Retail Energy Operations
Our retail energy operations segment consists of SouthStar, a joint venture currently owned 85%by our subsidiary, Georgia Natural Gas Company, and 15% by Piedmont. SouthStar markets natural gas and related services under the trade name Georgia Natural Gas to retail customers on an unregulated basis, primarily in Georgia as well as Ohio and Florida. In addition, SouthStar markets gas to larger commercial and industrial customers in Alabama, Tennessee, North Carolina, South Carolina and Georgia. Based on its market share, SouthStar is the largest Marketer of natural gas in Georgia, with average customers in excess of 500,000 over the last three years.
Prior to January 1, 2010, we owned a 70% interest in SouthStar and Piedmont owned 30%. However, in July 2009, we entered into an amended joint venture agreement with Piedmont pursuant to which we purchased an additional 15% ownership interest for $58 million, effective January 1, 2010, thus increasing our interest to 85%. This purchase will affect our consolidated statements of financial position, but will not result in a gain or loss on our consolidated statements of income. Prior to the effectivenessof our ownership increase, SouthStar’s earnings for customers in Georgia were allocated 75% to us and 25% to Piedmont, while its earnings for customers in Ohio and Florida were allocated 70% to us and 30% to Piedmont. Earnings are now allocated entirely in accordance with the ownership interests. We have no contractual rights to acquire Piedmont’s remaining 15% ownership interests. The amended agreement was approved by the Georgia Commission in October 2009.
SouthStar is governed by an executive committee, which is comprised of sixmembers, three representatives fromAGL Resources and three from Piedmont. Under a joint venture agreement, all significant management decisions require the unanimous approval of the SouthStar executive committee; accordingly, our 85% financial interest is considered to be noncontrolling. We record the earnings allocated to Piedmont as a noncontrolling interest in our consolidated statements of income, and we record Piedmont’s portion of SouthStar’s capital as a noncontrolling interest in our consolidated statements of financial position.
SouthStar’s operations are sensitive to seasonal weather, natural gas prices, customer growth and consumption patterns similar to those affecting our utility operations. SouthStar’s retail pricing strategies and the use of a variety of hedging strategies, such as futures, options, swaps, weather derivative instruments and other risk management tools, help to ensure retail customer costs are covered to mitigate the potential effect of these issues and commodity price risk on its operations. For more information on SouthStar’s energy marketing and risk management activities, see Item 7A, “Quantitative and Qualitative Disclosures About Market Risk – Commodity Price Risk.”
Competition SouthStar competes with other energy Marketers to provide natural gas and related services to customers in Georgia and the Southeast. In the Georgia market, SouthStar continues to experience the negative impact to operating margins from increased competition and an increase in the number of customers seeking the most competitive price plans. In addition, similar to our distribution operations, SouthStar faces competition based on customer preferences for natural gas compared to other energy products and the comparative prices of those products. Also, price volatility in the wholesale natural gas commodity market has contributed to an increase in competition for residential and commercial customers.
SouthStar continues to use a variety of targeted marketing programs to attract new customers and to retain existing ones. Despite these efforts we have seen a 4% decline in average customer count for the year ended December 31, 2009, as compared to 2008. We believe this decline reflects some of the same economic conditions that have affected our utility businesses as well as the more competitive retail pricing market for natural gas in Georgia.SouthStar may also be affected by the conservation and bad debt trends, but its overall exposure is partially mitigated by the high credit quality of SouthStar’s customer base, lower wholesale natural gas prices in 2009, disciplined collection practices and the unregulated pricing structure in Georgia.
SouthStar continues to expand its business in other states as well. We are currently focusing these efforts on the Ohio and Florida markets.
Operating margin SouthStar generates operating margin primarily in three ways. The first is through the sale of natural gas to residential, commercial and industrial customers, primarily in Georgia where SouthStar captures a spread between wholesale and retail natural gas prices. The second is through the collection of monthly service fees and customer late payment fees.
SouthStar evaluates the combination of these two retail price components to ensure such pricing is structured to cover related retail customer costs, such as bad debt expense, customer service and billing, and lost and unaccounted-for gas, and to provide a reasonable profit, as well as being competitive to attract new customers and maintain market share. SouthStar’s operating margin is affected by seasonal weather, natural gas prices, customer growth and their related market share in Georgia, which has historically been in excess of approximately 33%, based on customer count. SouthStar employs strategies to attract and retain a higher creditquality customer base. These strategies result not only in higher operating margin, as these customers tend to utilize higher volumes of natural gas, but also help to mitigate bad debt expense due to the higher credit-quality of these customers.
The third way SouthStar generates operating margin is through its commercial operations of optimizing storage and transportation assets and effectively managing commodity risk, which enables SouthStar to maintain competitive retail prices and operating margin. SouthStar is allocated storage and pipeline capacity that is used to supply natural gas to its customers in Georgia. Through hedging transactions, SouthStar manages exposures arising from changing commodity prices using natural gas storage transactions to capture operating margin from natural gas pricing differences that occur over time. SouthStar’s risk management policies allow the use of derivative instruments for hedging and risk management purposes but prohibit