Executives
Dennis Barber - VP of IR
Mark Jacobs - President and CEO
Brian Landrum - EVP and COO
Rick Dobson - EVP and CFO
Analysts
John Kiani - Deutsche Bank
Daniel Eggers - Credit Suisse
Elizabeth Parrella - Merrill Lynch
Michael Lapides - Goldman Sachs
Lasan Johong - RBC Capital Markets
Reliant Energy, Inc. (RRI) Q3 FY08 Earnings Call November 7, 2008 8:00 AM ET
Operator
Good morning ladies and gentlemen, and welcome to the Reliant Energy Third Quarter 2008 Earnings Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Please note that this conference is being recorded.
I would now like to turn the call over to Mr. Dennis Barber. Mr. Barber, you may begin.
Dennis Barber - Vice President of Investor Relations
Good morning and welcome to Reliant Energy's third quarter 2008 earnings conference call. Leading the call this morning are Mark Jacobs, President and CEO; Brian Landrum, Chief Operating Officer; and Rick Dobson, our CFO. Following our prepared remarks, we'll have a question-and-answer session. Please limit yourself to one question with one follow-up, so others can participate.
Both our earnings release and the slide presentation, we are using today are available on our website at www.reliant.com in the Investors section. A replay of this call will also be available on the website approximately two hours after the call.
Consistent with our past practice, we're using several non-GAAP measures, to provide additional insight into operating results. Reconciliations of the non-GAAP measures to GAAP figures are available on the website. An item adjusted for this quarter is unrealized gains and losses on energy derivatives, which is an ongoing adjustment.
As many of you know, we update our outlook each quarter using forward commodity prices. The current outlook uses forward commodity prices as of September the 26th that was the last Friday of the quarter for which there was a traded contract for October.
In addition, the outlook is based upon the plant to unwind the credit enhance retail structure announced on September the 29. As we've also announced our board of directors is evaluating strategic alternatives to enhance shareholder value.
I would also remind you that any projections are forward-looking statements made on this call are subject to cautionary statements on forward-looking information contained in our SEC filings.
I'll now turn it over to Mark.
Mark Jacobs - President and Chief Executive Officer
Thank you, Dennis and good morning everyone. Welcome to our quarterly call. To say that the few weeks have been challenging would be a significant understatement. We're all experiencing a series of unprecedented events, both in terms of our industry and our economy as a whole. But when I step back from the turmoil in the financial markets, here is what I see; I see a company that has two valuable businesses. First, a wholesale business that is geographically diverse, one that has assets across the dispatch curve and utilizes a balance feel mix, a fleet that is operating at top core tile performance levels, and one that is well positioned to benefit from the eventual tightening of market fundamentals.
Second, a retail business that represents a strong and valuable customer franchise, a franchise that has generated $3.7 billion of contribution margin since the Texas market opened to competition in 2002. We have faced a number of challenges this year. Worldwide credit markets are disarray. The cost of capital has gone up significantly and it's availably is severely constraint.
The economic outlook is very uncertain and its direction will impact our industry in the near term. Commodity prices have been on a roller coaster ride. After beginning the year at less then $8 per MMBtu, natural gas prices climb north of 13, only to collapse back into the $7 range.
Retail results in 2008 have been far below our expectations. In Q2, extreme weather combined with transmission constraints impacted our results. And, in September Hurricane Ike tore through the Texas Gulf coast leaving over 2 million customers without power and had significant consequences on the retail business.
Each of these factors in isolation presents challenges. The combination of them also impacted the credit enhance retail structure with Merrill Lynch. The world has changed since the credit sleeve was put in place in 2006. And we decided that an orderly unwind of the arrangement was our best course of action. We continue to work with Merrill Lynch to iron out the specific terms of the unwind agreement.
In order to facilitate Merrill Lynch's exit, we arranged financing commitments for $1 billion of additional capital. The amount of capital raised reflected the cash balances we build earlier in the year and proceeds from the Bighorn sale, which closed last month.
We are pleased to have completed the definitive documentation with First Reserve with a convertible preferred investment. The other component of the additional capital is a $650 million secured term loan. We're working to complete a definitive loan agreement with Goldman Sachs.
There were a couple of reasons that we decided to pursue this approach. First, it provides adequate liquidity to operate our business in a challenging environment. That in turn, provided us with more certainty to protect the value of underlying assets.
Second, it gives us flexibility to evaluate other courses of action. The unwind of the credit sleeve and the related financings represent a base case for us. The updated outlook for 2009 and 2010 is based on the completion of these transactions.
Let me now address the strategic alternatives process, which we announced on October 6. In light of the significant changes in our operating environment, it's an appropriate time to step back and examine all of our alternatives. To see if there is another approach that creates more value for shareholders versus completing the new financings.
As we've said we do not intend to disclose developments related to the review of alternatives until the board has approved the course of action. Accordingly, we will not be able to address any specifics related to this review during the Q&A portion of today's call. But I think it's important to provide some additional context with the review that the board has undertaken.
The unwind that the Merrill Lynch credit sleeve requires significant additional capital. All of that capital relates to the retail business and Reliant shares associated with the commercial and industrial segment. We had pursued a strategy in the retail business that was predicated on the Merrill Lynch credit support and a $0.40 per megawatt our capital cost.
With access to Merrill's balance sheet, we grew C&I part of our business. But the orderly unwind of the credit sleeve has significant implications. It means that overtime the capital requirements for retail will come back on to our balance sheet. In the implication of that is the margin from commercial and industrial business, doesn't cover its cost to capital with Reliant responsible for collateral obligations.
In addition to looking at broad alternatives, we are also examining actions that address these specific challenges in a more targeted fashion.
Turning to the retail business on slide 4, Brian will go through the detail, but here are the key takeaways. First, we're modifying our supply strategy. Although new supply strategy will result in higher expected supply cost overtime, we expect it to result in a tighter distribution of earnings going forward.
Second, we're undertaking a top to bottom review of all our core processes that support the business to ensure that we have the right people, skills and systems to deliver consistent financial results.
Retail results for the quarter and the outlook for the balance of the year reflect the impact of hurricane Ike and they are inline with our preannouncement at the end of September. The outlook for 2009 and 2010 incorporates our view that the mass market business is well positioned to generate attractive profit levels. The outlook also includes the assumption that we wind down the C&I segment in recognition of its capital requirements and its earnings power relative to our cost of capital.
Turning to the wholesale business, our portfolio is well diversified across regions, dispatch type and fuel mix. Over the longer term, we believe this portfolio is well positioned to benefit from tightening supply demand fundamentals. But we recognize that there is tremendous uncertainty in the current environment with respect to the economic outlook and commodity prices. We must therefore, evaluate a wide range of potential scenarios to ensure that we have to ware with all to operate through a significant downside case.
I would note that we have several factors working in our favor. First, the significant portion of margin over the next several years is from locked in capacity sales. In fact just under a half of open wholesale gross margin is from capacity and PPA revenue in 2009 and 2010.
Second, we have several base coal plants that produce margin in virtually any scenario. We expect capital expenditures to decline significantly starting in 2009 as the scrubber installation program is completed. And we have the flexibility in our plant O&M spending to adopt the changing market conditions.
We're also examining other actions that maybe appropriate in the current environment. With respect to Q3 wholesale results, you'll see good operational performance. We're seeing the benefits of our investments since 2004 to get the top quartile performance levels.
On the other hand, market conditions reflect the impact of lower commodity prices at mild weather. The wholesale outlook is based on forward commodity prices at the end of September. As we've discussed, commodity price volatility has a significant impact on our near term earnings outlook.
But I think it's important to keep in mind that over the longer-term, we expect tightening supply demand fundamentals to improve earnings levels.
I'll now turn the call over to Brian Landrum, our Chief Operating Officer.
Brian Landrum - Executive Vice President and Chief Operating Officer
Thanks Mark. Let me start with retail on slide 6. The foundation of our retail business is a strong valuable customer franchise. In the mass market segment, we serve 1.7 million customers. Since market opening, we've outperformed other large incumbents and are strong number 2 in mass market share. Our customers give us high marks for customer satisfaction as well.
In the most recent JD power survey of the ERCOT retail market, we rate highest in customer satisfaction among the large incumbent providers and third over all. Over the year's, we have successfully provided value to our customers for generating substantial contribution margin.
As Mark said, we've delivered $3.7 billion in contribution margin since market opening and 400 to 500 million each year from 2005 to 2007. We've achieved these results across the volatile periods including the impact of hurricanes Rita and Katrina in late 2005 and end of 2006.
During this period, we were able to achieved target margins, how we operated with the consistent hedge strategy of buying natural gas to our expected load, and buying heat rate to 2 standard deviations above normal load. This operating approach gives us fairly stable returns. In 2008, we experiences extreme events that lower results and exposed gaps in our retail operations.
As slide 7 shows the primary source of variability in the retail business comes from actual volumes and cost being different than what has been hedged.
Let me describe this slide briefly. The Y axis shows actual cost versus hedged cost. This happens when actual power prices in the month are higher or lower than the cost of power procured when customer prices were set.
The X axis shows actual load versus hedged volumes. From 2002 to 2007, these variances were small and manageable. In the second quarter of 2008, however, we saw extraordinary conjunction and the hottest weather in 30 years, along with much higher natural gas prices.
As a result, we had to buy sizable volumes from the market at much higher cost than we hedged, consistent with the upper right of the slide. Hurricane Ike eliminated the large portion of a load in the Houston zone for much of September. This followed a dramatic drop in wholesale power prices. Consequently, we were selling back excess supply at a loss consistent with the lower left of the slide.
We also had execution issues in our forecasting, pricing and costing processes that contributed to the poor 2008 results in retail. To address these issues and the increase cost of capital from the credit crisis. We plan to operate the retail business in the way that maintains our customer franchise, yet lowers our stress collateral exposure and reduces earnings variability.
In the outlook, we assume a wind down of the C&I business. C&I generates about 30% of retail contribution margin, but requires about 70% of the capital. This level of margin is insufficient to cover the higher cost of capital to operate C&I using our balance sheet.
On the other hand, the mass segment earns about 70% of the retail margin that needs about 30% of the capital, which generates an attractive return. The outlook assumes we will continue to operate the mass business.
To reduce earnings variability, we're designing and implementing changes in our hedging approach such as matching supply and load by zone, buying flexible supply for volumes above 2 standard deviations in some months, reviewing energy sales in purchase contract language and considering weather and additional gas hedges to mitigate extreme events.
These changes will add costs that we have assumed will not be passed through to customers. Also, the review of people, skills and systems begun in the second quarter to improve our results as continuing, with particular focus on pricing, costing and forecasting.
On slide 8, the retail financial outlook is updated to reflect our base case of an ongoing mass business with reduced earnings variability and a wind down of our C&I book.
C&I should earn between $50 million and $75 million in 2009 with the decline in 2010 to $25 million to $50 million due to the lack of new business to replace the expiring contract. The mass market segment is expected to earn $200 million to $250 million in contribution margin in 2009 and 2010.
The reduction from the prior outlook is due to the assumed line down of the C&I segment to lower stress collateral requirements, higher hedging cost to the earnings variability and lower volumes in the mass segment.
Now let me shift to wholesale on slide 9. The investment made in recent years and operations excellence is paying-off with commercial capacity factor for the quarter at over 91%. We continue to be on track to deliver top quartile, CCF results of over 87% in 2008.
The outlook for wholesale reflects lower dark spreads in the forward markets. Despite the lower commodity curves, we are well positioned to generate substantial open energy margin. Over $500 million of 2009 and 2010 margin is from capacity sales and PPA's, over 90% of which are not tied to commodity prices.
Further, low cost base load generation in PJM from stations such Seward, Shawville, Portland, Keystone and Conemaugh have significant earnings power even in low commodity environments. I would also note that we sold approximately 40 Bcf of gas ford that will act as a hedge to some of our generation and create free cash flow under various ford price curves.
This reduced stress collateral as part of the unwind of the Merrill Lynch Credit Agreement. The scrubbers at Keystone and Cheswick continue to be on track to go into operation in the first half of 2009.
This will further diversify our fleet such that about half of our coal generation will be scrubbed. Consistent with past practice, we procured our forecasting coal needs for 2009. The average delivered coal cost for 2009 a roughly a $100 a ton. The mark-to-market on this position can be found in the appendix.
Despite the near term economic uncertainty, we believe that with the limited additions of new supply our diversified asset base will generate long term value from tightening supply and demand. Let me now turn call over to Rick Dobson, our Chief Financial Officer
Rick Dobson - Executive Vice President and Chief Financial Officer
Thanks Brian. Let's start with a financial overview on slide 11. Our open EBITDA was $105 million in third quarter of 2008. This was $338 million lower than 2007, primarily driven by challenges in our retail segment as a result of hurricane Ike in lower host of economic generation due to tightening spreads between the price of power and coal and milder whether in the Northeast. Adjust EBITDA was $134 million greater than open EBITDA primarily due to in the money coal hedges.
Now Lets turn to the wholesale business on slide 12. The previously discuss tightening spreads between power and coal prices in very mild weather in our operating regions during the third quarter with a primary catalyst for 4 terawatt hours of lower economic generation. This combined with higher coal prices in 2008 resulted in negative year-over-year Open energy gross margin variance of approximately $100 million.
Improved capacity payments in PJM California into a lesser extent MISO with the major drivers behind improved other margin of $57 million. As consideration for lower O&M cost, we ended 2008 third quarter $38 million lower than 2007.
Let's now move to the retail operations on slide 13. As Brian previously discussed hurricane Ike, the third most astrictive hurricane to ever hit United States resulted in massive outages and was the primary driver of our 306 million negative third quarter variance.
Moving to slide 14, let's take a look at our year-to-date cash flows. In short, the year-to-date performance of our wholesale segment and lower interest payments with the primary drivers behind our positive free cash flow variance year-over-year.
Now let's move to our 2008 to 2010 outlook on slide 15. Our outlook is based on commodity prices as of September 26, 2008. It also includes fundamental changes in our retail business. For the mass business, our outlook includes higher supply cost, reduced earnings volatility resulting from actions that Brian described earlier.
For the C&I business, our outlook shows a reduced earnings in collateral needs from running down that business. This combination of these actions has resulted in lower 2009 and 2010 retail outlook.
The outlook also includes the new term-loan in convertible preferred financings, while excluding the Merry Lynch sleeve fees. Even with lower commodity prices and lower retail outlook, our combined businesses would generate $1 million to $1.2 billion of free cash flow in 2009 and 2010.
As we have seen commodity prices can be extremely volatile, in the appendix we provide directional sensitivities related to the major commodity price drivers, so you can make adjustments to date's specific outlook amount based on subsequent commodity pricing movements.
Now I'll spend time talking about a Merrill Lynch orderly unwind. First, what does an orderly unwind mean to us? An orderly unwind means that overtime, we will bring onto our balance sheet the retail segments collateral requirements once we have reduced those to a size that fits comfortably into our liquidity profile.
Turning to slide 16, an orderly unwind also start with ample liquidity. Thus, we believe that 2.7 billion of liquidity including the 1 billion in commitments for new capital along with our free cash flow profile will allow from orderly unwind that I just described.
Lets now move to slide 17, potential retail collateral requirements. A key factor to understand is that our retail sales contracts do not call for collateral postings, but our retail supply contracts do. Postings may take the form of a letter of credit or a cash posting.
This slide depicts the types of collateral in a retail business and gives you an idea of how the positions roll off naturally. Our collateral postings form the three categories, those which are fixed, some that are semi-variable and some that vary with commodity prices movements.
The fixed, as the name implies do not very significantly overtime and is represented by the role title ISO, TDSP, et cetera. These are postings to our regional independent system operators for state licenses, PUC requirements as well as to provide us a parker ignition and are necessary to operate in these regions.
The next row label payables represent our expectations that we will prepay for 50 days of power supplies, once the sleeve is completely unwound. This number will likely have some seasonal commodity price fluctuation. So, we think about this in the semi-variable use of liquidity.
The row headed initial margin is the posting requirements for fixed price derivative supply contracts. Initial margin also has some variation depending on the amount of term customers. So, we think about this as semi-variable. The out of the money position related to these fixed price supply positions are shown in the graph as variation margins.
The graph also shows how these positions naturally decline overtime. Variation margin contains the most variability as it moves commodity prices. Relative to our fixed price supply position, we post when prices go down and we get our postings back when prices increase.
Overall, this is all timing and these postings return to us as the transactions culminate. Focusing on the bottom of the slide, you see Reliant had contingent collateral. These Bcfe amounts become a variation collateral posting if commodity prices move down.
We expect to use a combination of levers, shown in the right hand box in this slide to accelerate the natural decline of our collateral requirements and continued exposures for the C&I business. These levers include the following plans; we saw in the C&I business, we're accelerating its wind down, finding alternative credit support vehicle, using the portion of our wholesale fleet that is highly correlated to natural gas as an internal hedge, replacing fixed price retail supply positions with options as well as other negotiated transactions to reduce collateral needs.
So to summarize, it's clearly evident that the vast majority of collateral requirements and contingent collateral emanate from the C&I business. As you can see from the graph that even without the use of levers, the Bcfe drops rapidly over a relatively short period of time.
We intend to reduce collateral requirements and contingent exposures to the point, where the remaining retail segment fits comfortably into our liquidity profile as part of an orderly unwind of the Merrill Lynch credit sleeve.
I will now turn it back over to Mark for some concluding remarks.
Mark Jacobs - President and Chief Executive Officer
Thanks Rick. Let me wrap up on slide 18 with a summary of key points. We have two valuable businesses, a well diversified portfolio of generation assets and a retail business that has a strong and loyal customer base at its core.
We're addressing the challenges faced by our industry in the economy as of whole. The plan to unwind the Merrill Lynch credit sleeve and raise additional capital provides adequate liquidity to operate the business.
At the same time, we are exploring to full range of options to identify opportunities to improve upon that plan. We believe that the mass market retail business is well positioned to deliver attractive financial results in 2009 and beyond. And we are responding to changing market conditions by winding down our C&I segment.
We are also taking actions to reduce earnings variability in that business and improve the supporting processes. In the wholesale business, we are looking at number of different scenarios including the stress downside cases. And we are confident that we can operate through those scenarios. But, we have a robust long-term value proposition based on supply demand fundamentals.
Before we move to the Q&A, I wanted to remind you that we will not be able to address any questions related to the board's review of strategic alternatives until the board has approved the course of action.
Operator, let's open the line for questions.
Question And Answer
Operator
Thank you. We will now begin the question and answer session. [Operator Instructions]. The first question is from John Kiani from Deutsche Bank. Please go ahead.
John Kiani - Deutsche Bank
Good morning.
Mark Jacobs - President and Chief Executive Officer
Good morning, John.
John Kiani - Deutsche Bank
I... my phone was cutting up, so I may have missed what you said, but I have a couple of questions around the contingent collateral on the retail business. And than also a comment you had made Brian on wholesale and on hedging. Did you say where you currently stand on reducing the Bcfe exposure and collateral postings for the retail business, and can you remind us of what the target was under the financing agreements please.
Rick Dobson - Executive Vice President and Chief Financial Officer
Yeah, this... Mark, if you want, you can take that, I can address the numbers aspect of it.
John Kiani - Deutsche Bank
Great.
Rick Dobson - Executive Vice President and Chief Financial Officer
Slide 17 --
John Kiani - Deutsche Bank
Yes.
Rick Dobson - Executive Vice President and Chief Financial Officer
Basically gives you a snapshot that we're at 400 Bcfe and then the Goldman Sachs requirement that we're working on right now requires us to initially get to 300 Bcfe and then ultimately in a couple of months to 280.
John Kiani - Deutsche Bank
Got you. So, you're currently a 400, that's the 284 plus the 116.
Rick Dobson - Executive Vice President and Chief Financial Officer
That's right, John.
John Kiani - Deutsche Bank
But you need to be at 300 to affect the Goldman Sachs loan agreement?
Rick Dobson - Executive Vice President and Chief Financial Officer
That's a condition process of the Goldman Sachs loan. That's correct.
John Kiani - Deutsche Bank
Okay. And then the box on the right hand side that shows the levers to reduce collateral requirements, that's what we should look at for your message of reducing it by another 100, and then on top of that another 20 Bcf?
Rick Dobson - Executive Vice President and Chief Financial Officer
Those are the tools that we would used to reduce... yeah, down, that's just for the condition of funding.
John Kiani - Deutsche Bank
Right.
Rick Dobson - Executive Vice President and Chief Financial Officer
Obviously, we'll not talk about bringing the collateral requirements into a place that fits comfortably; we'll continue to drive it down below that level.
John Kiani - Deutsche Bank
And, are the... is the wholesale hedge and the options... the coal options on gas, I guess are those the two biggest levers or drivers that you have?
Rick Dobson - Executive Vice President and Chief Financial Officer
I wouldn't pinpoint any of those drivers bigger than the other ones. We have a lot of things in play right now John, and one we have executed is the initial wholesale hedge back in October 3rd, we have a lot other things in flight right now to work out.
John Kiani - Deutsche Bank
Yeah. Okay. So, then actually that goes to my other question, Brian, I think you made a comment about a wholesale hedge, can you give a little more detail on what you said there, I didn't quite catch what you said?
Brian Landrum - Executive Vice President and Chief Operating Officer
What I said was John, that we've put on about 40 Bcf of gas and as Rick said that was put on in the first week of October, and it provides both free cash flow during under various scenarios for our wholesale business, as well as it was part of the reducing stress collateral under the Merrill Lynch unwind.
John Kiani - Deutsche Bank
So, is there an internal hedge with yourself?
Brian Landrum - Executive Vice President and Chief Operating Officer
Yes.
John Kiani - Deutsche Bank
So, then is the way to think about is that you stripped off 40 Bcfe hedges in the retail business. Were you... and where you had effectively bought either financially or physically 40 Bcfe of gas to hedge the supply agreements, supply obligations on the retail side, and then sort of I guess the resulting 40 Bcfe of open shore position on the retail side, you're saying internally, then will act as a natural hedge or hedge against your long powering gas position in PGM and MISO, is that what you are saying?
Brian Landrum - Executive Vice President and Chief Operating Officer
Right John. Go ahead, Mark.
Mark Jacobs - President and Chief Executive Officer
I'll just say that's right. In fact its more than just acting as there is actually your contract between the wholesale the retails for those 40 Bcfe.
Brian Landrum - Executive Vice President and Chief Operating Officer
But the hedge is that both highly gas correlated hedges. So, the effectiveness of those particular are high.
John Kiani - Deutsche Bank
And can you give us a sense on correlation, I guess then the real relationship there is that you're short power maybe in ERCOT and different regions ERCOT and then Houston zone and then in your long power in MISO and in PGM West, can you talk about some of the historical correlations and relationships between those two different zones and I really haven't looked at the spreads between Texas and Ohio and Pennsylvania?
Brian Landrum - Executive Vice President and Chief Operating Officer
John, this is Brian, all I can tell you is that as we look at these hedges we do a very strict effect in the screen for high levels of gas correlation, so that we can kind of lean on these as effective hedges.
John Kiani - Deutsche Bank
And how does the heat rate portion work because I guess what is if we have really hot weather in Texas or what happened like in the second quarter, where the MCPE was widening and heat rates spikes, how do you mange the heat grade exposure around that position? Where could mild weather, lets say in the Midwest and what not it could be really hot down here like it is some times.
Unidentified Company Representative
John, now I think its heat... we still have the heat rate covered in Texas through those arrangements. So, this is really just a gas hedge, here that I think that in terms of how that covers the exposure. But we are still open to heat rate just to be clear in the wholesale business as well, it's just a gas hedge.
John Kiani - Deutsche Bank
Okay. That's helpful and then just one last question on that same lines, then from a financing perspective, can you just talk about kind of the decision making process that you all went through, and perhaps the difference in what you saw as the cost of capital between the Goldman Sachs in the first reserve, financings versus perhaps trying to sell a plant or to, was it execution risk and the difficulty in timing of getting plant sold in a timely manner or was it pricing? Can you just talk a little bit about how you thought about financing when you first came out with your new plant please?
Unidentified Company Representative
Well, I'd say that as we looked at the situation here in September, there were a number of things that played into the situation. And clearly, the retail earnings had been below our expectations in 2008 largely due to the hurricane.
As you know that the retail business does have a working capital facility that has a minimum EBITDA covenant. And so, one of the things we had talked about leading up to that, we were looking at strategies to address that either amending that working capital facility, or terminating the facility.
And I'd say that's something that we've had the view that we could terminate that facility, but I would acknowledge that something that reasonable people could disagree on, and Merrill has reserved its rights on that point of view.
And let me add to that we had that time in the market a lot of turmoil in the financial markets, the cost for Merrill, its operating performance is at. My expectation is going up considerably for them through the form of more cash that they're likely posting and higher cost associated with that. And that represented a big concentration of credit from our standpoint, in a market where we've seen several institutions fail.
And you put all this together, and we've felt that pursuing a path here that maintained a lot of uncertainty in that credit sleeve really didn't make a lot of sense for us, and what made sense was to put together a plan that provide... had a lot of certainty with it. And I think what's important about that plan we announced on 9/29 is that in our view that protects the core value of the company, but importantly gives us flexibility to review other alternatives which is really where the strategic alternatives process kicks in.
John Kiani - Deutsche Bank
Okay. Thanks Mark.
Mark Jacobs - President and Chief Executive Officer
Thanks.
Operator
The next question is from Dan Eggers from Credit Suisse. Please go ahead.
Daniel Eggers - Credit Suisse
Hey good morning. On the 40 Bcf gas hedge, how much more room do you guys have to increase that relationship between wholesale and retail where you have comfort in the gas correlation between the margins?
Rick Dobson - Executive Vice President and Chief Financial Officer
Dan, it's Rick. There is a lever... we haven't described exactly how big that is, there is more Bcfe probably in the 80 to 90 range as you look at that. That's highly correlated. It's a lever, I want to be really specific and it's 80 to 90 per year, I want to clear about that. I want to be very specific that we are looking at number of levers and the other data [ph] points around selling C&I and options and things like that are also very viable. So it's going to be a combination, it's not going to... we're not going to completely lean on that wholesale hedge, and I don't want to give that impression on this whole call.
Daniel Eggers - Credit Suisse
Okay. So, I guess right now that is... it looks like, if you look at where your gas hedged or gas exposed from last time, we have one of these updates till today, it looks the bulk of the move down has probably been this swap arrangement so far?
Rick Dobson - Executive Vice President and Chief Financial Officer
Yes.
Daniel Eggers - Credit Suisse
Okay. For the terms of the agreement with Goldman Sachs and for its reserve, where you guys are today, you couldn't close the transaction if you wanted to because your gas exposure is above their threshold. Is that correct?
Rick Dobson - Executive Vice President and Chief Financial Officer
That's... as of today we haven't classified the condition presence [ph]. But we're working really hard right now on getting there on the Goldman Sachs. I think the thing to keep in mind, as Mark said, as we move forward these commitments form a base foundation from which we are assessing a lot of strategic alternatives to move forward. And so we've got a period of time here on the way to the commitment end date of 11/26 to execute a number of things to get to where we need to be.
Daniel Eggers - Credit Suisse
All right, I mean it sounds like... not talk to the Board but it sounds like there is a process towards the C&I sale. What is the book value you guys have or what do you guys have on your books for the value of the retail business or the C&I business?
Rick Dobson - Executive Vice President and Chief Financial Officer
Dan, that is a low... in terms of book value of it, it's a low capital investment business. I want to say that the book value of retail in total is probably in a $150 million range ballpark.
Unidentified Company Representative
Yes, it's pretty... it's pretty small.
Daniel Eggers - Credit Suisse
Okay. When you guys... since all this has happened from a customer renewal perspective, are you guys renewing contracts? Are you renewing term contracts? And are you renewing contracts at levels that would reflect your new perceived cost of capital?
Brian Landrum - Executive Vice President and Chief Operating Officer
Dan, this is Brian. The retail business is still doing well in this environment, particularly the mass business we are continuing, as, if you will, business as usual except for the strategic changes that I described to reduce earnings variability by improving our hedges and taking kind of a lower risk approach to pricing and our other processes. On the C&I side, except where we are currently contractually obligated, we are not renewing or pursuing new business. And we are including our expected cost of capital in the transactions where we're... the full cost of... anticipated cost of capital in our transactions that we're required to bid and where we have that capacity under the contract.
Daniel Eggers - Credit Suisse
So, does that mean the mass margin, I mean the cost has gone up from a provider perspective. Does that mean that $25 megawatt hour thereabout number, is that still where the gross margin number looks like or is that number going up because of financial costs are now below gross margin line?
Brian Landrum - Executive Vice President and Chief Operating Officer
Well, what we give, Dan, in this conversation and again, our retail business has a strong customer franchise especially the mass business, as we look forward as a strong customer franchise, we have high level of customer satisfaction. And also don't want to make it sound like we're in someway unhappy with our C&I team's performance, that business has performed as we wanted it to under the collateral cost that we have under the Merrill Lynch agreement. Just as we look at the cost of capital associated with our, Dan [ph], view of kind of cost to maintain collateral in the C&I business, it just doesn't make sense on the margin levels we're in C&I to compensate for that capital.
On the mass side, what we've said is that we're going to see higher costs associated with hedging that we believe will be difficult for us or that we won't be able to... we won't pass through to customers. And that will lower the unit margins three times slightly and that's why you see... the part of why you see the $200 million to $250 million target for contribution margin for the mass business.
Dennis Barber - Vice President of Investor Relations
Operator, we'll move on to the next question.
Operator
Thank you. The next question comes from Elizabeth Parrella from Merrill Lynch. Please go ahead.
Elizabeth Parrella - Merrill Lynch
Thank you. Just going back to this 40 Bcfe hedge on the wholesale side, trying to understand it a little better, would that show up, for example, as an adjustment between open and adjusted wholesale gross margins, if this forecast had been produced sort of based on things after you have done this hedge, which was I think done in early October? Is that the right way to think about how this is going to show up from a wholesale standpoint?
Brian Landrum - Executive Vice President and Chief Operating Officer
Elizabeth I think that's right. I think that's how we would do it. We would treat it as in the hedge section of our documents that you see in this deck, referring to the appendix that shows that hedge value... that the effect of those 40 Bs will show up there.
Elizabeth Parrella - Merrill Lynch
Okay. And does that all relate to 2009 or is it extending to the next twelve months from October? How should we think about the timing of this?
Rick Dobson - Executive Vice President and Chief Financial Officer
Elizabeth it's Rick. The hedge is broken into 9 and 10, the majority is in 9 but there is a portion in 10 also.
Elizabeth Parrella - Merrill Lynch
Can you split it for us?
Rick Dobson - Executive Vice President and Chief Financial Officer
The split is roughly like a 27:13 split.
Elizabeth Parrella - Merrill Lynch
Okay.
Rick Dobson - Executive Vice President and Chief Financial Officer
Plus or minus a Bcf here and there but that's what I recall.
Elizabeth Parrella - Merrill Lynch
Okay and then I wanted to go back just to the extension of the agreement with Merrill et cetera. Can you sort of characterize for us what's driving the need to continue extending? How would you just sort of characterize the discussions? Is it more of an issue in terms of getting to an agreement or is it really that was driving the process is that you'd like to have more time to play out the strategic alternatives and see where that goes? What's kind of driving these two paths in terms of the need to continue extending? Like to get a better feel on the discussions you are having.
And also is it right to assume that basically the First Reserve in GS facility is also kind of around the same basis that they would continue to be extended along with the Merrill Lynch deal, so that need to be the case?
Mark Jacobs - President and Chief Executive Officer
Elizabeth look, we believe we are on a path that makes a lot of sense for shareholders, our debt holders and other stakeholders. And the unwind in the credit split with Merrill Lynch is a key component of that plan we announced on September 29. And as I mentioned that plan from our standpoint protects the core value of the company and gives us flexibility to review other alternatives.
I believe it's both strongly in Reliant's interest and Merrill Lynch's interest to conduct an orderly unwind to the credit split and our focus is that working with Merrill Lynch on the specifics of how that unwind is to take place. And as Rick went through some of the details, there is a lot of complexity as you can appreciate in that, that was an agreement that you may recall took several months to get in place when we did. And so working out the specific arrangements and exactly how that unwind is going to take place, there is a lot of complexity too there. But, again our focus has been working with Merrill Lynch on the specifics to that unwind and really can't comment beyond that.
Second part of your question on the financings, we do have some dates coming up here, Rick had mentioned in November 26 date where we need to have the definitive loan [ph] documentation completed with Goldman Sachs. We've already completed that with First Reserve. There is a provision in that First Reserve document that if we extend the waiver expiration date with Merrill Lynch it automatically extents with First Reserve up through the end of the year.
Elizabeth Parrella - Merrill Lynch
And just on this November 26 date with GS, in my understanding is that you then have to... you have to get to the 300 by November 26, is that the right way to interpret it or is it --
Mark Jacobs - President and Chief Executive Officer
We have to reach definitive documentation is a target date there and obviously the specifics in 300 Bcf would be a funding condition, but all of these specifics of that would be contained in the definitive documentation.
Elizabeth Parrella - Merrill Lynch
But you don't need to get to 300 for the definitive agreement, just to close on it?
Mark Jacobs - President and Chief Executive Officer
We need to get... that's correct.
Elizabeth Parrella - Merrill Lynch
Okay, but I mean, if I understand this whole process correctly, there is no reason to try to accelerate the whole closing of either of these deals if it turns out to some better alternative. That seems to be a pacing item in all of this. Is that not the right way to interpret it?
Mark Jacobs - President and Chief Executive Officer
Well, I think and again the way I described this is that plan we announced on the 29 of September we really think about that is a base case alternative. Okay. And that's the plan that protects the underlying value of the assets and it gives us adequate liquidity to operate the business. At the same time just given everything going on in the market, it is an appropriate time to step back and say is there a better alternative for us than moving forward and completing those financings and the orderly unwind on the terms that we had additionally agreed with Merrill Lynch.
Elizabeth Parrella - Merrill Lynch
Okay, thank you.
Mark Jacobs - President and Chief Executive Officer
And we're working hard just to be clear too... Elizabeth we're working hard to complete that base case plan, at the same time we're looking at other alternatives.
Operator
The next question is from Michael Lapides from Goldman Sachs. Please go ahead.
Michael Lapides - Goldman Sachs
Hi, can I change the topic a little bit here? Looking at the backup data of the granular data on plant-by-plant output in the back of the release, couple of questions. Can you just talk high level about the actual generation output at the MISO coal plants during the third quarter versus third quarter '07 and that some of the PJM ones I don't know, like Cheswick maybe Elrama could bid. That's all pretty significant declines year-over-year in the summer peak season.
Brian Landrum - Executive Vice President and Chief Operating Officer
Yes Michael, this is Brian. The factors... we've talked about these factors before but let me step back and just describe what we saw during the third quarter in western PJM and MISO. There are two primary reasons why we saw lower generation in 2008 third quarter versus '07. The first one is that we had mild weather, much milder weather than what we saw in '07 and even milder than normal in those regions.
Second is that we continue to see... during the third quarter we continued to see the higher coal costs. So we continue to see the uneconomic bidding where some of our peers in the region are bidding their cost of coal versus the market price of coal. And those had double... kind of those together have an effect on our economic generation in those regions.
Michael Lapides - Goldman Sachs
Okay. I guess just kind for thinking for next 12 months, 24 months, how much do you expect the latter trend to continue? And how do you think about it when putting together your financial plans?
Brian Landrum - Executive Vice President and Chief Operating Officer
Well, we do two things Michael, let me just give this... one thing I want to reiterate is, our stations today kind of across our fleet, we are getting to top quartile levels of performance on availability. And our plan for 2009 is to get to that same level of cost for that level of availability. So we're currently realizing the benefits of the operational excellence and investments that we made over the past few years.
And I feel very good about the strength and the diversity of our wholesale fleet. And as I mentioned with the scrubbers coming on line at Cheswick and Keystone, the diversity of our portfolio is going up as we go to be even that half scrubbed than un-scrubbed. As it relates to our forecast we've essentially used forward prices as our expectations for run hours we're going to see in the 2009 and '10. We also do make some adjustments on sort of analytical basis and some judgment around what we think that bidding behavior is going to be.
Of course, as the commodity moves around, the effect of o that bidding behavior varies. And so we do take that into account as well in our decisions.
Michael Lapides - Goldman Sachs
Okay. Thank you guys.
Operator
The next question comes from Lasan Johong from RBC Capital Markets, please go ahead.
Lasan Johong - RBC Capital Markets
Thank you. I want to logistically understand a couple of things. Why not sell the C&I business, why shutting it down, is there no market for this sale of this business unit even if [ph] it is $10 million?
Mark Jacobs - President and Chief Executive Officer
Yeah, Lasan it's Mark. What I'd say, I've put that in the bucket of one of the strategic alternatives there when we are considering the full range of those. So, we've not said that we wouldn't consider selling it. What we've described is a base case plan of completing the financings that we announced on September 29, and the Merrill unwind agreement. But we are looking at the full range of other strategic alternatives, but it's really not appropriate for us to comment as I've mentioned on the specifics of those until the Board determines a course of action.
Lasan Johong - RBC Capital Markets
Oh I see. Okay. And the 40 Bcfe on the hedge that you did internally, how much of that or what portion of the wholesale business... does this 40 Bcfe represent on an gas equivalent basis?
Rick Dobson - Executive Vice President and Chief Financial Officer
Well that would be 40 Bcfe, probably be 15% on a round the clock basis. You think on peak we do about on peak would be 40 Bcfe against about a 120 Bcfe equivalents for the coal generation fleet that produce about 12 hours on peak, assuming a 10 year rate. I think that's a question we can take offline and giving exact percentage but it's a relatively small, probably about one-third of our on-peak but, I'd say, would you take it offline and Dennis and Monica can kind of walk you through we think about that.
Brian Landrum - Executive Vice President and Chief Operating Officer
Also Lasan remember that 40 B's that Rick is talking about are spread over 2009 and 10. So let us take this offline and give you a specific percentage. It should be a small percentage of the total.
Lasan Johong - RBC Capital Markets
Got it and then can you give us some sense of what recent transactions have been consummated in retail business on a per customer basis?
Rick Dobson - Executive Vice President and Chief Financial Officer
Lasan I don't have that data so we could follow up with you after the call. There really is a set... have been fairly limited transaction here, there's been a few on the C&I side and a few on the mass market side. Obviously we're in a different market environment today for those past transactions. So why don't we follow up with you after the call to get you the data we have on that.
Lasan Johong - RBC Capital Markets
And one last question, how much of the C&I business, if you had kept it and it was normal running business. How much would that C&I business have contributed to say for 2010 open EBITDA?
Brian Landrum - Executive Vice President and Chief Operating Officer
I can give it to you in contribution margin Lasan. As we... assuming that we have a collateral cost that's in... similar to what we see in the current Merrill Lynch agreement, we would have seen about a 120 million of contribution margin in 2009 and about a 140 million of contribution margin in 2010 from those businesses.
Lasan Johong - RBC Capital Markets
Thanks very much.
Brian Landrum - Executive Vice President and Chief Operating Officer
That is Orchard and outside of Orchard for C&I.
Lasan Johong - RBC Capital Markets
Got it, thank you.
Operator
The next question is a follow-up question from John Kiani from Deutsche Bank. Please go ahead.
John Kiani - Deutsche Bank
Hi thanks for taking my follow-up. One more question on the internal or corporate hedge or what not, how do you think, Brian, about the natural gas basis exposure between Houston Ship Channel, Waha wherever else in Texas you have load, and the MISO PGM region where you have plants?
Brian Landrum - Executive Vice President and Chief Operating Officer
John, what I can tell you is that we look at these correlations and we looked at the correlations between regions, including the issue you are raising and go to where we can be comfortable that this is a highly correlated hedge.
John Kiani - Deutsche Bank
Okay, got it. So I guess question though was that, did you hedge the gas basis exposure as well or not?
Rick Dobson - Executive Vice President and Chief Financial Officer
It's pure NYMEX at this point.
John Kiani - Deutsche Bank
Got you.
Mark Jacobs - President and Chief Executive Officer
And John, I'd say those hedges were pointed at our coal plants in the eastern part of PJM that are much more highly correlated with gas prices. So some of the western PJM and MISO plants that you are referring to where we've seen some basis issues, larger basis issues before, we're not pointing that hedge at those plants. It's really the ones that are on peak where gases on the margin there is a very high correlation.
Rick Dobson - Executive Vice President and Chief Financial Officer
And John it's Rick. Also we... there is a lot of reason... I kind of defer at little offline. Lasan [ph], that's a lot of detailed thought went into the correlation and just how much is really available for that type of hedge. Why it's... probably more appropriate to go offline. So... before our thinking versus taking a lot of time on this call for that but --
John Kiani - Deutsche Bank
That's fine and thinking about the potential use of gas NYMEX call options, is a another vehicle or lever I think you had mentioned Rick.
Rick Dobson - Executive Vice President and Chief Financial Officer
Yes.
John Kiani - Deutsche Bank
Is option premium or cost assumption for using NYMEX call options embedded in your new 2009-2010 outlook?
Rick Dobson - Executive Vice President and Chief Financial Officer
It is not embedded in that right now.
Mark Jacobs - President and Chief Executive Officer
But I think, John, as you know with an option again there is... it changes your payoff diagram a little bit. One of the things we are looking at is ways that we can structure products with customers to take advantages of those options here or so. It's... can be an effective way to reduce the contingent collateral exposure but obviously the way that we would structure and use those things would be taking into account the impact or the potential impact on earnings and making sure that we are not putting ourselves in a situation where we're going to have a lot of earnings variability here because of the way we supply with options.
Rick Dobson - Executive Vice President and Chief Financial Officer
And Mark, I just appreciate all these comments but I don't... I don't like to get... I think we focus on any one lever, we've got a bunch of levers we're going to use.
John Kiani - Deutsche Bank
Sure.
Rick Dobson - Executive Vice President and Chief Financial Officer
So I think the combination of these will get us down to levels that give us a lot of comfort to bring the... hopefully bring the retail business on our balance sheet.
John Kiani - Deutsche Bank
Okay, thank you.
Operator
There are no further questions at this time. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may all disconnect. .
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