Carim Khouzami - Executive Director, IR
Mayo Shattuck - Chairman, President and CEO
Mike Wallace - Vice Chairman
Jack Thayer - SVP and CFO
Greg Gordon - Citi
John Kiani - Deutsche Bank
David Frank - Caterpillar Capital
Paul Patterson - Glenrock Associates
Constellation Energy Group, Inc. (CEG) Q4 2008 Earnings Call February 18, 2009 8:30 AM ET
Good morning and welcome to the Constellation Energy's Fourth Quarter and Full-Year 2008 Earnings Conference. At this time, all participants are in a listen-only mode. (Operator Instructions). Today's conference is being recorded. If you have any objections, you may disconnect at this time.
I will now turn the meeting over to the Executive Director of Investor Relations for Constellation Energy, Mr. Carim Khouzami. Sir, you may begin.
Thank you. Welcome to our fourth quarter earnings call. We appreciate you being with us this morning.
On slide 2, before we begin our presentation, let me remind you that our comments today will include forward-looking statements, which are subject to certain risks and uncertainties. For a complete discussion of these risks, we encourage you to read our documents on file with the SEC. Our presentation today is being webcast and the slides are available on our website, which you can access at www.constellation.com under Investor Relations.
On slide 3, you will notice that we will use non-GAAP financial measures in this presentation to help you understand our operating performance. We have attached an appendix to the charts on the website, reconciling non-GAAP measures to GAAP measures.
With that I would like to turn the time over to Mayo Shattuck, Chairman, President and CEO of Constellation Energy.
Thank you, Carim. Good morning, everybody. Let me quickly review our agenda for the morning. First, I am going to provide a strategic overview that will discuss the events of 2008 and where we plan to take the company in 2009 and beyond. Mike Wallace will then give an update on Constellation's nuclear program and the status of our joint venture arrangement with our partner EDF. And finally, Jack Thayer, our Chief Financial Officer will review 2008 in our perspective financials. After Jack I have some closing remarks and then we will some time for questions.
I will start off on page 5. This morning we reported a GAAP loss of $7.34 per share for 2008. despite the fact that we have previously discuss the accounting impacts of our merger activities it is still jarring to see how these items flow through our P&L. I think it is important for me to take a moment and discuss the main drivers and differentiate the actual operational aspects of this loss from those that were accounting in nature.
As you can see in the chart, during 2008 we had a number of special items. The most notable is the $6.72 per share charge related to our merger activities. This charge largely consists of the conversion of the MidAmerican preferred stock and termination costs. During the year we also reported impairment charges of $3.04 per share. These charges included the write-off of goodwill that occurred with the MidAmerican transaction and the depressed values of some holdings costs by weaken financial markets. Jack will spend some time later in the presentation walking you through the details of these charges.
On the right, you can see that by excluding the special charges, our 2008 adjusted earnings would have been $3.50 per share.
Turning to slide 6. During 2008 market events and internal issues help shape and influence the decisions we made. Heading into the year, we determine that our balance sheet could not support the significant growth of our capital-intensive commodities business long-term. Accordingly we began to explore strategic options including the sale or JV of this business. We embarked on a process and solicited bids from interested parties. Although interest levels were high following the collapse of Bear Stearns we determine we could not get reasonable value for our business.
As you will recall at the time, most of you at this financial distress to be temporal and largely isolated incidence. We continue to believe that market fundamental still pointed to continued increases in global demand and higher prices for commodities. We, therefore, did not reduce the extent of our commodities risk exposure at this time expecting as normalcy return, we would recommence the sales process begun early in the year.
The decision resulted in record mark-to-market profits in the second quarter, however, due to their unrealized nature the profits were largely non-cash. The volatility in commodity prices they contributed to the strong portfolio management and trading results also required us to post incremental collateral to maintain economic hedges supporting our generation and global coal activities.
Asymmetrical nature of these businesses collateral posting requirements compounded the magnitude of the problem negatively impacting our overall liquidity. After the disclosure of the down grade collateral error in August, we found ourselves playing catch-up in a market that were showing signs of duress. But we took dramatic steps to secure incremental financing and significantly reduced our risk profile, we ultimately were unable to stay at ahead of rapidly deteriorating market forces.
The MidAmerican transaction was structured at a time of extreme stress, the first step in that transaction solved the liquidity problem and the second step which was the acquisition of the entire company, allowed us to consider other offers under certain circumstances. The window that was left open for a topping bid, however, got smaller through the fall. The complexity of our commodity's operations was the principle returns but virtually all of our likely [suitors] also suffered deteriorating market values in access to capital. Contractually, we of course, were not permitted to solicit alternative outcomes. All the while EDF steadfastly worked on finding a solution. They had a large vested interest in us through an equity interest in Constellation and our UniStar joint venture and that consistently expressed an interest in pursuing the acquisition of existing nuclear assets.
Prior to the merger with MidAmerican we also had extensive discussions about further investment at the current company level. EDF pursuit of British Energy and our agreement with MidAmerican probably could have dampened their enthusiasm for Constellations, but they persevered and just before the December shareholder vote they submitted a non-confirming topping bid.
So, if you turn to slide 7, on the surface I know it seems obvious that $4.5 billion bid for 1.5 of the nuclear fleet had to be superior to $4.7 billion deal for the whole company. However, care was required in addressing our liquidity needs, the terms of existing credit facilities, the regulatory approval process and the prospects for real value recovery in our stock price. The negotiations for EDF validated that their bid was superior, but also enabled us to structure the transaction to allow for what we believe is real value creation for both parties in the long-term.
Further EDF was clear to indicate that this investment was an important step in the industrial strategy to enter into the US marketplace. We examined the EDF price for its attractiveness and all the relevant metrics, by store norms the $2300 per kilowatt paid for our nuclear fleet is greater than those of recent transactions. However, this metric failed to adjust for the specific economics of each plant including hedges such as PPAs. A more relevant metric to look at is the multiple of hedged EBITDA paid. Using the purchase price of $4.5 billion, the 2011 EBITDA multiple is more than ten times. This is before we include any realization in 2011 of negative value hedges conveyed to the joint venture.
As part of the agreement, at close we will be conveying a negative $700 million of value on a present value basis. The present value will be calculated two days before close and will be discounted at 10%. Similar to the purchase price, the value conveyed and the discount rate are set, although the specific contracts that will be conveyed are still under discussion.
We have shown on the chart what the EBITDA multiple would be if a portion of the negative value conveyed is realized in 2011. While the price will be paid for 50% of the fleet on this basis, it's clearly attractive for us. Their offer reflects the future value of the business. I know both sides expect that the long-term value of nuclear assets will appreciate and we will both prospectively benefit as reserve margins and carbon inevitably drive future power prices higher.
If you turn to slide 8, while the EDF transaction represents fair value for the assets, it also facilitates our ability to earn our way back to higher shareholder value and allows us to consider new nuclear possibilities. As important, it also offers immediate and significant restoration to the balance sheet. The significant non-cash impact to equity of the MidAmerican breakup which flowed through our P&L in 2008 is more than restored with EDF transaction.
Our book value under this transaction increases to $6.8 billion as seen here and our capital ratio has improved significantly. Upon completion, the transactions purchase accounting releases the hidden value of our nuclear assets and right sizes their contribution to the assets on our balance sheet. It also provides greater transparency to the inherent value of the company.
We turn to slide 9. During 2009 we will align our reporting structure to reflect the way we will manage the business in 2010 and beyond. Most of you are already familiar with our regulated utility Baltimore Gas and Electric which will continue to serve 1.2 million electric and 650,000 gas customers in Maryland.
As you can see on the chart, beginning in 2010, the merchant group will be divided in two parts to provide a more transparent view of the profitability of the businesses and how well each has been managed. Our generation assets will be split into two separate reporting units, one will be our non-nuclear generation segment which will include approximately 5300 megawatts of fossil plants and renewable facilities primarily in the PJM region. The other will be our nuclear segment that will include our 50% stake in our nuclear joint venture with EDS which will own and operate approximately 3900 megawatts of existing nuclear facilities in PJM in New York.
In addition, it will also include UniStar which will continue to work towards developing new nuclear facilities throughout the US. Our customer supply group will continue to be a leading supplier of retail and wholesale power and gas although in a smaller higher return basis.
In 2010, we will no longer refer to the commodities group as the distinct business. Rather we will integrate the skills intellectual capital and people that price physical commodities, manage risks, hedge load and originate physical supply to be part of the customer supplier generation groups. With respect to hedging activities in particular starting in 2010 the customer supply in generation groups will report the earnings on an as realized basis rather than on the current as priced methodology for management reporting purposes.
Management objectives in this reporting will allow investors to better assess the true risks and profitability of each business providing greater visibility into our results and the way we manage our business.
On slide 10. As we discussed earlier entering in a definitive agreement with EDF provides us with the path towards stability and liquidity to remain a viable standalone company. This transaction also further cements the relationship between our two companies. We are laser focused on closing the EDF transaction and remain excited at the prospect what our partnership may accomplish in the future. We have also been executing another fronts with the objective of right sizing our strategic footprint.
In January and February, we executed many of the strategic divestitures, we identified last fall. The first was the announced sale of our international coal and freight business to subsidiary of Goldman Sachs. The second and equally significant initiative was, the announced sales of our Houston downstream gas business to Macquarie.
Importantly, as part of this agreement, we will enter into a supply arrangement that will provide us with the gas supply needed to support our retail gas customer supply business while reducing our credit requirement. We expect both transactions to close during the first half of 2009 collectively by the time we close and based on today's market prices we expect the combined transactions to return approximately $1 billion of currently posted collateral.
In addition, we expect the divestitures to further reduce our downgrade collateral requirements by approximate 400 million. Additionally, as we had indicated in August, we have also divested a majority of our upstream gas properties. These are not collateral intensive assets, however, they are capital consumptive in nature. We have also made progress in our efforts to right size our customer facing businesses to be inline with both our balance sheet and support. The scale of these businesses will be determined by incorporating factors such as own generation, physically contracted generated, what our maximum potential exposure could be and the cost of capital required to support the exposure.
Prospectively, our customer facing businesses will be smaller with higher returns taking into account the higher cost of capital and our owned and contracted generation positions. We continue to take steps to reduce operating cost throughout organization. In December, we announced an 8% reduction in headcount reflecting our reduced strategic footprint. We have begun 24 months effort to streamline our systems and operations and these actions will yield material savings. These steps to reduce corporate and business unit overhead and integrate staff functions across the organization will also improve the flow of information and operational control.
We have already registered significant cost savings and operational benefits and expect to see further incremental opportunities to achieve savings. Finally, we have made the management changes necessary to focus on and execute our business strategy.
On slide 11. The next 12 to 24 months will be a transition period focused on specific objectives that will help strengthen the company. We have already spoken about the importance of the EDF joint venture and we will work with our partners to close this transaction as soon as possible.
Our management team's near-term focus is to return to our core strengths, these include owning and operating both nuclear and non-nuclear plants, continue to maintain strong retail and wholesale customer relationships through our customer supply business, and continue to provide safe and reliable utility service to our customer in Maryland. In addition, we will continue to leverage across our organization, our expertise, and being able to price physical assets which we believe gives us the competitive advantages over our competitors.
At the corporate level, we are also focused on balancing cash flow with earnings as we manage across all our business. In addition, in order to help assure that we have the near-term capital we need in extreme market conditions. We plan to maintain liquidity cushion in excess of our downgrade collateral levels. We are committed to taking a disciplined approach in managing our collateral and liquidity. We are actively changing the way we run our businesses. Within our customer supply group we have changed our pricing to reflect increased cost of contingent capital. With the market environment causing reduction and competition in the market where we are focused, we have been able to adjust our pricing and continue to write new business.
We continue to take actions that will help de-risk our commodities portfolio. Jack will talk will more about the specific actions we are taking to do this but from a high level we are repurposing and changing the objectives of our commodities group. This group will continue to provide risk management services and we use to hedge our generation fleet and to originate and secure contractual power for retail and wholesale customer supply businesses. To a lesser extent, we will selectively deploy risk capital and leverage our market insight and physical power strategies to earn superior risk adjusted returns.
We will closely manage these activities by using strict return on capital requirement and we will report (inaudible) deployed in this fashion and related results on a quarterly basis. Importantly, we will we undertake this with the disciplined understanding of our overall liquidity needs and capabilities.
Finally, we are committed to sustaining and improving our investment grade rating as we reduce the scope of our activities. All of these initiatives require near-term execution and a design to specifically strengthen our company. Successfully executed, they allow us to maintain the flexibility we need to respond to longer term opportunities and drive substantial future increases and shareholder value.
With that, I will turn the call over to Mike Wallace, Constellation's Vice Chairman. Mike?
Thanks Mayo. In this next segment, I will focus on the new joint venture with EDF as well as our existing joint venture with UniStar Nuclear Energy. The new joint venture provides strategic entry for EDF into the key US nuclear market and develops an industrial partnership and investment in Constellation.
As EDF Chairman and Chief Executive Officer, Pierre Gadonneix said in December "EDF Group has long believed that there are significant benefits to be realized between the development of new nuclear assets and the operation and ownership of existing nuclear facilities, such as those owned and operated by Constellation Energy. This agreement will contribute significantly to non-CO2 emitting energy generation in the US inflow."
We too at Constellation are excited by the prospect of what this joint-venture can bring together. The largest nuclear operator in the world, and a top-tier US nuclear fleet that is continuing to improve year-after-year.
In fact, let me point out to you that as of today, Calvert Cliffs Unit 2 is within two days of time to world record for continues generation of a pressurized water reactor at 687 days. And based on the planned to Breaker Day for it's upcoming refilling outage Calvert Cliffs Unit 2 will set a new world record at 691 days of continues generation. We are proud of this kind of operational performance, and we look forward to continued excellent operational reliability and safety performance in our new joint-venture.
Turning to slide 13, I will focus on our efforts to close the new joint-venture. Our transaction closing efforts have been initially focused on getting the required regulatory filing submitted. And indeed this effort was completed late January.
You see the list of filings on this slide along with the anticipated timeframe for approval. The Nuclear Regulatory Commission indirect license transfer application is anticipated to be gating item for regulatory approval, and we expect this approval on the third quarter.
As you maybe aware, the primary focus of the NRC review is fitness to own and operate nuclear plants, financial strength and management capability, and the negation action plans to preclude foreign controller domination of licenses.
CFIUS, the Committee on Foreign Investment in the United States is an interagency committee of United States government that reviews the national security implications for foreign investments in US companies or operations. They will evaluate our transaction to assure no national security impairment may arise from it.
The FERC application requirements are to demonstrate that there are no adverse impacts on rates, regulation, competition and no cross-subsidization. In the SEC filing is for the transfers of various licenses held by the three nuclear plants. We have high confidence in all our filings and anticipate all will be approved by the July, August timeframe.
In addition to this regulatory filings, we have been engaged with state officials and are actively briefing the Maryland Public Service Commission on this transaction maintaining a cooperative dialogue and responding to its inquires.
We believe the advantages to Maryland are significant, both in the short-term and over the long-term and that this transaction does not involved any substantial influence by EDF and BGE or on the ratepayers of Maryland.
Turning to slide 14, now I would like to describe the other commitments to EDF will make as a part of the Asset Purchase Agreement in addition to the immediate $1 billion cash investment.
EDF and Constellation entered into a two-year asset put option that allows Constellation to sell to EDF up to $2 billion of non-nuclear generation assets. Also, EDF has provided constellation $600 million interim backstop liquidity facility available until regulatory approval is granted for transfer of at least $600 million of generation assets that could be sold under the asset put option.
As a demonstration of its commitment to the US nuclear renaissance, and in particular Maryland's future role in that renaissance, following the close of the joint-venture EDF will move its US headquarters to Maryland.
EDF will also invest $20 million in a new visitor and environmental center at Calvert Cliffs. If Calvert Cliffs is built, it will be one of the largest economic and industrial development projects in Maryland's history, and with meaningfully help to meet the state's growing demand for energy.
Additionally, it is estimated that each new reactor that is built would create 4,000 new construction jobs and approximately 400 permanent positions. Further as part of its commitment to Maryland, EDF will contribute $36 million in the Constellation Energy Group Foundation to support future charitable endeavors for the long-term benefit of the Baltimore Community in the state of Maryland.
It is also important to note that Constellation and EDF are actively engaged in a number of implementation issues. They will ensure, we have the efficient, effective joint organization. Examples of these issues include the power marketing arraignments for the plant's output, the detailed organizational structures of the joint-venture and opportunities for bringing EDF employees into the joint-venture.
Turning to slide 15, I would now like to update you on our UniStar joint-venture. As you know, Constellation Energy undertook its first steps toward new nuclear development activities in 2005, when we formed UniStar Nuclear, LLC to jointly market the US EPR technology with the Areva.
Since then we have been successfully working to position Constellation Energy and UniStar Nuclear Energy. Our strategic joint-venture with EDF formed in 2007 as the leader in the US nuclear renaissance.
The strength of our team goes beyond our partnership with EDF. Our joint-venture with Areva was the foundation for UniStar as we indicated we were pursuing four standardized units as the base fleet going forward.
We've identified Bechtel as the construction engineer that we will use for the US EPR. We added Alstom to the team, is supplier of the turbine generators for those units and the Accenture was selected for our information infrastructure platform. Consistently, our approach has been to build a world-class team of strategic partners, who together will assure standardization and best practices for the US EPR fleet.
It should be noted that each of our partners is the number one supplier in their area of expertise in the US nuclear industry. In addition, the validity of our model has been demonstrated in the marketplace as both [Amrin] and PPL engaged with us for the development of their combined license applications to the NRC.
2008 was a year of great accomplishments for the UniStar team. All four US EPR projects filed their combined license applications and have had those applications documented by the NRC for review. As such these projects remain eligible for production tax credits.
All four US EPR projects submitted their loan guarantee applications with the Department of Energy. And our strategic partners have demonstrated their commitments to the new Nuclear Renaissance in United States through announced industrial investment.
Alstom announced the $200 million turbine generator facility in Chattanooga, Tennessee, potentially creating 350 plus jobs. Areva has teamed with Northrop Grumman to announce a $363 million facility in Newport News, Virginia, to manufacture steam generators for US Nuclear power plant, creating 540 jobs.
Areva has announced plans for a $2 billion uranium enrichment facility in Bonneville, Idaho, that will create 250 jobs. And as I indicated previously, now EDF will be moving its US headquarters to Maryland.
New nuclear is legacy issue, and new nuclear is good for the country. Federal loan guarantee support for new nuclear projects could spur more than $150 billion of private sector capital investment into the US economy contributing to the buildup of US manufacturing and creating potentially tens of thousands of high quality American jobs and it is structured to be done without costs of the US taxpayer.
Cancellation energy is taking a leading role as the nuclear power industry is committing billion of dollars in direct private sector investment in UniStar and its partners are at the forefront of the nuclear renaissance.
Turning to slide 16, NRC licensing is the pacing item for the first project Calvert Cliffs Unit 3. The NRC has published their target date for the final rule making in mid-2012. However, UniStar and Areva are working closely with the NRC to accelerate this date.
We have been working proactively through the process in the state of Maryland to obtain the Certificate of Public Convenience and Necessity, or CPCM. A part of receipt of which we can began preliminary site work in 2009 for the Calvert Cliffs 3 plant, subject to the receipt of any additional required permits or approvals. In addition with EDS investment, we will also be breaking ground on a new $20 million visitor and environmental center at the site.
Turning to slide 17, the DOE loan guarantee program is a critical component in funding new nuclear investment. The current program authorizes the DOE to provide loan guarantees for up to 80% of the total cost of new nuclear projects. The cost of the guarantees is paid for by the owners, and it is based on the credit worthiness of the project.
The primary role of the government will be to provide financial assurance to the project lenders. Commercial banks and the federal finance bank by issuing guarantee. The recent financial crisis has significantly reduced the likelihood of financing new nuclear projects without government support.
The DOE loan program is the best path available to secure debt for new nuclear. We are pleased to tell you that our Calvert Cliffs 3 project was one of five, selected by the Department of Energy to move into the due diligence phase of the program.
Further, we believe current authorized funding is adequate for three projects, and that our Calvert Cliffs 3 should be one of these projects. Moreover, we are hopeful the Calvert Cliffs 3 will receive a conditional commitment before the end of this year.
Constellation Energy like many companies, currently have some constraints on the level of capital investment it can support. However, the UniStar model was developed from the start as a flexible model.
As we look the EDF and other partners to work with us, we will execute a strategy that is consistent with the capital we choose to make available. UniStar is currently evaluating various capital structures and financing plans that may include federal loan guarantees, support from export credit agencies and sponsor or partner equity contributions.
As we continue to work with DOE, we will further refine the project capital structure and financing plan. UniStar is well aware the uncertainties and risk inherent with building a new nuclear plant, and we continue focus on our disciplined risk managed approach to making business decisions and future commitments, and thus drive down the level of uncertainty.
We have the right team of suppliers, partners and customers. We have selected the right technology with the highest safety and security margins, and licensed in both France and Finland with two units currently under construction in Europe, and another two units underdevelopment in China.
And we believe it is the right time. Calvert Cliffs 3 is poised and ready to proceed as soon as the government provides lenders with loan assurance through the loan guarantee program.
Turning to slide 18. Before I turn the presentation over to Jack, I would like to make a few closing remarks. Through our new joint-venture with EDF and our UniStar partnership, we will be leveraging a partnership that is proven and successful.
We have worked closely with EDF over the past two years, and we are confident our nuclear fleet will benefit from working with a large nuclear operator that knows our assets and who is committed to making this industrial investment.
Also, our relationship with EDF provides us with additional options to be a leader in new nuclear development through the UniStar joint-venture as well as placing us in a leading position to take advantage of future market opportunities.
Moreover, we believe Constellation has an exciting opportunity to continue with UniStar partnership with EDF in a meaningful way towards the development of new nuclear in the United States. As EDF brings construction experience, global scale and procurement leverage as the largest owner/operator of nuclear plants in the world. Also, EDF has the financial strength to support the significant capital that will be required for new nuclear construction.
Lastly, we will work with EDF to help the US simultaneously meet its CO2 reduction target while adding needed base load capacity to answer the nation's growing need for carbon-free energy, positioning Maryland as a leader in the future of carbon-free US energy development.
Now, I would like to turn the presentation over to Jack for the financial overview.
Thank you Mike, and good morning everyone. I'm turning to slide 20, and I will review our financials for 2008.
On slide 20, you see that fourth quarter GAAP earnings were a loss of $7.75 per share. Excluding special items, adjusted earnings per share for the quarter were a positive $0.03 per share. For the full year, GAAP earnings were a loss of $7.34 per share, excluding special items adjusted earnings per share for the full year were $3.57.
Let me take a moment and walk you through some of the special items that negatively impacted earnings through 2008. For the full year, merger related cost totaled $6.72 per share. These charges reflect the cash cost of $663 million, and non-cash accounting charges of $541 million, largely consisting of the conversion of the MidAmerican preferred stock and termination cost.
We also recognized approximately $3.04 of impairment charges during 2008. These charges capture the economic impact on our assets, investments and company stock of significant decreases in commodity and market prices.
In the third and fourth quarters, we wrote down the value of our upstream gas assets, Constellation's goodwill, our interest in Constellation Energy Partners and our nuclear decommissioning trust fund.
In 2008 as a result of the Maryland settlement, we achieved with the Maryland PSC, BGE provided residential customers with pretax credits totaling approximately $189 million. This resulted in a full year after tax loss of $0.62 per share. Other one-time items in 2008 resulted in a loss of $0.16.
Turning to slide 21. Adjusted earnings for 2008 were $3.57 per share as compared to $4.60 in 2007. During 2008, our Merchant segment was down $1.08 year-over-year and utility was up $0.11.
At the Merchant segment, the significant increase in energy commodity prices during the second quarter was a record earnings of $1.74 per share. During the third and fourth quarter, decline in price environment had the opposite effect on our portfolio. In the third and fourth quarter, we also focused on de-risking the business, and not on new business origination.
The full year portfolio of management and trading contribution of a loss of $1.39 as well as a lower level of originated new business led to a significant year-over-year reduction in segment earnings.
The utility turned in a solid performance in 2008, compared to the prior year adjusted earnings were $0.11 higher due primarily to benefit secure through the Maryland settlement and lower operating expense, which were offset impart by higher bad debt and interest expense.
Turning to slide 22 and a review of 2008 cash flow. During 2008 on a net basis, we used $894 million of cash resulting in an ending cash balance of $202 million at year end. Our operating activities used approximately $1.3 billion, primarily driven by increases in collateral and margin postings of approximately $1 billion during the year.
Cash payments to MidAmerican of approximately $600 million also negatively impacted operating cash flow. Collectively these uses of cash more than offset the $279 million of positive cash flow from business operations.
Investing activities accounted for approximately $2.7 billion of cash outflows, primarily related to capital investments including environmental capital spending of $555 million and asset acquisitions including $344 million spent to acquire and build-up the Hillabee, Granbury and West Valley power plants.
The cash proceeds of $1 billion received from the issuance of the EDF preferred stock in December is included as restricted cash proceeds, which were then used in January to attire the MidAmerican node.
During the year translation completed at multiple financings, including $1 billion of preferred equity issuances to, both EDF and MidAmerican as part of the respective transactions and an initial $1.1 billion of other debt issuances.
Additionally, the company had a net issuance of $815 million in short-term borrowings primarily in the form of credit facility draws, offsetting these cash inflows were $335 million in dividend payments and $465 million related to debt retirements and other activities.
Turning to slide 23. Year-end 2008 net available liquidity was approximately $2.35 billion, which compares favorably to the estimated year end downgrade collateral requirement of approximately $1.77 billion. Posted letters of credit were $3.65 billion, while cash drawn against facilities was $870 million, leaving $2.15 billion in available bank facilities at the end of December.
Please note that the cash balance of approximately $200 million listed above excludes the $1 billion of restricted cash received from EDF in December that was used to repay MidAmerican $1 billion note in early January.
Turning to slide 24, and it's a discussion regarding our efforts to reduce the scale of our commodities' activities and portfolio. Since September, we have taken steps to reduce the scope and scale of our commodities' activities. Through these actions we have reduced margin power positions, reduced length in our trading book, reduced our exposure to commodity price fluctuations and related margining on hedges to customer supply contracts and decreased exchange and ISO collateral postings.
In the top left chart, we showed that we have reduced our mark-to-market value at risk by 44% during the fourth quarter. Due to reductions in our opening derivative exposure and the conversion of power length to heat rate length. In the bottom left chart you see that our efforts to reduce margin positions resulted in decline in our collateral positing sensitivity under our price stress scenario.
On the right side, we show the decline in collateral postings to exchanges in regional ISOs. Since September 19, our initial margin posting to exchanges has declined by approximately 30% through year-end, reflecting our reduction in exchange positions.
Finally, our ISO positing have declined by 23% as we have actively increased our use of physical hedges and consolidated to our collateral requirements when possible.
As a result, we are comfortable reducing the range of potential one time cost we could see as we reduced our commodities' portfolio and resize our activities. As you recall in December, we signaled that we can see incremental losses of as much as $1 per share as we reduced our portfolio. Given the success of our efforts to-date, we are now comfortable reducing the potential incremental one-time cost of unwinding our commodities' portfolio to $0.50
Tuning to slide 25, in a discussion of economic value at risk. Looking at this chart you can see we have successfully reduced our economy value at risk from approximately $195 million in September to $90 million at the end of January 2009. Consistent with the flattening of our risk position discussed in the previous slide, the primary drivers of this reduction are the sale of outright power link, the conversion of power length to heat rate length. Another events highlighted on the slide, it must also be noted that the unit cost of value at risk has also decreased in the same period as prices and volatility has declined.
In addition to reducing net positions and shrinking overall portfolio scale, we have reduced the size of our exposure to daily collateral posting by flattening our exposure to margin power positions and hedges. We remain committed to reducing the scale our commodities portfolio reducing our exposure to margining and we will continue to update you on our progress.
Turning to slide 26. Let me now turn to 2009 and discuss the financial initiatives that are essential to our success going forward. The EDF transaction is a transforming event and we will continue to work with our partners to close the transaction as quickly as possible. We are working diligently to finalize the new joint venture structure giving consideration to the tax accounting and earnings implications of different structures.
As I have discussed we are committed to a disciplined approach to our balance sheet, collateral and liquidity. In order to meet near-term needs, we will allocate capital in a prudent manner across our businesses. This includes sizing the level of business we undertake to reflect the cost of the contingent capital and working capital needed to run our business.
More importantly, we will be directing capital towards business where our customers are covering the full cost of the physical and credit intermediation function we provide. This should enable us to use roughly a third of the proceeds from EDF transactions retire debt. We will also reserve a significant portion of these proceeds to sustain an appropriate cushion of our down rate collateral requirement to ensure that we have the necessary capital on hand to meet the capital and credit requirements of our business. Efforts to reduce the strategic footprint of our business also continue.
In January and February, we announced the divestiture of non-strategic assets including our international coal and freight and Huston downstream gas businesses. These sales will return approximately $1 billion of collateral to us based on current market prices. They will also reduce our downgrade collateral by approximately $400 million. We anticipate closing these transactions in the first half of 2009.
Finally, during 2009, we will refine our reporting structure to improve transparency and help you monitor the results of each of our businesses with the expectation that we will roll this new framework out starting in 2010.
Turning to slide 27. After the challenges of 2008, cash flow is our main focus in 2009. To this end, we have identified the key risk we could face in 2009 and are carefully monitoring them and taking appropriate actions to proactively address them.
We continue to see the global credit crisis in access to liquidity as our top risk. As Mayo have discussed we are actively monitoring our sources and uses of liquidity and are taking specific actions to conserve cash. We are monitoring net available liquidity and working to determine appropriate capital allocation and pricing across the businesses.
We are carefully monitoring portfolio of credit quality as the current economic environment has increased the risk of default in our retail and wholesale customer supply businesses. We have increased the monitoring of receivables and bad debt expense and our requiring deposits of all retail customers that do not meet pre-existing credit conditions. We are also adding credit restructuring and workout staff to our credit department in anticipation of higher default rates in 2009.
As a leading player in the wholesale and retail markets, we will be affected by demand destruction and are monitoring demand patterns of different customer segments in geographic regions. We are enforcing the provisions in our retail contracts to minimize the impact of decrease usage.
To mitigate the impact of further declines in commodity prices, we have increased our hedge ratios for the generation in the near to medium term. We continue to adjust these hedge ratios based on a fundamental view on price.
Finally, we reduced the overall size of our trading portfolio, adjusted positions to reflect the decline in market liquidity and are in the process of unwinding less liquid spread to further reduce our basis risk. As you can see, we are prudently monitoring risk and will track performance and update you on our progress as we move forward.
Turning to slide 28, in our liquidity. A key component of our 2009 improved liquidity story will be the settlement of our mark-to-market assets. This chart assumes forward prices realize and no incremental new businesses added. Under this assumed scenario, we expect to realize over $500 million in cash, due to the settlement of our mark-to-market positions in 2009. We expect the cash realization of mark-to-market gains that recorded in previous periods to improve available liquidity over the next three years.
Turning to slide 29. In addition to realized mark-to-market cash profits, the settlement in realization of 2009 positions is estimated to return $1.2 billion of collateral across our total merchant portfolio. An incremental 800 million of collateral is expected to be returned in 2010. New business will partially offset this collateral realization. We expect to size this level of business in accordance with our balance sheet and access to capital.
Turning to slide 30. I have spoken at length this morning regarding our collateral postings. As of December 31, 2008 our net collateral postings were approximately $4.5 billion, although collateral postings are highly dependent upon commodity price movements and business activities. As of December 31, the largest user of collateral was our customer supply business reflecting the dramatic decline in power prices in the fourth quarter.
Going forward, we expect to reduce the amount of collateral we post in order to support our business activities. By the end of the second quarter we expect to have completed the sales of our international coal and freight in Houston downstream gas businesses which require an estimated $1 billion in collateral support, respectively in our customer supply business we are pursuing a smaller high return business size relative to owned and contracted physical generation.
These actions will result in greatly reduced levels of posted collateral as compared to hedging with financial contracts. The chart on the right assuming no changes in underlying commodity prices shows our projected use of collateral-wide business at the end of 2009. By year-end we expect total collateral use to be approximately $2.8 billion across generation, customer supply and commodities.
As you can see commodities which by then will have been reduced in scale, will use a very small amount inn net collateral.
Turning to slide 31, and a review of our projected available liquidity. Here we forecast our net liquidity by quarter for 2009 and 2010. The significant 2009 improvements in liquidity are driven primarily by the addition of the EDF put option, the roll-off of margin positions and the second quarter divestiture of the Houston and International businesses.
EDF transaction is expected to close in September and result in a net reduction of liquidity. Drivers include the subsequent repayment of debt and reduced credit facilities triggered by the sale of a portion of our nuclear assets to EDF.
Given the reduction in credit facilities, we planned to use cash from proceeds to post-collateral if letter of credit capacity is not sufficient. We see further expected reduction in liquidity in the fourth quarter from the expected voluntary repayment of $1 billion of debt.
Looking at 2010, we expect increased free cash flow combined with the roll-off of letter of credit collateral to result in an improving liquidity profile for the first three quarters. However, with the expiration of the $2 billion put a year-end projected liquidity falls to approximately $2 billion. We will address this issue during the next two years, as we refine strategy and capital structure.
Turning to slide 32. In our forecast, we consider both expected outcomes and stress scenarios. Here, we measure our net available liquidity position under stress scenarios. In this graph, 2009 monthly net available liquidity has expanded from the previous page but shown here as the red line. We have added our downgrade collateral requirement assume to be $1.8 billion through March and falling to $1.4 billion by May to a stress business scenario.
These stress results are approximately 20% lower than our stress analysis performed five weeks ago and reflect a similar reduction in margins 2009 positions. Further reductions in our marginable power positions will reduce our collateral sensitivity to commodity price changes.
Based on a Monte Carlo price simulation at a 95% confidence level, we have stressed key price sensitive sources and uses of net available liquidity including existing business collateral needs. Customer supply new business collateral needs and gross margin realization variability. We have also stressed capital and O&M expense variability and contingent wholesale credit capital needs.
As you can see, we have adequate available liquidity even in stress scenarios in 2009. Although now pictured here is the same is true in 2010.
Turing to slide 33. Having addressed liquidity less returned earnings, we are projecting 2009 earnings per share of $2.90 to $3.20 per share. This is roughly inline with the guidance we provided in December. Although we have backed off the high end of our range by $0.10 to reflect steps taken to hedge the fleet in a declining price environment.
These figures exclude the economic impact of our divested properties, for comparability year-over-year, we provide a second call and this shows our guidance excluding the impact of the share dilution caused by the issuance of approximately 20 million shares to MidAmerican in December 2008.
Before dilution, the mid-point of our merchant segment guidance range is below our 2008 results of $2.69 per share driven by the impact of reduced level of wholesale power gross margin as well as higher interest expense partially offset by lower cost.
Generation is expected to be relatively flat with higher gross margin to the roll-off of below market hedges offset by the impact of the expected EBIT loss to the formation of the nuclear joint venture.
Before dilution our utility segment guidance is inline with 2008 results of $0.85 per share. We expect higher electric distribution revenues to be offset by higher expenses related to inflation and higher interest expense.
As noted, starting in 2009, we will exclude UniStar equity and earnings from our reported adjusted results. As a development stage joint venture in which we recognize non-cash equity and earnings, UniStar's results are not expected to be relevant in understanding Constellation’s earnings or in the valuation of Constellation. The non-cash equity and earnings is expected to be a loss of $0.08 per share in 2009 compared to a loss of $0.02 in 2008. The 2009 earnings guidance range also excludes any impact of the recently announced sale of our international coal and freight and downstream gas trading business and any results of operations from these businesses prior to close.
Turning to slide 34, and a review of projected earnings by segments. BGE will invest in the PSC approved energy efficient programs for customers in 2009. These programs are a component of our strategy to meet the in-power Maryland goals and design to deliver savings to customers.
This year BGE will continue to deploy smart thermostats and load control switches to electric residential customers and continue its smart energy pricing pilot. These programs will deliver savings to customers while providing BGE with appropriate cost recovery including a reasonable return on invested capital.
With the implementation of large commercial and industrial electric decoupling in early 2009, BGE’s electric and gas delivery revenues addressed the disincentive of energy efficiency. Importantly BGE’s decoupling mechanism allows its retained value of future customer growth. This important policy change aligns BGE's interest with those of its customers and regulators in pursuit to Maryland stated energy efficiency goals.
The decoupling decision and the recent approval of one-year amortization of expected 2009 energy efficiency program cost. A working example of our improved relationship with Maryland PSC, these decisions balanced the energy needs of consumers with the financial help of the utility.
During late 2009, BGE intents to seek rate increases as permitted under the March 2008 settlement between Constellation, BGE and Maryland's political and regulatory leaders. This would likely be effective in 2010 and it would be our first electric rate increase since 1992. The increase is captive 5%.
Turning to slide 35. This chart presents our generation earnings outlook without taking into effect the impact of the joint venture. The chart provides an update on how changes in market forward prices and hedging activity effect generation EBITDA. For 2009, generation is forecasting un-hedged EBITDA of $1.4 billion, netting the hedging impact of approximately negative $400 million hedged EBITDA forecast to be about $1 billion.
The current hedged EBITDA forecast for generation is $1.2 billion in 2012. As you can see at the bottom of the chart we are maintaining high annual hedged percentages over the next two years in an effort to insulate cash flow and earnings from declining commodity prices.
Turning to slide 36. The customer supply group is focused on appropriately pricing risk, reducing capital needs and earning appropriate returns on capital. We are underwriting new business in a fashion that passes through the increased cost of physical and credit intermediation risk to our customers and it enables us to earn an appropriate return on our invested capital. Further, we will continually review our credit policies and adjust for current economic conditions. These actions include requiring deposits from new retail customers that do not meet pre-existing credit conditions. By focusing retail power growth in markets where we already own working contracts for generation. We expect to reduce the margin requirements in our business.
We will continue to pursue wholesale and mid-marketing transactions that are collateral efficient. In addition, we plan to finalize a gas supply agreement with Macquarie Cook Energy which will free up approximately $450 million at today's prices associated with the retail gas business. This is an important component of the $1 billion of collateral return previously discussed.
From a cost perspective in 2008 we streamlined this business and reduced the operating cost. These efforts will continue in 2009 as we work to leverage scale and standardized processes and products to further improve efficiency and profitability.
Turning to slide 37. As Mayo discussed Constellation has repurposed and fundamentally changed the commodities groups objectives. We expect structured products backlog to contribute $156 million of gross margin in 2009. While we are resizing the scope and scale of this business, we continue to believe that the intellectual capital embedded in this organization provides Constellation with adorable competitive advantage in our cyclical commodity intensive business.
In addition to serving as the risk clearing house for all commercial activities commodities groups results will continue to incorporate the expected results of deploying small amounts of risk capital for our proprietary trading and investment purposes. We expect our portfolio management and trading group to realize $18 million of gross margin from portfolio management and trading in 2009. This is a significant reduction from our 2008 business plan level of $392 million.
Importantly, the same team that has successfully reduced and flattened the trading portfolio will be charged with deploying perspective speculative risks capital. While we have divested substantial aspects of our commodities business, we have retained certain aspects that we will continue to look to exit. This include certain upstream gas properties and our shipping joint-venture with the Restis Group as well as gas transport positions within our physical gas marketing business. These retained investments will have minimal impact on our 2009 earnings.
Turning to slide 38. In 2009 capital spending is expected to decrease by approximately $400 million to $1.8 billion, primarily related to reduced major environmental and generation spent in the Merchant segment.
In 2010, capital spending is forecasted to be $1.5 billion. The decline is due to the completion of major environment projects and the Hillabee power plant. This is partially offset by spending on BGE's Smart Energy Savers initiatives, including advance metering in the main response. After the close of the nuclear joint-venture with EDF.
Approximately $400 million to $500 million of annual capital spend will move to the joint-venture. Additional new growth investment will be considered on a case-by-case basis as opportunities are identified and available and projected liquidity permits investing.
Turning to slide 39. Our projections for 2009 in the associated balance sheet in credit metrics are shown here adjusted for the joint-venture with EDF. Going forward, we expect our businesses to generate significant excess cash flow after dividends, allowing us to de-leverage and strengthen our balance sheet.
Our projected 2009 credit metrics are driven primarily by a substantial reduction in leverage and improvements in FFO. In addition to the January 2009 repayments of the $1 billion MidAmerican note, we expect to retire $500 million of debt in September.
The $1 billion EDF preferred security and up to $1 billion of incremental debt by year end, we expect FFO to improve in 2009 from the realization of previously originated mark-to-market contracts.
2009 debt to adjusted total capital including imputed debt is expected to be 42% to 46% and in the 29% to 33% range excluding imputed debt. In addition to plan debt reductions in 2009, Constellation's debt to adjusted total capital ratio will also benefit from a gain on the sale of 49.99% of the nuclear joint-venture.
Turning to slide 40, we expect to increase cash by approximately $1.2 billion in 2009. The largest driver is the sale of 49.99% of our nuclear business to EDF, which is expected to result in an after tax cash inflow of over $2.1 billion after repayment of the EDF preferred. We are forecasting in operating cash inflow for the year of approximately $2 billion after accounting for the joint-venture. The biggest drivers of the consolidated operating cash flow are the expected current year net income and mark-to-market contract realizations.
Investing cash flows for the year are forecasted to be approximately $2.4 billion driven by the $3.1 billion of after tax proceeds related to the nuclear asset sale to EDF, and the release of $1 billion of restricted cash to payoff the MidAmerican note. Offset in part by capital spending of approximately $1.7 billion.
Financing cash flows are forecasted to use approximately $3.2 billion as the company repays debt over the course of the year. Payments to EDF and MidAmerican combined with scheduled retirement of $500 million note as well as the voluntary retirement of another $1 billion are the primary drivers.
Financing cash flows in 2009, receive a benefit as compared to 2008, when the reduction of the dividend from $1.91 per share to $0.96. The annual estimated savings of this reduction is approximately $190 million.
Turning to slide 41. Let me close by taking a moment to talk about 2009 and beyond guidance. For 2009 as previously discussed, we expect earnings per share to be in the range of $2.90 to $3.20 per share.
For 2010, we are expecting earnings per share to be in the range of $3.05 to $3.45 per share. As we continue to finalize our joint-venture structure with the EDF, we will update you and revise our guidance as necessary.
As currently hedged in 2011 and beyond Constellation's earnings are increasing dark spreads and heat rates. We show our exposures in the right side of the slide, in 2012 with PPA's roll off, we are increasingly sensitive to power prices.
With that I will turn the call back over to Mayo for concluding comments.
Great. Thank you, Jack. Before turning it over for questions, let me take a moment to summarize the investment pieces in Constellation. First although 2009 will be a transitional year for us, beginning in 2010 and beyond we have a very attractive fleet of low cost environmentally advantaged generating assets, located primarily in PJM in New York.
As we moved forward, the profitability of this fleet is expected to increase as we see many of the
As we move forward the profitability of this fleet is expected to increase as we see many of the below marker hedges roll off, potentially accelerated in the near-term by hedges that maybe allocated to the joint-venture with EDF.
Second, is our regulated utility, the Maryland PSC is committed to the implementation of efficiency in conservation projects as well as improving system reliability. We will work with the commission to move these initiatives forward and will deploy incremental capital provided that the returns support the investment.
Third is our retail and wholesale businesses. We will be moving towards smaller, higher return business sides relative to own and contracted physical generation. Although this new strategy will decrease our overall volumes, we will continue to include our cost of capital and the price we offer to customers.
What you will see is an overall reduction in the capital needed to support this business and much higher returns. Finally, we have made the management changes, we feel were needed to help drive our new strategy and strengthen our company going forward.
We will be adjusting our reporting framework, so that our reporting is more closely aligned to our activity. This will lead to greater transparency and will make us more accountable to you as you will now have a better and clear understanding of we manage each of our businesses.
So finally, I would like to add that over the past year it was nearly impossible to be a business leader anywhere in America without feeling humble, and I feel that sense of humility very much myself.
As CEO, I take full responsibility for what has occurred in Constellation and for the steps we have taken and will take as we weather this storm. At my request and with the consent of the Constellation's board of directors, I'm forgoing any bonus for 2008. Please take this as a modest, but firm signal that I will do all that I can do to help steer this great company back to health with renewed growth.
We have made some significant strides in the past five months. But as we have discussed today, much remains to accomplish. With this leadership team, we have reaffirmed the foundation of discipline, execution and accountability.
I believe we are on the right path, even given this current economic environment I am also admittedly optimistic that we have a workable solution to our balance sheet issues that we have a strong international strategic partner that we have strategically important businesses with committed employees and that we have to means to earn back your trust and to earn to right to grow. We are determine to make progress on that path everyday.
And now we will be happy to answer your questions.
Question -and-Answer Session
Thank you. We are now ready to begin the question-and-answer session. (Operator Instructions). Our first question comes from Greg Gordon with Citi.
Greg Gordon - Citi
Thanks, good morning.
Good morning, Greg.
Greg Gordon - Citi
Looking at the disclosure on slide 35, which is the generation earnings outlook EDF JV, you have broken out to hedges between PPA/RSAs and other hedges. So when I think about the $700 million of present value of hedges that are going into the JV, those are the some total of both of those lines, correct?
Some portion of both of those is going into the JV, a 100% of the PPA/RSAs and some percentage of the other hedges, is that the right interpretation?
No, Greg, This is Jack. The PPAs and the RSAs associated with our Nine Mile in Gannett plants convey to the convey to JV in an effort to address hedges against Calvert Cliffs in the transaction given the timeframe in which we were negotiating with EDF rather than identify specific hedges what we agreed to was a contractual value.
The $700 million of underwater hedges that will convey is incremental to those PPAs and RSAs, and we're working with our partner EDF to negotiate, which other hedges we will put out of our portfolio and allocate to the joint-venture prior to confirmation of the transaction.
Greg Gordon - Citi
Okay, so the $700 million is incremental to the PPAs and RSA line item that goes on a pro rata basis with the JV right?
Greg Gordon - Citi
And so some portion of that under hedge line will essentially be also transferred to the JV, is that the right interpretation.
I would say the $700 million could take many forms.
Greg Gordon - Citi
One form it could be conveyed is to convey these underwater positions to the joint-venture, but we will be working through that over the balance of the next six months or so to identify the form and fashion that $700 million will take.
Greg Gordon - Citi
Is it possible that that take the form of some kind of payment in lieu? In other words.
I think it’s fair to say that they could take many forms, but what is contractually committed is the $700 million present value at a 10% discount rate.
Greg Gordon - Citi
Okay, thanks. My second question is indirectly concerning with, I'm sure there will be plenty of people who don't want to dig into on the Q&A, but my question is what's going on Baltimore, in the legislature in Maryland vis-à-vis, the potential for new regulations that would allow the Maryland PSC to have further regulatory over side this merger, how do you handicap those prospects and how much of a delay would that generate. And my main concern there being how it impacts your liquidity to close?
Greg, this is Mayo. There is some proposed legislation. Obviously the session is sort of in midstream. We are working with all the constituencies in Maryland at this point including the legislation, the administration and the commission to sort of ascertain, what is best process for closing the transaction? And I think as you probably read our position has been that we are going to be completely cooperative with the PSC. We have anticipated their review; we are cooperating with their review.
The litmus test associated with a transaction of this type, we believe has to do with whether pay another party such as EDF has any influence over the activities and policies of BGE. We believe that the commission has all the authority to order any protections that are required in that respect. Those might go along the lines of ring-fencing as an example. So what we are attempting to do in our discussions and hopefully working in collaboration with all the parties that are interested in this transaction and its outcome is to make sure that PSE does conduct the appropriate review and does in fact issue orders of which we have complete intention of complying with providing their reasonable.
And so I do expect in next several weeks, we will call less around solutions in that respect, so hopefully that will mean that we don't require any sort of legislative action, but expect that the next several weeks and during this session we will reach the resolution to how that’s going to proceed.
Greg Gordon - Citi
Thank you, Mayo.
Thank you our next question comes from John Kiani with Deutsche Bank.
John Kiani - Deutsche Bank
Good morning, John.
John Kiani - Deutsche Bank
I was comparing slide 60 in your presentation to your third quarter 10-Q, can you explain why the size of the trading book increased from what looks like about $35 billion aside in the third quarter 10-Q to about $50 billion aside in today's presentation, and what the fall in commodity price environment, and I guess also it looks like the net fair value of the disclosure of the book decreased by about $270 million from the third quarter 10-Q to today.
Sure, John. This is Jack. I think it's important to note that we did see a number of significant changes throughout the year related to commodity prices, and perhaps a bit of historical context as you might recall during the second quarter when commodity prices were at their height, we saw a gross derivative assets scale that was approximating $80 billion.
During the third quarter as prices came down, the overall relationship of both our, and I think it's important to note, we have a highly hedged portfolio. The relationship relative to those price declines caused our overall derivative assets and liabilities to shrink.
During the fourth quarter as you have seen prices declined further this has had the impact of relative to our increased hedge level of increasing both the derivative assets and liabilities to $50 billion on a net basis, obviously we believe this to be prudent economic and manageable risk and we have the appropriate liquidity. And we are tracking the collateral requirements of the respective assets and liability hedges in such a fashion that we are appropriately addressing it.
John Kiani - Deutsche Bank
So, sorry Jack, I am little confused. Are you saying that because you layered on additional hedges for the book the overall size of the book actually grew by this $15 billion even net of commodity prices falling, is that everything?
I don’t think you should say net of, I think commodity prices falling dramatically as what. If you think about the dramatic high and low between Q2 and Q4.
John Kiani - Deutsche Bank
Yeah, I am looking Q3 to Q4.
No, I understand but I think you need to understand the relationship between the nature of our hedged book. So in Q2 as prices were dramatically higher the fact that we were hedged because our gross derivative positions to take on significant scale. As those prices return to more historic levels. In Q3 we saw the size of that gross derivative position decline. As prices have declined significantly during the fourth quarter since then you in fact had inversion of assets and liabilities and that decline in prices has caused our gross derivative position to go up relative to Q3.
This has been further influenced by incremental hedges that we put on during the third quarter in order to insolate us from what we perceive to be a rapidly declining price environment.
John Kiani - Deutsche Bank
Okay. And then on slide 31, where you projected your net available liquidity, is there, are you assuming any tax payments or tax leakage on the $700 million of below market hedges, that you are transferring in the pro-forma cash or liquidity forecast?
I would say that the $700 million can separate really from this result. We are not assuming any tax leakage associated with that, but importantly we are not assuming any tax benefit from tax optimization structures that we might that we are working with EDF to put in place, we are assuming that the lease tax efficient structure for consideration here.
John Kiani - Deutsche Bank
Okay. Thanks for that. Then finally on slide 71, I was trying to understand just kind of going forward the composition of earnings in the merchant business and I know you had discussed some of the ratcheting back obviously in the substantial decrease in the activities of commodities, origination, marketing and trading efforts and what not. On slide 71 at least for '09 it looks like roughly $900 million of gross margin is coming from global commodities and customer supply and then if I adjust the generation for on a pro-forma basis to 49% JV, to me it looks like roughly 50% of gross margin comes from commodities customer supply global commodities origination and those activities. Is that the correct way to think about it going forward?
I would say that one you need to consider the $700 million of underwater hedges that will be conveyed. I think it's important to note that with the PPAs associated with our nuclear assets. We are currently selling power from Nine Mile and unit one and two at roughly $34 per megawatt hour. We are selling power from [Ganet] at $44 per megawatt hour. Now Nine Mile 1 rolls off in '09 and Nine Mile 2 rolls off in 2011 but then there is a revenue sharing agreement where above $44 the former owners of that get 80% of the upside. So the earnings power associated with and [Ganet] PPA is in place through 2014.
I would say the earnings power associated with those assets is modest I think the exposure to power prices is largely related to Nine Mile 1 and Covert. We have seen power prices come off dramatically. And so I think that the relative earnings mix between customer and supply should orient the business mix far more towards generation than towards customer supply. And as we have discussed commodities, this 272 in 2009 is primarily driven by backlog realization.
So I think in the end generation will be about 60% of merchant earnings and customer supply will be roughly 40%.
John Kiani - Deutsche Bank
Okay, thank you.
Thank you. Our next question comes from David Frank with Caterpillar Capital.
David Frank - Caterpillar Capital
Yeah. Hi, good morning.
Good morning, David.
David Frank - Caterpillar Capital
I guess, if you go back to the transaction with EDF and as point regarding the transfer of the $700 million of value, I mean, if I was to dump this down. You are basically taking underwater contracts, you are putting them to a JV and you are pushing half of the underwater uneconomic value to EDF and is this what helps increase or provide growth for 2010?
In calculating 2010's growth, we have allocated a portion of that $700 million of underwater hedges to 2010.
David Frank - Caterpillar Capital
So, this is, I guess, I'm just wondering because your stock is clearly sending the signals that investors either do not believe or do not trust some of this data or maybe the data is not flushed out enough so. I'm really just trying to get some of the drivers to that '10 if, why is your stock trading at less than seven times 2010 earnings right now? And what other aspects is, what other drivers are there for 2010 for your company that's going to provide for growth versus '09 besides this $700 million of contracts? Or is that the big driver?
I would say David, I certainly can't comment on why our or where our stock is trading. What I will say is we can, in terms of growth drivers as you will recall, we have had the impact of significantly underwater hedges muting our earnings throughout the 2010 '11 period. Historically, in previous business plans, commodities group was ineffective bridge to the roll off of those underwater hedges in this transaction in negotiating the $700 million of underwater value which could take the form of hedges going to the joint venture of which $350 million will be worn by EDF.
We have allocated a portion of, a deadly portion of those underwater hedges to 2010 in part because that's when a significant amount of the underwater mess is in our hedge book. So I would say that our earnings growth is driven primarily by in affect the same story that we have been discussing before the roll off of underwater hedges. And prospectively in 2010 and beyond we like many power companies will be recently exposed to dark spreads, feed rates and power prices as you move further out. And I think that’s an active choice by this management team to insulate ourselves in '09 and '10 where we see increasing declines in power prices. But preserve the potential for future upside in '11 and beyond.
This is Mayo, I am not gone talk specifically by value but obviously we have tried to stir everyone since the announcement of transaction towards this call recognizing that there is awful lot of information in this presentation with respect to how the transaction worked and how the $700 million worked and I think probably more importantly, that the positive status of our liquidity and our own general confidence with respect to how we are managing the optimization portfolio in the commodities area. So I think with greater clarity on how those things are going. Probably the most important point as Jack alluded to is, what is our sensitivity to price on the upside from the fleet overtime.
And I think that there is some positive implications to that so I completely recognize that the relative out of us since the EDF transaction really was required on our part after two very complicated transactions we wanted to get the information right. We also wanted to convey sort of some more important elements of our liquidity status and our trading activities that you would all have to be comfortable through this disclosure today as to where things stand.
David Frank - Caterpillar Capital
Right so I understand that these contracts that were dragging down your earnings and as they go to market you get growth in earnings. So you are putting this amount as the JV now I guess common sense would indicate when those underwater contracts or whatever it is that $700 million of uneconomic value you are putting there. When those expire and go to market there should be another list at some point in future. So I guess my question to you is, at what point on an average do those uneconomic contracts that you are putting to these JV expire. So that we could then look out for some point in the future and say yes they are getting helped by a lift in '10 but then they roll-off in '11 we should get another benefit or '12 or whatever the year is?
David and I do think it’s important to note this $700 million of conveyed value could take many forms but if we are to discuss it in terms of hedges the bulk of our underwater positions or hedges put on during the lower power price periods roll-off in 2011.
David Frank - Caterpillar Capital
It’s fundamentally a smoothing effect and I think it’s also important to note we do believe that the same reserve margin consideration that drove power prices higher in 2008. They are going to be as relevant as we moved through this economic cycle and the opportunity as you layer our carbon and other environmental aspects we believe we are well positioned.
David Frank - Caterpillar Capital
Okay. All right. I know it's very complicated. Thank you for your time.
Thank you. Our final question comes from Paul Patterson with Glenrock Associates.
Paul Patterson - Glenrock Associates
Good morning, guys.
Good morning, Paul.
Paul Patterson - Glenrock Associates
The as realized and as priced things that you are going to do enhance transparency, could you just tells us what as price means? I mean just the little more clarity what's you are planning to doing there?
So, Paul, as you may recall in 2008 we transitioned to--
With a new reporting structure.
Reporting our customer supply business on an as priced margin basis and then the risk embedded with the positive or negative side of that equation was then in effect transferred and owned by our portfolio management and trading organization within commodities group. Historically, we have been able to create value through optimizing portfolios and that organization due to very effective job of doing so and managing through difficult risk such as what we saw in Texas this summer.
Prospectively, what we will be doing is roughly providing that same level of portfolio management expertise and managing to in effect a range of distribution to the business that we sell on as priced basis to try and drive to an as realized margin that is at that level of as priced business or better. But recognizing that as you, we will reduce the level of distribution that we might see because as you try and expand that distribution it obviously have base with it increased risk.
So I think prospectively the as realized should allow you to, should allow us to demonstrate and for you to see how well we are managing the physical and credit risk embedded within the business.
Paul Patterson - Glenrock Associates
Okay on slide 72 the amortization of contract, is that…
I didn't 72?
Paul Patterson - Glenrock Associates
Yes on slide 72 the energy contract amortization I think it's off the depreciation does that flow through the income statement as well and as that in guidance.
Paul Patterson - Glenrock Associates
Okay and then just finally in terms of the, in terms of the just David Frank's question on the $700 million is this, you guys are not, how much of that I guess is in 2010. I wasn’t clear on that, is there a specific number or is that sort of their, some sort of legal room around that in terms of how that's driving 2010.
That status to be determined, but you can expect that the majority would be in 2010 and 11.
Paul Patterson - Glenrock Associates
Okay thanks a lot.
Thank you all very much. And we will look forward to talking to you in the next quarter. Thank you.
This does conclude today's conference. You may disconnect at this time. Thank you.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: firstname.lastname@example.org. Thank you!