Constellation Energy Group, Inc. Q1 2010 Earnings Call Transcript

| About: Constellation Energy (CEG)

Constellation Energy Group, Inc. (NYSE:CEG)

Q1 2010 Earnings Call

April 30, 2010 8:30 am ET

Executives

Carim Khouzami - Executive Director of Investor Relations

Mayo Shattuck - Chairman, President, and CEO

Jack Thayer - CFO

Kathy Hyle – COO

Mike Wallace – Vice Chairman

Analysts

Dan Eggers – Credit Suisse

Andrew Weisel – Macquarie

Greg Gordon – Morgan Stanley

David Frank – Catapult

Paul Fremont – Jefferies

Reza Hatefi – Decade Capital

Operator

(Operator Instructions) Welcome to the Constellation Energy Group’s First Quarter Earnings Conference Call. I will now turn the meeting over to the Executive Director of Investor Relations for Constellation, Mr. Carim Khouzami.

Carim Khouzami

On slide two, before we begin our presentation, let me remind you that our comments today will include forward looking statements which are subject to certain risks and uncertainties. For a complete discussion of these risks, we encourage you to read our documents on file with the SEC. Our presentation is being webcast and the slides are available on our website, which you can access at www.constellation.com under Investor Relations.

On slide three, you will notice we will use non-GAAP financial measures in this presentation to help you understand our operating performance. We have attached an appendix to the charts on the website, reconciling non-GAAP measures to GAAP measures.

With that, I would like to turn the time over to Mayo Shattuck, Chairman, President, and CEO of Constellation Energy.

Mayo Shattuck

This morning we reported first quarter adjusted earnings of $1.43 per share. Including one time items Constellation reported first quarter GAAP earnings of $0.95 per share. We are reaffirming our 2010 guidance range of $3.05 to $3.45 per share. We are lowering our 2011 guidance range by $0.20 to $3.25 to $3.65 per share.

This reflects the impact of significantly lower forward commodity prices on our Generation fleet which contributes to a reduction in our 2011 earnings outlook of approximately $0.40. We expect this decline to be offset in part by improving earnings from our NewEnergy segment. Jack will discuss this in more detail during the financial section of the presentation.

During the quarter, our NewEnergy segment continued to generate strong new business with retail margins averaging at the upper end of our targeted range of $5.00 to $7.00 per MWH. The cash flows and earnings associated with these new contracts will be recorded over their duration which average about 18 months.

We recently finalized our agreement with the DOE for a $200 million Smart Grid stimulus grant. We are excited about this project which represents the best of breed in the new generation of utility operations. Our Smart Grid system will transform BGEs relationship with its customers, improving service, billing and general reliability while providing significant energy and peak demand savings.

Additionally this system will provide greater insight into BGEs operations better informing capital investments in other operational decisions. We await a Maryland PSC order regarding our proposed initiative which we expect during the second quarter.

This month we announced the close of Criterion a 70 MW wind project located in Western Maryland. The project is expected to cost about $140 million and will be constructed and owned by Constellation. This project includes the 20 year power purchase agreement with the Old Dominion Electric Cooperative for energy and renewable energy credits produced by the wind facility.

This facility adds to Constellation’s growing clean energy portfolio which now includes about 1,000 MW of renewable power generation owned or under contract from sources including solar, hydro, geothermal, and biomass, in addition to the 3,800 MW of clean nuclear energy that we operate.

Also this month we announced an agreement with Navasota holdings to purchase two combined cycle gas plants in Texas for $365 million the equivalent of $332 per KW roughly one third the price of new construction. We view this acquisition as an important first step in our strategy of acquiring attractively priced generating assets in regions where new energies load obligations exceed our physical generation capacity.

Let’s turn to slide five where I’ll speak more about the details of this transaction. The Navasota transaction includes the purchase of two efficient clean natural gas assets, Colorado Bend and Quail Run. Taking advantage of a very favorable entry point in the asset economic cycle this transaction provides an opportunity to reestablish a physical generation footprint in an attractive market. The transaction includes two 550 MW facilities that commenced operation in 2007 and 2008.

The Colorado Bend plant is located in the Houston Zone, ERCOT’s premium priced zone. The Quail Run plant is located in the West Zone near Odessa, Texas an area where substantial ancillary services are needed to manage reliability given the regions significant wind build out.

On a stand along basis we expect this transaction to yield an attractive un-levered rate of return that is based on today’s curves within our 8% to 10% target range. Jack will speak to the details of these assumptions that factored into calculating these returns.

This acquisition will also support our retail and wholesale load serving activities in ERCOT reducing our net load position by approximately 21% in 2011. These dispatchable units will provide a risk management benefit to our NewEnergy business in Texas, helping us manage and mitigate risk associated with energy price spikes and providing valuable ancillary services for our load business.

Each plant has a 275 MW expansion in the advanced development stage while currently not economic this option provides with the long term capability to develop additional capacity in ERCOT and further balance Constellation’s generation capacity and new energy load obligations in that region.

If you’d turn to slide six. As we discussed throughout 2009, lower total energy demand, idle industrial capacity and reduced commercial activity contributed to overall economic weakness and in turn lower power prices. Over the first quarter 2010 forward natural gas prices continued to decline despite some strength in prompt gas, owing to the potential for increased supply from expanding shale gas production in L&G imports.

Forward power prices dropped during the quarter by a greater rate than natural gas as forward heat rates contracted due to forecasts for continued low energy demand, weak industrial recovery, and market transformation programs such as demand side management and smart grid technology. Forward dark spread for typical contracts also fell during this period to levels below break even economics as the price of coal was supported by increased overseas demand for different types of coal. We view this to be a temporary phenomenon that will not be sustained over the longer term.

Constellation’s fully hedged profile in 2010 helps reduce the impact of the lower commodity price environment on our earnings and cash flows. As we look ahead to 2012 Constellation is approximately 46% hedged with many of these hedges struck significantly above current market prices.

Let’s now turn to slide seven to discuss some of the market fundamentals that we’re seeing that could spur such a recovery in commodity prices. Within our five year planning horizon, we see forces that may help return energy demand and reserve margins to 2006 and 2007 levels. Increasing estimates for GDP and industrial production suggest that load growth will resume.

On a regional basis we have seen the most improvements in load and highly industrial regions such as the Midwest and ERCOT. In these regions the industrial recovery has helped pull overall consumption higher. On the supply side, the downturn in power demand and prices will likely forestall new investment in generation and transmission, for example projects like path and lead to a tightening of reserve margins as load demand increases.

Also, the volume of new renewable energy being added to the grid is depressing forward prices but also spurring greater intermittency and spot market volatility. This is driving our focus on gas fire generation with cycling capabilities becoming increasingly valuable. Offsetting these supply increases is the probability of more coal fire plant retirements due to age and negative economic returns and over the longer term, pollution control requirements and regulatory and other legislative mandates. Some forecasts contemplate more than 22 GW of retirements over the next decade.

Although the current commodity price environment is challenging, looking forward our industry is on the cusp of great change and for those companies with the right strategy we believe there is robust financial potential. Policy, economics, technology, and the potential for tougher environmental standards are combining to shift the long term supply and demand fundamentals of our industry. These are changes we welcome and are prepared to meet through our near term generation acquisition strategy and our longer term pursuit of new nuclear.

Before I turn it over to Jack, let’s turn to slide eight to review our investment thesis. Our NewEnergy segment is a leading supplier of electricity and gas to more than 30,000 customers across the country. We are leveraging our existing customer relationships to cross sell energy products and solutions to further meet their energy management needs, providing us with new sources of revenues.

We are also piloting residential retail offerings in markets where the existing headroom supports customer switching. The current low commodity price environment has reduced the NewEnergy segments contingent and other capital requirements which means that we are able to grow new business volumes without a significant impact on current balance sheet and liquidity profile.

This segment will help offset the negative impact of lower commodity prices on our Generation segments earnings. Additionally, since NewEnergy is the segment with the higher return on equity the associated earnings and cash flow growth will also play an important role in sustaining our FFO levels and insulating our credit metrics.

Over the longer term, as power prices rebound, we will expect the contingent and other capital requirements of NewEnergy to increase, maintaining and growing volume levels in a higher priced environment is dependent upon more efficient capital means to hedge the business. In a higher priced environment physical generation provides a collaterally efficient hedge to the load business. The long term roll generation plays in sustaining our NewEnergy business is one reason why acquiring additional generating assets in the current environment is a high priority.

To this end we still have a sizeable excess cash balance earmarked for asset acquisitions at attractive values even after announcing plans to develop a solar facility at Mout Saint Mary’s University and established incremental $90 million fund to develop other solar projects, construct our Criterion wind project in Western Maryland and acquire the Navasota plants in Texas.

Near term, these investments strengthen the company from capital standpoint and longer term these investments position Constellation to benefit from any commodity price recovery.

At our regulated utility we remain focused on meeting our customer’s needs for better reliability, efficiency in managing their energy bills. We have increased our capital spend programs at the utility in order to meet these needs. These planned investments will grow the utilities rate base and should provide a reasonable rate of return to drive improved BGE earnings.

Finally, through our UniStar partnership we continue to advance the development of new nuclear unit at Calvert Cliffs, another key milestone lies ahead as we wait the OE’s decision on who will be provided with the Federal loan guarantee. Being able to lever the project with a DOE loan guarantee and limiting our exposure to cost overruns and delays should result in attractive risk adjusted returns for our shareholders. These factors, among others, are essential to future decisions to build the plant.

With that I’ll turn the presentation over to Jack Thayer to review the financial results.

Jack Thayer

Turning to slide 10 I’ll review our financials for this first quarter 2010. Backing out one time special items our first quarter adjusted earnings were $1.43 per share. Strong performances by each of our core business operations contributed to these positive results. As Mayo mentioned, our GAAP earnings for the first quarter 2010 were $0.95 per share. During the quarter we recognized special items of $0.48 per share. Details of these items can be found on slide 16 in the additional modeling section.

BGE recorded adjusted earnings of $0.32 per share for the first quarter 2010 as compared to $0.41 per share for the first quarter of 2009. As you may know, BGE records approximately half of its annual earnings in the first quarter of any given year on account of the seasonal demand for natural gas and electricity.

The decrease in earnings per share as compared to the first quarter 2009 is largely attributable to the effects of the winter storms endured in the Mid Atlantic region, as record snow storms blankets this area, causing outages and line damage which BGE employees worked around the clock to restore. Costs related to storms in the first quarter 2010 were approximately $0.06 higher than for the same period in 2009.

Our Generation segment reported adjusted earnings of $0.44 per share down $0.04 as compared to adjusted earnings of $0.48 in the first quarter of 2009. Given that we are fully hedged in 2010 the quarter’s decline in spot prices did not have a material impact on our first quarter earnings. Rather, the decrease in earnings per share as compared to the first quarter 2009 is related to the sale of 50% of our nuclear assets to EDF, partially offset by lower interest expenses due to the retirement of the EDF preferred stock in conjunction with the close of the sale.

Our NewEnergy segment operations reported adjusted earnings of $0.54 per share in 2010 as compared to the adjusted loss of $0.15 for the first quarter 2009. This favorable year on year quarterly variance is primarily driven by costs related to de-risking our business in 2009 and improved retail power margins during 2010. Also captured in our NewEnergy segment is the positive impact of the Novation contracts related to our legacy UK coal and freight business.

These novations resulted in bringing forward into the first quarter approximately $0.19 of non-cash earnings. This is expected to be offset later in 2010 by non-cash losses associated with other contract novations. We do not expect any further material novations or contribution related to our legacy UK coal and freight business to occur.

Finally, our in the money PPA with our CENG joint venture contributed $0.13 to our first quarter 2010 adjusted earnings.

Turning to slide 11. As Mayo discussed earlier, during the quarter we announced our acquisition of two combined cycle plants in Texas from Navasota holdings. This acquisition provides us with a strong physical generation foundation in Texas that will compliment our NewEnergy activities in the state. The price paid for the project was attractive; with an IRR well within our targeted range of 8% to 10% un-levered returns for generation acquisitions and with an implied multiple of approximately seven times mid cycle EBITDA before considering the benefits these plants offer our NewEnergy business.

These projected returns consider our modeling of the specific plants and our long term assumptions about the ERCOT market. Let me take a moment to describe some of these assumptions. Increasing wind generation in ERCOT will have a beneficial impact on combined cycle plants like Colorado Bend and Quail Run, as wind contributes to additional system variability going forward given the intermittency of the resource.

This should require the region to procure more ancillary services and the cycle plants more often during the high priced periods caused by wind fluctuation. Colorado Bend and Quail Run and both highly flexible plants and will benefit from both additional ancillary revenues and greater run time. Furthermore, by added these plans Constellation is reducing its exposure to costly super peak pricing in Texas, which exceeded $1,000 per MW hour during seven days in 2009 and 15 days in 2008.

ERCOT is one of the most price volatile and dynamic power markets. Texas is also one of the fastest growing states in the US where higher than average load growth is projected. However, the current commodity market and the lack of a capacity product means that new build economics will be challenging in Texas in the near future.

At the same time, Texas has one of the lowest reserve margins in the country currently 22% and its expected to decline to 10% by 2015 according to ERCOT’s estimates. Typically reserve margins falling below 15% is viewed as a new build signal. Accordingly we would expect to see longer term spark spread expansion required to support new build economics. Overall we’re excited about the transaction in Texas and it is one that we hope to replicate during this low commodity and asset price environment.

Let’s now turn to slide 12 to review our Generation fleet’s economics. This is a slide that’s likely familiar to most of you. It represents our generation earnings outlook providing an update on how changes in forward prices and hedging activity affects our Generation segments earnings. In 2010 our Generation fleet has been full hedged since the beginning of the year, thereby insulating it from the recent fall in spot and forward commodity prices during the first quarter.

As you’re all aware, during the first quarter, forward power prices across the country fell by a significant amount. In the regions where we own plants around the clock forward prices declined by approximately $7 to $9 per MWH. Moreover, the fall in power prices was not a company by a similar fall and coal prices resulting in tighter dark spreads and reductions in earnings projected to come from our open generation positions.

As we look forward to 2011 and 2012 although less hedged than in 2010 we still maintain high annual hedge percentages relative to our peers. Our hedge ratios are 74% and 46% in 2011 and 2012 respectively. Given the magnitude of the decline in commodity prices and the tightening of dark spreads the move during the quarter had a material impact on our Generation earnings outlook. Since the start of the year, for example, our forecast for 2011 Generation EBIT has fallen by approximately $110 million.

The impact of falling forward commodity prices is being felt by every company in our industry. However, our competitive business model with a strong NewEnergy business outlook is reducing the impact of declining prices on our overall earnings. As we’ve said in the past, our retail load serving business typically originates higher margins during troughs in the commodity cycle. Expanded margins and prospectively growing load volumes during periods of low power prices increases earnings at NewEnergy, helping insulate Constellation from trough periods in the power cycle.

Let’s now turn to slide 13 where I’ll discuss the business mix of our NewEnergy segment. As we discussed with you during our analyst day, our NewEnergy segment is a leading provider of load to retail and wholesale customers. However, in addition to selling more power and gas to customers we’re also focused on leveraging our customer relationships to cross sell our energy products and solutions increasing our share of our customer’s total energy spend.

Within our NewEnergy segment we have different activities, some of whose margins typically move with or counter to commodity price movements and some that are largely independent of moves and prices. Customer power and gas includes our retail and wholesale power and retail gas operations. These operations are counter cyclical to the broader commodity markets and currently represent the largest portion of our NewEnergy segment, accounting for approximately only 70% to 80% of the total business mix.

Our upstream gas business consists of six fields with proven reserves of approximately 280 bcf primarily located in the Woodford basin. These assets provide an effective hedge to approximately 30% of our overall gas needs in 2010. These assets are levered to a recovering commodity prices primarily gas, although these fields do also product some natural gas, liquids and crude oil. This also provides collaterally efficient means to offset the impact of changing gas prices on our Generation fleet. Currently these assets represent approximately 10% to 15% of NewEnergy’s total business mix.

Customer services and solutions provide large commercial, industrial and governmental customers with solutions such as energy efficiency, automated demand response, and behind the meter solar. We also provide products such as energy audits and service contracts tailored to meet the needs of residential and small commercial customers.

These activities offer services and provide benefits to customers through every stage in the commodity cycle and are therefore independent of commodity price movements. While we have plans to grow this segment as we increase our cross selling efforts to our customers, currently these activities represent a total of approximately 10% to 15% of NewEnergy’s total business mix.

Turning to slide 14, to review our earnings guidance. Let me conclude by reviewing our earnings guidance for 2010 and 2011. Our 2010 guidance range remains unchanged of $3.05 to $3.45 per share. We have, as Mayo mentioned at the start, lowered our 2011 guidance by $0.20 to $3.25 to $3.65 per share reflecting the $0.40 impact of lower commodity prices on our Generation fleet offset in part by $0.20 higher expected new energy earnings.

As you can see on this slide, using our new reporting framework, we’re able to provide you with our 2010 and 2011 guidance on a segment level basis, thereby allowing you to better understand the merits of our competitive business model where increasing NewEnergy earnings helps to offset declining Generation earnings.

Let me now take a moment and walk you through the 2010 and 2011 guidance by segment. After earning $0.80 on an adjusted basis in 2009 we are forecasting BGE to earn between $0.55 and $0.70 in 2010 the decrease is driven by higher O&M expenses as well as higher depreciation due to increased investment. In 2011 we expect to earn an adequate risk adjusted returns on an increasing investments in BGE infrastructure and smart energy programs.

On Generation segment earned $2.11 on an adjusted basis in 2009. In 2010 we expect the earnings contribution from this segment to decrease to a range of $1.05 to $1.20 per share, largely driven by the loss of earnings related to the sale of 50% of our nuclear assets. The lost earning, however, are partially offset by the $0.56 of benefit we received from our below market PPA with a nuclear joint venture. In 2011, as we discussed, declining power prices have negatively impacted this segment costing the segments earnings forecast to decline approximately $0.40 per share.

During 2009 our NewEnergy segment contributed $0.46 on an adjusted per share basis driven by lower volumes that were offset by higher margins on new business. In 2010 we expect this segment to contribute $0.80 to $0.95 of earnings with a continued roll off of lower margin contracts and increased cross selling opportunities.

In 2011 the retail and wholesale businesses are expected to continue their increasing earnings trend with the roll off of lower margin contracts, higher origination volumes and the realization of new retail business at the higher end of our margin expectation of $5.00 to $7.00 per MWH. For 2011 we expect NewEnergy to be between $1.20 and $1.40 per share up $0.20 from the range we showed you as of year end 2009.

As currently hedged in 2012 and beyond, Constellation’s earnings are increasingly leveraged to dark spreads and the right power prices. We show our exposures on the right side of the slide. In 2012 as PPAs roll off we, like many of our industry peers, are increasingly sensitive to power prices.

Let me now turn the time back to Mayo for some concluding comments.

Mayo Shattuck

Before turning the call over to questions let me conclude with just a few thoughts. The uncertainty of the current commodity environment weighs heavily on everyone on this call. We, however, see opportunity. We have built a company and a strategy with the flexibility to deal with all phases of the commodity cycle, weather and the troughs and harvesting value at the peaks. We are using our excess cash balances and financial stability to further transform Constellation into the leading customer focused merchant generation company. Our first quarter is an important step on the road to realizing this strategic vision.

With that, I’ll turn it over for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Dan Eggers – Credit Suisse

Dan Eggers – Credit Suisse

I was wondering if you could just elaborate a little bit more on the NewEnergy expansion. From what we saw at the analyst day, am I hearing that the volumes you guys expect to sell out of NewEnergy you’re going to go higher than the stable number you talked about before?

Jack Thayer

With respect to margins we continue to see them coming in at the high end of the $5.00 to $7.00 range. To your volumes comment, as you recall, in a declining price environment we have to reserve less collateral against perspective market stresses. In the current environment we see the opportunity to expand the volumes perceptively of the business we’re doing without any impact to the balance sheet or our available net liquidity.

Kathy Hyle

We’re very pleased with the business opportunities that we’ve seen this past quarter in particular the margin. Volumes, I believe we have in one of the modeling pages and you can see that we’re forecasting I believe 134 TWH of volume, pretty equally split between the retail and the wholesale business for 2010 and that’s pretty consistent with what we shared with you at analyst day.

Dan Eggers – Credit Suisse

We’re then assuming that, how much volume increase do you have based on the lower collateral obligations, does that mean that 134 is 150 or 160 or is it more small increments of increased volumes?

Kathy Hyle

For 2010 134 is what we think we’re going to do this year as you look out maybe you start thinking about 10 to 12 TWH increase as a range for 2011.

Dan Eggers – Credit Suisse

What are you guys seeing with the financial reform package coming through right now how it’s going to affect the trading and positioning around the NewEnergy business broadly and then within the specifics of the business.

Mayo Shattuck

You probably prefaced that correctly where it might be a little too early. It’s been a very, very dynamic week on that front. I think that the industry is still very much focused on the end user exemption language and the definition of major swaps, swap dealer and I think we believe that, that’s probably the most important issue; we believe that the intent is actually to have an end user exemption.

We continue to be very much involved in that debate with all constituencies and I think that the industry representatives EEI and others involved in this debate have really spent an enormous amount of productive effort making sure people understand what is an obviously complicated issue. We will not let up on that with the prospect obviously that there are amendments to come and there is a regulatory process and rule making process to come.

I think that it’s going to be important that all of us continue to focus on the intent and I think that we feel that the work done today is going to end up in a place where the industry falls largely under this end user exemption issue.

Dan Eggers – Credit Suisse

Any thoughts on when you expect to hear the DOE on the loan guarantee?

Mike Wallace

Our application with the DOE is complete now after months of interaction and complying with their requests for additional data and reviews. Further, our negotiations with DOE are now finished. The key step that we now await is approval by the DOE credit review board, that is the final step at DOE that’s required so that they can issue their commitment letter. We understand there’s also a White House review process underway as well. In summary, given all that we anticipate getting a DOE loan guarantee commitment letter in the next several weeks.

Operator

Your next question comes from Andrew Weisel – Macquarie

Andrew Weisel – Macquarie

The first question has to do with the volumes in NewEnergy it looks like they’ve actually, the projected volumes for this year have actually come down by about 5 TWH from the last update. Given the counter cyclical nature and the lower power prices why is that directionally going down and is that conservative?

Kathy Hyle

The volumes that we have in the 134 it’s just our current forecast and update and it contemplates whatever activities we’re seeing from the economic cycle and this mix of the business between our wholesale and our retail business. We feel very strong about what we’ve seen in the quarter with respect to new originated business from both a volume and more particularly from a margin standpoint and we feel pretty comfortable with what we’re presenting here today.

Andrew Weisel – Macquarie

About future asset acquisitions, obviously you can’t get too specific but should we think about the regional priorities based on where you’re most short load or is it more a matter of which regions are most appealing kind of in absolute terms?

Mayo Shattuck

Our objectives continue to be the same that we’ve expressed obviously an interest in the Northeast and Texas as being the places where we have the largest load obligations and the least amount of Generation capacity, in the case of Nepool none. We will continue to focus on both regions, those are the highest priorities. We think that during the course of the year there are going to be some opportunities that arise in those regions.

Andrew Weisel – Macquarie

2010 you’re basically fully hedged but for some reason it looks like the average hedge prices have come down by a couple percent. How does that work there just mathematically?

Jack Thayer

The answer to that question is quite simple. This is the amount for the remainder of the year whereas the prior estimate was for a full year so it’s really just the nature of hedges rolling off and impacting the averages.

Operator

Your next question comes from Greg Gordon – Morgan Stanley

Greg Gordon – Morgan Stanley

I jumped on a little bit late; I just heard the tail end of what you said your economic assumptions were for the acquisition of the Navasota plant. Can you review that again?

Jack Thayer

In terms of un-levered returns we’d expect to earn within our targeted range of 8% to 10% on a mid cycle EBITDA we believe we paid seven times EBITDA for the plant and that’s before you consider any of the insurance benefits or business support benefits of the plant for our ERCOT retail activities and wholesale activities.

Greg Gordon – Morgan Stanley

You’re basically assuming then that spark spreads rise from where they are now by $5.00 or $6.00 per MWH because right now it looks to me based on that math like you’re assuming a spark spread closer to $20 a MWH?

Jack Thayer

I think in looking at those plants it’s important not just to focus on actual spark spreads but also the ancillary services that these plants provide. They do offer the ability to respond quickly to the intermittency associated with wind. I think on a longer term perspective the fundamentals certainly support an increase in heat rates in ERCOT you’re seeing demand grow there that state is growing faster and participating in the economic recovery to a greater degree than many of the other states in the union.

We do see reserve margins there getting below that 15% threshold that does tend to signal new build responses and in ERCOT it’s going to have to show up in power prices as opposed to capacity that you would see in a market like PJM.

Greg Gordon – Morgan Stanley

There’s some combination of increases in heat rate and/or ancillary services that adds several dollars a MWH to revenue versus where the curve currently is?

Jack Thayer

That’s correct plus the capacity factor of the plants we would expect it to increase as reserve markets tighten.

Greg Gordon – Morgan Stanley

There’s a dynamic impact, reserve margins tighten, capacity utilization goes up, at the same time that you’re realized revenue per MWH goes up but clearly you can’t justify buying the plants at the price you paid if you assumed that current forward curves were accurate? Asked another way, what EBITDA multiples did you pay on 2011 cash flow if the current curve were to continue to be in place?

Jack Thayer

Your earlier comment about our anticipation of recovery that exceeds current forwards plus the impact on the expected capacity factors that the assets is what makes the acquisition economic. These assets are uniquely leveraged to a recovery particularly given the price we paid for the assets, the transaction is modestly dilutive in ’10 and ’11 and we’d expect it to be break even and accretive in ’12 and beyond.

Greg Gordon – Morgan Stanley

My understanding was these assets were on the market for some time and lots of different potential acquirers had an opportunity to look at them. It seems that your rationale for acquiring them makes sense to me but it doesn’t seem like there’s any secret sauce to this. Where do you see something different do you think or where do you have a different edge versus let’s say the dozen or other entities which had an opportunity to look at these assets?

Jack Thayer

There was an auction process with these assets so if that’s what you mean by being on the market for some period of time. Clearly we won an auction process. I would suggest the secret sauce is the relationship that these assets of forward from a risk management perspective our NewEnergy business so insulating us from the super peak power price exposures and allowing us to hedge those exposures with gas which is far less volatile than the $1,000 per MWH prices we tend to see with some frequency in Texas during low wind, high temperature periods.

Greg Gordon – Morgan Stanley

You basically bought yourself a heat rate cap on top of the assets working based on your economic assumptions you also bought yourself a heat rate cap for your retail business?

Jack Thayer

It certainly insulates or clips the super peak exposure that is uniquely sized in the ERCOT market given their willingness to let power prices send new build signals because they don’t have the capacity market.

Operator

Your next question comes from David Frank – Catapult

David Frank – Catapult

Do you have an estimate or could you provide us in percentage terms an estimate of NewEnergy’s your expected NewEnergy’s contributions to total earnings beyond 2011?

Jack Thayer

No. I think at this point given the time span between now and 2012 I don’t think that would be prudent given the open position we maintain and our expectations for a power price recovery.

David Frank – Catapult

When I look to slide eight you have a bullet you talked about participating in the development of new nuclear and your partnership with EDF. You have a little segment that talks about attractive assuming among other things you minimize your exposure to cost over runs and delays. Is this where maybe the hidden value in that put could come into play?

Mayo Shattuck

As we talked about on analyst day, there are a number of issues that we’ve been addressing for close to four years now with respect to knocking off the risk profile of building a new nuclear plant. Certainly one of the big hurdles right in front of us is the loan guarantee process and in fact there’s a little bit of good news in the week in the sense that there seems to be growing support for expanding the volumes underneath the loan guarantee program, hopefully that’ll manifest itself.

We have within the last month or so since analyst day just continued in the same path of developing processes to mitigate the other risks that we have associated with the project. Obviously cost over run is an issue that naturally we and our investors would be concerned about. We have a significant partner in all of this looking at the same economic issues and they have other broader aspirations and interests around the world with respect to the development of particularly the French nuclear industry. All of these things are in very active discussion at this point, as you might imagine this is a big year for new nuclear.

As we suggested last time we take all of these variables into account in very active discussions with our partner and as those unfold during the course of the year we’ll be as disclosive about that as we can be. I definitely would represent that this is sort of the big year as most of these major risks get consummated and mitigated if we’re to proceed.

Operator

Your next question comes from Paul Fremont – Jefferies

Paul Fremont – Jefferies

I’m confused on a number of fronts. You guys had an analyst meeting at the end of March in a commodity price environment that’s virtually identical to today but you chose to take down your guidance on the Generation side today rather than a month ago. Were you anticipating some improvement in the commodity prices between the analyst meeting and today or what was the logic there?

Jack Thayer

Clearly as we spoke to you and other analysts going into that meeting we acknowledged that prices had come down markedly during the quarter. As you know, we maintain an active investor calendar and so it was no secret that there was going to be some impact on perspective 2011 and beyond earnings if we marked to current market.

With respect to the focus of that analyst day it was very much on the new segment outlook and we didn’t want to distract from the focus on the segment reporting and the fundamentals of the business by marking our earnings to market. With respect to what we’ve seen in power prices, we certainly gave you the detail and transparency to make your own assumptions in your models with respect to what the impact could be if you mark those earnings to market. I think we’ve been probably somewhat progressive relative to peers in the industry in acknowledging what the impact of the current forward markets will be on our 2011 earnings relative to peers and beyond.

The final point I’d make is while we knew where prices were going to be given that the forwards you see are March 23rd, since that point if you were to market the end of April here we’ve seen a modest recovery from that period of somewhere between 4% and 8% in 2011 if you look at PGM and New York pricings. I don’t know that I would characterize our analyst day and the decision to reduce guidance here today as being addressed in a way that you perhaps described.

Paul Fremont – Jefferies

The second area of confusion for me is you’ve talked about multiple of EBITDA in mid cycle. What you haven’t said is what should we expect is the EBITDA of the Texas plants. I think our own calculations were coming out somewhere in the $10 million range is that a reasonable assumption to use for EBITDA contribution in ’11 or are you coming up with something materially different?

Jack Thayer

I think it’s fair to say that with respect to those assets we’ve given you the heat rate, you know the capacity factors that they’ve been running and you can make your own assumptions around what the contributions from those specific assets will be in 2010 and 2011. I did comment earlier that the acquisition is modestly dilutive to ’10 and ’11 EPS and becomes break even to accretive in ’12 and beyond.

Paul Fremont – Jefferies

Are the Texas assets included in the non-nuclear generation earnings outlook statistics or are they excluded from that?

Jack Thayer

They are not in there as we have not closed on the acquisition yet.

Paul Fremont – Jefferies

Back at the analysts day the numbers that you provided I think had a return on cash assumption of 1.75% pre-tax is that assumption still what we should assume is baked into your guidance numbers?

Jack Thayer

Basically we used one year Libor strip to calculate the returns on the cash. I don’t think there’s been any meaningful news in Libor in that one year strip period.

Operator

Your last question comes from Reza Hatefi – Decade Capital

Reza Hatefi – Decade Capital

Could you expand, talk a little bit more about the increase in guidance at NewEnergy in 2011 I guess it was a $0.20 increase and what drove that?

Jack Thayer

The short answer is higher than anticipated margins on new originated business and renewal business as well as expectations to grow other aspects of our NewEnergy business.

Reza Hatefi – Decade Capital

Is the new guidance envisioning more volume in there than your prior guidance?

Jack Thayer

For 2011 it’s contemplated, as Kathy Hyle mentioned approximately 10 to 12 TWH of volume growth.

Reza Hatefi – Decade Capital

You mean 10 to 12 TWH of volume growth versus your prior guidance or just versus 2010?

Jack Thayer

Versus 2010.

Reza Hatefi – Decade Capital

How about versus your prior 2011 guidance? Are you now seeing more volumes and that was the main driver of the $0.20 increase in guidance or is it that you signed some great deals recently that you’re now embedding in that guidance?

Jack Thayer

It’s entirely related with the decline in power prices that we’ve seen the collateral we have to reserve against stress scenarios is smaller on a per unit basis which allows us to with our current available liquidity and balance sheet to do a higher volume of business.

Reza Hatefi – Decade Capital

I’m looking at slide 28, I noticed that for example in 2013 your non-nuclear plants are hedged 25% and then on slide 14 the total coal volumes are 14.8 TWH and gas/oil is 2.1 TWH. Seems like the total Generation volumes are lower in 2013 versus your analyst day slides but yet your hedged percentages are also lower, it’s now 25% it was 29% at the analyst day. The analyst day also had higher volumes. Could you explain what happened there, I would have thought the hedge percentage would have gone up with lower volumes?

Jack Thayer

The reality is once you get out to 2013 there’s not a liquid market. So to the extent that we’re taking actions to forward hedge our fossil generation further out the curve generally that’s done in the PGM market through gas as well as some longer term wholesale obligations. Given the time and duration between now and then we would expect obviously these numbers to change meaningfully each quarter in every year up through 2013 given the normal cadence of hedging in our business.

Reza Hatefi – Decade Capital

It’s like mixed products of hedges and that’s why that number moves around?

Jack Thayer

If you think about how we hedge the business the bulk of it is through our NewEnergy business with 18 month customer contracts. If you think about a normal hedging profile we’re hedging our fleet roughly 2.5% each month going through the year in the forward year. That relationship decreases as you get further out the curve given there’s no liquid market really and you have to use proxies to hedge the fleet based on a macro outlook for power prices out the curve.

Reza Hatefi – Decade Capital

None of the hedges were monetized or anything like that.

Jack Thayer

No. Its just normal course hedge management of the fleet on a current year plus three basis.

Mayo Shattuck

Thank you all very much for attending this morning and we will see you next quarter.

Operator

This does conclude today’s conference. Thank you for attending. You may disconnect at this time.

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