7. Asset Retirement Obligations
In June 2001, the FASB issued SFAS No. 143 which addresses financial accounting and reporting for legal obligations associated with the retirement of tangible long-lived assets and the related asset retirement costs. The standard applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or normal use of the asset. Asset retirement obligations at Duke Energy relate primarily to the decommissioning of nuclear power facilities, the retirement of certain gathering pipelines and processing facilities, the retirement of some gas-fired power plants, obligations related to right-of-way agreements and contractual leases for land use.
SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred, if a reasonable estimate of fair value can be made. The fair value of the liability is added to the carrying amount of the associated asset. This additional carrying amount is then depreciated over the life of the asset. The liability increases due to the passage of time based on the time value of money until the obligation is settled.
In accordance with SFAS No. 143, Duke Energy identified certain assets that have an indeterminate life, and thus a future retirement obligation is not determinable. These assets included on-shore and some off-shore pipelines, certain processing plants and distribution facilities and some gas-fired power plants. A liability for these asset retirement obligations will be recorded when a fair value is determinable.
Upon adoption of SFAS No. 143, Duke Energy's regulated electric and regulated natural gas operations classified removal and nuclear decommissioning costs for property that does not have an associated legal retirement obligation as a regulatory liability, in accordance with regulatory treatment. The total amount of removal and nuclear decommissioning costs included in Other Deferred Credits and Other Liabilities on the Consolidated Balance Sheets was $1,207 million as of December 31, 2003, which consisted of $1,190 million related to regulated electric operations and $17 million related to regulated natural gas operations. The total amount of removal and nuclear decommissioning costs included as a liability in Other Deferred Credits and Other Liabilities on the Consolidated Balance Sheets was $1,160 million as of December 31, 2002, which consisted of $1,139 million related to regulated electric operations and $21 million related to regulated natural gas operations.
SFAS No. 143 was effective for fiscal years beginning after June 15, 2002, and was adopted by Duke Energy on January 1, 2003. As of January 1, 2003, the implementation of SFAS No. 143 resulted in a net increase in total assets of $863 million, consisting primarily of an increase in net property, plant and equipment of $213 million and an increase in regulatory assets of $650 million. Liabilities increased by $874 million, primarily representing the establishment of an asset retirement obligation liability of $1,599 million, reduced by the amount that was already recorded as a nuclear decommissioning liability of $708 million. Substantially all of the obligations are related to Duke Energy's regulated electric operations. The adoption of SFAS No. 143 had no impact on the income of the regulated electric operations, as the effects were offset by the establishment of a regulatory asset and a regulatory liability pursuant to SFAS No. 71. Duke Energy has received approval from both the NCUC and PSCSC to defer all cumulative and future income statement impacts related to SFAS No. 143. For obligations related to non-regulated operations, a net-of-tax cumulative effect of a change in accounting principle adjustment of $11 million was recorded in the first quarter of 2003 as a reduction in earnings.
The following table shows the asset retirement obligation liability as though SFAS No. 143 had been in effect for the three prior years.
Pro forma Asset Retirement Obligation Liability
| (in millions) | ||||
|---|---|---|---|---|
| January 1, 2001 | $ | 1,374 | ||
| December 31, 2001 | 1,476 | |||
| December 31, 2002 | 1,599 | |||
The pro forma net income and related basic and diluted earnings per share effects of adopting SFAS No. 143 are not shown due to their immaterial impact.
The asset retirement obligation is adjusted each quarter for any liabilities incurred or settled during the period, accretion expense and any revisions made to the estimated cash flows.
Reconciliation of Asset Retirement Obligation Liability for the Year Ended December 31, 2003
| (in millions) | ||||
|---|---|---|---|---|
| Balance as of January 1, 2003 | $ | 1,599 |
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| Liabilities settled | (7) |
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| Accretion expense | 111 |
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| Revisions in estimated cash flows | (2) |
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| Foreign currency adjustment | 6 |
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| Balance as of December 31, 2003 | $ | 1,707 |
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Accretion expense for the year ended December 31, 2003 included approximately $106 million related to Duke Energy's regulated electric operations and has been deferred in accordance with SFAS No. 71 as discussed above. The fair value of assets legally restricted for the purpose of settling asset retirement obligations was $925 million as of December 31, 2003.
Nuclear Decommissioning Costs. Estimated site-specific nuclear decommissioning costs, including the cost of decommissioning plant components not subject to radioactive contamination, total approximately $1.9 billion in 1999 dollars, based on decommissioning studies completed in 1999 (studies are completed every five years). This includes costs related to Duke Energy's 12.5% ownership in the Catawba Nuclear Station. The other joint owners of the Catawba Nuclear Station are responsible for decommissioning costs related to their ownership interests in the station. Both the NCUC and the PSCSC have allowed Duke Energy to recover estimated decommissioning costs through retail rates over the expected remaining service periods of Duke Energy's nuclear stations.
The operating licenses for Duke Energy's nuclear units are subject to extension. In December 2003, Duke Energy was granted license renewals for the Catawba and McGuire Nuclear Stations. In 2000, Duke Energy was granted a license renewal for the Oconee Nuclear Station. The service period extension of the nuclear units will not impact depreciation or nuclear decommissioning rates unless justified by future depreciation and decommissioning studies, which will be filed with the NCUC and the PSCSC upon completion.
Current Operating Licenses for Duke Energy's Nuclear Units
| Unit | Expiration Year |
|---|---|
| McGuire 1 | 2041 |
| McGuire 2 | 2043 |
| Catawba 1 | 2043 |
| Catawba 2 | 2043 |
| Oconee 1 and 2 | 2033 |
| Oconee 3 | 2034 |
During 2003, Duke Energy expensed approximately $56 million and contributed $56 million of cash to external funds for decommissioning costs (external reserve) and expensed an additional $11 million to the internal funds for decommissioning costs (internal reserve). During 2002, Duke Energy expensed approximately $59 million, and contributed $56 million of cash to the external reserve and expensed an additional $9 million to the internal reserve. Nuclear units are currently depreciated at an annual rate of 4.7%, of which 1.61% is for decommissioning. The balance of the external reserve was $925 million as of December 31, 2003 and $708 million as of December 31, 2002. These amounts are reflected in the Consolidated Balance Sheets as Nuclear Decommissioning Trust Funds (asset).
On February 5, 2004, the NCUC issued an order requiring Duke Energy to transition the internal reserve to the external reserve over a ten-year period, beginning on January 1, 2008, with the annual transfer level at a minimum of 10% of the North Carolina internal reserve as of December 31, 2007, and with the actual transfer of funds occurring no later than December 31 of each calendar year beginning in 2008. The NCUC also ordered that as of December 31, 2007, there shall be no further funding of internal reserve and all future decommissioning requirements must be fully funded externally.
The external reserve is invested primarily in domestic and international equity securities, fixed-rate, fixed-income securities and cash and cash equivalents and is recorded at its fair value in the Consolidated Balance Sheets. Per Nuclear Regulatory Commission (NRC), PSCSC, NCUC, and Internal Revenue Service mandates, these funds may be used only for activities related to nuclear decommissioning. Those investments are exposed to price fluctuations in equity markets and changes in interest rates. Because the accounting for nuclear decommissioning recognizes that costs are recovered through Franchised Electric's rates, fluctuations in equity prices or interest rates do not affect consolidated results of operations or cash flows. Management believes that the decommissioning costs being recovered through rates, when coupled with expected fund earnings, are sufficient to provide for the cost of decommissioning.
A provision in the Energy Policy Act of 1992 established a fund for the decontamination and decommissioning of the DOE's uranium enrichment plants (the D&D Fund). Licensees are subject to an annual assessment for 15 years based on their pro rata share of past enrichment services. Lawsuits filed by Duke Energy and other utilities challenging the constitutionality of the D&D Fund have been dismissed. The annual assessment is recorded in the Consolidated Statements of Operations as Fuel Used in Electric Generation and Purchased Power. Duke Energy has paid $118 million into the fund, including $11 million during 2003. The remaining liability and regulatory assets of $33 million as of December 31, 2003 and $44 million as of December 31, 2002 are reflected in the Consolidated Balance Sheets as Deferred Credits and Other Liabilities, and Regulatory Assets and Deferred Debits.