CURRENT ISSUES

Print

Electric Competition. Wholesale Competition. The Energy Policy Act of 1992 and the FERC’s subsequent rulemaking activities opened the wholesale energy market to competition. Open-access transmission for wholesale customers, as defined by the FERC’s rules, provides energy suppliers, including Duke Energy, with opportunities to sell and deliver capacity and energy at market-based prices. From the FERC’s open-access rule, Franchised Electric obtained the rights to sell capacity and energy at market-based rates from its own assets, which also allows Franchised Electric to purchase, at attractive rates, a portion of its capacity and energy requirements resulting in lower overall costs to customers. Open access also provides Franchised Electric’s existing wholesale customers with competitive opportunities to seek other suppliers for their capacity and energy requirements.

In 1999 and 2000, the FERC issued its Order 2000 and Order 2000-A regarding Regional Transmission Organizations (RTOs). These orders set minimum characteristics and functions RTOs must meet, including independent authority to establish the terms and conditions of transmission service over the facilities they control. The orders provide for an open and flexible RTO structure to meet the needs of the market, and for the possibility of incentive ratemaking and other benefits for transmission owners that participate.

As a result of these rulemakings, Duke Power and the franchised electric units of two other investor-owned utilities, Progress Energy (formerly known as Carolina Power & Light Company) and South Carolina Electric & Gas Company, planned to establish GridSouth Transco, LLC (GridSouth), as an RTO responsible for the functional control of the companies’ combined transmission systems. As of December 31, 2002, Duke Energy had invested $37 million in GridSouth, including carrying costs. This amount is included in Other Regulatory Assets and Deferred Debits on the Consolidated Balance Sheets. The sponsors expected that GridSouth would be substantially operational by the FERC’s Order 2000 “deadline” date of December 15, 2001. In March 2001, GridSouth received provisional approval from the FERC. However, in July 2001 the FERC ordered GridSouth and other utilities in the Southeast to join in a mediation to negotiate terms of a southeastern RTO. It does not appear that the FERC will issue an order specifically based on that proceeding. In 2002, the GridSouth sponsors withdrew their applications to the NCUC and the PSCSC for approval of the transfer of functional control of their electric transmission assets to GridSouth, and announced that development of the GridSouth implementation project had been suspended until the sponsors have an opportunity to further consider regulatory circumstances and the outcome of initiatives such as the FERC’s Notice of Proposed Rulemaking (NOPR) on Standard Market Design (SMD) and the RTO cost/benefit study initiated by the Southeastern Association of Regulatory Utility Commissioners (SEARUC). The SEARUC cost/benefit study, issued in November 2002, states that under most scenarios neither RTOs nor SMDs provide net benefits to retail customers in the Southeast over the next few years. The final rule from the SMD NOPR is not expected to be issued until after July 2003. Duke Energy believes that more open wholesale electric markets will at some point provide benefits to consumers and other market participants. Duke Energy continues to examine its specific options relative to RTOs in light of the existing complex regulatory environment. Management believes its investment in GridSouth is probable of recovery.

Retail Competition. Currently, Franchised Electric operates as a vertically integrated, investor-owned utility with exclusive rights to supply electricity in a franchised service territory – a 22,000-square-mile service territory in North and South Carolina. In its retail business, the NCUC and the PSCSC regulate Franchised Electric’s service and rates. Any future implementation of retail deregulation or competition will likely impact all entities owning electric generating assets. Beginning in the late 1990’s, the NCUC and the PSCSC studied the merits of restructuring the electric utility industry in North and South Carolina respectively. In 1997, North Carolina passed a bill that established a study commission, including legislators, customers, utilities and a member of an environmental group, to examine whether competition should be implemented in the state. In 2000, the North Carolina study commission unanimously approved a set of recommendations on electric restructuring and submitted a report containing these recommendations to the General Assembly. Among other things, the North Carolina report recommended retail deregulation beginning partially in 2005 and fully in 2006. However, legislation required to implement such recommendations was never introduced. In South Carolina, the South Carolina Senate established the Restructuring Task Force and the South Carolina House designated the Subcommittee on Utility Deregulation. Definitive dates for implementing retail deregulation were contemplated, but not established in South Carolina. There is currently no movement in South Carolina’s General Assembly to move forward with the implementation of retail deregulation.

Currently, the electric utility industry is predominantly regulated on a basis designed to recover the cost of providing electric power to customers. If cost-based regulation were to be discontinued in the industry for any reason, including competitive pressure on the cost-based prices of electricity, profits could be reduced and electric utilities might be required to reduce their asset balances to reflect a market basis less than cost. Discontinuance of cost-based regulation would also require affected utilities to write-off their associated regulatory assets. Duke Energy’s regulatory assets are included in the Consolidated Balance Sheets and the portion of these regulatory assets related to Franchised Electric is approximately $1.0 billion, including primarily purchased capacity costs, deferred debt expense and deferred taxes related to regulatory assets. Duke Energy is recovering substantially all of these regulatory assets through its current wholesale and retail electric rates and may attempt to continue to recover these assets during any future transition to competition. In addition, Duke Energy would seek to recover the costs of its electric generating facilities in excess of the market price of power at the time of any future transition to competition.

Today, the pace of electricity restructuring varies quite substantially across the U.S. Duke Energy is actively engaged in most markets, particularly those in which it owns assets. Duke Energy continues to believe that wholesale competitive markets bring added value to consumers; therefore, Duke Energy supports the continued restructuring of wholesale electric markets through a disciplined, prudent transition to regional markets. Transforming the current regulated industry into efficient, competitive wholesale and retail electric markets is a complex undertaking, and will continue to require careful planning and coordination between federal and state regulators and other key stakeholders. The key to effective competition is fairness among customers, service providers and investors. Duke Energy intends to continue to work with customers, legislators and regulators to address all the important issues. Management currently cannot predict the impact, if any, of these competitive forces on future consolidated results of operations, cash flows or financial position.

Natural Gas Competition. Wholesale Competition. In 2000, the FERC issued Order 637, which revised its regulations for the intended purpose of improving the competitiveness and efficiency of natural gas markets. Order 637 effects changes in capacity segmentation, rights of first refusal (ROFR), scheduling procedures, as well as various reporting requirements intended to provide more transparent pricing information and permit more effective monitoring of the market. The FERC also required each interstate pipeline to submit individual compliance filings to implement the requirements of Order 637. Several parties, including Duke Energy, filed appeals in the District of Columbia Court of Appeals seeking court review of various aspects of Order 637, including (i) the right of customers to segment their capacity rights in a manner that would allow both a forwardhaul and a backhaul transportation transaction to a single delivery point, and (ii) the ROFR granted to existing customers the right to extend contracts beyond the end of the contract’s primary term. In 2002, the District of Columbia Court of Appeals generally affirmed the Order but remanded certain issues to the FERC for further disposition, including the forwardhaul/backhaul and ROFR issues. These matters are still under review by the FERC. In addition to the Order 637 general rulemaking proceeding, Duke Energy’s interstate pipelines made individual tariff filings to comply with the requirements of Order 637. These individual compliance proceedings are in different stages of the review approval and implementation process before the FERC. Management believes that the implementation of Order 637 will have no material adverse effect on Duke Energy’s future consolidated results of operations, cash flows or financial position.

In addition, the FERC is continually proposing and implementing new rules and regulations affecting those segments of the natural gas industry, most notably interstate natural gas transmission companies that remain subject to the FERC’s jurisdiction. These initiatives may also affect the intrastate transportation of gas under certain circumstances. The stated purpose of these regulatory changes is to promote competition among the various sectors of the natural gas industry and these initiatives generally reflect more light-handed regulation of the natural gas industry.

Retail Competition. Changes in regulation to allow retail competition could affect Duke Energy’s natural gas transportation contracts with local natural gas distribution companies. Since natural gas retail deregulation is in the very early stages of development, management believes the effects of this matter will have no material adverse effect on Duke Energy’s future consolidated results of operations, cash flows or financial position.