Note 1 - Summary of Signif+icant Accounting Policies

 

Principles of Consolidation.  The Company consolidates all entities in which it has a controlling financial interest.  The equity method is used to account for entities in which the Company has a non-controlling financial interest.  All significant intercompany balances and transactions are eliminated.

 

            During the quarter ended March 31, 2011, the Company sold its 50% equity method investments in Seneca Energy and Model City for $59.4 million, resulting in a gain of $50.9 million.  Seneca Energy and Model City generate and sell electricity using methane gas obtained from landfills owned by outside parties.

 

            The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

 

Reclassification.  Certain prior year amounts have been reclassified to conform with current year presentation.  This includes the reclassification of $63.7 million from Other Regulatory Liabilities to Other Regulatory Assets on the Consolidated Balance Sheet at September 30, 2011.  This reclassification pertains to pension and post-retirement benefit regulatory asset and regulatory liability balances.  The Company has switched from a “gross” presentation to a “net” presentation, which is consistent with the methodology used by the various regulators in analyzing such regulatory asset and liability balances.  This reclassification did not impact the Consolidated Statement of Income.  In the March 31, 2011 Consolidated Statement of Cash Flows, the change in Other Liabilities was increased by $0.5 million and the change in Other Assets was reduced by $0.5 million.

 

Earnings for Interim Periods.  The Company, in its opinion, has included all adjustments that are necessary for a fair statement of the results of operations for the reported periods. The consolidated financial statements and notes thereto, included herein, should be read in conjunction with the financial statements and notes for the years ended September 30, 2011, 2010 and 2009 that are included in the Company's 2011 Form 10-K.  The consolidated financial statements for the year ended September 30, 2012 will be audited by the Company's independent registered public accounting firm after the end of the fiscal year.

 

            The earnings for the six months ended March 31, 2012 should not be taken as a prediction of earnings for the entire fiscal year ending September 30, 2012.  Most of the business of the Utility and Energy Marketing segments is seasonal in nature and is influenced by weather conditions.  Due to the seasonal nature of the heating business in the Utility and Energy Marketing segments, earnings during the winter months normally represent a substantial part of the earnings that those segments are expected to achieve for the entire fiscal year.  The Company’s business segments are discussed more fully in Note 7 – Business Segment Information.

 

Consolidated Statement of Cash Flows.  For purposes of the Consolidated Statement of Cash Flows, the Company considers all highly liquid debt instruments purchased with a maturity of generally three months or less to be cash equivalents. 

 

At March 31, 2012, the Company accrued $93.6 million of capital expenditures in the Exploration and Production segment, the majority of which was in the Appalachian region.  The Company also accrued $12.9 million of capital expenditures in the Pipeline and Storage segment and $7.9 million of capital expenditures in the All Other category at March 31, 2012.  These amounts were excluded from the Consolidated Statement of Cash Flows at March 31, 2012 since they represent non-cash investing activities at that date.  Accrued capital expenditures at March 31, 2012 are included in Other Accruals and Current Liabilities on the Consolidated Balance Sheet.

 

At September 30, 2011, the Company accrued $63.5 million of capital expenditures in the Exploration and Production segment, the majority of which was in the Appalachian region. The Company also accrued $7.3 million of capital expenditures in the Pipeline and Storage segment.  In addition, the Company accrued $1.4 million of capital expenditures in the All Other category.  These amounts were excluded from the Consolidated Statement of Cash Flows at September 30, 2011 since they represented non-cash investing activities at that date.  These capital expenditures were paid during the quarter ended December 31, 2011 and have been included in the Consolidated Statement of Cash Flows for the six months ended March 31, 2012.  Accrued capital expenditures at September 30, 2011 are included in Other Accruals and Current Liabilities on the Consolidated Balance Sheet.

 

At March 31, 2011, the Company accrued $43.9 million of capital expenditures in the Exploration and Production segment, the majority of which was in the Appalachian region.  The Company also accrued $2.0 million of capital expenditures in the Pipeline and Storage segment at March 31, 2011.  These amounts were excluded from the Consolidated Statement of Cash Flows at March 31, 2011 since they represented non-cash investing activities at that date. 

 

At September 30, 2010, the Company accrued $55.5 million of capital expenditures in the Exploration and Production segment, the majority of which was in the Appalachian region. This amount was excluded from the Consolidated Statement of Cash Flows at September 30, 2010 since it represented a non-cash investing activity at that date. These capital expenditures were paid during the quarter ended December 31, 2010 and have been included in the Consolidated Statement of Cash Flows for the six months ended March 31, 2011. 

 

Hedging Collateral Deposits.  This is an account title for cash held in margin accounts funded by the Company to serve as collateral for hedging positions.  At March 31, 2012, the Company had hedging collateral deposits of $10.1 million related to its exchange-traded futures contracts and $8.8 million related to its over-the-counter crude oil swap agreements.  At September 30, 2011, the Company had hedging collateral deposits of $5.5 million related to its exchange-traded futures contracts and $14.2 million related to its over-the-counter crude oil swap agreements.  In accordance with its accounting policy, the Company does not offset hedging collateral deposits paid or received against related derivative financial instruments liability or asset balances.

 

Gas Stored Underground - Current.  In the Utility segment, gas stored underground – current is carried at lower of cost or market, on a LIFO method.  Gas stored underground – current normally declines during the first and second quarters of the year and is replenished during the third and fourth quarters.  In the Utility segment, the current cost of replacing gas withdrawn from storage is recorded in the Consolidated Statements of Income and a reserve for gas replacement is recorded in the Consolidated Balance Sheets under the caption “Other Accruals and Current Liabilities.”  Such reserve, which amounted to $52.1 million at March 31, 2012, is reduced to zero by September 30 of each year as the inventory is replenished.

 

Property, Plant and Equipment.  In the Company’s Exploration and Production segment, oil and gas property acquisition, exploration and development costs are capitalized under the full cost method of accounting. Under this methodology, all costs associated with property acquisition, exploration and development activities are capitalized, including internal costs directly identified with acquisition, exploration and development activities. The internal costs that are capitalized do not include any costs related to production, general corporate overhead, or similar activities. The Company does not recognize any gain or loss on the sale or other disposition of oil and gas properties unless the gain or loss would significantly alter the relationship between capitalized costs and proved reserves of oil and gas attributable to a cost center.

 

Capitalized costs include costs related to unproved properties, which are excluded from amortization until proved reserves are found or it is determined that the unproved properties are impaired.  Such costs amounted to $275.2 million and $226.3 million at March 31, 2012 and September 30, 2011, respectively.  All costs related to unproved properties are reviewed quarterly to determine if impairment has occurred. The amount of any impairment is transferred to the pool of capitalized costs being amortized.

 

Capitalized costs are subject to the SEC full cost ceiling test. The ceiling test, which is performed each quarter, determines a limit, or ceiling, on the amount of property acquisition, exploration and development costs that can be capitalized. The ceiling under this test represents (a) the present value of estimated future net cash flows, excluding future cash outflows associated with settling asset retirement obligations that have been accrued on the balance sheet, using a discount factor of 10%, which is computed by applying prices of oil and gas (as adjusted for hedging) to estimated future production of proved oil and gas reserves as of the date of the latest balance sheet, less estimated future expenditures, plus (b) the cost of unevaluated properties not being depleted, less (c) income tax effects related to the differences between the book and tax basis of the properties. The natural gas and oil prices used to calculate the full cost ceiling are based on an unweighted arithmetic average of the first day of the month oil and gas prices for each month within the twelve-month period prior to the end of the reporting period. If capitalized costs, net of accumulated depreciation, depletion and amortization and related deferred income taxes, exceed the ceiling at the end of any quarter, a permanent impairment is required to be charged to earnings in that quarter.  At March 31, 2012, the ceiling exceeded the book value of the oil and gas properties by approximately $279.6 million.

 

Accumulated Other Comprehensive Loss.  The components of Accumulated Other Comprehensive Loss, net of related tax effect, are as follows (in thousands):

 

		At March 31, 2012		At September 30, 2011
Funded Status of the Pension and        Other Post-Retirement Benefit Plans		$(89,587)		$(89,587)
Net Unrealized Gain on Derivative                Financial Instruments		34,385		40,979
Net Unrealized Gain on Securities     Available for Sale		3,313		909
Accumulated Other Comprehensive      Loss		$(51,889)		$(47,699)

 

Other Current Assets.  The components of the Company’s Other Current Assets are as follows (in thousands):

 

	At March 31, 2012		At September 30, 2011
Prepayments	$3,246		$9,489
Prepaid Property and Other Taxes	20,760		13,240
Federal Income Taxes Receivable	390		385
State Income Taxes Receivable	1,955		6,124
Fair Values of Firm Commitments	14,003		9,096
	$40,354		$38,334

 

Earnings Per Common Share.  Basic earnings per common share is computed by dividing net income available for common stock by the weighted average number of common shares outstanding for the period. Diluted earnings per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.  For purposes of determining earnings per common share, the only potentially dilutive securities the Company has outstanding are stock options, SARs and restricted stock units.  The diluted weighted average shares outstanding shown on the Consolidated Statements of Income reflects the potential dilution as a result of these securities as determined using the Treasury Stock Method.  Stock options, SARs and restricted stock units that are antidilutive are excluded from the calculation of diluted earnings per common share.  There were 879,847 and 297,081 securities excluded as being antidilutive for the quarter and six months ended March 31, 2012, respectively.  There were 10,959 and 140 securities excluded as being antidilutive for the quarter and six months ended March 31, 2011, respectively. 

 

Stock-Based Compensation.  During the six months ended March 31, 2012, the Company granted 166,000 non-performance based SARs having a weighted average exercise price of $55.09 per share.  The weighted average grant date fair value of these SARs was $11.20 per share.  These SARs will be settled in shares of common stock of the Company and are considered equity awards under the current authoritative guidance for stock-based compensation.  The accounting for those SARs is the same as the accounting for stock options.   There were no SARs granted during the quarter ended March 31, 2012.  The non-performance based SARs granted during the six months ended March 31, 2012 vest annually in one-third increments and become exercisable on the third anniversary of the date of grant.  The weighted average grant date fair value of these non-performance based SARs granted during the six months ended March 31, 2012 was estimated on the date of grant using the same accounting treatment that is applied for stock options.  There were no stock options granted during the quarter or six months ended March 31, 2012. 

 

The Company granted 41,525 restricted share awards (non-vested stock as defined by the current accounting literature) during the six months ended March 31, 2012.  The weighted average fair value of such restricted shares was $55.09 per share. There were no restricted share awards granted during the quarter ended March 31, 2012.  In addition, the Company granted 1,500 and 57,500 restricted stock units during the quarter and six months ended March 31, 2012, respectively. The weighted average fair value of such restricted stock units was $43.84 per share and $48.64 per share for the quarter and six months ended March 31, 2012, respectively. Restricted stock units represent the right to receive shares of common stock of the Company (or the equivalent value in cash or a combination of cash and shares of common stock of the Company, as determined by the Company) at the end of a specified time period. These restricted stock units do not entitle the participant to receive dividends during the vesting period. The accounting for these restricted stock units is the same as the accounting for restricted share awards, except that the fair value at the date of grant of the restricted stock units must be reduced by the present value of forgone dividends over the vesting term of the award.

 

The Company did not fully recognize a tax benefit from excess tax deductions related to stock-based compensation for calendar years 2011 through 2009 due to tax loss carryforwards.  The Company expects to recognize additional tax benefits of $32.6 million as an adjustment to Paid in Capital in future years as the tax loss carryforwards are utilized. 

 

New Authoritative Accounting and Financial Reporting Guidance.  In May 2011, the FASB issued authoritative guidance regarding fair value measurement as a joint project with the IASB.  The objective of the guidance was to bring together as closely as possible the fair value measurement and disclosure guidance issued by the two boards.  The guidance includes a few updates to measurement guidance and some enhanced disclosure requirements.  For all Level 3 fair value measurements, the guidance requires quantitative information about significant unobservable inputs used and a description of the valuation processes in place.  The guidance also requires a qualitative discussion about the sensitivity of recurring Level 3 fair value measurements and information about any transfers between Level 1 and Level 2 of the fair value hierarchy.  The new guidance also contains a requirement that all fair value measurements, whether they are recorded on the balance sheet or disclosed in the footnotes, be classified as Level 1, Level 2 or Level 3 within the fair value hierarchy.  This authoritative guidance became effective for the quarter ended March 31, 2012.  The Company has updated its disclosures to reflect the new requirements in Note 2 – Fair Value Measurements.   

 

In June 2011, the FASB issued authoritative guidance regarding the presentation of comprehensive income.  The new guidance allows companies only two choices for presenting net income and other comprehensive income: in a single continuous statement, or in two separate, but consecutive, statements.  The guidance eliminates the current option to report other comprehensive income and its components in the statement of changes in equity.  This authoritative guidance will be effective as of the Company’s first quarter of fiscal 2013 and is not expected to have a significant impact on the Company’s results of operations. 

 

In September 2011, the FASB issued revised authoritative guidance that simplifies the testing of goodwill for impairment.  The revised guidance allows companies the option to perform a “qualitative” assessment to determine whether further impairment testing is necessary.  The revised authoritative guidance is required to be effective for the Company’s annual impairment test performed in fiscal 2013.  While early adoption is permitted, the Company has not adopted the new provisions to date.

 

In December 2011, the FASB issued authoritative guidance requiring enhanced disclosures regarding offsetting assets and liabilities.  Companies are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement.  This authoritative guidance will be effective as of the Company’s first quarter of fiscal 2014 and is not expected to have a significant impact on the Company’s financial statements.

Note 2 – Fair Value Measurements

 

The FASB authoritative guidance regarding fair value measurements establishes a fair-value hierarchy and prioritizes the inputs used in valuation techniques that measure fair value. Those inputs are prioritized into three levels. Level 1 inputs are unadjusted quoted prices in active markets for assets or liabilities that the Company can access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly at the measurement date. Level 3 inputs are unobservable inputs for the asset or liability at the measurement date. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels.

 

The following table sets forth, by level within the fair value hierarchy, the Company's financial assets and liabilities (as applicable) that were accounted for at fair value on a recurring basis as of March 31, 2012 and September 30, 2011.  Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

Recurring Fair Value Measures	At fair value as of March 31, 2012
(Thousands of Dollars)	Level 1	Level 2	Level 3	Total
Assets:
Cash Equivalents – Money Market Mutual Funds	$ 162,382	$            -	$             -	$  162,382
Derivative Financial Instruments:
Commodity Futures Contracts – Gas	576	-	-	576
Over the Counter Swaps – Gas	-	121,184	-	121,184
Other Investments:
Balanced Equity Mutual Fund	24,234	-	-	24,234
Common Stock – Financial Services Industry	5,355	-	-	5,355
Other Common Stock	293	-	-	293
Hedging Collateral Deposits	18,872	-	-	18,872
Total	$211,712	$   121,184	$            -	$ 332,896
Liabilities:
Derivative Financial Instruments:
Commodity Futures Contracts – Gas	$    6,690	$             -	$              -	$      6,690
Over the Counter Swaps – Oil	-	-	68,754	68,754
Over the Counter Swaps – Gas	-	(8,557)	-	(8,557)
Total	$    6,690	$     (8,557)	$    68,754	$    66,887
Total Net Assets/(Liabilities)	$205,022	$   129,741	$  (68,754)	$  266,009

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Recurring Fair Value Measures		At fair value as of September 30, 2011
(Thousands of Dollars)	Level 1		Level 2	Level 3	Total
Assets:
Cash Equivalents – Money Market Mutual Funds	$ 32,444		$             -	$             -	$  32,444
Derivative Financial Instruments:
Over the Counter Swaps – Gas	-		75,113	-	75,113
Over the Counter Swaps – Oil	-		-	972	972
Other Investments:
Balanced Equity Mutual Fund	19,882		-	-	19,882
Common Stock – Financial Services Industry	4,478		-	-	4,478
Other Common Stock	226		-	-	226
Hedging Collateral Deposits	19,701		-	-	19,701
Total	$76,731		$    75,113	$         972	$ 152,816
Liabilities:
Derivative Financial Instruments:
Commodity Futures Contracts – Gas	$    3,292		$             -	$              -	$       3,292
Over the Counter Swaps – Oil	-		-	6,382	6,382
Total	$    3,292		$             -	$      6,382	$       9,674
Total Net Assets/(Liabilities)	$  73,439		$   75,113	$    (5,410)	$   143,142

 

Derivative Financial Instruments

 

At March 31, 2012, the derivative financial instruments reported in Level 1 consist of natural gas NYMEX futures contracts used in the Company’s Energy Marketing and Pipeline and Storage segments (at September 30, 2011, the derivative financial instruments reported in Level 1 consist of NYMEX futures used in the Company’s Energy Marketing segment). Hedging collateral deposits of $10.1 million (at March 31, 2012) and $5.5 million (at September 30, 2011), which are associated with these futures contracts have been reported in Level 1 as well. The derivative financial instruments reported in Level 2 at March 31, 2012 and September 30, 2011 consist of natural gas price swap agreements used in the Company’s Exploration and Production and Energy Marketing segments. The fair value of the Level 2 price swap agreements is based on an internal, discounted cash flow model that uses observable inputs (i.e. LIBOR based discount rates and basis differential information, if applicable, at active natural gas and crude oil trading markets). The derivative financial instruments reported in Level 3 consist of all of the Company’s Exploration and Production segment’s crude oil price swap agreements at March 31, 2012 and September 30, 2011.  Hedging collateral deposits of $8.8 million and $14.2 million associated with these crude oil price swap agreements have been reported in Level 1 at March 31, 2012 and September 30, 2011, respectively. The fair value of the Level 3 crude oil price swap agreements is based on an internal, discounted cash flow model that uses both observable (i.e. LIBOR based discount rates) and unobservable inputs (i.e. basis differential information of crude oil trading markets with low trading volume).  The significant unobservable input used in the fair value measurement of the over-the-counter crude oil swaps is the basis differential between Midway Sunset oil and NYMEX contracts.  Significant changes in the assumed basis differential could result in a significant change in value of the derivative financial instrument.  At March 31, 2012, it was assumed that Midway Sunset oil was 110.3% of NYMEX.  This is based on a historical twelve month average of Midway Sunset oil sales verses NYMEX settlements.  During this twelve month period, the price of Midway Sunset oil ranged from 104.5% to 125.0% of NYMEX.  If the basis differential between Midway Sunset oil and NYMEX contracts used in the fair value measurement calculation at March 31, 2012 had been 10 percentage points lower, the fair value of the Level 3 crude oil price swap agreements liability would have been approximately $25.6 million lower.  If the basis differential between Midway Sunset oil and NYMEX contracts used in the fair value measurement at March 31, 2012 had been 10 percentage points higher, the fair value measurement of the Level 3 crude oil price swap agreements liability would have been approximately $25.8 million higher.  These calculated amounts are based solely on basis differential changes and do not take into account any other changes to the fair value measurement calculation. 

 

Based on an assessment of the counterparties’ credit risk, the fair market value of the price swap agreements reported as Level 2 assets has been reduced by $0.9 million at March 31, 2012 and the fair market value of the price swap agreements reported as Level 2 and Level 3 assets has been reduced by $2.0 million at September 30, 2011. Based on an assessment of the Company’s credit risk, the fair market value of the price swap agreements reported as Level 2 and Level 3 liabilities at March 31, 2012 has been reduced by $0.1 million and the fair market value of the price swap agreements reported as Level 3 liabilities has not been reduced at September 30, 2011. These credit reserves were determined by applying default probabilities to the anticipated cash flows that the Company is either expecting from its counterparties or expecting to pay to its counterparties.

 

The tables listed below provide reconciliations of the beginning and ending net balances for assets and liabilities measured at fair value and classified as Level 3 for the quarters and six months ended March 31, 2012 and 2011, respectively. For the quarters and six months ended March 31, 2012 and March 31, 2011, no transfers in or out of Level 1 or Level 2 occurred.  There were no purchases or sales of derivative financial instruments during the periods presented in the tables below.  All settlements of the derivative financial instruments are reflected in the Gains/Losses Realized and Included in Earnings column of the tables below.

 

Fair Value Measurements Using Unobservable Inputs (Level 3)
(Thousands of Dollars)		Total Gains/Losses
	January 1,  2012	(Gains)/ Losses Realized and Included in Earnings	Gains/(Losses) Unrealized and Included in Other Comprehensive Income (Loss)	Transfer In/Out of Level 3	March 31, 2012
Derivative Financial Instruments(2)	$(54,773)	$13,523(1)	$(27,504)	$         -	$(68,754)

 

⁽¹⁾ Amounts are reported in Operating Revenues in the Consolidated Statement of Income for the three months ended March 31, 2012. 

⁽²⁾ Derivative Financial Instruments are shown on a net basis.

 

Fair Value Measurements Using Unobservable Inputs (Level 3)
(Thousands of Dollars)		Total Gains/Losses
	October 1,  2011	(Gains)/ Losses Realized and Included in Earnings	Gains/(Losses) Unrealized and Included in Other Comprehensive Income (Loss)	Transfer In/Out of Level 3	March 31, 2012
Derivative Financial Instruments(2)	$(5,410)	$26,135(1)	$(89,479)	$         -	$(68,754)

 

⁽¹⁾ Amounts are reported in Operating Revenues in the Consolidated Statement of Income for the six months ended March 31, 2012. 

⁽²⁾ Derivative Financial Instruments are shown on a net basis.

 

Fair Value Measurements Using Unobservable Inputs (Level 3)
(Thousands of Dollars)		Total Gains/Losses
	January 1,  2011	(Gains)/ Losses Realized and Included in Earnings	Gains/(Losses) Unrealized and Included in Other Comprehensive Income (Loss)	Transfer In/Out of Level 3	March 31, 2011
Derivative Financial Instruments(2)	$(37,407)	$9,566(1)	$(44,072)	$         -	$(71,913)

 

⁽¹⁾ Amounts are reported in Operating Revenues in the Consolidated Statement of Income for the three months ended March 31, 2011. 

⁽²⁾ Derivative Financial Instruments are shown on a net basis.

 

Fair Value Measurements Using Unobservable Inputs (Level 3)
(Thousands of Dollars)		Total Gains/Losses
	October 1,  2010	(Gains)/ Losses Realized and Included in Earnings	Gains/(Losses) Unrealized and Included in Other Comprehensive Income (Loss)	Transfer In/Out of Level 3	March 31, 2011
Derivative Financial Instruments(2)	$(16,483)	$13,168(1)	$(68,598)	$         -	$(71,913)

 

⁽¹⁾ Amounts are reported in Operating Revenues in the Consolidated Statement of Income for the six months ended March 31, 2011. 

⁽²⁾ Derivative Financial Instruments are shown on a net basis.

Note 3 – Financial Instruments

 

Long-Term Debt.  The fair market value of the Company’s debt, as presented in the table below, was determined using a discounted cash flow model, which incorporates the Company’s credit ratings and current market conditions in determining the yield, and subsequently, the fair market value of the debt.  Based on these criteria, the fair market value of long-term debt, including current portion, was as follows (in thousands):

                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

	March 31, 2012		September 30, 2011
	Carrying Amount	Fair Value	Carrying Amount	Fair Value
Long-Term Debt	$1,399,000	$1,554,323	$1,049,000	$1,198,585

 

The fair value amounts are not intended to reflect principal amounts that the Company will ultimately be required to pay. Carrying amounts for other financial instruments recorded on the Company’s Consolidated Balance Sheets approximate fair value. The fair value of long-term debt was calculated using observable inputs (U.S. Treasuries/LIBOR for the risk free component and company specific credit spread information – generally obtained from recent trade activity in the debt).  As such, the Company considers the debt to be Level 2.

 

Temporary cash investments, notes payable to banks and commercial paper are stated at cost. Temporary cash investments are considered Level 1, while notes payable to banks and commercial paper are considered to be Level 2.  Given the short-term nature of the notes payable to banks and commercial paper, the Company believes cost is a reasonable approximation of fair value.

 

Other Investments.  Investments in life insurance are stated at their cash surrender values or net present value as discussed below. Investments in an equity mutual fund and the stock of an insurance company (marketable equity securities), as discussed below, are stated at fair value based on quoted market prices.

 

            Other investments include cash surrender values of insurance contracts (net present value in the case of split-dollar collateral assignment arrangements) and marketable equity securities. The values of the insurance contracts amounted to $55.7 million and $54.8 million at March 31, 2012 and September 30, 2011, respectively. The fair value of the equity mutual fund was $24.2 million at March 31, 2012 and $19.9 million at September 30, 2011. The gross unrealized gain on this equity mutual fund was $2.2 million at March 31, 2012.  The gross unrealized loss on the equity mutual fund was $0.7 million at September 30, 2011.  The fair value of the stock of an insurance company was $5.4 million at March 31, 2012 and $4.5 million at September 30, 2011. The gross unrealized gain on this stock was $2.9 million at March 31, 2012 and $2.1 million at September 30, 2011. The insurance contracts and marketable equity securities are primarily informal funding mechanisms for various benefit obligations the Company has to certain employees.

 

Derivative Financial Instruments.  The Company uses derivative instruments to manage commodity price risk in the Exploration and Production and Energy Marketing segments. The Company enters into futures contracts and over-the-counter swap agreements for natural gas and crude oil to manage the price risk associated with forecasted sales of gas and oil. The Company also enters into futures contracts and swaps to manage the risk associated with forecasted gas purchases, storage of gas, withdrawal of gas from storage to meet customer demand and the potential decline in the value of gas held in storage. The duration of the majority of the Company’s hedges does not typically exceed 3 years.

 

The Company has presented its net derivative assets and liabilities as “Fair Value of Derivative Financial Instruments” on its Consolidated Balance Sheets at March 31, 2012 and September 30, 2011.  All of the derivative financial instruments reported on those line items related to commodity contracts as discussed in the paragraph above.

 

The following table discloses the fair value of derivative contracts on a gross-contract basis as opposed to the net-contract basis presentation on the Consolidated Balance Sheets at March 31, 2012 and September 30, 2011.

 

	Fair Values of Derivative Instruments
	(Dollar Amounts in Thousands)
Derivatives Designated as Hedging Instruments	Gross Asset Derivatives	Gross Liability Derivatives
Commodity Contracts – at March 31, 2012	$  135,583	$      80,710
Commodity Contracts – at September 30, 2011	$    90,253	$      23,842

 

Cash flow hedges

 

For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income (loss) and reclassified into earnings in the period or periods during which the hedged transaction affects earnings.  Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. 

 

As of March 31, 2012, the Company’s Exploration and Production segment had the following commodity derivative contracts (swaps) outstanding to hedge forecasted sales (where the Company uses short positions (i.e. positions that pay-off in the event of commodity price decline) to mitigate the risk of decreasing revenues and earnings):

 

Commodity	Units
Natural Gas	72.5 Bcf (all short positions)
Crude Oil	2,502,000 Bbls (all short positions)

 

As of March 31, 2012, the Company’s Energy Marketing segment had the following commodity derivative contracts (futures contracts and swaps) outstanding to hedge forecasted sales (where the Company uses short positions to mitigate the risk associated with natural gas price decreases and its impact on decreasing revenues and earnings) and purchases (where the Company uses long positions (i.e. positions that pay-off in the event of commodity price increases) to mitigate the risk of increasing natural gas prices, which would lead to increased purchased gas expense and decreased earnings):

 

Commodity	Units
Natural Gas	8.8 Bcf (5.3 Bcf short positions (forecasted storage withdrawals) and 3.5 Bcf long positions (forecasted storage injections))

 

 

 

 

 

As of March 31, 2012, the Company’s Pipeline and Storage segment has the following commodity derivative contracts (futures contracts) outstanding to hedge forecasted sales (where the Company uses short positions to mitigate the risk associated with natural gas price decreases and its impact on decreasing revenues and earnings):

 

Commodity	Units
Natural Gas	1.2 Bcf (all short positions)

 

As of March 31, 2012, the Company’s Exploration and Production segment had $59.0 million ($34.4 million after tax) of net hedging gains included in the accumulated other comprehensive income (loss) balance. It is expected that $42.2 million ($24.6 million after tax) of these gains will be reclassified into the Consolidated Statement of Income within the next 12 months as the expected sales of the underlying commodities occur. See Note 1, under Accumulated Other Comprehensive Income (Loss), for the after-tax gain (loss) pertaining to derivative financial instruments for both the Exploration and Production and Energy Marketing segments.

 

As of March 31, 2012, the Company’s Energy Marketing segment had less than $0.1 million of net hedging losses included in the accumulated other comprehensive income (loss) balance. See Note 1, under Accumulated Other Comprehensive Income (Loss), for the after-tax gain pertaining to derivative financial instruments for both the Exploration and Production and Energy Marketing segments.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Effect of Derivative Financial Instruments on the Statement of Financial Performance for the Three Months Ended March 31, 2012 and 2011 (Thousands of Dollars)
Derivatives in Cash Flow Hedging Relationships	Amount of Derivative Gain or (Loss) Recognized in Other Comprehensive Income (Loss) on the Consolidated Statement of Comprehensive Income (Loss) (Effective Portion) for the Three Months Ended March 31,		Location of Derivative Gain or (Loss) Reclassified from Accumulated Other Comprehensive Income (Loss) on the Consolidated Balance Sheet into the Consolidated Statement of Income (Effective Portion)	Amount of Derivative Gain or (Loss) Reclassified from Accumulated Other Comprehensive Income (Loss) on the Consolidated Balance Sheet into the Consolidated Statement of Income (Effective Portion) for the Three Months Ended March 31,			Location of Derivative Gain or (Loss) Recognized in the Consolidated Statement of Income (Ineffective Portion and Amount Excluded from Effectiveness Testing)	Derivative Gain or (Loss) Recognized in the Consolidated Statement of Income (Ineffective Portion and Amount Excluded from Effectiveness Testing) for the Three Months Ended  March 31,
	2012	2011		2012		2011		2012	2011
Commodity Contracts – Exploration & Production segment	$13,463	$(41,586)	Operating Revenue	$ 12,569		$  1,956	Operating Revenue	$     -	$     -
Commodity Contracts – Energy Marketing segment	$      459	$      872	Purchased Gas	$  3,040		$  5,256	Operating Revenue	$     -	$     -
Commodity Contracts – Pipeline & Storage segment	$     576	$     (130)	Operating Revenue	$     576		$         -	Operating Revenue	$     -	$     -
Total	$14,498	$(40,844)		$16,185		$ 7,212		$     -	$     -

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Effect of Derivative Financial Instruments on the Statement of Financial Performance for the Six Months Ended March 31, 2012 and 2011 (Thousands of Dollars)
Derivatives in Cash Flow Hedging Relationships	Amount of Derivative Gain or (Loss) Recognized in Other Comprehensive Income (Loss) on the Consolidated Statement of Comprehensive Income (Loss) (Effective Portion) for the Six Months Ended March 31,		Location of Derivative Gain or (Loss) Reclassified from Accumulated Other Comprehensive Income (Loss) on the Consolidated Balance Sheet into the Consolidated Statement of Income (Effective Portion)	Amount of Derivative Gain or (Loss) Reclassified from Accumulated Other Comprehensive Income (Loss) on the Consolidated Balance Sheet into the Consolidated Statement of Income (Effective Portion) for the Six Months Ended March 31,		Location of Derivative Gain or (Loss) Recognized in the Consolidated Statement of Income (Ineffective Portion and Amount Excluded from Effectiveness Testing)	Derivative Gain or (Loss) Recognized in the Consolidated Statement of Income (Ineffective Portion and Amount Excluded from Effectiveness Testing) for the Six Months Ended March 31,
	2012	2011		2012	2011		2012	2011
Commodity Contracts – Exploration & Production segment	$  9,539	$(68,368)	Operating Revenue	$17,990	$10,963	Operating Revenue	$     -	$     -
Commodity Contracts – Energy Marketing segment	$  6,538	$      603	Purchased Gas	$  9,484	$  5,302	Operating Revenue	$     -	$     -
Commodity Contracts – Pipeline & Storage segment	$     576	$     (215)	Operating Revenue	$   576	$          -	Operating Revenue	$     -	$     -
Total	$16,653	$(67,980)		$28,050	$16,265		$     -	$     -

 

Fair value hedges

 

The Company’s Energy Marketing segment utilizes fair value hedges to mitigate risk associated with fixed price sales commitments, fixed price purchase commitments, and the decline in the value of certain natural gas held in storage. With respect to fixed price sales commitments, the Company enters into long positions to mitigate the risk of price increases for natural gas supplies that could occur after the Company enters into fixed price sales agreements with its customers. With respect to fixed price purchase commitments, the Company enters into short positions to mitigate the risk of price decreases that could occur after the Company locks into fixed price purchase deals with its suppliers. With respect to storage hedges, the Company enters into short positions to mitigate the risk of price decreases that could result in a lower of cost or market writedown of the value of natural gas in storage that is recorded in the Company’s financial statements. As of March 31, 2012, the Company’s Energy Marketing segment had fair value hedges covering approximately 9.5 Bcf (7.4 Bcf of fixed price sales commitments (all long positions), 1.8 Bcf of fixed price  purchase commitments (all short positions) and 0.3 Bcf of commitments related to the withdrawal of storage gas (all short positions)). For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative as well as the offsetting gain or loss on the hedged item attributable to the hedged risk completely offset each other in current earnings, as shown below.

 

Consolidated Statement of Income	Gain/(Loss) on Derivative	Gain/(Loss) on Commitment
Operating Revenues	$     89,855	$   (89,855)
Purchased Gas	$1,108,074	$(1,108,074)

 

Derivatives in Fair Value Hedging Relationships – Energy Marketing segment	Location of Derivative Gain or (Loss) Recognized in the Consolidated Statement of Income	Amount of Derivative Gain or (Loss) Recognized in the Consolidated Statement of Income for the Six Months Ended March 31, 2012 (In Thousands)
Commodity Contracts – Hedge of fixed price sales commitments of natural gas	Operating Revenues	$        90
Commodity Contracts – Hedge of fixed price purchase commitments of natural gas	Purchased Gas	$      924
Commodity Contracts – Hedge of natural gas held in storage	Purchased Gas	$      184
		$   1,198

 

The Company may be exposed to credit risk on any of the derivative financial instruments that are in a gain position. Credit risk relates to the risk of loss that the Company would incur as a result of nonperformance by counterparties pursuant to the terms of their contractual obligations. To mitigate such credit risk, management performs a credit check, and then on a quarterly basis monitors counterparty credit exposure. The majority of the Company’s counterparties are financial institutions and energy traders. The Company has over-the-counter swap positions with eleven counterparties of which nine are in a net gain position.   On average, the Company had $13.3 million of credit exposure per counterparty in a gain position at March 31, 2012. The maximum credit exposure per counterparty in a gain position at March 31, 2012 was $22.7 million. The Company had not received any collateral from these counterparties at March 31, 2012 since the Company’s gain position on such derivative financial instruments had not exceeded the established thresholds at which the counterparties would be required to post collateral, nor had the counterparties’ credit ratings declined to levels at which the counterparties were required to post collateral.

 

As of March 31, 2012, nine of the eleven counterparties to the Company’s outstanding derivative instrument contracts (specifically the over-the-counter swaps) had a common credit-risk related contingency feature. In the event the Company’s credit rating increases or falls below a certain threshold (applicable debt ratings), the available credit extended to the Company would either increase or decrease. A decline in the Company’s credit rating, in and of itself, would not cause the Company to be required to  increase the level  of its hedging collateral deposits (in the form of cash deposits, letters of credit or treasury debt instruments). If the Company’s outstanding derivative instrument contracts were in a liability position (or if the current liability were larger) and/or the Company’s credit rating declined, then additional hedging collateral deposits may be required. At March 31, 2012, the fair market value of the derivative financial instrument assets with a credit-risk related contingency feature was $82.0 million according to the Company’s internal model (discussed in Note 2 — Fair Value Measurements). At March 31, 2012, the fair market value of the derivative financial instrument liabilities with a credit-risk related contingency feature was $60.2  million according to the Company’s  internal model  (discussed in Note 2 — Fair Value Measurements). For its over-the-counter crude oil swap agreements, which are in a liability position, the Company was required to post $8.8 million in hedging collateral deposits at March 31, 2012. This is discussed in Note 1 under Hedging Collateral Deposits.

 

For its exchange traded futures contracts, which are in a liability position, the Company had posted $10.1 million in hedging collateral as of March 31, 2012. As these are exchange traded futures contracts, there are no specific credit-risk related contingency features. The Company posts hedging collateral based on open positions and margin requirements it has with its counterparties.

 

The Company’s requirement to post hedging collateral deposits is based on the fair value determined by the Company’s counterparties, which may differ from the Company’s assessment of fair value. Hedging collateral deposits may also include closed derivative positions in which the broker has not cleared the cash from the account to offset the derivative liability. The Company records liabilities related to closed derivative positions in Other Accruals and Current Liabilities on the Consolidated Balance Sheet. These liabilities are relieved when the broker clears the cash from the hedging collateral deposit account. This is discussed in Note 1 under Hedging Collateral Deposits.