KeySpan Facilities Income Fund (TSX:KEY.UN)

Transcription

1 Q1 QUARTERLY REPORT for the period ending March 31, 2004 Announces First Quarter Results 2004 FIRST QUARTER HIGHLIGHTS Announced secondary offering of trust units to fund the acquisition of a 36% additional interest in KeySpan Energy Canada Partnership, increasing the Fund s ownership interest to 75%. Generated cash from the Partnership for distribution of $15.5 million ($0.36 per unit equivalent) in the first quarter and distributed $11.8 million ($0.27 per trust unit, or 9.08 cents per unit per month) to Unitholders. Reported contribution of $15.6 million ($15.0 million in 2003) from the facilities business, up 4% from 2003 and $6.4 million from marketing, down from the 2003 record first quarter of $7.9 million, largely as a result of the termination of the gas marketing business. Agreed to acquire an additional interest in the Wabasca pipeline. Initiated several internal growth projects for startup later this year. Message to Unitholders Over the past year I have spoken to many unitholders about KeySpan s opportunities. Throughout that time I have identified the drilling activity ongoing in our areas of operation, the many internal growth projects available to us, and the potential to undertake attractive acquisitions. I am happy to report that KeySpan has been successful on several of these fronts in 2003, has had a very successful first quarter and is positioned well for the future. _ 1

2 In the first quarter we have posted very strong financial results, as the contribution from our facilities business exceeded last year s results and NGL marketing was only slightly lower than the record first quarter of Our cash available for distribution significantly exceeded distributions paid to unitholders, reflecting strong operational performance. Also, maintenance capital expenditures in the first quarter are typically lower than in the remainder of the year. We have commenced work on several internal growth opportunities. Our CO 2 liquification project at the Rimbey gas plant is in the commissioning stage, and is expected to be fully operational by mid May. We are pleased with the progress of the Brazeau Northeast Gathering System construction and expect it will be operational in August of this year. Most of the other projects will start up later this year and will provide additional cash flow to the business. Further details are provided later in this report. We are encouraged by the opportunities available to us with respect to acquisitions. We have agreed to acquire an additional 19% working interest in the Wabasca pipeline in the first quarter, increasing our ownership to 69%, subject to rights of first refusal. We continue to evaluate other opportunities, but we will only pursue those that fit our corporate vision and are accretive to cash flow and value. On February 26, 2004 we announced a secondary offering of million trust units to fund the acquisition from KeySpan Corporation of an additional 36% working interest in KeySpan Energy Canada Partnership. This transaction closed on April 1, and increased the Fund s interest in the Partnership to 75%. In April, following the closing of the secondary offering, Gerald Luterman left KeySpan s board of directors. I would like to express my thanks to Gerry for his guidance and support over the past year. On behalf of the Fund s trustees, directors and management team, I look forward to your continued support. Jim V. Bertram President and CEO KeySpan Facilities Income Fund This report includes separate financial statements for the Partnership, which encompasses all of the business of KeySpan, and for the Fund, which represents a 39.1% ownership interest in the Partnership throughout the first quarter. Beginning in the second quarter, the Fund s financial statements will reflect its 75% interest in the Partnership. Except where noted, this report describes the business of KeySpan Energy Canada Partnership. Business Review KeySpan Energy Canada Partnership (the Partnership or KeySpan ) operates one of the largest natural gas midstream businesses in Canada. Its gathering and processing facilities consist of 13 natural gas processing plants and associated gathering pipelines and compressors, strategically located in the west central and foothills areas of Alberta. KeySpan also has an extensive natural gas liquids (NGLs) infrastructure consisting of pipelines, processing and storage in Edmonton and Fort Saskatchewan, Alberta, and markets NGLs to customers throughout North America. KeySpan s revenues are largely derived from geographically diverse natural gas processing plants and associated assets. These revenues are fee-for-service based with no exposure to commodity prices. The remainder of KeySpan s revenues are derived from its NGL marketing business, focused on the marketing of by-products recovered from the processing of raw gas, including NGLs and sulphur. KeySpan s facilities infrastructure provides significant competitive advantage to its NGL marketing business. KeySpan has diversified sources of NGL supply and a diversified customer base across North America. The following table shows the contribution of each of KeySpan s operating segments, and includes inter-segment transactions between the facilities and marketing segments that are eliminated in the Partnership s financial statements. _ 2

3 Three months ended Contribution by Operating Segment March 31 $ millions Facilities contribution Marketing contribution Total contribution Other expenses 3 (10.1) (10.0) Net income Notes: Facilities contribution and Marketing contribution, as defined below, are not standard measures under Canadian generally accepted accounting principles. Therefore, these measures may not be comparable with the calculation of similar measures for other companies. Contribution refers to operating revenues less operating expenses (marketing cost of goods sold, plant processing and gathering expenses and pipeline expenses, where applicable). 1. Facilities contribution includes revenues for processing and storage services provided to KeySpan s marketing business. 2. Marketing contribution includes expenses for processing and storage services provided by KeySpan s facilities and direct marketing general and administrative costs. 3. Other expenses include corporate general and administrative, depreciation and amortization, accretion and income tax. Corporate general and administrative and other costs exclude the direct marketing general and administrative costs. FACILITIES Gathering and Processing Land and drilling activity in the areas surrounding KeySpan facilities continued at the record levels experienced in In the first quarter, 2004 facilities contribution increased 4% compared to the first quarter of Gas processing throughput remained at about the same level as the fourth quarter, with gross throughput averaging 707 million cubic feet per day, representing a 52% utilization rate. In the Foothills Region, continued high levels of activity and producer success in the Easyford area promise to increase sour gas throughput at the Bigoray and Brazeau River gas plants. Processing capacity for this gas is currently restricted, waiting for completion of the plant debottlenecking project at Bigoray, modifications to the Easyford battery and startup of the Brazeau Northeast Gathering System. The Bigoray gas plant process modifications are underway to allow additional processing of sour gas beginning in August. Modifications at the Easyford battery were completed in the first quarter and throughput has been increased from 2,950 bbls/day to 9,400 bbls/day of oil and associated solution gas. In March, KeySpan announced it had begun construction of the Brazeau Northeast Gathering System, a new $18.4 million, 84 km sour gas pipeline extending from the highly prospective Pembina area of Alberta to the Brazeau River gas plant. KeySpan s ownership interest has been finalized at 30.7%. Construction of the 6 and 8 inch pipeline is well underway and completion is expected to occur in August. Strong drilling activity is also occurring adjacent to the Strachan North pipeline and the Garrington/Lanaway pipeline system. In the Rimbey Corridor, the first quarter saw a continuation of the increased drilling activity which began in the fourth quarter of Twenty-seven active producers licensed 126 gas wells in the quarter, a 40% increase over the same period last year. This activity continues to demonstrate the westward trend in the basin, toward KeySpan s areas of operations. While shallow sweet gas production represented about half of this activity, several successful Leduc wells are expected to add additional sour gas production at the Rimbey plant in the second quarter. The Rimbey plant continues to benefit from NGL volumes trucked in for processing from other gas plants in the area, including KeySpan s Strachan gas plant. These volumes have increased Rimbey s NGL processing utilization to over 80%. The first quarter was a busy quarter for internal growth projects. Commissioning of the CO 2 liquification project at the Rimbey plant began in April and will be completed by mid-may. At the Strachan gas plant, work began on the addition of a waste heat recovery boiler that will reduce the fuel gas consumption and provide cost savings to be shared by both plant owners and producers. KeySpan expects this project will be operational in August, along with the Bigoray and Brazeau River projects described above. _ 3

4 In February, KeySpan agreed to acquire an additional 19% working interest in the Wabasca River oil pipeline for $2 million, increasing its ownership to 69%. This transaction is subject to rights of first refusal provisions which have the potential to reduce the working interest acquired. The transaction is expected to close in late May. NGL Facilities NGL processing facilities continued to operate at high utilization rates throughout the first quarter, and utilization of the Fort Saskatchewan NGL processing plants exceeded 100% of KeySpan net capacity. In the first quarter KeySpan signed an agreement to provide committed condensate cavern storage at Fort Saskatchewan. New NGL truck loading facilities were completed at the Medicine River gas plant to allow KeySpan to divert NGL volumes from competitor pipelines to the Rimbey plant for processing and transportation, increasing the utilization of KeySpan s NGL infrastructure. Economic conditions allowed sales gas in the first quarter to be diverted to the Rimbey gas plant for reprocessing. KeySpan is able to utilize the specialized processing facilities at Rimbey to extract additional natural gas liquids from certain sales gas streams on a discretionary basis when conditions permit, enhancing cash flows. MARKETING The first quarter marketing contribution of $6.4 million was $1.5 million lower than the record results posted in the first quarter of 2003 due to the elimination of gas marketing revenues in late Strong NGL demand in the first quarter, caused by cold weather combined with the resumption of transportation capacity, resulted in sales volumes averaging 48,100 barrels per day versus 40,800 last year. The contract year for NGL purchases and sales typically runs from April 1 to March 31. In the first quarter, KeySpan s team of marketing professionals concluded a very successful 2004 product purchase and sale program. NGL purchases are expected to exceed the 2003 supply volumes, and sales contracts were renewed with propane and butane customers in Canada and the US, maintaining KeySpan s diversity of customers and markets. In order to continue to efficiently manage these increasing volumes, KeySpan has increased its fleet of leased rail cars. Management s Discussion and Analysis Management's discussion and analysis is a review of the results of operations and the liquidity and capital resources of the KeySpan Facilities Income Fund (the Fund ) and of KeySpan Energy Canada Partnership (the Partnership or KeySpan ). It should be read in conjunction with the accompanying unaudited consolidated financial statements of the Fund and the Partnership for the quarter ended March 31, 2004 and the notes thereto as well as the audited financial statements of the Fund and the Partnership for the year ended December 31, 2003 and the related management s discussion and analysis. The Fund was created on April 3, 2003 and began operations on May 30, 2003 with an initial public offering of trust units, acquiring a 39.1% indirect interest in KeySpan. Pursuant to transactions completed in connection with the initial public offering, KeySpan acquired KeySpan Energy Facilities Limited ( KEFL ) and KeySpan Energy Canada Company ( KECC ) on May 30, The Statement of Income contained in the unaudited consolidated financial statements of KeySpan presents the results of operations of KeySpan, KEFL, and KECC for the three-month period ended March 31, The information presented by KeySpan for the comparative period of 2003 represents only the results of operations of KeySpan. Accordingly, some of the variances described in this report include the effect of these acquisitions and readers are cautioned that certain information included in the financial statements for prior periods may not be directly comparable. Distributable Cash Flow as defined in the Partnership Agreement and described in note 3 of the interim consolidated financial statements of the Partnership is not a standard measure under Canadian generally accepted accounting principles and therefore may not be comparable with the calculation of similar measures for other companies. _ 4

5 KEYSPAN FACILITIES INCOME FUND RESULTS OF OPERATIONS The Fund reported net earnings of $4.6 million or $ per trust unit for the first quarter of 2004 based upon 17,000,000 trust units outstanding at the end of the period. The earnings were attributable to the Fund s 39.1% interest in the consolidated earnings of KeySpan for the three months ended March 31, LIQUIDITY AND CAPITAL RESOURCES The Fund does not actively operate a business and is dependent upon distributions from KeySpan for earnings. During the first quarter of 2004, the Fund has received $4.6 million of distributions from KeySpan and paid distributions to Unitholders of $4.6 million. In addition, as at March 31, 2004, the Fund has accrued $1.5 million of distributions receivable from KeySpan and $1.5 million of distributions payable to Unitholders. It has no cash from operations and no external debt. SUBSEQUENT EVENT On April 1, 2004, the Fund completed an equity offering of 15,617,000 units for net proceeds of approximately $186.3 million. The proceeds of the offering were used to acquire an additional interest of 35.9% in KeySpan, bringing the Fund s ownership interest in KeySpan to 75%. As a result of the increase in ownership interest, the financial statements of the Fund will be presented on a consolidated basis, rather than an equity basis, commencing with the second quarter of KEYSPAN ENERGY CANADA PARTNERSHIP RESULTS OF OPERATIONS Net income earned during the first quarter of 2004 was $11.9 million, down $1.0 million from last year, due primarily to higher interest costs and lower marketing results offset by the earnings generated from the acquisition of KEFL on May 30, Operating margin Facilities activities accounted for approximately 61% of operating margin* during the first quarter of 2004 compared to 59% in Facilities as a portion of the total margin in the first quarter is typically lower than the remainder of the year due to the higher first quarter marketing contribution resulting from the strong product demand and higher prices of the winter season. Three months ended March 31 Operating margin* - $ millions Facilities Marketing Corporate Note: * Operating margin, which is defined as operating revenues minus operating expenses, is not a standard measure under Canadian generally accepted accounting principles and therefore may not be comparable with the calculation of similar measures for other companies. Facilities Operating margin generated from gathering, processing and pipeline activities is not significantly exposed to changes in operating costs as much of the revenue stream is generated on a cost-of-service basis. This fee arrangement provides a mechanism for the recovery of operating costs plus a return on capital. _ 5

6 Facilities operating margin of $12.7 million was virtually unchanged from $12.9 million in the first quarter of Compared to 2003, lower throughput volumes in the Foothills Region were offset by higher volumes in the Rimbey Corridor where drilling activity has increased. Also, greater NGL volumes from other plants and reprocessing activities at the Rimbey plant also contributed positively to operating margin. Marketing Marketing operating margin of $7.8 million for the first quarter of 2004 were $1.1 million lower compared to the same period last year, due primarily to the wind-up of the natural gas marketing business. The operating margin was contributed entirely by the NGL marketing business, where stronger demand and improved transportation logistics resulted in greater sales volumes compared to In the first quarter of 2004, NGL sales volumes averaged 48,100 barrels per day compared to 40,800 barrels per day during the same period last year. Non-operating expenses and other earnings During the first quarter of 2004, non-operating expenses of $8.4 million decreased by $0.6 from the same period last year. General and administrative expenses of $3.1 million were $0.9 million lower than in the first quarter of This is due primarily to lower incentive compensation costs and greater overhead recoveries, partially offset by the inclusion of administrative expenses relating to KEFL. Interest expense, net of interest revenue, was $2.1 million compared to the $0.1 million of interest revenue in the previous year. Approximately $1.8 million of the interest expense was related to the long-term senior secured notes issued in August The remainder of the interest expense was due to short-term borrowings to finance working capital requirements and capital expenditures. In the first quarter of 2003 KeySpan did not have any debt obligations. Equity earnings of $0.8 million in the first quarter of 2004 relate to an investment held by KEFL. Because the Partnership did not acquire KEFL until May 30, 2003, there were no equity earnings in the first quarter of The unrealized gain on financial instruments of $0.9 million during the first quarter of 2004 relates to the change in fair value of NGL price swaps. These contracts are not eligible for hedge accounting pursuant to the criteria established by the CICA Accounting Guideline 13, Hedging Relationships ( AcG-13 ). At the time of settlement, the unrealized gain or loss will be reversed and the actual gain or loss included in revenue or cost of sales for that period. In 2003 hedge accounting was applied to all financial contracts and as a result there are no changes in fair value reported for the same period last year. A more detailed explanation of the accounting treatment is described in the new accounting pronouncements section later in the report. Critical accounting estimates In the preparation of KeySpan's consolidated financial statements, management has made estimates that affect the recorded amounts of certain of KeySpan's assets, liabilities, revenues and expenses. A description of the accounting estimates and the methodologies and assumptions underlying the estimates are described in management s discussion and analysis presented with the December 31, 2003 annual consolidated financial statements of the Partnership. There have been no changes to the methodologies and assumptions. The most significant estimates are those indicated below: Estimation of facility revenues and operating expenses: At March 31, 2004, operating revenues and accounts receivable for the facilities segment contain an estimate of $6.8 million for March 2004 operations. Operating expenses and accounts payable contain an estimate of $1.9 million for the same period. There are no known trends, events or uncertainties to indicate that actual results will vary significantly from the estimates used, nor would any expected variance have a material effect on the financial condition of KeySpan. Estimation of facility equalization adjustments: Much of the revenue from the gathering, processing and pipeline assets in the facilities segment is generated on a cost-ofservice basis. Under this method, the operating component of the fee is a pro rata share of the operating costs for the facility, calculated based upon total throughput. Users of the facility are charged a fee per unit based upon estimated costs and throughput, with an adjustment to actual completed at the end of each year. Each quarter, throughput volumes and operating costs are reviewed to determine whether the estimated unit fee charged during the quarter properly reflects the actual volumes and costs, and the allocation of revenues and operating costs to other plant owners is also reviewed. Appropriate adjustments to the revenue recognized in the quarter and allocations to other owners are recorded. _ 6

7 At March 31, 2004, for the facilities segment, operating revenues and accounts receivable contain an adjustment incremental revenues of $1.5 million. There are no known trends, events or uncertainties to indicate that actual results will vary significantly from the estimates used nor would any expected variance have a material effect on the financial condition of KeySpan. Estimation of NGL marketing revenues and product purchases: At March 31, 2004, NGL marketing sales and accounts receivable contain an estimate for March 2004 revenues of $16.4 million. NGL marketing cost of goods sold and accounts payable contain an estimate of NGL product purchases of $41.9 million. There are no known trends, events or uncertainties to indicate that actual results will vary significantly from the estimates used nor would any expected variance have a material effect on the financial condition of KeySpan. LIQUIDITY AND CAPITAL RESOURCES During the three months ended March 31, 2004, cash provided by operating activities was $44.5 million, an increase of $10.7 million from the same period last year. The increase was attributable to the cash generated from the sale of NGL product from inventory in 2004, partially offset by lower earnings and changes in other non cash assets and liabilities. Working capital at the end of the quarter was $34.0 million, down slightly from $34.5 million at December 31, During the first quarter of 2004, the Partnership repaid $23.5 million of borrowings from short-term bank credit facilities and paid $7.9 million of distributions. At quarter end cash on hand was $14.4 million and the Partnership had no borrowings from its short-term bank credit facilities. The working capital requirements and industry factors affecting liquidity are substantially unchanged from those described in management s discussion and analysis presented with the Partnership s December 31, 2003 consolidated financial statements. Standard and Poor s has assigned the Fund an SR-3 stability rating, indicating the expectation of a high level of stability in distributions. Three months ended March Capital Spending - $ million In the first quarter of 2004, additions to property, plant and equipment amounted to $5.1 million. This consisted of $4.9 million of growth capital and $0.2 million of maintenance capital. Growth capital expenditures were primarily related to the construction of the CO 2 liquification plant at Rimbey and the Brazeau Northeast Gathering System. The CO 2 liquification plant introduces a new revenue opportunity for KeySpan while the Brazeau Northeast Gathering System establishes new capture areas and accesses raw natural gas supplies in the Pembina area that are not currently being delivered to the Brazeau plant. The maintenance capital expenditures were related to numerous small projects. DISTRIBUTABLE CASH FLOW KeySpan pays distributions to its partners on a monthly basis from its Distributable Cash Flow, as defined in the Partnership Agreement. KeySpan's Distributable Cash Flow for each month will generally be all of its cash flow from operations for such month, including dividends received from subsidiaries, after satisfaction of its debt service obligations (principal and interest), reclamation expenditures, maintenance capital expenditures, other expense obligations and reasonable reserves for working capital and capital expenditures as may be considered appropriate by the board of directors of the Managing Partner. For the first quarter of 2004, Distributable Cash Flow was $15.5 million and KeySpan declared cash distributions to partners of $11.8 million, of which the Fund s share was $4.6 million. The cash surplus was due primarily to the strong performance of the NGL marketing business and the absence of maintenance capital expenditures in the quarter. These variances commonly occur in the first quarter as high winter demand for NGL products enhances results and maintenance activities are typically undertaken later in the year. For these reasons, the cash surplus has been retained in the Partnership. The board of _ 7

8 directors of the Managing Partner will consider increasing the level of cash distributions when it is confident that the increase is sustainable. SELECTED FINANCIAL INFORMATION Neither the Fund nor KeySpan prepared quarterly statements prior to the Fund becoming a reporting issuer on May 30, The following table presents selected financial information for KeySpan (restated due to the changes in accounting policies as described in the new accounting pronouncements section later in this report. Mar. 31, 2003 Jun. 30, 2003 Three month period ended Sept. 30, 2003 Dec. 31, 2003 Mar. 31, 2004 Operating revenues - $000 Facilities gathering, processing and pipelines 23,212 24,391 24,676 24,956 23,532 Marketing sales 228, , , , ,983 Other revenues Total operating revenues 251, , , , ,811 Net income 12,944 9,003 7,333 8,570 11,921 Cash distributions 168,417 12,179 11,702 11,848 March 31, 2004 compared to December 31, 2003 For the first quarter of 2004, operating revenues from facilities were $23.5 million, down $1.4 million from the previous quarter. The decrease was primarily attributable to lower equalization adjustments than in the previous quarter. For the first quarter of 2004, marketing revenues of $169.0 million increased by $21.3 million from the previous quarter due to higher NGL volumes and prices. Net income for the first quarter of 2004 of $11.9 million increased by $3.3 million due primarily to the strong performance of the Marketing business segment and the unrealized gain on financial instruments. December 31, 2003 compared to September 30, 2003 For the fourth quarter of 2003, marketing revenues of $147.7 million were up $24.0 million due to higher NGL sales volumes and prices. Net income for the fourth quarter of 2003 was $8.6 million, up $1.2 million from the previous quarter, due primarily to the stronger performance from the NGL marketing business. Distributions for the fourth quarter of 2003 were $11.7 million, down $0.5 million from the previous quarter, as distributions to KeySpan Energy Development Co. ( KEDCO ) were reduced as a result of the expiry of the gas marketing contract termination payments on November 30, September 30, 2003 compared to June 30, 2003 For the third quarter of 2003, marketing revenues of $123.7 million were down $14.6 million from the previous quarter due primarily to the expiry and winding up of natural gas sales contracts. Net income for the third quarter was $7.3 million, down $1.6 million from the previous quarter, due primarily to higher interest costs. Prior to May 30, 2003, KeySpan had no external debt. Distributions for the third quarter of 2003 were $12.2 million, down $156.2 million from the previous quarter which included the dividends related to the restructuring of KeySpan prior to its acquisition by the Fund. _ 8

9 June 30, 2003 compared to March 31, 2003 For the second quarter of 2003, operating revenues from facilities were $24.4 million, up $1.2 million from the previous quarter. The acquisition of KEFL by KeySpan and take or pay revenues earned at the Paddle River plant offset the lower volumes at the Brazeau plant due to the turnaround at that plant. For the second quarter of 2003, marketing revenues of $138.3 million were down $90.1 million from the previous quarter due to lower NGL volumes and prices and the winding-up of the natural gas marketing business. Net income for the second quarter of 2003 was $9.0 million, down $3.9 million from the previous quarter, due primarily to the strong performance of the NGL marketing business in the first quarter where strong per unit margins were earned due to lower than average North American inventory levels. Distributions for the second quarter of 2003 were $168.4 million due primarily to the distributions paid to KEDCO prior to the Fund's acquisition of an indirect interest in KeySpan. NEW ACCOUNTING PRONOUNCEMENTS Financial instruments Effective January 1, 2004, KeySpan adopted CICA Accounting Guideline 13, Hedging Relationships ( AcG-13 ) and commenced application of the accounting treatment specified in the CICA Emerging Issues Committee Abstract EIC-128, Accounting for Trading, Speculative or Non-Hedging Derivative Financial Instruments ( EIC-128 ). AcG-13 clarifies the circumstances in which hedge accounting is appropriate and includes the requirements for the identification, documentation, designation and effectiveness of hedges. The guideline also identifies situations where hedge accounting is to be discontinued. EIC-128 requires that all derivative instruments that do not qualify for hedge accounting under AcG-13 or are not designated as a hedge, be recorded on the statement of financial position at their fair market value, either as an asset or liability. Changes in their fair market value are recognized in earnings in the period they occur. KeySpan has applied the criteria of AcG-13 to all financial instruments and discontinued hedge accounting for those that do not meet the effectiveness criteria of the guideline. At January 1, 2004, KeySpan recorded an unrealized loss of $0.3 million in deferred charges on the consolidated statement of financial position that is being recognized in earnings over the life of the previously designated hedged items. The effect of these contracts on earnings for the quarter ended March 31, 2004 was an unrealized gain of $0.9 million. At maturity, the cash settlement value of these contracts will be reflected in marketing revenues or cost of sales. However, while the contracts are held, KeySpan expects the adoption of this new accounting standard to introduce volatility to earnings due to the reporting of unrealized gains and losses. These unrealized items will be reported separately on the consolidated statement of income and will have no effect on Distributable Cash Flow. General accounting principles In July 2003, the CICA approved section 1100, General Accounting Principles effective for fiscal years beginning on or after January 1, As a result, KeySpan began expensing significant turnaround costs commencing January 1, For the year ended December 31, 2003 these costs were capitalized and depreciated over the estimated period until the next scheduled significant turnaround, which ranged from two to four years. This change in accounting policy has been applied retroactively and resulted in a decrease in net property, plant and equipment of approximately $4.7 million and a decrease in partners equity of approximately $4.7 million on January 1, The impact of this new accounting pronouncement on the consolidated statement of income for the year ended December 31, 2003, had it been adopted on January 1, 2003, would be a reduction in net income of $2.4 million and an increase in net income of $0.2 million for the three months ended March 31, There would have been no change to Distributable Cash Flow in the year, as the reduction in net income of approximately $2.4 million and the reduction of depreciation and amortization expense of $1.5 million are offset by the decrease in maintenance capital of $3.9 million. _ 9

10 This change in accounting policy is expected to introduce volatility to earnings, as turnaround costs will vary depending on the number and timing of plant turnarounds in a particular period. Distributable Cash Flow will be unaffected, as maintenance capital, a deduction when calculating Distributable Cash Flow, will be reduced by a corresponding amount. Asset retirement obligation The Partnership has retroactively adopted the Canadian accounting standard outlined in the CICA Handbook section 3110, Asset Retirement Obligations. Under the new section, the fair value of estimated asset retirement obligations is recognized in the period in which they are incurred if a reasonable estimate of a fair value can be determined. Asset retirement obligations include those legal obligations where KeySpan will be required to retire tangible long-lived assets such as gathering and processing facilities as well as items for which the Partnership has made promissory estoppel. The asset retirement cost, deemed to be the fair value of the retirement obligation, is capitalized as part of the cost of the related long-lived asset and allocated to expense on a basis consistent with depreciation and amortization. Amortization of asset retirement costs are included in depreciation and amortization in the consolidated statement of income. Increases in the ARO resulting from the passage of time are recorded as accretion expense in the consolidated statement of income, over the estimated time period until settlement of the obligation. Actual expenditures incurred are charged against the accumulated asset retirement obligation. The Partnership previously estimated costs of site restoration and abandonment and recorded them into earnings based on the estimated life of the asset and accumulated a liability on the consolidated statement of financial position. Upon adoption, all prior periods have been restated for the change in accounting policy. The change results in a decrease in net income of $0.1 million for the three months ended March 31, 2003 ($0.2 million for the year ended December 31, 2003). The effect of this change on the December 31, 2003 consolidated statement of financial position is an increase in assets of $1.6 million, an increase in liabilities of $4.5 million and a decrease in retained earnings of $2.9 million. Investor Information DISTRIBUTIONS TO UNITHOLDERS Distributions to Unitholders of $ per unit for the first quarter of 2004 were consistent with expectations. The Fund is focused on ensuring stable long-term distributions that grow over time. TAXABILITY OF 2004 DISTRIBUTIONS For Canadian residents, the Fund expects its 2004 distributions will be fully tax-deferred by way of a return of capital. This tax deferral results primarily from the Partnership s ability to shelter its taxable income with capital cost allowance claims on its facilities. Unitholders should seek independent tax advice in respect of the consequences to them of acquiring, holding and disposing of Units. SUPPLEMENTARY INFORMATION KeySpan has provided a further breakdown of KeySpan s operational and financial results on its website at under Investor Information, Financial Information. Included are volumetric and contribution information by major business unit. FORWARD LOOKING STATEMENTS This document contains certain forward-looking statements that involve significant known and unknown risks and uncertainties. A number of factors could cause actual results to differ materially from the results discussed in the forwardlooking statements, many of which are beyond the control of the Fund and KeySpan. Some of these factors are discussed in the Fund s public filings with Canadian Securities Administrators, filed on No assurances can be given that actual results will be consistent with these forward-looking statements. Forward-looking statements in this document are presented as of, and are subject to changes after this date. However, the Fund disclaims any intention to update or revise these forward-looking statements, whether as a result of new information, future events or otherwise. _ 10

11 FIRST QUARTER RESULTS CONFERENCE CALL AND WEBCAST KeySpan will be conducting a conference call and webcast for investors, analysts, brokers and media representatives to discuss the first quarter at 8:00 am MDT (10:00 am EDT) on Wednesday, May 12, Callers may participate by either dialing or A recording of the call will be available for replay until midnight, May 19, 2004 by dialing or and entering pass code followed by the # key. Internet users can listen to the call live on KeySpan s website at under Investor Information, Webcasts. Shortly after the call, an audio archive will be posted on the website for 90 days. QUESTIONS KeySpan welcomes questions from interested parties. Calls should be directed to John Cobb, Director, Investor Relations at , or toll free at Information on KeySpan can also be found on our website at _ 11

12 KeySpan Facilities Income Fund Interim Consolidated Statements of Financial Position (All amounts expressed in thousands of Canadian dollars, except where otherwise noted) (unaudited) March 31, December 31, As at $ $ ASSETS Current assets Distributions receivable 1,544 1,544 1,544 1,544 Investment in KeySpan Energy Canada Partnership (note 3) 156, ,984 Investment in KeySpan Canada Management Ltd. (note 3) , ,536 LIABILITIES AND UNITHOLDERS EQUITY Current liabilities Due to related parties 62 Distributions payable 1,544 1,544 1,606 1,544 Unitholders equity (note 4) 155, , , ,536 See accompanying notes to the interim consolidated financial statements 12

13 KeySpan Facilities Income Fund Interim Consolidated Statements of Earnings and Unitholders Equity (All amounts expressed in thousands of Canadian dollars, except where otherwise noted) (unaudited) March 31, 2004 For three months ended $ Revenues Equity earnings from KeySpan Energy Canada Partnership and KeySpan Canada Management Ltd. (note 3) 4,660 4,660 Expenses Management and administrative (note 6) Other expenses Net earnings 4,597 Weighted average number of trust units outstanding 17,000,000 Net earnings per weighted average trust unit (basic and diluted) Consolidated Statement of Unitholders Equity Unitholders equity, beginning of period 155,992 Net earnings 4,597 Distributions (note 7) (4,630) Unitholders equity, end of period 155,959 Distributions to unitholders and distributions per trust unit See note 7 See accompanying notes to the interim consolidated financial statements 13

14 KeySpan Facilities Income Fund Interim Consolidated Statement of Cash Flows (All amounts expressed in thousands of Canadian dollars, except where otherwise noted) (unaudited) March 31, 2004 For three months ended $ OPERATING ACTIVITIES Net earnings 4,597 Items not requiring cash: Equity earnings from KeySpan Energy Canada Partnership and KeySpan Canada Management Ltd. (4,660) (63) Changes in non-cash working capital 63 Cash provided by operating activities INVESTING ACTIVITIES Acquisition of interest in KeySpan Energy Canada Partnership (note 3) Acquisition of interest in KeySpan Canada Management Ltd. (note 3) Cash provided by investing activities FINANCING ACTIVITIES Distributions received 4,631 Distributions paid (4,631) Cash provided by financing activities Decrease in cash and cash equivalents Cash and cash equivalents, beginning of period Cash and cash equivalents, end of period See accompanying notes to the interim consolidated financial statements 14

15 KeySpan Facilities Income Fund Notes to Interim Consolidated Financial Statements For three months ended March 31, 2004 (All amounts expressed in thousands of Canadian dollars, except where otherwise noted) (unaudited) 1. STRUCTURE OF THE FUND KeySpan Facilities Income Fund (the Fund ) is an unincorporated open-ended trust established under the laws of the Province of Alberta pursuant to the Fund Declaration of Trust dated April 3, The Fund indirectly owns a 39.1% interest in KeySpan Energy Canada Partnership ( KeySpan or the Partnership ). The Fund commenced operations on May 30, 2003, with the initial acquisition of a 34.5% interest in the Partnership. The acquisition of the Fund s indirect interest in the Partnership has been accounted for based on the Fund s cost (see note 3). The Partnership is involved in the business of gathering, processing, transporting, buying and selling petroleum, natural gas, natural gas liquids and related products, electricity and thermal energy and other related businesses. The Partnership is managed by KeySpan Canada Management Ltd. ( KCML or the Managing Partner ). The Fund makes monthly cash distributions to unitholders of record on the last business day of each month. The amount of the distributions per trust unit are equal to the pro rata share of the distribution received from the Partnership and, in the event of the termination of the Fund, participating pro rata in the net assets remaining after satisfaction of all liabilities. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The consolidated financial statements of the Fund have been prepared in accordance with Canadian generally accepted accounting principles. The accounting policies applied are consistent with those outlined in the Fund s audited financial statements for the period from inception on April 3, 2003 to December 31, These consolidated financial statements for the three months ended March 31, 2004, do not include all disclosures required in the audited annual financial statements and should be read in conjunction with the audited annual financial statements. Certain amounts in these financial statements have been reclassified to conform to the current year financial statement presentation. 3. ACQUISITIONS On May 30, 2003, the Fund issued 15,000,000 trust units as an initial public offering (the Initial Offering ) at a price of $10.00 per trust unit for net proceeds of $139,375 after transaction fees of $10,625. Net proceeds received for the Initial Offering were used to purchase a 34.5% indirect interest in the Partnership for consideration of $139,368. At the same time, the Fund acquired 34,490 shares of the KCML, the managing partner of the Partnership, representing a 34.5% interest in KCML, for consideration of $7. KCML has a 0.005% interest in the Partnership. On June 10, 2003, under the over-allotment option, the Fund issued an additional 2,000,000 trust units at a price of $10.00 per unit for net proceeds of $18,850,000 after transaction fees of $1,150. The proceeds were used to purchase an additional 4.6% interest in Partnership for $18,849 and an additional 4,600 common shares of KCML for $1. KEYSPAN FACILITIES INCOME FUND Notes to unaudited interim consolidated financial statements 15

16 The equity investment in the Partnership was comprised of: Acquisition cost 158,217 Equity earnings 8,572 Distributions to the Fund (10,805) Investment in the Partnership, December 31, ,984 Equity earnings 4,659 Distributions to the Fund (4,631) Investment in the Partnership, March 31, ,012 The equity investment in KCML was comprised of: Acquisition cost 8 Equity earnings Investment in KCML, December 31, Equity earnings 1 Investment in KCML, March 31, $ $ 4. UNITHOLDERS EQUITY The Fund Declaration of Trust provides that an unlimited number of trust units may be authorized and issued. Each trust unit is transferable, and represents an equal undivided beneficial interest in any distribution from the Fund and in the net assets of the Fund in the event of termination or winding-up of the Fund. All trust units are of the same class with equal rights and privileges. The Declaration of Trust also provides for the issuance of an unlimited number of special trust units that will be used solely for providing voting rights to persons holding securities that are directly or indirectly exchangeable for units and that, by their terms, have voting rights in the Fund. The trust units are redeemable at the holder s option at an amount equal to the lesser of: (i) 90% of the weighted average price per unit at which the units during the period of the last 10 days during which the trust units were traded on the Toronto Stock Exchange; and (ii) an amount equal to (a) the closing market price of the units; (b) an amount equal to the average of the highest and lowest prices of units if there was trading on the date on which the units were tendered for redemption; or (c) the average of the last bid and ask prices if there was no trading on the date on which the units were tendered for redemption. Redemptions are subject to a maximum of $50 cash redemptions in any particular month. Redemptions in excess of this amount will be paid by way of a distribution in specie of assets of the Fund that may include Commercial Trust Series 2 notes. TRUST UNITS ISSUED AND UNITHOLDERS EQUITY Number of Units Amount $ Initial Offering, net of transaction fees of $11,775 17,000, ,225 Net earnings 8,572 Distributions declared (10,805) As at December 31, ,000, ,992 KEYSPAN FACILITIES INCOME FUND Notes to unaudited interim consolidated financial statements 16

17 Net earnings 4,597 Distributions declared (4,630) As at March 31, ,000, ,959 The weighted average numbers of trust units outstanding for the period from inception to December 31, 2003 and for the three months ended March 31, 2004 were 13,356,618 and 17,000,000 respectively. Transaction costs of $11,775 were incurred by the Fund in issuing trust units. These costs are deductible for income tax purposes on a straight-line basis over a five-year period. Each unitholder will be required to include in computing income for tax purposes for a particular taxation year their pro rata share of the Fund s income that was paid or payable in that year to the unitholder and that was deducted by the Fund in computing its income. 5. RELATED PARTY TRANSACTIONS KCML is a 39.1% owned subsidiary of the Fund and is the managing partner of the Partnership. KCML provides management and administrative services to the Fund and the Partnership on a cost recovery basis. KEDCO owns the remaining 60.9% interest in KCML. As at March 31, 2004, the Fund had the following balances receivable from and due to related parties in the normal course of business: Distributions receivable from the Partnership $1,544 Due to related parties $ ECONOMIC DEPENDENCE For the purposes of declaring distributions, the Fund is entirely dependent on cash distributions received from the Partnership. 7. RECONCILIATION OF DISTRIBUTIONS ACCRUING TO UNITHOLDERS For three months ended March 31, 2004 Net earnings 4,597 Add: Distributions accrued 4,630 Less: Equity earnings from the Partnership and the Managing Partner (4,660) Distributions accruing to unitholders during the period 4,567 Weighted average number of trust units outstanding 17,000,000 Distributions accruing to unitholders per weighted average trust unit SUBSEQUENT EVENTS On April 1, 2004, the Fund completed an equity offering of 15,617,000 units for net proceeds of approximately $186.3 million. The proceeds of the offering were used to acquire an additional interest of 35.9% in KeySpan. KEYSPAN FACILITIES INCOME FUND Notes to unaudited interim consolidated financial statements 17

18 KeySpan Energy Canada Partnership Interim Consolidated Statements of Financial Position (All amounts expressed in thousands of Canadian dollars) (unaudited) As at March 31, December 31, $ $ ASSETS (restated note 2) Current assets Cash and cash equivalents 14,399 6,367 Accounts receivable 113, ,472 Inventory 8,630 27,458 Prepaid expenses 2,536 3,043 Due from related parties (note 9) , ,293 Property, plant and equipment (note 2) 556, ,043 Other assets 13,716 13,716 Long-term investments (note 4) 13,941 13,095 Intangible assets 6,442 6,609 Deferred costs (note 6) 1,121 1,161 Future tax asset (note 8) 3,429 3, , ,817 LIABILITIES AND PARTNERS EQUITY Current liabilities Accounts payable and accrued liabilities 99,293 94,650 Distribution payable 3,951 3,689 Deposits payable 1,465 1,465 Due to related parties (note 9) Current portion of debt (note 6) 23, , ,761 Long-term debt (note 6) 125, ,000 Asset retirement obligation (note 2 and 7) 11,003 10, , ,590 Commitments and contingencies (note 11) Partners equity Related party transaction adjustment 15,069 15,069 Partners equity 478, , , , , ,817 See accompanying notes to the interim consolidated financial statements 18

19 KeySpan Energy Canada Partnership Interim Consolidated Statements of Income and Partners Equity (All amounts expressed in thousands of Canadian dollars) (unaudited) Three months ended March $ $ Operating revenues (restated note 2) Marketing sales 168, ,905 Facilities gathering, processing and pipelines 23,532 23,212 Marketing service fees 1,469 Other revenue , ,604 Operating expenses Marketing cost of goods sold 161, ,433 Facilities gathering, processing and pipelines 10,818 10, , ,721 20,799 21,883 Depreciation and amortization (note 2) 4,698 4,783 General and administrative 3,106 4,038 Accretion expense (note 2 and note 7) Interest expense 2,117 (48) Equity (earnings) from long-term investments (note 4) (846) Unrealized (gain) on financial instrument (note 1) (899) 8,365 8,939 Net income before tax 12,434 12,944 Income tax expense (note 8) 513 Net income 11,921 12,944 Partners equity, beginning of period 478, ,711 Change in accounting policies (note 2) (4,978) Partners distributions (note 3) (11,848) Partners equity, end of period 478, ,677 See accompanying notes to the interim consolidated financial statements 19