First Quarter Report FOR THE THREE MONTHS ENDED JUNE 30, 2004 A04-356

Transcription

1 First Quarter Report FOR THE THREE MONTHS ENDED JUNE 30, 2004 A04-356

2 First Quarter Report CONTENTS 1. Overview Financial Performance Measures Lines of Business a) Generation b) Distribution c) Engineering Services d) Field Services Corporate Highlights e) Safety Performance f) Human Resources g) Regulatory h) Accenture Business Services for Utilities British Columbia Transmission Corporation First Quarter Report 2

3 1. Overview KEY HIGHLIGHTS Financial Consolidated net income for the three months ended June 30, 2004, was $8 million (before deferral account transfers; see note below*), compared with break-even results for the same period last year. The primary reason for the increase in net income is an increase in margins (revenue less energy costs) of $21 million. Also contributing to the increase in net income was a decrease of $12 million in operations, maintenance and administration expenditures. Offsetting these favourable variances are increases in finance charges and amortization expense of $14 million and $10 million respectively. Net income after deferral account transfers is $52 million for the three months ended June 30, compared with break-even results for the same period last year. BC Hydro s forecast net income before deferral account transfers for fiscal 2005 is approximately $275 million. The forecast of $275 million is a decrease of $113 million from the forecast of $388 million in BC Hydro s February 2004 Service Plan and a decrease of $131 million from the forecast of $406 million disclosed in BC Hydro s 2004 Annual Report. The reduction in forecast net income of $131 million from the 2004 Annual Report is largely due to the impact of lower-than-normal inflows due to drier-than-normal weather. Water inflows are expected to be 87 per cent of normal, compared with the 94 per cent of normal expected in the previous forecast. Lower water inflows reduce the availability of low-cost hydro generation and increase the reliance on other sources of supply. Partially offsetting the impact of lower water inflows are lowerthan-expected finance charges, due to lower debt balances at the end of the fiscal 2004 and lower-thanexpected amortization expense, due to lower-thanforecast fiscal 2004 capital expenditures. On April 2, 2004, BC Hydro filed a Revised Evidentiary Update as part of its 2004/2005 and 2005/2006 Revenue Requirement Application. BC Hydro revised its Revenue Requirement Application to propose a rate increase of 8.9 per cent in fiscal 2005, consisting of an interim 7.23 per cent increase effective April 1, 2004, and a further 1.67 per cent to be effective when approved by the British Columbia Utilities Commission (BCUC). If the BCUC does not approve the full amount of the interim increase, the difference will be fully refunded to customers with interest. BC Hydro is subject to various risks and uncertainties that can cause significant volatility in the earnings. Factors such as the level of water inflows into its reservoirs, market prices for electricity and natural gas, interest rates, foreign exchange rates, weather and regulatory and government policies influence both the operation of the BC Hydro system and its earnings. A reduction in water inflows into reservoirs results in a greater reliance on energy purchases or increased use of the Burrard Generating Station, which can both result in higher costs of energy. As a result of these risks and uncertainties, BC Hydro s net income before deferral account transfers for fiscal 2005 could range from $195 million to $435 million under various plausible scenarios. *Note on Deferral Accounts: As disclosed in the Management Discussion and Analysis section in the 2004 Annual Report, the Province issued a Special Directive that directs the BCUC to authorize BC Hydro to establish the Heritage Deferral Account and the Trade Income Deferral Account effective April 1, These accounts are intended to result in assigning domestic ratepayers the benefit of BC Hydro s low-cost generation assets and related activities, as well as an appropriate share of risks associated with the ownership and operation of these assets (the Heritage Resources ). As part of the Revenue Requirement Application related to fiscal 2005 and 2006, BC Hydro has applied for the establishment of a Non-Heritage Asset Deferral Account to manage the impact of certain other non-controllable cost variances. The impact of this account would be to defer specific types of cost variances through transfers to/from the accounts by adjustment of net income. First Quarter Report 3

4 KEY HIGHLIGHTS Performance Plan BC Hydro had a successful first quarter as reflected in its performance measures. Five of the six corporate measures reported on either met (3) or exceeded (2) their quarterly targets. BC Hydro was below its quarterly net income target primarily as a result of higher-than-anticipated energy imports and costs, lower-than-expected residential revenues, due to warmer-than-normal spring temperatures, and higher-than-forecast finance charges as a result of the weaker Canadian dollar. BC Hydro met its quarterly reliability target, with the average number of hours per interruption less than target and overall system availability better than target. BC Hydro was above its quarterly safety target, as measured by All Injury Frequency. BC Hydro is benefiting from the focus that has been placed on safety and performance improvement through awareness, planning, training and safe work practices. BC Hydro was above its quarterly strategic workforce planning target, as hiring began sooner than anticipated. Domestic Supply and Demand Compared with the first three months of the previous fiscal year, BC Hydro s total electricity revenues were up 208 GWh or 1.8 per cent. Industrial sales were up 220 GWh or 5.8 per cent, Light Industrial sales were up 51 GWh or 1.2 per cent and Residential sales declined by 82 GWh or 2.4 per cent. The snowpack accumulation through the winter and spring was below normal, both for the large interior basins in the Williston, Kinbasket and Kootenay regions and for Vancouver Island and the Lower Mainland. The weighted BC Hydro total system inflow forecast for the period February through September 2004 is 87 per cent of normal (with a standard error of plus or minus 10 per cent). The combined storage in BC Hydro reservoirs at June 30, 2004, was nine per cent below average or about 2,500 GWh below the historical average for this time of year. System storage energy on June 30, 2004, was about four per cent less than the same date last year. With system energy below normal, net energy purchases will be required through to the end of the fiscal year. Lines of Business Power Smart continues implementing its comprehensive 10-year plan to reach an annual target of 3,600 GWh per year in new energy savings. For the first quarter of this fiscal year, total cumulative energy was saved at a rate of 1,021 GWh per year, placing Power Smart ahead of the first-quarter target of 1,000 GWh per year, and on track to reach this year s cumulative target of 1,315 GWh per year. In June, the Natural Resources Canada Office of Energy Efficiency recognized BC Hydro s Power Smart with an award for ENERGY STAR Market Transformation. BC Hydro was praised for its Power Smart initiatives that encourage residential and business customers to adopt ENERGY STAR qualified products and other energyefficient technologies and was named ENERGY STAR Participant of the Year. The nine-kilometre 2L33 underground transmission cable installed between Horne Payne substation in Burnaby and Cathedral Square substation in Vancouver was energized successfully on April 29. The 2L33 cable reinforces the aging electrical transmission infrastructure serving the metropolitan Vancouver area. The relationship between BC Hydro and Accenture Business Services for Utilities continues to mature and was the subject of review at the end of Year 1. Initiatives are being undertaken to address internal client satisfaction and strengthen the outsourcing relationship where opportunities exist. In May, the federal government announced that funding had been approved for the cleanup of the Rock Bay property in Victoria s inner harbour. The property is owned by BC Hydro and Transport Canada. Joint Indemnification and Implementation Agreements between BC Hydro and Transport Canada were finalized. Remediation of the site will commence in the summer of First Quarter Report 4

5 2. Financial MANAGEMENT DISCUSSION AND ANALYSIS The Management Discussion and Analysis reports on BC Hydro s consolidated results and financial position. This discussion should be read in conjunction with the Management Discussion and Analysis presented in the 2004 Annual Report, the 2004 Annual Consolidated Financial Statements of BC Hydro and the interim consolidated financial statements of BC Hydro for the three months ended June 30, 2004 and This report contains forward-looking statements, including statements regarding the business and anticipated financial performance of BC Hydro. These statements are subject to a number of risks and uncertainties that may cause actual results to differ materially from those contemplated in the forward-looking statements. Consolidated Results of Operations Net income of $8 million before deferral account transfers for the three months ended June 30, 2004, compares with a break-even result in the same period in the previous year. The primary reason for the increase in net income is an increase in margins (revenues less energy costs) of approximately $21 million. Also contributing to the increase in net income was a decrease of $12 million in operations, maintenance and administration expenditures. Offsetting these favourable variances are increases in finance charges and amortization expense of $14 million and $10 million respectively. These reasons are discussed in more detail below. OPERATING HIGHLIGHTS For the Three Months Ended June 30 (Unaudited) in Gigawatt hours % change Electricity Sold Residential 3,267 3,349 (2.4)% Light industrial and commercial 4,137 4, % Large industrial 3,997 3, % Other energy sales % 11,701 11, % Electricity trade 6,906 7,652 18,607 19,145 First Quarter Report 5

6 MANAGEMENT DISCUSSION AND ANALYSIS Domestic Revenues Domestic revenues of $632 million for the three months ended June 30, 2004, were $49 million higher than the same period in the previous year. This increase is due to the 7.23 per cent interim rate increase effective April 1, 2004, increased consumption in the large industrial sector and a larger customer base. Electricity Trade Revenues BC Hydro s electricity system is interconnected with systems in Alberta and the western United States. This interconnection facilitates sales and purchases of electricity outside of British Columbia. Electricity trade activities are carried out by Powerex, a wholly-owned subsidiary of BC Hydro. While it engages in electricity trade, BC Hydro ensures its ability to meet domestic requirements is not put under undue risk as a result of these transactions. Electricity trade activities help BC Hydro balance its system by being able to import energy to meet domestic demand when there is a supply shortage in the system due to such factors as low water inflows. Exports are made only after ensuring domestic demand requirements can be met. Electricity trade revenues also include natural gas sales which are related to thermal generation requirements. Net electricity trade revenues for the three months ended June 30, 2004, were $186 million, a decrease of $13 million from the same period in the prior year. The decrease was due to a 10 per cent reduction in sales volumes to 6,906 GWh in the quarter ended June 30, from 7,652 GWh in the same period last year. The effect of lower sales volumes was partly offset by a seven per cent increase in average sales price from $56 per MWh in the prior year to $60 per MWh this year. The increase in market prices is caused by several factors including lower energy available from low-cost hydro generation in the region and tighter natural gas supplies. The decrease in sales volumes was due primarily to lower reservoir levels and transmission restrictions between B.C. and the United States. Energy Costs Energy costs are comprised of the following sources of supply: For the three months ended June 30 ($ in millions) (in GWh) ($ per MWh) Hydro 1 $ 48 $ 49 8,563 8,641 $ 5.6 $ 5.7 Purchases from Independent Power Producers and other long-term purchase contracts ,225 1, Other electricity purchases ,530 10, Natural gas Non-integrated Transmission charges and other expenses Total $ 406 $ ,433 20,193 $ 31.7 $ Net of storage exchange due to the Non-Treaty Storage Agreement with Bonneville Power Administration, Kootenay Canal Plant Agreement with Aquila Networks Canada and Keenleyside Entitlement Agreement with Columbia Power Corporation. 2 Other electricity purchases in dollars includes purchases for trade activities shown net of derivatives. Gigawatt hours and $ per MWh are shown at gross cost. 3 Includes costs of remarketed gas of approximately $33 million for the three months ended June 30, 2004 compared to $26 million for the same period for the prior year. Remarketed gas is natural gas purchased for the purpose of resale. The volumes shown for natural gas relate only to gas used for thermal generation. First Quarter Report 6

7 MANAGEMENT DISCUSSION AND ANALYSIS The mix of sources of supply is impacted by variables such as the market price of energy, water inflows, reservoir levels, energy demand and environmental and social impacts. For the three months ended June 30, 2004, energy costs of $406 million were $15 million higher compared to the same period in the previous year. The increase in energy costs is primarily due to higher prices for purchased electricity and a reduction in low-cost hydro-generation. The increase in electricity market prices was caused by several factors including lower hydro availability and tighter natural gas supplies. These increases reflect the impact of lower water inflows into the reservoirs which reduced the availability of low-cost hydro-generation and resulted in a greater level of energy imports to meet demand. Water inflows into BC Hydro s reservoirs were six per cent lower at June 30, 2004, compared to June 30, This resulted in a reduction in reservoir levels and the volume of low-cost hydro generation. BC Hydro s electricity imports to meet its domestic load requirements for the three months ended June 30, 2004 were 2,520 GWh compared to 1,967 GWh for the same period of the previous year. The decision to import energy instead of utilizing hydro generation is based on many factors, such as the forecast market price of energy in future periods relative to the current period, current reservoir levels and future demand requirements. Operating constraints related to legal and regulatory obligations such as minimum reservoir levels and stream flow requirements also affected the decision to import energy. BC Hydro currently anticipates importing approximately 6,600 GWh for domestic use this year, approximately 12 per cent of its domestic load. The combined storage in BC Hydro reservoirs at June 30, 2004, was 91 per cent of average ( per cent) (average storage levels relate to the average from 1985 to 2003) with the Williston Reservoir on the Peace River system at 94 per cent of average ( per cent) and the Kinbasket Reservoir on the Columbia River system at 76 per cent of average ( per cent). Operations, Maintenance and Administration Total operations, maintenance and administration expenditures for the three months ended June 30, 2004 were $12 million lower than for the same period in the previous year. The primary reason for the decrease is timing of expenditure programs this year compared to the same period in the previous year, lower maintenance expenditures related to thermal generation and completion of major information system projects in the prior year. Taxes Taxes, which are comprised of school taxes and grants in lieu of taxes, were $36 million for the three months ended June 30, Taxes were similar to the same period in the prior year. Finance Charges Finance charges for the three months ended June 30, 2004, were $14 million higher than for the same period in the previous year. The increase in finance charges is primarily due to lower sinking fund income and to new accounting rules requiring mark-to-market accounting on certain risk management activities. Amortization Expense Amortization expense for the three months ended June 30, 2004, was $10 million higher than for the same period in the previous year. The increase in amortization expense is primarily due to increased amortization expenses for computer projects implemented in the prior year and deferred demand-side management expenditures. First Quarter Report 7

8 MANAGEMENT DISCUSSION AND ANALYSIS Liquidity and Capital Resources Cash flow provided by operating activities for the quarter ended June 30, 2004, was $215 million, equal to the same period in the previous year. Capital expenditures, including demand-side management programs were as follows: For three months ended June 30 (in millions) Generation replacements and expansion $ 23 $ 23 Transmission lines and substation replacements and expansion Distribution improvements and expansion General computers, vehicles, etc Change in working capital related to capital asset expenditures Capital asset expenditures per Consolidated Statement of Cash Flows Power Smart (Demand-side management) 27 8 Total capital expenditures per Consolidated Statement of Cash Flows $ 140 $ Adjustment from accrual to cash expenditures on the Consolidated Statement of Cash Flows. The decrease in Transmission lines, substation improvements and expansion is due to timing of construction project schedules this year compared to the same period in the previous year. The increase in Distribution improvements is due to a higher volume of customer construction. The decrease in general expenditures is primarily due to the completion of a major integrated information system in the previous year. The increase in Power Smart expenditures is due to timing of incentive payments based on customer-driven project schedules. During the three months ended June 30, 2004, BC Hydro issued $530 million in new bonds. The funds from these issues, together with an increase in revolving borrowings, were used to redeem $435 million of bonds and to fund the payment to the province and capital expenditures. The net long-term debt balance (net of sinking funds) at June 30, 2004 was $7,146 million, compared to $6,900 million at March 31, The increase in debt was impacted by the weaker Canadian dollar, which increased the Canadian equivalent of U.S. debt, by approximately $60 million. The Canadian dollar at June 30, 2004, was U.S.$0.7497, compared with U.S.$ at March 31, Revenue Requirement Application On December 15, 2003, BC Hydro submitted its revenue requirement application to the British Columbia Utilities Commission (the Commission ) requesting a general rate increase of 7.23 percent effective April 1, 2004 and a further 2.0 percent increase effective April 1, On January 23, 2004, the Commission approved the first rate increase of 7.23 per cent on an interim basis effective April 1, On April 2, 2004, BC Hydro revised its revenue requirement application to propose a rate increase of 8.9 per cent in fiscal 2005 with no increase in fiscal The incremental rate increase of 1.67 per cent for fiscal 2005 will become effective based on the date of approval by the Commission. A full public hearing began in May 2004 and was completed in June Subsequent to the hearing BC Hydro and the intervenors filed final arguments with the Commission. A final decision from the Commission is expected by fall If the Commission does not approve the full amount of the interim increase, the difference will be fully refunded to customers with interest. First Quarter Report 8

9 MANAGEMENT DISCUSSION AND ANALYSIS Powerex Legal Proceedings On October 31, 2003, the U.S. Federal Energy Regulatory Commission ( FERC ) Trial Staff cleared Powerex of allegations of inappropriate market behavior and concluded that Powerex played a positive role in the energy market during the California energy crisis of 2000 and In the agreement the Trial Staff of FERC rejected California s claims that it was owed more than US$1 billion by Powerex. The agreement received approval from FERC and calls for further litigation to be suspended pending this approval. However, FERC s approval of the settlement is still subject to rehearing and subsequent appeal to the courts and could be affected by other legal proceedings relating to the California power markets. As was disclosed in the notes to BC Hydro s 2004 Annual Consolidated Financial Statements, Powerex still faces possible additional costs as several investigations and regulatory proceedings at the state and federal levels are also looking into causes of the high wholesale electricity prices in the western United States during 2000 and These investigations are to determine if suppliers should be required to refund some of the revenue earned during this period. BC Hydro has recorded provisions for uncollectible amounts and legal costs associated with the ongoing legal and regulatory impacts of the California energy crisis. Management believes these provisions are sufficient to provide for any remaining exposure. Deferral Accounts As disclosed in the Management Discussion and Analysis in the 2004 Annual Report, the Province issued a Special Directive that directs the British Columbia Utilities Commission to authorize BC Hydro to establish the Heritage Deferral Account and the Trade Income Deferral Account effective April 1, These accounts are intended to result in assigning domestic ratepayers the benefit of BC Hydro s low-cost generation assets and related activities, as well as an appropriate share of risks associated with the ownership and operation of these assets (the Heritage Resources ). As part of the Revenue Requirement Application related to fiscal 2005 and 2006, BC Hydro has applied for the establishment of a Non-Heritage Asset Deferral Account to manage the impact of certain other non-controllable cost variances. The impact of this account would be to defer specific types of cost variances through transfers to/from the accounts by adjustment of net income. While the deferral accounts are still under review by the Commission, BC Hydro has recorded the following amounts in the financial statements for the three months ended June 30, Income Statement (in millions) Balance Sheet Increase (Decrease) net income Account Heritage Deferral Account $ (54) $ 54 Non-Heritage Asset Deferral Account (28) 28 Trade Income Deferral Account 38 (38) Total Deferral Accounts $ 44 $ 44 First Quarter Report 9

10 MANAGEMENT DISCUSSION AND ANALYSIS Business Risks/Uncertainties BC Hydro is subject to various risks and uncertainties that cause significant volatility in its earnings. Factors such as the level of water inflows into its reservoirs, market prices for electricity and natural gas, interest rates, foreign exchange rates, weather and regulatory and government policies influence both the operation of the BC Hydro system and its earnings. A reduction in water inflows into reservoirs results in a greater reliance on energy purchases or use of the Burrard Generating Station, both of which can increase the costs of energy. While these risks cannot be eliminated, as they are largely non-controllable, some may be mitigated to a certain degree as disclosed in BC Hydro s 2004 Annual Report. In addition, the impact of the revenue requirement application decision by the Commission on BC Hydro s earnings and operations will not be known until fall Management s assessment of business risk/uncertainties is ongoing and the risks/uncertainties to BC Hydro have not changed materially from the Management Discussion and Analysis presented in the 2004 Annual Report. Future Outlook BC Hydro s net income for this fiscal year is forecast to be $275 million before any transfers to/from the deferral accounts. This is a reduction of $131 million from the 2004 Annual Report and is largely due to the impact of lower-than-normal water inflows which result in higherthan-expected energy purchases and costs. BC Hydro s income can fluctuate significantly due largely to noncontrollable factors such as the market price of energy, weather, interest rates and water inflows. The range of income, before deferral account transfers, under plausible scenarios is estimated to be between $195 million and $435 million. BC Hydro s forecast net income after deferral account transfers for fiscal 2005 is approximately $447 million. The forecast of $447 million is after the impacts of lower water inflows and higher energy purchase prices have been taken into account through the proposed deferral accounts. First Quarter Report 10

11 FINANCIALS CONSOLIDATED STATEMENT OF OPERATIONS for the Three Months Ended June 30 (Unaudited) (in millions) (Restated Note 3) Revenues Residential $ 217 $ 208 Light industrial and commercial Large industrial Other energy sales Miscellaneous Electricity trade Expenses Energy costs Maintenance Operations and administration Taxes Amortization Income Before Finance Charges and Deferral Account Transfers Finance charges Income Before Deferral Account Transfers 8 Transfer (to) from: (Note 5) Heritage Deferral Account 54 Non-Heritage Deferral Account 28 Trade Income Deferral Account (38) Net Income $ 52 $ See accompanying notes to the interim consolidated financial statements. CONSOLIDATED STATEMENT OF RETAINED EARNINGS for the Three Months Ended June 30 (Unaudited) (in millions) Retained earnings, beginning of period as previously reported $ 1,634 $ 1,609 Note 3: Adoption of new accounting standard for asset retirement obligations Retained earnings, beginning of period as restated $ 1,875 $ 1,838 Net Income 52 Accrued Payment to the Province (41) Retained earnings, end of period $ 1,886 $ 1,838 See accompanying notes to the interim consolidated financial statements. First Quarter Report 11

12 FINANCIALS CONSOLIDATED BALANCE SHEET as at June 30 as at March 31 (in millions) 2004 (Unaudited) 2004 (Restated Note 3) ASSETS Capital Assets Capital assets in service $ 15,393 $ 15,307 Less accumulated amortization 6,024 5,922 9,369 9,385 Unfinished construction ,899 9,900 Current Assets Cash and cash equivalents Accounts receivable and accrued revenue Materials and supplies Prepaid expenses Unrealized gains on mark-to-market transactions Other Assets and Deferred Charges Loan receivable 3 2 Sinking funds Demand-side management programs Deferred debt costs Deferral accounts (Note 5) 44 1,378 1,294 $ 12,143 $ 11,862 LIABILITIES AND EQUITY Long-Term Debt Long-term debt net of sinking funds $ 7,146 $ 6,900 Sinking funds presented as assets ,121 7,881 Foreign Currency Contracts Current Liabilities Accounts payable and accrued liabilities Accrued interest Accrued Payment to the Province Unrealized losses on mark-to-market transactions Deferred Credits and Other Liabilities Asset retirement obligations (Note 3) Deferred revenue Contributions arising from the Columbia River Treaty Contributions in aid of construction ,107 1,104 Retained Earnings 1,886 1,875 $ 12,143 $ 11,862 See accompanying notes to the interim consolidated financial statements. On behalf of the Board: L.I. (Larry) Bell Chair A.D. (Alice) Laberge Chair, Audit and Risk Management Committee First Quarter Report 12

13 FINANCIALS CONSOLIDATED STATEMENT OF CASH FLOWS for the Three Months Ended June 30 (Unaudited) (in millions) (Restated Note 3) Operating Activities Net income $ 52 $ Adjustments for: Amortization Deferral accounts (44) Other non-cash items 46 (18) Working capital changes Cash provided by operating activities Investing Activities Loan receivable (1) (2) Capital asset expenditures (113) (157) Contributions in aid of construction 16 4 Demand-side management programs (27) (8) Cash provided by investing activities (125) (163) Financing Activities Bonds: Issued Retired (435) (300) Revolving borrowings Sinking funds Deferred debt costs (5) 7 Settlement of interest rate swaps (5) Cash provided by financing activities Payment to the Province (73) (338) Increase in cash and cash equivalents Cash and cash equivalents at beginning of period 47 4 Cash and cash equivalents at end of period $ 257 $ 35 Supplemental disclosure of cash flow information Interest paid $ 118 $ 104 See accompanying notes to the interim consolidated financial statements. First Quarter Report 13

14 NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) JUNE 30, 2004 Business of BC Hydro British Columbia Hydro and Power Authority ( BC Hydro ) is a provincial Crown corporation. BC Hydro s mission is to provide integrated energy solutions to customers in an environmentally and socially responsible manner. BC Hydro serves more than 1.6 million customers in an area containing over 94 per cent of British Columbia s population. Between 43,000 and 54,000 gigawatt hours of electricity are generated annually, depending upon prevailing water levels. Electricity is delivered to customers mainly through an interconnected system of more than 73,000 kilometres of transmission and distribution lines. BC Hydro s Board of Directors is appointed by the Lieutenant-Governor in Council and is responsible for the overall direction of the company. Note 1: Accounting Policies These interim consolidated financial statements have been prepared by management in accordance with Canadian generally accepted accounting principles ( GAAP ) for preparation of interim financial statements and do not conform in all respects to the disclosure requirements for annual financial statements. These interim consolidated financial statements follow the same accounting policies as the most recent annual consolidated financial statements except for the accounting of asset retirement obligations and hedging relationships as discussed below. These interim consolidated financial statements take into account certain accounting practices by regulatory bodies that differ from the accounting practices applied in unregulated enterprises. The differences specifically relate to certain deferred charges. These interim consolidated financial statements and the notes should be read in conjunction with the Audited Consolidated Financial Statements and accompanying notes in BC Hydro s 2004 Annual Report. On April 1, 2004, BC Hydro adopted two new accounting standards in accordance with the CICA Handbook. The first, Section 3110 Asset Retirement Obligations, replaces the provision for Future Removal and Site Restoration that had been recorded in accordance with the previous requirements of CICA Handbook Section Asset Retirement Obligations are disclosed in Note 3. The second, Accounting Guideline 13 Hedging Relationships, was adopted with respect to hedging transactions and is disclosed described in Note 4. Certain figures for the previous period have been reclassified to conform to presentation in the current period. Note 2: Seasonality of Operating Results Due to the seasonal nature of the BC Hydro s operations, interim operations statements are not indicative of operations on an annual basis. Seasonal impacts of weather, including its impact on water inflow levels, energy consumption demand levels within the region, and market prices of energy, can have a significant impact on BC Hydro s operating results. Note 3: Asset Retirement Obligations For fiscal periods to March 31, 2004, BC Hydro recorded a provision for the estimated future costs associated with the retirement and decommissioning of its distribution, transmission and generation facilities in accordance with the previous requirements of CICA Handbook Section Effective April 1, 2004, BC Hydro adopted the new section (Section 3110 Asset Retirement Obligations ) which addresses accounting and reporting for obligations associated with the retirement of long-lived assets. This new section amends Section 3061 and applies only to legal obligations associated with the retirement of long-lived assets. BC Hydro is required to record the net present value of a liability at the time it is incurred if an estimate can be determined. When a liability is initially recorded, BC Hydro will capitalize the costs by increasing the carrying value of the long-lived asset. The liability is adjusted for the passage of time through accretion (interest) expense and the asset is amortized over the useful life of the related asset. The change in accounting policy has been applied retroactively with restatement of prior periods. The change in accounting policy requires BC Hydro to remove the existing provision for future removal and site restoration costs. Asset retirement obligations and associated capital assets will be set up for assets that it is First Quarter Report 14

15 NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) JUNE 30, 2004 legally obligated to retire, with the difference between the existing provision and the net liability created by the new accounting policy being an adjustment to retained earnings. The majority of BC Hydro s facilities have an indeterminate life, and thus a future retirement obligation is not determinable. The net impacts of this change in accounting policy are summarized below: for the Three Months Ended June (in millions) Increase (Decrease) Opening balances Retained earnings $ 241 $ 229 Capital assets, net 8 8 Deferred Credits and Other Liabilities (233) (164) Net income 4 Note 4: Hedging Relationships In December 2001, the CICA issued Accounting Guideline 13, Hedging Relationships. The effective date of this Guideline was deferred to fiscal years beginning on or after July 1, The Guideline addresses the types of items that qualify for hedge accounting, the formal documentation required to enable the use of hedge accounting and the requirement to evaluate hedges for effectiveness. The Guideline does not specify how hedge accounting should be applied but EIC 128, Accounting for Trading, Speculative or Non-hedging Derivative Financial Instruments, requires derivatives that are not designated as hedges to be recorded at fair value on the Company s consolidated balance sheet, with changes in fair value recorded in earnings. This Guideline was adopted prospectively effective April 1, 2004, for treasury instruments. The hedge accounting provisions were adopted for energy trading activities in fiscal Note 5: Deferral Accounts During fiscal 2004, the Province issued a Special Directive that directs the British Columbia Utilities Commission (the Commission ) to authorize BC Hydro to establish the Heritage Deferral Account and the Trade Income Deferral Account effective April 1, These accounts are intended to result in assigning domestic ratepayers the benefit of BC Hydro s low-cost generation assets and related activities, as well as an appropriate share of risks associated with the ownership and operation of these assets (the Heritage Resources ). Heritage Deferral Account The Heritage Deferral Account is intended to mitigate the impact of certain variances between the forecast and actual costs of service associated with the Heritage Resources. The impact of this account is to defer the impact of these cost variances through transfers to or from the account by adjustment of net income. Trade Income Deferral Account The Trade Income Deferral Account is intended to mitigate the uncertainty associated with forecasting the net income of BC Hydro s electricity trade activities. The impact of this account is to defer the difference between forecast and actual Trade Income. For the purposes of this calculation, Trade Income is defined as the Net Income of Powerex based on Canadian GAAP. The Special Directive provides that in each fiscal year the portion of the variance between forecast and actual Trade Income in excess of $200 million per year or a loss in Trade Income will not be included in the Trade Income Deferral Account. Non-Heritage Asset Deferral Account As part of the Revenue Requirement Application related to fiscal 2005 and 2006, BC Hydro has applied for the establishment of a Non-Heritage Asset Deferral Account to manage the impact of certain other non-controllable cost variances. The impact of this account would be to defer specific types of cost variance through transfers to or from the account by adjustment of net income. First Quarter Report 15

16 NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) JUNE 30, 2004 As at June 30, 2004 the deferral accounts on the balance sheet are: (in millions) Balance Account Heritage Deferral Account $ 54 Non-Heritage Asset Deferral Account 28 Trade Income Deferral Account (38) Total Deferral Accounts $ 44 Note 6: Commitments and Contingencies Alcan Inc.: During fiscal 2002, Enron Corp. ( Enron ) and certain of its subsidiaries, including Enron Power Marketing, Inc. ( EPMI ), filed for bankruptcy protection. As a result, Powerex s Power Purchase and Sale Agreement with EPMI terminated, giving rise to a termination payment of US$100 million becoming due from EPMI. Under a 1997 agreement among Alcan Inc., formerly Alcan Aluminum Limited, ( Alcan ), EPMI, Powerex and BC Hydro, Alcan agreed to remain liable to Powerex for the payment obligations of EPMI. Alcan did not pay the termination payment when demand was made by Powerex, and the matter was referred to arbitration in the United States. Early in 2003 an arbitration award was issued which required Alcan to pay Powerex US$100 million within 30 days, with interest accruing thereafter. This amount was not paid and Powerex commenced enforcement proceedings in the British Columbia Supreme Court (the B.C. Enforcement Proceedings ). The B.C. Enforcement Proceedings were adjourned pending the outcome of an application by Alcan in the U.S. District Court to have the arbitration award set aside. Alcan s application was subsequently denied and Alcan appealed that decision to the Ninth Circuit Court of Appeals. Despite the appeal, Powerex resumed the B.C. Enforcement Proceedings and its application was heard in April On June 30, 2004, a judgment was issued in the B.C. Enforcement Proceedings that requires Alcan to pay the US$100 million plus accrued interest into a trust account. These funds will be available for use by Powerex upon its posting of security satisfactory to Alcan. The B.C. Enforcement Proceedings have been adjourned pending the outcome of Alcan s appeal in the U.S. courts, which is not expected prior to mid Any recovery in respect of the arbitration award will be recorded in the financial statements when the uncertainties regarding the case have been resolved. Other: There are no other material changes to the commitments and contingencies disclosed in the notes to BC Hydro s 2004 Audited Annual Consolidated Financial Statements. Note 7: Employee Future Benefits BC Hydro s cost for employee future benefits for the three months ended June 30 was $19 million (2003: $19 million). First Quarter Report 16

17 NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) JUNE 30, 2004 Note 8: Segmented Information Three months ended June 30, 2004 Consolidation Adjustments/ (in millions) Distribution Transmission Generation Powerex Other Eliminations Total $ $ $ $ $ $ $ External revenues (4) (6) Inter-segment revenues (835) Net income (loss) 5 (21) (7) (44) 3 52 Total assets 3,497 3,189 4, (619) 12,143 Three months ended June 30, 2003 (restated) 4 Consolidation Adjustments/ (in millions) Distribution Transmission Generation Powerex Other Eliminations Total $ $ $ $ $ $ $ External revenues (16) Inter-segment revenues (743) Net income (loss) (90) (65) 3 Total assets 3,240 3,094 4, (478) 11,744 1 Includes inter-segment receivables of $482 million ($200 million for three months ended June 30, 2003). 2 Mainly consists of capital assets such as office buildings, vehicles and computer equipment. 3 These adjustments mainly relate to the difference between BC Hydro s management reporting, used for risk management and performance measurement purposes, and Canadian GAAP. For management reporting purposes, energy purchases bought for future resale are expensed when the energy is sold. The energy purchased for future resale is also marked to market each month. For GAAP reporting purposes, energy purchases bought for future resale are expensed in the period of purchase. 4 Restated for retroactive application of the asset retirement obligations accounting standard (Note 3). 5 Net income includes deferral account transfers (Note 5). First Quarter Report 17

18 3. Performance Measures BC HYDRO OVERALL BC Hydro will accomplish its vision of being North America s leading sustainable energy company by building on its solid base of clean, renewable hydropower assets, by employing a skilled and capable workforce, by delivering excellent financial and operational performance, and by attaining strong public support. The company s four key goals reflect this ambition. Strong financial performance by optimizing financial performance to ensure stable earnings. Quality service by focusing on customer satisfaction and service reliability. Good environmental and social performance by continuing to manage priority environmental and social issues. Skilled workforce, safe workplace by ensuring that the right people are in the right roles at the right time. Performance Measures, s, and Results Performance measurement, both financial and nonfinancial, is an integral part of BC Hydro s Strategic Management Process. Performance measures and targets that align with BC Hydro s strategic goals and objectives are set out in the company s February 2004 Service Plan. This section provides BC Hydro s overall performance results for the first quarter, April 1 to June 30, The Lines of Business performance is disclosed in the Lines of Business sections of this report. Legend (for all Performance Measures) Significantly better than target Meets target (within range) Significantly below target Net Income (in millions) Q1 04/05 $8 $36 Q1 03/04 $(83) Net Income is defined as total revenue less total expenses before transfers to deferral accounts. The targets are based on current cost and revenue drivers and the impact that cost reduction and/or revenue enhancement initiatives will have on these drivers. Net Income before transfer to deferral accounts of $8 million was $28 million below plan primarily as a result of higher-than-plan imports combined with higher-thanexpected energy prices. Partially offsetting this negative variance were higher trade revenues, also due to higher prices. Additionally, residential revenues were below plan as a result of warmer-than-normal temperatures and finance charges were above plan as a result of the weaker Canadian dollar. These results were partially offset by timing differences in Capital (amortization) and Operations, Maintenance, and Administration (OMA) expenditures due to the start dates of some programs and projects. Net income for the three months ended June 30, 2004, was higher than for the same period last year as a result of higher revenues and lower OMA expenditures, offset partially by higher finance charges. Reliability ASAI Q1 04/ % % Q1 03/ % % CAIDI Q1 04/ hrs hrs. Q1 03/ hrs hrs. First Quarter Report 18

19 PERFORMANCE MEASURES BC HYDRO OVERALL Reliability is defined in terms of Average System Availability Index (ASAI) and Customer Average Interruption Duration Index (CAIDI). These indices are electric utility industry standards that are typically calculated on rolling 12-month periods. For purposes of these comparisons, the measures have been calculated on the basis of results for the quarter in isolation. This enables BC Hydro to better identify the affect of specific events that adversely impact performance with a view to implementing corrective action where appropriate. Each measure uses customer-hours lost as a starting point. ASAI looks at customer-hours lost in relation to the total hours available to all customers. ASAI has been calculated as the percentage of time power is available in the 3-month period, expressed as 2,190 hours. An ASAI of per cent means that power was available for 2, hours during the 3-month period, i.e., parts of the system were unavailable for an average of 30 minutes per customer in the quarter. CAIDI is the average hours per interruption based on total hours lost for the specific customers affected by such interruption. For the three months year-to-date, 848,133 customer-hours were lost, representing a six per cent reduction over the corresponding three months for the previous five years (fiscal 1999 to 2003) and a 27 per cent reduction from fiscal Trees accounted for 20.5 per cent of the customer-hours lost. Other causes included distribution equipment failures (14.5 per cent), motor vehicle accidents (14.0 per cent), adverse weather (9.6 per cent) and source outages (8.3 per cent). All Injury Frequency Q1 04/ Q1 03/ All Injury Frequency is defined as the total number of employee injuries (Medical Aids and Disabling Injuries) occurring in the 12 months prior to the report date, relative to the number of worked hours in the same period. For this measurement, Medical Aid injuries are defined as those where a professional medical practitioner has rendered services beyond the level defined as first aid in relation to the injury incident, and the employee was not absent from work beyond time lost on the day of the injury. Disabling injuries are defined as those that involve the employee being absent from work beyond the day of the injury. The calculation is based on injuries experienced by BC Hydro over the previous 12 months and is relative to person-hours that have been worked over that same period. BC Hydro s safety performance is significantly better than target due to the dramatic improvements achieved in the Field Services Line of Business during the first quarter of fiscal 2005, and the maintenance of low incident rates in all other Lines of Business. The focus that BC Hydro has placed on safety improvement over the last several years has had a positive impact on safety performance, and this is demonstrated by the company s favourable placement in the top quartile of peers within the Canadian Electricity Association. BC Hydro s management and workforce remain committed to achieve further incident reduction and performance improvement through safety leadership activities, employee involvement, personal accountability, planning, training and safe work practices. Environmental Regulatory Compliance Q1 04/05 6 Incidents 7 Incidents Q1 03/04 3 Incidents 7 Incidents Fiscal 2004/2005 actual and target results no longer include the British Columbia Transmission Corporation s (BCTC) externally reportable, preventable environmental incidents. Fiscal 2003/2004 first quarter actual and target results have been adjusted to remove BCTC results, for comparison purposes. Environmental Regulatory Compliance is defined as the number of externally reportable, preventable environmental incidents. For this type of measure there is an inherent risk of unreported incidents. BC Hydro is currently reviewing its controls to attempt to ensure that all applicable incidents are reported. First Quarter Report 19

20 PERFORMANCE MEASURES BC HYDRO OVERALL Results are slightly lower than the apportioned annual target for this quarter, and are within the normal quarterto-quarter variability observed historically. Of the six incidents (three equipment failure and three human error), none was categorized as severe. Based on fiscal 2004/2005 first quarter results, BC Hydro is on track to meet the Environmental Regulatory Compliance measure annual target. Conservation Gigawatt Hours Q1 04/05 1,021 GWh/year 1,000 GWh/year management process for anticipating, scoping and planning the alignment of needed critical workforce capabilities to meet BC Hydro s strategic business goals. The targets were set based on internally performed needs assessments. The Approved Strategic Workforce Positions Filled measure is on track to meet the annual target of 71 positions with 56 per cent of SWfP positions filled at the end of the first quarter. POWEREX Net Income (in millions) Q1 03/ GWh/year 400 GWh/year Conservation Gigawatt Hours is defined as the cumulative annual gigawatt hours saved as a result of economic demand-side management. The targets are based on net savings from current Power Smart programs and programs expected to come onstream. The targets include both residential and business demand-side management. The actual number of 1,021 GWh per year includes discounts for free riders, free drivers and measurement and verification. Free riders refers to those who participate in a program but would have done so without an incentive; free drivers refers to those who do not participate in a program (e.g., use a coupon) but are influenced by it and proceed because of it; measurement and verification allows for energy savings that may be lower than initial estimates when actually measured. Approved Strategic Workforce Positions Filled Q1 04/05 $45 $7 Q1 03/04 $38 $10 Net Income is defined as total revenue less total expenses. The targets are based on current cost and revenue drivers and the impact that cost reduction and/or revenue enhancement initiatives will have on these drivers. Powerex s first quarter Net Income is tracking higher-thanplan. While volumes are below plan, profit margins are higher-than-plan due to favourable price spreads in the spot market. Restrictions on transmission lines to California have reduced sales volumes. Although total sales volumes are now forecast to be lower-than-plan, Powerex will likely continue to meet its income target due to higher profit margins. Transactions per Employee Q1 04/ Q1 04/ Q1 03/ Approved Strategic Workforce Positions Filled is defined as the number of positions filled under BC Hydro s Strategic Workforce Planning (SWfP) initiative. SWfP is the Transactions per Employee is defined as the number of transactions conducted by Powerex, divided by the number of Powerex employees. The increase in actual transactions per employee was due to a larger number of Eastern and Real Time transactions. First Quarter Report 20