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Risk Management

Material Risk Issues

The Failure to Operate Energy Facilities Safely and Reliably Could Adversely Affect the Company

Con Edison provides electricity, gas and steam service using energy facilities, many of which are located either in, or close to, densely populated public places. A failure of, or damage to, these facilities, or an error in the operation or maintenance of these facilities, could result in bodily injury or death, property damage, the release of hazardous substances or extended service interruptions. In such event, the company could be required to pay substantial amounts, which may not be covered by the company’s insurance policies, to repair or replace their facilities, compensate others for injury or death or other damage, and settle any proceedings initiated by state utility regulators or other regulatory agencies. The occurrence of such an event could also adversely affect the cost and availability of insurance. Changes to judicial doctrines could further expand the company’s liability for service interruptions.

The Failure to Properly Complete Construction Projects Could Adversely Affect the Company

Con Edison’s ongoing construction program includes large energy transmission, substation, and distribution system projects. The failure to properly complete these projects timely and effectively could adversely affect the company’s ability to meet their customers’ growing energy needs with the high level of safety and reliability that they currently provide, which would adversely affect the companies.

The Failure of Processes and Systems and the Performance of Employees and Contractors Could Adversely Affect the Company

Con Edison has developed business processes for operations, customer service, legal compliance, personnel, accounting, planning and other matters. Some of the company’s information systems and communications systems have been operating for many years, and may become obsolete. The company is implementing new financial and supply chain enterprise resource planning information systems. The failure of the company’s business processes or information or communication systems could adversely affect the company’s operations and liquidity and result in substantial liability, higher costs and increased regulatory requirements. The failure by the company’s employees or contractors to follow procedures, or their unsafe actions, errors or intentional misconduct, or work stoppages could also adversely affect the company.

The Company Is Extensively Regulated and Is Subject to Penalties

Con Edison’s operations require numerous permits, approvals, and certificates from various federal, state and local governmental agencies. State utility regulators may seek to impose substantial penalties on the company for violations of state utility laws, regulations or orders. In addition, the utilities rate plans usually include penalties for failing to meet certain operating standards. FERC has the authority to impose penalties on the utilities and the competitive energy businesses, which could be substantial, for violations of the Federal Power Act, the Natural Gas Act or related rules, including reliability rules. Environmental agencies may seek penalties for failure to comply with laws, regulations or permits. The company may also be subject to penalties from other regulatory agencies. The company may be subject to new laws, regulations, accounting standards or other requirements or the revision or reinterpretation of such requirements, which could adversely affect the companies.

Con Edison’s Rate Plans May Not Provide a Reasonable Return

Con Edison rate plans are approved by state utility regulators that limit the rates they can charge their customers. The rates are generally designed for, but do not guarantee, the recovery of the utilities’ cost of service (including a return on equity). The company’s rate plans can involve complex accounting and other calculations, a mistake in which could have a substantial adverse affect on the company. Rates usually may not be changed during the specified terms of the rate plans other than to recover energy costs and limited other exceptions. The company’s actual costs may exceed levels provided for such costs in the rate plans. The company’s rate plans usually include penalties for failing to meet certain operating standards. State utility regulators can initiate proceedings to prohibit the company from recovering from their customers the cost of service (including energy costs) that the regulators determine to have been imprudently incurred. The company has from time to time entered into settlement agreements to resolve various prudence proceedings.

The Company May Be Adversely Affected By Changes to Its Rate Plans

Con Edison’s rate plans typically require action by regulators at their expiration dates, which may include approval of new plans with different provisions. The need to recover from customers increasing costs, taxes, or state-mandated assessments or surcharges could adversely affect the company’s opportunity to obtain new rate plans that provide a reasonable rate of return and continue important provisions of current rate plans. The company’s current New York electric and gas rate plans include revenue decoupling mechanisms. Their New York electric, gas, and steam rate plans include provisions for the recovery of energy costs and reconciliation of the actual amount of pension and other postretirement, environmental and certain other costs to amounts reflected in rates.

The Company Is Exposed to Risks from the Environmental Consequences of Their Operations

Con Edison is exposed to risks relating to climate change and related matters. Con Edison of New York may also be impacted by regulations requiring reductions in air emissions. In addition, the utilities are responsible for hazardous substances, such as asbestos, PCBs and coal tar, that have been used or produced in the course of the utilities’ operations and are present on properties or in facilities and equipment currently or previously owned by them. Electric and magnetic fields are found wherever electricity is used. The company could be adversely affected if a causal relationship between these fields and adverse health effects were to be established. Negative perceptions about electric and magnetic fields can make it more difficult to construct facilities needed for the companies’ operations.

A Disruption in The Wholesale Energy Markets or Failure by an Energy Supplier Could Adversely Affect the Company

Almost all the electricity and gas the utilities sell to their full-service customers is purchased through the wholesale energy markets or pursuant to contracts with energy suppliers. Con Edison Energy and Con Edison Solutions also depend on wholesale energy markets to supply electricity to their customers. A disruption in the wholesale energy markets or a failure on the part of the company’s energy suppliers or operators of energy delivery systems that connect to the utility's energy facilities could adversely affect the company’s ability to meet its customers’ energy needs and adversely affect the company.

The Company Has Substantial Unfunded Pension and Other Postretirement Benefit Liabilities

Con Edison has substantial unfunded pension and other postretirement benefit liabilities. The utilities expect to make substantial contributions to their pension and other postretirement benefit plans. Significant declines in the market values of the investments held to fund the pension and other postretirement benefits could trigger substantial funding requirements under governmental regulations.

Con Edison’s Ability to Pay Dividends or Interest Depends on Dividends from Its Subsidiaries

Con Edison’s ability to pay dividends on its common stock or interest on its external borrowings depends primarily on the dividends and other distributions it receives from its subsidiaries. The dividends that the subsidiaries may pay to Con Edison are limited by the NYSPSC to not more than 100 percent of their respective income available for dividends calculated on a two-year rolling average basis, with certain exceptions.

The Company Requires Access to Capital Markets to Satisfy Funding Requirements

Con Edison estimates that their construction expenditures will exceed $6 billion over the next three years. The company expects to use internally-generated funds, equity contributions from Con Edison and external borrowings to fund the construction expenditures. The competitive energy businesses are evaluating opportunities to invest in renewable generation and energy-related infrastructure projects that would require funds in excess of those produced in the businesses. Con Edison expects to finance its capital requirements primarily through internally generated funds and the sale of its securities. The company does not expect to need to issue additional common equity in 2012. Changes in financial market conditions or in the companies’ credit ratings could adversely affect their ability to raise new capital and the cost thereof.

The Internal Revenue Service Has Disallowed Substantial Tax Deductions Taken by the Company

Con Edison’s federal income tax returns reflect certain tax positions with which the Internal Revenue Service does not or may not agree, particularly its tax positions for Con Edison’s Lease in / Lease Out transactions and the deduction of the cost of certain repairs to utility plants for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility.

A Cyber Attack Could Adversely Affect the Company

Con Edison and other operators of critical energy infrastructure may face a heightened risk of cyber attack. In the event of such an attack, the utilities and the competitive energy businesses could have their operations disrupted, financial and other information systems impaired, property damaged and customer information stolen; experience substantial loss of revenues, response costs and other financial loss; and be subject to increased regulation, litigation and damage to their reputation.

The Company Also Faces Other Risks that Are Beyond Its Control

Con Edison’s results of operations can be affected by circumstances or events that are beyond its control. Weather directly influences the demand for electricity, gas, and steam service, and can affect the price of energy commodities. Natural disasters, such as a major storm, heat wave, hurricane, or terrorist attack or related acts of war could damage company facilities. As a provider of essential utility services, the company may experience more severe consequences from attempting to operate during and after such events. In addition, pandemic illness could potentially disrupt the company’s employees and contractors from providing essential utility services. Economic conditions can affect customers’ demand and ability to pay for service, which could adversely affect the company.

Indian Point

Con Edison currently has a 16-year power purchase agreement (commencing August 2001) with Indian Point for 350MW of the almost 1,300 MW it generates annually. The nuclear facility, which is owned by Entergy Corporation, is up for permit renewal. If the renewal is not approved, it could mean the plant would be closed as early as 2015. The loss of this energy supply source has the potential to impact both reliability and emissions throughout the State of New York and for our customers in the Con Edison service territory.

In November 2012, the NYSPSC directed Con Edison of New York to work with the New York Power Authority (NYPA) to develop a contingency plan to address reliability concerns associated with this potential closure. In February 2013, Con Edison and NYPA submitted their plans, which take into account incremental Con Edison energy-efficiency and demand management programs. The plan provides for the New York transmission owners, subject to required approvals, to begin developing three proposed transmission projects for implementation by 2016. The plan also provides for the issuance by NYPA of a request for proposals for generation and transmission projects that could also be in service by 2016. Under the plan, the New York State Public Service Commission is to designate which projects are authorized to be implemented.

Lease In / Lease Out

In 1997 and 1999, Con Edison Development entered into a transaction in which it leased property and then immediately subleased it back to the lessor (termed Lease In / Lease Out, or LILO transactions). The transactions respectively involve electric generating and gas distribution facilities in the Netherlands. In accordance with the accounting rules for leases, Con Edison is accounting for the two LILO transactions as leveraged leases.

In an audit of Con Edison’s tax return for 1997, the IRS disallowed tax losses in connection with the 1997 LILO transaction. In December 2005, Con Edison paid a $0.3 million income tax deficiency asserted by the IRS for the tax year 1997 with respect to the 1997 LILO transaction. In April 2006, the company paid interest of $0.2 million associated with the deficiency and commenced an action in the United States Court of Federal Claims, titled Consolidated Edison Company of New York, Inc. v. United States, to obtain a refund of tax and interest. A trial was completed in November 2007. In October 2009, the court issued a decision in favor of the company concluding that the 1997 LILO transaction was, in substance, a true lease that possessed economic substance, the loans relating to the lease constituted bona fide indebtedness, and the deductions for the 1997 LILO transactions claimed by the company in its 1997 federal income tax return are allowable. In January 2013, the United States Court of Appeals for the Federal Circuit reversed the October 2009 trial court decision and disallowed the tax deductions claimed by the company relating to the 1997 LILO transaction.

Con Edison plans to request the United States Court of Appeals to grant rehearing en banc of the January 2013 decision. As a result of the January 2013 Court of Appeals decision, Con Edison expects to record an estimated charge of between $150 million and $170 million (after-tax) in the first quarter of 2013 to reflect the interest on disallowed federal and state income tax deductions and, as required by the accounting rules for leveraged lease transactions, the recalculation of the accounting effect of the LILO transactions. The transactions did not impact earnings in 2012, 2011 or 2010.

In January 2013, to defray interest charges, the company deposited $447 million with federal and state tax agencies relating primarily to the potential tax liability from these transactions in past tax years and interest thereon. The company estimates (based on current market values) that if it were to negotiate the termination of the transactions, it could receive cash proceeds of approximately $210 million (pre-tax), which amount could be higher or lower depending on the negotiations.