REGULATION

The Electric Discount and Energy Competition Act (EDECA) is the legal framework for New Jersey's public utility and wholesale energy landscape. NJNG is required, pursuant to a written order by the BPU under EDECA, to open its residential markets to competition from third-party natural gas suppliers. Customers can choose the supplier of their natural gas commodity in NJNG's service territory.

As required by EDECA, NJNG's rates are segregated into two primary components, the commodity portion, which represents the wholesale cost of natural gas, including the cost for interstate pipeline capacity to transport the gas to NJNG's service territory, and the delivery portion, which represents the transportation of the commodity portion through NJNG's gas distribution system to the end-use customer. NJNG does not earn utility gross margin on the commodity portion of its natural gas sales. NJNG earns utility gross margin through the delivery of natural gas to its customers, regardless of whether it or a third-party supplier provides the wholesale natural gas commodity.

Under EDECA, the BPU is required to audit the state's energy utilities every two years. The primary purpose of the audit is to ensure that utilities and their affiliates offering unregulated retail services do not have unfair competitive advantage over nonaffiliated providers of similar retail services. A combined competitive services and management audit of NJNG commenced in November 2006, and a final report on findings and recommendations was approved by the BPU on January 28, 2009. As of September 30, 2011, all recommendations have been implemented by NJNG and a completion letter was received from the BPU on October 24, 2011 that finalized the audit.

NJNG is subject to cost-based regulation, therefore, it is permitted to recover authorized operating expenses and earn a reasonable return on its utility investment based on the BPU's approval, in accordance with accounting guidance applicable to regulated operations. The impact of the ratemaking process and decisions authorized by the BPU allows NJNG to capitalize or defer certain costs that are expected to be recovered from its customers as regulatory assets and to recognize certain obligations representing amounts that are probable future expenditures as regulatory liabilities.

As recovery of regulatory assets is subject to BPU approval, if there are any changes in regulatory positions that indicate recovery is not probable, the related cost would be charged to income in the period of such determination.

Regulatory assets and liabilities included on the Consolidated Balance Sheets as of September 30, are comprised of the following:



(Thousands)	2011		2010
Regulatory assets-current
Underrecovered gas costs	$	—	$	36,485
Conservation Incentive Program	9,178		14,960
Derivatives, net	8,452		—
Other	—		21
Total current	$	17,630	$	51,466
Regulatory assets-noncurrent
Environmental remediation costs
Expended, net of recoveries	$	75,646	$	75,707
Liability for future expenditures	182,900		201,600
Deferred income taxes	10,879		13,860
Derivatives, net	—		16,497
Energy Efficiency Program	11,906		3,958
New Jersey Clean Energy Program	20,144		30,935
Postemployment and other benefit costs	123,827		106,225
Other	8,883		5,819
Total noncurrent	$	434,185	$	454,601
Regulatory liability-current
Overrecovered gas costs	$	4,633	$	—
Total current	$	4,633	$	—
Regulatory liabilities-noncurrent
Cost of removal obligation	$	59,752	$	57,648
Other	85		—
Total noncurrent	$	59,837	$	57,648

NJNG's recovery of costs is facilitated through its base rates, BGSS and other regulatory riders. NJNG is required to make an annual filing to the BPU by June 1 of each year for review of its BGSS, Conservation Incentive Program (CIP) and various other programs and related rates. Annual rate changes are requested to be effective at the beginning of the following fiscal year. In addition, NJNG is also permitted to request approval of certain rate or program changes on an interim basis. All rate and program changes are subject to proper notification, and BPU review and approval.

Gas Costs

NJNG recovers its cost of gas through the BGSS rate component of its customers' bills. NJNG's cost of gas includes the purchased cost of the natural gas commodity, fees paid to pipelines and storage facilities, adjustments as a result of incentive programs, and hedging transactions. Under-recovered gas costs represent a regulatory asset that generally occurs during periods when NJNG's BGSS rates are lower than actual costs and requests amounts to be recovered from customers in the future. Conversely, over-recovered gas costs represent a regulatory liability that generally occurs when NJNG's BGSS rates are higher than actual costs and requests approval to returned to customers including interest, when applicable, in accordance with NJNG's approved tariff.

Conservation Incentive Program

The CIP is designed to decouple the link between customer usage and NJNG's utility gross margin to allow NJNG to encourage its customers to conserve energy. In addition to permitting NJNG to recover utility gross margin variations related to customer usage, the CIP replaced NJNG's previous weather normalization mechanism allowing NJNG to mitigate the impact of weather on its gross margin. Such utility gross margin variations are recovered in the year following the end of the CIP usage year, without interest, and are subject to additional conditions, including an earnings test and an evaluation of BGSS related savings.

Derivatives

Derivatives are utilized by NJNG to manage the price risk associated with its natural gas purchasing activities and to participate in certain BGSS incentive programs. The gains and losses associated with NJNG's derivatives are recoverable through its BGSS, as noted above, without interest. See Note 4. Derivatives.

Environmental Remediation Costs Recovery

NJNG is responsible for the cleanup of certain former gas manufacturing facilities. Actual expenditures are recovered, with interest, over seven year rolling periods, through a RA rate rider. Recovery for NJNG's estimated future liability will be requested when actual expenditures are incurred. See Note 13. Commitments and Contingencies.

Deferred Income Taxes

In 1993, NJNG adopted the provisions of ASC 740, Income Taxes, which changed the method used to determine deferred tax assets and liabilities. Upon adoption, NJNG recognized a transition adjustment and corresponding regulatory asset representing the difference between NJNG's existing deferred tax amounts compared with the deferred tax amounts calculated in accordance with the change in method prescribed by ASC 740. NJNG recovers the regulatory asset associated with these tax impacts through future base rates, without interest.

New Jersey Clean Energy Program (NJCEP)

The NJCEP is a statewide program that encourages energy efficiency and renewable energy. Funding amounts are determined by the BPU and all New Jersey utilities are required to share in the funding obligation. NJNG recovers the costs associated with its NJCEP obligation, including interest, through its Societal Benefits Clause (SBC) rate rider.

Energy Efficiency Program (EE)

NJNG administers certain programs that supplement the states' NJCEP and that allows NJNG to promote clean energy to its residential and commercial customers, as described further below. NJNG will recover related expenditures and a weighted average cost of capital through an EE rate rider, as approved by the BPU, over a four to ten year period depending upon the initiative.

Postemployment and Other Benefit Costs

Represents NJNG's underfunded postemployment benefit obligations that the Company began recognizing in fiscal 2006, and revalues each year, as a result of changes in the accounting provisions of ASC 715, Compensation and Benefits, as well as a fiscal 2010 tax charge resulting from a change in the deductibility of federal subsidies associated with Medicare D, both of which are deferred as regulatory assets and are recoverable, without interest, in base rates. See Note 10. Employee Benefit Plans.

Other Regulatory Assets

Other regulatory assets consists primarily of deferred costs associated with certain components of NJNG's SBC, as discussed further below, and NJNG's compliance with federal and state mandated pipeline integrity management (PIM) provisions. NJNG's related costs to maintain the operational integrity of its distribution and transmission main are recoverable, subject to BPU review and approval, in its next base rate case. NJNG is limited to recording a regulatory asset that does not exceed $700,000 per year. In addition, to the extent that project costs are lower than the approved PIM annual expense of $1.4 million, NJNG will record a regulatory liability that will be refundable as a credit to customers' gas costs when the net cumulative liability exceeds $1 million.

Cost of Removal Obligation

NJNG accrues and collects for cost of removal in base rates. A regulatory liability represents collections in excess of actual expenditures, which the Company will return to customers over approximately 48 years, through a reduction in the depreciation expense component of NJNG's base rates, as approved by the BPU in NJNG's last base rate case.

The following is a description of regulatory proceedings during fiscal 2010 and 2011:

BGSS and CIP

BGSS rates are normally revised on an annual basis. In addition, to manage the fluctuations in wholesale natural gas costs, NJNG has the ability to make two interim filings during the fiscal year period to adjust residential and small commercial customer BGSS rates on a self-implementing and provisional basis. NJNG is also permitted to refund or credit back a portion of the commodity costs to customers when the natural gas commodity costs decrease in comparison to amounts projected or to amounts previously collected from customers. During fiscal 2010, NJNG provided refunds and bill credits of approximately $110.4 million to NJNG's residential and small commercial customers due to a decline in the wholesale price of natural gas. Commodity prices have since stabilized, therefore, there were no refunds or rate adjustments during fiscal 2011.

Concurrent with the annual BGSS filing, NJNG also files for an annual review of its CIP. The CIP was initially approved as a three-year program through September 2009. During fiscal 2010 the BPU approved an extension of the program through September 30, 2013. NJNG's annual BGSS and CIP filings are summarized as follows:


•	June 2009 BGSS/CIP filing - In June 2010, the BPU issued their final order approving NJNG's BGSS rate reduction of 17.2 percent for the average residential heating customer for fiscal 2010 and NJNG's recovery of $6.9 million of CIP rates representing amounts accrued and estimated through September 2009.

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June 2010 BGSS/CIP filing - The BPU approved NJNG's request to reduce rates for a 3.5 percent decrease for the average residential heating customer related to the BGSS rate effective September 16, 2010. This offsets NJNG's request for an increase in the CIP recovery rate, approved by the BPU effective October 1, 2010, allowing for a total annual recovery of $12.1 million representing CIP amounts accrued and estimated through September 30, 2010. The BPU issued their final order approving this filing in April 2011.

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June 2011 BGSS/CIP filing - NJNG proposed to reduce BGSS rates 9.1 percent for the average residential heating customer as a result of cost control and natural gas purchasing strategies, as well as lower natural gas prices. In addition, NJNG requested approval to modify its CIP recovery rates resulting in a decrease to the total annual recovery of $3 million. The proposed CIP rates result in an increase to all classes except residential heat, which represents a decrease. In September 2011, the BPU approved the changes effective October 1, 2011, on a provisional basis.

On November 17, 2011, NJNG notified the BPU that it will provide bill credits of approximately $71.2 million to NJNG's residential and small commercial customers as a result of the decline in the wholesale price of natural gas and a change in the methodology used to develop estimates of unaccounted-for gas. This refund to customers is currently classified as customers' credit balances and deposits on the Company's Consolidated Balance Sheets.

BGSS Incentive Programs

NJNG is eligible to receive financial incentives for reducing BGSS costs through a series of utility gross margin-sharing programs that include off-system sales, capacity release, storage incentive and Financial Risk Management (FRM) programs. In August 2011, the BPU approved an extension of NJNG's BGSS incentive programs for four years through October 31, 2015, maintaining the existing margin-sharing percentages. This agreement also permits the Company to annually propose a process to evaluate and discuss alternative incentive programs, should performance of the existing incentives or market conditions warrant re-evaluation.

Accelerated Infrastructure Programs (AIP)

NJNG has significant annual capital expenditures associated with the management of its natural gas distribution and transmission system and its associated pipeline integrity.

During fiscal 2009, NJNG implemented its AIP, commencing construction on fourteen infrastructure projects at a BPU approved cost of $70.8 million (AIP I). AIP was initially approved by the BPU as a two-year program, to enhance the reliability of NJNG's gas distribution system and to support economic development and job growth in New Jersey. During fiscal 2011, the BPU approved an extension to NJNG's AIP, allowing for additional capital investments of $60.2 million (AIP II) to be made through October 31, 2012. NJNG defers the costs associated with the AIP projects, including NJNG's weighted cost of capital, and upon regulatory approval recovers these investments through its base rates. Annual filings include the following:


•	June 2010 AIP filing - NJNG requested approval of its AIP expenditures for capital improvements during the period from August 2009 through August 31, 2010, which was approved by the BPU in September 2010, permitting an increase of $4.2 million in base rate revenue, including an overall weighted average cost of capital of 7.76 percent, effective October 1, 2010.

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June 2011 AIP filing - NJNG filed for AIP base rate cost recovery, which represented an increase of $4.7 million to $8.9 million annually, related to AIP I and AIP II infrastructure investments installed in NJNG's distribution and transmission systems. A settlement was reached and approved by the BPU effective October 1, 2011. The rate changes included a weighted average cost of capital of 7.12 percent for AIP II. The existing weighted average cost of capital for AIP I remained the same. An additional filing will be submitted in October 2012, requesting base rate changes to be effective in January 1, 2013.

Energy Efficiency Programs (EE)

NJNG commenced its EE programs during fiscal 2009, allowing it to promote energy efficiency to its residential and commercial customers while stimulating state and local economies through the creation of jobs. The BPU initially approved program expenditures and recovery of approximately $21.1 million over a four year-period, to facilitate home energy audits and to provide financing alternatives including rebates and other incentives designed to encourage the installation of high efficiency heating and cooling equipment. In September 2010, NJNG received BPU approval for recovery of an additional $9.6 million in energy efficiency investments, effective January 1, 2011, to be recovered over a five to ten-year period, depending on the rebate or financing initiative. The approval allowed for an extension of certain existing initiatives, as well as new or expanded funding incentives for commercial customers. In January 2011, NJNG notified the BPU that its proposed solar incentive component was withdrawn. On July 15, 2011, NJNG filed a separate EE petition to extend its current EE Programs through December 31, 2012. As of September 30, 2011, NJNG has spent a total of $26.1 million related to these initiatives.

The EE Program investments and costs are filed with the BPU on an annual basis and include the following:


•	June 2010 EE filing - NJNG requested that the existing EE Rider rate be maintained in anticipation of the its planned request for BPU approval of additional program expenditures, as noted above.


•	June 2011 EE filing - NJNG requested that the existing EE rate remain the same through an amended filing on July 15, 2011.

Societal Benefits Clause (SBC)

The SBC is comprised of three primary riders that allow NJNG to recover costs associated with USF, which is a permanent statewide program for all natural gas and electric utilities for the benefit of income-eligible customers, manufactured gas plant (MGP) remediation, and the NJCEP. NJNG has submitted the following filings to the BPU, which includes a report of program expenditures incurred each program year:

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June 2010 SBC filing - NJNG filed an application to maintain the existing MGP factor and NJCEP rate. In November 2011, NJNG, the BPU and Rate Counsel executed a stipulation agreeing to maintain the existing MGP and NJCEP rates. In addition, natural gas utilities in the State of New Jersey collectively filed with the BPU to increase the statewide USF rate to be effective October 1, 2010. Effective November 1, 2010, the BPU approved the recovery of the USF program year budget, resulting in an overall increase to the average monthly bill of a residential heating customer by 0.03percent, and the recovery of deferred USF administrative costs.


•	June 2011 USF filing - NJNG filed for a 0.1 percent decrease in the annual USF recovery rate, which was approved by the BPU, effective November 1, 2011.

Other Regulatory Initiatives

On June 16, 2011, NJNG submitted a filing with the BPU seeking authority to invest up to $15 million to build compressed natural gas vehicle refueling stations in Monmouth, Ocean and Morris counties. If approved, NJNG would begin construction of the stations and complete them by no later than December 31, 2012. NJNG would submit a cost recovery filing to the BPU in October 2012, requesting a base rate change to be effective in early 2013. Proceeds from the delivery of the associated natural gas, along with any available federal and state incentives, are proposed to be credited back to customers to help offset the cost of this investment.