ITEM 1. BUSINESS.
GENERAL
Transcontinental Gas Pipe Line Corporation (Transco) is an interstate natural gas transmission company which owns a natural gas pipeline system extending from Texas, Louisiana, Mississippi and the Gulf of Mexico through the states of Alabama, Georgia, South Carolina, North Carolina, Virginia, Maryland, Pennsylvania and New Jersey to the New York City metropolitan area. Transco's principal business is the transportation of natural gas.
The number of full time employees of Transco at December 31, 1997 was 1,512.
Transco is an indirect wholly-owned subsidiary of The Williams Companies, Inc. (Williams). Prior to May 1, 1995, Transco was an indirect wholly-owned subsidiary of Transco Energy Company (TEC).
On December 12, 1994, TEC and Williams announced that they had entered into a merger agreement pursuant to which Williams acquired through a cash tender offer 24.6 million shares, or approximately 60%, of the outstanding shares of TEC's common stock for $430.5 million. The cash tender offer was then followed by a stock merger (Merger) in which shares of TEC common stock not purchased in the tender offer were exchanged for Williams' common stock valued at $334 million. On the May 1, 1995 effective date of the Merger, TEC declared and paid as dividends to Williams all of TEC's interest in Transco.
For additional discussion and the accounting treatment of the Merger, see "Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 1. Corporate Structure and Control and 2. Summary of Significant Accounting Policies."
At December 31, 1997, Transco's system had a mainline delivery capacity of approximately 3.8 Bcf of gas per day from production areas to its primary markets. Using its Leidy Line and market-area storage capacity, Transco can deliver an additional 2.9 Bcf of gas per day for a system-wide delivery capacity total of approximately 6.7 Bcf
As used in this report, the term "Mcf" means thousand cubic feet, the term "MMcf" means million cubic feet, the term "Bcf" means billion cubic feet, the term "Tcf" means trillion cubic feet, the term "Mcf/d" means thousand cubic feet per day, the term "MMcf/d" means million cubic feet per day, the term "Bcf/d" means billion cubic feet per day, the term "MMBtu" means million British Thermal Units and the term "TBtu" means trillion British Thermal Units.
of gas per day. The system is composed of approximately 10,500 miles of mainline and branch transmission pipelines, 43 compressor stations, six storage locations and four processing plants. Compression facilities at sea level rated capacity total approximately 1.3 million horsepower.
Transco has natural gas storage capacity in five underground storage fields located on or near its pipeline system and/or market areas and operates three of these storage fields and an additional liquefied natural gas (LNG) storage facility. The total top gas storage capacity available to Transco and its customers in such storage fields and LNG facility is approximately 216 Bcf of gas. Storage capacity permits Transco's customers to inject gas into storage during the summer and off-peak periods for delivery during peak winter demand periods.
Transco's gas pipeline facilities are generally owned in fee. However, a substantial portion of such facilities are constructed and maintained pursuant to rights-of-way, easements, permits, licenses or consents on and across real property owned by others. Compressor stations, with appurtenant facilities, are located in whole or in part either on lands owned or on sites held under leases or permits issued or approved by public authorities. The storage facilities are either owned or contracted for under long-term leases or easements.
In 1992, the Federal Energy Regulatory Commission (FERC) issued Order 636 which made fundamental changes in the way natural gas pipelines conduct their businesses. The FERC's stated purpose of Order 636 was to improve the competitive structure of the natural gas pipeline industry by, among other things, unbundling a pipeline's merchant role from its transportation services; ensuring "equality" of transportation services including equal access to all sources of gas; providing "no-notice" firm transportation services that are equal in quality to bundled sales service; establishing a capacity release program and changing rate design methodology from modified fixed-variable (MFV) to straight fixed-variable (SFV), unless the pipeline and its customers agree to, and the FERC approves, a different form of rate design methodology. Effective November 1, 1993, Transco implemented its Order 636 restructuring plan. For a discussion of Order 636 see "Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 3. Contingent Liabilities and Commitments - Rate and Regulatory Matters Order 636."
After FERC approval in 1993, TEC realigned its gas marketing businesses under the common management of Transco Gas Marketing Company (TGMC), an affiliate of Transco, which, through an agency agreement, began to manage all jurisdictional merchant sales of Transco. In May 1995, Williams Energy Services Company (WESCO), an affiliate of Transco, became the successor to the TGMC agency agreement and began to manage Transco's jurisdictional merchant sales.
Also, in May 1995, the operation of certain production area facilities were transferred to Williams Field Services Group, Inc. (WFS), an affiliated company. In February 1996, Transco filed an application with the FERC for an order authorizing the abandonment of certain facilities located onshore and offshore in Texas, Louisiana and Mississippi by conveyance to Williams Gas Processing Gulf Coast Company (WGP), an affiliate of Transco. The net book value recorded by Transco at December 31, 1997 of the facilities, including the purchase price allocation to Transco, was approximately $529 million. Estimated operating income recorded by Transco for the year ended December 31, 1997 associated with the facilities was $15 million; however, such operating income may not be representative of the effects of the spin-down on Transco's future operating income due to various factors, including future regulatory actions. Concurrently, WGP filed a petition for declaratory order requesting a determination that its gathering services and rates be exempt from FERC regulation under the Natural Gas Act. In September 1996, the FERC issued an order dismissing Transco's application and WGP's petition for declaratory order. In October 1996, Transco and WGP filed a joint request for rehearing of the FERC's September order. In August 1997, Transco and WGP filed a motion for expedited rehearing. Pending the outcome of the rehearing request and in an effort to expedite abandonment of at least a portion of the facilities included in the February 1996 application, in February 1998, Transco filed a separate application with the FERC seeking authorization to abandon by conveyance to WGP, Transco's onshore Tilden/McMullen gathering system which is located in Texas. The net book value at December 31, 1997, of the Tilden/McMullen facilities was $25 million, the entirety of which is included in the $529 million net book value for the facilities described in the February 1996 application.
MARKETS AND TRANSPORTATION
Transco's natural gas pipeline system serves customers in Texas and eleven southeast and Atlantic seaboard states including major metropolitan areas in Georgia, North Carolina, New York, New Jersey and Pennsylvania.
Transco's major gas transportation customers are public utilities and municipalities that provide service to residential, commercial, industrial and electric generation end users. Shippers on Transco's pipeline system include public utilities, municipalities, intrastate pipelines, direct industrial users, electrical generators, marketers and producers. Transco's largest customer in 1997, Public Service Electric and Gas Company, accounted for approximately 10 percent of Transco's total operating revenues. Transco's firm transportation agreements are generally long-term agreements with various expiration dates and account for the major portion of Transco's business. Additionally, Transco offers interruptible transportation services under shorter term agreements.
Transco's total system deliveries for the years 1997, 1996 and 1995 are shown below.
Transco's facilities are divided into seven rate zones. Four are located in the production area and three are located in the market area. Long-haul transportation is gas that is received in one of the production-area zones and delivered in a market-area zone. Market-area transportation is gas that is both received and delivered within market-area zones. Production-area transportation is gas that is both received and delivered within production-area zones.
As a result of the fundamental business changes resulting from FERC Order 636, especially the shifting of the responsibility for gas supply from the pipeline companies to local distribution companies (LDCs), maintaining committed proved gas reserves is no longer material to Transco's transportation business.
PIPELINE PROJECTS
SUNBELT EXPANSION PROJECT In November 1997, Transco completed and placed into service the SunBelt Expansion Project. This project added approximately 146 MMcf/d of firm transportation capacity to markets in Georgia, South Carolina and North Carolina. The total cost of the expansion was approximately $85 million, of which $61 million was invested in 1997.
MOBILE BAY LATERAL EXPANSION PROJECT In January 1998, the FERC approved the Mobile Bay Lateral Expansion Project, an expansion of Transco's existing 123-mile Mobile Bay Lateral. The project is expected to provide new firm transportation capacity of 350 MMcf/d from the outer continental shelf to Transco's Station 82 and increase capacity on the existing onshore lateral from 520 MMcf/d to 784 MMcf/d. The project is targeted to be placed into service in two phases during 1998 at a cost of approximately $120 million, of which approximately $36 million was invested during 1997.
PINE NEEDLE LNG COMPANY, LLC In February 1997, Pine Needle LNG Company, LLC, which is owned by wholly-owned subsidiaries of Transco and several of its major customers, commenced construction of its liquefied natural gas (LNG) storage project in
Guilford County, North Carolina. The project will have 4 Bcf of storage capacity and 400 MMcf/d of withdrawal capacity, and is expected to be placed into service on or about May 1, 1999. The project is estimated to cost approximately $107 million. Wholly-owned subsidiaries of Transco will operate the facility and have a 35% ownership interest. Transco expects to make equity investments of approximately $19 million in this project.
CARDINAL PIPELINE SYSTEM PROJECT In November 1997, the North Carolina Utilities Commission issued an order approving the Cardinal Pipeline System Project. Wholly-owned subsidiaries of Transco and three of its North Carolina customers will own Cardinal, which will involve the acquisition of the existing 37-mile Cardinal pipeline in North Carolina and construction of an approximately 67-mile extension of the pipeline to new interconnections near Clayton County, North Carolina. This project will provide 140 MMcf/d of additional firm transportation capacity to North Carolina markets and is expected to be placed into service by the end of 1999. A wholly owned subsidiary of Transco will operate the pipeline and have a 45% ownership interest in the project. Transco expects to make equity investments of approximately $22 million in this project, of which approximately $0.9 million was invested during 1997.
SEABOARD AND POCONO EXPANSION PROJECTS In April 1997, Transco withdrew its FERC certificate application for the Seaboard Expansion Project and filed an application with the FERC for the Pocono Expansion Project, which was completed and placed into service in November 1997. Pocono added 35 MMcf/d of firm transportation capacity on Transco's Leidy Line in Pennsylvania. The estimated cost of the expansion is approximately $9.8 million.
PIEDMONT/MAIDEN LATERAL EXPANSION PROJECT In August 1997, the FERC issued a certificate authorizing Transco to expand its existing Maiden Lateral to Piedmont Natural Gas Company, Inc. in Lincoln and Catawba Counties, North Carolina. The project facilities include 17.77 miles of 16-inch pipeline loop and an expansion of Transco's existing Lowesville Meter Station. The project was placed into service in November 1997. The estimated cost for the facilities is approximately $13 million.
1998 CHEROKEE EXPANSION PROJECT In January 1998, the FERC approved the 1998 Cherokee Expansion Project, an incremental expansion of Transco's pipeline system in its southern market area which will provide approximately 84 MMcf/d of new firm transportation capacity on Transco's system by a proposed in-service date of November 1, 1998. The estimated cost for this project is $68 million, of which $9.3 million was invested during 1997.
CUMBERLAND PIPELINE PROJECT In December 1997, wholly-owned subsidiaries of Transco and AGL Resources Inc. (AGL) formed Cumberland Gas Pipeline Company. Under this project, existing pipeline facilities of Transco and AGL will be expanded northward into Tennessee, establishing a 135-mile pipeline that is expected to provide firm
transportation capacity to markets in Georgia and Tennessee by the 2000-2001 winter heating season. The project is expected to be submitted for FERC approval in the third quarter of 1998. Wholly-owned subsidiaries of Transco will operate the pipeline facilities and have a 50% ownership interest. Transco estimates that the total cost of this project will be up to $115 million, and expects to make equity investments of up to $29 million. To complement the Cumberland project, Transco will offer additional pipeline capacity from the terminus of its existing Mobile Bay Lateral in Choctaw County, Alabama, to its interconnect with Cumberland at Transco's Station 125 in Walton County, Georgia, at a cost of up to $120 million.
MARKETLINK EXPANSION PROJECT In March 1997, Transco announced its MarketLink Expansion Project. MarketLink will expand Transco's Leidy Line and market-area mainline facilities, providing the final transportation link for several pipeline projects designed to transport Canadian and Rocky Mountain gas supplies to eastern markets. The total cost and capacity of the project, which is targeted to be in service for the 1999-2000 winter heating season, will be determined based on market subscriptions. Transco plans to file for FERC approval of the project during the first quarter of 1998.
INDEPENDENCE PIPELINE PROJECT In March 1997, Independence Pipeline Company (Independence) filed with the FERC an application, which was amended in December 1997, for approval to construct and operate a pipeline consisting of approximately 400 miles of 36-inch diameter pipe from ANR Pipeline Company's existing compressor station at Defiance, Ohio to Transco's facilities at Leidy, Pennsylvania. Independence will provide approximately 916 MMcf/d of firm transportation capacity and is expected to be in service in the 1999-2000 time frame. The estimated cost of the project is $678 million, and Transco's equity contributions will be approximately $68 million based on its expected one-third ownership interest in the project.
CROSS BAY PIPELINE PROJECT In January 1998, Transco and Duke Energy Corporation announced plans to form a joint venture to develop a new natural gas pipeline project into New York City. The project, called the Cross Bay Pipeline, will combine Duke's previously announced Excelsior(sm) project with the existing Long Beach delivery facilities on Transco's system into a new integrated delivery pipeline. The project will provide up to 700 MMcf/d of natural gas deliveries on a phased-in basis, with the in-service date of the initial phase being targeted for 1999.
REGULATORY MATTERS
Transco's transportation rates are established through the FERC ratemaking process. Key determinants in the ratemaking process are (i) volume throughput assumptions, (ii) costs of providing service, including depreciation rates and (iii) allowed rate of return, including the equity component of a pipeline's capital structure. Rate design and the allocation of costs between the demand and commodity rates also impact profitability. As
a result of the ratemaking process, a portion of Transco's revenues may have been collected subject to refund.
Effective September 1, 1992, Transco changed from the MFV method of rate design to the SFV method of rate design. Under MFV rate design, all fixed costs, with the exception of return on equity and income taxes, are included in a demand charge to customers and return on equity and income taxes are recovered as part of a volumetric charge to customers. Accordingly, under MFV rate design, overall throughput has a significant impact on operating income. Under the SFV method of rate design, all fixed costs, including return on equity and income taxes, are included in a demand charge to customers and all variable costs are recovered through a commodity charge to customers. While the use of SFV rate design limits Transco's opportunity to earn incremental revenues through increased throughput, it also minimizes Transco's risk associated with fluctuations in throughput.
For a discussion of additional regulatory matters, see "Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements- 3. Contingent Liabilities and Commitments - Rate and Regulatory Matters."
SALES SERVICE
As discussed above, WESCO (and TGMC prior to the Merger) manages Transco's jurisdictional merchant sales, which are made to customers pursuant to a blanket sales certificate issued by the FERC. Most of these sales are made through a Firm Sales (FS) program which gives customers the option to purchase daily quantities of gas from Transco at market-responsive prices in exchange for a demand charge payment.
Transco's gas sales volumes managed by WESCO and TGMC for the years 1997, 1996 and 1995 are shown below.
Gas Sales Volumes (TBtu) 1997 1996 1995 - ------------------------ ------- ------- ------- Long-term sales........................... 192.9 227.9 219.7 Short-term sales.......................... 21.8 37.9 95.5 ------- ------- ------- Total gas sales...................... 214.7 265.8 315.2 ======= ======= =======
TRANSACTIONS WITH AFFILIATES
Transco engages in transactions with Williams and other Williams subsidiaries, characteristic of group operations. See "Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements- 2. Summary of Significant Accounting Policies and 9. Transactions With Major Customers and Affiliates."
REGULATION
INTERSTATE GAS PIPELINE OPERATIONS Transco's transmission and storage activities are subject to regulation by the FERC under the Natural Gas Act of 1938 (Natural Gas Act) and under the Natural Gas Policy Act of 1978 (NGPA), and, as such, Transco's rates and charges for the transportation of natural gas in interstate commerce, the extension, enlargement or abandonment of jurisdictional facilities, and accounting, among other things, are subject to regulation. Transco holds certificates of public convenience and necessity issued by the FERC authorizing ownership and operation of all pipelines, facilities and properties considered jurisdictional for which certificates are required under the Natural Gas Act. Transco is also subject to the Natural Gas Pipeline Safety Act of 1968, as amended by Title I of the Pipeline Safety Act of 1979, which regulates safety requirements in the design, construction, operation and maintenance of interstate gas transmission facilities.
INTRASTATE GAS PIPELINE OPERATIONS The Cardinal Pipeline System Project (see Part I, Item 1, Pipeline Projects) is a North Carolina natural gas pipeline project which is subject to the jurisdiction of the North Carolina Utilities Commission.
ENVIRONMENTAL Transco is subject to the National Environmental Policy Act and federal, state and local laws and regulations relating to environmental quality control. Management believes that, with respect to any capital expenditures and operation and maintenance expenses required to meet applicable environmental standards and regulations, the FERC would grant the requisite rate relief so that, for the most part, such expenditures would be recoverable in rates. For this reason, management believes that compliance with applicable environmental requirements is not likely to have a material effect upon its earnings or competitive position. See "Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 3. Contingent Liabilities and Commitments - Environmental Matters."
COMPETITION
Although Transco continues to be regulated by the FERC pursuant to the Natural Gas Act and the NGPA, competition for pipeline services continues to intensify, due primarily to changes in regulation. Although FERC Order 636, implemented in 1993, probably has contributed most to increased competition in pipeline services, other changes in federal and state regulation also promise to increase competition.
FERC Order 636 required that the natural gas, transportation, and other services formerly provided in bundled form by pipelines be unbundled, resulting in non-discriminatory open access transportation services, and encouraged the establishment of market hubs. These and other factors have led to a commodity market in gas and to increasingly competitive markets in natural gas services, including competitive secondary
markets in pipeline capacity. Pipeline capacity is being used more efficiently, and peaking and storage services are increasingly effective substitutes for annual pipeline capacity.
FERC Order 636 also changed rate design for pipelines. This change has reduced short term risk of cost recovery by pipelines with fully subscribed capacity but, together with slow growth in gas demand and more efficient use of pipeline capacity and increased availability of substitutes for it, increased the risk of contract non-renewal or capacity turnback. Transco continues to charge rates that are approved by the FERC on a cost of service basis.
Transco is aware that several state jurisdictions have been involved in implementing changes similar to the changes that have occurred at the federal level under Order 636. Such activity, frequently referred to as "LDC unbundling," has been most pronounced in the states of New York, New Jersey, Georgia, and Pennsylvania. New York and New Jersey began establishing LDC unbundling regulations in 1995 and continue to develop regulations regarding LDC unbundling. Georgia enacted an LDC unbundling program in 1997. Pennsylvania is currently considering LDC unbundling and may enact such legislation in 1998. In addition, Maryland and Delaware currently have pilot unbundling programs for industrial, commercial, and residential end-users. Management expects these regulations to encourage greater competition in the natural gas marketplace.
The pace and extent of LDC unbundling and electric power industry restructuring, and their impacts, remain uncertain at this time. Competition in retail gas markets should lead to more efficient use of pipeline capacity and greater preference for shorter term contracts. The potential impact of electric power industry restructuring is particularly uncertain because gas competes with electricity in residential, commercial, and industrial end uses, and with other fuels, especially coal, in electricity generation. Although the net impact of electric restructuring on gas demand is uncertain, especially in the short run, the long run impact is expected to be increased gas use for power generation relative to direct use in residential, commercial, and industrial applications.
FORWARD-LOOKING INFORMATION
Certain matters discussed in this report, excluding historical information, include forward-looking statements that are subject to risks and uncertainties. Although Transco believes such forward-looking statements are based on reasonable assumptions, no assurance can be given that every objective will be reached. Such statements are made in reliance on the safe harbor protections provided under the Private Securities Litigation Reform Act of 1995.
As required by such Act, Transco hereby identifies the following important factors that could cause actual results to differ materially from any results projected, forecasted, estimated or budgeted by Transco in forward-looking statements: (i) risks and uncertainties
related to changes in general economic conditions in the United States, changes in laws and regulations to which Transco is subject, including tax, environmental and employment laws and regulations, the cost and effects of legal and administrative claims and proceedings against Transco or its subsidiaries or which may be brought against Transco or its subsidiaries and conditions of the capital markets utilized by Transco to access capital to finance operations; (ii) risks and uncertainties related to the impact of future federal and state regulation of business activities, including allowed rates of return and the resolution of other matters discussed herein; and (iii) risks and uncertainties related to the ability to develop expanded markets as well as maintaining existing markets. In addition, future utilization of pipeline capacity will depend on energy prices, competition from other pipelines and alternate fuels, the general level of natural gas demand and weather conditions, among other things. Further, gas prices which directly impact transportation and operating profits may fluctuate in unpredictable ways.
ITEM 2.
ITEM 2. PROPERTIES.
See "Item 1. Business."
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
GATHERING FACILITIES SPIN-DOWN ORDER (DOCKET NOS. CP96-206-000 AND CP96-207- 000) In February 1996, Transco filed an application with the FERC for an order authorizing the abandonment of certain facilities located onshore and offshore in Texas, Louisiana and Mississippi by conveyance to Williams Gas Processing - Gulf Coast Company (WGP), an affiliate of Transco. The net book value recorded by Transco at December 31, 1997 of the facilities, including the purchase price allocation to Transco, was approximately $529 million. Estimated operating income recorded by Transco for the year ended December 31, 1997 associated with the facilities was $15 million; however, such operating income may not be representative of the effects of the spin-down on Transco's future operating income due to various factors, including future regulatory actions. Concurrently, WGP filed a petition for declaratory order requesting a determination that its gathering services and rates be exempt from FERC regulation under the Natural Gas Act. On September 25, 1996, the FERC issued an order dismissing Transco's application and WGP's petition for declaratory order. On October 25, 1996, Transco and WGP filed a joint request for rehearing of the FERC's September 25 order, and in August 1997 filed a request that rehearing be expedited. Pending the outcome of the rehearing request and in an effort to expedite abandonment of at least a portion of the facilities included in the February 1996 application, in February 1998 Transco filed a separate application with the FERC seeking authorization to abandon by conveyance to WGP, Transco's onshore Tilden/McMullen gathering system which is located in Texas. The net book value at December 31, 1997 of the Tilden/McMullen facilities was $25 million, the entirety of which is included in the $529 million net book value for the facilities described in the February 1996 application.
ROYALTY CLAIMS AND LITIGATION In connection with Transco's renegotiations with producers to resolve take-or-pay and other contract claims and to amend gas purchase contracts, Transco entered into certain settlements which may require the indemnification by Transco of certain claims for additional royalties which the producers may be required to pay as a result of such settlements. Transco has been made aware of demands on producers for additional royalties and such producers may receive other demands which could result in claims against Transco pursuant to the indemnification provisions in their respective settlements. Indemnification for royalties will depend on, among other things, the specific lease provisions between the producer and the lessor and the terms of the settlement between the producer and Transco.
On March 15, 1994, a lawsuit was filed in the 189th Judicial District Court of Harris County, Texas (Texaco, Inc. vs. Transcontinental Gas Pipe Line Corporation). In this lawsuit, the plaintiff has claimed approximately $23 million, including interest and attorneys' fees for reimbursements of settlement amounts paid to royalty owners. On October 16, 1997, a jury verdict in this case found that Transco was required to pay Texaco damages of $14.5 million plus $3.75 million in attorney's fees. The trial judge initially deferred entering judgment and directed the parties to participate in mediation of this matter. Following mediation, which did not result in a resolution of this matter, the trial judge entered judgment consistent with the jury verdict and also awarded prejudgment interest of $5.0 million. Transco continues to believe that it has meritorious defenses to Texaco's claims which it intends to pursue vigorously on appeal.
In addition, Transco was notified by Freeport-McMoRan, Inc. (FMP) in February 1995, that pursuant to a settlement with the Mineral Management Service (MMS) of the MMS' claim for royalties due under gas contracts between Transco and FMP which had been modified pursuant to settlement agreements made in 1986 and 1989, FMP was asserting a claim for indemnification of approximately $6 million, including interest, under the excess royalty provisions of those settlement agreements. On or about March 3, 1995, Transco filed suit against FMP, FM Properties Operating Co. and FMP Operating Company in the 53rd Judicial District Court of Travis County, Texas, under the Texas Uniform Declaratory Judgements Act seeking a determination that Transco is not liable to defendants under the terms of the settlement agreements. On April 3, 1995, the defendants filed their answer and a plea in abatement. On or about March 30, 1995, FMP and FM Properties Operating Co. filed a petition for specific performance seeking recovery against Transco for the sums claimed under the settlement agreements. On May 4, 1995, Transco filed an answer denying any liability to plaintiffs.
In August 1996, a lawsuit was filed against Transco and certain Transco affiliates by a royalty owner in a gas producing field in Brooks County, Texas alleging a claim for incorrect computation of royalties. Transco is alleged to have purchased gas from the field. Transco has filed an answer denying liability for the claim.
OTHER LITIGATION In July 1996, Canadian Occidental of California (CXY) filed a lawsuit against Transco and certain Transco affiliates demanding an accounting relating to alleged take-or-pay deficiencies under seven gas purchase contracts for the years 1982 and 1983. CXY has since amended its original petition to demand an accounting under the seven contracts through the year 1992. Transco has answered the lawsuit asserting that the alleged deficiencies were settled in an agreement with CXY in 1986 or, alternatively, that the claims are barred by the statute of limitation.
ENVIRONMENTAL MATTERS
Transco is subject to extensive federal, state and local environmental laws and regulations which affect Transco's operations related to the construction and operation of its pipeline facilities. Appropriate governmental authorities may enforce these laws and regulations with a variety of civil and criminal enforcement measures, including monetary penalties, assessment and remediation requirements and injunctions as to future compliance. Transco's use and disposal of hazardous materials are subject to the requirements of the federal Toxic Substances Control Act (TSCA), the federal Resource Conservation and Recovery Act (RCRA) and comparable state statutes. The Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), also known as "Superfund," imposes liability, without regard to fault or the legality of the original act, for release of a "hazardous substance" into the environment. Because these laws and regulations change from time to time, practices that have been acceptable to the industry and to the regulators have to be changed and assessment and monitoring have to be undertaken to determine whether those practices have damaged the environment and whether remediation is required. Since 1989, Transco has had studies underway to test certain of its facilities for the presence of toxic and hazardous substances to determine to what extent, if any, remediation may be necessary. On the basis of the findings to date, Transco estimates that environmental assessment and remediation costs that will be incurred over the next five years under TSCA, RCRA, CERCLA and comparable state statutes will total approximately $25 million to $30 million, measured on an undiscounted basis. This estimate depends upon a number of assumptions concerning the scope of remediation that will be required at certain locations and the cost of remedial measures to be undertaken. Transco is continuing to conduct environmental assessments and is implementing a variety of remedial measures that may result in increases or decreases in the total estimated costs. At December 31, 1997, Transco had a reserve of approximately $25 million for these estimated costs that has been recorded in current liabilities and other long-term liabilities in the accompanying Consolidated Balance Sheet.
Transco considers environmental assessment and remediation costs and costs associated with compliance with environmental standards to be recoverable through rates, since they are prudent costs incurred in the ordinary course of business. To date, Transco has been permitted recovery of environmental costs incurred, and it is Transco's intent to continue seeking recovery of such costs, as incurred, through rate filings. Therefore, these
estimated costs of environmental assessment and remediation have been recorded as regulatory assets in the accompanying Consolidated Balance Sheet.
Transco has used lubricating oils containing polychlorinated biphenyls (PCBs) and, although the use of such oils was discontinued in the 1970s, has discovered residual PCB contamination in equipment and soils at certain gas compressor station sites. Transco has worked closely with the U. S. Environmental Protection Agency (EPA) and state regulatory authorities regarding PCB issues, and has a program to assess and remediate such conditions where they exist, the costs of which are included in the $25 million to $30 million range discussed above. Civil penalties have been assessed by the EPA against other major pipeline companies for the alleged improper use and disposal of PCBs. Transco has received and responded to information requests from the EPA. Although penalties have not presently been asserted, no assurances can be given that the EPA will not seek such penalties in the future.
Transco has been identified as a potentially responsible party (PRP) at various Superfund and state waste disposal sites. Based on present volumetric estimates and other factors, Transco's estimated aggregate exposure for remediation of these sites is less than $500,000. The estimated remediation costs for all such sites have been included in Transco's environmental reserve discussed above. Liability under CERCLA (and applicable state law) can be joint and several with other PRPs. Although volumetric allocation is a factor in assessing liability, it is not necessarily determinative; thus, the ultimate liability could be substantially greater than the amounts described above.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Since Transco meets the conditions set forth in General Instruction (I)(1)(a) and (b) of Form 10-K, this information is omitted.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Transco is an indirect wholly-owned subsidiary of Williams; therefore, Transco's common stock is not publicly traded.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
Since Transco meets the conditions set forth in General Instruction (I)(1)(a) and (b) of Form 10-K, this information is omitted.
ITEM 7.
ITEM 7. MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS. (THIS DISCUSSION SHOULD BE READ IN CONJUNCTION WITH ITEM 8, FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.)
INTRODUCTION
As discussed in Note 1, Corporate Structure and Control, of the Notes to Consolidated Financial Statements included in Item 8
Item 8 herein, for a discussion of Transco's rate and regulatory matters.
EFFECT OF INFLATION
Transco generally has experienced increased costs due to the effect of inflation on the cost of labor, materials and supplies, and property, plant and equipment. A portion of the increased labor and materials and supplies cost can directly affect income through increased maintenance and operating costs. The cumulative impact of inflation over a number of years has resulted in increased costs for current replacement of productive facilities. The majority of Transco's property, plant and equipment and inventory is subject to ratemaking treatment, and under current FERC practices, recovery is limited to historical costs. While amounts in excess of historical cost are not recoverable under current FERC practices, Transco believes it will be allowed to recover and earn a return based on increased actual cost incurred when existing facilities are replaced. Cost based regulation along with competition and other market factors limit Transco's ability to price services or products based upon inflation's effect on costs.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Page Report of Independent Auditors.................................... 23 Consolidated Balance Sheet........................................ 24-25 Consolidated Statement of Income.................................. 26 Consolidated Statement of Common Stockholder's Equity............. 27 Consolidated Statement of Cash Flows.............................. 28-29 Notes to Consolidated Financial Statements........................ 30-57
REPORT OF INDEPENDENT AUDITORS
Transcontinental Gas Pipe Line Corporation The Board of Directors
We have audited the accompanying consolidated balance sheet of Transcontinental Gas Pipe Line Corporation as of December 31, 1997 and 1996, and the related consolidated statements of income, common stockholder's equity, and cash flows for the years ended December 31, 1997 and 1996 and the periods from January 1, 1995 to January 17, 1995, and from January 18, 1995 to December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements 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, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Transcontinental Gas Pipe Line Corporation at December 31, 1997 and 1996, and the consolidated results of its operations and its cash flows for the years ended December 31, 1997 and 1996 and the periods from January 1, 1995 to January 17, 1995, and from January 18, 1995 to December 31, 1995, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Tulsa, Oklahoma February 13, 1998
TRANSCONTINENTAL GAS PIPE LINE CORPORATION
CONSOLIDATED BALANCE SHEET THOUSANDS OF DOLLARS
TRANSCONTINENTAL GAS PIPE LINE CORPORATION
CONSOLIDATED BALANCE SHEET THOUSANDS OF DOLLARS
The acquisition of Transco Energy Company and subsidiaries, including Transco, by The Williams Companies, Inc. was accounted for using the purchase method of accounting. Accordingly, the purchase price was "pushed-down" and recorded in the accompanying financial statements which affects the comparability of the post-acquisition and pre-acquisition financial position, results of operations and cash flows.
TRANSCONTINENTAL GAS PIPE LINE CORPORATION
CONSOLIDATED STATEMENT OF INCOME THOUSANDS OF DOLLARS
The acquisition of Transco Energy Company and subsidiaries, including Transco, by The Williams Companies, Inc. was accounted for using the purchase method of accounting. Accordingly, the purchase price was "pushed-down" and recorded in the accompanying financial statements which affects the comparability of the post-acquisition and pre-acquisition financial position, results of operations and cash flows.
TRANSCONTINENTAL GAS PIPE LINE CORPORATION
CONSOLIDATED STATEMENT OF COMMON STOCKHOLDER'S EQUITY THOUSANDS OF DOLLARS
The acquisition of Transco Energy Company and subsidiaries, including Transco, by The Williams Companies, Inc. was accounted for using the purchase method of accounting. Accordingly, the purchase price was "pushed-down" and recorded in the accompanying financial statements which affects the comparability of the post-acquisition and pre-acquisition financial position, results of operations and cash flows.
TRANSCONTINENTAL GAS PIPE LINE CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS THOUSANDS OF DOLLARS
													
The acquisition of Transco Energy Company and subsidiaries, including Transco, by The Williams Companies, Inc. was accounted for using the purchase method of accounting. Accordingly, the purchase price was "pushed-down" and recorded in the accompanying financial statements which affects the comparability of the post-acquisition and pre-acquisition financial position, results of operations and cash flows.
TRANSCONTINENTAL GAS PIPE LINE CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS THOUSANDS OF DOLLARS
TRANSCONTINENTAL GAS PIPE LINE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Corporate Structure and Control..................................... 30 2. Summary of Significant Accounting Policies.......................... 31 3. Contingent Liabilities and Commitments.............................. 34 4. Debt, Financing Arrangements and Leases............................. 45 5. Preferred Stock..................................................... 47 6. Employee Benefit Plans.............................................. 48 7. Income Taxes........................................................ 52 8. Financial Instruments............................................... 54 9. Transactions with Major Customers and Affiliates.................... 55 10. Quarterly Information (Unaudited)................................... 56
1. CORPORATE STRUCTURE AND CONTROL
Transcontinental Gas Pipe Line Corporation (Transco) is a wholly-owned subsidiary of Williams Interstate Natural Gas Systems, Inc. (WINGS). WINGS is a wholly-owned subsidiary of The Williams Companies, Inc. (Williams). Prior to May 1, 1995, Transco was a wholly-owned subsidiary of Transco Gas Company (TGC). TGC is a wholly-owned subsidiary of Transco Energy Company (TEC).
On December 12, 1994, TEC and Williams announced that they had entered into a merger agreement (Merger Agreement) pursuant to which Williams acquired through a cash tender offer 24.6 million shares, or approximately 60%, of the outstanding shares of TEC's common stock for $430.5 million. The cash tender offer was then followed by a stock merger (Merger) in which shares of TEC common stock not purchased in the tender offer were exchanged for Williams' common stock valued at $334 million.
The tender offer began on December 16, 1994 and expired on January 17, 1995. Approximately 35.2 million shares, or approximately 86.7%, of the outstanding shares of TEC's common stock were tendered to Williams for purchase. Pursuant to the Merger Agreement, on January 18, 1995, Williams accepted for payment 24.6 million shares of TEC's common stock for $17.50 per share as the first step in acquiring the entire equity interest of TEC. The exchange of the remainder of the outstanding shares of TEC's common stock for Williams' common stock was approved by a majority of TEC's stockholders on April 28, 1995 and occurred on the May 1, 1995 effective date of the Merger. On May 1, 1995, TEC declared and paid as a dividend to Williams all of TEC's interest in Transco.
Transco's Board of Directors declared a non-cash common stock dividend equal to the net book value of the assets transferred to Williams of $8.3 million in 1996 and $1.5 million in 1995 and non-cash return of capital to Williams of $0.7 million in 1995.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS Transco is an interstate natural gas transmission company which owns a natural gas pipeline system extending from Texas, Louisiana, Mississippi and the Gulf of Mexico through the states of Alabama, Georgia, South Carolina, North Carolina, Virginia, Maryland, Pennsylvania and New Jersey to the New York City metropolitan area. The system serves customers in Texas and the eleven southeast and Atlantic seaboard states mentioned above, including major metropolitan areas in Georgia, North Carolina, New York, New Jersey and Pennsylvania.
BASIS OF PRESENTATION The acquisition of TEC and its subsidiaries, including Transco, by Williams has been accounted for using the purchase method of accounting. Accordingly, an allocation of the purchase price was assigned to the assets and liabilities of Transco based on their estimated fair values. The accompanying post-acquisition consolidated financial statements reflect Transco's share of the purchase price. The purchase price allocation to Transco primarily consisted of a $1.5 billion allocation to property, plant and equipment, which is being amortized on a straight-line basis, and adjustments to deferred taxes based upon the book basis of the net assets recorded as a result of the acquisition. Current Federal Energy Regulatory Commission (FERC) policy does not permit Transco to recover through rates amounts in excess of original cost.
Further, as a result of the change in control of Transco on January 18, 1995 and the effects of the allocation of the purchase price, Transco's Consolidated Statement of Income, Consolidated Statement of Common Stockholder's Equity and Consolidated Statement of Cash Flows for the twelve months ended December 31, 1995 have been segregated into a pre-acquisition period ending January 17, 1995 and a post-acquisition period beginning January 18, 1995.
Prior to May 1, 1995 and as a subsidiary of TEC, Transco engaged in transactions with TEC and other TEC subsidiaries, characteristic of group operations. For consolidated cash management purposes, Transco made interest-bearing advances to TEC and received interest-bearing advances and capital contributions from TEC. These advances were represented by demand notes. As general TEC corporate policy, the interest rate on intercompany demand notes was 1-1/2% below the prime rate of Citibank, N.A.
Effective May 1, 1995, Transco began participation in Williams' cash management program. On that date, the balance of the advances due to TEC were transferred by TEC to Williams. Subsequent to May 1, 1995, Transco repaid advances due Williams and made advances to Williams. These advances are represented by demand notes. Transco
currently expects to receive payment of these advances within the next twelve months and has recorded such advances as current in the accompanying Consolidated Balance Sheet. The interest rate on intercompany demand notes is the London Interbank Offered Rate on the first day of the month plus a fixed rate of 0.325%.
After FERC approval in January 1993, Transco realigned its gas marketing business under the management of Transco Gas Marketing Company (TGMC), which, through an agency agreement, began to manage all jurisdictional merchant gas sales of Transco. In May 1995, Williams Energy Services Company (WESCO) became the successor to the TGMC agency agreement and began to manage Transco's jurisdictional merchant sales. The long-term purchase agreements managed by WESCO remain in Transco's name, as do the corresponding sales of such purchased gas. Therefore, Transco continues to record natural gas sales revenues and the related accounts receivable and cost of natural gas sales and the related accounts payable for the jurisdictional merchant sales that are managed by WESCO. Through the agency agreement, WESCO receives all margins associated with jurisdictional merchant gas sales business and, as Transco's agent, assumes all market and credit risk associated with Transco's jurisdictional merchant gas sales. Consequently, Transco's merchant gas sales service has no impact on its operating income or results of operation.
PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Transco and majority-owned subsidiaries. Companies in which Transco and its subsidiaries own 20 percent to 50 percent of the voting common stock are accounted for under the equity method.
PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment is recorded at cost, adjusted in 1995 to reflect the allocation of the purchase price as discussed above. Gains or losses from the ordinary sale or retirement of property, plant and equipment are credited or charged to accumulated depreciation; other gains or losses are recorded in net income.
Depreciation rates used for major regulated gas plant facilities at year-end 1997, 1996, and 1995 were:
Category of Property 1997 1996 1995 - ---------------------- ----------- ----------- -----------
Gathering facilities.................. 2.60%-3.80% 2.60%-3.80% 6.22% Storage facilities.................... 2.50% 2.50% 2.50% Onshore transmission facilities....... 2.35% 2.35% 2.65% Offshore transmission facilities...... 2.25% 2.25% 3.75%-7.78%
Depreciation of general plant is provided on a group basis at straight-line rates.
Under the terms of a settlement in Transco's general rate case in Docket No. RP95- 197, which was effective September 1, 1995, Transco agreed to reduce depreciation rates for certain categories of property. The reduction in depreciation rates had no effect on operating or net income due to an offsetting reduction in operating revenues, but did result in lower cash flows from operations. The reduction in rates was recorded in 1996, retroactive to September 1, 1995.
ACCOUNTING FOR INCOME TAXES Williams and its wholly-owned subsidiaries, which includes Transco, file a consolidated federal income tax return. It is Williams' policy to charge or credit each subsidiary with an amount equivalent to its federal income tax expense or benefit computed as if each subsidiary had filed a separate return.
Transco uses the liability method of accounting for deferred income taxes which requires, among other things, provisions for all temporary differences between the financial basis and the tax basis in Transco's assets and liabilities and adjustments to the existing deferred tax balances for changes in tax rates, whereby such balances will more closely approximate the actual taxes to be paid.
REVENUE RECOGNITION Transco recognizes revenues for the sale of its commodities in the period of delivery and recognizes revenue for the transportation of gas in the period the service is provided based upon contractual terms. Transco is subject to FERC regulations and, accordingly, certain revenues are collected subject to possible refunds pending final FERC orders. Transco records rate refund accruals based on management's estimate of the expected outcome of these proceedings.
ALLOWANCES FOR DOUBTFUL RECEIVABLES Due to its customer base, Transco has not historically experienced recurring credit losses in connection with its receivables. As a result, receivables determined to be uncollectible are reserved or written off in the period of such determination. At December 31, 1997 and 1996, Transco had no allowance for doubtful accounts.
USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION The allowance for funds used during construction (AFUDC) represents the cost of funds applicable to regulated natural gas transmission plant under construction as permitted by FERC regulatory practices. The allowance for borrowed funds used during construction was $2.4 million, $2.1 million and $1.1 million for 1997, 1996 and 1995, respectively. The allowance for equity funds was $5.4 million, $4.7 million and $6.0 million for 1997, 1996 and 1995, respectively.
GAS IN STORAGE Transco utilizes the last-in, first-out (LIFO) method of accounting for inventory gas in storage.
GAS IMBALANCES In the course of providing transportation services to customers, Transco may receive different quantities of gas from shippers than the quantities delivered on behalf of those shippers. Additionally, Transco transports gas on various pipeline systems which may deliver different quantities of gas on behalf of Transco than the quantities of gas received from Transco. These transactions result in gas transportation and exchange imbalance receivables and payables which are recovered or repaid in cash or through the receipt or delivery of gas in the future and are recorded in the accompanying Consolidated Balance Sheet. Settlement of imbalances requires agreement between the pipelines and shippers as to allocations of volumes to specific transportation contracts and timing of delivery of gas based on operational conditions. Transco's rate structure includes a method whereby most imbalances generated after August 1, 1991 are settled on a monthly basis. Imbalances predating August 1, 1991 are being recovered or repaid in cash or through the receipt or delivery of gas in the future upon agreements of allocation and as permitted by operating conditions. These imbalances have been classified as current assets or current liabilities at December 31, 1997 and 1996.
EMPLOYEE STOCK-BASED AWARDS Employee stock-based awards are accounted for under Accounting Principles Board Opinion (APBO) No. 25, "Accounting for Stock Issued to Employees" and related interpretations. Williams' fixed plan common stock options do not result in compensation expense, because the exercise price of the stock options equals the market price of the underlying stock on the date of grant.
NEW ACCOUNTING STANDARDS In June 1997, the Financial Accounting Standards Board issued two new accounting standards, SFAS No. 130, "Reporting Comprehensive Income," and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." Both standards, effective for fiscal years beginning after December 15, 1997, are disclosure oriented standards. Therefore, neither standard will affect Transco's reported consolidated results of operations, financial position or cash flows.
RECLASSIFICATIONS Certain reclassifications have been made in the 1996 and 1995 financial statements to conform to the 1997 presentation.
3. CONTINGENT LIABILITIES AND COMMITMENTS
RATE AND REGULATORY MATTERS
GENERAL RATE CASE (DOCKET NO. RP97-71) On November 1, 1996, Transco submitted to the FERC a general rate case filing principally designed to recover costs associated with increased capital expenditures. These increased capital expenditures primarily relate to system reliability, integrity and Clean Air Act compliance.
When stated on a comparable basis, the rates Transco placed into effect on May 1, 1997, represent an annual cost of service increase of approximately $47 million over the cost of service underlying the rates contained in the settlement of Transco's last general rate filing (Docket No. RP95-197). The rates, which are subject to refund, are designed using the straight fixed-variable rate design method.
The filing also included (1) a pro-forma proposal to roll-in the costs of Transco's Leidy Line and Southern expansion incremental projects and (2) a pro-forma proposal to make interruptible transportation (IT) backhaul rates equal to the IT forward haul rates. The pro-forma proposals would be made effective prospectively only after final FERC approval.
On November 29, 1996, the FERC issued an order accepting Transco's filing, suspending its effectiveness until May 2, 1997 and establishing a hearing to examine the reasonableness of Transco's proposed rates. In addition, the order consolidated Transco's pro forma roll-in proposal with the Phase II hearing in Docket No. RP95-197, and directed that the record in that proceeding be supplemented to the extent necessary. On February 3, 1997, the FERC issued an order on rehearing of its November 29, 1996 order which, among other things, revised the effective date for the proposed rates to May 1, 1997.
On January 20, 1998, Transco filed a Stipulation and Agreement for approval by the FERC, documenting a settlement with all of the active parties in this proceeding. The settlement resolves all cost of service, throughput and other issues in this proceeding, except rate of return, capital structure and certain minor cost allocation and rate design issues. The issues not resolved by the settlement will be litigated by the parties.
GENERAL RATE CASE (DOCKET NO. RP95-197) On March 1, 1995, Transco filed with the FERC a general rate case that proposed changes in the rates for Transco's transportation, sales and storage service rate schedules effective April 1, 1995. The changes in rates, if accepted as proposed, would have generated additional annual jurisdictional revenues of approximately $132 million over the pre-filed rates in effect, based, among other things, on an increase in Transco's cost of capital resulting from an increase in the equity component of the capital structure used (the filing was based on Transco's own capital structure) and in the cost of equity from the pre-filed rate of return on equity of 14.45% to the proposed rate of return on equity of 15.25%. Transco also proposed certain changes to the terms and conditions of its tariff, including the elimination of the IT crediting mechanism.
On March 31, 1995, the FERC issued an order on Transco's filing which accepted and suspended the tariff sheets relating to Transco's rates, to be effective September 1, 1995, subject to refund, and established hearing procedures. The March 31 order also accepted, effective April 1, 1995, the tariff sheets changing Transco's terms and conditions
of service, subject to the outcome of a technical conference. As to the elimination of the IT crediting mechanism, the FERC permitted Transco to eliminate the IT crediting mechanism subject to the outcome of a hearing to determine the reasonableness of Transco's test period throughput projections for interruptible services. On August 31, 1995, Transco filed to place the rates filed on March 1, 1995 into effect on September 1, 1995, as adjusted to reflect certain changes subsequent to the March 1 filing. The FERC accepted Transco's filing, subject to the outcome of the hearing and technical conference established by the FERC's March 31 order.
At a prehearing conference, the presiding Administrative Law Judge (ALJ) adopted a procedural schedule establishing a phased hearing for the rate issues raised by Transco's filing. Phase I of the hearing was limited to the issues of the rate of return and capital structure. Phase II of the hearing was to address the remaining rate issues.
The hearing before the ALJ in Phase I concluded in December 1995. On December 18, 1996, the ALJ issued his initial decision in Phase I, which, as to capital structure, found that Williams controlled Transco's financing and imputed Williams' capital structure to Transco, resulting in a capital structure consisting of 47.72% long term debt, 4.07% preferred equity, and 48.21% common equity, and found that Transco should use Williams' cost of long term debt (8.89%) and its cost of preferred equity (8.80%) as of June 30, 1995. As to rate of return, the ALJ recommended a rate of return on equity of 11.50%.
On August 1, 1997, the FERC issued an order modifying the initial decision issued on December 18, 1996 by the ALJ in the Phase I proceeding determining the capital structure and rate of return for Transco. As to capital structure, the FERC reversed the ALJ's use of the Williams capital structure, and applied a new modified capital structure policy to find that Transco's own capital structure, consisting of 57.58% equity, should be used for developing the rate of return in this proceeding. As to rate of return on equity, the FERC affirmed the overall methodology used by the ALJ in his initial decision, but reversed the ALJ's decision in order to revise the manner in which the long-range growth component of that methodology is determined to be consistent with the FERC's recent decisions on that issue. The order required that Transco make a compliance filing consistent with the revised methodology, stating that refunds will be determined once the FERC rules on that compliance filing. Transco has sought rehearing of the FERC's order asserting, among other things, that the FERC's methodology for calculating rates of return is flawed. Other parties in the case have also sought rehearing of the FERC's order claiming, among other things, that FERC should not have reversed the ALJ with respect to the issue of the appropriate capital structure for ratemaking purposes.
On June 19, 1996, Transco filed with the FERC a Stipulation and Agreement which resolved cost of service (subject to the outcome of capital structure and rate of return in the Phase I proceeding), throughput level and mix, and certain cost allocation and rate
design issues. The agreement also reserved certain other issues for hearing in Phase II, including the issue of rolled-in pricing for incremental Leidy Line services. With the exception of one party that filed comments opposing the settlement and one party that took no position on the merits of the settlement, all active parties and the FERC's staff either supported the settlement or did not oppose it. Transco began billing the settlement rates to non-contesting parties effective August 1, 1996.
On October 9, 1996, Transco filed with the FERC a Stipulation and Agreement which, subject to the outcome of the litigation of the reserved issues in Phase I and Phase II in this proceeding, settled the issues of cost of service and throughput with the one party that opposed the resolution of those issues in the June 19, 1996 settlement.
On November 1, 1996, the FERC issued an order approving the June 19 agreement, and on December 23, 1996, FERC approved the October 9, 1996 agreement. On February 3, 1997, the FERC denied rehearing of its November 1, 1996 order. As a result, Transco made refunds on May 30, 1997 of approximately $79.0 million, including interest, under Docket No. RP95-197 for which Transco had previously provided a reserve.
The hearing concerning the Phase II issues not resolved by the June 19, 1996 and October 9, 1996 agreements concluded in November 1996. A supplemental hearing to consider Transco's roll-in proposal filed in Docket No. RP97-71, as discussed above, was completed in June 1997. The issues addressed in both hearings are pending before the ALJ.
On October 4, 1995, the FERC issued an order on the tariff issues addressed at a technical conference held pursuant to the FERC's March 31 order. The FERC required that Transco make certain tariff changes consistent with the October 4 order (most of which were agreed to by Transco at the technical conference). Among other things, the October 4 order directed that Transco modify its tariff concerning shipper access to secondary receipt points. On May 29, 1996, the FERC accepted Transco's filing effective June 1, 1996 to implement secondary receipt point access, but also required Transco to show cause why firm backhauls should not be required on Transco's system. Following a technical conference on the issue in Docket No. RP96-211, the FERC required Transco to offer a firm backhaul service which Transco implemented, subject to further FERC action, on January 1, 1997.
RATE OF RETURN CALCULATION As discussed above, on August 1, 1997, the FERC issued an order addressing, among other things, the authorized rate of return for Transco's 1995 rate case (Docket No. RP95-197). In the order, the FERC continued its practice of utilizing a methodology for calculating rates of return that incorporates a long-term growth rate component. The long-term growth rate component used by the FERC is now a projection of U.S. gross domestic product growth rates. Generally, calculating rates of
return utilizing a methodology which includes a long-term growth rate component results in rates of return that are lower than they would be if the long-term growth rate component were not included in the methodology. As indicated above, Transco has sought rehearing of the FERC order in an effort to have the FERC change its rate of return methodology with respect to both pending and future rate cases. On January 30, 1998, the FERC convened a public conference to explore, among other things, possible modifications to the FERC's rate of return methodology.
GENERAL RATE CASE (DOCKET NO. RP92-137) On March 2, 1992, Transco filed with the FERC a general rate case that proposed an increase in transportation rates, and also included a change to straight-fixed-variable (SFV) rate design. On September 1, 1992, the increased rates went into effect, subject to refund.
On May 3, 1993, Transco filed with the FERC a Stipulation and Agreement with regard to Docket No. RP92-137. On November 4, 1993, the FERC issued an order accepting the settlement, and the settlement became effective on April 1, 1994. The settlement resolved all issues in Docket No. RP92-137 except (i) issues relating to Transco's rate of return (see discussion below), and (ii) the issue of the appropriate load factor for the design of Transco's interruptible rates, which the FERC referred to a hearing in Docket No. RP92-137, for prospective effect only. In addition, in the settlement, Transco agreed to file a new general section 4 rate case to be effective no later than September 1, 1995 (see discussion above of Docket No. RP95-197). During 1995, Transco made refunds of approximately $62.2 million, including interest, under Docket No. RP92-137 for which Transco had previously provided a reserve.
On September 17, 1992, the FERC issued a decision addressing the single issue of the appropriate rate of return in Docket No. RP92-137. The FERC, using a hypothetical capital structure based on the average capital structure of a group of seven publicly-traded companies with pipeline subsidiaries, determined Transco's appropriate rate of return on equity to be 14.45%. On December 23, 1994, the D.C. Circuit Court issued an opinion remanding to the FERC for further consideration the FERC's September 17, 1992 order. The D.C. Circuit Court determined that the FERC had failed to explain adequately its decisions to use a hypothetical capital structure for Transco, to select a rate of return on equity at the top range of reasonableness, and to use as a proxy group to develop Transco's hypothetical capital structure a group of publicly-traded parent companies with pipeline subsidiaries rather than a group of regulated pipelines. On April 10, 1996, the FERC issued its order on remand and adopted Transco's capital structure as the appropriate capital structure for ratemaking purposes, reversing its previous orders adopting a hypothetical capital structure. The FERC made no adjustment to Transco's rate of return on equity, adopting a 14.45% rate of return on equity. On September 17, 1996, Transco made refunds required under the FERC order of approximately $3.2 million, for which Transco had previously provided a reserve. On November 5, 1997, the D.C. Circuit Court denied a petition for review of the FERC's orders.
Transco has expressed to the FERC concerns that inconsistent treatment under Order 636 of Transco and its competitor pipelines with regard to rate design and cost allocation issues in the production area may result in rates which could make Transco less competitive, both in terms of production-area and long-haul transportation. A hearing before an ALJ, dealing with, among other things, Transco's production-area rate design, concluded in June 1994. On July 19, 1995, the ALJ issued an initial decision finding that Transco's proposed production area rate design, and its existing use of a system wide cost of service and allocation of firm capacity in the production area are unjust and unreasonable. The ALJ therefore recommended that Transco divide its costs between its production area and market area, and permit its customers to renominate their firm entitlements.
On July 3, 1996, the FERC issued an order on review of the ALJ's initial decision concerning, among other things, Transco's production area rate design. The FERC rejected the ALJ's recommendations that Transco divide its costs between its production area and market area, and permit its customers to renominate their firm entitlements. The FERC also concluded that Transco may offer firm service on its supply laterals through an open season and eliminate its IT feeder service in favor of an interruptible service option that does not afford shippers feeding firm transportation on Transco's production area mainline a priority over other interruptible transportation. On December 18, 1996, the FERC denied rehearing of its July 3, 1996 Order.
Several parties, including Transco, have filed petitions for review in the D.C. Circuit Court of the FERC's orders addressing production area rate design issues.
ORDER 636 On November 1, 1993, Transco implemented Order 636. Prior to its implementation of Order 636, Transco received orders from the FERC which, among other things, (i) required Transco to revise its throughput projection for rate purposes to reflect a mix of throughput that includes a higher level of interruptible transportation, (ii) accepted Transco's proposal for rolled-in rate treatment of its Mobile Bay facilities and exempted Transco from having to reflect Mobile Bay transportation volumes and related revenues in a separate interruptible revenue crediting mechanism, (iii) approved a Stipulation and Agreement filed with the FERC by Transco and its sales customers resolving certain sales service issues and mooting potential issues regarding Transco's recovery of gas supply realignment (GSR) costs associated with Transco's firm sales service, and (iv) referred certain matters to the hearing in Docket No. RP92-137 (discussed above).
Transco and certain other parties have filed appeals of certain of the FERC's orders to the D.C. Circuit Court. Among the issues raised by the parties is the issue of whether the separately stated gathering rates charged by Transco should be subject to refund. On February 13, 1995, the D.C. Circuit Court issued an order holding all appeals of
restructuring orders arising out of Order 636 in abeyance until the court rendered an opinion in the appeals of Order 636.
On July 16, 1996, the D.C. Circuit Court issued a decision which in part affirmed and in part remanded Order 636. However, the court stated that Order 636 would remain in effect until the FERC issued a final order on remand after considering the remanded issues. With the issuance of this decision, the stay on the appeals of individual pipeline's restructuring cases was lifted.
On February 27, 1997, the FERC issued an order in response to the remand of Order 636 by the D.C. Circuit Court in July 1996. In that order, the FERC (i) reaffirmed its decision to allow pipelines to recover 100% of their GSR costs, (ii) allows the pipelines to propose an appropriate percentage of GSR costs to be recovered from IT customers, (iii) modified its right-of-first refusal policy to require firm capacity holders to match any term bid up to five years to keep their capacity, rather than the 20 year term adopted in Order 636, (iv) reaffirmed that straight fixed variable mitigation must be applied on a customer-by-customer basis, (v) requires prospectively that no-notice service be offered to all customers on a non-discriminatory basis, and (vi) reaffirmed that it will determine on a case-by-case basis the eligibility of a downstream pipeline's customers for the upstream pipeline's one-part, small customer rate.
Order 636 provides that pipelines should be allowed the opportunity to recover all prudently incurred transition costs. Transco does not expect to incur GSR costs associated with its firm sales service and Transco's non-GSR transition costs are anticipated to be insignificant. However, Transco expects that any Order 636 transition costs incurred should be recovered from its customers subject only to the costs and other risks associated with the difference between the time such costs are incurred and the time when those costs may be recovered from customers.
GATHERING FACILITIES SPIN-DOWN ORDER (DOCKET NOS. CP96-206-000 AND CP96-207- 000) In February 1996, Transco filed an application with the FERC for an order authorizing the abandonment of certain facilities located onshore and offshore in Texas, Louisiana and Mississippi by conveyance to Williams Gas Processing - Gulf Coast Company (WGP), an affiliate of Transco. The net book value recorded by Transco at December 31, 1997 of the facilities, including the purchase price allocation to Transco, was approximately $529 million. Estimated operating income recorded by Transco for the year ended December 31, 1997 associated with the facilities was $15 million; however, such operating income may not be representative of the effects of the spin-down on Transco's future operating income due to various factors, including future regulatory actions. Concurrently, WGP filed a petition for declaratory order requesting a determination that its gathering services and rates be exempt from FERC regulation under the Natural Gas Act. On September 25, 1996, the FERC issued an order dismissing Transco's application and WGP's petition for declaratory order. On October 25, 1996,
Transco and WGP filed a joint request for rehearing of the FERC's September 25 order, and in August 1997 filed a request that rehearing be expedited. Pending the outcome of the rehearing request and in an effort to expedite abandonment of at least a portion of the facilities included in the February 1996 application, in February 1998 Transco filed a separate application with the FERC seeking authorization to abandon by conveyance to WGP, Transco's onshore Tilden/McMullen gathering system which is located in Texas. The net book value at December 31, 1997 of the Tilden/McMullen facilities was $25 million, the entirety of which is included in the $529 million net book value for the facilities described in the February 1996 application.
LEGAL PROCEEDINGS
ROYALTY CLAIMS AND LITIGATION In connection with Transco's renegotiations with producers to resolve take-or-pay and other contract claims and to amend gas purchase contracts, Transco entered into certain settlements which may require the indemnification by Transco of certain claims for additional royalties which the producers may be required to pay as a result of such settlements. Transco has been made aware of demands on producers for additional royalties and such producers may receive other demands which could result in claims against Transco pursuant to the indemnification provisions in their respective settlements. Indemnification for royalties will depend on, among other things, the specific lease provisions between the producer and the lessor and the terms of the settlement between the producer and Transco.
On March 15, 1994, a lawsuit was filed in the 189th Judicial District Court of Harris County, Texas (Texaco, Inc. vs. Transcontinental Gas Pipe Line Corporation). In this lawsuit, the plaintiff has claimed approximately $23 million, including interest and attorneys' fees for reimbursements of settlement amounts paid to royalty owners. On October 16, 1997, a jury verdict in this case found that Transco was required to pay Texaco damages of $14.5 million plus $3.75 million in attorney's fees. The trial judge initially deferred entering judgment and directed the parties to participate in mediation of this matter. Following mediation, which did not result in a resolution of this matter, the trial judge entered judgment consistent with the jury verdict and also awarded prejudgment interest of $5.0 million. Transco continues to believe that it has meritorious defenses to Texaco's claims which it intends to pursue vigorously on appeal.
In addition, Transco was notified by Freeport-McMoRan, Inc. (FMP) in February 1995, that pursuant to a settlement with the Mineral Management Service (MMS) of the MMS' claim for royalties due under gas contracts between Transco and FMP which had been modified pursuant to settlement agreements made in 1986 and 1989, FMP was asserting a claim for indemnification of approximately $6 million, including interest, under the excess royalty provisions of those settlement agreements. On or about March 3, 1995, Transco filed suit against FMP, FM Properties Operating Co. and FMP Operating Company in the 53rd Judicial District Court of Travis County, Texas, under the Texas
Uniform Declaratory Judgements Act seeking a determination that Transco is not liable to defendants under the terms of the settlement agreements. On April 3, 1995, the defendants filed their answer and a plea in abatement. On or about March 30, 1995, FMP and FM Properties Operating Co. filed a petition for specific performance seeking recovery against Transco for the sums claimed under the settlement agreements. On May 4, 1995, Transco filed an answer denying any liability to plaintiffs.
In August 1996, a lawsuit was filed against Transco and certain Transco affiliates by a royalty owner in a gas producing field in Brooks County, Texas alleging a claim for incorrect computation of royalties. Transco is alleged to have purchased gas from the field. Transco has filed an answer denying liability for the claim.
OTHER LITIGATION In July 1996, Canadian Occidental of California (CXY) filed a lawsuit against Transco and certain Transco affiliates demanding an accounting relating to alleged take-or-pay deficiencies under seven gas purchase contracts for the years 1982 and 1983. CXY has since amended its original petition to demand an accounting under the seven contracts through the year 1992. Transco has answered the lawsuit asserting that the alleged deficiencies were settled in an agreement with CXY in 1986 or, alternatively, that the claims are barred by the statute of limitation.
ENVIRONMENTAL MATTERS
Transco is subject to extensive federal, state and local environmental laws and regulations which affect Transco's operations related to the construction and operation of its pipeline facilities. Appropriate governmental authorities may enforce these laws and regulations with a variety of civil and criminal enforcement measures, including monetary penalties, assessment and remediation requirements and injunctions as to future compliance. Transco's use and disposal of hazardous materials are subject to the requirements of the federal Toxic Substances Control Act (TSCA), the federal Resource Conservation and Recovery Act (RCRA) and comparable state statutes. The Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), also known as "Superfund," imposes liability, without regard to fault or the legality of the original act, for release of a "hazardous substance" into the environment. Because these laws and regulations change from time to time, practices that have been acceptable to the industry and to the regulators have to be changed and assessment and monitoring have to be undertaken to determine whether those practices have damaged the environment and whether remediation is required. Since 1989, Transco has had studies underway to test certain of its facilities for the presence of toxic and hazardous substances to determine to what extent, if any, remediation may be necessary. On the basis of the findings to date, Transco estimates that environmental assessment and remediation costs that will be incurred over the next five years under TSCA, RCRA, CERCLA and comparable state statutes will total approximately $25 million to $30 million, measured on an undiscounted basis. This estimate depends upon a number of assumptions concerning the scope of
remediation that will be required at certain locations and the cost of remedial measures to be undertaken. Transco is continuing to conduct environmental assessments and is implementing a variety of remedial measures that may result in increases or decreases in the total estimated costs. At December 31, 1997, Transco had a reserve of approximately $25 million for these estimated costs that has been recorded in current liabilities and other long-term liabilities in the accompanying Consolidated Balance Sheet.
Transco considers environmental assessment and remediation costs and costs associated with compliance with environmental standards to be recoverable through rates, since they are prudent costs incurred in the ordinary course of business. To date, Transco has been permitted recovery of environmental costs incurred, and it is Transco's intent to continue seeking recovery of such costs, as incurred, through rate filings. Therefore, these estimated costs of environmental assessment and remediation have been recorded as regulatory assets in the accompanying Consolidated Balance Sheet.
Transco has used lubricating oils containing polychlorinated biphenyls (PCBs) and, although the use of such oils was discontinued in the 1970s, has discovered residual PCB contamination in equipment and soils at certain gas compressor station sites. Transco has worked closely with the U. S. Environmental Protection Agency (EPA) and state regulatory authorities regarding PCB issues, and has a program to assess and remediate such conditions where they exist, the costs of which are included in the $25 million to $30 million range discussed above. Civil penalties have been assessed by the EPA against other major pipeline companies for the alleged improper use and disposal of PCBs. Transco has received and responded to information requests from the EPA. Although penalties have not presently been asserted, no assurances can be given that the EPA will not seek such penalties in the future.
Transco has been identified as a potentially responsible party (PRP) at various Superfund and state waste disposal sites. Based on present volumetric estimates and other factors, Transco's estimated aggregate exposure for remediation of these sites is less than $500,000. The estimated remediation costs for all such sites have been included in Transco's environmental reserve discussed above. Liability under CERCLA (and applicable state law) can be joint and several with other PRPs. Although volumetric allocation is a factor in assessing liability, it is not necessarily determinative; thus, the ultimate liability could be substantially greater than the amounts described above.
Transco is also subject to the federal Clean Air Act and to the federal Clean Air Act Amendments of 1990 (1990 Amendments), which added significantly to the existing requirements established by the federal Clean Air Act. The 1990 Amendments required that the EPA issue new regulations, mainly related to mobile sources, air toxics, ozone non-attainment areas and acid rain. During the last few years Transco has been acquiring all necessary permits and installing new emission control devices required for new or modified facilities in areas designated as attainment by EPA and is continuing that process.
Transco operates facilities in some areas of the country currently designated as non-attainment and it anticipates that in 1998 the EPA may designate additional new non-attainment areas which might impact Transco's operations. Pursuant to non-attainment area requirements of the 1990 Amendments, Transco is completing scheduled installation of new air pollution controls on existing sources at certain facilities in order to achieve attainment of air quality standards in regions where they are not currently achieved, and anticipates that additional facilities may be subject to increased controls within five years. For many of these facilities, Transco is completing installation of more cost effective, innovative compressor engine control designs developed by the Company, and it is therefore not possible to precisely determine the control costs pending completion of performance testing and final state approval. The control additions described above, required to comply with current federal Clean Air Act requirements and the 1990 Amendments, are estimated to cost in the range of $20 million to $30 million over the next five years and will be recorded as additions to property, plant and equipment as the facilities are added. If the EPA designates additional new non-attainment areas in 1998 which impact Transco's operations, the cost of additions to property, plant and equipment is expected to increase, but Transco is unable at this time to estimate with any certainty the cost of additions that may be required. Transco considers costs associated with compliance with the federal Clean Air Act and the 1990 Amendments to be prudent costs incurred in the ordinary course of business and, therefore, recoverable through its rates.
SUMMARY
While no assurances may be given, Transco does not believe that the ultimate resolution of the foregoing matters, taken as a whole and after consideration of amounts accrued, recovery from customers, insurance coverage or other indemnification arrangements, will have a materially adverse effect upon Transco's future financial position, results of operations and cash flow requirements.
OTHER COMMITMENTS
COMMITMENTS FOR CONSTRUCTION Transco has commitments for construction and acquisition of property, plant and equipment of approximately $54 million at December 31, 1997 of which the majority relates to construction materials for projects.
4. DEBT, FINANCING ARRANGEMENTS AND LEASES
LONG-TERM DEBT At December 31, 1997 and 1996, long-term debt issues were outstanding as follows (in thousands):
1997 1996 --------- --------- Debentures: 9-1/8% due 1998-2017....................... $ - $150,000 7.08% due 2026............................. 200,000 200,000 7.25% due 2026............................. 200,000 200,000 --------- --------- Total debentures....................... 400,000 550,000 --------- ---------
Notes: 8-1/8% due 1997............................ - 99,000 8-7/8% due 2002............................ 125,000 125,000 Variable rate due 2002..................... 150,000 - Credit Agreement........................... 160,000 - --------- --------- Total notes............................ 435,000 224,000 --------- --------- Total long-term debt issues................... 835,000 774,000 Unamortized debt premium................... 2,832 6,076 Current maturities......................... - (99,000) --------- ---------
Total long-term debt, less current maturities. $837,832 $681,076 ========= =========
Sinking fund or prepayment requirements applicable to long-term debt outstanding at December 31, 1997 are as follows (in thousands):
2001: 7.08% Debentures.............................. $ 200,000 ============
2002: 8-7/8% Note................................... $ 125,000 Variable rate note............................ 150,000 Credit Agreement.............................. 160,000 ------------ Total...................................... $ 435,000 ============
There are no sinking fund requirements applicable to long-term debt outstanding for the years 1998 through 2000.
No property is pledged as collateral under any of the long-term debt issues.
On July 15, 1996, Transco issued $200 million of debentures (7.08% Debentures), which pay interest at 7.08% per annum on January 15 and July 15 of each year, beginning January 15, 1997. The 7.08% Debentures mature on July 15, 2026, but are subject to
redemption, at anytime after July 15, 2001, at Transco's option, in whole or part, at a specified redemption price, plus accrued and unpaid interest to the date of redemption. The holder of each 7.08% Debenture may elect between May 15, 2001 and June 15, 2001 to have such 7.08% Debenture repaid on July 15, 2001 at 100% of the principal amount. Because of this option available to the holder, the 7.08% Debentures has been included in the sinking fund or prepayment requirements for the year 2001 in the table above. The 7.08% Debentures have no sinking fund provisions.
On January 15, 1997, Transco redeemed $99 million of its 8-1/8% Notes.
On July 31, 1997, Transco entered into a $150 million, five-year bank agreement, with variable interest rates based on the London Interbank Offered Rate.
Williams and certain of its subsidiaries, including Transco, are parties to a $1 billion credit agreement (Credit Agreement), under which Transco can borrow up to $400 million. Interest rates vary with current market conditions based on the base rate of Citibank N.A., three-month certificates of deposit of major United States money market banks, federal funds rate or the London Interbank Offered Rate. As of December 31, 1997, Transco had $160 million in outstanding borrowings under this agreement.
In September 1997, Williams and certain of its subsidiaries, including Transco, initiated a restructuring of its debt portfolio. On October 8, 1997, Transco borrowed $160 million under the Credit Agreement to fund the redemption of its entire $150 million issue of 9-1/8% Debentures originally due February 1, 2017, at a total redemption price of $156.4 million, plus accrued interest. As a result of the revaluation of Transco's debt at the time of its acquisition by Williams in 1995, Transco recorded an extraordinary gain of $4.6 million ($2.9 million, net of tax) from the early redemption of the 9-1/8% Debentures. The $6.4 million premium will be amortized over the remaining original life of the debentures based on FERC accounting requirements.
On January 16, 1998, Transco issued $200 million of notes that mature on January 15, 2005, and $100 million of notes that mature on January 15, 2008, which pay interest at 6-1/8% and 6-1/4%, respectively, per annum on January 15 and July 15 of each year, beginning July 15, 1998. The Notes are not subject to redemption and have no sinking fund provisions. Proceeds from the Notes were used for general corporate purposes, including the repayment of $160 million borrowed under the Credit Agreement.
SHORT-TERM DEBT Transco is a party to two short-term money market facilities, under which it can borrow up to an aggregate of $90 million. Interest rates vary with current market conditions. During 1997 and 1996, Transco had no borrowings under these agreements.
RESTRICTIVE COVENANTS At December 31, 1997, none of Transco's debt instruments restrict the amount of dividends distributable.
SALE OF RECEIVABLES Transco is a party to an agreement that expires on January 29, 1999 pursuant to which Transco can sell to an investor up to $100 million of undivided interests in certain of its trade receivables. At both December 31, 1997 and 1996, interests in $100 million of these receivables were held by the investor.
LEASE OBLIGATIONS Transco has a 20-year lease agreement with Transco Tower Limited for its headquarters building (Transco Tower) which expires in 2004. Transco has an option to renew and extend the existing lease term under the same provisions for three successive renewal terms of five years each. During 1996 and 1995, Transco entered into sublease agreements that also expire in 2004.
The future minimum lease payments under Transco's various operating leases, including the Transco Tower lease, net of future minimum sublease receipts under Transco's existing sublease agreements, are as follows (in thousands):
Operating Leases ----------------------------------------------- Transco Tower Other Leases Total -------------- ------------ ----------
1998......................... $ 22,877 $ 3,709 $ 26,586 1999......................... 22,795 3,709 26,504 2000......................... 21,307 3,192 24,499 2001......................... 23,590 3,088 26,678 2002......................... 23,546 3,088 26,634 Thereafter................... 29,423 9,994 39,417 -------------- ----------- ---------- Total net minimum obligations $ 143,538 $ 26,780 $ 170,318 ============== =========== ==========
The allocation of the purchase price to the assets and liabilities of Transco based on their estimated fair values resulted in the recording in 1995 of a liability of $53.0 million for the estimated unused space and the amount that Transco's Transco Tower lease obligation was in excess of fair value. The $53.0 million liability is being amortized over the term of the lease.
Transco's lease expense was $18.0 million in 1997, $17.0 million in 1996 and $20.1 million in 1995.
5. PREFERRED STOCK
Transco has authorized 10,000,000 shares of cumulative first preferred stock without par value, of which none were outstanding at December 31, 1997 or 1996. Transco has authorized 2,000,000 shares of cumulative second preferred stock without par value.
None of the second preferred had been issued at December 31, 1997. Transco redeemed all outstanding shares of its cumulative preferred stock series in March 1995 for $49.7 million, or $100 per share, plus accrued dividends of $0.6 million.
6. EMPLOYEE BENEFIT PLANS
RETIREMENT PLANS Prior to the Merger, Transco participated in a retirement plan (Retirement Plan) with TEC and certain of its subsidiaries that covered substantially all of Transco's officers and regular employees. Transco's officers and employees comprised a majority of the total officers and employees of TEC and its subsidiaries. Subsequent to the Merger, the Retirement Plan covers only Transco's officers and employees.
The benefits under the Retirement Plan are determined by a formula based on the employee's years of service and average final compensation. The Retirement Plan provides for the vesting of employees after five years of credited service. Transco's funding policy is to contribute an amount at least equal to the minimum funding requirements actuarially determined by an independent actuary in accordance with the Employee Retirement Income Security Act of 1974. Plan assets consist primarily of commingled funds and assets held in a master trust. The master trust is comprised primarily of domestic and foreign common and preferred stocks, corporate bonds, United States government securities and commercial paper.
The following table sets forth the funded status of the Retirement Plan at December 31, 1997 and 1996, and the amount of accrued pension liability for Transco and TEC as of December 31, 1997 and 1996 (in thousands):
The allocation of the purchase price to the assets and liabilities of Transco and TEC based on their estimated fair values resulted in the recording of an additional pension liability of $19.2 million, $17.3 million of which was recorded by Transco, representing the amount that the projected benefit obligation exceeded the plan assets. The amounts of pension costs deferred at December 31, 1997 and 1996 were $6.9 million and $5.4 million, respectively, and are expected to be recovered through future rates over the average remaining service period for active employees.
The following table sets forth the components of the Retirement Plan's net pension cost for Transco for the years ended December 31, 1997 and 1996 and Transco and TEC for the year ended December 31, 1995 (in thousands):
1997 1996 1995 --------- -------- --------
Service cost-benefits earned during the period $ 6,212 $ 5,847 $ 4,716 Interest cost on projected benefit obligation 15,808 14,240 12,111 Actual return on plan assets............... (27,769) (32,978) (37,958) Net amortization and deferral.............. 10,939 16,792 25,666 --------- -------- -------- Net pension cost........................... $ 5,190 $ 3,901 $ 4,535 ========= ======== ========
Transco's share of the Retirement Plan's net pension costs for 1995 was $4.2 million.
The projected unit credit method is used to determine the actuarial present value of the accumulated benefit obligation and the projected benefit obligation. The following table summarizes the various assumptions used to determine the projected benefit obligation for the Retirement Plan for the years 1997, 1996 and 1995:
1997 1996 1995 ------ ------ ------ Discount rate................................... 7.25% 7.50% 7.25% Rate of increase in future compensation levels 5.0% 5.0% 5.0% Expected long-term rate of return on assets 10% 10% 10%
Pension costs are determined using the assumptions as of the beginning of the year. The funded status is determined using the assumptions as of the end of the year.
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS Prior to January 1, 1996, Transco participated in a plan with TEC and certain of its subsidiaries (TEC Plan) that provided certain health care and life insurance benefits for retired employees of Transco. Effective January 1, 1996, Transco began participation in a plan with Williams and its subsidiaries (Williams Plan) that provides similar benefits for retired employees of Transco that were hired prior to January 1, 1996.
The plans provide benefits to retired Transco employees who worked full-time for five years, attained age 55 while in service and participated in Transco's Retirement Plan. The plans provide for retiree contributions and contain other cost-sharing features such as deductibles and coinsurance. The accounting for the plans anticipates future cost-sharing changes to the written plans that are consistent with Williams' expressed intent to increase the retiree contribution rate annually, generally in line with health care cost increases.
The benefits for all retired Transco employees are currently funded monthly to the extent recovery from customers can be achieved. Plan assets consist of assets held in two master trusts. One of the master trusts was previously described in the discussion of the retirement plan and the other consists primarily of domestic and foreign common stocks, government bonds and commercial paper held in a trust established under the provisions of section 501(c)(9) of the Internal Revenue Code.
The following table sets forth the funded status of the plans at December 31, 1997 and 1996, reconciled with the accrued postretirement benefits for Transco at December 31, 1997 and 1996 (in thousands):
1997 1996 -------- -------- Accumulated postretirement benefit obligation: Retirees.................................. $ 77,673 $ 77,249 Fully eligible active plan participants... 12,228 6,634 Other active plan participants............ 32,536 20,710 -------- -------- 122,437 104,593 Plan assets at market value................... 75,871 65,320 -------- -------- Accumulated postretirement benefit obligation in excess of plan assets...................... 46,566 39,273 Unrecognized net gain......................... 14,975 23,248 Unrecognized prior service cost............... 8,535 9,311 -------- -------- Accrued postretirement benefits............... $ 70,076 $ 71,832 ======== ========
The allocation of the purchase price to the assets and liabilities of Transco and TEC based on their estimated fair values resulted in the recording of a postretirement benefits liability of $86.9 million representing the amount that the accumulated postretirement benefit obligation exceeded the plan assets. The amounts of postretirement benefits costs deferred as a regulatory asset at December 31, 1997 and 1996 were $60.7 million and $64.8 million, respectively, and are expected to be recovered through future rates over the remaining amortization period of the unrecognized transition obligation.
The following table sets forth the components of the plans' net periodic postretirement benefit cost for Transco for the years ended December 31, 1997 and 1996 and Transco and TEC for the year ended December 31, 1995 (in thousands):
1997 1996 1995 --------- -------- --------- Service cost-benefits earned during the period $ 2,024 $ 1,639 $ 2,619 Interest cost on accumulated postretirement benefit obligation............................ 7,945 7,860 8,929 Actual return on plan assets.................. (8,502) (6,868) (7,651) Net amortization and deferral................. 7,816 7,226 9,623 --------- --------- -------- Net periodic postretirement benefit cost...... $ 9,283 $ 9,857 $13,520 ========= ========= ========
Transco's share of the TEC Plan's net periodic postretirement benefit cost for 1995 was $12.7 million.
The annual rate of increase in the per capita cost of covered health care benefits for 1998 was assumed to be 8.5% to 9.5%. The rate was assumed to decrease gradually to 5% for the year 2006 and remain at that level thereafter. Increasing the assumed health care cost trend rate by one percent in each year would increase the accumulated postretirement benefit obligation for health care benefits as of December 31, 1997 by $14.1 million and the aggregate of the service and interest cost components of the net periodic postretirement health care benefit cost for 1997 by $1.4 million.
The following table summarizes the various assumptions used to determine the accumulated postretirement benefit obligation for the plans for the years 1997, 1996 and 1995:
1997 1996 1995 ------ ------ ------ Discount rate................................ 7.25% 7.50% 7.25% After-tax expected long-term rate of return on assets 6% 6% 6%
Postretirement benefits costs are determined using the assumptions as of the beginning of the year. The funded status is determined using the assumptions as of the end of the year.
In December 1992, the FERC issued a Statement of Policy which allows jurisdictional pipelines to recognize allowances for prudently incurred costs of postretirement benefits other than pensions on an accrual basis consistent with the accounting principles set forth in SFAS No. 106. Transco believes that all costs of providing postretirement benefits to its employees are necessary and prudent operating expenses and that such costs are recoverable in rates.
THRIFT PLAN During 1995, Transco sponsored a defined-contribution plan (Thrift Plan) covering substantially all employees. Company contributions were based on employees' compensation and, in part, matched employee contributions. Compensation expense of $3.3 million was recognized by Transco in 1995.
Effective January 1, 1996, the Thrift Plan was merged with a Williams defined-contribution plan and Transco employees became eligible to participate in the Williams plan. Compensation expense of $3.4 million and $4.4 million was recognized by Transco in 1997 and 1996, respectively.
EMPLOYEE STOCK-BASED AWARDS Williams has several plans providing for common stock-based awards to its employees and employees of its subsidiaries. The plans permit the granting of various types of awards including, but not limited to, stock options, stock appreciation rights, restricted stock and deferred stock. Awards may be granted for no consideration other than prior and future services. The purchase price per share for stock options may not be less than the market price of the underlying stock on the date of grant. Stock options generally become exercisable after five years, subject to accelerated vesting if certain future stock prices are achieved. Stock options expire ten years after grant.
Williams' employee stock-based awards are accounted for under APBO No. 25, "Accounting for Stock Issued to Employees" and related interpretations. Williams' fixed plan common stock options do not result in compensation expense, because the exercise price of the stock options equals the market price of the underlying stock on the date of grant.
SFAS No. 123, "Accounting for Stock-Based Compensation," requires that companies who continue to apply APBO No. 25 disclose pro forma net income assuming that the fair-value method in SFAS No. 123 had been applied in measuring compensation cost. Pro
forma net income for Transco, beginning with 1995 employee stock-based awards was $109.4 million, $95.3 million and $74.4 million for 1997, 1996 and 1995, respectively. Reported net income was $111.4 million, $95.5 million and $76.0 million for 1997, 1996 and 1995, respectively. Pro forma amounts for 1997 reflect the remaining total compensation expense from the awards made in 1996, as these awards fully vested in 1997 as a result of the accelerated vesting provisions. Pro forma amounts for 1995 reflect total compensation expense from the awards made in 1995, as these awards fully vested in 1995 as a result of the accelerated vesting provisions. Since compensation expense from stock options is recognized over the future years' vesting period, and additional awards generally are made each year, pro forma amounts may not be representative of future years' amounts.
The following summary reflects stock options related to 1997 and 1996 (options in thousands):
1997 1996 ------- ----------
Options granted................................... 546 861 Weighted-average grant date fair value............ $ 5.98 $ 3.92 Options outstanding - December 31................. 1,987 1,714 Options exercisable - December 31................. 1,465 948
Data for 1996 has been restated to reflect a two-for-one stock split declared on November 20, 1997.
The fair value of the stock options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions: expected life of the stock options of five years; volatility of the expected market price of Williams common stock of 23 percent (24 percent in 1996); risk-free interest rate of 6.1 percent (6.2 percent in 1996); and a dividend yield of 2.4 percent (3 percent in 1996).
7. INCOME TAXES
Following is a summary of the provision for income taxes for 1997, 1996 and 1995 (in thousands):
Following is a reconciliation of the provision for income taxes at the federal statutory rate to the provision for income taxes (in thousands):
Significant components of deferred income tax assets and liabilities as of December 31, 1997 and 1996 are as follows (in thousands):
8. FINANCIAL INSTRUMENTS
FAIR VALUE OF FINANCIAL INSTRUMENTS
CARRYING AMOUNT AND FAIR VALUES The carrying amount and estimated fair values of Transco's financial instruments as of December 31, 1997 and 1996 are as follows (in thousands):
FAIR VALUE METHODS The following methods and assumptions were used in estimating fair values:
For cash and short-term financial assets (advances to affiliates), the carrying amount is a reasonable estimate of fair value due to the short maturity of those instruments.
For Transco's publicly traded long-term debt, estimated fair value is based on quoted market prices at year end. For Transco's private debt, all at variable interest rates, estimated fair value is equivalent to the carrying amount.
CREDIT AND MARKET RISK
TRADE RECEIVABLES As of December 31, 1997 and 1996, Transco had trade receivables of $23 million and $49 million, respectively. These trade receivables primarily are due from local distribution companies and other pipeline companies predominantly located in the eastern United States. Transco's credit risk exposure in the event of nonperformance by the other parties is limited to the face value of the receivables. No collateral is required on these receivables. Transco has not historically experienced significant credit losses in connection with its trade receivables.
Transco sells, with limited recourse, certain trade receivables. The aggregate limit under the receivables facilities was $100 million at December 31, 1997 and 1996. Transco received $28 million of proceeds in 1997, $21 million in 1996 and $108 million in 1995. At December 31, 1997 and 1996, $100 million of such receivables had been sold. Based on amounts outstanding at December 31, 1997 and 1996 the maximum contractual credit loss under these arrangements is approximately $15 million for each year, but the likelihood of loss is considered to be remote.
9. TRANSACTIONS WITH MAJOR CUSTOMERS AND AFFILIATES
MAJOR CUSTOMER The sales, transportation and storage revenues received from Public Service Electric and Gas Company, the major customer of Transco, were $139.3 million in 1997, $158.1 million in 1996 and $166.7 million in 1995.
AFFILIATES Included in Transco's sales and transportation revenues for 1997, 1996 and 1995 are revenues applicable to sales and transportation for affiliates of $79.2 million, $124.3 million and $173.9 million, respectively.
The rates charged to provide sales and transportation services to affiliates are the same as those that are charged to similarly-situated nonaffiliated customers. The significant decrease in 1997 sales and transportation revenue reflects the impact of diminished gas supplies available for sale by Transco as Transco's gas purchase contracts expire or terminate.
After FERC approval in January 1993, TEC realigned its gas marketing businesses under the common management of TGMC, which, through an agency agreement, began to manage all jurisdictional merchant sales of Transco. In May 1995, WESCO became the successor to the TGMC agency agreement and began to manage Transco's jurisdictional merchant sales. For the years ended December 31, 1997, 1996 and 1995, included in Transco's cost of sales is $31.4 million, $34.7 million and $20.6 million, respectively, representing agency fees billed to Transco by WESCO and TGMC under the agency agreement.
Included in Transco's cost of sales for 1997, 1996 and 1995 is purchased gas cost from affiliates of $405.1 million, $466.8 million and $131.5 million, respectively.
All gas purchases are made at market or contract prices. The decrease in 1997 for purchased gas cost reflects lower prices, reduction of the number of long-term FS customers and milder weather conditions in the first quarter of 1997.
Transco has long-term gas purchase contracts containing either fixed prices or variable prices that are at a significant premium to the estimated market price. However, due to contract expirations and estimated deliverability declines, Transco's estimated purchase commitments under such gas purchase contracts are not material to Transco's total gas purchases. Furthermore, through the agency agreement with Transco, WESCO has assumed management of Transco's merchant sales service and, as Transco's agent, is at risk for any above-spot-market gas costs that it may incur.
Also included in Transco's cost of transportation is transportation expense of $4.3 million in 1997, $17.5 million in 1996 and $36.4 million in 1995 applicable to the transportation of gas by Texas Gas Transmission Corporation (Texas Gas). The significant decrease in 1997 is mainly due to a full year's effect of the conversion of certain Transco
shippers from bundled service to unbundled service compared to only a five months' effect for 1996. Texas Gas is regulated by the FERC and its transportation rates charged to Transco are approved by the FERC.
TEC had a policy of charging subsidiary companies for management services provided by the parent company and other affiliated companies. Transco's administrative and general expenses for January through April 1995 included $10.9 million for management services charged by TEC. Effective May 1, 1995, Williams began charging corporate expenses to Transco for services similar to those previously provided by TEC or incurred directly by Transco. Included in Transco's administrative and general expenses for 1997, 1996 and 1995 were $14.7 million, $14.5 million and $8.5 million, respectively, for such corporate expenses charged by Williams. Management considers the cost of these services to be reasonable.
Transco entered into an operating agreement with Williams Field Services (WFS) effective May 1, 1995 whereby WFS, as Transco's agent, assumed operational control of Transco's gas gathering facilities. Included in Transco's operation and maintenance expenses for 1997, 1996 and 1995, are $37.3 million, $35.6 million and $24.4 million, respectively, charged by WFS to operate Transco's gas gathering facilities.
10. QUARTERLY INFORMATION (UNAUDITED)
The following summarizes selected quarterly financial data for 1997 and 1996 (in thousands):
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
Since Transco meets the conditions set forth in General Instruction (I)(1)(a) and (b) of Form 10-K, this information is omitted.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
PAGE REFERENCE TO 1997 10-K ------------ A. INDEX
1. FINANCIAL STATEMENTS:
Report of Independent Auditors - Ernst & Young LLP 23
Consolidated Balance Sheet as of December 31, 1997 and 1996 24-25
Consolidated Statement of Income for the Years Ended December 31, 1997 and 1996 and the Periods January 1, 1995 to January 17, 1995, and January 18, 1995 to December 31, 1995. 26
Consolidated Statement of Common Stockholder's Equity for the Years Ended December 31, 1997 and 1996 and the Periods January 1, 1995 to January 17, 1995, and January 18, 1995 to December 31, 1995. 27
Consolidated Statement of Cash Flows for the Years Ended December 31, 1997 and 1996 and the Periods January 1, 1995 to January 17, 1995, and January 18, 1995 to December 31, 1995. 28-29
Notes to Consolidated Financial Statements 30-57
2. FINANCIAL STATEMENT SCHEDULES:
The following schedules are omitted because of the absence of the conditions under which they are required:
I, II, III, IV, and V.
3. EXHIBITS:
The following instruments are included as exhibits to this report. Those exhibits below incorporated by reference herein are indicated as such by the information supplied in the parenthetical thereafter. If no parenthetical appears after an exhibit, copies of the instrument have been included herewith.
( 2) PLAN OF ACQUISITION, REORGANIZATION ARRANGEMENT, LIQUIDATION OR SUCCESSION
- 1 Agreement and Plan of Merger dated as of December 12, 1994 by and among The Williams Companies, Inc., WC Acquisition Corp. and Transco Energy Company. (Exhibit 2 to Transco Energy Company Schedule 14D-9 Commission File Number 005-19963)
- 2 Amendment to Agreement and Plan of Merger dated as of February 17, 1995 by and among The Williams Companies, Inc., WC Acquisition Corp. and Transco Energy Company. (Exhibit (2)-2 to Transco Energy Company Form 10-K for 1994 Commission File Number 1-7513)
- 3 Stock Option Agreement dated as of December 12, 1994 by and between The Williams Companies, Inc. and Transco Energy Company. (Exhibit 3 to Transco Energy Company Schedule 14D-9 Commission File Number 005-19963)
( 3) ARTICLES OF INCORPORATION AND BY-LAWS
- 1 Second Restated Certificate of Incorporation, as amended, of Transco. (Exhibit 3.1 to Transco Form 8-K dated January 23, 1987 Commission File Number 1-7584)
a) Certificate of Amendment, dated July 30, 1992, of the Second Restated Certificate of Incorporation (Exhibit (10)-17(a) to Transco Energy Company Form 10-K for 1993 Commission File Number 1-7513)
b) Certificate of Amendment, dated December 22, 1986, of the Second Restated Certificate of Incorporation (Exhibit (10)-17(b) to Transco Energy Company Form 10-K for 1993 Commission File Number 1-7513)
c) Certificate of Amendment, dated August 5, 1987, of the Second Restated Certificate of Incorporation (Exhibit (10)-17(c) to Transco Energy Company Form 10-K for 1993 Commission File Number 1-7513)
- 2 By-Laws of Transco, as Amended and Restated May 2, 1995 (Exhibit (3)-2 to Transco Form 10-K for 1995 Commission File Number 1-7584)
( 4) INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES
- 1 Indenture dated September 15, 1992 between Transco and the Bank of New York, as Trustee (Exhibit 4.2 to Transco Form 8-K dated September 17, 1992 Commission File Number 1-7584)
- 2 Indenture dated July 15, 1996 between Transco and Citibank, N.A., as Trustee (Exhibit 4.1 to Transco Form S-3 dated April 2, 1996 Transco Registration Statement No. 333-2155)
- 3 Indenture dated January 16, 1998 between Transco and Citibank, N.A., as Trustee (Exhibit 4.1 to Transco Form S-3 dated September 8, 1997 Transco Registration Statement No. 333-27311)
- 4 Second Amended and Restated Credit Agreement dated as of July 23, 1997 by and among Transco, The Williams Companies, Texas Gas Transmission Corporation, Northwest Pipeline Corporation, WilTel Communications, LLC, Williams Holdings of Delaware, Inc. and Citibank N.A. as agent and the Banks named therein (Exhibit 4(c) to The Williams Companies Form 10-K for 1997 Commission File Number 1-4174)
(10) MATERIAL CONTRACTS
- 1 Transco Energy Company Tran$tock Employee Stock Ownership Plan (Transco Energy Company Registration Statement No. 33-11721)
- 2 Lease Agreement, dated October 5, 1981, between Transco and Post Oak/Alabama, a Texas partnership. (Exhibit (10)-7 to Transco Energy Company Form 10-K for 1989 Commission File Number 1-7513)
(21) SUBSIDIARIES OF THE REGISTRANT
(23) CONSENT OF INDEPENDENT AUDITORS
(24) POWER OF ATTORNEY WITH CERTIFIED RESOLUTION
(27) FINANCIAL DATA SCHEDULE
4. REPORTS ON FORM 8-K:
None.
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, on this 26th day of March, 1998.
TRANSCONTINENTAL GAS PIPE LINE CORPORATION (Registrant)
By:/s/ JAMES C. BOURNE ------------------- James C. Bourne Controller
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on this 26th day of March, 1998, by the following persons on behalf of the registrant and in the capacities indicated.
SIGNATURE TITLE --------- -----
/s/ KEITH E. BAILEY * Chairman of the Board ----------------------- Keith E. Bailey
/s/ BRIAN E. O'NEILL * Director, President and Chief Executive Officer ---------------------- Brian E. O'Neill (Principal Executive Officer)
/s/ CUBA WADLINGTON, Jr.* Director -------------------------- Cuba Wadlington, Jr.
/s/ NICK A. BACILE * Vice President (Principal Financial Officer) -------------------- Nick A. Bacile
/s/ JAMES C. BOURNE * Controller (Principal Accounting Officer) --------------------- James C. Bourne
* By /s/ JAMES C. BOURNE --------------------------- James C. Bourne Attorney-in-fact