10-K 1 d627851d10k.htm FORM 10-K Form 10-K
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-K

Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Fiscal Year Ended September 30, 2013

 

  Commission
  File Number
 

Exact name of registrant as specified in its charter and

principal office address and telephone number

  

State of

Incorporation

  

I.R.S.

Employer Identification No.

 1-16163

 

WGL Holdings, Inc.

101 Constitution Ave., N.W.

Washington, D.C. 20080

(703) 750-2000

   Virginia    52-2210912

 0-49807

 

Washington Gas Light Company

101 Constitution Ave., N.W.

Washington, D.C. 20080

(703) 750-4440

  

District of

Columbia

and Virginia

   53-0162882

 

Securities registered pursuant to Section 12(b) of the Act (as of September 30, 2013):
Title of each class   

Name of each exchange on which registered

WGL Holdings, Inc. common stock, no par value

  

New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act (as of September 30, 2013):
Title of each class    Name of each exchange on which registered

 

Washington Gas Light Company preferred stock,

cumulative, without par value:

    

 

      $4.25 Series

  

 

Over-the-Counter Bulletin Board

      $4.80 Series

  

Over-the-Counter Bulletin Board

      $5.00 Series

  

Over-the-Counter Bulletin Board

Indicate by check mark if each registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

WGL Holdings, Inc.

  

Yes [X]  No [   ]

Washington Gas Light Company

  

Yes [   ]  No [X]

Indicate by check mark if each registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes [   ]  No [X]

Indicate by check mark whether each registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrants were required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes [X]  No [   ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes [X]  No [   ].

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrants’ knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [   ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

WGL Holdings, Inc.:

 

Large Accelerated Filer [X]

   Accelerated Filer [   ]   

Non-Accelerated Filer [   ]

   Smaller Reporting Company [   ]
  

(Do not check if a smaller reporting company)

Washington Gas Light Company:

Large Accelerated Filer [   ]

   Accelerated Filer [   ]   

Non-Accelerated Filer [X]

   Smaller Reporting Company [   ]
  

(Do not check if a smaller reporting company)

Indicate by check mark whether each registrant is a shell company (as defined in Rule 12b-2 of the Act):  Yes [   ]  No [X]

The aggregate market value of the voting common equity held by non-affiliates of the registrant, WGL Holdings, Inc., amounted to $2,266,658,547 as of March 31, 2013.

WGL Holdings, Inc. common stock, no par value outstanding as of October 31, 2013: 51,809,755 shares.

All of the outstanding shares of common stock ($1 par value) of Washington Gas Light Company were held by WGL Holdings, Inc. as of October 31, 2013.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of WGL Holdings, Inc.’s definitive Proxy Statement and Washington Gas Light Company’s definitive Information Statement in connection with the 2014 Annual Meeting of Shareholders, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A and 14C not later than 120 days after September 30, 2013, are incorporated in Part III of this report.


Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

For the Fiscal Year Ended September 30, 2013

Table of Contents

 

PART I

  

 

 
Introduction      1   
 

Filing Format

     1   
 

Safe Harbor for Forward-Looking Statements

     1   

Glossary of Key Terms and Definitions

     3   

Item 1.

 

Business

     5   
 

Corporate Overview

     5   
 

Industry Segments

     5   
 

Environmental Matters

     14   
 

Other Information

     14   

Item 1A.     

 

Risk Factors

     15   

Item 1B.

 

Unresolved Staff Comments

     19   

Item 2.

 

Properties

     20   

Item 3.

 

Legal Proceedings

     21   

Item 4.

 

Mine Safety Disclosures

     22   

Executive Officers of the Registrants

     23   

 

PART II

  

 

 

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     24   

Item 6.

 

Selected Financial Data

     25   

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     27   

Item 7A.

 

Quantitative and Qualitative Disclosures about Market Risk

     69   

Item 8.

 

Financial Statements and Supplementary Data

     69   
 

WGL Holdings, Inc.

     70   
 

Washington Gas Light Company

     76   
 

Notes to Consolidated Financial Statements

     82   
 

Supplementary Financial Information—Quarterly Financial Data (Unaudited)

     139   

Item 9.

 

Changes In and Disagreements with Accountants on Accounting and Financial Disclosure

     140   

Item 9A.

 

Controls and Procedures

     140   

Item 9B.

 

Other Information

     143   

 

PART III

  

 

 

Item 10.

 

Directors, Executive Officers and Corporate Governance of the Registrants

     144   

Item 11.

 

Executive Compensation

     144   

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     144   

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

     144   

Item 14.

 

Principal Accounting Fees and Services

     144   

 

PART IV

  

 

 

Item 15.

 

Exhibits and Financial Statement Schedules

     145   

Signatures

     151   

 

(i)


Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

INTRODUCTION

 

 

FILING FORMAT

This annual report on Form 10-K is a combined report being filed by two separate registrants: WGL Holdings, Inc. (WGL Holdings) and Washington Gas Light Company (Washington Gas). Except where the content clearly indicates otherwise, any reference in the report to “WGL Holdings,” “we,” “us” or “our” is to the holding company or the consolidated entity of WGL Holdings and all of its subsidiaries, including Washington Gas which is a distinct registrant that is a wholly owned subsidiary of WGL Holdings.

The Management’s Discussion and Analysis of Financial Condition and Results of Operations (Management’s Discussion) included under Item 7 is divided into two major sections for WGL Holdings and Washington Gas. The Consolidated Financial Statements of WGL Holdings and the Financial Statements of Washington Gas are included under Item 8 as well as the Notes to Consolidated Financial Statements that are presented on a combined basis for both WGL Holdings and Washington Gas.

SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS

Certain matters discussed in this report, excluding historical information, include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to the outlook for earnings, revenues and other future financial business performance or strategies and expectations. Forward-looking statements are typically identified by words such as, but not limited to, “estimates,” “expects,” “anticipates,” “intends,” “believes,” “plans,” and similar expressions, or future or conditional verbs such as “will,” “should,” “would” and “could.” Although the registrants, WGL Holdings and Washington Gas, believe such forward-looking statements are based on reasonable assumptions, they cannot give assurance that every objective will be achieved. Forward-looking statements speak only as of today, and the registrants assume no duty to update them. The following factors, among others, could cause actual results to differ materially from forward-looking statements or historical performance:

 

   

the level and rate at which costs and expenses are incurred and the extent to which they are allowed to be recovered from customers through the regulatory process in connection with constructing, operating and maintaining Washington Gas’ distribution system;

 

   

the ability to implement successful approaches to modify the current or future composition of gas delivered to customers or to remediate the effects of the current or future composition of gas delivered to customers, as a result of the introduction of gas from the Dominion Cove Point or Elba Island facilities to Washington Gas’ distribution system or changes in the composition of domestic natural gas as a result of liquids processing and new domestic sources of natural gas;

 

   

the availability of natural gas supply and interstate pipeline transportation and storage capacity;

 

   

the ability of natural gas producers, pipeline gatherers and natural gas processors to deliver natural gas into interstate pipelines for delivery by those interstate pipelines to the entrance points of Washington Gas’ distribution system as a result of factors beyond our control;

 

   

changes and developments in economic, competitive, political and regulatory conditions;

 

   

changes in capital and energy commodity market conditions;

 

   

changes in credit ratings of debt securities of WGL Holdings or Washington Gas that may affect access to capital or the cost of debt;

 

   

changes in credit market conditions and creditworthiness of customers and suppliers;

 

   

changes in relevant laws and regulations, including tax, environmental, pipeline integrity and employment laws and regulations;

 

   

legislative, regulatory and judicial mandates or decisions affecting business operations or the timing of recovery of costs and expenses;

 

   

the timing and success of business and product development efforts and technological improvements;

 

   

the pace of deregulation efforts and the availability of other competitive alternatives to our products and services;

 

   

changes in accounting principles;

 

   

new commodity purchase and sales contracts or financial contracts and modifications in the terms of existing contracts that may materially affect fair value calculations under derivative accounting requirements;

 

   

the ability to manage the outsourcing of several business processes;

 

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WGL Holdings, Inc.

Washington Gas Light Company

 

   

acts of nature;

 

   

terrorist activities and

 

   

other uncertainties.

The outcome of negotiations and discussions that the registrants may hold with other parties from time to time regarding utility and energy-related investments and strategic transactions that are both recurring and non-recurring may also affect future performance. All such factors are difficult to predict accurately and are generally beyond the direct control of the registrants. Accordingly, while they believe that the assumptions are reasonable, the registrants cannot ensure that all expectations and objectives will be realized. Readers are urged to use care and consider the risks, uncertainties and other factors that could affect the registrants’ business as described in this annual report on Form 10-K. All forward-looking statements made in this report rely upon the safe harbor protections provided under the Private Securities Litigation Reform Act of 1995.

 

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WGL Holdings, Inc.

Washington Gas Light Company

Part I

 

GLOSSARY OF KEY TERMS AND DEFINITIONS

 

 

 

Active Customer Meters: Natural gas meters that are physically connected to a building structure within the Washington Gas distribution system and that receive active service.

 

Asset Optimization Program: A program to optimize the value of Washington Gas’ long-term natural gas transportation and storage capacity resources during periods when these resources are not being used to physically serve customers.

 

Bundled Service: Service in which customers purchase both the natural gas commodity and the distribution or delivery of the commodity from the local regulated utility. When customers purchase bundled service from Washington Gas, no mark-up is applied to the cost of the natural gas commodity that is passed through to customers.

 

Business Process Outsourcing (BPO) Agreement: An agreement whereby a service provider performs certain functions that have historically been performed by Washington Gas employees and resources.

 

Conservation and Ratemaking Efficiency (CARE Plan): A decoupling rate mechanism designed to adjust the actual non-gas distribution revenues to the level of allowed distribution revenues authorized in the Company’s most recent rate case proceeding and provides cost effective conservation and energy efficient programs.

 

City Gate: A point or measuring station at which a gas distribution company such as Washington Gas receives natural gas from an unaffiliated pipeline or transmission system.

 

Cooling Degree Day (CDD): A measure of the variation in weather based on the extent to which the daily average temperature is above 65 degrees Fahrenheit.

 

CARE Ratemaking Adjustment (CRA): A billing mechanism that is designed to minimize the effect of factors such as conservation on utility net revenues.

 

Commercial Energy Systems: Formerly known as the “design-build energy systems” segment, the commercial energy systems segment includes the operations of Washington Gas Energy Systems, Inc. and WGSW, Inc.

 

Delivery Service: The regulated distribution or delivery of natural gas to retail customers. Washington Gas provides delivery service to retail customers in Washington, D.C. and parts of Maryland and Virginia.

 

Design Day: Washington Gas’ design day represents the maximum anticipated demand on Washington Gas’ distribution system during a 24-hour period assuming a five-degree Fahrenheit average temperature and 17 miles per hour average wind, considered to be the coldest conditions expected to be experienced in the Washington, D.C. region.

 

Federal Energy Regulatory Commission (FERC): An independent agency of the federal government that regulates the interstate transmission of electricity, natural gas, and oil. The FERC also reviews proposals to build liquefied natural gas terminals and interstate natural gas pipelines.

  

Financial Contract: A contract in which no commodity is transferred between parties and only cash payments are exchanged in amounts equal to the financial benefit of holding the contract.

 

Firm Customers: Customers whose gas supply will not be disrupted to meet the needs of other customers. Typically, this class of customer comprises residential customers and most commercial customers.

 

Gas Administrative Charge (GAC): A regulatory mechanism designed to remove the cost of uncollectible accounts expense related to gas costs from base rates and instead, permits Washington Gas to collect an amount for this expense through its Purchased Gas Charge provision.

 

Generally Accepted Accounting Principles (GAAP): A standard framework of accounting rules used to prepare, present and report financial statements in the United States of America.

 

Gross Margin: A non-GAAP measure calculated as operating revenues, less the associated cost of natural gas or electricity and revenue taxes. Used to measure the success of the retail energy-marketing segment’s core strategy for the sale of natural gas and electricity.

 

Heating Degree Day (HDD): A measure of the variation in weather based on the extent to which the daily average temperature falls below 65 degrees Fahrenheit.

 

Heavy Hydrocarbons (HHCs): Compounds, such as hexane, that Washington Gas is injecting into its distribution system to treat vaporized liquefied natural gas or domestic sources of gas that have had such HHCs removed as a result of liquids processing.

 

Interruptible Customers: Large commercial customers whose service can be temporarily interrupted in order for the regulated utility to meet the needs of firm customers. These customers pay a lower delivery rate than firm customers and they must be able to readily substitute an alternate fuel for natural gas.

 

Liquefied Natural Gas (LNG): The liquid form of natural gas.

 

Lower of Cost or Market: The process of adjusting the value of inventory to reflect the lesser of its original cost or its current market value.

 

Mark-to-Market: The process of adjusting the carrying value of a position held in a physical or financial derivative to reflect its current fair value.

 

Midstream Energy Services: Formerly known as the wholesale energy solutions segment, the midstream energy services segment includes the operations of WGL Midstream, Inc.

 

New Customer Meters Added: Natural gas meters that are newly connected to a building structure within the Washington Gas distribution system. Service may or may not have been activated.

 

Normal Weather: A forecast of expected HDDs or CDDs based on the previous 30 years of historical HDD or CDD data.

 

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Washington Gas Light Company

Part I

 

PSC of DC: The Public Service Commission of the District of Columbia is a three-member board that regulates Washington Gas’ distribution operations in the District of Columbia.

 

PSC of MD: The Maryland Public Service Commission is a five-member board that regulates Washington Gas’ distribution operations in Maryland.

 

Purchased Gas Charge (PGC): The purchased gas charge represents the cost of gas, gas transportation, gas storage services purchased and other gas related costs. The purchased gas charge is collected from customers through tariffs established by the regulatory commissions that have jurisdiction over Washington Gas.

 

Regulated Utility Segment: Includes the operations of Washington Gas that are regulated by regulatory commissions located in the District of Columbia, Maryland and Virginia, and the operations of Hampshire Gas Company that are regulated by the Federal Energy Regulatory Commission.

 

Retail Energy-Marketing Segment: Unregulated sales of natural gas and electricity to end users by our subsidiary, Washington Gas Energy Services, Inc.

 

Return on Average Common Equity: Net income divided by average common shareholders’ equity.

 

Revenue Normalization Adjustment (RNA): A regulatory billing mechanism designed to stabilize the level of net revenues collected from customers by eliminating the effect of deviations in customer usage caused by variations in weather from normal levels, and other factors such as conservation.

 

Steps to Advance Virginia’s Energy (SAVE Plan): A plan that provides for accelerated recovery mechanisms for costs of eligible infrastructure replacement programs.

 

SCC of VA: The Commonwealth of Virginia State Corporation Commission is a three-member board that regulates Washington Gas’ distribution operations in Virginia.

 

Service Area: The region in which Washington Gas operates. The service area includes the District of Columbia, and the surrounding metropolitan areas in Maryland and Virginia.

 

Solar Renewable Energy Credits (SREC): a certificate representing the “green attributes” of one megawatt-hour (MWh) of electricity generated from solar energy.

 

Sendout: The total gas that is produced, purchased, or withdrawn from storage within a certain interval of time.

 

Tariffs: Documents approved by the regulatory commission in each jurisdiction that set the prices Washington Gas may charge and the practices it must follow when providing utility service to its customers.

 

Third Party Marketer: Unregulated companies that sell natural gas and electricity directly to retail customers. Washington Gas Energy Services, Inc., an affiliate of Washington Gas and a wholly owned subsidiary company of Washington Gas Resources Corporation, is a third-party marketer.

  

Therm: A natural gas unit of measurement that includes a standard measure for heating value. We report our natural gas sales and deliveries in therms. A therm of gas contains 100,000 British thermal units of heat, or the energy equivalent of burning approximately 100 cubic feet of natural gas under normal conditions. Ten million therms equal approximately one billion cubic feet of natural gas.

 

Unbundling: The separation of the delivery of natural gas or electricity from the sale of these commodities and related services that, in the past, were provided only by a regulated utility.

 

Utility Net Revenues: A non-GAAP measure calculated as operating revenues less the associated cost of energy and applicable revenue taxes. Used to analyze the profitability of the regulated utility segment, as the cost of gas associated with sales to customers and revenue taxes are generally pass through amounts.

 

Value-At-Risk: A risk measurement that estimates the largest expected loss over a specified period of time under normal market conditions within a specified probabilistic confidence interval.

 

Washington Gas: Washington Gas Light Company is a subsidiary of WGL Holdings, Inc. that sells and delivers natural gas primarily to retail customers in accordance with tariffs approved by the PSC of DC, the PSC of MD and the SCC of VA.

 

Washington Gas Resources: Washington Gas Resources Corporation is a subsidiary of WGL Holdings, Inc. that owns the majority of the non-utility subsidiaries.

 

Weather Derivative: A financial instrument that provides financial protection from the effects of variations from normal weather.

 

Weather Normalization Adjustment (WNA): A billing adjustment mechanism that is designed to minimize the effect of variations from normal weather on utility net revenues.

 

WGESystems: Washington Gas Energy Systems, Inc. is a subsidiary of Washington Gas Resources Corporation, which provides commercial energy efficient and sustainable solutions to government and commercial clients.

 

WGL Holdings: WGL Holdings, Inc. is a holding company that is the parent company of Washington Gas Light Company and its subsidiaries.

 

WGL Midstream (formerly Capitol Energy Ventures): WGL Midstream, Inc. is a subsidiary of Washington Gas Resources that engages in acquiring and optimizing natural gas storage and transportation assets.

 

WGEServices: Washington Gas Energy Services, Inc. is a subsidiary of Washington Gas Resources Corporation that sells natural gas and electricity to retail customers on an unregulated basis.

 

WGSW: WGSW, Inc. is a subsidiary of Washington Gas Resources Corporation that was formed to invest in certain renewable energy projects.

 

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WGL Holdings, Inc.

Washington Gas Light Company

Part I

Item 1. Business

ITEM 1.  BUSINESS

 

 

 

CORPORATE OVERVIEW

WGL HOLDINGS, INC.

WGL Holdings was established on November 1, 2000 as a Virginia corporation. Through its wholly owned subsidiaries, it sells and delivers natural gas and provides energy-related products and services to customers primarily in the District of Columbia and the surrounding metropolitan areas in Maryland and Virginia, though our non-utility segments now provide various energy services in twenty-nine states. WGL Holdings, Inc. promotes the efficient use of clean natural gas and renewable energy to improve the environment for the benefit of customers, investors, employees, and the communities it serves. WGL Holdings owns all of the shares of common stock of Washington Gas, Washington Gas Resources, Hampshire Gas Company (Hampshire) and Crab Run Gas Company (Crab Run). Washington Gas Resources owns four unregulated subsidiaries that include WGEServices, WGESystems, WGL Midstream (previously known as Capitol Energy Ventures effective November 7, 2013) and WGSW.

 

LOGO

 

*Holding company whose stand alone results are reported in “other activities”.

 

Industry Segments

Our segments include Regulated Utility, Retail Energy-Marketing, Commercial Energy Systems and Midstream Energy Services. Transactions and activities not specifically identified in one of these four segments are reported as “Other Activities.”

During the first quarter of fiscal year 2013, we made certain changes to our operating segments to reflect the recent growth of our non-utility business activities and the impact of those activities on our financial performance. All activities of WGSW are reported within the Commercial Energy Systems segment. WGSW had previously been reported within “Other Activities”. WGSW is a holding company formed to invest in alternative energy assets. As these operations align with those of the Commercial Energy Systems segment, and our chief operating decision maker reviews the operations of these units together, their combination for reporting purposes was deemed appropriate. In the fourth quarter, we changed the segment name of Wholesale Energy Solutions to Midstream Energy Services to reflect changes in the nature of our wholesale business operations. In response to significant changes in market dynamics, our operations in this segment are now focused on the investment, acquisition and asset optimization of midstream infrastructure assets. The four segments are described more fully below.

 

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Washington Gas Light Company

Part I

Item 1. Business (continued)

 

REGULATED UTILITY SEGMENT

Washington Gas Light Company

The regulated utility segment consists of Washington Gas and Hampshire and represents approximately 82% of WGL Holdings’ total assets. Washington Gas is a regulated public utility that sells and delivers natural gas to retail customers in accordance with tariffs approved by regulatory commissions in the District of Columbia and adjoining areas in Maryland, Virginia and several cities and towns in the northern Shenandoah Valley of Virginia. Washington Gas has been engaged in the natural gas distribution business since its incorporation by an Act of Congress in 1848. Washington Gas has been a Virginia corporation since 1953 and a corporation of the District of Columbia since 1957.

Washington Gas sells natural gas to customers who have elected not to purchase natural gas from unregulated third party marketers (refer to the section entitled “Natural Gas Unbundling”). Washington Gas recovers the cost of the natural gas purchased to serve firm customers through recovery mechanisms as approved in jurisdictional tariffs. Any difference between gas costs incurred on behalf of firm customers and the gas costs recovered from those customers is deferred on the balance sheet as an amount to be collected from or refunded to customers in future periods. Therefore, increases or decreases in the cost of gas associated with sales made to firm customers have no direct effect on Washington Gas’ net revenues and net income.

Washington Gas, under its asset optimization program, makes use of storage and transportation capacity resources when those assets are not required to serve utility customers. The objective of this program is to derive a profit to be shared with its utility customers by entering into commodity-related physical and financial contracts with third parties (refer to the section entitled “Asset Optimization” for further discussion of the asset optimization program). Unless otherwise noted, therm deliveries reported for the regulated utility segment do not include those related to the asset optimization program.

At September 30, 2013, Washington Gas’ service area had a population estimated at 5.6 million and included over two million households and commercial structures. Washington Gas operations are such that the loss of any one customer or group of customers would not have a significant adverse effect on its business. The following table lists the number of active customer meters and therms delivered by jurisdiction as of and for the year ended September 30, 2013 and 2012, respectively.

 

Active Customer Meters and Therms Delivered by Jurisdiction  
Jurisdiction   Active Customer
Meters as of
  September 30, 2013  
   

Millions of Therms
Delivered

Fiscal Year Ended
  September 30, 2013  

    Active Customer
Meters as of
  September 30, 2012  
   

Millions of Therms
Delivered

Fiscal Year Ended
   September 30, 2012   

 

District of Columbia

    154,982       300.4       154,818       261.0  

Maryland

    448,916       865.7       443,201       931.1  

Virginia

    501,225       614.8       496,090       522.7  

Total

    1,105,123       1,780.9       1,094,109       1,714.8  

For additional information about gas deliveries and meter statistics, refer to the section entitled “Results of Operations” in Management’s Discussion and Analysis for Washington Gas.

Hampshire Gas Company

Hampshire owns full and partial interests in underground natural gas storage facilities, including pipeline delivery facilities located in and around Hampshire County, West Virginia, and operates those facilities to serve Washington Gas, which purchases all of the storage services of Hampshire. Washington Gas includes the cost of these services in the bills sent to its customers. Hampshire operates under a “pass-through” cost of service-based tariff approved by the FERC, and adjusts its billing rates to Washington Gas on a periodic basis to account for changes in its investment in utility plant and associated expenses.

Factors critical to the success of the regulated utility segment include: (i) operating a safe and reliable natural gas distribution system; (ii) having sufficient natural gas supplies to meet customer demands; (iii) being competitive with other sources of energy such as electricity, fuel oil and propane; (iv) having access to sources of liquidity; (v) recovering the costs and expenses of this business in the rates charged to customers and (vi) earning a just and reasonable rate of return on invested capital. The regulated utility segment reported total operating revenues related to gas sales and deliveries to external customers of approximately $1.2 billion, $1.1 billion, and $1.3 billion in fiscal years ended September 30, 2013, 2012 and 2011, respectively.

Rates and Regulatory Matters

Washington Gas is regulated by the PSC of DC, the PSC of MD and the SCC of VA which approve its terms of service and the billing rates that it charges to its customers. Hampshire is regulated by the FERC. The rates charged to utility customers are designed to recover Washington Gas’ operating expenses and natural gas commodity costs and to provide a return on its investment in the net assets used in its firm gas sales and delivery service. For a discussion of current rates and regulatory matters, refer to the section entitled “Rates and Regulatory Matters” in Management’s Discussion and Analysis for Washington Gas.

 

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WGL Holdings, Inc.

Washington Gas Light Company

Part I

Item 1. Business (continued)

 

District of Columbia Jurisdiction

The PSC of DC typically consists of three full-time members who are appointed by the Mayor with the advice and consent of the District of Columbia City Council. The term of each commissioner is four years with no limitations on the number of terms that can be served. The PSC of DC has no time limitation in which it must make decisions regarding modifications to base rates charged by Washington Gas to its customers; however it targets resolving pending rate cases within nine months from the date a rate case is filed.

Maryland Jurisdiction

The PSC of MD consists of five full-time members who are appointed by the Governor with the advice and consent of the Senate of Maryland. Each commissioner is appointed to a five-year term, with no limit on the number of terms that can be served.

When Washington Gas files for a rate increase, the PSC of MD may initially suspend the proposed increase for 180 days, and then has the option to extend the suspension for an additional 30 days. If action has not been taken after 210 days, the requested rates become effective subject to refund.

Virginia Jurisdiction

The SCC of VA consists of three full-time members who are elected by the General Assembly of Virginia. Each commissioner has a six-year term with no limitation on the number of terms that can be served.

Either of two methods may be used to request a modification of existing rates. Washington Gas may file an application for a general rate increase in which it may propose new adjustments to the cost of service that are different from those previously approved for Washington Gas by the SCC of VA, as well as a revised return on equity. The proposed rates under this process may take effect 150 days after the filing, subject to refund pending the outcome of the SCC of VA’s action on the application.

Alternatively, an expedited rate case procedure allows proposed rate increases to be effective 30 days after the filing date, also subject to refund. Under this procedure, Washington Gas may not propose new adjustments for issues not approved in its last general rate case, or request a change in its authorized return on common equity. Once filed, other parties may propose new adjustments or a change in the cost of capital from the level authorized in its last general rate case. The expedited rate case procedure may not be available if the SCC of VA decides that there has been a substantial change in circumstances since the last general rate case filed by Washington Gas.

Seasonality of Business Operations

Washington Gas’ business is weather-sensitive and seasonal because the majority of its business is derived from residential and small commercial customers who use natural gas for space heating. Excluding deliveries for electric generation, in fiscal year 2013 and 2012, approximately 77% and 74%, respectively, of the total therms delivered in Washington Gas’ service area occurred during its first and second fiscal quarters. Washington Gas’ earnings are typically generated during these two quarters, and Washington Gas historically incurs net losses in the third and fourth fiscal quarters. The seasonal nature of the business creates large variations in short-term cash requirements, primarily due to the fluctuations in the level of customer accounts receivable, unbilled revenues and storage gas inventories. Washington Gas finances these seasonal requirements primarily through the sale of commercial paper and unsecured short-term bank loans. For information on our management of weather risk, refer to the section entitled “Weather Risk” in Management’s Discussion and Analysis. For information about management of cash requirements, refer to the section entitled “Liquidity and Capital Resources” in Management’s Discussion and Analysis.

Natural Gas Supply and Capacity

Capacity and Supply Requirements

Washington Gas is responsible for acquiring sufficient natural gas supplies, interstate pipeline capacity and storage capacity to meet customer demand. As such, Washington Gas has adopted a diversified portfolio approach designed to address constraints on supply by using multiple supply receipt points, dependable interstate pipeline transportation and storage arrangements, and its own substantial storage and peak shaving capabilities. Washington Gas’ supply and pipeline capacity plan is based on forecasted system requirements, and takes into account estimated load growth, attrition, conservation, geographic location, interstate pipeline and storage capacity and contractual limitations and the forecasted movement of customers between bundled service and delivery service. Under reduced supply conditions, Washington Gas may implement contingency plans in order to maximize the number of customers served. Contingency plans include requests to the general population to conserve and target curtailments to specific sections of the system, consistent with curtailment tariffs approved by regulators in each of Washington Gas’ three jurisdictions.

 

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Washington Gas Light Company

Part I

Item 1. Business (continued)

 

Washington Gas obtains natural gas supplies that originate from multiple regions throughout the United States and Canada. At September 30, 2013 and 2012, Washington Gas had service agreements with four pipeline companies that provided firm transportation and/or storage services directly to Washington Gas’ city gate. For fiscal years 2013 and 2012, these contracts have expiration dates ranging from fiscal years 2014 to 2029 and 2013 to 2029, respectively.

Projects for Expanding Capacity

Washington Gas buys natural gas on a short-term basis to support growing customer demand, and has contracted with various interstate pipeline and storage companies to expand its storage and transportation capacity. The following projects are in progress to expand Washington Gas’ transportation and/or storage capacity.

 

Projects For Expanding Transportation and Storage Capacity (in therms)
Pipeline Service Provider    Daily Capacity    Annual Capacity       In-Service Date    
(Fiscal Year)

Dominion Transmission Inc. Alleghany Storage (formerly Storage Factory)

   1 million    60 million    2014

Transcontinental Gas Pipe Line Company, LLC Leidy Southeast

   .135 million         2016

Washington Gas will continue to monitor other opportunities to acquire or participate in obtaining additional pipeline and storage capacity that will support customer growth and improve or maintain the high level of service expected by its customer base.

Asset Optimization Derivative Contracts

Under the asset optimization program, Washington Gas utilizes its storage and transportation capacity resources when they are not being used to serve its utility customers. Washington Gas executes commodity-related physical and financial contracts in the form of forwards, futures and options as part of an asset optimization program that is managed by its internal staff. These transactions are accounted for as derivatives. The objective of this program is to derive a profit to be shared with its utility customers. Washington Gas enters into these derivative transaction contracts to lock in operating margins that will ultimately be shared between Washington Gas customers and shareholders. Since these sharing mechanisms are approved by our regulators in all three jurisdictions, any changes in fair value of the derivatives are recorded through earnings or as regulatory assets or liabilities, if realized gains and losses will be included in the rates charged to customers.

The derivatives used under this program are subject to fair value accounting treatment. This may cause significant period-to-period volatility in earnings from unrealized gains and losses associated with changes in fair value for the portion of net profits to be retained for shareholders. However, this volatility does not change the locked-in operating margins that Washington Gas will ultimately realize from these transactions. All physically and financially settled contracts under our asset optimization program are reported on a net basis in the statements of income in “Utility cost of gas.” Total net margins including unrealized gains and losses recorded to “Utility cost of gas” after sharing and management fees associated with all asset optimization transactions for the year ended September 30, 2013 and the prior two fiscal years were a net loss of $33.2 million, and net gains of $28.3 million and $1.9 million respectively.

Refer to the sections entitled “Results of Operations — Regulated Utility” and “Market Risk” in Management’s Discussion and Analysis for further discussion of the asset optimization program and its effect on earnings.

Annual Sendout

As reflected in the table below, Washington Gas received natural gas from multiple sources in fiscal year 2013 and expects to use those same sources to satisfy customer demand in fiscal year 2014. Firm transportation denotes gas transported directly to the entry point of Washington Gas’ distribution system in contractual volumes. Transportation storage denotes volumes stored by a pipeline during the spring, summer and fall for withdrawal and delivery to the Washington Gas distribution system during the winter heating season to meet load requirements. Peak load requirements are met by: (i) underground natural gas storage at the Hampshire storage field; (ii) the local production of propane air plants located at Washington Gas-owned facilities in Rockville, Maryland (Rockville Station) and in Springfield, Virginia (Ravensworth Station) and (iii) other peak-shaving resources. Unregulated third party marketers acquire interstate pipeline and storage capacity and the natural gas commodity on behalf of Washington Gas’ delivery service customers under customer choice programs. Washington Gas also provides transportation, storage and peaking resources to unregulated third party marketers (refer to the section entitled “Natural Gas Unbundling”). These retail marketers have natural gas delivered to the entry point of Washington Gas’ distribution system on behalf of those utility customers that have decided to acquire their natural gas commodity on an unbundled basis, as discussed below.

 

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Item 1. Business (continued)

 

Excluding the sendout of sales and deliveries of natural gas used for electric generation, total sendout on the system was 1,651 million therms during fiscal year 2013, compared to total sendout of 1,429 million therms during fiscal year 2012. The increase in 2013 was the result of weather in fiscal year 2013 that was colder than fiscal year 2012. The sendout for fiscal year 2014 is estimated at 1,630 million therms (based on normal weather). The sources of delivery and related volumes that were used to satisfy the requirements of fiscal year 2013 and those projected for pipeline year 2014 are shown in the following table.

 

Sources of Delivery for Annual Sendout  
(In millions of therms)   

Fiscal Year       

 

 
Sources of Delivery    Actual
2012 
           Actual
2013 
             Projected  
2014
 

Firm Transportation

     496              613           606        

Transportation Storage

     226              261           247        

Hampshire Storage, Company-Owned Propane-Air Plants, and other Peak-Shaving Resources

     20              18           18        

Unregulated Third Party Marketers

     687                759             759        

Total

     1,429                1,651             1,630        

Design Day Sendout

The effectiveness of Washington Gas’ capacity resource plan is largely dependent on the sources used to satisfy forecasted and actual customer demand requirements for its design day. For planning purposes, Washington Gas assumes that all interruptible customers will be curtailed on the design day. Washington Gas’ forecasted design day demand for the 2013-2014 winter season is 18.8 million therms and Washington Gas’ projected sources of delivery for design day sendout is 19.8 million therms. This provides a reserve margin of approximately 5.2%. Washington Gas plans for the optimal utilization of its storage and peaking capacity to reduce its dependency on firm transportation and to lower pipeline capacity costs. The following table reflects the sources of delivery that are projected to be used to satisfy the forecasted design day sendout estimate for fiscal year 2014.

 

Projected Sources of Delivery for Design Day Sendout  
  (In millions of therms)   Fiscal Year 2014  
  Sources of Delivery     Volumes         Percent      

  Firm Transportation

      5.5       28 %  

  Transportation Storage

      7.5       38 %  

  Hampshire Storage, Company-Owned Propane-Air Plants and other Peak- Shaving Resources

      6.6       33 %  

  Unregulated Third Party Marketers

      0.2       1 %  

  Total

      19.8       100 %  

Natural Gas Unbundling

At September 30, 2013, customer choice programs for natural gas customers were available to all of Washington Gas’ regulated utility customers in the District of Columbia, Maryland and Virginia. These programs allow customers to purchase their natural gas from unregulated third party marketers, rather than purchasing this commodity as part of a bundled service from the local utility. Of Washington Gas’ 1.105 million active customers at September 30, 2013, approximately 172,000 customers purchased their natural gas commodity from unregulated third party marketers.

 

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Washington Gas Light Company

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Item 1. Business (continued)

 

The following table provides the status of customer choice programs in Washington Gas’ jurisdictions at September 30, 2013.

 

Status of Customer Choice Programs  
At September 30, 2013  
Jurisdiction      Customer Class      Eligible Customers  
              Total            % Participating    

  District of Columbia

  

Firm:

     
  

Residential

     142,249        11
  

Commercial

     12,543        34
  

Interruptible

     190        95

  Maryland

  

Firm:

     
  

Residential

     418,974        20
  

Commercial

     29,709        41
  

Interruptible

     233        99

  Virginia

  

Firm:

     
  

Residential

     472,639        10
  

Commercial

     28,374        31
    

Interruptible

     212        99

  Total

          1,105,123           

When customers choose to purchase the natural gas commodity from unregulated third party marketers, Washington Gas’ net income is not affected because Washington Gas charges its customers the cost of gas without any mark-up. When customers select an unregulated third party marketer as their gas supplier, Washington Gas continues to charge these customers to deliver natural gas through its distribution system at rates identical to the delivery portion of the bundled sales service customers.

Competition

The Natural Gas Delivery Function

The natural gas delivery function, the core business of Washington Gas, continues to be regulated by local and state regulatory commissions. In developing this core business, Washington Gas has invested $3.9 billion as of September 30, 2013 to construct and operate a safe and reliable distribution system. Because of the high fixed costs and significant safety and environmental considerations associated with building and operating a distribution system, Washington Gas expects to continue being the only owner and operator of a distribution system in its current franchise area for the foreseeable future. The nature of Washington Gas’ customer base and the distance of most customers from interstate pipelines mitigate the threat of bypass of its facilities by other potential delivery service providers.

Competition with Other Energy Products

Washington Gas faces competition based on customers’ preference for other energy products and the prices of those products compared to natural gas. In the residential market, which generates a significant portion of Washington Gas’ net income, the most significant product competition occurs between natural gas and electricity. Because the cost of electricity is affected by the cost of fuel used to generate electricity, such as natural gas, Washington Gas generally maintains a price advantage over competitive electricity supply in its service area for traditional residential uses of energy such as heating, water heating and cooking. Washington Gas continues to attract the majority of the new residential construction market in its service territory, and consumers’ continuing preference for natural gas allows Washington Gas to maintain a strong market presence. The following table lists the increase in the number of active customer meters by jurisdiction and major rate class for the year ended September 30, 2013.

 

New Customer Meters by Area         
      Residential     

 

Commercial and
Interruptible

     Group Meter
Apartments
           Total        

Maryland

     5,904        289        21        6,214  

Virginia

     5,187        410        7        5,604  

District of Columbia

     534        103        13        650  

Total

     11,625        802        41        12,468  

In the interruptible market, fuel oil is the prevalent energy alternative to natural gas. Washington Gas’ success in this market depends largely on the relationship between natural gas and oil prices. The supply of natural gas primarily is derived from domestic sources, and the relationship between supply and demand generally has the greatest impact on natural gas prices. Since the source of a large portion of oil comes from foreign countries, political events and foreign currency conversion rates can influence oil supplies and prices to domestic consumers.

 

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Washington Gas Light Company

Part I

Item 1. Business (continued)

 

RETAIL ENERGY-MARKETING SEGMENT

Description

The retail energy-marketing segment consists of the operations of WGEServices, which competes with regulated utilities and other unregulated third party marketers to sell natural gas and/or electricity directly to residential, commercial and industrial customers in Maryland, Virginia, Delaware, Pennsylvania and the District of Columbia. WGEServices buys natural gas and electricity with the objective of earning a profit through competitively priced sales contracts with end-users. These commodities are delivered to retail customers through the distribution systems owned by regulated utilities. Washington Gas delivers the majority of natural gas sold by WGEServices, and unaffiliated electric utilities deliver all of the electricity sold. Additionally, WGEServices bills its customers either independently or through the billing services of the regulated utilities that deliver its commodities. Refer to Note 18—Related Party Transactions of the Notes to Consolidated Financial Statements for further discussion of our purchase of receivables program.

WGEServices also sells wind and other renewable energy credits and carbon offsets to retail customers. WGEServices does not own or operate any other natural gas, production, transmission or distribution assets.

At September 30, 2013, 2012 and 2011, respectively, WGEServices served approximately 168,000, 177,000 and 172,000 residential, commercial and industrial natural gas customer accounts and approximately 180,000, 194,000 and 183,000 residential, commercial and industrial electricity customer accounts located in Maryland, Virginia, Delaware, Pennsylvania and the District of Columbia. Its customer concentration is such that the loss of any one customer or group of customers would not have a significant adverse effect on its business.

Factors critical to managing the retail energy-marketing segment include:

 

   

managing the market risk of the difference between the price committed to customers under sales contracts and the cost of natural gas and electricity needed to satisfy these commitments, including capacity and transmission costs and costs to meet renewable portfolio standards;

   

managing credit risks associated with customers and suppliers;

   

having sufficient deliverability of natural gas and electric supplies and transportation to serve the demand of its customers which can be affected by the ability of natural gas producers, pipeline gatherers, natural gas processors, interstate pipelines, electricity generators and regional electric transmission operators to deliver the respective commodities;

   

access to sources of financial liquidity;

   

controlling the level of selling, general and administrative expenses, including customer acquisition expenses and

   

the ability to access markets through customer choice programs or other forms of deregulation.

The retail energy-marketing segment’s total operating revenues from external customers were $1.3 billion for both fiscal years ended September 30, 2013 and 2012 and $1.4 billion in fiscal year 2011.

Seasonality of Business Operations

The operations of WGEServices are seasonal, with larger amounts of electricity being sold in the summer months and larger amounts of natural gas being sold in the winter months. Working capital requirements can vary significantly during the year and these variations are financed through internally generated funds and WGL Holdings’ issuance of commercial paper and unsecured short-term bank loans. WGEServices accesses these funds through the WGL Holdings money pool. For a discussion of the WGL Holdings money pool, refer to the section entitled “Money Pool” in Management’s Discussion and Analysis.

Natural Gas and Electricity Supply

On February 20, 2013, WGEServices entered into a five-year secured supply arrangement with Shell Energy North America (US), LP (Shell Energy). Under this arrangement, WGEServices has the ability to purchase the majority of its power, natural gas and related products from Shell Energy in a structure that reduces WGEServices’ cash flow risk from collateral posting requirements. While Shell is intended to be the majority provider of natural gas and electricity, WGEServices retains the right to purchase supply from other providers.

Natural gas supplies are delivered to WGEServices’ market territories through several interstate natural gas pipelines. To supplement WGEServices’ natural gas supplies during periods of high customer demand, WGEServices maintains gas storage inventory in storage facilities that are assigned by natural gas utilities such as Washington Gas. This storage inventory enables WGEServices to meet daily and monthly fluctuations in demand and to minimize the effect of market price volatility.

 

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Washington Gas Light Company

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The PJM Interconnection (PJM) is a regional transmission organization that regulates and coordinates generation supply and the wholesale delivery of electricity in the states and jurisdictions where WGEServices operates. WGEServices buys wholesale and sells retail electricity in the PJM market territory, subject to its rules and regulations. PJM requires that its market participants have sufficient load capacity to serve their customers’ load requirements.

Competition

Natural Gas

WGEServices competes with regulated gas utilities and other third party marketers to sell natural gas to customers both inside and outside of the Washington Gas service area. Marketers of natural gas compete largely on price; therefore, gross margins are relatively small. To provide competitive pricing to its retail customers and in adherence to its risk management policies and procedures, WGEServices manages its natural gas contract portfolio by closely matching the commitments for gas deliveries from wholesale suppliers with requirements to serve retail sales customers. For a discussion of WGEServices’ exposure to and management of price risk, refer to the section entitled “Market Risk—Price Risk Related to the Retail Energy-Marketing Segment” in Management’s Discussion and Analysis.

Electricity

WGEServices competes with regulated electric utilities and other third party marketers to sell electricity to customers. Marketers of electric supply compete largely on price; therefore, gross margins are relatively small. To provide competitive pricing to its retail customers and in adherence to its risk management policies and procedures, WGEServices manages its electricity contract portfolio by closely matching the commitment for electricity deliveries from suppliers with requirements to serve sales customers. For a discussion of WGEServices’ exposure to and management of price risk, refer to the section entitled “Market Risk—Price Risk Related to the Retail Energy-Marketing Segment” in Management’s Discussion and Analysis.

WGEServices’ residential and small commercial electric customer growth opportunities are significantly affected by the price for Standard Offer Service (SOS) offered by electric utilities. These rates are periodically reset for each customer class based on the regulatory requirements in each jurisdiction. Customer growth opportunities either expand or contract due to the relationship of these SOS rates to current market prices.

COMMERCIAL ENERGY SYSTEMS SEGMENT

Description

The commercial energy systems segment consists of the operations of WGESystems, WGSW and the results of operations of affiliate owned commercial solar projects. WGESystems provides energy efficiency and sustainability solutions to governmental and commercial clients. These solutions include energy efficiency projects and distributed generation assets that we own and operate such as Solar PV systems, combined heat and power plants, and fuel cells. WGESystems also focuses on upgrading the mechanical, electrical, water and energy-related infrastructure of large governmental and commercial facilities by implementing both traditional as well as alternative energy technologies, primarily in the District of Columbia, Maryland and Virginia. In addition to these three regions, WGESystems is also expanding its portfolio of Solar Photovoltaic (Solar PV) power generating systems into Arizona, California, Connecticut, Delaware, Georgia, Hawaii, Massachusetts, New Jersey and New Mexico. WGESystems is also evaluating opportunities in other geographical locations within the United States. The commercial energy systems segment derived approximately 84% of its revenues from work completed for various agencies of the Federal Government in fiscal year 2013 and the remainder from its commercial solar assets.

As of September 30, 2013 and 2012, WGESystems had infrastructure upgrade work backlogs of $17.4 million and $46.1 million, respectively. These backlogs include only work associated with signed contracts. As of September 30, 2013, the approximate value of backlog to be completed beyond fiscal year 2014 was $1.7 million.

Factors critical to the success of the commercial energy systems segment include:

 

   

generating adequate sales commitments from the government and private sectors in the facility construction and retrofit markets;

   

building a stable base of customer relationships;

   

estimating and managing fixed-price contracts with contractors;

   

managing selling, general and administrative expenses;

   

managing price and operational risk associated with solar projects and

   

successful operation and optimization of all commercial assets.

 

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Washington Gas Light Company

Part I

Item 1. Business (continued)

 

This segment comprises the operations of WGSW, which was formed to invest in solar power generation and other energy efficiency solutions for customers. See Note 17: Investments in Non-Consolidated Affiliates for details on these investments.

The commercial energy systems segment made up 36% of the total expenditures for capital assets. The chart below illustrates the capital investments by operating segment for the year ended September 30, 2013:

 

LOGO

Competition

There are many competitors in this business segment. Within the government sector, competitors primarily include companies contracting with customers under Energy Savings Performance Contracting (ESPC) as well as utilities providing services under Utility Energy Saving Contracts (UESC). In the commercial markets, in addition to ESPCs, competitors include manufacturers of equipment and control systems and consulting firms. In the renewable energy and distributed generation maket, competitors primarily include other developers, tax equity investors and lending institutions. WGESystems competes on the basis of strong customer relationships developed over many years of implementing successful projects, developing and maintaining strong supplier relationships, and focusing in areas where it can bring relevant expertise.

MIDSTREAM ENERGY SERVICES SEGMENT

Description

The Midstream Energy Services segment, which consists of the operations of WGL Midstream, engages in developing, acquiring, managing and optimizing natural gas storage and transportation assets. WGL Midstream enters into both physical and financial derivative transactions to mitigate risks while maximizing potential profits from the optimization of these assets under its management. These derivatives may cause significant period-to-period volatility in earnings as recorded under GAAP; however, this volatility will not change the operating margins that WGL Midstream will ultimately realize from sales to customers or counterparties. WGL Midstream’s customers and counterparties include producers, utilities, local distribution companies, power generators, wholesale energy suppliers, pipelines and storage facilities. WGL Midstream’s risk management policy requires it to closely match its forward physical and financial positions with its asset base, thereby minimizing its price risk exposure. For a discussion of WGL Midstream’s exposure to and management of price risk, refer to the section entitled “Market Risk—Price Risk Related to the Other Non-Utility Segment” in Management’s Discussion and Analysis.

WGL Midstream competes with other midstream infrastructure and energy services companies, wholesale energy suppliers and other non-utility affiliates of regulated utilities for the acquisition of natural gas storage and transportation assets. Factors critical to the success of WGL Midstream’s operations include: (i) adhering to strong internal risk management policies; (ii) winning business in a competitive marketplace; (iii) managing credit risks associated with customers and counterparties; (iv) accessing sources of financial liquidity and (v) managing the level of general and administrative expenses.

 

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Washington Gas Light Company

Part I

Item 1. Business (continued)

 

In May 2013, WGL Midstream entered into an equity investment in Constitution Pipeline Company, LLC. The pipeline is designed to transport at least 650,000 dekatherms of natural gas per day from the Marcellus region in northern Pennsylvania to major northeastern markets. See Note 17: Variable Interest Entities and Other Non-Consolidated Investments for further details regarding this project.

OTHER ACTIVITIES

Activities and transactions that are not significant enough on a stand-alone basis to warrant treatment as an operating segment, and that do not fit into one of our other operating segments, are aggregated as “Other activities” and are included as part of non-utility operations in the operating segment financial information. Administrative and business development activity costs associated with WGL Holdings and Washington Gas Resources are included in this segment.

ENVIRONMENTAL MATTERS

We are subject to federal, state and local laws and regulations related to environmental matters. These laws and regulations may require expenditures over a long timeframe to control environmental effects. Almost all of the environmental liabilities we have recorded are for costs expected to be incurred to remediate sites where we or a predecessor affiliate operated manufactured gas plants (MGPs). Estimates of liabilities for environmental response costs are difficult to determine with precision because of the various factors that can affect their ultimate level. These factors include, but are not limited to, the following:

 

   

the complexity of the site;

 

   

changes in environmental laws and regulations at the federal, state and local levels;

 

   

the number of regulatory agencies or other parties involved;

 

   

new technology that renders previous technology obsolete or experience with existing technology that proves ineffective;

 

   

the level of remediation required and

 

   

variations between the estimated and actual period of time that must be dedicated to respond to an environmentally-contaminated site.

Washington Gas has identified up to ten sites where it or its predecessors may have operated MGPs. Washington Gas’ last use of an MGP was in 1984. In connection with these operations, we are aware that coal tar and certain other by-products of the gas manufacturing process are present at or near some former sites, and may be present at others. Based on the information available to us, we have concluded that none of the sites are likely to present an unacceptable risk to human health or the environment, and either the appropriate remediation is being undertaken, or Washington Gas believes no remediation is necessary. The impact of these matters is not expected to have a material effect on Washington Gas’ financial position, cash flows, capital expenditures, earnings or competitive position. See Note 12—Environmental Matters of the Notes to Consolidated Financial Statements for further discussion of environmental response costs.

OTHER INFORMATION

At September 30, 2013, we had 1,416 employees comprising 1,297 utility and 119 non-utility employees. At September 30, 2012, we had 1,362 employees comprising 1,235 utility and 127 non-utility employees.

Our code of conduct, corporate governance guidelines, and charters for the governance, audit and human resources committees of the Board of Directors are available on the corporate Web site www.wglholdings.com under the “Corporate Governance” link, and any changes or amendments to these documents will also be posted to this section of our Web site. Copies may be obtained by request to the Corporate Secretary at WGL Holdings, Inc., 101 Constitution Ave., N.W., Washington, D.C. 20080. Also on the corporate web site is additional information about WGL Holdings and free access to our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments filed with or furnished to the Securities and Exchange Commission.

Our Chairman and Chief Executive Officer certified to the New York Stock Exchange (NYSE) on March 25, 2013 that, as of that date, he was unaware of any violation by WGL Holdings of the NYSE’s corporate governance listing standards.

Our research and development costs during fiscal years 2013, 2012 and 2011 were not material.

 

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Washington Gas Light Company

Part I

Item 1A. Risk Factors

ITEM 1A. RISK FACTORS

 

 

The risk factors described below should be read in conjunction with other information included or incorporated by reference in this annual report on Form 10-K, including an in-depth discussion of these risks in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The risks and uncertainties described below are not the only risks and uncertainties facing us that could adversely affect our results of operations, cash flows and financial condition.

WGL HOLDINGS, INC.

Our business may be adversely affected if we are unable to pay dividends on our common stock and principal and interest on our outstanding debt.

WGL Holdings is a holding company whose assets consist primarily of investments in subsidiaries. Accordingly, we conduct all of our operations through our subsidiaries. Our ability to pay dividends on our common stock and to pay principal and accrued interest on our outstanding debt depends on the payment of dividends to us by certain of our subsidiaries or the repayment of funds to us by our principal subsidiaries. The extent to which our subsidiaries do not pay dividends or repay funds to us may adversely affect our ability to pay dividends to holders of our common stock and principal and interest to holders of our debt.

If we are unable to access sources of liquidity or capital, or the cost of funds increases significantly, our subsidiaries’ businesses may be adversely affected.

Our ability to obtain adequate and cost effective financing depends on our credit ratings as well as the liquidity of financial markets. Our credit ratings depend largely on the financial performance of our subsidiaries, and a downgrade in our current credit ratings could adversely affect our access to sources of liquidity and capital, as well as our borrowing costs.

We have credit risk that could adversely affect our results of operations, cash flows and financial condition.

We extend credit to counterparties. While we have prudent risk management policies in place, including credit policies, netting arrangements and margining provisions incorporated in contractual agreements, the risk exists that we may not be able to collect amounts owed to us.

Derivatives legislation and implementing rules could have an adverse impact on our ability to hedge risks associated with our business.

The Dodd-Frank Act regulates derivative transactions, which include certain instruments used in our risk management activities. The Dodd-Frank Act requires that most swaps be cleared through a registered clearing facility and traded on a designated exchange or swap execution facility, with certain exceptions for entities that use swaps to hedge or mitigate commercial risk. Although the Dodd-Frank Act includes significant new provisions regarding the regulation of derivatives, the impact of those requirements have not been fully implemented by both the SEC and the Commodities Futures Trading Commission. The legislation and any new regulations could increase the operational and transactional cost of derivatives contracts and affect the number and/or creditworthiness of available counterparties.

Cyber attacks, including cyber-terrorism or other information technology security breaches, could disrupt our business operations and/or result in the loss or exposure of confidential or sensitive information.

Security breaches of our information technology infrastructure, including cyber attacks and cyber-terrorism, could lead to disruptions of our distribution or otherwise adversely impact our ability to safely operate our pipeline systems and serve our customers effectively. An attack on or failure of information technology systems could result in the unauthorized release of customer, employee or other confidential or sensitive data. The foregoing events could adversely affect our business reputation, diminish customer confidence, subject us to financial liability or increased regulation, increase our costs and expose us to material legal claims and liability and adversely affect our operations and financial results. While we maintain system security protocols, there is no guarantee that the measures we have implemented to protect against unauthorized access to secured data are adequate to safeguard against all data security breaches.

Natural disasters and catastrophic events, including terrorist acts, may adversely affect our business.

Catastrophic events such as fires, earthquakes, explosions, floods, tornados, terrorist acts, or other similar occurrences could adversely affect Washington Gas’ facilities and operations. Washington Gas has emergency planning and training programs in place to respond to events that could cause business interruptions. However, unanticipated events or a

 

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Washington Gas Light Company

Part I

Item 1A. Risk Factors (continued)

 

combination of events, failure in resources needed to respond to events, or a slow or an inadequate response to events may have an adverse impact on the operations, financial condition, and results of operations of Washington Gas. The availability of insurance covering catastrophic events may be limited or may result in higher deductibles, higher premiums, and more restrictive policy terms.

WGEServices’ business, earnings and cash requirements are highly weather sensitive and seasonal.

The operations of WGEServices, our retail energy-marketing subsidiary, are weather sensitive and seasonal, with a significant portion of revenues derived from the sale of natural gas to retail customers for space heating during the winter months, and from the sale of electricity to customers for cooling during the summer months. Weather conditions directly influence the volume of natural gas and electricity delivered to customers. Weather conditions can also affect the short-term pricing of energy supplies that WGEServices may need to procure to meet the needs of its customers. Deviations in weather from normal levels and the seasonal nature of WGEServices’ business can create large variations in earnings and short-term cash requirements.

The ability of WGEServices to meet customers’ natural gas and electricity requirements may be impaired if contracted supply is not available or delivered in a timely manner.

Sufficient capability to deliver natural gas and electric supplies to serve the demand of WGEServices’ customers is dependent upon the ability of natural gas producers, pipeline gatherers, natural gas processors, interstate pipelines, suppliers of electricity and regional electric transmission operators to meet these requirements. If WGEServices is unable to secure adequate supplies in a timely manner, either due to the failure of its suppliers to deliver the contracted commodity or the inability to secure additional quantities during significant abnormal weather conditions, it may be unable to meet its customer requirements. Such inability to meet its delivery obligations to customers could result in WGEServices experiencing defaults on contractual terms with its customers, penalties and financial damage payments, the loss of certain licenses and operating authorities, and/or a need to return customers to the regulated utility companies, such as Washington Gas.

The risk management strategies and related hedging activities of WGEServices may not be effective in managing risks and may cause increased volatility in its earnings.

WGEServices is exposed to commodity price risk to the extent its natural gas and electricity purchases and obligations are not closely matched to its sales commitments in terms of volume and pricing. In addition, WGEServices is exposed to pricing of certain services provided or required by the power pool in which it operates. WGEServices attempts to manage its exposure to commodity price risk, as well as its exposure to weather and delivery risks by hedging, setting risk limits, customer pricing terms and employing other risk management tools and procedures. These risk management activities may not be as effective as planned, and cannot eliminate all of WGEServices’ risks.

WGEServices relies on guarantees and access to cash collateral from WGL Holdings.

The ability of WGEServices to purchase natural gas and electricity from suppliers is dependent upon guarantees issued on its behalf by WGL Holdings, and upon access to cash collateral through the issuance of commercial paper and unsecured short-term bank loans by WGL Holdings. Should WGL Holdings not renew such guarantees, provide access to cash collateral, or if WGL Holdings’ credit ratings are downgraded, the ability of WGEServices to make commodity purchases at reasonable prices may be impaired.

Regulatory developments may negatively affect WGEServices.

The regulations that govern the conduct of competitive energy marketers are subject to change as the result of legislation or regulatory proceedings. Changes in these regulatory rules could reduce customer growth opportunities for WGEServices, or could reduce the profit opportunities associated with certain groups of existing or potential new customers.

Competition may negatively affect WGEServices.

WGEServices competes with other non-regulated retail suppliers of natural gas and electricity, as well as with the commodity rate offerings of electric and gas utilities. Increases in competition including utility commodity rate offers that are below prevailing market rates may result in a loss of sales volumes or a reduction in growth opportunities.

Investing in certain non-controlling interests in investments may limit our ability to manage risks associated with these investments.

We have, and may acquire additional, non-controlling interests in investments. We may not have the right or power to direct the management of these interests in investments. In addition, other participants may become bankrupt or have other economic or business objectives that could negatively impact our investments.

 

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WGL Holdings, Inc.

Washington Gas Light Company

Part I

Item 1A. Risk Factors (continued)

 

Investments in renewable energy projects are subject to substantial risks and uncertainty.

Returns on investments in renewable energy projects depend upon current regulatory and tax incentives, which are subject to uncertainty with respect to their extent and future availability. As a result, investments in renewable energy projects face the risk that the current incentives will expire or become modified in the future thereby adversely affecting existing projects, economic performance and future potential for growth in this area.

Delays in the Federal Government budget appropriations may negatively impact WGESystems earnings.

The operations of WGESystems are sensitive to federal government agencies’ receipt of funding in a timely manner. A significant portion of revenues is derived from implementing projects related to energy efficiency and energy conservation measures for federal government agencies in the Washington DC metro area. Lack of timely funding of these federal agencies directly impacts completion of ongoing projects and the ability of WGESystems to obtain new contracts, and as a result will negatively impact earnings.

WGESystems’ earnings may be negatively impacted by the Solar Renewable Energy Credit (SREC) markets.

A significant portion of revenues of WGESystems is derived from the sale of SRECs produced as a result of owning and operating commercial solar systems. SREC pricing is determined by the market in each of the states where the solar systems are installed. Oversupply of the SRECs in any state as a result of overbuilding of solar systems in the state will result in higher supply of SRECs than demand requires, which will negatively impact the price of SRECs. Any legislative change in a state that reduces renewable portfolio standards or alternative compliance payment requirements for renewable energy may negatively impact the price of SRECs.

Changes to the Federal Investment Tax Credit (ITC) Policies may negatively affect WGESystems’ and WGSW’s earnings.

Part of WGESystems and WGSW’s investment strategy for owning and operating energy assets and selling energy to customers is based on the current ITC provision in the tax code that allow WGL Holdings to reduce its tax burden by investing in renewable and alternative energy assets like solar, ductless heat pumps and fuel cells. The current ITC provisions allow WGL Holdings to reduce its tax burden by the equivalent of up to 30% for every dollar invested in renewable energy assets. A reduction or elimination of the ITC tax provisions for renewable and alternative energy assets may have a negative impact on WGESystems’ and WGSW’s continued growth.

WASHINGTON GAS LIGHT COMPANY

Changes in the regulatory environment or unfavorable rate regulation, which can be affected by new laws or political considerations, may restrict or delay Washington Gas’ ability to earn a reasonable rate of return on its invested capital to provide utility service and to recover fully its operating costs.

Washington Gas is regulated by several regulatory commissions and agencies. These regulatory commissions generally have authority over many of the activities of Washington Gas’ business including, but not limited to, the rates it charges to its customers, the amount and type of securities it can issue, the nature of investments it can make, the nature and quality of services it provides, safety standards, collection practices and other matters. These regulators also may modify Washington Gas’ rates to change the level, type and methods that it utilizes to recover its costs, including the costs to acquire, store, transport and deliver natural gas. The actions of regulatory commissions may restrict or delay Washington Gas’ ability to earn a reasonable rate of return on invested capital and/or fully recover operating costs.

Washington Gas’ ability to meet customers’ natural gas requirements may be impaired if its contracted gas supplies and interstate pipeline and storage services are not available or delivered in a timely manner.

Washington Gas is responsible for acquiring sufficient natural gas supplies, interstate pipeline capacity and storage capacity to meet current and future customers’ annual and seasonal natural gas requirements. If Washington Gas is not able to maintain a reliable and adequate natural gas supply and sufficient pipeline capacity to deliver that supply, it may be unable to meet its customers’ requirements.

Washington Gas needs to acquire additional capacity to deliver natural gas on the coldest days of the year, and it may not receive the necessary authorizations to do so in a timely manner.

Washington Gas needs to acquire additional interstate pipeline transportation or storage capacity and construct transmission and distribution pipe to deliver additional capacity into growth areas on our system. The availability of these options may be limited by market supply and demand, the timing of Washington Gas’ participation in new interstate pipeline construction projects and local permitting requirements as well as the acquisition of rights of way. This could cause an interruption in Washington Gas’ ability to satisfy the needs of some of its customers.

 

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WGL Holdings, Inc.

Washington Gas Light Company

Part I

Item 1A. Risk Factors (continued)

 

Washington Gas was planning to construct a one billion cubic foot liquefied natural gas (LNG) storage facility in Chillum, Maryland to meet its customers’ forecasted demand for natural gas. The new storage facility was expected to be completed and in service by the 2019-2020 winter heating season; however, the United States District Court for the District of Maryland ruled that local zoning laws that have prohibited our construction of this plant are authoritative. We appealed this court’s ruling but did not prevail.

Operating issues could affect public safety and the reliability of Washington Gas’ distribution system, which could materially affect Washington Gas’ results of operations, financial condition and cash flows.

Washington Gas’ business is exposed to operating issues that could affect the public safety and reliability of its distribution system. Operating issues such as leaks, mechanical problems and accidents could result in significant costs to Washington Gas’ business and loss of customer confidence. Washington Gas may be unable to recover from customers through the regulatory process all or some of these costs and earn its authorized rate of return on these costs.

The receipt of low HHC gas into Washington Gas’ distribution system may result in higher operating expenses and capital expenditures that may have a material effect on its financial condition, results of operations and cash flows, and may impact system safety.

An increase in the volume of natural gas that contains a low concentration of HHCs is likely to result in increased leaks in Washington Gas’ distribution system. Additional operating expenses and capital expenditures may be necessary to contend with the receipt of increased volumes of low HHC gas into Washington Gas’ distribution system if the current preventative and remedial measures to mitigate leaks in affected portions of Washington Gas’ distribution system are unsuccessful. These additional expenditures may not be recoverable or may not be recoverable on a timely basis from customers. Additionally, such operating expenses and capital expenditures may not be timely enough to mitigate the challenges posed by increased volumes of low HHC gas and could result in leakage in couplings at a rate that would compromise our ability to respond to these leaks in a timely manner, possibly affecting safety in portions of our distribution system.

Changes in the relative prices of alternative forms of energy may strengthen or weaken the competitive position of Washington Gas’ delivery service. If the competitive position of natural gas service weakens, it may reduce the number of natural gas customers in the future and negatively affect Washington Gas’ future cash flows and net income.

The price of natural gas delivery service that Washington Gas provides competes with the price of other forms of energy such as electricity, oil and propane. Changing prices of natural gas versus other sources of energy can cause the competitive position of our natural gas delivery service to improve or decline. A decline in the competitive position of natural gas service in relation to alternative energy sources can lead to fewer natural gas customers, lower volumes of natural gas delivered, lower cash flows and lower net income.

A decline in the economy may reduce net revenue growth and reduce future net income and cash flows.

A decline in the economy of the region in which Washington Gas operates might adversely affect Washington Gas’ ability to grow its customer base and collect revenues from existing customers, which may negatively affect net revenue growth and increase costs.

If Washington Gas is unable to access sources of liquidity or capital, or the cost of funds increases significantly, Washington Gas’ business may be adversely affected.

Washington Gas’ ability to obtain adequate and cost effective financing depends on its credit ratings as well as the liquidity of financial markets. Washington Gas’ credit ratings depend largely on its financial performance, and a downgrade in current credit ratings could adversely affect its access to sources of liquidity and capital, as well as its borrowing costs and ability to earn its authorized rate of return.

As a wholly owned subsidiary of WGL Holdings, Washington Gas depends solely on WGL Holdings to raise new common equity capital and contribute that common equity to Washington Gas. If WGL Holdings is unable to raise common equity capital, this also could adversely affect Washington Gas’ credit ratings and its ability to earn its authorized rate of return. An increase in the interest rates Washington Gas pays without the recognition of the higher cost of debt in rates charged to its customers would materially affect future net income and cash flows.

Washington Gas’ risk management strategies and related hedging activities may not be effective in managing its risks, and may result in additional liability for which rate recovery may be disallowed and cause increased volatility in its earnings.

Washington Gas’ business requirements expose it to commodity price, weather, credit and interest-rate risks. Washington Gas attempts to manage its risk exposures through regulatory recovery mechanisms, hedging, the use of risk limits and by employing other risk management tools and procedures. Risk management activities may not be as effective as planned, and cannot eliminate all risks. Washington Gas also may be exposed to additional liability should the anticipated revenue recovery of costs or losses incurred with certain of these risk management activities be subsequently excluded from the determination of revenues by a regulator.

 

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Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part I

Item 1A. Risk Factors (concluded)

 

Washington Gas’ facilities and operations may be impaired by cyber-attacks or acts of terrorism.

Washington Gas’ distribution, storage facilities and IT infrastructure may be targeted by terrorist activities. Resulting damage could cause disruption of the ability to meet customer requirements. A security breach of Washington Gas’ information systems could impact the reliability of the distribution system or result in the theft of sensitive customer or employee information.

Terrorist attacks may also disrupt capital markets and Washington Gas’ ability to raise capital. A terrorist attack on Washington Gas’ facilities or those of its natural gas suppliers or customers could result in a significant decrease in revenues or a significant increase in response costs.

Washington Gas may face certain regulatory and financial risks related to climate change legislation.

Future proposals to limit greenhouse gas (GHG) emissions, measured in carbon dioxide equivalent units, could adversely affect our operating and service costs and demand for our product. In the past, the United States Congress has considered legislative proposals to limit GHG emissions. Should future proposals become law, the adoption could increase utility costs and prices charged to utility customers.

Washington Gas may face certain regulatory and financial risks related to pipeline safety legislation.

A number of proposals to implement increased oversight over pipeline operations and increased investment in facilities to inspect pipeline facilities, upgrade pipeline facilities, or control the impact of a breach of such facilities are pending at the federal level. Additional operating expenses and capital expenditures may be necessary to remain in compliance with the increased federal oversight resulting from such proposals. While we cannot predict with certainty the extent of these expenses and expenditures or when they will become effective, the adoption of such proposals could result in significant additional costs to Washington Gas’ business. Washington Gas may be unable to recover from customers through the regulatory process all or some of these costs and its authorized rate of return on these costs.

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

 

None.

 

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WGL Holdings, Inc.

Washington Gas Light Company

Part I

Item 2. Properties

ITEM 2. PROPERTIES

 

At September 30, 2013, Washington Gas provided services in various areas of the District of Columbia, Maryland and Virginia, and held certificates of convenience and necessity, licenses and permits necessary to maintain and operate its properties and businesses. The regulated utility segment is the only segment where property, plant and equipment are significant assets.

Property, plant and equipment are stated at original cost, including labor, materials, taxes and overhead costs incurred during the construction period. Washington Gas calculates depreciation applicable to its utility gas plant in service primarily using a straight-line method over the estimated remaining life of the plant. The composite depreciation and amortization rate of the regulated utility was 2.86%, 2.87% and 2.84% during fiscal years 2013, 2012 and 2011, respectively, which included an allowance for estimated accrued non-legal asset removal costs (see Note 1 —Accounting Policy of the Notes to Consolidated Financial Statements).

At September 30, 2013, Washington Gas had approximately 667 miles of transmission mains, 12,897 miles of distribution mains and 13,380 miles of distribution services. Washington Gas has the storage capacity for approximately 15.0 million gallons of propane for peak-shaving.

Washington Gas owns approximately 40 acres of land and three buildings (two completed in 2012 and one in 1970, respectively) at 6801, 6803 and 6805 Industrial Road in Springfield, Virginia. The Springfield site houses both operating and certain administrative functions of the utility. The old operations center is unused and is being marketed for sale. Washington Gas also holds title to land and buildings used as substations for its utility operations.

Washington Gas also has peak shaving facilities to enhance deliverability in periods of peak demand in the winter that consist of propane air plants in Springfield, Virginia (Ravensworth Plant) and Rockville, Maryland (Rockville Plant). Hampshire owns full and partial interests in, and operates underground natural gas storage facilities in Hampshire County, West Virginia. Hampshire accesses the storage field through 12 storage wells that are connected to an 18-mile transmission pipeline system. Concurrent with acquiring and protecting its storage rights, Hampshire has historically acquired certain exploration and development rights in West Virginia principally in the Oriskany Sandstone, the Marcellus Shale and other shale formations. These rights are predominately owned by lease and they are applicable to approximately 26,000 gross acres for the storage facilities of which 12,200 acres may be subject to exploration in addition to its storage function. Hampshire also operates a compressor station utilized to increase line pressure for injection of gas into storage. For fiscal year 2014, we estimate that the Hampshire storage facility has the capacity to supply approximately 4.2 billion cubic feet of natural gas to Washington Gas’ system for meeting winter season demands.

Washington Gas owns a 12-acre parcel of land located in Southeast Washington, D.C. Washington Gas entered into an agreement with a national developer to develop this land in phases. Washington Gas selected the developer to design, execute and manage the various phases of the development. The development, Maritime Plaza, is intended to be a mixed-use commercial project that will be implemented in five phases. The first two phases have been developed, with Washington Gas retaining a 99-year ground lease on each phase. See the section entitled “Environmental Matters” under Item 1 of this report for additional information regarding this development.

In addition, WGESystems owns 37 megawatts of installed solar capacity in 11 different states at September 30, 2013 .

Facilities utilized by our corporate headquarters, as well as by the retail energy-marketing and commercial energy systems segments, are located in the Washington, D.C. and Baltimore metropolitan area and are leased.

The Mortgage of Washington Gas dated January 1, 1933 (Mortgage), as supplemented and amended, securing any First Mortgage Bonds (FMBs) it issues, constitutes a direct lien on substantially all property and franchises owned by Washington Gas other than a small amount of property that is expressly excluded. At September 30, 2013 and 2012, there was no debt outstanding under the Mortgage.

Washington Gas executed a supplemental indenture to its unsecured Medium-Term Note (MTN) indenture on September 1, 1993, providing that Washington Gas will not issue any FMBs under its Mortgage without also securing all MTNs with all other debt secured by the Mortgage.

 

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Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part I

Item 3. Legal Proceedings

ITEM 3. LEGAL PROCEEDINGS

 

The nature of our business ordinarily results in periodic regulatory proceedings before various state and federal authorities. For information regarding pending federal and state regulatory matters, see Note 13—Commitments and Contingencies, contained in Part II under the Notes to Consolidated Financial Statements.

On December 30, 2011, a complaint was filed against Washington Gas in the Superior Court of the District of Columbia. The complaint was filed on behalf of six plaintiffs who are collectively seeking damages in the amount of $110 million. The plaintiffs in the case are: Stephen D. Vermillion III, Jennifer Vermillion, Anna Cederberg Heard, C.J.C. (a minor), and Adrienne Connolly and James Connolly. Pursuant to the complaint, the plaintiffs have sued Washington Gas for various personal injuries and damages allegedly related to, and negligently caused by, pollutants located at Washington Gas’ East Station site at which a manufactured gas plant was formerly operated. The East Station site is adjacent to the Anacostia River in Washington, DC. Washington Gas has filed third-party complaints against the United States and the District of Columbia for contribution, and a counterclaim against James Connolly for any unmet notice obligations. On April 9, 2013, the United States filed a notice of removal to remove the case from the Superior Court to the U.S. District Court for the District of Columbia. On June 20, 2013, the case was subsequently remanded back to the Superior Court. Ultimately, all claims related to this matter were settled in October 2013.

On August 14, 2012, a third-party complaint was filed against Washington Gas and WGL Holdings, Inc. in the Arlington County Circuit Court in Virginia (the Court) by The Carlin Limited Partnership and Foundation Property Management, Inc. (The Carlin). The case involves a complaint filed by plaintiff Marianne Karklins, against The Carlin, seeking $50 million in damages for injuries sustained as a result of an explosion and fire in an apartment on May 21, 2011. Pursuant to the complaint, the plaintiff asserts claims of negligence and negligence per se against The Carlin for her injuries. The third-party complaint was filed on behalf of The Carlin and seeks contribution for any sums awarded to the plaintiff. Washington Gas and WGL Holdings, Inc. filed a demurrer which was sustained by the Court in a letter opinion dated November 28, 2012, effectively dismissing the third-party complaint. The Court allowed the defendants to file an amended third-party complaint and a subsequent demurrer to this amended third-party complaint was overruled. Shortly thereafter, plaintiff filed an amended complaint adding Washington Gas and WGL Holdings, Inc. as defendants. Washington Gas and WGL Holdings, Inc. sought dismissal of the amended complaint and, as a result, WGL Holdings, Inc. was dismissed from the action without prejudice. Prior to trial which was scheduled to start October 7, 2013, and upon the request of The Carlin, all parties participated in non-binding mediation. Non-binding mediation has resulted in dismissal of the case with prejudice and a settlement of all claims.

 

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Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part I

Item 4. Mine Safety

ITEM 4. MINE SAFETY DISCLOSURES

 

Not Applicable.

 

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Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part I

EXECUTIVE OFFICERS OF THE REGISTRANTS

 

The names, ages and positions of the executive officers of the registrants at October 31, 2013, are listed below along with their business experience during the past five years. The age of each officer listed is as of the date of filing of this report. There is no family relationship among the officers.

Unless otherwise indicated, all officers have served continuously since the dates indicated, and all positions are executive officers listed with Washington Gas Light Company.

 

Executive Officers

Name, Age and Position with the registrants   

Date Elected or

Appointed       

 

Vincent L. Ammann, Jr., Age 54 (1)

  

Senior Vice President and Chief Financial Officer

   October 1, 2013

Vice President and Chief Financial Officer

   September 30, 2006

Gautam Chandra, Age 47 (1)

  

Vice President—Business Development, Strategy and Non-Utility Operations

   October 1, 2011

Vice President—Business Development, Strategy and Business Process Outsourcing and Non-Utility Operations

   October 1, 2009

Vice President—Business Process Outsourcing and Non-Utility Operations

   July 2, 2007

Adrian P. Chapman, Age 56 (1)

  

President and Chief Operating Officer

   October 1, 2009

Vice President—Operations, Regulatory Affairs and Energy Acquisition

   October 1, 2005

William R. Ford, Age 58 (1)

  

Vice President and Chief Accounting Officer

   October 1, 2013

Controller

   October 1, 2010

Division Head—Assistant Controller

   January 26, 2009

Director—Assistant to the Controller

   June 13, 2005

Marcellous P. Frye, Jr., Age 46

  

Vice President—Support Services

   March 21, 2008

Eric C. Grant, Age 56

  

Vice President—Corporate Relations

   October 1, 2009

Director—Corporate Communications

   September 4, 2007

Luanne S. Gutermuth, Age 51

  

Vice President—Human Resources and Organization Development

   October 1, 2010

Division Head—Consumer Services

   July 31, 2008

Terry D. McCallister, Age 57 (1)

  

Chairman of the Board and Chief Executive Officer

   October 1, 2009

President and Chief Operating Officer

   October 1, 2001

Anthony M. Nee, Age 57 (1)

  

Vice President and Treasurer

   October 1, 2013

Treasurer

   February 14, 2009

Division Head—Risk Management

   December 8, 2003

Arden T. Phillips, Age 42 (1)

  

Corporate Secretary and Governance Officer

   October 1, 2010

Assistant Secretary

   March 5, 2007

Roberta W. Sims, Age 59

  

Vice President—Regulatory Affairs and Energy Acquisition

   October 1, 2009

Vice President—Corporate Relations and Communication

   January 31, 1996

Douglas A. Staebler, Age 53

  

Vice President—Operations, Engineering, Construction and Safety

   October 31, 2006

Leslie T. Thornton, Age 55 (1,2)

  

Vice President and General Counsel

   January 1, 2012

Counsel to the Chairman

 

  

November 28, 2011

 

(1) At September 30, 2013, Executive Officer of both WGL Holdings, Inc. and Washington Gas Light Company.

(2) Ms. Thornton was previously a partner at Dickstein Shapiro, LLP where she managed sensitive internal corporate, federal government and state attorney general investigations.

 

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WGL Holdings, Inc.

Part II

Item 5. Market for Registrant’s Common Equity, Related

Stockholder Matters and Issuer Purchases of Equity Securities

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

At October 31, 2013, WGL Holdings had 10,517 common shareholders of record. During fiscal years 2013 and 2012, WGL Holdings’ common stock was listed for trading on the New York Stock Exchange and was shown under the ticker symbol “WGL.” We did not purchase any of our outstanding common stock and had no restrictions on dividends during fiscal years 2013 or 2012. The table below shows quarterly price ranges and quarterly dividends paid for the fiscal years ended September 30, 2013 and 2012.

 

Common Stock Price Range and Dividends Paid
      High        Low         

Dividends Paid   

Per Share   

       Dividend
Payment Date

Fiscal Year 2013

                       

Fourth quarter

   $ 46.96          $ 40.00            $ 0.42000                8/1/2013   

Third quarter

     46.22            41.16              0.42000                5/1/2013   

Second quarter

     44.30            38.30              0.40000                2/1/2013   

First quarter

     40.33            35.96              0.40000                11/1/2012    

Fiscal Year 2012

                       

Fourth quarter

   $         41.53          $         38.97            $         0.4000                8/1/2012   

Third quarter

     41.30            37.65              0.4000                5/1/2012   

Second quarter

     44.97            39.85              0.3875                2/1/2012   

First quarter

     44.99            36.84              0.3875                11/1/2011    

 

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WGL Holdings, Inc.

Part II

Item 6. Selected Financial Data

ITEM 6. SELECTED FINANCIAL DATA

 

The following table presents selected financial data for WGL Holdings derived from our financial statements as of and for the last five fiscal years. The information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the audited Consolidated Financial Statements and the Notes to the Consolidated Financial Statements.

 

(In thousands, except per share data)                                    
Years Ended September 30,    2013     2012     2011     2010     2009  

 

 

SUMMARY OF EARNINGS

          

Operating Revenues

          

Utility

   $     1,174,724     $     1,109,355     $     1,264,580     $     1,297,786     $     1,481,089   

Non-utility

     1,291,414       1,315,955       1,486,921       1,411,090       1,225,767   

 

 

Total operating revenues

   $ 2,466,138     $ 2,425,310     $ 2,751,501     $ 2,708,876     $ 2,706,856   

 

 

Income from continuing operations

   $ 80,253     $ 139,818     $ 117,050     $ 109,885     $ 120,373   

 

 

COMMON STOCK DATA

          

Earnings per average share:

          

Basic

   $ 1.55     $ 2.71     $ 2.29     $ 2.17     $ 2.40   

Diluted

   $ 1.55     $ 2.71     $ 2.28     $ 2.16     $ 2.39   

Dividends Declared per share

   $ 1.6600     $ 1.5875     $ 1.5400     $ 1.5000     $ 1.4575   

Shares outstanding—year end (thousands)

     51,774       51,612       51,365       50,975       50,143   

CAPITALIZATION-YEAR END

          

Common shareholders’ equity

   $ 1,274,545     $ 1,269,556     $ 1,202,715     $ 1,153,395     $ 1,097,698   

Washington Gas Light Company preferred stock

     28,173       28,173       28,173       28,173       28,173   

Long-term debt, excluding current maturities

     524,067       589,202       587,213       592,875       561,830   

 

 

Total capitalization

   $ 1,826,785     $ 1,886,931     $ 1,818,101     $ 1,774,443     $ 1,687,701   

 

 

OTHER FINANCIAL DATA

          

Property, plant and equipment-net—year-end

   $ 2,907,463     $ 2,667,413     $ 2,489,901     $ 2,346,208     $ 2,269,141   

 

 

Total assets—year-end

   $ 4,260,060     $ 4,110,947     $ 3,809,034     $ 3,643,894     $ 3,349,890   

 

 

 

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Washington Gas Light Company

Part II

Item 6. Selected Financial Data

ITEM 6. SELECTED FINANCIAL DATA

 

The following table presents selected financial data for Washington Gas derived from the financial statements as of and for the last five fiscal years. The information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the audited Consolidated Financial Statements and the Notes to the Consolidated Financial Statements.

 

(In thousands, except per share data)                               

 

 
Years Ended September 30,    2013     2012     2011     2010     2009  

 

 

SUMMARY OF EARNINGS

          

Operating Revenues

          

Utility

   $ 1,200,357      $ 1,137,666      $ 1,288,539      $ 1,321,446      $ 1,505,875  

Non-utility

     -         -         -         75       41  

 

 

Total operating revenues

   $     1,200,357      $     1,137,666      $     1,288,539      $     1,321,521      $     1,505,916  

 

 

Income from continuing operations

   $ 71,002      $ 108,726      $ 68,270      $ 101,029      $ 105,265  

 

 

CAPITALIZATION-YEAR END

          

Common shareholder’s equity

   $ 1,024,583      $ 1,025,743      $ 990,135      $ 994,876      $ 966,439  

Preferred stock

     28,173       28,173       28,173       28,173       28,173  

Long-term debt, excluding current maturities

     524,067       589,202       587,213       592,875       561,830  

 

 

Total capitalization

   $ 1,576,823      $ 1,643,118      $ 1,605,521      $ 1,615,924      $ 1,556,442  

 

 

OTHER FINANCIAL DATA

          

Property, plant and equipment-net—year-end

   $ 2,724,881      $ 2,574,396      $ 2,448,574      $ 2,329,528      $ 2,255,870  

 

 

Total assets—year-end

   $ 3,474,389      $ 3,503,265      $ 3,379,048      $ 3,270,276      $ 3,051,572  

 

 

UTILITY GAS SALES AND DELIVERIES (thousands of therms)

          

Gas sold and delivered

          

Residential firm

     660,424       540,206       677,558       662,357       689,986  

Commercial and industrial

          

Firm

     180,942       149,515       179,207       170,534       203,039  

Interruptible

     2,897       2,042       2,573       3,649       3,377  

 

 

Total gas sold and delivered

     844,263       691,763       859,338       836,540       896,402  

 

 

Gas delivered for others

          

Firm

     488,182       436,698       501,187       481,099       462,051  

Interruptible

     270,884       243,031       271,421       267,823       273,820  

Electric generation

     177,533       343,315       140,557       172,995       102,759  

 

 

Total gas delivered for others

     936,599       1,023,044       913,165       921,917       838,630  

 

 

Total utility gas sales and deliveries

     1,780,862       1,714,807       1,772,503       1,758,457       1,735,032  

 

 

OTHER STATISTICS

          

Active customer meters—year-end

     1,105,123       1,094,109       1,082,983       1,073,722       1,064,071  

New customer meters added

     12,468       11,250       9,868       10,563       11,011  

Heating degree days—actual

     3,769       3,036       3,999       3,825       4,211  

Weather percent colder (warmer) than normal

     (0.2 )%      (20.1 )%      6.1      1.6      11.6 

 

 

 

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WGL Holdings, Inc.

Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

INTRODUCTION

This Management’s Discussion and Analysis of Financial Condition and Results of Operations (Management’s Discussion) analyzes the financial condition, results of operations and cash flows of WGL Holdings and its subsidiaries. It also includes management’s analysis of past financial results and potential factors that may affect future results, potential future risks and approaches that may be used to manage them. Except where the content clearly indicates otherwise, “WGL Holdings,” “we,” “us” or “our” refers to the holding company or the consolidated entity of WGL Holdings and all of its subsidiaries.

Management’s Discussion is divided into the following two major sections:

 

   

WGL Holdings—This section describes the financial condition and results of operations of WGL Holdings and its subsidiaries on a consolidated basis. It includes discussions of our regulated operations, including Washington Gas and Hampshire, and our non-utility operations.

 

   

Washington Gas—This section describes the financial condition and results of operations of Washington Gas, a wholly owned subsidiary of WGL Holdings, which comprises the majority of the regulated utility segment.

Both sections of Management’s Discussion—WGL Holdings and Washington Gas—are designed to provide an understanding of our operations and financial performance and should be read in conjunction with the respective company’s financial statements and the combined Notes to Consolidated Financial Statements in this annual report.

Unless otherwise noted, earnings per share amounts are presented on a diluted basis, and are based on weighted average common and common equivalent shares outstanding.

 

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Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

Management’s Discussion Table of Contents

 

     Page      

Executive Overview

     28     

Primary Factors Affecting WGL Holdings and Washington Gas

     28     

Critical Accounting Policies

     33     

Stock Based Compensation

     36     

WGL Holdings, Inc.

     37     

Results of Operations

     37     

Liquidity and Capital Resources

     43     

Contractual Obligations, Off-Balance Sheet Arrangements and Other Commercial Commitments

     50     

Credit Risk

     53     

Market Risk

     55     

Washington Gas Light Company

     61     

Results of Operations

     61     

Liquidity and Capital Resources

     63     

Rates and Regulatory Matters

     64     

EXECUTIVE OVERVIEW

Introduction

WGL Holdings, through its wholly owned subsidiaries, sells and delivers natural gas and provides a variety of energy-related products and services to customers primarily in the District of Columbia and the surrounding metropolitan areas in Maryland and Virginia.

WGL Holdings has four operating segments:

 

   

regulated utility;

 

   

retail energy-marketing;

 

   

commercial energy systems; and

 

   

midstream energy services.

Our core subsidiary, Washington Gas, engages in the delivery and sale of natural gas that is regulated by regulatory commissions in the District of Columbia, Maryland and Virginia. Through the wholly owned unregulated subsidiaries of Washington Gas Resources, we offer energy-related products and services. We offer competitively priced natural gas, electricity and energy from renewable sources to customers through WGEServices, our non-utility retail energy-marketing subsidiary. We offer efficient and sustainable commercial energy solutions focused on upgrading energy related systems of large government and commercial facilities as well as own and operate distributed generation assets such as Solar PV systems through WGESystems and WGSW. WGL Midstream engages in acquiring and optimizing natural gas storage and transportation assets.

Activities and transactions that are not significant enough on a stand-alone basis to warrant treatment as an operating segment, and that do not fit into one of our four operating segments, are aggregated as “Other Activities” and are included as part of non-utility operations. Administrative and business development costs associated with WGL Holdings and Washington Gas Resources are also included in “Other activities.”

Refer to the Business section under Item 1 of this report for further discussion of our regulated utility and non-utility business segments. For further discussion of our financial performance by operating segment, refer to Note 16 —Operating Segment Reporting of the Notes to Consolidated Financial Statements.

PRIMARY FACTORS AFFECTING WGL HOLDINGS AND WASHINGTON GAS

The following is a summary of the primary factors that affect the operations and/or financial performance of our regulated and unregulated businesses. Refer to the sections entitled “Business” and “Risk Factors” under Item 1 and Item 1A, respectively, of this report for additional discussion of these and other factors that affect the operations and/or financial performance of WGL Holdings and Washington Gas.

 

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WGL Holdings, Inc.

Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

Weather Conditions and Weather Patterns

Washington Gas.  Washington Gas’ operations are seasonal, with a significant portion of its revenues derived from the delivery of natural gas to residential and commercial heating customers during the winter heating season. Weather conditions directly influence the volume of natural gas delivered by Washington Gas. Weather patterns tend to be more volatile during “shoulder” months within our fiscal year in which Washington Gas is going into or coming out of the primary portion of its winter heating season. During the shoulder months within quarters ending December 31 (particularly in October and November) and June 30 (particularly in April and May), customer heating usage may not correlate highly with historical levels or with the level of heating degree days (HDDs) that occur, particularly when weather patterns experienced are not consistently cold or warm.

Washington Gas’ rates are determined on the basis of expected normal weather conditions. Washington Gas has weather protection strategies that are designed to neutralize the estimated financial effects of variations from normal weather. Refer to the section entitled “Market Risk—Weather Risk” for a further discussion of Washington Gas’ weather protection strategies.

WGEServices.  The financial results of our retail energy-marketing subsidiary, WGEServices, are also affected by deviations in weather from normal levels and abnormal customer usage during the shoulder months described above. Because WGEServices sells both natural gas and electricity, its financial results may fluctuate due to unpredictable deviations in weather during the winter heating and summer cooling seasons. WGEServices purchases weather-related instruments to help manage this risk. Refer to the section entitled “Market Risk—Weather Risk” for further discussion of WGEServices’ weather-related instruments.

WGL Midstream.  Variations from normal weather may also affect the financial results of our wholesale energy business, WGL Midstream, primarily with regards to summer - winter storage spreads and in transportation spreads throughout the fiscal year. WGL Midstream manages these weather risks with, among other things, physical and financial hedging. Refer to the section entitled “Market Risk—Weather Risk” for further discussion of WGL Midstream’s weather-related instruments.

Regulatory Environment, Regulatory Decisions and Changes in Legislation

Washington Gas is regulated by the PSC of DC, the PSC of MD and the SCC of VA. These regulatory commissions approve the terms and conditions of service and the rates that Washington Gas can charge customers for its rate-regulated services in their respective jurisdictions. Changes in these rates as ordered by regulatory commissions affect Washington Gas’ financial performance.

Washington Gas expects that regulatory commissions will continue to set the prices and terms for delivery service that give it an opportunity to recover reasonable operating expenses and earn a just and reasonable rate of return on the capital invested in its distribution system.

WGEServices is subject to regulation by the public service commissions of the states in which the company is authorized as a competitive service provider. These regulatory commissions: (i) authorize WGEServices to provide service, review certain terms and conditions of service and (ii) establish the regulatory rules for interactions between the utility and the competitive service provider. In addition, these regulatory commissions issue orders and promulgate rules that establish the broad structure and conduct of retail energy markets. Changes to the rules and orders by the regulatory commissions may affect WGEServices’ financial performance.

WGL Holdings has completed an internal assessment in preparation for the Dodd-Frank Act (the Act) legislation and requirements. The Company’s determination is that none of its entities, either separately or in the aggregate, will be classified as swap dealers or major swap participants under the Act.

Availability of Natural Gas Supply and Pipeline Transportation and Storage Capacity

Washington Gas.  Washington Gas is responsible for acquiring sufficient natural gas supplies, interstate pipeline capacity and storage capacity to meet its customer requirements. As such, Washington Gas must contract for reliable, adequate supplies and delivery capacity to its distribution system, while considering: (i) the dynamics of the commodity supply and interstate pipeline and storage capacity markets; (ii) its own on-system natural gas peaking facilities and (iii) the characteristics of its customer base. Energy-marketing companies that sell natural gas to customers located within Washington Gas’ service territory are responsible for acquiring natural gas for their customers; however, Washington Gas allocates certain storage and pipeline capacity related to these customers in accordance with regulatory requirements.

The increase in demand for pipeline and storage capacity compared to the available capacity is a business issue for local distribution companies, such as Washington Gas. To help maintain the adequacy of pipeline and storage capacity

 

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Washington Gas Light Company

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Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

for its growing customer base, Washington Gas has contracted with various interstate pipeline and storage companies for expanded transportation and storage capacity services. The last of these capacity expansion projects is expected to be placed into service during fiscal year 2016. Washington Gas will continue to monitor other opportunities to acquire or participate in additional pipeline and storage capacity that will support customer growth and improve or maintain the high level of service expected by its customer base.

WGEServices.  WGEServices contracts for storage and pipeline capacity to meet its customers’ needs primarily through transportation releases and storage services allocated from the utility companies in the various service territories in which it provides retail energy commodity.

WGL Midstream.  WGL Midstream contracts for storage and pipeline capacity in its asset optimization activities through both long term contracts and short term transportation releases. WGL Midstream also contracts for physical natural gas supply on both a long term and short term basis.

Diversity of Natural Gas Supply

Washington Gas.  An objective of Washington Gas’ supply sourcing strategy is to diversify receipts from multiple production areas to meet all firm customers’ natural gas supply requirements. This strategy is designed to protect Washington Gas’ receipt of supply from being curtailed by possible financial difficulties of a single supplier, natural disasters and other unforeseen events, and to take advantage of competitive commodity prices associated with natural gas supplies.

WGEServices.  WGEServices has the ability to purchase the majority of its natural gas from Shell Energy under a five-year secured supply arrangement but maintains the right to purchase supply from other providers to meet demand. To supplement WGEServices’ natural gas supplies during periods of high customer demand, WGEServices maintains gas inventories in storage facilities that are allocated by natural gas utilities such as Washington Gas.

WGL Midstream.  WGL Midstream buys and sells wholesale natural gas across a diversified base of counterparties. WGL Midstream’s activities are also diversified across many liquid regional markets across the United States.

Volatility of Natural Gas and Electricity Prices

Volatility of natural gas and electricity prices impacts the regulated utility segment and the non-utility retail energy-marketing segment as described below.

Washington Gas.  Under its regulated gas cost recovery mechanisms, Washington Gas records cost of gas expense equal to revenue from customers associated with this cost for each period reported. Consequently, an increase in the cost of gas due to an increase in the purchase price of the natural gas commodity generally has no short-term direct effect on Washington Gas’ net income.

However, to the extent Washington Gas does not have regulatory mechanisms in place to mitigate the indirect effects of higher gas prices, its net income may decrease for factors such as: (i) lower natural gas consumption caused by customer conservation; (ii) increased short-term interest expense to finance a higher natural gas storage and accounts receivables balances and (iii) higher expenses for uncollectible accounts.

WGEServices.  WGEServices may be positively or negatively affected indirectly by significant changes in the wholesale price of natural gas and electricity. WGEServices’ risk management policies and procedures are designed to minimize the risk that WGEServices’ purchase commitments and the related sales commitments do not closely match (refer to the section entitled “Market Risk” for further discussion of WGEServices’ mitigation of commodity price risk). Additionally, in the short-term, volatile energy prices may change the costs associated with uncollectible accounts, borrowing costs, certain fees paid to public service commissions and other costs. To the extent that cost increases cannot be recovered from retail customers due to competitive factors, WGEServices’ operating results would be negatively affected.

WGL Midstream.  WGL Midstream can be positively or negatively affected by significant volatility in the wholesale price of natural gas. WGL Midstream risk management policies and procedures are designed to minimize the risk that purchase commitments and the related sale commitments do not closely match. In general, opportunities for asset optimization activities are increased for WGL Midstream with increased volatility in natural gas prices. These opportunities are primarily in short term transportation and storage spreads, seasonal storage spreads and long term supply or basis transactions.

 

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WGL Holdings, Inc.

Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

Non-Weather Related Changes in Natural Gas Consumption Patterns

Natural gas supply requirements for the utility are affected by changes in the natural gas consumption patterns of our customers that are driven by factors other than weather. Natural gas usage per customer may decline as customers change their consumption patterns in response to: (i) more volatile and higher natural gas prices, as discussed above; (ii) customer upgrades to energy efficient appliances and (iii) a decline in the economy in the region in which we operate.

For each jurisdiction in which Washington Gas operates, changes in customer usage profiles are reflected in rate case proceedings and rates are adjusted accordingly. Changes in customer usage by existing customers that occur subsequent to rate case proceedings in the Maryland jurisdiction generally will not change revenues because the RNA mechanism stabilizes the level of delivery charge revenues received from customers.

In Virginia, decoupling rate mechanisms for residential, small commercial and industrial and group metered apartment customers permit Washington Gas to adjust revenues for non-weather related changes in customer usage. The WNA and the CRA are billing mechanisms that eliminate the effects of both weather and other factors such as conservation.

In the District of Columbia, decreases in existing customer usage that occur subsequent to Washington Gas’ most recent rate case proceeding will have the effect of reducing revenues, which may be offset by additions of new customers.

Maintaining the Safety and Reliability of the Natural Gas Distribution System

Maintaining and improving the public safety and reliability of Washington Gas’ distribution system is our highest priority providing benefits to both customers and investors through lower costs and improved customer service. Washington Gas continually monitors and reviews changes in requirements of the codes and regulations that govern the operation of the distribution system and refines its safety practices, with a particular focus on design, construction, maintenance, operation, replacement, inspection and monitoring practices to meet or exceed these requirements. Significant changes in regulations can impact the cost of operating and maintaining the system. Operational issues that affect public safety and the reliability of Washington distribution system that are not addressed within a timely and adequate manner could adversely affect our future earnings and cash flows, as well as result in a loss of customer confidence.

Competitive Environment

Washington Gas.  Washington Gas faces competition based on customers’ preference for natural gas compared to other energy products, and the comparative prices of those products. The most significant product competition occurs between natural gas and electricity in the residential market. Changes in the competitive position of natural gas relative to electricity and other energy products have the potential of causing a decline in the number of future natural gas customers. At present, Washington Gas has seen no significant evidence that changes in the competitive position of natural gas has contributed to such a decline.

The residential market generates a significant portion of Washington Gas’ net income. In its service territory, Washington Gas continues to attract the majority of the new residential construction market. Consumers’ continuing preference for natural gas allows Washington Gas to maintain a strong market presence.

In each of the jurisdictions served by Washington Gas, regulators and utilities have implemented customer choice programs to purchase natural gas. These programs allow customers the choice of purchasing their natural gas from unregulated third party marketers, rather than from the local utility. There is no direct effect on Washington Gas’ net income when customers purchase their natural gas commodity from unregulated third party marketers because Washington Gas charges its customers the cost of gas without any mark-up. The transfer of sales customers to third party marketers does reduce the level of investment in storage inventory, thereby lowering our recovery of carrying charges.

WGEServices.  WGEServices competes with regulated utilities and other unregulated third party marketers to sell the natural gas and electric commodity to customers. Marketers of these commodities compete largely on price; therefore, gross margins are relatively small. WGEServices is exposed to certain credit and market risks associated with both its natural gas and electric supply (refer to the sections entitled “Credit Risk” and “Market Risk” for further discussion of these risk exposures and how WGEServices manages them).

WGEServices’ electric sales growth opportunities are significantly affected by the price for Standard Offer Service (SOS) offered by electric utilities. These rates, often identified by customer class, are periodically reset based on the regulatory requirements in each jurisdiction. Future opportunities to add new electric customers will be dependent on the competitiveness of WGEServices’ rates relative to SOS rates offered by local electric utilities as well as the prices offered by other energy marketers.

 

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Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

WGL Midstream.  WGL Midstream competes in the wholesale natural gas markets with other third party wholesale marketers to buy and sell natural gas as well as storage and pipeline capacity. Marketers of these commodities compete largely on price; therefore, gross margins are relatively small. WGL Midstream is exposed to certain credit and market risks associated with its asset optimization activities (refer to the sections entitled “Credit Risk” and “Market Risk” for further discussion of these risk exposures and how WGL Midstream manages them).

Environmental Matters

We are subject to federal, state and local laws and regulations related to environmental matters. These evolving laws and regulations may require expenditures over a long timeframe. It is our position that, at this time, the appropriate remediation is being undertaken at all the relevant sites. Refer to Note 12 —Environmental Matters of the Notes to Consolidated Financial Statements for further discussion of these matters.

Industry Consolidation

In recent years, the energy industry has seen a number of consolidations, combinations, disaggregations and strategic alliances. Consolidation will present combining entities with the challenges of remaining focused on the customer and integrating different organizations. Others in the energy industry are discontinuing operations in certain portions of the energy industry or divesting portions of their business and facilities.

From time to time, we perform studies and, in some cases, hold discussions regarding utility and energy-related investments and strategic transactions with other companies. The ultimate effect on us of any such investments and transactions that may occur cannot be determined at this time.

Economic Conditions and Interest Rates

We operate in one of the nation’s largest regional economies, including several of the nation’s wealthiest counties. Our service territory’s economic strength has allowed long-term stable expansion of Washington Gas’ regulated customer base and has provided active markets for our subsidiaries’ energy-related products and services. However, concerns exist about the region’s close ties to the federal government, particularly related to the local effects of across-the-board spending cuts (also known as “sequester”) and the recent federal shutdown. While it will take time for these impacts to be fully understood, we are optimistic about improvement when appropriate budget legislation is written and government activity resumes on a more normal footing.

The national economy has shown continued modest growth in gross domestic product, personal consumption and fixed investment during fiscal 2013. The unemployment rate has also improved modestly.

In this low-growth and uncertain environment, WGL Holdings and Washington Gas may be affected by continued levels of customer conservation and, particularly as driven by the local economy, year-over-year changes in uncollectible accounts expense. Refer to “Non-Weather Related Changes in Natural Gas Consumption Patterns”, above, for a discussion of regulatory mechanisms in place to mitigate the effects of customer conservation at Washington Gas.

Treasury interest rates fell slightly during fiscal year 2013, as the Federal Reserve, despite of market expectations, did not taper its quantitative easing activities. Year-over-year, national inflation was 1.2% as measured by the consumer price index for urban consumers (CPI-U), but inflation is a concern longer term. Refer to “Inflation” below for a discussion of the regulatory impacts of inflation and the section entitled “General Factors Affecting Liquidity” for a discussion of our access to capital markets.

We require short-term debt financing to manage our working capital needs and long-term debt financing to support the capital expenditures of Washington Gas. A rise in interest expense without the timely recognition of the higher cost of debt in our utility rates could adversely affect future earnings. A rise in short-term interest rates from current low levels, without the higher cost of debt being reflected in the prices charged to customers, could also negatively affect the results of operations of our retail energy-marketing segment.

Inflation

From time to time, Washington Gas seeks approval for rate increases from regulatory commissions to help it manage the effects of inflation on its operating costs, capital investment and returns. Inflation has a significant effect on Washington Gas’ replacement cost of plant and equipment. While the regulatory commissions having jurisdiction over Washington Gas’ retail rates allow only historical cost depreciation to be recovered in rates, we anticipate that Washington Gas should be allowed to recover the increased costs of its investment and earn a return thereon after replacement of facilities occurs.

 

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Washington Gas Light Company

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Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

Use of Business Process Outsourcing

In fiscal year 2007, Washington Gas entered into a 10-year BPO agreement with Accenture PLC (Accenture) to outsource certain of its business processes related to human resources, information technology, consumer services and finance operations. While Washington Gas expects the agreement to continue to benefit customers and shareholders during the term of the contract, the continued management of service levels provided is critical to the success of this outsourcing arrangement.

Washington Gas has implemented a BPO Governance organization and a comprehensive set of processes to monitor and control the cost effectiveness and quality of services provided through the BPO.

Labor Contracts, Including Labor and Benefit Costs

Washington Gas has five labor contracts with bargaining units represented by three labor unions. In January 2012, Washington Gas completed negotiations on a three-year labor contract with the Teamsters Local Union No. 96 (Local 96), an affiliate of the International Brotherhood of Teamsters. The contract covers approximately 540 employees and is effective June 1, 2012 through May 31, 2015. On April 1, 2013, Washington Gas entered into a three year labor contract with The Office and Professional Employees International Union Local No. 2 (A.F.L.-C.I.O.). The contract covers approximately 115 employees and is effective beginning April 1, 2013 through March 31, 2016. Local 96, representing union-eligible employees in the Shenandoah Gas division of Washington Gas, has a three-year labor contract with Washington Gas that became effective on August 1, 2012 and expires on July 31, 2015. This contract covers approximately 23 employees. Additionally, on August 1, 2011, Washington Gas entered into two new three-year labor contracts with the International Brotherhood of Electrical Workers Local 1900, that together cover approximately 23 employees. These two contracts expire on July 31, 2014. Washington Gas is subject to the terms of its labor contracts with respect to operating practices and compensation matters dealing with employees represented by the various bargaining units described above.

Changes in Accounting Principles

We cannot predict the nature or the effect of potential future changes in accounting regulations or practices that have yet to be issued on our operating results and financial condition. New accounting standards are issued by the Financial Accounting Standards Board (FASB) and the U.S. Securities and Exchange Commission (SEC) from time to time that change the way we record and recognize revenues, expenses, assets and liabilities.

CRITICAL ACCOUNTING POLICIES

Preparation of financial statements and related disclosures in compliance with Generally Accepted Accounting Principles in the United States of America requires the selection and the application of appropriate technical accounting guidance to the relevant facts and circumstances of our operations, as well as our use of estimates to compile the consolidated financial statements. The application of these accounting policies involves judgment regarding estimates and projected outcomes of future events, including the likelihood of success of particular regulatory initiatives, the likelihood of realizing estimates for legal and environmental contingencies, and the probability of recovering costs and investments in both the regulated utility and non-regulated business segments.

We have identified the following critical accounting policies discussed below that require our judgment and estimation, where the resulting estimates have a material effect on the consolidated financial statements.

Accounting for Unbilled Revenue

For regulated deliveries of natural gas, Washington Gas reads meters and bills customers on a monthly cycle basis. The billing cycles for customers do not coincide with the accounting periods used for financial reporting purposes. Washington Gas accrues unbilled revenues for gas that has been delivered but not yet billed at the end of an accounting period. In connection with this accrual, Washington Gas must estimate the amount of gas that has not been accounted for on its delivery system and must estimate the amount of the unbilled revenue by jurisdiction and customer class. A similar computation is made for WGEServices to accrue unbilled revenues for both gas and electricity.

 

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Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

Accounting for Regulatory Operations—Regulatory Assets and Liabilities

A significant portion of our business is subject to regulation by independent government entities. As the regulated utility industry continues to address competitive market issues, the cost-of-service regulation used to compensate Washington Gas for the cost of its regulated operations will continue to evolve. Non-traditional ratemaking initiatives and market-based pricing of products and services could have additional long-term financial implications for us. The carrying cost of Washington Gas’ investment in fixed assets assumes continued regulatory oversight of our operations.

Washington Gas’ jurisdictional tariffs contain mechanisms that provide for the recovery of the cost of gas applicable to firm customers. Under these mechanisms, Washington Gas periodically adjusts its firm customers’ rates to reflect increases and decreases in the cost of gas. Annually, Washington Gas reconciles the difference between the gas costs collected from firm customers and the cost of gas incurred, defers any difference and either recovers deficiencies from, or refunds excess costs to, customers over a subsequent twelve-month period.

Washington Gas accounts for its regulated operations in accordance with FASB Accounting Standards Codification (ASC) Topic 980, Regulated Operations (ASC Topic 980), which results in differences in the application of GAAP between regulated and unregulated businesses. ASC Topic 980 requires recording regulatory assets and liabilities for certain transactions that would have been treated as expense or revenue in unregulated businesses. Future regulatory changes or changes in the competitive environment could result in WGL Holdings and Washington Gas discontinuing the application of ASC Topic 980 for some of its business and require the write-off of the portion of any regulatory asset or liability for which recovery or refund is no longer probable. If Washington Gas were required to discontinue the application of ASC Topic 980 for any of its operations, it would record a non-cash charge or credit to income for the net book value of its regulatory assets and liabilities. Other adjustments might also be required.

The current regulatory environment and Washington Gas’ specific facts and circumstances support both the continued application of FASB ASC Topic 980 for our regulatory activities and the conclusion that all of our regulatory assets and liabilities as of September 30, 2013 are recoverable or refundable through rates charged to customers.

Accounting for Income Taxes

We recognize deferred income tax assets and liabilities for all temporary differences between the financial statement basis and the tax basis of assets and liabilities, including those where regulators prohibit deferred income tax treatment for ratemaking purposes of Washington Gas. Regulatory assets or liabilities, corresponding to such additional deferred tax assets or liabilities, may be recorded to the extent recoverable from or payable to customers through the ratemaking process. Amounts applicable to income taxes due from and due to customers primarily represent differences between the book and tax basis of net utility plant in service.

Effective October 1, 2007, we adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (ASC Topic 740, Income Taxes). ASC Topic 740 clarifies the accounting for uncertain events related to income taxes recognized in financial statements. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Refer to Note 9—Income taxes of the Notes to the Consolidated Financial Statements for further discussion of income taxes.

Accounting for Contingencies

We account for contingent liabilities utilizing ASC Topic 450, Contingencies. By their nature, the amount of the contingency and the timing of a contingent event are subject to our judgment of such events and our estimates of the amounts. Actual results related to contingencies may be difficult to predict and could differ significantly from the estimates included in reported earnings. For a discussion of contingencies, see Note 13—Commitments and Contingencies of the Notes to Consolidated Financial Statements.

Accounting for Derivative and Fair Value Instruments

We enter into both physical and financial contracts for the purchase and sale of natural gas and electricity. We designate a portion of our physical contracts related to the purchase of natural gas and electricity to serve our customers as “normal purchases and normal sales” and therefore, they are not subject to the fair value accounting requirements of ASC Topic 815, Derivatives and Hedging. The financial contracts and the portion of the physical contracts that qualify as derivative instruments and are subject to the mark-to-market accounting requirements are recorded on the balance sheet at fair value. Changes in the fair value of derivative instruments recoverable or refundable to customers and therefore subject to ASC Topic 980 are recorded as regulatory assets or liabilities, while changes in the fair value of derivative instruments not affected by rate regulation are reflected in income. Washington Gas also utilizes derivative instruments that are designed to minimize the risk of interest-rate volatility associated with planned issuances of debt securities.

 

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Washington Gas Light Company

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Financial Condition and Results of Operations (continued)

 

Our judgment is required in determining the appropriate accounting treatment for our derivative instruments. This judgment involves various factors, including our ability to: (i) evaluate contracts and other activities as derivative instruments subject to the accounting guidelines of ASC Topic 815; (ii) determine whether or not our derivative instruments are recoverable from or refundable to customers in future periods and (iii) derive the estimated fair value of our derivative instruments. See Note 14— Derivative and Weather-Related Instruments for a discussion of our derivatives.

Fair value is based on actively quoted market prices when they are available. In the absence of actively quoted market prices, we seek indicative price information from external sources, including broker quotes and industry publications. If pricing information from external sources is not available, we must estimate prices based on available historical and near-term future price information and/or the use of statistical methods. These inputs are used with industry standard valuation methodologies. See Note 15— Fair Value Measurements for a discussion of our valuation methodologies.

Accounting for Pension and Other Post-Retirement Benefit Plans

Washington Gas maintains a qualified, trusteed, employee-non-contributory defined benefit pension plan (qualified pension plan) covering most active and vested former employees of Washington Gas and a separate non-funded defined benefit supplemental retirement plan (DB SERP) covering most executive officers. Washington Gas accrues the estimated benefit obligation for all of our defined benefit plans as earned by the covered employees. For the unfunded DB SERP and defined benefit restoration plan (DB Restoration), Washington Gas pays, from internal funds, the individual benefits as they are due. Beginning in 2009, the Company began closing these plans to new entrants. As of January 1, 2010, all new employees were entitled to defined contribution plans, and certain management employees receive benefits under a non-funded defined benefit restoration plan. Washington Gas also provides certain healthcare and life insurance benefits for retired employees which are accrued and funded in a trust on an actuarial basis over the work life of the retirees. The qualified pension plan, DB SERP, DB Restoration and health and post-retirement plans are collectively referred to as the “Plans.”

The measurement of the Plans’ obligations and costs is dependent on a variety of factors, such as employee demographics, the level of contributions made to the Plans, earnings on the Plans’ assets and mortality rates. The following assumptions are also critical to this measurement. These assumptions are derived on an annual basis with the assistance of a third party actuarial firm:

 

   

Discount rate,

 

   

Expected long-term return on plan assets,

 

   

Rate of compensation increase, and

 

   

Healthcare cost trend rate.

We determine the discount rate based on a bond portfolio analysis of high quality bonds (AA- as assigned by Standard & Poor’s or Aa3 as assigned by Moody’s or better) whose maturities match or exceed our expected benefit payments. We determine the expected long-term rate of return by averaging the expected earnings for the target asset portfolio. In developing the expected rate of return assumption, we evaluate an analysis of historical actual performance and long-term return projections, which gives consideration to the asset mix and anticipated length of obligation of the Plans. Historically, the expected long-term return on plan assets has been lower for the health and life benefit plan than for the qualified pension plan due to differences in the allocation of the assets in the plan trusts and the taxable status of one of the trusts. We calculate the rate of compensation increase based on salary expectations, expected inflation levels and promotional expectations. The healthcare cost trend rate is determined by working with insurance carriers, reviewing historical claims data for the health and life benefit plan, and analyzing market expectations.

 

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Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

The following table illustrates the effect of changing these actuarial assumptions, while holding all other assumptions constant:

 

Effect of Changing Critical Actuarial Assumptions
(In millions)    Pension Benefits    Health and Life Benefits
Actuarial Assumptions    Percentage-Point
Change in
Assumption
   Increase
(Decrease) in
Ending
Obligation
   Increase
(Decrease) in
Annual Cost
   Increase
(Decrease) in
Ending
Obligation
   Increase  
(Decrease) in  
Annual Cost  

Expected long-term return on plan assets

   +/– 1.00 pt.    n/a    $(6.2) / $6.2    n/a    $(3.2) / $3.2  

Discount rate

   +/– 0.25 pt.    $(24.4) / $25.7    $(2.1) / $2.2    $(14.4) / $15.3    $(1.5) / $1.6  

Rate of compensation increase

   +/– 0.25 pt.    $4.3 / $(4.2)    $1.1 / $(1.1)    n/a    n/a  

Healthcare cost trend rate

   +/– 1.00 pt.    n/a    n/a    $61.0 / $(50.2)    $11.5 / $(8.9)  

Differences between actuarial assumptions and actual plan results are deferred and amortized into cost when the accumulated differences exceed ten percent of the greater of the Projected Benefit Obligation or the market-related value of the plan assets. If necessary, the excess is amortized over the average remaining service period of active employees. At September 30, 2013, the discount rate for the pension, DB SERP and DB Restoration plans increased to 5.0%, 4.5% and 4.5%, respectively from 4.0% for the comparable period. The health and post-retirement plans discount rate also increased to 5.1% from 4.0% during the same period. The higher discount rates reflect the change in long-term interest rates primarily due to current market conditions. Refer to Note 10—Pension and Other Post-Retirement Benefit Plans of the Notes to Consolidated Financial Statements for a listing of the actuarial assumptions used and for further discussion of the accounting for the Plans.

Stock-Based Compensation

We account for our stock-based compensation in accordance with ASC Topic 718, Compensation—Stock Compensation. Under ASC Topic 718, we measure and record compensation expense for both our stock option and performance share awards based on their fair value at the date of grant. Our performance units, however, are liability awards as they settle in cash; therefore, we measure and record compensation expense for these awards based on their fair value at the end of each period until their vesting date. These annual valuations cause fluctuations in earnings that do not occur under the accounting requirements of either our stock options or performance shares.

We issued both performance shares and performance units in fiscal year 2013; however, we did not issue stock options. As of September 30, 2013, option grants from prior years are outstanding with exercise prices equal to the market value of our common stock on the date of each grant. Our stock options generally have a vesting period of three years, and expire ten years from the date of each grant.

Both our performance units and performance shares are valued using a Monte Carlo simulation model that reflects assumptions about expected market conditions. Performance units and performance shares are granted at target levels determined by the Board of Directors. Any performance units that may be earned pursuant to terms of the grant will be paid in cash and are valued at $1.00 per performance unit. Any performance shares that are earned will be paid in shares of common stock of WGL Holdings. The actual number of performance units and performance shares that may be earned varies based on the total shareholder return of WGL Holdings relative to a peer group over the three-year performance period. Median performance relative to the peer group earns performance units and performance shares at the targeted levels. The maximum that can be earned is 200% of the targeted levels and the minimum is zero.

Refer to Notes 1 and 11—Accounting Policies and Stock-Based Compensation of the Notes to Consolidated Financial Statements for a further discussion of our share-based awards.

 

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Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

WGL HOLDINGS, INC.

RESULTS OF OPERATIONS

We analyze the operating results using utility net revenues for the regulated utility segment and gross margins for the retail energy-marketing segment. Both utility net revenues and gross margins are calculated as revenues less the associated cost of energy and applicable revenue taxes. We believe utility net revenues is a better measure to analyze profitability than gross operating revenues because the cost of the natural gas commodity and revenue taxes are generally included in the rates that Washington Gas charges to customers, as reflected in operating revenues. Accordingly, changes in the cost of gas and revenue taxes associated with sales made to customers generally have no direct effect on utility net revenues, operating income or net income. We consider gross margins to be a better reflection of profitability than gross revenues or gross energy costs for our retail energy-marketing segment because gross margins are a direct measure of the success of our core strategy for the sale of natural gas and electricity.

Neither utility net revenues nor gross margins should be considered as an alternative to, or a more meaningful indicator of our operating performance, than net income. Our measures of utility net revenues and retail energy-marketing gross margins may not be comparable to similarly titled measures of other companies. Refer to the sections entitled “Results of Operations—Regulated Utility Operating Results” and “Results of Operations—Non-Utility Operating Results” for the calculation of utility net revenues and gross margins, respectively, as well as a reconciliation to operating income and net income for both segments.

Summary Results

WGL Holdings reported net income of $80.3 million, $139.8 million and $117.1 million for the fiscal years ended September 30, 2013, 2012 and 2011, respectively. We earned a return on average common equity of 6.3%, 11.3% and 9.9%, respectively, during each of these three fiscal years.

The following table summarizes our net income (loss) by operating segment for fiscal years ended September 30, 2013, 2012 and 2011.

 

        Net Income (Loss) by Operating Segment  
      Years Ended September 30,     Increase (Decrease)  
(In millions)    2013     2012     2011    

2013

vs. 2012

   

2012

vs. 2011

 

Regulated utility

   $     71.8     $ 109.7     $ 69.2     $ (37.9   $ 40.5  

Non-utility operations:

          

Retail energy-marketing

     33.0       39.3       49.0       (6.3     (9.7

Commercial energy systems

     3.0       2.4       (0.5               0.6       2.9  

Midstream energy services

     (18.8     (9.1     2.2       (9.7     (11.3

Other activities

     (7.9     (2.5     (2.8     (5.4     0.3  

Total non-utility

   $ 9.3     $ 30.1     $ 47.9     $ (20.8   $ (17.8

Intersegment Eliminations

   $ (0.8   $ -     $ -     $ (0.8   $ -  

Net income

   $ 80.3     $     139.8     $     117.1     $ (59.5   $           22.7  

Earnings per average common share

          

Basic

   $ 1.55     $ 2.71     $ 2.29     $ (1.16   $ 0.42  

Diluted

   $ 1.55     $ 2.71     $ 2.28     $ (1.16   $ 0.43  

 

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Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

Regulated Utility Operating Results

The following table summarizes the regulated utility segment’s operating results for fiscal years ended September 30, 2013, 2012 and 2011.

 

Regulated Utility Operating Results           
       Years Ended September 30,      Increase (Decrease)  
(In millions)    2013     2012      2011     

2013

vs. 2012

   

2012

vs. 2011

 

Utility net revenues:

            

Operating revenues

   $     1,200.4     $     1,137.7      $     1,288.5      $             62.7     $ (150.8

Less: Cost of gas

     521.5       421.5        619.6        100.0       (198.1

Revenue taxes

     81.4       74.2        83.7        7.2       (9.5

Total utility net revenues

     597.5       642.0        585.2        (44.5     56.8  

Operation and maintenance

     292.2       279.3        277.5        12.9       1.8  

Depreciation and amortization

     100.4       95.0        90.3        5.4       4.7  

General taxes and other assessments

     52.3       50.8        52.6        1.5       (1.8

Operating income

     152.6       216.9        164.8        (64.3     52.1  

Other income (expenses)-net, including preferred stock dividends

     (0.3     1.2        1.3        (1.5     (0.1

Interest expense

     35.6       36.1        40.5        (0.5     (4.4

Income Tax Expense

     44.9       72.3        56.4        (27.4     15.9  

Net income

   $ 71.8     $ 109.7      $ 69.2      $ (37.9   $ 40.5  

Fiscal Year 2013 vs. Fiscal Year 2012.  The $37.9 million decrease in net income primarily reflects:

 

   

$61.3 million decrease in unrealized margins associated with our asset optimization program;

   

$11.5 million increase in employee incentives and benefits primarily due to a decrease in the discount rate;

   

$5.3 million of recoveries in 2012 (adjusted by recoveries this year) associated with a loss previously recognized in 2011 for refunds to customers ordered by the PSC of MD related to a cash settlement of gas imbalance with competitive service providers; and

   

$4.7 million in higher depreciation expense due to the growth in investment in utility plant.

Partially offsetting these unfavorable variances were:

 

   

$3.4 million in higher net revenues attributed to the warm weather impacts of 2012 that were in excess of our weather protection provisions;

   

$3.5 million in higher revenues due to the timing of rate relief in Maryland and the District of Columbia;

   

$3.4 million increase in revenues related to the growth in average active customer meters;

   

$2.6 million in favorable effects of changes in natural gas consumption patterns in the District of Columbia;

   

$2.4 million in lower environmental expense primarily due to net insurance proceeds;

   

$2.3 million in lower bad debt expense due to a reduction in customer delinquencies and charge-offs; and

   

$1.4 million in lower income taxes due to a decrease in the effective tax rate primarily driven by the write-off in 2012 of regulatory assets related to the tax effects of Medicare Part D.

Fiscal Year 2012 vs. Fiscal Year 2011. The $40.5 million increase in net income primarily reflects:

 

   

$29.1 million increase in unrealized margins associated with our asset optimization program;

   

$28.3 million in higher revenues due to the implementation of new rates in Maryland and Virginia;

   

$5.3 million estimated loss related to the probable refund to customers recorded in 2011 compared to the probable recovery of approximately $3.8 million of such losses recorded in 2012 in connection with an order by the PSC of MD related to a cash settlement of gas imbalances with competitive service providers;

   

$4.4 million in lower interest expense related to both lower interest rates and decreased borrowing levels;

 

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Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

   

$4.0 million increase in revenues related to the growth of more than 8,900 average customer meters; and

   

$1.9 decrease in the effective tax rate, including write-offs of regulatory assets related to the tax effect of Medicare Part D.

Partially offsetting these favorable variances were:

 

   

$5.0 million impairment of the old operations center;

   

$4.7 million in higher depreciation expense due to the growth in investment in utility plant;

   

$6.0 million in higher compensation and benefit costs; and

   

$2.7 million in lower realized margins associated with our asset optimization program, including the favorable impact of a commission decision in Maryland in the asset optimization case in 2012.

Utility Net Revenues. The following table provides the key factors contributing to the changes in the utility net revenues of the regulated utility segment between years.

 

Composition of Changes in Utility Net Revenues  
      Increase (Decrease)  
(In millions)   

2013    

vs. 2012    

   

2012    

vs. 2011   

 

Customer growth

   $ 3.4       $ 4.0     

Estimated weather effects

     9.5       (12.2)     

Natural gas consumption patterns

     2.6       -     

Impact of rate cases

     3.5       28.3     

Accelerated pipe replacement programs

     3.5       0.7     

Asset optimization:

    

Realized margins

     (0.5     (1.2)     

Unrealized mark-to-market valuations

     (61.3     29.1     

Lower-of-cost or market adjustment

     0.3       (1.5)     

Storage carrying costs

     (2.3     (0.5)     

Competitive service provider imbalance cash settlement

     (5.3     10.7     

Other

     2.1       (0.6)     

Total

   $ (44.5     $ 56.8     

Customer growth — Average active customer meters increased by more than 10,900 from fiscal year 2012 to 2013. Average active customer meters increased by more than 8,900 from fiscal year 2011 to 2012.

Estimated weather effects — Weather, when measured by HDDs, was 0.2% warmer than normal during the year ended September 30, 2013, 20.1% warmer than normal during the year ended September 30, 2012, and 6.1% colder than normal during the year ended September 30, 2011. Washington Gas has a weather protection strategy that is designed to neutralize the estimated financial effects of variations from normal weather on net income (refer to the section entitled “Weather Risk” for further discussion of our weather protection strategy). Washington Gas executed heating degree day derivative contracts to manage its exposure to variations from normal weather in the District of Columbia. Changes in the fair value of this derivative are reflected in operation and maintenance expenses and offset the benefits reflected above. There were no material effects on net income attributed to colder or warmer weather for the years ended September 30, 2013 or 2011. Due to the extremely warm weather, our weather protection instruments were not sufficient to offset approximately $3.4 million of the reduction in revenue for the year ended September 30, 2012.

Natural Gas consumption patterns — The variance in net revenues reflects the changes in natural gas consumption patterns in the District of Columbia. These changes may be affected by shifts in weather patterns in which customer heating usage may not correlate highly with average historical levels of usage per HDD. Natural gas consumption patterns may also be affected by non-weather related factors such as customer conservation.

Impact of rate cases — The year over year variance for 2013 and 2012 reflects new base rates that were approved in the District of Columbia, effective June 4, 2013. The year over year variance for 2012 and 2011 reflects new base rates that were approved in Maryland, effective November 14, 2011 and in Virginia, effective October 1, 2011.

 

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Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

Accelerated pipe replacement programs — Revenues increased related to the return on investment and recovery of costs associated with an accelerated pipeline replacement program in Virginia and a targeted mechanically coupled pipe replacement and encapsulation program in the District of Columbia.

Asset optimization — We recorded a net unrealized loss associated with our energy-related derivatives of $45.4 million for the fiscal year ended September 30, 2013, a net unrealized gain of $15.9 million for the fiscal year ended September 30, 2012 and a net unrealized loss of $13.2 million for the year ended September 30, 2011. When these derivatives settle, any unrealized amounts will ultimately reverse and Washington Gas will realize margins in combination with related transactions that these derivatives economically hedge. Washington Gas recorded no lower-of-cost or market adjustments related to its storage gas inventory during the fiscal year ended September 30, 2013. For the fiscal years ended September 30, 2012 and 2011, Washington Gas recorded lower-of-cost or market adjustments, after the effects of regulatory sharing, of $1.5 million, and $0.3 million, respectively. Refer to the section entitled “Market Risk—Price Risk Related to the Regulated Utility Segment” for further discussion of our asset optimization program.

Storage Carrying Costs — Each jurisdiction provides for the recovery of carrying costs based on the cost of capital in each jurisdiction, multiplied by the monthly average balance of storage gas inventory. The year over year comparisons reflect lower average storage gas inventory investment balances primarily due to lower weighted average cost of gas in inventory.

Competitive Service Provider imbalance cash settlement — In September 2011, the PSC of MD ordered Washington Gas to refund to customers an amount associated with a cash settlement of gas imbalances with competitive service providers. The order remanded the matter to a hearing examiner to determine the amount of the refund as the difference between charges made to customers and the charges that would have been incurred had the imbalances been made up through volumetric adjustments. An estimated loss was recorded in fiscal year 2011 of $5.3 million to reflect the probable refund to customers. In 2012, based on Washington Gas’ decision to seek recovery from third party marketers, $4.8 million was recognized as a receivable, resulting in a favorable year-over-year variance of $10.7 million. For 2013, there is no cost associated with this settlement, resulting in an unfavorable year-over-year variance of $5.3 million.

Operation and Maintenance Expenses. The following table provides the key factors contributing to the changes in operation and maintenance expenses of the regulated utility segment between years.

 

        Composition of Changes in Operation and Maintenance Expenses  
            Increase/(Decrease)  
(In millions)     2013 vs. 2012      2012 vs. 2011     

Employee benefits

   $ 9.3                  $ 2.3          

BPO regulatory asset amortization/impairment

     -                  (8.9)          

Impairment loss

     (1.5)                  5.0          

Weather-related instruments:

     

Benefit/(loss)

     6.1                  (8.9)          

Premium costs and fair value effects

     1.1                  (2.4)          

Labor and incentive plans

     5.0                  3.7          

Hexane Costs

     -                  1.8          

Net insurance proceeds

     (2.4)                  -          

Bad debt expense

     (2.3)                  (0.2)          

Support services and other IT infrastructure projects

     -                  1.7          

Operations, engineering, compliance and safety

     (0.8)                  4.7          

Other

     (1.6)                  3.0          

Total

   $ 12.9                $ 1.8           

Employee benefits — The increase in employee benefits expense for both year over year comparisons reflects higher pension and other post-retirement benefits due to changes in the discount rate and other plan assumptions used to measure the benefit obligation.

BPO regulatory asset amortization/impairment — The year-over-year comparison of fiscal year 2012 to 2011 reflects expenses in 2011 that were not incurred in 2012, including the final year of amortization in Virginia and the write-off of the $5.5 million regulatory asset in Maryland.

 

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Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

Impairment loss — During fiscal year 2013, Washington Gas recorded a $2.6 million impairment loss on a previous operations facility by reducing the carrying amount of $24.9 million down to its fair value of $22.3 million and a $0.5 million impairment loss for the unrecoverable portion of the Chillum LNG storage facility. In 2012, Washington Gas incurred a $5.0 million impairment loss on the previous operations facility by reducing the carrying amount of $29.9 million down to its fair value of $24.9 million. There were no impairment indicators identified for the year ended September 30, 2011.

Weather-related instrument benefits/losses — The effects of hedging variations from normal weather in the District of Columbia for fiscal years 2013, 2012, and 2011 are recorded to operation and maintenance expense. During fiscal year 2013, Washington Gas recorded gains of $0.3 million (pre-tax) related to its weather-related instruments as a result of warmer-than-normal weather and received a benefit of $0.7 million for premiums on its weather-related instruments. During fiscal year 2012, Washington Gas recorded gains of $6.3 million (pre-tax) related to its weather-related instruments as a result of warmer-than-normal weather and received a benefit of $0.8 million for premiums on its weather-related instruments. During fiscal year 2011, Washington Gas recorded losses of $3.1 million (pre-tax) related to its weather-related instruments as a result of colder-than-normal weather and received a benefit of $0.3 million for premiums on its weather-related instruments. The benefits or losses of the weather-related instruments are offset by the effect of weather on utility net revenues.

Labor and incentive plans — The increase in expense for year over year comparisons is primarily due to higher direct labor costs driven by general wage increases.

Hexane costs — The increase in expense in fiscal year 2012 compared to 2011 reflects the expiration of the recovery mechanisms for hexane as a result of the Virginia rate case. All hexane costs allocated to Virginia were deferred in 2011 as a regulatory asset under the regulatory mechanism that was in existence at the time. The increase in expense in fiscal year 2012 compared to 2011 reflects the expiration of the recovery mechanisms for hexane as a result of the Virginia rate case. All hexane costs allocated to Virginia were deferred in 2011 as a regulatory asset under the regulatory mechanism that was in existence at the time.

Net insurance proceeds — In 2013, Washington Gas received proceeds from an environmental insurance policy for past and future claims, partially offset by costs associated with environmental claims and regulatory sharing.

Bad debt expense — The decrease in expense in fiscal year 2013 compared to 2012 and 2012 to 2011 reflects a reduction in customer delinquencies and charge-offs.

Support services and other information technology infrastructure projects — The increase 2012 compared to 2011 reflects higher project expenses primarily attributable to system upgrades.

Operations, engineering, compliance and safety — The decrease in expense in fiscal year 2013 compared to 2012 reflects a reduction in paying costs. The increase 2012 compared to 2011 reflects the cost of multiple workforce planning initiatives and higher expenses related to system safety programs.

Depreciation and Amortization.  The following table provides the key factors contributing to the changes in depreciation and amortization of the regulated utility segment between years.

 

Composition of Changes in Depreciation and Amortization  
      Increase (Decrease)          
(In millions)    2013 vs. 2012         2012 vs. 2011      

Property, plant and equipment

       $     4.7                   $  8.4             

Amortization reversal

     (1.3)                -             

New depreciation rates—District of Columbia

     (0.3)                -             

New depreciation rates—Virginia

     -                 (1.4)            

Retroactive depreciation adjustment—Virginia

     2.3                 (2.3)            

Total

       $ 5.4                   $     4.7             

New depreciation rates—The increase in depreciation expense for fiscal year ended 2013 compared to 2012 and 2012 compared to 2011 is primarily attributed to the growth in our investment in utility plant. New District of Columbia depreciation rates were effective June 4, 2013 resulting in a $0.3 million reduction in rates during fiscal year 2013. New Virginia depreciation rates were computed retroactive to January 1, 2010 and resulted in a $2.3 million reduction in rates during fiscal year 2012.

 

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Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

Retail Energy-Marketing

Our retail energy-marketing subsidiary, WGEServices, was established in 1997 and sells natural gas and electricity on an unregulated, competitive basis directly to residential, commercial and industrial customers. The following table depicts the retail energy-marketing segment’s operating results along with selected statistical data.

 

Retail-Energy Marketing Financial and Statistical Data  

 

 
     Years Ended September 30,      Increase (Decrease)  

 

 
       2013       2012        2011      2013  
vs. 2012  
    2012          
vs. 2011     
 

 

 

Operating Results (In millions)

            

Gross margins:

            

Operating revenues

   $     1,279.3     $     1,267.1      $     1,443.2      $ 12.2     $ (176.1)   

Less: Cost of energy

     1,164.8       1,139.2        1,300.9        25.6       (161.7)   

Revenue taxes

     6.8       5.8        5.6        1.0       0.2   

 

 

Total gross margins

     107.7       122.1        136.7        (14.4     (14.6)   

Operation expenses

     49.6       52.2        52.0        (2.6     0.2   

Depreciation and amortization

     0.7       0.7        0.7        -        

General taxes and other assessments—other

     4.4       4.0        4.2        0.4       (0.2)   

 

 

Operating income

     53.0       65.2        79.8        (12.2     (14.6)   

Other income (expenses)-net

     0.2       -        -        0.2        

Income tax expense

     20.2       25.9        30.8        (5.7     (4.9)   

 

 

Net income

   $ 33.0     $ 39.3      $ 49.0      $ (6.3   $ (9.7)   

 

 

Analysis of gross margins (In millions)

            

Natural gas

            

Realized margins

   $ 44.1     $ 34.9      $ 44.1      $ 9.2     $ (9.2)   

Unrealized mark-to-market gains (losses)

     (1.7     6.9        5.5        (8.6     1.4   

 

 

Total gross margins—natural gas

     42.4       41.8        49.6        0.6       (7.8)   

 

 

Electricity

            

Realized margins

   $ 58.6     $ 78.8      $ 68.0      $ (20.2   $ 10.8   

Unrealized mark-to-market gains (losses)

     6.7       1.5        19.1        5.2       (17.6)   

 

 

Total gross margins—electricity

     65.3       80.3        87.1        (15.0     (6.8)   

 

 

Total gross margins

   $ 107.7     $ 122.1      $ 136.7      $ (14.4   $ (14.6)   

 

 

Other Retail-Energy Marketing Statistics

            

Natural gas

            

Therm sales (millions of therms)

     702.5       610.4        678.4        92.1       (68.0)   

Number of customers (end of period)

     167,900       177,500        172,200        (9,600     5,300   

Electricity

            

Electricity sales (millions of kWhs)

     12,133.0       11,794.9        10,793.1              338.1             1,001.8   

Number of accounts (end of period)

     179,900       194,300        182,500        (14,400     11,800   

 

 

Fiscal Year 2013 vs. Fiscal Year 2012.  The retail energy-marketing segment reported net income of $33.0 million for the fiscal year 2013 compared to net income of $39.3 million reported for fiscal year 2012. This comparison primarily reflects lower gross margins from the sale of electricity.

Gross margins from natural gas sales increased $0.6 million in fiscal year 2013 from the prior year. This increase reflects $8.6 million in lower unrealized mark-to-market margins on energy-related derivatives resulting from fluctuating market prices and higher realized margins of $9.2 million due to higher retail sales volumes resulting from colder weather compared to fiscal year 2012 and increased margins on portfolio optimization activities.

Gross margins from electric sales decreased $15.0 million in fiscal year 2013 over the prior year. This decrease reflects $5.2 million in higher unrealized mark-to-market margins on energy-related derivatives from fluctuating market prices offset by a $20.2 million decrease in realized margins due to the timing differences in margin recognition as well as higher load servicing costs associated with fixed price contracts.

 

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Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

Fiscal Year 2012 vs. Fiscal Year 2011.  The retail energy-marketing segment reported net income of $39.3 million for the fiscal year 2012 compared to net income of $49.0 million reported for fiscal year 2011. This reduction primarily reflects lower gross margins from the sale of natural gas and electricity.

Gross margins from natural gas sales decreased $7.8 million in fiscal year 2012 from the prior year. This decrease reflects a $1.4 million increase in unrealized mark-to-market margins on energy-related derivatives resulting from fluctuating market prices and a decrease in realized margins of $9.2 million due to lower retail sales volumes resulting from warm weather and lower unit margins on portfolio optimization activities compared to fiscal year 2011.

Gross margins from electric sales decreased $6.8 million in fiscal year 2012 over the prior year. This decrease reflects a $17.6 million change in unrealized mark-to-market margins on energy-related derivatives from fluctuating market prices and a $10.8 million increase in realized margins due to higher electric sales volumes associated with customer growth and favorable weather and pricing on electricity supply.

Commercial Energy Systems

The commercial energy systems segment reported net income of $3.0 million and $2.4 million in fiscal years 2013 and 2012, respectively and a net loss of $0.5 million in fiscal year 2011. The year-over-year variances for all years are primarily due to increased returns from additional investments in commercial and residential solar assets partially offset by continued weakness in the federal energy efficiency contracting business.

Midstream Energy Services

Midstream Energy Services reported a net loss of $18.8 million for 2013, a net loss of $9.1 million for 2012 and net income of $2.2 million for 2011. The variance between 2013 and 2012 is driven by organizational costs incurred for the Constitution Pipeline Project, unrealized losses from long-term purchase contracts, continued compression of storage spreads and higher operation and maintenance expense as a result of new storage and optimization arrangements. The variance between 2012 and 2011 reflects low storage and transportation spreads due to warm weather, which negatively affected optimization opportunities, resulting in lower realized earnings and a reduction in the carrying value of the storage inventory. In addition, operation and maintenance expense was higher as a result of investments in new storage and optimization arrangements, as well as costs incurred for the Commonwealth Pipeline project.

Other Non-Utility Activities

As previously discussed, transactions that are not significant enough on a stand-alone basis to warrant treatment as an operating segment, and that do not fit into one of our four operating segments, are aggregated as “Other Activities” and included as part of non-utility operations. Results for our other non-utility activities reflect net losses of $7.9 million, $2.5 million and $2.8 million for fiscal years 2013, 2012, and 2011, respectively. The increase for 2013 over 2012 reflects our corporate branding initiative costs and an increase in our on-going business development activities.

Intersegment Eliminations

Intersegment Eliminations represents a timing difference between Commercial Energy Systems’ recognition of revenue for the sale of SRECs to Retail Energy-Marketing and Retail Energy-Marketing’s recognition of the associated expense. Retail Energy-Marketing has recorded a portion of the SREC’s purchased as inventory to be used in future periods and will expense them at that time.

LIQUIDITY AND CAPITAL RESOURCES

General Factors Affecting Liquidity

Access to short-term debt markets is necessary for maintaining satisfactory liquidity to operate our businesses on a near-term basis. Our most significant short-term financing requirements include the acquisition of natural gas, electricity and pipeline capacity, and the need to finance accounts receivable and storage gas inventory. The need for long-term capital is driven primarily by capital expenditures and maturities of long-term debt.

Our ability to obtain adequate and cost effective financing depends on our credit ratings, the liquidity of financial markets, and investor demand for our securities. Our credit ratings depend largely on the financial performance of our subsidiaries, and a downgrade in our current credit ratings could require us to post additional collateral with our wholesale counterparties and could adversely affect both our borrowing costs and our access to sources of liquidity and capital. Also potentially affecting access to short-term debt capital are any restrictions that might be placed upon us, such as ratings

 

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Washington Gas Light Company

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Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

triggers or requirements to provide creditors with additional support in the event of a determination of insufficient creditworthiness. During fiscal year 2013, WGL Holdings met its liquidity and capital needs through the retention of earnings and the issuance of commercial paper and common stock. Washington Gas met its liquidity and capital needs through the retention of operating cash flow and the issuance of commercial paper. Both WGL Holdings and Washington Gas believe that they will be able to meet their liquidity and capital needs through fiscal year 2014 through a mixture of operating cash flow, issuances of commercial paper, and in the case of Washington Gas, issuance of MTNs.

We have a goal to maintain our common equity ratio in the mid-50% range of total consolidated capital. The level of this ratio varies during the fiscal year due to the seasonal nature of our business. This seasonality is also evident in the variability of our short-term debt balances, which are typically higher in the fall and winter months and substantially lower in the spring when a significant portion of our current assets are converted into cash at the end of the heating season. Accomplishing this capital structure objective and maintaining sufficient cash flow are necessary to maintain attractive credit ratings for WGL Holdings and Washington Gas, and to allow access to capital at reasonable costs.

As of September 30, 2013, total consolidated capitalization, including current maturities of long-term debt and excluding notes payable, comprised 67.3% common equity, 1.5% preferred stock and 31.2% long-term debt. Our cash flow requirements and our ability to provide satisfactory resources to meet those requirements are primarily influenced by the activities of Washington Gas and WGEServices along with our increasing other non-utility investments in renewable energy and pipeline projects.

Our plans provide for sufficient liquidity to satisfy our financial obligations. As of September 30, 2013, we had no restrictions on our cash balances or retained earnings that would affect the payment of common or preferred stock dividends by either WGL Holdings or Washington Gas.

Short-Term Cash Requirements and Related Financing

Washington Gas’ business is weather sensitive and seasonal, causing short-term cash requirements to vary significantly during the year. Approximately 77% of the total therms delivered in Washington Gas’ service area (excluding deliveries to two electric generation facilities) occur during the first and second fiscal quarters. Accordingly, Washington Gas typically earns more net income in the first six months of the fiscal year than it does for the entire fiscal year. During the first six months of our fiscal year, Washington Gas’ large sales volumes cause its cash requirements to peak when combined storage inventory, accounts receivable, and unbilled revenues are at their highest levels. During the last six months of our fiscal year, after the heating season, Washington Gas will typically experience a seasonal net loss due to reduced demand for natural gas. During this period, many of Washington Gas’ assets are converted into cash, which Washington Gas generally uses to reduce and sometimes eliminate short-term debt and to acquire storage gas for the next heating season.

Washington Gas, WGEServices and WGL Midstream have seasonal short-term cash requirements to fund the purchase of storage gas inventory in advance of the winter heating periods when a large portion of the storage gas is sold. As of September 30, 2013 and 2012, Washington Gas had balances in gas storage of $132.2 million and $114.5 million, respectively, WGEServices had balances in gas storage of $49.1 million and $46.8 million, respectively, and WGL Midstream had balances in gas storage of $166.0 million and $122.9 million, respectively. Washington Gas collects the cost of gas under cost recovery mechanisms approved by its regulators. WGEServices collects revenues that are designed to reimburse commodity costs used to supply their retail customer and wholesale counterparty contracts. WGL Midstream collects revenues that are designed to reimburse commodity costs used to supply wholesale counterparties. Variations in the timing of cash receipts from customers under these collection methods can significantly affect short-term cash requirements. In addition, Washington Gas and WGEServices pay their respective commodity suppliers before collecting the accounts receivable balances resulting from these sales. WGEServices and WGL Midstream derive their funding from short-term debt issued by WGL Holdings. Additionally, Washington Gas, WGEServices and WGL Midstream may be required to post cash collateral for certain purchases. WGEServices and WGL Midstream may be required to provide parent guarantees from WGL Holdings for certain transactions.

Variations in the timing of collections of gas costs under its recovery mechanisms can significantly affect short-term cash requirements for Washington Gas. At September 30, 2013 and 2012, Washington Gas had $0.6 million net over-collections and $11.7 million net under-collections of gas costs, respectively, reflected in current assets/liabilities as gas costs due from/to customers. Most of the fiscal year 2013 balance will be refunded to customers in fiscal year 2014. Amounts under-collected or over-collected that are generated during the current gas cost recovery cycle are deferred as a regulatory asset or liability on the balance sheet until September 1st of each year, at which time the accumulated amount is transferred to gas costs due from/to customers as appropriate. At September 30, 2013 and 2012 Washington Gas had a net regulatory asset of $13.8 million and $20.2 million, respectively, related to the current gas recovery cycle.

WGL Holdings and Washington Gas use short-term debt in the form of commercial paper or unsecured short-term bank loans to fund seasonal cash requirements. Our policy is to maintain back-up bank credit facilities in an amount equal to or greater than our expected maximum commercial paper position. Bank credit balances available to WGL Holdings and Washington Gas net of commercial paper balances were $201.4 million and $225.5 million at September 30, 2013 and

 

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Washington Gas Light Company

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Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

$301.1 million and $251.2 million at September 30, 2012, respectively. The credit facility for WGL Holdings permits it to borrow up to $450.0 million, and further permits, with the banks’ approval, additional borrowings of $100.0 million for a maximum potential total of $550.0 million. The credit facility for Washington Gas permits it to borrow up to $350.0 million, and further permits, with the banks’ approval, additional borrowings of $100.0 million for a maximum potential total of $450.0 million. The interest rate on loans made under each of the credit facilities are a fluctuating rate per annum that are set using certain parameters at the time each loan is made. These credit agreements provide for a term of five years and expire on April 3, 2017. The credit agreements each have two one-year extension options. Refer to Note 5—Long-Term Debt of the Notes to the Consolidated Financial Statements for further information.

To manage credit risk, Washington Gas, WGEServices and WGL Midstream may require deposits from certain customers and suppliers, which are reported as current liabilities in “Customer deposits and advance payments” in the accompanying balance sheet. At September 30, 2013 and 2012, these amounts totaled $67.2 million and $89.3 million, respectively. Both balances consist primarily of customer deposits for Washington Gas.

For Washington Gas, deposits from customers may be refunded to the depositor-customer at various times throughout the year based on the customer’s payment habits. At the same time, other customers make new deposits that cause the balance of customer deposits to remain relatively steady. There are no restrictions on Washington Gas’ use of these customer deposits. Washington Gas pays interest to its customers on these deposits in accordance with the requirements of its regulatory commissions.

For WGEServices and WGL Midstream, deposits typically represent collateral for transactions with wholesale counterparties. These deposits may be required to be repaid or increased at any time based on the current value of WGEServices’ or WGL Midstream’s net position with the counterparty. Currently there are no restrictions on the use of deposited funds and interest is paid to the counterparty on these deposits in accordance with its contractual obligations. Refer to the section entitled “Credit Risk” for further discussion of our management of credit risk.

Money Pool

WGL Holdings has money pool arrangements with and among its non-utility subsidiaries to coordinate and provide for certain short term cash and working capital requirements. This money pool also accumulates cash from the periodic issuance of WGL Holdings’ common stock from the company’s dividend reinvestment program and stock based compensation programs as well as the operations of certain unregulated subsidiaries. In return, the money pool provides short-term loans to other unregulated subsidiaries to meet various working capital needs. Washington Gas does not participate in the money pool.

Long-Term Cash Requirements and Related Financing

The primary drivers of our long-term cash requirements include capital expenditures, long-term debt maturities and decisions to refinance long-term debt. Our capital expenditures primarily relate to adding new utility customers and system supply as well as maintaining the safety and reliability of Washington Gas’ distribution system (refer to the section entitled “Capital Expenditures” below).

At September 30, 2013, Washington Gas had the capacity under a shelf registration to issue up to $450.0 million of additional Medium Term Notes (MTNs). Washington Gas has authority from its regulators to issue other forms of debt, including private placements. The following describes long-term debt issuance activity during fiscal year 2013 and 2012.

Fiscal Year 2013 MTN Activity.  There were no MTN or private placement issuances or retirements for the year ended September 30, 2013.

Fiscal Year 2012 MTN Activity.  On June 19, 2012, Washington Gas retired $25.0 million of 5.90% MTNs. On February 27, 2012, Washington Gas retired $25.0 million of 6.00% MTNs and on October 17 and 19, 2011, Washington Gas retired $7.0 million of 6.05% MTNs and $20.0 million of 6.00% MTNs, respectively.

We are exposed to interest-rate risk associated with our debt financing. Prior to issuing long-term debt, Washington Gas may utilize derivative instruments to minimize its exposure to the risk of interest-rate volatility. Refer to the section entitled “Interest-Rate Risk” for further discussion of our interest-rate risk management activity.

Security Ratings

The table below reflects the current credit ratings for the outstanding debt instruments of WGL Holdings and Washington Gas. Changes in credit ratings may affect WGL Holdings’ and Washington Gas’ cost of short-term and long-term debt and their access to the capital markets. A security rating is not a recommendation to buy, sell or hold securities.

 

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Washington Gas Light Company

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The rating may be subject to revision or withdrawal at any time by the assigning rating organization and each rating should be evaluated independently of any other rating. On October 5, 2012, Fitch Ratings lowered the commercial paper rating of Washington Gas from F1+ to F1 in adherence to changes in short-term rating criteria for non-financial corporate issuers published on August 9, 2012.

 

     WGL Holdings   Washington Gas
Rating Service  

 

Unsecured

 Medium-Term Notes 
(Indicative)
(a)

  Commercial Paper  

Unsecured

Medium-Term Notes

  Commercial Paper

Fitch Ratings(b)

  A+   F1   AA-   F1

Moody’s Investors Service(c)

  Not Rated   P-2   A2   P-1

Standard & Poor’s Ratings Services(d)

  A+   A-1   A+   A-1

(a) Indicates the ratings that may be applicable if WGL Holdings were to issue unsecured MTNs.

(b) The long-term debt ratings outlook issued by Fitch Ratings for WGL Holdings and Washington Gas is stable. On October 5, 2012, Fitch Ratings lowered the commercial paper rating of Washington Gas from F1+ to F1 in adherence to changes in short-term rating criteria for non-financial corporate issuers published on August 9, 2012.

(c) The long-term debt ratings outlook issued by Moody’s Investors Service for Washington Gas is stable.

(d) The long-term debt ratings outlook issued by Standard & Poor’s Rating Services for WGL Holdings and Washington Gas is stable.

Ratings Triggers and Certain Debt Covenants

WGL Holdings and Washington Gas pay credit facility fees, which in some cases are based on the long-term debt ratings of Washington Gas. In the event the long-term debt of Washington Gas is downgraded below certain levels, WGL Holdings and Washington Gas would be required to pay higher fees. There are five different levels of fees. The credit facility for WGL Holdings defines its applicable fee level as one level below the level applicable to Washington Gas. Under the terms of the credit facilities, the lowest level facility fee is 6.0 basis points and the highest is 17.5 basis points.

Under the terms of WGL Holdings’ and Washington Gas’ credit agreements, the ratio of consolidated financial indebtedness to consolidated total capitalization cannot exceed 0.65 to 1.0 (65.0%). In addition, WGL Holdings and Washington Gas are required to inform lenders of changes in corporate existence, financial conditions, litigation and environmental warranties that might have a material effect on debt ratings. The failure to inform the lenders’ agent of material changes in these areas might constitute default under the agreements. Additionally, failure to pay principal or interest on any other indebtedness may be deemed a default under our credit agreements. A default, if not remedied, may lead to a suspension of further loans and/or acceleration in which obligations become immediately due and payable. At September 30, 2013, we were in compliance with all of the covenants under our revolving credit facilities.

For certain of Washington Gas’ natural gas purchase and pipeline capacity agreements, if the long-term debt of Washington Gas is downgraded to or below the lower of a BBB- rating by Standard & Poor’s or a Baa3 rating by Moody’s Investors Service, or if Washington Gas is deemed by a counterparty not to be creditworthy, then the counterparty may withhold service or deliveries, or may require additional credit support. For certain other agreements, if the counterparty’s credit exposure to Washington Gas exceeds a contractually defined threshold amount, or if Washington Gas’ credit rating declines by a certain rating level, then the counterparty may require additional credit support. At September 30, 2013, Washington Gas would not be required to provide additional credit support by these arrangements if its long-term credit rating was to be downgraded by one rating level.

WGL Holdings guarantees payments for certain purchases of natural gas and electricity on behalf of WGEServices and WGL Midstream (refer to “Contractual Obligations, Off-Balance Sheet Arrangements and Other Commercial Commitments” for a further discussion of these guarantees). If the credit rating of WGL Holdings declines, WGEServices and WGL Midstream may be required to provide additional credit support for these purchase contracts. At September 30, 2013, neither WGEServices nor WGL Midstream would be required to provide additional credit support for these arrangements if the long-term credit rating of WGL Holdings was to be downgraded by one rating level.

 

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Washington Gas Light Company

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Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

Cash Flows Provided by Operating Activities

Net cash provided by operating activities reflects net income before preferred stock dividends, as adjusted for non-cash earnings and charges and changes in working capital. The primary drivers for our operating cash flows are cash payments received from natural gas and electricity customers, offset by our payments for natural gas and electricity costs, operation and maintenance expenses, taxes and interest costs.

Net cash provided by operating activities increased by $100.4 million from $217.6 million in fiscal year 2012 compared to $318.0 million for fiscal year 2013 primarily due to:

 

   

$64.0 million decrease in the change in pension and post-retirement benefit contributions.

 

   

$77.4 million decrease in the change in accounts receivable and unbilled revenues.

 

   

$50.0 million decrease in the change in gas costs (current) and other regulatory assets / liabilities - net primarily due to an increase in mark-to-market adjustments along with an increase in price.

 

   

$71.7 million increase in storage gas due to higher average inventory prices and increased inventory.

Net cash provided by operating activities totaled $217.6 million for fiscal year 2012 compared to $295.7 million in fiscal year 2011 primarily due to:

 

   

$82 million increase in pension contributions.

 

   

$65.4 million increase in accounts receivable and unbilled revenues—net primarily due to increased sales volumes associated with Washington Gas’ asset optimization program and unbilled revenue related to increased Retail Energy-Marketing sales.

 

   

$16.4 million increase in other prepayments primarily due to additional tax payments made in the fiscal year along with solar tax credits.

 

   

$84.3 million increase in accumulated deferred income taxes of which $53.1 million relates to bonus depreciation, and

 

   

$22.7 million decrease in gas costs (current and deferred) and other regulatory assets / liabilities—net primarily due to a decrease in mark-to-market adjustments. Along with a reduction in volumes purchased at lower prices in addition to a reduction in recoveries due to lower cycle sales at lower prices.

Cash Flows Provided By Financing Activities

Cash flows provided by financing activities totaled $46.3 million in fiscal year 2013 primarily due to:

 

   

$125.4 million increase in notes payable, primarily used to finance gas purchase and storage inventory costs for planned growth.

 

   

$86.1 million dividend payment on common and preferred stock.

Cash flows provided by financing activities totaled $55.2 million in fiscal year 2012 primarily due to:

 

   

$208.3 million increase in notes payable, primarily used to finance $105.1 million is related to gas purchase and storage inventory costs for planned growth and $82.0 million for pension contributions.

 

   

$77.2 million dividend payment on common and preferred stock.

 

   

The retirement of $77.0 million of MTNs.

Cash flows used in financing activities totaled $85.9 million in fiscal year 2011 primarily due to:

 

   

$61.0 million net decrease in notes payable due to lower working capital requirements driven principally by lower storage gas inventory costs and gas purchase costs.

 

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Washington Gas Light Company

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$71.9 million dividend payment on common stock partially offset by $5.0 million in cash proceeds from the issuance of common stock pursuant to our stock-based compensation plan, and

 

   

During fiscal year 2011, we retired $30.0 million of MTNs and issued $75.0 million of lower-cost MTNs (refer to the section entitled “Long-Term Cash Requirements and Related Financing”).

The following table reflects the issuances and retirements of long-term debt that occurred during fiscal years 2013, 2012 and 2011 (also refer to Note 5 —Long-Term Debt of the Notes to Consolidated Financial Statements).

 

Long-Term Debt Activity  

 

 
     2013      2012         2011    

 

 
($ In millions)    Interest Rate      Amount      Interest Rate     Amount     Interest Rate     Amount  

 

 

Medium-term notes

              

Issued

     n/a       $           -         -     $ -        5.21   $ 75.0  

Retired

     n/a         -        5.90 – 6.05     (77.0     6.64     (30.0)   

Other financing

              

Issued (a)

     n/a         -        2.77 – 3.38               6.2       4.31 – 4.53               5.7  

Retired (b)

     n/a         -        3.94     (4.2     5.57 – 7.40     (9.2)   

 

 

Total

      $ -         $ (75.0     $ 41.5  

 

 

(a) Includes the non-cash issuances of project debt financing of $6.2 million and $5.7 million for fiscal years 2012 and, 2011, respectively.

(b) Includes the non-cash extinguishments of project debt financing of $4.2 million for fiscal year 2012 and $9.2 million for 2011.

Cash Flows Used in Investing Activities

Net cash flows used in investing activities totaled $371.1 million, $266.8 million and $214.3 million during fiscal years 2013, 2012 and 2011, respectively, which primarily consists of capital expenditures made on behalf of Washington Gas and investments in commercial Solar PV facilities. Additionally during fiscal year 2013 and 2012, we invested $62.9 million and $24.6 million, respectively, in other non-utility projects.

Capital Investments

The following table depicts our actual capital investments for fiscal years 2011, 2012 and 2013, and projected capital investments for fiscal years 2014 through 2018. Our capital outlays include expenditures to extend service to new areas, and to ensure safe, reliable and improved service for our utility and to grow our non-utility investments.

 

Capital Investments  

 

 
       Actual                 Projected         

(In millions)

     2011        2012        2013         2014         2015         2016         2017         2018         Total   

 

 

New business

   $ 40.2     $ 53.5     $ 71.3       $ 81.1      $ 91.5      $ 107.7      $ 133.3      $ 122.5      $ 536.1   

Replacements

     71.2       99.2       103.9         136.0        130.4        129.7        126.7        126.7        649.5   

LNG storage facility

     0.1       0.1       -         -        -        -        -        -         

SOC redevelopment project

     49.8       27.3       0.3         -        -        -        -        -         

Customer information system

     -       -       -         18.6        27.6        28.2        5.4        -        79.8   

Other utility

     31.6       29.4       52.2         69.3        28.2        20.6        31.7        33.0        182.8   

Cash basis adjustments

     (17.1     (9.8     -         -        -        -        -        -         

 

 

Total utility(a)

     175.8       199.7       227.7         305.0        277.7        286.2        297.1        282.2        1,448.2   

 

 

Solar

     31.8       60.3       133.5         120.0        100.1        100.1        100.1        100.1        520.4   

Other

     6.7       6.8       9.9         16.8        40.2        0.6        0.6        0.7        58.9   

 

 

Total investments

   $     214.3     $     266.8     $     371.1       $     441.8      $     418.0      $     386.9      $     397.8      $     383.0      $     2,027.5   

 

 

(a) Excludes Allowance for Funds Used During Construction. Includes capital expenditures accrued and capital expenditure adjustments recorded in the fiscal year.

 

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Washington Gas Light Company

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Item 7. Management’s Discussion and Analysis of

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The 2014 to 2018 projected periods include $536.1 million for continued growth to serve new customers and $649.5 million for the replacement and betterment of existing distribution facilities, including $163.5 million of expenditures for replacement projects intended to meet the requirements of the Virginia SAVE legislation as described in an application made by Washington Gas with the Virginia Public Service Commission on August 4, 2010, $93.7 million of expenditures for a mechanically coupled pipeline encapsulation program in the District of Columbia and $165.0 million of planned expenditures under the Maryland accelerated pipe replacement program. Projected expenditures also reflect $182.8 million of other utility expenditures, which include general plant.

 

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Washington Gas Light Company

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Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

CONTRACTUAL OBLIGATIONS, OFF-BALANCE SHEET ARRANGEMENTS AND OTHER COMMERCIAL COMMITMENTS

Contractual Obligations

WGL Holdings and Washington Gas have certain contractual obligations that extend beyond fiscal year 2013. These commitments include long-term debt, lease obligations and unconditional purchase obligations for pipeline capacity, transportation and storage services, and certain natural gas and electricity commodity commitments. The estimated obligations as of September 30, 2013 for future fiscal years are shown below.

 

Estimated Contractual Obligations and Commercial Commitments  
     Years Ended September 30,  

 

 
(In millions)      Total      2014       2015       2016      2017      2018       Thereafter  

 

 

Pipeline and storage contracts(a)

   $ 2,636.1        $ 207.3      $ 210.7      $ 245.2      $ 238.0      $ 228.6      $ 1,506.3   

Medium-term notes(b)

     583.0          67.0        20.0        25.0        -        -        471.0   

Interest expense(c)

     421.1          32.7        30.9        29.2        28.8        28.8        270.7   

Gas purchase commitments

                    

   —Washington Gas(d)

     1,186.5          85.6        69.9        85.1        93.0        87.6        765.3   

   —WGEServices(e)

     251.3          162.7        66.5        19.7        2.4        -         

   —WGL Midstream(d)

     478.8          16.2        5.6        2.4        28.1        29.0        397.5   

Electric purchase commitments(f)

     623.7          391.5        180.9        48.5        2.6        0.2         

Operating leases

     25.8          5.7        5.8        4.9        4.0        3.6        1.8   

Business process outsourcing(g)

     122.1          32.9        32.5        33.1        23.6        -         

Other long-term commitments(h)

     28.5          11.7        6.1        4.9        3.7        1.8        0.3   

 

 

Total

   $     6,356.9        $     1,013.3      $     628.9      $     498.0      $     424.2      $     379.6      $     3,412.9   

 

 

(a)Represents minimum payments under natural gas transportation, storage and peaking contracts that have expiration dates through fiscal year 2029. Additionally, includes minimum payments for WGEServices and WGL Midstream pipeline contracts.

(b)Represents scheduled repayment of principal. Excludes $6.7 million in debt that is anticipated to be a non-cash extinguishment of project debt financing (refer to the section entitled “Construction Project Financing”).

(c)Represents the scheduled interest payments associated with MTNs and other long-term debt.

(d)Includes short-term commitments to purchase fixed volumes of natural gas, as well as long-term gas purchase commitments that contain fixed volume purchase requirements. Cost estimates are based on both forward market prices and option premiums for fixed volume purchases under these purchase commitments.

(e)Represents commitments based on a combination of market prices at September 30, 2013 and fixed price as well as index priced contract commitments for natural gas delivered to various city gate stations, including the cost of transportation to that point, which is bundled in the purchase price.

(f)Represents electric purchase commitments that are based on existing fixed price and fixed volume contracts. Also includes $7.2 million related to renewable energy credits.

(g)Represents fixed costs to the service provider related to the 10-year contract for business process outsourcing. These payments do not reflect potential inflationary adjustments included in the contract. Including these inflationary adjustments, required payments to the service provider could total $145.9 million over the remaining contract term.

(h)Includes Shell agreement minimum program fees, certain information technology service contracts and committed payments related to certain environmental response costs and excludes uncertain tax positions.

The table above reflects fixed and variable obligations. Certain of these estimates reflect likely purchases under various contracts, and may differ from minimum future contractual commitments disclosed in Note 13 —Commitments of the Notes to Consolidated Financial Statements.

For commitments related to Washington Gas’ pension and post-retirement benefit plans, during fiscal year 2013, Washington Gas did not contribute to its qualified pension plan but did contribute $1.8 million to its non-funded DB SERP. In addition, Washington Gas contributed $18.0 million to its health and life insurance benefit plans during fiscal year 2013. During fiscal year 2014, Washington Gas does not expect to make a contribution to its qualified pension plan but does expect to make a payment totaling $3.5 million to its non-funded DB SERP. Washington Gas expects to contribute $10.0 million to our health and life insurance benefit plans during fiscal year 2014. For a further discussion of our pension and post-retirement benefit plans, refer to Note 10—Pension and Other Post-Retirement Benefit Plans of the Notes to Consolidated Financial Statements.

 

50


Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

Construction Project Financing

To fund certain of its construction projects, Washington Gas enters into financing arrangements with third party lenders. As part of these financing arrangements, Washington Gas’ customers agree to make principal and interest payments over a period of time, typically beginning after the projects are completed. Washington Gas assigns these customer payment streams to the lender. As the lender funds the construction project, Washington Gas establishes a receivable representing its customers’ obligations to remit principal and interest and a long-term payable to the lender. When these projects are formally “accepted” by the customer as completed, Washington Gas transfers the ownership of the receivable to the lender and removes both the receivable and the long-term financing from its financial statements. As of September 30, 2013 and 2012, work on these construction projects that was not completed or accepted by customers was valued at $6.7 million and $6.2 million, respectively, which are recorded on the balance sheet as a receivable in “Deferred Charges and Other Assets—Other” with the corresponding long-term obligation to the lender in “Long-term debt.” At any time before these contracts are accepted by the customer, should there be a contract default, such as, among other things, a delay in completing the project, the lender may call on Washington Gas to fund the unpaid principal in exchange for which Washington Gas would receive the right to the stream of payments from the customer. Construction projects are financed primarily for government agencies, which Washington Gas considers to have minimal credit risk. Based on this assessment and previous collection experience, Washington Gas did not record a corresponding reserve for bad debts related to these receivables at September 30, 2013 and September 30, 2012.

Financial Guarantees

WGL Holdings guarantees payments primarily for certain purchases of natural gas and electricity on behalf of WGEServices and for certain natural gas commitments on behalf of WGL Midstream. At September 30, 2013, these guarantees totaled $305.4 million and $193.2 million for WGEServices and WGL Midstream, respectively. The amount of such guarantees is periodically adjusted to reflect changes in the level of financial exposure related to these purchase commitments. We also receive financial guarantees or other collateral from counterparties when required by our credit policy (refer to the section entitled “Credit Risk” for a further discussion of our credit policy). WGL Holdings also issued guarantees totaling $7.8 million at September 30, 2013 on behalf of certain of our non-utility subsidiaries and unconsolidated investments associated with their banking transactions. Of the total guarantees of $506.4 million, $6.0 million expired in October 2013. The remaining guarantees do not have specific maturity dates. For all of its financial guarantees, WGL Holdings may cancel any or all future obligations upon written notice to the counterparty, however, WGL Holdings would continue to be responsible for the obligations created under the guarantees prior to the effective date of the cancellation.

Effective October 1, 2011, WGL Holdings began charging fees for guarantees to its subsidiaries in an amount equal to the daily guarantee exposure multiplied by a monthly weighted average interest rate. During the years ended September 30, 2013 and 2012, the total fees charged by WGL Holdings to its subsidiaries were $0.3 million and $0.6 million, respectively. The majority of these fees were charged to WGEServices. These fees have been eliminated in the accompanying consolidated financial statements of WGL Holdings. Refer to Note 13—Commitments and Contingencies of the Notes to Consolidated Financial Statements for further discussion of our guarantees.

Chillum LNG Facility

To meet customer’s forecasted peak demand for natural gas, Washington Gas had incorporated in its plans the construction of a proposed one billion cubic foot LNG storage facility at the Chillum station on land owned by Washington Gas in Chillum, Maryland (the LNG Facility), where natural gas storage facilities previously existed. The engineering division of the PSC of MD confirmed an analysis that had been presented by Washington Gas and found the proposed LNG Facility to be safely sited.

In 2006, the District Council of Prince George’s County Maryland denied Washington Gas’ application for a special zoning exception related to its proposed construction of the LNG Facility because of the District Council’s position that newly enacted zoning restrictions prohibit such construction. Washington Gas appealed this decision to the Prince George’s County Circuit Court (the Circuit Court); however, the case was subsequently redirected to the administrative process of the District Council by the Circuit Court.

In 2008, Washington Gas filed a Complaint for Declaratory and Injunctive Relief with the United States District Court for the District of Maryland (the U.S. District Court) seeking a declaratory judgment that all local laws relating to safety and location of the facility are preempted by Federal and State law. The U.S. District Court denied Washington Gas’ motion for summary judgment. However, Washington Gas filed an amended complaint. On March 9, 2012, the U.S. District Court issued an order and memorandum opinion that denied Washington Gas’ motion for summary judgment. Washington Gas filed a notice of appeal with the U.S. Circuit Court of Appeals for the Fourth Circuit on April 3, 2012. On March 25, 2013, the United States District Court of Appeals for the Fourth Circuit upheld the U.S. District Court’s denial of motion for summary judgment. The court’s mandate went into effect April 16, 2013. No further appeals are planned at this time. Washington Gas must apply for a permit from the County to permit existing non-conforming uses.

 

51


Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

To date, Washington Gas has incurred $8.5 million of costs related to the LNG Facility. At March 31, 2013, these costs were reclassified from “Property, Plant and Equipment” to “Deferred Charges and Other Assets-Regulatory Assets, Other” in the accompanying balance sheets due to the recoverability of the regulatory asset. In a pending base rate case in Maryland, the Public Utility Law Judge issued a proposed order recommending Washington Gas be allowed to recover the Maryland jurisdiction’s share of these costs over a 10-year period with no return on the unamortized balance over the recovery period. Washington Gas recorded a $0.5 million impairment charge for the year ended September 30, 2013 to reflect the disallowance of a return on the unrecovered cost balances.

Washington Gas has contracted for sufficient natural gas supply resources to meet the growing forecasted seasonal and design demand. Washington Gas also has planned system infrastructure improvements to assure adequate capacity to fulfill its franchise obligation to provide safe, adequate and reasonably priced natural gas service to its customers.

Operating Issues Related To Changes in Natural Gas Supply

In fiscal year 2005, Washington Gas began addressing a significant increase in the number of natural gas leaks on its distribution system in a portion of Prince George’s County, Maryland. Natural gas containing a low concentration of HHCs can cause the seals in certain mechanical couplings on the Washington Gas distribution system to shrink increasing the propensity for the coupling to leak. Independent laboratory tests performed on behalf of Washington Gas have shown that, in a laboratory environment, the injection of HHCs into gas with low concentrations of HHC can be effective in offsetting the affect of the low HHC gas on the seals in couplings which increases their sealing force and, in turn, reduces the propensity for the affected couplings to leak.

To resolve the significant increase in leaks, Washington Gas replaced gas service lines and replaced or rehabilitated gas mains that contained the affected mechanical couplings in Prince George’s County. Additionally, Washington Gas constructed three facilities to inject HHCs into the gas stream entering the Washington Gas distribution system. Washington Gas continues to mitigate the impact of low HHC gas from whatever source through accelerating the replacement of mechanically coupled pipeline and the operation of three HHC injection facilities.

The current forecast for mechanical coupling remediation and replacement work in Virginia includes expenditures of $191.4 million, over a five-year period beginning on January 1, 2013. This represents Washington Gas’ Steps to Advance Virginia’s Energy Plan (SAVE Plan), which the SCC of VA initially approved on April 21, 2011, and for which the SCC of VA approved an amendment on November 15, 2012. For the District of Columbia, the forecast includes the continuation of the December 16, 2009 settlement in the District of Columbia that includes a targeted mechanically coupled pipe replacement and encapsulation program that is now estimated to cost $35.0 million and is expected to take approximately seven years to complete. Rate recovery of the expenditures has been approved by the SCC of VA and the PSC of DC.

In Washington Gas’ most recent base rate proceeding in the District of Columbia, the PSC of DC approved continuation of the rate recovery mechanism for the replacement or encapsulation of certain vintage mechanically coupled pipe at the original $28.0 million funding level. Washington Gas’ request for reconsideration of the PSC of DC’s denial of an additional $7.0 million to fund this program is pending review by the PSC of DC. Washington Gas’ request for funding of further pipe replacements under an accelerated pipe replacement program has been deferred pending review of additional filings, as directed in the PSC of DC’s May 15, 2013 opinion and order. Additionally, Washington Gas has budgeted approximately $48.0 million related to a planned five-year mechanically coupled pipe replacement program in Maryland. The accelerated pipe replacement plan in Maryland was proposed as a thirty-year program with $115.0 million to be spent during the first five years.

On May 2, 2013, Maryland Governor Martin J. O’Malley signed into law the Maryland Strategic Infrastructure Development and Enhancement Program (STRIDE). The STRIDE program allows Washington Gas to replace and reinforce its natural gas infrastructure system more rapidly. The STRIDE program provides funding for gas pipeline upgrades through a small surcharge approved by the Maryland Public Service Commission for residential, commercial and industrial customers. The program will reduce costs to utility customers through less frequent base rate cases and lower operational expenses in the future. On November 7, 2013, Washington Gas submitted an application before the PSC of Maryland requesting an approval for a five-year Rider to recover costs of the proposed eligible infrastructure replacement projects. Washington Gas proposes to modify and expand its currently authorized program by spending approximately $200 million over the next five years to expedite replacement and reinforcement of its system.

Additional operating expenses and capital expenditures may be necessary to contend with leaks caused by increased volumes of low HHC gas flowing into Washington Gas’ distribution system. Such additional operating expenses and capital expenditures may not be timely enough to mitigate the challenges posed by increased volumes of low HHC gas, potentially resulting in leakage from mechanical couplings at a rate that could compromise the safety of our distribution system.

 

52


Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

Commonwealth Pipeline

In February 2012, WGL Midstream entered into a joint development agreement with UGI Energy Services, Inc. (UGI) and Inergy Midstream, L.P. (Inergy), to jointly market and develop an interstate pipeline named the Commonwealth Pipeline. The proposed interstate pipeline would have consisted of pipeline extending south from the terminus of Inergy’s Marc I line in Lycoming County, Pennsylvania.

Although the initial response to the non-binding open season was positive, subsequent efforts to convert this response into binding commitments have not been successful. WGL Midstream has determined not to pursue the project further and is investing in other opportunities in the Marcellus region. WGL Midstream wrote off approximately $0.5 million of costs that had been capitalized associated with this project.

Constitution Pipeline

In May 2013, WGL Midstream entered into an equity investment in Constitution Pipeline Company, LLC. The pipeline project is designed to transport at least 650,000 dekatherms of natural gas per day from the Marcellus region in northern Pennsylvania to major northeastern markets. Fully contracted with long-term commitments from established natural gas producers currently operating in Pennsylvania, the pipeline will originate from the Marcellus production areas in Susquehanna County, PA., and interconnect with the Iroquois Gas Transmission and Tennessee Gas Pipeline systems in Schoharie County, N.Y.

Construction of the pipeline is expected to begin in the third quarter of 2014 and is scheduled to be in service by March 2015. An affiliate of Williams Partners will construct, operate and maintain the new 30-inch, 121-mile long transmission pipeline.

WGL Midstream will invest an estimated $68 million in the project for a 10% share in the pipeline venture. WGL Midstream joins Williams Partners L.P. (41% share), Cabot Oil and Gas Corporation (25% share) and Piedmont Natural Gas (24% share) in the project.

In June 2013, Constitution Pipeline filed a formal certificate application with Federal Energy Regulatory Commission (FERC), the federal agency charged with the regulation of interstate pipelines.

CREDIT RISK

Wholesale Credit Risk

Certain wholesale suppliers that sell natural gas to any or all of Washington Gas, WGEServices, and WGL Midstream may have relatively low credit ratings or may not be rated by major credit rating agencies.

Washington Gas enters into transactions with wholesale counterparties for the purpose of meeting firm ratepayer commitments, to optimize the value of its long-term capacity assets, and for hedging natural gas costs. In the event of a counterparty’s failure to deliver contracted volumes of gas or fulfill its payment obligations, Washington Gas may incur losses that would typically be passed through to its sales customers under the purchased gas cost adjustment mechanisms. Washington Gas may be at risk for financial loss to the extent these losses are not passed through to its customers.

For WGEServices, any failure of wholesale counterparties to deliver natural gas or electricity under existing contracts could cause financial exposure for the difference between the price at which WGEServices has contracted to buy these commodities and their replacement cost from another supplier. To the extent that WGEServices sells natural gas to these wholesale counterparties, WGEServices may be exposed to payment risk if WGEServices is in a net receivable position. Additionally, WGEServices enters into contracts with counterparties to hedge the costs of natural gas and electricity. Depending on the ability of the counterparties to fulfill their commitments, WGEServices could be at risk for financial loss.

WGL Midstream enters into transactions with wholesale counterparties to optimize its portfolio of contracted and managed natural gas assets. Any failure of wholesale counterparties to deliver natural gas under existing contracts could cause financial exposure for the difference between the price at which WGL Midstream has contracted to buy these commodities and their replacement cost. To the extent that WGL Midstream sells natural gas to these wholesale counterparties, WGL Midstream may be exposed to payment risk if it is in a net receivable position. In addition, WGL Midstream enters into contracts with counterparties to hedge the costs of natural gas. Depending on the ability of the counterparties to fulfill their commitments, WGL Midstream could be at risk for financial loss.

 

53


Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

Washington Gas, WGEServices, and WGL Midstream operate under an existing credit policy that is designed to mitigate credit risks through requirements for credit enhancements including, but not limited to, letters of credit, parent guarantees and cash collateral when deemed necessary. In accordance with this policy, Washington Gas, WGEServices, and WGL Midstream have each obtained credit enhancements from certain of their counterparties. If certain counterparties or their guarantors meet the policy’s credit worthiness criteria, Washington Gas, WGEServices, and WGL Midstream may grant unsecured credit to those counterparties or their guarantors. The credit worthiness of all counterparties is continuously monitored.

Washington Gas, WGEServices and WGL Midstream are also subject to the collateral requirements of their counterparties. At September 30, 2013, Washington Gas, WGEServices and WGL Midstream provided $3.0 million, $15.7 million and $8.1 million in cash collateral to counterparties, respectively.

The following table provides information on our credit exposure, net of collateral, to wholesale counterparties as of September 30, 2013 for Washington Gas, WGEServices and WGL Midstream, separately.

 

Credit Exposure to Wholesale Counterparties  

 

 
Rating(a)         Exposure
Before Credit
Collateral
(b)
          Offsetting Credit
Collateral Held(c)
    Net
Exposure
    Number of
Counterparties
Greater Than
10%
(d)
       

 

Net Exposure of 
Counterparties 
Greater Than 10% 

 

 

 

Washington Gas

               

Investment Grade

  $          18.4     $          -     $ 18.4     1   $          11.9   

Non-Investment Grade

      4.8         4.5       0.3     1       0.3   

No External Ratings

      3.4         -       3.4     1       3.3   

 

 

WGEServices

               

Investment Grade

  $          0.1     $          -     $ 0.1     1   $          0.1   

Non-Investment Grade

      -         -       -     -        

No External Ratings

      -         -       -     -        

 

 

WGL Midstream

               

Investment Grade

  $          10.4     $          -     $ 10.4     2   $          5.0   

Non-Investment Grade

      -         -       -     -        

No External Ratings

      2.5         -       2.5     1       2.2   

 

 

(a) Investment Grade is primarily determined using publicly available credit ratings of the counterparty. If the counter party has provided a guarantee by a higher-rated entity (e.g., its parent), it is determined based upon the rating of it guarantor. Included in “Investment Grade” are counterparties with a minimum Standard & Poor’s or Moody’s Investor Service rating of BBB- or Baa3, respectively.

(b) Includes the net of all open positions on energy-related derivatives subject to fair value accounting requirements, the net receivable/payable for realized transactions and net open positions for contracts designated as normal purchases and normal sales and not recorded on our balance sheet. Amounts due from counterparties are offset by liabilities payable to those counterparties to the extent that legally enforceable netting arrangements are in place.

(c) Represents cash deposits and letters of credit received from counterparties, not adjusted for probability of default.

(d) Using a percentage of the net exposure.

Retail Credit Risk

Washington Gas is exposed to the risk of non-payment of utility bills by certain of its customers. To manage this customer credit risk, Washington Gas may require cash deposits from its high risk customers to cover payment of their bills until the requirements for the deposit refunds are met. In addition, Washington Gas implemented a Purchase of Receivables (POR) program as approved by the PSC of MD, whereby it purchases receivables from participating energy marketers at approved discount rates. Under the program, Washington Gas is exposed to the risk of non-payment by the retail customers for these receivables. This risk is factored into the approved discount rate at which Washington Gas purchases the receivables.

WGEServices is also exposed to the risk of non-payment by its retail customers. WGEServices manages this risk by evaluating the credit quality of certain new customers as well as by monitoring collections from existing customers. To the extent necessary, WGEServices can obtain collateral from, or terminate service to, its existing customers based on credit quality criteria. In addition, WGEServices participates in POR programs with certain Maryland and Pennsylvania utilities, whereby it sells its receivables to various utilities at approved discount rates. Under the POR programs, WGEServices is exposed to the risk of non-payment by its retail customers for delivered commodities that have not yet been billed. Once the invoices are billed, however, the associated credit risk is assumed by the purchasing utilities. While participation in POR programs reduces the risk of collection and fixes a discount rate on the receivables, there is a risk that the discount rate paid to participate in the POR program will exceed the actual bad debt expense and billing fees associated with these receivables.

 

54


Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

WGSW is indirectly subject to retail credit risk associated with non-payment by customers who lease solar equipment or maintain energy service agreements through ASD Solar LP, Skyline Innovations, Inc. and EchoFirst Finance Company LLC. This credit risk is mitigated with minimum credit quality criteria established in each of WGSW’s agreements. This criteria must be satisfied for WGSW to participate in the project financing arrangement or partnership interest.

WGL Midstream is not subject to retail credit risk.

MARKET RISK

We are exposed to various forms of market risk including commodity price risk, weather risk and interest-rate risk. The following discussion describes these risks and our management of them.

Price Risk Related to the Regulated Utility Segment

Washington Gas faces price risk associated with the purchase and sale of natural gas. Washington Gas generally recovers the cost of the natural gas to serve customers through gas cost recovery mechanisms as approved in jurisdictional tariffs; therefore, a change in the price of natural gas generally has no direct effect on Washington Gas’ net income. However, Washington Gas is responsible for following competitive and reasonable practices in purchasing natural gas for its customers.

To manage price risk associated with its natural gas supply to its firm customers, Washington Gas: (i) actively manages its gas supply portfolio to balance sales and delivery obligations; (ii) injects natural gas into storage during the summer months when prices are historically lower, and withdraws that gas during the winter heating season when prices are historically higher and (iii) enters into hedging contracts and other contracts that qualify as derivative instruments related to the sale and purchase of natural gas.

Washington Gas executes commodity-related physical and financial contracts in the form of forwards, futures and option contracts as part of an asset optimization program that is managed by its internal staff. These transactions are accounted for as derivatives. Under this program, Washington Gas realizes value from its long-term natural gas transportation and storage capacity resources when not being fully used to serve utility customers. Regulatory sharing mechanisms in all three jurisdictions allow the profit from these transactions to be shared between Washington Gas’ customers and shareholders.

The following two tables summarize the changes in the fair value of our net assets (liabilities) associated with the Regulated Utility segment’s energy-related derivatives during the fiscal year ended September 30, 2013.

 

Regulated Utility Segment  
Changes in Fair Value of Energy-Related Derivatives  

 

 
(In millions)       

 

 

Net assets (liabilities) at September 30, 2012

   $     47.3   

Net fair value of contracts entered into during the period

     (92.8

Other changes in net fair value

     (68.2

Realized net settlement of derivatives

     6.0   

 

 

Net assets (liabilities) at September 30, 2013

   $ (107.7

 

 
Regulated Utility Segment  
Roll Forward of Energy-Related Derivatives  

 

 
(In millions)       

 

 

Net assets (liabilities) at September 30, 2012

   $     47.3   

Recorded to income

     (45.9

Recorded to regulatory assets/liabilities

     (115.1

Realized net settlement of derivatives

     6.0   

 

 

Net assets (liabilities) at September 30, 2013

   $ (107.7

 

 

 

55


Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

The maturity dates of our net assets (liabilities) associated with the regulated utility segment’s energy-related derivatives recorded at fair value at September 30, 2013, is summarized in the following table based on the level of the fair value calculation under ASC Topic 820:

 

Regulated Utility Segment  
Maturity of Net Assets (Liabilities) Associated with our Energy-Related Derivatives  

 

 
     Years Ended September 30,  

 

 
(In millions)    Total     2014     2015     2016     2017     2018     Thereafter    

 

 

Level 1 — Quoted prices in active markets

   $ -     $ -     $ -     $ -     $ -     $       -     $  

Level 2 — Significant other observable inputs

           25.9                 5.9             5.4             14.4             0.1       -             0.1   

Level 3 — Significant unobservable inputs

     (133.6     (23.7     (8.1     (17.4     (7.5     (7.0     (69.9)   

 

 

Total net assets (liabilities) associated with our energy-related derivatives

   $ (107.7   $ (17.8)      $ (2.7   $ (3.0   $ (7.4   $ (7.0   $ (69.8)   

 

 

Fair value changed due to the addition of long-term purchase contracts valued using unobservable inputs. Refer to Note 14, Derivative and Weather-Related Instruments and Note 15, Fair Value Measurements of the Notes to Consolidated Financial Statements for a further discussion of our derivative activities and fair value measurements.

Price Risk Related to the Non-Utility Segments

Retail Energy Marketing. Our retail energy-marketing subsidiary, WGEServices, sells natural gas and electricity to retail customers at both fixed and indexed prices. WGEServices must manage daily and seasonal demand fluctuations for these products. Price risk exists to the extent WGEServices does not closely match the timing and volume of natural gas and electricity it purchases with the related fixed price or indexed sales commitments. WGEServices’ risk management policies and procedures are designed to minimize this risk.

A portion of WGEServices’ annual natural gas sales volumes is subject to variations in customer demand associated with fluctuations in weather and other factors. Purchases of natural gas to fulfill retail sales commitments are generally made under fixed-volume contracts based on certain weather assumptions. If there is significant deviation from normal weather or other factors which affect customer usage, purchase commitments may differ significantly from actual customer usage. To the extent that WGEServices cannot match its customer requirements and supply commitments, it may be exposed to commodity price and volume variances, which could negatively impact gross margins (refer to the section entitled “Weather Risk” for a further discussion of our management of weather risk). WGEServices manages these risks through the use of derivative instruments, including financial products.

WGEServices procures electricity supply under contract structures in which WGEServices assumes the responsibility of matching its customer requirements with its supply purchases. WGEServices assembles the various components of supply, including electric energy from various suppliers, and capacity, ancillary services and transmission service from the PJM Interconnection, a regional transmission organization, to match its customer requirements in accordance with its risk management policy.

To the extent WGEServices has not sufficiently matched its customer requirements with its supply commitments or the extent to which it is exposed to price changes in services from the PJM Interconnection, it could be exposed to electricity commodity price risk. WGEServices may manage this risk through the use of derivative instruments, including financial products.

WGEServices’ electric business is also exposed to fluctuations in weather and varying customer usage. Purchases generally are made under fixed-price, fixed-volume contracts that are based on certain weather assumptions. If there are significant deviations in weather or usage from these assumptions, WGEServices may incur price and volume variances that could negatively impact gross margins (refer to the section entitled “Weather Risk” for a further discussion of our management of weather risk).

 

56


Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

The following two tables summarize the changes in the fair value of our net assets (liabilities) associated with the Retail Energy-Marketing segment’s energy-related derivatives during the fiscal year ended September 30, 2013.

 

Retail Energy-Marketing Segment

Changes in Fair Value of Energy-Related Derivatives

 

 

 
(In millions)       

 

 

Net assets (liabilities) at September 30, 2012

   $ (14.2)   

Net fair value of contracts entered into during the period

     0.2   

Other changes in net fair value

     (16.1)   

Realized net settlement of derivatives

     19.7   

 

 

Net assets (liabilities) at September 30, 2013

   $ (10.4)   

 

 

Retail Energy-Marketing Segment

Roll Forward of Energy-Related Derivatives

 

 

 
(In millions)       

 

 

Net assets (liabilities) at September 30, 2012

   $ (14.2)   

Recorded to income

     (14.7)   

Recorded to accounts payable

     (1.2)   

Net option premium payments

      

Realized net settlement of derivatives

          19.7   

 

 

Net assets (liabilities) at September 30, 2013

   $ (10.4)   

 

 

The maturity dates of our net assets (liabilities) associated with the retail energy-marketing segments’ energy-related derivatives recorded at fair value at September 30, 2013 is summarized in the following table based on the level of the fair value calculation under ASC Topic 820:

 

Retail Energy-Marketing Segment

Maturity of Net Assets (Liabilities) Associated with our Energy-Related Derivatives

 

 

 
    Years Ended September 30,  

 

 
(In millions)       Total             2014             2015             2016             2017             2018           Thereafter    

 

 

Level 1 — Quoted prices in active markets

  $ -     $ -     $ -     $ -     $ -     $ -     $  

Level 2 — Significant other observable inputs

    (15.9     (13.9     (1.9     (0.1     -       -        

Level 3 — Significant unobservable inputs

    5.5       7.0       (1.0     (0.5     -       -        

 

 

Total net assets (liabilities) associated with our energy-related derivatives

  $ (10.4   $ (6.9   $ (2.9   $ (0.6   $ -     $ -     $  

 

 

Refer to Note 14, Derivative and Weather-Related Instruments and Note 15, Fair Value Measurements of the Notes to Consolidated Financial Statements for a further discussion of our derivative activities and fair value measurements.

Midstream Energy Services. WGL Midstream engages in wholesale commodity transactions to optimize its contracted and managed natural gas assets. Price risk exists to the extent WGL Midstream does not closely match the volume of physical natural gas it purchases with the related forward sales entered into as hedges. WGL Midstream’s risk management policies and procedures are designed to minimize this risk. Depending upon the nature of its forward hedges, WGL Midstream may also be exposed to fluctuations in mark-to-market valuations based on changes in forward price curves. WGL Midstream pays fixed, fair market prices for its owned storage assets and is subject to variations in annual summer-winter spreads associated with weather and other market factors. To the extent there are significant variations in weather that effects contract seasonal storage spreads, WGL Midstream may incur price variances that negatively impact expected gross margins (refer to the section entitled “Weather Risk” for a further discussion of our management of weather risk). WGL Midstream manages this risk through the use of derivative instruments, including financial products.

 

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Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

The following two tables summarize the changes in the fair value of our net assets (liabilities) associated with the Midstream Energy Services segments’ energy-related derivatives during the fiscal year ended September 30, 2013.

 

Midstream Energy Services

Changes in Fair Value of Energy-Related Derivatives

 

 

 
(In millions)       

 

 

Net assets (liabilities) at September 30, 2012

   $ 19.7   

Net fair value of contracts entered into during the period

     (1.1)   

Other changes in net fair value

              3.5   

Realized net settlement of derivatives

     (32.6)   

 

 

Net assets (liabilities) at September 30, 2013

   $ (10.5)   

 

 

Midstream Energy Services

Roll Forward of Energy-Related Derivatives

 

 

 

(In millions)

  

 

 

Net assets (liabilities) at September 30, 2012

   $ 19.7   

Recorded to income

     2.4   

Recorded to accounts payable

      

Net option premium payments

      

Realized net settlement of derivatives

     (32.6)   

 

 

Net assets (liabilities) at September 30, 2013

   $ (10.5)   

 

 

The maturity dates of our net assets (liabilities) associated with the Midstream Energy Services segments’ energy-related derivatives recorded at fair value at September 30, 2013 is summarized in the following table based on the level of the fair value calculation under ASC Topic 820:

 

Midstream Energy Services

Maturity of Net Assets (Liabilities) Associated with our Energy-Related Derivatives

 

 

 
    Years Ended September 30,  

 

 
(In millions)       Total             2014             2015             2016             2017             2018           Thereafter   

 

 

Level 1 — Quoted prices in active markets

  $ -     $ -     $     -     $ -     $ -     $ -     $ -  

Level 2 — Significant other observable inputs

    14.2       14.2       -       -       -       -       -  

Level 3 — Significant unobservable inputs

    (24.7     -       -       (2.6     (2.6     (2.3     (17.2

 

 

Total net assets (liabilities) associated with our energy-related derivatives

  $ (10.5   $ 14.2     $ -     $ (2.6   $ (2.6   $ (2.3   $ (17.2

 

 

Other. WGSW holds project financing arrangements and a limited partnership interest associated with distributed generating solar assets for a fair market value based on an independent appraisal. The project financing arrangements allow WGSW to lease back those solar assets to the counterparty with a fixed target rate of return over a period of 6-20 years. Price risk exists through the components used to achieve the target rate of return since the components are based on market leasing prices for retail customers and cost of solar panels. Similarly, in WGSW’s limited partnership interest solar assets are purchased by and leased to retail customers through the partnership. The purchased solar assets are expected to achieve a target rate of return from the lease payments being collected from the retail customers, therefore the price risk exists between the leasing prices for solar assets and the purchase price of the solar assets. WGSW manages this price risk through its investment agreements and evaluation of the asset purchase in conjunction with the inception of the lease.

Refer to Note 14, Derivative and Weather-Related Instruments and Note 15, Fair Value Measurements of the Notes to Consolidated Financial Statements for further discussion of our derivative activities and fair value measurements.

Value-at-Risk. WGEServices measures the market risk of its energy commodity portfolio by determining its value-at-risk. Value-at-risk is an estimate of the maximum loss that can be expected at some level of probability if a portfolio is held for a given time period. The value-at-risk calculation for natural gas and electric portfolios include assumptions for normal weather, new customers and renewing customers for which supply commitments have been secured. Based on a 95% confidence interval for a one-day holding period, WGEServices’ value-at-risk at September 30, 2013 was approximately $14,900 and $36,100, related to its natural gas and electric portfolios, respectively. At September 30, 2012, WGEServices’ value-at-risk was approximately $900 and $13,900, related to its natural gas and electric portfolios, respectively. The high, low and average value-at-risk for natural gas was $74,500, $200 and $10,500, respectively. The high, low and average value-at-risk for electric was $64,500, $7,700 and $20,200, respectively.

 

58


Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

Weather Risk

We are exposed to various forms of weather risk in both our regulated utility and non-utility business segments. To the extent Washington Gas does not have weather-related instruments or billing adjustment mechanisms in place, its revenues are volume driven and its current rates are based upon an assumption of normal weather. Without weather protection strategies, variations from normal weather will cause our earnings to increase or decrease depending on the weather pattern. Washington Gas has either filed for or currently has in place weather protection strategies that are designed to neutralize the estimated financial effects of weather on its net income within a reasonable range of weather expectations, as discussed below.

The financial results of our retail energy-marketing business, WGEServices, are affected by variations from normal weather primarily in the winter relating to its natural gas sales, and throughout the fiscal year relating to its electricity sales. WGEServices manages these weather risks with, among other things, weather-related instruments.

Variations from normal weather may also affect the financial results of our midstream energy business, WGL Midstream, primarily with regards to summer - winter storage spreads and in transportation spreads throughout the fiscal year. WGL Midstream manages these weather risks with, among other things, locational, physical and financial basis hedging.

Billing Adjustment Mechanisms. In Maryland, Washington Gas has a RNA billing mechanism that is designed to stabilize the level of net revenues collected from Maryland customers by eliminating the effect of deviations in customer usage caused by variations in weather from normal levels and other factors such as conservation. In Virginia, Washington Gas has a WNA billing adjustment mechanism that is designed to eliminate the effect of variations in weather from normal levels on utility net revenues. Additionally, as part of the CARE plan, Washington Gas has a CRA mechanism, which, coupled with the WNA, eliminates the effect of both weather and other factors such as conservation for residential customers in Virginia. For a discussion of current rates and regulatory matters, refer to the section entitled “Rates and Regulatory Matters” for Washington Gas.

For the RNA, WNA, and CRA mechanisms, periods of colder-than-normal weather generally would cause Washington Gas to record a reduction to its revenues and establish a refund liability to customers, while the opposite would generally result during periods of warmer-than-normal weather. However, factors such as volatile weather patterns and customer conservation may cause the RNA and the CARE adjustment to function conversely because they adjust billed revenues to provide a designed level of net revenue per meter.

Weather-Related Instruments. On August 12, 2012, Washington Gas executed HDD weather-related contracts to manage its financial exposure to variations from normal weather in the District of Columbia for fiscal year 2013 resulting in a net premium payment to Washington Gas of $0.7 million. Under these contracts, Washington Gas purchased protections against net revenue shortfalls due to warmer-than-normal weather and sold colder-than-normal weather benefits. Because weather was warmer than normal during 2013, Washington Gas received $1.0 million (including the net premium) from its weather-related instruments. For fiscal year 2012 and 2011, Washington Gas received $7.1 million and $0.3 million, including net payments, from these derivative contracts.

On November 8, 2013, Washington Gas filed an application for approval of a Weather Normalization Adjustment (WNA) before the Public Service Commission of the District of Columbia. The proposal would authorize Washington Gas to implement a rate design mechanism that would eliminate the variability of weather from the calculation of revenues and offer customers more stability in their bills during colder than normal winter heating seasons.

WGEServices utilizes HDD instruments from time to time to manage weather risks related to its natural gas and electricity sales. WGEServices also utilizes CDD instruments and other instruments to manage weather and price risks related to its electricity sales during the summer cooling season. These instruments cover a portion of WGEServices’ estimated revenue or energy-related cost exposure to variations in HDDs or CDDs. Refer to Note 14—Derivative and Weather-Related Instruments of the Notes to Consolidated Financial Statements for further discussion of the accounting for these weather-related instruments.

 

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Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

Interest-Rate Risk

We are exposed to interest-rate risk associated with our short-term and long-term financing. Management of this risk is discussed below.

Short-Term Debt. At September 30, 2013 and 2012, WGL Holdings and its subsidiaries had outstanding notes payable of $373.1 million and $247.7 million, respectively. The carrying amount of our short-term debt approximates fair value. In fiscal year 2013, a change of 100 basis points in the underlying average interest rate for our short-term debt would have caused a change in interest expense of approximately $0.8 million.

Long-Term Debt. At September 30, 2013, we had fixed-rate MTNs and other long-term debt aggregating $524.1 million in principal amount, excluding current maturities and unamortized discounts, and having a fair value of $630.2 million. Fair value is defined as the present value of the debt securities’ future cash flows discounted at interest rates that reflect market conditions as of September 30, 2013. While these are fixed-rate instruments and, therefore, do not expose us to the risk of earnings loss due to changes in market interest rates, they are subject to changes in fair value as market interest rates change. A total of $372.5 million, or approximately 72%, of Washington Gas’ outstanding MTNs, excluding current maturities, have make-whole call options, which require us to pay a premium in addition to the face amount if these options are exercised.

Using sensitivity analyses to measure this market risk exposure, we estimate that the fair value of our long-term debt would increase by approximately $22.5 million or decrease by approximately $21.1 million if interest rates were to decline or increase by 10%, or 25 basis points, respectively, from current market levels. In general, such an increase or decrease in fair value would impact earnings and cash flows only if Washington Gas were to reacquire all or a portion of these instruments in the open market prior to their maturity.

Derivative Instruments. Washington Gas utilizes derivative instruments from time to time in order to minimize its exposure to the risk of interest-rate volatility. On July 18, 2013, Washington Gas entered into an interest-rate derivative transaction to mitigate a substantial portion of the risk of rising interest rates associated with future debt issuances. At September 30, 2013, the fair value of the interest rate derivative transaction was minimal. Refer to the section entitled “Long-Term Cash Requirements and Related Financing” for further discussion of our interest-rate risk management activity.

 

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Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

WASHINGTON GAS LIGHT COMPANY

This section of Management’s Discussion focuses on Washington Gas for the reported periods. In many cases, explanations and disclosures for both WGL Holdings and Washington Gas are substantially the same.

RESULTS OF OPERATIONS

The results of operations for the regulated utility segment and Washington Gas are substantially the same; therefore, this section primarily focuses on statistical information and other information that is not discussed in the results of operations for the regulated utility segment. Refer to the section entitled “Results of Operations—Regulated Utility” for WGL Holdings for a detailed discussion of the results of operations for the regulated utility segment.

Washington Gas’ net income applicable to its common stock was $71.0 million, $108.7 million and $68.3 million for the fiscal years ended September 30, 2013, 2012 and 2011, respectively. Net income decreased $37.7 million in fiscal year 2013 compared to fiscal year 2012 primarily due to:

 

   

a decrease in unrealized margins associated with our asset optimization program;

   

an increase in employee incentives and benefits primarily due to a decrease in the discount rate;

   

recoveries in 2012 (adjusted by recoveries this year) associated with a loss previously recognized in 2011 for refunds to customers ordered by the PSC of MD related to a cash settlement of gas imbalances with competitive service providers and

   

higher depreciation expense due to the growth in investment in utility plant.

Partially offsetting these unfavorable variances were:

 

   

higher net revenues attributed to the warm weather impacts of 2012 that were in excess of our weather protection provisions;

   

higher revenues due to the timing of rate relief in Maryland and the District of Columbia;

   

lower bad debt expense due to a reduction in customer delinquencies and charge-offs;

   

lower environmental expense due primarily to net insurance proceeds;

   

an increase in revenues related to the growth in average active customer meters;

   

favorable effects of changes in natural gas consumption patterns in the District of Columbia; and

   

lower income taxes due to a decrease in the effective tax rate driven primarily by the write-off in 2012 of regulatory assets related to the tax effects of Medicare Part D.

Net income for fiscal year 2012 income increased $40.4 million compared to fiscal year 2011 primarily due to:

 

   

an increase in unrealized margins associated with our asset optimization program;

   

higher revenues due to the implementation of new rates in Maryland and Virginia;

   

recognition in 2012 of the probable recovery of losses recorded in 2011 for a probable refund to customers in connection with an order by the PSC of MD related to a cash settlement of gas imbalances with competitive service providers;

   

lower interest expense related to both lower interest rates and decreased borrowing levels;

   

higher revenues related to the growth in average customer meters and

   

a decrease in the effective tax rate, including write-offs of regulatory assets related to the tax effect of Medicare Part D.

Partially offsetting these favorable variances were:

 

   

a one-time impairment of the old operations center;

   

higher compensation and benefit costs and

   

higher depreciation expense due to the growth in investment in utility plant and lower realized margins associated with our asset optimization program, including the favorable impact of a commission decision in Maryland in the asset optimization case.

 

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Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

Key gas delivery, weather and meter statistics are shown in the table below for the fiscal years ending September 30, 2013, 2012 and 2011.

 

Gas Deliveries, Weather and Meter Statistics  

 

 
    Years Ended September 30,     Increase (decrease)  

 

&nbs