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GAZ MÉTRO LIMITED PARTNERSHIP
ANNUAL INFORMATION FORM
Fiscal year ended September 30, 2008
December 10, 2008
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TABLE OF CONTENTS
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS ........................ 4 ITEM 1 - INCORPORATION ......................................................................................................... 8
1.1 Partners...................................................................................................................8 1.2 General ...................................................................................................................9
ITEM 2 - GENERAL DEVELOPMENT OF BUSINESS ........................................................... 10 ITEM 3 - NARRATIVE DESCRIPTION OF MAIN AREAS OF ACTIVITIES ..................... 14
3.1 Energy Distribution ..............................................................................................14 3.1.1 Distribution of Natural Gas in Quebec .......................................................14 3.1.1.1 Regulatory Process and Rates .............................................................14 3.1.1.2 Gas Supply ...........................................................................................19 3.1.1.3 Market ..................................................................................................21 3.1.1.4 Main Industrial Customers ..................................................................26 3.1.1.5 System Operations................................................................................27 3.1.1.6 Environmental Protection ....................................................................28 3.1.2 Distribution of Natural Gas and Electricity in Vermont.............................31 3.1.2.1 VGS ......................................................................................................32 3.1.2.2 Green Mountain Power........................................................................33
3.2 Natural Gas Transportation ..................................................................................35 3.3 Natural Gas Storage..............................................................................................36 3.4 Energy Services and Other ...................................................................................37
3.4.1 Energy Services ..........................................................................................37 3.4.2 Water Sector ...............................................................................................37 3.4.3 Fibre Optic Sector.......................................................................................37
3.5 LNG Terminal and Wind Power Projects ............................................................37 3.5.1 LNG Terminal Project ................................................................................37 3.5.2 Wind Power Projects ..................................................................................38
3.6 Human Resources Management ...........................................................................38 3.7 Financial Management .........................................................................................39
ITEM 4 - SELECTED FINANCIAL INFORMATION............................................................... 41 4.1 Income Distribution..............................................................................................42
4.1.1 Distributions ...............................................................................................42 4.1.2 Distributions History ..................................................................................42 4.1.3 Restrictions on Distributions and Issuance of Long-Term Debt under
the Deeds Creating and Governing the Long-Term Debt...........................42 4.2 Tax Considerations...............................................................................................43
ITEM 5 - LEGAL PROCEEDINGS.............................................................................................. 43 ITEM 6 - MARKET FOR SECURITIES, CAPITAL STRUCTURE AND TRANSFER
AGENT AND REGISTRAR.......................................................................................... 44 6.1 Market for Securities ............................................................................................44 6.2 Comparative Return Graphs.................................................................................44 6.3 Capital Structure...................................................................................................45 6.4 Transfer Agent and Registrar ...............................................................................46
ITEM 7 - DIRECTORS AND OFFICERS.................................................................................... 46 ITEM 8 - ADDITIONAL INFORMATION.................................................................................. 46
8.1 Governance Information.......................................................................................46 8.2 Audit Committee Information ..............................................................................46 8.3 Interests of Experts...............................................................................................46 8.4 Material Contracts ................................................................................................47
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8.4.1 Financial Contracts .....................................................................................47 8.4.2 Operating Contracts....................................................................................47 8.4.2.1 Transportation Contracts with TCPL ..................................................47 8.4.2.2 Storage and Transportation Contracts with UG..................................48
8.5 Complaints or Concerns .......................................................................................48 8.6 Risks ....................................................................................................................49 8.7 Other Information.................................................................................................54
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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS To allow investors to better understand Gaz Métro’s (as such term is defined in the Glossary of Terms) outlook for the future and make more informed investment decisions, certain statements in this Annual Information Form may be forward-looking, in particular those relating to actions, activities, events, results or developments that Gaz Métro and GMi (as such term is defined in the Glossary of Terms), Gaz Métro’s General Partner, expect or anticipate will or may occur in the future, and other statements that are not historical facts. Such forward-looking information reflects the intentions, plans, expectations and opinions of GMi’s management regarding Gaz Métro’s future growth, operating results, performance and business prospects and opportunities. The words “plans”, “expects” or “does not expect”, “is expected”, “budgeted”, “scheduled”, “estimated”, “forecasts”, “intends”, “anticipates” or “does not anticipate”, or “believes”, or variations of such words and expressions or statements that certain actions, events or results “may”, “could”, “would”, “might” or “will” be taken, occur, be achieved, and similar expressions, as they relate to Gaz Métro and GMi, often identify forward-looking statements. The forward-looking statements in this Annual Information Form include statements with respect to the general development of the business, growth or profitability outlook, the potential equity interest of Gazprom Marketing & Trading USA, Inc. in Rabaska Limited Partnership, the possible commissioning of the wind power projects in which Gaz Métro is involved through one of its subsidiaries and the application to Gaz Métro of the rules relating to Specified Investment Flow-through Entities. Such forward-looking statements reflect management’s current opinions and are based on information currently available to management. Forward-looking statements involve known and unknown risks and uncertainties and other factors outside management’s control. A number of factors could cause actual results of Gaz Métro and GMi to differ materially from the results discussed in the forward-looking statements, including, but not limited to, as described under Item 8.6 Risks and in Gaz Métro’s and GMi’s disclosure filings. Although the forward-looking statements contained herein are based upon what management believes to be reasonable assumptions, management cannot assure investors that actual results will be consistent with these forward-looking statements. Assumptions underlying the forward-looking statements contained in this Annual Information Form include assumptions to the effect that no unforeseen changes in the legislative and operating framework of energy markets in Quebec and in the State of Vermont will occur, and that no significant event occurring outside the ordinary course of business, such as a natural disaster or other calamity, will occur. These forward-looking statements are made as of the date of this Annual Information Form, and management assumes no obligation to update or revise them to reflect new events or circumstances, except as required pursuant to applicable securities laws. These statements do not reflect the potential impact of any unusual item or of any business combination or other transaction that may be announced or that may occur after the date hereof. Readers are cautioned not to place undue reliance on these forward-looking statements.
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Measurement Conversion
The data used in this Annual Information Form are stated in metric units. Metric unit equivalents in the imperial system, including their respective abbreviations, are: Metric Units Approximate imperial equivalent Thousand cubic metres (103m3) 35.31 thousand cubic feet (Mcf) Million cubic metres (106m3) 35.31 million cubic feet (MMcf) Billion cubic metres (109m3) 35.31 billion cubic feet (Bcf) Gigajoule (Gj) 0.95 million de BTUs (MMBTU) Kilometre (km) 0.62 mile Unless otherwise indicated, the term "dollars" means Canadian dollars in this Annual Information Form. If foreign currencies are translated into Canadian dollars, the foreign exchange rate used is the rate at the date of the event to which reference is made. Unless otherwise indicated, the information in this Annual Information Form is as of September 30, 2008.
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GLOSSARY OF TERMS In this Annual Information Form: "Aqua-Rehab/Aqua Data Group" means Groupe Aqua-Rehab Inc.; Aqua-Rehab Inc. and Aqua-Rehab (USA), Inc.; 3632491 Canada Inc.; Aqua Data Inc.; Aqua Data (US) Inc. and their respective subsidiaries. "Commercial market" means primarily commercial, institutional and multiple dwelling units as well as small and medium size businesses. "CO2 eq." means carbon dioxide equivalent (CO2). "DBRS" means DBRS Limited. "FERC" means the United States Federal Energy Regulatory Commission. "Gaz Métro" means Gaz Métro Limited Partnership. "GHG" means greenhouse gases. "GMi" means Gaz Métro inc. "Gaz Métro Plus Group" means Gaz Métro Plus Limited Partnership; Servitech Energy Limited Partnership; CDH Solutions & Operations Limited Partnership; Climatisation et Chauffage Urbains de Montréal, s.e.c.; HydroSolution, L.P.; MTO Telecom Inc. and their respective subsidiaries. "Green Mountain Power" means Green Mountain Power Corporation. "Industrial market" means primarily large industrial businesses. "Interest", as the case may be, in a Non-regulated energy activity or a Permitted economic activity means (i) an investment therein by way of ownership of assets, securities or loans, and (ii) the indebtedness of a person other than Gaz Métro in respect thereof for which Gaz Métro is liable. "Intragaz Group" means Intragaz inc.; Intragas Holding, Limited Partnership; Intragas Exploration, Limited Partnership; Intragas, Limited Partnership and their respective subsidiaries. "LNG" means liquefied natural gas. "LNG plant" means the natural gas liquefaction, storage and regasification plant of Gaz Métro located in Montreal, Quebec. “MDDEP” means Ministère du Développement durable, de l’Environnement et des Parcs of Quebec. "NEB" means Canada’s National Energy Board. "NNEEC" means Northern New England Energy Corporation (formerly Northern New England Gas Corporation). "Non-regulated energy activity" means any activity in the energy sector that is not a Regulated energy activity and that is directly or indirectly complementary to a Regulated energy activity carried on by Gaz Métro, whether or not such Regulated energy activity is carried on in the same geographical territory, but excluding any oil and gas exploration activity. "Permitted economic activity" means any economic activity, other than a Regulated energy activity and a Non-regulated energy activity, excluding oil and gas exploration activity. "PNGTS" means Portland Natural Gas Transmission System. "Régie" means the Régie de l’énergie (Quebec) or, depending on the context, its predecessor, the Régie du gaz naturel (Quebec). "Regulated energy activity" means any activity in the energy sector that is regulated by a regulatory authority, it being understood that any activity in the energy sector which, on August 12, 1991, was regulated by a regulatory authority is deemed to still be regulated. "Residential market" means primarily residential customers. "S&P" means Standard & Poor’s, a division of The McGraw-Hill Companies, Inc.
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"System gas" means natural gas supplied by Gaz Métro rather than by an independent supplier selected by the customer. “TCE” means TransCanada Energy Ltd. "TCPL" means TransCanada PipeLines Limited. "TQM" means Trans Québec & Maritimes Pipeline Inc., as mandatary for TQM Pipeline and Company, Limited Partnership. "UG" means Union Gas Limited. "VGS" means Vermont Gas Systems, Inc. "VPSB" means Vermont Public Service Board.
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ITEM 1 - INCORPORATION
Gaz Métro is a limited partnership formed on October 1st, 1987 pursuant to the laws of the Province of Quebec under the name "Gaz Plus and Company, Limited Partnership". On August 5, 1991, the original Limited Partnership Agreement was amended and its name was changed to "Gaz Métropolitain and Company, Limited Partnership" as part of a corporate reorganization of GMi and Gaz Métro under which GMi transferred substantially all of its business and assets to Gaz Métro in exchange for units of Gaz Métro and the assumption by Gaz Métro of substantially all of GMi's liabilities, other than the subordinated debt issued to Noverco Inc., its parent company. On January 14, 1993, the Limited Partnership Agreement was amended again to change the status of Gaz Métro to a publicly traded partnership on February 1st, 1993, at which time the units of Gaz Métro were listed on the Toronto Stock Exchange. On November 5, 1996, the Limited Partnership Agreement was amended again to provide for certain limitations on Gaz Métro’s activities, as more fully described under Item 1.2 General. On November 18, 2003, the name was again changed to "Gaz Métro Limited Partnership". Gaz Métro's principal place of business is located at 1717 du Havre Street, Montreal, Quebec H2K 2X3. Gaz Métro is registered as a limited partnership with the Registraire des entreprises (Quebec) and as an extra-provincial limited partnership in each province of Canada other than Quebec.
1.1 PARTNERS
Since the corporate reorganization of 1991, GMi has acted as the General Partner of Gaz Métro in accordance with the Limited Partnership Agreement of Gaz Métro. On September 30, 2008, GMi held 71.0% of the 120,452,214 outstanding units of Gaz Métro (including the 8,551 units held as a limited partner by Gaz Métro Plus Inc., a wholly-owned subsidiary of GMi). The remaining units were held by the public. The following diagram shows the "shareholdings" of Gaz Métro on September 30, 2008.
On September 30, 2008:
(1) The General Partner of Trencap L.P. was Capital d’Amérique CDPQ inc. (0.01%), a subsidiary of the Caisse de dépôt et placement du Québec which, as a limited partner of Trencap L.P., held 51.11% of its units. The other limited partners were Fonds de solidarité des travailleurs du Québec (F.T.Q.) (16.66%), SNC-Lavalin Inc. (11.11%), British Columbia Investment Management Corporation (11.11%), the Régime des rentes du Mouvement Desjardins (8.33%) and the Régime de retraite de l’Université du Québec (1.67%).
(2) Enbridge Inc. held its shares through its subsidiary, IPL System Inc. (3) GDF SUEZ (formerly Gaz de France) held its shares through its subsidiary, Laurentides Investissements S.A. (4) SNC-Lavalin Inc., as a Limited Partner, held 2,913,753 (2.4%) of the units held by the public.
GMi
Gaz Métro Public
Noverco Inc.
50.4%
29.0%(4)71.0%
100%
17.5% 32.1%
Limited Partners
General Partner
Trencap L.P. (1) Enbridge Inc.(2) GDF SUEZ(3)
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Pursuant to Gaz Métro’s Limited Partnership Agreement, GMi has the exclusive power and authority to administer, manage, control and operate the business of Gaz Métro and to hold all the rights to its assets. GMi must exercise its powers and discharge its duties with reasonable skill and with all the care of a prudent and diligent reasonable person, as would a director of a company under similar circumstances. The authority and powers vested in GMi to manage the business and affairs of Gaz Métro are broad and include all the powers necessary or incidental to carry on the business of Gaz Métro. No Limited Partner is permitted, in such capacity, to take part in the administration, management or control of the affairs of Gaz Métro. Furthermore, since all of GMi’s shares are held by Noverco Inc., the Limited Partners cannot select the Directors of GMi. GMi receives a fee of $50,000 per fiscal year and is entitled to charge Gaz Métro for all of the expenses it incurs in acting as General Partner.
The removal of GMi as General Partner of Gaz Métro must be approved by an extraordinary resolution of the Partners of Gaz Métro. Moreover, GMi may not cease to act as General Partner nor dispose of all or part of its interest in the units of Gaz Métro without an extraordinary resolution of the bondholders pursuant to the trust, hypothec, mortgage and pledge deeds governing the first mortgage bonds of GMi.
1.2 GENERAL
Gaz Métro’s Limited Partnership Agreement stipulates that it shall only carry on Regulated energy activities, Non-regulated energy activities and Permitted economic activities, except that:
i) Gaz Métro shall not increase its Interests in Non-regulated energy activities if, after giving effect thereto, the aggregate amount of the Interests of Gaz Métro in Non-regulated energy activities and in Permitted economic activities would exceed 10% of the amount of the assets of Gaz Métro calculated on the basis of its last annual non-consolidated financial statements plus, if any, the amount of the increase in the assets of Gaz Métro resulting from such increase in the Interests of Gaz Métro in Non-regulated energy activities; and
ii) Gaz Métro shall not increase its Interests in Permitted economic activities if, after giving
effect thereto, the aggregate amount of the Interests of Gaz Métro in Permitted economic activities would exceed 5% of the amount of the assets of Gaz Métro calculated on the basis of its last annual non-consolidated financial statements plus, if any, the amount of the increase in the assets of Gaz Métro resulting from such increase in the Interests of Gaz Métro in Permitted economic activities.
On September 30, 2008, Gaz Métro’s Interests in Non-regulated energy activities and
Permitted economic activities amounted to $83.6 million, namely 3.3% of its non-consolidated assets, and its Interests in Permitted economic activities amounted to $29.4 million, namely 1.2% of its non-consolidated assets. In comparison, on September 30, 2007, Gaz Métro’s Interests in Non-regulated energy activities and Permitted economic activities amounted to $85.7 million, namely 3.5% of its non-consolidated assets, and its Interests in Permitted economic activities amounted to $27.5 million, namely 1.1% of its non-consolidated assets.
This Limited Partnership Agreement also stipulates that Gaz Métro shall carry on its activities
until September 30, 2090, unless it is dissolved before, and that its capital shall consist of an unlimited number of units, the General Partner being responsible for their issuance.
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ITEM 2 - GENERAL DEVELOPMENT OF BUSINESS
Mission
"Gaz Métro supplies energy services and solutions to its target clientele. Gaz Métro aims to be recognized as:
a leader in the energy field;
a performing, upright, socially responsible, environmentally caring enterprise;
a reliable and responsible supplier whose customers appreciate the quality of the service
and the expertise provided; and
a leading financial and operating partner that generates ideas and achieves them.
Gaz Métro counts on a solid partnering arrangement with its employees to achieve this mission, the ultimate objective of which is to fulfil the expectations of customers and investors respectively."
Gaz Métro continues to believe that the success of any business of tomorrow, as is the case
today, will depend on its ability to satisfy its three pillars, namely its investors, its customers and its employees, while respecting the community and ensuring sustainable development.
It also believes it will have to earn the confidence of the general public, which means sensible
intelligent development in terms of environmental considerations. Objectives
Gaz Métro's financial objective continues to be to provide its Partners with a stable
predictable return accompanied by growth in value over the years. While achieving this objective depends largely on the performance of the Quebec natural gas distribution activity, it also depends on its ability to develop its other activities profitably while maintaining relatively the same overall business risk profile.
From a business perspective, Gaz Métro intends to continue to grow its clientele and provide
its customers with high-quality energy services at the lowest possible cost, through policies and programs aimed at motivating its employees and business partners.
From a regulatory perspective, virtually all of Gaz Métro’s activities are regulated. Consequently, income and profitability are commensurate with the level of investments in Gaz Métro’s networks and the rate of return allowed by the various regulatory bodies. It is therefore important to remain on the outlook for potential additional investment opportunities in the various networks.
Gaz Métro’s current main areas of activities are the distribution of energy, transportation of
natural gas and storage of natural gas, as well as energy services and other activities not related to energy.
The following diagram illustrates Gaz Métro’s main areas of activities as well as the main enterprises related thereto, including the percentage voting rights held directly or indirectly by Gaz Métro or GMi and the jurisdiction of incorporation of such entities.
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(1) Wholly-owned by NNEEC, a wholly-owned subsidiary of Gaz Métro. (2) 38.3% interest owned by Northern New England Investment Company, Inc., a wholly-owned subsidiary of NNEEC. (3) Interests varying from 40% to 60% depending on enterprises in the group. (4) Interests varying from 49.8% to 100% depending on enterprises in the group. (5) Interests varying from 20% to 100% depending on enterprises in the group.
In each fiscal year, many events and conditions influence the general development of Gaz Métro’s business. The following events and conditions have, among others, influenced such development over the last three fiscal years: 2008 Distribution of natural gas in Quebec
The Régie established the base rate of return on Partners’ deemed common equity allocated to the distribution of natural gas at 8.76%, plus a return of 0.18% based on anticipated productivity gains for the 2009 fiscal year;
The Régie allowed Gaz Métro to keep the after-tax incentive return earned of $5.6 million for
the 2007 fiscal year (namely $8.3 million before income taxes), as well as one-quarter of the overearnings, namely $2.2 million after income taxes (namely $3.2 million before income taxes);
The Régie agreed to characterize Gaz Métro’s contribution to the Green Fund as an
exogenous factor and approved the methodology proposed by Gaz Métro to bill the cost thereof to its customers, namely at a rate of 0.67¢/m3, effective on January 1st, 2008;
The Régie refused to implement the rate changes effective on January 1st, 2008 following the
temporary suspension of TCE’s electricity production activities for the year starting on January 1st, 2008. The suspension was extended for the 2009 year. However, the Régie did allow Gaz Métro to increase the fixed component of Tariff D4 effective on October 1st, 2008; and
The price of natural gas fluctuated: progressive increase starting in February 2008 as a result
of the sharp increase in the price of oil, which encouraged greater use of natural gas in the North American market and pushed its price up, followed by a decrease during the last months of the 2008 fiscal year;
Energy distribution Transportation of natural gas
Energy services and other
Gaz Métro
Gaz Métro VGS(1) (Vermont, U.S.) Green Mountain Power(1)
(Vermont, U.S.)
TQM (Quebec, Canada) 50 % PNGTS(2)
(Maine, U.S.)
Gaz Métro Plus Group(4)
(Quebec, Canada) Aqua-Rehab / Aqua-Data Group(5)
(Quebec, Canada)
Storage of natural gas
Intragaz Group(3)
(Quebec, Canada)
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Other
Award, on May 5, 2008, to Gaz Métro, jointly with Boralex Inc., of two wind power projects for a total installed capacity of 272 megawatts following a call for tenders by Hydro-Québec Distribution for 2,000 megawatts of wind power energy, and signature of two electricity supply agreements on June 25, 2008.
2007 Distribution of natural gas in Quebec
The Régie approved a regulatory framework that includes a five-year performance incentive mechanism, effective on October 1st, 2007;
The Régie established the base rate of return on Partners’ deemed common equity allocated to
the distribution of natural gas at 9.05%, plus a return of 0.47% based on anticipated productivity gains for the 2008 fiscal year;
The Régie allowed Gaz Métro to keep the after-tax incentive return earned of $2,421,000 for
the 2006 fiscal year (namely $3,558,000 before income taxes), as well as one-quarter of the overearnings, after adjustments, of $2,210,000 after income taxes (namely $3,213,000 before income taxes);
The price of natural gas was kept relatively low due to abundance of natural gas available on
the North American market; and
The Régie cancelled the exclusion of $3,571,562 from Gaz Métro’s rate base following the revocation request submitted in 2006;
Others
On April, 12, 2007, NNEEC, a wholly-owned subsidiary of Gaz Métro, acquired all the outstanding shares of Green Mountain Power for US$187.0 million, excluding transaction costs (representing a net consideration of $224.3 million);
The Régie reduced the rate applicable to the Pointe-du-Lac natural gas storage site owned by
the Intragaz Group, retroactive to May 1st, 2006;
On October 10, 2006, SNC-Lavalin inc. acquired 2.9 million units of Gaz Métro for $50.0 million (representing a net consideration of $49.9 million);
On October 31, 2006, the Canadian government announced its proposal to change the tax
system for listed flow-through entities, which affects listed public limited partnerships, including Gaz Métro;
The government of Quebec introduced an annual duty payable by every distributor of natural
gas, fuel and combustible in Quebec (including Gaz Métro), which will be paid into the Green Fund. The rate and calculation of the annual duty are determined by regulation based on carbon dioxide emissions generated by the combustion of the combustibles to which the duty applies; and
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Gaz Métro was awarded Grand Prix québécois de la qualité – Catégorie Grande entreprise de services, établissement ou filiale de grande entreprise in recognition of its excellent results in terms of quality improvement.
2006 Distribution of natural gas in Quebec
The Régie established the base rate of return on Partners’ deemed common equity allocated to the distribution of natural gas at 8.73%, plus a return of 0.84% based on anticipated productivity gains for the 2007 fiscal year;
The Régie allowed Gaz Métro to keep the after-tax incentive return earned of $5,294,000 for
the 2005 fiscal year (namely $7,548,000 before income taxes);
In its June 22, 2006 decision, the Régie stated that Gaz Métro’s decision to carry out the Sainte-Sophie/Saint-Jérôme project was not prudent and excluded the cost overruns of $3,571,562 for the project from the rate base. Gaz Métro filed a revocation request with the Régie to have this rate base exclusion revoked, which was allowed during the 2007 fiscal year;
Gaz Métro submitted a request to the Régie, on March 8, 2006, for approval to set up a
Task Force to review the current performance incentive mechanism, which led to a decision approving the new incentive mechanism in the 2007 fiscal year; and
The price of natural gas fluctuated: initial increase as a result of Hurricanes Katrina and Rita,
followed by a decrease because of mild temperatures during the 2005-2006 winter; Others
On June 21, 2006, NNEEC (wholly-owned subsidiary of Gaz Métro) entered into an agreement with Green Mountain Power to acquire all the outstanding shares of Green Mountain Power for US$187.0 million, excluding transaction costs (representing a net consideration of $224.3 million);
The VPSB introduced a new regulatory framework for VGS, including an adjustment
mechanism for the price of natural gas sold to customers that reflects its acquisition cost; and
Amendment by Gaz Métro of its corporate mission to meet the respective expectations of customers and investors.
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ITEM 3 - NARRATIVE DESCRIPTION OF MAIN AREAS OF ACTIVITIES
Gaz Métro’s core business is the distribution of natural gas in Quebec. For the 2008 fiscal year, it accounted for 82% of Gaz Métro’s consolidated adjusted net income, compared to 81% of Gaz Métro’s consolidated adjusted net income for the 2007 fiscal year. Adjusted net income corresponds to the net income increased by an amount of $26.2 million representing a special future income tax expense as of September 30, 2007, resulting from the Minister of Finance’s Tax Fairness Plan tabled on October 31, 2006 concerning the taxation of public income trusts and limited partnerships (Specified Investment Flow-through Entities). This future income tax liability was reduced by $1.1 million during the 2008 fiscal year. Gaz Métro delivers approximately 97% of the natural gas consumed in Quebec while VGS, a wholly-owned subsidiary of NNEEC, which is a wholly-owned subsidiary of Gaz Métro, is the sole gas distributor in the State of Vermont, in the United States; the distribution of natural gas by Gaz Métro and VGS accounted for 82.6% of the consolidated revenues of Gaz Métro for the 2008 fiscal year, compared to 87.5%1 for the 2007 fiscal year.
Gaz Métro also carries on an electricity business and transports and stores natural gas and provides energy-related and other services through subsidiaries, joint ventures and companies subject to significant influence. A number of items specifically related to these activities, in particular the distribution of energy, are commented on below. For further information thereon, reference is made to Gaz Métro's Management’s Discussion and Analysis for 2008 (available on SEDAR’s Website at www.sedar.com), which should be read in conjunction with Gaz Métro's audited consolidated financial statements for the fiscal year ended September 30, 2008 (also available on SEDAR’s Website). These documents are expressly incorporated herein by reference and are an integral part of this Annual Information Form.
3.1 ENERGY DISTRIBUTION
Since April 12, 2007, the Energy Distribution Sector, formerly called the "Natural Gas Distribution Sector", includes the electricity distribution activities of Green Mountain Power, in addition to the natural gas distribution activities in Quebec and Vermont.
3.1.1 Distribution of Natural Gas in Quebec
3.1.1.1 Regulatory Process and Rates
a) Regulatory Process
The transportation, distribution, supply and storage of natural gas delivered through pipelines in Quebec are subject to the provisions of the Act respecting the Régie de l’énergie (Quebec) and the Building Act (Quebec) and to certain provisions of the Gas, Water and Electricity Companies Act (Quebec).
Gaz Métro’s natural gas distribution activity in Quebec is regulated by the Régie. The
Régie sets or modifies the rates and conditions for the supply, transportation and delivery of natural gas by a distributor as well as the rates for storage. The Régie also oversees the activities of a distributor, determines its rate of return and reviews consumer complaints. Furthermore, the Régie is empowered to set the conditions for the installation of a distributor’s facilities in the municipalities.
1 This percentage has been adjusted since the 93.6% shown in 2007 also included the electricity distribution activities of Green Mountain Power.
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Within its territory, a distributor has the obligation to supply and deliver natural gas to anyone who requests it, and to deliver natural gas which certain users have opted to purchase from a third party. However, under certain conditions, the Act respecting the Régie de l’énergie (Quebec) allows the distributor to apply to the Régie to be exempted from the requirement to deliver natural gas or to provide service to a consumer.
In reviewing an application to set or modify a rate, the Régie must determine the rate
base of the distributor, that is the unamortized balance of the investments that were made by the distributor to provide such service. The Régie must also determine the aggregate costs it considers necessary to cover the cost of providing the service. It must also allow a reasonable return on the distributor’s rate base and make provision for measures or incentive mechanisms to improve the distributor’s performance and the satisfaction of customer needs. The rate of return reflects the cost of financing the capital structure that the Régie considers appropriate to finance the distributor’s rate base. The rate of return is determined based on the cost of the debt and the return that the Régie considers reasonable on the Partners’ average equity.
The cost of natural gas is fully reflected in supply rates billed to customers by means of
an automatic monthly adjustment mechanism established for this purpose whereby variations are levelled over a forward-looking moving 12-month period.
In a decision dated December 19, 1990, the Régie determined that the following
principles applied to the 1992 base year and to any other subsequent rate year:
i) for regulatory purposes and for determining the rate of return on Gaz Métro’s rate base, the Régie will use a defined capital structure and financing costs that are compatible with such capital structure, including a rate of return on the Partners’ average equity;
ii) as Gaz Métro’s net income is taxable in the hands of the Partners, the Régie will
recognize the tax consequences and will take into account, for the determination of Gaz Métro’s operating expenses, deemed taxes related to current income taxes, large corporations tax (which has since been abolished), and a deemed capital tax.
For rate-setting purposes, the capital structure recognized by the Régie for the
distribution of natural gas in Quebec includes 54% in the form of debt, 7.5% in the form of deemed preferred shares and 38.5% in the form of deemed common equity. The deemed preferred shares are remunerated at the rate applicable to each of the share issues made prior to the August 1991 corporate reorganization until they mature and, thereafter, at the market rate at the time of their deemed replacement. Remuneration on common equity shall be at the rate authorized by the Régie. Deemed current income and capital taxes are calculated as if the August 1991 corporate reorganization had not taken place and assuming that Gaz Métro is a taxable Canadian corporation.
On April 26, 2007, the Régie approved Gaz Métro’s performance incentive mechanism
applicable from October 1st, 2007 to September 30, 2012. The approval by the Régie provides that the mechanism will be re-evaluated after the filing of the 2009-2010 rate application.
The mechanism, which is similar to the one in force since 2000, as slightly amended in
2004, provides an incentive for Gaz Métro to always be more productive. Accordingly, Gaz Métro’s performance is measured before the start of the fiscal year, by comparing the rates required to cover the budgeted costs (excluding the cost of gas) with the rates that would result from indexing based on the Consumer Price Index (CPI Quebec) less a productivity factor (“X” factor) of 0.3% (the “revenue cap”). Any favourable variance, considered a
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productivity gain, is shared with customers: at least 50% for customers and a maximum of 50% for Gaz Métro as an incentive return on average Partners’ equity, up to 375 basis points. If Gaz Métro maintains its performance, it can benefit on average for five years from the incentive return flowing from the productivity gains. The gains will be included in the revenue cap by applying a five-year rolling average. The comparison neutralizes the impact of certain external factors, including, among others, changes in interest rates, the evolution of volumes beyond a pre-determined threshold, the vagaries of weather, the evolution of transportation and storage costs as well the changes in income and capital tax rates. Since October 1st, 2007, revenues are normalized to take account of the combined impact on revenues of wind and temperature differences from normal. The new mechanism also makes it possible for Gaz Métro to increase the revenue cap by $14.6 million, that is $10.7 million in 2008 and $3.9 million in 2009, in order to compensate it for lower natural gas consumption, since 2000, by customers, mainly on account of energy conservation and efficiency measures. A new Global Energy Efficiency Plan performance incentive was also introduced. The maximum incentive of $4.0 million per year is conditional on the achievement of a cumulative energy savings objective over five years. Lastly, if the allowed rates generate overearnings (also called excess return in financial reports), as recognized after the end of a fiscal year, customers would recover the major portion, that is at least 75%, and Gaz Métro would keep a maximum of 25%.
Gaz Métro can only share in the productivity gains if various service quality indicators
are maintained. It also has to reimburse customers for penalties ranging from $100,000 to $200,000 for each service quality indicator for which a minimum threshold is not achieved.
In the event the rates required to cover costs exceed the rates indexed for inflation
less 0.3%, Gaz Métro may use those rates but would have to offset these excesses with future productivity gains or overearnings. If it fails to do so, at the end of the period covered by the mechanism, it will have to reimburse such excesses up to a percentage of the rate base which, at the date hereof, would represent approximately $13.6 million.
The mechanism approved by the Régie includes an Energy Efficiency Fund that is
financed partly from the customers’ share of the productivity gains and partly with a fixed contribution of $1.5 million starting in the 2009 fiscal year. The Fund gives priority to innovative energy efficiency initiatives by Gaz Métro’s current and potential customers. On September 30, 2008, the Fund had $17.3 million.
Because it covers several years and because of its overall approach, the incentive
mechanism fosters better planning of asset management and cost control, sales growth as well as a higher return on investments for the benefit of Gaz Métro’s customers and Partners. Furthermore, if required by the economic or competitive situation, Gaz Métro may annually ask the Régie to adjust its rates in order to continue to earn the reasonable return allowed by the Régie.
The incentive mechanism includes provisions for a review thereof under certain
circumstances, in particular if no incentive return is earned for a period of three years.
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b) Rate of Return Formula
In its 2008 rate case, the Régie allowed Gaz Métro a rate of return of 9.05% on Partners’ equity allocated to the distribution of natural gas for the 2008 fiscal year, that is 14 basis points higher than the rate of return formula in effect until 2007 would have given, but lower than what Gaz Métro had requested in the rate case to better reflect its business risk as well as the market’s expectations.
In the 2009 rate case, Gaz Métro asked the Régie to take account, for purposes of the rate
of return formula, of a particular financial context for that year; namely, that while, in Gaz Métro’s opinion, the increase in the credit spreads justified an increase in the allowed rate of return, the application of the present formula established by the Régie in the 2008 rate case produced the opposite result. The credit spread is defined as the difference between, on the one hand, the returns on GMi’s long-term first mortgage bonds (30 years), which are loaned to Gaz Métro on similar terms and conditions and, on the other hand, the returns on government of Canada bonds (30 years). Gaz Métro therefore requested that the application of the automatic adjustment formula be stayed for that year, by maintaining the same base rate of return as authorized in 2008, that is 9.05%, and increasing it by 20 basis points to take account of Gaz Métro’s higher issue costs incurred when it issues units in the market. In its November 12, 2008 decision, the Régie rejected Gaz Métro’s request because, in its opinion, lacking expert evidence, it would be inappropriate to stay the application of the rate of return adjustment formula.
The Régie established the authorized base rate of return on Partners’ deemed common
equity for the 2009 fiscal year at 8.76%, which is the rate obtained when using the present rate of return formula.
c) Main Decisions by the Régie during the Past Year
i) 2009 Rate Case
The rates for the 2009 fiscal year were agreed on by Gaz Métro and the various intervenors recognized by the Régie who joined the Task Force, with the exception of a dissent by the Canadian Federation of Independent Business concerning payment of the contribution to the Energy Efficiency Fund and a number of dissents by TCE, in particular with respect to the increase to the rate applicable to it. The rate proposal was submitted to the Régie in June 2008 and a decision was rendered on November 12, 2008. On November 24, 2008, Gaz Métro filed an application describing the effects of such decision. On December 1st, 2008, the Régie then rendered a final decision on the rates for the 2009 fiscal year, approving the 2009 rate schedule effective on December 1st, 2008. As the decision was not known on October 1st, 2008, namely the beginning of the 2009 fiscal year, provisional rates had been approved by the Régie on September 24, 2008. The difference between the provisional rates and the rates approved by the Régie for the 2009 fiscal year will be recorded in a deferred charges account that will be amortized in the 2010 fiscal year, thereby allowing its recovery through rates. For the fiscal year beginning on October 1st, 2008, the base rate of return on Partners’ deemed common equity allocated to the distribution of natural gas in Quebec was set at 8.76%. For the 2009 fiscal year, the performance incentive mechanism makes it possible to generate an incentive return of 0.18% as well as a performance incentive in respect of the Global Energy Efficiency Plan. Distribution rates charged to customers,
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excluding the contribution to the Green Fund, are 4.22% higher on average than during the 2008 fiscal year. The Régie approved some of the Task Force’s requests, in particular the request concerning the treatment of accumulated vacation pay, the financial derivatives program and the rate strategy. The Régie also approved the changes to the normalization method presented by Gaz Métro in the rate application. The Régie approved the gas supply plan, subject to certain changes to be made to specific items by Gaz Métro. The Régie rejected Gaz Métro’s request concerning the allocation in the rates of the annual contribution payable to the Agence de l’efficacité énergétique (such obligation being more fully described under Item 3.1.1.6 e) Legislative framework), but approved the inclusion of amounts already paid and amounts to be paid in a deferred charges account until a decision is rendered on the Comprehensive Plan for Energy Efficiency and New Technologies.
ii) Construction of Water Tank and Fire Pump Room at LNG Plant Following a break in the water main on Boulevard Pie IX in Montreal, Quebec, in September 2007, tests performed by Gaz Métro on the functioning of the fire system at the LNG Plant showed that the pressure of the City of Montreal’s line, coupled with the LNG Plant’s water entry, was insufficient to adequately supply the hydraulic load of the fire systems. Gaz Métro submitted a project, evaluated at $1.52 million, to supply water to the fire systems at the LNG Plant in the event of a major failure of the City of Montreal’s water system. The installation of a 1.6 million litre concrete tank, combined with a fire pump room, will ensure that the LNG Plant has the necessary independent water supply for its fire systems. On April 23, 2008, the Régie approved the project based on the budget submitted by Gaz Métro.
iii) 2007 Closing
With respect to the 2007 fiscal year, the Régie, in its May 8, 2008 decision, as confirmed in its final decision of June 20, 2008, noted Gaz Métro’s results and achievement of an overall average of 99.7% for the performance indicators, which allowed it to keep the entire incentive return earned of $5.6 million after income taxes (namely $8.3 million before income taxes) and entitling it to one-quarter of the overearnings, namely $2.2 million after income taxes (namely $3.2 million before income taxes). The Régie also noted an achieved rate of return, including incentive return, of 9.90% compared to an allowed rate of return of 9.57%. The Régie said it was satisfied with the profitability of the gas system extensions of less than $1.5 million.
iv) Change to Tariff D4 and Inclusion of Green Fund Contribution in Gaz Métro’s Rates
Change to Tariff D4 Tariff D4 is the rate for Gaz Métro’s customers that use large gas volumes on a stable basis, mainly industrial customers. The Tariff D4 sub-rates billed to customers depend on their consumption.
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As more fully described under Item 3.1.1.4 Main Industrial Customers, following the temporary suspension of TCE’s activities during the 2008 fiscal year, Gaz Métro filed a request with the Régie to increase the fixed component and reduce the variable component of the last sub-rate of Tariff D4 as of January 1st, 2008. At that time, TCE was the only customer billed at that sub-rate. The Régie authorized the rate changes requested to that sub-rate, effective on October 1st, 2008. However, it rejected Gaz Métro’s request to have the changes effective as of January 1st, 2008. Green Fund Contribution and Gaz Métro’s Rates On December 14, 2007, the Regulation respecting the annual duty payable to the Green Fund came into force. As more fully described under Item 3.1.1.6 e) Legislative framework, Gaz Métro must pay an annual duty to the Green Fund. Its contribution was established at $38.0 million for the 2008 fiscal year. On December 12, 2007, Gaz Métro asked the Régie to approve changes to its rates in order to recover the amount of the duty paid to the Green Fund. The Régie agreed to characterize the Green Fund contribution as an exogenous factor and approved the methodology proposed by Gaz Métro, namely a rate of 0.67¢/m³, effective as of January 1st, 2008. Consequently, the amount of such duty is billed to Gaz Métro’s customers. The Régie also approved that the uncollected amounts on account of the Green Fund duty for the period of October 1st to December 31, 2007 be recorded in a deferred charges account, which will be amortized in the 2009 fiscal year.
3.1.1.2 Gas Supply
a) Availability of Natural Gas
During the 2008 fiscal year, there were less quantities of natural gas available on the
North American continent than the previous year, in particular as a result of the depletion of storage surpluses in the United States.
This fiscal year was marked by a sharp increase in oil prices, which had a number of
impacts on the North American natural gas market. The high prices of petroleum products encouraged greater use of natural gas, pushing its price up. In addition, the high LNG prices in Asia and Europe, often indexed to the price of oil, caused a substantial decrease in LNG imports in North America compared to the previous year.
However, there was a substantial increase in the production of natural gas in the
United States this year. This was largely due to shale gas deposits, such as Barnett Shale in Texas. The technological progress with respect to horizontal drilling and hydraulic fracturing reduced the costs of developing this type of resource, which is found in large quantities on the North American continent.
b) Direct Purchases
Gaz Métro’s customers can purchase their own natural gas directly from a supplier of
their choice. Direct purchase customers generally entrust Gaz Métro with the responsibility of moving the gas from the location indicated to their facilities. Some of them look after having the gas transported to Gaz Métro’s distribution system. During the 2008 fiscal year, direct purchases accounted for approximately 57% of all volumes delivered to Gaz Métro's customers, compared to approximately 60% during the previous year.
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c) System Gas System gas deliveries accounted for approximately 43% of all deliveries during the
2008 fiscal year, compared to approximately 40% during the 2007 fiscal year. System gas is supplied to Gaz Métro’s customers who do not use the direct purchase option.
Gaz Métro has annual System gas supply contracts with a number of suppliers. Prices
paid are determined according to a recognized published index, to which is added, from time to time, a premium negotiated by the parties. Gaz Métro also buys System gas on a spot basis in order to adapt to the fluctuations in demand and operating conditions of its system.
While Gaz Métro purchases most of its System gas in Alberta, a portion is also purchased
at the Dawn hub (in Ontario). Gaz Métro uses derivative financial instruments to mitigate fluctuations in natural gas
prices. This is done within the framework of a policy which is reviewed annually by the Régie. The policy determines the applicable conditions that Gaz Métro must respect so that the effects of using derivative financial instruments may be recognized in the gas supply rate.
d) Transportation
The only two pipelines that supply Gaz Métro are owned by TCPL and TQM, a
subcontractor of TCPL. In spite of this situation, Gaz Métro has built up a diversified transportation portfolio in terms of maturities and points of origin. Most of these capacities can be renewed every year at Gaz Métro’s option. The important elements of the portfolio are presented annually to the Régie within the framework of the approval of Gaz Métro’s supply plan’s update.
Gaz Métro has transportation contracts with TCPL for the biggest portion of the gas
volumes that are delivered to its exclusive distribution territory. It has annual transportation capacity with TCPL of 4,404 106m3 between Western Canada and its territory and a daily capacity of 10,324 103m3 between the Ontario peninsula and its territory. Gaz Métro also has transportation contracts obtained on the secondary market for 1,320 103m3 per day between the Ontario peninsula and its territory.
Gaz Métro also has transportation capacities of 8,046 103m3 per day on the UG system in
Ontario between Dawn and Toronto. It also has transportation capacity of 1,924 103m3 per day on TCPL’s intra-Alberta system.
In order to substitute for its own transportation capacity, Gaz Métro may also sign spot
contracts with suppliers for gas delivered directly to its distribution territory.
e) Compressor Fuel
Pursuant to transportation contracts, shippers must provide the fuel required to operate compressors located along the transportation system. Compressor fuel now represents approximately 3% to 6% of volumes transported to Quebec. Gaz Métro purchases the compressor fuel required to transport the System gas, and direct purchase customers have to provide the compressor fuel required to transport their own gas.
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f) Storage Required by the Natural Gas Distributor As a natural gas distributor, Gaz Métro has natural gas underground storage contracts for
519.9 106m3 in southwestern Ontario (Dawn) pursuant to long-term contracts with UG. Gaz Métro also has two leases for underground facilities operated by the Intragaz Group. One is at Pointe-du-Lac, Quebec, where natural gas volumes of up to 80 106m3 per year are injected and withdrawn on a cyclical basis. The other is for the facility at St-Flavien, Quebec. The maximum daily withdrawal capacity from the St-Flavien facility amounts to 1,484 103m3 and the total available volume amounts to 120 106m3.
Peak winter demand is supplied by the LNG plant, which has a capacity of 58.6 106m3.
The maximum volume that can be withdrawn per day can be as much as 5,749 103m3. The transportation and storage contracts referred to under Items d) and f) above are more
fully described under Item 8.4 Material contracts.
3.1.1.3 Market
For the 2008 and 2007 fiscal years, normalized deliveries (for normal temperature and, since October 1st, 2007, wind velocity also) of natural gas in Quebec and revenues were as follows:
2008
Deliveries
%
Revenues
%
(106m3) (millions of $) Industrial market • Firm service 2,266.1 39 453.7 27 • Interruptible service 737.3 13 90.3 5 Commercial market 2,193.9 38 793.9 48 Residential market 607.5 10 328.0 20 5,804.8 100 1,665.9 100
2007
Deliveries
%
Revenues
%
(106m3) (millions of $) Industrial market • Firm service 2,920.2 47 428.9 27 • Interruptible service 577.0 9 85.1 5 Commercial market 2,129.7 34 745.9 47 Residential market 623.3 10 318.5 20 6,250.2 100 1,578.5 100
The market allocation method was changed in 2008 to improve the classification of
existing customers. As a result, volumes of deliveries and revenues for the 2007 fiscal year have been restated based on this new methodology to make the figures for 2007 comparable with those for 2008. While this restatement changed the volumes of deliveries and revenue breakdowns amongst the various markets, it did not affect total revenues and deliveries for the 2007 fiscal year.
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a) Competitive Situation
The 2008 fiscal year was marked by spiking natural gas prices. Although Gaz Métro’s supply price (price of System gas) during the first four months of the year was less than the average of $6.31/Gj for the previous year, it rose quickly after that: from $5.97 in January 2008, it reached a high of $9.37/Gj in July 2008 and then ended at $7.16/Gj in September 2008. This represents an average increase of 13% in the price of System gas over the 2007 fiscal year. Gaz Métro’s financial derivatives program, as more fully described under Item 3.1.1.2 Gas Supply, reduced the price of natural gas for customers by an average of $0.24/Gj.
The sudden increase in the price of natural gas during the 2008 fiscal year can be explained by the factors described under Item 3.1.1.2 Gas Supply.
The increase in oil prices also pushed the price of fuel oil up to an historical level. Between October 2007 and September 2008, N° 2 fuel oil traded at an average price that was 50% higher than during the previous fiscal year. N° 6 fuel oil (also called heavy fuel oil) was 66% higher than during the previous fiscal year. However, like the price of natural gas, and even though it remained high, oil prices fell during the last few months of the fiscal year.
Residential Market
Based on average prices for the 2008 fiscal year, it was only slightly more expensive to heat a new house that uses highly efficient equipment with natural gas than with electricity. However, heating with natural gas was up to 12% more expensive than electricity for an older house with less efficient equipment. In spite of the substantial increase in the price of supply during the year, the competitive position of natural gas in relation to electricity remained similar to last year’s. This results from the fact that customers who use natural gas mainly for heating were not affected to any great extent by the sharp increase in prices, which came at the end of the winter when the largest part of their annual consumption was completed.
Heating with natural gas instead of No2 fuel oil generated significant savings for all residential customers. Depending on the size of the house and the efficiency of the equipment used, the savings varied from 20% to 30%. This is a significant improvement in the competitive advantage of natural gas in relation to No2 fuel oil compared to the last few years.
The following graph shows the annual cost of using No2 fuel oil, electricity and natural
gas for a single family house during the 2006 to 2008 fiscal years:
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Commercial Market
Based on average prices for the 2008 fiscal year, natural gas maintained its competitive advantage over electricity.
In this market, natural gas was an average of 12% less expensive than electricity for customers who consume less than 100,000 m3 annually. The spread ranged from 14% to 37% for customers who consume between 100,000 m3 and 400,000 m3 annually, and could be as much as 43% for customers who consume 400,000 m3 and more annually. This is similar to the situation in the previous year.
However, in spite of this favourable situation for natural gas, Hydro-Québec’s off-peak
rate available at a marginal rate of 2.93¢/kWh hurt the competitiveness of natural gas in this market when additional electric equipment is installed to optimize off-peak electricity consumption.
Based on the average prices for the 2008 fiscal year, natural gas was also much less
expensive than No2 fuel oil. For customers who consume less than 100,000 m3 annually, it was in average 44% less expensive. It varied from 61% to 87% for customers who consume between 100,000 m3 and 400,000 m3 annually and could be as much as 90% for customers who consume 400,000 m3 and more annually. In comparison, during the 2007 fiscal year, natural gas was 13% less expensive for customers who consume less than 100,000 m3, 21% to 41% less for customers who consume between 100,000 m3 and 400,000 m3 and 43% for customers who consume 400,000 m3 and more.
Evolution of annual cost of using energy for single newly-built family house of 205 m2 with highly efficient equipment
$2,372 $2,321
$2,885
$1,899 $1,985 $2,027 $2,115
$1,955$2,036
$ -
$500
$1,000
$1,500
$2,000
$2,500
$3,000
2006 2007 2008 Fuel oil Electricity Natural gas
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The following graph shows the annual cost of using No2 fuel oil, electricity (excluding
optimized off-peak electricity consumption) and natural gas for an average size commercial customer during the 2006 to 2008 fiscal years:
However, for commercial customers who purchase their natural gas directly, this
information on the competitive situation varies based on the terms and conditions of their supply contract and the date it was executed.
Industrial Market
During the 2008 fiscal year, and for the first time in several years, natural gas was less
expensive than No6 fuel oil on the long-term market in the industrial market. However, access to an off-peak electricity rate for customers in this market makes natural gas more expensive than electricity for them.
The following graph shows the annual cost of using No2 fuel oil, No6 fuel oil, off-peak
electricity and natural gas for an industrial interruptible service customer during the 2006 to 2008 fiscal years:
$25,584 $24,492
$33,301
$23,547 $24,651 $25,165
$24,195
$20,579 $21,448
$-
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
2006 2007 2008
$
Evolution of annual cost of using energy for an average size commercial building (Consumption equivalent to 41 500 m3 of natural gas per year)
Fuel Oil Electricity Natural gas
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On the spot market, where natural gas had only been competitive during a few summer months for the past two years, it was less expensive than No6 fuel oil throughout the 2008 fiscal year, with the exception of one week.
Evolution of competitive situation of natural gason spot market during the 2008 fiscal year
$0
$5
$10
$15
$20
$25
2007
-10-01
2007
-11-12
2007
-12-27
2008
-02-12
2008
-03-27
2008
-05-08
2008
-06-20
2008
-08-04
2008
-09-16
$/Gj
No. 6 fuel oil $/Gj Natural gas $/Gj
Evolution of unit cost of using energy for an industrial customer
(Consumption equivalent to 10 106 m3 to 25 106 m3 per year in interruptible service)
7.93
12.01
15.64 14.99
20.05
11.66
7.07 7.57 7.767.241
9.98 9.45
0.0 2.0 4.0 6.0 8.0
10.0 12.0 14.0 16.0 18.0 20.0 22.0
2006 2007 2008
$ Gj
No 6 fuel oil (2% sulfur) “NY CARGO” (including transportation cost: $0.75/barrel)
No2 fuel oil Source: OIL BUYER’S GUIDE (including transportation cost of 1 ¢/litre)
Natural gas (1-year contract at Empress) Source: ENERDATA (including transportation, load-balancing, distribution and compressor fuel)
Tariff L electricity used off peak 1 This number has been adjusted to reflect updated data.
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b) New sales and Evolution of Demand in Quebec
During the 2008 fiscal year, Gaz Métro entered into 6,305 new contracts, which is 1,245 more than during the previous fiscal year. They include 1,346 with customers who replaced their electric or oil heating system with a natural gas furnace. In spite of the decrease over the years in the number of fuel oil customers likely to convert to natural gas, very high fuel oil prices persuaded nearly twice as many of them as last year to convert to natural gas. In new housing projects that have access to natural gas, there was a substantial increase in natural gas equipment installed in proportion to the total number of installations, which resulted in a significant increase in the number of new contracts. In total, these new contracts account for a potential total annual consumption of 14.36 106m3.
In Quebec, as a result of these new sales, the penetration rate in the new housing market reached 12.26%, compared to 8.94%2 during the 2007 fiscal year. In the Greater Montreal Area, the penetration rate reached 23.43%, compared to 17.10%2 during the 2007 fiscal year.
In the commercial market, 2,778 new contracts were signed, which are comprised of 735 contracts for additional consumption by existing customers and 2,043 new contracts. This is less than in the 2007 fiscal year when 2,123 new contracts and 836 contracts for additional consumption were signed. Nevertheless, the average potential consumption associated with these sales represents a total volume of 101.85 106m3, which is a significant increase over the total volume of 93.44 106m3 during the previous fiscal year.
New industrial sales generated a total volume of 607 106m3, which is more than double the volume of 247.59 106m3 during the previous fiscal year. Short-term interruptible service sales contributed to this result because of the favourable short-term competitive position for natural gas throughout nearly the entire year. This type of transaction generated volumes amounting to 280 106m3 during the 2008 fiscal year, compared to 155.35 106m3 during the 2007 fiscal year.
c) Energy Efficiency
Gaz Métro continues to promote energy efficiency. During the 2008 fiscal year, the
24,000,000 m3 energy conservation objective of the Global Energy Efficiency Plan was largely surpassed. A total of 30,864,877 m3 was conserved as a result of customer participation in Gaz Métro’s energy efficiency programs. The data are compiled by Gaz Métro and the actual savings represent the consumption of approximately 10,450 typical single family houses. These savings enabled Gaz Métro to earn the entire $4.0 million Global Energy Efficiency Plan performance incentive provided for under its performance incentive mechanism.
3.1.1.4 Main Industrial Customers
TCE is Gaz Métro’s main industrial customer. On July 23, 2004, Gaz Métro signed a
contract with TCE that covers the period from April 1st, 2006 to August 31, 2026. Under the contract, Gaz Métro must deliver the natural gas needed for the production of 550 megawatts of electricity for TCE’s Bécancour (Quebec) cogeneration plant.
2 These percentages have been adjusted to reflect the fact this calculation is now based on Gaz Métro’s fiscal year instead of the calendar year. Based on the calendar year, the percentages for 2007 were 9.7% and 19%, respectively.
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On November 26, 2007, following the Régie’s approval of the agreement between Hydro-Québec and TCE for the temporary suspension of the electric production activities at TCE’s Bécancour plant for the year starting on January 1st, 2008, Gaz Métro filed a request with the Régie to increase the fixed component and reduce the variable component of the last sub-rate of Tariff D4, which is the rate applicable to TCE, effective on January 1st, 2008.
On July 8, 2008, the Régie rendered its decision, rejecting the request to implement the
new rates effective on January 1st, 2008. It stated that under the current regulatory framework, it fixes the tariffs each year based on projected costs for a given reference year. This ensures rate predictability and stability. However, the Régie, noting that the amendments to the contract between Hydro-Québec and TCE affect the predictability of the stability of TCE’s consumption, authorized Gaz Métro to implement the requested changes effective on October 1st, 2008.
In its decision, the Régie felt it was appropriate to establish the level of the minimum
daily obligation of the last sub-rate of Tariff D4 by extrapolating the current rate structure based on the average decrease in the minimum daily obligation of the Tariff D4 sub-rates. It also asked Gaz Métro to submit a complete file on the stable service Tariffs with its 2010 rate application, establishing the relationship between the rate structure and the cost allocation for each sub-rate.
On July 4, 2008, Hydro-Québec asked the Régie to extend the suspension of TCE’s
electricity production activities at its Bécancour plant for the entire 2009 calendar year. In its decision of September 10, 2008, the Régie approved that request for a second consecutive year.
Deliveries to TCE for the 2008 fiscal year represented approximately 4.55% of
Gaz Métro’s total deliveries, which represents 1.23% of its total distribution revenues. However, under the contract signed on July 23, 2004, TCE must pay to Gaz Métro a minimum annual amount at the unit rate for the minimum daily obligation of the stable service Tariff (as established in the Tariffs approved by the Régie) multiplied by the daily volume TCE agreed to consume (2,639,219 m3) multiplied by 365 days (or 366 days during leap years), which represented 73% of the revenues generated by TCE for the 2008 fiscal year.
Deliveries to the other two large customers of Gaz Métro for the 2008 fiscal year
represented 8.45% of its total deliveries, that is 2.31% of its total distribution revenues. 3.1.1.5 System Operations Gaz Métro’s primary objective is to ensure continuous safe gas supply to all customers.
To do so, constant efforts are made to ensure that facilities are protected through effective system maintenance and improvement programs.
In 2008, as is customary every year, the preventive maintenance program was fully
carried out. In addition, certain system reinforcement measures were put in place this year, including looping of certain antenna pipelines.
As public safety and system security remain priorities for Gaz Métro, its system
sectorization program completed last year created 14 independent sectors on the Island of Montreal, Quebec, which makes it possible to isolate one of them in the event of an emergency while maintaining safe supply for the others.
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In connection with the third-party damage prevention program, Gaz Métro continued, in collaboration with Info-Excavation, the Régie du Bâtiment and the Commission de la santé et de la sécurité du travail, to increase the awareness of municipalities and excavation contractors. Gaz Métro is actively involved with the Québec Alliance for the protection of underground facilities, which promotes best practices in this area. 3.1.1.6 Environmental Protection
a) ISO 14001-2004 Standard
In January 2008, in order to maintain its ISO 14001-2004 registration, Gaz Métro had its
environmental management system audited by an independent auditor, with the result that it maintained its registration. Gaz Métro has an internal committee that is responsible for defining the environmental strategies, monitoring its environmental performance and proposing required improvements when appropriate.
b) Environmental Management of Site
In connection with a five-year (2004-2009) agreement with the MDDEP, Gaz Métro
continued the decontamination, started in 2000, of its head office land located at 1717 du Havre Street in Montreal, Quebec. The contamination comes from the operation of a manufactured gas plant that was on that land more than 50 years ago before Gaz Métro acquired it.
For this purpose, between 2006 and 2008, Gaz Métro invested $600,000 to
decontaminate the land and upgrade its pumping system. All the analyses that had to be done and all the reports that had to be submitted to the MDDEP, in particular for monitoring the quality of the air and underground and surface water, were provided in accordance with the terms of the agreement with the MDDEP.
Possible work to widen Notre-Dame Street in Montreal, Quebec, is presently being studied by the Ministère des Transports of Quebec. As currently planned, if the street is widened, a small part of Gaz Métro’s head office land would be expropriated in order to build a ramp towards Notre-Dame Street. Consequently, if the project is carried out in accordance with the current plan, the existing agreement with the MDDEP may have to be amended.
c) Climate Change and Greenhouse Gases
All natural gas distributors in Canada use the same GHG inventory method. In
September 2007, Gaz Métro and all other natural gas distributors in Canada updated the list of emission factors included in the GHG emissions inventory method in order to improve the accuracy of their estimates. The methodology was updated with a view to providing to the government of Canada, in 2008, the GHG emissions and other atmospheric pollutants report for the 2006 calendar year (this obligation is more fully described in paragraph e) of this Item). The update of the emissions factors used did not result in any significant change to Gaz Métro’s GHG emissions inventory.
During the 2007 calendar year, Gaz Métro’s GHG emissions totalled 60,304 tonnes CO2 eq., that is a 23.2% reduction in its GHG emissions and a 35.5% reduction in the intensity of its GHG emissions (by volume of natural gas delivered) compared to their 1990 level. As those emissions totalled 78,552 tonnes CO2 eq. in 1990, Gaz Métro achieved its objective of limiting, until 2008, the intensity of its GHG emissions to 20% below their 1990 level. Gaz Métro’s GHG emissions during the 2006 calendar year totalled
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59,657 tonnes CO2 eq., that is a reduction of 24.1%3 in emissions and 30.3 %3 in intensity compared to their 1990 level.
As part of the performance incentive mechanism approved by the Régie and more fully
described under Item 3.1.1.1 a) Regulatory process, the Régie approved Gaz Métro’s GHG emissions management plan, which provides for annual reductions of its GHG emissions by 350 tonnes CO2 eq. through the implementation of recurring projects or plans. During the 2008 fiscal year, Gaz Métro reduced its GHG emissions by 1,425 tonnes CO2 eq. below those of the 2007 fiscal year and therefore significantly exceeded its objective.
d) Recognitions Received by Gaz Métro
On May 31, 2007, Gaz Métro received the "Go Green" certification from the Building
Owners and Managers Association ("BOMA") for the management of its head office building. This voluntary environmental certification recognizes the efforts of building owners and managers who have implemented, or are planning to implement, the best environmental practices to manage their building. On November 29, 2007, Gaz Métro also received BOMA's "Go Green Plus" certification for the same building. This certification measures each building's environmental factors such as energy use, indoor health and environmental performance against the best industry operation and management practices.
Furthermore, in October 2007, the Carbon Disclosure Project recognized Gaz Métro as
one of Canada’s leaders in reporting on its climate change initiatives and accomplishments. This important recognition allows Gaz Métro to be included in the Climate Disclosure Leadership index for the excellence of its reporting. In November 2008, following the preparation of its Carbon Disclosure Project in the spring 2008, Gaz Métro was recognized as the first of Canada’s leaders in reporting on its climate change initiatives and accomplishments.
e) Legislative Framework
The Act to ensure Canada meets its global climate change obligations under the Kyoto
Protocol was assented to and came into force on June 22, 2007. The objective of this Act is to ensure that the federal government respects its GHG reduction objectives under the Kyoto Protocol by adopting, amending or repealing the appropriate regulations. Gaz Métro will not be able to evaluate the impact of the Act until the federal government has adopted the regulations. As of the date hereof, no such regulations have been adopted.
On October 26, 2007, the government of Canada published its plan to combat climate
change entitled “Turning the Corner”. Under this plan, the Notice with respect to reporting of information on air pollutants, greenhouse gases and other substances for the 2006 calendar year was published in the Gazette of Canada, Part I, on December 8, 2007. Pursuant to that Notice, Gaz Métro had to file a report concerning its GHG emissions and other atmospheric pollutants for the 2006 calendar year. Such report was submitted to Environment Canada.
On March 10, 2008, the government of Canada published a portion of the details of its
“Turning the Corner” plan in a document entitled “Turning the Corner: Regulatory Framework for Industrial Greenhouse Gas Emissions”. The plan establishes mandatory GHG emissions intensity reduction targets in relation to 2006 emissions. For some industries, the plan provides thresholds below which no emissions intensity reduction will be mandatory. For
3 These percentages have been adjusted based on the update of the emission factors of the methodology. The percentages shown in 2007 were 28% and 34.1%, respectively.
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the natural gas pipeline industry, that threshold was fixed at 50,000 tonnes CO2 eq. of GHG emissions (excluding natural gas fugitive emissions) per year. The federal government has not yet adopted any regulations to implement the plan. As natural gas fugitive emissions represent most of Gaz Métro’s GHG emissions (namely 36,105 tonnes CO2 eq. out of a total of 60,304 tonnes CO2 eq. during the 2007 calendar year), if the threshold provided for in future regulations remains at that level, Gaz Métro should not have any obligation to reduce its GHG emissions under such regulations.
Accordingly, there are no binding federal regulations for reducing GHG emissions,
except for the annual report on GHG emissions that must be submitted to the federal government by enterprises that emit more than 100,000 tonnes CO2 eq. each year, a threshold that the federal government sets annually. Gaz Métro is not subject to this obligation because, as mentioned above, it emitted 60,304 tonnes CO2 eq. for all its equipment and facilities during the 2007 calendar year. Gaz Métro’s submission of such a report is therefore done on a voluntary basis.
The government of Quebec has adhered to the Western Regional Climate Initiative,
which includes some U.S. states and Canadian provinces (Ontario, Manitoba and British Columbia). The objective of this agreement is to encourage collaboration among these governments in identifying, evaluating and implementing means of reducing GHG emissions, in particular by developing a cap-and-trade program limiting GHG emissions and providing for carbon credits exchange. For this purpose, the American states and Canadian provinces that signed the agreement fixed GHG emission reduction targets by 2020. Based on currently available information, the government of Quebec plans to adopt regulations for the achievement of those targets that would be effective starting in 2012. As the targets in the agreement are more stringent than those proposed by the government of Canada, the regulations might apply to Gaz Métro’s activities.
On December 13, 2006, an Act respecting the implementation of the Quebec Energy
Strategy and amending certain legislative provisions came into force. The statute provides that every energy distributor (including Gaz Métro) must pay an annual contribution to the Agence de l'efficacité énergétique du Québec to subsidize its activities. On February 23, 2008, the regulation which establishes the method of calculating such annual contribution was published and came into force on March 9, 2008. It provides that the annual contribution is payable in four equal instalments, on March 31, June 30, September 30 and December 31 of each year. For the 2008 fiscal year, Gaz Métro paid the aggregate amount of $2.31 million to the Agence de l’efficacité énergétique du Québec.
The statute also provides that a distributor of natural gas, fuel or combustibles for energy
purposes shall pay an annual duty to the MDDEP, which will pay it to the Green Fund it has created. On December 14, 2007, the regulation that establishes the rate and method of calculating such annual duty came into effect. Such regulation provides that the annual duty is payable in four equal instalments, on March 31, June 30, September 30 and December 31 of each year. For the 2008 fiscal year, Gaz Métro paid the aggregate amount of $38.0 million. Since the amount of such duty is billed to Gaz Métro’s customers, the obligation to pay it has a negative impact on its competitive position compared to electricity, which is not subject to the duty, but has a favourable impact compared to fuel oil, which is generally subject to a higher duty.
On October 1st, 2007, the government of Quebec issued the Plan gouvernemental de
réduction de la consommation de mazout lourd visant à améliorer la qualité de l'air et réduire les émissions de gaz à effet de serre. The plan focuses on six points, including i) the implementation of a financial incentives program that also offers maximum financial
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assistance of $40 per tonne of GHG avoided for users who stop using heavy fuel oil in favour of cleaner alternatives and ii) the reduction of sulphur content in heavy fuel oil to 1.5% by weight in 2009 and 1% by weight in 2010 for territories where natural gas is available. The reduction of sulphur content in heavy fuel oil should, according to the MDDEP, increase the price of heavy fuel oil. If that is the case, the competitive position of Gaz Métro should be improved compared to heavy fuel oil. As of the date hereof, no regulations have been adopted.
Finally, pursuant to the Regulation respecting mandatory reporting of certain emissions
of contaminants into the atmosphere, enacted pursuant to the Environment Quality Act (Quebec), every operator whose enterprise, facility or establishment emits a contaminant listed in that Regulation into the atmosphere at a level that is equal to or greater than the threshold prescribed for this contaminant must report to the MDDEP the quantity of this contaminant that the facility, establishment or enterprise emitted into the atmosphere in the preceding calendar year. During the 2007 calendar year, Gaz Métro did not emit any of these contaminants.
During the 2008 fiscal year, the environmental protection requirements did not have any
material financial or operational impact on Gaz Métro’s capital expenditures, net income and competitive position, save and except for the impact on the competitive position of the obligation to pay the duty to the Green Fund described above under this Item. In management’s view, those requirements will not have any such financial or operational impacts during the 2009 fiscal year.
3.1.2 Distribution of Natural Gas and Electricity in Vermont
On April 12, 2007, NNEEC, a wholly-owned subsidiary of Gaz Métro, proceeded with the closing of a transaction with Green Mountain Power pursuant to the terms of the agreement entered with Green Mountain Power on June 21, 2006. Accordingly, NNEEC acquired all of the outstanding shares of Green Mountain Power for cash consideration at a price of US$35 per share, for a total purchase price of US$187.0 million, excluding transaction costs (representing a net consideration of $224.3 million). Green Mountain Power, the second largest electricity distributor in the State of Vermont in the United States, transports, distributes and sells electricity and provides electric network construction services in that State.
VGS, which is also a wholly-owned subsidiary of NNEEC, is the sole gas distributor in the
State of Vermont in the United States and provides other energy-related services, including increasing energy efficiency by repairing gas equipment.
VGS and Green Mountain Power are regulated by the VPSB. The rates for their activities are
established on a cost of service method, which enables them to fix their revenues so as to recover the costs they expect to incur to serve their customers and earn a reasonable base return on the shareholder’s equity. The shareholder’s equity was 55% of the rate base for the 2008 and 2007 fiscal years, in the case of VGS, and 52.2% and 52.8%, for the 2008 and 2007 fiscal years, respectively, in the case of Green Mountain Power. For VGS, the allowed base rate of return has been 10.5% since October 1st, 2006. In the case of Green Mountain Power, the allowed rate of return is adjusted annually based on a formula tied to changes in yield on the 10-year U.S. Treasury Note. For the period of January 1st, 2007 to December 31, 2007, its allowed base rate of return was 10.25%. For the period of January 1st, 2008 to December 31, 2008, its allowed base rate of return is 10.21%.
Since October 1st, 2006, VGS has been subject to a new regulatory framework approved by
the VPSB, which includes a quarterly adjustment mechanism for the price of natural gas sold to customers that reflects its acquisition cost and a mechanism for some sharing in over or under gas cost
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recovery as well as an annual rate application for the other items, excluding the cost of gas. The annual rate application also includes a mechanism for sharing in productivity gains as well as an earning sharing mechanism when the actual return is outside of a 50 basis point dead band from the allowed return on equity. On November 21, 2007, VGS filed its first rate application under its performance incentive mechanism with the VPSB, which included a 13.5% increase in its distribution rates. The VPSB approved it on January 22, 2008.
The VPSB approved an Alternative Regulation Plan for Green Mountain Power that came
into force on February 1st, 2007 for three years. The main components of the plan are an adjustment mechanism for electricity supply, a mechanism for sharing returns in excess of the return allowed on the deemed shareholder’s equity as well as a sharing of revenue shortfalls when they are less than the return allowed on the deemed shareholder’s equity, an annual adjustment of the base rate calculated on a cost of service method and an annual adjustment of the allowed base rate of return.
VGS and Green Mountain Power do not benefit from a temperature and wind normalization
mechanism and their deliveries therefore vary based on actual temperature and wind velocity. The earnings of VGS, whose customers are more highly concentrated in the space heating market, are therefore affected to a greater extent by temperature and wind velocity fluctuations.
3.1.2.1 VGS
VGS obtains all of its supply from Canada. During the 2008 fiscal year, VGS had three base load supply contracts that provided the majority of VGS’ supply. Numerous other suppliers provided spot supply on an as-needed basis. The price of VGS’ base load contracts are all indexed to recognized, liquid market points.
In addition, VGS has a storage contract with Gaz Métro. Under the contract, VGS delivers natural gas to Parkway, Ontario during the injection season (typically April through September) and Gaz Métro delivers the gas to Philipsburg, Quebec, the point of interconnection of the VGS and TCPL’s systems.
During the 2008 fiscal year, VGS achieved 3% customer growth, signing 1,503 new
contracts representing a 255,546 Mcf increase in annual sales. During the previous fiscal year, VGS had signed 1,112 new contracts representing a 233,227 Mcf increase in annual sales. This was due to a substantial increase in conversions within the “In Fill” sector driven by a favourable competitive position to No. 2 fuel oil. According to the Vermont Department of Public Service, the average cost per MMBTU during the 2008 fiscal year was US$22.36 for natural gas compared with US$33.36 for No. 2 fuel oil, US$41.24 for propane and US$39.79 for electricity.
Since the early 1990’s, VGS has offered a comprehensive portfolio of energy efficiency programs. During the 2008 fiscal year, VGS invested about US$1.5 million in its energy efficiency programs, compared to US$1.3 million during the 2007 fiscal year. Annual savings are in excess of 83,000 Gj/year. In addition, the programs have a favourable cost recovery structure, allowing program expenses to be deferred between rate proceedings and VGS to earn a return on deferred balances.
VGS’ six energy efficiency programs have been recognized nationally in the
United States; such programs were recognized by the American Council for an Energy-Efficient Economy, a non profit research group based in Washington, D.C., as outstanding efficiency programs. Since their creation, VGS’ programs have assisted over 17,000 of its customers through equipment replacement, retrofit and construction programs.
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In VGS’ market, natural gas enjoys a substantial competitive advantage when compared with other energy sources in the residential, commercial and industrial air and water heating markets.
The net income generated by VGS accounts for 2.5% of Gaz Métro’s consolidated
adjusted net income for the 2008 fiscal year, compared to 2.3% of Gaz Métro’s consolidated adjusted net income for the 2007 fiscal year.
3.1.2.2 Green Mountain Power
Green Mountain Power’s territory covers approximately one-quarter of the State of
Vermont’s population, in the United States. Although it produces part of the electricity it distributes, Green Mountain Power meets most of its customer demand through a series of long-term physical and financial contracts. Its supply portfolio includes various generation sources, the main ones being hydroelectricity and nuclear power. The following chart illustrates the breakdown of Green Mountain Power’s power sources for the period of October 2007 to September 2008:
Green Mountain Power expects essentially all of its estimated load requirements
through 2009 to be met by its contracts and owned generation and other power supply resources. Green Mountain Power’s contracts and resources significantly reduce Green Mountain Power's exposure to volatility in wholesale energy market prices. Green Mountain Power’s most significant power supply contracts are the Hydro-Québec Vermont Joint Owners Contract and a contract with Entergy Nuclear Vermont Yankee, LLC ("ENVY"), which together are expected to cover between 75% and 80% of Green Mountain Power’s retail load in 2009. The prices in these contracts allow Green Mountain Power to enjoy stable and competitive retail electric rates relative to other utilities in Vermont and the other New England states.
While Green Mountain Power’s major power purchase contracts still have a number
of years to run, Green Mountain Power has already undertaken discussions with its suppliers
Biomass4.2%
Fuel oil andNatural gas
1.5%
Net purchases on market
4.6%
Hydro-Quebec36.5% Nuclear power
42.0%
Hydro independent producers
4.0% Electric facilities owned by GMP
7.2%
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regarding potential extension of existing contracts and evaluates, on a on-going basis, alternative supply sources. The ENVY contract is for power produced by the Vermont Yankee nuclear power station in Vernon, Vermont. The operating license for Vermont Yankee expires in March 2012. ENVY has filed with the U.S. Nuclear Regulatory Commission and the Vermont Public Service Board to extend this license for an additional 20 years. The Vermont State Legislature must also approve the license extension.
In addition to the Hydro-Quebec Vermont Joint Owners Contract, in November 1996, Green Mountain Power and Hydro-Québec entered into an agreement which grants Hydro-Québec an option to call power sold to Green Mountain Power at prices that are expected to be below estimated future market rates which Green Mountain Power would have to pay to purchase additional electric power, if required as a result of the exercise of such call. This agreement is effective through October 2015. Green Mountain Power’s management’s estimate of the fair value of the future net cost of such agreement as at September 30, 2008 is approximately US$18.2 million; such costs are recovered in rates. Green Mountain Power’s objective is to hedge the risk of such contract by using financial derivatives (fixed-price swaps) or forward electricity purchases if additional electric power is necessary as a result of the exercise of such call by Hydro-Québec.
Green Mountain Power actively promotes energy efficiency. Efficiency services to customers are primarily provided through an energy efficiency utility, which is financed through a separate charge on electric bills. In addition, as part of the regulatory approval of NNEEC’s acquisition of Green Mountain Power, Green Mountain Power has created the Green Mountain Power Efficiency Fund. Through such Fund, Green Mountain Power will invest in total approximately US$9.0 million towards additional efficiency programs for Green Mountain Power customers through 2013. As at September 30, 2008, US$2.1 million had been invested in such Fund.
Green Mountain Power was the first northeastern U.S. utility to become a member of
the Chicago Climate Exchange, a self-regulatory exchange that administers a market for reducing and trading GHG credits. Green Mountain Power has achieved its voluntary goal to reduce its emissions by 4.25% below its 1998 - 2001 baseline average by the end of the 2007 calendar year. Its goal for the 2008 calendar year is to reduce its emissions by 4.5% of its baseline. Green Mountain Power also offers to customers a renewable energy rate permitting customers to designate renewable resources equal to 25%, 50%, 75% or even 100% of their monthly use.
Green Mountain Mountain Power has a 33.2% and 29.2% direct equity ownership interest, respectively, in Vermont Transco LLC4 and Vermont Electric Power Company, the owner and operator of the transmission system in Vermont over which bulk power is delivered to all electric utilities in Vermont. The total amount of this investment as of September 30, 2008 was approximately US$78.7 million. Green Mountain Power currently receives an 11.5% annual return on this investment, which rate of return is approved by the FERC. The amount of such return is applied to Green Mountain Power’s regulated cost of service to benefit retail customers.
Green Mountain Power has added 587 new customers in the period of
October 1st, 2007 through September 30, 2008, compared to 433 for the period of April 12 to September 30, 2007 (namely, the date of acquisition by NNEEC). The average number of customers served is approximately 94,000.
4 It also has a 12.52% indirect equity ownership interest through Vermont Electric Power Company, for a total interest of 36.9%.
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Green Mountain Power has one major retail customer, International Business
Machines Corporation (IBM) that accounted for 23% of retail megawatthour sales, and 15.3% of retail operating revenues for the period of October 1st, 2007 to September 30, 2008, compared to 22.8% and 15.5%, respectively, for the period of April 12 to September 30, 2007. No other Green Mountain Power customer accounts for more than 1% of retail megawatthour sales. The following chart illustrates the breakdown of Green Mountain Power’s customers by retail sales during the period of October 2007 to September 2008:
In Green Mountain Power’s market, competition takes several forms. At the
wholesale level, in New England, a detailed competitive market framework was implemented that has resulted in bid-based wholesale competition of power suppliers rather than prices set under cost of service regulation. At the retail level, customers have long had energy options such as propane, natural gas or oil for heating, cooling and water heating. There also exists the potential for municipalities located in Green Mountain Power’s service territory, with the citizens’ approval, to form and operate municipally-owned utilities.
The net income generated by Green Mountain Power accounts for 5.6% of Gaz Métro’s consolidated adjusted net income for the 2008 fiscal year, compared to 1.2% of Gaz Métro’s consolidated adjustment net income for the 2007 fiscal year (that is for the period following its acquisition by NNEEC on April 12, 2007).
3.2 NATURAL GAS TRANSPORTATION
In Canada, transportation activities are regulated by the NEB and in the United States by the FERC. Gaz Métro owns significant financial interests in three natural gas transportation enterprises, namely TQM, PNGTS and Champion Pipe Line Corporation Ltd. The first is a 50% interest in TQM, which operates a gas pipeline in Quebec that connects upstream with that of TCPL and downstream with those of PNGTS and Gaz Métro. In addition, Champion Pipe Line Corporation Ltd., a wholly-owned subsidiary of Gaz Métro, operates two gas pipelines that cross the Ontario border to supply Gaz Métro's distribution system in northwestern Quebec. Their activities are regulated by the NEB with respect to revenue determination, tolls, construction and operations. The NEB approves the rates based on the annual cost of service, which includes deemed income and capital taxes. The rate of return on equity is based on the rate of return formula approved by the NEB and adopted during hearing RH-2-94 on the cost of capital of a number of pipeline companies. The deemed equity component is 30% of the rate base in the case of TQM and 46% in the case of Champion Pipe Line Corporation Ltd. TQM's authorized return is 8.71% for its fiscal year ending December 31, 2008
Residential customers29%
1%
34%
Commercial and industrial customers with small
and medium consumption
36%
Other
Commercial and industrial customers with
large consumption
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compared to 8.46% for the preceding year. For Champion Pipe Line Corporation Ltd., it is 9.05% for its fiscal year ending September 30, 2008, compared to 8.73% for the preceding year.
On December 17, 2007, TQM filed a rate application with the NEB to have its authorized rate
of return increased so it would better reflect its economic reality and business risk. This application covers its 2007 and 2008 fiscal years. The hearings were held in September and October 2008 and a decision is expected at the beginning of 2009.
TQM, which has signed a preliminary natural gas transportation contract with TCPL to
connect possible Gros-Cacouna LNG terminal to its pipeline, will not file a request with the NEB following Cacouna Energy’s withdrawal of its service application on March 26, 2008. As provided in the contract, on June 26, 2008, TQM was reimbursed for costs it had incurred since the commencement of the project.
The pipeline owned by PNGTS, in which Gaz Métro owns a 38.3% indirect interest,
originates at the Quebec border and extends to the suburbs of Boston. The objective of the FERC regulations is to ensure the recovery, through rates, of the costs expected to be incurred to serve customers and a reasonable base return on Partners' equity. The last rate application filed in October 2001 has been effective since April 1st, 2002. PNGTS filed a rate application with the FERC on April 1st, 2008 to get its tolls increased. On September 1st, 2008, PNGTS increased its transportation tolls, based on the rate application with the FERC. Until it receives the FERC’s final approval, PNGTS is recording a provision for the difference in transportation revenues, using the new tolls and the tolls approved in the last settlement. The hearings are expected to start on March 10, 2009.
The loss, over the last few years, of two large customers with whom PNGTS had long-term
contracts, coupled with the difficulties in concluding the same type of contract with other customers to replace the lost volumes, hurt the results expected from this investment interest. PNGTS’ main challenge continues therefore to be active and vigilant in seizing business opportunities that will enable it to maximize the profitability of the capacity of its transportation system.
The net income generated by this Sector accounts for 11.8% of Gaz Métro’s consolidated
adjusted net income for the 2008 fiscal year, compared to 9.4% of Gaz Métro’s consolidated adjusted net income for the 2007 fiscal year.
3.3 NATURAL GAS STORAGE
Gaz Métro owns an interest in the Intragaz Group whose activities are mainly underground natural gas storage; those activities tally with Gaz Métro’s mission because the storage of natural gas in Quebec is part of its supply chain. The Intragaz Group operates the only two underground storage facilities in Gaz Métro’s service territory in Quebec. Gaz Métro is also its only customer. Its rates are approved by the Régie on the basis of avoided costs. On June 6, 2007, the Régie rendered a decision concerning the rates for the Pointe-du-Lac storage site owned by the Intragaz Group. The decision reduced the rate, retroactive to May 1st, 2006, which reduced its net income.
The adjusted net income generated by this sector accounts for 2.3% of Gaz Métro’s
consolidated adjusted net income for the 2008 fiscal year, compared to 2.1% of Gaz Métro’s consolidated adjusted net income for the 2007 fiscal year.
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3.4 ENERGY SERVICES AND OTHER
Through subsidiaries, joint ventures and companies subject to significant influence, Gaz Métro sells goods and services in the energy business, water and waste water systems, and fibre optic fields.
The decrease in adjusted net income from this sector has resulted in a loss which accounts for 1.2% of Gaz Métro’s consolidated adjusted net income for the 2008 fiscal year, compared to an income accounting for 5.4% of Gaz Métro’s consolidated adjusted net income for the 2007 fiscal year. 3.4.1 Energy Services
Energy services are non-regulated activities and include energy and technology services, sale, leasing and maintenance of natural gas appliances, the leasing and sale of water heaters and district heating and cooling.
On February 14, 2006, Gaz Métro and Dalkia International joined forces. Dalkia is internationally renowned in energy production and district heating. The main objective of the resulting joint venture, CDH Solutions & Operations L.P, is to acquire and develop district heating and cooling plants in Canada’s major cities. Gaz Métro’s interest in Climatisation et Chauffage Urbains de Montréal, s.e.c., which provides the same services to areas of Montreal, was transferred on that date to the new entity, thereby reducing Gaz Métro’s interest therein from 100% to 50%.
3.4.2 Water Sector
Gaz Métro’s objective is to provide diagnosis (through its wholly-owned subsidiary, Aqua Data Inc.) and rehabilitation (through its wholly-owned subsidiary, Groupe Aqua Rehab Inc.) services for municipal water and wastewater systems under multi-year contracts. These activities will likely experience attractive growth in the future since integrated water distribution and wastewater collection system master plans have become mandatory in Quebec for obtaining government grants. 3.4.3 Fibre Optic Sector
Gaz Métro owns a 49.8% indirect interest in MTO Telecom Inc., which operates a high bandwidth fibre optic network that mainly serves Montreal, Toronto and Ottawa. Growth of MTO's commercial clientele, combined with tight control over operating costs, should improve the company's earnings over the next few years.
3.5 LNG TERMINAL AND WIND POWER PROJECTS 3.5.1 LNG Terminal Project
Gaz Métro owns an interest in Rabaska Limited Partnership for the development of the LNG terminal project in Lévis, Quebec, known as “Rabaska”, with its partners, Enbridge Inc. and GDF SUEZ (formerly Gaz de France).
On February 28, 2008, Rabaska Limited Partnership received authorization from the
Canadian federal government to build its LNG terminal. This was the final important authorization expected, following receipt of the Quebec government’s approval in October 2007. By means of a decree issued on October 24, 2007, the Quebec government approved the carrying out of the part of such project relating to the construction of a LNG terminal in Lévis, on the conditions set forth therein.
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Rabaska Limited Partnership is currently endeavouring to secure its LNG supplies. In this respect, on May 15, 2008, the partners of such project signed a letter of intent with Gazprom Marketing & Trading USA, Inc., OAO Gazprom’s U.S. subsidiary, for all of the terminal’s regasification capacity. Following the signing of final agreements, Gazprom Marketing & Trading USA, Inc. would acquire an equity interest in Rabaska Limited Partnership, which would dilute the interest of the initial partners. The partners originally contemplated to reach final agreements before the end of the year 2008. This schedule is now slightly postponed as the discussions are still progressing but at a slower pace. External factors and uncertainties in the financial, commodity and construction markets have slowed down the finalization of the agreements.
Development expenditures included in results and related to the Rabaska LNG terminal amounted to $2.9 million for the 2008 fiscal year, compared to $0.2 million for the previous year. Gaz Métro maintains its approach of not capitalizing any cost related to the project development (excluding lands purchases for which Rabaska Limited Partnership intends to exercise its options) as long as it does not have reasonable assurance that the project will generate benefits in the future. In Gaz Métro’s view, this assurance could be obtained, among other things, when Rabaska Limited Partnership has secured its LNG supplies.
3.5.2 Wind Power Projects
On May 5, 2008, following a call for tenders by Hydro-Québec Distribution for 2,000 megawatts of wind power energy, Gaz Métro, jointly with Boralex Inc., was awarded two wind power projects for a total installed capacity of 272 megawatts. The two wind farms are located on the Seigneurie de Beaupré lands. On June 25, 2008, two electricity supply agreements expiring on December 1st, 2033, were signed by Hydro-Québec Distribution, Boralex Inc. and 9198-5218 Québec inc., a wholly-owned subsidiary of Gaz Métro. The Régie approved these agreements on October 17, 2008. GMi has given Hydro-Québec Distribution two unconditional guarantees totalling $1.4 million for all obligations of 9198-5218 Québec inc. under the electricity supply agreements. GMi could be required to provide additional guarantees at a later date, depending on progress of the work associated with the contracts. Gaz Métro expects that it will be able to carry out the next phases of the wind power projects. On an ongoing basis, until the in-service date, the partners must, among other things, obtain the authorization decree from the MDDEP, continue their discussions to obtain the appropriate financing and sign contracts with the turbine supplier during 2009, in anticipation of the two wind farms being operational towards the end of 2013.
3.6 Human Resources Management
As at September 30, 2008, Gaz Métro, including its subsidiaries and affiliates, had
2,151 regular and temporary employees. Gaz Métro had 1,305 regular and temporary employees, 66% of whom were unionized. The
collective agreement for office workers, affiliated with the SEPB-Québec union (which is itself affiliated with the Fédération des travailleurs et travailleuses du Québec (FTQ)), was signed on October 30, 2007 and will expire on August 31, 2010. The collective agreement for the sales representatives, also affiliated with the SEPB-Québec union, expired on September 30, 2007 and an agreement in principle setting out the terms of the new collective agreement was approved on November 26, 2008. The collective agreement for the blue-collar workers, who are affiliated with the Confédération des syndicats nationaux (CSN), was signed on September 20, 2006 and will expire on September 30, 2009. Gaz Métro has good relations with its various unions and their representatives. In management’s view, relations with employees are generally stable.
Since 2000, Gaz Métro has been measuring its organizational performance with the
QUALImètre, which is a worldwide diagnostic tool that allows Quebec enterprises to compare their
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management and business practices with the best organizations around the world. Since its self-evaluation in 2000, Gaz Métro has implemented innovative management approaches. These approaches, which are aligned with the corporate orientations, have enabled it to significantly improve its results and receive the Grand Prix québecois de la qualité 2006 – Catégorie Grande entreprise de services, établissement ou filiale de grande entreprise. This year, Gaz Métro reached another milestone when it exceeded the results obtained in 2006 on the QUALImètre scale, which enabled it to join the ranks of worldwide leading enterprises. This excellent result is testimony to Gaz Métro’s continuous efforts to achieve a high level of organizational performance.
Among the other enterprises in the Energy Distribution Sector, Green Mountain Power had
191 employees, 103 of whom were unionized. Their collective agreement runs until December 31, 2012. VGS had 116 employees, 40 of whom were unionized. Their collective agreement was renewed on June 1st, 2008 and expires on May 31, 2011.
The enterprises in the Transportation and Storage Sectors had 25 employees, none of whom
was unionized, and the Energy Services and Other Sector had 514 employees, 167 of whom were unionized.
The key to Gaz Metro’s success lies partly in the specialized skills and knowledge required to
operate and maintain the natural gas distribution system. A succession plan to ensure the transfer of skills as employees retire as planned has been in place since 2005 and is updated twice a year. This bi-annual exercise enables Gaz Métro to evaluate its vulnerability to future shortages in some specialized trades and implement action plans that are also monitored twice a year. Some of Gaz Métro’s subsidiaries and affiliates also have a succession plan with a similar objective.
The École de technologie gazière (operated by Gaz Métro) continues to offer education
programs about gas trades to an increasingly large outside clientele, which helps prepare succession in Quebec’s gas industry.
3.7 FINANCIAL MANAGEMENT
Gaz Métro’s financial strength depends on, among other things, its ability to manage the issues related to gas availability at competitive prices, customer demand, the regulatory framework and the capital structure. Its financial health also depends on its ability to earn the return allowed by the Régie. These issues have already been discussed.
For historical reasons, in most cases where Gaz Métro needs debt financing for its activities, GMi raises the funds on the market and loans the proceeds to Gaz Métro on similar terms and conditions.
On December 21, 2004, GMi entered into a Credit Agreement for $400.0 million, maturing on December 21, 2009 and guaranteed by Gaz Métro. Every year starting on December 1st, 2005, the Credit Agreement can, subject to the approval of the lenders, be extended for one year. In February 2008, GMi extended the agreement until December 21, 2012. During the 2005 fiscal year, GMi issued an information circular for the issue of short-term promissory notes (also called commercial paper) of up to $400.0 million. The proceeds from the issue of these notes will be loaned to Gaz Métro on the same terms and conditions. Notes are issued based on Gaz Métro’s financial requirements and are supported by the Credit Agreement described above.
On July 10, 2006, GMi issued $300.0 million Series J first mortgage bonds. The issue was made in two tranches of $150.0 million each bearing interest at the annual rate of 5.45% (15 years) and 5.70% (30 years) respectively. The two series mature on July 12, 2021 and July 10, 2036 respectively. The proceeds of the issue were loaned to Gaz Métro on similar terms and conditions.
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On October 10, 2006, Gaz Métro also announced the closing of a private placement whereby
it issued 2,913,753 units to SNC-Lavalin Inc. at a price of $17.16 per unit, for total proceeds of $50.0 million (representing a net consideration of $49.9 million). The issue was made to maintain the required regulatory capital structure for the Quebec natural gas distribution activity.
On April 10, 2007, Gaz Métro entered into a bridge-loan agreement with Bank of Montreal, guaranteed by GMi, for a maximum of US$200.0 million, maturing on October 9, 2008. On September 9, 2008, this agreement was extended until October 9, 2009. Gaz Métro has drawn US$100.0 million and the equivalent of US$78.0 million (which represented $89.5 million at the time), of which US$100.0 million was loaned to NNEEC, and US$78.0 million was invested in the form of equity in NNEEC, to enable it to pay for the acquisition of the shares of Green Mountain Power (as described under Item 3.1.2 Distribution of natural gas and electricity in Vermont). Following the issue of the notes described below, NNEEC repaid US$100.0 million to Gaz Métro, which in turn repaid an equivalent amount to Bank of Montreal. On September 30, 2008, the outstanding balance of the bridge-loan was $73.3 million.
On June 19, 2007, NNEEC issued two series of senior notes of US$50.0 million each to partially finance the acquisition of the shares of Green Mountain Power (as described under Item 3.1.2 Distribution of natural gas and electricity in Vermont). The two series of notes bear interest of 5.93% and 6.12% respectively and mature on June 19, 2017 and 2022.
As of September 30, 2008, Gaz Métro owned asset-backed commercial paper totalling $1.5 million on a consolidated basis. A total valuation allowance of 42% of the original value of such commercial paper was recorded in Gaz Métro’s books.
On October 14, 2008, GMi issued Series L first mortgage bonds in the amount of $150.0 million. The bonds bear interest at an annual rate of 5.40% and mature on April 15, 2013. The proceeds of the issue were loaned to Gaz Métro on similar terms and conditions.
Gaz Métro has shown that it is able to manage the various business risks confronting it. Consequently, Gaz Métro and GMi continue to receive solid credit ratings from S&P and DBRS. GMi has A ratings (S&P and DBRS) for its first mortgage bonds, and A-1 (low) (S&P) and R-1 (low) (DBRS) for its commercial paper. Gaz Métro and GMi also have corporate ratings of A-(S&P).
S&P’s Issuer Credit Rating (also called corporate rating) is a current opinion of a borrower’s overall financial capacity (its creditworthiness) to perform its financial obligations. This opinion focuses on the borrower’s capacity to meet its financial obligations as they become due.
S&P’s ratings for debt instruments range from a high of AAA to a low of D. The ratings from AA to CCC may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories. According to S&P’s rating system, debt securities rated A are somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher-rated categories. However, the obligor's capacity to meet its financial commitments is still strong.
DBRS’s ratings for debt instruments range from a high of AAA to a low of D. The assignment of a “high” or “low” designation within each rating category indicates relative standing within such category. The absence of a “high” or “low” designation indicates the rating is in the “middle” of the category. The “high”, “middle” and “low” grades are not used for the AAA and D categories. According to DBRS’ rating system, debt securities rated A are characterized as satisfactory credit quality. Protection of interest and principal is still substantial, but the degree of strength of
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entities having A rated securities is less than that of entities having AA rated securities. While A is a respectable rating, entities having securities in this category are considered to be more susceptible to adverse economic conditions and have greater cyclical tendencies than entities having higher-rated securities.
S&P’s ratings for commercial paper range from a high of A-1 to a low of D. A “high”, “mid” or “low” designation may be assigned to A-1 ratings only. S&P’s A-1 (low) rating is the third highest of eight categories. According to S&P’s rating system, commercial paper rated A-1 (low) is slightly more susceptible to the adverse effects of changes in circumstances and economic conditions than commercial paper having a higher rating. However, the obligor’s capacity to meet its financial commitments is satisfactory.
DBRS’s ratings for commercial paper range from a high of R-1 to a low of D. A “high”, “middle” or “low” designation may be assigned to R-1 and R-2 ratings only. DBRS’ R-1 (low) rating is the third highest of ten categories. According to DBRS’ rating system, commercial paper rated R-1 (low) is of satisfactory credit quality. The outlook for key liquidity, debt and profitability ratios is not normally as favourable as with higher rating categories, but these considerations are still respectable. Any qualifying negative factors that exist are considered manageable, and the borrower is normally of sufficient size to have some influence in its industry.
On February 8, 2008, S&P changed the outlook for GMi and Gaz Métro from negative to
stable and confirmed GMi’s and Gaz Métro’s credit ratings. In S&P’s opinion, the outlook change reflects, among other things, prudent operations and balance sheet management and moderate investments in other sectors related to energy. The outlook had been changed from stable to negative on June 22, 2006 following the announced acquisition of Green Mountain Power by NNEEC. In S&P's view at the time, Green Mountain Power's regulatory environment and Gaz Métro's development strategy, which could increase the proportion of its investments in non-regulated activities, could have altered Gaz Métro's overall business risk.
Gaz Métro also has solid ratings for the stability of its distributions, that is SR-2 by S&P and
STA-2 (middle) by DBRS. The stability ratings, which were SR-1 and STA-1 (low) respectively, were downgraded following the announcement of the reduction in the distribution in May 2006.
The stability ratings of S&P and DBRS include seven categories, that is SR-1 to SR-7 for S&P and STA-1 to STA-7 for DBRS. The SR-2 rating is the second highest stability rating given by S&P and represents a very high level of stability with respect to the distributable cash compared to other income funds on the Canadian market, including income trusts, limited partnerships, royalty trusts and real estate investment trusts. The STA-2 rating is the second highest stability rating given by DBRS, and is given to income funds whose distributable income levels per unit should not likely be affected unfavourably and materially by foreseeable events. A “high”, “middle” or “low” notation indicates the classification within a specific category.
These credit ratings do not constitute recommendations to purchase, sell or hold positions and
the rating agencies that gave them can change or withdraw them at any time. ITEM 4 - SELECTED FINANCIAL INFORMATION
Consolidated financial data for the fiscal years ended September 30, 2008 and 2007 are included in Gaz Métro’s Management’s Discussion and Analysis for 2008, which should be read in conjunction with the audited consolidated financial statements of Gaz Métro for the year ended September 30, 2008 and which are available, among other places, on SEDAR’s Website at www.sedar.com.
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Consolidated revenues and net income for the fiscal year ended September 30, 2008 totalled $2,171.9 million and $154.4 million respectively, compared to $1,957.5 million and $122.8 million for the previous year. The consolidated adjusted net income for the fiscal year 2008 (such term being explained before under Item 3 Narrative Description of Main Areas of Activities) totalled $153.3 million, compared to $149.0 million for the previous year.
Otherwise, it is to be noted that the distribution of natural gas and electricity is very seasonal,
which means most of the deliveries by energy distributors are in winter. 4.1 INCOME DISTRIBUTION 4.1.1 Distributions
Since it became public, Gaz Métro has distributed substantially all of the net income earned during each fiscal year. In principle, distributions are made on the first Gaz Métro’s working day following the end of a calendar quarter, i.e. the first working day of January, April, July and October of each year to Partners of record at the close of business on December 15, March 15, June 15 and September 15 of each year respectively, or if the Toronto Stock Exchange is not open on that date, the first following day it is open.
Gaz Métro occasionally reviews the level of the distribution in light of anticipated changes in
income, which largely depend on changes in the rate of return allowed by the Régie and other regulatory bodies, as well as on the profitability of its non-regulated activities. 4.1.2 Distributions History
The following table shows the distributions to Gaz Métro’s Partners over the last three fiscal years.
Fiscal years ended September 30
2008 2007 2006 Distributions paid to Partners (in millions of $)
149.4
148.4
156.3
Distributions per unit paid to Partners (in $)
1.24
1.24
1.33
Gaz Métro distributed $0.31 per unit on October 1st, 2008 to Partners of record on
September 15, 2008 and has announced that a distribution of $0.31 per unit will be paid on January 5, 2009 to Partners of record on December 15, 2008.
4.1.3 Restrictions on Distributions and Issuance of Long-Term Debt under the Deeds Creating and Governing the Long-Term Debt
The deeds and agreements creating and governing the long-term debt of Gaz Métro, or the long-term debt for which Gaz Métro is responsible, impose certain restrictions on the distribution of earnings and the issuance of long-term debt by Gaz Métro. Under such deeds and agreements, which define the expressions "aggregate capitalization" and "long-term debt":
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i) Gaz Métro may not, as long as first mortgage bonds remain outstanding, make any such distribution if, after giving effect thereto, Gaz Métro’s aggregate long-term debt exceeds 75% of its aggregate capitalization;
ii) Gaz Métro may not issue, assume or guarantee long-term debt if all such long-term debt
issued, assumed or guaranteed by Gaz Métro and outstanding on the date of the proposed issuance, assumption or guarantee exceeds 65% of the aggregate capitalization of Gaz Métro on that date, after giving effect to the issue, assumption or guarantee and the receipt and allocation of the proceeds therefrom; and
iii) Gaz Métro may not issue, assume or guarantee long-term debt if earnings available for
payment of interest charges during any period of 12 consecutive months selected by Gaz Métro out of 18 such months preceding the date of the proposed issuance, assumption or guarantee of the new long-term debt have been less than one and one-half times the sum of the annualized interest charges on all long-term debt issued, assumed or guaranteed by Gaz Métro outstanding at the date of such proposed issuance, assumption or guarantee and the annualized interest charges on the long-term debt proposed to be issued, assumed or guaranteed.
Gaz Métro calculates these ratios on the basis of its non-consolidated financial statements.
4.2 TAX CONSIDERATIONS
On June 22, 2007, the House of Commons adopted Bill C-52 enacting the Income Tax Act amendments implementing the proposals in the Minister of Finance’s Tax Fairness Plan tabled on October 31, 2006 with respect to the taxation of public income trusts and limited partnerships (Specified Investment Flow-through Entities). As a result of these amendments, effective on October 1st, 2010, income tax (presently paid by each Partner) will be paid at the level of Gaz Métro at the applicable corporate tax rate and after-tax distributions will be considered as dividends for tax purposes.
On July 14, 2008, the Department of Finance (Canada) published legislative proposals
including income tax measures which i) are intended, among other things, to facilitate the conversion to corporations of Specified Investment Flow-through Entities (also called SIFT) (as defined in Bill C-52) and ii) include tax measures previously announced by the Department of Finance (Canada) on December 20, 2007 intended to further clarify certain aspects of the Specified Investment Flow-through Entities rules.
In their present form, the amendments would reduce income that can be distributed because it
would be after tax. During the 2008 fiscal year, approximately 85% of Gaz Métro’s income before taxes came from entities that were not taxable at the Partnership level. Only that portion would be affected by the change in the law as of October 1st, 2010. The impact on the Partners would depend on their individual tax status. Gaz Métro is analyzing its various alternatives.
ITEM 5 - LEGAL PROCEEDINGS
Gaz Métro is cited in claims and lawsuits in the normal course of its activities. In the opinion of management, these claims and lawsuits are, for the most part, covered by appropriate insurance coverage and the overall amount of the contingent liability relating to these claims and lawsuits should not have a significant impact on Gaz Métro’s consolidated income or its financial situation.
VGS and Green Mountain Power, subsidiaries of NNEEC, jointly with others, have been
cited as being potentially responsible for polluting land on which a manufactured gas plant that ceased
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operations in 1966 was located. In 1999, a settlement protocol was signed by the Environmental Protection Agency and the enterprises involved. It included an action plan to restore the site and a cost sharing method. This action plan was confirmed by the VPSB in 2001 and has generally proven efficient except for a small portion of the contaminated area, for which the Environmental Protection Agency is currently approving a new action plan. The VPSB has agreed that the costs incurred to date by VGS and Green Mountain Power can be recovered in rates over a period of 10 to 20 years. If future outlays exceed the provisions already recorded in the books, new requests to recover such amounts in rates will be submitted to the VPSB. In the opinion of Gaz Métro’s management, the costs that might arise in connection with this settlement protocol would not be significant for Gaz Métro.
ITEM 6 - MARKET FOR SECURITIES, CAPITAL STRUCTURE AND TRANSFER
AGENT AND REGISTRAR 6.1 MARKET FOR SECURITIES
Gaz Métro’s units have been listed on the Toronto Stock Exchange since February 1st, 1993 under the symbol "GZM.UN". The following table shows the price ranges and the number of units traded for each month of the 2008 fiscal year:
GZM.UN/TSX
High ($)
Low ($)
Close ($)
Volume (units)
October 07 16.16 15.47 16.00 890,935 November 07 16.40 14.31 14.75 897,924 December 07 16.34 13.77 16.34 1,539,665 January 08 16.30 14.50 15.54 881,377 February 08 16.07 15.26 15.80 585,973 March 08 16.18 15.31 15.56 478,133 April 08 15.56 14.35 15.00 840,290 May 08 16.20 14.90 16.11 827,948 June 08 16.30 15.00 15.19 574,807 July 08 15.45 14.38 14.95 541,844 August 08 16.19 14.66 16.05 656,410 September 08 16.10 14.28 14.60 686,498
6.2 COMPARATIVE RETURN GRAPHS
The following graph compares the total cumulative return on a $100 investment in units of Gaz Métro to the total cumulative return of the S&P/TSX composite index of the Toronto Stock Exchange from September 30, 1998 to September 30, 2008:
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Given the limited partnership status of Gaz Métro and the fact that it pays virtually all of its
income to its Partners in every fiscal year, the financial markets consider Gaz Métro’s units to be more like income securities than common shares. Therefore, it is not very meaningful to compare the return on Gaz Métro's units to the total return of the Toronto Stock Exchange's capped utilities index.
For information purposes, the following graph shows the evolution of the yield on 5-year Canada bonds and the return on Gaz Métro’s units since September 30, 1998. The return is calculated by dividing the annual distribution by the market value of Gaz Métro's units on September 30 of each year.
6.3 CAPITAL STRUCTURE Gaz Métro can issue an unlimited number of units. On September 30, 2008, there were 120,452,214 units issued and outstanding. Gaz Métro has reserved 1,000,000 units for a unit option plan for executives named by the Board of Directors of GMi. On September 30, 2008, 77,297 options (allowing the purchase of a total of 37,363 units) were issued and outstanding. Such option plan will be terminated on December 31, 2008, and the unexercised options as at such date will be void. The Board of Directors does not intend to issue new options before the termination of such option plan.
Unless expressly provided to the contrary by the Limited Partnership Agreement, each unit
0 $
$50
$100
$150
$200
$250
$300
$350
$400
sept-98 sept-99 sept-00 sept-01 sept-02 sept-03 sept-04 sept-05 sept-06 sept-07 sept-08
Gaz Métro S&P/TSX
0 %
1%
2%
3%
4%
5%
6%
7%
8%
9%
sept-98 sept-99 sept-00 sept-01 sept-02 sept-03 sept-04 sept-05 sept-06 sept-07 sept-08
Gaz Métro 5-yr Canada Bonds
Gaz Métro S&P/TSX
Sept. 98 $100.00 $100.00 Sept. 99 $104.17 $125.86 Sept. 00 $103.85 $190.06 Sept. 01 $117.82 $126.98 Sept. 02 $140.02 $116.81 Sept. 03 $168.32 $143.04 Sept. 04 $185.96 $169.96 Sept. 05 $211.51 $219.90 Sept. 06 $177.44 $240.37 Sept. 07 $174.14 $295.35 Sept. 08 $171.89 $253.08
Distribution Yield 5-year Gaz Métro Canada Bonds
Sept. 98 7.31% 4.78% Sept. 99 7.29% 5.62% Sept. 00 7.95% 5.76% Sept. 01 7.83% 4.65% Sept. 02 7.07% 4.14% Sept. 03 6.71% 3.78% Sept. 04 6.46% 4.03% Sept. 05 6.04% 3.63% Sept. 06 7.05% 3.90% Sept. 07 7.74% 4.21% Sept. 08 8.49% 3.16%
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issued and outstanding ranks equally with any other unit in all respects and is entitled to the same rights, privileges and obligations, including the right to receive income distributable by Gaz Métro. No unit has any preference, privilege or right whatsoever that ranks ahead of any other unit. Each unit entitles a holder to vote on any act or decision that has to be approved by the unitholders under the terms of the Limited Partnership Agreement.
In the event of the dissolution of Gaz Métro, its net assets would be distributed to the
unitholders on a prorata basis of their respective units at the date fixed for that purpose. 6.4 TRANSFER AGENT AND REGISTRAR
CIBC Mellon Trust Company is the transfer agent and registrar for the units of Gaz Métro. The main transfer register is maintained in Montreal, Quebec, Canada.
ITEM 7 - DIRECTORS AND OFFICERS
As indicated under Item 1 Incorporation, Gaz Métro’s activities are managed by its General Partner, GMi. Gaz Métro pays the costs and the compensation related to the Board of Directors and management of GMi. For additional information, reference is made to Item 7 Directors and Officers, Item 8.1 Compensation of Directors of GMi and Item 8.2 Statement of Executive Compensation in GMi’s Annual Information Form dated December 10, 2008. The text of such Items is expressly incorporated herein by reference and is an integral part of this Annual Information Form.
ITEM 8 - ADDITIONAL INFORMATION 8.1 GOVERNANCE INFORMATION
As indicated under Item 1 Incorporation, Gaz Métro's activities are managed by its General Partner, GMi. Information about the governance practices of GMi is provided under Item 8.4.1 Governance Information in GMi’s Annual Information Form dated December 10, 2008. The text of such Item is expressly incorporated herein by reference and is an integral part of this Annual Information Form.
8.2 AUDIT COMMITTEE INFORMATION
As indicated under Item 1 Incorporation, Gaz Métro's activities are managed by its General Partner, GMi. For information about the Audit Committee of the Board of Directors of GMi, including the fees paid to the external auditors, refer to Item 8.4.2 Audit Committee Information in the Annual Information Form of GMi dated December 10, 2008. The text of such Item is expressly incorporated herein by reference and is an integral part of this Annual Information Form.
8.3 INTERESTS OF EXPERTS
Raymond Chabot Grant Thornton LLP, Chartered Accountants, act as independent auditors for Gaz Métro and GMi in accordance with the auditor's rules of professional conduct in Quebec, and consequently signed the auditors’ report on the annual financial statements of Gaz Métro and of GMi for the fiscal year ended on September 30, 2008.
During the 2008 fiscal year, Towers Perrin inc. provided consulting services with respect to executive compensation. During that period, neither Towers Perrin inc. nor its designated professionals owned, directly or indirectly, 1% or more of the issued and outstanding units of Gaz Métro.
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8.4 MATERIAL CONTRACTS
The following is a list of material contracts entered into by Gaz Métro during the 2008 fiscal year or previously and which are still in force: 8.4.1 Financial Contracts
On July 15, 1982, GMi entered into a trust indenture with La Compagnie de Fiducie, Canada Permanent (replaced by Montréal Trust Company of Canada, to which Computershare Trust Company of Canada succeeded as trustee, effective on June 30, 2000), as trustee, which was amended and restated pursuant to the Trust Deed of Hypothec, Mortgage and Pledge bearing formal date of August 12, 1991 entered into between GMi, Montréal Trust Company of Canada, as trustee (to which Computershare Trust Company of Canada succeeded as trustee, effective on June 30, 2000), and Gaz Métro, as guarantor, as further amended and supplemented by twenty supplemental trust deeds. Such Trust Deed governs the issuance of mortgage bonds by GMi and sets forth the first mortgage bondholders’ rights;
On August 12, 1991, Gaz Métro entered into a Trust Deed of Hypothec, Mortgage and Pledge
with Montréal Trust Company of Canada, as trustee (to which Computershare Trust Company of Canada succeeded as trustee, effective on June 30, 2000), as amended and supplemented by eighteen supplemental trust deeds. Such Trust Deed governs the issuance of mortgage bonds by Gaz Métro and sets forth the mortgage bondholders’ rights. It also provides for the creation of the universal hypothec on all of Gaz Métro’s assets in favour of holders of GMi’s first mortgage bonds issued under the Trust Deed described in the previous paragraph, the whole as security for Gaz Métro’s corporate guarantee pursuant to GMi’s Trust Deed.
On December 21, 2004, GMi entered into a credit agreement with Bank of Montreal,
guaranteed by Gaz Métro, as more fully described under Item 3.7 Financial management.
On April 10, 2007, Gaz Métro entered into a bridge-loan agreement with Bank of Montreal, guaranteed by GMi, as more fully described under Item 3.7 Financial management.
On October 8, 2008, GMi and Gaz Métro entered into a selling agency agreement with an underwriting syndicate led by BMO Nesbitt Burns Inc. whereby, on October 14, 2008, the underwriters subscribed for $150.0 million of Series L 5.40% first mortgage bonds maturing on April 15, 2013.
8.4.2 Operating Contracts
8.4.2.1 Transportation Contracts with TCPL
Gaz Métro and TCPL have entered into 13 transportation contracts. The first one was signed on October 31, 1988. The contract which first comes to maturity will expire on October 31, 2009, and the last one to come to maturity will expire on October 31, 2017. Under these contracts, TCPL must transport natural gas to Gaz Métro’s natural gas distribution system based on TCPL’s tolls, as approved or modified from time to time by the NEB.
Gaz Métro and TCPL have also entered into four transportation service contracts. The first one was signed on April 16, 1985. The contract which first comes to maturity will expire on April 15, 2009, and the last one to come to maturity will expire on October 31, 2015. Under these contracts, TCPL must transport natural gas to Gaz Métro’s natural gas
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distribution system from November 1st to April 15 inclusively of each year, based on TCPL’s tolls as approved or modified from time to time by the NEB.
8.4.2.2 Storage and Transportation Contracts with UG
Gaz Métro and UG have entered into four storage contracts. The first one was signed
on June 1st, 2000. The contract which first comes to maturity will expire on March 31, 2009, and the last one to come to maturity will expire on March 31, 2011. Under these contracts, UG must store natural gas for Gaz Métro based on UG’s Tariffs C1 or M12 (or a replacement tariff), depending on the circumstances, as approved or modified from time to time by the Ontario Energy Board.
Gaz Métro and UG have entered into 11 transportation contracts. The first one was
signed on January 30, 1990. The contract which first comes to maturity will expire on March 31, 2010, and the last one to come to maturity will expire on October 31, 2027. Under these contracts, UG must transport natural gas to Gaz Métro’s distribution system based on UG’s Tariffs C1 or M12 (or a replacement tariff), depending on the circumstances, as approved or modified from time to time by the Ontario Energy Board.
8.4.2.3 Storage Contract with Intragas, Limited Partnership On May 23, 2008, Gaz Métro and Intragas, Limited Partnership entered into a natural gas storage contract covering the period from May 1st, 2006 to April 30, 2011 based on Intragas, Limited Partnership’s Tariff E-4, as approved or modified from time to time by the Régie. On October 30, 1992, Gaz Métro and SOQUIP entered into a storage contract covering the period from April 21, 1998 to April 20, 2013. SOQUIP assigned the contract to Stogaz, Limited Partnership, which later assigned it to Intragas, Limited Partnership. The contract is based on Intragas, Limited Partnership’s Tariff E-2, as approved or modified from time to time by the Régie.
8.5 COMPLAINTS OR CONCERNS
Gaz Métro’s Policy respecting Quality of Financial Information states that any person wanting to make a complaint about accounting, internal accounting controls or the audit of Gaz Métro or GMi should send it to the Chief Internal Auditor as follows:
By mail: Gaz Métro
1717, rue du Havre Montréal (Quebec) H2K 2X3
By telephone: 1-866-598-3220
By email: [email protected]
The Chairman of the Audit Committee shall be promptly informed of each complaint. Similarly, any concern of an employee of Gaz Métro or one of its subsidiaries or affiliates
about questionable accounting or auditing matters may be sent anonymously or otherwise, as the employee wishes, to the Chief Internal Auditor, as indicated above, or to the Chairman of the Audit Committee, Réal Sureau, as follows:
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By mail : Gaz Métro 1717, rue du Havre Montréal (Quebec) H2K 2X3 By telephone: (514) 598-3400 By email: [email protected]
If the concern has been communicated to the Chief Internal Auditor, he shall promptly inform the Chairman of the Audit Committee thereof.
8.6 RISKS
This section describes the principal risks that could have a significant impact on the activities, financial situation and consolidated income of Gaz Métro. Other risks not presently known to Gaz Métro or that it currently believes to be immaterial, may also adversely affect its activities. This section also describes certain risk identification, evaluation and management practices that Gaz Métro has developed to mitigate such risks.
REGULATORY RISK
Decisions rendered by regulatory bodies, and in particular those rendered by the Régie and the NEB, in Canada, and by the VPSB and the FERC, in the United States, with respect, among other things, to the distribution and transportation rates and the authorized rate of return on deemed equity related to natural gas and electricity distribution and transportation activities, may have a significant impact on the financial results of Gaz Métro. Approximately 95 % of Gaz Métro’s consolidated revenues for its 2008 fiscal year are generated by activities that are regulated and subject to such decisions.
The rates are established by such regulatory bodies, usually on an annual basis, based on projections provided by Gaz Métro and its subsidiaries and joint ventures, as applicable. Any discrepancy between projections and actual data, in particular in regard to deliveries for a given year, could, depending on its nature, have a positive or negative effect on Gaz Métro’s income for that particular year. Furthermore, if economic or energy conditions become such that a performance incentive mechanism or any other methodology used to establish the rates or any of its components is no longer appropriate, this could also have an impact on Gaz Métro’s profitability. Therefore, Gaz Métro is very vigilant with respect to regulatory risk and attaches great importance to maintaining good relations with the various regulatory bodies and intervenors recognized by such bodies.
Starting on October 1st, 2011, Gaz Métro will have to present its financial statements according to the International Financing Reporting Standards (IFRS) as a result of the February 2008 announcement by Canada’s Accounting Standards Board (AcSB).
Contrary to generally accepted accounting principles (GAAP) currently in effect, the concept of rate-regulated activities does not exist under IFRS. Recovery of costs incurred through future rate increases is not a valid criterion for recognizing an asset according to IFRS. The implementation of such rules would have a significant impact for Gaz Métro in regard to the use of certain deferred charges and credits accounts. In addition, on the date of such transition, certain regulatory assets or liabilities may have to be written off, which would impact results as well as the balance sheet for the financial year affected by the transition.
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Finally, Gaz Métro, its subsidiaries and its joint ventures may have to modify certain aspects of the regulatory framework already approved by the relevant regulatory bodies to comply with IFRS standards, in order to limit their impact on Gaz Métro’s income by, among other things, readjusting proposed rates.
RISKS RELATED TO ECONOMIC CONDITIONS Economy
Gaz Métro’s activities are affected by general economic conditions. Poor economic conditions will have a negative impact on the activities of Gaz Métro’s industrial and commercial customers, and therefore on the demand for natural gas or electricity. For a number of years, Gaz Métro has pursued its efforts to increase natural gas’ market shares in the residential market where margins are higher, thereby reducing its vulnerability to the industrial and commercial markets. The increase in the number of customers in the residential market, which is closely related to the number of new housing starts and the price of natural gas, is however also subject to general economic conditions.
In Quebec, a significant reduction in natural gas demand at a time when it is difficult to significantly reduce Gaz Métro’s expenses related to the distribution of natural gas would push distribution rates up and could therefore adversely affect Gaz Métro’s ability to compete with other energy sources.
COMPETITION In Quebec
Natural gas competes with other available energy sources such as fuel oil and electricity. Therefore, Gaz Métro’s ability to achieve sound financial results is dependent, among other things, on the competitiveness of natural gas in relation to other available energy sources.
The price of electricity in the residential market is low. Therefore, electricity has the largest market share of this sector in Quebec. Considering the position of electricity in Quebec and in spite of the successive increases in electricity rates since 2004, natural gas must continuously face strong competition from electricity in the residential market, a situation largely due to the fluctuation in the price of natural gas as a commodity, which must be sold to Gaz Métro’s customers at cost. However, the use of more efficient equipment reduces the cost differential between the two energy sources. Furthermore, when the price of No. 2 fuel oil is substantially higher than that of natural gas as a commodity, the competitiveness of natural gas is generally favourable compared to fuel oil in the residential market.
In the commercial market, the competitiveness of natural gas is generally favourable compared to electricity. Furthermore, when the price of No. 2 fuel oil is substantially higher than that of natural gas as a commodity, the competitiveness of natural gas is generally favourable in this market.
In the industrial market, the competitiveness of natural gas may be subject to large fluctuations, since it is closely related to fluctuations in the price of natural gas compared with heavy fuel oil. Most customers in this market can use more than one energy source to cover their energy needs. The low rate charged to these customers, on a volume basis, makes Gaz Métro less vulnerable to such fluctuations. Furthermore, Gaz Métro has a rate that allows it to sell its distribution service based on the price of heavy fuel oil for periods that may last a few days to almost a year.
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Furthermore, the Quebec government’s announcement, on October 1st, 2007, of a major plan whereby industrial businesses would have access to a financing program to purchase more efficient equipment or convert to more environmentally friendly energy sources than heavy fuel oil might encourage the use of natural gas as an energy source.
Additionally, since the implementation, on December 14, 2007, of the Regulation respecting the annual duty payable to the Green Fund in Quebec, Gaz Métro, like other fuel oil distributors, must pay to the government an annual duty on volumes of natural gas distributed. Since the amount of such duty is billed to Gaz Métro’s customers, the obligation to pay it has a negative impact on natural gas’ competitiveness compared to electricity, which is not subject to such duty, but a positive impact compared to fuel oil, which is subject to a generally higher duty.
In Vermont, United States
Natural gas generally enjoys a substantial competitive advantage when compared with other energy sources in the residential, commercial and industrial air and water heating markets. Electricity is almost exclusively used for lighting and as a drive force and is therefore not subject to any significant actual competition.
OPERATIONAL RISKS Energy Supply
Gaz Métro and VGS depend on various suppliers, carriers and storage operators for their natural gas supply, which comes primarily from Western Canada. The failure of one of these parties to deliver natural gas or provide related services, as well as a major disruption in the supply chain with no possible recourse to alternative supply sources, could have a negative impact on Gaz Métro and its ability, or VGS’s ability, to distribute natural gas to its customers.
To meet its energy needs, Green Mountain Power depends on various supply contracts. There is no guaranty that those contracts will be renewed upon expiry or on favourable terms and conditions. If those contracts were not renewed upon expiry, and if Green Mountain Power could not have access to alternative energy sources, its ability to respond to customer demand might be hindered, which could have a negative impact on Gaz Métro’s income. While the electricity supply contracts still have a number of years to run, discussions have already been undertaken to ensure access to various reliable supply sources at a good price.
Continuity of Activities
Ensuring that distribution activities are not interrupted depends on Gaz Métro’s ability to protect the distribution systems and equipment as well as the information stored in data centres from damage due to fire, natural disasters, power outages, break-ins, computer viruses, acts of war or terrorism and other similar situations. Any one of these events could interrupt service temporarily, with repercussions on customers and operating results.
Gaz Métro has adopted reasonable measures to minimize such risk. Gaz Métro has very strict policies with respect to safeguarding assets and information, which it follows rigorously. Furthermore, it encourages its contractors to adopt industry’s best practices in order to minimize the risk of incidents.
Gaz Métro has also implemented an emergency measures management system which applies in the case of natural or technological events or events resulting from human intervention.
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Gaz Métro also carries insurance coverages with reputable insurers for amounts that are considered sufficient given the nature of its activities and size.
Environment, Health and Safety
Gaz Métro’s activities and facilities are subject to extensive environmental laws and regulations that govern, among other things, emission of contaminants, transportation and storage of hazardous material, waste disposal and decontamination of contaminated sites. To continue its operations, Gaz Métro must maintain in effect several environmental authorizations or other permits issued by competent authorities. Any breach of these obligations could result in fines or other sanctions.
The transportation, storage and distribution of natural gas also present potential collateral risks for the environment, health and safety, such as leaks or explosions. Such risks could result in severe injuries or casualties, significant property damage or pollution, which could lead to significant losses for Gaz Métro.
Gaz Métro places a high degree of importance on environmental matters and on the health and safety of its employees, its business partners, its customers and the community. Therefore, it created a health and safety department. It also implemented an environmental management system (that is subject to an annual external audit), registered since 2000 under the ISO 14001 international standard, which is recognized for its strict requirements that provide for a rigorous environmental management of the registered company’s activities. This environmental management system aims at ensuring that Gaz Métro’s activities continuously comply with the applicable environmental regulations. To this end, the system monitors, among other things, the environmental impact of Gaz Métro’s activities and provides a procedure relating to environmental emergencies.
Human Resources
Gaz Métro’s personnel is composed of unionized and non-unionized employees. If Gaz Métro is not in a position to negotiate the renewal of collective agreements upon expiry, this could result in labour disputes or work stoppages, which in turn could have a negative impact on Gaz Métro’s current activities. Gaz Métro has stable relationships with its various unions and their representatives.
The key to Gaz Métro’s success lies partly in the specialized skills and knowledge required for operating and maintaining the natural gas or electricity distribution system. Such skills are currently available; however, to protect itself from the risk of a future shortage in such specialized trades, Gaz Métro and some of its subsidiaries and joint ventures have developed a succession plan to ensure the transfer of skills as their employees retire.
Business Partners
For certain projects, Gaz Métro or its subsidiaries or joint ventures, as applicable, enter into joint venture agreements with various partners. The success of these projects rests largely on the satisfactory performance of obligations by Gaz Métro or such subsidiaries or joint ventures, on the one hand, and by these partners, on the other hand. The failure of one of the partners to perform its obligations could impose on Gaz Métro or such subsidiaries or joint ventures additional financial and performance obligations, which could result in higher costs.
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Loss of an Important Customer
In the natural gas transportation sector, Gaz Métro’s subsidiaries and joint ventures, as applicable, depend on a limited number of customers. The failure of one of these customers to perform its obligations could have a negative impact on Gaz Métro’s financial condition or income.
MARKET RISKS Exchange Rate Fluctuations
Part of Gaz Métro’s net income from the distribution and transportation sectors is generated in U.S. dollar. Gaz Métro’s operating results are therefore affected by the fluctuation of the U.S. dollar in relation to the Canadian dollar. Any significant depreciation of the U.S. dollar in relation to the Canadian dollar has a negative impact on Gaz Métro’s results and on the value of its investments.
Interest Rates Fluctuations
Gaz Métro is exposed to the risk of interest rates fluctuations. Gaz Métro manages such risk mainly through an interest rate setting policy allowing it to maintain a significant portion of its long-term debt at a fixed rate.
However, Gaz Métro is exposed to the risk of interest rates on its floating-rate bank borrowings and the floating-rate portion of its long-term debt. Some of the subsidiaries and joint ventures of Gaz Métro use interest rate swaps to fix interest rates on a portion of floating-rate borrowings.
Cost of Energy
In Quebec, Gaz Métro’s customers are exposed to the risk of fluctuations in the price of natural gas as a commodity, which Gaz Métro must sell to them at cost. Gaz Métro uses natural gas related derivative financial instruments to manage its customers’ exposure to natural gas price volatility. All natural gas price fluctuations, including gains and losses on derivative financial instruments, are recorded in deferred charges or credits accounts in order to be included in future rates, as required by the Régie.
In Vermont, VGS and Green Mountain Power also use natural gas and electricity related derivative financial instruments, respectively, to manage their customers’ exposure to price volatility for these types of energy. In addition, VGS and Green Mountain Power benefit from an adjustment mechanism that minimizes risks related to fluctuation in the prices of these types of energy.
LIQUIDITY AND FINANCING RISKS
To satisfy its financial needs, Gaz Métro relies, among other things, on cash generated by its activities. The liquidity risk is the risk that Gaz Métro would be unable to perform its financial obligations as they become due. Gaz Métro manages the liquidity risk by forecasting its cash flows in order to determine its financing needs and by ensuring that it has sufficient cash and credit facilities to fulfil its needs and to perform its financial obligations as they become due. Therefore, Gaz Métro, directly or through GMi, uses a combination of committed and demand credit facilities as well as access to financial markets to meet this goal. However, any significant reduction in Gaz Métro’s or GMi’s ability to access financial markets, by reason of, for example, a significant change in economic conditions, the general condition of financial markets, a negative perception by financial markets of Gaz Métro’s or GMi’s financial situation or outlook, or a significant downgrade of Gaz Métro’s credit
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or stability ratings or GMi’s credit ratings, could have a negative impact on the activities, the financial condition or the income of Gaz Métro.
INVESTMENT RISKS Financing of Investments in Companies
Gaz Métro provides to its subsidiaries and joint ventures a portion of the capital needed for their development. If it were to discontinue this financing, and such subsidiaries or joint ventures did not have alternative financing, it could have a negative impact on the value of investments in these entities and, therefore, on Gaz Métro’s results.
Value of Investments
The value of certain investments in subsidiaries and joint ventures could deteriorate if they are unable to generate sufficient earnings to justify the amounts invested. Persistent difficult economic conditions or an unfavourable competitive situation may force Gaz Métro to write down certain investments, which could have a negative impact on its results.
CREDIT RISK
Counterparty credit risk represents the risk that a counterparty to a derivative financial instrument entered into with Gaz Métro or one of its subsidiaries or joint ventures does not perform its obligations pursuant to the agreements entered into with it and that such situation results in a financial loss for Gaz Métro or such subsidiary or joint venture. This risk is mitigated by using credit risk management techniques that provide for an assessment of a counterparty’s creditworthiness and the monitoring of its evolution, entering into agreements with several counterparties, setting risk limits, monitoring risk related to such limits, establishing credit support agreements and obtaining financial guarantees where warranted. Gaz Métro closely monitors and manages counterparty credit risk concentration.
Customer credit risk represents the risk that a customer of Gaz Métro or one of its subsidiaries or joint ventures fails to pay the amount it owes and that such situation results in a financial loss for Gaz Métro or such subsidiary or joint venture. This risk is mitigated through the use of various means, including security deposits from customers, as authorized by regulatory bodies.
8.7 OTHER INFORMATION
Additional financial and related information are provided in the audited financial statements and Management's Discussion and Analysis of Gaz Métro for the 2008 fiscal year. Copies of Gaz Métro’s Management’s Discussion and Analysis for 2008, the 2008 audited financial statements and any other public document issued by Gaz Métro or GMi (including the annual information forms and any other documents expressly incorporated therein by reference and, when Gaz Métro or GMi makes an offering under a short form prospectus, the short form prospectus and a copy of the documents incorporated therein by reference) may be obtained from the Investor Relations Service, Gaz Métro, 1717 du Havre, Montreal, Quebec H2K 2X3, by telephone: 514-598-3039, by fax: 514-521-8168 and by email: [email protected] or by consulting the Website: www.gazmetro.com. These documents are also available on SEDAR’s Website at www.sedar.com.
