GAAP Results
The first quarter 2009 reported net income included $663 million (after tax) in unrealized commodity-related mark-to-market net gains that reflected the impact of lower forward natural gas prices on positions in Energy Future’s long-term hedging program (discussed further below) and $134 million (after tax) in unrealized mark-to-market net gains on interest rate swaps entered into to hedge variable interest rate expense. These items were partially offset by a noncash impairment charge of $90 million resulting from the completion of the fair value calculation supporting the goodwill impairment charge that was recorded in the fourth quarter of 2008.
The first quarter 2008 reported net loss included $1.026 billion (after tax) in unrealized mark-to-market net losses largely related to the long-term hedging program.
Adjusted (non-GAAP) Operating Results
For the first quarter 2009, adjusted (non-GAAP) operating results totaled a net loss of $265 million compared to a net loss of $243 million for the first quarter 2008. The $22 million decrease includes a $12 million effect of net income attributable to noncontrolling interests, reflecting the sale of an approximate 20 % interest of Oncor’s equity in November 2008, as well as a $27 million decrease in the operating results of the regulated business, partially offset by a $17 million increase in the operating results of the competitive business.
Key drivers of the $27 million decrease in earnings of the regulated business included the effects of milder weather and the weaker economy on revenues, as well as higher transmission and other operating costs. In addition, higher interest expense reflected borrowings to support growth and increased interest rates due to the refinancing of short-term borrowings with long-term debt in September 2008.
The principal driver of the $17 million increase in earnings of the competitive business was an around $45 million improvement in contribution margin reflecting a reduction in amortization of intangible assets arising from purchase accounting, higher margin from asset management activities, lower purchased power costs incurred during plant outages and higher nuclear-fueled generation that offset the effects of lower coal-fueled generation. Offsetting drivers to the increase in contribution margin included higher retail system transition and bad debt expenses, as well as higher maintenance costs associated with coal-fueled generation plant outages, all totaling $13 million, and increased interest expense of $13 million reflecting increased amortization of interest rate hedge losses.
Long-Term Hedging Program
The Energy Future’s long-term hedging program is designed to reduce exposure to changes in future electricity prices due to changes in the price of natural gas. Under the program, subsidiaries of Energy Future have entered into market transactions involving natural gas-related financial instruments. As of March 31, 2009, these subsidiaries have effectively sold forward around 1.9 billion MMBtu of natural gas (equivalent to the natural gas exposure of approximately 240,000 GWh at an assumed 8.0 market heat rate) over the period from 2009 to 2014 at average annual sales prices ranging from $7.20 per MMBtu to $8.05 per MMBtu. These forward sales include related put and call transactions (referred to as collars), primarily in the outer years of the program, that effectively hedge natural gas prices within a range. Collars represented around 5% of the positions in the program at March 31, 2009, with the approximate weighted average strike prices under the collars being a floor of $7.80 per MMBtu and a ceiling of $11.75 per MMBtu. For the five-year period from April 1, 2009 to March 31, 2014, and taking into consideration the estimated portfolio impacts of forward retail and wholesale power sales, the hedging transactions result in Energy Future having effectively hedged around 79% of its expected baseload generation natural gas price exposure for such period (on an average basis for such period and assuming an 8.0 market heat rate).
Based on the size of the long-term hedging program as of March 31, 2009, a $1.00/MMBtu change in natural gas prices across the period from 2009 through 2014 would result in the recognition by Energy Future of up to around $1.9 billion in pretax unrealized mark-to-market gains or losses. Significant effects of changes in forward natural gas prices are reflected in net income (GAAP) as discussed above. Reported unrealized mark-to-market net gains (pre tax) associated with the long-term hedging program totaled $1.1 billion for the first quarter 2009, reflecting declines in forward natural gas prices. Given the volatility of natural gas prices, it is not possible to predict future reported unrealized mark-to-market net gains or losses and the actual net gains or losses that will ultimately be realized upon settlement of the hedge positions in future years. If natural gas prices at settlement are lower than the prices of the hedge positions, the hedges are expected to mitigate the otherwise negative effect on earnings of lower wholesale electricity prices. However, if natural gas prices at settlement are higher than the prices of the hedge positions, the hedges are expected to dampen the otherwise positive effect on earnings of higher wholesale electricity prices and will in this context be viewed as having resulted in an opportunity cost. The cumulative unrealized mark-to-market net gains/(losses) related to positions in the long-term hedging program totaled a net gain (pre-tax) of $2.0 billion and $871 million at March 31, 2009 and December 31, 2008, respectively.
