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Calpine Corporation (NYSE:CPN)

Q4 2012 Earnings Conference Call

February 13, 2013 10:00 a.m. ET

Executives

Jack Fusco – CEO

Thad Hill – President and COO

Zamir Rauf – CFO

Thad Miller – Chief Legal Officer

Bryan Kimzey – VP of Investor Relations

Analysts

Julien Dumoulin-Smith – UBS

Neil Mehta – Goldman Sachs

Stephen Byrd – Morgan Stanley

Keith Stanley – Deutsche Bank

Ali Agha – SunTrust Robinson

Angie Storozynski – Macquarie Capital

Gregg Orrill – Barclays Capital

Jay Dobson – Wunderlich Securities

Andrew Bischof – Morningstar

Brandon Blossman – Tudor Pickering Holt

Dave Katz – JP Morgan

Operator

Good morning, ladies and gentlemen, and welcome to the Calpine Corporation Fourth Quarter 2012 Earnings Call. My name is Brandon and I will be the operator for today’s call. (Operator Instructions) Please note that this conference is being recorded.

I will now turn it over to Mr. Bryan Kimzey, Vice President of Investor Relations. Mr. Kimzey, you may begin.

Bryan Kimzey

Thank you, operator, and good morning, everyone. I’d like to welcome you to Calpine’s Investor Update Conference Call covering our fourth quarter and full-year 2012 results. Today’s call is being broadcast live over the phone and via webcast which can be found on our website at www.calpine.com. You will find the access to the webcast and a copy of the accompanying presentation materials in the Investor Relations section of our website.

Before we begin, I’d like to announce that Calpine will be hosting an Investor and Analyst Meeting on Wednesday, April 10, 2013 from 1:00 p.m. to 5:00 p.m. Central in Houston, Texas. Members of the Calpine management team will present their views on the company and its markets and provide updates on financial, regulatory and strategic initiatives. More information about the event, including online registration and a link to the live webcast, can be found on the Investor Relations section of our website at www.calpine.com.

Joining me for this morning’s call are Jack Fusco, our Chief Executive Officer; Thad Hill, our President and Chief Operating Officer; and Zamir Rauf, our Chief Financial Officer. Thad Miller, our Chief Legal Officer is also with us to address any questions you may have on legal and regulatory issues.

Before we begin the presentation, I encourage all listeners to review the Safe Harbor statement included on Slide 2 of the presentation which explains the risks of forward-looking statements and the use of non-GAAP financial measures. For additional information, please refer to our most recent SEC filings, which are on file with the SEC and on Calpine’s website.

Additionally, we would like to advise you that statements made during this call are made as of this date, and listeners to any replay should understand that the passage of time by itself will diminish the quality of these statements.

After our prepared remarks, we’ll open the lines for questions. In the interest of time, each caller will be allowed one question and one follow-up only.

I will now turn the call over to Jack to lead our presentation.

Jack Fusco

Thank you, Bryan. And thank you, everyone, for your continued interest in Calpine.

As you’ve read in this morning’s press release and as you’ll hear in further detail throughout this call, 2012 was an exemplary year for Calpine on all fronts. From an operations perspective, our 2012 combined cycle capacity factor was 52%, up nearly 23% over 2011 and the highest that it’s been in a decade. The fleet produced a record 116 billion kilowatt hours of electricity during the year, making us one of the nation’s largest suppliers of wholesale electricity. What that says about our future potential is very encouraging to me. With the right market signals, our fleet could produce significantly more than this amount, with virtually no significant capital expenditures.

Just as impressive was our forced outage factor, which was the lowest ever for our fleet and it sets a new high watermark for excellence in operations. These accomplishments were achieved while still demonstrating our commitment to our employees, their quality of life, health and safety. My thanks and congratulations to the entire Calpine team for making 2012 a remarkable year and Calpine an exceptional place to work.

I have made a commitment to all of you. We will be good stewards of your capital. In 2012, we continued to execute on our capital allocation strategy on all fronts, asset monetization, asset acquisitions and share repurchases.

We originated more than 2,100 megawatts of long-term contracts with our customers, including today’s announcement of a new 10-year PPA with TVA from our Decatur plant in the Southeast. We sold nearly 1,500 megawatts of capacity in Wisconsin and South Carolina for approximately $830 million. We reinvested approximately half of those proceeds into a market that we find strategic, Texas, with the acquisition of an 800-megawatt combined-cycle power plant. We are on target to bring approximately 1,600 megawatts of additional natural gas-fired capacity online in California, Texas and Delaware over the next 2.5 years.

And finally, we continue to opportunistically reinvest in our own company, buying back 7.25% of our outstanding shares at what we believe to be attractive valuations. As a result of our focus on excellence in operations and effective capital allocation, our 2012 financial results were strong and in line with our expectations. Our adjusted free cash flow per share came in at $1.20, a 19% increase over 2011.

Although it is early in 2013, we are maintaining the momentum created in 2012 and are on track to deliver strong financial performance. Today, we are reaffirming our 2013 adjusted EBITDA and adjusted free cash flow guidance and are raising our adjusted free cash flow per share midpoint guidance to $1.50 a share, a 25% increase compared to 2012.

Turning to Slide 5, we continue to believe Calpine provides a compelling value proposition for investors looking to gain exposure to the combined cycle recovery at a substantial discount to replacement cost. Calpine’s current enterprise valuation implies approximately $625 a KW, overall price for Calpine’s total capacity. But the underlying value placed in our combined cycle and cogeneration steamed fleet is skewed by several factors, the most important impact being the significant value in the Geysers geothermal fields.

After adjusting for these factors with conservative assumptions, the implied valuation on just our modern natural gas-fired combined-cycle fleet is actually approximately $500 a KW, which is well below today’s replacement cost. And this implied valuation doesn’t even factor in the value of our long-term contracts or the location and flexibility of our power plant portfolio.

Needless to say, you can see why we believe there is plenty of potential for us to realize incremental value as our investment thesis plays out, markets reform and the economy recovers, and why I feel strongly about repurchasing our stock at these levels. We have now completed our original $600 million share buyback program. As you may have heard me say in the past, we evaluate all options on allocation of capital in a manner that we believe maximizes the potential return to our shareholders.

After a strong financial performance in 2012, we are fortunate to have a significant amount of cash to deploy in 2013. As a result, we are increasing our share repurchase authorization by $400 million for an aggregate $1 billion of capital that we’ve allocated to reinvesting in Calpine. We will continue to be opportunistic in our exercise of the program and view it as a surrogate for investing in combined-cycle assets and in meaningful discount and thereby placing us in a position to generate greater returns for our shareholders.

Calpine’s assets are uniquely positioned to benefit from the combination of secular and fundamental trends that favor natural gas-fired generation, including the abundant and affordable supply of clean natural gas, stricter environmental regulations, aging uneconomic power generation infrastructure and the increasing need for dispatchable power plants to successfully integrate intermittent renewables into the grid. As a result, gas-fired capacity factors are rising and power prices must also rise to incentivize replacement capacity. Therefore, we are double levered to the combined cycle recovery.

In addition, our management team is employing a disciplined capital allocation strategy to redeploy capital into higher-return assets or otherwise into our deeply discounted existing fleet through share repurchases. This strategy is projected to yield a 15% to 20% compounded annual growth rate and adjusted free cash flow per share, which should translate into an equivalent annualized total return for our shareholders.

Given how highly we regard our assets, it is critical that we work to preserve their value particularly on the regulatory front. Turning to the following slide, there are three key areas we are actively engaged defending the integrity of our markets. First is demand response, which raises concerns on many levels. From an environmental perspective, the fact that regulators consider an uncontrolled, inefficient generator set as an acceptable resource is inconsistent with the administration’s goals of cleaner air. Specifically, the recent EPA ruling that allows these back-up generators to run even more hours without emission controls runs counter to cleaner air and the notion of a national climate change dialog. Economically, the fact that demand response resources are compensated the same or more than an efficient emissions-controlled and tested power plant creates an unlevel playing field. This is one of several examples where DR has afforded more favorable conditions as a market participant than other forms of generation, thereby jeopardizing electric reliability.

On that note, I’d like to recognize ISO New England for requiring demand response resources to bid into the day-ahead market every day of the year, a step closer towards creating comparability in that marketplace.

Finally, there is also the issue of delivery obligation. According to the recent PJM independent market monitoring report, last year, more than 25% of the demand response that received capacity payments bought their way out of their commitments, effectively arbitraging the market without ever having had to demonstrate a true resource available to fulfill it. In the same vein, we are also working to prevent the proliferation of noncompetitive generation, where politicians and regulators are, in effect, choosing winners instead of allowing the markets to work.

The slide shows a number of uneconomic projects that continue to move forward, despite the fact that there are far more efficient and cost-effective alternatives available. Unfortunately, as a result, retail consumers have yet to fully reap the benefits of low wholesale power prices, and low-cost energy providers are discouraged from continuing to invest.

Finally, we’re working to encourage a promotion of fair, transparent and stable price signals. In California, the market’s inherent discrimination between old and new generation creates meaningful challenges for existing capacity and discourages the investment necessary to ensure integration of renewable resources into the grid.

Meanwhile, in Texas, the discussions continue on market reforms as the summer months approach us and meaningful action is needed. In all cases, we continue to advocate for fair, transparent and stable price signals, as well as market-driven solutions in wholesale energy and capacity markets that result in nondiscriminatory forward-price signals for investors.

With that, I will now hand it over to Thad Hill for a review of our operations and our market outlook.

John Hill

Thank you, Jack, and good morning to everyone on the call. For us, 2012 was an exceptional year. I have never been prouder of our team’s operational and commercial accomplishments. First, our operations team, led by John Adams, performed well on all fronts including safety, fleet availability and cost, and as Jack mentioned, produced 116 billion kilowatt hours.

Commercially, we had great success as well. Our commercial operations team, led by Steve Pruett, successfully optimized our portfolio to take advantage of oil gas prices nationally, the nuclear outage and drier weather in California and this despite a milder summer in Texas. The commercial team’s effort was one of the primary factors that enabled us to deliver on the high end of our original guidance range.

From a customer perspective, we delivered some key contracts, including five- and seven-year contracts for capacity on our Los Medanos and Gilroy facilities, these are key in a challenging California market; a suite of contracts for our Oneta plant in Oklahoma at very attractive relative economics, a great accomplishment considering that only a few years ago, Oneta was considered one of our more challenged assets; and as announced today, a new tenure PPA off Decatur with the TVA.

On growth, given the strong free cash flow that Zamir will talk about, and even after returning money to our shareholders, we’ve been investing in a portfolio of attractive projects. In 2012, not only did we continue to make progress with the construction at our contracted Los Esteros and Russell City plants in California, we also launched construction efforts that are expansions at Deer Park and Channel in Texas, where we are adding capacity at a discount. And we significantly advanced the development efforts for our Garrison facility in Delaware where we expect to kick off construction this quarter.

In 2013, we are focused on four goals: first, keep our eye on the ball, continue our best-in-class operational performance; second, commercially, continue to use the information we have to make informed portfolio management calls; third, continue our customer focus, particularly in the Southeast, where our recent originated contracts have yielded attractive compensation levels and in California, where commercial efforts can provide solutions from our construction shortcomings, Jack and I will both be very focused on this; fourth, originate attractive growth opportunities to be considered in our overall capital allocation decisions. Todd Thornton, who many of you know has been our Treasurer, is now leading this effort.

The next slide shows our operational statistics for 2012 in more detail. Safety-wise, we delivered a top-quartile performance, but we desire to do even better. A strong safety culture not only is the right thing to do for our employees and our families, but is emblematic of a detail-oriented and strong operating culture. At Calpine, we have kicked off a safety-first-to-zero initiative with the clear goal of zero lost-time accidents.

From a unit availability standpoint, 2012 was record breaking. As you can see, we delivered a 1.6% fleet-wide forced outage factor. In the third quarter, when availability is most important, it was even better at 0.9%. At our upcoming Investor Day, John Adams will explain the programs and efforts that drive these results. We are very proud of our plant engineering and outage services teams. Well done.

With fewer and shorter forced outages, we’ve also been able to keep a tight control on our costs, despite producing almost 25% more megawatt hours year-over-year. Although our variable expense was up, things like chemicals and other consumables, our regular maintenance expenses and equipment failure expenses were down. Again, hats off to the team.

Finally, in the upper right are our annual megawatt hours produced. Texas, the North and the Southeast are all up primarily due to the widespread coal-to-gas switching that we saw in the first half of 2012 with extremely low gas prices when combined with our outstanding availability. The West was up more substantially, more than 50%, given the lower hydro year and the San Onofre nuclear outage.

And finally, the Geysers production was above 6.1 million megawatt hours. Although throughout the rest of the geothermal landscape, power producers are struggling to maintain production, our Geysers continue to deliver year in and year out.

The next slide shows our typical hedge disclosure. As you know, we gave you $200 million guidance for this year, in part, because of the large open heat rate position we have carried into 2013. As a reminder, part of this open position is driven by the changes in our portfolio over the past year, including the sale of Riverside and Broad River, both of which were contracted, and the addition of Bosque which was merchant. Though we have added incremental hedges since last quarter, primarily in the shoulder or non-summer months, we have also seen increases in volume expectations, particularly in the West.

As a result of these offsets, along with both the lower level of market liquidity and foreign prices that generally have not yet met our expectations, we remain relatively open on heat rates which factors into the current guidance range.

Meanwhile, our 2013 gas position remains neutral. On the right, you can see where the forwards for 2013 were at our last call and as of last week. For 2014 and 2015, we’re materially open both heat rate and gas. At our upcoming Investor Day, Steve Pruett and Caleb Stephenson will walk you through a more detailed view of our markets and how we manage the business commercially.

Today, I’d like to spend just a couple of minutes on Texas and PJM. Moving now to Texas, the debate around the state and in Austin continues around what the right structural fixes that will encourage new-generation investment in order to ensure power reliability. Given the ongoing discussion at the commission, the legislative session and the complicated subject matter, it is likely to take well into 2013 before this debate is effectively resolved. As we’ve said before, we are advocating for a capacity market. We believe that over time it will be, by far, the best mechanism to encourage the needed new investment.

Even while the longer-term structural capacity versus energy discussion continues, with summer approaching and concern growing, we do believe it is reasonable that there could be a near-term down-payment on market reform. Given the current systems and the short timeframe, we believe that PUC could and should either expand the operating reserves or raise prices whenever back-up units, called the non-spin reserve, are called. Either way, it is essentially an operating reserve expansion that would increase the number of hours where there is either scarcity pricing or some price increase.

Currently in Texas, it is our estimate that the on-peak summer from May to September has priced it about $40 per megawatt hour, plus seven hours at the system-wide offer cap of $5,000 per megawatt hour. This compares to the same months of 2011 when there were nearly 22 hours of scarcity pricing or 2012 when there was only one hour. The chart on the right shows that by effectively raising the operating reserves somewhere between 2,000 and 4,000 megawatts, and most of the proposals circulating are in or near that range, the number of intervals with either scarcity pricing or administrative pricing would increase dramatically.

In a back cast, it shows that 2012 would have looked much like 2011, and 2011 would have been several times higher in number of hours during which the use of operating reserves would have been necessary. This could certainly have the effect of raising Texas prices, which is necessary for near-term reliability. This, in our view, is not yet reflected in 2013 forwards. We are continuing our advocacy at capacity markets but are heartened that the commissioners, whether supportive of capacity markets or not, see the need for fundamental reform and believe that near-term action is required.

Finally, the following slide addresses forward energy prices in PJM, which have been the subject of a lot of discussion and analyst reports. As you can see, the forward spark spread is materially similar in 2015 to 2012 actual and 2013 forwards, which makes very little sense to us. Even with somewhat stagnant load on the East Coast, something we believe could change, there is no fundamental justification for the current forwards.

The simplest way to think about the PJM market is that capacity prices have been flattish. Coal retirements have been more or less offset with the low load growth and the bidding of new resources, especially demand response or DR. However, the impact on energy prices will be very different. Essentially, approximately 10,000 megawatts or so of coal with variable prices below $50 per megawatt hour are mostly being replaced with demand response.

Much of that demand response, by some analyst reports as much as 25% to 30% in the RTO and even higher in some sub-regions, is backed by behind-the-meter generation which the EPA has just effectively blessed by not requiring emission controls. And it’s worth noting that under new rules that went into effect last year, economic DR bids can now set price. And as an aside, when emergency DR is called, the price should reflect scarcity.

So, in terms of capacity in PJM, a significant number of 10 heat rate coal plants burning $4 per MMBtu delivered fuel are being replaced with 14 heat rate virtual plants burning $18 per MMBtu fuel. Of course, this doesn’t include the non-generation back DR which could have even higher pricing.

The way we think about it is that nearly 10,000 megawatts of coal are being pulled out of the supply stack on the left and largely replaced with what will effectively bid and operate as well-fired peakers. Although the remaining questions about the effective grid reliability with increased usage at these resources and the potential for fatigue over time, in our view, the effect on energy prices could be very positive.

With that, I’ll turn it over to Zamir.

Zamir Rauf

Thank you, Thad, and good morning, everyone. As you can see, my first slide demonstrates the continued strength of our financial performance, despite the economic softness and natural gas price volatility we’ve experienced in 2011 and 2012.

Our employees’ focus on ensuring the availability of our units, capturing market opportunities and managing cost allowed us to deliver on our financial commitments for the year, with adjusted EBITDA and adjusted free cash flow each reaching the high end of our original guidance range.

Looking ahead to 2013, we are well-positioned relative to our guidance. As Jack mentioned, we are reaffirming our 2013 adjusted free cash flow and adjusted EBITDA guidance ranges, and are increasing our adjusted free cash flow per share midpoint. We remain focused on measuring our performance by this metric and are pleased with the progress we have continued to make on this front.

Since our last call, we have also made significant progress towards executing on our capital allocation strategy. We closed the Bosque acquisition last November, completed our $600 million share repurchase program and achieved record unrestricted liquidity, our measure of liquidity available for capital allocation.

In addition, earlier this week, we repriced all of our corporate term loans, lowering the interest rate on approximately $2.5 billion of debt by 50 basis points, saving us more than $10 million of interest expense, which is slightly over $0.02 of adjusted free cash flow per share for this year and slightly more thereafter.

As we had mentioned on our third quarter call, and as you have seen from our fourth quarter results, our hedging profile was different in 2012 versus 2011. As I had previously explained, our hedges in 2012 were more seasonally shaped than those in 2011, such that the third quarter of 2012 benefited disproportionately to the fourth quarter. As such, on a year-over-year basis, our fourth quarter results are down $64 million, while our full-year results are up.

Let’s take a closer look at the quarterly activity on the following slide. In addition to the year-over-year seasonal hedging differences, adjusted EBITDA in our Southeast region was impacted by timing differences associated with the Decatur contract, which was expired throughout the fourth quarter of 2012, but has since been recontracted as of January 2013. Offsetting these declines, adjusted EBITDA in our North region benefited from higher capacity payments and, to a lesser extent, higher generation volumes.

Fourth quarter adjusted EBITDA was also impacted by $20 million of insurance reimbursements that disproportionately benefited plant operating expense during the fourth quarter of 2011. After accounting for these reimbursements, our plant operating expense was essentially flat year-over-year as our plant and maintenance personnel continued their focus on prudent cost control. Overall, our fourth quarter performance was in line with our expectations and enabled us to meet our guidance for the year, leaving us well-positioned as we head into 2013.

In fact, as shown on the following slide, we have never been stronger financially than we are today. Our liquidity available for capital allocation, reflected by the yellow line in the chart on the left, topped out at an all-time high as of year-end 2012. Meanwhile, we have no material near-term debt maturities, we continue to simplify our capital structure and we have been reducing the cost of our debt. In addition, our net-debt-to-adjusted-EBITDA ratio of 4.9 times is the lowest it has been in nearly three years. As such, we have begun 2013 with more than $1 billion of excess cash.

Over the course of the year, we expect to add $575 million to $775 million of free cash flow, a portion of which will be applied to our scheduled debt amortizations and committed growth CapEx. Based upon our strong financial position and robust excess cash, we have increased the size of our share repurchase program to a total of $1 billion. Assuming we complete the incremental $400 million of share repurchases during the year and assuming we don’t increase it further, we still expect to have between $825 million and $1.25 billion of excess cash as of year-end 2013.

However, as we have said before, we don’t plan to hoard cash. We will put our cash to work for our shareholders via disciplined growth, portfolio optimizations or continue opportunistic share repurchases in order to maximize shareholder value.

As you can see on the following slide, we have built a track record of executing on a very disciplined and well-balanced capital allocation program. Over the past two years, we have put more than $2 billion of capital to work. Our primary use of capital has been growth, including acquisitions along with our five announced construction projects. Share repurchases follow immediately behind growth in terms of dollars allocated. And today’s announcement indicates that we intend to keep share repurchases as a material part of our capital allocation program going forward.

One additional point worth noting in the pie chart, the early termination of our legacy interest rate swaps were a meaningful portion of our capital allocation for the past two years, but they were paid off in full during the first quarter of 2012. The table on the right highlights our ability to generate cash available for deployment in 2013 and our expectations for the next few years thereafter.

In 2013, we are projecting adjusting free cash flow of $575 million to $775 million. Of this amount, approximately $140 million will be applied toward scheduled debt amortizations and another $250 million will be applied towards our construction projects.

Unlike many of our peers, our capital allocation decisions beyond this point are entirely at our discretion. We have no legacy liabilities like environmental compliance or pension obligations to fulfill. As such, the balance of our adjusted free cash flow, along with our large balance of excess cash is available for capital allocation.

Looking ahead to 2014 and 2015, given the contributions of our new plants over the next few years and assuming the forward curves materialize at or above their current levels, our adjusted EBITDA is expected to have a favorable trajectory.

Meanwhile, thanks to our ongoing refinancing and repricing efforts, we expect cash interest payments to continue declining. Holding all else constant, these two trends alone mean growth and adjusted free cash flow. With committed growth CapEx declining annually in 2014 and 2015, as we complete our announced construction projects, the adjusted free cash flow that we have available for deployment should grow at an even higher rate, which will continue to feed our capital allocation pipeline.In sum, we have demonstrated our ability to effectively allocate capital and we’ll continue to do so as we grow adjusted free cash flow and adjusted free cash flow per share. We are well-positioned for the future and continue to look for opportunities to deploy our capital to earn the highest possible returns for our shareholders. As I previously mentioned, we do not plan to hoard cash and we will put it to work.

With that, I thank you once again for your time and your interest in Calpine. We will now open the lines for Q&A.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) And our first question comes from Julien Dumoulin-Smith from UBS. Please go ahead.

Julien Dumoulin-Smith – UBS

Hi. Good morning, guys.

Jack Fusco

Good morning, Julien.

Julien Dumoulin-Smith – UBS

So, first question, congrats on Decatur. I just wanted to get a little bit of sense as to where that pricing came out. And perhaps, I thought I had was a fourth quarter results in the Southeast seem to be down $19 million. Third quarter was down, call it $8-ish million. Is it kind of a good framework to think that if Decatur was out in the latest quarter and you lost about $10 million that, say, an annualized run rate on that plant would be about $40 million? Is that kind of a good thought process on that plant?

Thad Hill

Julien, without getting overly specific, I don’t think that your thought process is broken. So I think you’re getting there.

Julien Dumoulin-Smith – UBS

All right. Great. Thank you. And perhaps, more strategically and I don’t want to get ahead of your Analyst Day too much, but when you talk about putting cash back to work, obviously, you’ve made a decision about share repurchase here. What about other options on the table? You’ve, obviously, kind of alluded to a few in the past. How are you thinking about that right now given the cash balance?

Jack Fusco

Well, first, Julien, this is Jack. I think we feel very, very good that we’ve been blessed with having the surplus or excess cash that we have today. So we’re very pleased with that. Secondly, I mean, you all know that we’re not sitting back on our haunches and we’re always looking to invest that capital. So, whether we invest it in greenfield growth or acquisitions or back into Calpine, is a decision that we make every day. So the teams are working hard, looking for growth. I’ve mentioned this to you all before that, for me, tie goes to growing the business versus buying back more of our shares. But if we can’t make that happen and things get a little clearer throughout this year, you should expect us to redeploy that capital.

Julien Dumoulin-Smith – UBS

Great. Thank you, guys.

Zamir Rauf

And, Julien, I just want to follow up on that in terms of talking about how much cash we have and I probably should have said this in our prepared remarks. But we saved in excess of $150 million in taxes because of our NOLs this past year, between the asset sales and the business. So, if you look at value of NOLs and the tremendous benefits that it can generate, it’s a lot more, I think, than people expect.

Operator

Okay. Our next question comes from Neil Mehta from Goldman Sachs. Please go ahead.

Neil Mehta – Goldman Sachs

Good morning.

Jack Fusco

Good morning.

Neil Mehta – Goldman Sachs

As a follow-up on the Southeast here, with the plants that are remaining and where progress is needed, is the preference to recontract or divest?

Thad Hill

It depends on the individual circumstances. I mean the most important thing to us is that those assets are healthy and operating. In some places, there could be a utility that’s a natural buyer of the asset, and if that were the case, we’d do the right thing. In other places, the utility or the end customer may prefer contract for regulatory or balance sheet or other issues. And so, we’ve got – again, the most important thing is those assets are healthy and producing. And whether they’re under contract or whether they’re on somebody else’s balance sheet, we’ll do the best we can.

Neil Mehta – Goldman Sachs

Got it. And another question, we’ve seen weather-normal demand one of the trends in this quarter has certainly been weather-normal demand. Across the U.S., has been disappointing outside of Texas, which isn’t terrific. Is there a new normal for demand and how do you think about the implications for that new normal on some non-Texas markets?

Thad Hill

Right. Well, fair enough. The numbers that we’ve seen weather-adjusted demand, Texas, obviously, is continuing robustly. The West Coast is up and the East Coast is continuing to be flat to maybe down a little bit as we look around our coal regions.

The question of whether or not weather, as a percent of GDP, has changed or not is a pretty good one. The problem with it is from everything we see, industrial and commercial, where it’s continuing to grow and residential’s been almost stagnant, but this recession that we’ve – still come out of, was caused by a housing boom and housing starts have still not yet recovered. So I will tell you, underneath it all, we’re not – I don’t think that we’re yet willing to concede that there’s been a fundamental change in demand, again, commercial and industrial driven by GDP, and residential driven by housing starts. So we’ll see as housing continues to recover what happens.

Neil Mehta – Goldman Sachs

Thank you very much.

Operator

From Morgan Stanley, we have Stephen Byrd on the line. Please go ahead.

Stephen Byrd – Morgan Stanley

Good morning.

Jack Fusco

Good morning, Stephen.

Stephen Byrd – Morgan Stanley

Yeah. Just wanted to add on to the questions on the contracted assets you’ve had. You’ve been successful in getting good long-term contracts, both in the Southeast as well as in California. As you think about those assets, you have a large and are well-positioned, we’re in a low-yield environment and there are certainly a number of investors who would be very attracted to long-term low-risk cash flows. How do you think about the potential to monetize some of those contracted assets over time?

Thad Hill

Hey, Stephen. It’s Thad. First, on the contracts, I would say that all contracts are not equal. We’ve been very proud of our track record on those contracts. Some of those assets are probably important to maintain in the Calpine portfolio. Some contracts would have a very high value potentially to outside buyers, other contracts are a little more unique. So I’ll let Zamir or Jack take the broader question, but I would say that every contracted asset out there is not necessarily appropriate acquisition opportunity for yield-seeking investor, although some of them could be.

Jack Fusco

And, Stephen, as you know, we’re looking to monetize or receive maximum value of those for our portfolio. So whether it’s through a long-term contract, as Thad mentioned, if somebody who maybe doesn’t want to carry on their balance sheet, or if we have a customer that really – that values the asset more than us, I think we’ve proved we’ve been willing sellers of the portfolio. So, again, rest assured, we’re working hard. There’s no fire sell and we’re going to try to maximize the value for the shareholder.

Stephen Byrd – Morgan Stanley

Okay. Understood. That’s helpful. And just as a follow-up on the broader question of capital allocation. You laid out a very useful analysis of sort of how you’re – in your stock the market is valuing your combined-cycle assets. At $500 a kilowatt, that’s a pretty attractive level at which to buy back stocks. So is it fair – that’s certainly a metric that matters a lot to you as you think about growth options. Obviously, you have to look at IRRs, but just on a per-kilowatt basis, that would seem to create a pretty high bar to be in terms of growth when you can buy back your own stock at that kind of levels. Is that fair or have I kind of misread that?

Jack Fusco

It’s fair. We look at cash returns as we’ve talked about before, but I mean, the analysis that we laid out was just trying to put a little more color around why we think at these values. And today, you guys are giving us an opportunity to continue to buy back our stock at a deep discount to what replacement cost is for a combined-cycle plant.

Stephen Byrd – Morgan Stanley

Understood. Thank you very much.

Operator

From Deutsche Bank, we have Keith Stanley online. Please go ahead.

Keith Stanley – Deutsche Bank

Good morning. If I could follow-up quickly on Julien’s question, are there any more reasons than usual in 2013 that you can think of to retain some excess cash at this point just because of potential opportunities you may see right now across the business, whether it’s the M&A market as power has remained a little bit challenged here, organic growth opportunities, any desire to maintain greater flexibility right now for future refinancing activity or anything along those lines?

Jack Fusco

Yes. I think, Keith, it’s Jack Fusco, I’ll start and I’ll turn it over to Zamir, but for me personally, I look at the liquidity in the market in Slide 10, that hedging slide, at this stage of the game, we would have liked to have hedged out more of our product and we haven’t been able to, so we’re open this summer. So until we get a little more clarity on where forward prices are going and our ability to hedge some of that, I would personally like to keep some money in my pocket.

And, Zamir, I don’t know if you have anything else to add.

Zamir Rauf

No, I think that’s put well. I mean, we do have a lot of liquidity. And as Jack mentioned, we always want to keep a little bit of dry powder for opportunity that might come our way and given the fact that we are open as well. But we’re still putting a lot of capital to work. You’ve got to keep rating agency considerations and everything as you – but if you look at how much we’ve put to work over the past two years and look at how we’re starting up this year with the $400 million program, it’s definitely a robust capital allocation strategy.

Keith Stanley – Deutsche Bank

Thank you. That’s very helpful, and one follow-up, if I can. You referenced the NOL earlier and sell-side sort of estimates of value there. I’m not sure if you’d willing to share any estimates you have internally as to what you think the NOL is worth or just to help us model it a little better. Any rough sense of how much of the NOL you would intend to use to shield taxes over the next few years in your planning assumptions?

Zamir Rauf

We might unveil a little more detail on that on Analyst Day. I will tell you, though, that if you just look at the cash, it’s in excess of $150 million that we saved in 2012. If you look at that and then you think of that in terms of buying back stock, those NOLs are actually a lot more valuable, in my opinion, than most people are giving them. So I would say more to come on Analyst Day.

Keith Stanley – Deutsche Bank

Okay. Great. Thank you.

Operator

From SunTrust, we have Ali Agha online. Please go ahead.

Ali Agha – SunTrust Robinson

Thank you. Good morning.

Jack Fusco

Hi, Ali.

Ali Agha – SunTrust Robinson

Hey, Jack. My first question, for the last several quarters, you guys have laid out to us this disconnect between the forward curves and the fundamental analysis that you see out there. And I’m just wondering, what is a triggering event in your mind for that to change? And specifically, I guess, ERCOT, as you point out, if anything, ERCOT spreads have actually declined in the forward market the last few months despite what we have talked about on the supply/demand side. So any further insights on that disconnect and what needs to specifically trigger the change?

Thad Hill

Sure. First, the back-end of ERCOT – the ERCOT curve, right, has actually come up the last couple of months. So, I think on Page 10, we referenced the current year. So, there is – additionally, it’s getting there. But one of the real drivers, Ali, is liquidity. And I’ll come back to what the catalysts might be, which is there are not a lot of long-term buyers out there that are trying to cover shorts in the market and you’ve got long-term (inaudible) like us that would be willing to sell at a fair price. And so, you end up with that kind of situation.

Additionally, liquidity, certainly in Texas and California, is down a little bit. And in particular, in Texas, this has an impact and that’s been driven by a lot of the regulatory uncertainty that’s been out there. So we think the regulatory certainty being solved and we also think a hot summer, as the tightness begins to materialize in energy pricing, that would be very helpful for the long-term curve. So it’s moved the right way in Texas. It’s got more room to go. It’s not moved the right way in PJM, but we think that will change over time as well. But an event helps to show – current energy pricing reacting to something sure helps the forward curve.

Ali Agha – SunTrust Robinson

Yeah. And, Zamir, I wanted to clarify a point you made in one of your slides. When you’re looking at the trend for your adjusted EBITDA, 2014, 2015, are you saying to us that based on the forward curves, as they stand today, you see an upward drift, or did I hear you make this case that assuming improvements based on fundamentals, you see the upward drift? I want to be clear on what you said there.

Zamir Rauf

Yeah. I mean, look, I think that degrees of upward drift, obviously, at fundamentals it’s higher, but even at forwards, we definitely see a positive trajectory to EBITDA, Ali.

Ali Agha – SunTrust Robinson

On the current forward curve?

Zamir Rauf

Yes. On the current forward curve, correct.

Ali Agha – SunTrust Robinson

Got it. Thank you.

Zamir Rauf

Right. And don’t forget the new plants that are coming online, of course.

Ali Agha – SunTrust Robinson

Yes.

Operator

From Macquarie, we have Angie Storozynski online. Please go ahead.

Angie Storozynski – Macquarie Capital

Thank you. So, I’d like to – I have bit of a bigger-picture question. So it seems like we’re seeing a lot of discussion about new gas assets being proposed for both Texas and PJM. I mean, we have low natural gas prices because the financing is very low. I understand that the supply-demand fundamentals, as we see them now, do not seem to be reflected in forward power prices. But some of the newcomers are clearly jumping the gun and might be one of the reasons why there’s no more inflation in heat rates in the forward curve. How do you – I mean, do you think that that’s a legitimate argument and if we ever are actually going to see the true reflection of the supply-demand fundamentals in the forward curve for Texas and PJM?

Thad Hill

Angie, it’s Thad. I think the real question is how much money is out there that will flow into these markets unless people think that at the full replacement cost, it can return the loss of capital. And enough newbuilds are not funded, enough newbuilds are not in the queue to fix the problems. Undoubtedly, we’ll see incremental announcements, but announcements aren’t steel in the ground.

And the question is how much capital will actually flow until you end up with market reforms that people feel comfortable about. And we don’t think that, ultimately, the funding markets will be that deep until you strike a few times out in both PJM and taxes, things which we hoped are well on their way to be straightened out.

So, again, I’m not sure that the newbuild announcements are reflected in the forward curve because the forward curves are traded curves, and the people that are creating forward curves aren’t looking that far out. But market reform will be required which will help the markets.

Angie Storozynski – Macquarie Capital

Okay. Could you share with us your initial thoughts for the upcoming PJM capacity auction?

Thad Hill

I think it’s probably maybe a little too early to get into that, but I would say look, we think at a broad level, most folks have kind of said sideways we’re drifting down, and I won’t get specific, but I don’t think outside that general range that we view things are going fall through the floor or go through the roof either.

Angie Storozynski – Macquarie Capital

Okay. Thank you.

Operator

From Barclays, we have Gregg Orrill online. Please go ahead.

Gregg Orrill – Barclays Capital

Thanks. Good morning.

Jack Fusco

Good morning.

Gregg Orrill – Barclays Capital

Just another question on the long-term contracts. On Slide 10, you provided guidance on hedge margin and percentage hedge down to 15% and I was wondering if you could provide – extend that out to get a sense of what the value is beyond 2015.

Jack Fusco

Gregg, we’ve never given our hedge disclosures out beyond 2015. In our third year, we’ve always been about 30% hedge kind of longer term and I think that’s been kind of a consistent viewpoint that we’ve provided people. But as you move further out in time, it’s just it’s a long way out there, and we think two years of disclosure on this should be sufficient for now.

Gregg Orrill – Barclays Capital

Okay. Maybe one other question, just on your market thoughts around MISO and we’ve seen some MISO forecasts there that show equilibrium in the middle of the decade based on questions over whether environmental upgrades will be made. What are your thoughts there on whether that’s an attractive market for you?

Thad Hill

Yeah. Gregg, we’re not a big player in NISO. We have a couple of assets there today, and depending on what happens with Intergy, we’ll pick a couple of more. But, again, we’re not large players. But I’ll tell you this about MISO. And for us, the issue with MISO for us an investor is that there is no MOPAL protection that exists in PJM New England and other markets. And given that, MISO is not a likely place where we would put capital or spend huge amounts of time focused on until there’s a set of rules that actually enables, as Jack mentioned upfront, competitive generators compete fairly. So, we’ve got assets there. And we continue to work doing the best we can with those assets. But MISO is not a core focus for us until and if (inaudible) change.

Gregg Orrill – Barclays Capital

Thank you.

Operator

From Wunderlich Securities, we have Jay Dobson online. Please go ahead.

Jay Dobson – Wunderlich Securities

Hey. Good morning. Jack, on capital allocation, maybe just talk to us a little bit how you sized the share repurchase this time. Last time, it was two 300s, versus $500 million, versus, obviously, your desires for growth, maybe just help us understand how the $400 million came about.

Jack Fusco

Jay, as you know, unfortunately, it’s not just the management’s call. It takes the Board of Directors’ approval to do the share repurchase. So there’s always an element of negotiation for lack of a better word.

And again, as Zamir pointed out, we have a lot of excess cash. We also have a track record of deploying – or redeploying that cash when it’s appropriate. So we decided that – it took us most of last year to spend $463 million or reinvest that back into the company. So that $400 million is a big number for us to be opportunistic and to redeploy. And it’s going to take us some time to reinvest into this business. And I won’t say it’s the end of it and I won’t say it’s just the tip of the iceberg, but we have the benefit of actually having enough excess cash that we feel comfortable with what we’re investing in it this time.

Jay Dobson – Wunderlich Securities

But should we assume it’ll be completed this year, I mean knowing that it has, obviously, tensions in the system of other uses?

Jack Fusco

If the opportunity exist like they do today and we’re in the red, you should assume that we deploy that money and reinvest it as quickly as possible.

Jay Dobson – Wunderlich Securities

That’s great. And then, Thad, just a quick follow-up on PJM specifically, I know you addressed this part broadly on load growth, but in your prepared comments when you were speaking about PJM, you talked about some things could change on the load growth. Was there anything specific to PJM, or was that more your broader comments about GDP or load growth as a function of GDP?

Thad Hill

It was more specific of load growth as a function of GDP and housing.

Jay Dobson – Wunderlich Securities

Okay. Great. Thanks so much.

Operator

From Morningstar, we have Andy Bischof online. Please go ahead.

Andrew Bischof – Morningstar

Well, thanks. Then, obviously, a lot of talk now and in the past about PJM, you think there’s upside there. Are there unique issues there that would prevent you from either buying or adding to your existing assets there, building new plants there? Other than the economics, are there other unique issues, state regulation, et cetera, et cetera, land acquisition that would prevent you from expanding?

Thad Hill

No. None that we can think of. There’s nothing unique about PJM which creates a competitive barrier for us.

Andrew Bischof – Morningstar

And in Texas, anything there?

Thad Hill

No.

Andrew Bischof – Morningstar

Along those lines?

Thad Hill

No. No. In both, it’s a function of where we see economic opportunity, whether we will invest.

Andrew Bischof – Morningstar

Okay. Great. And one follow-up real quick, what do you estimate right now, if you can give us a number, on newbuild or expansion costs on a dollar per-kilowatt basis for your traditional CCGTs or something similar to that?

Thad Hill

That clearly depends on what part of the world – what part of the country you’re in. And along the Gulf Coast, I think a number a little south. We’re at $1,000 a KW is probably a fair ballpark. As you move to the East Coast, probably 10% to 15% higher and as you move to the West Coast, probably 10% to 15% beyond that.

Andrew Bischof – Morningstar

Okay. Perfect. Thanks so much for your help.

Operator

From Tudor Pickering Holt, we have Brandon Blossman online. Please go ahead.

Brandon Blossman – Tudor Pickering Holt

Good morning, guys.

Jack Fusco

Good morning.

Brandon Blossman – Tudor Pickering Holt

Hey, Thad, you touched on this in your prepared comments, so looking for any incremental color you have, but PJM demand response, what’s the end game there? I mean, can you see it continuing down the path that it currently is on, or does something have to have happen over the next two or three years to get it kind of back in line with what’s possible and probable?

Thad Hill

Well, first, I’d say, Brandon, that the growth has slowed in the highly penetrated areas. So, we saw – well, actually, in the period last May, under the prior auction, that in the eastern part of PJM, demand response had actually stopped growing. On the deferred regrowth in PJM, the demand response the last auction were in the areas to the West, which hadn’t had the higher penetration. So, it appears to us, unless something changes that at least in the eastern part of PJM and probably increasingly in the West, that we are approaching generally a saturation point.

And so, for us, the next big question is going to be how it performs. Starting in 2015 and 2016 and 2017 increasingly, (inaudible) unused reserve margin is going to begin getting called upon, then there’ll be a bunch of diesel gen sets going off. There’ll be a bunch of people cut, and there’s questions about the environmental issues and the fatigue and how the market plays that, but – so, the quick answer again is, we think we’re reaching saturation, particularly in the East, and likely there could be a lull until the stuff actually starts to get called on increasingly in the middle part of the decade and then we’ll see.

Brandon Blossman – Tudor Pickering Holt

Okay. Fair enough. And then just real quick, Zamir, net growth CapEx in 2013, $250 million both in 2013 and in 2014 and beyond; is that inclusive of expectations around project financing, or could that be an incremental deduct to that number?

Zamir Rauf

No, you could definitely put some debt on that number. This is just assuming that we use corporate cash to build these projects, which is the assumption at this point. But we can definitely add leverage to it.

Brandon Blossman – Tudor Pickering Holt

So, incremental upside to cash flow bottom line?

Zamir Rauf

Absolutely, absolutely.

Brandon Blossman – Tudor Pickering Holt

All right. Thanks, guys.

Jack Fusco

Thank you.

Operator

And our final question comes from Dave Katz from JPMorgan. Please go ahead.

Dave Katz – JP Morgan

Hi. Looking at the hedge margin for 2013 that you had in the 3Q 2012 slides from the ones that you have in this slide and assuming roughly the same megawatt generation implies that the additional hedges were done at a relatively low number. Would you be able to talk to that?

Thad Hill

Yeah. No, I’ll be happy to. A couple of things have moved on this chart. First, there are more megawatt hours – number of more megawatt hours that are embedded in this column versus the last time. So what we’ve got here is at least $1 of that move is just because the denominator has grown and the numerator’s kind of stayed flat. About $1 of the move was also due to the additional hedges which are below the higher number, obviously, as we’ve been hedging primarily in the shoulders. And then, thirdly, we’re a monthly liquidation and just there’s some math issues underneath it, but the way to think about it is a third are the additional hedges, a third is the denominator growing and a third is just some other smaller underneath in this. So, nothing fundamental and we would see this every year.

Dave Katz – JP Morgan

Okay. And then below that, in terms of the average megawatts in operation, in terms of the growth, I think from 2013 to 2014, it’s growing by about 552, but with Russell City and Los Esteros online for a full year, we would have expected that to grow more and to be substantially above where we are at present, at the end of 2012. Can you just get a little more granular on that as well?

Thad Hill

Well, I don’t – this is a 2013 weighted average number. At the end of 2012, if you’re looking, we did have two other assets which have since sold. So we sold the 800 megawatts in South Carolina and approximately 500 megawatts in Wisconsin. So moving from 2012 into 2013, there was a deduct for 200 megawatts.

So, what I’d suggest is, I mean, look, the adds this year, the Russell City and Los Esteros midyear. In mid-2014, you’ll see the two projects in Texas. And finally, in 2015, you’ll see Garrison. And the final note I’d make is this includes deconsolidated plants – excuse me, excludes deconsolidated plants. I can get with IR. So, the only changes should be the five projects under construction. No other changes should be in these numbers.

Dave Katz – JP Morgan

Okay. Thank you.

Operator

Thank you. I will now turn the call back over to Mr. Bryan Kimzey for any closing remarks.

Bryan Kimzey

Thanks to everyone for participating in our call today and we look forward to seeing you at our Investor Day in Houston on April 10. For those of you that joined late, an archived recording of the call will be made available for a limited time on our website. If you have any further questions, please don’t hesitate to call Investor Relations. Thanks again for your interest in Calpine Corporation.

Operator

Ladies and gentlemen, this concludes today’s conference. Thank you for joining. You may now disconnect.

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