| SOUTHERN UNION CO ITEM 1A Risk Factors The risks and uncertainties described below are not the only ones faced by the Company |
| Additional risks and uncertainties that it is unaware of, or that it currently deems immaterial, also may become important factors that affect it |
| If any of the following risks occur, the Company’s business, financial condition or results of operations could be materially and adversely affected |
| RISKS THAT RELATE TO SOUTHERN UNION Southern Union has substantial debt and depends on its ability to access the capital markets |
| Southern Union has a significant amount of debt outstanding |
| As of December 31, 2005, consolidated debt on the Consolidated Balance Sheet totaled dlra2dtta60 billion outstanding compared to total capital (long and short-term debt plus stockholders &apos equity) of dlra4dtta45 billion |
| The Company issued dlra1dtta6 billion of debt in connection with the initial financing of its March 1, 2006 acquisition of Sid Richardson Energy Services, Ltd |
| Such acquisition will be repaid with the proceeds from asset sales and the issuance of debt and/or equity |
| Some of the Company’s debt obligations contain financial covenants related to debt-to-capital ratios and interest coverage ratios |
| The Company’s failure to comply with any of these covenants could result in an event of default which, if not cured or waived, could result in the acceleration of outstanding debt obligations or render the Company unable to borrow under certain credit agreements |
| Any such acceleration would cause a material adverse change in the Company’s financial condition |
| The Company relies on access to both short-term and long-term credit as a significant source of liquidity for capital requirements not satisfied by the cash flow from its operations |
| Any worsening of the Company’s financial condition or a material decrease in its common stock price could hamper its ability to access the credit markets |
| External events also could increase the Company’s cost of borrowing or adversely affect its ability to access the capital markets |
| Further, because of the need for certain state regulatory approvals in order to incur debt and issue capital stock, the Company may not be able to access the capital markets on a timely basis |
| Restrictions on the Company’s ability to access capital markets could affect its ability to execute its business plan or limit its ability to pursue improvements or acquisitions on which it may otherwise rely for future growth |
| Credit ratings downgrades would increase the Company’s financing costs and limit its ability to access the capital markets |
| As of December 31, 2005, Southern Union’s debt, including Panhandle Energy’s debt, is currently rated Baa3 by Moodyapstas Investor Services, Inc, BBB by Standard & Poorapstas and BBB by Fitch Ratings |
| If its current credit ratings are downgraded below investment grade or if there are times when it is placed on "e credit watch, "e both borrowing costs and the costs of maintaining certain contractual relationships could increase |
| Lower credit ratings could also adversely affect relationships with state regulators, who may be unwilling to allow the Company to pass along increased funding costs to natural gas customers |
| 20 _________________________________________________________________ [42]Table of Contents The Company’s growth strategy entails risk for investors |
| The Company intends actively to pursue acquisitions in the energy industry to complement and diversify its existing businesses |
| As part of its growth strategy, Southern Union may: · examine and potentially acquire regulated or unregulated businesses, including transportation and storage assets and gathering and processing businesses within the natural gas industry; · enter into joint venture agreements and/or other transactions with other industry participants or financial investors; · selectively divest parts of its business, including parts of its core operations; and · continue expanding its existing operations |
| The Company’s ability to acquire new businesses will depend upon the extent to which opportunities become available, as well as, among other things: · its success in bidding for the opportunities; · its ability to assess the risks of the opportunities; · its ability to obtain regulatory approvals on favorable terms; and · its access to financing on acceptable terms |
| Once acquired, the Company’s ability to successfully integrate a new business into its existing operations will depend on the adequacy of implementation plans, including the ability to identify and retain employees to manage the acquired business, and the ability to achieve desired operating efficiencies |
| The successful integration of any businesses acquired in the future will entail numerous risks, including, among others: · the risk of diverting managementapstas attention from day-to-day operations; · the risk that the acquired businesses will require substantial capital and financial investments; · the risk that the investments will fail to perform in accordance with expectations; and · the risk of substantial difficulties in the transition and integration process |
| These factors could have a material adverse effect on the Company’s business, financial condition, results of operations and cash flows, particularly in the case of a larger acquisition or multiple acquisitions in a short period of time |
| Additionally, if the Company expands its existing operations, the success of any such expansion is subject to substantial risk and may expose the Company to significant costs |
| The Company cannot assure that its development or construction efforts will be successful |
| The consideration paid in connection with an investment or acquisition also affects the Company’s financial results |
| To the extent it issues shares of capital stock or other rights to purchase capital stock, including options or other rights, existing stockholders may be diluted and earnings per share may decrease |
| In addition, acquisitions or expansions may result in the incurrence of additional debt |
| The Company depends on distributions from its subsidiaries and joint ventures to meet its needs |
| The Company is dependent on the earnings and cash flows of, and dividends, loans, advances or other distributions from, its subsidiaries and joint ventures to generate the funds necessary to meet its obligations |
| The availability of distributions from such entities is subject to their earnings and capital requirements, the satisfaction of various covenants and conditions contained in financing documents by which they are bound or in their organizational documents, and in the case of the regulated subsidiaries, regulatory restrictions that limit their ability to distribute profits to Southern Union |
| The Company does not own 100 percent of CCE Holdings, and CCE Holdings in turn does not own 100 percent of Citrus, both of which require 100 percent owner consent for distributions |
| As such, the Company cannot control or guarantee the receipt of distributions from either entity |
| The Company’s operations are subject to all operating hazards and risks incident to handling, storing, transporting and providing customers with natural gas, including explosions, pollution, release of toxic substances, fires and other hazards, each of which could result in damage to or destruction of its facilities or damage to persons and property |
| If any of these events were to occur, the Company could suffer substantial losses |
| Moreover, as a result, the Company has been, and likely will be, a defendant in legal proceedings and litigation arising in the ordinary course of business |
| Although the Company maintains insurance coverage, such coverage may not be adequate to protect the Company from all material expenses related to these risks |
| The Company is subject to extensive federal, state and local laws and regulations regulating the environmental aspects of its business that may increase its costs of operation, expose it to environmental liabilities and require it to make material unbudgeted expenditures |
| The Company is subject to extensive federal, state and local laws and regulations regulating the environmental aspects of its business (including air emissions) |
| These laws and regulations are complex and have tended to become increasingly strict over time |
| These laws and regulations have necessitated, and in the future may necessitate, increased capital expenditures and operating costs |
| In addition, certain environmental laws can impose liability without regard to fault concerning contamination at a broad range of properties, including those currently or formerly owned, leased or operated properties and properties where the Company disposed of, or arranged for the disposal of, waste |
| The Company is currently monitoring or remediating contamination at a number of its facilities and at third party waste disposal sites pursuant to environmental laws and regulations and indemnification agreements |
| The Company cannot predict with certainty the sites for which it may be responsible, the amount of resulting cleanup obligations that may be imposed on it or the amount and timing of future expenditures related to environmental remediation because of the difficulty of estimating cleanup costs and the uncertainty of payment by other potentially responsible parties |
| Costs and obligations also can arise from claims for toxic torts and natural resource damages or from releases of hazardous materials on other properties as a result of ongoing operations or disposal of waste |
| Compliance with amended, new or more stringently enforced existing environmental requirements, or the future discovery of contamination, may require material unbudgeted expenditures |
| These costs or expenditures could have a material adverse effect on the Company’s business, financial condition or results of operations, particularly if such costs or expenditures are not fully recoverable from insurance or through the rates charged to customers or if they exceed any amounts that have been reserved |
| The US EPA recently modified environmental regulations applicable to its Spill Prevention, Control and Countermeasures (SPCC) program |
| The Company is currently reviewing the impact of these modifications to its operations and expects to expend resources on tank integrity and any associated corrective actions as well as potential upgrades to containment structures |
| Costs associated with tank integrity testing and resulting corrective actions cannot reasonably be estimated at this time |
| Terrorist attacks, such as the attacks that occurred on September 11, 2001, have resulted in increased costs, and the consequences of the War on Terror and the Iraq conflict may adversely impact the Company’s results of operations |
| The impact that terrorist attacks, such as the attacks of September 11, 2001, may have on the energy industry in general, and on the Company in particular, is not known at this time |
| Uncertainty surrounding military activity may affect the Company’s operations in unpredictable ways, including disruptions of fuel supplies and markets and the possibility that infrastructure facilities, including pipelines, LNG facilities, gathering facilities and processing plants, could be direct targets of, or indirect casualties of, an act of terror or a retaliatory strike |
| The Company may have to incur significant additional costs in the future to safeguard its physical assets |
| 22 _________________________________________________________________ [44]Table of Contents The Internal Revenue Service may challenge the like-kind exchange treatment the Company has taken or expects to take |
| Effective January 1, 2003, the Company consummated the sale of its Texas Operations to ONEOK for approximately dlra437 million |
| The sale of the Texas Operations and the acquisition of Panhandle Energy were structured in a manner intended to qualify as a like-kind exchange of property under Section 1031 of the IRC If like-kind exchange treatment were not to apply to these transactions, most of the tax gain realized with respect to the sale of the Texas Operations would be recognized currently |
| The like-kind exchange rules of the Internal Revenue Code are highly complex and their application to the sale of the Texas Operations and the Panhandle Energy acquisition is not entirely clear |
| If the Internal Revenue Service successfully denied the benefits of Section 1031 to the sale of the Texas Operations and the Panhandle Energy acquisition, the Company could be required to pay approximately dlra90 million of additional income tax (before any interest or penalty) for the 2003 taxable year |
| Under such circumstances, the Company expects that it would be entitled over time to additional depreciation deductions with respect to the Panhandle Energy assets as a result of the higher tax basis in such assets that would exist if the benefits of Section 1031 were not available |
| Similarly, the Company has structured the sale of the assets of its PG Energy division, the sale of the Rhode Island operations of the New England Gas Company division and the acquisition of the Sid Richardson Energy Services business in a manner intended to qualify as a like-kind exchange of property under Section 1031 of the IRC The Company is currently in the process of analyzing the potential like-kind exchange treatment of these assets to determine the amount of the potential tax deferral |
| RISKS THAT RELATE TO THE COMPANY’S TRANSPORTATION AND STORAGE BUSINESS The Company’s transportation and storage business is highly regulated |
| The Company’s transportation and storage business is subject to regulation by federal and state regulatory authorities |
| FERC, the US Department of Transportation and various state and local regulatory agencies regulate the interstate pipeline business |
| In particular, FERC regulates services provided and rates charged by Panhandle Energy, Transwestern and Florida Gas |
| In addition, the US Coast Guard has oversight over certain issues related to the importation of LNG The Company’s rates and operations are subject to regulation by federal regulators as well as the actions of the Congress and state legislatures and, in some respects, state regulators |
| The Company cannot predict or control what effect future actions of regulatory agencies may have on its business or its access to the capital markets |
| Furthermore, the nature and degree of regulation of natural gas companies has changed significantly during the past 25 years and there is no assurance that further substantial changes will not occur or that existing policies and rules will not be applied in a new or different manner |
| Should new regulatory requirements regarding the security of its pipeline system or new accounting treatment for certain entities be imposed, the Company could be subject to additional costs that could adversely affect its business, financial condition and results of operations if these costs are deemed unrecoverable in rates |
| The pipeline businesses are subject to competition |
| The interstate pipeline businesses of Panhandle Energy and CCE Holdings compete with those of other interstate and intrastate pipeline companies in the transportation and storage of natural gas |
| The principal elements of competition among pipelines are rates, terms of service and the flexibility and reliability of service |
| Natural gas competes with other forms of energy available to the Company’s customers and end-users, including electricity, coal and fuel oils |
| The primary competitive factor is price |
| Changes in the availability or price of natural gas and other forms of energy, the level of business activity, conservation, legislation and governmental regulations, the capability to convert to alternate fuels and other factors, including weather and natural gas storage levels, affect the demand for natural gas in the areas served by Panhandle Energy and CCE Holdings |
| 23 _________________________________________________________________ [45]Table of Contents The success of the pipeline businesses depends, in part, on factors beyond the Company’s control |
| Third parties own most of the natural gas transported and stored through the pipeline systems operated by Panhandle Energy and CCE Holdings |
| As a result, the volume of natural gas transported and stored depends on the actions of those third parties and is beyond the Company’s control |
| Further, the following factors, most of which also are beyond the Company’s control, may unfavorably impact its ability to maintain or increase current transmission and storage rates, to renegotiate existing contracts as they expire or to remarket unsubscribed capacity: · future weather conditions, including those that favor alternative energy sources; · the market price of natural gas; · price competition; · drilling activity and supply availability; · the expiration of significant contracts; · service area competition; and · regulatory actions |
| The success of the pipelines depends on the continued development of additional natural gas reserves in the vicinity of their facilities and their ability to access additional reserves to offset the natural decline from existing wells connected to their systems |
| The amount of revenue generated by Panhandle Energy and CCE Holdings depends substantially upon the volume of natural gas they transport |
| As the reserves available through the supply basins connected to the Panhandle Energy and CCE Holdings systems naturally decline, a decrease in development or production activity could cause a decrease in the volume of natural gas available for transmission |
| Investments by third parties in the development of new natural gas reserves connected to the Company’s facilities depend on many factors beyond the control of the Company |
| Fluctuations in energy commodity prices could adversely affect the pipeline businesses |
| If natural gas prices in the supply basins connected to the pipeline systems of Panhandle Energy and CCE Holdings are higher than prices in other natural gas producing regions, especially Canada, the volume of gas transported by the Company may be negatively impacted |
| The pipeline businesses are dependent on a small number of customers for a significant percentage of their sales |
| Panhandle Energy’s top four customers accounted for 52 percent of its 2005 revenue |
| Transwestern’s top three customers accounted for 49 percent of its 2005 revenue |
| Florida Gas’ top two customers accounted for 58 percent of its 2005 revenue |
| The loss of any one or more of these customers could have a negative adverse effect on the Company’s business, financial condition or results of operation |
| The pipeline revenues are generated under contracts that must be renegotiated periodically |
| The pipeline revenues of Panhandle Energy and CCE Holdings are generated under natural gas transportation contracts that expire periodically and must be replaced approximately every three years, on average |
| Although the Company will actively pursue the renegotiation, extension and/or replacement of all of its contracts, it cannot assure that Panhandle Energy and CCE Holdings will be able to extend or replace these contracts when they expire or that the terms of any renegotiated contracts will be as favorable as the existing contracts |
| If Panhandle Energy and CCE Holdings are unable to renew, extend or replace these contracts, or if Panhandle Energy and CCE Holdings renew them on less favorable terms, the Company may suffer a material reduction in revenues and earnings |
| 24 _________________________________________________________________ [46]Table of Contents The Company is exposed to the credit risk of its transportation and storage customers in the ordinary course of business |
| Transportation service contracts obligate customers to pay charges for reservation of capacity, or reservation charges, regardless of whether they transport natural gas on the pipeline system |
| As a result, the Company’s profitability will depend upon the continued financial performance and creditworthiness of its customers rather than just upon the amount of capacity provided under service contracts |
| Generally, customers are rated investment grade or, as permitted by the Company’s tariff, are required to make pre-payments or deposits, or to provide collateral, if their creditworthiness is questionable |
| Nevertheless, the Company cannot predict to what extent future declines in customers &apos creditworthiness may negatively impact its business |
| Substantial risks are involved in operating a natural gas pipeline system |
| Numerous operational risks are associated with the operation of a complex pipeline system |
| These include adverse weather conditions, accidents, the breakdown or failure of equipment or processes, the performance of pipeline facilities below expected levels of capacity and efficiency, the collision of equipment with pipeline facilities (such as may occur if a third party were to perform excavation or construction work near the facilities) and catastrophic events such as explosions, fires, earthquakes, floods, landslides, hurricanes, lightning or other similar events beyond the Company’s control |
| It is also possible that infrastructure facilities could be direct targets or indirect casualties of an act of terror |
| A casualty occurrence might result in injury or loss of life, extensive property damage or environmental damage |
| Insurance proceeds may not be adequate to cover all liabilities or expenses incurred or revenues lost |
| The inability to continue to access Tribal lands could adversely affect the Company’s ability to operate its pipeline system and the inability to recover the cost of right-of-way grants on tribal lands could adversely affect its financial results |
| The Company’s ability to operate its pipeline system on certain Tribal lands (lands held in trust by the United States for the benefit of a Native American Tribe) will depend on its success in maintaining existing rights-of-way and obtaining new rights-of-way on those Tribal lands |
| Securing additional rights-of-way is also critical to the Company’s ability to pursue expansion projects including Transwesternapstas proposed expansion of its San Juan lateral in New Mexico |
| The Company cannot assure that it will be able to acquire new rights-of-way on Tribal lands or maintain access to existing rights-of-way upon the expiration of the current grants |
| The Company’s financial position could be adversely affected if the costs of new or extended right-of-way grants cannot be recovered in rates |
| The Company’s assets and operations can be affected by weather and other natural phenomena |
| The Company’s pipeline system, especially those portions that are located offshore, are subject to adverse weather conditions including hurricanes, earthquakes, tornadoes, extreme temperatures and other natural phenomena, making it more difficult for the Company to realize the historic rates of return associated with these assets and operations |
| RISKS THAT RELATE TO THE COMPANY’S DISTRIBUTION BUSINESS The distribution business is highly regulated |
| The Company’s distribution business is subject to regulation by state regulatory authorities |
| The distribution business is regulated by the MPSC, the PPUC, the RIPUC and the MDTE These authorities regulate many aspects of the distribution operations, including construction and maintenance of facilities, operations, safety, the rates that can be charged customers and the maximum rates of return that the Company is allowed to realize |
| The ability to obtain rate increases and rate supplements to maintain the current rate of return depends upon regulatory discretion |
| 25 _________________________________________________________________ [47]Table of Contents The distribution business’ operating results and liquidity needs are seasonal in nature and can fluctuate based on weather conditions and natural gas prices |
| The gas distribution business is a seasonal business and is subject to weather conditions |
| A significant percentage of annual revenues and earnings occur in the traditional winter heating season when demand for natural gas usually increases due to colder weather conditions |
| The business is also subject to seasonal and other variations in working capital due to changes in natural gas prices and the fact that customers pay for the natural gas delivered to them after they use it, whereas the business is required to pay for the natural gas before delivery |
| The Rhode Island gas distribution business, which accounted for approximately 22 percent of the Company’s revenues for the year ended December 31, 2005, is the only region in which the Company operates a distribution business that benefits from weather normalization tariffs |
| As a result, fluctuations in weather between years may have a significant effect on results of operations and cash flows |
| In years with warm winters, revenues may be adversely affected |
| The Company’s revenues, operating results and financial condition may fluctuate with the distribution business’ ability to achieve timely and effective rate relief from state regulators |
| The distribution business is influenced by fluctuations in costs, including operating costs such as insurance, postretirement and other benefit costs, wages, changes in the provision for the allowance for doubtful accounts associated with volatile natural gas costs and other operating costs |
| The profitability of regulated operations depends on the business’ ability to pass through to its customers costs related to providing them service |
| To the extent that such operating costs increase in an amount greater than that for which rate recovery is allowed, this differential could impact operating results until the business files for and is allowed an increase in rates |
| The lag between an increase in costs and the rate relief obtained from the regulators can have a direct negative impact on operating results |
| As with any request for an increase in rates in a regulatory filing, once granted, the rate increase may not be adequate |
| In addition, regulators may prevent the business from passing along some costs in the form of higher rates |
| CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS The disclosure and analysis in this Form 10-K contains some forward-looking statements that set forth anticipated results based on management’s plans and assumptions |
| From time to time, Southern Union also provides forward-looking statements in other materials it releases to the public as well as oral forward-looking statements |
| Such statements give the Company’s current expectations or forecasts of future events; they do not relate strictly to historical or current facts |
| Southern Union has tried, wherever possible, to identify such statements by using words such as “anticipate,” “estimate,” “expect,” “project,” “intend,” “plan,” “believe,” “will” and similar expressions in connection with any discussion of future operating or financial performance |
| In particular, these include statements relating to future actions, future performance or results of current and anticipated products, expenses, interest rates, the outcome of contingencies, such as legal proceedings, and financial results |
| Southern Union cannot guarantee that any forward-looking statement will be realized, although management believes that the Company has been prudent in its plans and assumptions |
| Achievement of future results is subject to risks, uncertainties and potentially inaccurate assumptions |
| If known or unknown risks or uncertainties should materialize, or if underlying assumptions should prove inaccurate, actual results could differ materially from past results and those anticipated, estimated or projected |
| Readers should bear this in mind as they consider forward-looking statements |
| Southern Union undertakes no obligation publicly to update forward-looking statements, whether as a result of new information, future events or otherwise |
| Readers are advised, however, to consult any further disclosures the Company makes on related subjects in its 10-Q and 8-K reports to the SEC Also note that Southern Union provides the following cautionary discussion of risks, uncertainties and possibly inaccurate assumptions relevant to its businesses |
| These are factors that, individually or in the aggregate, management thinks could cause the Company’s actual results to differ materially from expected and historical results |
| Southern Union notes these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995 |
| Readers should understand that it is not possible to predict or identify all such factors |
| Consequently, readers should not consider the following to be a complete discussion of all potential risks or uncertainties |
| Factors that could cause actual results to differ materially from those expressed in the Company’s forward-looking statements include, but are not limited to, the following: · changes in demand for natural gas by the Company’s customers, in the composition of the Company’s customer base and in the sources of natural gas available to the Company; · the effects of inflation and the timing and extent of changes in the prices and overall demand for and availability of natural gas as well as electricity, oil, coal and other bulk materials and chemicals; · adverse weather conditions, such as warmer than normal weather in the Company’s service territories, and the operational impact of natural disasters such as Hurricanes Katrina and Rita; · changes in laws or regulations, third-party relations and approvals, decisions of courts, regulators and governmental bodies affecting or involving Southern Union, including deregulation initiatives and the impact of rate and tariff proceedings before FERC and various state regulatory commissions; · the speed and degree to which additional competition is introduced to Southern Union’s business and the resulting effect on revenues; · the outcome of pending and future litigation; · the Company’s ability to comply with or to challenge successfully existing or new environmental regulations; · unanticipated environmental liabilities; · risks relating to Southern Union’s recent acquisition of the Sid Richardson Energy Services business, including without limitation, the Company’s increased indebtedness resulting from that acquisition; · risks relating to the completion of Southern Union’s pending divestitures of PG Energy and the Rhode Island assets of New England Gas Company; · the Company’s ability to acquire new businesses and assets and integrate those operations into its existing operations, as well as its ability to expand its existing businesses and facilities; · the Company’s ability to control costs successfully and achieve operating efficiencies, including the purchase and implementation of new technologies for achieving such efficiencies; · the impact of factors affecting operations such as maintenance or repairs, environmental incidents, gas pipeline system constraints and relations with labor unions representing bargaining-unit employees; · exposure to customer concentration with a significant portion of revenues realized from a relatively small number of customers and any credit risks associated with the financial position of those customers; · changes in the ratings of the debt securities of Southern Union or any of its subsidiaries; · changes in interest rates and other general capital markets conditions, and in the Company’s ability to continue to access the capital markets; · acts of nature, sabotage, terrorism or other acts causing damage greater than the Company’s insurance coverage limits; · market risks beyond the Company’s control affecting its risk management activities including market liquidity, commodity price volatility and counterparty creditworthiness; and · other risks and unforeseen events |