Duke Energy North America
DENA operates and manages merchant power generation facilities and engages in commodity sales and services related to natural gas and electric power around its generation and contractual positions. DENA conducts business throughout the U.S. and Canada through Duke Energy North America and DETM. DETM is 40% owned by Exxon Mobil Corporation and 60% owned by Duke Energy. As discussed below, during 2003 certain key events led DENA to undertake a number of actions to change its existing business strategy.
As an active participant in the North American wholesale energy market, DENA has redefined its business strategy primarily in response to:
- Power generation oversupply in certain regions in the U.S., resulting in low spark spreads
- Reduction of major wholesale energy marketing and trading participants resulting in decreased market liquidity and increased collateral demands
As a result of these market developments DENA:
- Executed substantial re-organization efforts, resulting in significant staff and annual cost reductions
- Discontinued proprietary trading and other non-core businesses
- Decided to exit the Southeast region
- Resolved to wind down the operations of DETM. The majority of the commodity contracts have been eliminated or sold to third parties. DENA will continue its participation in the market through 100% Duke Energy-owned entities.
In the fourth quarter 2003, management decided to: a) exit the Southeast region through a contemplated disposition of its merchant generation plants located in that region, b) not use Duke Energy funds to complete construction and reduce DENA's interest in deferred plants, and c) wind-down DETM. These actions negatively impacted operating income by approximately $3.1 billion.
Previously, DETM was committed to market substantially all of ExxonMobil's U.S. and Canadian natural gas production through 2006. Beginning in March 2003, most of this natural gas production was no longer made available to be marketed by DETM. This change in gas supply along with the other key market events described above prompted the wind-down of DETM. As stated above, the majority of DETM's commodity contracts have been eliminated or sold to third parties during 2003 and the remaining actions to wind-down DETM's operations will continue in 2004.
In June 2003, DENA sold its 50% ownership interest in Duke/UAE Ref-Fuel for $325 million to Highstar Renewable Fuels LLC. DENA recorded a gain on the sale of approximately $178 million, which is included in Gains on Sales of Equity Investments in the Consolidated Statements of Operations.
Generation Assets
DENA currently owns or operates approximately 15,820 net MW of operating generation and has approximately 2,402 net MW of operating generation under construction. During 2003, DENA determined that the partially constructed power generation facilities, Moapa, Grays Harbor, and Luna (collectively the "deferred plants"), will not be completed with Duke Energy funds. DENA will look to sell and/or solicit funding for completion of the deferred plants in 2004. Additionally, DENA has decided to sell all of its power generation facilities in the Southeast U.S.
The following map shows DENA's power generation facilities.
Marketing Portfolio
The majority of DENA's portfolio of purchase and sales agreements incorporate market-sensitive pricing terms. Physical purchase and sales commitments involving significant price and location risk are generally hedged with financial derivatives. DENA's results may also fluctuate in response to seasonal demand for electricity, natural gas and other energy-related commodities. Additionally, weather has a significant impact on electricity and natural gas demand. (For information concerning DENA's risk-management activities, see "Management's Discussion and Analysis of Results of Operations and Financial Condition, Quantitative and Qualitative Disclosures About Market Risk" and Note 8 to the Consolidated Financial Statements, "Risk Management and Hedging Activities, Credit Risk and Financial Instruments.")
Customers
DENA markets electricity to investor-owned utilities, municipal power generators and other power marketers. DENA markets natural gas primarily to LDCs, electric power generators, municipalities, large industrial end-users and energy marketing companies. DENA also provides energy management services, such as supply and market aggregation, peaking services, dispatching, balancing, transportation, storage, tolling, contract negotiation and administration, as well as energy commodity risk management products and services.
Competition
DENA's competitors include utilities, other merchant electric generation companies in North America, certain financial institutions engaged in commodity trading, major integrated oil companies, major interstate pipelines and their marketing affiliates, brokers, marketers and distributors, and other domestic and international electric power and natural gas marketers. The price of commodities and services delivered, along with the quality and reliability of services provided, drive competition in the energy marketing business.
Over the past two years, there has been a significant reduction in number of market participants due to the profitability decline resulting from oversupply of generation, increase in regulation, cost of capital to maintain generation facilities, collateral requirements, and bankruptcies. With fewer market participants, liquidity has been further depressed.
Regulation
DENA's energy marketing activities are, in some circumstances, subject to the jurisdiction of the FERC. Current FERC policies permit DENA's trading and marketing entities to market natural gas, electricity and other energy-related commodities at market-based rates, subject to FERC jurisdiction. DENA continues to monitor the varied pace of wholesale electricity market restructuring. (For more information, see "Management's Discussion and Analysis of Results of Operations and Financial Condition, Current Issues—Electric Competition.")
Certain of DENA's generating stations in California sell electricity to the California ISO under "reliability must run" agreements; those sales are made at FERC regulated rates. In addition, several legal and regulatory proceedings at the state and federal levels are ongoing related to DENA's activities in California during the electricity supply situation and related to trading activities. (See Note 17 to the Consolidated Financial Statements, "Commitments and Contingencies—Litigation" for further discussion.)
The operation and maintenance of DENA's power plants in California will be subject to regulation pursuant to rules that are currently being promulgated by state authorities. The new rules are intended to increase the reliability of the generation supply in California by setting maintenance standards and regulating when plants may be taken out of service for routine maintenance. Duke Energy does not believe that the new rules, when finalized, will have a material impact on the operation of its power plants in California.
DENA is subject to the jurisdiction of the EPA and state environmental agencies. (For a discussion of environmental regulation, see "Environmental Matters" in this section.)