Management’s Discussion and Analysis should be read in conjunction with the audited Consolidated Financial Statements of TransCanada PipeLines Limited (TransCanada or the company) and the notes thereto for the year ended December 31, 2002.
Earnings Increase TransCanada’s net income applicable to common shares from continuing operations (net earnings) increased $61 million or nine per cent to $747 million or $1.56 per share in 2002 compared to $686 million or $1.44 per share in 2001.
Funds Flow Increase Funds generated from continuing operations increased $203 million or 13 per cent to $1.8 billion in 2002 compared to $1.6 billion in 2001.
Balance Sheet Strengthened In 2002, TransCanada continued to strengthen its balance sheet as it repaid debt maturities of $486 million, reduced notes payable by $46 million and increased shareholders’ equity by $320 million.
Dividend Increase On January 28, 2003, the Board of Directors of TransCanada raised the quarterly dividend on the company’s outstanding common shares eight per cent from $0.25 per share to $0.27 per share for the quarter ending March 31, 2003.
Growth in Core Businesses In 2002, TransCanada invested more than $800 million in its gas transmission and power businesses from internally generated cash flow.
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Year ended December 31 |
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2002 |
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2001 |
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2000 |
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(millions of dollars)
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Transmission |
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653 |
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585 |
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623 |
Power |
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146 |
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168 |
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85 |
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Corporate |
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(52) |
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(67) |
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(80) |
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Continuing operations |
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747 |
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686 |
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628 |
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Discontinued operations |
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– |
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(67) |
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61 |
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Net Income Applicable to Common Shares |
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747 |
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619 |
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689 |
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Net income applicable to common shares for the year ended December 31, 2002, was $747 million or $1.56 per share. This compares to net income of $619 million or $1.30 per share in 2001 which included a net loss from discontinued operations of $67 million or $0.14 per share, and net income of $689 million or $1.45 per share in 2000, which included net income from discontinued operations of $61 million or $0.13 per share.
TransCanada’s net income applicable to common shares from continuing operations for the year ended December 31, 2002, was $747 million or $1.56 per share compared to $686 million or $1.44 per share for 2001 and $628 million or $1.32 per share for 2000. The increase in 2002 compared to 2001 is primarily due to higher earnings from the Transmission business and reduced expenses in the Corporate segment, partially offset by lower earnings from the Power segment. The increase in 2001 compared to 2000 was primarily due to higher earnings from the Power business, as well as reduced financial and preferred equity charges. In 2001, the Power segment earnings reflected the company’s ability to capture significant market opportunities created by high market prices and power price volatility.
In June 2002, TransCanada received the National Energy Board (NEB) decision on its Fair Return application (Fair Return decision) to determine the cost of capital to be included in the calculation of 2001 and 2002 final tolls on its Canadian Mainline. The results for the year ended December 31, 2002 include after-tax net income of $36 million or $0.08 per share representing the impact of the Fair Return decision for 2001 ($16 million) and 2002 ($20 million). The 2002 results also include $7 million relating to TransCanada’s proportionate share of a favourable ruling for Great Lakes Gas Transmission Limited Partnership (Great Lakes) with respect to Minnesota use tax paid in prior years. In 2002, TransCanada chose to expense stock options and the impact of this accounting change was a $2 million charge to net income for the year ended December 31, 2002.
Net income applicable to common shares from continuing operations in 2000 included gains on the sale of assets amounting to $30 million, after tax, or $0.06 per share, and tax recoveries of $28 million or $0.06 per share, reflecting the impact of tax law and income tax rate changes in the February 2000 and October 2000 Federal budgets.
TransCanada’s Mission is to be one of the most profitable, competitive and reliable providers of wholesale natural gas transportation and electric power across North America, with strong roots in the Western Canada Sedimentary Basin (WCSB) and key customer relationships in consuming regions.
TransCanada’s Strategies to achieve this mission continue to be:
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Sustain, grow and optimize the company’s North American natural gas transmission business; |
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Establish a new regulated business model that provides value to customers, reduces the long-term risks of the Canadian long-haul pipelines and allows the company to earn a fair and competitive return; |
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Grow the power business; |
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Pursue operational excellence, with a focus on providing low-cost, reliable service to the company’s customers; |
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Maintain and utilize the company’s strong financial position. |
TransCanada’s focus on the disciplined implementation of the strategies resulted in strong financial performance in 2002 with increases in net income and operating cash flow, as well as the maintenance of a solid balance sheet. Strong internally generated cash flow allowed TransCanada to continue to repay debt maturities, invest in the core businesses of natural gas transmission and power, and maintain a strong liquidity position. In addition, TransCanada’s financial position and performance enabled the Board of Directors to raise the quarterly dividend on the company’s common shares from $0.20 per share in 2000, to $0.225 per share in 2001, to $0.25 per share in 2002, and to $0.27 per share for the quarter ended March 31, 2003.
The company’s access to capital markets remains strong. During 2002, TransCanada established a new $1.5 billion syndicated credit facility, replacing existing lines of credit set to expire in mid-2003, and also filed universal shelf prospectuses with Canadian and United States securities regulators qualifying for issuance $2 billion and US$1 billion of securities, respectively.
The company invested more than $800 million in natural gas transmission and power assets in 2002 pursuant to the strategies of growing and optimizing the natural gas transmission network and power business. In the Transmission business, TransCanada continued to connect incremental natural gas supply within the WCSB, expanded its pipeline system in western Alberta and British Columbia to meet growing demand in California and the Pacific Northwest, and achieved growth in its investments in North American Pipeline Ventures (NAPV). In 2002, TransCanada pursued pipeline opportunities to move Mackenzie Delta and Alaska North Slope natural gas to markets throughout North America. In the Power business, TransCanada started operations at two new power plants, completed the acquisition of the ManChief power plant and announced plans to acquire a 31.6 per cent equity interest in Bruce Power L.P. for $376 million, subject to closing adjustments.
TransCanada held extensive discussions with industry stakeholders throughout 2002 on a future business model for its Canadian regulated pipelines. These stakeholder discussions and TransCanada’s view of the future business model influenced the 2003 Canadian Mainline Tolls and Tariff Application filed with the NEB in September 2002 and the proposed rate design changes to the Alberta System filed with the Alberta Energy and Utilities Board (EUB) in January 2003. In June 2001, TransCanada filed the Fair Return application with the NEB, seeking an after-tax weighted average cost of capital (ATWACC) of 7.5 per cent to be included in the Canadian Mainline tolls for 2001 and 2002. In June 2002, following a hearing, the NEB released its decision not to adopt the ATWACC methodology, but did increase the deemed common equity from 30 per cent to 33 per cent. Although disappointed with the NEB’s decision, which in TransCanada’s opinion does not adequately recognize the long-term business risks of the Canadian Mainline, the company remains committed to the Canadian pipeline business. In February 2003, the NEB denied TransCanada’s request for a review and variance of the Fair Return decision.
TransCanada will continue to implement its strategy in 2003. The company’s main focus in 2003 will be to evaluate opportunities to grow and optimize the natural gas transmission and power businesses with a view to enhancing shareholder value and meeting customers’ unique requirements in a constantly changing marketplace. The company will also focus on TransCanada’s commitment to an operational excellence business model and advancement of the future business model for its Canadian regulated pipelines. The company’s earnings and cash flow, combined with the solid balance sheet and liquidity at December 31, 2002, provide the financial flexibility for TransCanada to make disciplined investments in the two core businesses, with a primary focus on the acquisition and construction of highly efficient and well-positioned assets.
In February 2003, TransCanada announced a settlement with the customers on the Alberta System. This settlement, if approved by the EUB, will result in a decline in the fixed revenue requirement from $1.347 billion in 2002 to $1.277 billion in 2003. A reduction in 2003 net earnings as a result of this settlement is expected to be approximately $40 million after tax. TransCanada worked with its customers to negotiate a settlement that represented a balance of customer and shareholder interests. However, the Fair Return decision rendered by the NEB had a significant impact on the terms of reaching the settlement, as it provided a benchmark for negotiations on the Alberta System.
The company’s competitive strengths continue to be:
Transmission
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Unparalleled Market Access High capacity connections from the WCSB to premier North American markets give the company a strategic position in the continental natural gas market, offering producers the connectivity, penetration and flexibility they need to capitalize on growing demand. With the current capacity, infrastructure, market access, and ease of expansion offered by TransCanada’s transmission systems, the company has a competitive advantage in attracting new natural gas supply from the North and British Columbia. |
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Experience and Expertise TransCanada has a half century of expertise in large diameter, cold weather natural gas pipeline construction. The company is a leading builder and operator of large gas turbine compressor stations, and is the operator of one of the largest, most sophisticated, remote-controlled pipeline networks in the world. |
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Operational Excellence The company has a solid reputation for reliability and safety and is focused on providing low-cost, reliable service by utilizing and applying innovation and best practices. |
Power
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Broad Understanding of Continental Markets TransCanada has extensive knowledge of North American energy markets, opportunities and competitors, with an in-depth understanding of the company’s core markets. In addition, the company has significant power deregulation experience. |
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Ability to Structure Deals and Manage Risk The company’s analytical, deal structuring and risk management skills have been a key element of success, complemented by marketing operations to capitalize on opportunities presented by market volatility. |
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Operational Excellence TransCanada’s power business is characterized by a commitment to industry-leading performance, as evidenced by a highly efficient generating fleet of turbines that operated at an average availability of 95 per cent in 2002. The company’s strong management team has a proven track record in maximizing value from existing assets and in developing quality opportunities, both in new acquisitions and greenfield projects. |
The two most significant challenges to TransCanada’s pipeline business in the long term are competition and the risk of declining supply in the WCSB. Over the past several years TransCanada has been working diligently with all stakeholders to provide value to its customers in the form of flexible, cost-competitive services and to earn a fair risk-adjusted return on its pipeline assets.
There will be significant opportunities to continue to grow TransCanada’s pipeline business. North American natural gas demand is expected to grow by more than 25 per cent over the next 10 years. There is considerable concern that supply from the traditional supply basins in North America will not be able to meet this increased demand for natural gas. Alternative supplies such as from Alaska, the Mackenzie Delta and liquefied natural gas (LNG) may be required to meet this demand. TransCanada is well-positioned to build and operate the infrastructure to bring these new supplies to market.
TransCanada’s high capacity connections from the WCSB to premier North American markets position the company well to move northern natural gas. TransCanada brings real competitive advantages to these projects. In the event that incremental LNG imports will be needed to meet market requirements in North America, TransCanada has the technology and pipeline capacity to bring this supply to market. Both the northern gas and LNG supplies are longer term prospects for TransCanada.
The growth of TransCanada’s power business faces a number of challenges, including the uncertainties related to deregulation, long-term availability of fuel at economic prices, excess power generation, and the price of power in the long term.
TransCanada’s strategy to grow its power business is supported by an expectation that the majority of the increase in natural gas demand is driven by the demand for power. Although there has been a significant increase in power supply in some markets over the past few years, TransCanada believes that there are niche opportunities available to build its power business. The increased demand for power and steam in the Alberta oil sands and other industrial sectors presents significant opportunities for growth. TransCanada has significant experience and competitive advantages in developing cogeneration facilities.
A key aspect to TransCanada’s growth strategy focuses on the acquisition of existing pipeline and power assets. As a result of economic turmoil experienced by certain of TransCanada’s competitors, the company expects to pursue acquisition opportunities that would create shareholder value.
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