ML20206H979

New England Electric Sys Annual Rept,1985

ML20206H979
Person / Time
Site:	Millstone, Seabrook, 05000000
Issue date:	12/31/1985
From:	Bok J, Huntington S NEW ENGLAND ELECTRIC SYSTEM
To:
Shared Package
ML20206H943	List: ML20206H948 ML20206H960 ML20206H979 ML20206J033 ML20206J040 ML20206J046 ML20206J052 ML20206J057 ML20206J067
References
NUDOCS 8606260374
Download: ML20206H979 (44)

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On the cover:

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A lineman installs conductor spacers or the direct current transmission line that will bring low-cost energy to New England from Quebec.Thisseguntof thelineis located near Comerford Stationin

.i New Hampshire.

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Financial Highlights

• 1985 1984 1983 Earnings per average share 5 3.15 5 3.02 5 2.74 Dividends declared per share 5 1.83

$ 1.725 5 1.625 Annual dividend rate-year end 5 1.92 5 1.80

$ 1.70 Book value per share-year end

$ 18.81 517.44 516.13 Alarket price per share-year end

$25.00

$ 18.50

$19.50 Return on average common equity 17.3 %

18.0 %

17.6 %

• Adiusted to reflect two-for.one common share spht for sbarcholJers of record on January 24.1986 Book Value Per Share-Year End Alarket Price Per Share-Year End Adjusted to reflect two-for-one Adjusted to reflect two-for-one common share split common share split

$26.00

$26.00 i

24.00 24.00 22.00 22.00 20.00 20.00

$196 1

$18.81

$jgg

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18.00

$ 17,44 18.00 I

$16.13 16.00 16.00

$14.95

$14.14 14.00 14.00

$12%

12.00 12.00 10.00 10.00 1981 1982 1983 1984 1985 1981 1982 1983 1984 1985 l

t i

New England Electric System (NEES) is a public nities. Other subsidiaries include a wholesale gen-utility holding company headquartered in erating company, New England Power Company, Westborough, Massachusetts. Subsidiaries include which operates 21 generating stations; an oil and gas l

three retail operating companies-Massachusetts exploration and fuels company, New England Electric Company, which serves 829,000 customers Energy Incorporated; a transmission service com-in 146 Massachusetts communities; The Narra-pany, New England Electric Transmission Cor-gansett Electric Company, which serves 288,000 poration; a conservation service company, NEES customers in 27 Rhode Island commur.ities; and Energy, Inc.; and a service company, New England l

Granite State Electric Company, which serves Power Service Company.

l 30,000 customers in 21 New Hampshire commu-l 1

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We believe our emphasis on low costs to our cus-7 gp., 4.

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tomers increases the likelihood that our regula-

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V tors will allow us to earn good returns for our shareholders.

Rate case activity was modest in 1985, with our three retail subsidiaries reducing their rates by a total

DearShareholder:

of $18.6 million. At the wholesale level, our gen-1985 was a good year for both you, our investors, erating subsidiary has reached a partial settlement and our customers-earnings were up and our aver-of a rate increase request filed with the Federal age cost per kilowatthour was down.

Energy Regulatory Commission last summer. The partial settlement, which is subject to Commission Our earnings per average common share, after approval, permits an annual rate increase of $40 mil-adjustment for a two-for-one share split, were a rec-lion. The settlement reflects mclusion in rate base of ord $3.13-a 17.3 percent return on average com-our full investment in the Millstone 3 nuclear unit as mon equity. In November, the Board of Directors

' " """"" * """' I " * * "i I P"' 'I "' A P '~

increased the annual dividend rate from $1.80 to tion of the increase is subject to refund pending the

$ 1.92 per share, the seventh increase in hve years.

Dividends declared in 1985 represent a pavout of

"".*"* """.wes@ don of our request to remer our nwestment m the Seabrook 2 nuclear unit.

58 percent of earnings.

1985 System kilowatthour sales to ultimate cus-In November, the Directors approved the two-for-tomers increased by 2.6 percent over 1984 sales.

one split of outstanding common shares. Share-Tiu.s rate of growth is about one-half the annual holders of record on January 24,1986, received one growth experienced in 1983 and 1984, but close to additional share for each share then owned.

our ten-year average growth of 2.5 percent per year.

The average cost per kilowatthour to ultimate cus-Although the economic upturn of the past two years tomers decreased by 4.5 percent in 1985 and is now has leveled off, the local economy is still strong.

lower than it was in 1981. This lower price level con-We are currently projecting that we can keep our tinues to place us m. the low-cost third of major elec-long-term kilowarthour growth under two percent tric utih.. ties m New England. The decline in cost per annually. We recognize, however, the uncertainty of kilowatthour is the product of our successful coal this projection and the need for flexible plans to meet conversions, significantly lower coal and oil prices, a range of possible growth rates. Our new 15-year and continued strict attention to cost control. The corporate plan, NEESPLAN 11, stresses balanced plan-conversion of 1,500 megawatts of od-fired generat-ning to meet our customers, future needs at the low-i ing capacity to coal burning has already saved our est cost. The report that follows this letter discusses customers more than $300 million.Thanks to lower the balanced planning process and the status of our coal prices and our coal-fired, coal-carrying ship,

+

efforts to implement NEESPLAN II.

Energy Independence, our deh.vered cost of coal has declined by 20 percent in the last five years.

2 w

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Good progress was made in 1985 toward complet-Frederic E. Greenman was elected vice president and ing the 1,150 megawatt hiillstone 3 and Seabrook 1 general counsel of the System, effectiveJune 1,1985.

nuclear units. Millstone 3, in which we have a 12 Mr. Greenman is a former assistant attorney general percent interest, received its operating license from for Massachusetts and has been a member of the the Nuclear Regulatory Commission on January 31, System's legal department since 1969.

1986, and is expected to reach commercial opera-tion this spring. Construction of Seabrook 1,in We were saddened by the death in September of Robert E Krause who retired as chairman of the which we have a 10 percent interest, was 95 percent complete by the end of the year. Although project NEES board at the end of 1977, after nearly 30 years management's target for commercial operation of service. Mr. Krause joined the System in 1948 and remains October 31,1986, regulatory proceedmgs was elected president in 1963. He served as the Sys-concerning emergency response plans for the area tem's chief executive officer from 1970 through 1973*

around the plant could significantly delay, or possibly even prevent, commercial operation.

We are proud of the dedicated service of our 5,000 We also made good progress in 1985 toward empl yees thmugu%e year and especiaHy foHow-completing the direct current transmission link ing Hurricane Gloria m September. Once aga,n, i

between New England and Hydro-Quebec. Phase 1 empi yees e rned financial bonuses through our "8'# * ' *### 8

1. 1. • "88' of the project is expected to be completed this sum-mer, at which point New England will begin import-customer cost, safety, and other operational goak ing approximately three billion kilowarthours of The outstanding efforts of our employees contmue to serv ur cust mers and shareholders well.

electricity annually. In October, the New England Power Pool and Hydro-Quebec signed a firm energy contract for a second phase, bringing an additional

(& 71(

seven billion kilowatthours a year to New England beginning in 1990. System subsidiaries will build and operate both the Phase 1 and Phase 2 facilities.

Joan T. Bok While declining oil and gas prices have helped lower Chairman the rates to our customers, they have hurt the eco-nomics of our oil and gas program. As a result, we i

do not expect to report any profits in the foreseeable 6 -

=t' future from our current investments in this business and could incur shareholder losses. Due to the Samuel Huntington uncertainty associated with our oil and gas program President and l

caused by the precipitous decline in market prices, ChiefExecutive Officer our independent auditors have qualified their opin-ion on our 1985 financial statements. Please see page February 27,1986 13 for further discussion of this program.

3

s

[ Energy Conservation All participating custom:rs in the

! During 1985,the System introduced z nes are {fered free energy audits.

For mdustnal and commercial cus-its Enterprise Plan, a comprehensive, t mers, the Massachusetts retail sub-multifaceted energy conservation sidiary will pay the installation costs I demonstration program incorporating IS *e c nservan n measures, based i conservation measures for both resi.

n Projected or realized savings in

[ dential and commercial / industrial electricity usage. For residennal

' customers in 20 Massachusetts cust mers, the subsidiary will finance

, communities.The communitiet are 2 grouped into two Enterprise Zones in

< central and western Massachusetts.

d l

The New England Economy Continues to Grom designed to avoid the financial risks that would be increased sales generated by the strong New England associated with sole reliance on a major construc-economy and the System's continuing efforts to hold tion program to meet our customers' future needs.

costs down made 1985 an excellent year for the Sys-Finally, providing good service at low cost to cus-tem, its customers, and its shareholders, tomers is the best way to show our regulators that we are doing a good job, thus helping to ensure that During 1983, sales to ultimate customers increased we are given the opportunity to earn a fair return on by 2.6 percent, driven largelv by the continuing our utility business.

growth m. the high technology, trade, and service industries that predominate in our service territory.

Under Balanced Planning, we evaluate and imple-This increase follows two years when sales have ment an array of programs to meet our customers' grown more than five percent. The strong sales needs for a reliable,least-cost supply of electricity.

growth has produced excellent short-term results, On the demand side, we use conservation and load but it highlights the longer-term challenges that management to save energy and control demand.

we face in planning for a reliable,least-cost supply On the supply side, we plan to extend the lives and for our customers. To meet these chailenges, the improve the performance of our existing power System announced in 1985 a new corporate plan, plants, encourage the development of alternate energy production in our service territory, and pur-NEESPIAN II.

ther sources of economical generation. Under su Balanced Planning:

the Balanced Planning approach, all options are The Cornerstone o[xrtsviax si The heart of NEEsPuN ii is Balanced Planning-the

?v lu ted consistently and the best mix of options is implemented to meet the NEESPLAN 11 goals. Rather consistent economic evaluation of all resources avail-than rely on a sm.gle solution to meet our customers, able to serve the electricity needs of our customers.

needs, we expect to achieve least-cost, reliable ser-The plan focuses on demand-side measures as well vice with a portfoh.o of energy investments that both as the more traditional supply-side solutions. Its control demand and increase supply.

goals are to provide an adequate supply of electricity l

to our customers at the lowest possible cost and to encourage our customers to use electricity efficiently.

l By developing least-cost solutions for our customers, we enhance the likelihood of consistent returns for l

our shareholders. First, a least-cost plan protects our revenue base in an era of growing competition within our industry. Second, the diverse and flexible solutions developed under Balanced Planning are 4

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Photovoltaics The projectis being conductedin Gardner, Massachusetts.'llirty As part ofits ongoing renewable homes, as well as the libraq

' y hall,

, energy and conservation programs, a local restaurant, store, and commu-the System initiated a $1 million nity college, will be equipped with model Photovoltaic Community P otovoltaic systems, which convert h

Research Project in 1985. It is one sunlightintoelectricity. Allof the of the largest research orojects of its homes are located close together so typein the nation.

that data can be obtained on the impact of a cluster of systems on the A

The plan is diverse and flexible, permitting us to installing a cluster of photovoltaic systems in Gard-respond quickly and efficiently to changes in eco-ner, hiassachusetts. This project is one of the largest nomic conditions. For example, we currently esti-of its typt in the nation. The project will help deter-mate that our average annual load growth will be mine the effects of photovoltaic systems on local dis-under two percent, leading to a need for new gener-tribution facilities. It will also allow us to evaluate ating capacity in the year 2001. However, if the their performance and customer acceptability under recently experienced above-average load growth con-a range of operating conditions.

tinues, the need for additional generation could be In addition, we have implemented a one-way radio advanced sigmficantly. By focusing on the demands control load management program m Rhode of our customers, we can h.. he uncertainty asso-mit t Island and a batch solar water heating program in ciated with this growth. By implementing a wide N,ew Hampshire.

range of projects, we can ensure that adequate sup-plies are available. By limiting the size of our con-We are also helping our customers use electricity struction program, we reduce the risk to both our efficiently through supporting legislation mandating customers and our investors.

energy-efficient appliance standards and by making The implementation of NEESPLAN !! is well under

""". tion services available to large customers.

NEES Energy, our shared savings subsidiary, contin-way. The following sections summarize the progress ues to help its customers ach.ieve sigmficant conser-that was made in the past year.

varion of energy. The energy savings produced by Energy Consertution NEES Energy range from 10 to 40 percent. During and Load Afanagement Programs 1985, new customers included the Providence public During 1985, we embarked on an innovative conser-school system in Rhode Island, a hospital and the vation project-the Enterprise Plan. The plan covers public school system in Worcester, Alassachusetts, 20 Alassachusetts cities and towns. It includes sev-and the University of Rhode Island.

eral conservation incentives offered to the 35,000 All of these programs fonr.he foundation for the resident al, commercial, and industrial customers System s future conservation and load management m these communities. We are using shared savings, mitiatives. The practical experience from these low-ctst financing, and outright grants to spur con-programs is essential to ensure that the technology servation by our customus. The data we gather m.

works and that the programs are both acceptable to the pmgram will assist us in designing an efficient, customers and can be implemented efficiently and eau, and etfective conservation program for System-fairly. These n...utiauves w>ll help prepare us to imple-wide implementab.on.

ment conservation and load management across our We are also continuing our evaluation of new tech-System when it is appropriate under the consistent nologies. As part of the Enterprise Plan, we are economic criteria specified in NEh5 PLAN II.

i 6

same distribution tecJer ; ht u sterns u dtaic equipnient atul its ;witential of partiupation in the l(H L kilow att, w III he monitored for two scars.

use in helpmg to meet our customers' tcJeralls supportcJ mstallation at a I hri> ugh this new pri> grani, the 5s s-my m hd wbnd m Md hm6m te'n W i!I lc.lin nitirt ahinut the p<iten-

'I he pri>ic< t.ilvi is.iimed.it helping tii Phi >t < > Sciit t.\\1i< h.itid aial l< >hii P<in-tial impJtt of.I signlhtant sat dration dcsclop New I ngland's fledghng solar tiatow ski ot.\\ds anteJ k nergy Sys-( nt phi >ti ni d t ai< s i >n < >iir dist ribut iiin ph< >ti nidtai< indtistrs.

teiiis, In<. install ph< >tinidrait p.iiicls u stem. \\\\ c w Ill (tht.lin data < >n t he iin a h< >Inc In (,a rJ nct,.\\ t au.it h tisetts.

I he proicct adds to the extensne pcrt< >rma nt t i st t urrcnt si d.lr phi nt( >-

phiirinidt.iic experiente that t he 5s s-t< m has gained through its tour scars N.5 m5

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Availability improvement is a second (Photo, far left) Vernon Station in element of the plant life extension pro-Vernon, Vermont, the System's oldest gram.The term refers to the percent generating plant, which began opera-of time a generating unit is available tion in 1909,is an example of a plant i for service. We have set an availability functioning well as a result of a care-I target for thermal units of two to four ful,long-term maintenance program. percent above the national average for (Photo, left) George Webster, superin-similar urits. For hydro units, our tendent, and crew members prepare to goal is to maintain their current high install a new water wheelin the tur-availability. bine pit of a Vernon hydroelectric unit. Existing Incilities: Plant Life Extension The successful performance of our coal-fired, self-NEESPLAN II recognizes that our existing facilities . unloading coal ship, the Energy Independence, has are one of our most valuable resources for the future. helped reduce the delivered cost of our coal. Three These facilities were built at a fraction of the cost of factors-coal conversion, changes in energy markets, new generating capacity. Thanks to our coal conver-and an aggressive approach to fuel procurement sion program, they generate electricity with a and transportation-have resulted in fossil fuel costs diverse, low-cost mixture of fuels. in 1985 that were 36 percent lower than in 1981. NEESPLAN H is designed to preserve and expand the Alternate energy, nuclear power, and hydro power benefits that our existing plants produce. We are supply the remaining 23 percent of our customers' evaluating all of our existing facilities against our needs. In future years, the contribution from these least-cost planning criteria and, if economically three components will increase, further diversifying justified, plan to make the appropriate capital invest-our energy mix and reducing the impact associated ments necessary to extend their lives. In addition, we with a supply or price disruption in any fuel. will be taking steps to maintain or improve, where g,Mources of Electricity: appropriate, the operating performance of these Alternate E,nergy Supplies plants throughout their extended lives. Aggressive Under NEESPLAN II, the System,s emphasis on performance targets have been established for all of alternate energy has continued. We have m.ereased our plants, and we are enhancing our maintenance our long-term alternate energy projecnon to 300 i and operating practices in a manner that will ensure I megawatts. that the targets are met. 1 Alternate energy is becoming a significant source of Fuel diversity is central to our long-term planning. electricity on our system. We now have 210 mega-Six of our major generating units at Brayton P..oint watts operating on the system and 100 megawatts and Salem Harbor stations have been converted i under contract for future operation. Trash-burning from o.l to coal. In 1979,78 percent of our electnc-plants are the largest alternate energy source in our itv was generated with oil. In 1985, that figure was service territory. In addition, many customers are 32 percent and coal provided 43 percent. The con-now evaluating cogeneration as an option. A new versions have already reduced our customers, costs alternate energy pricing poh.ey should allow us to by more than $300 million. capitalize on these sources while ensuring that our primary goal-an adequate supply of electricity at the lowest possible cost -is achieved. 9

-Ry f& ' Alternate Energy / p *p / As of the end ot 1985, the System had t h,d ugned power purchase agreements

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5-As part of NEESPLAN 1:, the System k h.*1, /h with hse trash-to-energy facihties in 4 x-anticipates obtaining 500 megawatts 2 .. Yi of capacity from renewable sources of (,: r b .E New E.ngland, totahng about 160 a- ~ 9 -, _, f. 3. J c. megawatts. Iwo of these projects are +. energy by the year 2000. A large com-f

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-n. m ..: m . 4./ currenth producing electricity, pro-ponent of this capacity is expected to am- ? .t .. '.1 viding a total of 70 megawatts of m- -c come from trash-to-energy facd. ities, .3. 4 ;' y, A, / " capacity to the System s energy mix. which we estimate can provide more 19e -..?. They dnplace approximately,< 00,000 3., n. ,. u than 180 megawatts. .. ?g 53....O. yd NL. t barrels of oil per year. ~- .4 . _] f... Q.., -(,'.k, r ., C c w

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~ & q ; W [g Neic Nntrces of I lectricity: y 3 Millstone l ~ nit 3.inti vibroui l ' nit I ,.~ f h ,a $j ;MM$w% y3li.= a... I he hvstem's wh(>lesale stibsidi.iry (>w iw a ix)rti()ii (it . # 9@'@ h [ a A 'MRWA two nuclear units now tinder u nhtrtlCrion. It h.n a hjki 12 percent, or 140 megawatt, ou nership interest in Millst()ne [Init 5 and a l(l pertent, or lI 5 Micpaw atI, k [ M p Q[ N D,h,$ @ W ownership interest iii seabrook l' nit 1. Millstone i$d vp pg M < [Illit $ reCelVed its ()perating IICelbe if(llli the NtiClear !MM $P--EbMNS%A [(egtllat()ry C()Minllwion in lantiar) l 9S6, and sh()tild 6 Q, Si&$;.KC$i;SQgl, QNQ FQq y he in service bv Mav 19S6. I~he onwtrtiCri()n schel we,., ,'~W <~ w7 / W. N e T,,W5 WQR kWhNNSFNM%, w g. N -x. Q -: ule for heabrook l' nit I still targets ()Ctober $1, . f^ W: - -y q g _ u p @- w.W.@w : a l%h tor a)mmercial (>peratit)n. II)weser, reglila- -b .4y'W .--c y; y$@ y#,'_ r 5 M tory pr()Ceedings a)tild signlNCantl) delas, < >r p()wl- .a 4 bly CVen present, CommerCla} ()perati(in. See N(ite 'Mp.A, 9 R- . ~ G Sw.g@y s s xe P, g Wgn.4.gggg#1 b-4 ()I D.()tes t() b.lilanClal htatements.,.T.he a >m-yj n t y.q gg'* .p hu ~~. 5t.gby : q - v gg-m~u a. ~yq e@f4 ; +!. c-plCtlon (4 these units uill pr() vide an inip()rtaiit n 33 1 sollrCe of new base-l()ad pencrating CapaClty f()r the 6% s p.: i... n ' - hVstCm alid t()r New 'ngland as a whi>le. I he tinits <'C Wil! also make a signifiCant Contribution tow ard diVerslIVing ()ttr Iuel v)ttrCes. The high onts arid l(>iig lead tiines asv>Ciated u ith these and other large geiierating tinits ar(>tind the Collntry highhght the nuportanCe or the Balanced I'lannliig apprt)aCh t(> l(>ng-teriii titility planning. [Ising this to(>l, we will neither rels exCitisisels <>ii new alihtitlCilon as the v>le v)ltiti(>ii t(> ( >tir tuttire sllpplV obhgatl(ith, n()r rtile () tit a)lhtitiCil()n as an ()ptioli. Ikather, it will be intllided With a}l ()ther ()ptilifh to prodllCe the Ic.nt-a nt, long-teriii plan. ~- The result will be a balanced, tleuble. and dnerst solution that produces the least Cost to Customers _R under a range ot economic Conditions. Valles } h dri> < >n the Pau ruset Itner m Rhode Island is representatne of th< 11 small hs Jro unus inon whhh the % stem bus s enero. Valles l h dro 7 10

-p e One of these projects, completed m pnyects and will pursue ways to ' [ -;ij 1985, is the Signal Environmental Sy s-encourage their development. Wi$ tems Inc. trash-to-energy facihty m C An#N ,~.D < Photo, lefti Up to 1,500 ions or trash m.w, y-yc

x North Andoser, Massachusetts. The per day are consumed at the Signal q

plant burns trash from more than 20 Em ironmental Systems Inc. facility m communities. Water heated by the North Andoser. IPhoto, right) The' I. l* burning trash becomes steam that Si nal tmlin is gmd with emis-Y6hff ~ dnves a turbme generator to produce , ion-control ss stems that clean emis- 'I"' " '" F-sions betore fiue gases reach the stack. - + The System u di contmue to negotiate contracts with tuture trash-to-energy Neu soun es of I let tru ity: llulropuchec l'ro/cct ( (>ilslstellt u lth si i si i -x s ii, ac hase taken lead n >le li' t he c( >nst rth ti()l1 i)I.1 direc t t tirrent liltert( H) ilettit)n betuce!) New I Mglaihl.lih} IInln >-()llebet that u!il allow us to retene hulroclectric energs f rom the hu e James Bas proicct. l'nder Phase I ot the proiett, we are buikhng direct current trans-gg _ -~ aAM_- .nission tacihties and a conserter termmal near f' -l.[$ ( Gwkw c ' T' s. O -ANo u I Ianl}whlrc. ( ()nstrucil()ll is pn >teeding ahead ()I 4,"i{.. "(.QWA [ m m. I l11 Phase 2 < >t the pn >ict t, the interc(>nilettit)n's ps. Cap.lcl[s u ill be e\\palldell In)lH h9(I t(I 2,I h N I Illegaw atts,.lik! the tralismiwi(ni t.icilities w ill be e\\tclklct} int () Maw.ithtisetts. 'I he Phase 2 pn >icct is n()u in the licensing pn >cew, aiki carlv decisi(nis has e beell tas(>r.lble. ( ()nstrlletl(H1 is schedtiled t() beuiti iii 19S' alkl [() bt c()n1pleted Jtiriiig 1991) w hen the Phase 2 aintract beo)ines ettective. l ike the other elements of si i si>i u u, the Il>Jro-()tlebet pn >]ect niects ()tir criteria f()r least-u)st plan-ning. l'he hs stem's share (>t the purthases, about IS perteilt, still Jisersitv ()tir cilergs iiii\\, li)uer ()tir ellergs u)sts,.llhl pn) vide rellabl!lt v aild Cap.lCity benefits t, our customers. The proicct is an napor Iani elenlent ill ()tir lt Hld-ternl fialdilCet} Plall. pf(idthed 1.2 iiiillniii Lilt m arth iurs t il pt nu Cl In l 9% 5, displ it Ilie 2,I h h I b,li reI% t if i1ll. }l

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megawatts.Two New England Elec-10 years beginningin 1990.The cost tric System subsidiaries will expand of this electricity will be below the the interconnection for this phase costof the fossil fuelenergyit will along an existing right-of-way. As a displace. result of the firm energy contract for (Photo) Hydm-Quebec's La Grande 3 Phase 2, signed in October 1985, Hydro-Quebec will sell to New facility alone has a generating capac-ity of more than 2,000 megawatts. It England an additional 7 billion kilo-is one of several facilitiesin the La warthours of electricity per year for y Grande complex. ,y x Oiland Gas Exploration Program which is regulated by the Federal Energy Regulatory After the 1973 oil embargo, the Securities and Commission (FERC). In any contested FERC pro-Exchange Commission (SEC) authorized the System ceeding involving the recovery of such losses, we to create a new subsidiary to find and develop oil would rely on the modified pricing policy approved and gas properties in the United States. The objective by the SEC and the fact that the old program has was to ensure for the benefit of our customers the been conducted in the interest of ratepayers. availability of secure, reasonably priced fuels. As However, we do not have assurance that FERC originally authorized, the return to shareholders would allow recovery. If FERC denied recovery, we from the business was fixed at that allowed on elec-would be required to write down the value of our oil tric utility operations, and savings or losses were and gas properties. Based on year end 1985 to be reflected in fuel costs to electric customers. prices and oil and gas reserves, the write-down Through 1985, fuel savings from the program of would be about $130 mi? lion after tax, and subse-about $10 million have been passed on to customers. quent declines in market prices would increase this We were successful last year m obtaining an order amount. In the event of disailowance of recovery, from the SEC approving a modified pricing poh. New England Energy Incorporated (NEEI) might ev defining the way we account for the program. As termmate the modified pricing policy. From then on, a result of the new policy, profits and losses from profits and losses from both the old and new pro-grams would be retained by NEES. (See Note A-3 investments in new oil and gas prospects from the of,, Notes to Fm.ancial Statements.',) beginning of 1984 on will be solely for the account of our shareholders. We expect the old program, As a result of the sharp declines in market prices, we consisting of pre-1984 prospects and encompassing expect investments in new prospects in 1986 to be most of our investment to date, to continue to be tied modest. Our continuation in the business is subject to our utility business for at least a number of years. to annual review and to approval of the SEC. The impact of precipitous declines in oil and gas Balanced Planning WillContinue market prices in recent months now makes it likely The fundamentallesson of the past 15 years, that no that the old program v.ill generate losses. If oil and single best option exists for our energy future, con-gas market prices do not increase, there is the further tinues to guide the New England Electric System. We prospect that these losses could substantially exceed will continue to develop new programs and strate-a $13 million after tax accoutaing reserve ue.:ted for gies to implement all options of our long-range plan, that purpose. Under the modified pricing policy, any NEESPLAN II. In this way, we will strive to maintain such excess losses would be passed to our wholesale an adequate supply of electricity for our customers generating subsidiary, New England Power Com-at the lowest possible cost and to continue to provide pany (NEP). NEP, in turn, would seek recovery of a good return for you, our shareholders. these costs from its customers under its fuel clause, 13

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Financial Review Earnings and Earnings per average share for 1985 rose four 58 percent payout of earnings. dividends percent to $3.15 compared with $3.02 in 1984, In November 1985, the Board of Directors after adjustment for a two-for-one common share declared a two-for-one common share split for split. Over the last 10 years, earnings per share shareholders of record on January 24,1986. All have increased at a compound growth rate of 10 per share amounts have been adjusted to reflect percent. The annual dividend rate was raised 6.7 the split. The market price of New England Elec-percent or 12 cents per share in November 1985, tric System (NEES) common shares was $25 per and now is $1.92 per share on an annual basis. share at year end, which is 133 percent of year Dividends of $1.83 declared in 1985 represent a end book value. OperatingE nue The $42 million decrease in operating revenue tially offsetting this decrease was a 2.6 percent in 1985 was primarily due to a reduction in fuel increase in kilowarthour sales to ultimate recovery revenues, reflecting lower fuel costs. Par-customers. Operating Total operating expenses decreased by $18 million Also contributing to higher maintenance costs expenses in 1985. This decrease resulted from lower fuel were overhauls of generating units, including costs, including the fuel component of purchased New England Power's (NEP) largest coal-fired electric energy. Partially offsetting this decrease unit, Brayton Point Unit 3, while it was out of was an increase in other operation and mainte-service from August 1985 to February 1986 due nance expenses. This increase includes approxi-to a structural failure of a coal storage silo. (See mately $7 million of costs charged to expense Note F-3 of" Notes to Financial Statements.") associated with Hurricane Gloria in September Depreciation and amortization expense also 1985. An additional $5 million of Hurricane increased in 1985 primarily as a result of oil and Gloria costs, incurred by Narragansett Electric, gas operations and the Oil Conservation Adjust-were not charged to expense, but to a storm con-ment. (See Note A-6.) (See pages 36 and 37 for a tingency fund that is being funded through rates. discussion of the effects of inflation.) Earnings Per Average Share Dividends Declared Per Share-Annual Rate Adjusted to reflect two-for-one Adjusted to reflect two-for-one common share split common share split $3.25 - u. 3 3 $2.00 : - ~ - - - U.02 3.00 g. 52.74 1.75 --u 2.75 s1. 2.50 - 5 st3s 1.50; 2.25 u. 52.02 51. 00 ' 1.25 > - - - - 1.75 ' s1.73H _M $3, st41 p, 1.50 - 1.00 5 97 1.25 ' $1.15 1.00 .75 ' 1977 1979 1981 1983 1985 1977 1979 1981 19?) 1985 15

Allowance for AFDC increased by 47 percent in 1985 due January 1,1984 a rate increase reflecting the funds used during to increases in construction work in progress inclusion of additional amounts of CWIPin rate construction (CWIP), principally associated with the Seabmok I base. AFDC is not recorded on CWIP included in (AFDC) and hiillstone 3 nuclear projects. The decrease in rate base. (See Note F-3.) 1984 resulted from NEP putting into effect on Other income / Other income increased by $5 million in 1985. respectively, for the purpose of establishing (expense)-net This increase includes approximately 57 million a reserve for construction costs incurred since due to a 1985 Federal Energy Regulatory Com-September 1983 on the Seabmok 2 nuclear unit. mission (FERC) decision that allowed NEP to (See Note C.) Partially offsetting the increase in recover amounts written off prior to the end of other income in 1985 was a $4 million decrease in 1983 related to the Pilgrim 2 nuclear unit. (See interest income from temporary cash investments Note C.) Also,in 1985 and 1984, NEP recorded and an approximate 55 million charge to other charges to other income in the amounts of income to increase New England Energy incorpo-approximately 53 million and $10 million, rated's (NEEl) crossover reserve. (See Note A-3.) l 1 Seabrook Substantial progress was made on construction of rion of the unit could be delayed or prevented if j nuclear units Seabrook I during 1985. Although completion of emergency response plans are not approved. NEP construction of the unit appears more likely than believes that Seabrook 2 is effectively cancelled it did previously, possible further unfavorable reg-and is seeking recovery of its investment as a ulatory developments, financial difficulties being property loss in a rate proceeding before the experienced by a number of joint owners, and FERC. As part of rate proceedings to recover the other more general problems pertaining to con-costs of Seabrook 2 and Seabrook 1, whether struction of nuclear power plants, still render completed or cancelled, the prudence of such eventual completion uncertain. In addition, even costs could be at issue. (See Notes C and F-4.) if construction is completed, commercial opera-Oil and gas In October 1985, the Securities and Exchange this uncertainty, our independent auditors have operations Commission (SEC) approved our proposal to qualified their opinion on our 1985 financial modify the Pricing Policy for NEEl.These statements. Based on year end prices, the write-changes allow the eventual conversion of NEEl to down would have been approximately $130 mil-a non-rate regulated company. As discussed in lion after tax at December 31,1985.This amount Note A-3,it is likely in light of recent precipitous increased significantly in 1985 due to declines in declines in oil and gas market prices that NEEl oil and gas market prices. Subsequent declines in will generate operating losses in the future. Such market prices would have a similar effect. losses would first be applied against the crossover In 1985, NEEl's net investment in oil and gas reserve amounting to $13 million after tax at properties increased by 564 million and proved December 31,1985. Any losses in excess of this reserves increased by 2.5 million equivalent bar-reserve would be passed on to NEP as part of rels. Revenues in 1985 were $49 million. The net NEP's cost of fuel. NEP does not have assurance loss for the year of approximately 512 million that the FERC would permit recovery of these was principally incurred on the new, non-rate losses from customers. If such losses were ruled regulated program due to write-downs required by by the FERC not to be recoverable, the NEES Sys-SEC accounting rules that limit capitalized costs tem would be required to write down against to an amount approximating the present value of earnings the value of oil and gas properties in proved oil and gas reserves. (See Note A-3.) accordanc: with SEC accounting rules. Due to 1985 capital in 1985, cash construction expenditures for NEP part of a Seabrook related financing proceedin expenditures and and the retail electric subsidiaries totaled $201 the Alassachusetts Department of Public Utilities financing million. These expenditures included approxi-( AIDPU) effectively denied approval of NEP's mately 539 million spent on the Seabrook I proposed financing plan. As part of a plan to jointly-owned nuclear unit and $53 million spent retire high coupon bonds, the AIDPU,in a subse-on the hiillstone 3 jointly-owned nuclear unit. quent proceeding, approved NEP's issuance in Internally generated cash provided substan-November 1985 of $38.5 million of general and tially all of these construction expenditures in refunding mortgage bonds to support the issu-1985, compared with approximately 70 percent ance of pollution control revenue bonds by the in 1984 and 54 percent in 1983. In April 1985, as Connecticut Development Authority. NEP also 16

retired 534 million of 16% percent bonds and 57 tion (NEET), our transmission service company, million of 16 percent bonds. Early in the year, expects to complete its portion of the intercon-NEP retired at maturity $25 million of 3 % per-nection hetween the Hydro-Quebec system and cent bonds and Alassachusetts Electric retired at New England by mid 1986. Upon completion of maturity 58.5 million of 3 % percent bonds. the interconnection, Hydro-Quebec will begin in 1985, oil and gas exploration and develop-selling electricity to NEP and New England. Cash ment expenditures totaled 5122 million,includ-construction expenditures amounted to 551 mil-ing capitalized interest costs of $38 million. Bank lion in 1985. loans financed $14 million and equity contribu-NEES raised 536 million of equity in 1985 tions by NEES financed $15 million of the through the issuance of new common shares expenditures, and the remainder came principally under the System's dividend reinvestment and from internal funds. common share purchase plan and employee share New England ElectricTransmission Corpora-plans. 1986 capital Cash construction expenditures for NEP and the ment. NEET intends to obtain approximately expenditures and retail electiic subsidiaries are estimated to be 575 million oflong-term financing in 1986 to financing 5205 million in 1986. These estimated expendi-repay borrowings under that agreement. tures include $28 million for Seabrook I and $12 NEP plans to issue 530 million of pollution million for Atillstone 3. control bonds in 1986. NEP also plans to retire Internally generated cash is expected to pro-additional high coupon bonds in 1986. In Janu-vide approximately 85 percent of these needs in ary 1986, Narragansett Electric issued 540 mil-1986, and we estimate that over the next three lion of 10% percent first mortgage bonds. The years internal funds should provide all of the proceeds were used in part to redeem all of its necessary construction requirements. These esti-outstanding 13 percent first mortgage bonds and mates are based on the continued inclusion of a to retire maturing 3 % percent first mortgage portion of CWIP in rate base as discussed below. bonds. In 1986, expenditures for our oil and gas activ-Bond ratings for Narragansett Electric, Alassa-ities are estimated to be 590 million, including chusetts Electric and NEP are single A or double A. capitalized interest costs of $35 million. Internal No public offering of NEES common shares is funds are estimated to provide 65 percent of these currently planned for 1986 or the foreseeable needs in 1986. future. However,in 1986, the System expects to NEET's cash construction expenditures for the raise about $30 million of equity through the interconnection with Hydro-Quebec are esti-issuance of new common shares under its divi-mated to be $35 million in 1986 and will be dend reinvestment and common share purchase financed under its revolving bank credit agree-plan and employee share plans. Rate activity Alassachusetts Electric received permission to in NEP's W-6 rate case, the only remaining lower its retail rates by $ 10 million effective Janu-issue concerns the inclusion of a portion of CWIP ary 1,1985 and by 55 million effective Alay 1, in rate base, which is being collected subject to 1985. Narragansett Electric also lowered its rates refund. In conjunction with the W-7 partial ser-by $3.3 million effective Alay 1,1985, while tiement, NEP's potential refund obligation in W-6 Granite State Electric lowered its rates by will be reduced subject to FERC approval. (See 1 5300.000 effective October 1,1985. Note F-3.) In February 1986, a partial settlement was In accordance with a FERC rule, which has reached in NEP's W-7 wholesale rate case. This been vacated in part and remanded to the FERC settlement, which is subject to the approval of the for further action by a U.S. Court of Appeals, FERC, will increase rates by $40 million on an NEP has included CWIP in rate base, which annual basis. The settlement rate reflects inclu-yields approximately $43 million in annual revo-sion in rate base of the full amount of NEP's raes. Shodd this decision ultimately result in the investment in the Atillstone 3 nuclear unit upon exclusion of CWIP from rate base, NEP's cash its commercial operation. NEP's request to amor-flow would be reduced, but there would be no tize its investment in Seabrook 2 is not addressed reduction in net income because AFDC would be in the settlement and remains contested.This recorded. (See Notes A-5 and F-3.) The majority investment accounts for 520 million of the of NEP's CWIPin rate Lase and AFDCis attrib-increase on an annual basis and will be collected utable to the Seabrook 1 and Atillstone 3 con-1 i subject to refund. (See Notes C and F-3.) struction projects. I 17

New England Electric System and Subsidiaries Selected Financial Data Year ended December 31 (millions of dollars, except per share data) 4 1985 1984 1983 1982 1981 Operating revenue: Electric sales (excluding fuel cost recovery) $ 908 $ 882 $ 802 5 711 $ 622 Fuel cost recovery 462 530 507 482 641 Other utility revenue 25 26 23 20 19 Oilsales 16 13 13 13 7 Gas sales 33 35 29 36 15 Total operating revenue $1,444 $1,486 $1,374 $1,262 $ 1,304 Total fuel cost * $ 475 $ 543 $ 522 $ 497 $ 651 Net income $ 164 $ 152 $ 133 $ 108 91 Average common shares" 52,083,490 50,176,454 48,366,894 46,585,694 44,967,164 Per share data:" s l Net income $ 3.15 $ 3.02 $ 2.74 $ 2.33 $ 2.02 Dividends declared $ 1.83 $1.725 $1.625 $1.475 $1.328 i Total assets $3,687 $3,441 $3,131 $2,804 $2,533 Capitalization: Common share equity $ 993 $ 888 $ 792 5 708 $ 644 Cumulative preferred stock subject to mandatory redemption 43 43 45 46 22 Other cumulative preferred stock 162 162 162 162 162 Long-term debt 1,364 1,361 1,220 1,065 991 Total capitalization $2,562 $2,454 $2,219 $1,981 $1,819 l Total electric sales (millions of kilowatthours) 18,338 18,256 17,025 16,388 16,582 l Cost per KWH to ultimate customers (cents) 7.58 7.94 7.87 7.46 7.90 System maximum demand (megawatts) 3,555 3,379 3,234 3,171 3,144 l Number of employees 5,004 4,989 5,058 5,126 5,177 l Number of customers 1,147,399 1,122,930 1,102,470 1,086,094 1,071,722 ' Includes fuel component of purchased electric energy, fuel handling and other related costs " Ad usted to reflect two-for-one common share split (Note E) i Cost Per KWH - Actual Dollars Customers Served Per Employee -1985 Dollars 9.5e 240 r- '9 1 N.34e 229 l 9.0 212 l f 200 I - - --- ------- -- - 7 9 0 g,5 S.50s -. _ _.. ~ t l g.31 e 8.22 g l 180 i-- - - -- 171 - - 794#- 8.0 g9g. --- 7.87c 160 7,$ -.- -.. -..-~ -......l+b8f 4, ,40 l 7,9 - -. -. -. ~ - 3 39 _.. 1981 1981-1983 1984 1985 1973 1976 1979 1982 1985 18

New England Elcctric System and Subsidiaries i Statemcnts of Consolidated Income Year ended December 31 (thousands of dollars) 1985 1984 1983 Operating revenue (Note A) $1,444,279 51,485,727 $ 1,373,878 Operating expenses: Fuel for generation 375,997 433,861 408,569 Purchased electric energy: Fossil and interchange i11,896 114,287 113,918 Nuclear entitlements 87,535 85,896 80,228 Other operation 196,295 182,818 175,433 Maintenance 99,401 76,296 81,743 Depreciation and amortization (Notes A and C) 166,867 150,726 133,896 Taxes, other than federalincome 94,711 93,573 93,127 Federalincome taxes (Note B) 110,078 122,917 105,168 Total operating expenses 1,242,780 1,260,374 1,192,082 Operating income 201,499 225,353 181,796 Otherincome(Note A): Allowance for equity funds used during construction 38,404 23,815 32,897 Equity in income of nuclear power companies 7,615 6,435 6,147 Other income /(expense)-net (Note C) 4,351 (1,107) (8,811) Federal taxes on other income-credit (Note B) 11,671 8,845 11,509 Operating and other income 263,540 263,341 223,538 Interest: Interest on long-term debt 94,148 94,051 83,015 Other interest 4,170 14,098 5,974 Allowance for borrowed funds used during construction, net of deferred federalincome taxes of $12,408,510,462 { and $12,066 (Note A) (14,731) (12,402) (14,228) Total interest 83,587 95,747 74,761 Income afrer interest 179,953 167,594 148,777 Preferred dividends of subsidiaries 15,875 15.993 16,158 Net income 5 164,078 $ 151,601 5 132,619 Average common shares

• 52,083,490 50,176,454 48,366,894 Per share data:*

Net income 3.15 5 3.02 5 2.74 Dividends declared 5 1.83 1.725 1.625

• Ad usted to re' lect two for-one common share spht (Note E) i The accompanying notes are an integral part of these financial statements.

19

New England Electric System and Subsidiaries Consolidated Balance Shects At December 31 (thousands of dollars) 1985 1984 Assets Utility plant, at original cost (Note A) 52,503,276 52,424,373 Construction work in progress (Notes C and F) 909,792 832,971 3,413,068 3,257,344 Less accumulated provisions for depreciation and amortization 847,586 776,117 Net utility plant 2,565,482 2,481,227 Proved oil and gas p roperties, at fidi cost (Note A) 852,334 709,201 Unproved properties 59,507 80,522 911,841 789,723 Less accumulated provision for amortization 239,644 181,262 Net oil and gas properties 672,197 608,461 Investments (Note A): Nuclear power companies, at equity 45,162 44,918 Other subsidiaries, at equity 15,383 12,295 Other investments, at cost 7,310 7,015 Total investments 67,855 64,228 Current assets: Cash, including temporary cash investments of $3,413 and $29,500 6,344 32,400 Accounts receivable, less reserves (Note F) 178,591 136,422 Fuel, materials and supplies, at average cost (Note F) 65,046 77,884 Other current assets 3,188 1,930 Total current assets 253,169 248,636 Unamortized property losses (Notes C and F) 109,127 30,498 Deferred charges and other assets 19,057 7,977 53,686,887 $3,441,027 Capitalization Capitali:ation (see accompanying statements): and liabilities Common share equity 5 992,924 5 888,386 Cumulative preferred stock subject to mandatory redemption 42,500 42,528 Other cumulative preferred stock 162,528 162,528 Long-term debt 1,363,983 1,360,849 Total capitalization 2,561,935 2,454,291 Current liabilities: Long-term debt due within one year 14,155 36,305 Short-term debt (Note D) 80,907 20,553 Accounts payable (Note F) 146,075 126,981 Accrued taxes 14,911 43,796 Accrued interest 22,906 24,715 DividenJs declared 26,580 24,166 Other current liabilities 22,308 24,344 Total current liabilities 327,842 300,860 Deferred federal and state inceme taxes (Note P) 584,720 483,357 Unamortized investment tax credits (Note B) 146,422 138,548 Other reserves and deferred credits (Notes A and C) 65,968 63,971 Commitments and contingencies (Notes A, C and F) ) $3,686,887 . $3,441,027 The accompanying notes are an integral part of these financial statements. 20

New England Elcctric System and Subsidiaries Statements of Changes in Consolidated Financial Position Year ended December 31 (thousands of dollars) 1985 1984 1983 Sources of Net income $164,078 $151,601 $132,619 l internally Depreciation and amortization 166,867 150,726 133,896 generated funds investment tax credits-net 8,485 13,479 19,370 Deferred federal and state income taxes 88,955 65,167 43,089 Allowance for funds used during construction, net of l deferred federalincome taxes of $12,408, $10,462 and l $12,066 (53,135) (36,217) (47,125) 375,250 344,756 281,849 Dividends on NEES common shares (95,412) (86,635) (78,667) Net funds from internal sources 279,838 258,121 203,182 Sources of NEES common shares 35,888 31,245 30,332 enternally Long-term debt-issues 59,125 193,678 168,677 generated funds Long-term debt-retirements (78,408) (18,855) (107,993) i Preferred stock-retirements (1,250) (1,250) (1,250) Changes in short-term debt 60,354 (57,397) 41,660 Net funds from external sources 75,709 147,421 131,426 Sources of funds $355,547 $405,542 $334,608 Applications Construction expenditures, excluding allowance of funds for funds used during construction $200,659 $229,949 $231,068 Oil and gas exploration and development 122,118 164,801 148,533 Investments 3,627 3,371 10,059 Changes in working capital and other items 29,143 7,421 (55,052) Applications of funds $355,547 $405,542 $334,608 Detail of Cash, including temporary cash investments 5 (26,056) $ 29,491 5 (9,743) changes in Accounts receivable 42,169 (24,393) 36,948 1 working capital Fuel, materials and supplies (12,838) (6,321) (9,662) and other items Other current assets 1,258 181 1,003 Accounts payable (19,094) 22,878 (21,604) Current liabilities-other 30,316 9,385 (34,022) Other items 13,388 (23,800) (17,972) $ 29,143 $ 7,421 5(55,052) 4 New England Electric System and Subsidiaries Statements of Consolidated Retained Earnings War caded December 31 (thousands of dollars) 1985 1984 1983 Retained earni5gs at beginning of year $433,722 $368,756 $314,804 Net income 164,078 151,601 132,619 Cash dividends on common shares (95,412) (86,635) (78,667) Retained earnings at end of year $502,388 $433,722 $368,756 The accompanying notes are an integral part of these financial statements. ~21

New England Electric System and Subsidiaries Consolidated Statements of Capitalization At December 31 (thousands of dollars) Common share equity (Note E) 1985 1984 Common shares, par value $1 per share Authorized-75,000,000 shares Outstanding-52,779,994 and 50,935,94S shares

• 5 52,780

$ 50,936 Paid-in capital

• 437,756 403,728 Retained earnings 502,388 433,722 Total common share equity 5992,924

$888,386

• Ad usted to reflect two-for-one common share spht (Note E) i Cumulative preferred stock of subsidiaries 1985 1984 Shares outstanding Company Par value 1985 1984 Cumulative preferred stock subject to mandatory redemption (Note H)

New England Power Company 11.04% Series 5 25 700,000 750,000 5 17,500 5 18,750 (less shares held at cost for sinking fund) (50,000) (1,222) 13.48% Series 100 250,000 250,000 25,000 25,000 950,000 950,000 42,500 42,528 Other cumulative preferred stock 4 Massachusetts Electric Company 4.44% Series 100 75,000 75,000 7,500 7,500 4.76% Series 100 75,000 75,000 7,500 7,500 7.80% Series 100 150,000 150,000 15,000 15,000 7.84% Series 100 200,000 200,000 20,000 20,000 The Narragansett Electric Company 4 %% Series 50 180,000 180,000 9,000 9,000 4.64% Series 50 150,000 150,000 7,500 7,500 8.00% Series 50 200,000 200,000 10,000 10,000 New England Power Company 6.00 % 100 80,140 80,140 . 8,014 8,014 4.56% Series 100 100,000 100,000 10,000 10,000 4.60% Series 100 80,140 80,140 8,014 8,014 4.64% Series 100 100,000 100,000 10,000 10,000 6.08% Series 100 100,000 100,000 10,000 10,000 7.24% Series 100 150,000 150,000 15,000 15,000 8.40% Series 100 150,000 150,000 15,000 15,000 8.68% Series 100 100,000 100,000 10,000 10,000 1,890,280 1,890,280 162,528 162,528-l Total cumulative preferred stock of subsidiaries (annual dividend requirement of $15,874 for 1985 and 1984) 2,840,280 2,840,280 $205,028 5205,056 l 22

Long-term debt (Note G) 1985 1984 Company Rate hiaturity Notes Granite State Electric Company 9%% 1986 $ 2,400 5 3,200 i Granite State Electric Company 12.55 % 2000 4,000 l New England Electric System 8%% 1987 13,500 15,500 New England Energy incorporated (Note G) variable 1994 394,000 380,000 hiassachusetts Electric Company 8%% 1992 185 190 l First mortgage bonds hiassachusetts Series D 3%% 1985 8,500 I Electric Series F 5 % 1991 17,490 17,490 Company Series G 4%% 1992 60,000 60,000 Series H 4%% 1993 10,000 10,000 Series 1 5%% 1996 10,000 10,000 l SeriesJ 7%% 1998 15,000 15,000 l Series K 7%% 1999 15,000 15,000 Series At 7%% 2002 20,000 20,000 l Series O 12%% 2012 25,000 25,000 The Series E 3%% 1986 9,750 9,750 { Narragansett Series F 4%% 1994 4,600 4,600 Electric Series G 6%% 1998 7,500 7,500 Company Series I 7%% 2002 7,500 7,500 SeriesJ 9 % 2004 9,700 9,700 Series h1 13 % 2010 20,000 20,000 Series N 17%% 2012 4,000 4,600 Series 0 12%% 2014 20,000 20,000 New England Series F 3%% 1985 25,000 Power Series G 4%% 1987 10,000 10,000 Company Series H 4 % 1988 10,000 10,000 Series 1 4%% 1991 20,000 20,000 Series J 4%% 1992 12,000 12,000 Series K 4%% 1993 10,000 10,000 Series L 6%% 1996 10,000 10,000 Series h1 6%% 1997 15,000 15,000 Series N 7%% 1998 20,000 20,000 . Series O 7%% 1998 20,000 20,000 Series P 8%% 1999 15,000 15,000 Series R 7%% 2002 25,000 25,000 Series S 8%% 2003 40,000 40,000 Series T 8%% 2003 40,000 40,000 Series U 10%% 2005 72,800 72,800 General and New England Series H 8 % 1988 4,150 4,150 refunding Power Series A 8%% 2007 50,000 50,000 mortgage bonds Company Series B 9%% 2008 50,000 50,000 Series E 16 % 2011 39,716 47,000 Series F 16%% 2012 12,781 47,000 Series D 9%% 2013 90,000 90,000 Series G 9%% 2013 16,150 16,150 Series i 10%% 2013 16,600 16,600 Series J 10%% 2013 79,250 79,250 Series K variable 2015 38,500 Less funds held by trustee, Series H,1,j and K (Note G) (1,670) (4,295) Unamortized discounts and premiums (6,764) (7,031) Total long-term debt 1,378,138 1,397,154 Long-term debt due within one year (14,155) (36,305) i Long-term debt $1,363,983 51,360,849 i The accompanying notes are an integral part of these financial statements. 23

New England Electric System and Subsidiarics Notes to Financial Statements t Note A Significant accounting policies

1. Basis of The consolidated financial statements include the Hydro-Quebec electric system and New England.

consolidation accounts of New England Electric System (NEES) NEET has entered into agreements with partici-and all subsidiaries except NEES Energy, Inc. and pating New England utilities, including New New England Electric Transmission Corporation England Power Company (NEP), providing for (NEET), which are recorded at equity. NEES the joint financial support of the facilities. Four Energy is a company involved in energy conserva-minority-owned nuclear power companies and a tion services whose operations are different from shipping joint venture are also valued at equity. the consolidated group. NEET is a transmission All significant intercompany transactions between service company that is building facilities consolidated subsidiaries have been eliminated. to transmit hydroelectric power between the

2. System of The accounts of NEES and its utility subsidiaries System of Accounts prescribed by regulatory bod-accounts are maintained in accordance with the Uniform ies having jurisdiction.

3. Oil and gas New England Energy incorporated (NEEI) is activities, including interest paid to banks and a operations engaged in various activities relating to fuel sup-limited return paid to NEES on its investment in ply for the System companies as authorized NEEl. The SEC rules applicable to non-rate regu-by the Securities and Exchange Commission lated companies do not permit certain costs to be (SEC). These activities presently include (a) par-capitalized. In addition, the SEC's full cost " ceil-ticipation (pnncipally through a partnership with ing test" calculation requires non-rate regulated a non-affiliated oil company) in domestic oil and companies to write down capitalized costs to a gas exploration, development and production, level which approximates the present value of its (b) sale of fuel oil purchased in the open market proved oil and gas reserves.

to NEP and (c) operation, through a joint ven-In October 1985, the SEC approved the Sys-ture, of a coal-fired, coal-carrying ship. tem's proposal for the modification and phasing NEEl follows the full cost method of account-out of the Pricing Policy and the eventual conver-ing for its oil and gas operations, under which sion of NEEl to a non-rate regulated company. As capitalized costs relating to wells and leases a result of the modified Pricing Policy, NEEI's oil determined to be either commercial or non-com-and gas exploration program will consist of two mercial are amortized using the unit of produc-parts. The first part (old program) is composed tion method. of prospects entered into through December 31, Until late 1985, NEEl operated under an inter-1983. The second part (new program) is com-company pricing policy (Pricing Policy) approved posed of prospects entered into since December by the SEC.The Pricing Policy provided that any 31,1983. j excess (or deficiency) in the proceeds from the The old program will continue to operate in a sale of NEEl production (all of which to date has rate regulated status until the modified Pricing bten sold to non-affiliated third prties), over Policy is terminated. If the modified Pricing Pol-costs, was passed on to (or recovered from) NEP. icy had been terminated and the old program had Under the Pricing Policy, NEEl passed approxi-become non-rate regulated at December 31, mately S10 million af savings on to NEP aal uhi-1985, NEEl would have been required to write mately to retail customers. To date, no losses have down its assets in the old program to meet the been passed on to NEP. SEC's full cost ceiling test. This write-down On accourt of the Pricing Policy, NEElis would have been approximately $130 million considered to be a rate regulated company. As after tax based on NEEl's oil and gas prices such, NEEl has not been subject to certain SEC and proved reserves at the end of 1985. This accounting rules, applicable to non-rate regulated amount significantly increased in 1985 due to companies, which limit the costs of oil and gas declines in oil and gas prices and further declines property that could be capitalized. The Pricing in prices would have a similar effect. However, in Policy has allowed NEEl to capitalize all costs accordance with the modifications approved by incurred in connection with its fuel exploration the SEC, the termination of the modified Pricing 24

Policy will not occur until an accounting reserve NEP does not hase assurance that the FERC (crossover reserve), initially established in 1983, would allow recovery. In the event of disallow-becomes sufhcient to offset any required write-ance of recovery, the NEES System would be down, the old program properties are substan-required to write down against earnings the value tially produced out or NEEl terminates the modi-of oil and gas properties in accordance with the fied Pricing Policy under circumstances described SEC's ceiling test, and NEEl might terminate the below. At that time, the old program would modified Pricing Policy. From then on, profits and become non-rate regulated for SEC accounting losses from the old and new programs would be purposes. retained by NEES. Under the terms of the modi 6ed Pricing Policy, Under the modified Pricing Policy, NEES does any savings generated by the sale of production not expect to earn a return on its investment of from the old program will no longer be passed approximately $40 million in NEEl's old pro-i l directly to NEP. Instead, NEEl will make a per gram for the foreseeable future. It has not recog-l barrel compensating payment to NEP from any nized any return on its investment in NEEl over operating profits realized from the sale of produc-the last three years. tion from the prospects included in the old pro-As a result of the SEC's approval in October gram. Any remaining operating profits will go to 1985, profits and losses from NEEI's new pro-( the crossover reserve. Should the old program gram will be retained by NEES. Therefore, the generate operating losses, which is likely in light new program is considered to be non-rate regu-of recent precipitous declines in oil and gas mar-lated and is subject to the SEC accounting rules i ket prices, they would reduce this reserve. The described above. Since the beginning of 1984, crossover reserve amounted to $13 million after NEES,in anticipation of the SEC's approval, had tax at December 31,1985. Should the crossover been recognizing in its income statement the esti-reserse be exhausted, further losses would be mated effect of applying these accounting rules to passed on to NEP as part of NEP's cost of fuel. NEEl's new program. In 1984 and 1985, the Sys-NEP would seek recovery of these costs from its tem recorded after tax net losses from the new customers under its fuel clause, which is subject program of 54.5 million and $10.3 million, to regulation by the Federal Energy Regulatory respectively. SinceJanuary 1,1984, NEEl's total Commission (FERC). expenditures on the new program have amounted in any contested FERC proceeding involving to 534 million. the recovery of such losses, NEP would rely on NEEl's costs incurred and capitalized in con-the modified Pricing Policy approved by the SEC nection with its oil and gas exploration and and the fact that the old program has been con-development activities are as follows: ducted in the interest of ratepayers. However, Year ended December 31 (thousands of dollars) 1985 1984 1983 Leases 5 24,181 5 46,297 5 50,237 Exploration 46,550 71,966 48,935 Development 55,797 50,857 41,583 Other (4,410) (4,319) 7,778 Total $122,118 5164,801 5148,533 Included in the above amounts are lease costs of respectively, of costs of capital for the years l 57,456,000, exploration costs of $10,557,000 1985,1984 and 1983. and development costs of $390,000 in 1985, and The following table presents costs by cate-lease costs of 59,461,000 and exploration costs gory and the years in which they were incurred. of 56,223,000 in 1984, which relate to the new These costs are included in the " Consolidated program. The above totals also include 11alance Sheets" under the caption " Unproved $38,128,000,538,916,000 and $40,749,000, properties." (thousands of dollars) 1985 1984 1983 Prior years Total i Acquisition costs 5 5,646 5 10,863 5 8,151 5 20,834 5 45,494 Exploration costs 2,102 4,062 2,814 29 9,007 Development costs 3,420 1,586 5,006 Total 5 11,168 5 16,511 5 10,965 5 20,863 $ 59,507 included in the 1985 costs are acquisition costs of costs of 55,669,000 which relate to the new pro-54,576,000, exploration costs of $147,000 and gram. NEEI estimates that the majority of these development costs of 593,000 which relate to the costs will be included in proved oil and gas prop-new program. The 1984 costs include acquisition erties by December 31,1987. Approximately 60 25

percent of the total acquisition costs relate to opment costs relate to wells which may be either leases on which drilling had not yet begun as of currently drilling, or completed, but which have December 31,1985. The remainder of the acqui-not yet been determined to be either commercial sition costs and all of the exploration and devel-or non-commercial.

4. Revenue The utility subsidiaries record revenue as billed billed. NEEl recognizes revenue from sales to on a cycle billing basis. No revenue is recorded third parties when receised from its partners.

for electricity that has been delivered but not

5. Utility plant The utility subsidiaries capitalize, as part of con-mate inclusion in the rate base and in the provi-struction costs, an item called allowance for sion for depreciation. The composite rates funds used during construction (AFDC), which approximate the pre-tax costs of funds (11.9 per-represents the composite interest and equity costs cent in 1985 and 1984 and 11.7 percent in 1983).

of capital funds used to finance that portion of Consistent with past regulatory approvals, tax construction costs not eligible for inclusion in benefits on the borrowed funds component of j rate base. in 1985, $248 million of construction AFDC are deferred and amortized over the esti-work in progress (CWip) was included in rate mated lives of the property giving rise to the tax base, subject to refund (see Note F-3). AFDC is benefits. j recognized as a cost of " Utility plant." Accord-In the " Statements of Consolidated Income," i ingly, AFDC is capitalized in the same manner as the borrowed funds component of AFDC is pre-construction labor and material costs, with off-sented net of related deferred federalincome setting credits to "Other income" and " Interest." taxes as detailed below. An additional effect of This method is in accordance with an established this presentation is the allocation of a credit of regulatory approved rate-making practice under equal amount, resulting from the deductibility of which a utility is permitted a return on, and the capitalized interest expense, to "Other income: recovery of, these capital costs through their ulti-Federal taxes on other income-credit?' Year ended December 31 (thousands of dollars) 1985 1984 1983 Allowance for borrowed funds used during construction 5 27,139 5 22,864 $ 26,294 Related deferred federal income taxes (Note 11) (12,408) (10,462) (12,066) Allowance for borrowed funds used during construction-net 14,731 12,402 14,228 Allowance for equity funds used during construction 38,404 23,815 32,897 Total allowance for funds used during construction-net S 53,135 $ 36,217 $ 47,125 Costs of current repairs and minor replacements or otherwise disposed of, together with costs of of plants and properties are charged to mainte-removal less salvage, is charged to " Accumulated nance expense accounts as incurred. Plant retired provisions for depreciation and amortization."

6. Depreciation The depreciation and amortization expense Income"is composed of the following:

and amortization included in the " Statements of Consolidated Year ended December 31 (thousands of dollars) 1985 1984 1983 Depreciation S 77,450 $ 74,485 $ 71,958 Amortiration: Oil and gas properties 60,770 55,093 42,953 Property losses 13,213 11,473 12,453 Oil Conservation Adjustment (OCA) 15,434 9,675 6,532 Total depreciation and amortization expense $166,867 $150,726 $133,896 l l 26

4 Depreciation is provided annually on a straight-lives. The provisions for depreciation as a per-line basis in amounts at least sufficient to amor-centage of weighted average depreciable property tize the undepreciated cost of depreciable utility by plant category are as follows: properties over their estimated remaining service i f Year ended December 31 1985 1984 1983 i Hydro producnon 1.5 % 1.5 % 1.5 % Thermal production 4.4 % 4.3% 4.2% 3 Other 3.2 % 3.2% 3.2% Combined 3.4 % 3.4% 3.4% l [ Oil and gas property amortization is based on to customers (OCA) was designed to allow the [ a percentage calculated by dividing each year's accelerated recovery of expenditures for coal I production by total estimated proved and prob-conversion facilities at the Salem Harbor Sta-able reserves (unit of production method). In tion, both during and after the conversion period, addition, amortization includes a write-off of out of savings from burning coal. Total expendi-approximately $16.3 million in 1985 and $8.2 tures through December 31,1985 were million in 1984 pursuant to SEC rules applicable $103,701,000. At December 31,1985, accu-to non rate regulated oil and gas companies. (See mulated provisions for OCA amortization Note A-3.) amounted to $33,215,000. The difference, The amortization of property losses relates to amounting to $70,486,000, remains to be cancelled nuclear power plants. (See Note C.) recovered. In the event that changes in circum-j The Oil Conservation Adjustment (OCA) stances prevent such accelerated recovery, the amortization represents the net amount recovered OCA provisions allow NEP to revert to tradi-( from customers for the amortization of certain tional means of cost recovery. coal conversion facilities. This current charge

7. Retirement plans The plans are noncontributory and provide retire-plans decreased in 1985. Increases in the costs of ment benefits for substantially all employees.

these supplemental plans in 1984 and an increase Current service costs are funded annually; prior in a supplemental payment to retirees were the service costs are being funded over a 20-year principal reasons for the 1984 increase in pension period; actuarial gains and losses are being amor-costs. tized over a 10-year period. Total pension cost, The comparison, as shown below, of the mar-including the amortization of prior service costs ket value of pension fund assets with the actuarial and of actuarial gains and losses, was $6,312,000 present value of accumulated plan benefits is pro-in 1985, $10,087,000 in 1984 and $6,761,000 in vided as a measure of the financial condition of 1983. the plans if they had been terminated as of April The decrease in pension costin 1985 is princi-1,1985 and 1984. The comparison shows that pally due to actuarial gains on plan investments. the plans' net assets cxceed the actuarial present In addition, the costs of certain supplemental value of all plan benefits earned to date. At April 1 (thousands of dollars) 1985 1984 Actuarial present value of accumulated plan benefits: Vested $210,663 $189,631 Non-vested 3,086 6,015 Total $213,749 $195,646 Net assets available for plan benefits $331,422 $297,541 The above calculation of the actuarial present However, System plan benefits are based on value of accumulated plan benefits used an average salary levels during the final years of investment return of 8.9 percent in 1985 and employment. Therefore, future salary increases f 1984, which represents a weighted average of will increase plan benefits. The actuarial liability, theinterest rates used by the Pension Benefit . shown on the following page, was calculated Guaranty Corporation (a federal insurer of pen-using the plans' actuarial funding method and sion benefits); the above calculation does not assumptions, including an assumption for future. reflect any future salary increases. salary increases. 27

At April 1 (thousa:Es of dollars) 1985 1984 Net assets available for plan benefits $331,422 $297,541 Actuarialliability 319,086 297,497 Excess of net assetrover actuarialliability $ 12,336 5 44 Certain health care atd life insurance benef;ts The cost of these benetics, which amounted to 3' are provided to substantially all retired employ- $3,870,000 in 1985 and $3,484,000 in 1984,is ces. Such benefits are not funded by the System. charged to expense when paid. - Note B Total federal income taxes in the " Statements of Consolidated Income" are as follows: Year ended December 31 (thousands of dollars) 1985 1984 1983 Income taxes charged to operations $110,078 $122,917 $105,168 income taxes credit < d to "Other income" (11,671) (8,845) (11,509) Incame taxes netted against AFDC-borrowed funds (Note A-5) 12,408 10,462 12,066 Total federalincome taxes $110,815 $124,534 $105,725 Total federal income taxes, as shciwn above, consist of the following components: Year ended December 31 (tlEsands of dollars) 1985 1984 1983 Current income taxes 5 11,103 $ 40,257 $ 35,246 Deferred income taxes 91,227 70,798 51,109 investment tax credits-ner: 8,485 13,479 19,370 Total federalincome taxes $110,815 $124,534 $105,725 Investment tax credits of subsidiaries are deferred tax credits-net principally reflects reductions and amortized over the estimated lives of the in current federal income taxes attributable to property giving rise to the credits. Investment investment tax credits which have been deferred. Certain subsidiaries, with regulatory approval, details the components of the deferred federal have adopted comprehensive interperiod tax income taxes of these subsidiaries: allocation (normalization). ne following table Year ended December 31 (thousands of dollars) 1985 1984 1983 Allowance foi borrowed fonds used during construction (Note A-5) $ 12,408 $ 10,462 $ 12,066 Excess tax depreciation and amortization 22,905 23,367 24,006 Oil and gas costs capitalized for book purposts and dyducted for tax purposes 49,026 64,565 53,76i NEEl reserve (Note A-3) - (2,477) ' (7,732) Unamortized property losses (Note C) 24,352 Other. 6,431 2,213 (1,571) Reversal'of prior year tax deterrals (21,418) (29,S09_) (29,421) Deferred federalincome taxes $ 91,227 $ 70,798 - $ 51,109 The tax effect of the cumulative amoun$of timing This amount has not been recorded because the differences at December 31,1985, for which regulatory process is expected to allow such deferred federalincome taxes have not been pro-amcunts to be recovered from customers when vided,is approximately $PS million. the taxes are ultim.itely' payable. I' mm 28

t If Total federal income taxes differ from the rate to income before taxes. The reasons for the 5 amounts computed by applying the statutory tax differences are as follows: I Year ended December 31 (thousands of dollars) 1985 1984 1983 L Computed tax at statutory rate of 46 percent $133,753 $ 134,379 $117,071 ) Increases /(reductions)in tax resulting from: Allowance for equity funds used during construction (17,666) (10,955) (15,133) Book versus tax depreciation not normalized 6,629 6,810 6,751 } Amortization ofinvestment tax credits (6,302) (4,732) (3,499) All other differences (5,599) (968) 535 Total federalincome taxes $110,815 $124,534 $105,725 Effective federalincome tax rate 38.1 % 42.6 % 41.5 % Federal income tax returns for NEES and its on by the Internal Revenue Service through 1981. subsidiaries have been examined and reported ) Note C included in the " Consolidated Balance Sheets" Alay 1984, a FERC administrative law judge (} Property losses under " Unamortized property losses" are the ruled that NEP could not recover approximately unamortized portions of the costs of four can- $8 million ofits expenditures for Pilgrim 2 which celled nuclear generating projects. were in dispute. Prior to the end of 1983, NEP In December 1979, NEP cancelled plans to wrote off the disputed portion to "Other income / { build two nuclear generating units in Charles-(expense)-net l' However,on April 11,1985,the town, Rhode Island. Commencing June 1,1980, FERC issued an opinica and order reversing the NEP began to amortize and to recover through administrative law judge's decision, and ruled rates this loss of approximately $28 million ($17 that NEP could recover its entire investment in million after tax) over a five-year period. The Pilgrim 2. As a result, NEP's net income in 1985 state regulatory commissions approved the pass-was increased by approximately $5 million. The through of these costs to the System's retail cus-FERC decision has been appealed to the courts by tomers. The amortization and recovery of the loss an intervenor. was completed in hiay 1985. NEPis a joint owner of the Seabrook 2 nuclear On December 31,1980, a non-affiliated com-generating unit. NEP believes that the unit is pany announced cancellation of plans to build effectively cancelled. At December 31,1985, NEP two nuclear generating units in hiontague, has included approximately $83 million ($48 hiassachusetts. As a part-owner, NEP had million after tax) of costs related to Seabrook 2 in expended approximately $5 million ($3 million unamortized property losses. Seabrook 2 costs at after tax) in the hiontague units. Commencing December 31,1984 were included in CWIP. In Alarch 1,1982, NEP began to amortize and July 1985, NEP filed a rate case with the FERC recover through rates these costs over a five-that included the recovery of Seabrook 2 costs as year penod. The state regulatory commissions a property loss over a five-year period. The FERC approved the pass-through of these costs to the has permitted such recovery to commence on System's retail customers. Alarch 1,1986, subject to refund pending investi-On September 23,1981, a non-affiliated com-gation. The prudence of NEP's investment could pany announced cancellation of plans to build the be at issue in this investigation. (See Notes F-4 Pilgrim 2 nuclear generating unit in Plymouth, and F-5.) hiassachusetts. As a part-owner, NEP had NEP stopped accruing AFDC on Seabrook 2 as expended approximately $50 million ($29 mil-of April 1984. NEP has established reserves lion after tax) in the unit. Commencing Alarch 1, amounting to approximately $20 million, 1982, NEP began to amortize and recover included in "Other reserves and deferred credits," through rates these costs over an eight-year at December 31,1985 for construction costs from ) period, subject to refund pending the outcome of September 1983 to date and for AFDC from Sep-proceedings before the FERC. The state regula-tember 1983 through April 1984.The 1985 por-tory commissions approved the pass-through of tion of this reserve amounted to $3.2 million. these costs to the System's retail customers. In 29

Note D NEES and its subsidiaries have lines of credit At December 31,1985 and 1984,55,593,000 Short-term with banks totaling 5250 million, of which 56 and $14,297,000, respectively, of the proceeds borrowing million had been borrowed at December 31,1985 from certain short-term pollution control revenue and $51 million supported commercial paper i onds issued on behalf of NEP were held by trus-borrowings. There are no formal compensating tees in construction funds. These funds will be balance arrangements. Fees are paid in lieu of disbursed as qualified construction costs are compensating balances on most lines of credit incurred by NEP and, accordingly, these amounts and operating balances provide compensation for have been offset against the total short-term debt other lines of credit. outstanding. Note E On November 26,1985, the Board of Directors number of shares for all periods included in the Share capital of declared a two-for-one split of outstanding NEES financial statements and notes have been adjusted New England common shares, effected in the form of a com-to reflect the split. Electric System mon share dividend, to shareholders of record on NEES issued and sold additional common January 24,1986.The par value of the common shares,51 par value,in 1985,1984 and 1983, shares was not changed as a result of the split pursuant to a Dividend Reinvestment and Com-and, accordingly, common shares were increased mon Share Purchase Plan, an Employee Share and paid-in-capital was decreased at December Ownership Plan, Employee Thrift Plans and a 31,1985 by $26,390,000 and at December 31, Goals Program. 1984 by $25,468,000. All per share data and 1985 1984 1983 Paid-in Paid-in Paid-in (thousands of dollars) Par capital Par capital Par capital Dividend Reirvestment and Common Share Purchase Plan

• S1,383 525,245 51,418 522,464 51,228 519,822 Employee Share Ownership Plan
• 177 3,428 202 3,316 336 5,804 Employee Thrift Plans
• 212 4,064 218 3,627 172 2,937 Goals Program
• 72 1,307 Other*

(16) (16) 2 15 1 $1,844 $34,028 $ 1,838 $29,391 51,738 528,578

• Ad usteJ to rettect two-for-one common Aare spht i

Note F (1) The consolidated utility subsidiaries' con-programs in 1986 are estimated to be 590 mil-Commitments struction expenditures, excluding AFDC, are lion. At December 31,1985, substantial com-and estimated to be $205 million in 1986. The oil and mitments had been made relative to these contingencies gas subsidiary's expenditures, including costs of construction and exploration and development capital, for its exploration and development programs. (2) Under NEP's current arrangements for fuel to cover the non-affiliate's services. The agree-supply, certain of its fuel contracts are assigned to ment can be terminated on three months' notice. a non-affiliate which purchases fuel under these Fuel inventory held by the non-affiliate for NEP contracts and in the open market, holds the fuel amounted to $18,265,000 at December 31,1985. in inventory, as owner, and sells the fuel to NEP at This amount is included in the " Consolidated the time of burn at prices reflecting its cost of the Balance Sheets" in " Fuel, materials and supplies" fuel. In addition, NEP pays monthly charges and in " Accounts payable?' (3) In NEP's W-6 rate case, the only remaining the settlement agreement, such potential refund issue relates to $43 million in annual revenues, obligation is limited to that portion related to being collected since January 1,1984 subject to Seabrook 1, amounting to $21 million on an { refund, due to the inclusion of a portion of CWIP annual basis. These revenues would be refunded in rate base.This inclusion of CWIP in rate base only if, prior to the in-service date of Seabrook 1, is in accordance with a FERC rule, discussed the FERC issues an order requiring refunds below. On February 7,1986, NEP filed with the resulting from a September 1985 decision of the FERC a partial settlement agreement in its 1986 U.S. Court of Appeals for the District of Colum-W-7 rate case.This settlement,if approved by the bia Circuit.This decision vacated in part and FERC, will reduce NEP's potential refund obliga-remanded to the FERC for further action the tion of its W-6 CWIP in rate base revenues. Under FERC's decision that adopted the rule allowing a l l 30

g portion of CWIP in rate base. The Court's deci-tion of this outage, and in November 1985, an sion was based in part on the ground that the administrative law judge ruled that NEP's recov-I FERC had not adequately considered the poten-ery of these costs was proper. This decision is now tial anticompetitive effects. In February 1986, the being reviewed by the full commission. FERC issued an interim rule that,in large part, Brayton Point Unit 3 also had an outage from readopted its previous CWIP rule pending the late August 1985 to February 1986 as a result of ( Commission's review of the issues raised in the the structural failure of one ofits five coal storage Court's decision. Exclusior. of CWIP from rate silos. NEP anticipates that most repair costs will base, whether retroactive or not, would reduce be covered by insurance. In addition, NEP had NEP's after-tax cash flow, but would not reduce insurance coverage for $25 million of replace-l net income because AFDC would be recorded on ment power costs beyond an initial 30-day the amount of CWIP not ircluded in rate base. deductible period. Replacement power costs in NEP experienced an extended outage from 1985 exceeded the 525 million level of coverage August 1983 through February 1984 at its and, as in the case of the prior outage, NEP is Brayton Point Unit 3, the System's largest coal-including such excess in fuel adjustment clause fired unit, due to a major turbine failure. In con-billings. At December 31,1985, NEP had nection with the outage, NEP included approxi-recorded a receivable for reimbursement of the mately 520 million of replacement power costs in 525 million of replacement power costs covered its fuel adjustment clause billings. At the request by insurance. of third parties, the FERC initiated an investiga-(4) NEP is one of 16 participants, and holds a as a financial planning date for commercial oper-joint ownership share of approximately 10 per-ation. If commercial operation were delayed until cent,in Seabrook 1, a 1150 A1W nuclear generat-October 1987, NEP's total completed cost of Sea-ing unit under construction in Seabrook, New brook I would increase to 5480 million,includ-Hampshire. NEP also has the same ownership ing AFDC. share of Seabrook 2, construction of which was Receipt of an operating license from the reduced to the lowest feasible level in September Nuclear Regulatory Commission (NRC) is neces-1983 and suspended altogether in April 1984. sary in order to commence operation of Seabrook 1. NEP believes that Seabrook 2 is effectively can-The most significant remaining licensing issue for celled, and at December 31,1985 has included its Seabrook is the off-site emergency response plan, expenditures for Seabrook 2 in " Unamortized including evacuation plans. Plans for hiassachu-property losses." (See Note C.) setts and New Hampshire and 23 municipalities Through December 31,1985, NEP's expend-in both states within a ten mile radius of the site itures including AFDC for Seabrook 1 and facili-must be approved by the NRC prior to Seabrook 1 ties common to Seabrook 1 and 2 were $378 receiving a full power license. The NRC will base million, excluding nuclear fuel. its conclusion regarding these plans in part on the Construction of Seabrook I commenced in findings of the Federal Emergency hianagement l 1976 under the direction of Public Service Com-Agency (FEh1 A) as to whether the plans are ade-pany of New Hampshire (PSNH), the lead owner. quate and capable of being implemented to pro-The completion schedule estimatri by the lead tect the public within ten miles of the plant in the owner has, during the course of construction, unlikely event of an emergency. d been extended substantially and its estimates of There are various lawsuits pending concerning the cost of the unit have significantly increased. portions of the New Hampshire and hiassachu-InJune 1984, responsibility for management of setts plans, and controversy over the plans exists construction of Seabrook I was delegated to New in many affected New Hampshire and hiassachu-Hampshire Yankee,a division of PSNH. At setts communities. Also, the Attorneys General of December 31,1985, New Hampshire Yankee Alassachusetts and New Hampshire, some of the estimated that Seabrook 1 was 95 percent com-municipalities and other intervenors actively plete. NEP's estimated total completed cost, oppose issuance of an NRC operating license. based on the most recent New Hampshire Yankee The New Hampshire plan was submitted to the formal budget and schedule, amounts to 5440 FEh1 A in December 1985. The Atassachusetts j million, including AFDC. This schedule calls for plan has not yet been finalized or submitted. One I a commercial operation date of October 1986. town, Amesbury, hiassachusetts, voted at a town However, as discussed below, significant diffi-meeting in November 1985 not to participate in culties must still be overcome before Seabrook I the planning process. This vote does not preclude becomes commercially operational, and any delay the Governor of hiassachusetts from imposing a in the commercial operation date would result in state developed plan on the town of Amesbury, increases in cost. It appears likely that the review although it is not clear whether he will do so. It is of emergency response plans, discussed below, also unclear whether or when hiassachusetts will will create a delay, which could be substantial. complete its plan and submit it to the FEhiA. NEP has for some time been using October 1987 An NRClicensing board has published a 31

schedule for review of the New Hampshire plan tracts for the sale of power generated by Sea-that indicates hearings would commence in July brook station is the subject of lawsuits filed by a ( 1986. New Hampshire Yankee has stated that ratepayers' group in hiassachusetts, a Vermont adherence to this schedule would likely result public agency, and by one of Ath1WEC's member in a delay of commercial opera: ion beyond systems, which has also withheld a Seabrook October 31,1986. 'Ihe licensing board has not payment to Aih1WEC. scheduled a review of the hiassachusetts plan. PSNH has arranged to raise approximately f During 1984 and 1985, state regulatory agen- $280 million through the issuance of long-term cies issued orders that created many uncertainties secured indebtedness. The New Han4pshire Pub-as to the continued participation in Seabrook I lic Utilities Commission (NHPUC) approved the by various joint owners, and also as to the ability proposed financing, and the New Hampshire k of certain joint owners to continue to pay their Supreme Court affirmed the NHPUC approval on share of ongoing construction costs. january 31,1986. Regulatory agencies in hiaine and Vermont Substantial progress was made on construction ordered participants in their respective juris-of Seabrook 1 during 1985. Although completion dictions to pursue disengagement from Seabrook 1, of construction of the unit appears more likely to seli their shares and to pursue cancellation of than it did previously, possible further unfavor-the project.Three hiaine participants and one able regulatory developments, financial diffi-Vermont participant, owning an aggregate 11.2 culties being experienced by a number of joint percent, have entered into non-bindingletter owners, and other more general problems per-agreements in principle with Eastern Utilities taining to construction of nuclear power plants, Associates (EUA) whereby an EUA subsidiary still render eventual completion uncertain. In would acquire their ownership shares. The addition, even if construction is completed, proposed transfers are subject to conditions and delays or problems with the emergency response regulatory approvals. planning procedure may significantly delay or In financing proceedings before the hiassachu-prevent the granting of an operating license by setts Department of Public Utilities (h1DPU) the NRC. Thus, it is possible that construction involving four joint owners, including NEP, the could be completed, but the unit would not be h1DPU denied approval of further Seabrook I allowed to operate. NEP continues to believe that bond issues by the hiassachusetts hiunicipal completion and operation of Seabrook 1 is in the Wholesale Electric Company (hih1WEC) and best interest of its customers and New England, imposed conditions on approval of the financing provided that it is completed and an operating j requests of the three investor-owned hiassachu-license is obtained in a timely fashion. setts owners (including NEP) that such owners NEP also participates, with a joint owner-treated as tantamount to denial of approval. ship share of approximately 12.2 percent,in htill-NEP and Canal Electric Company each intends stone 3, a 1150 hiW nuclear generating unit to continue to pay its share of construction costs. under construction in Waterford, Connecticut. NEP expects, based on current estimates, to have Subsidiaries of Northeast Utihnes are the lead sufficient internally-generated funds and short-owners. An NRC full power operating license term borrowing capability to meet such payment was obtained in January 1986. Nuclear fuel has obligations without approval of the N1DPU. The been loaded. The lead owners have stated that the third such owner, Fitchburg Gas and Electric umt remains on schedule for a hiay 1986 com-Light Company (Fitchburg), has been withhold-mercial operation date. NEP's estimated com- ) ing payments of its 0.9 percent share of Seabrook pleted cost for hiillstone 3, based on the lead construction costs since Alay 15,1985. Certain owners' December 1985 estimate,is $485 mil-joint owners and other entities, including NEES, lion. Through December 31,1985, NEP's have advanced funds to the project in order to expenditures for hiillstone 3 were 5458 million, alleviate the shortfall created by Fitchburg's fail-excluding nuclear fuel. In February 1986, a settle-ure to pay. At December 31,1985, NEES had ment agreement was reached that effectively advanced $587,000 to the project, which has allows NEP to include all its hiilistone 3 expendi-been charged to expense. Fitchburg has agreed tures in rate base when the project is placed in in principle to sell its ownership interest to EUA's service.The settlement is subject to FERC subsidiary, subject to conditions and regulatory approval. ( approvals. See Note C for a discussion of NEP's requested ) In October 1985, hih1WEC completed a $120 rate treatment of its investment in Seabrook 2. million financing maturing in October 1986 to With regard to the cffective cancellation of enaHe it to pay its Seabrook obligations, h1DPU Seabrook 2 and to Seabrook 1, whether it oper-approval was not required for the sale. In Febru-ates or is cancelled, recovery through rates of ary 1986, hih1WEC re luested that the Af DPU NEP's investment would be subject to FERC approve a long-term financing and its request is approval as part of a rate proceeding, and the pending.The validity of certain hih1WEC con-prudence of such investment, including the terms 32

of the joint ownership agreement, could be at recovery of NEP's Seabrook investments is uncer-issue. NEP continues to believe that its expendi-tain. Although NEP, therefore, cannot predict the tures on these units were prudent, and that the outcome of rate proceedings involving NEP's Sea-FERC will continue to permit the recovery over brook investments, it does not believe that the time of prudently incurred costs through rates. amount of any disallowance of recovery of the The FERC has not in the past allowed utilities to expenditures would have a substantial adverse earn a return on their investment in cancelled effect (reduction of more than 10 percent) on plants during the period the costs are being NEES common share equity. Disallowance by the recovered through rates. However, the FERC is FERC of a greater amount could have a substan-currently re-examining this policy (see Note F-5). tial adverse effect on the financial condition of 4 The amount of any disallowance by the FERC of NEP and the System. (5) In December 1985, the iinancial Accounting counting. (However,in NEP's W-7 rate case, NEP Standards Board (FASB) issued proposed new has requested that the FERC allow NEP to earn a rules for regulated enterprises governing the return on the unamortized property loss associ-accounting for property losses and for newly ated with Seabrook 2.) completed plants. Although NEP has been in addition, the amount and timing of inclusion allowed in the past to amortize and recover in NEP's rate base of an investment in a com-through rates over time costs incurred in connec-pleted nuclear unit and the prudence of such tion with its property losses,it has not been investment could be at issue. Under the proposed allowed to include any of these amounts in rate new rules being considered by the FASB, any dis-base and has, therefore, not earned a return on allowance of the recovery of such investment the unamortized balance of such costs. In such would require an immediate charge to income situations,if NEP is not allowed to earn a return equal to the amount of any such disallowance. If I and if the proposed new rules being considered by the recovery of a portion of the costs related to a the FASB are adopted, utilities, including NEP, completed plant is deferred to future periods, the would be required to record the unamortized proposed new FASB rules would permit deferring amounts at a discounted value. His proposed the recognition of such costs in income only if change,if adopted, would require a current certain strict criteria related to the timing and charge to income equal to the effect of such dis-assurance of the future recovery plan are met. (6) In addition to the matters discussed above, cancellation of construction or operation of, } the utility subsidiaries, in common with other theirexisting or planned facilities. Any of utilities, are subject generally to other safety and these requirements could result in increased environmental regulatory requirements, which costs to these subsidiaries and their customers. may result in the modification or delay in, or (7) For a discussion relating to the uncertainty investments in oil and gas properties, see concerning the recovery by the System of its Note A-3. Note G The indentures relating to mortgage bonds of refunding mortgage bonds can require NEP to Long-term debt utility subsidiaries require sinking fund install-repurchase the bonds in 1988 and annually there-l ments totaling 56,695,000 in 1986,56,595,000 after. In such event, NEP would expect to remar-in 1987,56,495,000 in 1988, $6,495,000 in 1989 .et such bonds at prevailing interest rates. and $6,495,000 in 1990. The issuers of the mort-The annual interest requirement on the out-gage bonds may elect to satisfy these installments standinglong-term debt of NEES and its in cash, in bonds or by evidencing to the trustees utility subsidiaries at December 31,1985 is additional property in amounts as provided $88,010,000. therein. Substantially all the properties of the util-At December 31,1985 and 1984, $1,670,000 ity subsidiaries are subject to the lien tMe and $4,295,000 of the proceeds from certain pol-indentures under which the first mortgage bonds lution control revenue bonds issued on behalf of and general and refunding mortgage bonds have NEP were held by trustees in construction funds 1 been issued. to be disbursed as qualified construction costs are The aggregate cash payments required on long-incurred by NEP. term debt and to retire maturing mortgage bonds NEEI has revolving credit and term loan agree-by NEES and its utility subsidiaries for the years ments with three banks providing for borrowings ended December 31,1986 through 1990, are as of up to a total of $500 millian in four different follows: $14,155,000 in 1986, $21,505,000 in portions. The first portion is secured by a pledge 1987, $14,155,000 in 1988, $5,000 in 1989 and of NEEl's rights with respect to NEP under the $5,000 in 1990. Holders of pollution control rev-Pricing Policy on behalf of old program prospects enue bonds secured by NEP's Series K general and (see Note A-3). The second portion is secured by 33

a mortgage on selected old program oil and gas value assigned to the currently mortgaged oil and properties. The third portion, which applies to gas properties. NEEl is also required to maintain the new program,is supported by a Capital a minimum net worth of 540 million, including Maintenance Agreement between NEES and subordinated notes payable to NEES. At Decem-NEEl.The fourth portion is secured by a mort-ber 31,1985, interest rates on borrowings of gage on selected oil and gas properties in the new 5394 million (5312 million under the first por-3 l program. All four portions operate as revolving tion,569 million under the second portion,513 C l credit loans through December 31,1989, at million under the third portion and 5 under which time they convert to five-year term loans the fourth portion) ranged from 8.6 percent to with equal quarterly amortization. The total 12.9 percent. Based on the oil and gas properties d amount of borrowings that may be outstanding mortgaged at December 31,1985, NEEl had under the second and fourth portions of the additional borrowing capacity of 575 million agreement at any one time is a function of the under this agreement. Note H On September 1 of each year, NEP's 11.04% treasury in anticipation of the annual sinking Redeemable Series of cumulative preferred stock is subject to fund requirement. There were no shares held in preferred stock a mandatory annual sinking fund requirement treasury at December 31,1985. NEP also has for the retirement of 50,000 shares per year at 525 million of 13.48% cumulative preferred 526.285 per share. At December 31,1984 and stock outstanding, which is subject to a manda-1983,50,000 and 24,900 shares, respectively, tory annual sinking fund requirement for the had been purchased in the open market at a cost retirement of 12,500 shares per > car at $100.75 of $1,222,000 and $658,000 and were held in per share commencing on September 1,1987. 1 Report ofIndependent Certified Public Accountants To the Board of Directors and Shareholders of New England Electric System: We have examined the consohdated balance sheets and the consolidated statements of capitalization of New England Electric System and subsidiaries as of December 31,1985 and 1984 and the related consol-idated statements of income, retained earnings and changes in financial position for each of the three years in the period ended December 31,1985. Our examinations were made in accordance with generally accepted auditing standards and, accordingly, included such tests of the accounting records and such other auditing procedures as we considered necessary in the circumstances. As more fully described in Note A-3 of" Notes to Financial Statements," a subsidiary has a substantial investment in oil and gas properties at December 31,1985. With the precipitous declines in oil and gas i market prices in early 1986, there is uncertainty whether these invested amounts will ultimately be recovered. In our opinion, subject to the effects on the consolidated financial statements of such adjustments,if any, as might have been required had the outcome of the uncertainty referred to in the preceding para-graph been known, the consolidated financial statements referred to above present fairly the consolidated financial position of New England Electric System and subsidiaries as of December 31,1985 and 1984, and the consolidated results of their operations and changes in their consolidated financial position for each of the three years in the period ended December 31,1985,in conformity with generally accepted accounting principles applied on a consistent basis.

==? Boston, Massachusetts February 19,1986 34

New England Electric System and Subsidiaries Supplementary Information on Business Segments (unaudited) The consolidated group operates in two principal domestic industry segments. (thousands of dollars) Electric Oil and gas Consolidated Year ended Operating revenue $1,394,936 $ 49,343 $ 1,444,279 December 31,1985 Depreciation and amortization 106,097 60,770 166,867 Other operating expenses 958,458 7,377 965,835 Federalincome taxes 124.691 (14,613) 110,078 Operating income /(loss) 205,690 (4,191) 201,499 Interest expense 68,907 2,272 71,179 income from equity investments 10,056 10,056 Other income /(expense)-net 29,109 (5,407) 23,702 Net income /(loss) $ 175,948 $ (11,870) $ 164,078 Total assets $3,012,147 $674,740 $3,686,887 Investments at equity 5 60,545 5 60,545 3 Capital expenditures $ 200,659 $122,118 $ 322,777 Year ended Operating revenue $ 1,437,738 5 47,989 $1,485,727 December 31,1984 Depreciation and amortization 95,633 55,093 150,726 Other operating expenses 983,100 3,631 986,731 Federalincome taxes 129,224 (6,307) 122,917 l Operating income /(loss) 229,781 (4,428) 225,353 Interest expense 85,285 85,285 i income from equity investments 6,099 6,099 Other income /(expense)-net 5,458 (24) 5,434 Net income /(loss) $ 156,053 $ (4,452) $ 151,601 Total assets $2,829,066 $611,961 $3,441,027 investments at equity $ 57,213 $ 57,213 Capital expenditures 5 229,949 $164,801 $ 394,750 Year ended Operating revenue $1,331,982 $ 41,896 $ 1,373,878 December 31,1983 Depreciation and amortization 90,943 42,953 133,896 Other operating expenses 949,758 3,260 953,018 Federalincome taxes 111,785 (6,617) 105,168 ) Operating income 179,496 2,300 181,796 Interest expense 62,695 62,695 Income from equity investments 6,204 6,204 Other income /(expense)-net 12,314 (5,000) 7,314 f Net income /(loss) $ 135,319 5 (2,700) $ 132,619 i Total assets $2,632,030 $499,201 $3,131,231 Investments at equity $ 56,414 56,414 Capital expenditures 5 231,068 $148,533 $ 379,601 See Note A-3 of " Notes to Financial Statements" for the purpose of eventually converting the rate for a more complete discussion of oil and gas regulated program to a non-rate regulated status operations, and changes in the regulated status and (b) a $10.3 million after tax net loss from / of the oil and gas program. operations on the non-rate regulated program. g In 1985, the SEC granted approval to divide The net loss in 1984 of $4.5 million reflects the NEEl's oil and gas exploration and development after tax net loss from operations on the non-rate } activities into two programs: a rate regulated regulated program. program and a non-rate regulated program. The net loss in 1983 reflects a $2.7 million ) The net loss for 1985 of $11.9 million includes after tax addition to the crossover reserve (a) a $1.6 million after tax addition to an described above. 9 accounting reserve (crossover reserve) established RB

New England Electric System and Subsidiaries Supplementary Information on the Estimated Impact of Inflation (unaudited) The following information depicts the impact of costs. inflation on the System's income and assets. This This approach attempts to show the System's material should be treated with caution as no financial results as if all ofits utility plant (gener-method yet devised does this job clearly and sim-ating stations, transmission lines, etc.) and all its b ply. Rather, inflation information is still in the oil and gas properties had been budt or developed development stage. using 1985 industry costs. The numbers in the following tables have been There are obvious weaknesses in this approach, prepared under the guidelines established by particularly with regard t< regulated sompanies FASB Statements.These statements require the like those in NEES. In addition, due to the uncer-impact of inflation to be measured using the tain nature of oil and gas exploration, the " cur- " current cost" approach. rent cost" of our oil and gas properties is pre-The " current cost" approach attempts to sented as a reasonable estimate and not a precise address the impact of specific inflation on an amount. However, these weaknesses should not industry. For this purpose, the System's historical detract from the conclusion that inflation has cost of utility plant has been adjusted by using reduced the value of shareholder earnings and the the Handy-Whitman Index of Public Utility Con-System's dividends. struction Costs. The current cost of our oil and In Table 1, four adjustments are shown. These gas properties has been estimated by applying adjustments are explained below. relevant oil and gas ir.dustry indices to historical Adjustment 1. An adjustment is made to historical depreciation zation expense amount was determined by apply-Depreciation and amortization expense to show the larger ing System depreciation and amortization rates and amount the System would need to expense in to the 1985 estimated " current cost" value. j amortization 1985 if the cost of utility plant and oil and gas income tax expense has not been adjusted expense properties were adjusted to show 1985 inflated because only historical depreciation and amorti-values. This adjusted depreciation and amorti-zation are currently deductible for tax purposes. 4 Adjustment 2. hionetary assets (cash and accounts receivable, latter gain in value as these obligations will be hionetary assets for example) and monetary liabilities (such as paid off in cheaper dollars (dollars of less value). and lia'ailities obligations to repay money borrowed) are The System has more monetary liabilities than adjusted for inflation. The former lose value due monetary assets, which resulted in a net gain in to the erosion of their purchasing power.The purchasing power in 1985. Adjustment 3. The general inflation rate for 1985, as measured increase in value of utility plant and oi! and gas General vs. by the Consumer Price Index, was higher than the properties during the year was $83 million less specific inflation specific inflation rate that impacted our utility than it would have been had the value increased plant and oil and gas properties. Therefore, the at the generalintlation rate. Adjustment 4. The final adjustment results from the fact that a considered to be a monetary asset. And, because Regulatory impact regulated company such as our System is only monetary assets lose value during periods of allowed, under current regulatory practice, to inflation, a loss must be recorded to reflect the recover an amount that is a function of the histor-current year's impact of holding utility plant and ical cost of investments in utility plant and oil and oil and gas properties. This adjustment is, how-gas properties. This recovery over time, which ever, reduced by the amounts reflected in adjust-may be viewed as a stream of revenues,is therefore ments 1 and 3. v 36

1 1 Table 1. Current cost i Statement of Year ended December 31,1985 (millions of dollars) approach ? consolidated income adjusted Net income-as reported in the income statement $ 164 forinflation Adjustment 1. Depreciation and amortization expense (130) Adjusted net income for 1985 $ 34 Other adjustments Adjustment 2. Monetary assets and liabilities 5 87 Adjustment 3. General vs. specific inflation * $ (83) Adjustment 4. Regulatory impact $ 92 4

• At December 31,1985, the current cost of utshty plant and od and gas pmperties was appmsimately $4,884 million while the net historical cost recoverabic through depreciation and amortization was appnnimately 53.238 milhon.

Table 2. The following table shows selected financial data for the per share amounts. Some of this data is i Five year adjusted for the effects of inflation. This data is from the table presented above. y comparison shown in millions of average 1985 dollars except j of selected Year ended December 31 1985 1984 1983 1982 1981 e supplementary financial data Operating revenue excluding fuel l adjusted for cost recovery $ 982 $ 990 $ 935 5 870 $ 784 cliccts of Fuel cost recovery revenue 462 549 548 536 758 inflation Total operating revenue $1,444 $ 1,539 $1,483 $1,406 $1,542 Ilistorical cost information adjusted for specifc price increases (current cost): B Adjusted net income /(loss) $ 34 $ 38 5 23 (6) $ (11) j income /(loss) per average ) common share $.66 5.76 $.49 $ (.13) $ (.24) Increase in general price level over increase in specific prices after adjustment for impact of regula-tion (Adjustment 3 plus Adjustment 4) 9 (6) 10 $ 31 $ (85) ( I Generalinformation: ) Net assets at historical cost at year end $ 976 $ 907 $ 841 5 780 $ 737 Net gain from intlation-adjusted monetary assets and liabilities 87 92 81 5 70 $ 145 Inflation-adjusted cash dividends declared per average common share $1.830 $ 1.786 $1.755 $1.644 $1.570 s Inflation-adjusted market price per average common share at year end $24.58 $ 18.89 $20.70 $18.32 $ 14.16 Average Consumer Price Index 322.2 311.1 298.4 289.1 272.4 ) T 37

i New England Electric System and Subsidiaries Supplementary Information on Oil and Gas Activities (unaudited) l l The estimates of NEEl's proved reserves and to the estimated proved reserves for 1983 1984 proved developed reserves of oil and gas, all and 1985 are as follows: located within the United States, and changes Crude oil and ) condensate Natural gas (thousands of Bbl) (thousands of h1CF) Proved reserves as of December 31,1982 2,336 61,531 Revisions of previous estimates 472 (243) Extensions, discoveries and other additions 985 17,290 Production (493) (8,559) Proved reserves as of December 31,1983 3,300 70,019 Revisions of previous estimates (142) 22,284 Extensions, discoveries and other additions 1,732 64,435 Production (528) (9,375) Proved reserves as of December 31,1984 4,362 147,363 Revisions of previous estimates (48) 4,531 Extensions, discoveries and other additions 323 22,920 ) Production (685) (9,848) Proved reserves as of December 31,1985 3,952 164,966 Year end average Proved selling price developed reserves

• Crude oil and Crude oil and condensate Natural gas condensate Natural gas (per Bbl)

(per h1CF) (thousands (thousands of Bbl) of h1CF) December 31,1982 $33.01 $4.40 2,336 61,397 December 31,1983 528.00 $3.84 3,298 67,274 December 31,1984 $28.52 $3.73 3,122 94,897 December 31,1985 $26.19 $2.97 2,980 157,443 ' Amounts restated to reflect reclassification by independent petroleum engmeering consultants of certain reserves from proved reserves (undeveloped) to proved developed reserves. g Proved reserves are estimated quantities of crude 35,000 Bbis, respectively, of crude oil and con-oil, condensate and natural gas which geological densate and 1,302,000 h1CF and 60,000 h1CF, and engineering data demonstrate with reasona-respectively, of natural gas which relate to the ( ble certainty to be recoverable in future years new program. from known oil and gas reservoirs under existing The estimates of NEEl's proved and proved economic and operating conditions. Proved devel-developed reserves were prepared by independent oped reserves are those proved reserves reasona-petroleum engineering consultants, Keplinger and bly expected to be recovered through existing Associates,Inc. of Dallas, Texas and Thomas C. wells with existing equipment and operating Frick, Petroleum Consultant, of Dallas, Texas. methods. Included in the proved reserves and The reserves are estimates only and should not be proved developed reserves at December 31,1985 construed as exact quantities. Future conditions and 1984 are approximately 140,000 Bbls and may affect the recovery of estimated reserves. 38 [

g. System Directors l As of December 31,1985 s W. Douglas Bell A1alcolm hicLane a Chairman and President Chief Executive Officer Orr & Reno, P.A. State Aiutual Life Assurance Attornevs Co.of America Concord, New Hampshire Worcester, Atassachusetts Audit Committee Executive Committee Felix A. hiirando,Jr. Joan IBok Private investor Chairman New York, New York New England Electric System Compensation Committee Westborough, Atassachusetts Compensation Committee Executive Committee Guy W. Nichols Former Chairman and Chief Executive Officer James H. Hunter New England Electric System Former President Westborough, Aiassachusetts James Hunter Aiachine Co.,Inc. Audit Committee Textde machinery manufacturer North Adams, Atassachusetts Compensation Committee John D. Ritchie President J.D.R. Consultancy, Inc. Samuel Huntington hianagement consultants President and Stone Ridge, New York Chief Executive Officer Executive Committee New England Electric System Westborough, Aiassachusetts i Compensation Committee

1. ### ^'" ###

Executive Committee on nza Bus Lines,Inc. Providence, Rhode Island 9 John E Kaslow Executive Vice President and Chief Operating Officer New England Electric System Anne Wexler Westborough, Aiassachusetts Chairman Wexler, Reynolds, Harrison Edward H. Ladd & Schule, Inc. President ' # " E#"'#"' # "'" * " Standish, Ayer & Wood,Inc. Washington, DC Investment counselors Compensation Committee l Boston, Alassachusetts Audit Committee James Q. Wilson Professor Joshua A. AfcClure Harvard University l President Cambridge, hiassachusetts l American Custom Kitchens,Inc. Audit Committee 1 Providence, Rhode Island I s Audit Committee 1 39 i

System Officers System Subsidiaries As of December 31,1985 Joan T Bok hiassachusetts Electric Company Chairman 25 Research Drive Westborough, hiassachusetts 01582 Edward E. hiulligan, President Samuel Huntingtor: President and The Narragansett Electric Company Chief Executive Officer 280 hielrose Street Providence, Rhode Island 02901 Robert C. Smith, President John E Kaslow Executive Vice President Granite State Electric Company and Chief Operating Officer 33 West Lebanon Road Lebanon, New Hampshire 03766 Russell A. Holden, President PaulJ. Sullivan Senior Vice President New EnglandIbwer Company 25 Research Drive Robert O. Bigelow Westborough, hiassachusetts 01582 Vice President New England Energyincorporated 25 Research Drive Frederic E. Greenman Westborough, hiassachusetts 01582 Vice President, General Glenn R. Schleede, President Counsel, and Secretary New England Electric Transmission Corporation Alfred D. Houston 4 Park Street Vice President-Finance Concord, New Hampshire 03301 NEES Energy,Inc. George P. Sasde. 82 Florence Street Vice Pres, dent i hlarlborough, hiassachusetts 01752 New England Power Service Company John H. Dickson 25 Research Drive Treasurer Westborough, hiassachusetts 01582 d 40

j Shareholder Information New Eng!and 1985 1984 Electric System Price range Dividend Price range Dividend common shares High Low declared High Low declared f First quarter

• 519'% 6 518 %

5.45 520 % $17 5.425 Second quarter * $22% $19 % 5.45 518 514 5.425 ( Third quarter * $23 % $20 5.45 517' 515 % 5.425 j Fourth quarter * $25 % $20% 5.48 519 % 517 % 5.45

• Adjusted to reflect two-for-one common share spht (Note E)

The total number of shareholders at December 31,1985 was 77,781. l l Selected First Second Third Fourth quarterly (thousands of dollars) quarter quarter" quarter quarter fmancial 1985 t information I (unaudited) Operating revenue $376,928 5341,779 5361,371 5364,201 Operating income 5 58,164 5 45,358 5 48,555 5 49,422 l Net income 5 47,055 5 42,132 5 39,655 5 35,236 ( Net income per average share' 5 .91 5 .81 5 .76 5 .67 1984 Operating revenue $397,470 5355,182 5378,708 5354,367 Operating income 5 61,121 5 49,052 5 57,247 5 57,933 l Net income 5 41,943 5 32,090 5 40,402 5 37,166 Net income per average share

• 5

.85 5 .64 5 .80 .73

• Adiusted to retlect two-for-one common share sph (Note E)
• *See discussion of Pilgnm 2 (Note C)

Shareholder Questions about shareholder records, quar-New England Electric System services terly dividend payments, reinvestment of divi-Shareholder Services Department dends and optional cash payments should be Post Office Box 770 directed to: Westborough, Alassachusetts 01581-0770 b Transfer agent The First National Bank of Boston I and 100 Federal Street registrar Boston, Alassachusetts 02110 Stock exchange New York Stock Exchange listings Boston Stock Exchange Trading symbol NES Annual meeting The annual meeting of New England Electric 225 Clarendon Street, Boston, Alassachusetts,on notice System will be held at New England Life Hall, April 22,1986, at 10:30 a.m. Form 10K and Copies of the annual report on Form 10K to New England Electric System Statistical the Securities and Exchange Commission and Shareholder Services Department Report a Statistical Report for 1985 are available, free Post Office Box 770 of charge, by writing to: Westborough, Alassachusetts 01581-0770 The name "New England Electnc System" means the trustee or trustees for the time being (as trustee or trustees but not personally) under an Agreement and Declaration of Trust dated January 2,1926, as amended, w hich is hereby referred to, and a copy of w hah, as amended, has been filed with the Secretary of The Commonwealth of Massachusetts. Any agreement,obhgation or habihty made, entered into orincurred by or on behalf of New England Electric System binds only its trust estate, and no shareholder, direttor, trustee, officer or agent thereof assumes or shall be held to any habihty therefor. This report is not to be considered as an offer to sell or buy or sohcitation of an offer to sell or buy any wcunty.

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