 1996, the U.S. Court of Appeals for the District of Columbia Circuit, in response to a suit brought by 25 electric utilities and 18 states and state agencies, unanimously ruled that the DOE has a legal obligation to begin taking spent nuclear fuel by January 31, 1998. The DOE has not yet established an interim or permanent storage facility, and has indicated that it will be unable to begin acceptance of spent nuclear fuel for disposal by January 31, 1998. Further, Congress is considering amendments to the Nuclear Waste Policy Act of 1982 that could give the DOE authority to proceed with the development of a federal interim storage facility. In the event the DOE does not begin accepting spent nuclear fuel, existing on- site spent nuclear fuel storage capacities at BV Unit 1, BV Unit 2 and Perry Unit 1 are expected to be sufficient until 2016 (end of operating license), 2013 and 2011, respectively.
On January 31, 1997, Duquesne joined 35 other electric utilities and 46 states, state agencies and regulatory commissions in filing a suit in the U.S. Court of Appeals for the District of Columbia against the DOE. The suit requests the court to suspend the utilities' payments into the Nuclear Waste Fund and to place future payments into an escrow account until the DOE fulfills its obligation to accept spent nuclear fuel. Significant additional expenditures for the storage of spent nuclear fuel at BV Unit 2 and Perry Unit 1 could be required if the DOE does not fulfill its obligation to accept spent nuclear fuel.
Uranium Enrichment Decontamination and Decommissioning - -------------------------------------------------------------------------------
Nuclear reactor licensees in the United States are assessed annually for the decontamination and decommissioning of DOE uranium enrichment facilities. Assessments are based on the amount of uranium a utility had processed for enrichment prior to enactment of the National Energy Policy Act of 1992 (NEPA) and are to be paid by such utilities over a 15-year period. At December 31, 1996, Duquesne's liability for contributions was approximately $9.3 million (subject to an inflation adjustment). Contributions, when made, are currently recovered from customers through the ECR.
Environmental Matters - -------------------------------------------------------------------------------
The Comprehensive Environmental Response, Compensation and Liability Act of 1980 and the Superfund Amendments and Reauthorization Act of 1986 (Superfund) established a variety of informational and environmental action programs. The United States Environmental Protection Agency (EPA) informed Duquesne of its potential involvement in three hazardous waste sites. Duquesne reached agreements to make de minimus financial payments in 1995 related to two sites in order to resolve any associated liability. Related to the remaining site, Duquesne believes that available defenses, along with other factors (including overall limited involvement, low estimated remediation costs and other solvent, potentially responsible parties) will limit any potential liability that Duquesne may have for cleanup costs. Duquesne believes that any settlement or associated costs related to the remaining site will not have a materially adverse effect on its financial position, results of operations or cash flows.
As required by Title V of the Clean Air Act Amendments (Clean Air Act), Duquesne filed comprehensive air operating permit applications for Cheswick, Elrama, BI and Phillips during the last half of 1995. These applications are still pending approval. Duquesne also filed its Title IV Phase II Clean Air Act compliance plan with the PUC on December 27, 1995.
Although Duquesne believes it has satisfied all of the Phase I Acid Rain Program requirements of the Clean Air Act, Phase II Acid Rain Program requires significant additional reductions of sulfur dioxide (SO\\2\\) and oxides of nitrogen (NO\\X\\) by the year 2000. Duquesne currently has 662 MW of nuclear capacity and 1,187 MW of coal capacity equipped with SO\\2\\ emission- reducing equipment (including 300 MW of property held for future use at Phillips). Through the year 2000, Duquesne is considering a combination of compliance methods that include fuel switching; increased use of, and improvements in, SO\\2\\ emission-reducing equipment; low NO\\X\\ burner technology; and the purchase of emission allowances for those remaining stations not in compliance.
In addition to the Title IV Acid Rain Program requirements, Duquesne is responsible for additional NO\\X\\ reduction requirements to meet Ozone Ambient Air Quality Standards under Title I of the Clean Air Act. Flue gas conditioning and post-combustion NO\\X\\ reduction technologies may be employed if economically justified. Also, Duquesne is examining and developing innovative emissions technologies designed to reduce costs. Duquesne continues to work with the operators of its jointly owned stations to implement cost-effective compliance strategies to meet these requirements.
Duquesne is closely monitoring other potential future air quality programs and air emission control requirements that could result from more stringent ambient air quality and emission standards for SO\\2\\ and NO\\X\\ particulates and other by-products of coal combustion. Duquesne expects the Pennsylvania Department of Environmental Protection (DEP) to finalize in 1997 a regulation to implement the additional NO\\X\\ control requirements that were recommended by the Ozone Transport Commission. The estimated costs to comply with this program have been included in Duquesne's capital cost estimates through the year 2000. Since other potential programs are in various stages of discussion and consideration, it is impossible to make reasonable estimates of the potential costs and impacts, if any. Duquesne currently estimates that additional capital costs to comply with Clean Air Act requirements through the year 2000 will be approximately $20 million.
Duquesne has developed, patented and installed low NO\\X\\ burner technology for the Elrama boilers. These cost-effective NO\\X\\ reduction systems installed on the Elrama roof-fired boilers were specified as the benchmark for the industry for this class of boilers in the EPA's final Group II rulemaking. Duquesne is also currently evaluating additional low-cost, developmental NO\\X\\ reduction technologies at Cheswick and Elrama. An Artificial Neural Network control system enhancement, co-sponsored by the Electric Power Research Institute and Duquesne, will be demonstrated at Cheswick. The Gas Research Institute and Duquesne are sponsoring a targeted natural gas reburn demonstration at Elrama. Both demonstrations were initiated in 1996 and will be completed in 1997.
In 1992, the DEP issued Residual Waste Management Regulations governing the generation and management of non-hazardous residual waste, such as coal ash. Duquesne is assessing the sites it utilizes and has developed compliance strategies that are currently under review by the DEP. Capital costs of $2.5 million were incurred by Duquesne in 1996 to comply with these DEP regulations. Based on information currently available, an additional $2.8 million will be spent in 1997. The additional capital cost of compliance through the year 2000 is estimated, based on current information, to be $15 million. This estimate is subject to the results of groundwater assessments and DEP final approval of compliance plans.
Duquesne is involved in various other environmental matters. Duquesne believes that such matters, in total, will not have a materially adverse effect on its financial position, results of operations or cash flows.
Outlook - -------------------------------------------------------------------------------
Competition
The electric utility industry continues to undergo fundamental change in response to open transmission access and increased availability of energy alternatives. Under historical PUC ratemaking, regulated electric utilities were granted exclusive geographic franchises to sell electricity in exchange for making investments and incurring obligations to serve customers under the then- existing regulatory framework. Through the ratemaking process, those prudently incurred costs were recovered from customers, along with a return on the investment. Additionally, certain operating costs were approved for deferral for future recovery from customers. As a result of this historical ratemaking process, utilities have assets recorded on their balance sheets at above-market costs and have commitments to purchase power at above-market prices (transition costs).
In Pennsylvania, under the Customer Choice Act which became effective on January 1, 1997, consumers in a utility's traditional franchised territory will ultimately be able to purchase electricity at market prices from a variety of electric generation suppliers. Before the phase-in to customer choice begins in 1999, the PUC expects utilities to take vigorous steps to mitigate transition costs as much as possible without increasing the price they currently charge customers. The PUC will determine what portion of a utility's remaining transition costs will be recoverable from customers through a CTC. This charge will be paid by consumers who choose alternative generation suppliers as well as customers who choose their franchised utility. The CTC could last as long as 2005, providing a utility a total of up to nine years to recover transition costs. An overall four-and-one-half year price cap will be imposed on the transmission and distribution charges of electric utility companies. Additionally, electric utility companies may not increase the generation price component of prices as long as transition costs are being recovered, with certain exceptions. If a utility ultimately is unable to recover its transition costs within this pricing structure and timeframe, the costs will be written off.
Duquesne has already been effective in mitigating its exposure to transition costs. As the following table demonstrates, generating plant, decommissioning and related regulatory asset costs have been reduced by approximately $400 million during the past two years. These reductions have resulted from a variety of strategies, such as selling generating assets, accelerating recovery of fixed costs, increasing nuclear decommissioning charges and reducing capitalized costs. Duquesne expects to continue these steps to address its remaining transition costs. The Customer Choice Act provides another option to mitigate transition costs. With PUC approval, utilities are permitted to issue transition bonds with a maturity of 10 years or less. Proceeds can be used to reduce transition costs. Duquesne is currently reviewing this alternative as well as others to further mitigate its transition costs. (See "Regulation" and "Rate Matters" discussions on pages 1 and 5.)
Any estimate of transition costs, including those in the table above, is forward-looking and is highly dependent on estimates of the future market prices for electric power. Higher market prices for electricity reduce transition cost exposure, while lower market prices increase exposure. As part of its transition filing, Duquesne is
proposing to make a long-term sale of electricity during the transition period to determine the market rate for power. In addition to market-related impacts, any estimate of the ultimate level of transition costs also depends on, among other things, the extent to which such costs are deemed recoverable by the PUC, the ongoing level of Duquesne's costs of operations, regional and national economic conditions, and growth of Duquesne's sales. Duquesne anticipates making its transition filing, including the identification of potential transition costs, as required by the PUC by August 1, 1997. The PUC is expected to rule on Duquesne's ability to recover these costs through a CTC by May 1, 1998. Duquesne believes, based upon prior rulings of the PUC, that it is entitled to recover substantially all of its transition costs, but cannot predict the outcome of this regulatory process. In the event that the PUC rules that any or all of these transition costs cannot be recovered through a CTC mechanism or Duquesne fails to satisfy the requirements of SFAS No. 71, these costs will be written off. As Duquesne has substantial exposure to transition costs relative to its size, significant transition cost write-offs could have a materially adverse effect on Duquesne's financial position, results of operations and cash flows. Various financial covenants and restrictions could be violated if substantial write-off of assets or recognition of liabilities occurs.
In addition to the mitigation of transition costs, Duquesne has been preparing for competition in a variety of ways. Duquesne has been building its financial strength through the retirement and refinancing of long-term debt. In 1995, Duquesne's restrictive first mortgage bond indenture was replaced with a new indenture with more flexible provisions. In 1996, Duquesne issued MIPS to further add to its financial flexibility and creditworthiness.
Duquesne has better positioned its business for competition through improving operations and enhancing customer relations. In recognition of impending industry competition and in an effort to optimize its generation resources, in 1989 Duquesne signed a contract with Delmarva Power for a bulk power sale for a period of 20 years. This initiative would have resulted in the refurbishment and return to service of Duquesne's cold-reserved generating stations. Following the plan's failure to receive regulatory approval, in 1990 Duquesne announced a second long-term power sale initiative to restart these power plants. This plan would have provided significant impetus to economic development in Pennsylvania as well as providing Duquesne's customers with substantial benefits in the form of lower rates. Duquesne's efforts to upgrade and maintain the cold-reserved units have enabled Duquesne to utilize the BI units to meet peak demand during periods of extreme weather in recent years and have enabled the BI units to more quickly return to service as part of the Ft. Martin sale. In 1991, Duquesne reorganized into strategic business units along market lines and instituted cost reduction targets for capital, operation and maintenance, and inventory expenditures. Workforce reductions were achieved primarily through attrition. Since 1989 Duquesne has reduced its number of employees by 25 percent. Recently, Duquesne signed a three-year contract extension with its bargaining unit employees through September 2001. Throughout the period, Duquesne has been aggressively reducing its fuel costs, achieving a 13 percent reduction in the unit cost of fuel since 1990. These measures have enabled Duquesne to reduce its rates by nearly 36 percent, in real terms, since 1990. When considering the price freeze component of Duquesne's Mitigation Plan, prices will have declined by nearly 50 percent in real terms during the decade of the 1990s. From a customer relations standpoint, Duquesne negotiated long- term contracts with more than 30 key industrial and commercial customers and was recognized in 1996 for its economic development efforts in attracting major new industrial expansions. In 1995, Duquesne became one of the first electric utilities in the country to offer a full customer service guarantee and also guaranteed to match any competing electricity supplier's price for new businesses or for the expansion of existing businesses. Duquesne also is offering to customers increased bill-paying options, including an advanced technology service that enables customers to electronically receive and pay their electric bills. This service assists major customers just as its earlier Electricheck option helped smaller commercial and residential customers. Additionally, Duquesne will be positioned to offer customers a wide range of new services with the Customer Advanced Reliability System (CARS). Utility customers will be linked to CARS by encoder receiver transmitters contained in new or retrofitted electric meters. Data communications offered by this technology are expected to result in improved reliability, security, and customer satisfaction.
At the national level, in 1996 the FERC issued two related final rules that address the terms on which electric utilities will be required to provide wholesale suppliers of electric energy with non-discriminatory access to the utility's wholesale transmission system. The first rule, Order No. 888, requires each public utility that owns, controls or operates interstate transmission facilities to file a tariff offering unbundled transmission services containing non-rate terms that conform to the FERC's pro forma tariff. Order No. 888 also allows full recovery of prudently incurred costs from departing customers. FERC deferred to state regulators with respect to retail access, recovery of retail transition costs and the scope of state regulatory jurisdiction. The second rule, Order No. 889, prohibits transmission owners and their affiliates from gaining preferential access to information concerning transmission and establishes a code of conduct to ensure the complete separation of a utility's wholesale power marketing and transmission operation functions.
Finally, the FERC simultaneously issued a new Notice of Proposed Rulemaking (NOPR) on Capacity Reservation Open Access Transmission Tariffs (CRT), which would require all market participants to reserve firm capacity rights between designated receipt and delivery points. If adopted, the CRT would replace the open access pro forma tariff implemented in Order No. 888. (See "Transmission Access" discussion below.)
Duquesne is aware of the foregoing state and federal regulatory and business uncertainties and is attempting to position itself to effectively operate in a more competitive environment.
Transmission Access
In March 1994, Duquesne submitted, pursuant to the Federal Power Act, two separate "good faith" requests for transmission service with APS and the Pennsylvania-New Jersey-Maryland Interconnection Association (PJM Companies). Because of a lack of progress on pricing and other issues, Duquesne subsequently filed with the FERC applications for transmission service. In May 1995, the FERC instructed APS and the PJM Companies to provide transmission service to Duquesne and directed the parties to negotiate specific rates, terms and conditions. No terms were agreed to, and briefs were filed with the FERC outlining the areas of disagreement. The matter is now pending before the FERC. In July 1996, Duquesne filed with the FERC a request for acceptance of a capacity reservation tariff to replace the previously filed FERC Order No. 888 pro forma tariff. (See "Competition" discussion on page 13.) Duquesne's tariff proposes to adopt marginal cost pricing for transmission service on Duquesne's transmission system. In February 1997, the FERC rejected Duquesne's tariff filing, but permitted Duquesne to request a hearing to determine whether Duquesne's tariff is just and reasonable as well as consistent with or superior to the Order No. 888 pro forma tariff. Duquesne has requested such a hearing.
Duquesne is currently evaluating the impact of FERC regulatory actions on these proceedings. Duquesne cannot predict the final outcome of these proceedings.
Beaver Valley Power Station (BVPS) Steam Generators
BVPS's two units are equipped with steam generators designed and built by Westinghouse Electric Corporation (Westinghouse). Similar to other Westinghouse nuclear plants, outside diameter stress corrosion cracking (ODSCC) has occurred in the steam generator tubes of both units. The units continue to have the capability to operate at 100 percent reactor power although 15 percent of BV Unit 1 and 2 percent of BV Unit 2 steam generator tubes have been removed from service. Material acceleration in the rate of ODSCC could lead to a loss in plant efficiency and significant repairs or replacement of BV Unit 1 steam generators. The total replacement cost of the BV Unit 1 steam generators is estimated at $125 million, $59 million of which would be Duquesne's responsibility. The earliest that the BV Unit 1 steam generators could be replaced during a scheduled refueling outage is the fall of 2000.
Other - -------------------------------------------------------------------------------
Retirement Plan Measurement Assumptions
Duquesne increased the discount rate used to determine the projected benefit obligation on Duquesne's retirement plans at December 31, 1996 to 7.5 percent. The assumed change in future compensation levels and assumed rate of return on plan assets were also increased to reflect current market and economic conditions. The effects of these changes on Duquesne's retirement plan obligations are reflected in the amounts shown in "Employee Benefits," Note N to the consolidated financial statements, on page 55. The resulting change in related expenses for subsequent years is not expected to be material.
Except for historical information contained herein, the matters discussed in this Annual Report on Form 10-K, are forward-looking statements that involve risks and uncertainties including, but not limited to, economic, competitive, governmental and technological factors affecting Duquesne's operations, markets, products, services and prices, and other factors discussed in Duquesne's filings with the Securities and Exchange Commission.
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Executive Officers of the Registrant
Set forth below are the names, ages as of March 1, 1997, positions and brief accounts of the business experience during the past five years of the executive officers of Duquesne.
Item 2.
Item 2. Properties.
Duquesne's properties consist of electric generating stations, transmission and distribution facilities, and supplemental properties and appurtenances, comprising as a whole an integrated electric utility system, located in Allegheny, Beaver and Westmoreland counties in southwestern Pennsylvania.
Duquesne owns all or a portion of the following generating units except Beaver Valley Unit 2, which is leased.
(1) Amounts represent Duquesne's share of the unit which is owned by Duquesne in common with one or more other electric utilities (or, in the case of Beaver Valley Unit 2, leased by Duquesne).
(2) Amount represents Duquesne's share of the unit, which was sold on October 31, 1996.
Duquesne owns 24 transmission substations (including interests in common in the step-up transformers at Sammis Unit 7; Eastlake Unit 5; Bruce Mansfield Unit 1; Beaver Valley Unit 1; Beaver Valley Unit 2; Perry Unit 1; Bruce Mansfield Unit 2; and Bruce Mansfield Unit 3) and 562 distribution substations. Duquesne has 714 circuit-miles of transmission lines, comprising 345,000, 138,000 and 69,000 volt lines. Street lighting and distribution circuits of 23,000 volts and less include approximately 50,000 miles of lines and cable.
Duquesne owns the Warwick Mine, including 4,849 acres owned in fee of unmined coal lands and mining rights, located on the Monongahela River in Greene County, Pennsylvania, approximately 83 river miles from Pittsburgh. (See Item 1. BUSINESS. "Fossil Fuel" discussion on page 9.)
Additional information relating to Item 2. PROPERTIES, is set forth in Note D, "Property, Plant and Equipment," of the consolidated financial statements for year ended December 31, 1996, on page 42. The information is incorporated here by reference.
Item 3.
Item 3. Legal Proceedings.
Rate-Related Legal Proceedings, Property, Plant and Equipment-Related Legal Proceedings and Environmental Legal Proceedings - --------------------------------------------------------------------------------
Eastlake Unit 5
In September 1995, Duquesne commenced arbitration against CEI, seeking damages, termination of the Operating Agreement for Eastlake Unit 5 (Eastlake) and partition of the parties' interests in Eastlake through a sale and division of the proceeds. The arbitration demand alleged, among other things, the improper allocation by CEI of fuel and related costs; the mismanagement of the administration of the Saginaw coal contract in connection with the closing of the Saginaw mine, which historically supplied coal to Eastlake; and the concealment by CEI of material information. In October 1995, CEI commenced an action against Duquesne in the Court of Common Pleas, Lake County, Ohio seeking to enjoin Duquesne from taking any action to effect a partition on the basis of a waiver of partition covenant contained in the deed to the land underlying Eastlake. CEI also seeks monetary damages from Duquesne for alleged unpaid joint costs in connection with the operation of Eastlake. Duquesne removed the action to the United States District Court for the Northern District of Ohio, Eastern Division, where it is now pending. Currently, the parties are engaged in settlement discussions. To provide the parties with the opportunity to settle their claims, the court has postponed litigation proceedings until April 1, 1997.
Proceedings involving Duquesne's rates are reported in Item 1. BUSINESS "Rate Matters." Proceedings involving Property, Plant and Equipment are reported in Item 1. BUSINESS "Property, Plant and Equipment." Proceedings involving environmental matters are reported in Item 1. BUSINESS "Environmental Matters."
Item 4.
Item 4. Submission of Matters to a Vote Of Security Holders.
Not applicable.
Part II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters.
Duquesne's common stock is not publicly traded. Effective July 7, 1989, Duquesne became a wholly owned subsidiary of DQE, the holding company formed as part of a shareholder-approved restructuring. As a result of the restructuring, Duquesne's shareholders received DQE common stock in exchange for their shares of Duquesne common stock, which were cancelled. DQE owns all of Duquesne's outstanding common stock, which consists of 10 shares. As such, this item is not applicable to Duquesne because all its common equity is held solely by DQE. During 1996 and 1995, Duquesne declared quarterly dividends on its common stock totaling $276 million and $144 million, respectively.
Item 6.
Item 6. Selected Financial Data.
Selected financial data for Duquesne for each of the six years in the period ended December 31, 1996, are set forth on page 59. The financial data is incorporated here by reference.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Management's discussion and analysis of financial condition and results of operations are set forth in Item 1. BUSINESS. The discussion and analysis are incorporated here by reference.
Item 8.
Item 8. Consolidated Financial Statements and Supplementary Data.
The Consolidated Balance Sheet of Duquesne Light Company and its subsidiary as of December 31, 1996 and 1995, and the related Statements of Consolidated Income, Retained Earnings and Cash Flows for each of the three years in the period ended December 31, 1996, together with the Independent Auditors' Report dated January 28, 1997, are set forth in pages 34 to 58 of this Report. The consolidated financial statements and report are incorporated here by reference. Quarterly financial information is included on page 58 in Note O to Duquesne's consolidated financial statements and is incorporated here by reference.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Part III
Item 10.
Item 10. Directors and Executive Officers of the Registrant.
All directors of DQE are also directors of Duquesne. Information relating to DQE's and Duquesne's board of directors is set forth on page 6 of the 1996 DQE Annual Report to Shareholders filed here as part of this Report in Exhibit 99.2. The information is incorporated here by reference. Information relating to the executive officers of the Registrant is set forth in Part I of this Report under the caption "Executive Officers of the Registrant."
Item 11.
Item 11. Executive Compensation.
The information relating to executive compensation is set forth in Exhibit 99.1, filed as part of this Report. The information is incorporated here by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
DQE is the beneficial owner and holder of all shares of outstanding Common Stock, $1 par value, of Duquesne Light, consisting of 10 shares as of February 21, 1997. Information relating to the ownership of equity securities of DQE and Duquesne Light by directors and executive officers of Duquesne Light is set forth in Exhibit 99.1, filed as part of this Report. The information is incorporated here by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions.
None.
Part IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a)(1) The following information is set forth here on pages 34 through 58:
Report of Independent Certified Public Accountants.
Statement of Consolidated Income for the Three Years Ended December 31, 1996.
Consolidated Balance Sheet, December 31, 1996 and 1995.
Statement of Consolidated Cash Flows for the Three Years Ended December 31, 1996.
Statement of Consolidated Retained Earnings for the Three Years Ended December 31, 1996.
Notes to Consolidated Financial Statements.
(a)(2) The following financial statement schedule and the related Report of Independent Certified Public Accountants (See pages 32 and 34.) are filed here as a part of this Report:
Schedule for the Three Years Ended December 31, 1996:
II- Valuation and Qualifying Accounts.
The remaining schedules are omitted because of the absence of the conditions under which they are required or because the information called for is shown in the financial statements or notes to the financial statements.
(a)(3) Exhibits are set forth in the Exhibits Index on pages 21 through 31, and incorporated here by reference. Documents other than those designated as being filed here are incorporated here by reference. Previously filed documents incorporated by reference to a DQE Annual Report on Form 10-K, a Quarterly Report on Form 10-Q or a Current Report on Form 8-K are at Securities and Exchange Commission File No. 1-10290. Documents incorporated by reference to a Duquesne Light Company Annual Report on Form 10-K, Quarterly Report on Form 10-Q or a Current Report on Form 8-K are at Securities and Exchange Commission File No. 1-956. The Exhibits include the management contracts and compensatory plans or arrangements required to be filed as exhibits to this Form 10-K by Item 601(d)(10)(iii), of Regulation S-K.
(b) Reports on Form 8-K filed during the twelve months ended December 31, 1996:
(1) May 13, 1996 - The following event was reported:
Item 7. Statement re: Calculation of Ratio of Earnings to Combined Fixed Charges and Preferred and Preference Stock Dividend Requirements.
No financial statements were filed with this report.
x An additional document, substantially identical in all material respects to this Exhibit, has been entered into relating to one additional limited partnership Owner Participant. Although the additional document may differ in some respects (such as name of the Owner Participant, dollar amounts and percentages), there are no material details in which the document differs from this Exhibit.
y Additional documents, substantially identical in all material respects to this Exhibit, have been entered into relating to four additional corporate Owner Participants. Although the additional documents may differ in some respects (such as names of the Owner Participants, dollar amounts and percentages), there are no material details in which the documents differ from this Exhibit.
z Additional documents, substantially identical in all material respects to this Exhibit, have been entered into relating to six additional Owner Participants. Although the additional documents may differ in some respects (such as names of the Owner Participants, dollar amounts and percentages), there are no material details in which the documents differ from this Exhibit.
Copies of the exhibits listed above will be furnished, upon request, to holders or beneficial owners of any class of Duquesne's stock as of February 21, 1997, subject to payment in advance of the cost of reproducing the exhibits requested.
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SCHEDULE II
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS For the Years Ended December 31, 1996, 1995 and 1994 (Thousands of Dollars)
Notes: (A) Recovery of accounts previously written off. (B) Accounts receivable written off.
Signatures
Pursuant to the requirements of Section 13 or 15(d) 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.
DUQUESNE LIGHT COMPANY (Registrant)
Date: March 25, 1997 By: /s/ David D. Marshall ----------------------------- (Signature) David D. Marshall President, Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Report of Independent Certified Public Accountants
To the Directors and Stockholder of Duquesne Light Company:
We have audited the accompanying consolidated balance sheet of Duquesne Light Company (a wholly owned subsidiary of DQE) and its subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, retained earnings, and cash flows for each of the three years in the period ended December 31, 1996. Our audits also included the financial statement schedule listed in the Index at Item 14. These financial statements and financial statement schedule are the responsibility of Duquesne's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
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 provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Duquesne Light Company and its subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ Deloitte & Touche LLP DELOITTE & TOUCHE LLP Pittsburgh, Pennsylvania January 28, 1997
See notes to consolidated financial statements.
See notes to consolidated financial statements.
See notes to consolidated financial statements.
Supplemental Cash Flow Information
See notes to consolidated financial statements.
See notes to consolidated financial statements.
Notes to Consolidated Financial Statements
A. Summary of Significant Accounting Policies
Consolidation - -------------------------------------------------------------------------------- Duquesne Light Company (Duquesne) is a wholly owned subsidiary of DQE, an energy services holding company. Duquesne is engaged in the production, transmission, distribution and sale of electric energy. Duquesne has one wholly owned subsidiary, Monongahela Light and Power which makes long-term investments.
All material intercompany balances and transactions have been eliminated in the preparation of the consolidated financial statements of Duquesne.
Basis of Accounting - -------------------------------------------------------------------------------- Duquesne is subject to the accounting and reporting requirements of the United States Securities and Exchange Commission (SEC). In addition, Duquesne's operations are subject to regulation by the Pennsylvania Public Utility Commission (PUC) and the Federal Energy Regulatory Commission (FERC) under the Federal Power Act with respect to rates for interstate sales, transmission of electric power, accounting and other matters.
Duquesne's consolidated financial statements report regulatory assets and liabilities in accordance with Statement of Financial Accounting Standards No. 71, Accounting for the Effects of Certain Types of Regulation (SFAS No. 71), and reflect the effects of the current ratemaking process. In accordance with SFAS No. 71, Duquesne's consolidated financial statements reflect regulatory assets and liabilities consistent with cost-based, pre-competition ratemaking regulations. (See "Rate Matters," Note F, on page 44.)
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. The reported amounts of revenues and expenses during the reporting period may also be affected by the estimates and assumptions management is required to make. Actual results could differ from those estimates.
Revenues from Sales of Electricity - -------------------------------------------------------------------------------- Meters are read monthly and electric utility customers are billed on the same basis. Revenues are recorded in the accounting periods for which they are billed, with the exception of energy cost recovery revenues. (See "Energy Cost Rate Adjustment Clause (ECR)" discussion on page 40.)
Duquesne's Electric Service Territory - -------------------------------------------------------------------------------- Duquesne provides electric service to customers in Allegheny County, including the City of Pittsburgh, Beaver County and Westmoreland County. This represents approximately 800 square miles in southwestern Pennsylvania, located within a 500-mile radius of one-half of the population of the United States and Canada. The population of the area served by Duquesne's operations, based on 1990 census data, is approximately 1,510,000, of whom 370,000 reside in the City of Pittsburgh. In addition to serving approximately 580,000 direct customers, Duquesne also sells electricity to other utilities.
Energy Cost Rate Adjustment Clause (ECR) - -------------------------------------------------------------------------------- Through the ECR, Duquesne recovers (to the extent that such amounts are not included in base rates) nuclear fuel, fossil fuel and purchased power expenses and, also through the ECR, passes to its customers the profits from short-term power sales to other utilities (collectively, ECR energy costs). Nuclear fuel expense is recorded on the basis of the quantity of electric energy generated and includes such costs as the fee imposed by the United States Department of Energy (DOE) for future disposal and ultimate storage and disposition of spent nuclear fuel. Fossil fuel expense includes the costs of coal, natural gas and fuel oil used in the generation of electricity.
On Duquesne's statement of consolidated income, these ECR revenues are included as a component of operating revenues. For ECR purposes, Duquesne defers fuel and other energy expenses for recovery, or refunding, in subsequent years. The deferrals reflect the difference between the amount that Duquesne is currently collecting from customers and its actual ECR energy costs. The PUC annually reviews Duquesne's ECR energy costs for the fiscal year April through March, compares them to previously projected ECR energy costs, and adjusts the ECR for over- or under-recoveries and for two PUC-established coal cost standards. (See "Deferred Coal Costs" and "Warwick Mine Costs" discussions, Note F, on pages 45 and 46.)
Over- or under-recoveries from customers are recorded in the consolidated balance sheet as payable to, or receivable from, customers. At December 31, 1996 and 1995, $1.8 million and $5.8 million were payable to customers and shown as other current liabilities.
Under the Electricity Generation Customer Choice and Competition Act (Customer Choice Act), Duquesne may replace the ECR effective April 1, 1997 by rolling its ECR energy costs into its base rates. The effect of this change would be to provide to Duquesne an opportunity to further mitigate its deferred energy costs based upon its ability to manage its energy costs. Under Duquesne's PUC-approved Mitigation Plan, the level of energy cost recovery is capped at 1.47 cents per kilowatt-hour (KWH) through May 2001. To the extent that projections do not support recovery of previously deferred costs through this pricing mechanism, these costs would become transition costs subject to recovery through a competitive transition charge (CTC). (See "Customer Choice Act" and "Mitigation Plan" discussions, Note F, on page 44.)
Maintenance - -------------------------------------------------------------------------------- Incremental maintenance expense incurred for refueling outages at Duquesne's nuclear units is deferred for amortization over the period between refueling outages (generally 18 months). Duquesne accrues, over the periods between outages, anticipated expenses for scheduled major fossil generating station outages. Maintenance costs incurred for non-major scheduled outages and for forced outages are charged to expense as such costs are incurred.
Depreciation and Amortization - -------------------------------------------------------------------------------- Depreciation of property, plant and equipment, including plant-related intangibles, is recorded on a straight-line basis over the estimated remaining useful lives of properties. Amortization of other intangibles is recorded on a straight-line basis over a five-year period. Depreciation and amortization of other properties are calculated on various bases.
Duquesne records decommissioning costs under the category of depreciation and amortization expense and accrues a liability, equal to that amount, for nuclear decommissioning expense. On Duquesne's consolidated balance sheet, the decommissioning trusts have been reflected in other long-term investments, and the related liability has been recorded as other non-current liabilities. (See "Nuclear Decommissioning" discussion, Note J, on page 49.)
Duquesne's composite depreciation rate increased from 3.5 percent to 4.25 percent effective May 1, 1996 and 3.0 percent to 3.5 percent effective January 1, 1995. Also in 1996, Duquesne expensed $9 million related to the depreciation portion of deferred rate synchronization costs in conjunction with Duquesne's Mitigation Plan.
Income Taxes - -------------------------------------------------------------------------------- Duquesne uses the liability method in computing deferred taxes on all differences between book and tax bases of assets. These book/tax differences occur when events and transactions recognized for financial reporting purposes are not recognized in the same period for tax purposes. The deferred tax liability or asset is also adjusted in the period of enactment for the effect of changes in tax laws or rates.
Duquesne recognizes a regulatory asset for the deferred tax liabilities that are expected to be recovered from customers through rates. (See "Rate Matters," Note F, and "Income Taxes," Note H, on pages 44 and 46.)
Duquesne reflects the amortization of the regulatory tax receivable resulting from reversals of deferred taxes as depreciation and amortization expense. Reversals of accumulated deferred income taxes are included in income tax expense.
When applied to reduce Duquesne's income tax liability, investment tax credits related to electric utility property generally are deferred. Such credits are subsequently reflected, over the lives of the related assets, as reductions to income tax expense.
Property, Plant and Equipment - -------------------------------------------------------------------------------- The asset values of Duquesne's properties are stated at original construction cost, which includes related payroll taxes, pensions and other fringe benefits, as well as administrative and general costs. Also included in original construction cost is an allowance for funds used during construction (AFC), which represents the estimated cost of debt and equity funds used to finance construction.
Additions to, and replacements of, property units are charged to plant accounts. Maintenance, repairs and replacement of minor items of property are recorded as expenses when they are incurred. The costs of properties that are retired (plus removal costs and less any salvage value) are charged to accumulated depreciation and amortization.
Substantially all of Duquesne's properties are subject to a first mortgage lien.
Asset Impairment - -------------------------------------------------------------------------------- The effects of adopting Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of (SFAS No. 121), on January 1, 1996 did not have a material impact on Duquesne's financial position, results of operations or cash flows, based on the current regulatory structure in which it operates. As competitive factors influence pricing in the utility industry, this assessment may change in the future. The general requirements of SFAS No. 121 apply to non- current assets and require impairment to be considered whenever evidence suggests that it is no longer probable that future cash flows in an amount at least equal to the asset book value will result.
Stock-Based Compensation - -------------------------------------------------------------------------------- Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS No. 123) encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. Duquesne has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of DQE's stock at the date of the grant over the amount an employee must pay to acquire the stock. Compensation cost for stock appreciation rights is recorded annually based on the quoted market price of DQE's stock at the end of the period.
Temporary Cash Investments - -------------------------------------------------------------------------------- Temporary cash investments are short-term, highly liquid investments with original maturities of three or fewer months. They are stated at market, which approximates cost. Duquesne considers temporary cash investments to be cash equivalents.
Reclassifications - ------------------------------------------------------------------------------- The 1995 and 1994 consolidated financial statements have been reclassified to conform with accounting presentations adopted during 1996.
B. Receivables
Duquesne and an unaffiliated corporation have an agreement that entitles Duquesne to sell, and the corporation to purchase, on an ongoing basis, up to $50 million of accounts receivable. Duquesne had no receivables sold at December 31, 1996. At December 31, 1995, Duquesne had sold $7 million of receivables to the unaffiliated corporation. The accounts receivable sales agreement, which expires in June 1997, is one of many sources of funds available to Duquesne. Duquesne has not determined, but may attempt to extend the agreement or to replace the facility with a similar arrangement or to eliminate it upon expiration.
C. Changes in Working Capital Other Than Cash
D. Property, Plant and Equipment
In addition to its wholly owned generating units, Duquesne, together with other electric utilities, has an ownership or leasehold interest in certain jointly owned units. Duquesne is required to pay its share of the construction and operating costs of the units. Duquesne's share of the operating expenses of the units is included in the statement of consolidated income.
(a) The unit is equipped with flue gas desulfurization equipment. (b) The Nuclear Regulatory Commission (NRC) has granted a license to operate through January 2016. (c) On October 2, 1987, Duquesne sold its 13.74 percent interest in Beaver Valley Unit 2 and leased it back; the sale was exclusive of transmission and common facilities. Amounts shown represent facilities not sold and subsequent leasehold improvements. (d) The NRC has granted a license to operate through May 2027. (e) The NRC has granted a license to operate through March 2026. (f) A portion of the proceeds of the sale of the Ft. Martin Power Station is expected to be used to fund reliability enhancements to the Brunot Island (BI) Unit 3 combustion turbine. The reliability enhancements are contingent upon the projects meeting a least-cost test versus other potential sources of peaking capacity. BI Units 2a and 2b were moved from property held for future use to electric plant in service in 1996, in accordance with Duquesne's Mitigation Plan. (See "Mitigation Plan" discussion, Note F, on page 44.)
E. Long-Term Investments
At December 31, 1996 and 1995, the fair market value of Duquesne's investment in DQE common stock was $59.3 million and $66.8 million. At December 31, 1996 and 1995, the cost of Duquesne's investment in DQE common stock was $40.3 million and $43.9 million.
Duquesne makes equity investments in affordable housing. At December 31, 1996, Duquesne had investments in eight affordable housing developments.
Deferred income primarily relates to Duquesne's lease investments. Deferred amounts will be recognized as income over the lives of the underlying lease investments over periods generally not exceeding five years.
Duquesne's other investments are primarily in assets of nuclear decommissioning trusts and marketable securities. In accordance with SFAS No. 115, these investments are classified as available-for-sale and are stated at market value. The amount of unrealized holding gains related to marketable securities at both December 31, 1996 and 1995 are $19.0 million and $22.9 million ($11.1 million and $13.4 million net of tax).
F. Rate Matters
Customer Choice Act - ------------------------------------------------------------------------------- Under the Customer Choice Act, which went into effect on January 1, 1997, Pennsylvania has become a leader in customer choice. The Customer Choice Act will enable Pennsylvania's electric utility customers to purchase electricity at market prices from a variety of electric generation suppliers (customer choice). Electric utility restructuring will be accomplished through a two-stage process consisting of a pilot period (running through 1998) and a phase-in period (1999 through 2001). Before the phase-in to customer choice begins in 1999, the PUC expects utilities to take vigorous steps to mitigate transition costs as much as possible without increasing the price they currently charge customers. The PUC will determine what portion of a utility's remaining transition costs will be recoverable from customers through a CTC. This charge will be paid by consumers who choose alternative generation suppliers as well as customers who choose their franchised utility. The CTC could last as long as 2005, providing a utility a total of up to nine years to recover transition costs. An overall four-and-one-half year price cap will be imposed on the transmission and distribution charges of electric utility companies. Additionally, electric utility companies may not increase the generation price component of prices as long as transition costs are being recovered, with certain exceptions. If a utility ultimately is unable to recover its transition costs within this pricing structure and timeframe, the costs will be written off.
Mitigation Plan - -------------------------------------------------------------------------------
Duquesne has taken a number of steps to mitigate its potential transition costs. In addition to the steps taken during the last 10 years to prepare for competition, effective January 1, 1995, Duquesne accelerated its rate of depreciation on its fixed nuclear assets without seeking a rate increase to recover the additional costs. On October 31, 1996, the sale of Duquesne's ownership interest in the Ft. Martin Power Station (Ft. Martin) was completed. Ft. Martin Unit 1 was owned 50 percent by Duquesne and 50 percent by its operator, Allegheny Power System. The sale and a plan, to be funded in part by the proceeds of the Ft. Martin transaction, were approved by the PUC on May 23, 1996. Under the approved plan, Duquesne will not increase its base rates for a period of five years through May 2001. In addition, Duquesne recorded in October 1996 a one-time reduction of approximately $130 million in the book value of Duquesne's nuclear plant investment. The proceeds from the sale are expected to be used to fund reliability enhancements to the BI Unit 3 combustion turbine and to reduce Duquesne's capitalization. The approved plan also provides for incremental increases of $25 million in depreciation and amortization expense in 1996, 1997 and 1998 related to Duquesne's nuclear investment, as well as additional annual contributions to its nuclear plant decommissioning funds of $5 million, without any increase in existing electric rates. Also, Duquesne will record an annual $5 million credit to the ECR during the plan period to compensate Duquesne's customers for lost profits from any short-term power sales foregone by the sale of its ownership interest in Ft. Martin. In addition, Duquesne will cap energy costs, beginning April 1, 1997 through the remainder of the plan period, at a historical five-year average of 1.47 cents per KWH. In accordance with the approved plan, Duquesne has expensed $9 million related to the depreciation portion of the deferred rate synchronization costs associated with Beaver Valley Unit 2 (BV Unit 2) and Perry Unit 1. Duquesne's approved plan provides for the amortization of the remaining deferred rate synchronization costs over a 10-year period. At December 31, 1996, the unamortized portion of these costs totaled $41.4 million, net of deferred fuel savings related to the two units. (See "Deferred Rate Synchronization Costs" discussion on page 45.) Finally, Duquesne's approved plan also provides for annual assistance of $0.5 million to low-income customers.
Regulatory Assets - ------------------------------------------------------------------------------- As a result of the application of SFAS No. 71, Duquesne records regulatory assets on its consolidated balance sheet. The regulatory assets represent probable future revenue to Duquesne because provisions for these costs are currently included, or are expected to be included, in charges to electric utility customers through the ratemaking process.
A company's electric utility operations or a portion of such operations could cease to meet the SFAS No. 71 criteria for various reasons, including a change in the FERC regulations or the competition-related changes in the PUC regulations. (See "Customer Choice Act" discussion above.) Duquesne currently believes its electricity generating assets and related regulatory assets continue to satisfy these criteria in
light of the transition to competitive generation under the Customer Choice Act. Should any portion of Duquesne's electric utility operations be deemed to no longer meet the SFAS No. 71 criteria, Duquesne may be required to write off any above-market cost assets, the recovery of which is uncertain, and any regulatory assets or liabilities for those operations that no longer meet these requirements.
(a) The premiums paid to reacquire debt prior to scheduled maturity dates are deferred for amortization over the life of the debt issued to finance the reacquisitions. (b) The premium paid to refinance the BV Unit 2 lease was deferred for amortization over the life of the lease. (c) Includes amounts for recovery of accrued compensated absences and accrued claims for workers' compensation. (d) During the third quarter of 1996, Duquesne completed recovery of its investment in Perry Unit 2.
Deferred Rate Synchronization Costs - ------------------------------------------------------------------------------- In 1987, the PUC approved Duquesne's petition to defer initial operating and other costs of BV Unit 2 and Perry Unit 1. Duquesne deferred the costs incurred from November 1987, when the units went into commercial operation, until March 1988, when a rate order was issued. In its rate order, the PUC postponed ruling on whether these costs would be recoverable from Duquesne's customers. Duquesne is not earning a return on the deferred costs. (See "Mitigation Plan" discussion on page 44.)
Deferred Coal Costs - ------------------------------------------------------------------------------- The PUC has established two market price coal cost standards for Duquesne. One applies only to coal delivered at the Bruce Mansfield Power Station (Bruce Mansfield). The other, the system-wide coal cost standard, applies to coal delivered to the remainder of Duquesne's system. Both standards are updated monthly to reflect prevailing market prices of similar coal. The PUC has directed Duquesne to defer recovery of the delivered cost of coal to the extent that such cost exceeds generally prevailing market prices for similar coal, as determined by the PUC. The PUC allows deferred amounts to be recovered from customers when the delivered costs of coal fall below such PUC-determined prevailing market prices.
In 1990, the PUC approved a joint petition for settlement that clarified certain aspects of the system-wide coal cost standard. Duquesne has exercised options to extend the coal cost standard through March 2000. The unrecovered cost of Bruce Mansfield coal was $9.6 million and $8.4 million, and the unrecovered cost of the remainder of the system-wide coal was $2.6 million and $4.4 million at December 31, 1996 and 1995. Duquesne believes that all deferred coal costs will be recovered.
Warwick Mine Costs - ------------------------------------------------------------------------------- The 1990 joint petition for settlement also recognized costs at Duquesne's Warwick Mine, which had been excluded from rate base since 1981, and allowed for recovery of such costs, including the costs of ultimately closing the mine. (See "Deferred Coal Costs" discussion on page 45.) In 1990, Duquesne entered into an agreement under which an unaffiliated company will operate the mine until March 2000 and sell the coal produced. Production began in late 1990. The contract operator at Warwick Mine notified Duquesne that its financial circumstances and geologic conditions caused it to cease operations late in 1996. Therefore, Duquesne is pursuing its remedies and is currently negotiating to retain an operator for the mine as a smaller sized operation. Additionally, Duquesne will continue to purchase coal on the open market. In the past year, the Warwick Mine supplied slightly less than one-fifth of the coal used in the production of electricity at Duquesne's wholly owned and jointly owned plants. This change should not impact Duquesne's ability to recover all of its investment in Warwick Mine, the $2.6 million of unrecovered system-wide cost of coal which excludes Bruce Mansfield, or to accrue funds for future liabilities. It is anticipated that this effort will be successfully completed by March 31, 2000 when the system-wide coal cost cap expires.
Costs at the Warwick Mine and Duquesne's investment in the mine are expected to be recovered through the cost of coal in the ECR. Recovery is subject to the system-wide coal cost standard and the cap agreed to as part of Duquesne's Mitigation Plan. Duquesne also has an opportunity to earn a return on its investment in the mine through the cost of coal during the period of the system-wide coal cost standard, including extensions. At December 31, 1996, Duquesne's net investment in the mine was $11.4 million. The current estimated liability for mine closing, including final site reclamation, mine water treatment and certain labor liabilities, is $47.6 million, and Duquesne has recorded a liability on the consolidated balance sheet of approximately $20.2 million toward these costs.
Property Held for Future Use - ------------------------------------------------------------------------------- In 1986, the PUC approved Duquesne's request to remove Phillips Power Station (Phillips) and a portion of Brunot Island (BI) from service and from rate base. In accordance with Duquesne's Mitigation Plan, 112 MWs related to BI Units 2a and 2b were moved from property held for future use to electric plant in service in 1996. Duquesne expects to recover its investment in BI Units 3 and 4, which remain in property held for future use through future electricity sales. Duquesne believes its investment in BI will be necessary in order to meet future business needs. A portion of the proceeds of the sale of Ft. Martin is expected to be used to fund reliability enhancements to the BI Unit 3 combustion turbine. The reliability enhancements are contingent upon the projects meeting a least-cost test versus other potential sources of peaking capacity. (See "Mitigation Plan" discussion on page 44.) Duquesne is analyzing the effects of customer choice on its future generating requirements. Duquesne is planning to seek recovery of its investment and associated costs of Phillips through a CTC. In the event that market demand, transmission access or rate recovery do not support the utilization of these plants, Duquesne may have to write off part or all of these investments and associated costs. At December 31, 1996, Duquesne's net of tax investment in Phillips and BI held for future use was $53.6 million and $17.2 million.
G. Short-Term Borrowing and Revolving Credit Arrangements
At December 31, 1996, Duquesne had a $150 million extendible revolving credit arrangement expiring in October 1997. Interest rates can, in accordance with the option selected at the time of the borrowing, be based on prime, Eurodollar or certificate of deposit rates. Commitment fees are based on the unborrowed amount of the commitment. The credit facility contains a two-year repayment period for any amount outstanding at the expiration of the revolving credit period. At December 31, 1996 and 1995, there were no short-term borrowings outstanding.
H. Income Taxes
Since DQE's formation in 1989, Duquesne has filed consolidated federal income tax returns with its parent and other companies in the affiliated group. The annual federal corporate income tax returns have been audited by the Internal Revenue Service (IRS) for the tax years through 1992. The tax years 1993 through 1996 remain subject to IRS review. Duquesne does not believe that final settlement of the federal income tax returns for the years 1991 through 1996 will have a materially adverse effect on its financial position, results of operations or cash flows.
Total income taxes differ from the amount computed by applying the statutory federal income tax rate to income before income taxes.
Duquesne leases nuclear fuel, a portion of a nuclear generating plant, certain office buildings, computer equipment, and other property and equipment.
(a) Includes $2,618 in 1996 and $2,910 in 1995 of capital leases with associated obligations retired.
In 1987, Duquesne sold and leased back its 13.74 percent interest in BV Unit 2; the sale was exclusive of transmission and common facilities. The total sales price of $537.9 million was the appraised value of Duquesne's interest in the property. Duquesne subsequently leased back its interest in the unit for a term of 29.5 years. The lease provides for semi-annual payments and is accounted for as an operating lease. Duquesne is responsible under the terms of the lease for all costs of its interest in the unit. In December 1992, Duquesne participated in the refinancing of collateralized lease bonds to take advantage of lower interest rates and reduce the annual lease payments. The bonds were originally issued in 1987 for the purpose of partially financing the lease of BV Unit 2. In accordance with the BV Unit 2 lease agreement, Duquesne paid the premiums of approximately $36.4 million as a supplemental rent payment to the lessors. This amount was deferred and is being amortized over the remaining lease term. At December 31, 1996, the deferred balance was approximately $30.1 million.
Leased nuclear fuel is amortized as the fuel is burned and charged to fuel and purchased power expense on the statement of consolidated income. The amortization of all other leased property is based on rental payments made. These lease-related expenses are charged to operating expenses on the statement of consolidated income.
(a) Includes current obligations of $20.9 million at December 31, 1996.
Future minimum lease payments for capital leases are related principally to the estimated use of nuclear fuel financed through leasing arrangements and building leases. Future minimum lease payments for operating leases are related principally to BV Unit 2 and certain corporate offices.
Future payments due to Duquesne, as of December 31, 1996, under subleases of certain corporate office space are approximately $4.5 million in 1997, $4.6 million in 1998 and $18.5 million thereafter.
J. Commitments and Contingencies
Construction - ------------------------------------------------------------------------------- Duquesne estimates that it will spend, excluding AFC and nuclear fuel, approximately $110 million, $110 million and $95 million for construction during 1997, 1998 and 1999. These estimates also exclude any potential expenditures for reliability enhancements to the BI Unit 3 combustion turbine. (See "Mitigation Plan" discussion, Note F, on page 44.)
Nuclear-Related Matters - ------------------------------------------------------------------------------- Duquesne has an ownership interest in three nuclear units, two of which it operates. The operation of a nuclear facility involves special risks, potential liabilities, and specific regulatory and safety requirements. Specific information about risk management and potential liabilities is discussed below.
Nuclear Decommissioning. The PUC ruled that recovery of the decommissioning costs for Beaver Valley Unit 1 (BV Unit 1) could begin in 1977, and that recovery for BV Unit 2 and Perry Unit 1 could begin in 1988. Duquesne expects to decommission BV Unit 1, BV Unit 2 and Perry Unit 1 no earlier than the expiration of each plant's operating license in 2016, 2027 and 2026. At the end of its operating life, BV Unit 1 may be placed in safe storage until BV Unit 2 is ready to be decommissioned, at which time the units may be decommissioned together.
Based on site-specific studies finalized in 1992 for BV Unit 2, and in 1994 for BV Unit 1 and Perry Unit 1, Duquesne's share of the total estimated decommissioning costs, including removal and decontamination costs, currently being used to determine Duquesne's cost of service, is $122 million for BV Unit 1, $35 million for BV Unit 2, and $67 million for Perry Unit 1. A study will be performed in 1997 to update Duquesne's estimated decommissioning costs of BV Unit 1 and BV Unit 2.
On July 18, 1996, the PUC issued a Proposed Policy Statement Regarding Nuclear Decommissioning Cost Estimation and Cost Recovery for the purpose of obtaining comments from the public. The proposed policy includes guidelines for a site-specific study to estimate the cost of decommissioning. Guidelines require that studies be performed at least every five years, address radiological and non-radiological costs, and include a contingency factor of not more than 10 percent. Under the proposed policy, annual decommissioning funding levels are based on an annuity calculation recognizing inflation in the cost
estimates and earnings on fund assets. With respect to the transition to a competitive generation market, the Customer Choice Act requires that utilities include a plan to mitigate any shortfall in decommissioning trust fund payments for the life of the facility with any future decommissioning filings. Consistent with this requirement, Duquesne has increased its nuclear decommissioning funding by $5 million under the PUC-approved plan for the sale of Duquesne's ownership interest in Ft. Martin. (See "Mitigation Plan" discussion, Note F, on page 44.) These additional annual contributions bring the total annual funding to approximately $9 million. Also, on October 17, 1996, the PUC adopted an Accounting Order filed by Duquesne to recognize the increased funding as part of Duquesne's cost of service. Duquesne expects to receive approval from the IRS for qualification of 100 percent of additional nuclear decommissioning trust funding for BV Unit 2 and Perry Unit 1, and 79 percent for BV Unit 1.
Funding for nuclear decommissioning costs is deposited in external, segregated trust accounts and may be invested in a portfolio of corporate common stock and debt securities, municipal bonds, certificates of deposit and United States government securities. Trust fund earnings increase the fund balance and the recorded liability. The market value of the aggregate trust fund balances at December 31, 1996 totaled approximately $33.7 million.
Nuclear Insurance. The Price-Anderson Amendments to the Atomic Energy Act of 1954 limit public liability from a single incident at a nuclear plant to $8.9 billion. The maximum available private primary insurance of $200 million has been purchased by Duquesne. Additional protection of $8.7 billion would be provided by an assessment of up to $79.3 million per incident on each nuclear unit in the United States. Duquesne's maximum total possible assessment, $59.4 million, which is based on its ownership or leasehold interests in three nuclear generating units, would be limited to a maximum of $7.5 million per incident per year. This assessment is subject to indexing for inflation and may be subject to state premium taxes. If funds prove insufficient to pay claims, the United States Congress could impose other revenue-raising measures on the nuclear industry.
Duquesne's share of insurance coverage for property damage, decommissioning and decontamination liability is $1.2 billion. Duquesne would be responsible for its share of any damages in excess of insurance coverage. In addition, if the property damage reserves of Nuclear Electric Insurance Limited (NEIL), an industry mutual insurance company that provides a portion of this coverage, are inadequate to cover claims arising from an incident at any United States nuclear site covered by that insurer, Duquesne could be assessed retrospective premiums totaling a maximum of $7.3 million.
In addition, Duquesne participates in a NEIL program that provides insurance for the increased cost of generation and/or purchased power resulting from an accidental outage of a nuclear unit. Subject to the policy limit, the coverage provides for 100 percent of the estimated incremental costs per week during the 52-week period starting 21 weeks after an accident and 80 percent of such estimate per week for the following 104 weeks, with no coverage thereafter. If NEIL's losses for this program ever exceed its reserves, Duquesne could be assessed retrospective premiums totaling a maximum of $3.5 million.
Beaver Valley Power Station (BVPS) Steam Generators. BVPS's two units are equipped with steam generators designed and built by Westinghouse Electric Corporation (Westinghouse). Similar to other Westinghouse nuclear plants, outside diameter stress corrosion cracking (ODSCC) has occurred in the steam generator tubes of both units. BV Unit 1, which was placed in service in 1976, has required removal of approximately 15 percent of its steam generator tubes from service through a process called "plugging." However, BV Unit 1 continues to have the capability to operate at 100 percent reactor power and has the ability to return tubes to service by repairing them through a process called "sleeving." To date, no tubes at either BV Unit 1 or BV Unit 2 have been sleeved. BV Unit 2, which was placed in service 11 years after BV Unit 1, has not yet exhibited the degree of ODSCC experienced at BV Unit 1. Approximately 2 percent of BV Unit 2's tubes are plugged; however, it is too early in the life of the unit to determine the extent to which ODSCC may become a problem.
Duquesne has undertaken certain measures, such as increased inspections, water chemistry control and tube plugging, to minimize the operational impact of and to reduce susceptibility to ODSCC. Although Duquesne has taken these steps to allay the effects of ODSCC, the inherent potential for future ODSCC in steam generator tubes of the Westinghouse design still exists. Material acceleration in the rate of ODSCC could lead to a loss of plant efficiency, significant repairs or the possible replacement of the BV Unit 1 steam generators. The total replacement cost of the BV Unit 1 steam generators is currently estimated at $125 million. Duquesne would be responsible for $59 million of this total, which includes the cost of equipment removal and replacement steam generators but excludes replacement power costs. The earliest that the BV Unit 1 steam generators could be replaced during a scheduled refueling outage is the fall of 2000.
BV Unit 1 completed its 11th refueling outage on May 11, 1996. The outage lasted 49 days and was the shortest refueling outage in the history of the unit. During the outage, various inspections of the unit's steam generators were made, including examinations using a new "Plus Point" probe. As a result of these inspections, Duquesne returned to service tubes that had previously been plugged. Following the refueling outage, 85 percent of the steam generator tubes were in service, approximately 1 percent more than at the beginning of the outage.
BV Unit 2 completed its sixth refueling outage on December 16, 1996. The outage lasted 107 days due to unanticipated repairs to two residual heat removal pumps and reactor head vent valves. Various inspections of the unit's steam generators, including inspections using the Plus Point probe, were completed. Upon completion of the outage, approximately 98 percent of the unit's steam generator tubes remained in service.
Duquesne continues to explore all viable means of managing ODSCC, including new repair technologies, and plans to continue to perform 100 percent tube inspections during future refueling outages, which occur at, approximately, 18-month intervals for each unit. Duquesne will continue to monitor and evaluate the condition of the BVPS steam generators.
Spent Nuclear Fuel Disposal. The Nuclear Waste Policy Act of 1982 established a policy for handling and disposing of spent nuclear fuel and a policy requiring the establishment of a final repository to accept spent nuclear fuel. Electric utility companies have entered into contracts with the DOE for the permanent disposal of spent nuclear fuel and high-level radioactive waste in compliance with this legislation. The DOE has indicated that its repository under these contracts will not be available for acceptance of spent nuclear fuel before 2010. On July 23, 1996, the U.S. Court of Appeals for the District of Columbia Circuit, in response to a suit brought by 25 electric utilities and 18 states and state agencies, unanimously ruled that the DOE has a legal obligation to begin taking spent nuclear fuel by January 31, 1998. The DOE has not yet established an interim or permanent storage facility, and has indicated that it will be unable to begin acceptance of spent nuclear fuel for disposal by January 31, 1998. Further, Congress is considering amendments to the Nuclear Waste Policy Act of 1982 that could give the DOE authority to proceed with the development of a federal interim storage facility. In the event the DOE does not begin accepting spent nuclear fuel, existing on-site spent nuclear fuel storage capacities at BV Unit 1, BV Unit 2 and Perry Unit 1 are expected to be sufficient until 2016 (end of operating license), 2013 and 2011, respectively.
On January 31, 1997, Duquesne joined 35 other electric utilities and 46 states, state agencies and regulatory commissions in filing a suit in the U.S. Court of Appeals for the District of Columbia against the DOE. The suit requests the court to suspend the utilities' payments into the Nuclear Waste Fund and to place future payments into an escrow account until the DOE fulfills its obligation to accept spent nuclear fuel. Significant additional expenditures for the storage of spent nuclear fuel at BV Unit 2 and Perry Unit 1 could be required if the DOE does not fulfill its obligation to accept spent nuclear fuel.
Uranium Enrichment Decontamination and Decommissioning. Nuclear reactor licensees in the United States are assessed annually for the decontamination and decommissioning of DOE uranium enrichment facilities. Assessments are based on the amount of uranium a utility had processed for enrichment prior to enactment of the National Energy Policy Act of 1992 (NEPA) and are to be paid by such utilities over a 15-year period. At December 31, 1996, Duquesne's liability for contributions was approximately $9.3 million (subject to an inflation adjustment). Contributions, when made, are currently recovered from customers through the ECR.
Fossil Decommissioning - ------------------------------------------------------------------------------- In Pennsylvania, current ratemaking does not allow utilities to recover future decommissioning costs through depreciation charges during the operating life of fossil-fired generating stations. In 1996, the Financial Accounting Standard Board issued an exposure draft, Accounting for Certain Liabilities Related to Closure or Removal of Long-Lived Assets. The primary effect of this exposure draft would be to change the way Duquesne accounts for nuclear and fossil decommissioning costs. The exposure draft calls for recording the present value of estimated future cash flows to decommission Duquesne's nuclear and fossil power plants as an increase to asset balances and as a liability. This amount is currently estimated to be $299.5 million. Duquesne will seek to recover these costs through a CTC.
Guarantees - ------------------------------------------------------------------------------- Duquesne and the other owners of Bruce Mansfield have guaranteed certain debt and lease obligations related to a coal supply contract for Bruce Mansfield. At December 31, 1996 Duquesne's share of these guarantees was $20.3 million. The prices paid for the coal by the companies under this contract are expected to be sufficient to meet debt and lease obligations to be satisfied in the year 2000. (See "Deferred Coal Costs" discussion, Note F, on page 45.) The minimum future payments to be made by Duquesne solely in relation to these obligations are $5.9 million in 1997, $5.6 million in 1998, $5.3 million in 1999, and $4.2 million in 2000. Duquesne's total payments for coal purchased under the contract were $26.9 million in 1996, $28.9 million in 1995, and $23.3 million in 1994.
Residual Waste Management Regulations - ------------------------------------------------------------------------------- In 1992, the Pennsylvania Department of Environmental Protection (DEP) issued Residual Waste Management Regulations governing the generation and management of non-hazardous residual waste, such as coal ash. Duquesne is assessing the sites it utilizes and has developed compliance strategies that are currently under review by the DEP. Capital costs of $2.5 million were incurred by Duquesne in 1996 to comply with these DEP regulations. Based on information currently available, an additional $2.8 million will be spent in 1997. The additional capital cost of compliance through the year 2000 is estimated, based on current information, to be $15 million. This estimate is subject to the results of groundwater assessments and DEP final approval of compliance plans.
Employees - ------------------------------------------------------------------------------- In November 1996, Duquesne reached an agreement on a three-year contract extension through September 30, 2001 with the International Brotherhood of Electrical Workers (IBEW), which represents approximately 2,000 of Duquesne's employees.
Other - ------------------------------------------------------------------------------- Duquesne is involved in various other legal proceedings and environmental matters. Duquesne believes that such proceedings and matters, in total, will not have a materially adverse effect on its financial position, results of operations or cash flows.
K. Long-Term Debt
The pollution control notes arise from the sale of bonds by public authorities for the purposes of financing construction of pollution control facilities at Duquesne's plants or refunding previously issued bonds. Duquesne is obligated to pay the principal and interest on these bonds. For certain of the pollution control notes, there is an annual commitment fee for an irrevocable letter of credit. Under certain circumstances, the letter of credit is available for the payment of interest on, or redemption of, all or a portion of the notes.
(a) Excludes $50.0 million related to current maturities on November 15, 1997. (b) Excludes $50.0 million related to a current maturity on May 15, 1996. (c) The pollution control notes have adjustable interest rates. The interest rates at year-end averaged 3.7 percent in 1996 and 3.9 percent in 1995.
At December 31, 1996, sinking fund requirements and maturities of long-term debt outstanding for the next five years were $50.0 million in 1997, $75.1 million in 1998, $75.4 million in 1999, $100.4 million in 2000, and $0.4 million in 2001.
Total interest costs incurred were $94.6 million in 1996, $103.3 million in 1995, and $107.7 million in 1994. Interest costs attributable to long-term debt and other interest were $90.1 million, $98.0 million and $102.1 million in 1996, 1995 and 1994, respectively. Interest costs incurred also include $4.5 million, $5.3 million and $5.6 million attributable to capital leases in 1996, 1995 and 1994, respectively. Of these amounts, $0.8 million in 1996, $1.0 million in 1995, and $0.6 million in 1994 were capitalized as AFC. Debt discount or premium and related issuance expenses are amortized over the lives of the applicable issues.
During 1994, Duquesne's BV Unit 2 lease arrangement was amended to reflect an increase in federal income tax rates. At the same time, the associated letter of credit securing the lessor's equity interest in the unit was increased from $188 million to $194 million and the term of the letter of credit was extended to 1999. If certain specified events occur, the letter of credit could be drawn down by the owners, the leases could terminate, and collateralized lease bonds ($391.8 million at December 31, 1996) would become direct obligations of Duquesne.
At December 31, 1996 and 1995, Duquesne was in compliance with all of its debt covenants.
At December 31, 1996, the fair value of Duquesne's long-term debt, including current maturities and sinking fund requirements, estimated on the basis of quoted market prices for the same or similar issues or current rates offered to Duquesne for debt of the same remaining maturities, was $1,321.6 million. The principal amount included in Duquesne's consolidated balance sheet is $1,325.9 million.
L. Preferred and Preference Stock
(a) Preferred stock: 4,000,000 authorized shares; $50 par value; cumulative (b) $50 per share involuntary liquidation value (c) Non-redeemable (d) 500 authorized shares; 10 issued $300,000 par value; involuntary liquidation value $300,000 per share; mandatory redemption beginning August 2000 (e) Cumulative Monthly Income Preferred Securities Series A: 6,000,000 authorized shares; $25 involuntary liquidation value (f) Preference stock: 8,000,000 authorized shares; $1 par value cumulative (g) $35.50 per share involuntary liquidation value
Holders of Duquesne's preferred stock are entitled to cumulative quarterly dividends. If four quarterly dividends on any series of preferred stock are in arrears, holders of the preferred stock are entitled to elect a majority of Duquesne's board of directors until all dividends have been paid. Holders of Duquesne's preference stock are entitled to receive cumulative quarterly dividends if dividends on all series of preferred stock are paid. If six quarterly dividends on any series of preference stock are in arrears, holders of the preference stock are entitled to elect two of Duquesne's directors until all dividends have been paid. At December 31, 1996, Duquesne had made all dividend payments. Preferred and preference dividends were $12.0 million, $5.3 million and $6.0 million in 1996, 1995 and 1994. Total preferred and preference stock had involuntary liquidation values of $242.5 million and $93.1 million, which exceeded par by $28.2 million and $28.8 million at December 31, 1996 and 1995.
In December 1991, Duquesne established an Employee Stock Ownership Plan (ESOP) to provide matching contributions for a 401(k) Retirement Savings Plan for Management Employees. (See "Employee Benefits," Note N, on page 55.) Duquesne issued and sold 845,070 shares of preference stock, plan series A to the trustee of the ESOP. As consideration for the stock, Duquesne received a note valued at $30 million from the trustee. The preference stock has an annual dividend rate of $2.80 per share, and each share of the preference stock is exchangeable for one and one-half shares of DQE common stock. At December 31, 1996, $19.5 million of preference stock issued in connection with the establishment of the ESOP had been offset, for financial statement purposes, by the recognition of a deferred ESOP benefit. Dividends on the preference stock and cash contributions from Duquesne are used to repay the ESOP note. Duquesne made cash contributions of approximately $1.4 million for 1996, $1.6 million for 1995, and $2.2 million for 1994. These cash contributions were the difference between the ESOP debt service and the amount of dividends on ESOP shares ($2.3 million in 1996 and 1995, and $2.4 million in 1994). As shares of preference stock are allocated to the accounts of participants in the ESOP, Duquesne recognizes compensation expense, and the amount of the deferred compensation benefit is amortized.
Duquesne recognized compensation expense related to the 401(k) plans of $2.3 million in 1996, $2.3 million in 1995, and $1.8 million in 1994. Outstanding preferred and preference stock is generally callable, on notice of not less than 30 days, at stated prices plus accrued dividends.
M. Common Stock and Capital Surplus
In July 1989, Duquesne became a wholly owned subsidiary of DQE, the holding company formed as part of a shareholder-approved restructuring. As a result of the restructuring, DQE common stock replaced all outstanding shares of Duquesne common stock, except for 10 shares which DQE holds.
DQE or its predecessor, Duquesne, has continuously paid dividends on common stock since 1953. Dividends may be paid on DQE common stock to the extent permitted by law and as declared by its board of directors. However, in Duquesne's Restated Articles of incorporation, provisions relating to preferred and preference stock may restrict the payment of Duquesne's common dividends. No dividends or distributions may be made on Duquesne's common stock if Duquesne has not paid dividends or sinking fund obligations on its preferred or preference stock. Further, the aggregate amount of Duquesne's common stock dividend payments or distributions may not exceed certain percentages of net income if the ratio of common stockholder's equity to total capitalization is less than specified percentages. As all of Duquesne's common stock is owned by DQE, to the extent that Duquesne cannot pay common dividends, DQE may not be able to pay dividends to its common shareholders. No part of the retained earnings of Duquesne was restricted at December 31, 1996.
N. Employee Benefits
Retirement Plans - ------------------------------------------------------------------------------- Duquesne maintains retirement plans to provide pensions for all eligible employees. Upon retirement, an employee receives a monthly pension based on his or her length of service and compensation. The cost of funding the pension plan is determined by the unit credit actuarial cost method. Duquesne's policy is to record this cost as an expense and to fund the pension plans by an amount that is at least equal to the minimum funding requirements of the Employee Retirement Income Security Act of 1974 (ERISA) but that does not exceed the maximum tax-deductible amount for the year. Pension costs charged to expense or construction were $11.9 million for 1996, $6.1 million for 1995, and $8.9 million for 1994.
Pension assets consist primarily of common stocks, United States obligations and corporate debt securities.
Retirement Savings Plan and Other Benefit Options - ------------------------------------------------------------------------------- Duquesne sponsors separate 401(k) retirement plans for its management and bargaining unit employees.
The 401(k) Retirement Savings Plan for Management Employees provides that Duquesne will match employee contributions to a 401(k) account up to a maximum of 6 percent of an employee's eligible salary. Duquesne's match consists of a $0.25 base match per eligible contribution dollar and an additional $0.25 incentive match per eligible contribution dollar, if Board-approved targets are achieved. The 1996 incentive target for management was accomplished. Duquesne is funding its matching contributions to the 401(k) Retirement Savings Plan for Management Employees with payments to an ESOP established in December 1991. (See "Preferred and Preference Stock," Note L, on page 54.)
The 401(k) Retirement Savings Plan for IBEW Represented Employees provides that, beginning in 1995, Duquesne will match employee contributions to a 401(k) account up to a maximum of 4 percent of an employee's eligible salary. Duquesne's match consists of a $0.25 base match per eligible contribution dollar and an additional $0.25 incentive match per eligible contribution dollar, if certain targets are met. In 1996, these incentive targets were not met by Duquesne's union-represented employees.
DQE's shareholders have approved a long-term incentive plan through which Duquesne may grant management employees options to purchase, during the years 1987 through 2006, up to a total of 7.5 million shares of DQE's common stock at prices equal to the fair market value of such stock on the dates the options were granted. At December 31, 1996, approximately 3.1 million of these shares were available for future grants.
As of December 31, 1996, 1995 and 1994, active grants totaled 1,698,000; 2,159,000; and 2,118,000 shares. Exercise prices of these options ranged from $8.2084 to $30.875 at December 31, 1996, and from $8.2084 to $27.625 at December 31, 1995, and from $8.2084 to $23.0833 at December 31, 1994. Expiration dates of these grants ranged from 1997 to 2006 at December 31, 1996; from 1997 to 2005 at December 31, 1995; and from 1997 to 2004 at December 31, 1994. As of December 31, 1996, 1995 and 1994, stock appreciation rights (SARs) had been granted in connection with 984,000; 1,202,000; and 1,190,000 of the options outstanding. During 1996, 715,000 SARs were exercised; 267,000 options were exercised at prices ranging from $8.2084 to $20.3334; and 150 options were cancelled. During 1995, 367,000 SARs were exercised; 133,000 options were exercised at prices ranging from $8.2084 to $21.6667; and 28,000 options were cancelled. During 1994, 1,254,000 SARs were exercised; 339,000 options were exercised at prices ranging from $8.2084 to $18.9167; and 80,000 options were cancelled. Of the active grants at December 31, 1996, 1995 and 1994, 668,000; 929,000; and 918,000 were not exercisable.
Other Post-Retirement Benefits - ------------------------------------------------------------------------------- In addition to pension benefits, Duquesne provides certain health care benefits and life insurance for some retired employees. Substantially all of Duquesne's full-time employees may, upon attaining the age of 55 and meeting certain service requirements, become eligible for the same benefits available to retired employees. Participating retirees make contributions, which are adjusted annually, to the health care plan. The life insurance plan is non-contributory. Company-provided health care benefits terminate when covered individuals become eligible for Medicare benefits or reach age 65, whichever comes first. Duquesne funds actual expenditures for obligations under the plans on a "pay-as-you-go" basis. Duquesne has the right to modify or terminate the plans.
Duquesne accrues the actuarially determined costs of the aforementioned post-retirement benefits over the period from the date of hire until the date the employee becomes fully eligible for benefits. Duquesne has elected to amortize the transition liability over 20 years.
The accumulated post-retirement benefit obligation comprises the present value of the estimated future benefits payable to current retirees and a pro rata portion of estimated benefits payable to active employees after retirement.
O. Quarterly Financial Information (Unaudited)
Summary of Selected Quarterly Financial Data (Thousands of Dollars, Except Per Share Amounts) - ------------------------------------------------------------------------------- [The quarterly data reflect seasonal weather variations in Duquesne's service territory.]
(a) Restated to conform with presentations adopted during 1996.
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Except for historical information contained herein, the matters discussed in this Annual Report on Form 10-K, are forward-looking statements that involve risks and uncertainties including, but not limited to, economic, competitive, governmental and technological factors affecting Duquesne's operations, markets, products, services and prices, and other factors discussed in Duquesne's filings with the Securities and Exchange Commission.
SELECTED FINANCIAL DATA
Glossary of Terms Following are explanations of certain financial and operating terms used in our report.
Competitive Transition Charge (CTC)/ Intangible Transition Charge (ITC) - -------------------------------------------------------------------------------- During the electric utility restructuring from the traditional regulatory framework to customer choice, utilities will have the opportunity to recover transition costs from customers through a surcharge, or competitive transition charge. Alternatively, if the utility gains PUC approval and securitizes its transition costs, it may then charge an intangible transition charge.
Customer Choice - -------------------------------------------------------------------------------- The Pennsylvania Customer Choice Act (see "Customer Choice Act" discussion on page 5) will give customers the right to contract for electricity at market prices from PUC-approved electric generation suppliers.
Decommissioning Costs - -------------------------------------------------------------------------------- Decommissioning costs are expenses to be incurred in connection with the entombment, decontamination, dismantlement, removal and disposal of structures, systems and components of a power plant that has permanently ceased the production of electric energy.
Deferred Energy Costs - -------------------------------------------------------------------------------- In conjunction with the Energy Cost Rate Adjustment Clause, Duquesne records deferred energy costs to offset differences between actual energy costs and the level of energy costs currently recovered from its rate-regulated electric utility customers.
Demand - -------------------------------------------------------------------------------- Demand is the amount of electricity delivered to consumers at any instant or averaged over a period of time.
Energy Cost Rate Adjustment Clause (ECR) - -------------------------------------------------------------------------------- Duquesne recovers through the ECR, to the extent that such amounts are not included in base rates, the cost of nuclear fuel, fossil fuel and purchased power costs and passes to its customers the profits from short-term power sales to other utilities.
Federal Energy Regulatory Commission (FERC) - -------------------------------------------------------------------------------- The FERC is an independent five-member commission within the United States Department of Energy. Among its many responsibilities, the FERC sets rates and charges for the wholesale transportation and sale of natural gas and electricity.
Kilowatt (KW) - -------------------------------------------------------------------------------- A kilowatt is equal to 1,000 watts. A watt is the rate at which electricity is generated or consumed. A kilowatt-hour (KWH) is a measure of the quantity of electricity generated or consumed in one hour.
Peak Demand - -------------------------------------------------------------------------------- Peak demand is the amount of electricity required during periods of highest usage. Peak periods fluctuate by season and generally occur in the morning hours in winter and in late afternoon during the summer.
Pennsylvania Public Utility Commission (PUC) - -------------------------------------------------------------------------------- The PUC is the Pennsylvania governmental body that regulates all utilities (electric, gas, telephone, water, etc.) and is made up of five members nominated by the governor and confirmed by the senate.
Regulatory Assets - -------------------------------------------------------------------------------- Regulatory assets are costs that Duquesne would otherwise have charged to expense which are capitalized or deferred because these costs are currently being recovered or because it is probable that the PUC and the FERC will allow recovery of these costs through the ratemaking process. For example, under traditional regulation, tax benefits associated with electric generating assets were required to be immediately passed on to a utility's customers. These same benefits later would be incurred as a tax cost, which the utility would expect to collect from its customers under the traditional regulatory framework.
Transition Costs - -------------------------------------------------------------------------------- Transition or stranded costs are the net present value of a utility's known or measurable costs related to electric generation that are recoverable under the current regulatory framework, but which may not be recoverable in a competitive generation market and which will remain following mitigation efforts taken by such utility to recover the costs. Examples of potential transition costs include regulatory assets; the unfunded portion of decommissioning costs; costs of employee severance, retraining, early retirement, and outplacement; and generation-related costs, including the associated capital costs. The PUC will determine the level of transition costs a utility may recover.
Unbundled Electric Service - -------------------------------------------------------------------------------- Electric utilities traditionally have been obligated to serve customers from the generation through the delivery of electricity. Under the Pennsylvania Customer Choice Act, electric service will be unbundled. Although customer choice will give consumers their choice of electric generation suppliers, delivery of the electricity from the generation supplier to the consumer will remain the responsibility of the existing franchised utility.