FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934

DUKE ENERGY FIELD SERVICES, LLC
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 20032004

INDEX

CAUTIONARY STATEMENT ABOUT FORWARD-LOOKING STATEMENTS

     Our reports, filings and other public announcements may from time to time contain statements that do not directly or exclusively relate to historical facts. Such statements are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. You can typically identify forward-looking statements by the use of forward-looking words, such as “may,” “will,” “could,” “project,” “believe,” “anticipate,” “expect,” “estimate,” “continue,” “potential,” “plan,” “forecast” and other similar words.

     All of such statements other thanthat are not statements of historical facts, including statements regarding our future financial position, business strategy, budgets, projected costs and plans and objectives of management for future operations, are forward-looking statements.

     These forward-looking statements reflect our intentions, plans, expectations, assumptions and beliefs about future events and are subject to risks, uncertainties and other factors, many of which are outside our control. Important factors that could cause actual results to differ materially from the expectations expressed or implied in the forward-looking statements include known and unknown risks. Known risks include, but are not limited to, the following:

	•		our ability to access the debt and equity markets, which will depend on general market conditions and our credit ratings for our debt obligations;
	•		our use of derivative financial instruments to hedge commodity and interest rate risks;
	•		the level of creditworthiness of counterparties to transactions;
	•		the amount of collateral required to be posted from time to time in our transactions;
	•		changes in laws and regulations, particularly with regard to taxes, safety and protection of the environment or the increased regulation of the gathering and processing industry;

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	•		the timing and extent of changes in commodity prices, interest rates, foreign currency exchange rates and demand for our services;
	•		weather and other natural phenomena;
	•		industry changes, including the impact of consolidations and changes in competition;
	•		our ability to obtain required approvals for construction or modernization of gathering and processing facilities, and the timing of production from such facilities, which are dependent on the issuance by federal, state and municipal governments, or agencies thereof, of building, environmental and other permits, the availability of specialized contractors and work force and prices of and demand for products;
	•		the extent of success in connecting natural gas supplies to gathering and processing systems;
	•		the effect of accounting policies issued periodically by accounting standard-setting bodies; and
	•		general economic conditions, including any potential effects arising from terrorist attacks, the situation in Iraq and any consequential hostilities or other hostilities.

     In light of these risks, uncertainties and assumptions, the events described in the forward-looking statements might not occur or might occur to a different extent or at a different time than we have described. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

DUKE ENERGY FIELD SERVICES, LLC

See Condensed Notes to Consolidated Financial Statements.

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^a Mark-to-market- An accounting method whereby the change in the fair value of the asset or liability is recognized in the Consolidated Statements of Operations in Trading and marketing net margin during the current period.

^b Hedge method- An accounting method whereby the change in the fair value of the asset or liability is recorded in the Consolidated Balance Sheets and there is no recognition in the Consolidated Statements of Operations for the effective portion until the hedged transaction occurs.

^c Accrual method- An accounting method whereby there is no recognition in the Consolidated Statements of Operations for changes in fair value of a contract until the service is provided or the associated delivery of product occurs.

     For derivatives designated as a cash flow hedge contracts, the Companyor a fair value hedge, we formally assesses,assess, both at the inception of the hedge contract’s inception and on an ongoing basis, whether the hedge contract is highly effective in offsetting changes in fair values or cash flows of hedged items. The Company excludesWe exclude the time value of the options when assessing hedge effectiveness.

     When available, quoted market prices or prices obtained through external sources are used to verify a contract’s fair value. For contracts with a delivery location or duration for which quoted market prices are not available, fair value is determined based on pricing models developed primarily from historical and expected correlations with quoted market prices.

     Values are adjusted to reflect the credit risk inherent in the transaction as well as the potential impact of liquidating the open positions held in an orderly manner over a reasonable time period under current conditions. Changes in market prices and management estimates directly affect the estimated fair value of these contracts. Accordingly, it is reasonably possible that such estimates may change in the near term.

     Commodity Trading and Marketing — A favorable or unfavorable price movement of any derivative contract held for trading and marketing purposes is reported as Trading and Marketing Net Marginmarketing net margin in the Consolidated Statements of Operations. An offsetting amount is recorded in the Consolidated Balance Sheets as Unrealized Gainsgains or Unrealized Losseslosses on Mark-to-Marketmark-to-market and Hedging Transactions.hedging transactions. When a contract is settled,the contractual delivery period occurs, the realized gain or loss is reclassified to aan account receivable or payable account. Settlement has no revenue presentation effect on the Consolidated Statements of Operations.

     See the “New Accounting Standards” section below for a discussion of the implications of EITF Issue 02-03, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities,” on the accounting for trading activities subsequent to October 25, 2002.payable.

     Commodity Cash Flow Hedges — The fair value of a derivative designated as a cash flow hedge is recorded in the Consolidated Balance Sheets as Unrealized gains or Unrealized losses on mark-to-market and hedging transactions. The effective portion of the change in fair value of a derivative designated and qualified as a cash flow hedge is includedrecorded in the Consolidated Balance Sheets as Accumulated Other Comprehensive Income (Loss)other comprehensive income (“AOCI”) until earnings are affected byand the ineffective portion is recorded in the Consolidated Statements of Operations. During the period in which the hedged item. Settlementtransaction occurs, amounts of cash flow hedgesin AOCI associated with the hedged transaction are removed from AOCI and recorded inreclassified to the Consolidated Statements of Operations in the same accounts as the item being hedged. The Company discontinuesWe discontinue hedge accounting prospectively when it is determined that the derivative no longer qualifies as an effective hedge, or when it is no longer probable that the hedged transaction will occur. When hedge accounting is discontinued because the derivative no longer qualifies as an effective hedge, the derivative continues to be carried on the Consolidated Balance Sheets at its fair value, withvalue; however, subsequent changes in its fair value are recognized in current-periodcurrent period earnings. Gains and losses related to discontinued hedges that were previously accumulated in AOCI will remain in AOCI until earnings are affected by the hedged item,transaction occurs, unless it is no longer probable that the hedged transaction will occur, in which case, the gains and losses that were accumulatedpreviously deferred in AOCI will be immediately recognized in current-periodcurrent

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period earnings. At June 30, 2004 and December 31, 2003, $16 million and $29 million, respectively, of losses related to cash flow hedges were deferred in AOCI.

     Commodity Fair Value Hedges — Changes in the fair value of a derivative that is designated and qualifies as a fair value hedge are included in the Consolidated Statements of Operations as Sales of Natural Gasnatural gas and Petroleum Productspetroleum products and Purchases of Natural Gasnatural gas and Petroleum Products,petroleum products, as appropriate.appropriate, and are included in the Consolidated Balance Sheets as Unrealized gains or Unrealized losses on mark-to-market and hedging transactions. Changes in the fair value of the physical portion of a fair value hedge (i.e., the hedged item) are recorded in the Consolidated Statements of Operations in the same accounts as the changes in the fair value of the derivative, with offsetting amounts in the Consolidated Balance Sheets as Other Current Assets,current assets, Other Noncurrent Assets,noncurrent assets, Other Current Liabilitiescurrent liabilities or Other Long Term Liabilities,long term liabilities, as appropriate.

     Interest Rate Fair Value Hedges — The CompanyWe periodically entersenter into interest rate swaps to convert some of itsour fixed-rate long term debt to floating-rate long term debt. Hedged items in fair value hedges are marked-to-market with the respective derivative instruments. Accordingly, the Company’sour hedged fixed-rate debt is carried at fair value. The terms of the outstanding swapswaps match those of the associated debt which permits the assumption of no ineffectiveness, as defined by SFAS No. 133. As such, for the life of the swapswaps, no ineffectiveness will be recognized.

     Income TaxesDistributions –— TheUnder the terms of our Limited Liability Company isAgreement (the “LLC Agreement”), we are required to make quarterly distributions to Duke Energy and ConocoPhillips based on allocated taxable income. The distributions areLLC Agreement, as amended, provides for taxable income to be allocated in accordance with Internal Revenue Code Section 704(c). This Code Section accounts for the variation between the adjusted tax basis and the fair market value of assets contributed to the joint venture. The distribution is based on the highest taxable income allocated to either

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member, with the other member receiving a proportionate amount to maintain the ownership capital accounts at 69.7% for Duke Energy and 30.3% for ConocoPhillips. During the six months ended June 30, 2004, we paid distributions of $11 million based on estimated annual taxable income allocated to the members according to their respective ownership percentages. As of June 30, 2004, additional distributions payable of $5 million were included in Other current liabilities in the Consolidated Balance Sheets.

     In 2003, our board of directors approved a plan to consider the payment of a quarterly dividend to Duke Energy and ConocoPhillips. The board of directors may consider net income, cash flow or any other criteria deemed appropriate for determining the amount of the quarterly dividend to be paid. The LLC Agreement restricts making distributions, which would include these dividends, except with the approval of both members. During the six months ended June 30, 2004, with the approval of both members, we paid a total dividend of $137 million to the members, allocated in accordance with their respective ownership percentages.

     Stock-Based Compensation— Under Duke Energy’s 1998 Long Term Incentive Plan, stock options for Duke Energy’s common stock may be granted to the Company’sour key employees. The Company accountsWe account for stock-based compensation using the intrinsic value recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and FASB Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation (an Interpretation of APB Opinion No. 25).” Under this method, any compensation cost is measured as the quoted market price of stock at the date of the grant less the amount an employee must pay to acquire the stock. Since the exercise price for all options granted under those plansthe plan was equal to the market value of the underlying common stock on the date of grant, no compensation cost is recognized in the accompanying Consolidated Statements of Operations. Restricted stock grants and phantom stock awards and stock-based performance awards are recorded as compensation cost over the required vesting period, as compensation cost, based on the marketfair value on the date of grant. Performance awards are recorded as compensation cost over the required vesting period, based on the fair value of the awards at the balance sheet date.

The following disclosures reflecttable shows what earnings available for members’ interest would have been if we had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” to stock options and reflects the provisions of SFAS No. 148 “Accounting for Stock-Based Compensation — Transition and Disclosure — an amendment of FASB Statement No. 123.”

     The following table shows what earnings available for members’ interest would have been if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for7

Pro Forma Stock-Based Compensation” to all stock-based compensation awards.

     Accumulated Other Comprehensive Income (Loss) —The components of and changes in accumulated other comprehensive income (loss) are as follows:

7Accumulated Other Comprehensive Income

     Cumulative Effect of ChangesChange in Accounting Principles— The CompanyWe adopted the provisions of EITF Issue 02-03 (“EITF 02-03”), “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and for Contracts Involved in Energy Trading and Risk Management Activities,” that required new non-derivative energy trading contracts entered into after October 25, 2002 to be accounted for under the accrual accounting basis. Non-derivative energy trading contracts recorded in the Consolidated Balance Sheet as of January 1, 2003 that existed at October 25, 2002 and inventories that were recorded at fair value were adjusted to historical cost via a cumulative effect adjustment of $5 million as a reduction to earnings in the first quarter of 2003.

     We adopted the provisions of SFAS No. 143 (“SFAS 143”), “Accounting for Asset Retirement Obligations” onObligations,” as of January 1, 2003.2003 which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. In accordance with the transition provisions of SFAS No. 143, the Companywe recorded asset retirement liabilities and a cumulative-effectcumulative effect adjustment of $17.4$18 million as a reduction to earnings in earnings. In addition, in accordance with the EITF’s October 2002 consensus on Issue No. 02-03, on January 1, 2003, the Company decreased its inventories from fair value to historical cost and recorded a $5.4 million cumulative-effect adjustment as a reduction in earnings.first quarter of 2003.

     New Accounting Standards— In May 2003, the FASB issued SFAS No. 150 (“SFAS 150”), “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.Equity” including the deferral of certain effective dates as a result of the provisions of FASB Staff Position 150-3, “Effective Date, Disclosures, and Transition for Mandatorily Redeemable Noncontrolling Interests Under FASB Statement No. 150, ‘Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity’.” SFAS No. 150 requires that certain financial instruments that could previously be accounted for as equity, be classified as liabilities in statements of financial positionthe consolidated balance sheets and initially recorded at fair value. In addition to its requirements for the classification and measurement of financial instruments in its scope, SFAS No. 150 also requires disclosures about the nature and terms of the financial instruments and about alternative ways of settling the instruments. The provisions of SFAS No. 150 are effective for all financial instruments entered into or modified after May 31, 2003, and are otherwise effective at the beginning of the first interim period beginning after June 15, 2003. Upon adoption on July 1, 2003, the Company will reclassify itswe reclassified our preferred members’ interest, which were mandatorily redeemable, of $200 million from mezzanine equity to long-term liabilities at its fair value of approximately $200 million. Future disbursementslong term debt and prospectively classified accrued or paid distributions on these securities, which had previously been classified as dividends, on these preferred members’ interest will be classified as interest expense. During 2003, we redeemed the remaining $200 million of these securities in cash.

     In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” which amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. SFAS No. 149 clarifies the discussion around initial net investment, clarifies when a derivative contains a financing component, and amends the definition of an underlying to conform it to language used in FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” In addition, SFAS No. 149 also incorporates certain of the Derivative Implementation Group Implementation Issues. The provisions of SFAS No. 149 are effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The guidance is to be applied to hedging relationships on a prospective basis. The Company does not anticipate SFAS No. 149 will have a material impact on its consolidated results of operations, cash flows or financial position.8

     In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities.” FIN 46Entities” which requires an entity to consolidate a variable interest entity if it is the primary beneficiary of a variable interest entity’s activities to consolidate the variable interest entity’s activities. The primary beneficiary isentity. We adopted the party that absorbs a majorityprovisions of the expected losses and/or receives a majority of the expected residual returns of the variable interest entity’s activities. FIN 46 is immediately applicable to variable interest entities created, or interests in variable interest entities obtained, after January 31, 2003. For those variable interest entities created, or interests in variable interest entities obtained, on or before January 31, 2003, and its related interpretations (“FIN 46 is required to be applied46R”) in the first fiscal year or interim period beginning after June 15, 2003. FIN 46 may be applied prospectively withquarter of 2004. As a cumulative-effect adjustmentresult, we consolidated one entity, previously accounted for under the equity method of accounting, on January 1, 2004. This entity, which is a substantive entity, had total assets of approximately $92 million as of the date it is first applied, or by restating previously issued financial statements with a cumulative-effect adjustment as of the beginning of the first year restated. FIN 46 also requires certain disclosures of an entity’s relationship with variable interest entities. The Company has not identified any variable interest entities created, or interests in variable interest entities obtained, after January 31, 2003 and continues to assess the existence of any interests in variable interest entities created on or prior to January 31, 2003. It is reasonably possible that the Company will disclose information about variable interest entities upon the application1, 2004. Adoption of FIN 46, primarily as the result of investments it has in certain unconsolidated affiliates. For all of these unconsolidated affiliates, the Company believes that its maximum exposure to loss would be equal to its investment in these entities, plus its potential obligations under its guarantees of unconsolidated debt. At June 30, 2003, the Company’s total investment in, plus the value of any guaranteed debt for entities that have a reasonable possibility to be determined to be variable interest entities, was approximately $160.7 million. The Company continues to assess FIN 46 but does not anticipate that it will have a46R had no material impacteffect on itsour consolidated results of operations, cash flows or financial position.

     In November 2002, the FASB issued Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” which elaborates on the disclosures to be made by a guarantor about its obligations under certain guarantees issued. It

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also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The Company adopted the initial recognition and measurement provisions of FIN 45 effective January 1, 2003. Adoption of the new interpretation had no material effect on the Company’s consolidated results of operations, cash flows or financial position.

     In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The Company adopted the provisions of SFAS No. 146 for restructuring activities initiated after December 31, 2002. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF No. 94-3, a liability for an exit cost would have been recognized at the date of an entity’s commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amounts recognized.

     In June 2002,July 2003, the EITF reached a partial consensus onin EITF Issue No. 02-03, “Issues Involved in03-11 (“EITF 03-11”), “Reporting Realized Gains and Losses on Derivative Instruments that are Subject to FASB Statement No. 133, Accounting for Derivative ContractsInstruments and Hedging Activities, and Not Held for Trading Purposes, and Contracts Involved in Energy Trading and Risk Management Activities.” The EITF concluded that effective for periods ending after July 15, 2002, mark-to-marketdetermining whether realized gains and losses on energy tradingderivative contracts (including those to be physically settled) must be shown on a net basis in the Consolidated Statements of Operations. The Company had previously chosen to report certain of its energy trading contracts on a gross basis, as sales in operating revenues and the associated costs recorded as purchases in costs and expenses, in accordance with prevailing industry practice.

     In October 2002, the EITF, as part of their further deliberations on Issue No. 02-03, rescinded the consensus reached in Issue No. 98-10. As a result, all energy trading contracts that do not meet the definition of a derivative under SFAS No. 133, and trading inventories that previously had been recorded at fair values, must now be recorded at the lower of cost or market and are reported on an accrual basis resulting in the recognition of earnings or losses at the time of contract settlement or termination. New non-derivative energy trading contracts entered into after October 25, 2002 should be accounted for under the accrual accounting basis. Non-derivative energy trading contracts on the Consolidated Balance Sheet as of January 1, 2003 that existed at October 25, 2002 and inventories that were recorded at fair values have been adjusted to the lower of historical cost or market via a cumulative-effect adjustment of $5.4 million as a reduction to 2003 earnings. In connection with the consensus reached on Issue No. 02-03, the FASB staff observed that, effective July 1, 2002, an entity should not recognize unrealized gains or losses at the inception of a derivative instrument unless the fair value of that instrument is evidenced by quoted market prices or current market transactions.

     In October 2002, the EITF also reached a consensus on Issue No. 02-03 that, effective for periods beginning after December 15, 2002, all gains and losses on all derivative instruments held for trading purposes should be shownreported on a net or gross basis inis a matter of judgment that depends on the income statement. Gainsrelevant facts and losses on non-derivative energy trading contracts should similarly be presented on a gross or net basis in connection withcircumstances. In analyzing the guidance in Issue No.facts and circumstances, EITF 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent.Agent” and Opinion No. 29, “Accounting for Nonmonetary Transactions,” Upon applicationshould be considered. EITF 03-11 is effective for transactions or arrangements entered into after September 30, 2003. The adoption of this presentation, comparative financial statements for prior periods are required to be reclassified to conform to the consensus other than for energy trading contracts that were shown on a net basis under Issue No. 98-10. Accordingly, for the three and six months ended June 30, 2003, derivative instruments that are held for trading and marketing purposes and are accounted for under mark-to-market accounting are included in Trading and Marketing Net Margin on the Consolidated Statements of Operations. For the three and six months ended June 30, 2002, Trading and Marketing Net Margin also includes the net margin on non-derivative energy trading contracts (primarily gas storage inventories and the related physical purchases and sales) that no longer qualify for net presentation after the rescission of Issue No. 98-10. The new gross versus net revenue presentation requirementsEITF 03-11 had no impactmaterial effect on operating incomeour consolidated results of operations, cash flows or net income.

     In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations,” which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The standard applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or normal use of the

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asset. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred, if a reasonable estimate of fair value can be made. The fair value of the liability is added to the carrying amount of the associated asset. This additional carrying amount is then depreciated over the life of the asset. The liability increases due to the passage of time based on the time value of money until the obligation is settled. The Company adopted the provisions of SFAS No. 143 as of January 1, 2003. In accordance with the transition provisions of SFAS No. 143, the Company recorded a cumulative-effect adjustment of $17.4 million as a reduction in 2003 earnings.position.

     In May 2003, the EITF reached consensus in EITF Issue No. 01-08 (“EITF 01-08”), “Determining Whether an Arrangement Contains a Lease,” to clarify the requirements of identifying whether an arrangement should be accounted for as a lease at its inception. The guidance in the consensus is designed to mandate reporting revenue as rental or leasing income that otherwise would be reported as part of product sales or service revenue. EITF Issue No. 01-08 requires both parties to an arrangement to determine whether a service contract or similar arrangement is or includes a lease within the scope of SFAS No. 13, “Accounting for Leases.” The consensus is to be applied prospectively to arrangements agreed to, modified, or acquired in business combinations in fiscal periods beginning on July 1, 2003. The Company is currently assessing the impactadoption of EITF Issue No. 01-08 will havehad no material effect on itsour consolidated results of operations, cash flows or financial position.

     Reclassifications—Certain prior period amounts have been reclassified in the Consolidated Financial Statements and notes thereto to conform to the current period presentation. Included in the reclassified amounts are increases in both Sales of natural gas and petroleum products and in Purchases of natural gas and petroleum products in the amount of approximately $223 million and $459 million, respectively, for the three and six months ended June 30, 2003. This reclassification resulted from intersegment trading activities being eliminated twice from the Consolidated Statements of Operations during the six months ended June 30, 2003. Management has concluded that these reclassifications are not material to the fair presentation of our financial statements.

3. Acquisitions and Dispositions

     On March 10, 2004, we entered into an agreement to acquire gathering, processing and transmission assets in Southeast New Mexico from ConocoPhillips, a related party, for a total purchase price of approximately $80 million, consisting of $74 million in cash and the assumption of approximately $6 million of liabilities. The transaction closed during the second quarter of 2004.

     In February 2004, we sold gas gathering and processing plant assets in West Texas to a third party purchaser for a sales price of approximately $62 million. These assets comprised a component of the Company for purposes of reporting discontinued operations. All prior period operations have been revised to reflect these assets as discontinued operations.

     During the six months ended June 30, 2003, we sold gathering, transmission and processing assets to two separate buyers for a combined sales price of approximately $90 million. These assets comprised a component of the Company for purposes of reporting discontinued operations. All prior period operations have been revised to reflect these assets as discontinued operations.

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     The following table sets forth selected financial information associated with the assets discussed above which are accounted for as discontinued operations:

4. Derivative Instruments, Hedging Activities and Credit and Risk

Commodity price risk —The Company’s principal operations of gathering, processing, transportation, marketing and trading and storage of natural gas, and the accompanying operations of fractionation, transportation, trading and marketing of NGLs create commodity price risk exposure due to market fluctuations in commodity prices, primarily with respect to the prices of NGLs, natural gas and crude oil. As an owner and operator of natural gas processing and other midstream assets, the Company has an inherent exposure to market variables and commodity price risk. The amount and type of price risk is dependent on the underlying natural gas contracts entered into to purchase and process raw gas. Risk is also dependent on the types and mechanisms for sales of natural gas and natural gas liquid products produced, processed, transported or stored.

Energy trading (market) risk —Certain of the Company’s subsidiaries are engaged in the business of trading energy related products and services including managing purchase and sales portfolios, storage contracts and facilities, and transportation commitments for products. These energy trading operations are exposed to market variables and commodity price risk with respect to these products and services, and may enter into physical contracts and financial instruments with the objective of realizing a positive margin from the purchase and sale of commodity-based instruments.

Corporate economic risks —The Company enters into debt arrangements that are exposed to market risks related to changes in interest rates. The Company periodically uses interest rate lock agreements and interest rate swaps to hedge interest rate risk associated with debt. The Company’s primary goals include (1) maintaining an appropriate ratio of fixed-rate debt to total debt for the Company’s debt rating; (2) reducing volatility of earnings resulting from interest rate fluctuations; and (3) locking in attractive interest rates based on historical rates.

Counterparty risks —The Company sells various commodities (i.e., natural gas, NGLs and crude oil) to a variety of customers. The natural gas customers include local utilities, industrial consumers, independent power producers and merchant energy trading organizations. The NGLs customers range from large, multi-national petrochemical and refining companies to small regional retail propane distributors. Substantially all of the Company’s NGLs sales are made at market-based prices, including approximately 40% of NGLs production that is committed to ConocoPhillips and Chevron Phillips Chemical LLC, under a contract with a primary term that expires on January 1, 2015. This concentration of credit risk may affect the Company’s overall credit risk in that these customers may be similarly affected by changes in economic, regulatory or other factors. On transactions where the Company is exposed to credit risk, the Company analyzes the counterparties’ financial condition prior to entering into an agreement, establishes credit limits and monitors the appropriateness of these limits on an ongoing basis. The corporate credit policy prescribes the use of master collateral agreements to mitigate credit exposure.

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The collateral agreements provide for a counterparty to post cash or letters of credit for exposure in excess of the established threshold. The threshold amount represents an open credit limit, determined in accordance with the corporate credit policy. The collateral agreements also provide that the failure to post collateral is sufficient cause to terminate a contract and liquidate all positions.

     Physical forward contracts and financial derivatives are generally cash settled at the expiration of the contract term. These transactions are generally subject to specific credit provisions within the contracts that would allow the seller, at its discretion, to suspend deliveries, cancel agreements or continue deliveries to the buyer after the buyer provides security for payment satisfactory to the seller.

     Commodity cash flow hedges —The Company usesWe may, from time to time, use cash flow hedges, as specifically defined by SFAS No. 133, to reduce the potential negative impact that commodity price changes could have on the Company’sour earnings and its ability to adequately plan for cash needed for debt service, dividends, capital expenditures and tax distributions. The Company’s primary corporate hedging goals include maintaining minimum cash flows to fund debt service, dividends, production replacement, maintenance capital projects and tax distributions; and retaining a high percentage of potential upside relating to price increases of NGLs.

     The Company usesWe use natural gas, crude oil and NGLsNGL swaps and options to hedge the impact of market fluctuations in the prices of NGLs,NGL, natural gas and other energy-related products. For the three and six months ended June 30, 2004, the recognition in the Consolidated Statements of Operations of the cumulative changes in the fair value of these hedge instruments reduced revenues by $23 million and $41 million, respectively, compared to $24 million and $63 million, respectively, in the same periods of 2003. The above changes in the fair value of these hedge instruments include the effects of any ineffectiveness, which for the six months ended June 30, 2004 and 2003, the Company recognizedwere a net loss of $63.2 million, of which a $3.0$1 million gain represented the total ineffectiveness of all cash flow hedges and a $66.2$3 million loss, represented the total derivative settlements.respectively. No derivative gains or losses were reclassified from AOCI to current period earnings as a result of the discontinuance of cash flow hedges related to any forecasted transactions that are not probable of occurring.

     Gains and losses on derivative contracts that are reclassified from AOCI to current period earnings are included in the line item in which the hedged item is recorded. As of June 30, 2003, $51.42004, $16 million of the remaining deferred net losses on derivative instruments in AOCI are expected to be reclassified into earnings duringwithin the next 12 months as the hedgehedged transactions occur; however, due to the volatility of the commodities markets, the corresponding value in AOCI is subject to change prior to its reclassification into earnings. The maximumremaining term over which the Company iswe are currently hedging itsour exposure to the variability of future cash flows is three years.through the end of 2004.

     Commodity fair value hedges—The Company uses We use fair value hedges to hedge exposure to changes in the fair value of an asset or a liability (or an identified portion thereof) that is attributable to price risk. The Company hedgesWe may hedge producer price locks (fixed price gas purchases) and market locks (fixed price gas sales) to reduce the Company’sour exposure to fixed price risk via swapping out the fixed price risk for a floating price position (New York Mercantile Exchange or index based).

     For the six months ended June 30, 2003,2004, the gains or losses representing the ineffective portion of the Company’sour fair value hedges were not significant.material. All components of each derivative’s gain or loss are included in the assessment of hedge effectiveness, unless otherwise noted. The CompanyWe did not have any firm commitments that no longer qualified as fair value hedge items and therefore, did not recognize an associated gain or loss.

     Interest rate fair value hedge hedges—In October 2001, the Companywe entered into an interest rate swap to convert the fixed interest rate$250 million of $250.0 million offixed-rate debt securities that were issued in August 2000 to floating rate debt. The interest rate fair value hedge is at a floating rate based on a six-month London Interbank Offered Rate (“LIBOR”), which is re-priced semiannually through 2005. In August 2003, we entered into two additional interest rate swaps to convert $100 million of fixed-rate debt securities issued on August 16, 2000 to floating rate debt. These interest rate fair value hedges are also at a floating rate based on six-month LIBOR, which is re-priced semiannually through 2030. The swap meetsswaps meet conditions which permit the assumption of no ineffectiveness, as defined by SFAS No. 133. As such, for the life of the swapswaps no ineffectiveness will be recognized. As of June 30, 2003,2004, the fair value of the interest rate swap of $16.3swaps was a $6 million wasasset, which is included in the Consolidated Balance Sheets as Unrealized Gainsgains or Losseslosses on Tradingmark-to-market and Hedging Transactionshedging transactions with an offset to the underlying debt included in Long Term Debt.term debt.

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     Commodity Derivatives — Trading and Marketing—The trading and marketing of energy related products and services exposes the Companyus to the fluctuations in the market values of traded instruments. We manage our trading and marketed instruments. The Company manages its traded and marketed instrument portfoliosmarketing portfolio with strict policies which limit exposure to market risk and require daily reporting to management of potential financial exposure. These policies include statistical risk tolerance limits using historical price movements to calculate a daily earnings at risk measurement.

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4.5. Asset Retirement Obligations

SFAS No. 143,“Accounting for Asset Retirement Obligations.”In June 2001, the FASB issued SFAS No. 143 which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The standard applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or normal use of the asset. The Company’s asset retirement obligations relate primarily to the retirement of various gathering pipelines and processing facilities, obligations related to right-of-way agreements and contractual leases for land use.Obligation

     SFAS No. 143 requires thatThe following table summarizes changes in the fair value of a liability for an asset retirement obligation be recognizedfor the six months ended June 30, 2004 and 2003, respectively.

6. Goodwill and Other Intangibles

     The changes in the period in which it is incurred, if a reasonable estimate of fair value can be made. The fair value of the liability is added to the carrying amount of goodwill for the associated asset. This additionalsix months ended June 30, 2004 are as follows:

     There were no impairments of goodwill during the six months ended June 30, 2004.

     The gross carrying amount is then depreciated overand accumulated amortization for commodity sales and purchases contracts are as follows:

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     During the life of the asset. The liability increases due to the passage of time based on the time value of money until the obligation is settled.

     The Company identified various assets as having an indeterminate life in accordance with SFAS No. 143, which do not trigger a requirement to establish a fair value for future retirement obligationssix months ended June 30, 2004 and 2003, we recorded amortization expense associated with such assets. These assets include certain pipelines, processing plantscommodity sales and distribution facilities. A liabilitypurchases contracts of $5 million. The average remaining amortization period for these asset retirement obligations will be recorded if and when a future retirement obligationcontracts is identified.

     SFAS No. 143 was effectiveapproximately 7 years. Estimated amortization for fiscal years beginning after June 15, 2002, and was adopted by the Company on January 1, 2003. At January 1, 2003, the implementation of SFAS No. 143 resulted in a net increase in total assets of $25.1 million, consisting of an increase in net property, plant and equipment. Long term liabilities increased by $42.5 million, which represents the establishment of an asset retirement obligation liability. A cumulative-effect of a change in accounting principle adjustment of $17.4 million was recorded in the first quarter of 2003, as a reduction in earnings.

     The following table shows the asset retirement obligation liability as though SFAS No. 143 had been in effectthese contracts for the prior three years.

General Insurance— We carry insurance coverage, with an affiliate of Duke Energy, that management believes is consistent with companies engaged in similar commercial operations with similar type properties. Our insurance coverage includes (1) commercial general public liability insurance for liabilities arising to third parties for bodily injury and property damage resulting from our operations; (2) workers’ compensation liability coverage to required statutory limits; (3) automobile liability insurance for all owned, non-owned and hired vehicles covering liabilities to third parties for bodily injury and property damage, and (4) property insurance covering the Company.replacement value of all real and personal property damage, including damages arising from boiler and machinery breakdowns, earthquake, flood damage and business interruption/extra expense. All coverages are subject to certain deductibles, terms and conditions common for companies with similar types of operations.

7.     We also maintain excess liability insurance coverage above the established primary limits for commercial general liability and automobile liability insurance. Limits, terms, conditions and deductibles are comparable to those carried by other energy companies of similar size.

Environmental- The operation of pipelines, plants and other facilities for gathering, transporting, processing, treating, or storing natural gas, NGL and other products is subject to stringent and complex laws and regulations pertaining to health, safety and the environment. As an owner or operator of these facilities, we must comply with United States and Canadian laws and regulations at the federal, state and local levels that relate to air and water quality, hazardous and solid waste management and disposal, and other environmental matters. The cost of planning, designing, constructing and operating pipelines, plants, and other facilities must incorporate compliance with environmental laws and regulations and safety standards. Failure to comply with these laws and regulations may trigger a variety of administrative, civil and potentially criminal enforcement measures, including citizen suits, which can include the assessment of monetary penalties, the imposition of remedial requirements, the issuance of injunctions or restrictions on operation. Management believes that, based on currently known information, compliance with these laws and regulations will not have a material adverse effect on our consolidated results of operations, financial position or cash flows.

Severance Program— On October 30, 2003, we communicated a company-wide voluntary and involuntary severance program to our employees to reduce approximately 6% of our workforce. The plan was completed on December 8, 2003 and included the reduction of 160 employees over the period from December 2003 through 2004. The severance liability that was recorded in the fourth quarter of 2003 was $6 million at December 31, 2003. Included in General and administrative expense in the Consolidated Statement of Operations during first quarter of 2004, the Company expensed an additional $1 million related to this severance program. The following table summarizes changes in the severance liability for the six months ended June 30, 2004.

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9. Business Segments