Mirant Corp. Q3 2008 Earnings Call Transcript

Mirant Corp. (MIR)

Q3 2008 Earnings Call

November 7, 2008 9:00 am ET

Executives

Steve Himes – Manager of Investor Relations

Ed Muller – Chairman and Chief Executive Officer

Jim Iaco – Chief Financial Officer

John O'Neal – Chief Commercial Officer

Robert Edgell – Chief Operating Officer

[Bill Holden] – Treasurer

[Paul Gillespie] – Senior Vice President of Tech

Analysts

Elizabeth Parrella – Merrill Lynch

[Nitten Dahila] – Barclays Capital

Brian Russo – Ladenburg Thalmann & Co.

Paul Patterson – Glenrock Associates

Robert Howard – Prospector Partners

Neel Mitra – Simmons & Company

Gregg Orrill – Barclays Capital

Brian Chin – Citigroup

Ivana Ergovic – Jefferies & Company, Inc.

Travis Miller – Morningstar

Ben Stapleton – Greywolf Capital

Presentation

Operator

Good day everyone and welcome to Mirant Corporation’s third quarter 2008 earnings call. (Operator instructions) For opening remarks and introductions I’d like to turn the conference over to Mr. Steve Himes, Director of Investor Relations at Mirant.

Steve Himes

Thank you for joining us today for Mirant’s third quarter 2008 earnings call. If you do not already have a copy, the press release, financial statements and third quarter filing with the SEC are available on our website www.mirant.com . The slide presentation is also available on our website and a replay of our call will be available, approximately two hours after we finish.

Speaking today will be Ed Muller, Mirant’s Chairman and Chief Executive Officer and Jim Iaco, Mirant’s Chief Financial Officer. Also in the room and available to answer questions are Bob Edgell, Chief Operating Officer, [Bill Holden], Treasurer, John O’Neal, Chief Commercial Officer and [Paul Gillespie], Senior Vice President of Tech.

Moving to slide one on the Safe Harbor, during the call we will make forward-looking statements which are subject to risks and uncertainties. Factors that could cause the actual results to differ materially from management’s projections, forecast, estimates and expectations, are discussed in the company’s SEC filing. We encourage you to read them.

Our slide presentation and discussion on this call may contain certain non-GAAP financial measures. For such measures reconciliation to the most directly comparable GAAP measure is available on our website or at the end of our slide presentation.

And with that I’d like to turn the call over to Ed.

Ed Muller

We’ll start on page three and I will try and tell you what page I’m on, on the webcast as I go along. And if I forget to, I’ll ask the folks here in the room with me to remind me. Starting on page three, as I think everyone in this sector has seen the market has been challenging. And that has been true for us as well.

The summer, our most important quarter in terms of results, was exceptionally mild. Gas prices fell dramatically from where they were in the first half of the year. Oil prices fell dramatically and have continued to fall. And eastern coal prices for the coals that we burn have stayed relatively high compressing dark spreads for us. All of these factors together have affected both our results, which you’ve seen and which we will discuss this morning, and our outlook for the business. That is our guidance both for this year and for 2009.

Notwithstanding these things, these facts, I want to emphasize we continue to have a strong balance sheet. We continue to have adequate liquidity for this business. Indeed, turning to page four, we are sufficiently confident about our liquidity position that we are, as we have announced this morning, resuming our program of returning cash to stockholders. And we will begin open market purchases for $200 million. We had previously returned $3.856 billion of cash since last November. And with this $200 million when it is completed, we will have returned a little over $4 billion.

We determine to recommence returning cash with this $200 million using the same four factors we had been using all along. That is, as you can see on page four, the outlook for the business, maintaining our credit profile, maintaining adequate liquidity, including for capital expenditures and maintaining sufficient working capital. We’re pleased that we can return, move forward returning $200 million and meet all of those criteria and continue to be comfortable with our balance sheet and with our liquidity.

Turning to page five, the results for the quarter, the first nine months, you can see that we are down, on both factors. The changes for the quarter, down in adjusted EBITDA, are principally attributed to lower energy gross margins in our Mid-Atlantic region, principally because of compressed dark spreads, to which I referred earlier, offset some by higher realized value of hedges and higher capacity revenues.

Turning to page six, I mentioned earlier that the market conditions were affecting our results. They are also affecting our guidance. As you can see we are reducing guidance for both this year and 2009, for each year by a little over $100 million. And you can see there on the lower right the primary drivers for this year, 2008, we have a combination of factors which Jim Iaco will go into in more detail.

Lower oil prices, which affect our results when we burn the oil in our plants, and also when we sell the oil out of our inventory which we have been doing. Compressed dark spreads as I mentioned earlier. And of course the mild weather that we experienced this summer. In 2009 the primary factor is compressed dark spreads.

On page seven the same kind of hedge information that we have provided in the past. We adopted, began the convention in August when we reported our hedge levels of showing you the lighter color on the columns what we had added since the last time we reported this and you can see that we have added fuel hedges, coal hedges here.

Also you will see for the first time, some little white boxes on the tops of some of the columns. What that reflects is a reduction in our net hedge position. And that comes about principally – it’s mainly in power here. It comes about principally, in fact overwhelmingly, because our forecasted expected generation has gone up.

So we have an amount of hedges in place, and we now think we’re going to generate more, run the plants more, we by definition are less hedged. And that’s the principal driver for why you see those various little white boxes there.

Turning to page eight, a further update on the market. As I said earlier, gas and power prices, I think I said earlier, gas and power prices have declined. I'd note that long-term gas prices still remain above $8.20 which when you look over, the last couple of years is a significant gas price and reflects supply and demand fundamentals in the market.

Heat rates have changed moderately, up a little in PJM, and declining some in New York and New England.

Spot coal prices, are down substantially about 30%. Longer-term coal prices have declined a little. I’d note on coal as I suspect everyone on this call understands, the gas markets are very liquid and therefore very efficient in pricing, oil the same; power, also quite efficient, coal less so and so this is maybe our attempt by being in the market to ascertain what prices are, but this is a much less liquid and active market.

As you can see in the chart to the left, which is for calendar year nine, taking various points along this year looking at the dark spread. The dark spread has compressed and it continues to be compressed. Because gas prices, after rising rapidly in the first half, looking forward, came down and have come down, and coal prices came up and haven’t come down much,. You can see a little like a blue squiggle there they’ve come down some but not much.

As I’ve said before, my own view is that looking at fundamentals we should over time see these coal prices come down. But the market is what the market is. And that is how we give our guidance and how we look at our business.

Page nine, same kind of charts we’ve been providing on reserve margins updated for our best current information. I think what’s important to understand here is the slope of the curves. It’s obvious that things have moved right. The economy is in recession and that means demand growth will slow. I suppose in some instances we may even see it go negative. I’m not aware of any yet, but we have seen signs of the rate of growth slowing, and that means that things will move right in terms of tightening the reserve margins.

Nonetheless the slope of the curves remains the same, which is fundamental I think in understanding both this company and our industry and that is that one way or the other, this recession will end just as all recessions end. Growth, demand as the economy grows the demand for electricity grows and we are not doing anything meaningful in this country to meet that growth. We weren’t doing it yesterday figuratively, we’re not doing it today and I don’t see any meaningful signs that we’re going to do it tomorrow.

As those reserve margins decline that should lead to higher heat rates, at least mathematically, and it should lead to higher capacity prices. And we don’t think those fundamentals to this business have changed. If anything all that’s happened is they have moved right.

Turning to page 10 on our Mid-Atlantic region, first I want to note that year-to-date we’re pleased that our equivalent forced outage rate is down to 7% compared to 9% last year. And we exclude in that determination for these numbers, Potomac River where we’ve had a variety of regulatory issues on how much of the plant we can run which we have now sorted out. And I’ll speak to that in a moment.

You can see that our gross margin is down, both for the quarter and for the first nine months. In the quarter is down because of lower energy margins, primarily because of the compressed dark spreads about which I’ve been speaking, offset some by higher realized value from hedges and higher capacity payments under the RPM or reliability pricing model of PJM.

Looking at page as I mentioned, we are moving forward with Potomac River to resolve the various, having resolved the regulatory issues, to do what is called the stack merge. We will combine the five stacks effectively into two for the five units there. This is underway as we speak.

If you were looking at the station you would see a very big crane parked behind it, which is working. And we as we have said previously we expect to have this work all done by the end of January and then to be able to run all five units unconstrained going forward.

On the Maryland Healthy Air Act, this is has been a large environmental CapEx program that we have underway for the three coal plant stations in Maryland. We are on schedule. We are however increasing our budget for it slightly by 4.6%. Our budget for some time has been $1.6 billion. We continually evaluate that. We’ve had some improvements, we’ve had some decrements, and when we netted out we have concluded we need to add $74 million to the budget and are doing so.

And finally the initial RGGI or Regional Greenhouse Gas Initiative auction took place on September 25th with an auction-clearing price of $3.07. I think it worth noting, that when we announced results and had a webcast like this in May of this year, there were no market indicators for this pricing and we did our own internal forecast and used that for guidance. And at that time we were using a number of $2.50. And there were a few among you I think who were skeptical of that.

In August there were some market indications and so we used those market indications and those market indications were $8.35. The auction cleared at $3.07. And if you think that means that I have enormous confidence in folks at Mirant who do forecasting of market conditions, I do.

Turning to page 12 the Northeast, our gross margins again are down, both for the quarter and the nine months. And this is for the quarter principally because of lower realized value from hedges. And lower energy gross margin because in April we shut down unit five at Lovett on the coal units there. And in fact the last unit that was operating at Lovett. And Lovett was then thereupon closed as an operating station and we begin its demolition which is proceeding right along.

California on page 13 you can see the numbers are flat across. Given that these plants are contracted this is what we ought to expect.

And with that we’ll turn to page 14 and Jim Iaco will go over the results.

Jim Iaco

As shown on slide 14 adjusted EBITDA for the third quarter of 2008 was $278 million as compared to $323 million for the third quarter of 2007, and $632 million for the nine months end at September 30, 2008 as compared to $774 million for the comparable period of 2007. The $45 million decrease in adjusted EBITDA for the third quarter of 2008, as Ed mentioned earlier, was principally due to a decrease in realized gross margin.

The $142 million decrease in adjusted EBITDA for the nine months ended September 30, 2008 was principally due to a decrease in realized gross margin, partially offset by $23 million increase in gains on sales of excess emission credits and a $17 million reduction in operating and maintenance expenses. I’ll cover the changes in the realized gross margin on the next slide.

Adjusted net income was $216 million for the third quarter of 2008 as compared to $323 million for the comparable period of 2007 and $440 million for the nine months ended September 30, 2008, as compared to $614 million for the comparable period of 2007. The increase in interest, taxes, depreciation and amortization for the 2008 periods is principally due to a decrease in interest income; the result of lower overall cash balances due to our share repurchases.

Significant items of reconciled adjusted net income to loss from continuing operations or, excuse me, to income from continuing operations are first, unrealized gains on derivatives which principally reflect the mark-to-market gains on our hedging activities increased $1.382 billion and $601 million in the third quarter of 2008 and for the nine months ended September 30, 2008 respectively.

This increase, which is primarily due to decreases in coal, power and natural gas prices, resulted in a net price risk management asset as of September 30, 2008 of $87 million as compared to a net price risk management liability as of June 30, 2008 of $1 billion $307 million.

Furthermore, as of September 30, 2008 the net fair value of our coal contracts which are not required to be mark-to-market under generally accepted accounting principles were approximately $694 million.

Moving down the table, in the second quarter of 2007 we recognize an impairment loss of $175 million related to the Lovett facility, and finally in the third quarter of 2007 we recognize other income of $362 million related to the Pepco settlement. Our average share count is lower in the 2008 periods as compared to the 2007 periods principally due to share repurchase.

Finally, our earnings per share based on adjusted net income was $1.17 for the third quarter of 2008 as compare to $1.14 for the 2007 third quarter and $2.03 for the nine months ended September 30, 2008 as compared to $2.17 for the comparable period of 2007. Per share information for adjusted net income is based on diluted weighted average shares outstanding.

Turning to slide 15, this slide presents the components of the company's realized gross margin for the third quarter and year-to-date periods of 2008 and 2007. Energy, shown as the light blue bar, represents gross margin from the generation of electricity at market prices, sales and purchases of emission allowances, fuel sales and purchases at market prices, fuel handling, steam sales and our proprietary trading and fuel oil management activities.

The decrease of $93 million for the third quarter of 2008 was principally attributable to an $84 million decrease in lower realized gross margins from our Mid-Atlantic operations primarily the result of compressed dark spreads, and a $15 million decrease in realized gross margins from our Northeast operations principally due to the shutdown of Lovett. The decrease of $187 million for the nine months ended September 30, 2008 was principally attributable to the following.

First, a $66 million decrease and the results from our fuel oil management activities primarily the result of lower prices and a $24 million decrease in the results from our proprietary trading activities mainly due to the timing of realized gains between periods.

In the nine months ended September 30, 2008, fuel oil management and proprietary trading contributed $48 million of realized gross margin versus $138 million for the comparable period of 2007. As a reminder, in 2007 we provided guidance that 2007 would have higher than normal contributions from fuel oil management activities, much of those higher than normal contributions were experienced in the second quarter of 2007.

Next, we had a $55 million decrease in realized gross margins from our Mid-Atlantic operations primarily the result of compressed dark spreads, and finally a $34 million decrease in realized gross margins from our Northeast operations principally due to the shutdown of Lovett in April of 2008.

Contracted in capacity, the dark blue bar, represents gross margin received from capacities sold in ISO administered capacity markets through RMR contracts and from ancillary services. 2007 results also include the back-to-back agreement which was terminated in August of 2007.

The $24 million decrease for the third quarter of 2008 was principally due to a $36 million refund of previous payments to Pepco which we received in the third quarter of 2007, and this amount was partially offset by a $9 million increase in 2008 capacity revenues from the PJM RPM capacity market.

The $113 million increase for the nine months ended September 30, 2008, was due to an increase of $130 million in capacity revenues from the RPM capacity market partially offset by $16 million in 2007 related to the terminated Pepco agreement.

Finally, the realized value of hedges, the yellow bar, reflects the actual incremental margin upon the settlement of our power and fuel hedging contracts including coal supply contracts.

Turning to slide 16, this slide presents cash flow information for the third quarter in year-to-date periods of 2008 and 2007. The $319 million increase in cash provided by operating activities in the third quarter of 2008 was principally due to a $384 million decrease in cash collateral requirements due to a decline in power prices, and a $76 million increase in cash provided by reductions of fuel oil inventory; both of these partially offset by the previously discussed reduction in realized gross margins.

The $83 million decrease in cash provided by operating activities for 2008 year-to-date period was principally due to the previously discussed reduction in realized gross margins and a $127 million decrease in working capital. Both of these partially offset by a $152 million decrease in cash collateral requirements and a $90 million increase in cash provided by reductions in our fuel oil inventory.

Reducing adjusted net cash provided by operating activities for total cash capital expenditures resulted in an adjusted free cash flow of $492 million for the third quarter of 2008 and $153 million for the 2008 year-to-date period.

Our Maryland Healthy Air Act capital expenditures which are nonrecurring in nature have been and will be funded by existing cash. Therefore more meaningful presentation of free cash flow is to use free cash flow adjusted for the expenditures related to the Maryland Healthy Air Act. Accordingly, adding back actual expenditures under that program results in an adjusted free cash flow of $603 million or $3.26 per share for the third quarter of 2008, and $450 million or $2.07 per share for the 2008 year-to-date period.

Turning to slide 17, this slide presents our debt and liquidity as of September 30, 2008. Consolidated debt which is $2 billion $755 million at September 30, 2008 is $340 million lower than consolidated debt at December 31, 2007, principally due to $135 million of repayments of the Mirant North America term loan and $200 million of purchases of Mirant America's generation senior notes due in 2011.

Our available cash and cash equivalents, including amounts available under the Mirant North America revolver and synthetic letter of credit facility, amounted to $2 billion $885 million at September 30, 2008. At September 30, 2008, Mirant North America had distributed to its parent all available cash that was permitted to be distributed under the terms of its debt agreements leaving approximately $549 million at Mirant North America and its subsidiaries.

After taking into account the financial results of Mirant North America for the nine moths ended September 30, 2008, we expect Mirant North America will be able to distribute to its parent approximately $109 million in November.

Turning to slide 18, as Ed previously mentioned, we are updating our guidance for 2008 and 2009. This update is based on forward market prices as of October 14, 2008. For 2008 we are revising our guidance from $877 million to $763 million and for 2009 from $1 billion $96 million to $981 million.

Deducting projected net interest expenditures and income taxes paid and factoring in projected changes in working capital, adjusted net cash flow provided by operations is projected to be $645 million and $765 million for 2008 and 2009 respectively.

Reducing adjusted net cash flow provided by operations by projected cash capital expenditures of $676 million and $764 million for 2008 and 2009 respectively derives an adjusted free cash flow deficit of $31 million for 2008 and adjusted free cash flow of $1 million for 2009.

Adding back in the Maryland Healthy Air Act capital expenditures for 2008 and 2009, which as I stated earlier are nonrecurring in nature and will be funded by existing cash on hand, result in an adjusted free cash flow without the Maryland Healthy Air Act CapEx of $441 million for 2008 and $494 million for 2009.

Our hedged realized gross margin for 2008 is $1 billion $372 million or 98% of our projected realized gross margin for the entire year. For 2009 our hedged realized gross margin is $1 billion $265 million or 77% of our projected realized gross margin. Hedged realized gross margin is defined as hedged merchant generation and other contracted capacity which would include RMR agreements and capacities sold in ISO administered capacity markets.

Finally, hedged adjusted EBITDA, which is defined as hedged realized gross margin reduced by our projected operating expenses for a full calendar year is $739 million or 97% of our projected adjusted EBITDA for 2008, and $606 million or 62% of our projected adjusted EBITDA for 2009.

Turning to slide 19, this slide presents the components of realized gross margin included in our guidance for 2008 and 2009. Realized gross margin is projected to increase from $1 billion $396 million for 2008 to $1 billion $640 million in 2009.

The $244 million increase is comprised of a $238 million increase in realized value of hedges and a $13 million increase in energy realized gross margins. Both of these partially offset by a $7 million decrease in contracted and capacity realized gross margins. I'll discuss this in more detail when we get to slide 21.

Turning to slide 20, this slide presents a bridge from our guidance for 2008 and 2009 given on August 8 to the update being provided today. For 2008 adjusted EBITDA is projected to decrease by $114 million. This change is primarily comprised of the following.

First, a $352 million decrease in energy gross margins principally due to a $289 million decrease through the changes in market prices, and a $64 million decrease in realized gross margins from our fuel oil management activities primarily due to a decrease in fuel oil prices. Finally, a $232 million increase in the realized value of our hedges.

For 2009 adjusted EBITDA is projected to decrease by $115 million. This change is comprised of the following. First, a $409 million decrease in energy gross margins principally due to a $477 million decrease due to changes in market prices partially offset by a $68 million decrease in carbon credit costs primarily reflecting a reduction from $8.35 per ton using our prior guidance to $3.48 per ton used in our current guidance.

The $3.48 per ton is based on current market prices and carbon credits that we have purchased. And finally, a $306 million increase in the realized value of hedges.

Turning to slide 21, this slide presents a bridge from our 2008 guidance to our 2009 guidance. Our 2009 guidance is $218 million higher than our 2008 guidance. This increase is comprised of the following.

First, a $7 million decrease in energy gross margins principally due to five factors. First, a $118 million decrease due to changes in market prices. Second, a $77 million increase in realized gross margins from our fuel oil management activities as a result of a decline in oil prices and the affect this had on the realization of our fuel oil inventory.

Because we hedge most of our inventory, most of the hedges against this fuel oil inventory will settle in 2009. The price decline that led to our reduced guidance for 2008 also leads to our hedges settling more positively in 2009 than when we last gave guidance. As we go forward we do not expect similar movements between periods because of reduced activity in this area.

Third, a $40 million increase in realized gross margins from our proprietary trading activities. Fourth, a $37 million increase in our commercial availability which reflects an overall improvement in commercial availability across the fleet, the largest single component being Potomac River. And fifth, a $43 million decrease due to carbon credit costs.

Next we have a $238 million increase in the realized value of hedges. Next a $13 million increase in contracted and capacity gross margins. And finally a $26 million decrease due to an increase in operating and other expenses, primarily related to a decrease in sales, of excess emission credits, and an increase in operating costs.

Turning to slide 22, let's address some of the key sensitivities regarding the guidance for 2008 and 2009 that we are providing today. As I indicated on slide 17, for 2008, our hedge adjusted EBITDA is 97% of our total projected adjusted EBITDA. Therefore, changes in the price of natural gas and changes due to heat rate movements will result in less than a $1 million change in adjusted EBITDA for the balance of 2008.

NYMEX gas prices utilized in our guidance are as of October 14, and are $6.89 per MMBtu for the balance of 2008, and $7.49 per MMBtu for 2009.

Based upon our unhedged adjusted EBITDA for 2009, a $1 price move in natural gas will result in a change in adjusted EBITDA of approximately $19 million for all of 2009. Energy price change, changes due to heat movements of 500 Btus per kilowatt-hour, will result in a change in adjusted EBITDA of approximately $33 million for all of 2009. The heat rates shown are 7 by 24 Pepco, forward-implied market heat rates as of October 14.

As I previously mentioned we have included a carbon costs of $43 million in our 2009 guidance. The sensitivity to adjusted EBITDA for a $1 change in the price of credit is approximately $7 million. This sensitivity is based on our hedged position and our view that power prices will increase as the cost of complying with RGGI increases.

Turning to Slide 23, this slide presents a breakdown of our projected capital expenditures for 2008 through 2010. Our normalized maintenance CapEx approximates $100 million per year, but as shown in the table is projected to be higher in the years of our Maryland Environmental CapEx Program, due to upgrades that will be timed in conjunction with our environmental retrofits.

As Ed mentioned earlier, the total estimated cost for compliance with the Maryland Healthy Air Act has been revised from $1 billion $600 million to $1 billion $674 million. We have expended $797 million through September 30, 2008, of which $500 million was spent prior to this year.

The table on this slide excludes funds related to potential brownfield or greenfield projects. Other environmental expenditures include $34 million deposited into escrow in the third quarter, pursuant to the Potomac River settlement. This amount will be spent between 2009 and 2011 for control of small dust particles at the Potomac River plant.

And with that, I'll turn it back to Ed who'll wrap up and open up the call for question, Ed.

Ed Muller

Thanks Jim, and I'm on Page 24. To recap, as I said at the beginning, we've been in a marketplace with significant volatility for the various commodities that affect how we perform, and it's affected our results and our outlook.

Notwithstanding those short-term phenomena, we continue to be strongly of the view that incumbent generators, like Mirant, are going to benefit from demand rising faster than supply. Even if that is delayed some, the trends remain inexorable.

We've had, and continue to have, and will continue to have a targeted maintenance program, and we are seeing the results of it with our equivalent forced outage rate coming down to 7% from 9% for the year-to-date, compared to last year.

We generate strong cash flows, and will generate strong cash flows as Jim described to you. We'll take that cash and invest it in the business when it's prudent to do so. And when we can't see a way to invest it prudently we'll return it, just as we have announced we are continuing to do today with $200 million.

Returning that cash, which we're pleased to be able to do, will not take away at all from the fact that we have a strong balance sheet with adequate liquidity for this business, and are comfortable with how we are poised for going forward. And with that we'll be happy to take some questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from Elizabeth Parrella – Merrill Lynch

Elizabeth Parrella – Merrill Lynch

Just going back to your announcement that you're going to go ahead and do $200 million of buy backs, one of the things you mentioned back in September was the PG&E RFO that you're participating in. Can you give us an update on the status of that, how that's looking and whether that was a factor in the decision or if it was more driven by stock price? Maybe you could just walk through those questions with us?

Ed Muller

Sure. I'd be glad to tell you as much as I can, Elizabeth. First, I'm limited in what I can tell you by confidentiality agreements, which we have to comply with, so I can't say more about the RFO that PG&E has out there.

We've looked at a variety of factors in sizing the $200 million, ranging from our expected capital expenditures to the outlook for the business, the fact that guidance has come down both for this year and next year by a little more than $100 million of EBITDA, effectively cash, by the fact as you will see in our 10-Q, that with the sharp fall in the equity markets we expect to have to make a cash contribution to our pension plan upwards of $60 million, by the fact as we've just said, that we have increased slightly the budget for the Maryland Environmental CapEx Program.

We've taken all that into account when we run a, as we have always for this, a downside case. We've been returning cash while we of course have a market case that we run and an upside case for our own internal purposes, we run in terms of determining how much cash we need to keep in the business, a downside case and in doing that, we've arrived for now at the $200 million.

Elizabeth Parrella – Merrill Lynch

The pension contribution that you mentioned, would that be in '09 and presumably that's in your cash flow guidance for next year?

Ed Muller

We are still evaluating this but our current thinking is that we would actually do it for this year.

Elizabeth Parrella – Merrill Lynch

And I'm sorry is it in the guidance now or is it not?

Ed Muller

It is in the guidance.

Elizabeth Parrella – Merrill Lynch

Question on a different topic for you, the hedging slide where you explained these white boxes that represent our effective reduction in the percentage hedged, mostly because you're expected generation has gone up.

Just trying to understand that a little better, because the forward curves are obviously lower than when, the last time you provided guidance and I guess I would think that under that scenario, the expected run times would be lower and your expected generation would be lower. Yet you're saying they're higher, so I'm just trying to understand that better.

Ed Muller

John O'Neal why don't you take that?

John O'Neal

Sure, Elizabeth it's principally due to two things. In the case of 2009, as we look at our position when it makes sense to do so we will occasionally buy back some of our hedges, so in the case of 2009 as the spread tightened up, we were in the market and bought back hedges for various points during the year.

For 2010 and beyond, really it's the net of two things. One is the decline in the spread as Ed described, but it's also the fact that now we're reflecting the fact that we're going to burn a higher sulfur coal in our units going forward.

Previously we had been assuming essentially a 3-pound sulfur spec for all of our coal units going forward, as we've gone through this year and updated our business plan for our five-year plan, we've modified that to reflect essentially a 4 pound sulfur coal going forward. There is a price differential between the two, as a result of that we saw some pick up in expected generation in our coal units. Going forward we're expecting a higher sulfur coal.

Operator

Your next question is from [Nitten Dahila] – Barclays Capital.

[Nitten Dahila] – Barclays Capital

I saw that you've been buying back lots of bonds and I think year-to-date you've bought back $200 million dollars and when you look at uses for cash, what is the right way to look at it? Do you have a target in terms of how much you would like to buy back?

Ed Muller

[Bill], why don’t you take this?

[Bill Holden]

No, we don’t have a target in how much we’d like to buy back and besides I really can’t comment on what we might do going forward. I can just expand a little bit on what Ed said on how we think about liquidity planning. And when we determine how much cash can be returned to stock holders we look at the expected cash requirements in the business and among the obligations that we look at are large debt maturities within the planning horizon.

Then we set the amount of cash that we think is prudent to return to stockholders, taking all of those factors into account in the downside case. And so as a result we do find that time to time depending on where the bank bonds are trading that we think it is advantageous to buy some of those in.

[Nitten Dahila] – Barclays Capital

When we look at the – your longer bonds in the low 70’s, you’re looking at them as being kind returned on those. How does that compare with some of the other options in terms of return that you are looking at?

[Bill Holden]

The long dated bonds really don’t factor in to our liquidity planning requirements. We haven’t looked seriously reacquiring some.

Operator

Your next question come from Brian Russo– Ladenburg Thalmann.

Brian Russo – Ladenburg Thalmann

Talk a little bit about your initiative on an unloading dock for I believe South American coal?

Ed Muller

I think what you are referring to is the barge unloader at the Morgantown station. And we built and it is in operation and we have been receiving coal at it.

Brian Russo – Ladenburg Thalmann

And what coal are you receiving?

John O’Neal

It is Columbian coal primarily.

Brian Russo – Ladenburg Thalmann

And how does the Columbian coal prices compare to, say the eastern App coal that you’ve been previously burning.

John O’Neal

Well when we first contracted for it, it obviously – there was a real price advantage to bring it in the international coals. With the run up that we saw in coal price internationally here in the first half of the year that dynamic changed and the international coal became much more expensive. Here just in the last month or so as coal prices have started to moderate somewhat, the international coals have started to become competitive again.

So right now I would have to say that the Colombian and some of the other international coals are probably pretty equal to what we’re seeing in the northern App.

Brian Russo – Ladenburg Thalmann

And what percentage of your overall coal burn would you say is the Colombian coal?

John O’Neal

You know, it is, right now I would say it is a relatively modest overall percentage. We side the barge unloader to be able to fully supply the Morgantown station, which is approximately three million of our total six million ton a year burn, so should prices warrant we have the ability to completely fuel the plant with international coals. Currently were not doing so.

Brian Russo – Ladenburg Thalmann

And then what’s driving the 40 million margin increase in prop trading, year-over-year, in ’09, '09 versus ’08?

John O’Neal

It’s driven principally by it’s – as we put off [positions] this year certain of those trades will realize in 2009. So it’s just the realization of positive value that we’ve created in ’08 that we will realize also ’09.

In addition to that there are some incremental expected realized value that we will create next year. So the net change of 40 million is really the year over year difference, some of which has already been created this year. We’ll realize next year in conjunction with new incremental realized value we expect to earn.

Operator

Your next question is from Paul Patterson – Glenrock Associates.

Paul Patterson – Glenrock Associates

I wanted to sort of follow up on, just make sure I understood your answer to Elizabeth’s question on the output. Basically if I understand it correctly you guys are going to be burning higher sulfur coal and that’s going to be basically increasing the output. Did I understand it correctly?

Ed Muller

Yes that’s right. We basically model a as you might expect the four pound is as we sit here today the sulfur spread differentials are set to the four pound. It's a little cheaper than the three pound so when we model that the deliver cost to the plant is lower, and thus our expected generation goes up.

Paul Patterson – Glenrock Associates

What are your expectations for CARE rules and how they factor into guidance and just in general what’s your outlook and expectation in terms of what is going to be happening, either in the courts or in Congress? Just what’s the thought process there?

John O’Neal

Paul, we’re using market price curves as of 10/14 for all of our guidance so first I’ll just say we’re anchoring all of our guidance based on what the market prices are. Clearly the market has – there is some expectation I think that obviously the CARE rules are in flux. They were I guess ruled by the court to be vacated. But that final rule has not yet been made, and there is some speculation that there might be a return of some form of CARE regulation beginning as early as 2009.

In addition to that I think that there is some expectation that Congress might take some action to codify the CARE rules or rules like CARE at some point soon. So I think that it’s obviously a very fluid situation. What we did for purpose of our guidance was take the market price curve as we observed on 10/14. Obviously with our scrubber program we have going in. We are insulated to a large extent against any real significant changes in SO2 prices.

Paul Patterson – Glenrock Associates

Okay. So any change in CARE probably won’t make that big an impact then.

John O’Neal

It has a very negligible impact on our business.

Paul Patterson – Glenrock Associates

And so-- okay just in terms of your political regulatory crystal ball, your expectation is that there'll be some form of CARE returning in 2009? Is that – did I understand you correctly, or?

Ed Muller

Paul I think while that’s logical I’m old enough to have watched these things move around. It’s like tax legislation; when it’s over I’ll tell you what it said.

Operator

We’ll go next to Robert Howard – Prospector Partners.

Robert Howard – Prospector Partners

Just wanted to check on – in your detail guidance assumption your '09 income taxes paid went down by $140 million compared to your last presentation. Just sort of does that means sort of you got the NOL sort of situation determined here or is that number still going to move around a little bit more until you've got something more ironed out?

[Paul Gillespie]

Sure. That’s basically the case. We have a lot more accurate estimate now, the NOL situation in our forecast, the taxable income going forward, so we don’t expect a big bounce unless the revenue numbers bounce again.

Robert Howard – Prospector Partners

And so can, in terms of going forward as we go out you know into 2010 and forward we could kind of assume that type of tax shield being available?

[Paul Gillespie]

Yes that’s correct. Once again assuming the guidance and the forecast basically stay where we think they are, yes.

Robert Howard – Prospector Partners

Another question, I saw something coming out yesterday about Harbinger getting permission from FERC to get a 25% stake, or be allowed to do that? Do you have any info on that or does it mean anything or?

Ed Muller

We read the same order that you’ve read and we'll have no comment beyond that.

Robert Howard – Prospector Partners

Okay. And the environmental CapEx for 2010 for Maryland, I guess there was a pretty big increase there. I don’t know. Is that where this increase for the Maryland, the extra $74 million is that kind of getting tacked on more to the end of the process, or is that more a shifting of expenditures between various things and so you now have a bigger number in 2010?

Jim Iaco

Yes, it’s the latter; it’s not the former. So it’s just a shifting and re-estimation of the timing of the expenditures. Remember we present that on a cash basis not on accrual basis.

Robert Howard – Prospector Partners

But with I guess more expenses in 2010 that doesn’t mean there are any issues with meeting the deadline to have everything in place?

Jim Iaco

To make it, to be perfectly clear, there are no issues with meeting the deadline. That is correct.

Operator

We’ll go next to Neel Mitra – Simmons & Company International

Neel Mitra – Simmons & Company International

Can you talk about how the changes in residual oil prices are affecting your overall results? From what I understand if prices go down it makes your oil fire plants more competitive with natural gas plants.

But this seems to affect your field oil management and trading position even more in the opposite direction. Netting out which drivers are more important and how do you look at managing the exposure going forward?

Jim Iaco

I'll start and then let John chime in a little bit if he wants to add or modify anything I say. Basically, the way that we've managed that business is we manage the entire fuel oil burn and sales of that and the management of our storage assets in one activity. So over the years, you've seen us report not only inter – the sales – the burn and the markup profit or loss that we make on sales to our plants, but also that to third parties.

What has occurred in the third quarter is we did – two things happened. First of all, prices went down from our previous guidance so on sales to both our plants and to third parties, we realized a lower margin and in addition, we made a conscience decision to reduce the volumes of our oil in our tanks, so we increased the sales to third parties. So with respect to that increase, you also had the impact of the price decline. John, do you want to add anything to that?

John O'Neal

Yes. No, I think that's, I mean, in general, you're correct. As fuel oil prices decline, we do see and as fuel oil gets cheaper relative to gas, we over time should see some incremental pickup at the oil fired units. We are just now starting to see some of that where, for example, in New England we're starting to see fuel oil get competitive with natural gas, particularly in the wintertime months where there's a very large gas basis for delivery into the New England markets.

We're starting to see some pickup at those markets beginning really in this winter. Obviously, it's been a long time since we've seen those oil units been economic with the very high price of fuel oil, but with the drop here we're seeing – fuel oil seems to be getting much more competitive with natural gas.

Neel Mitra – Simmons & Company International

And how's the declining dark spread affecting your 2008 results? It seems like you're almost fully hedged on [base-out] exposure for 2008 on both the power and coal side. And since in your last presentation, the sensitivity you gave for change in natural gas prices was very minimal. Why are we seeing such a big change in guidance from it for 2008?

Jim Iaco

Basically, it's due to a lot of our off-peak generation and there is an element there that's tied to volatility and therefore it's very difficult to hedge that. We can only hedge certain components of that. So when there's an increased amount of volatility in that with respect to that off-peak generation, you'll see some movements with respect to our results that somewhat aren't reflected in the hedge percentages.

Neel Mitra – Simmons & Company International

And when off-peak prices are too low and you don't dispatch, how often are you selling the coal back into the open market to, let's say, realize a profit in that regard?

John O'Neal

Yes, we have done some of that this year. Obviously as prices drop and again we're generally offering our units in at something akin to replacement cost for the coal. So as prices dropped, we would lose some expected generation thus putting us in a position to be able to sell some excess coal and we did some of that this year. However, we have suffered like a lot of market participants, problems with some of our suppliers not delivering all of our coal. So in 2008 we were not able to monetize all the coal that we expected to realize due in large part to some supplier problems.

Neel Mitra – Simmons & Company International

And how easy is it to monetize your coal? I mean, how far do you have to plan in advance for that to happen? If it's delivered to your plant, do you have any chance of, let's say, diverting it to someone else?

John O'Neal

Well, yes. Suffice to say, it's not nearly as easy as getting out of financial swaps for oil or gas or power. I mean, it is a physical market and it requires a fair amount of coordination to find a buyer on the other side who can burn that same spec coal. We have had some success doing that this year and expect that if prices remain high and spreads, dark spreads remain low, we would continue to be able to do that going forward.

Operator

Your next question comes from Gregg Orrill – Barclays Capital.

Gregg Orrill – Barclays Capital

I was wondering what the aggregate level of proprietary trading and fuel first and fuel oil management you're assuming in the '09 EBITDA guidance. You've given us sort of year-over-year and changes versus prior but I was just wondering what the aggregate number is?

Ed Muller

We have not historically, and have not done this time, broken out that activity separately. I don't think we've ever given that information as far as forward-looking information.

Gregg Orrill – Barclays Capital

What about the level of environmental CapEx you're looking at now in 2010?

Jim Iaco

I'm sorry, Greg. What do you mean?

Gregg Orrill – Barclays Capital

You said that there will still be some Maryland Healthy Air Act spending in 2010 as you've delayed – kind of like you delayed some of the spending a bit.

Ed Muller

No. The data we present is on a, as Jim said, on a cash basis. We expect to have the actual physical work done as scheduled in 2009. But in such it is customary that in such construction time tracks you pay the final payments later, after you've sorted out everything and there are withholds and so on and certifications of milestones, etc.

So this is just ordinary course that if we finish on day one, or on day 10, you haven't finished paying – laying out the cash on day 10; there's going to be into day 11 and 12 to do that and that's all this is.

Operator

Your next question comes from Brian Chin – Citigroup.

Brian Chin – Citigroup

Asked and answered, thank you very much.

Operator

Your next question comes from Ivana Ergovic – Jefferies & Company, Inc.

Ivana Ergovic – Jefferies & Company, Inc.

I just have a quick question, I was wondering what percentage of time is gas in the margin in the region where your coal plants are located?

John O'Neal

Ivana, I think it's north, in PJM generally, we – coal – gas is on the margin; it's just north of 50% of the time, I believe.

Ivana Ergovic – Jefferies & Company, Inc.

So mostly off-peak, you would say coal is on the margin?

John O'Neal

For many hours of the year, you're correct that coal is on the margin. There are times during the year where even gas is on the margin in the off-peak hours but most of the time coal is on the margin in the off-peak hours.

Ivana Ergovic – Jefferies & Company, Inc.

And another thing, so you said you're going to burn higher sulfur coal starting in 2009. Is it all the coal you're going to burn is going to be high sulfur or is it a mix of lower and higher? What's the percentage?

John O'Neal

Yes, it – yes, good question. Actually, it's in 2010, once the scrubbers go into service, we will be able to take in a higher sulfur call. We model on average about a four-pound sulfur coal; in reality, we'll do a variety of things to fuel the plant. There will be many times, based on economics where we'll be burning a much lower sulfur coal. The Colombian for example, as we talked about, has a sulfur content just over one-pounds per MMBtu. So there'll be times, based on economics, we'll be burning at a lower sulfur coal but what we model going forward is something akin to a four-pound sulfur.

Ivana Ergovic – Jefferies & Company, Inc.

Okay, so four-pound but starting in 2010.

John O'Neal

Correct.

Operator

Your next question comes from Travis Miller – Morningstar

Travis Miller – Morningstar

I have a follow-up to the decision to redo the stock repurchase program. I understand that you did that gas analysis and came up with the $200 million, what exactly changed in that analysis between the September decision to delay it and then the current decision?

Ed Muller

There are a host of factors and I can describe some of them but I can't describe all of them to you. But they include, for example, that we're going to be making a pension contribution. They include that we increase slightly the budget for the Maryland environmental program. They include that our result, expected results for '08 and '09 are each down by about $100 million. So those are certainly among the significant factors.

Travis Miller – Morningstar

Those would seem to be negative cash factors, correct?

Ed Muller

They are, they are negative cash factors, but they are cash factors that we have clarity on.

Travis Miller – Morningstar

So that was the uncertainty in September.

Ed Muller

We had more clarity on those items and other things between September and now.

Travis Miller – Morningstar

Was there any positive?

Ed Muller

There are some positives, yes.

Travis Miller – Morningstar

Is it anything that you can talk about?

Ed Muller

No.

Operator

Your next question comes from Ben Stapleton – Greywolf Capital.

Ben Stapleton – Greywolf Capital

Just one more question on the buy back. I understand the reasons with CapEx going up, EBITDA coming down, the pension, I mean, you still have a very sizeable cash position. I mean it seems still pretty conservative only to 200 and clearly your downside case must be pretty bad to sort of keep that much cash on the balance sheet. Could you just, in your view, is it fairly conservative to have that huge cash balance still on there?

Jim Iaco

No. Our downside case I'd characterize as reasonably conservative but keep in mind that as you look at the cash today, we do have a large amount of capital expenditures that are required in Maryland to complete the compliance with the Maryland Healthy Air Act. So I think as you look forward in time, you wouldn't expect we roll a year or two years forward and we get those obligations behind us, you wouldn't expect that we'd see the need to carry the same type of cash balances as we do today.

Ben Stapleton – Greywolf Capital

I just never thought with the stock having come off, I mean, it's still pretty accretive, pretty attractive to be more aggressive.

Operator

There are no further questions in the queue. I'd like to turn the conference back over to Mr. Himes for any additional or closing comments.

Steve Himes

Thanks everyone for joining us today. If you have any further questions, I'll be available by phone shortly. Thanks again.

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