Duke Energy’s credit rating last week was downgraded by both Standard & Poor’s Ratings Service (S&P) and Moody’s Investor Services, but managed to maintain its investment rating. As part of its attempts to boost its bottom line, the company on Wednesday completed the sale of its exploration and production subsidiary, Duke Energy Hydrocarbons LLC (DEH), to a private company for $83 million.

DEH, managed by Duke Energy North America (DENA), explored for natural gas and petroleum mostly in the Gulf of Mexico.

“We continue to be successful in opportunistic asset sales by capturing value through the divestiture of non-core assets,” said Robert T. Ladd, president of DENA. “At DENA, we are focusing on energy sales and marketing around our asset positions.”

“The sale of our hydrocarbons business is consistent with our overall North American portfolio management strategy,” said Duke Energy CEO Richard B. Priory. He said the transaction, combined with other asset sales announced this year, “puts us closer to our goal of approximately $1.5 billion in gross proceeds from asset sales for 2003.”

The sale came one day after Moody’s and S&P downgraded the company.

According to S&P, Duke Energy’s customer growth has been above average, with diversity among its large industrial customers. It said that the regulatory environment in its service territory is “generally supportive of credit quality, in light of a five-year rate freeze that allows Duke Power to preserve any cost savings, recover required capital expenditures for emissions reductions, and provide the ability to earn adequate returns on equity.”

Of its nonregulated operations, which include DENA, S&P noted that “substantial generation over-capacity in many markets within the U.S., and especially in the southeastern U.S., where reserve margins reach 40% and the market is dominated by low-cost coal fired plants, has affected wholesale prices and reduced spark spreads, challenging merchant generators, including DENA, to earn meaningful profits for the risk undertaken.”

Even though DENA has hedged most of its production for 2003 and 2004, “this production represents only one-third of the company’s total available production, indicating the lack of attractive pricing or volatility in the industry. Therefore, Standard & Poor’s is concerned that should the current low market prices for energy persist for the next several years, DENA may not be able to recover the substantial capital invested. Therefore, Standard & Poor’s recognizes a measure of incremental operating risk in this business.”

S&P noted that Duke had “endeavored to improve its consolidated business profile and reduce operating risk,” and said it expects the company to effectively unwind its remaining proprietary trading positions “in a timely manner without expending additional cash.”

S&P placed a negative outlook on Duke, reflecting its concern that “should Duke Energy’s consolidated financial or business profiles deteriorate from current levels over the next 12 to 18 months, ratings could be lowered further.” The ratings agency said it would monitor developments for further weakness in the merchant generation business; Duke’s ability to effectively terminate proprietary trading and marketing positions without adverse effect on the consolidated financial profile; continued strong financial performance at subsidiary Crescent Resources, as well as the franchised electric and natural gas transmission operations; and repayment of its debt.

Like S&P, Moody’s cut Duke Energy’s senior unsecured rating one notch to ‘Baa1,’ leaving it three notches above junk status, and dropped Duke Capital, which oversees the company’s trading and merchant power divisions, to ‘Baa3,’ the lowest investment-grade rating. The ratings of subsidiaries PanEnergy Corp. and Texas Eastern Gas Transmission also were cut one notch. The outlook for all the new ratings is stable, but Duke Energy Field Services’ ratings remain under review for downgrade.

“While we would have obviously preferred that Moody’s maintain the Duke Energy and Duke Capital credit ratings, we remain confident that the effectiveness of our actions in 2003 and beyond will significantly strengthen the balance sheet and limit our exposure to the current uncertainties in the merchant energy business,” said Priory. “We have made the tough decisions to ensure that we manage through this down cycle and maintain the financial strength necessary to capitalize on future opportunities.”

Priory said the action by Moody’s will not affect the company’s 2003 operational or financial plans. As a result,. he affirmed Duke’s 2003 earnings per share (EPS) guidance of $1.35-1.60, before the cumulative effect of changes in accounting principles, and the previously stated $1.10 per share annual dividend. On average, analysts expect the company to earn $1.42/share for the year, according to research firm Thomson First Call.

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