10-K 1 d816622d10k.htm 10-K 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, 2014

 

  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, 2014):
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, 2014):
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 $2,064,823,797 as of March 31, 2014.

WGL Holdings, Inc. common stock, no par value outstanding as of October 31, 2014: 49,708,750 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, 2014.

 

 

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 2015 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, 2014, 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, 2014

 

Table of Contents

 

PART I

  

 

 
Introduction   
 

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

     70   

Item 8.

 

Financial Statements and Supplementary Data

     70   
 

WGL Holdings, Inc.

     71   
 

Washington Gas Light Company

     77   
 

Notes to Consolidated Financial Statements

     83   
 

Supplementary Financial Information—Quarterly Financial Data (Unaudited)

     144   

Item 9.

 

Changes In and Disagreements with Accountants on Accounting and Financial Disclosure

     145   

Item 9A.

 

Controls and Procedures

     145   

Item 9B.

 

Other Information

     148   

 

PART III

  

 

 

Item 10.

 

Directors, Executive Officers and Corporate Governance of the Registrants

     149   

Item 11.

 

Executive Compensation

     149   

Item 12.

 

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

     149   

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

     149   

Item 14.

 

Principal Accounting Fees and Services

     149   

 

PART IV

  

 

 

Item 15.

 

Exhibits and Financial Statement Schedules

     150   

Signatures

     156   

 

(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) and Washington Gas Light Company (Washington Gas). Except where the content clearly indicates otherwise, any reference in the report to “WGL,” “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.

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 and Washington Gas. The Consolidated Financial Statements of WGL 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 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 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 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 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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Table of Contents
   

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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Table of Contents

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.

 

Accelerated Pipe Replacement Programs: Programs focused on replacement activities, targeting specific piping materials, installed years and/or locations which are undertaken on an expedited basis in an effort to improve safety, system reliability and to reduce potential greenhouse gas emissions. 

 

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 in the state of Virginia 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.

 

Distributed Generation Assets: Assets that use renewable energy sources including Solar Photovoltaic (Solar PV) systems, combined heat and power plants, and natural gas fuel cells to generate electricity near the point of consumption.

 

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.

 

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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WGL Holdings, Inc.

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 in the state of Maryland 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 Plan (SAVE Plan): A plan that provides for accelerated recovery mechanisms for costs of eligible infrastructure replacement programs in the state of Virginia.

 

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. Gas sendout is comprised of natural gas sales, exchanges, deliveries, natural gas used by the company and unaccounted-for gas.

 

Strategic Infrastructure Development and Enhancement Plan (STRIDE Plan): A plan to recover the reasonable and prudent costs associated with infrastructure replacements through monthly surcharges in the state of Maryland.

 

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

 

WGL Midstream: 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, Inc. (WGL) was established on November 1, 2000 as a Virginia corporation. Through our wholly owned subsidiaries, we sell and deliver natural gas and provide 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 provide various energy services in 31 states and the District of Columbia. WGL 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 owns all of the shares of common stock of Washington Gas Light Company (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 Washington Gas Energy Services, Inc. (WGEServices), Washington Gas Energy Systems, Inc. (WGESystems), WGL Midstream, Inc. (WGL Midstream) and WGSW, Inc. (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.” The four segments are described below.

 

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WGL Holdings, Inc.

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’s 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, 2014, Washington Gas’ service area had a population estimated at 5.8 million and included almost 2.2 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, 2014 and 2013, respectively.

 

Active Customer Meters and Therms Delivered by Jurisdiction  
Jurisdiction   Active Customer
Meters as of
  September 30, 2014  
    Millions of Therms
Delivered
Fiscal Year Ended
  September  30, 2014  
    Active Customer
Meters as of
  September 30, 2013  
    Millions of Therms
Delivered
Fiscal Year Ended
   September  30, 2013   
 

District of Columbia

    155,993       317.8       154,982       300.4  

Maryland

    454,273       891.7       448,916       865.7  

Virginia

    506,777       679.4       501,225       614.8  

Total

    1,117,043       1,888.9       1,105,123       1,780.9  

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 $1.4 billion, $1.2 billion, and $1.1 billion in fiscal years ended September 30, 2014, 2013 and 2012, respectively.

Regulatory Environment

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 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 2014 and 2013, approximately 79% and 77%, 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, 2014 and 2013, 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 2014 and 2013, these contracts have expiration dates ranging from fiscal years 2015 to 2032 and 2014 to 2029, respectively.

Transportation and Storage Additions

Washington Gas has contracted with various interstate pipeline and storage companies to add to its storage and transportation capacity. The following projects are in progress to increase Washington Gas’ transportation and/or storage capacity.

 

Transportation and Storage Capacity Additions (in therms)

Pipeline Service Provider    Daily Capacity    Annual Capacity       In-Service Date    
(Fiscal Year)

Dominion Transmission Inc. Alleghany Storage

   1 million    60 million    2015

Transcontinental Gas Pipe Line Company

   0.75 million    11 million    2015

Transcontinental Gas Pipe Line Company, LLC Leidy Southeast

   1.65 million    60 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 secure operating margins that will ultimately be shared between Washington Gas customers and shareholders. Because 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 which 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 attributed to shareholders. However, this volatility does not change the secured operating margins that Washington Gas expects to 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, 2014 and the prior two fiscal years were net losses of $35.4 million and $33.2 million and a net gain of $28.3 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 2014 and expects to use those same sources to satisfy customer demand in fiscal year 2015. 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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Washington Gas Light Company

Part I

Item 1. Business (continued)

 

Excluding the sendout of sales and deliveries of natural gas used for electric generation, the following table outlines total sendout of the system. The sources of delivery and related volumes that were used to satisfy the requirements of fiscal year 2014 and those projected for pipeline year 2015 are shown in the following table.

 

Sources of Delivery for Annual Sendout

 
(In millions of therms)   

Fiscal Year       

 

 
Sources of Delivery    Actual
2013 
           Actual
2014
 
(a)
             Projected  
2015
(b)
 

Firm Transportation

     613              622           604        

Transportation Storage

     261              269           252        

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

     18              20           19        

Unregulated Third Party Marketers

     759                851             775        

Total

     1,651                1,762             1,650        

(a) Higher 2014 sendouts is the result of colder weather than 2013.

(b) Based on normal weather.

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 2014-2015 winter season is 19.0 million therms and Washington Gas’ projected sources of delivery for design day sendout is 20.0 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 2015.

 

Projected Sources of Delivery for Design Day Sendout  
  (In millions of therms)    Fiscal Year 2015  
  Sources of Delivery      Volumes          Percent      

  Firm Transportation

       5.2        26 %  

  Transportation Storage

       8.5        43 %  

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

       6.1        30 %  

  Unregulated Third Party Marketers

       0.2        1 %  

  Total

       20.0        100 %  

Natural Gas Unbundling

At September 30, 2014, 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’ 1.1 million active customers at September 30, 2014, approximately 182,000 customers purchased their natural gas commodity from unregulated third party marketers.

 

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Washington Gas Light Company

Part I

Item 1. Business (continued)

 

The following table provides the status of customer choice programs in Washington Gas’ jurisdictions at September 30, 2014.

 

Participation in Customer Choice Programs  
At September 30, 2014  
Jurisdiction          Customer Class      Eligible Customers  
              Total            % Participating    

  District of Columbia

  

Firm:

     
  

Residential

     143,268        12
  

Commercial

     12,539        33
  

Interruptible

     186        94

  Maryland

  

Firm:

     
  

Residential

     424,152        22
  

Commercial

     29,906        43
  

Interruptible

     213        99
  

Electric Generation

     2        100

  Virginia

  

Firm:

     
  

Residential

     477,873        10
  

Commercial

     28,660        32
    

Interruptible

     244        80

  Total

          1,117,043           

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 $ 4.3 billion as of September 30, 2014 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 new customer meters added by jurisdiction and major rate class for the year ended September 30, 2014.

 

New Customer Meters by Area         
      Residential     

 

Commercial and
Interruptible

     Group Meter
Apartments
           Total        

Maryland

     5,490        296        8        5,794  

Virginia

     5,600        404        4        6,008  

District of Columbia

     1,371        130        24        1,525  

Total

     12,461        830        36        13,327  

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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WGL Holdings, Inc.

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 is one of several utilities that delivers gas to/on behalf of 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, 2014, WGEServices served approximately 157,000 residential, commercial and industrial natural gas customer accounts and approximately 162,000 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 the fiscal years ended September 30, 2014, 2013, and 2012.

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’s issuance of commercial paper and unsecured short-term bank loans. WGEServices accesses these funds through the WGL money pool. For a discussion of the WGL 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

Part I

Item 1. Business (continued)

 

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 distributed energy projects. This segment focuses on clean and energy efficient solutions for its customers, driving earnings through (i) owning and operating distributed generation assets such as Solar Photovoltaic (solar PV) systems, combined heat and power plants, and natural gas fuel cells (ii) upgrading the mechanical, electrical, water and energy-related infrastructure of large governmental and commercial facilities by implementing both traditional and alternative energy technologies; and (iii) passive investments in residential and commercial retail solar PV companies. This segment has assets and activities in 15 different states and the District of Columbia.

 

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Washington Gas Light Company

Part I

Item 1. Business (continued)

 

As of September 30, 2014 and 2013, this segment owned $242.7 million and $87.8 million, respectively, of operating distributed generation assets, generating a total of 85,141 megawatts in fiscal year 2014 and 33,526 megawatts in fiscal year 2013, respectively. Additionally, as of September 30, 2014, there was $107.9 million of signed projects under construction. These assets drive revenue through individual purchased power agreements and the sale of renewable energy credits. As of September 30, 2014, the assets in service have generated $66.4 million in investment tax credits and clean energy grants. These credits and grants are recognized as reductions in expense by amortizing them over the useful life of the underlying assets, typically 30 years.

The commercial energy systems segment made up 36% of the total WGL expenditures for capital investments for the year ended September 30, 2014 as shown in the chart below:

 

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 renewable energy and distributed generation market, competitors primarily include other developers, tax equity investors, distributed generation asset owner firms 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.

Critical Factors

Factors critical to the success of the commercial energy systems segment include: (i) generating adequate sales commitments from the government and private sectors in the facility construction and retrofit markets; (ii) generating adequate sales commitments from distributed generation channel partners and customers; (iii) building a stable base of customer relationships; (iv) estimating and managing fixed-price contracts with contractors; (v) managing selling, general and administrative expenses; (vi) managing price and operational risk associated with distributed energy projects and (vii) successful operation and optimization of all commercial assets.

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 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 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 provides customized energy solutions to its customers and counterparties including producers, utilities, local distribution companies, power generators, wholesale energy suppliers, pipelines and storage facilities. In May 2013, WGL Midstream entered into an equity investment in Constitution Pipeline Company, LLC for an estimated $72.0 million. 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. In February 2014, WGL Midstream entered into an equity investment in a regulated pipeline project called Central Penn Pipeline (Central Penn) for an estimated $410.0 million. Central Penn will be an approximately 177-mile pipeline originating in Susquehanna County, Pennsylvania and extending to Lancaster County, Pennsylvania that will have the capacity to transport and deliver up to approximately 1.7 million dekatherms per day of natural gas. See Note 17—Other Investments for further details regarding these projects.

 

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Washington Gas Light Company

Part I

Item 1. Business (concluded)

 

Competition

WGL Midstream competes with other midstream infrastructure and energy services companies, wholesale energy suppliers, producers and other non-utility affiliates of regulated utilities for the acquisition of natural gas storage and transportation assets.

Critical Factors

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) expertise in managing commodity markets; (v) accessing sources of financial liquidity and (vi) managing the level of general and administrative expenses.

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 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, 2014, we had 1,444 employees comprising 1,332 utility and 112 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 31, 2014 that, as of that date, he was unaware of any violation by WGL of the NYSE’s corporate governance listing standards.

Our research and development costs during fiscal years 2014, 2013 and 2012 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 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 material downgrade in our current credit ratings to below investment grade 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 law 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. WGL closely monitors both preventive and detective measures to manage these risks and maintains cyber risk insurance to mitigate a significant portion, but not all, of these risks and losses. To the extent that the occurrence of any of these cyber events is not fully covered by insurance, it could adversely affect WGL’s financial condition and results of operations.

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 combination of events, failure in resources needed to respond to events, or a slow or an inadequate response to events

 

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Washington Gas Light Company

Part I

Item 1A. Risk Factors (continued)

 

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 and WGL Midstream may not be effective in managing risks and may cause increased volatility in its earnings.

WGEServices and WGL Midstream are exposed to commodity price risk to the extent their natural gas and electricity commodity purchases and obligations are not closely matched to their sales commitments in terms of volume and pricing. In addition, WGEServices is exposed to pricing of certain ancillary services provided or required by the power pool in which it operates. WGEServices and WGL Midstream attempt to manage their exposure to commodity price risk, as well as their 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’ and WGL Midstream’s risks.

WGEServices and WGL Midstream rely on guarantees and access to cash collateral from WGL.

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

Regulatory developments may negatively affect WGEServices and WGL Midstream.

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. In addition, WGL Midstream’s pipeline investments are subject to Federal Energy Regulatory Commission (FERC) regulation and approval. Should FERC deny or delay approval for the midstream projects or enact additional regulations related to these activities, Midstream is at risk of loss for those investments.

Competition may negatively affect WGEServices and WGL Midstream.

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. 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.

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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Table of Contents

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 distributed energy systems. SREC pricing is determined by the market in each of the states where the distributed energy systems are installed. Oversupply of the SRECs in any state as a result of overbuilding of distributed energy 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 to reduce its tax burden by investing in renewable and alternative energy assets like distributed energy, ductless heat pumps and fuel cells. The current ITC provisions allow WGL 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 capital invested 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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Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part I

Item 1A. Risk Factors (continued)

 

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 or growth in 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, Washington Gas depends solely on WGL to raise new common equity capital and contribute that common equity to Washington Gas. If WGL 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 exposure 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 information technology 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. Washington Gas closely monitors both preventive and detective measures to manage these risks and maintains cyber risk insurance to mitigate a significant portion, but not all, of these risks and losses. To the extent that the occurrence of any of these cyber events is not fully covered by insurance, it could adversely affect Washington Gas’ financial condition and results of operations.

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 closely monitors both preventive and detective measures to manage these risks and maintains sabotage and terrorism insurance to mitigate a significant portion, but not all, of these risks and losses. To the extent that the occurrence of any of these terrorist events is not fully covered by insurance, it could adversely affect Washington Gas’ financial condition and results of operations.

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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Table of Contents

WGL Holdings, Inc.

Washington Gas Light Company

Part I

Item 2. Properties

ITEM 2. PROPERTIES

 

At September 30, 2014, 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 2.77%, 2.86% and 2.87% during fiscal years 2014, 2013 and 2012, respectively, which included an allowance for estimated accrued non-legal asset removal costs (see Note 1 —Accounting Policies of the Notes to Consolidated Financial Statements).

At September 30, 2014, Washington Gas had approximately 565 miles of transmission mains, 12,713 miles of distribution mains and 12,761 miles of distribution services.

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). At September 30, 2014, Washington Gas has the storage capacity for approximately 15.0 million gallons of propane for peak-shaving. 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 2015, 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 63.25 megawatts of installed solar capacity in 15 different states and the District of Columbia at September 30, 2014.

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, 2014 and 2013, 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 of the Notes to Consolidated Financial Statements for further discussion.

As previously disclosed, WGL has been cooperating with a Department of Justice (“the Department”) investigation of some of the federal contracting activities of one of its non-utility subsidiaries, WGESystems. The Department’s investigation concerned certain American Recovery and Reinvestment Act projects bid out by the General Services Administration in 2010, in which WGESystems participated as a subcontractor to an 8(a) prime contractor under the Small Business Administration’s 8(a) Business Development Program. On November 18, 2014, WGESystems entered into a deferred prosecution agreement with the Department, which will resolve the investigation. The agreement is for a two-year period, and the Department will not pursue the prosecution of WGESystems if WGESystems discharges its obligations under the agreement during the two-year term of the agreement. Pursuant to the agreement, WGESystems will pay fines and monetary penalties totaling $2,587,261 to the Department and implement and maintain certain remedial measures specified in the agreement.

 

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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, 2014, 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 55 (1)

  

Senior Vice President and Chief Financial Officer

   October 1, 2013

Vice President and Chief Financial Officer

   September 30, 2006

Gautam Chandra, Age 48 (1)

  

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

   October 1, 2014

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

Adrian P. Chapman, Age 57 (1)

  

President and Chief Operating Officer

   October 1, 2009

William R. Ford, Age 59 (1)

  

Vice President and Chief Accounting Officer

   October 1, 2013

Controller

   October 1, 2010

Division Head—Assistant Controller

   January 26, 2009

Marcellous P. Frye, Jr., Age 46

  

Vice President—Support Services

   March 21, 2008

Luanne S. Gutermuth, Age 52

  

Senior Vice President—Shared Services and Chief Human Resource Officer

   October 1, 2014

Vice President—Human Resources and Organization Development

   October 1, 2010

Division Head—Consumer Services

   July 31, 2008

Louis J. Hutchinson, III, Age 49 (3)

  

Vice President and Chief Revenue Officer

   October 1, 2014

Mark A. Lowe, Age 51

  

Vice President—Gas Supply and Engineering

   October 1, 2014

Division Head—Gas Supply

   March 10, 2008

Terry D. McCallister, Age 58 (1)

  

Chairman of the Board and Chief Executive Officer

   October 1, 2009

Anthony M. Nee, Age 58 (1)

  

Vice President and Treasurer

   October 1, 2013

Treasurer

   February 14, 2009

Roberta W. Sims, Age 60

  

Vice President—Rates and Regulatory Affairs

   October 1, 2014

Vice President—Regulatory Affairs and Energy Acquisition

   October 1, 2009

Douglas A. Staebler, Age 54

  

Senior Vice President—Utility Operations

   October 1, 2014

Vice President—Operations, Engineering, Construction and Safety

   October 31, 2006

Leslie T. Thornton, Age 56 (1,2)

  

Senior Vice President—General Counsel and Corporate Secretary

   October 1, 2014

Vice President and General Counsel

   January 1, 2012

Counsel to the Chairman

   November 28, 2011

Tracy L. Townsend, Age 48

  

Vice President—Construction, Compliance and Safety

   October 1, 2014

Division Head—Safety, Compliance, Construction Operations Support and Technology

   October 1, 2010

Division Head—Construction and Field Operations

  

October 1, 2009

 

(1) At September 30, 2014, 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.

(3) Mr. Hutchinson was previously a Senior Vice President at Constellation Energy where he led sales and marketing for the public sector and energy efficiency business lines.

 

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Table of Contents

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, 2014, WGL had 9,980 common shareholders of record. During fiscal years 2014 and 2013, WGL’s common stock was listed for trading on the New York Stock Exchange and was shown under the ticker symbol “WGL.” We did purchase some of our outstanding common stock during fiscal year 2014. We had no restrictions on dividends during fiscal years 2014 or 2013. The table below shows quarterly price ranges and quarterly dividends paid for the fiscal years ended September 30, 2014 and 2013.

 

Common Stock Price Range and Dividends Paid
      High        Low       

Dividends Paid   

Per Share   

     Dividend
Payment Date

Fiscal Year 2014

                   

Fourth quarter

   $ 44.71          $ 37.77          $ 0.4400              8/1/2014   

Third quarter

     43.12            37.94            0.4400              5/1/2014   

Second quarter

     40.72            35.35            0.4200              2/1/2014   

First quarter

     45.65            37.96            0.4200              11/1/2013    

Fiscal Year 2013

                   

Fourth quarter

   $         46.96          $         40.00          $         0.4200              8/1/2013   

Third quarter

     46.22            41.16            0.4200              5/1/2013   

Second quarter

     44.30            38.30            0.4000              2/1/2013   

First quarter

     40.33            35.96            0.4000              11/1/2012    

The following table provides information about purchases of our equity securities during the quarter ended September 30, 2014.

 

Issuer Purchases of Equity Securities  
                               
Period    Total number of  
shares purchased  
    Average price
paid per share
    Total number of
shares purchased as
part of publicly
announced plans or
programs
    Maximum number of
shares (or approximate
dollar value) that may
yet be purchased under
the plans or programs 
(a)
 

07/01/14 - 07/31/14

     -          $ -          -        $ -     

08/01/14 - 08/31/14

     403,199         $ 42.54        403,199     $ 150,000,000  

09/01/14 - 09/30/14

     901,305         $ 43.34        901,305     $ 150,000,000  

Total

     1,304,504         $ 43.12        1,304,504      $ 150,000,000  

(a) The share repurchase program was approved by the Board of Directors and announced on August 7, 2014 to repurchase WGL’s common stock up to an amount of $150 million. The shares may be repurchased in the open market or in privately negotiated transactions. The repurchase program is authorized for a two year period. During the quarter ended September 30, 2014, we repurchased 1.3 million shares of common stock at a total cost of approximately $56.1 million. This amount reflects the total since the program’s inception.

 

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Table of Contents

WGL Holdings, Inc.

Part II

Item 6. Selected Financial Data

ITEM 6. SELECTED FINANCIAL DATA

 

The following table presents selected financial data for WGL 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,    2014      2013      2012      2011      2010  

SUMMARY OF EARNINGS

              

Operating Revenues

              

Utility

   $     1,416,951      $     1,174,724      $     1,109,355      $     1,264,580      $     1,297,786   

Non-utility

     1,363,996        1,291,414        1,315,955        1,486,921        1,411,090   

 

 

Total operating revenues

   $ 2,780,947      $ 2,466,138      $ 2,425,310      $ 2,751,501      $ 2,708,876   

 

 

Income from continuing operations

   $ 105,940      $ 80,253      $ 139,818      $ 117,050      $ 109,885   

 

 

COMMON STOCK DATA

              

Earnings per average share:

              

Basic

   $ 2.05      $ 1.55      $ 2.71      $ 2.29      $ 2.17   

Diluted

   $ 2.05      $ 1.55      $ 2.71      $ 2.28      $ 2.16   

Dividends declared per share

   $ 1.7400      $ 1.6600      $ 1.5875      $ 1.5400      $ 1.5000   

Shares outstanding—year end (thousands)

     50,657        51,774        51,612        51,365        50,975   

CAPITALIZATION-YEAR END

              

Common shareholders’ equity

   $ 1,246,576      $ 1,274,545      $ 1,269,556      $ 1,202,715      $ 1,153,395   

Washington Gas Light Company preferred stock

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

Long-term debt, excluding current maturities

     679,228        524,067        589,202        587,213        592,875   

 

 

Total capitalization

   $ 1,953,977      $ 1,826,785      $ 1,886,931      $ 1,818,101      $ 1,774,443   

 

 

OTHER FINANCIAL DATA

              

Property, plant and equipment-net—year-end

   $ 3,314,445      $ 2,907,463      $ 2,667,413      $ 2,489,901      $ 2,346,208   

Total assets—year-end

   $ 4,856,499      $ 4,260,060      $ 4,110,947      $ 3,809,034      $ 3,643,894   

 

 

 

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Table of Contents

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,    2014     2013     2012     2011     2010  

 

 

SUMMARY OF EARNINGS

          

Operating Revenues

          

Utility

   $ 1,443,800      $ 1,200,357      $ 1,137,666      $ 1,288,539      $ 1,321,446  

Non-utility

     -         -         -          -          75  

 

 

Total operating revenues

   $     1,443,800      $ 1,200,357      $ 1,137,666      $ 1,288,539      $ 1,321,521  

 

 

Income from continuing operations

   $ 97,004      $ 71,002      $ 108,726      $ 68,270      $ 101,029  

 

 

CAPITALIZATION-YEAR END

          

Common shareholder’s equity

   $ 1,050,166      $ 1,024,583      $ 1,025,743      $ 990,135      $ 994,876  

Preferred stock

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

Long-term debt, excluding current maturities

     679,228       524,067       589,202       587,213       592,875  

 

 

Total capitalization

   $ 1,757,567      $ 1,576,823      $ 1,643,118      $ 1,605,521      $ 1,615,924  

 

 

OTHER FINANCIAL DATA

          

Property, plant and equipment-net—year-end

   $ 3,022,064      $ 2,724,882      $ 2,574,396      $ 2,448,574      $ 2,329,528  

Total assets—year-end

   $ 3,965,078      $ 3,474,389      $ 3,503,265      $ 3,379,048      $ 3,270,276  

 

 

UTILITY GAS SALES AND DELIVERIES (thousands of therms)

          

Gas sold and delivered

          

Residential firm

     738,963       660,424       540,206       677,558       662,357  

Commercial and industrial

          

Firm

     200,153       180,942       149,515       179,207       170,534  

Interruptible

     2,193       2,897       2,042       2,573       3,649  

 

 

Total gas sold and delivered

     941,309       844,263       691,763       859,338       836,540  

 

 

Gas delivered for others

          

Firm

     535,503       488,182       436,698       501,187       481,099  

Interruptible

     267,705       270,884       243,031       271,421       267,823  

Electric generation

     144,403       177,533       343,315       140,557       172,995  

 

 

Total gas delivered for others

     947,611       936,599       1,023,044       913,165       921,917  

 

 

Total utility gas sales and deliveries

     1,888,920       1,780,862       1,714,807       1,772,503       1,758,457  

 

 

OTHER STATISTICS

          

Active customer meters—year-end

     1,117,043       1,105,123       1,094,109       1,082,983       1,073,722  

New customer meters added

     13,327       12,468       11,250       9,868       10,563  

Heating degree days—actual

     4,111       3,769       3,036       3,999       3,825  

Weather percent colder (warmer) than normal

     9.6      (0.2 )%      (20.1 )%      6.1      1.6 

 

 

 

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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 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,” “we,” “us” or “our” refers to the holding company or the consolidated entity of WGL Holdings, Inc. and all of its subsidiaries.

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

 

   

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

 

   

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

Both sections of Management’s Discussion—WGL 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

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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

     29     

Critical Accounting Policies

     34     

WGL Holdings, Inc.

    

Results of Operations

     38     

Liquidity and Capital Resources

     45     

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

     53     

Credit Risk

     56     

Market Risk

     58     

Washington Gas Light Company

    

Results of Operations

     64     

Liquidity and Capital Resources

     66     

Rates and Regulatory Matters

     67     

EXECUTIVE OVERVIEW

Introduction

WGL, through its 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. In addition to our primary markets, WGL’s non-utility subsidiaries provide customized energy solutions across a much wider footprint, with business activities in 31 states and the District of Columbia.

WGL has four operating segments:

 

   

regulated utility;

 

   

retail energy-marketing;

 

   

commercial energy systems; and

 

   

midstream energy services.

Regulated Utility Operating Segment

The regulated utility operating segment is composed of our core subsidiary, Washington Gas. 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. Over the past fiscal year, our utility customer base continued to grow as we added approximately 12,000 active customer meters, representing a 1.1% growth rate. During the winter heating season, Washington Gas’ territory experienced record cold spikes, resulting in nine of the top 25 days of send out. The company’s distribution operated safely and continuously during these extreme conditions. The extreme weather also created significant opportunities for asset optimization activities, driving additional returns shared both with customers and shareholders. Finally, we now have implemented accelerated replacement plans in all three of our utility jurisdictions and we are successfully executing on these plans to invest in the safety and reliability of our utility system.

Through the wholly owned unregulated subsidiaries of Washington Gas Resources, we offer energy-related products and services through three different operating segments.

Retail Energy-Marketing Operating Segment

We offer competitively priced natural gas, electricity and energy from renewable sources to customers through WGEServices, our non-utility retail energy-marketing subsidiary. Our retail electric business has been a challenge for us this fiscal year, as electricity prices on the PJM Interconnection unexpectedly increased due to the extremely cold winter of 2014 coupled with higher capacity and ancillary charges. While our gas margins improved, the lower electricity margins more than offset these gains. We project the retail business will return to historical levels of profitability in coming years as cost structures stabilize and are fully reflected in market pricing.

 

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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)

 

Commercial Energy Systems Operating Segment

We offer efficient and sustainable commercial energy solutions focused on owning and operating distributed generation assets such as Solar Photovoltaic (Solar PV) systems through WGESystems and WGSW and upgrading energy related systems of large government and commercial facilities. This segment had a particularly strong fiscal year, with earnings growth driven by the investments we have made in distributed generation assets now in place across the country. One noteworthy installation is the 2.6 megawatt Bloom Energy natural gas fuel cell project in Santa Clara, California. This project, designed to provide earnings through a 20-year power purchase agreement, underscores WGESystems commitment to creating long-term earnings through distributed generation. As of September 30, 2014, we have over 60 megawatts in installed solar capacity and 3.4 megawatts of installed fuel cell capacity.

Midstream Energy Services Operating Segment

WGL Midstream engages in acquiring and optimizing natural gas storage and transportation assets. This was a successful fiscal year as extremely cold weather led to increased natural gas flow volumes and higher market prices such that the Midstream business was able to generate attractive margins from its portfolio of low-cost storage and transportation assets. In addition, the 2014 winter demonstrated the need for additional infrastructure to transport natural gas from the supply areas to market areas in the Northeast and Mid-Atlantic. During the fiscal year, WGL Midstream began to address this need and continued to execute its long-term strategy of investing in pipeline assets through its ownership interest in the Central Penn pipeline 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 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 and Washington Gas Resources are also included in “Other activities.” Fiscal years 2013 and 2014 results also included significant non-recurring legal expenses.

Overall, we remain confident about future earnings growth. This growth is primarily due to strong performance at our utility driven by disciplined cost control, asset optimization opportunities, higher infrastructure investment, and a lower effective tax rate. We also continue to see encouraging signs of economic growth and success on our marketing strategies.

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 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 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 highly correlate 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 minimize 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 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 Riskfor 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 storage injections, withdrawals and associated futures transactions as well as the pricing of point to point transportation transactions 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.

WGEServices is subject to regulation by the public service regulatory 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, rates and orders by the regulatory commissions may affect Washington Gas’ and WGEServices’ financial performance.

WGL has completed an internal assessment in preparation for the Dodd-Frank Act (the Act) and its requirements. WGL’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 must contract for reliable and adequate supplies as well as 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

Part II

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 segments 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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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 more 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 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, disaggregation 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 the nation’s fourth largest regional economy, including several of the nation’s wealthiest counties. Our service territory’s economic strength, high median household income, and low unemployment rate have allowed long-term stable expansion of Washington Gas’ regulated customer base and have provided active markets for our subsidiaries’ energy-related products and services.

The national economy has shown its strongest growth since the 2008 financial crisis during fiscal year 2014, with noteworthy increases in industrial production, manufacturing, and jobs. Shale oil and gas production continue to play a major role, and consumer spending has risen despite a lack of wage growth.

Even as the economic outlook has improved, WGL and Washington Gas may be affected by continued levels of customer conservation and 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 were mixed during fiscal year 2014, with short-term rates rising slightly and longer term rates flat to slightly down. The Federal Reserve has begun cutting back on its quantitative easing activities which could have the impact of raising interest rates, however, other market conditions have acted to suppress this impact.

Year-over-year, national inflation was 1.7% as measured by the consumer price index for urban consumers (CPI-U), but inflation remains 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 and the investments of WGESystems and WGL Midstream. 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 continued rise in short-term interest rates, 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

Part II

Item 7. Management’s Discussion and Analysis of

Financial Condition and Results of Operations (continued)

 

Use of Business Process Outsourcing

Washington Gas outsources certain of its business processes related to human resources, information technology, consumer services, construction, integrated supplier 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 these outsourcing arrangements.

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 four 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 500 employees and is effective June 1, 2012 through May 31, 2015. Local 96 also represents union-eligible employees in the Shenandoah Gas division of Washington Gas and 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 22 employees. 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 117 employees and is effective beginning April 1, 2013 through March 31, 2016. Additionally, on August 1, 2014, Washington Gas entered into a new three-year labor contract with the International Brotherhood of Electrical Workers Local 1900 that covers approximately 21 employees and will expire on July 31, 2017. 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.

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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WGL Holdings, Inc.

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 ASC Topic 980 for our regulatory activities and the conclusion that all of our regulatory assets and liabilities as of September 30, 2014 are recoverable or refundable through rates charged to customers. See Note 2—Regulated Operations of the Notes to Consolidated Financial Statements for further discussion of our regulated operations.

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. See Note 9—Income Taxes of the Notes to 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 Derivatives

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. WGL and Washington Gas also utilize 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

Part II

Item 7. Management’s Discussion and Analysis of

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 of the Notes to Consolidated Financial Statements for a discussion of our derivatives.

Accounting for Fair Value Instruments

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 of the Notes to Consolidated Financial Statements 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. In addition, on January 1, 2010, Washington Gas established a non-funded defined benefit restoration plan (DB Restoration) for the purpose of providing supplemental pension and pension-related benefits to a select group of management employees. 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 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    $(6.3) / $6.3    n/a    $(3.5) / $3.5  

Discount rate

   +/– 0.25 pt.    $(28.1) / $29.6    $(1.9) / $2.0    $(10.4) / $11.0    $(1.2) / $0.9  

Rate of compensation increase

   +/– 0.25 pt.    $5.0 / $(4.9)    $0.9 / $(0.9)    n/a    n/a  

Healthcare cost trend rate

   +/– 1.00 pt.    n/a    n/a    $10.5 / $(9.2)    $5.9 / $(5.0)  

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, 2014, the discount rate for the pension, DB SERP and DB Restoration plans decreased to 4.4%, 4.0% and 4.0%, from 5.0%, 4.5% and 4.5%, respectively, for the comparable period in the prior year. The health and post-retirement plans discount rate also decreased to 4.4% from 5.1% during the same period. The lower 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.

 

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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)

 

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 reported net income of $105.9 million, $80.3 million and $139.8 million for the fiscal years ended September 30, 2014, 2013 and 2012, respectively. We earned a return on average common equity of 8.4%, 6.3% and 11.3%, 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, 2014, 2013 and 2012.

 

Net Income (Loss) by Operating Segment  
      Years Ended September 30,     Increase (Decrease)  
(In millions)    2014     2013     2012     2014
vs. 2013
    2013
vs. 2012
 

Regulated utility

   $     98.0     $ 71.8     $ 109.7     $ 26.2     $ (37.9

Non-utility operations:

          

Retail energy-marketing

     8.2       33.0       39.3       (24.8     (6.3

Commercial energy systems

     5.4       3.0       2.4                 2.4       0.6  

Midstream energy services

     6.2       (18.8     (9.1     25.0       (9.7

Other activities

     (12.2     (7.9     (2.5     (4.3     (5.4

Total non-utility

   $ 7.6     $ 9.3     $ 30.1     $ (1.7   $ (20.8

Intersegment Eliminations

   $ 0.3     $ (0.8   $ -     $ 1.1     $ (0.8

Net income

   $ 105.9     $     80.3     $     139.8     $ 25.6     $           (59.5

Earnings per average common share

          

Basic

   $ 2.05     $ 1.55     $ 2.71     $ 0.50     $ (1.16

Diluted

   $ 2.05     $ 1.55     $ 2.71     $ 0.50     $ (1.16

 

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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)

 

Regulated Utility Operating Results

The following table summarizes the regulated utility segment’s operating results for fiscal years ended September 30, 2014, 2013 and 2012.

 

Regulated Utility Operating Results           
       Years Ended September 30,      Increase (Decrease)  
(In millions)    2014     2013      2012      2014
vs. 2013
    2013
vs. 2012
 

Utility net revenues:

            

Operating revenues

   $     1,443.8     $     1,200.4      $     1,137.7      $         243.4     $ 62.7  

Less: Cost of gas

     726.9       521.5        421.5        205.4       100.0  

Revenue taxes

     84.3       81.4        74.2        2.9       7.2  

Total utility net revenues

     632.6       597.5        642.0        35.1       (44.5

Operation and maintenance

     291.4       292.6        279.9        (1.2     12.7  

Depreciation and amortization

     104.1       100.4        95.0        3.7       5.4  

General taxes and other assessments

     53.4       52.3        50.8        1.1       1.5  

Operating income

     183.7       152.2        216.3        31.5       (64.1

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

     (0.4     0.1        1.8        (0.5     (1.7

Interest expense

     37.1       35.6        36.1        1.5       (0.5

Income Tax Expense

     48.2       44.9        72.3        3.3       (27.4

Net income

   $ 98.0     $ 71.8      $ 109.7      $ 26.2     $ (37.9

Fiscal Year 2014 vs. Fiscal Year 2013.  The $26.2 million increase in net income primarily reflects:

 

   

higher net revenues attributed to the colder weather impacts of 2014 that were in excess of our weather protection provisions;

   

higher revenues due to new base rates in Maryland and the District of Columbia;

   

increase in revenues related to the growth of more than 12,200 average active customer meters;

   

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

   

surcharge-based rate recovery related to the accelerated pipeline replacement programs;

   

higher realized margins associated with our asset optimization program;

   

lower expenses related to operations and maintenance activities; and a

   

decrease in the effective tax rate primarily due to the reinstatement of regulatory assets related to the tax effect of Med D and tax sharing among the consolidated affiliates.

Partially offsetting these favorable variances were:

 

   

higher unrealized losses associated with our asset optimization program; and

   

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

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

 

   

decrease in unrealized margins associated with our asset optimization program;

   

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

   

higher recoveries in 2012 (adjusted by recoveries in 2013) 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

   

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

 

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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)

 

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;

   

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;

   

lower environmental expense primarily due to net insurance proceeds;

   

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

   

lower income taxes due to a decrease in the effective tax rate.

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)    2014    
vs. 2013    
    2013    
vs. 2012   
 

Customer growth

   $ 8.1       $ 3.4     

Estimated weather effects

     5.3       9.5     

Natural gas consumption patterns

     1.8       2.6     

Impact of rate cases

     12.2        3.5     

Accelerated pipe replacement programs

     3.9       3.5     

Interruptible margins

     1.4       -     

Asset optimization:

    

Realized margins

     18.9       (0.5)     

Unrealized mark-to-market valuations

     (20.8     (61.3)     

Lower-of-cost or market adjustment

     (0.3     0.3     

Storage carrying costs

     1.1       (2.3)     

Competitive service provider imbalance cash settlement

     -       (5.3)     

Late fees and miscellaneous service charges

     1.7       -     

Other

     1.8       2.1     

Total

   $ 35.1       $ (44.5)     

Customer growth — Average active customer meters increased by more than 12,200 from fiscal year 2013 to 2014. Average active customer meters increased by more than 10,900 from fiscal year 2012 to 2013.

Estimated weather effects — Weather, when measured by HDDs in the District of Columbia, was 9.6% colder than normal during the year ended September 30, 2014 and 0.2% warmer than normal during the year ended September 30, 2013, and 20.1% warmer than normal during the year ended September 30, 2012 (refer to the section entitled “Weather Risk” for further discussion of our weather protection strategy).

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 2014 and 2013 reflects new base rates that were approved in the District of Columbia and Maryland, effective June 4, 2013 and November 23, 2013, respectively. 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.

 

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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)

 

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

Interruptible margins — The year over year variance for 2014 and 2013 is a result of a decrease in margin sharing with firm customers which is a direct result of the Maryland margin sharing target based on the rate case which was approved in November 2013. This consequently resulted in an increase in utility net revenues.

Asset optimization — We recorded an unrealized loss associated with our energy-related derivatives of $66.2 million for the fiscal year ended September 30, 2014, an unrealized loss of $45.4 million for the fiscal year ended September 30, 2013 and an unrealized gain of $15.9 million for the year ended September 30, 2012. 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. The losses recorded in 2014 are primarily due to unfavorable movements in the unobservable inputs used in the valuation of long-dated forward contracts. We believe that this value is not reflective of our ultimate cash flows as these purchases are utilized in the optimization of our long-term natural gas transportation and storage capacity resources, the value of which is not reflected at fair value. Unfavorably affecting asset optimization results were $0.2 million of lower-of-cost or market adjustments related to storage gas inventory for the year ended September 30, 2014. 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 year ended September 30, 2012, Washington Gas recorded lower-of-cost or market adjustments, after the effects of regulatory sharing, of $1.5 million. 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 pre-tax cost of capital, multiplied by the monthly average balance of storage gas inventory. The year over year comparisons for 2014 and 2013 reflect increased incremental carrying cost per therm and additional storage capacity in the current period compared to the same period of the prior fiscal year. For fiscal year 2013 compared to 2012, the comparison reflects lower average storage gas inventory investment balances primarily due to lower weighted average cost of gas in inventory.

Competitive Service Provider imbalance cash settlement — 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. 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)     2014 vs. 2013      2013 vs. 2012     

Employee benefits

   $ (18.1)                  $ 9.3          

Impairment loss

     (0.4)                  (1.5)          

Weather-related instruments:

     

Benefit

     0.3                  6.1          

Premium costs and fair value effects

     0.5                  1.1          

Labor and incentive plans

     3.0                  5.0          

Net insurance proceeds

     2.2                  (2.4)          

Uncollectible accounts

     4.7                  (2.3)          

Operations, engineering, compliance and safety

     7.7                  (0.8)          

Other

     (1.1)                  (1.8)          

Total

   $ (1.2)                $ 12.7          

Employee benefits — The decrease in employee benefits expense for 2014 to 2013 year over year comparison primarily relates to an amendment to the post-retirement benefits plan resulting in a re-measurement of the benefit obligation and a reduction in the net periodic expense for the current period compared to the same period in the prior year. The increase in employee benefits expense for 2013 to 2012 year over year comparison primarily 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.

 

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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 — On July 7, 2014, the SCC of VA disallowed recovery of carrying costs on certain deferred costs related to an abandoned liquefied natural gas facility, therefore, $1.9 million of the associated regulatory asset was impaired. 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 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.

Weather-related instrument benefits/losses — There were no derivative instruments hedging variations from normal weather in the District of Columbia for fiscal year 2014. The effects of hedging variations from normal weather in the District of Columbia for fiscal years 2013, and 2012 were 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. 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, increase in the number of employees and in overtime work driven primarily by cold weather.

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.

Uncollectible accounts — The increase in expense for year over year comparisons for fiscal year 2014 to 2013 is due to increased volumes of gas deliveries. In addition, Washington Gas provided an increased number of structured and deferred payment plans to customers in Maryland due to the extremely cold winter. The decrease in expense in fiscal year 2013 compared to 2012 reflects a reduction in customer delinquencies and charge-offs.

Operations, engineering, compliance and safety — The increase in expense in fiscal year 2014 compared to 2013 year-over year comparison reflects increased maintenance costs driven primarily by cold weather. The decrease in expense in fiscal year 2013 compared to 2012 year-over-year comparison reflects a reduction in paving costs.

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)    2014 vs. 2013         2013 vs. 2012      

Property, plant and equipment

       $     3.6                  $  4.7            

Amortization reversal

     (0.7)                (1.3)            

New depreciation rates—District of Columbia

     -                 (0.3)            

Accelerated pipe replacement programs

     0.8                 -            

Retroactive depreciation adjustment—Virginia

     -                 2.3            

Total

       $ 3.7                   $     5.4            

 

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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)

 

Non-Utility Operating Results

Retail Energy-Marketing

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)  

 

 
       2014       2013       2012      2014  
vs. 2013  
    2013          
vs. 2012     
 

 

 

Operating Results (In millions)

           

Gross margins:

           

Operating revenues

   $     1,310.3     $     1,279.3     $     1,267.1      $ 31.0     $ 12.2   

Less: Cost of energy

     1,239.0       1,164.8       1,139.2        74.2       25.6   

Revenue taxes

     8.3       6.8       5.8        1.5       1.0   

 

 

Total gross margins

     63.0       107.7       122.1        (44.7     (14.4)   

Operation expenses

     43.8       49.6       52.2        (5.8     (2.6)   

Depreciation and amortization

     0.7       0.7       0.7        -        

General taxes and other assessments—other

     4.6       4.4       4.0        0.2       0.4   

 

 

Operating income

     13.9       53.0       65.2        (39.1     (12.2)   

Other income (expenses)-net

     0.1       0.2       -         (0.1     0.2   

Income tax expense

     5.8       20.2       25.9        (14.4     (5.7)   

 

 

Net income

   $ 8.2     $ 33.0     $ 39.3      $ (24.8   $ (6.3)   

 

 

Analysis of gross margins (In millions)

           

Natural gas

           

Realized margins

   $ 59.0     $ 44.1     $ 34.9      $ 14.9     $ 9.2   

Unrealized mark-to-market gains (losses)

     5.2       (1.7     6.9        6.9       (8.6)   

 

 

Total gross margins—natural gas

     64.2       42.4       41.8        21.8       0.6   

 

 

Electricity

           

Realized margins

   $ 0.7     $ 58.6     $ 78.8      $ (57.9   $ (20.2)   

Unrealized mark-to-market gains (losses)

     (1.9     6.7       1.5        (8.6     5.2   

 

 

Total gross margins—electricity

     (1.2     65.3       80.3        (66.5     (15.0)   

 

 

Total gross margins

   $ 63.0     $ 107.7     $ 122.1      $ (44.7   $ (14.4)   

 

 

Other Retail-Energy Marketing Statistics

           

Natural gas

           

Therm sales (millions of therms)

     718.1       702.5       610.4              15.6       92.1   

Number of customers (end of period)

     156,600       167,900       177,500        (11,300     -9,600   

Electricity

           

Electricity sales (millions of kWhs)

     11,692.0       12,133.0       11,794.9        (441.0     338.1   

Number of accounts (end of period)

     162,100       179,900       194,300        (17,800           -14,400   

 

 

Fiscal Year 2014 vs. Fiscal Year 2013.  The retail energy-marketing segment reported net income of $8.2 million for the fiscal year 2014 compared to net income of $33.0 million reported for fiscal year 2013. This reduction primarily reflects lower gross margins from the sale of electricity.

Gross margins from natural gas sales increased $21.8 million in fiscal year 2014 from the prior year. This increase reflects higher spot sales to interruptible customers, hedge settlements and portfolio optimization activity as well as an increase in unrealized mark-to-market valuations due to fluctuating market prices.

Gross margins from electric sales decreased $66.5 million in fiscal year 2014 from the prior year due to higher capacity and ancillary service charges from the regional power grid operator (PJM) and a decrease in unrealized mark-to-market valuations due to fluctuating market prices.

Operating expenses were lower due to lower customer acquisition, billing and customer service costs.

 

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Washington Gas Light Company

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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 reduction 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 ancillary service charges associated with fixed price contracts.

Commercial Energy Systems

The tables below represent the financial results by division of the commercial energy systems segment for the fiscal years ended September 30, 2014, 2013, and 2012.

 

Commercial Energy Systems Segment Financial Information  
      Years Ended September 30,     Increase (Decrease)  
(In millions)    2014     2013     2012     2014
vs. 2013
    2013
vs. 2012
 

Federal revenues

   $       23.2      $       29.4     $       57.1     $ (6.2 )    $ (27.7

Distributed generation revenues

     17.0        5.3       3.0       11.7        2.3  

Total revenues

   $ 40.2      $ 34.7     $ 60.1     $ 5.5      $ (25.4

Cost of goods sold

     20.3        24.5       51.1       (4.2 )      (26.6

Operating expenses

     10.7        7.2       5.7       3.5        1.5  

Solar depreciation

     6.2        2.4       1.2       3.8        1.2  

Total expenses

   $ 37.2      $ 34.1     $ 58.0     $         3.1      $ (23.9

Operating income

   $ 3.0      $ 0.6     $ 2.1     $ 2.4      $ (1.5

Equity earnings

     2.0        1.1       0.9       0.9        0.2  

Other income

     1.8        1.2       0.4       0.6        0.8  

Interest expense

     0.4        0.2       0.1       0.2        0.1  

Total other income

   $ 3.4      $ 2.1     $ 1.2     $ 1.3      $ 0.9  

Earnings before income taxes

   $ 6.4      $ 2.7     $ 3.3     $ 3.7      $ (0.6

Income tax expense

     3.7        0.8       1.1       2.9        (0.3

Amortization of income tax credits & treasury grants

     (2.7 )      (1.1     (0.2     (1.6 )      (0.9

Net income

   $ 5.4      $ 3.0     $ 2.4     $ 2.4      $         0.6  

Net income (loss) by division :

          

Federal division

   $ (3.0 )    $ 0.1     $ 1.3     $ (3.1 )    $ (1.2

Distributed generation division

     5.9        2.0       1.2       3.9        0.8  

Investment solar division

     2.5        0.9       (0.1     1.6        1.0  

Total net income

   $ 5.4      $ 3.0      $ 2.4     $ 2.4      $ 0.6  

 

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Washington Gas Light Company

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The commercial energy systems segment reported net income of $5.4 million, $3.0 million and $2.4 million in fiscal years 2014, 2013 and 2012, respectively. The year-over-year variances for all years are primarily due to higher solar renewable credits, solar generation revenue from commercial solar assets and higher solar investment income.

Midstream Energy Services

Midstream Energy Services reported net income of $6.2 million, in fiscal year 2014 and net losses of $18.8 million and $9.1 million in fiscal years 2013 and 2012, respectively. The variance between 2014 and 2013 is driven by higher realized margins on physical and financial transactions associated with higher gas prices and unrealized gains on derivative instruments. Both 2014 and 2013 reflect expenses of approximately $4.0 million associated with its investments in the Central Penn Line and Constitution pipeline projects. 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. 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 $12.2 million, $7.9 million and $2.5 million for fiscal years 2014, 2013, and 2012, respectively. The year-over-year comparisons reflect business development costs, legal expenses and our corporate branding initiative costs.

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 accrued expenses relating to SREC’s that have been generated by Commercial Energy Systems but have not been transferred.

LIQUIDITY AND CAPITAL RESOURCES

General Factors Affecting Liquidity

Access to short-term debt markets is necessary for funding our short-term liquidity requirements, the most significant of which include buying natural gas, electricity, and pipeline capacity, and financing accounts receivable and storage gas inventory. Our need for access to long-term capital markets is driven primarily by capital expenditures, maturities of long-term debt, and the availability of government funding through deferred taxes.

During the fiscal year ended September 30, 2014, both WGL and Washington Gas met its liquidity and capital needs through retained earnings, the issuance of commercial paper and long-term debt.

 

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Washington Gas Light Company

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Our ability to access capital markets depends on our credit ratings, general market liquidity, and investor demand for our securities. Our credit ratings depend largely on the financial performance of our subsidiaries, and a ratings downgrade could both increase our borrowing costs and trigger the need for posting additional collateral with our wholesale counterparties or other creditors. In support of our credit ratings, we have a goal to maintain our common equity ratio in the 50% range of total consolidated capital. As of September 30, 2014, total consolidated capitalization, including current maturities of long-term debt and excluding notes payable, comprised 63.2% common equity, 1.4% preferred stock and 35.4% long-term debt. The level of this ratio varies during the fiscal year due to the seasonal nature of our business. This seasonality also affects 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. Our cash flow requirements and our ability to provide satisfactory resources to meet those requirements are primarily influenced by the activities of all of WGL’s operating segments.

Our plans provide for sufficient liquidity to satisfy our financial obligations. At September 30, 2014, 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 or Washington Gas.

Short-Term Cash Requirements and Related Financing

Washington Gas has seasonal short-term cash requirements to fund the purchase of storage gas inventory in advance of the winter heating season. At September 30, 2014 and September 30, 2013, Washington Gas had balances in gas storage of $156.1 million and $132.2 million, respectively. Washington Gas collects the cost of gas under cost recovery mechanisms approved by its regulators. Additionally, Washington Gas may be required to post cash collateral for certain purchases.

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, large amounts of Washington Gas’ current assets are converted to cash, which Washington Gas generally uses to reduce and sometimes eliminate short-term debt and acquire storage gas for the next heating season.

Variations in the timing of collections under its gas cost recovery mechanisms can significantly affect Washington Gas’ short-term cash requirements. At September 30, 2014 and September 30, 2013, Washington Gas had $9.8 million and $0.6 million in net over-collections, respectively, of gas costs reflected in current assets/liabilities as gas costs due to customers. 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 1 of each year, at which time the accumulated amount is transferred to gas costs due from/to customers as appropriate. At September 30, 2014 and September 30, 2013, Washington Gas had a net regulatory liability of $11.7 million and a net regulatory asset of $13.8 million, respectively, related to the current gas recovery cycle.

WGL 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 and Washington Gas net of commercial paper balances were $85.5 million and $261.0 million at September 30, 2014 and $201.4 million and $225.5 million at September 30, 2013, respectively. The credit facility for WGL 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’

 

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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)

 

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 will be a fluctuating rate per annum that will be set using certain parameters at the time each loan is made. WGL and Washington Gas incur credit facility fees, which in some cases are based on the long-term debt ratings of Washington Gas. In the event that the long-term debt of Washington Gas is downgraded below certain levels, WGL and Washington Gas would be required to pay higher fees. There are five different levels of fees. The credit facility for WGL 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 0.06% and the highest is 0.175%. 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 3—Short-Term Debt of the Notes to the Consolidated Financial Statements for further information.

A share repurchase program was approved by the Board of Directors and announced on August 7, 2014 to repurchase WGL’s common stock up to an amount of $150 million. The shares may be repurchased in the open market or in privately negotiated transactions. The repurchase program is authorized for a two year period. During the quarter ended September 30, 2014, we repurchased 1.3 million shares of common stock at a total cost of approximately $56.1 million. This amount reflects the total since the program’s inception.

To manage credit risk, Washington Gas may require certain customers and suppliers to provide deposits, which are reported as current liabilities in “Customer deposits and advance payments,” in the accompanying balance sheets. At September 30, 2014 and September 30, 2013, “Customer deposits and advance payments” totaled $68.3 million and $67.2 million, respectively.

For Washington Gas, deposits from customers may be refunded 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 would typically represent collateral for transactions with wholesale counterparties. These deposits may be reduced, 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.

WGEServices and WGL Midstream have seasonal short-term cash requirements to fund the purchase of storage gas inventory in advance of the winter heating season. At September 30, 2014 and September 30, 2013, WGEServices had balances in gas storage of $50.5 million and $49.1 million, respectively. WGEServices collects revenues that are designed to reimburse commodity costs used to supply their retail customer and wholesale counterparty contracts. At September 30, 2014 and September 30, 2013, WGL Midstream had balances in gas storage of $127.0 million and $166.0 million, respectively. As market opportunities arise, WGL Midstream collects revenues in excess of its commodity costs through its wholesale counterparty contracts. WGEServices and WGL Midstream derive funding to finance these activities from short-term debt issued by WGL. Additionally, 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 for certain transactions.

In addition to storage gas, WGL Midstream also has short-term cash requirements to fund the construction of the Central Penn Line pipeline. At September 30, 2014, WGL Midstream had short-term cash obligations of $26.1 million related to the Central Penn Line pipeline. At September 30, 2013, WGL Midstream did not have any obligations related to the Central Penn Line pipeline. WGL Midstream derives funding to finance these activities from short-term debt issued by WGL.

WGESystems has cash requirements to fund the construction and purchase of residential and commercial distributed generating systems. WGESystems derives funding to finance these activities from short-term debt issued by WGL but may also utilize long-term debt issued by WGL in the future.

 

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Washington Gas Light Company

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Financial Condition and Results of Operations (continued)

 

Money Pool

WGL has money pool arrangements with and among its subsidiaries to coordinate and provide for certain short term cash and working capital requirements. This money pool may also accumulate cash from the periodic issuance of WGL’s common stock from the company’s dividend reinvestment program and stock based compensation programs as well as the operations of certain subsidiaries. In return, the money pool provides short-term loans to its 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, non-utility investments, long-term debt maturities and decisions to refinance long-term debt and our share repurchase program. 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).

WGL Debt Issuances

On August 18, 2014, WGL entered into an Indenture with The Bank of New York Mellon (the “Trustee”) to issue an unlimited amount of debt securities. Supplemental indentures will supplement the Indenture and establish the respective terms of the notes. The offering of the notes has been registered under a shelf registration statement on Form S-3.

On October 24, 2014, WGL issued $100.0 million of 2.25% notes due November 1, 2019 (“2019 Notes”) and $125.0 million of 4.60% notes due November 1, 2044 (“2044 Notes”). The notes were priced at 99.79% and 99.23% of par, respectively. The 2019 Notes have a make whole call provision that WGL may exercise at any time on or after October 24, 2014 and prior to October 1, 2019. At any time on or after October 1, 2019, the 2019 Notes may be called at 100% of the principal of such notes, plus accrued and unpaid interest. The 2044 Notes have a make whole call provision that WGL may exercise at any time on or after October 24, 2014 and prior to May 1, 2044. At any time on or after May 1, 2044, the 2044 Notes may be called at 100% of the principal of such notes, plus accrued and unpaid interest. These transactions were executed with Wells Fargo Securities, LLC, BB&T Capital Markets, TD Securities and CIBC World Markets as underwriters. Proceeds from the sale of these notes will be used by WGL to primarily fund the repurchase of outstanding securities of WGL and capital investments of its non-utility subsidiaries.

Proceeds from the sale of these notes will be used by WGL to primarily fund the repurchase of outstanding securities of WGL and capital investments of its non-utility subsidiaries.

Washington Gas Debt Issuances

At September 30, 2014, Washington Gas had the capacity under a shelf registration to issue up to $275.0 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 2014 and 2013.

Fiscal Year 2014 Activity.  On December 5, 2013, Washington Gas issued $75.0 million in 5.00% MTN’s due on December 15, 2043. On September 12, 2014, Washington Gas issued $100.0 million of 4.22% fixed MTNs due September 15, 2044. Proceeds from these notes were used by Washington Gas to retire short-term debt used to refund long-term debt that was retired on September 10, 2014 with a coupon rate of 5.17%, and for general corporate purposes. On November 7, 2013, Washington Gas retired $37.0 million of 4.88% MTN’s and September 10, 2014, retired $30.0 million in 5.17% MTN’s.

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

We are exposed to interest-rate risk associated with our debt financing. Prior to issuing long-term debt, WGL and 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

Changes in credit ratings may affect WGL’s 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 January 30, 2014, Moody’s upgraded Washington Gas’ senior unsecured rating to A1 from A2. The table below reflects the credit ratings for the outstanding debt instruments of WGL and Washington Gas for the year ended September 30, 2014.

 

     WGL   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   A1   P-1

Standard & Poor’s Ratings Services(d)

  A+   A-1   A+   A-1

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

(b) The long-term debt ratings outlook issued by Fitch Ratings for WGL and Washington Gas is stable.

(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 and Washington Gas is stable.

On October 15, 2014, Fitch Ratings downgraded WGL’s credit rating for its senior unsecured debt to “A” from “A+.” On October 22, 2014, Moody’s assigned an issue credit rating for WGL’s senior unsecured debt of “A3” and S&P assigned an issue credit rating for WGL’s senior unsecured debt of “A.”

Ratings Triggers and Certain Debt Covenants

WGL and Washington Gas pay credit facility fees, which in some cases are based on the long-term debt ratings of Washington Gas. Under the terms of WGL’s 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 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, 2014, 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, 2014, 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 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 declines, WGEServices and WGL Midstream may be required to provide additional credit support for these purchase contracts. At September 30, 2014, 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.

Historical Cash Flows

The following table summarizes WGL’s net cash provided by (used in) operating, investing and financing activities for the fiscal years ended September 30, 2014, 2013 and 2012:

 

                    

 

 
    

Fiscal Years Ended September 30,

    Increase / (Decrease)    

Increase / (Decrease)

 

 

 
(In millions)    2014     2013     2012    

2014 vs. 2013

   

2013 vs. 2012

 

 

 

Cash provided by (used in):

          

Operating activities

   $     382.2      $     318.0     $     217.6     $     64.2      $     100.4  

Investing activities

   $ (422.1   $ (371.1   $ (266.8   $ (51.0   $ (104.3

Financing activities

   $ 45.2      $ 46.3     $ 55.2     $ (1.1   $ (8.9

 

 

 

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Financial Condition and Results of Operations (continued)

 

Cash Flows Provided by Operating Activities

The regulated utility’s cash flows from operating activities principally reflect gas sales and deliveries and the cost of operations. The volume of gas sales and deliveries is dependent primarily on factors external to the utility, such as growth of customer demand, weather, market prices for energy, economic conditions and measures that promote energy efficiency. Under revenue and weather normalization, ratemaking adjustments and decoupling mechanisms in place, changes in delivery volumes from levels assumed when rates were approved may affect the timing of cash flows but not net income. The price at which the utility provides energy to customers is determined in accordance with regulatory approved tariffs. In general, changes in the utility’s cost of purchased power, fuel and gas may affect the timing of cash flows but not net income because the costs are recovered in accordance with rate agreements. In addition, the regulated utility’s cash flow is impacted by the timing of derivative settlements.

The non-utility cash flows from operating activities primarily reflect the timing of receipts related to distributed generating and federal projects at commercial energy systems and the timing of receipts related to electric and gas bills for retail-energy marketing. The timing of gas purchases and sales resulting from asset optimization arrangements affect midstream energy services.

Net income is the result of cash and non-cash (or accrual) transactions. Only cash transactions affect WGL’s cash flows from operating activities. Principal non-cash charges include depreciation, accrued or deferred pension and other post-retirement benefit costs and deferred income tax expense. Non-cash charges or credits may also be accrued under the revenue decoupling and cost reconciliation mechanisms in the utilities’ rate plans.

Net cash provided by operating activities for the fiscal year ended September 30, 2014 increased by $64.2 million to $382.2 million from $318.0 million for fiscal year ended September 30, 2013. The change in net cash flows reflects increased sales volumes to customers due to our colder than normal weather winter heating season. Seasonal trends and timing are reflected within changes to accounts receivable, recoverable energy costs and accounts payable.

The change in regulatory assets principally reflects changes in deferred pension and post-retirement benefit costs in accordance with the accounting rules for retirement benefits.

Net cash provided by operating activities for fiscal year ended September 30, 2013 totaled $318.0 million compared to $217.6 million in fiscal year ended September 30, 2012. This change in net cash flows reflects an increase in storage gas due to higher inventory prices; increased inventory and a decrease in pension and post-retirement benefit contributions; and a decrease in the change in gas costs (current) and other regulatory assets/liabilities- net due to increase in mark-to-market adjustments along with an increase in price. Seasonal trends and timing are reflected within changes to accounts receivables, recoverable energy costs and accounts payable.

Cash Flows Provided By Financing Activities

Cash flows provided by financing activities totaled $45.2 million in fiscal year ended September 30, 2014 reflecting the issuance of $175.3 million in long-term debt; retirement of $67.0 million in MTNs; $80.4 million increase in notes payable used to finance gas purchase and storage inventory costs; $85.2 million of dividend payments on common and preferred stock and the repurchase of $56.1 million in common stock. Cash flows provided by financing activities totaled $46.3 million in fiscal year ended September 30, 2013 reflecting an increase in notes payable of $125.4 million used to finance gas purchase and storage inventory costs and $86.1 million of dividend payments on common and preferred stock. Cash flows provided by financing activities totaled $55.2 million in fiscal year ended September 30, 2012 reflecting a $208.3 million increase in notes payable used to finance gas purchase and storage inventory costs for planned non-utility growth and pension contributions; $77.2 million of dividend payments on common and preferred stock; and the retirement of $77.0 million in MTNs.

 

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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)

 

The following table reflects the issuances and retirements of long-term debt that occurred during the fiscal years 2014, 2013 and 2012 (also refer to Note 5 —Long Term Debt of Notes to Consolidated Financial Statements).

 

Long-Term Debt Activity  

 

 
     2014     2013          2012    

 

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

 

 

Medium-term notes

              

Issued

     4.22 – 5.00   $ 175.0       n/a       $           -        n/a      $ -  

Retired

     4.88 – 5.17     (67.0     n/a         -        5.90 – 6.05     (77.0)   

Other financing

              

Issued (a)

     2.52    
0.3
 
    n/a         -        2.77 – 3.38               6.2  

Retired (b)

     n/a        -       n/a         -        3.94     (4.2)   

Other activity

              

 

 

Total

     $       108.3        $ -        $ (75.0)   

 

 

(a) Includes the non-cash issuances of project debt financing of $0.3 million for fiscal year 2014 and $6.2 million for fiscal year 2012.

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

Cash Flows Used in Investing Activities

Net cash flows used in investing activities totaled $422.1 million, $371.1 million and $266.8 million during fiscal years 2014, 2013 and 2012, respectively, which primarily consists of capital expenditures made on behalf of Washington Gas and investments in commercial Solar PV facilities. Additionally we invested $31.4 million and $62.9 million, respectively, in other non-utility projects.

Capital Investments

The following table depicts our actual capital investments for fiscal years 2012, 2013 and 2014, and projected capital investments for fiscal years 2015 through 2019. 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.

 

 

 
    Actual        Projected   

(In millions)

    2012         2013         2014         2015         2016         2017         2018         2019         Total   

 

 

New business(a)

  $ 53.5     $ 71.3     $ 97.0       $ 85.6     $ 137.4     $ 142.1     $ 162.5     $ 171.2     $ 698.8  

Replacements:

                 

Regulatory plans

    33.4       40.2       51.7         91.1       94.7       95.7       96.2       96.6       474.3  

Other

    65.8       63.8         70.0         50.3       54.0       47.9       45.9       45.4       243.5  

Customer information system

    -       -        9.9         34.5       36.9       8.8       -       -       80.2  

Other utility

    56.8       52.5         82.2         41.6       49.8       60.9       54.9       46.8       254.0  

Cash basis adjustments

    (9.8     -        (24.5)        -       -       -       -         -  

 

 

Total utility(b)

    199.7       227.8       286.3         303.1       372.8       355.4       359.5       360.0       1,750.8  

 

 

Pipeline investments

    -       6.2         20.8         50.6       84.2       252.0       62.8       1.1       450.7  

Distributed generation

    41.8       83.7         108.2         123.0       100.0       100.0       100.0       100.0       523.0  

Other non-utility

    1.1       0.7       0.2         27.8       2.4       0.6       0.7       0.6       32.1  

 

 

Total investments

  $     242.6     $     318.4     $     415.5       $     504.5     $     559.4     $     708.0     $     523.0     $     461.7     $     2,756.6  

 

 

(a) Includes certain projects that support the existing distribution system.

(b) 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

Financial Condition and Results of Operations (continued)

 

The 2015 to 2019 projected periods include $ 698.8 million for continued growth to serve new customers and $717.8 million for the replacement and betterment of existing distribution facilities, including $474.3 million of expenditures for replacement projects intended to meet the requirements of the planned accelerated pipe replacement programs in all three jurisdictions served by Washington Gas.

 

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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 and Washington Gas have certain contractual obligations incurred in the normal course of business that require fixed and determinable payments in the future. These commitments include long-term debt, lease obligations, unconditional purchase obligations for pipeline capacity, transportation and storage services, certain natural gas and electricity commodity commitments and our commitments related to the business process outsourcing program.

The estimated obligations as of September 30, 2014 for future fiscal years are shown below.

 

Estimated Contractual Obligations and Commercial Commitments  
     Years Ended September 30,  

 

 
(In millions)      Total      2015      2016      2017      2018      2019      Thereafter  

 

 

Pipeline and storage contracts(a)

   $ 2,626.2       $ 213.2       $ 244.8       $ 236.0       $ 238.2       $ 226.5       $ 1,467.5   

Medium-term notes(b)

     691.0        20.0        25.0        -        -        50.0        596.0   

Interest expense(c)

     624.5        38.9        37.2        36.8        36.8        33.7        441.1   

Gas purchase commitments

                    

   —Washington Gas(d)

     4,522.5        280.0        288.9        336.7        323.2        303.5        2,990.2   

   —WGEServices(e)

     231.1        167.5        49.2        13.8        0.6        -         

   —WGL Midstream(d)

     15,453.1        29.2        24.4        80.2        906.0        933.4        13,479.9   

Electric purchase commitments(f)

     599.7        359.4        171.7        65.0        3.6        -         

Operating leases

     34.8        7.8        6.3        4.9        4.3        1.0        10.5   

Business process outsourcing(g)

     90.0        32.3        33.4        24.3        -        -         

Other long-term commitments(h)

     21.9        10.1        5.0        4.2        2.2        -        0.4   

 

 

Total

   $     24,894.8       $     1,158.4       $     885.9       $     801.9       $     1,514.9       $     1,548.1       $     18,985.6   

 

 

(a)Represents minimum payments for natural gas transportation, storage and peaking contracts that have expiration dates through fiscal year 2044. Additionally, includes minimum payments for WGEServices and WGL Midstream pipeline contracts.

(b)Represents scheduled repayment of principal. Excludes $8.3 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.

(d)Includes commitments to purchase fixed volumes of natural gas. All contracts are based on market prices, other than contracts for which there is a fixed price.

(e)Represents commitments based on a combination of market prices at September 30, 2014 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 $15.3 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 $107.4 million over the remaining contract term.

(h)Includes secured supply agreements’ 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 2014, 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 $16.0 million to its health and life insurance benefit plans during fiscal year 2014. During fiscal year 2015, Washington Gas does not expect to make a contribution to its qualified pension plan but does expect to make a payment totaling $4.1 million to its non-funded DB SERP. Washington Gas expects to make a contribution of $16.6 million to its health and life insurance benefit plans during fiscal year 2015. 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.

 

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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)

 

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, 2014 and 2013, work on these construction projects that was not completed or accepted by customers was valued at $8.3 million and $6.7 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, 2014 and September 30, 2013.

Financial Guarantees

WGL has guaranteed payments primarily for certain purchases of natural gas and electricity on behalf of WGEServices and for certain purchase commitments on behalf of WGL Midstream. At September 30, 2014, these guarantees totaled $227.3 million and $276.5 million for WGEServices and WGL Midstream, respectively. At September 30, 2014, the guarantees relating to WGESystems totaled $6.0 million. The amount of such guarantees is periodically adjusted to reflect changes in the level of financial exposure related to these purchase commitments. For all of our financial guarantees, WGL may cancel any or all future obligations upon written notice to the counterparty, but WGL would continue to be responsible for the obligations created under the guarantees prior to the effective date of the cancellation. WGL also has guaranteed payments for certain of our external partners. At September 30, 2014, these guarantees totaled $18.7 million. At September 30, 2014, WGL’s guarantees for all its subsidiaries and external partners totaled $528.5 million.

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, where natural gas storage facilities previously existed. Following a legal decision that effectively prevents Washington Gas to utilize the intended site for an LNG storage facility, Washington Gas abandoned its plans to continue this project. The costs incurred under the project totaled $8.5 million. 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.

The SCC of VA and the PSC of MD have approved recovery of the costs, but no return is allowed. As a result, Washington Gas has impaired $1.9 million and $0.5 million in fiscal years 2014 and 2013, respectively.

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.

 

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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)

 

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 caused the seals in certain mechanical couplings in Washington Gas’ distribution system to shrink, increasing the propensity for the coupling to leak. Independent laboratory tests performed on behalf of Washington Gas showed that the injection of HHCs offset the effect of the low HHC gas on the seals in couplings, reducing their propensity to leak.

Washington Gas constructed three facilities to inject HHCs into the gas stream entering the Washington Gas distribution system. In addition to injecting HHCs, 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 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 replacement of higher risk mains and services, including vintage mechanically coupled mains and services, in Virginia includes expenditures of $204.6 million, over the current five-year period beginning in fiscal year 2015. This represents a part of Washington Gas’ 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 $49.3 million and is expected to be completed in fiscal year 2016. The first $28.0 million is covered under the rate recovery mechanism approved in the 2009 settlement and the remaining forecasted expenditures are $23.6 million. Additionally, Washington Gas’ request for approval of $110.0 million for the funding of further pipe replacements, under an accelerated pipe replacement program was approved by Order issued by the PSC of DC on August 21, 2014. For Maryland, Washington Gas has budgeted approximately $204.4 million related to the first five years of the planned replacement of higher risk mains and services, including vintage mechanically coupled mains and services, which is part of Washington Gas’ approved STRIDE plan. Rate recovery of the expenditures has been approved by the SCC of VA, the PSC of MD, and the PSC of DC.

 

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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)

 

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.

Constitution Pipeline LLC has extended the range for the pipeline’s target in-service date to late 2015 through 2016 as a result of a longer than expected regulatory and permitting process. An affiliate of Williams Partners will construct, operate and maintain the new 30-inch, 126-mile long transmission pipeline.

WGL Midstream will invest an estimated $72 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 FERC.

Central Penn Line Pipeline

In February 2014, WGL Midstream entered into a limited liability company agreement and formed Meade, with COG Holdings LLC, Vega Midstream MPC LLC, and River Road Interests LLC.

Meade was formed to jointly develop and own, together with Transcontinental Gas Pipe Line Company, LLC (Transco), an approximately 177-mile pipeline originating in Susquehanna County, Pennsylvania and extending to Lancaster County, Pennsylvania (Central Penn Line) that will have the capacity to transport and deliver up to approximately 1.7 million dekatherms per day of natural gas. This pipeline will be an integral part of Transco’s recently announced “Atlantic Sunrise” project.

The Central Penn Line, as part of Atlantic Sunrise, is a natural gas pipeline designed to provide new firm transportation capacity from various supply points in northeast Pennsylvania to a delivery point into Transco’s mainline in southeast Pennsylvania. The Central Penn Line currently has a projected in-service date in the second half of 2017. WGL Midstream will invest an estimated $410 million for a 55% interest in Meade, and Meade will invest an estimated $746 million in the Central Penn Line for an approximate 39% interest in the Central Penn Line. Transco will have the remaining ownership interests.

Additionally, in February 2014, WGL Midstream entered into an agreement with Cabot Oil & Gas Corporation (Cabot) whereby WGL Midstream will purchase 500,000 dekatherms per day of natural gas from Cabot over a 15 year term. As part of this agreement, Cabot will acquire 500,000 dekatherms per day of firm gas transportation capacity on Transco’s Atlantic Sunrise project of which the Central Penn Line is a part. This capacity will be released to WGL Midstream.

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 hedge and optimize its portfolio of owned 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.

 

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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)

 

Washington Gas, WGEServices, and WGL Midstream operate under an existing wholesale counterparty 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 creditworthiness criteria, Washington Gas, WGEServices, and WGL Midstream may grant unsecured credit to those counterparties or their guarantors. The creditworthiness 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, 2014, Washington Gas, WGEServices and WGL Midstream provided $8.2 million, $11.0 million and $11.4 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, 2014 for Washington Gas, WGEServices and WGL Midstream, separately.

 

Credit Exposure to Wholesale Counterparties ($ In millions)  

 

 
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

  $          24.1     $          1.4     $ 22.7     3   $          16.7   

Non-Investment Grade

      2.2         2.2       -     -        

No External Ratings

      1.0         -       1.0     -        

 

 

WGEServices

               

Investment Grade

  $          4.1     $          -     $ 4.1     2   $          4.1   

Non-Investment Grade

      -         -       -     -        

No External Ratings

      -         -       -     -        

 

 

WGL Midstream

               

Investment Grade

  $          12.6     $          0.1     $ 12.5     2   $          11.1   

Non-Investment Grade

      -         -       -     -        

No External Ratings

      2.7         -       2.7     1       2.5   

 

 

(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 mark-to-market 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 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, District of Columbia 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 that sponsor POR programs. While participation in POR programs reduce 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.

 

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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)

 

WGESystems is subject to retail credit risk associated with customers who purchase electricity under long term agreements from distributed generation assets owned by the company. The customers undergo credit evaluation prior to contract execution and are monitored periodically during the contract term for payment performance and credit quality. These steps mitigate credit risk associated with the distributed generation asset customers.

WGSW is indirectly subject to retail credit risk associated with non-payment by customers who lease distributed energy equipment or maintain energy service agreements through ASD Solar LP, Nextility (formerly known as Skyline Innovations, Inc.) and SunEdison. This credit risk is mitigated with minimum credit quality criteria established in each of WGSW’s agreements. These 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 forward, 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, 2014.

 

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

 

 
(In millions)       

 

 

Net assets (liabilities) at September 30, 2013

   $      (107.7

Net fair value of contracts entered into during the period

     (19.1

Other changes in net fair value

     (211.5

Realized net settlement of derivatives

     56.1  

 

 

Net assets (liabilities) at September 30, 2014

   $ (282.2

 

 
Regulated Utility Segment  
Roll Forward of Energy-Related Derivatives  

 

 
(In millions)       

 

 

Net assets (liabilities) at September 30, 2013

   $     (107.7

Recorded to income

     (87.3

Recorded to regulatory assets/liabilities

     (143.3

Realized net settlement of derivatives

     56.1  

 

 

Net assets (liabilities) at September 30, 2014

   $ (282.2

 

 

 

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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 maturity dates of our net assets (liabilities) associated with the regulated utility segment’s energy-related derivatives recorded at fair value at September 30, 2014, 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     2015     2016     2017     2018     2019     Thereafter    

 

 

Level 1 — Quoted prices in active markets

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

Level 2 — Significant other observable inputs

           (11.6               (6.8           (4.4           (0.2           (0.2     -        

Level 3 — Significant unobservable inputs

     (270.6     (23.9     (23.9     (32.2     (22.7     (21.1       (146.8)   

 

 

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

   $ (282.2   $ (30.7)      $ (28.3   $ (32.4   $ (22.9   $ (21.1   $ (146.8)   

 

 

Fair value changed due primarily to unfavorable movements in the unobservable inputs used in the valuation of long-dated forwards. We believe that this value is not reflective of our ultimate cash flows as these purchases are utilized in the optimization of our long-term natural gas transportation and storage capacity resources, which are not reflected at fair value. 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 with its suppliers. 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 from other factors that 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 expected 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, in matching its customer requirements obligations. While the capacity and transmission costs within PJM are generally stable and identifiable several years into the future, the cost of ancillary services which support the reliable operation of the transmission system, does fluctuate as changes occur in the balance between generation and the consumption mix within the electric system. WGEServices could be exposed to price risk associated with changes in ancillary costs due to lack of available forward market products to sufficiently hedge those risks.

To the extent WGEServices has not sufficiently matched its customer requirements with its supply commitments, 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 expected gross margins (refer to the section entitled “Weather Risk” for a further discussion of our management of weather risk).

 

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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 Retail Energy-Marketing segment’s energy-related derivatives during the fiscal year ended September 30, 2014.

 

Retail Energy-Marketing Segment

Changes in Fair Value of Energy-Related Derivatives

 

 

 
(In millions)       

 

 

Net assets (liabilities) at September 30, 2013

   $ (10.4)   

Net fair value of contracts entered into during the period

     1.9   

Other changes in net fair value

     10.0   

Realized net settlement of derivatives

     (6.9)   

 

 

Net assets (liabilities) at September 30, 2014

   $ (5.4)   

 

 

Retail Energy-Marketing Segment

Roll Forward of Energy-Related Derivatives

 

 

 
(In millions)       

 

 

Net assets (liabilities) at September 30, 2013

   $ (10.4)   

Recorded to income

     10.3   

Recorded to accounts payable

           1.6   

Realized net settlement of derivatives

     (6.9)