ST. JOHN–S, NEWFOUNDLAND AND LABRADOR — (Marketwire) — 07/31/12 — Fortis Inc. (“Fortis” or the “Corporation”) (TSX: FTS) achieved second quarter net earnings attributable to common equity shareholders of $62 million, or $0.33 per common share, compared to $57 million, or $0.32 per common share, for the second quarter of 2011. For the first half of 2012, net earnings attributable to common equity shareholders were $183 million, or $0.97 per common share, compared to $173 million, or $0.98 per common share, for the first half of last year.
Performance for the quarter was driven by FortisAlberta and higher non-regulated hydroelectric generation, partially offset by increased corporate costs. A 7% increase in the weighted average number of common shares outstanding quarter over quarter, largely associated with the issuance of common equity in mid-2011, and $4 million ($3 million after tax), or $0.02 per common share, of acquisition-related expenses incurred during the second quarter of 2012 associated with the CH Energy Group, Inc. (“CH Energy Group”) transaction lowered earnings per common share in the second quarter of 2012.
Canadian Regulated Electric Utilities contributed earnings of $52 million, up $9 million from the second quarter of 2011. Earnings at FortisAlberta increased $8 million quarter over quarter, mainly due to growth in energy infrastructure investment, and increased transmission revenue and reduced depreciation as approved by the regulator, partially offset by a lower allowed rate of return on common shareholder–s equity (“ROE”).
FortisBC Electric and the City of Kelowna (the “City”) are in preliminary discussions for FortisBC Electric to purchase the City–s electricity distribution utility, which currently serves approximately 15,000 customers. The City–s electricity distribution assets have been operated and maintained by FortisBC Electric since 2000. Closing of the transaction is subject to certain conditions, negotiation of definitive agreements and certain approvals, including municipal and regulatory approvals. The parties are working towards closing the transaction by the end of the first quarter of 2013.
Canadian Regulated Gas Utilities delivered earnings of $13 million compared to $15 million for the second quarter of 2011. The decrease in earnings was mainly due to lower-than-expected customer additions and lower capitalized allowance for funds used during construction during 2012, partially offset by higher-than-expected gas transportation volumes to industrial customers.
Regulatory decisions were received in April 2012 for 2012/2013 customer gas delivery rates at the FortisBC Energy companies and 2012 customer electricity distribution rates at FortisAlberta. A decision on 2012/2013 customer electricity rates at FortisBC Electric is expected during the third quarter of 2012. A Generic Cost of Capital Proceeding in British Columbia to determine cost of capital, effective January 1, 2013, and a performance-based rate-regulation initiative in Alberta are continuing.
In June 2012 Newfoundland Power received regulatory approval of an increase in its allowed ROE to 8.80% for 2012 up from 8.38% for 2011. The Company expects to file a general rate application for 2013 customer rates during the third quarter of 2012.
Caribbean Regulated Electric Utilities contributed $6 million of earnings, comparable to the second quarter of 2011.
Consolidated capital expenditures, before customer contributions, were approximately $511 million in the first half of 2012. The Customer Care Enhancement Project at FortisBC–s gas business came into service at the beginning of January 2012. Construction continues on time and on budget on the $900 million Waneta Expansion hydroelectric generating facility (the “Waneta Expansion”) with approximately $345 million in total having been spent on the Waneta Expansion since construction began in late 2010.
Non-Regulated Fortis Generation contributed $5 million to earnings, up $3 million quarter over quarter. Improved performance mainly related to increased production in Belize due to higher rainfall.
Fortis Properties delivered earnings of $8 million, comparable to the second quarter of 2011.
Corporate and other expenses were $22 million, $5 million higher quarter over quarter, largely the result of CH Energy Group acquisition-related expenses of approximately $4 million ($3 million after tax) incurred during the second quarter of 2012 and a lower income tax recovery, partially offset by a foreign exchange gain of approximately $2 million recognized during the second quarter of 2012.
Cash flow from operating activities was $583 million for the first half of 2012, up $50 million from the first half of 2011, driven by favourable changes in working capital and higher earnings.
In February 2012 Fortis announced that it had entered into an agreement to acquire CH Energy Group for an aggregate purchase price of approximately US$1.5 billion, including the assumption of approximately US$500 million of debt on closing. CH Energy Group–s main business, Central Hudson Gas & Electric Corporation (“Central Hudson”), serves approximately 375,000 electric and gas customers in New York State–s Mid-Hudson River Valley. The transaction received CH Energy Group shareholder approval in June 2012 and regulatory approval from the Federal Energy Regulatory Commission and the Committee on Foreign Investment in the United States in July 2012. The New York State Public Service Commission is currently reviewing the application for approval of the transaction jointly filed by Fortis and CH Energy Group in April 2012. The acquisition is expected to close by the end of the first quarter of 2013 and be immediately accretive to earnings per common share of Fortis, excluding acquisition-related expenses.
Fortis raised gross proceeds of approximately $601 million in June 2012 upon issuance of 18,500,000 Subscription Receipts at $32.50 each to finance a portion of the purchase price of CH Energy Group. The proceeds are being held by an escrow agent pending satisfaction of closing conditions contained in the purchase agreement with CH Energy Group. Each Subscription Receipt will entitle the holder thereof to receive, on satisfaction of the closing conditions, one common share of Fortis.
In May 2012 and July 2012, Standard & Poor–s Ratings Service (“S&P”) and DBRS, respectively, affirmed the Corporation–s debt credit ratings at A- and A(low), respectively. Also, S&P removed the rating from credit watch with negative implications and DBRS removed the rating from under review with developing implications, where the ratings had been placed in February 2012 following the announcement of the CH Energy Group acquisition.
Fortis retroactively adopted accounting principles generally accepted in the United States (“US GAAP”), effective January 1, 2012, with the restatement of prior periods. The adoption of US GAAP did not have a material impact on the Corporation–s earnings per common share for the second quarter of 2012 or 2011.
“The second half of 2012 will continue to be very busy for Fortis, with significant regulatory proceedings continuing at our largest utilities and our annual capital program projected to reach a record $1.3 billion,” says Stan Marshall, President and Chief Executive Officer, Fortis Inc. “This investment in energy infrastructure will ensure we continue to meet our customers– energy needs with safe, reliable and cost-efficient supply.”
“We are also focused on closing the CH Energy Group transaction by the end of the first quarter of 2013,” says Marshall. “The addition of CH Energy Group to Fortis will deliver tangible benefits to customers of Central Hudson and support the utility–s focus on enhancing customer service. Central Hudson–s capital program from 2013 through 2016 is expected to add approximately $0.5 billion to the Fortis consolidated five-year $5.5 billion capital program,” he explains.
“We remain disciplined and patient in our pursuit of additional electric and gas utility acquisitions in the United States and Canada that will add value for Fortis shareholders,” concludes Marshall.
FORWARD-LOOKING STATEMENT
The following Fortis Inc. (“Fortis” or the “Corporation”) Management Discussion and Analysis (“MD&A”) has been prepared in accordance with National Instrument 51-102 – Continuous Disclosure Obligations. Financial information for 2012 and comparative periods contained in the MD&A has been prepared in accordance with accounting principles generally accepted in the United States (“US GAAP”) and is presented in Canadian dollars unless otherwise specified. The MD&A should be read in conjunction with the following: (i) the interim unaudited consolidated financial statements and notes thereto for the three and six months ended June 30, 2012, prepared in accordance with US GAAP; (ii) the audited consolidated financial statements and notes thereto for the year ended December 31, 2011, prepared in accordance with US GAAP and voluntarily filed on the System for Electronic Document Analysis and Retrieval (“SEDAR”) by Fortis on March 16, 2012; (iii) the audited consolidated financial statements and notes thereto for the year ended December 31, 2011, prepared in accordance with Canadian generally accepted accounting principles (“Canadian GAAP”); (iv) the “Supplemental Interim Consolidated Financial Statements for the Year Ended December 31, 2011 (Unaudited)” contained in the above-noted voluntary filing, which provides a detailed reconciliation between the Corporation–s interim unaudited consolidated 2011 Canadian GAAP financial statements and interim unaudited consolidated 2011 US GAAP financial statements; and (v) the MD&A for the year ended December 31, 2011 included in the Corporation–s 2011 Annual Report.
Fortis includes forward-looking information in the MD&A within the meaning of applicable securities laws in Canada (“forward-looking information”). The purpose of the forward-looking information is to provide management–s expectations regarding the Corporation–s future growth, results of operations, performance, business prospects and opportunities, and it may not be appropriate for other purposes. All forward-looking information is given pursuant to the safe harbour provisions of applicable Canadian securities legislation. The words “anticipates”, “believes”, “budgets”, “could”, “estimates”, “expects”, “forecasts”, “intends”, “may”, “might”, “plans”, “projects”, “schedule”, “should”, “will”, “would” and similar expressions are often intended to identify forward-looking information, although not all forward-looking information contains these identifying words. The forward-looking information reflects management–s current beliefs and is based on information currently available to the Corporation–s management. The forward-looking information in the MD&A includes, but is not limited to, statements regarding: the Corporation–s consolidated forecast gross capital expenditures for 2012 and in total over the five-year period 2012 through 2016; the nature, timing and amount of certain capital projects and their expected costs and time to complete; the expectation that the Corporation–s significant capital expenditure program should support continuing growth in earnings and dividends; forecast midyear rate base; the expectation that cash required to complete subsidiary capital expenditure programs will be sourced from a combination of cash from operations, borrowings under credit facilities, equity injections from Fortis and long-term debt offerings; the expected consolidated long-term debt maturities and repayments on average annually over the next five years; except for debt at the Exploits River Hydro Partnership (“Exploits Partnership”), the expectation that the Corporation and its subsidiaries will remain compliant with debt covenants during 2012; the possible acquisition of the City of Kelowna–s electricity distribution utility by FortisBC Electric; the expected timing of filing regulatory applications and of receipt of regulatory decisions; and the expected timing of the closing of the acquisition of CH Energy Group, Inc. (“CH Energy Group”) by Fortis and the expectation that the acquisition will be immediately accretive to earnings per common share, excluding acquisition-related expenses.
The forecasts and projections that make up the forward-looking information are based on assumptions which include, but are not limited to: the receipt of applicable regulatory approvals and requested rate orders; no significant variability in interest rates; no significant operational disruptions or environmental liability due to a catastrophic event or environmental upset caused by severe weather, other acts of nature or other major events; the continued ability to maintain the gas and electricity systems to ensure their continued performance; no severe and prolonged downturn in economic conditions; no significant decline in capital spending; no material capital project and financing cost overrun related to the construction of the Waneta Expansion hydroelectric generating facility; sufficient liquidity and capital resources; the expectation that the Corporation will receive appropriate compensation from the Government of Belize (“GOB”) for fair value of the Corporation–s investment in Belize Electricity that was expropriated by the GOB; the expectation that Belize Electric Company Limited (“BECOL”) will not be expropriated by the GOB; the expectation that the Corporation will receive fair compensation from the Government of Newfoundland and Labrador related to the expropriation of the Exploits Partnership–s hydroelectric assets and water rights; the continuation of regulator-approved mechanisms to flow through the commodity cost of natural gas and energy supply costs in customer rates; the ability to hedge exposures to fluctuations in foreign exchange rates, natural gas commodity prices and fuel prices; no significant counterparty defaults; the continued competitiveness of natural gas pricing when compared with electricity and other alternative sources of energy; the continued availability of natural gas, fuel and electricity supply; continuation and regulatory approval of power supply and capacity purchase contracts;
the receipt of regulatory and other approvals required in connection with the acquisition of CH Energy Group; the ability to fund defined benefit pension plans, earn the assumed long-term rates of return on the related assets and recover net pension costs in customer rates; no significant changes in government energy plans and environmental laws that may materially affect the operations and cash flows of the Corporation and its subsidiaries; maintenance of adequate insurance coverage; the ability to obtain and maintain licences and permits; retention of existing service areas; the ability to report under US GAAP beyond 2014 or the adoption of International Financial Reporting Standards (“IFRS”) after 2014 that allows for the recognition of regulatory assets and liabilities; the continued tax-deferred treatment of earnings from the Corporation–s Caribbean operations; continued maintenance of information technology (“IT”) infrastructure; continued favourable relations with First Nations; favourable labour relations; and sufficient human resources to deliver service and execute the capital program.
The forward-looking information is subject to risks, uncertainties and other factors that could cause actual results to differ materially from historical results or results anticipated by the forward-looking information. Factors which could cause results or events to differ from current expectations include, but are not limited to: regulatory risk; interest rate risk, including the uncertainty of the impact a continuation of a low interest rate environment may have on allowed rates of return on common shareholders– equity of the Corporation–s regulated utilities; operating and maintenance risks; risk associated with changes in economic conditions; capital project budget overrun, completion and financing risk in the Corporation–s non-regulated business; capital resources and liquidity risk; risk associated with the amount of compensation to be paid to Fortis for its investment in Belize Electricity that was expropriated by the GOB; the timeliness of the receipt of the compensation and the ability of the GOB to pay the compensation owing to Fortis; risk that the GOB may expropriate BECOL; an ultimate resolution of the expropriation of the hydroelectric assets and water rights of the Exploits Partnership that differs from that which is currently expected by management; weather and seasonality risk; commodity price risk; the continued ability to hedge foreign exchange risk; counterparty risk; competitiveness of natural gas; natural gas, fuel and electricity supply risk; risk associated with the continuation, renewal, replacement and/or regulatory approval of power supply and capacity purchase contracts; risks relating to the ability to close the acquisition of CH Energy Group, the timing of such closing and the realization of the anticipated benefits of the acquisition; the risk associated with defined benefit pension plan performance and funding requirements; risks related to FortisBC Energy (Vancouver Island) Inc.; environmental risks; insurance coverage risk; risk of loss of licences and permits; risk of loss of service area; risk of not being able to report under US GAAP beyond 2014 or risk that IFRS does not have an accounting standard for rate-regulated entities by the end of 2014 allowing for the recognition of regulatory assets and liabilities; risks related to changes in tax legislation; risk of failure of IT infrastructure; risk of not being able to access First Nations lands; labour relations risk; human resources risk; and risk of unexpected outcomes of legal proceedings currently against the Corporation. For additional information with respect to the Corporation–s risk factors, reference should be made to the Corporation–s continuous disclosure materials filed from time to time with Canadian securities regulatory authorities and to the heading “Business Risk Management” in the MD&A for the three and six months ended June 30, 2012 and for the year ended December 31, 2011.
All forward-looking information in the MD&A is qualified in its entirety by the above cautionary statements and, except as required by law, the Corporation undertakes no obligation to revise or update any forward-looking information as a result of new information, future events or otherwise after the date hereof.
CORPORATE OVERVIEW
Fortis is the largest investor-owned distribution utility in Canada, serving more than 2,000,000 gas and electricity customers. Its regulated holdings include electric utilities in five Canadian provinces and two Caribbean countries and a natural gas utility in British Columbia, Canada. Fortis owns non-regulated generation assets, primarily hydroelectric, across Canada and in Belize and Upstate New York, and hotels and commercial office and retail space in Canada. Year-to-date June 30, 2012, the Corporation–s electricity distribution systems met a combined peak demand of approximately 5,215 megawatts (“MW”) and its gas distribution system met a peak day demand of 1,335 terajoules (“TJ”). For additional information on the Corporation–s business segments, refer to Note 1 to the Corporation–s interim unaudited consolidated financial statements for the three and six months ended June 30, 2012 and to the “Corporate Overview” section of the 2011 Annual MD&A.
The key goals of the Corporation–s regulated utilities are to operate sound gas and electricity distribution systems, deliver gas and electricity safely and reliably at the lowest reasonable cost and conduct business in an environmentally responsible manner. The Corporation–s main business, utility operations, is highly regulated and the earnings of the Corporation–s regulated utilities are primarily determined under cost of service (“COS”) regulation.
Generally under COS regulation, the respective regulatory authority sets customer gas and/or electricity rates to permit a reasonable opportunity for the utility to recover, on a timely basis, estimated costs of providing service to customers, including a fair rate of return on a regulatory deemed or targeted capital structure applied to an approved regulatory asset value (“rate base”). The ability of a regulated utility to recover prudently incurred costs of providing service and earn the regulator-approved rate of return on common shareholders– equity (“ROE”) and/or rate of return on rate base assets (“ROA”) depends on the utility achieving the forecasts established in the rate-setting processes. As such, earnings of regulated utilities are generally impacted by: (i) changes in the regulator-approved allowed ROE and/or ROA; (ii) changes in rate base; (iii) changes in energy sales or gas delivery volumes; (iv) changes in the number and composition of customers; (v) variances between actual expenses incurred and forecast expenses used to determine revenue requirements and set customer rates; and (vi) timing differences within an annual financial reporting period, between when actual expenses are incurred and when they are recovered from customers in rates. When forward test years are used to establish revenue requirements and set base customer rates, these rates are not adjusted as a result of actual COS being different from that which is estimated, other than for certain prescribed costs that are eligible to be deferred on the balance sheet. In addition, the Corporation–s regulated utilities, where applicable, are permitted by their respective regulatory authority to flow through to customers, without markup, the cost of natural gas, fuel and/or purchased power through base customer rates and/or the use of rate stabilization and other mechanisms.
Pending Acquisition of CH Energy Group, Inc.: In February 2012 Fortis announced that it had entered into an agreement to acquire CH Energy Group, Inc. (“CH Energy Group”) for US$65.00 per common share in cash, for an aggregate purchase price of approximately US$1.5 billion, including the assumption of approximately US$500 million of debt on closing. CH Energy Group is an energy delivery company headquartered in Poughkeepsie, New York. Its main business, Central Hudson Gas & Electric Corporation, is a regulated transmission and distribution (“T&D”) utility serving approximately 300,000 electric and 75,000 natural gas customers in eight counties of New York State–s Mid-Hudson River Valley. The transaction received CH Energy Group shareholder approval in June 2012 and regulatory approval from the Federal Energy Regulatory Commission and the Committee on Foreign Investment in the United States in July 2012.
The acquisition is also subject to certain other approvals, including approval by the New York State Public Service Commission (the “NYSPSC”), and satisfaction of customary closing conditions. The NYSPSC is currently reviewing the application for approval of the transaction jointly filed by Fortis and CH Energy Group in April 2012. The acquisition is expected to close by the end of the first quarter of 2013 and be immediately accretive to earnings per common share, excluding acquisition-related expenses.
Subscription Receipts: In June 2012, to finance a portion of the pending acquisition of CH Energy Group, Fortis sold 18,500,000 Subscription Receipts at $32.50 each through a bought-deal offering underwritten by a syndicate of underwriters led by CIBC World Markets Inc., Scotia Capital Inc. and TD Securities Inc. (collectively the “Underwriters”), resulting in gross proceeds of approximately $601 million. The gross proceeds from the sale of the Subscription Receipts are being held by an escrow agent, pending receipt of all required approvals and satisfaction of closing conditions included in the agreement to acquire CH Energy Group (the “Release Conditions”). The Subscription Receipts began trading on the Toronto Stock Exchange on June 27, 2012 under the symbol “FTS.R”.
Each Subscription Receipt will entitle the holder thereof to receive, on satisfaction of the Release Conditions and without payment of additional consideration, one common share of Fortis and a cash payment equal to the dividends declared on Fortis common shares to holders of record during the period from June 27, 2012 to the date of issuance of the common shares in respect of the Subscription Receipts.
If the Release Conditions are not satisfied by June 30, 2013, or if the share purchase agreement relating to the acquisition of CH Energy Group is terminated prior to such time, holders of Subscription Receipts shall be entitled to receive from the escrow agent an amount equal to the full subscription price thereof plus their pro rata share of the interest earned on such amount.
Transition to US GAAP: In June 2011 the Ontario Securities Commission issued a decision allowing Fortis and its reporting issuer subsidiaries to prepare their financial statements, effective January 1, 2012 through to December 31, 2014, in accordance with US GAAP without qualifying as U.S. Securities and Exchange Commission (“SEC”) Issuers. The Corporation and its reporting issuer subsidiaries, therefore, adopted US GAAP as opposed to International Financial Reporting Standards (“IFRS”) on January 1, 2012. Earnings recognized under US GAAP are more closely aligned with earnings recognized under Canadian GAAP, mainly due to the continued recognition of regulatory assets and liabilities under US GAAP. A transition to IFRS would likely have resulted in the derecognition of some, or perhaps all, of the Corporation–s regulatory assets and liabilities and caused significant volatility in the Corporation–s consolidated earnings. On March 16, 2012, Fortis voluntarily prepared and filed audited consolidated US GAAP financial statements for the year ended December 31, 2011 with 2010 comparatives. Also included in the voluntary filing were: (i) a detailed reconciliation between the Corporation–s audited consolidated Canadian GAAP and audited consolidated US GAAP financial statements for fiscal 2011, including 2010 comparatives; and (ii) a detailed reconciliation between the Corporation–s 2011 interim unaudited consolidated Canadian GAAP and 2011 interim unaudited consolidated US GAAP financial statements. For further information, refer to the “New Accounting Policies” section of this MD&A.
Purchase of the Electricity Distribution Assets in Port Colborne: In April 2012 FortisOntario exercised its option to purchase all of the assets previously leased by the Company under an operating lease agreement with the City of Port Colborne for the purchase option price of approximately $7 million. The exercise of the purchase option, which qualifies as a business combination, provides ownership and legal title to all of the assets, including equipment, real property and distribution assets, which constitutes the electricity distribution system in Port Colborne.
Pending Acquisition of the Electricity Distribution Utility from the City of Kelowna: FortisBC Electric and the City of Kelowna (the “City”) are in preliminary discussions for FortisBC Electric to purchase the City–s electricity distribution utility, which currently serves approximately 15,000 customers. FortisBC Electric provides the City with electricity under a wholesale tariff and has operated and maintained its assets since 2000. Closing of the transaction is subject to certain conditions, negotiation of definitive agreements and certain approvals, including municipal and regulatory approvals. The parties are working towards closing the transaction by the end of the first quarter of 2013.
Re-Organization of Non-Regulated Generation Operations: Effective July 1, 2012, the legal ownership of the six small non-regulated hydroelectric generating facilities in eastern Ontario, with a combined generating capacity of 8 MW, was transferred from Fortis Properties to a limited partnership directly held by Fortis. FortisBC Electric is assuming management responsibility for the operations of the above-noted facilities, as well as for the four non-regulated hydroelectric generating facilities in Upstate New York, with a combined generating capacity of 23 MW, owned by FortisUS Energy Corporation (“FortisUS Energy”).
FINANCIAL HIGHLIGHTS
Fortis has adopted a strategy of profitable growth with earnings per common share as the primary measure of performance. The Corporation–s business is segmented by franchise area and, depending on regulatory requirements, by the nature of the assets. Key financial highlights for the second quarter and year-to-date periods ended June 30, 2012 and June 30, 2011 are provided in the following table.
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SEGMENTED RESULTS OF OPERATIONS
For a discussion of the nature of regulation and material regulatory decisions and applications pertaining to the Corporation–s regulated utilities, refer to the “Regulatory Highlights” section of this MD&A. A discussion of the financial results of the Corporation–s reporting segments is as follows.
REGULATED GAS UTILITIES – CANADIAN
FORTISBC ENERGY COMPANIES (1)
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With the implementation of the new Customer Care Enhancement Project on January 1, 2012, the FortisBC Energy companies changed their definition of a customer. As a result of this change, the FortisBC Energy companies adjusted their combined customer count downwards by approximately 18,000, effective January 1, 2012. As at June 30, 2012, the total number of customers served by the FortisBC Energy companies was approximately 937,000.
The FortisBC Energy companies earn approximately the same margin regardless of whether a customer contracts for the purchase and delivery of natural gas or only for the delivery of natural gas. As a result of the operation of regulator-approved deferral mechanisms, changes in consumption levels and the commodity cost of natural gas from those forecast to set residential and commercial customer gas rates do not materially affect earnings.
Seasonality has a material impact on the earnings of the FortisBC Energy companies as a major portion of the gas distributed is used for space heating. Most of the annual earnings of the FortisBC Energy companies are realized in the first and fourth quarters.
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REGULATED ELECTRIC UTILITIES – CANADIAN
FORTISALBERTA
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As a significant portion of FortisAlberta–s distribution revenue is derived from fixed or largely fixed billing determinants, changes in quantities of energy delivered are not entirely correlated with changes in revenue. Revenue is a function of numerous variables, many of which are independent of actual energy deliveries.
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FORTISBC ELECTRIC (1)
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NEWFOUNDLAND POWER
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OTHER CANADIAN ELECTRIC UTILITIES (1)
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REGULATED ELECTRIC UTILITIES – CARIBBEAN (1)
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NON-REGULATED – FORTIS GENERATION (1)
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In May 2011 the generator at Moose River–s hydroelectric generating facility in Upstate New York sustained electrical damage. Repairs to the generator were completed in the second quarter of 2012 but another repair continues to keep the generating facility offline. Revenue for the first half of 2012 reflected insurance amounts received related to the loss of earnings during the period in the first half of 2012 when generator was being repaired.
NON-REGULATED – FORTIS PROPERTIES (1)
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CORPORATE AND OTHER (1)
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REGULATORY HIGHLIGHTS
The nature of regulation and material regulatory decisions and applications associated with each of the Corporation–s regulated gas and electric utilities for the first half of 2012 are summarized as follows.
CONSOLIDATED FINANCIAL POSITION
The following table outlines the significant changes in the consolidated balance sheets between June 30, 2012 and December 31, 2011.
LIQUIDITY AND CAPITAL RESOURCES
The table below outlines the Corporation–s consolidated sources and uses of cash for the three and six months ended June 30, 2012, as compared to the same periods in 2011, followed by a discussion of the nature of the variances in cash flows.
Operating Activities: Cash flow from operating activities was $24 million higher quarter over quarter. The increase was primarily due to: (i) favourable changes in working capital; (ii) the collection from customers of regulator-approved increased depreciation and amortization costs, mainly at the FortisBC Energy companies; and (iii) higher earnings. The favourable changes in working capital quarter over quarter were associated with changes in accounts receivable, partially offset by changes in accounts payable and other current liabilities. The increase was partially offset by unfavourable changes in long-term regulatory deferral accounts and a pension solvency deficit funding payment made by Newfoundland Power during the second quarter of 2012.
Cash flow from operating activities was $50 million higher year to date compared to the same period last year, due to the same factors discussed above for the quarter. Favourable changes in working capital year to date compared to the same period last year, however, were associated with changes in accounts receivable and current regulatory deferral accounts, partially offset by changes in inventories and accounts payable and other current liabilities.
Investing Activities: Cash used in investing activities was $7 million higher for the quarter and $1 million higher year to date. Lower capital spending at the FortisBC Energy companies, FortisBC Electric and the utilities in the Caribbean for the quarter and year to date was largely offset by an increase in capital spending at FortisAlberta for the quarter and year to date and an increase in capital spending related to the non-regulated Waneta Expansion year to date. Capital expenditures for the first half of 2011 included those of Belize Electricity up to June 20, 2011, when the utility was expropriated by the Government of Belize.
Cash used in investing activities also reflects the acquisition of the remaining assets of Port Colborne Hydro by FortisOntario in April 2012 for approximately $7 million.
Financing Activities: Cash provided by financing activities was $108 million lower quarter over quarter. The decrease was primarily due to: (i) lower proceeds from the issuance of common shares; (ii) higher repayments of long-term debt; (iii) lower proceeds from long-term debt; (iv) lower advances from non-controlling interests; (v) issue costs related to the June 2012 Subscription Receipts offering; and (vi) higher common share dividends. The decrease was partially offset by higher net borrowings under committed credit facilities classified as long term and lower repayments of short-term borrowings.
Cash provided by financing activities was $94 million lower year to date compared to the same period last year. The decrease was due to the same factors discussed above for the quarter; however, advances from non-controlling interests were higher year to date compared to the same period last year.
Net proceeds from short-term borrowings were $5 million for the quarter compared to net repayments of short-term borrowings of $102 million for the same quarter last year. Net repayments of short-term borrowings were $78 million year to date compared to $200 million for the same period last year. The changes for the quarter and year-to-date periods were driven by the FortisBC Energy companies and Caribbean Utilities.
Proceeds from long-term debt, net of issue costs, repayments of long-term debt and capital lease and finance obligations, and net borrowings under committed credit facilities for the quarter and year to date compared to the same periods last year are summarized in the following tables.
Borrowings under credit facilities by the utilities are primarily in support of their capital expenditure programs and/or for working capital requirements. Repayments are primarily financed through the issuance of long-term debt, cash from operations and/or equity injections from Fortis. From time to time, proceeds from preference share, common share and long-term debt offerings are used to repay borrowings under the Corporation–s committed credit facility.
Advances of approximately $27 million for the quarter and $56 million year to date were received from non-controlling interests in the Waneta Partnership to finance capital spending related to the Waneta Expansion, compared to $40 million received for the second quarter of 2011 and $57 million received year-to-date 2011. In January 2012 advances of approximately $12 million were received from two First Nations bands representing their 15% equity investment in the LNG storage facility on Vancouver Island.
In June 2011 Fortis issued 9.1 million common shares for gross proceeds of $300 million. The net proceeds of $288 million were used to repay borrowings under credit facilities and finance equity injections into the utilities in western Canada and the Waneta Expansion in support of infrastructure investment, and for general corporate purposes.
Common share dividends paid during the second quarter of 2012 were $42 million, net of $15 million in dividends reinvested, compared to $36 million, net of $15 million in dividends reinvested, paid during the same quarter of 2011. Common share dividends paid in the first half of 2012 were $86 million, net of $28 million in dividends reinvested, compared to $71 million, net of $31 million in dividends reinvested, paid in the first half of 2011. The dividend paid per common share for the first and second quarters of 2012 was $0.30 compared to $0.29 for the first and second quarters of 2011. The weighted average number of common shares outstanding for the second quarter and year to date was 189.6 million and 189.3 million, respectively, compared to 177.1 million and 175.8 million for the second quarter and year to date, respectively, in 2011.
CONTRACTUAL OBLIGATIONS
As at June 30, 2012, consolidated contractual obligations of Fortis over the next five years and for periods thereafter are outlined in the following table. A detailed description of the nature of the obligations is provided in the 2011 Annual MD&A and below, where applicable. The presentation of certain contractual obligations has changed from that provided in the 2011 Annual MD&A, due to the adoption of US GAAP. For further information concerning these changes, refer to the 2011 audited consolidated financial statements prepared in accordance with US GAAP and voluntarily filed on SEDAR.
Other contractual obligations, which are not reflected in the above table, did not materially change from those disclosed in the 2011 Annual MD&A, except as described below.
In January 2012 two First Nations bands each invested approximately $6 million in equity in the Mount Hayes LNG storage facility, representing a 15% equity interest in the Mount Hayes Limited Partnership, with FEVI holding the controlling 85% ownership interest. The non-controlling interests hold put options, which, if exercised, would require FEVI to repurchase the 15% ownership interest for cash, in accordance with the terms of the partnership agreement.
Caribbean Utilities has a primary fuel supply contract with a major supplier and is committed to purchasing approximately 80% of the Company–s diesel fuel requirements from this supplier for the operation of Caribbean Utilities– diesel-powered generating plant. The contract contains an automatic renewal clause for the years 2010 through to 2012. The approximate quantity per the contract on an annual basis is 10.1 million imperial gallons for 2012. The Company has renewed the contract to July 2012 and is in the process of negotiating terms of a new contract.
In February 2012 Fortis entered into an agreement to acquire CH Energy Group for US$1.5 billion, including the assumption of approximately US$500 million in debt on closing. The acquisition is expected to close by the end of the first quarter of 2013. In June 2012, to finance a portion of the purchase price of CH Energy Group, Fortis sold 18,500,000 Subscription Receipts at $32.50 each resulting in gross proceeds of approximately $601 million. Each Subscription Receipt will entitle the holder thereof to receive, on satisfaction of the Release Conditions and without payment of additional consideration, one common share of Fortis and a cash payment equal to the dividends declared on Fortis common shares to holders of record during the period from June 27, 2012 to the date of issuance of the common shares in respect of the Subscription Receipts. For further information on the pending acquisition of CH Energy Group and the Subscription Receipts offering, refer to the “Corporate Overview” section of this MD&A.
For a discussion of the nature and amount of the Corporation–s consolidated capital expenditure program, which is not included in the Contractual Obligations table above, refer to the “Capital Expenditure Program” section of this MD&A.
CAPITAL STRUCTURE
The Corporation–s principal businesses of regulated gas and electricity distribution require ongoing access to capital to enable the utilities to fund maintenance and expansion of infrastructure. Fortis raises debt at the subsidiary level to ensure regulatory transparency, tax efficiency and financing flexibility. Fortis generally finances a significant portion of acquisitions at the corporate level with proceeds from common share, preference share and long-term debt offerings. To help ensure access to capital, the Corporation targets a consolidated long-term capital structure containing approximately 40% equity, including preference shares, and 60% debt, as well as investment-grade credit ratings. Each of the Corporation–s regulated utilities maintains its own capital structure in line with the deemed capital structure reflected in each of the utility–s customer rates.
The consolidated capital structure of Fortis is presented in the following table.
The improvement in the capital structure was primarily due to: (i) an increase in cash; (ii) lower short-term borrowings; (iii) net earnings attributable to common equity shareholders, net of dividends; and (iv) common shares issued mainly under the Corporation–s dividend reinvestment plan. The capital structure was also impacted by an increase in long-term debt, mainly due to higher borrowings under the Corporation–s committed credit facility in support of utility infrastructure investment, partially offset by regularly scheduled debt repayments.
CREDIT RATINGS
The Corporation–s credit ratings are as follows:
In May 2012 and July 2012, S&P and DBRS, respectively, affirmed the Corporation–s debt credit ratings. Also, S&P and DBRS removed the ratings from credit watch with negative implications and under review with developing implications, respectively, where the ratings had been placed in February 2012, mainly reflecting the Corporation–s financing plans for the pending acquisition of CH Energy Group and the expected completion of the Waneta Expansion on time and on budget.
The above-noted credit ratings reflect the Corporation–s low business-risk profile and diversity of its operations, the stand-alone nature and financial separation of each of the regulated subsidiaries of Fortis, management–s commitment to maintaining low levels of debt at the holding company level, the Corporation–s reasonable credit metrics and its demonstrated ability and continued focus on acquiring and integrating stable regulated utility businesses financed on a conservative basis.
CAPITAL EXPENDITURE PROGRAM
Capital investment in infrastructure is required to ensure continued and enhanced performance, reliability and safety of the gas and electricity systems and to meet customer growth. All costs considered to be maintenance and repairs are expensed as incurred. Costs related to replacements, upgrades and betterments of capital assets are capitalized as incurred.
A breakdown of the $511 million in gross capital expenditures by segment for the first half of 2012 is provided in the following table.
Planned capital expenditures are based on detailed forecasts of energy demand, weather, cost of labour and materials, as well as other factors, including economic conditions, which could change and cause actual expenditures to differ from forecasts.
There have been no material changes in the overall expected level, nature and timing of the Corporation–s significant capital projects from those that were disclosed in the 2011 Annual MD&A. Gross consolidated capital expenditures for 2012 are forecasted at a record of approximately $1.3 billion.
FEI–s Customer Care Enhancement Project, at an estimated total project cost of $110 million, came into service at the beginning of January 2012. Most of the remaining $30 million of the project costs were incurred in the first half of 2012, with remaining smaller payments expected to be made during 2012.
Construction progress on the $900 million Waneta Expansion is going well and the project is currently on schedule and on budget. Major construction activities on-site include the completion of the excavation of the intake, powerhouse and power tunnels. Approximately $345 million in total has been spent on the Waneta Expansion since construction began late in 2010.
Over the five-year period 2012 through 2016, consolidated gross capital expenditures are expected to be approximately $5.5 billion, consistent with that disclosed in the 2011 Annual MD&A. The addition of CH Energy Group is expected to add approximately $0.5 billion to the Corporation–s consolidated capital expenditure program from 2013 through 2016. Approximately 65% of the $5.5 billion capital program is expected to be incurred at the regulated electric utilities, driven by FortisAlberta and FortisBC Electric. Approximately 21% and 14% of the capital program is expected to be incurred at the regulated gas utilities and non-regulated operations, respectively. Capital expenditures at the regulated utilities are subject to regulatory approval. Over the five-year period excluding CH Energy Group, on average annually, 39% of utility capital spending is expected to be incurred to meet customer growth; 38% is expected to be incurred to ensure continued and enhanced performance, reliability and safety of generation and T&D assets (i.e., sustaining capital expenditures); and 23% is expected to be incurred for facilities, equipment, vehicles, information technology and other assets.
CASH FLOW REQUIREMENTS
At the subsidiary level, it is expected that operating expenses and interest costs will generally be paid out of subsidiary operating cash flows, with varying levels of residual cash flow available for subsidiary capital expenditures and/or dividend payments to Fortis. Borrowings under credit facilities may be required from time to time to support seasonal working capital requirements. Cash required to complete subsidiary capital expenditure programs is also expected to be financed from a combination of borrowings under credit facilities, equity injections from Fortis and long-term debt offerings.
The Corporation–s ability to service its debt obligations and pay dividends on its common shares and preference shares is dependent on the financial results of the operating subsidiaries and the related cash payments from these subsidiaries. Certain regulated subsidiaries may be subject to restrictions that may limit their ability to distribute cash to Fortis. Cash required of Fortis to support subsidiary capital expenditure programs and finance acquisitions is expected to be derived from a combination of borrowings under the Corporation–s committed credit facility and proceeds from the issuance of common shares, preference shares and long-term debt. Depending on the timing of cash payments from the subsidiaries, borrowings under the Corporation–s committed credit facility may be required from time to time to support the servicing of debt and payment of dividends.
As at June 30, 2012, management expects consolidated long-term debt maturities and repayments to average approximately $295 million annually over the next five years. The combination of available credit facilities and relatively low annual debt maturities and repayments provide the Corporation and its subsidiaries with flexibility in the timing of access to capital markets.
In May 2012 Fortis filed a base shelf prospectus under which Fortis may, from time to time during the 25-month period from May 10, 2012, offer, by way of a prospectus supplement, common shares, preference shares, subscription receipts and/or unsecured debentures in the aggregate amount of up to $1.3 billion (or the equivalent in US dollars or other currencies). The base shelf prospectus provides the Corporation with flexibility to access securities markets in a timely manner. The nature, size and timing of any offering of securities under the Corporation–s base shelf prospectus will be consistent with the past capital raising practices of the Corporation and continue to be dependant upon the Corporation–s assessment of its requirements for funding and general market conditions.
To finance a portion of the Corporation–s pending acquisition of CH Energy Group, Fortis offered and sold, by way of a prospectus supplement, approximately $601 million in Subscription Receipts under a bought-deal offering with a syndicate of underwriters. For further information refer to the “Corporate Overview” section of this MD&A.
As the hydroelectric assets and water rights of the Exploits River Hydro Partnership (“Exploits Partnership”) had been provided as security for the Exploits Partnership term loan, the expropriation of such assets and rights by the Government of Newfoundland and Labrador constituted an event of default under the loan. The term loan is without recourse to Fortis and was approximately $55 million as at June 30, 2012 (December 31, 2011 – $56 million). The lenders of the term loan have not demanded accelerated repayment. The scheduled repayments under the term loan are being made by Nalcor Energy, a Crown corporation, acting as agent for the Government of Newfoundland and Labrador with respect to expropriation matters. For further information refer to Note 19 to the Corporation–s interim unaudited consolidated financial statements for the three and six months ended June 30, 2012.
Except for the debt at the Exploits Partnership, as discussed above, Fortis and its subsidiaries were in compliance with debt covenants as at June 30, 2012 and are expected to remain compliant throughout the remainder of 2012.
CREDIT FACILITIES
As at June 30, 2012, the Corporation and its subsidiaries had consolidated credit facilities of approximately $2.5 billion, of which $2.0 billion was unused, including $815 million unused under the Corporation–s $1 billion committed revolving corporate credit facility. The credit facilities are syndicated mostly with the seven largest Canadian banks, with no one bank holding more than 20% of these facilities. Approximately $2.3 billion of the total credit facilities are committed facilities with maturities ranging from 2013 through 2017.
The following summary outlines the credit facilities of the Corporation and its subsidiaries.
As at June 30, 2012 and December 31, 2011, certain borrowings under the Corporation–s and subsidiaries– credit facilities were classified as long-term debt. These borrowings are under long-term committed credit facilities and management–s intention is to refinance these borrowings with long-term permanent financing during future periods.
In March 2012 Newfoundland Power renegotiated and amended its $100 million unsecured committed revolving credit facility, obtaining an extension to the maturity of the facility to August 2017 from August 2015. The amended credit facility agreement reflects a decrease in pricing but, otherwise, contains substantially similar terms and conditions as the previous credit facility agreement.
In April 2012 FortisBC Electric renegotiated and amended its credit facility agreement resulting in an extension to the maturity of the Company–s $150 million unsecured committed revolving credit facility with $100 million now maturing in May 2015 and $50 million now maturing in May 2013.
In May 2012 FHI extended its $30 million operating credit facility to mature in May 2013 from May 2012. The new agreement contains substantially similar terms and conditions as the previous credit facility agreement.
In May 2012 Fortis increased the amount available for borrowing under its committed revolving corporate credit facility from $800 million to $1 billion, as permitted under the credit facility agreement.
In May 2012 Caribbean Utilities renegotiated and increased the amount available for borrowing under its unsecured credit facilities to US$47 million from US$33 million.
In June 2012 FortisOntario entered into a new short-term credit facility agreement for $30 million replacing two short-term credit facilities totaling $20 million. The new credit facility agreement reflects a decrease in pricing and improved terms and conditions. In July 2012 the former credit facilities were terminated.
In July 2012 FEI entered into a one-year extension of its $500 million unsecured committed revolving credit facility agreement, amending the maturity date from August 2013 to August 2014. The amended agreement reflects an increase in pricing but, otherwise, contains substantially similar terms and conditions as the previous credit facility agreement.
In July 2012 FortisAlberta renegotiated and amended its $250 million unsecured committed revolving credit facility, obtaining an extension to the maturity of the facility to August 2016 from September 2015 and a decrease in pricing. The amended credit facility agreement otherwise contains substantially similar terms and conditions as the previous credit facility agreement.
FINANCIAL INSTRUMENTS
The carrying values of the Corporation–s consolidated financial instruments approximate their fair values, reflecting the short-term maturity, normal trade credit terms and/or nature of these instruments, except as follows.
The fair value of long-term debt is calculated using quoted market prices when available. When quoted market prices are not available, the fair value is determined by discounting the future cash flows of the specific debt instrument at an estimated yield to maturity equivalent to benchmark government bonds or treasury bills, with similar terms to maturity, plus a credit risk premium equal to that of issuers of similar credit quality. Since the Corporation does not intend to settle the long-term debt or promissory note prior to maturity, the fair value estimate does not represent an actual liability and, therefore, does not include exchange or settlement costs.
The financial instruments table above excludes the long-term other asset associated with the Corporation–s previous investment in Belize Electricity. The fair value of the Corporation–s expropriated investment in Belize Electricity determined under the Government of Belize–s valuation is significantly lower than the fair value determined under the Corporation–s independent valuation of the utility. Due to uncertainty in the ultimate amount and ability of the Government of Belize to pay compensation owing to Fortis for the expropriation of Belize Electricity, the Corporation has recorded the long-term other asset at the carrying value of the Corporation–s previous investment in Belize Electricity, including foreign exchange impacts, which was approximately $106 million as at June 30, 2012.
Risk Management: The Corporation–s earnings from, and net investments in, foreign subsidiaries are exposed to fluctuations in the US dollar-to-Canadian dollar exchange rate. The Corporation has effectively decreased the above exposure through the use of US dollar borrowings at the corporate level. The foreign exchange gain or loss on the translation of US dollar-denominated interest expense partially offsets the foreign exchange loss or gain on the translation of the Corporation–s foreign subsidiaries– earnings, which are denominated in US dollars. The reporting currency of Caribbean Utilities, Fortis Turks and Caicos, FortisUS Energy and Belize Electric Company Limited is the US dollar. Belize Electricity–s financial results were denominated in Belizean dollars, which are pegged to the US dollar.
As at June 30, 2012, the Corporation–s corporately issued US$550 million (December 31, 2011 – US$550 million) long-term debt had been designated as an effective hedge of the Corporation–s foreign net investments. As at June 30, 2012, the Corporation had approximately US$13 million (December 31, 2011 – US$6 million) in foreign net investments remaining to be hedged. Foreign currency exchange rate fluctuations associated with the translation of the Corporation–s corporately issued US dollar borrowings designated as effective hedges are recorded in other comprehensive income and serve to help offset unrealized foreign currency exchange gains and losses on the net investments in foreign subsidiaries, which gains and losses are also recorded in other comprehensive income.
Effective June 20, 2011, the Corporation–s asset associated with its investment in Belize Electricity does not qualify for hedge accounting as Belize Electricity is no longer a foreign subsidiary of Fortis. As a result, during 2011, a portion of corporately issued debt that previously hedged the former investment in Belize Electricity was no longer an effective hedge. Effective from June 20, 2011, foreign exchange gains and losses on the translation of the asset associated with Belize Electricity and the corporately issued US dollar-denominated debt that previously qualified as a hedge of the investment were recognized in earnings. As a result, the Corporation recognized a net foreign exchange gain in earnings of approximately $2 million and $0.5 million during the three and six months ended June 30, 2012, respectively.
From time to time, the Corporation and its subsidiaries hedge exposures to fluctuations in interest rates, foreign exchange rates and fuel and natural gas prices through the use of derivative financial instruments. The Corporation and its subsidiaries do not hold or issue derivative financial instruments for trading purposes. As at June 30, 2012, the Corporation–s derivative contracts consisted of fuel option contracts, natural gas swap and option contracts, and gas purchase contract premiums. The fuel option contracts are held by Caribbean Utilities and the remaining derivative instruments are held by the FortisBC Energy companies.
The following table summarizes the Corporation–s derivative financial instruments.
The fuel option contracts are used by Caribbean Utilities to reduce the impact of volatility in fuel prices on customer rates, as approved by the regulator under the Company–s Fuel Price Volatility Management Program.
The natural gas derivatives held by the FortisBC Energy companies are used to fix the effective purchase price of natural gas, as the majority of the natural gas supply contracts at the FortisBC Energy companies have floating, rather than fixed, prices. The price risk-management strategy of the FortisBC Energy companies aims to improve the likelihood that natural gas prices remain competitive, to mitigate gas price volatility on customer rates and to reduce the risk of regional price discrepancies. As directed by the BCUC, FEI and FEVI suspended their commodity hedging activities in 2011, which has continued into 2012, with the exception of certain limited swaps as permitted by the BCUC. The existing hedging contracts will continue in effect through to their maturity and the FortisBC Energy companies– ability to fully recover the commodity cost of gas in customer rates remains unchanged.
The changes in the fair values of the fuel option contracts and natural gas derivatives are deferred as a regulatory asset or liability for recovery from, or refund to, customers in future rates, as permitted by the regulators. The fair values of the derivative financial instruments were recorded in accounts payable as at June 30, 2012 and as at December 31, 2011.
The fair value of the fuel option contracts reflects only the value of the heating oil derivative and not the offsetting change in the value of the underlying future purchases of heating oil and is calculated using published market prices for heating oil. The fair value of the natural gas derivatives is calculated using the present value of cash flows based on market prices and forward curves for the commodity cost of natural gas. The fair values of the fuel option contracts and natural gas derivatives are estimates of the amounts that would have to be received or paid to terminate the outstanding contracts as at the balance sheet dates.
The fair values of the Corporation–s financial instruments, including derivatives, reflect point-in-time estimates based on current and relevant market information about the instruments as at the balance sheet dates. The estimates cannot be determined with precision as they involve uncertainties and matters of judgment and, therefore, may not be relevant in predicting the Corporation–s future consolidated earnings or cash flows.
OFF-BALANCE SHEET ARRANGEMENTS
With the exception of letters of credit outstanding of $68 million, as at June 30, 2012, the Corporation had no off-balance sheet arrangements, such as transactions, agreements or contractual arrangements with unconsolidated entities, structured finance entities, special purpose entities or variable interest entities, that are reasonably likely to materially affect liquidity or the availability of, or requirements for, capital resources.
BUSINESS RISK MANAGEMENT
There were no changes in the Corporation–s significant business risks during the first half of 2012 from those disclosed in the 2011 Annual MD&A, except for those described below.
Regulatory Risk: In April 2012 regulatory decisions were received for 2012 and 2013 customer gas delivery rates at the FortisBC Energy