Richard B. Priory
Chairman of the Board
Chief Executive Officer

WHAT HAPPENED IN 2002?

The young merchant energy sector, which had enjoyed an enormous upswing in previous years, experienced its first major down cycle in 2002. The turn was stunning, swift and severe.

Some regions that had capacity shortfalls just a year ago experienced a rapid upsurge in supply. We had focused on the development activities of large, established generators, but we underestimated the build-out efforts of some smaller local and regional energy merchants. Rapid additions to generating capacity, coupled with the extended economic downturn, resulted in a sharp decline in power margins and volatility.

In the wake of the Enron bankruptcy, credit rating agencies focused more intently on cash and coverage ratios for all companies, but particularly for the energy sector. As business conditions worsened, companies faced enormous increases in their capital costs, and in many cases were shut out of the capital markets. The dramatic credit decline of many energy customers and wholesale market participants reduced the size, length and volume of energy transactions in the marketplace.

Finally, regulatory uncertainty, changes in accounting standards and securities laws, investigations and litigation further discouraged investment and confidence in our sector. Moreover, this occurred in the context of an alarming crisis of trust in business in general, brought on by accounting missteps and improprieties, allegations of business scandals and growing skepticism about the effectiveness of corporate governance.

All of these factors converged to create dramatic changes in the energy marketplace, and to substantially reduce the earnings opportunity for our merchant energy businesses Duke Energy North America (DENA) and Duke Energy International (DEI). Our total reported earnings before interest and taxes (EBIT) of $2.87 billion fell $1.39 billion short of 2001 EBIT of $4.26 billion. Ongoing 2002 EBIT (excluding one-time charges) was $3.62 billion, compared to $4.34 billion in 2001 – primarily due to substantially lower results at DENA.