PPL Corporation (NYSE:PPL)
Wolfe Research Power and Gas Leaders Conference Call
September 24, 2013 10:15 ET
Leo Denault - Chief Executive Officer, Entergy Corp.
Bill Spence - Chairman and Chief Executive Officer, PPL
Caroline Dorsa - Chief Financial Officer, Public Service Enterprise Group
Steve Fleishman - Wolfe Research
Steve Fleishman - Wolfe Research
Okay. We are going to get started with our next panel. So, I think this will be a really interesting panel. At least this is a question, I title the question I think about a lot, can the integration model work? So, we’ll see the answers to that question, but I think it’s one of the issues we have been wrestling with a lot over the last year. We are going to start off with Entergy with Leo Denault. Leo is the Chief Executive Officer of Entergy. Then we will go to PPL with Bill Spence. Bill is the Chairman and CEO of PPL. And then finally, we will end with Public Service Enterprise Group better known as PEG with Caroline Dorsa, who is the Chief Financial Officer. So let me give it to Leo to kick us off. Thanks.
Thanks Steve and thanks to all of you who have come out to listen to us this morning. I will leave it to them to answer the question, yes or no. We’ll leave the suspense for Steve for a little while.
As you know, some of what I would say is going to be forward-looking, so I just encourage you to look at – to read this word for word , and then to look at our website for more information. And also I will mention a few things about the ITC transaction. There are some disclosures out there, filings by ITC and by TransCo that I would encourage you to look at as well as read this page word for word in addition to that. As you know, the way the company sits today is I guess a hybrid model in terms of ownership of merchant generator as well as integrated electric utilities in the Gulf South. For our part, we do believe that there is a rationale behind separation of those businesses, but I won’t go into that today, just suffice it to say that at the moment this is the way the company sits. The merchant business is predominantly nuclear plants in the Northeast, some fossil units in the Gulf South as well as a district energy business that we just announced the sale of, and then we had utilities in the Gulf South, fully integrated model continues to be a generation transmission and distribution at least for the time being and two gas LDCs.
As we have been saying for the last several months this year, one of the objectives of the company going forward into 2014 and beyond is to try and simplify what we have going on. We have a significant amount of activity, significant amount of initiatives that are geared towards improving a lot in life as it relates to the improving results, improving cash flow, reducing costs, make our rates lower, but in addition to those efforts that are geared towards improving results and those all -- each one of these imperatives is designed to improve results that is to increase earnings, increase growth, increase cash flow. At the same point in time, we are trying to limit the amount of uncertainty that goes around with the company to limit basically the discount rate associated with that value proposition as well. So, if you go through each imperative that we have today or anything that we may come up with in the future, you can ask yourself the question as how this benefits the customers, how this benefit the shareholders, how this benefit our employees in the communities we serve. That’s the improving results part, but also you will notice that we have got a significant effort towards reducing the amount of activity that’s going on within the company so that we are easier to follow, easier to value, or easier to talk about that the story is a little bit simpler going forward.
And I will just give an update on some of these imperatives. I won’t go into too much detail given time for the panel and provide more time for other panelists, but one of the biggest initiatives we have had going on for the last several years is our transition into MISO. A big benefit to customers, estimates of $1.4 billion of savings to customers which will result in lower rates over the course of the next 10 years. In addition to providing savings to customers and lowering rates, it obviously reduces risk, reduces risk of our operations around the transmission system, it improves transparency around the transmission system, and it provides less regulatory overhang of our transmission system and how that integrates with the rest of utility as we move forward into the future. We have been working on not only the regulatory conditions that we have to get through to get ourselves transitioned into MISO, but we have also been working quite diligently on practicing operations within MISO going through testing, making sure our systems are in place, making sure that everyone knows their role in the changing market as we get into the Day 2 Market that is what MISO provides for us going forward.
In addition to the transition to MISO, it’s timed around its initiation as we exit the system agreement with Entergy Arkansas. As you all know in 2015, we will also exit the system agreement with Entergy Mississippi and part of our conditional approval in Texas is for us to also file within the next month or so the exit of Texas from the system agreement provide that 8-year notice. In addition to that, we are seeking a way to get Texas out of the system agreement earlier than the 8-year notice that both Arkansas and Mississippi have had to deal with. What you’d see as you go through for the system agreement once Texas exit, what all you have left in the system agreement is the Louisiana companies, Entergy Gulf States Louisiana, Entergy Louisiana and Entergy New Orleans. So that’s a question the necessity of the agreement going forward or whether there is some sort of changed agreement that we can provide the benefits to the system as it’s designed by just the Louisiana companies.
As you know, the system agreement has been a very complicated beast for us for quite sometime. It’s been the source of over 30 years of issues and litigation. And again getting ourselves some resolution around the system agreement and eliminating that uncertainty is again something that we believe provides real value to all of us as we go forward as we can get ourselves out of some of that litigious nature of what’s kind of gotten us caught in the middle from time-to-time makes things a little bit more difficult for all of you to follow.
The next step with the transmission business is the ITC transaction, significant benefits we believe in four areas for our customers there. We believe that improved reliability will result from a singular focused transmission enterprise. We believe that we will have induced congestion in the Day 2 Market, where congestion has a visible cost. We’ll be able to reduce that through the singular focus and planning model of a transmission only company managing that system. We believe that there will be access to different generation than we provide today just by virtue of the fact that ITC will plan across our region and not just for the Entergy customer base, but for a much broader region that goes beyond just really MISO but would also include other regions around MISO that could provide benefits.
We also believe that that appearance of a different model with a singularly focused non-generator managing that system that it’s likely that new generation will show up in the footprint that otherwise wouldn’t. And the access to that generation will also reduce cost to our customers. Again the ITC transaction will reduce cost to our customers provide through better reliability, lower congestion and access to more generation that’s lower cost going forward in addition to what we would see just out of MISO.
As you know, we filed in Texas or re-filed in Texas yesterday. Our filing in Texas is in many ways the same filing that we had already made, but with some additions. The additions of the rate mitigation plan and the other commitments that have been made that were not allowed on the record in Texas. If you observed the August 9 meeting and read Commissioner Anderson’s memo at that point in time, they were in a new process box in their point of view that they could not consider the rate mitigation plan. So the rate mitigation plan is now on the record. In addition, we have put in some testimony around some benefits that are associated with economies of scale and scope from the combination of the two transmission businesses the synergies associated with that. And we address all of the 26 conditions that were put in Commissioner Anderson’s memo to the Chair. And we believe that we have gone – we have basically been able to address each of those with a positive outcome through the commitments that have been made and the rate mitigation plan in the filing as we had it originally.
We have also asked for an expedited process to try and get this approval before the end of the year. And it is our desire that we would be able to get the commission themselves to preside over the hearings, that’s something that they brought up in their open meeting on August 9. And by doing that and by the predominance of the record that we already had the discovery that we already have the RFIs that we already have been part of this record at the outset we believe that it’s reasonable to think that we should be able to get that done, but we will see what their procedural schedule is as the process goes forward. And as we do that, we have got filings tomorrow in Mississippi and then we will have to reinvigorate the process in the other jurisdictions that suspended their hearing, their processes once we got into the situation of withdrawing our filing in Texas over that year towards trying to getting approval before the end of the year.
The other thing that we have got on the utilities side is moderate growth as we have always had within the Entergy service territory. It’s not a straight line, but typically we see ourselves in the 1% to 2% growth rate, we believe that’s just left alone. The service territory we have about 1% to 1.25% growth rate going forward. We like other people have seen the impact of energy efficiency. Seeing that impact our residential customers, we have also seen some of that in some of the other customer classes as well. And on the horizon, we are making sure that we prepare ourselves to look at what distributor generation may or may not do to us as we proceed into the course of the next 5 years to 10 years of our story.
But we also have a unique situation at the moment in terms of economic development activity that presents itself within the footprint that we serve in the Gulf South manufacturing whether it be of LNG terminals, steel mills, the chemical base are all driven by what’s going on the natural gas markets, the oil markets and the business friendly nature of what we have in the Gulf South. There is a significant amount of projects out there already that we know about, about $50 billion worth of investment we have got a significant number of jobs associated with this, about 45 projects only about 10% of which have actually come to fruition at this point. So our objective to reinvigorate the economic development process to make sure that we not only get as much of these projects that are already out there as we can, but also to look forward to trying to get additional projects.
The benefit of that spread our fixed cost over more megawatt hours is going to result in lower cost to our customers, which will again make us more competitive and to the extent that we can provide the vehicle for which we can make productive investments, investments and things that actually add customers that add rate base and growth. At the same point in time, we think that’s going to be beneficial to us. As opposed to what we see across the industry today and we have our share of this as well where you have cost structure increases that aren’t really providing one more megawatt hour than not adding one more customer, whether it be environmental compliance around coal units, whether it’s Fukushima costs around nuclear units, critical infrastructure protection, reliability requirements, some of those that don’t actually add another megawatt hour of load or another megawatt hour of production. Some of the environmental costs reduce the amount of production that you have in terms of parasitic load and things like that.
We would like to gear ours more towards growth to the extent we can and this is something that we have to make sure that we take advantage of as much as we can. We also are geared towards trying to keep our costs low and the business more efficient through our human capital management program. There is a significant amount of that the utility that we talked about and certainly we have our share of investments going forward either with or without transmission.
Turning our focus to EWC, EWC is a little bit different situation with the declining gas prices that have made our service territory and our rates very competitive, have certainly taken their toll as it relates to what’s going on with the merchant fleet, particularly the nuclear plants in the Northeast. With HCM process, we spent a lot of time trying to make sure that we get as efficient – cost efficient as we can in that business. We are trying to simplify the story. I know many of you didn’t know we own District Energy utility announced the sale, but the fact the matter is that things like that we need to pair down to get build some time to work on the more important things like new licensing of Indian Point and what to do with the rest of the fleet up there. The announced closure of Vermont Yankee should provide incremental cash flow over the next 5 years, the neutral to positive to earnings as we go through the next 5-year period. Difficult decision though in the fact that it impacts the community impacts our employees, but certainly it was a decision that the economics grow and nothing else.
The other thing that we are working on is market design. Obviously, one of the contributing factors to the closure of Vermont Yankee was not only the gas market, but it also had a lot to do with the cost structure and it had something to do with the way markets are designed, not adequately compensating assets for the benefits that they provide to the region and that’s something that we are working on.
Lower Hudson Valley, capacity zone in New York is a step in the right direction. We have been working on that quite a bit. That should provide some benefit, some uplift for Indian Point and should actually provide some incentive for people to bring capacity into the region, but more work needs to be done. Just as an example, when we announced the closure of Vermont Yankee, the next day, prices for the next three years rose, you would say moderately, but the overall impact into the market of the incremental cost caused primarily by gas basis differentials of that day was about $1 billion over the 15-year, 16-year, 17-year timeframe. Those 3 years right after we closed Vermont Yankee. That’s the kind of impact that the retirement of that asset looks like. It might have had on the market between that and the things that we saw go on in the New England market beginning of the year, there is certainly some things that need to be done to market design, to improve not only the investment decisions that the people who are already there to bring new capacity and but also to provide reliable service in those regions.
So I guess to summarize the utility at some place that we continue to focus that we are going to continue to put more and more focus on in the coming years. The simplification of the story between now and 2014 will allow us to really work on the growth aspects in utility both through more efficiency, reduction cost, improving our results that way, but also trying to take advantage of the growth opportunities that we have on the load side as well and to make sure that we can push out any of those negative impacts in terms of bottom line results that we would see otherwise from energy efficiency and distributor generation.
On the EWC side focusing again on simplification to the extent we can improve the results and making sure that we make the right calls around assets whether it would be the sale of District Energy or the closure of Vermont Yankee so that we really get our focus on what’s important going forward. And again by 2000 – this time next year we should be a much simpler, easier company we talk about, doesn’t mean we won’t have interesting things going on, we just hope to have fewer of them going on at any one point in time. Thank you.
Steve Fleishman - Wolfe Research
Thanks Leo and good morning everyone. Here we go. Before I start today, let me just, as Leo did, remind you of the fact that I am going to be talking about future events and forward-looking statements, some of the Safe Harbor provisions and actual results may vary. And again as Leo stated please look at our appendix and read those words carefully. I am also going to be talking ongoing earnings which – and other non-GAAP financial measures. So a description of those can also be found and reconciliations in our appendix today.
Let me start this morning with just a brief overview for those of you that may not be familiar with the PPL story and looking at kind of where our assets reside. Our legacy assets are in Pennsylvania with not only our PPL Electric Utilities, the regulated T&D wires business, but also our competitive gen fleet which is comprised primarily of coal, nuclear and hydro assets, but also complemented some very flexible oil and natural gas assets. And we also deliver electricity to about 1.4 million customers in Eastern and Central Pennsylvania as highlighted by the properties shaded in blue and the state there. The pins in blue represent about 9,000 megawatts of generation that we own and operate in Pennsylvania as well as the 1,200 megawatts of competitive coal and hydro generation assets that we have in the state of Montana. With the acquisition of Louisville Gas Electric and Kentucky Utilities in 2010, we also operate fully integrated regulated utilities in the states of Kentucky and Virginia serving over 1.2 million customers and operating a gen fleet there of over 8000 megawatts.
As far as our international operations they consist of our WPD South Wales, Southwest as well as the East and West Midlands properties that we picked up from E.ON back in 2011. Our four UK regulated businesses are actually the largest in the UK as measured by the combined regulated asset base. And there in the UK we serve over 7.8 million customers. And interestingly we have been operating actually for quite some time since 1996 in the UK, so a lot of experience there.
The next slide really shows what I would concern is our investment thesis where we believe we are very well positioned for the future based on our rate regulated businesses that are going to drive our earnings and cash flow for the foreseeable future and providing stability and security to our earnings forecast as well as benefits to our dividend and credit ratings. In fact, over 85% of our projected earnings this year 2013 will be coming from our regulated businesses. These businesses are projected to grow significantly. We have a lot of organic growth opportunity in these businesses with our planned CapEx programs driving a compound annual growth rate in our regulated businesses of nearly 8% over the next 5 years. Much of this rate base growth comes from planned CapEx, it’s already been reviewed by regulators with little lag in earning return for share owners. The business mix improvements that we have made over the past 2 years have resulted in an excellent business risk profile rating from Standard & Poor’s putting us in a category with only handful of other companies.
This more stable earnings mix also makes our dividend more secure and gives us a platform for continued growth even in pressured commodity cycles as evidenced by the increase in our dividend that we announced earlier this year. And while wholesale electricity prices remain a bit challenging, our high quality competitive fleet provides upside once those markets improve in the longer term. Our efficient and environmentally competitive coal plants of PJM are complemented by a flexible mix of gas fired, nuclear and hydro units that position us very well in one of the largest markets in PJM in the world. This fuel mix also differentiates our company from a number of our competitors providing us some competitive advantages in a variety of market conditions.
And last, we have consistently proven our operational excellence and our ability to make and execute on the right strategic and tactical calls in our view as we continue to grow share on our value. For example, our UK team is performing best-in-class now among our UK peers as shown by our out-performance in cost and customer service metrics. And in our domestic regulated operations, our teams have been working very hard through general work rate cases last year and awarded increases of 10.25% and allowed ROE in Kentucky and 10.4% distribution ROE in Pennsylvania.
This next slide shows our CapEx spending over the next several years. And I do want to mention that much of this expenditure is subject to real-time or nearly real-time returns on enough capital significantly reducing the regulatory lag that would otherwise occur especially in this low load growth environment. In fact, over two-thirds or more than $10 billion of our CapEx will be in this category through the year 2017.
On our WPD operations, we are allowed real-time returns open on every dollar capital we spend based on the real-time constructive regulatory framework there in the UK. In Kentucky, we operate under regulation that allows for the near real-time return up in the majority of capital that we spend on environmental control equipment for our coal combustion generation, which is the bulk of the capital we are going to be spending in the next several years. In Pennsylvania, PPL Electric Utilities has a significant and growing transmission business aimed at improving regional reliability through capital projects to receive FERC formula rates. In addition, beginning in July of this year, we are allowed to recover reliability based distribution CapEx through a disc mechanism as a result of a bill that was passed and signed into law last year.
Moving on to the UK let me look at each of the businesses, starting with the UK. This is a highly attractive rate regulated business for us, distribution-only. The system there provides or as I mentioned pre-approved 5-year forward-looking formula revenues, which are inflation adjusted take into account capital spending, O&M cost, financing needs and we faced no volumetric risk given the revenue requirement nature of the model there. We have got the ability to earn in addition some incentive revenues that can be quite substantial based on the quality of customer service and by determining how efficient we are as an operator.
As shown here in the chart on the lower left hand side, you can see that or the lower right hand side, we have earned over $185 million in annual revenue bonuses based on performance over the past 8 regulatory years for exceeding specific metrics. It also reflects the great work of our management team there being able to turnaround the two acquired Midlands’ operations formerly Central Networks in the very high performing companies in a very short period of time. We have taken that same low cost operating model that exist in the Southwest in South Wales integrated it into the East and West Midlands and are achieving strong results there as demonstrated through the level of bonus revenues that you see.
I think Ofgem is very supportive of the work we have been able to accomplish in such a short timeframe. And as many of you know, we are currently in the process of a regulatory review for the next price control period called RIIO-ED1, which would extend for an 8-year period through March 2023. We filed our business plan early in the third quarter, remained confident that our focus for companies can be fast-tracked in this process providing incentive awards and certainty much earlier than companies that go through the extended review process. So we look forward to November when Ofgem is expected to issue their initial assessment of the business plans and letting us know whether it’s fast-tracked or not.
Moving on to our domestic businesses let me start with our Kentucky regulated operations. These are efficient well-run utilities that project significant rate base growth in the coming years. Indicative of the constructive regulatory climate there, we have got mechanisms in place that provide for timely recovery of a substantial portion of the CapEx plans over the next five years. And as I mentioned, we get recovery of and on capital projects to retrofit legacy coal plants with modern technology to meet new EPA regulations and receive real-time recovery at a 10.25% ROE. We currently estimate compound annual growth in our Kentucky rate base of almost 9% over the next 5 years which would puts us at over $10 billion in rate base by the end of 2017.
Moving on to Pennsylvania, we are also forecasting significant rate base growth in both our T&D operations. On the transmission side, we estimate annual growth rate of roughly 22% through 2017, driven by a couple of very large projects to improve aging transmission facilities in Pennsylvania the 145 miles Susquehanna-Roseland transmission project that we are in partnership with PSE&G is a good example. And we also have the Northeast-Pocono reliability project, again a very large project that we expect to drive that transmission growth. We expect that Susquehanna-Roseland to be fully energized in June of 2015, with the majority of the construction to occur this year and through the end of next year. You will find additional information on the project in the appendix of today’s presentation.
We are also continuing to upgrade the aging infrastructure in our Pennsylvania distribution system that covers 29 counties in the state of Pennsylvania. Our distribution improvement efforts are expected to result in a 5% compound annual growth rate base over the next 5 years. The state is very supportive with these efforts. And as I mentioned, we were able to have approved the Act 11 that provide a more timely recovery mechanism in the state.
On the supply side of our business while the energy industry continues to face the challenge of low wholesale power prices, our diverse competitive fleet continues to be well positioned in our view. On the operational front on PJM we have more than 1200 megawatts – 2,400 megawatts of low cost nuclear and hydro assets. We have also got about 2,800 megawatts of efficient super-critical coal units that are substantially in compliance with new emission standards and we are not looking in any major capital investments for compliance. In addition, we have got 2,400 megawatts of gas fired plants in PJM that have been running at near base load levels given the low gas prices and that fleet has benefited from those gas prices and will help to offset some of our un-hedged dark spread risk associated with coal assets. And this is one of the benefits of the fleet diversity in addition to the fuel types we have, the dispatch response that we can deploy, as well as the technology that helps us in a variety of different market conditions.
On the cost side of the business, the team has done a great job responding to the more challenged commodity prices. And we have taken a lot of costs out of the business already, in fact in the last two business planning cycles we have taken out over $1 billion of CapEx. And we have also been successful at controlling the O&M spending. And we plan to eliminate an additional $25 million to $50 million in O&M by 2015. In fact I think it will be at the high end of that range. Of course we are trying to be judicious and balance the needs to keep the cash flow and the earnings positive across the enterprise with a belief that ultimately we are going to see a recovery in energy and capacity prices and we want to make sure our units are able to perform when we get to that point.
Last slide, I just wanted to mention our dividend profile, I have highlighted the business segments each with unique opportunities to provide strong shareowner returns, but we know that the dividend is an important component of our shareowner returns and important piece of the total shareowner returns. So this chart shows the security of our current dividend in that projected ongoing earnings per share from our regulated businesses more than covers our current dividend. The projected rate base growth or expectations regarding earned ROEs and the timing of general rate case position us very well to continue to grow that dividend. Finally, we are delivering on the commitments we have made to our investors over the past several years providing a stable and growing investment for shareowners coupled with the secure and growing dividend.
That concludes my prepared remarks. Steve and I look forward to the questions in a little bit.
Steve Fleishman - Wolfe Research
And I’ll turn it over to you, Caroline.
Thank you, Bill. Thank you, Steve. Good morning everyone. I look forward to talking a little bit now about PSEG. And then we will have our conversation and I guess try to answer that question that we haven’t answered yet, right. So I will start off by also citing the (goals). Okay, consistent with the theme, what’s consistent across our presentations good forward-looking statements. So I encourage you of course to reference ours and of course our materials in our 10-K filings as well and also our GAAP disclaimer. And I have problem with this one. Here we go, since we will be discussing GAAP and non-GAAP numbers as we typically do when we cite our earnings.
So starting with our strategy and I think those of you are familiar with PSEG are familiar with this page, but I think it’s always worth repeating. We have really looked at our business and manage our entire business whether it is the power business or the utility business under three key principles: disciplined investment, rigorous review of our investment opportunities to ensure that they create not only value for our customers, but value for our shareholders, operational excellence in everything we do, very rigorous metric assessment for everything that we engage in to ensure that we are always pushing towards top quartile performance and then financial strength. As you know, we have a very strong balance sheet and I will talk a little bit about how that positions us well for our growth in the utility as we go forward as a result of our filing for Energy Strong. And of course an engaged workforce is what makes this all happen. So those have been the tenants of our strategy, our financial business and operational strategy. They have been consistent for quite a number of years and we think they do provide the best opportunity for value for our customers, reliability for our customers and regulators and results for our shareholders.
In terms of our company and businesses, we are an integrated as are the other companies here this morning. You know our three businesses, but let me just review briefly for you. Under the PSEG umbrella is PSE&G, our regulated gas and electric utility all situated in New Jersey, assets of just over $19 billion at last year’s year end and you can see the operating earnings for last year as well. We are we think a premier utility in the state of New Jersey and positioned well for additional investment opportunities, which I will talk a little bit more about in a moment or two, but they are both on the transmission side as well as on the distribution side in a contemporaneous return framework on the distribution side and in a formula rate framework on the transmission side, so good opportunities and I think a lot more for us there, which I will talk about.
PSEG Power, our wholesale energy generation company, about $11 billion in assets and you can see last year’s operating earnings there as well. We think we operate a low-cost environmentally friendly and diverse fleet that has some advantages based on its location and also the diversity of its fleet.
And then Energy Holdings, a smaller business for us, assets of about $1.5 billion, you can see the earnings there. And in that business, we are really focused on growing our renewable profile with solar investments that we have made there. Other things that we used to have there, for example, international investments are now totally gone. And so, while we are cleaning up some of the rest of that portfolio, the focus is really growing that renewable business all with PPAs, so not merchant exposure.
So just a moment on PSE&G in terms of our footprint, so the map of New Jersey as you can see the light blue is the gas territory and the shaded area is the electric territory, a little more or little less than 2 million customers depending on whether electric or gas counting each customer for each business once in each column. You can see that in terms of our mix, we are highly commercial relative to residential on the electric side and very light on industrial, not a lot of manufacture in the state of New Jersey. That flips around of course when you get to the gas business, which is predominantly residential and then flips around to commercial there. We have an approved ROE from our last distribution rate case in 2010 of 10.3% on a 51.2% equity ratio, and we are earning that authorized return.
On the transmission side, we have a formula rate of 11.68% on our base formula rate and then we have some incentives on some programs Susquehanna-Roseland as Bill mentioned for us is at 12.93% ROE again under a formula rate basis. We have no current plans to go back in for a rate case. We don’t need to do so in the near-term. And as we talk about incremental utility investments, they come on top of and with incremental clause recovery on top of our base distribution rates, and I will talk more about those in a moment.
In terms of some of the things that we have gotten approval for in addition to our base distribution rates, you can see some of the initiatives we have made under the state’s Energy Master Plan. In terms of solar, we have a pretty significant program as you can see by the number of megawatts for the total program, both a loan program to incent third-parties, but also a Solar for All program and we own the actual solar assets, and then you can see a pretty significant amount of total megawatts for those programs. And then some energy efficiency programs which we have also undertaken to improve the efficiency of energy utilization for our customers. All of these programs have been done with incremental rate making mechanisms sitting on top of our distribution, so contemporaneous clause recoveries, no regulatory lags. So, we support some of the states’ social goals in terms of promoting renewables and promoting energy efficiency in ways that we think work for our customers but also don’t cause any regulatory lag for our shareholders and have all been approved with essentially the 10.3% return post our rate case everything that was approved there. Our most recent solar program was approved with 10.0%.
In terms of the power business, we do like our power profile and you can see the location of our units here on the map. Most of our units are in New Jersey, as you know, but we do have units in Pennsylvania, in Connecticut, and in New York. The things that we think characterizes this portfolio well is fuel flexibility, so we are about 57% nuclear, if you look at actual generation. And then the next biggest piece is gas and then coal, and of course gas has been running more than coal. So we have fuel flexibility across all the fuel types. Our two major New Jersey coal plants actually also run on gas, so we have inherent fuel flexibility even in our largest coal plants in the State of New Jersey.
So a lot of opportunity we think to take advantage of the best fuel mix for our profitability. Our assets are obviously located near load centers and we have a diversity that is base load, intermediate, and peaking , so we are able to serve full requirements contracts like BGS. We will retain that diversity and efficiency. In 2016, we have already announced and I know many of you are familiar with some of the deactivations of HEDD related units, but we still retain a full fleet all the way up through peaking and have some opportunities for expansion. So, we like the reliability of this fleet, we like its cost profile, it does not need significant capital investments. All of our coal plants already have the investments needed to meet the mass rules, and the only significant spend that we have is for the Peach Bottom site which we co-own with Exelon and they manage for actual upgrade, so an NPV positive transaction.
So, we think a nicely situated fleet of assets near load with nice diversity and flexibility, and also as some of you have been asking us recently with nice access to low cost Marcellus gas. So, we do access Marcellus gas for some of our fleet in addition to Henry Hub gas, and you can see the statistics there, give us the opportunity to utilize that low cost gas both to benefit our customers in terms of utility, but also -- and their gas supply, but also our power plants.
In terms of where we are going, going forward, this is a nice picture of some key metrics if you look at from 2008 to 2012 and then from 2012 to 2015 what we have been able to accomplish. Good control on actual O&M growth from 2008 to 2012 versus the planned O&M of 2.4, but the actual is less than a percentage point. Our current forecast is about 2.2 on a CAGR basis going forward. In terms of rate base, I think a really good story there, you can see how much money we have put into our rate base growth from where we were in 2008 to where we are at the end of 2012 and where we expect to be in 2015. And again that transmission, Energy Master Plan growth is all contemporaneous or formula rate, and then we have new filings underway for Energy Strong, which I will talk about in a moment that can give us even incremental rate base growth.
On power, you can see the statistics there in terms of what we have been able to do in terms of generating incremental terawatt hours and managing key metrics like our E4D rate. Solar, you see how we have grown it from really nothing in 2008 in holdings and then LIPA earnings, something many of you are aware of, we start in 2014 under our current existing contracts, should add about $0.03 a share.
In terms of our guidance, our guidance we are maintaining at $2.25 to $2.50 a share this year, but we did note at the end of the second quarter that if there – with normal weather and normal operating performance, we expect to be at the upper end of that guidance driven by power being at the upper end of its guidance.
In terms of the mix of our businesses, so you can see over time as the rate base has grown for PSE&G, PSE&G is becoming close to 50% of our operating earnings versus where it had been just a few years ago more like a quarter of our operating earnings, and we do anticipate double-digit growth in PSE&G’s operating earnings through 2015 based on already approved programs and the opportunity to grow our rate base both on the transmission side as well as the new approvals for things like solar as well.
In terms of the two businesses and contributions in the integrated models, what we are able to do in terms of our balance sheet. If you look at this chart which is 2012 actual data, you can see that both of our businesses are actually significant cash flow generators in terms of looking in cash from ops or sort of a cash flow statement kind of view. Both businesses, significant cash flow generators, we also started the – ended the year with net cash on the balance sheet. The net debt issuances are all utility net debt issuance to support the growth in our rate base, but you can see going to the uses side that it is PSE&G that has the majority of the capital investment. And again, that’s consistent with growing our rate base. As a result of this picture and if you were to roll this picture forward, we have the opportunity to support everything we are looking to do at PSE&G both approved and filed for Energy Strong without the need to do any equity issuance at all, because both businesses are significant cash flow from operations generators.
In terms of capital investment opportunity, here you can see the capital investments based on approved programs between now and 2015. With $6.3 billion at the utility, you can see the growth is $4.2 billion out of that $6.3 billion. So the majority of our capital is growth and the majority of our capital is utility growth with that contemporaneous or formula rate type treatment. We have the opportunity for new transmission investments over the same period of time beyond that base amount based on additional hardening of the system that we identified post-Sandy. And then new distribution of $1 billion represents the 3-year period for Energy Strong, the filing that we have made with the BPU for as much as $3.9 billion over a 10-year period which we have asked for $2.6 billion over the first 60 months or 5-year period all with contemporaneous return as well. That would give us an even greater opportunity to grow the PSE&G growth investments from $4.2 billion to over $5 billion over this period. So, we think a lot of opportunity there for even better rate base growth at the utility again serving our customers’ needs for reliability.
In terms of our balance sheet, given the strength that we start with and the opportunity to make these investments of just keeping the utilities debt structure at 51.2% equity. There is opportunity for us to do that without any need for equity issuance, because we ended last year with almost 60% equity in our capital structure.
And then in terms of dividend also to focus on that for a moment, well you can see the growth in our dividend over the past few year period, you can also see with the growth anticipated in PSE&G, you can see that PSE&G becomes a very significant contributor if you just took its income and look that its income relative to our dividend, it would be about in 80s in terms of the percentage sourcing of our dividend if you look at adjustment PSE&G’s earnings. So good safety and security from the dividend, but of course in terms of the place that we are putting money back to work, it is PSE&G because we have those good contemporaneous returns.
So overall, we think our value proposition is straightforward, strong, good reasonable risk adjusted rates of return, contemporaneous in nature, opportunity to grow the utility by double-digits based on approved programs with opportunities for upside based on our Energy Strong program, continuing to manage our cost that power and running a lean low cost fleet that is a net excess cash flow generator without significant capital investments gives us the opportunity to make those investments of the utility without having any dilution or equity issuance needs and support a solid dividend with the opportunity for future dividend growth.
So with that, I’ll stop and turn it over to Steve.
Steve Fleishman - Wolfe Research
Great, thanks Caroline. So maybe just to kick off with initial question, I am sure you guys have all and actually I guess Entergy actually tried to do some kind of review of separation scenarios of the company and at this point none of you have actually done it. Maybe you could give us a little sense of when you have looked at, what are some of the pros and cons that you are seeing through that analysis and why are you kind of where you are today? Bill, do you want to take this?
Sure, I will go ahead. So I think whenever you talk about a separation in today’s environment looking at the utility business standalone and the supply business for example standalone, I think on the pros side, the opportunity for kind of pure-play multiples probably is one of the stronger and more compelling reasons why it might want to consider some type of separation between the two businesses. I think there are benefits to perhaps on the supply side if you believe in critical mass and the need to grow the competitive generation fleet to a size in a low commodity market condition like we have seen now and spreading some of your overhead costs that’s going to be a significant driver to some synergies perhaps you can get. So bigger probably in this case might be better in the current environment, it’s not always the case but perhaps now it is I think that’s probably a pro.
On the cons side I think sometimes unravelling the supply business from what in many of our cases were formerly integrated utilities companies has some challenges, so there are some internal cost structural challenges with that. You have to be careful when you unwind that that if you don’t leave the utility holding company let’s say with some stranded costs, that’s potentially you have to look out for. I think how you finance the two companies is a key consideration too and again whatever you are left with depending on the business mix you start with could be a factor. And then there is some – there could be some tax complexities to it as well depending on what kind of tax basis you have in the legacy utility company and how you choose to kind of separate. So those are just kind of some preliminary thoughts on some of the pros and cons.
Obviously we think it’s a good idea if we separated them, good to try to do that. For us it will be different than either of my co-panelists and that it’s a couple thousand miles of geography between the majority of our merchant fleet and our utilities. They did not grow up together. They are function of the acquisitions that we made. They were geared towards operational improvements around nuclear plants that were underperforming for the most part and so we were able to turnaround those operations. But just because (inaudible) and River Bend our two nuclear plants does not make the merchant fleet and fully integrated utility, anything alike as far as business goes. So for us it’s a little bit easier to make that distinction because we didn’t grow up with those been in the same place. So all the pros are around starting with just two different businesses, they have two different value propositions, they have two different skill sets in terms of the commercial viability of them even though the assets that you operate are identical. And so there is a myriad of benefits that I won’t really go into, mostly they are commercial and local financial, etcetera but the business is really in our case don’t belong together.
The two cons that I would mention that are I guess philosophical not specific to us is. One, the operations are coming to scale the operation of 11 or 12 units versus 5 or 6. So I think that that is, we try to actually address that through how we are going to operate the fleets, when we are going to look at sustain, but that is certainly something that has been worthwhile for us as we have grown the fleet of nuclear plants to be able to operate across a much larger fleet from an operational standpoint and commercially the businesses are not the same. And I guess the other con is that we weren’t able to do.
I’ll add really echoing what Bill said. I think there are the potential for some of the dissynergies of causes you have to recreate to support service organizations. So that’s a little bit of a challenge. We do like the integrated model in terms of the kinds of efficiencies that gives us in terms of capital redeployment that’s not to say investors couldn’t do it on their own separated, but we do think it’s very efficient for us to be able to put money into the regulating utility during past times with power price really being lower than they have been before when the power company doesn’t need the capital investment. We do like the ability to have for a cross pollination of our people in terms of training and development. We do think that, that makes a lot of sense. So we do like the model. And I think everything as Bill said, I would echo there can be tax issues and all sorts of other things, but we do think our ability to look at each business and think about what’s the best opportunities for growth in one that might be at a different time if there is growth and another gives us nice opportunities.
Steve Fleishman - Wolfe Research
Okay. One other related question, none of you mentioned the rating agencies at least specifically. And I guess in theory it would be very hard to have a generation business on its own that’s investment grade, so maybe you give that up, but you also then have a pure distribution business or pure utility that maybe is a lot easier requirements to meet? So maybe just give some perspective on it, would there be a lot of embedded capital freed up separate because of that then the requirements you have to meet today to keep your solid investment grade, any perspective on that?
Sure. Well in PPL’s case, with the lower gas prices and some of the challenges we face in the capacity markets, we have really paired back a lot on the capital that goes towards generation fleet. And with the size of PPL today versus where we were with 85% of our earnings coming from the regulated side of the business, the allocation of capital issue isn’t probably as significant as it would be maybe in other cases. So we really are not deploying that much capital in towards the generation business at this time. And most of that big capital needs that we had for compliance type activities on the EPA front are behind us. So we don’t pay significant level new capital that needs to be deployed through that business. So it’s really not terribly important issue for us at this time. So I think it’s a good question because it does I think you point out a good issue there around the rating agencies and the financeability of pure merchant company with the sub-investment grade, I mean, that’s the nature of the business. And sitting inside a holding company like we have it may not be on its surface the most ideal, but there are some benefits as Caroline mentioned as well. So it’s again it’s a bit of some pros and cons.
Now, I would say similarly to Bill, I mean, clearly there can be some pros and cons similarly to what Bill mentioned, we don’t have a lot to invest in the merchant business as I mentioned other than things that have positive NPV. We do like frankly at the end of the day, we like the strategic flexibility that having an investment grade, solid investment grade rating as we do as you know on our power company gives us in terms of opportunities to use the balance sheet, if there are opportunities that present themselves. If we were separated, obviously, it would be very, very different, but we do think that financial strength gives us options as we can look at more opportunities to grow either company because we start with a balance sheet that has room and we like that.
Steve Fleishman - Wolfe Research
Okay, I will take one more question and then we will open it up for the audience. Just on the – one more question I guess on the unregulated businesses, just your perspectives on potential for power recovery and just I think all of these to some degree thinking a little bit better. Is that a view on, your views on natural gas, is that a view on just basic supply demand in your regions, kind of what are your point of view thoughts there or do you just not have a point of view and you are just going to kind of keep it out?
Again, I guess from our perspective, we do think things are going to get better. It’s a combination if I just review things that we are going to see some constructive room to the gas market. That’s going to be driven I think a little bit what we are seeing in some areas in our utility business, for example, a lot of the economic growth and the economic development opportunities we see are demand related factors. It doesn’t mean that we believe that gas is going to get back to where it was in 2007 and ‘08 but we do think that, that there is some reasons that gas will recover somewhat from where it is today. We also – it depends on what you talk about as today we also see that there is some things that just structurally are in the power markets where our units are that underplay heat rate in the forward market. And so we think that power prices themselves given the lack of liquidity and power longer term versus gas, you see what is an implied heat rate that is not necessarily what we see when things comes to turn and then we are diligently working to help the capacity markets as much as we can to actually perform the way they are supposed to, to both compensate people for the capacity that they currently own, but also to be in a position where they themselves letting the market run as opposed to some other form of fashion of capacity will actually encourage new capacity itself in a market way, most of them work today that difficult to see how long that’s going to happen just in the purely competitive nature of the capacity market itself as opposed to things that come around peripherally in some sort of special deal as it work.
In PJM, I think from a PPL perspective we see some maybe what I would say is improving, I wouldn’t say it’s a trend, but some improving signals that we are getting from PJM management that suggest that they are going to deal with couple of things hopefully before the next capacity auction in early next year and those things are important limitations. There was I think a surprise in the last auction with how much capacity was allowed into the auction from imports. I think you are going to deal with that. I think there were some issues around individual minimum offer price requirements, Mopar exceptions if you will, I think they are going to deal with that. There were some concerns about the level of demand response. I think there is some things underway with that.
And then finally there is this issue of the incremental capacity auctions and the potential for people to gain that with maybe not enough penalties in that structure. So I think to Leo’s point around market design, I think the ISOs are trying to address some of the concerns that they see coming down the pipe to make sure that they maintain enough capacity in the system to meet all the reliability requirements that we think that’s a good thing. And obviously with the last incremental auction that just went off last week came in at $111, that’s a very significant number that’s higher than any other incremental auction in the history of these incremental auctions. So that’s a positive.
On the energy side, I think to answer your question specifically, I see it more in the supply and demand fundamentals, Steve, than I do on improving gas prices. I think gas prices will improve somewhat, but I think it’s the power recovery is going to be driven more by demand and retirements, more retirements that are perhaps in this system and for prices today, and maybe the cost of compliance particularly with maths may not be fully embedded in the forward prices.
I’d say Steve on the capacity side for us that the last 3 years given where we are in Eastern PJM our capacity price results have actually been pretty steady in that $160 per megawatt dated range. So that’s been pretty consistent given the constraints of where we are. We do very much support on the PJM front, the design issues getting the rules right, things that Bill mentioned, things like demand response having to have the right rules around what it can bid. And if it’s going to be paid like a generator being more treated in terms of having to show up like a generator and demonstrate its liability like a generator, we support those things. We do support things that, that a system thinking carefully about the amount of imports and Mopar and having a stronger kind of Mopar message there.
On the energy side, we do observe that there does appear to be less liquidity in the forward curve than there had been before and you’ve seen some announcements of institutions indicate exit there which obviously does have issues for liquidity in the out years. That being said very important for us always nocturnally that we run the business and we plan the business on the forward curve. So in terms of how we think about our O&M, in terms of how we think about capital deployment between the businesses, in terms of how we look at opportunities in the power markets we always look at the forward curve as opposed to assume it’s wrong because while it probably won’t be exactly where prices turn out to be in a few years we don’t think it makes sense against that and pay money upfront for that. So well there maybe some liquidity pressures there, we are assessing that. We still run the business and certainly plan our cost and expenditures on the assumption of the forward curve.
Steve Fleishman - Wolfe Research
Okay. Let me open it up to the audience for any questions? We got Steven in the back there and then Rob?
With all the coal to gas switching that’s going on, do you hear a lot about how power flows would change substantially on the grid maybe than in different ways than they have been planning for 10 years ago I would say? I was just sort of wondering what kind of opportunities does that give you for transmission investments, new constraints somebody come up on the system and how did those opportunities maybe compared to lost power sales from your generation business, and how much maybe this one side offset the other?
So I will kick it off. For us, in terms of transmission investments, our investments are reliability driven by identified things in PJM in terms of reliability issues, so not a transfer capacity type of issues, but really more reliability issues and we have multi-billion dollar program underway there. That’s the PSE&G under the formula rate. Obviously, the opportunity for more investments under Energy Strong, are something else that we are looking at up to a $1.5 billion over 10 years. So opportunities there really present themselves because of the reliability issues that have been identified by PJM. We are not really in the business of looking at large scales that are energy transfer type transmission investment opportunities.
I’d probably echo what Caroline just said on the PPL side. And I think what the large transmission project they take so long to put into the planning process that by the time you get there, those anomalies if you will or those opportunities to arbitrage between gas and coal units may have gone away. So I don’t think we probably take that risk on that type of a project in light of how fickle some of these markets can be.
Yes, Marcellus shale by 2020 is expected to basically fully supply the Northeast gas demand. If the Utica develop, there will be even more gas in Northeast. We have already seen pretty significant basis differential. If you assume like an $0.80 or $1 basis differential at the Henry Hub, how will this affect power markets in your territories and how do you plan the business around this kind of scenario?
It’s such a tough one. I think Leo should answer that.
Well, I mean, there is a significant number of scenarios out there in terms of where gas markets may go and where power markets may go. I think the short answer to that is that as we are looking at where things are, we have got to run a lot of scenarios around where they might be. To the extent that some of those things show up and to the extent that we start to see actual reductions in gas prices versus where we are today, what we see real I mean I hate to say the base that Henry Hub to Northeast bases crash like it hasn’t already, but the fact of the matter is that as those things continue, it’s going to make it tough for those of us who have assets that are driven by some other fuel like nuclear power.
It’s that phenomenon was the base driver in the decision to close Vermont Yankee was the fact that gas prices are now much lower than they were before and then power markets we are in, there is not a lot of coal gas which is in the Northeast, where we are now is on coal, mostly gas, what it could be asked was oil. So the fact of the matter is that’s just the kind of thing that we need to make sure that we keep our eye on, we keep on top of and to the extent that you are running the coal plant and nuclear plant and things get worse before they get better, that just mean you got to keep an eye on your cost structure, you got to keep an eye on investment profile and you got to make some tough calls like what we already did with Vermont Yankee where it’s actually a better economic decision not to run the plant, we are going to continue to run the plant. Some of that is gas driven, some of that is cost driven and some of that is market design driven, but in fact matter is when you say how do you plan your business around that, we already do plan our business around that as a potential outcome of where things are today.
And just like what Caroline said, everything we do marks our plan to mark because as we all know particularly we have been around the competitive training side of the business, particularly as it was developed in days of the ‘90s and the early part of the 2000, that’s what the price is. If you want to sell something in 2015 today, there is a price for it and that’s a surprise, just because I think it should be higher or I believe it will go higher, it doesn’t change that.
Now the decision I make might be informed by whether I think it’s going to go higher or lower and we make those bets all the time. We normally make those bets as it relates to merchant fleet, we make those bets as it relates to the integrated utility fleet as well when we decide to build the gas plant versus the nuclear plant, versus the coal plant, versus some other technology. We are making a bet on the cost from all the commodities that go into that, whether it’s copper, whether it’s natural gas, whether it’s coal, whether it’s uranium and we are making a regulatory bet on what’s going to happen, whether it’s environmental control or Fukushima costs or whatever. We have to make those all the time.
So how do we look at it is we kind of do stochastic analysis of spreading what those potential outcomes might be and while we mark the plan to go to market and we are going to make our decisions based on how do we think that’s going to turn out and it market? There is one way to look at it is where we’ll all say well the market is here, we believe it’s going to be higher. You would make one decision based on that. If you could hit the market here you think its going to be lower you make a different decision while you had the opportunity even to hedge it out, so they’ve got (inaudible) work that makes some sort of call so far and then close the plant now or something like that.
I think one thing I’d add to that, when you think about that question, right it’s taking one variable albeit an important one and albeit one that seems to be in a sort of key change from where it was. But as we think about planning the business, right we have to think about the multiple variables. So we have to think about what’s going on there. What might be happening with the actual limitation of EPA regulations, what’s going to be happening what CO2 related regulations, what’s going happen to load growth, what’s going happen to renewable, what will be the government’s policy around all of those things, where might there be new build, where might there be plant closures.
So a single shot variable albeit a really important one, right, how does it find its way into power prices, what’s going to happen in different regions. We look at all of those together and so we can’t isolate one out and say if this happens, what will be the result, if you then you say what happens to other 20 things and then how far actually get plan for that. And that's kind of the way we try to look at them on an integrated basis. What are the interactions from one or the other, right and then how do we think about what that means for what we commit to put in the ground versus how we were and what we’re today and things like that. So it’s a little hard to disaggregate one and say on that vector would be this, you really just don’t build the business model that way.
Steve Fleishman - Wolfe Research
Okay. Question from…?
Leo, one of the drivers that you didn’t mention is the political one. And I wonder particularly in Texas if you could comment at all on the appointment of new commissioner especially it’s sort of been impossible to act on anything the way it was structured for the last year or so. And we now have a third commissioner which is hopefully going to do something. Do you have any insight at all on her and where she might be going, where she is closer to Chairman Nelson or not et cetera?
Our view is that she is going to be a very solid commissioner. She is going to do a good job. Certainly she is got to come up learning curve on a variety of the issues in Texas and it’s somewhat complicated by the Texas’ structure versus ERCOT versus not ERCOT. And so I think there is a learning curve there that she will be more than capable of getting at. And I think that she is going to be constructive in a lot of ways coming out of the Governor’s office as she has and the kind of things she has been involved in. And I think that it will just add to the commission and it has probably been difficult for them, just two commissioners to work their way through that process more than anything else and to understand the implications of well, what happens when they don’t agree more so than when they don’t or when they do agree.
So I think it will be helpful. It will be a new source of ideas coming with a different perspective. She certainly has a good background. Our view is that she can be very constructive, she is very intelligent, all of the things that you like to see in a commissioner and that they should probably all three work well together. And my guess is that I wouldn’t say that any commissioner aligns with any other commissioner on any, I think that they all are really well versed in the issues, they all get up to speed on themselves and make their own calls and really it’s along the way. And I don’t think she is going to be any different, I think she is going to do a real good job here.
Steve Fleishman - Wolfe Research
Great. Well, I think we ran out of time. Thank you very much for the panel. We are going to move relatively quickly to our next panel with NextEra and NRG.
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