Dynegy Inc. Q3 2008 Earnings Call Transcript

Nov. 6.08 | About: Dynegy Inc. (DYN)

Dynegy, Inc. (NYSE:DYN)

Q3 FY08 Earnings Call

November 6, 2008, 09:00 AM ET

Executives

Norelle V. Lundy - VP of Investor and Public Relations

Bruce A. Williamson - Chairman, President and CEO

Holli C. Nichols - EVP and CFO

Lynn A. Lednicky - EVP, Asset Management, Development and Regulatory Affairs

Jason A. Hochberg - EVP, Commercial and Market Analytics

Richard W. Eimer - EVP, Operations

Analysts

John Kiani - Deutsche Bank Securities

Andrew Smith - JPMorgan Securities Inc.

Gregg Orrill - Barclays Capital

Elizabeth Parrella - Merrill Lynch

Brian Taddeo - Broadpoint Capital

Brian Chin - Citigroup

Raymond Leung - Goldman Sachs

Walter Brenson - Lincoln Capitol

Operator

Welcome to the Dynegy Incorporated Third Quarter 2008 Financial Results Teleconference. At the request of Dynegy, this conference is being recorded for instant replay purposes. Please note that all lines will be in a listen-only mode until the question-and-answer portion of today's call. [Operator Instructions].

I would like to turn the conference over to Ms. Norelle Lundy, Vice President of Investor and Public Relations. Ma'am, you may begin.

Norelle V. Lundy - Vice President of Investor and Public Relations

Good morning, everyone, and welcome to Dynegy's investor conference call and webcast, covering the company's third quarter 2008 results. As it is our customary practice before we begin this morning, I would like to remind you that our call will include statements reflecting assumptions, expectations, projections, intentions, or beliefs about future events, especially with respect to our growth strategy and 2008 estimates.

These and other statements not relating strictly to historical or current facts are intended as forward-looking statements. Actual results that may vary materially from those expressed or implied in any forward-looking statements. For a description of the factors that may cause such a variance, I would direct you to the forward-looking statements legend contained in today's news release and in our SEC filings, which are available free of charge through our website at dynegy.com.

With that, I will now turn it over to our Chairman, President and CEO, Bruce Williamson.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Good morning, and thank you for joining us. Here with me this morning is Holli Nichols, our Chief Financial Officer along with several other members of our management team.

Let's now turn to the agenda for our call, which is highlighted on slide 3 for those of you following along via the webcast. I will begin this morning by providing some highlights for the third quarter which was weak in terms of having mild weather that reduced margins and volumes in several regions. Then I'll discuss some of Dynegy's advantages relative to the IPP sector and how we are positioned for the longer term.

Given the extreme market turmoil over the past several months this sector as a whole has experienced a significant reduction in equity value. I will discuss how investors should parse the sector so to speak and look at our differences. We believe that Dynegy has a number of key competitive advantages that should not be over looked or lumped in with others in the sector that have financial challenges and operating cost disadvantages. Holli will then provide our third quarter financial results, discuss the regional factors that impacted the quarter and update our 2008 guidance. She'll also provide some insight into 2009 regional performance drivers.

However, we will provide more detail on our 2009 outlook in December. I'll then wrap up by discussing our key differentiating factors and then we'll go to Q&A.

Please turn to slide 4 where I will cover our third quarter highlights. To start with adjusted EBITDA of $268 million which was down 23% period-over-period. This was largely due to mild or summer weather in two of our key operating regions, the Midwest and the Northeast.

Let me touch on the weather issue, according to the National Climatic Data Center as demonstrated in the slide and the charts at the bottom of the slide, the third quarter 2008 temperatures in the Midwest to Northeast were significantly cooler than third quarter 2007.

The only real exception was the West which continued to see some above normal temperatures.

This milder weather during the third quarter had the effect of reducing demand therefore reducing sale volumes and not unexpectedly some margins and spreads. The third quarter was also marked by extreme volatility in the U.S. financial market as well the power markets in which we participate. A drop in the market price for power created mark-to-market gains relating to certain forward power sales. This boosted our GAAP net income to $605 million which reflected $542 million in mark-to-market gains.

With our liquidity at approximately $2 billion, this is a strong company asset that is ample to help us to weather the current market conditions. In addition, our bank credit facility is locked in at LIBOR plus a 150 basis points through 2012 and we have no significant debt maturities until 2011.

While the third quarter weather in general market conditions didn't cooperate for us, we didn't let that stand in the way of one of the best quarters in terms of operations. The company's base load fleet achieved 95% in market availability and is a testament to the commitment and excellent of Rich's team.

Please turn to slide 5. Before I turn it over to Holli to discuss our results in greater detail. I'd like to discuss what we see as Dynegy's competitive advantages. Specifically, the work we've done to build and maintain a strong financial profile. Companies in the IPP sector tend to be painted with the same broad brush. But when you are evaluating companies in this industry, you need to look at some key differentiating factors. First, we had ample liquidity. It is strong and adequate for us to run our business without any need to tap the credit market.

As of November 3rd, we had approximately $2 billion in liquidity, including about $855 million of cash on hand. One way to think about our cash position is to compare it to our outstanding shares of approximately $840 million and that gives you more than about $1 a share. Additionally, we entered into a contingent letter of credit facility earlier this year that provides up to $300 million of additional liquidity that can be tapped in a rising commodity price environment.

We also maintain a very tight rein on our financial counterparties and currently have limited uncollateralized credit exposure to them.

Second, in terms of our debt profile, Dynegy again is in a strong position. We have no significant debt maturities until 2011 that means we have no maturity again requiring us to access the credit markets for several years. We work with a solid high quality bank group with our bank debt at LIBOR plus 150 basis points.

Today, our overall weighted average cost of debt is about 7.5%. This is a much better rate than you would expect if you needed to refinance in today's markets considering our credit rating or even one that is significantly higher than ours. And what's more our unsecured bonds have no significant restricted covenant.

Before, I move on, I'd like to give credit to our Treasury Group. They plan for continued season, got our financings done prior to the deterioration in the U.S capital market. As a result, we have not really been exposed to the current credit crisis because our team worked hard and got our financings done when the market was there rather than waiting for a need to materialize and then take the risk if the credit markets would be open. Because of this proactive approach, Dynegy in our opinion has one of the strongest, lowest cost and most flexible capital structures in the industry and one that is well equipped to weather the current turmoil in the financial market.

Please turn to slide 6. Here again, if you choose to differentiate the IPP sector. It's important to remember the basics. So let's us look at the simple equation of revenue minus cost of goods sold equals to profit margin. Let's start on the revenue side. While near term pricing has been impacted by natural gas volatility and a lack of liquidity due to the attrition of some financial players in general terms power prices has still risen year-over-year.

We have actively commercialized the significant portion of 2009 as when we saw attractive opportunities. Our strategy is commercializing the current year plus one or two years allows us the flexibility to respond to these market shifts. We do have the opportunity to sell into the rising markets and potentially reload or buyback some of the position at opportune times.

Over the longer term we believe that the global demand for commodities will continue to put upward pressure on power prices. In addition, to relative lack of new builds or power plant development should make the value of our incumbent assets rise, or simply put, very little new power plant development is going on in the country and very little can be economically justified in the current environment.

Before I move on to the cost side of the equation, I want to take a moment to address the impact of the economy on electricity demand. Longer term we believe the pattern of demand growth will continue. However, the current economic conditions could influence a short term slowdown in demand growth and push back market recovery by a year or so. Period-over-period, we believe that weather conditions continue to be the real demand driver. We attribute our lower volumes during the third quarter primarily to the much milder summer weather year-over-year these seasonal impacts happen, we need to position the company therefore to work through the cycle and profit over the longer term trend of tightening reserve margin a trend that we continue to see developing.

Going back to the economy on our business; consumer behavior does not tend to change as much in response to rising prices as it does with other fuels, such as gasoline you can drive less, but you really can not change the size of your house and therefore your electricity demand. And in addition many utilities that we sell to, offer balance billing options for consumers who aren't exposed to real time changes in power prices. So they simply continue to consume and gradually have this impact into their bill.

So with electricity prices, consumer see slower incremental changes that are less dramatic than with other energy commodities.

Let's now move on to the cost side of the equation, specifically coal prices. Our Midwest base load fleet uses a 100% Powder River Basin coal which has not seen the dramatic price increase that Eastern coal experienced as the result of global demand. In addition, we have strategic contracts that are significantly less in our exposure to the volatility of the spot coal market. These contracts are meant to ensure that we have adequate and yet affordable supply of fuel to run our plants. This yields a significant competitive advantage for our coal fleet.

Taking a closer look, a 100% of our rail transportation cost is contracted at a fixed price through 2013 with no fuel escalators. And more recently, the majority of our coal supply is now locked in through 2010 and a significant portion locked into 2012. As you can see on the graph, our delivered coal cost has been very stable and offers a significant advantage in terms of dispatch cost. In fact, our dispatch cost equates to approximately $20 per megawatt hour on average for the Midwest fleet.

So to sum up on our equation, with rising power prices over the longer term and stable cost, Dynegy is still well positioned for margin protection in the coal-on-coal environment in which we operate.

Please turn to slide 7. Our relatively fixed price coal and rail contracts and our position in MISO offer a key competitive advantage for Dynegy. As I mentioned, our Midwest fleet burns a 100% PRB which is not subject to the global demand, and price increases and volatility of Eastern and Central Appalachian coal. In MISO, coal sets the marginal price of power 50% to 65% of the time, where as natural gas is the marginal price setter in PJM.

As I just mentioned, our Midwest coal fleet has a cost of dispatch of about $20 per megawatt hour, compared to the $31 a megawatt hour for PRB spot and current market rail-based prices. Our relatively low dispatch cost allows the Midwest coal fleet to avoid the dark spread compression that is impacting other coal-fired generators, particularly those who use Appalachian coals and sell into regions where natural gas sets the margin.

Let me give you a specific example. In the previous slide I showed the Cin Hub power price of $63 for 2008. If a generator burned Appalachian coal, the cost of dispatch would probably be $60 to $63 this year. Therefore, generators would not locked in prices ahead of time may experience a compressed or even a negative spread and therefore limited run times. In a market where natural gas sets the margin these spreads would impact generators who use Appalachian coal even more negatively in the current natural gas pricing environment.

So again our delivered PRB prices are below spot prices and provide additional margin protection. These are long-term differentiations that investor should consider. The third quarter however, was impacted by mild weather, but our basic business plan and competitive advantages remain intact for the longer term business cycle, and our financial advantages protect the company from the current credit crisis.

With that I'd like to turn it over to Holli to cover the third quarter results in more detail.

Holli C. Nichols - Executive Vice President and Chief Financial Officer

Thanks Bruce. Before starting I'd like to point out that these materials do contain non-GAAP measures that are reconciled in the appendix to this presentation for your reference.

Now, let's turn to slide 9 for a look at our third quarter highlights. Adjusted EBITDA decreased from $348 million in the third quarter of '07 to $268 million in the third quarter of 2008, this is primarily due to much milder weather which led to lower prices in the Midwest, compressed spot spreads in the Northeast and lower volume.

Adjusted cash flows from operations increased period-over-period, primarily due to favorable changes in working capital. Year-to-date free cash flow includes environmental capital expenditures of $171 million which reflects our continuing investment in environmental upgrade to further reduce emissions of our Illinois fleet.

On a GAAP basis, we reported net income of $605 million for the third quarter of '08 which included mark-to-market gains of $542 million net of taxes. These gains reflect the decrease in forward market prices for power during the third quarter.

During the third quarter of '07, net income was $220 million which included mark-to-market gains of $12 million net of taxes. '07 also included $124 million from discontinued operations related primarily to the gain on the sale of CoGen Lyondell facility. Earlier Bruce touched on our strong capital and liquidity measures. As of November 3rd, liquidity was approximately $2 billion, with $855 million of cash on hand.

Please turn to slide 10 for discussion of our performance drivers for the quarter by segment.

Adjusted EBITDA was down 23% from the prior year on lower volume. This was primarily due to milder weather and compressed spot spreads as Bruce and I have both mentioned.

In the Midwest, we achieved an impressive 95% in market availability for the base load coal fleet which means that we were in the market running when the market called on us to do so. That said, volumes in the region were down primarily during off-peak hours, due to lower demand as a result of the mild summer weather.

In addition, hedging activity prevented us from realizing the full benefits of higher market crisis in 2008. In several cases the prices we committed to in late 2007 and early 2008 for the third quarter of 2008 deliveries were lower than the actual market price. This resulted in lost opportunity costs. These lower realized prices were partially offset by increased capacity revenues and opportunistic sale of emission credit.

In the West, we saw the hydro season extend later into the summer which is one of the reason volumes were lower for the quarter. But despite lower volumes results improved slightly due to the new Griffiths tolling agreement. In the Northeast, volumes decreased primarily due to the milder weather and compressed spot spreads.

There were several factors affectingrun times at our combined cycle plan. Independence experienced lower prices due to mild weather, impacting market conditions in upstate New York. Bridgeport had reduced run times during off-peak hours primarily due to compressed spot spreads. Volumes were also impacted by a 7 day unplanned outage. In addition, transmission congestion between Casco Bay and Mass Hub negatively impacted basis and limited our sales volume.

Please turn to slide 11 for an update on our 2008 guidance. Today we are reducing estimates from the previous guidance presented on August 7th. Our revision takes into account several factors. In the Midwest, we experienced decreased run time especially during off-peak hours versus planned expectations due to mild summer weather and lower forwards for the rest of 2008.

In the West, the adjustment primarily resulted from losses on Sandy Creek Interstate block and lower than expected resource adequacy and capacity payments. In the Northeast, South American coal cost increased following a price majeure related to our previous agreement that has since been re-contracted for 2008.

Additionally, the combined cycle facilities in the Northeast does not run as previously anticipated due to mild weather compressing spreads. These reductions were partially offset by reduced spending related to the development joint venture.

The new estimates all of which are down a $115 million from our previous estimates are $840 million of adjusted EBITDA, $395 million of adjusted cash flow from operations and $25 million of adjusted free cash flow.

I would also like to point out that we don't attempt to reforecast changes in working capital or collateral, as these items will ultimately be based on pricing at September 31st, which we don't try to predict.

Before moving on let me take a minute to give you some perspective on our performance for 2008. We are not satisfied with our results and we recognize that it's not ideal having to take our guidance estimates down. This year's result have been impacted by various factors, some of which have been beyond our control and others which we start to manage.

First, we experienced basic issues and forced outages in the Midwest. Second, the Northeast was challenged by an increase in South American coal costs following a price majeure. And third, summer weather was exceptionally mild which has impacted overall demand and compressed spot spreads.

Our management team is mindful of these issues and in all cases we are focused on exploring ways to mitigate these and other types of risk. I would note that even after taking guidance down we do expect cash flow from operations to more than cover our maintenance and environmental capital expenditures. This is very important as we are operating in a tough financial market. Having liquidity of $2 billion and no need to tap the market for capital is important. We worked hard to achieve this over the last couple of years and our liquidity positions as to weather today's volatile market.

Now, let me touch on a few items for you to watch to consolidate your modeling efforts.

Please turn to slide 12. Although, we will present 2009 financial estimates in December, here are some key drivers for you to think about in each region, including price, cost, and regional market characteristics. Beginning with the Midwest, our base load fleet has relatively fixed cost, and this provides margin protection in a region where coal generally sets the marginal price.

I said relatively fixed because as we have said before, our delivered coal contracts have historically increased approximately $0.10 per NNBTU year-over-year. Also, investors should look at the amount of megawatt plugs in PJM auctions. Another Midwest driver is basis, which we are attempting to mitigate by transacting primarily in Cin Hub rather than rather than PJM.

However, there is still a basis difference between Cin Hub and the ultimate physical delivery location and that should be monitored. In the West, we will derive about two-thirds of our earnings from tolling agreements. We expect increased tolls to positively influence earnings. For example, we have entered into new capacity arrangement regarding to our Morrow Bay facility beginning in 2009 and it runs to 2011.

Also, as I discussed earlier, hydro plays a major role in the West. And because of its intermittent nature, it creates some uncertainty and not facilitate our power market. In response, we tend to be more heavily contracted in the West than another region. Moving to the Northeast, margin compression from higher South American coal cost will influence results.

And in all of these regions, weather can have the greatest potential impact on the volumes of our fleet. Additionally spot spreads can potentially impact all of our regions. To sum up, each region is affected by a unique set of performance drivers and this diversity offers Dynegy an advantage in the IPP sector.

With that I want to thank you for your time and turn it over to Bruce.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Thank you, Holli. Please turn to slide 14. In closing, I would reiterate the key factors that we believe differentiate Dynegy in the IPP sector and help us weather the current market volatility. As Holli and I have both covered is the strong liquidity first of $2 billion in addition to no significant debt maturities until 2011 and a bank facility that goes through 2012. Dynegy also has a number of operational advantages as well, starting with our PRB fuel which we utilized to generate electricity.

Approximately 90% of our total coal fleet burns low cost PRB and a 100% of the Midwest does. And we principally operate in a region in the Midwest where coal sets the marginal price 50% to 65% of the time. The bottom line is that participants in the IPP sector are not all created equal. This redemption driven market over the past quarter as hedge funds were hit with redemptions and a loss on that leverage lines, has brought tremendous selling pressure. I hope that this redemption driven market is coming to an end in 2008.

Certainly, when we have over $1 a share, 30% or 40% of our equity value in cash and no financing needs, this is not anywhere close to the last cyclical downturn in our equity. Investors now have, in my opinion, an opportunity to differentiate amongst the sector and evaluate our financial progress and our operating fundamentals and how we're set up for the future.

With that, let's move on to the question-and-answer portion of the presentation. Operator we'll take the first call now.

Question And Answer

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. First question comes from John Kiani, Deutsche Bank.

John Kiani - Deutsche Bank Securities

Good morning.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Hi.

John Kiani - Deutsche Bank Securities

Bruce, on the second quarter call you all talked about being... I think you were substantially hedged for 2008. Can you give us some more insights into what you mean by substantially, does that mean 90% to 95% or closer to 100%, what does that mean in the more specifically for the Midwestern base load coal fleet, please?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Well, John substantially probably meant for the year being up around the 80% or so mark, somewhere around in there. We never want to take things up to a 100% of the expected run time, because then if you have an unplanned outage or something like that, that's going to lead to just an overall net short position. So we take it up towards statistically, we think we would be comfortable with it.

The third quarter traditionally is also the warm weather portion of the year. And so that's the time of the year that if you are going to keep a little bit of open length that would in a normal summer be a very prudent thing to do, because that's a little bit of remaining upside potential there. The way this summer came out with a very, very mild weather, as how we covered in particular reducing some run times in the off-peak hours, those volumes didn't materialize and the results are therefore driven down by the weather. I guess, I should ask Lynn or Jason if there's anything either to review or add.

John Kiani - Deutsche Bank Securities

Well actually that's somewhat helpful, Bruce I have a follow-up on that regard. And then so the way to think about that you all said, you are substantially hedged and that really means closer to 80% and that in fact for the third quarter, you had positioned yourself to be even net longer so maybe in the third quarter is even less than 80%? And then if I could take that a step further, can I assume that when you are saying 80% or if say it was even less than that in the third quarter, let's say that was 75%, but that's actually perhaps in the on-peak higher and the off-peak lower and that therefore you were even more open in the off-peak, and with the collapse in off-peak prices. Therefore, you are more exposed to, is that what is going on?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

I'll defer to Lynn and Jason on that one.

Lynn A. Lednicky - Executive Vice President, Asset Management, Development and Regulatory Affairs

Yes, John. I mean, in the off-peak, we tend to be more sold to make sure that we have that commitment taken care of because we do not expect to see a lot of volatility in off-peak prices. So our focus would be more on the on-peak prices, and having some exposure to the market in that period.

John Kiani - Deutsche Bank Securities

Okay. So then the way to think about it is that, even though you said you were substantially hedged for 2008, really for the third quarter, you might have been as much as 25% open.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Yes.

John Kiani - Deutsche Bank Securities

Okay. And then from a basis... for the basis perspective, you all mentioned that there was some basis margin erosion and basis hit in the third quarter again. Was any of that related to PJM West?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

There would have been some, although we began managing that position earlier in the year. And again, the basis exposure that we have exist both at Synergy and at PJM. We have better ability to manage what exposure we had at PJM than at Synergy.

Lynn A. Lednicky - Executive Vice President, Asset Management, Development and Regulatory Affairs

And we also add that, it settled out some in the third quarter and some in the fourth quarter as well, even if you are managing the position. I mean ultimately goes into your realized price at the end of the day.

John Kiani - Deutsche Bank Securities

So. Okay. So then going back to the second quarter call, when you all said and kind of disclosed that you had taken a pretty substantial basis hit. In the second quarter, it was my understanding based on your comments that there was not going to be... there will no longer be any additional hedges to the PJM West region and that you are going to focus solely on Synergy hub unless you bought from transmission rights. So I am a little bit perplexed as to why there was a basis hit in the third quarter with PJM West hedges?

Lynn A. Lednicky - Executive Vice President, Asset Management, Development and Regulatory Affairs

I'm not sure that we said that we had no exposure there, we said that we had reduced that, and that going forward, particularly as we go out further in time, that we would manage that differently. So I am not sure if there were some different understanding on your end. But, I mean that was what we were trying to convey. And then the larger part of the basis is related to Synergy, relative or rather than the PJM.

Jason A. Hochberg - Executive Vice President, Commercial and Market Analytics

Two basis there is, there's PJM to Synergy and then there's Synergy to basically our plants at Illinois. And at the end of the day, there are basis pieces that you just can't control. And so we had provided estimates of what we thought that would be, and I don't think there was anything terribly dramatic at the end of the day different, but it did have some impact, and I don't have the exact numbers.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

That would be a very small amount relative to the weather driven impact.

John Kiani - Deutsche Bank Securities

Okay. That's helpful. And I guess, going back to the substantially hedged comment. I mean it's my opinion that when a company says they are substantially hedged, that means probably 90% or above in that... it doesn't indicate that they are speculating and being open 25% going into the third quarter. I mean that's the way I read something like that and it becomes a little bit more of a surprise when there's that exposure there.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Okay we'll try to refine that.

John Kiani - Deutsche Bank Securities

Thank you.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Okay.

John Kiani - Deutsche Bank Securities

I think that would be good.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Okay.

Operator

The next question comes from Andy Smith, JPMorgan Chase.

Andrew Smith - JPMorgan Securities Inc.

Hi, good morning guys. Can you hear me okay?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Yes. Hi, Andy.

Andrew Smith - JPMorgan Securities Inc.

Good. Hopefully I managed to hang-up on a call here with my fine phone skills. So hopefully I don't repeat a question here. Had a couple of things I wanted to talk about, just following on to the hedging and the volume issue. Is it right to think in the Midwest that the bulk of the volume weakness came from, for example like at Kindle on Altalani [ph] in the off-peak or was it actually some of the bigger base load coal plants that were impacted.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Well it wouldn't have been bald one but Lynn.

Lynn A. Lednicky - Executive Vice President, Asset Management, Development and Regulatory Affairs

I mean look it was both. I mean we saw the drivers around Kindle and on Altalani a little bit different, those are more spreads.

Andrew Smith - JPMorgan Securities Inc.

Yes.

Lynn A. Lednicky - Executive Vice President, Asset Management, Development and Regulatory Affairs

And as we did talk about previously when you saw gas prices moving up sharply, you didn't see power prices move this much and so that spread compression effect to the combined cycled units. In the coal fleet we did tend to see more min gem situations in the Midwest than we have historically seen. So they were volume impacts there on the coal fleet as well.

Andrew Smith - JPMorgan Securities Inc.

Did that surprise you guys. Because I think I have heard you guys say in the past, there are kind of two things you worry about in Midwest one is volume and one is price and you said that we don't really worry about volume because we are so low down in the stock. Back to your point on slide 7, you told me about dispatch cost is pretty cheap, was that a shock to you guys?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

I think it was a surprise, yes.

Andrew Smith - JPMorgan Securities Inc.

Okay.

Lynn A. Lednicky - Executive Vice President, Asset Management, Development and Regulatory Affairs

And again I think its back to weather. We had a very relatively mild summer and that manifests itself in volume I mean it is not like volumes were down just across the board but when you get into the min gem situation and that's where we get affected.

Andrew Smith - JPMorgan Securities Inc.

Okay. Got you. So then I guess back to John's question as well about how you think about what a substantially hedge mean. I guess the rub is, you say your biggest volume risk comes to probably like the Kindle but then that's also your upside driver in a hot summer. Is that sort of a fair way to think about it? So you said that you won't necessarily protect that volume?

Lynn A. Lednicky - Executive Vice President, Asset Management, Development and Regulatory Affairs

Well, it's harder to protect that volume on the combined cycles. You are more likely to enter into some type of tolling arrangement, which means that you are not as sensitive to volume.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

But coaling in the Midwest has not been something--

Lynn A. Lednicky - Executive Vice President, Asset Management, Development and Regulatory Affairs

Yes, we've done that. We have some troubles on Kindle, but we do still have several units that are exposed to the market around that.

Andrew Smith - JPMorgan Securities Inc.

Okay, got you. All right, that's helpful. And then on the price majeure that you mentioned on the South American coal. I'm thinking that to me price majeure in the Texas sense, is that your supplier just decayed you on the contract so they could sell it better somewhere else. Or was it fairly a price reopen or something in that contract?

Lynn A. Lednicky - Executive Vice President, Asset Management, Development and Regulatory Affairs

You got it.

Holli C. Nichols - Executive Vice President and Chief Financial Officer

The former.

Andrew Smith - JPMorgan Securities Inc.

Okay. And then looking at '09, I mean what did you guys done to sort of protect that in '09? Or have you done anything with that yet?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Yes. Percentages that are taken care of for '09 Jason or Lynn?

Lynn A. Lednicky - Executive Vice President, Asset Management, Development and Regulatory Affairs

It's around the 30% of the volume right now. We try to diversify our supply options as best we can.

Jason A. Hochberg - Executive Vice President, Commercial and Market Analytics

I have a little more up-to-date news on that. I mean it's more, it's going to be more, it's more in the 50% to 60% zone in terms of supply that we've locked in. And what I'd say is that we are aware of that risk but there are obviously different levels of contracts that you have in place and while some of the price majeure that we experience weren't being... were based more on the term key stage if you will versus signed sealed contracts. So we've advanced a lot of that supply to the executed firm contract level versus more of the term sheet level.

Andrew Smith - JPMorgan Securities Inc.

Okay, got you, all right that's helpful. And then one last question, when we think about... and as you guys are going to give guidance here in a few weeks. When we think about '09 you guys have made comments in the past about when you go out and commercialize the book and you look to hedge forward, are you sort of look at this 15% growth hurdle, although it might be lumpy year-to-year. You look at that as sort of trajectory turn line out to mid cycle of keys if you will. We've seen heat wave on the margin compress in third quarter. I mean, how do we think about those various inputs in terms of what base do we start with when we start thinking about '09? Do we rewind back to the $1.40 billion that you guys had out there earlier this year, do we start with this quarter, if you can give us some color around that, that would be really helpful.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

I think that the 15% was a guideline for people to look out over about say about a five year period of time as markets tighten. Clearly, within that we were not forecasting an economic slowdown like we have going on. And so, I think Holli gave some pretty good phrases for people to triangulate on. And I would say that you should take this year and start basing it off of his year adjusting for things that Holli covered on her slide which everyone noticed that was the last slide she covered.

In terms of adjustments for coal cost in the Northeast which are going to be up, tolling contracts in PJM which are going to be higher and things like that. At slide 12 and I would think you are going to delta off of this year. I'd like to think then, Andy with still over the longer term with the relative lack of any new builds going on, power demand, growth being still pretty consistent year-over-year, although we may see a flattening or slow in this year. If you get back into that upper trajectory, as we see market recovery come in.

Andrew Smith - JPMorgan Securities Inc.

Okay. Great. I appreciate the effort and the comments. I'll see you guys, Sunday night.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Okay.

Operator

Next question comes from Gregg Orrill, Barclays Capital.

Gregg Orrill - Barclays Capital

Thanks very much. I was wondering if you could comment on the... or quantify the impact of the increased hydro volumes in the West. And also maybe looking forward to 2009, just kind of the general outlook on a normalized basis for the West I know you talked about a new capacity agreement from Morrow Bay. What are some of the uplifts we can look for there?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Gregg, the West... because it's such a hydro driven environment, that's why we have tended to commercialize that out longer term than just a current year plus one, that's why we have got things like tolling agreements that go out 10 years, in some cases. And so I would say you have to... again sort of start with this year, look to next year the incremental amount of the Morrow Bay toll I don't think we have come out with that will be in December guidance.

But, I don't think you'll see relative to the other two regions, you wouldn't see very much movement year-over-year in the West in particular, I mean you can look at like in the appendix on slide 20, you see the West last year was $76 million, this year $82 million. So it just doesn't move around in a big manner like the Midwest and the Northeast.

Lynn A. Lednicky - Executive Vice President, Asset Management, Development and Regulatory Affairs

And it's also because of the substantial amount of tolling arrangements and some RMR contracts and hedges that came from the LS acquisition, it's our most hedged region if you will and our most hedged region certainly for '09 and ballpark we went into the year, I believe 75% to 80% hedged and I wouldn't be... I think that's where we look to be in that same region in for next year.

So, the hydro and some less run times in the West has less of an impact than some other factors in the other regions because of the hedge nature. It impacted that open position.

Gregg Orrill - Barclays Capital

Got it. Thank you.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Okay.

Operator

Next question from Neil Mitra [ph], Simmons & Company.

Unidentified Analyst

Hi. Thanks. I know that the primary reason you've put a lot of fixed price power hedges on in PJM rather than at Synergy and Northern Illinois it was due to a lack of liquidity in those markets. Now that you have decided to bring those hedges back into MISO area for 2009. How do you see that even bigger problem of liquidity in the floor markets due to the lack of counterparties affecting your ability to effectively implement your current plus line hedging strategy going forward for, let's say 2010?

Jason A. Hochberg - Executive Vice President, Commercial and Market Analytics

I would say that, obviously liquidity is an issue, there are less players in the market. So, it's somewhat forced us to be pretty disciplined about implementing the hedges and that's why we began working on the hedging for next year, early in the year. And so it's not the type of situation where you can go out and say, I want to sell 1,500 megawatts tomorrow, it's more of the type of thing that, overtime you layer into it 100 megawatts, 200 megawatts at a time.

Conversely the ability to trade, if you will around the position I would say that's where it's impacted. Once you put the positions on, you're going to have to largely live with it. So I would say the practical effect is that A; I don't think... I think two things, I think one the ability to kind of move in and out of positions is reduced greatly. The second thing, is that it takes more time to put positions on. And then I'd also add a third observation which is that, the lack of liquidity I think, sometimes the price discovery or the upside if you will, is in the marketplace or the premiums from the forward marketplace. I think you're seeing that come in a bit.

And I think when you look at a forward curve today, it doesn't really... for Synergy which is in $58, $59 on-peak, when the days are coming in the 50s in October. There's not hell of a lot of premium in that market, today and when you've got a winter and a summer. So, you got to think about whether fixed price hedging at this point in time with the forward curve that's out there, and a lot of that being driven by liquidity is necessarily a great market to be in today.

Unidentified Analyst

So can we expect a more exposure in the day ahead markets or less hedging if the current situation persists?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

I think right now, Neil [ph]. What to amplify with what Jason said; I think it puts more emphasis on the team getting out there and working things and maybe at 50 megawatts at a time at 75 megawatts or 100 megawatts. And so it's still doing the same thing, but its basically putting those in much finer and smaller layers, rather than watching things and moving in 300, 400, 500 megawatts at a shot. So, I think it just means there's going to be a lot more than just general consistent activity hitting smaller layers all through the year.

Jason A. Hochberg - Executive Vice President, Commercial and Market Analytics

Yes,And then, Neil [ph] I'll just add to that and you've got to make judgments about whether... because financial hedges with the issues that are involved basis and operation risks and the like, you've got to make a judgment, whether the premium that is or is not in the market is worth it. So I would say that, at various times, it might be attractive and then other times it might want have a little more exposure to the day ahead, real time market, depending on what that market is doing.

And I think that the liquidity, I'd say it is more like it a haven flow. At times, strong and now there are people that are interested. And then it might have a weaker sale, and no ones that interested. So you got to pick your spots when you think you like that risk or what.

Unidentified Analyst

Okay. And from what I understand, utilized fixed price power hedges at your Midwest coal plant since coal and gas interchangeably set the price of power, but the user have you considered using gas swaps or more liquid hedging instruments, [indiscernible] had given the fact that gas is more often sets the price of power around the clock in that region?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

We have thought about it. Jason?

Jason A. Hochberg - Executive Vice President, Commercial and Market Analytics

Yes, I'd say, I think I look at it more as like a tool in your tool belt, and you've got to do something... you got to think about to use and it does provide the benefit to liquidity, but like a lot of things... and I think you've probably seen that in some other companies in the sector, there are issues associated with it which is that if the key rates come in or the market is not as liquid on the power side, you might get disconnected from your fundamentals.

So the way I think about is that something we've got to use and at various times we might want to use it and deploy it in our portfolio. But I would never see a scenario under the current set of circumstances where we'd say, we're going to hedge the entire plant there using natural gas or some Midwest. I think it's something you think about when you like the risk reward and other avenues aren't open, but it's certainly applaudable in a strategy that we think about from time-to-time.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

But in many ways Neil, it's just like in hedging Midwest out to PJM where that's the location base is different this is just the power versus gas basis. It's not something that's going to be taken lightly and its going to... if the team looks to that sees that, something they want to do, it's also going to take some additional approvals to do it.

Unidentified Analyst

Okay great. Thank you very much.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Okay.

Operator

Next question from Elizabeth Parrella, Merrill Lynch.

Elizabeth Parrella - Merrill Lynch

Thank you. Bruce you mentioned that with regards to coal hedging, you have got significant amount of hedges even beyond 2010 for 2012 and something new on the PRB side. Can you quantify for us sort of what you mentioned and how much do you have hedged for '11 and '12. Is the pricing similar to the pattern for 2010 when you get these modest escalators or is there something closer to market or something of a step up in price beyond 2010?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

It's in the range of 30% to 40% and now I would say that same sort of trajectory or the same trend is intact.

Elizabeth Parrella - Merrill Lynch

Okay. Also can you hollow your comments with regards to the drivers of the lower guidance for 2008? Is it possible to quantify some of those factors and also to talk about how much of this has already been effectively realized versus the things that happened before?

Holli C. Nichols - Executive Vice President and Chief Financial Officer

To some extent we can, I mean I would say that the milder weather that we saw in the third quarter and how we've seen the '08 gas pricing and therefore the power pricing come down, has... is that majority of the driver of this decrease. And so there's a regional portion of this that has already occurred as of the third quarter.

And then what I would say when you think about the exposure for the remainder of the year, you are going to find that based off those curves that were at the beginning of October 7th, I believe, yes. So that was already a fairly weak I want to say that the remainder of the year for gas was 710 at that point. So there is quite a lot baked in. Now, that's not to say obviously that there couldn't be further downside but we feel like we've taken into account and especially as we sit here in the November that there should not be a tremendous amount of volatility associated with what's left.

Elizabeth Parrella - Merrill Lynch

What about the South American forced majeure when do that happen and how much of that hurt?

Holli C. Nichols - Executive Vice President and Chief Financial Officer

I think it's in the $10 million to $15 million range for 2008.

Elizabeth Parrella - Merrill Lynch

Was that all in the third quarter?

Holli C. Nichols - Executive Vice President and Chief Financial Officer

Well, it runs for the balance of the year.

Elizabeth Parrella - Merrill Lynch

Okay.

Holli C. Nichols - Executive Vice President and Chief Financial Officer

As being required to re-price it.

Elizabeth Parrella - Merrill Lynch

Okay. So the $10 million to $15 million impact is basically from the date of the forced majeure which I guess was sometime in the third quarter?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Yes, Elizabeth, the forced majeure probably happened a little bit sooner than that but only a portion of the coal was subject to that and that has all been priced now. And in fact we are getting close to the last deliveries of the year. I mean it's only a few more weeks left. So that should be pretty well done. We don't feel like we have any additional exposure on that or for the balance of this year. And as Jason said earlier we still have some coals that's not been priced for next year but we are making good progress on that.

Elizabeth Parrella - Merrill Lynch

Yes, that was the other question I wanted to ask about with regard to the South American coal for [indiscernible]. I think in 2008 the average delivered price is like in a low... 320 - 330 something like that. How should we thinking about the number for next year given that you got, I think as Jason said maybe 50% to 60% pretty well locked-in at this time for next year?

Holli C. Nichols - Executive Vice President and Chief Financial Officer

Obviously, we will be giving a full guidance in just a few weeks Elizabeth. But I think directionally certainly you would expect that number to be higher. So I think we prefer to just to lay all this out at one-time.

Jason A. Hochberg - Executive Vice President, Commercial and Market Analytics

And we put in the presentation in the graph what the market looks like and I think some of our, we're laying in overtime to the hedges. So we've given you kind of a spot view. I would expect that to be below where the market is trading today. But how we said, there will be an increase, an increase in cost.

Elizabeth Parrella - Merrill Lynch

Okay. Thank you.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Okay.

Operator

Next question comes from Brian Taddeo, Broadpoint Capital.

Brian Taddeo - Broadpoint Capital

Good morning.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Good morning.

Brian Taddeo - Broadpoint Capital

Just quickly, going back to the hedging. I know you have... a lot of talk about the words and what it means. And we talk about '09 you're having a significant portion hedge for '09 or commercialize. I mean treating about that being 50% or something less than that at this point, and just kind of curious to see if there were hedges layered in throughout the third quarter if that was pretty static from if we are looking at second quarter?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

We came into this year, I'll give you a guideline of that. We came into this year at around I think we said 50% to 65%, the year before was around 50% I would say on any given year, we start at 50% and with prices, if they were attractive during the year, we probably would move up from there. I think overall this year, you could plan on benchmarking '09 at a level equal to where we came into '08 at or maybe a little bit higher.

Brian Taddeo - Broadpoint Capital

Okay. And then with regards to guidance as far as my numbers are correct. I mean it looks like... we should expect a fourth quarter, that's down probably $100 million year-over-year in terms of EBITDA. I mean is that mainly driven by the lower commodity prices now or is there something else back there in any other outages or I think that's, they weren't originally planned for?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

No, I mean I think our outage schedule year-over-year is probably pretty comparable, Rich?

Richard W. Eimer - Executive Vice President, Operations

Yes, year-over-year it was pretty comparable, some issue that have caused a little bit of concern there.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Okay.I would say it's really just driven by prices lower year-over-year for the fourth quarter.

Brian Taddeo - Broadpoint Capital

The higher coal prices and the lower coal prices?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Yes, higher coal prices in the Northeast and then lower prices. Yes.

Brian Taddeo - Broadpoint Capital

If there were any... have you noticed any gas coming down and switching from coal to gas in any of the regions?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

The big region that we're in and myself know, what we try to layout one of the slide was that clearly, I think that we're getting to the point and PJM where that's liable to be something that's going to be impacting, some people will be watching our run times but are not aligning pretty closely because that's the big asset we've got in PJM, we don't have a big position over there.

Brian Taddeo - Broadpoint Capital

And have you seen anything in PJM yet or no?

Jason A. Hochberg - Executive Vice President, Commercial and Market Analytics

No, I would say no. and if anything... some of the combined cycle volumes are actually little bit lower. So I think there is a lot of people in the market have their whole spoken for and people have various probably bidding strategies and the like. So I think those are... the effects you are not going to see those immediately if something that you should keep an eye on for 2009 and 2010. As the higher pricing, higher coal pricing really starts to kick in and people offer their bidding strategies.

Brian Taddeo - Broadpoint Capital

Got it. And one last thing, in the Northeast you talked about one of the issues this quarter being transmission congestion. But given your lack of whether... less volumes going to system seems like congestion, less like other being congestion. I mean is there something different that's driving that? Just sort of an ongoing issue?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

No, I think it was really mainly driven by weather and the lack of heat for demand down in... let's say in the Boston area.

Brian Taddeo - Broadpoint Capital

Okay. Thank you very much.

Operator

Next questions comes from Brian Chin, Citigroup

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Hi, Brian

Brian Chin - Citigroup

Hi, Bruce. When you guys received coal that has been contracted, do you have the ability to turnaround and resell that in the open coal market or are you locked-in and you now have to burn that coal?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Effectively no. Lynn is telling me we can do a very, very small amount of it, but its not, that's not an active part of our business.

Brian Chin - Citigroup

Do you think other coal fire generators in MISO and in PJM have a similar set up where they don't have the ability to resell the coal back out?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

I really don't know.

Lynn A. Lednicky - Executive Vice President, Asset Management, Development and Regulatory Affairs

Look, the only thing I would add there Brian, is remember, with the weather events in the Midwest this summer, coal deliveries were somewhat impacted and we drew down on our inventories. And so we have actually been focused on getting our inventories where we would like them to be. We didn't have an operational problem with that, but we try to balance our coal supply pretty close to what our needs are.

Brian Chin - Citigroup

Okay. That's great. Thanks a lot.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Yes.

Operator

Question comes from Raymond Leung, Goldman Sachs.

Raymond Leung - Goldman Sachs

Hi, everyone. Just a couple of questions, given the changing dynamics with counterparty risk and cost of credit. How should we think... you've provided a pretty big buffer on liquidity, how should we think about what's the appropriate level of liquidity in cash that you should keep. And how should we think about your capital structure going forward with respect to leverage, is that going to... what are you guys thinking about on that context?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Well, with regard to capital... I'll take the back half first, with regard to capital structure you look at our debt maturity profile and with no debt of material amount due till 2011 there's not going to be a lot of change that takes in place there. Simply because we do not have debt coming to maturity.

In terms of the cash and liquidity that we have on hand, in this environment we've been spending most of this year watching that liquidity build up and the cash build up. We said we would evaluate things after we saw how 2008 is shaping up and how 2009, and have a kind of a clear line sight at 2010. When we said that back last December, I don't think we were anticipating this type of economic slowdown and clearly a credit market kind of freeze up. So it feels very good right now from a running the company stand point to have this amount of cash and liquidity.

So you do not need access any credit market. I guess I would say in a normal time moving forward, clearly the company doesn't need to have almost a billion dollars of cash. Sort of around in order to make working capital needs. But these are not normal times.

Holli C. Nichols - Executive Vice President and Chief Financial Officer

And I would add is that, what we... the way we think about our liquidity is to obviously anticipate manage for the future. Commodity prices are extremely low right now which means our collateral needs are quite low. When you see a spike in prices which might be hard to imagine we see here today. It's obviously very possible in the next year that we see commodity prices run again and as an example when you think back to June 30th.

Obviously, we've had some other improvements on liquidity since then but we were less than a billion dollars of liquidity compared to where we are today. And that is because of the very high pricing and what we want to make sure that we allow ourselves the opportunity to do it. When we see the ability in the market become a little more liquid, our current year plus 1 hedging strategy requires us to maintain a reasonable amount of collateral to manage through the fluctuations in the commodity cycle.

So I absolutely would reiterate and agree with Bruce. It's almost a $1 billion of cash sitting around may not be the most effective manner in achieving that but you will see it's always carry a very sufficient amount of liquidity because of the collateral needs of this business.

Raymond Leung - Goldman Sachs

Okay. Thank you.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Okay. Operator, we'll do one more question.

Operator

Your last question comes from Walter Brenson with Lincoln Capitol.

Walter Brenson - Lincoln Capitol

Thank you. Just wanted to get back a little bit on your hedging strategy. So if I understand correctly, you typically enter a quarter something like 80% hedged for that quarter and through forward contract set influences you from volume risk as well as fixed price. So correct me if I am wrong. But if that's the case I guess I am not clear why you are putting such a big emphasis on weather potentially impacting volumes on a quarter-to-quarter basis with the impact typically only be on that 20% that you leave open?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

First of we haven't said that we just come into a quarter at 80%. We've come into different years, this year we came in at 50% to 65% hedge and as we went through the year we've layered more forward sales and as went through the year. However, the third quarter being the quarter when you normally have some warm weather and it's kind of a big volume in run time quarter we kept a little more open in that quarter.

And then the weather clearly didn't materialized. And then actually had some reduction, so given the soft weather that's reduced the run times and then that back to them obviously we'll produce the result that you see. It's not a simple thing of just saying that we know we'll have a guaranteed sale amount and you sell 8-tence of it and keep 2-tence open, and then you know you're going to sell that remaining 2-tence, because you can have the overall volume drop off as well as the price drop off.

Walter Brenson - Lincoln Capitol

Okay. But I just want to make sure, I didn't miss understand to the extent that you are hedge whether 80% or something are lower, you don't have volume risk on that piece right?

Bruce A. Williamson - Chairman, President and Chief Executive Officer

On the portions that are sold?

Walter Brenson - Lincoln Capitol

Yes.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

In effect, that's more or less right. I mean you didn't have operational risk to the extent that you have an averaging you have to go fill that volume. So it's the opposite risk. Yes.

Walter Brenson - Lincoln Capitol

I understand that.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

We do have that. Just to be clear so you can understand that, but yes you do have that, but otherwise no, if you made a forward sale, you have made a forward sale.

Walter Brenson - Lincoln Capitol

Right. And then on the... you said that typically you would commercialize more of the off-peak. Yet for the third quarter you actually pointed to lower run times off-peak in the Midwest. So did you commercialize less than you might typically off-peak in the third quarter?

Jason A. Hochberg - Executive Vice President, Commercial and Market Analytics

No, probably not, typical.

Walter Brenson - Lincoln Capitol

Okay. All right, thank you.

Bruce A. Williamson - Chairman, President and Chief Executive Officer

Okay. Before ending this morning's call, we do have some upcoming events for various members of the management team that they'll be participating in later this year. On November 9th and 10th the team will be at the Edison Electric Institute Financial Conference in Phoenix and I will see a number of you there.

On December 10th and 11th, we'll be in New York City to present 2009 guidance estimates and meet with many of you as we've done in the past. At this meeting we'll provide some insights into our view of the future, cover our forecast earnings, cash flow, and capital expenditures and sensitivities for 2009.

Thank you for your time again this morning and we look forward to seeing some of you in Phoenix next week.

Operator

This does conclude today's conference. You may disconnect at this time. .

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