Exelon Corp. (NYSE:EXC)
Q3 2009 Earnings Call
October 23, 2009; 11:00 am ET
John Rowe - Chairman & Chief Executive Officer
Matthew Hilzinger - Senior Vice President & Chief Financial Officer
Chris Crane - President & Chief Operating Officer
Ken Cornew - Senior Vice President
Anne Pramaggiore - Vice President of Regulatory & Strategic Services
Denis O’Brien - Executive Vice President, President & Chief Executive Officer of PECO
Tom Terry - Vice President & General Tax Officer
Karie Anderson - Vice President of Investor Relations
Hugh Wynne - Sanford Bernstein
Jonathan Arnold - Deutsche Bank
Daniel Eggers - Credit Suisse
Nathan Judge - Atlantic Equities
Paul Ridzon - KeyBanc
Welcome to the Exelon third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. (Operator Instructions)
I’d now like to turn the conference over to Karie Anderson, Vice President of Investor Relations. Please go ahead.
Thank you, Beverley. Good morning, welcome to Exelon’s third quarter 2009 earnings review and conference call update. Thank you for joining us today. We issued our earnings release this morning; if you haven’t received that the release is available on the Exelon website at www.exeloncorp.com or you can call Dolores Munguia at 312-394-5222 and she will fax or email the release to you.
Before we begin today’s discussion let me remind you that the earnings release and other matters we discuss on today’s call contain forward-looking statements and estimates that are subject to various risks and uncertainty, as well as adjusted non-GAAP operating earnings.
Please refer to today’s 8-K or other filings for discussions of factors that may cause results to differ from management’s projections, forecasts and expectations and for a reconciliation of operating to GAAP earnings.
Leading the call today are John Rowe, Exelon’s Chairman and Chief Executive Officer; and Matthew Hilzinger, Exelon’s Senior Vice President and Chief Financial Officer. They are joined by other members of Exelon’s Senior Management Team’s who will be available to answer your questions. We have scheduled 60 minutes for this call.
I will now turn the call over to John Rowe, Exelon’s CEO.
Thank you, Karie. Good morning everyone. My key messages for today are on slide three of your materials, but first, we are achieving our financial commitments despite difficult weather, difficult economic and difficult marketing conditions. We again delivered excellent generation and utility performance through the summer months. We have increased our financial flexibility by using tools given by the improving capital markets and also by Federal pension legislation.
The Illinois legislature passed the bad debt rider for ComEd, which is now awaiting Illinois Commerce Commission implementation. Our utilities unveiled Smart Grid plans totaling $1 million of potential investment and have filed applications for Federal stimulus dollars for part of those funds. In Washington we continue to be very active in the push for climate change legislation.
Now let me turn to our financial and operating results for the quarter. We reported operating earnings of $0.96 per share for the quarter. That is in the upper half of our guidance range of $0.90 to $1 per share. We achieved this in spite of $0.07 per share of unfavorable weather conditions at ComEd and PECO during the third quarter as compared to our normal weather assumption. The generation fleet performed well with a capacity factor of 94.7% in the nuclear fleet for the quarter.
Our fossil fleet had the highest year-to-date commercial availability factor that it has at 94.1%, this is the highest since we started tracking in 2005. The hedges we entered into in prior years when markets were better again proved effective at Exelon Generation, with average realized energy margins only 1% lower quarter-over-quarter despite, spot prices being 60% and 50% lower at PJM-West hub and Ni-Hub.
Our delivery companies continue to execute with ComEd delivering the best year-to-date results in its recorded history for both outage duration and outage frequency. PECO’s separate reliability performance was also the best on record and we delivered on our committed to cost savings across all our operating companies. I am very, very proud of our management for doing everything they could on both the performance and cost side to help us deal with the weather and market conditions that we faced.
Turning to the full year, we believe we can achieve 2009 operating earnings within our guidance range, albeit near the lower end of that range. We believe we can do this in spite of the substantial magnitude of the challenge we faced. Unfavorable weather and lower load conditions which reduced our year-to-date reported earnings by $0.18 per share versus our original assumptions.
Pension and OPEB costs increased $0.11 per share due to a drop in year end entrance rates after we issued our 2009 earnings guidance last November. Last, but by no means least, we had faced spot power prices during the first nine months that were about 50% lower than our original planning assumptions. We have coped with these challenges through a relentless focus on cost and I’m particularly grateful to our COO, Chris Crane, for leading that effort. He has not only met the assignments we have given him, he has exceeded them.
Over the course of the third quarter, we identified approximately $100 million of additional one-time opportunities to reduce 2009 costs. That allows us to stay within our guidance range for the year. At the present time, we believe our operating earnings for 2009 will be within a range of $4 to $4.10 per share. We will, of course, continue to work on a whole lot of other ways to deliver results.
During the course of this year, we increased our forecasted cash flows from operations by $850 million over our original assumptions, largely due to changes in the tax laws and tax planning. We have improved our financial flexibility by making a $350 million discretionary pension contribution and refinancing the $1.2 billion of debt at favorable rates. Matt will discuss those shortly.
Let me now comment just a bit on energy markets. The results of last Monday’s second auction for PECO’s residential and small C&I load were released on Wednesday. Wholesale prices for PECO’s residential and commercial products were $79.96 per megawatt hour and $85.85 per megawatt hour. The combination of these first two procurements suggest the rate increase from generation of only about 4% for PECO’s residential customers. Again, this shows that competitive markets are working in Pennsylvania.
In September, the Illinois Power Agency filed its plan for ComEd’s next procurement with the Commerce Commission. The IPA will continue to procure block energy products for a three year period, which our base load nuclear fleet in the Midwest is ideally suited to serve.
We are pleased that FirstEnergy has announced that it is planning to join PJM. This illustrates that PJM remains the premier wholesale market in the Northeast. We believe that First Energy’s joining PJM will create further operating efficiencies within that market.
Now we’re working, as always, on strengthening our regulatory and financial position at both ComEd and PECO. PECO is on track to deliver a return on equity in excess of 11% in 2009. We believe ComEd will have recovered its returns to approximately 8% and thanks to Frank Clark, Anne Pramaggiore and Darryl Bradford, we believe ComEd is on track to achieve a return of nearly 10% in 2010.
As you all know, that’s a substantial recovery at ComEd. This reflects the benefit of ComEd’s cost reductions and its increased use of riders to meet ROE targets. In the third quarter the Illinois legislature enacted a bad debt rider that will provide ComEd with more timely recovery of its bad debt costs. We expect to receive a commission decision on implementing that rider in the first quarter of 2010.
Last week the commission approved ComEd’s request for recovery of ComEd’s Smart Meter Pilot Program. ComEd’s success in both cost reductions and using riders for specific expenditures has allowed it to defer a full rate case filing until 2010. I believe this will ultimately be in ComEd’s benefit and Exelon’s benefit.
In the third quarter both ComEd and PECO made filings for Smart Grid investments totaling over $1 billion and they included applications for Federal stimulus dollars totaling $375 million. A very large portion of the utilities in the country have filed stimulus requests and we do not yet know who will be successful or how DOE will implement dealing with these requests.
Legislators, commissioners and community groups have all worked with us to support these requests. I believe that the Smart Grid requests not only have a high likelihood of regulatory recovery, but I also believe they help our overall regulatory programs because our commissioners believe these are positive and productive efforts to give customers more control over their own usage.
We have one bit of particular good news on the Generation front, and that is that the Nuclear Regulatory Commission approved the relicensing of our Three Mile Island Nuclear Unit this week. That license will be extended through 2034. I would also urge you to pay attention to one bit of news affecting another company. As you all know, our Q’s and K’s for many years have reported substantial tax issues involving the like kind exchanges that we entered into some years back and up until now there have been I think two court cases, which have affirmed the IRS position on particular facts.
Within the last week there as been a case involving consolidated Edison which makes very clear that these are fact based cases and since we believe we have good tracks we believe that helps both our potential litigating position and our negotiating position with the IRS. That said, this remains an area of substantial attention for the company, but it’s a nice to have a little good news on that front.
Now I want to close with a few more words on climate legislation. As you all know, Exelon identified the climate challenge as something to pay attention to from both a management point of view and a legislative point of view a long time ago. Climate change was one of the factors we took into account when we sold the ComEd fossil plant a decade ago.
Climate change is the reason we put together our Exelon 20:20 plan to neutralize our carbon footprint. I started working with the National Commission on Energy Policy on ways of dealing with climate change at least seven years ago, and we believe that climate change legislation is coming ever closer to passing.
Betsy Moler and I work with the Edison Electric Institute with USCAP and others to try to develop a cap and trade system in a format that the Senate will adopt. We are absolutely convinced that cap and trade legislation is the way to deal with climate that offers the best chance of keeping costs down for our customers and creating an earnings opportunity for our shareholders.
We worked on getting it through the House when the bill was pending in the House. We are now working with individual senators from both parties. We all are working with other like-minded corporations in various states while the news seems to change almost every week on climate, I think the most recent news is very positive.
About 10 to 12 days ago Senators Kerry and Graham, senator Graham being a Republican from South Carolina, senator Kerry being a Democrat from Massachusetts and a co-sponsor of the Boxer-Kerry Bill, indicated their willingness to work together on a bipartisan cap and trade program.
I think this suggest that the matter is not quite as polarized in the Senate as some feared it would be. We look forward to working with Chairman Boxer, with senator Kerry, with senator Graham, with our own senators, and with any of the senators who have an interest in finding a cost effective solution to the climate challenge, and I have been personally spending a great deal of time on this and Betsy Moler is probably spending 80% of her time on this.
We’re doing everything we can to try to see that it’s set up to pass when the Senate is ready to take up the matter. There’s been a great deal of common effort in this regard and I think we’re seeing some real progress again. In the same time, we’re very proud of what’s going on within Exelon itself on climate.
We are one-third of the way along the road to meeting our emission reduction goal; you can see that in Exelon 2020, which is posted on our website. We have used the Exelon 2020 framework to evaluate the cost of different ways of reducing CO2 and other greenhouse gases in terms of dollars per ton of avoided CO2 and we continue to make real progress.
Exelon 2020 has gone from being a directional vector for a real plan on how to meet power supply needs within our territories in a low carbon way. For the fourth year in a row, Exelon was named to the Dow Jones Sustainability Index and we continue to be a leader in dealing with this problem and especially a leader in dealing with it in a way that’s good for both our customers and our shareholders.
I’ll now turn this over to Matt.
Thank you, John, and good morning, everyone. As John mentioned, Exelon produced results consistent with our expectations for the quarter despite historically cool weather at both utilities and the continued impacts of the economy on our business. I’ve highlighted my key messages for this morning on slide four.
Moving to slide five, we reported operating earnings of $0.96 per share in the third quarter of 2009 compared to $1.07 in the third quarter of 2008. Our results reflect higher earnings at ComEd offset by reduced earnings at Exelon generation with PECO holding flat.
Turning to Exelon Generation on slide six, Generation’s results were $0.16 per share lower quarter-over-quarter driven by portfolio and market conditions as depressed power prices continue to be seen across all regions. We saw a $0.06 per share decline in market conditions with $0.03 per share coming from our South Region portfolio due to declines in natural gas prices and spark spreads. We also saw $0.04 of unfavorability in rate around fuel related to higher nuclear fuel cost and lower nuclear volumes.
Yet despite increases in pension and OPEB expenses Generation held O&M flat in the third quarter compared to the prior year and is on track to meet its increased goal for the full year O&M cost savings. As you can see on slide seven, our 2009 hedged amounts of 98% to 100% reflect a fully hedged position for us as we always leave a small amount of operational length to address unplanned outages in the fleet.
Our ratable hedging program has an enabled us to realize revenue in our portfolio at significantly higher levels than spot market prices, because we are on a 36 month ratable plan we locked in the large majority of our 2009 sales in 2007 and 2008, which has resulted in our delivering stable cash flows with little expected variance despite declines in power prices since this time last year.
Looking forward to 2010, we continue to execute on our ratable plan and are now hedged right around 90%, consistent with our goal of being around 95% hedged as we move into the next delivery year. The 2010 overall expected Generation hedged of 88% to 91% has not changed significantly since the second quarter. In the Midwest region we are a bit ahead of a purely ratable plan as we continue to execute retail and wholesale sales to meet year end hedge.
In the Mid-Atlantic region we are seeing slight reductions in load estimates on full requirement products resulting from switching in the commercial and industrial customer classes both in Pennsylvania as some utilities begin to transition to market rates and in New Jersey in the BGS auction. We are also seeing some reduction in demand in the Mid-Atlantic as a result of the recession.
These factors were generally offset by incremental sales during the third quarter. In our South region we have seen some reductions in expected Generation because lower market implied heat rates in ERCOT are resulting in lower dispatch levels for our combined cycle units. Our South region portfolio is much smaller than the Midwest and Mid-Atlantic, so relatively small changes tend to have a large impact on the percentage of expected Generation hedged.
For 2011 we are now hedged at 63% to 66% on a total portfolio basis with many of the same trends I described in 2010 also coming through in 2011, except in the Midwest region where Generation’s 3000 mega watt financial swap with ComEd keeps it a bit ahead of a purely ratable plan.
We continue to employ put options in our portfolio to manage risk on the downside and give us optionality on the upside as commodity prices recover. The bands of expected gross margin outcomes across all years continue to tighten and you’ll see by the calculations that we have provided in our disclosures that our 2009 expected gross margin is within about $5 million of where we stood at the time of our second quarter call.
Turning to slide eight, ComEd’s earnings increased $0.02 per share compared to earnings in the prior period last year primarily driven by $0.06 per share from higher electric distribution rates. ComEd continues to meet its cost management goals for the year, delivering O&M savings of $0.03 per share quarter-over-quarter despite higher pension and benefit costs.
ComEd was unfavorably impacted by $0.03 per share due to much cooler than normal weather in our traditional peak period this summer. We had the second coldest July in 118 years without a single day above 90 degrees compared to last year cooling degree days were down 34%.
On slide nine we provided an update of ComEd load trends, weather normalized load for the third quarter was down 3.8% over the third quarter last year contributing $0.01 per share of unfavorability to ComEd’s quarterly results. Load in the large commercial and industrial class was down 8.6%, but due to demand based rate design for these customers the revenue impact is not dollar-for-dollar and we saw only a 5.2% decline from the large C&I class in quarterly distribution revenues year-over-year excluding the impacts of the rate case.
We are modifying ComEd’s load forecast across all customer classes to be down 3.4% for the year versus our previous expectation for 2009 of negative 3.0%. For the fourth quarter, we expect to see a moderation in the rate of decline compared to the same period last year largely due to the fact that the impacts of the economic crisis were already being felt by the end of 2008.
Looking ahead, we are currently forecasting that we’ll begin to see some recovery in ComEd’s large C&I load around the middle of 2010 as production begins to rebound and we begin to see some modest growth in the Chicago Gross Metro Product. In the residential and small C&I segments, we see recovery over an extended period for ComEd.
We have 20,000 fewer customers on the system now versus a year ago and we are projecting lingering high unemployment and declining use per customer due to energy efficiency programs. As a result, we are currently forecasting load in the residential class to hold essentially flat in 2010.
Moving now to PECO on slide 10, cooler than normal weather costs is about $0.01 per share in earnings versus the third quarter last year. PECO is also controlling its cost, achieving a $0.04 per share reduction in bad debt expense through enhancements to its credit and collection processes of accounts receivables and holding the line on all other O&M costs.
Load declines continue to impact PECO as well, resulting in a reduction of $0.03 per share versus the third quarter last year. We’ve provided an update of PECO load trends on slide 11. For the full year 2009, we are projecting a decline in load of 2.7% across all customer classes versus our prior projection of negative 1.8%.
Residential load has declined 5.5% this quarter, compared to third quarter last year and we are forecasting a decline in residential load for the full year of about 2.5%. These declines are a result of both reductions in usage per customer, as well as a decline in the number of residential customers on the system, about 4,000 less customers than last year.
Unemployment in Philadelphia area is better than the national average at 8.5%, but represents the highest unemployment rate we’ve seen in the region since 1982. In the large C&I class, we are seeing the biggest negative impact from the manufacturing, petroleum and pharmaceutical segments and we are not forecasting much growth in the Philadelphia Gross Metro Product through 2010.
Looking forward to 2010 for PECO, we expect that PECO will have negative load next year of about 1.3%, principally due to the impacts of energy efficiency programs required by Act 129 in Pennsylvania, which begin next year. There’s no simple or exact answer to the question of when this recession will end.
As we mentioned last quarter, the large C&I reductions we’re seeing both at ComEd and PECO are more the result of shift reductions and not wholesale shutdowns of businesses. We see a reasonable possibility of a recovery in our service territories beginning in mid 2010 and our 2010 forecasted load growth reflects that, but we continue to monitor national and regional economic data closely to look for continued signs of stabilization.
Despite the continued declines in load, the unusually cool summer, and the continued pressures on power markets, we have generated overall results in our operating earnings consistent with expectations again this quarter, largely as a result of our cost reduction initiative.
Moving to slide 12, earlier this year, we announced that we were targeting $150 million in operational O&M savings for 2009. On our second quarter call we’ve reported that we had achieved $68 million of that amount. I’m very pleased to say that we have already met our target for the full year and we expect to achieve even more before the year is out.
We are on track to deliver about $100 million of additional onetime O&M reductions above the $150 million, we previously committed to. We’ve been able to achieve these onetime cuts by taking aggressive actions in such areas as contracting supply and controlling overtime spend.
As a result of our efforts we have offset a significant portion of unfavorability from weather load and market conditions that we have seen this year and particularly in the third quarter and you will now see that our new 2009 O&M target is $4.4 billion.
Along with our cost savings, we are also expecting to deliver increased cash from our operations for the full year of $5.6 billion, an increase of the $850 million over our original 2009 estimates. Increases in cash are driven by our achieved cost savings, changes in PJM billing practices and other one-time items such as bonus depreciation benefits under the economic stimulus plan and cash tax planning strategies. We are deploying that cash in a number of ways.
We continue to offer a stable annual dividend of $2.10 per share and we are beginning to invest in growth projects such as our Nuclear uprates, which offer returns in excess of our cost of capital and we have increased our financial flexibility going forward to a voluntary $350 million contribution to our pension plan in September, which I highlighted on slide 13.
Our voluntary contribution of $350 million during the third quarter accomplished three goals. First, we reduced our expected Pension Contributions in 2011 by $1 billion. Second, on a present value basis reduced our overall expected required contributions of the next 10 years by over $300 million. Third, we lowered the volatility of future required contributions.
We also achieved greater financial flexibility this quarter through our liability management efforts at Exelon Corp and Generation. Last month, we took advantage of strong capital markets by issuing $1.5 billion of Exelon Generation Senior Notes and purchasing approximately $1.5 billion of Corporate and Generation Senior Notes, which included about $300 million of tax exempt debt.
The result was a reduction in the cost of debt at Exelon Corp and Generation by approximately $12 million per year and an extension of the duration of a maturity profile by over six and a half years. Today, we expect to close on a $67 million 364 day credit facility with a group of 26 community and minority owned banks. We are very proud to put our commitment to diversity into action by supporting these businesses in our communities.
Finally, we are projecting an FFO to debt metric of 41% at Exelon Corp plus Generation for the year, which supports strong investment grade ratings and allows us to maintain flexibility in our liquidity requirements and have continued access to the capital markets. All three agencies now have stable outlooks at Exelon and Generation. During the third quarter S&P, upgraded ComEd’s senior secured debt to a [Myers] and Moody’s upgraded ComEd’s senior secured debt to be AA1.
In closing, we remain focused on delivering on the commitments we have made to you. We are also taking advantage of opportunities to improve our financial flexibility and create value as the market recovers. With that we’re ready to take your questions.
(Operator Instructions) Your first question comes from Hugh Wynne - Sanford Bernstein.
Hugh Wynne - Sanford Bernstein
You mentioned that, you expect cash from operations to rise by about $150 million to $5.6 billion, even though you are now contributing $350 million to your pension fund, implying that you’ve been able to increase cash generation of the business by something like $500 million. When I look at your financial coverage ratios, it seems to be having a materially positive impact.
Now, based on your cash flow statement, the improvement seems to derive from deferred income taxes, which are $740 million at the end of nine months as compared to about $150 million at the end of six months. My question then is, what have you been able to do on the tax front? Is this a benefit that’s going to reverse next year or can this cash be put in the bank? What should we expect on a going-forward basis?
Let me just start with overall where we are with cash, that the $850 million is against our original planning assumptions and guidance that we had given to the Street, so about $400 million of that is coming from the stimulus plan.
About $300 million of that is coming from some tax planning that Tom Terry and the tax groups have done around repairs deductions. This quarter we got a methodology change with the IRS around repairs reduction, that’s going to generate about $300 million this year. There’s a piece of that that will flow into next year and the remaining balance is really coming from some of the PJM changes that we get in working capital.
So that’s where the $850 million is coming from. You are seeing the deferred taxes change a little bit. It’s primarily around the manufacturer’s deduction that we see and the repairs allowance that we expect to get a benefit from. So the manufacturer’s deduction, I think next year is expected to increase and we may get a little bit of a benefit up and beyond where we are this year and the repairs deduction, as I said, is more onetime and we’ll get a little bit as we go into next year.
Hugh Wynne - Sanford Bernstein
Matt, can you try to the comment just quickly on the forward hedging program? It seems that your estimated open gross margin in 2011 is now about $400 million lower than you estimated at the end of Q1 and that has occurred despite a slight increase of $0.20 in the price of natural gas and it seems to reflect about a $2.50 reduction in ATC Energy prices at Ni-Hub and PJM West. My question is, do you see that compression and forward spark spreads as persisting? What impact, if any has that forward spark spread compassion had on your hedging?
Ken Cornew, is much better to answer that than, Matt, for me. Ken.
As you know, we study these prices in the Midwest and across our whole portfolio very carefully. I think your short and quick analysis is right. We’ve seen those estimated open gross margins fall as power prices have fallen. We have been able to take the opportunity to hedge, while that was occurring and add some value with our hedges and you can see and calculate that, when you get to the expected gross margin level.
Midwest power prices currently are somewhat depressed and our view is there is some upside in Midwest power prices relative to current forwards. Obviously, the prices are driven by gas and coal, future demand for electricity, new generation build such as wind build out and transmission constraints that we’ve been also following very carefully. When we analyze all those factors holistically, Hugh, we see that prices have upside, several dollars of upside in Midwest power prices.
We watch the Ni-Hub spread very carefully and if you looked at 2011 earlier in the year, those spreads were significant and they have contracted and we’ve seen some very recent contraction in those spreads, which is feeding into what I just talked about. I think the power prices are a little low and have some upside to them and we’re starting to see a little bit of that movement right now in these prices.
Your next question comes from Jonathan Arnold - Deutsche Bank.
Jonathan Arnold - Deutsche Bank
I wanted to ask another question on the open gross margin. Looking specifically at the Q3 disclosure on 2011 you’re showing a number that’s about $200 million lower than you showed at Q2 and in the reference prices that you give us are down less than $1 in terms of power and based on your own sensitivities that would kind of my math suggests explain about $50 million of the move in gross margin. So I’m just wondering what else is going on in that open gross margin number other than power price moves that would be significant?
Ken will follow up on that too, but just let me say we continue to make some sales and that’s part of the answer to the question. Ken, will you pick up?
Yes, Jonathan, as you know, the open gross margin is the implied margin of our portfolio completely unhedged, so $1 move in power price is a much larger move. We have 140,000 gigawatt-hours of nuclear power and incremental marginal power. So if you make a $1 move in price, you’re going to see a much bigger move in expected estimated open gross margin that our sensitivities are tailored toward the move in expected gross margin as a result of our hedging and hopefully I think that explains the difference.
Jonathan Arnold - Deutsche Bank
Then just one other thing, you talked about the $100 million of additional O&M savings; I think you characterized as being one-time items. Can you remind us or talk a little about how much of the $150 million of base savings you expect now to be sustainable versus one time?
The $150 million is sustainable, the additional $100 million that we found in the third quarter, as we said, is not. It’s around areas like, as we said, managing overtime. The utilities have done an excellent job over the summer, the weather has not hampered them to require them significant storm or heat related degradation. The rest of the savings is in a lot of different buckets, it’s materials, contracting, travel, entertainment, it’s significant belt tightening across the business.
Jonathan Arnold - Deutsche Bank
Is it fair to say that that will occur more in Q3 than in Q4 or that it was ratable?
We managed it more in three and reduced four’s budgets and baked those numbers in already. We’ll continue to look for our carriers and we believe that we’ll find some more, but this is the most substantial part we found thus far.
Your next question comes from Daniel Eggers - Credit Suisse.
Daniel Eggers - Credit Suisse
John, you’re talking about climate change legislation and where that’s headed. I was just kind of the knock-on effect of whether we see renewable energy policy along those lines, how you see those policies being married together? Then how you guys would expect renewable policy or greater growth in renewable capacity to affect your power markets?
First, we believe that, like in the House bill, the ultimate Senate package will include both cap and trade and a reasonable renewable package. My latest information supporting that comes from a meeting that U.S. cap folks had with Carol Browner, where she said unequivocally. The administration, does not want an energy only bill it wants an energy and climate bill. I believe that’s where the force is happening. So I’m a little less concerned than I once was that we might get the renewable provision without the cap and trade provision.
So I think that’s basically good news. Now obviously, we remain concerned that if renewable portfolio standards go too high the customer hurts, because they pay much too much for the renewables and we hurt because, the renewables depress the market and as far as we’re concerned that it’s not a good situation. I think that both in Illinois and Pennsylvania and at the Federal level, we’re going to keep those to reasonable levels. Anne Pramaggiore is here and she can spell out for you, if you want what the current Illinois standard is.
We thought the Waxman-Markey provisions were fairly reasonable on the Federal standard. Frankly, we’ll be just as happy to see a Federal standard, but Anne or Dennis, do want to add anything to that?
No, I would just say in Illinois we have a renewable portfolio standard, it came into play in the 2007 legislation. It starts out at 2% in 2008 and increases to 25% in 2025 and the, I think, helpful feature from a customer standpoint is, there is a cap on impact on customer rate and it cannot exceed 2% increase to the total rate. So that’s helpful, I think in terms of managing the customer impact, but also meeting the expectation that we bring some renewables into the portfolio.
In Pennsylvania the renewable legislation was passed in 2004, kicks in the first year that each company comes out of transition. PECO has already done some early compliance with that. We think that legislation makes a lot of sense. There’s another bill in the Legislature in Pennsylvania, House Bill 80, which increases those numbers. The Legislature in Pennsylvania is pretty worn out by the budget proposition and I’m not sure much else happened this session.
Daniel Eggers - Credit Suisse
I guess just one other question on the outlook for demand. Can you just run through the underlying economic assumptions behind the flattened or flattish and the negative demand growth trends you’re expecting and potential that you feel that is overly conservative versus a middle of the road set of assumptions for next year?
I think we’re pretty much consistent with nearly everybody else, which suggests that the economy has probably bottomed the recession. To quote Larry Summers and others technically ended, but we don’t see much recovery coming back very rapidly at all. In other words, we start to see some upward movement particularly at ComEd in the second half of next year, but we’re not talking about getting back to the kind of levels we were at in ‘07 and ‘08 for four or five years. Denis, Anne, do you want to add to that?
I’ll just add from a PECO perspective. 2010, we see a negative growth of 1.3%. If you take out the PECO energy efficiency estimates that are on top of that, the growth is about a negative 0.3%. So we’re seeing that our energy efficiency programs will kick in and add about a negative 1% on growth.
If you just strip out the energy efficiency affect for a second, the residential starts with some negative growth in the first half and gets better in the second half. The small C&I, follows the same trend and at this point we’re calling the large C&I flat for the year. We then put the negative 1% overlay for the energy efficiency program and that overlay is being put almost wholly on the residential class.
I would add just a couple points from the ComEd standpoint. Matt mentioned the structure of our large C&I rate, actually our C&I rates in general, being helpful to mitigate our exposure. We’ve got about 98% of our C&I rates either in the demand charge or a customer charge, so that’s very helpful to us. Frankly, our overall rate structure including residential is about 64% either in demand or a customer charge. So that’s helpful to us going forward.
Looking into 2010, I think in 2009 we’ve seen the large C&I class in particular. I think bring the trend line down and we see a little bit of a class shift and 2010, where the large C&I starts to comeback middle of the year and residential is probably taking a little bit more of a hit than we’ve seen in 2009.
We actually went out and surveyed our large C&I customers to try to get a sense of whether what we were seeing in the model was consistent with some anecdotal evidence and it seems to be fairly consistent in that some customers are indicating they’re bringing more load back next year. Some information and data sectors as well as some green energy sector. The green energy sector seems to be indicating that they’ll bring a little bit more load back on next year.
I think just a nutshell, what we’ve seen is that the PECO load has dropped less than the ComEd load, because they have less, really every industry, it also comeback a little more slowly. So that’s the best we can do, but what we’re seeing is very much what the general economic commentary you’ll see.
Your next question comes from Nathan Judge - Atlantic Equities.
Nathan Judge - Atlantic Equities
I just want to ask a few more questions on that hedging, please. If you look at the percentage of expected generation hedged in the Mid-Atlantic specifically, it hasn’t changed from the second quarter. Just considering that the PECO option happened, could you just comment if there is any change in strategy with regard to hedging in the Mid-Atlantic?
There has not been a basic change in strategy. We have reviewed very carefully our position on whether there should be a change in strategy. We think we can comply with our ratable hedging guidelines and still have plenty of upside left over for the future, but with that let me have Ken answer the more specific part of your question.
As you know, we’re modeling our portfolio and expected generation dispatch and expected volumes of sales coming from load following type contracts. In the Mid-Atlantic in particular, we’ve seen a couple things since the last hedge disclosure. We’ve seen higher generation expectations in the region and that would by itself tend to lower the percent hedged calculation.
Also we’re looking at load growth or lack of load growth that Denis just talked about, and switching assumptions for the load following type contracts we have in the region and we’ve made adjustments based on best information we have available there. That also will put downward pressure on the hedge percentage. That being said, we have incrementally hedged in the region to negate those and we’re still within a percentage as we disclosed.
No change in strategy, we continue to hedge as our strategy has dictated consistently. We did get somewhat ahead of ratable between the first and second disclosure and were afforded with downward price pressure the ability to take a little slower approach in the third quarter, which I think has been a very positive strategy for us, but largely we are staying on plan.
I have one question that Karie Anderson has received from a number of you on the phone over the last several days and just because it’s been asked one at a time I’d like to ask it so I’d like to her to ask it, so I can answer it and have it done. Karie?
John, the question I’ve received is, what are you thinking about M&A? There’s been some specific remarks in the press this week.
Well, the remarks in the press this week have been about Calpine. We have great respect for Calpine as a company, we think they have wonderful assets and we’ve looked at them many times in the past. We’ve never been able to put together a plan for a transaction that would make any sense, because it would violate our guidelines about dilution. Our position on M&A is very simple. Our eyes are always open, but we know that most of our shareholders are very reluctant to see us get into another transaction.
We deeply believe in our commitments to you that we don’t do them if they’re not going to be value added. We know you don’t want a lot of dilution. We have significant earnings challenges with the lower commodity markets and we’re focusing our attention on what we can do internally, particularly things like our Nuclear uprates starting, Ian’s Transmission Company and that sort of thing. So we’re very much internally focused and you know us well enough to know that our eyes are always open and our pocketbooks are usually closed.
Your final question comes from Paul Ridzon - KeyBanc.
Paul Ridzon - KeyBanc
John, you just answered my big question, but a follow-up is, the repair expensing versus capitalizing. Is that really all one-time or does that flow into future periods? I know Matt said, some could hit ‘10, but is there just an ongoing impact and what does that imply about rate base?
Regarding rate base, right now we’ve only claimed a benefit at the Generation Company, that’s the only place, which we’ve had the change in method approved. The biggest bit of the benefit will be in 2009, which is the year of the method change, but there will be an annual incremental benefit as we incur cost that are deductible rather than being capitalized.
The thing I would add is that the method change is in connection with the way that we do our taxes, not the way that we do our books. So the policy that we have around capital and expense remains what it’s been.
I wish to make very clear, based on 25 years of hard knocks. We make investments in our delivery customers because our companies need the investments, not because we want to build rate base. I mean rate base gets built easily enough and the issue is trying to manage your investments, so you have a high confidence in getting a return on them and that’s what we’re focused on there.
Paul Ridzon - KeyBanc
Are you looking at potentially doing something on the regulated side along the same tax strategy?
We’re continuing to evaluate that. The IRS is more directly open to considering the method change on the generation side. They’re clearer on the criteria for getting there, but we are continuing to look at the T&D side.
Paul Ridzon - KeyBanc
Then just on the biggest piece hitting ‘09 is that because we’re getting kind of a retroactive restatement of prior year tax positions?
Yes, it’s the catch up adjustment from the beginning of the Generation business in ‘01 through the end of ‘08.
Just to close. In the third quarter, we had a sick economy and rotten weather and we met our commitments to you. We’re hard at work doing that for the fourth quarter too. I believe we can do it. I’m terribly proud of what nuclear has done in the last quarter. Denis and Frank Clark are continuing to improve PECO and ComEd. They just get better all the time. The way that Ken Cornew and Ian McLean designed the hedging strategy three, four, five years ago has been paying off for you and for us.
The commodity cycle is at a low, we all know it’s a low. We’re in a hunkering down period, but we’re doing our best to continue to deliver value to you and we think both the operations and the assets continue to do that. So we will see you all at the November EEI financial conference. By that time, we’ll be able to do our best to give you an estimate on next year’s earnings.
As you all know, it’s going to be a little tougher, because we have had less hedged during that period when the times were better, but we’re hard at work on making our cost cuttings work and we’re continuing to look for internal ways to grow your earnings. So we are in the mine hard at work digging coal or uranium, or whatever it is that we dig and we’ll keep making money for you. Thanks a bunch.
Thank you, Beverly. That concludes our call.
Thank you. Ladies and gentlemen, this concludes today’s conference call. You may now disconnect.
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