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Executives

Dennis Barber – VP, IR

Mark Jacobs – President and CEO

Rick Dobson – EVP and CFO

Analysts

Dan Eggers – Credit Suisse

Lasan Johong – RBC Capital Markets

Brandon Blossman – Tudor, Pickering

Angie Storozynski – Macquarie

Matt Milam – Seneca Capital

Gregg Orrill – Barclays Capital

Ameet Thakkar – Bank of America

Brian Russo – Ladenburg Thalmann

Jeffrey Coviello – Duquesne Capital

Julien Dumoulin-Smith – UBS

Jeff Gildersleeve – Millennium Partners

RRI Energy, Inc. (RRI) Q2 2010 Earnings Call Transcript July 30, 2010 8:30 AM ET

Operator

Welcome to the RRI Energy's second quarter 2010 earnings conference call. My name is Sandra, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Mr. Dennis Barber. Mr. Barber, you may begin.

Dennis Barber

Good morning, and welcome to RRI Energy's second quarter conference call. Leading the call this morning are Mark Jacobs, president and CEO; and, Rick Dobson, our chief financial officer. Following our prepared remarks, we'll have a question-and-answer session. The earnings release as well as the slide presentation we are using today is available on our Web site at www.rrienergy.com in the Investor Relations section. A replay of this call will also be available on the Web site approximately two hours after the call.

Consistent with our past practice, we're using several non-GAAP measures to provide additional insight into the operating results. Reconciliations for the non-GAAP measures to GAAP figures are available on the Web site. One of the items we adjusted for this quarter was merger related costs associated with our proposed merger with Mirant Corporation. As we previously indicated, we're not updating the 2010 or 2011 outlook in light of our pending merger with Mirant, and do not expect to do so until after the transaction is closed.

I would remind you that the principal near term drivers of our open and adjusted EBITDA are commodity prices. We have provided some commodity price sensitivities that allow you to generally understand the impact commodity price changes would have on the outlook.

Turning to slides two of the presentation, all projections or forward-looking statements we make today, including about the proposed merger with Mirant, are based on our current expectations and involved risks, assumptions, and uncertainties. These statements are subject to the Safe Harbors contained in this slide. Actual results may differ materially from our projections or forward-looking statements as a result of many factors, including those described in this slide and in our SEC filings. The Safe Harbors in slide three describe how you may obtain copies of the SEC filed materials related to the proposed merger. Information regarding persons who may be participants in the merger solicitation is also described in the slide. We urge you to read all these Safe Harbors and the referenced materials.

I'll now turn it over to Mark.

Mark Jacobs

Thank you, Dennis, and good morning, everyone. Welcome to our second quarter earnings call. This morning, we released our Q2 2010 results, which are summarized on slide five. We reported open EBITDA of $4 million, and breakeven adjusted EBITDA. For the first six- months of the year, open EBITDA was $29 million and adjusted EBITDA was $32 million. Each of these figures was up versus 2009. Rick will take you through the results in more detail, including comments on free cash flow.

The headlines are that progress against our 2010 initiatives is largely on track despite a challenging commodity price in economic environment, although there are reasons for cautious optimism.

On slide six, I'll cover the highlights of the quarter. Without question, the most significant event was our announced merger with Mirant to form GenOn Energy. Before updating you on the merger, there are several other topics that I wanted to touch on.

As you know, capacity revenue provides an important source of predictable base earnings for our fleet. And we have (inaudible) comes from energy margin. In May, PGM conducted the RPM capacity auction for planning year 2013. You will recall the planning year 2013 covers seven months of calendar year 2013 and five months of calendar year 2014. We bid roughly 7,500 megawatts into the auction and cleared 94% of what we bid. As with the previous RPM auction, several of the eastern zones cleared at significantly higher prices than RTO.

In terms of our results, we cleared more than 4,300 megawatts in Eastern Mac and Mac; had a weighted average price of $231 per megawatt day and over 2,700 RTO megawatts at $28 per megawatt day. In aggregate, the RPM capacity market for planning year 2013 will provide $394 million of revenue. That represents the second highest revenue level we've cleared since the RPM model was implemented. Our forward book of capacity and PPA revenue now stands in excess of $1.6 billion from 2011 through 2014.

As you will recall, we previously implemented a modest hedging program for 2010 and 2011 with the objective of being free cash flow breakeven or better irrespective of market conditions. The hedges have performed as we expected them to. And we remain on track to deliver these results. We've also taken a first step towards hedging in 2012, with a modest guest hedge that Rick will discuss in more detail.

Turning to the Cheswick scrubber, we completed the tie-in of the scrubber last month. And it's fully operational. With its completion, about half of our coal-generated megawatt hours come from scrub plants.

On slide seven, I wanted to provide you an update on the merger with Mirant. There are three significant steps to get the transaction closed, regulatory approvals, financing, and shareholder approval. In terms of regulatory approvals, we're complete with the New York Public Service Commission. With respect to FERC, the comment period lapsed on June 17th without any material comments. We expect approval in the near term.

I'm sure most of you saw our announcement a couple of weeks ago that we received a second request related to the Hart-Scott-Rodino clearance. We'll continue to fully cooperate with the Department of Justice in its review of the transaction. And we're not aware of any material issues.

On the financing front, we've made good progress. To remind you between Mirant and RRI, there's approximately $1.8 billion of debt we intend to address prior to closing as well as replacing our respective revolving credit arrangements with the new facility. We have obtained commitments for our lead lenders for a new revolving credit facility. Our current working assumption is that we'll have a $500 million secured term loan and $1.4 billion of unsecured bonds of the GenOn current level. We remain confident that we can complete the financing in a timely fashion.

With regard to shareholder approval, we filed a preliminary joint proxy statement with the SEC on May 28. We filed an amendment to that document on July 6th in response to comments we received from the SEC. And I expect that we'll file another amendment to the S4 in the next couple of weeks in response to second round comments. Once we're completed with the SEC comment process, we'll set a date for a special meeting, and may have a proxy statement to shareholders. The bottom line is that we're on track to close the transaction by the end of the year.

On slide eight, I wanted to update you on the merger integration efforts. Bill Holden from Mirant, and I, co-chaired the integration team. The full integration team meets weekly in person and has made excellent progress. We completed all of the GenOn personnel decisions within 60 days of the transaction announcement.

We've also completed a function-by-function cost rollout for GenOn. Completion of these two steps gives us a very high confidence level in our ability to deliver $150 million of corporate support in G&A cost savings in a timely manner. The integration team is also focused on day one integration issues so that we're able to operate seamlessly once the transaction is closed. Longer term, we're building GenOn with the best operating practice for each of Mirant and RRI Energy, which I believe will yield additional bottom line results over time.

Before turning the call over to Rick, I wanted to touch on the external landscape on slide nine. Market fundamentals continue to be challenging, but have shown some signs of improvement. Forward gas-coal spreads continue to soften having declined from the beginning of the year, driven by weaker natural gas prices and coal prices that have remained essentially flat, whether adjusted US power demand has grown over the past year nearing increased economic activity.

In our regions, the bounce back in MISO in western parts of PJM has been most notable. Forward heat rates in PJM and MISO declined earlier in the year, hitting a low point around the end of Q1. More recently, forward cursor heat rates and off-peak power prices have strengthened significantly. Added to that, the hot weather in the Eastern US during late June and July has showed up a day ahead in real time markets and provided a good start to Q3.

The regulatory and political front has been active of late. Nine days ago, the president signed financial reform legislation into law. While the legislation was aimed at the financial industry, it could have some impacts on the power industry, most notably in the area of derivatives clearing and settlement. Most of RRI's derivative activities cleared on an exchange. And we don't see a material near term impact on our business from the legislation.

Over the last several years, I've discussed my belief that we'll see increasingly stringent environmental regulations over time. In July, the EPA published its replacement for care, the transport rule, for comments, with plans to finalize the rule in 2011. The new rule is consistent with our expectations of a cap-and-trade approach. And it includes incentives to retire older uncontrolled coal units.

As you're well aware, the EPA has several other proceedings underway that will impact the economics of operating coal plants. Those include hazardous air pollutants, national ambient air quality standards, and coal combustion by-products. Most of these are pointed at mid-decade compliance. The effect of new more stringent environmental rules, if implemented, is that many older coal units without emission controls will likely be retired. In fact, we've already seen several companies announced plans to retire units. And I expect that list will grow considerably over the next couple of years. To be clear, some of our plants will likely be on that list as well.

Several of you are now asking questions about what I describe as the next order effect, what those retirements will mean for the economics of our business. The first point is that we're not talking about a small amount of capacity. Nationwide, we believe that new environmental regulations could lead to the retirement of 40 gigawatts of capacity. And if combined with compressed gas-coal spreads that we have today, the number could be as high as 90 gigawatts.

Retirements of anywhere near this magnitude of the nation's generation supply would have to be managed carefully to ensure system reliability. However, the key point is that retirements could lead to significantly tighter supply demand conditions over time, which in turn would lead to higher capacity and energy prices.

The second point is it would have a material impact on the commodities the industry uses as fuel. Retirements at the upper-ended range I mentioned would translate into an additional 8-plus Bcf per day of demand for natural gas. At the same time, demand for thermal coal will decline by roughly by 175 million tons per year. These changes in the relative demand for gas and coal would likely result in higher gas-coal spreads that we're seeing today. The bottom line is that the industry retirement of marginal coal plants would likely lead to improved economics for the assets that remain in the stack.

I'll now turn the coal over to Rick Dobson.

Rick Dobson

Thank you, Mark. Let's turn to slide 11 and talk about the key takeaways for the second quarter. Our open EBITDA was $4 million in the second quarter of 2010, a $14 million improvement over 2009. This improvement was driven by increases in open energy gross margin as a result of better economic conditions and warmer weather. Increases in PJM capacity is better reflected in other margin and lower adjusted G&A as our alignment to a pure merchant generator platform was completed in the latter half of 2009.

As we talked about in prior periods, the 2010 outage schedule called for a higher level of outage work this year. And this is the key driver behind our increased O&M spending of $28 million and the partial offset to the improvements previously discussed.

Our 2010 adjusted EBITDA was slightly less that our open EBITDA as our hedges and other items were a small negative in the second quarter. Our 2010 coal procurement was at prices substantially below 2009, accounting for the vast majority of the $65 million positive variance in hedges relative to 2009.

Moving on to free cash flow, as many of you know, our second quarter is generally a low point in our business as much of our outage spending and cash interest payments occur during this period. But that being the case, we used $85 million of cash year-to-date in 2010 versus $147 million in 2009. The year-over-year improvement was primarily as a result of lower environmental expenditures with the completion of the Cheswick scrubber and improved adjusted EBITDA previously discussed.

Let's turn to slide 12, where we illustrate our effectiveness and efficiency metrics year-to-date through June. At this point in the year, these metrics are influenced by the significance of our planned outage schedule, which typically occurs in the late first quarter to mid-second quarter, and by events outside of expectations. Year-to-date, we saw a TMCF performance below 2009, with efficiency measures roughly equivalent to what we saw in 2009.

So let me touch on a couple of high-level explanations. We completed significant plant and maintenance outage work principally in our Portland and Cheswick stations, and we also tied in the Cheswick scrubber in the second quarter. The significant outage work, along with plant performance that was modestly below expectations, was the primary catalysts behind our lower TMCF year-to-date. We have taken actions that we expect to yield improved results in the third quarter where we capture the majority of our margin.

Let's now review slide 13. As you will recall, we implemented a hedging program for 2010 and 2011 designed to deliver free cash flow to break even or better as a means of protecting our existing cash position. We have made no material changes to this hedge profile. We also have staff that will review hedging for 2012 during the 2010 time period. With that being said, in the second quarter of this year, we purchased 12 Bcf of $5 per MMB-2 natural gas put options to protect against downside price exposure and sold 12 Bcf of $8 per MMB-2 natural gas coal options to offset a substantial portion of the put option costs while leading material upside price appreciation.

As you know, our coal fleet experiences have open energy gross margin changes of approximately $100 million for every $1 for MMB-2 change in gas price. This 12 Bcf hedge represents about 12% of our coal fleet's gas price exposure or 7% of our PJM coal fleet total generation. I would expect, as we move into the hedging program, that we will use other tools to mitigate downside price risk. The combination of our hedging program, balance sheet philosophy, and solid liquidity profile leaves us well-positioned to create long term shareholder value.

With that, let me turn it back to Mark to wrap.

Mark Jacobs

Thanks, Rick. Let me conclude my comments on slide 14. Our business is highly leveraged to a commodity price and economic recovery if the fundamental value proposition in any merchant power stock. Our focus is on creating value to the things that we can control. The merger with Mirant creates near term value through a corporate support in G&A cost savings, value that is within our control, value that can be delivered irrespective of the direction of commodity prices. At the same time, the merger preserves the fundamental value proposition of a recovery in commodity prices and supply demand fundamentals. The bottom line is that GenOn will have increased efficiency and an improved long term position over either Mirant or RRI on a stand-alone basis.

With that, operator, let's open the line for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) The first question is from Dan Eggers from Credit Suisse. Please go ahead.

Dan Eggers – Credit Suisse

Hi. Good morning, guys. Can we talk a little bit about O&M in the quarter? I guess, with the Cheswick scrubber coming out. How much, on a run rate basis, was O&M higher because of the Cheswick environmental tie-in? And then how many days was it down or unavailable to affect the availability of the unit in the quarter?

Rick Dobson

Dan, it's Rick. The number I have between the tie-in and some additional boiler inspection work we did, we spent about $15 million more at Cheswick.

Dan Eggers – Credit Suisse

And how many?

Mark Jacobs

The outage was about 60 days.

Dan Eggers – Credit Suisse

Sixty days, okay. And I think coming into the year – I know you guys aren't giving guidance. But you're coming into the year, you guys had said I think O&M for generation somewhere in the – almost $570 million. Are you tracking along those levels of a higher number in the second quarter that was in that expectation? Or are you guys seeing more pressure than you thought coming into the year?

Mark Jacobs

Dan, it's Mark. Again, we are not – as we described, we're not going to provide an outlook or updated outlook here until the merger closes. But I will take you back to the outlook that we have provided at the beginning of the year. That did have about $30 million increase in O&M spending from 2009 to 2010. That was really aimed at – planned out as expenses. As Rick described in his prepared comments, the delta in Q2 2010 versus Q2 2009 was really almost entirely funded out in spending.

Dan Eggers – Credit Suisse

Do you have no surprises so far this year?

Mark Jacobs

No.

Dan Eggers – Credit Suisse

Okay. And then I guess just on hedging doing a little more activity, can you share your thought process on hedging, your willingness to hedge ahead of the deal closing, and how that's tying into the philosophy that you and GenOn team have constructed?

Mark Jacobs

Sure. Well, until the transaction closes, we're operating the company in what's we believe in the best interest for our shareholders. And that's really a separate question from how will GenOn hedge prospectively. As we've discussed, in the type of commodity price environment we are managing, risk is a very high priority for us. We feel like it's important that we set the company offer position, the company – so that we're able to be free cash flow breakeven or better, irrespective of commodity price environments.

I don't want to be in a position where we're having to rely on raising external financing to make ends meet. And so, that's really been the driver between the hedging program that we put in place for 2010 and 2011. And as we discussed on our last couple of calls, we discussed that we were going to start looking at 2012.

One of the things in the construct that we've – the first step we've taken – and I would emphasized that it's a fairly small step that we've taken. But we try to do this in a way that gave us downside protection in the event that we see a decline in commodity prices, but also leaves us a lot of upside if we see improvements in the market.

Dan Eggers – Credit Suisse

And you guys see – have you locked in enough the hedges and capacity sales forward that '11 free cash flow has now been locked in to be least breakeven.

Mark Jacobs

Again, as Rick mentioned, with no changes to the '11 hedging profile in the quarter here, but the hedges we had put in place coming into the quarter were at a level that we believe will deliver those results irrespective of the commodity price environment.

Dan Eggers – Credit Suisse

Okay. Thank you, guys.

Operator

Thank you. The next question is from Lasan Johong from RBC Capital Markets. Please go ahead.

Lasan Johong – RBC Capital Markets

Thank you. Mark, if the 40-gigawatt trans-closure scenario comes through, are you suggesting that ROI has enough firepower left over that the economics of the company is at least neutral and potentially even better than neutral?

Mark Jacobs

Well, Lasan, what I would point out in the type of economic environment that we're in today, we have provided detail in our investor conference last summer. It's also included in our 10-K filings, where we put our different assets into tiers. And I would say that the tier that is most at risk is our territory assets. But the reality is in the type of gas-coal spread and supply demand fundamentals we have today, those assets are barely keeping their head above water.

And so, a lot of that depends on your commodity price assumptions going forward. But if we keep the same type of gas-coal spreads we have and if this new environmental regulations are enacted as scheduled, and if that would lead to the retirement to some of those units, from my standpoint that isn't going to result in a material erosion of earnings power against the market conditions we have today.

I think the more interesting point then is if you look at this from an industry-wide standpoint because certainly, RRI Energy is not the only company that has assets that are in this category. And you roll forward and say, "What would that mean to the industry conditions?" Your model of the industry, as I've said, I'm sure you've started to look at this. But our work would indicate that that would have a very meaningful impact on supply demand fundamentals. And if you looked at what happens to dispatch curves, what happens to capacity market curves in that scenario, it would be fairly significant positive effect for the remaining part of the fleet.

Lasan Johong – RBC Capital Markets

Okay. Then the next obvious question is that, obviously 40 gigawatts of new – of shutdown plants up to maybe 90 suggest that our reserve margins are tight and pretty dramatic. That means that construction of new gas lines or power plants ought to be within the next two or three years starting up. Are you at least starting to look at your options on where to build, what to build, and who to contract with and at what price?

Mark Jacobs

Lasan, as we described before, we have a very disciplined capital investment philosophy. And again, I think one of the challenges that we've seen in the power industry is that when you look at the economic recurrence from new build assets, they have tended to under earn cost of capital. That being said, I would say all of these, really, is going to be from my time standpoint – from a practical standpoint, timing standpoint after we close the merger with Mirant. So this is really going to be a question for the GenOn management team, for the GenOn Board of Directors going forward. And I know it's going to be something that will be – after we close the merger, we'll be in conversation with you about our strategy on that – exactly the topic.

Lasan Johong – RBC Capital Markets

But the forward curve is, as we all know, less than realistic. So would you be willing to say the – your acts going forward – action going forward would pretty much ignore forward curve fundamentals and look at more basic fundamentals reality as you would say?

Mark Jacobs

Well, I guess the way I would characterize it is certainly, the forward curve is an input into decisions like that. But it's not the only – it's not the only input in there. And certainly, I'd like to say that we all know that the forward curve is wrong, we just don't know by what direction and by how much. And certainly, fundamental – long term fundamental views that commodity prices and supply-demand fundamentals are very, very important decisions that would go into that analysis as well.

Lasan Johong – RBC Capital Markets

Okay, last question for me. After you've done your review of costs at the GenOn merger – after the merger, are you getting optimistic that there may be some more savings above and beyond the $150 million.

Mark Jacobs

Well, I'd say this, before we announced the merger, we had done a fair bit of work with our colleagues in Mirant in developing that $150 million synergy level. What we've done, since we've announced the merger and the integration efforts is really get a lot more granular with that. So what I would tell you today is we've done this detailed cost rollouts that really provides us a much more detailed blueprint of exactly how we're going to get the $150 million cost synergy.

So I had a high confidence level when we announced the transaction that we could achieve this. I would tell you today, my confidence level is even higher now that we've got that detailed roadmap in place. I also mentioned, Lasan, that we are committed to building GenOn with the best practices from each of Mirant's – and ROI. I'm sure that over time that that's going to resolve additional bottom line results. But we're not going to be announcing anything until we have a high confidence delivered. And I would really look until after the merger is closed for us to comeback as the GenOn leadership team and update you how we're doing against that $150 million and any other opportunities we may have found.

Lasan Johong – RBC Capital Markets

Thank you very much.

Operator

Thank you. The next question is from Brandon Blossman from Tudor, Pickering. Please go ahead.

Brandon Blossman – Tudor, Pickering

Good morning, guys.

Mark Jacobs

Good morning, Brandon.

Brandon Blossman – Tudor, Pickering

I guess let's hit coal hedging first. The 50% that you have on '11, is it safe to assume that around half of that is Seward?

Rick Dobson

Yes, Rick here, Brandon. As you know, that Seward has longer term fuel arrangements as is the Keystone-Konama [ph] relationship. So that would be a big chunk of what we have hedged in 2011.

Yes, Brandon, I don't have the exact numbers. I don't think it would be – I don't think it would be half. It would be a big portion. I don't think it'd be half. That would be – and further think of it – 3.6 (inaudible) generation comes off that. Yes, it would be less than that. But Dennis at Monaca [ph] drilled into the exact numbers for you to break down – 50% down.

Brandon Blossman – Tudor, Pickering

Okay. And as a follow-up to that, are you out in the market at all or thinking about being out in the market for '11 procurement?

Mark Jacobs

We are in the process of '11 procurement, I would expect, by sometime this fall, Brandon. We will have priced the balance of our – most of the balance of our expected 2011 burn.

Brandon Blossman – Tudor, Pickering

And are you willing to provide any color either on the rail or the coal side as far as what the market looks like and what reality is versus what we see in the forward curve and the spot prices.

Mark Jacobs

Yes. I think the general observation that I did in the prepared comments. Generally, we've seen the coal market being essentially flat from the beginning of the year.

Brandon Blossman – Tudor, Pickering

And that would be a bit divergent from what we're seeing in the prompt month price activity?

Mark Jacobs

Yes, again. We're getting into the contracting period now so I really can't comment specific on when those contracts are going to come out.

Brandon Blossman – Tudor, Pickering

Fair enough. And then secondly, merger savings, it sounds like you've completed your work. You've come out with $150 million in savings, which is essentially where you got it to before. Is there any upside there? You feel like $150 million is the floor and there's some potential for more?

Mark Jacobs

Well, I wouldn't characterize, Brandon. We completed our work. I'd say we've completed our planning. We have to execute against that now to actually achieve those savings once the merger is closed and that will be something that we're going to be very keenly focused on 2011, is the actions to deliver those savings.

You know, again as I mentioned to the previous question, I'm sure as we go through this and put the company together with the best operating practices from each, I'm sure we're going to find other opportunities that will drop to the bottom line. But until we can specifically identify those and have a high level of confidence that we're going to achieve those, I just don't feel like it's appropriate to get out in front of ourselves in announcing additional numbers.

So I would look for us to communicate to you after the merger is closed and we can give you then an update on how we're doing against the $150 and if we're finding additional opportunities on top of that.

Brandon Blossman – Tudor, Pickering

Okay. Thanks for that color.

Operator

The next question is from Angie Storozynski from Macquarie. Please go ahead.

Angie Storozynski – Macquarie

Thank you. I have two questions. The first one about the capacity auction, you mentioned the very good result of the latest auction. How do you see your company bidding into the next auction given the recent EPA regulations? Is there any thinking as to now going to be bidding the coal plants that are in this third group that you identified for emission – well for environmental retrofit. Any comments?

Rick Dobson

Yes, Angie. It's a great question. And as you know I can't comment specifically on bidding strategy and that auction is still nine and a half months away from where we are today. But clearly, we will be looking at is the environmental landscape continues to evolve. That auction will cover seven months in calendar year 2014 and five months in calendar year 2015. So it is getting into the period where we may see some of these additional environmental regulations kicking in.

So one of the things we've talked about is that, from our standpoint, very important to get clarity on those environmental rules and regulations so we can make good economic decisions. But clearly, however those rules play out or the additional clarity is absolutely going to be factored in as we make decisions about how we would bid those units into the next RPM auction.

Angie Storozynski – Macquarie

Okay. And one more question about the environmental CapEx. In the proxy statement, the projected CapEx for 2014 that Mirant's management included in the proxy for your company seems to be significantly above your projections, could you explain what's the reason for that for 2014?

Rick Dobson

Sure. Well, in connection with the discussions we had with Mirant, we provided each other a financial forecast. And as you would expect, we did a number of analyses with their figures as well as our figures that our board and our financial advisors evaluated.

The delta that you're talking about was an analysis that Mirant had done in connection with their evaluation of a combination with us, and it's really not appropriate for us to comment on the evaluation. That's really a question, I think, that's better directed towards the Mirant team.

Angie Storozynski – Macquarie

But it had – okay. I'll ask Mirant then. Thank you

Operator

Thank you. The next question is from Matt Milam from Seneca Capital. Please go ahead.

Matt Milam – Seneca Capital

Good morning, guys.

Mark Jacobs

Good morning, Matt.

Matt Milam – Seneca Capital

Mark, you mentioned the meaningful second order benefits from the contemplated clean air regulations, particularly that 20% reduction in coal demand and we've seen others publish similar analyses directionally. Is it fair to think about the 2014 EBITDA estimate in the proxy as a first pass to the magnitude of that or would that be upside to those numbers?

Mark Jacobs

Matt, as you know we are not going to be updating our earnings outlook until after the merger with Mirant is closed. The projections that you're referring to were once were included in our amended S-4 filing.

Just to give you a context, those were projections that were used by our respective boards of directors and financial advisors in evaluating the transaction with Mirant. They were based on forward curves as of March 16th and the S-4 has more information on some of the specific commodity price assumptions that were used in there. And I really can't comment any further on what's in that S-4, but let me make some general observations about our fleet.

As you know, our earnings are significantly implied by or significantly impacted by what changes in commodity prices. We've discussed in the past changes how those can impact the profitability of our fleet both through improved unit margins as well as generation volumes. And as you know, a good portion of our fleet, our mid-merit coal plants were expected generation volumes can fluctuate meaningfully with commodity price changes.

Matt Milam – Seneca Capital

Got you. Thank you.

Operator

Thank you. The next question is from Gregg Orrill from Barclays Capital. Please go ahead.

Gregg Orrill – Barclays Capital

Thanks very much. Just a general question about the environmental regulation coming down the pipe – the transport rule and the HAP rule and the best available control technology update, what do you think of the timing that you'll start to see some of these shut downs that you're talking about? Is it 2014 or what do you think of a decision-making timeline there?

Mark Jacobs

Greg, these decisions are driven by economics. We provided transparency at our investor conference last summer and in our 10-K filings regarding the tiering of assets and the types of environmental projects that we're likely to consider over time.

Today, each of these plants is providing a positive cash contribution and in some cases, we've modified the way we operate the units so that they can keep their head above water. And again, I'd go back to some of the conversations we've had with you in the past about the seasonal operating model we put in at New Castle as an example.

They also represent a nice option if we were to see gas-coal spreads expand. Now, the factor that's going to change the economics of those units is compliance dates with new environmental regulations, be they the transport rule that would be the cap in trade and require us to procure market-based emission allowance for those assets, or be it the HAP rule which is a maximum available control technology. That will really force the decision on our assessment there. But we're really – as I said, I would look for compliance dates of those environmental regulations to be the forcing decision on does it make sense to retire the unit, does it make sense to buy emission allowances to provide that or does it make sense to invest capital to reduce the emissions.

Gregg Orrill – Barclays Capital

Okay. Just one other quick one, it looked like commodity margin in the quarter was down in the west and other segments. Can you comment on that?

Mark Jacobs

Sure. In the west, as you know our fleet is largely an intermediate fleet. So 2Q, we generally don't get a lot of run hours and part of what you're going to see then in the other segment is our Indian River plant was under a PTA in 2009 that expired at the end of 2000 – expired at the end of 2009. Now, we did sign that unit up for summer deal so you're going to see some earnings contribution in that other segment in Q3.

Rick Dobson

Greg, prices out in the west were not nearly as volatile as they were in the prior year and the prior period. So yes, that was incorrectly interpreted. So the east was – all that warm weather hit the east, pretty fairly mild in the West.

Gregg Orrill – Barclays Capital

Okay. Thanks a lot.

Operator

The next question is from Ameet Thakkar from Bank of America. Please go ahead.

Ameet Thakkar – Bank of America

Good morning, guys.

Mark Jacobs

Good morning.

Ameet Thakkar – Bank of America

Hey Mark, you talked about 40 to 90-gigawatt hours of coal retirements and that it's based on more stringent environmental regulations. How should we think about as far as –- obviously, not all of that is going to shut down at once. Do you see a potential for some of your tier 2 and tier 3 plants being able to receive RMR payments in an interim period?

Mark Jacobs

Well, I think different companies are going to think about it differently, so we’ve already started to see announcements here. And actually, if you go and look over the last couple of months, the pace of announcements of retired units have started to accelerate. So you’ve got some companies that are already proactively making decisions to do that. I described, a little bit earlier, our philosophy which is as long as we can continue to operate an asset and get a positive cash contribution margin, we intend to do so. But I’m sure there’re others that would think about things similar.

So I think the forcing device again on the decision to retire units for a number folks is going to be compliance dates with new environmental regulations. And so that really depends on how the rule-making process at the EPA plays out and they've laid out a timetable for each of these rules. In my experience, that would probably a best case and, oftentimes, these proceedings get delayed beyond the target dates. But that’s the date I’d be looking for the retirements that are going to happen to occur.

And then in terms of RMR payments, one the comments – depending on how much retirements happen. I think that’s going to have to be managed very carefully here to ensure system reliability because when you take that amount of generation, if you just assume that that closed tomorrow, we would have real trouble from a system reliability and reserve margins would not be at a level that would be adequate to ensure system reliability. So I’m sure that there is, in many instances, will be whether there are RMR agreements or transmission upgrades that need to happen demand system reliability.

But I don’t think there’s any question. It would be a big challenge for the industry to retire that much capacity because you don’t have nearly that much capacity in the pipeline to replace it. And the other point, when you look at the current economic landscape it doesn’t really support our view, the construction of new generation assets today.

Ameet Thakkar – Bank of America

And then the incremental gas burn you referred to, is that a mixture of additional dispatch of existing gas assets and assumed construction of additional gas units to bridge that gap?

Mark Jacobs

Yes. We do a lot of different scenario modeling here, but in the scenario where you have that much generation that comes out, that’s exactly – yet really gas generation, in a large part, is going to fit – fill in the void of the coal generation that gets shut down. So that’s going to result in a lot of extra gas demand.

And that's 8 BCF a day, the figure I used in the prepared comments, if we are at the upper end of the retirement. That’s a pretty significant figures. As most of you know, the gas market is about a 60 BCF-a-day market. So we are talking about a number that’s 12%, 14% increase in the gas market; and similarly on the coal side, 175 million tons there out of 1.1 billion ton-a-year market. That’s 15% or so of the coal volume.

Ameet Thakkar – Bank of America

Thank you very much, Mark.

Operator

The next question is from Brian Russo from Ladenburg Thalmann. Please go ahead.

Brian Russo – Ladenburg Thalmann

Hi, good morning.

Mark Jacobs

Good morning.

Brian Russo – Ladenburg Thalmann

Most of my questions have been asked and answered but I just thought maybe you could just comment on some of the specific plant performance in the quarter and the generation volumes in terms of Seward. It looked like it was up fairly significantly and I would imagine some had outages a year ago. But maybe you can talk about some of the increased volumes that may have been driven by market conditions, maybe at the adjacent station versus some of the other changes, up – meaningful changes up or down here.

Mark Jacobs

Yes. Brian, you absolutely nailed it, which are the big drivers and the changes and the generation volumes from the plants are going to be principally associated with the plant outage schedule. And as we mentioned, we added more robust planned outage scheduling Q2 of this year. For the plants that did not have the outages, you're going to – that's going to show up as additional generation volume. And particularly, as we got into June and we started to see some more extreme weather, we got more generation hours of some of the mid-Mirant coal plants than we would traditionally see. That I'd say whether in your planned outages or your two big factors, they're going to drive those generation changes.

Brian Russo – Ladenburg Thalmann

And The Hunterstown CCGT volumes look like they were pretty big. Was that the result of warm weather in June?

Mark Jacobs

Yes, absolutely the result of warm weather. And again, with the continued compression in natural gas prices that combined cycle plants get more competitive with the mid-Mirant coal plants. So there's a little bit of that that you would see earlier in the quarter. But I'd say, as we got in to June, most of our units were running flat out. We had several days where a lot of the – even very high heat rate CTs and the point we're running.

Brian Russo – Ladenburg Thalmann

I would imagine that trend has continued into the third quarter.

Mark Jacobs

July has been – we've seen a lot of extreme weather. And again, a lot of the – when you look at the daily day-ahead PJM prices and MISO prices, big increases in those prices, and again a lot of generation volume that we've seen here from our – in the month of July.

Brian Russo – Ladenburg Thalmann

Okay. Great. Thank you very much.

Operator

Thank you. The next question is from Jeffrey Coviello from Duquesne Capital. Please go ahead.

Jeffrey Coviello – Duquesne Capital

Hi. Good morning. How are you?

Mark Jacobs

Good morning, Jeff.

Jeffrey Coviello – Duquesne Capital

I have a question on – another question on the O&M level. I guess that the increase this quarter was primarily from Cheswick and the merger related costs. And that's like you said – just to clarify, was best consistent with what you've expected for this year?

Mark Jacobs

Yes, let me – there are not any merger-related costs in the O&M figure. We've treated that as a special item. So that increase, Jeff, that you see is almost exclusively an increase in planned outages expense. And again, I go back to when we introduced our outlook at the beginning of the year, it had a pretty significant increase in O&M expense tied to planned O&M expenses.

And so, late Q1 and Q2 is when we do a big chunk of the planned outages here in the shoulder months so that we minimize the effect of loss margin while those plants are offline. So that's really what you're seeing. It's that plan that we've put in place at the beginning of the year come to fruition.

Rick Dobson

Hey, Jeff. And it was specifically primarily aimed at Portland and Cheswick. If you can compare year-over-year, you would see the bulk of that 28 explained by the two outages, there's a lot of boiler spend in those periods.

Jeffrey Coviello – Duquesne Capital

Got it. And the other follow-up question was – I know you're not giving any kind of forward outlook. But in the past, you've discussed this level of O&M being higher than what you'd expect going forward for 2011. Is that still consistent? Was it more planned out than you had intended than you would in a normal year?

Mark Jacobs

No, I don't think we described that this was a higher level in the past, Jeff. I think you're going to see O&M expenses. There's going to be a little bit of variation year-to-year because most of the significant co-units we're on are going to be on three or four-year outage cycles. So depending on how many units we're doing major planned outages on each year is going to get some variation to that O&M figure.

Jeffrey Coviello – Duquesne Capital

I got it. So then, if I look back in the fourth quarter – or fourth, '11 is lower it's because of those planned outages, but then it's going to fluctuate year-to-year going forward.

Mark Jacobs

Right.

Jeffrey Coviello – Duquesne Capital

Right. I got it. Thank you.

Operator

Thank you. The next question is from Julien Dumoulin-Smith from UBS. Please go ahead.

Julien Dumoulin-Smith – UBS

Hi. Good morning. Thank you.

Mark Jacobs

Julien?

Julien Dumoulin-Smith – UBS

Hi. A quick question with regards to the S-4 – amended S-4, again with regards to the $458 million in 2014. I know you addressed it previously. But I just wanted to make (inaudible) if you could address the year-on-year improvement from 2013. Is that basically at the end of the day a capacity factor improvement story?

Mark Jacobs

Julien, again, as I mentioned the numbers that are on that S-4 were based off projections that we shared with Mirant for evaluation of transaction. They were based off of commodity curves on March 16th. I'm not going to comment any further on those numbers because those are not our outlook. And again, I don't intend to make those an update as to the outlook.

But I would tell you is just – generally, if I go back to earnings drivers that we've talked about, the driver I played before, obviously, commodity prices have a big impact on our expected earnings level. Yet also, with our mid-Mirant coal plants, changes in commodity prices translate not only into higher unit margins, but can translate into a change in expected generation volumes.

Julien Dumoulin-Smith – UBS

All right. Great. And then secondly – and I don't mean to hammer the question a little bit too much, but looking at all the various regulations, is there any – I mean, from your vantage point, is there any ability to see any kind of merging or meshing of the various regulations at least to form some uniform time table at all? I mean is there any discussion on that, be it at the EPA or in DC, in terms of just trying to grasp all the issues at a single go, if you will?

Mark Jacobs

Well, in many cases, these are being driven by different factors in terms of the different role-making proceedings. I think a point that you're raising, which is something I believe that certainly the ISOs are starting to grab is that collectively addressing these issues in a comprehensive way, there's a lot of value in doing that. We talked a little bit earlier about the potential impact on reliability if all of these regulations force a sizeable shutdown in coal fleets. And we're really going to have to do this in a fairly thoughtful way.

My view of those conversations is just now starting to occur. But there is something to do because it's going to be a big challenge for the industry to manage through the time period of adding on all these additional environmental regulations. But doing it in a way where we don't compromise reliability.

Julien Dumoulin-Smith – UBS

Excellent. Thank you. Have a good day.

Mark Jacobs

Sandra, I think we'll take one more question.

Operator

Thank you. The last question will come from Jeff Gildersleeve from Millennium Partners. Please go ahead.

Jeff Gildersleeve – Millennium Partners

Thank you. Good morning.

Mark Jacobs

Good morning, Jeff.

Jeff Gildersleeve – Millennium Partners

I just wanted – as you've given the favorable environment in the credit markets, what's your flexibility about being opportunistic on timing related to the refinancings?

Rick Dobson

Well, Jeff. The initial focus for the team was to get the revolving credit facility commitments for that knocked down, which as I mentioned earlier, I'm pleased to report that we've completed that step. The next step in the process is for the syndication to go forward and to prepare for the underwriting. The team is looking at the market windows and being prepared for that. But really, beyond that I can't comment specifically on the timing here again until we're – launch a transaction, that will be next time that you're going to hear something about the financing and the timing.

Jeff Gildersleeve – Millennium Partners

Okay. But there's nothing through the approvals that's holding you back from doing something – you have flexibility to address that from now until the fall.

Rick Dobson

Well we – as you know, we have to complete the financing. That's one of the conditions to closing the merger and there are a number of procedural steps that you have to go through documentation-wise to prepare an offering of bonds in the term loans. And the team has been very busy at work on that in the last couple of months, again really with the goal of putting us in a position to – when we see an attractive window in the market, to be able to capitalize on it.

Jeff Gildersleeve – Millennium Partners

Great. Thank you.

Mark Jacobs

Well, thank you for your participation today. If you have further questions, please feel free to call Monica or myself later today. Have a great day. Thanks.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.

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