(19) DISCONTINUED OPERATIONS
PHI’s (loss) income from discontinued operations, net of income taxes, is comprised of the following:
| For the Year Ended December 31, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| (millions of dollars) | ||||||||||||
|
Cross-border energy lease investments |
$ | (327 | ) | $ | 41 | $ | 36 | |||||
|
Pepco Energy Services’ retail electric and natural gas supply businesses |
5 | 26 | 2 | |||||||||
|
Conectiv Energy |
— | — | (3 | ) | ||||||||
|
|
|
|
|
|
|
|||||||
|
(Loss) income from discontinued operations, net of income taxes |
$ | (322 | ) | $ | 67 | $ | 35 | |||||
|
|
|
|
|
|
|
|||||||
Cross-Border Energy Lease Investments
Between 1994 and 2002, PCI entered into cross-border energy lease investments consisting of hydroelectric generation facilities, coal-fired electric generation facilities and natural gas distribution networks located outside of the United States. Each of these lease investments was structured as a sale and leaseback transaction commonly referred to as a sale-in, lease-out, or SILO, transaction. As of December 31, 2013 and 2012, the lease portfolio consisted of zero investments and six investments, respectively, with a net investment value of zero and $1,237 million, respectively.
During the second and third quarters of 2013, PHI terminated early all of its interests in the six remaining lease investments. PHI received aggregate net cash proceeds from these early terminations of $873 million (net of aggregate termination payments of $2.0 billion used to retire the non-recourse debt associated with the terminated leases) and recorded an aggregate pre-tax loss, including transaction costs, of approximately $3 million ($2 million after-tax), representing the excess of the carrying value of the terminated leases over the net cash proceeds received. As a result, PHI has reported the results of operations of the cross-border energy lease investments as discontinued operations in all periods presented in the accompanying consolidated statements of (loss) income. Further, the assets and liabilities related to the cross-border energy lease investments are reported as held for disposition as of each date in the accompanying consolidated balance sheets.
Operating Results
The operating results for the cross-border energy lease investments are as follows:
| For the Year Ended December 31, | ||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| (millions of dollars) | ||||||||||||
|
Operating revenue from PHI’s cross-border energy lease investments |
$ | 7 | $ | 50 | $ | 55 | ||||||
|
Non-cash charge to reduce carrying value of PHI’s cross-border energy lease investments |
(373 | ) | — | (7 | ) | |||||||
|
|
|
|
|
|
|
|||||||
|
Total operating revenue |
$ | (366 | ) | $ | 50 | $ | 48 | |||||
|
|
|
|
|
|
|
|||||||
|
(Loss) income from operations of discontinued operations, net of income taxes (a) |
$ | (325 | ) | $ | 32 | $ | 33 | |||||
|
Net (losses) gains associated with the early termination of the cross-border energy lease investments, net of income taxes (b) |
(2 | ) | 9 | 3 | ||||||||
|
|
|
|
|
|
|
|||||||
|
(Loss) income from discontinued operations, net of income taxes |
$ | (327 | ) | $ | 41 | $ | 36 | |||||
|
|
|
|
|
|
|
|||||||
| (a) | Includes income tax (benefit) expense of approximately $(44) million, $5 million and $(2) million for the years ended December 31, 2013, 2012 and 2011, respectively. |
| (b) | Includes income tax (benefit) expense of approximately $(1) million, $30 million and $36 million for the years ended December 31, 2013, 2012 and 2011, respectively. |
On January 9, 2013, the U.S. Court of Appeals for the Federal Circuit issued an opinion in Consolidated Edison Company of New York, Inc. & Subsidiaries v. United States (to which PHI is not a party) that disallowed tax benefits associated with Consolidated Edison’s cross-border lease transaction. As a result of the court’s ruling in this case, PHI determined in the first quarter of 2013 that its tax position with respect to the benefits associated with its cross-border energy leases no longer met the more-likely-than-not standard of recognition for accounting purposes, and PCI recorded after-tax non-cash charges of $323 million in the first quarter of 2013 and $6 million in the second quarter of 2013, consisting of the following components:
| • | A non-cash pre-tax charge of $373 million ($313 million after-tax) to reduce the carrying value of these cross-border energy lease investments under FASB guidance on leases (ASC 840). This pre-tax charge was originally recorded in the consolidated statements of (loss) income as a reduction in operating revenue and is now reflected in (loss) income from discontinued operations, net of income taxes. |
| • | A non-cash charge of $16 million after-tax to reflect the anticipated additional net interest expense under FASB guidance for income taxes (ASC 740) related to estimated federal and state income tax obligations for the period over which the tax benefits may be disallowed. This after-tax charge was originally recorded in the consolidated statements of (loss) income as an increase in income tax expense and is now reflected in (loss) income from discontinued operations, net of income taxes. The after-tax interest charge for PHI on a consolidated basis was $70 million and this amount was allocated to each member of PHI’s consolidated group as if each member was a separate taxpayer, resulting in the recognition of a $12 million interest benefit for the Power Delivery segment, and interest expense of $16 million for PCI and $66 million for Corporate and Other, respectively. |
PHI had also previously made certain business assumptions regarding foreign investment opportunities available at the end of the full lease terms. In view of the change in PHI’s tax position with respect to the tax benefits associated with the cross-border energy lease investments and PHI’s resulting decision to pursue the early termination of these investments, management concluded in the first quarter of 2013 that these business assumptions were no longer supportable and the tax effects of this conclusion were reflected in the after-tax charge of $313 million described above.
PHI accrued no penalties associated with its re-assessment of the likely outcome of tax positions associated with the cross-border energy lease investments. While the IRS could require PHI to pay a penalty of up to 20% of the amount of additional taxes due, PHI believes that it is more likely than not that no such penalty will be incurred, and therefore no amount for any potential penalty was included in the charge.
During 2012, PHI entered into early termination agreements with two lessees involving all of the leases comprising one of the original eight lease investments. The early terminations of the leases were negotiated at the request of the lessees. PHI received net cash proceeds of $202 million (net of a termination payment of $520 million used to retire the non-recourse debt associated with the terminated leases) and recorded a pre-tax gain of $39 million, representing the excess of the net cash proceeds over the carrying value of the lease investments.
During 2011, PHI entered into early termination agreements with two lessees involving all of the leases comprising one of the original eight lease investments and a small portion of the leases comprising a second lease investment. The early terminations of the leases were negotiated at the request of the lessees. PHI received net cash proceeds of $161 million (net of a termination payment of $423 million used to retire the non-recourse debt associated with the terminated leases) and recorded a pre-tax gain of $39 million, representing the excess of the net cash proceeds over the carrying value of the lease investments.
With respect to the leases terminated in 2012 and 2011, PHI had previously made certain business assumptions regarding foreign investment opportunities available at the end of the full lease terms. Because the leases were terminated in each case earlier than full term, management decided not to pursue these opportunities and recognized the related tax consequences by recording income tax charges in the amounts of $16 million and $22 million for the years ended December 31, 2012 and 2011, respectively. The after-tax gains on the lease terminations were $9 million and $3 million for the years ended December 31, 2012 and 2011, respectively, including the income tax charges discussed above and an income tax provision at the statutory Federal rate of $14 million for each early lease termination. As of December 31, 2012, PHI had no intent to terminate early any other leases in the lease portfolio and maintained its assertion that the foreign earnings recognized at the end of the lease term with respect to certain of these remaining leases will remain invested abroad. See Note (15), “Commitments and Contingencies – PHI’s Cross-Border Energy Lease Investments,” regarding a subsequent change in management’s intent.
PHI was required to assess on a periodic basis the likely outcome of tax positions relating to its cross-border energy lease investments and, if there was a change or a projected change in the timing of the tax benefits generated by the transactions, PHI was required to recalculate the value of its net investment. In that regard, PHI modified its tax cash flow assumptions in 2011 and recorded a non-cash pre-tax charge of $7 million to reduce the carrying value of its net investment. The tax cash flow assumptions changed in 2011 as a result of the enactment of tax regulations in the District of Columbia to implement the mandatory unitary combined reporting method. The charge was recorded as a reduction in cross-border energy lease investment revenue in 2011.
For additional information concerning these cross-border energy lease investments, see Note (15), “Commitments and Contingencies – PHI’s Cross-Border Energy Lease Investments.”
Balance Sheet Information
As of December 31, 2013 and 2012, the assets held for disposition and liabilities associated with assets held for disposition related to the cross-border energy lease investments are:
| 2013 | 2012 | |||||||
| (millions of dollars) | ||||||||
|
Scheduled lease payments to PHI, net of non-recourse debt |
$ | — | $ | 1,852 | ||||
|
Less: Unearned and deferred income |
— | (615 | ) | |||||
|
|
|
|
|
|||||
|
Assets held for disposition |
$ | — | $ | 1,237 | ||||
|
|
|
|
|
|||||
|
Liabilities associated with assets held for disposition |
$ | — | $ | 1 | ||||
|
|
|
|
|
|||||
To ensure credit quality, PHI regularly monitored the financial performance and condition of the lessees under the former cross-border energy lease investments. Changes in credit quality were assessed to determine whether they affected the carrying value of the leases. PHI compared each lessee’s performance to annual compliance requirements set by the terms and conditions of the leases and compared published credit ratings to minimum credit rating requirements in the leases for lessees with public credit ratings. In addition, PHI routinely met with senior executives of the lessees to discuss their company and asset performance. If the annual compliance requirements or minimum credit ratings were not met, remedies would have been available under the leases.
The table below shows PHI’s net investment in these leases by the published credit ratings of the lessees as of December 31:
|
Lessee Rating (a) |
2013 | 2012 | ||||||
| (millions of dollars) | ||||||||
|
Rated Entities |
||||||||
|
AA/Aa and above |
$ | — | $ | 766 | ||||
|
A |
— | 471 | ||||||
|
|
|
|
|
|||||
|
Total |
$ | — | $ | 1,237 | ||||
|
|
|
|
|
|||||
| (a) | Excludes the credit ratings associated with collateral posted by the lessees in these transactions. |
Retail Electric and Natural Gas Supply Businesses of Pepco Energy Services
On March 21, 2013, Pepco Energy Services entered into an agreement whereby a third party assumed all the rights and obligations of the remaining natural gas supply customer contracts, and the associated supply obligations, inventory and derivative contracts. The transaction was completed on April 1, 2013. In addition, in the second quarter of 2013, Pepco Energy Services completed the wind-down of its retail electric supply business by terminating its remaining customer supply and wholesale purchase obligations beyond June 30, 2013. As a result, PHI has reported the results of operations of Pepco Energy Services’ retail electric and natural gas supply businesses as discontinued operations in all periods presented in the accompanying consolidated statements of (loss) income. Further, the assets and liabilities of Pepco Energy Services’ retail electric and natural gas supply businesses are reported as held for disposition as of each date presented in the accompanying consolidated balance sheets.
Operating Results
The operating results for the retail electric and natural gas supply businesses of Pepco Energy Services are as follows:
| For the Year Ended December 31, |
||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| (millions of dollars) | ||||||||||||
|
Operating revenue |
$ | 84 | $ | 415 | $ | 954 | ||||||
|
|
|
|
|
|
|
|||||||
|
Income from operations of discontinued operations, net of income taxes |
$ | 4 | $ | 26 | $ | 2 | ||||||
|
Net gains associated with accelerated disposition of retail electric and natural gas contracts, net of income taxes |
1 | — | — | |||||||||
|
|
|
|
|
|
|
|||||||
|
Income from discontinued operations, net of income taxes (a) |
$ | 5 | $ | 26 | $ | 2 | ||||||
|
|
|
|
|
|
|
|||||||
| (a) | Includes income tax expense of approximately $3 million, $18 million and $1 million for the years ended December 31, 2013, 2012 and 2011, respectively. |
Balance Sheet Information
As of December 31, 2013 and 2012, the retail electric and natural gas supply businesses of Pepco Energy Services had net accounts receivable of zero and $33 million, respectively, inventory assets of $1 million and $3 million, respectively, gross derivative assets of zero and $1 million respectively, other current assets of zero and $1 million, respectively, accrued liabilities of $1 million and $20 million, respectively, gross derivative liabilities of zero and $21 million, respectively, exclusive of the collateral pledged by Pepco Energy Services against the derivative liabilities, and other current liabilities of zero and $1 million, respectively. As of December 31, 2012, the derivative assets were considered level 1 within the fair value hierarchy, and $11 million and $10 million of the derivative liabilities were considered levels 1 and 2, respectively, within the fair value hierarchy.
Derivative Instruments and Hedging Activities
Derivatives were used by the retail electric and natural gas supply businesses of Pepco Energy Services to hedge commodity price risk.
The retail electric and natural gas supply businesses of Pepco Energy Services entered into energy commodity contracts in the form of natural gas futures, swaps, options and forward contracts to hedge commodity price risk in connection with the purchase of physical natural gas and electricity for distribution to customers. The primary risk management objective was to manage the spread between retail sales commitments and the cost of supply used to service those commitments to ensure stable cash flows and lock in favorable prices and margins when they became available. There were no derivatives for Pepco Energy Services as of December 31, 2013.
Commodity contracts held by the retail electric and natural gas supply businesses of Pepco Energy Services that were not designated for hedge accounting, did not qualify for hedge accounting, or did not meet the requirements for normal purchase and normal sale accounting, were marked to market through current earnings. Forward contracts that met the requirements for normal purchase and normal sale accounting were recorded on an accrual basis.
The table below identifies the balance sheet location and fair values of the retail electric and natural gas supply businesses’ derivative instruments as of December 31, 2012:
| As of December 31, 2012 | ||||||||||||||||||||
|
Balance Sheet Caption |
Derivatives Designated as Hedging Instruments (a) |
Other Derivative Instruments |
Gross Derivative Instruments |
Effects of Cash Collateral and Netting |
Net Derivative Instruments |
|||||||||||||||
| (millions of dollars) | ||||||||||||||||||||
|
Assets held for disposition (current assets) |
$ | — | $ | 1 | $ | 1 | $ | — | $ | 1 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
|
Total Derivative assets |
— | 1 | 1 | — | 1 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
|
Liabilities associated with assets held for disposition (current liabilities) |
(10 | ) | (9 | ) | (19 | ) | 16 | (3 | ) | |||||||||||
|
Liabilities associated with assets held for disposition (non-current liabilities) |
(1 | ) | (1 | ) | (2 | ) | 2 | — | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
|
Total Derivative liabilities |
(11 | ) | (10 | ) | (21 | ) | 18 | (3 | ) | |||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
|
Net Derivative (liability) asset |
$ | (11 | ) | $ | (9 | ) | $ | (20 | ) | $ | 18 | $ | (2 | ) | ||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| (a) | Amounts included in Derivatives Designated as Hedging Instruments primarily consist of derivatives that were designated as cash flow hedges prior to Pepco Energy Services’ election to discontinue cash flow hedge accounting for these derivatives. |
Under FASB guidance on the offsetting of balance sheet accounts (ASC 210-20), the retail electric and natural gas supply businesses of Pepco Energy Services offset the fair value amounts recognized for derivative instruments and the fair value amounts recognized for related collateral positions executed with the same counterparty under master netting agreements. No derivative assets or liabilities were available to be offset under master netting agreements as of December 31, 2012. Cash collateral pledged to counterparties with the right to reclaim of $18 million (including cash deposits on commodity brokerage accounts) was offset against these derivative positions.
As of December 31, 2013 and 2012, all cash collateral pledged by the retail electric and natural gas supply businesses related to derivative instruments accounted for at fair value was entitled to be offset under master netting agreements.
Derivatives Designated as Hedging Instruments
At December 31, 2012, the cumulative net pre-tax loss related to effective cash flow hedges of the retail electric and natural gas supply businesses of Pepco Energy Services included in AOCL was $10 million ($6 million after-tax). With the assumption by a third party, on April 1, 2013, of all the rights and obligations of the derivative contracts associated with the retail natural gas supply business, and the completion of the wind-down of the retail electric supply business in the second quarter of 2013, all of the losses deferred in AOCL associated with derivatives that Pepco Energy Services had previously designated as cash flow hedges were reclassified into income. As a result, a loss of $10 million ($6 million after-tax) was reclassified from AOCL to (Loss) income from discontinued operations, net of income taxes, for the year ended December 31, 2013.
Other Derivative Activity
The retail electric and natural gas supply businesses of Pepco Energy Services held certain derivatives that were not in hedge accounting relationships and were not designated as normal purchases or normal sales. These derivatives were recorded at fair value on the balance sheet with the gain or loss for changes in fair value recorded through (Loss) income from discontinued operations, net of income taxes.
For the years ended December 31, 2013, 2012, and 2011, the amount of the derivative gain (loss) for the retail electric and natural gas supply businesses of Pepco Energy Services recognized in (Loss) income from discontinued operations, net of income taxes is provided in the table below:
| For the Year Ended December 31, |
||||||||||||
| 2013 | 2012 | 2011 | ||||||||||
| (millions of dollars) | ||||||||||||
|
Reclassification of mark-to-market to realized on settlement of contracts |
$ | 10 | $ | 27 | $ | — | ||||||
|
Unrealized mark-to-market loss |
— | (3 | ) | (30 | ) | |||||||
|
|
|
|
|
|
|
|||||||
|
Total net gain (loss) |
$ | 10 | $ | 24 | $ | (30 | ) | |||||
|
|
|
|
|
|
|
|||||||
As of December 31, 2013, the retail electric and natural gas supply businesses of Pepco Energy Services had no outstanding commodity forward contracts or derivative positions.
As of December 31, 2012, the retail electric and natural gas supply businesses of Pepco Energy Services had the following net outstanding commodity forward contract quantities and net position on derivatives that did not qualify for hedge accounting:
| December 31, 2012 | ||||||||
|
Commodity |
Quantity | Net Position | ||||||
|
Financial transmission rights (MWh) |
181,008 | Long | ||||||
|
Electricity (MWh) |
261,240 | Long | ||||||
|
Natural gas (MMBtu) |
2,867,500 | Long | ||||||
As of December 31, 2013, Pepco Energy Services had posted net cash collateral of $3 million and letters of credit of less than $1 million. As December 31, 2012, Pepco Energy Services had posted net cash collateral of $25 million and letters of credit of less than $1 million.
Conectiv Energy
In April 2010, the Board of Directors approved a plan for the disposition of PHI’s competitive wholesale power generation, marketing and supply business, which had been conducted through Conectiv Energy. On July 1, 2010, PHI completed the sale of Conectiv Energy’s wholesale power generation business to Calpine. The disposition of Conectiv Energy’s remaining assets and businesses, consisting of its load service supply contracts, energy hedging portfolio, certain tolling agreements and other assets not included in the Calpine sale, has been completed.
Conectiv Energy’s loss from discontinued operations, net of income taxes, for the years ended December 31, 2013, 2012 and 2011, was zero, zero and $3 million, respectively. Conectiv Energy’s other comprehensive income from discontinued operations, net of income taxes, for each of the years ended December 31, 2013, 2012 and 2011, was zero.