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Calpine Corporation (NYSE:CPN)

Q2 2014 Earnings Conference Call

August 01, 2014, 10:00 AM ET

Executives

Bryan Kimzey - Vice President, Investor Relations

Thad Hill - President and Chief Executive Officer

Steven Pruett - Chief Commercial Officer

Zamir Rauf - Executive Vice President and Chief Financial Officer

Thaddeus Miller - Executive Vice President, Chief Legal Officer and Secretary

Analysts

Neel Mitra - Tudor, Pickering, Holt

Michael Lapides - Goldman Sachs

Brian Chin - Merrill Lynch

Steven Fleishman - Wolfe Research

Stephen Byrd - Morgan Stanley

Julien Dumoulin-Smith - UBS

Angie Storozynski - Macquarie Capital

Gregg Orrill - Barclays

Jon Cohen - ISI Group

Ali Agha - SunTrust

Operator

Good morning, and welcome to the second quarter earnings call. My name is Brendan, and I'll be your operator for today. (Operator Instructions) And I will now turn it over to Mr. Bryan Kimzey, Vice President of Investor Relations. Mr. Kimzey, you may begin.

Bryan Kimzey

Thank you, operator, and good morning, everyone. I'd like to welcome you to Calpine's investor update conference call covering our second quarter 2014 results.

Today's call is being broadcast live over the phone and via webcast, which can be found on our website at www.calpine.com. You will find access to the webcast and a copy of the accompanying presentation materials in the Investor Relations section of our website.

Joining me for this morning's call are Thad Hill, our President and Chief Executive Officer; Steve Pruett, our Chief Commercial Officer; and Zamir Rauf, our Chief Financial Officer. In addition, Thad Miller, our Chief Legal Officer, is also with us to address any questions you may have on legal and regulatory issues.

Before we begin the presentation, I encourage all listeners to review the Safe Harbor Statement included on Slide 2 of the presentation, which explains the risks of forward-looking statements and the use of non-GAAP financial measures. For additional information, please refer to our most recent SEC filings, which are on file with the SEC and on Calpine's website.

Additionally, we would like to advise you that the statements made during this call are made as of this date, and listeners to any replay should understand that the passage of time by itself will diminish the quality of these statements. After our prepared remarks, we'll open the lines for questions. In the interest of time, each caller will be allowed one question and one follow-up only.

I'll now turn the call over to Thad, to lead our presentation.

Thad Hill

Thank you, Bryan, and good morning to all of you on the call. Thank you for your interest in Calpine and for your time this morning.

We are off to a strong start in 2014. Today, we are reporting adjusted EBITDA of $413 million for the second quarter. And even more importantly, we are reaffirming our full year guidance of $1.9 billion to $2.0 billion of adjusted EBITDA, $785 million to $885 million of adjusted free cash flow and $1.85 to $2.10 of adjusted free cash flow per share.

This guidance reaffirmation is the result of our solid operations both at the plants and commercially, and in spite of the Southeast asset sale and the extraordinarily mild weather experienced in the eastern two-thirds of the country so far this summer.

Operationally, we had no lost-time accidents this year and the fleet is operating very well. Commercially, we are announcing four new contracts, most notably a new 10-year contract with Southern California Edison for 225 megawatts, off of for the Geysers starting in 2017; as well as a contract in Wisconsin, off of the RockGen plant; and two others in Texas.

With the Southeast transaction now closed, we've already begun deploying the proceeds, having bought back $500 million of stock or approximately 5% of the company, since our last call and almost 20% cumulatively since the inception of the stock buyback program. More than $300 million of the repurchases since May were executed on an incremental authorization, which leaves us with $566 million of remaining authorization.

In addition, we are continuing to advance our accretive growth pipeline with the announcement of a new combined cycle gas turbine plant at our York site in PJM, which Steve Pruett will discuss in more detail.

In June, we also completed our expansions on the Houston Ship Channel, while Garrison remains on track for commercial operation by June of 2015. We are continuing to execute across the board strategically, financially and operationally, and as you will see on the following slide, we are committed to efficiently and expeditiously deploying our cash.

Turing to the next slide. I'd like to discuss our capital allocation progress and plans in more detail. Since our 2014 first quarter call, we have already committed more than $1 billion by investing in Calpine stock and improving our balance sheet and delivering accretive growth.

Nevertheless, by the end of 2014, before any other actions that we might take, we expect to have between $1.3 billion and $1.4 billion of excess cash remaining to deploy. As you know, we run our business as a cash business. We make all of our capital allocation decisions based on maximizing returns to equity, while being prudent with our balance sheet.

Over the last several years, our efforts have been fairly well-balanced. After accounting for debt and balance sheet management, roughly half of our available free cash flow has been returned to shareholders and about half is fund to growth through either M&A or construction.

Calpine produces very strong recurring free cash flow. And although any individual year may differ, based on opportunities that present themselves, over time we think the strong cash flow will enable us to continue to do both, return money to shareholders and grow, and to both in a balanced manner. Our most important financial metric is adjusted free cash flow per share and we will be relentlessly focused on making decisions to drive this growth.

As you can see, based on the midpoint of this year's guidance, we're on track to deliver a three-year CAGR of 25% adjusted free cash flow per share growth, demonstrating the value we've delivered through our capital allocation efforts along the way. Sometimes that means buying back stock, sometimes adding assets through development or M&A and sometimes selling assets like we did with the Southeast divestiture.

With that in mind, we have made significant progress since our last earnings call towards putting capital to work. Zamir will review these efforts in more detail. But at a high level, we've repurchased $0.5 billion of stock. We are investing nearly another $0.5 billion in restructuring our debt, creating balance sheet flexibility, while generating meaningful interest savings. And we're announcing new accretive growth with our combined cycle in PJM that holds true to our philosophy of investing only where there is a long-term contract or a discount to replacement cost.

As I mentioned, we have committed more than $1 billion and still expect to have $1.3 billion or so of excess cash available to us by the end of 2014. You can rest assured that we will reinvest in accretive growth or return it to shareholders. We are actively considering a range of options to deploy it, but we will be financially disciplined in our decision making with our goal of delivering adjusted free cash flow per share growth at the forefront.

On the next slide, I'd like to discuss three key messages that highlight what makes Calpine a good investment for you, our shareholders, or for that matter, for our own use of cash. They are: first, the fundamentals are strong and improving in our key markets; second, Calpine has been very active in managing our portfolio for growth and value, and we have a good pipeline of upcoming opportunities to deploy capital in attractive ways; third, unlike virtually every other competitor, the risk of lower gas price environment over the next couple of years does not threaten our business model, in fact it provides us opportunity.

So first, the fundamentals. Coming out of the polar vortex, there is real concern about the fragility of our bulk power electric system. One-half of one mild summer later, the concern has disappeared as forward power prices have come down, because of extremely weak price liquidation this summer.

The point here is that despite this recent lack of confidence, the physical reality is no different. The fundamentals and the regulatory environment are in the right place. Of our three major markets, not one of them to be less fragile three years from now. More fragility is more volatility, which our business is perfectly set up to capture.

As Steve, will discuss in some detail, our business in California is in fine shape and continue to do well with less exposure to the downside than has been reported. The fundamentals in Texas will march forward with strong load growth and further wind room volatility. In PJM, the fundamentals for gas plants will improve over the next three years with large retirements, the potential for very low sustained local gas prices and some modified market rules.

It is also worth noting that at a macro level FERC itself is increasingly focused on a new watch phrase for the industry, price formation. What this means is that out-of-market actions by independent system operators or states should not be allowed to interfere with the underlying economics of the energy markets, a constructive sign for power pricing.

While these fundamentals play out, we are very busy managing our portfolio and creating growth opportunities for our business. In last year we have completed an acquisition in Texas, sold the Southeast Six Pack, landed some important new contracts, completed the expansion of two power plants in Texas, maintained progress of our Garrison plant in Delaware, and today are announcing the new plant in Pennsylvania.

Over the next 12 months, we expect our vigorous pace to continue. M&A is always a possibility, but we will remain disciplined. From an organic growth standpoint, we have low dollar per kW expansion opportunities remaining in Texas. We are actively involved in some long-term contract discussions related to new construction. And on the Gulf Coast, we are pursuing cogeneration opportunities.

Not all of these projects will come to fruition, but some will. We have every intention of continuing to reinvest a large portion of the cash our business generates back into new opportunities, and we're constantly developing the pipeline.

Finally, let me remind you the resilience of the Calpine fleet in a low gas price environment. As you do, we have our views on natural gas, and we think there is room for prices to dip even further in 2015. But whether gas prices go up or down matters far more significantly to every other merchant generator or hybrid utility than to us.

We remain largely indifferent, because as gas prices go up or down, both our cost and revenues moves up or down. As you can see in the chart on the right, if our portfolio were completely unhedged, whether gas goes from $2 to $6 per MMBtu, there is only a plus or minus $100 million swing in margin across our unhedged portfolio. Notable, but relatively small compared to our 2014 guidance range of $1.9 billion to $2.0 billion of adjusted EBITDA.

This graph is what we call the Calpine smile. As gas moves below about $4 per MMBtu, our exposure to falling gas prices is mitigated, as we generate more megawatt hours, and therefore more margin. As gas rises above $4, we give up the incremental megawatt hours and we make more margin on the megawatt hours we produce, because we are among the most efficient generators and our margin is the gas price times the efficiency difference. Therefore, the higher the gas price, the higher the margin.

All-in-all, sustainable gas prices may actually be better for us. We believe that should gas price remain at or below current levels, there is an increased likelihood, particularly when combined with CSAPR rules and upcoming greenhouse gas rules, there will be another round of retirements for mothballs in Texas and the Mid-Atlantic.

Wrapping up on the following slide, I want to take a minute to recognize John Adams, our Executive Vice President of Power Operations, and his team, on the excellent work they're doing in operating our fleet this year. This slide shows that our safety performance is continuing to improve, and as I mentioned at the outset, we've had zero lost-time accidents this year. A culture that performs along safety also operates well, given the attention to detail and diligence a strong safety culture creates.

These results show up in the lower left, where we report our forced-outage factors. Our 1.5% forced-outage factor is a record low for the second quarter. To the lower right, our traditional honor roll at notable plant performance for the quarter is presented. Well done to our power operations team. The upper right shows our annual production year-over-year, the biggest difference is Texas, where we have added capacity at Guadalupe and our new Deer Park and Channel expansions and enjoyed a cold spring.

With that, I'll now turn it over to Steve Pruett, who will now be joining Zamir in our prepared comments, and will focus markets, our hedged profile and alike. Please join me in welcoming Steve to his first official earnings call.

Steven Pruett

Thank you, Thad, and good morning, everyone. Commercially, we are off to a very good start this year, having successfully managed both extreme winter weather and the rather mild start to the summer. All of those efforts have been made easier by the excellent operations that Thad just described. So let me echo his comments of thanks to the team and congratulation on the job well done.

With the completion of the Southeast asset sale, Calpine's fleet is now concentrated in the three most robust competitive wholesale power markets in America, PJM, Texas and California. As you have already heard, each market varies in terms of the key drivers of value, particularly over the next few years.

Let's go through each of them in a bit more details, starting with PJM. Despite a more fragile market in the coming years, the forward curves in PJM have become backwardated, currently reflecting annual on-peak spark spreads similar to where the market has cleared over the past three years. Not only does this backwardation seem to underappreciate the announced changes in the supply landscape, it also fails to reflect other favorable signals in the marketplace, including those observed most recently in the RPM auction.

Two key auction takeaways worth mentioning. First, although demand response cleared slightly less capacity than last year, it continues to make up a meaningful portion of the market reserve margin, as shown on the slide. There remains much uncertainty, as to the role of DR going forward, in both the energy and capacity markets. However, we feel very confident that regardless of the outcome, we can expect increased volatility in the PJM energy markets over the next few years, which we are ideally positioned to respond to.

Secondly, nearly 12,000 megawatts of solid fuel resources were offered into the auction that did not clear. With the improved financial discipline demonstrated by this year's bidding practices, one must wonder whether some of the 12,000 megawatts could be candidates for additional retirement announcements in the future, particularly in light of abundance of Marcellus and Utica gas that continues to pressure solid fuel and nuclear resources in the region.

Consistent with our expectations, and as you can see from the chart on the bottom left of the slide, the gas price in the Mid-Atlantic is much lower than Henry Hub in the summer. And we expect it will remain so for the medium term. As Thad mentioned earlier, Calpine's natural gas-fired fleet is resilient to low natural gas prices, since volumes increase and market heat rates expand, as shown in chart on the lower right.

Given our view on both market fundamentals and advantages for natural gas power generation and PJM, we are strengthening our position in the market with our York 2 plant having cleared this year's auction. York 2 will be a 760 megawatt combined-cycle power plant co-located with our existing York Energy Center, West of Philadelphia, positioned to benefit from Marcellus-advantaged natural gas prices. York 2 will feature dual fuel capability that will help ensure reliability to the grid.

By leveraging existing infrastructure, another cost advantage is, we expect to add this capacity at a significant discount compared to today's average PJM merchant new build cost, allowing us to build at an estimated 5x to 6x adjusted EBITDA. In other words, we are investing at significant savings in a market whose fundamentals are sound, yet currently underappreciated.

Moving now to Texas. We are seeing similar disconnects between market fundamentals and forward prices. Texas' economy and load continues to grow, as can be seen by the various data points in the chart on the top left. On the supply side of the equation, despite recent announcements of new entry, baseload coal and nuclear units continue to face challenges from increased wind generation overnight.

Many older steam units face increased pressure with low runtimes. And the threat of CSAPR implementation lies just around the corner. The potential for existing units to change their dispatch, mothball or even retire, is very real, yet seems to be overlooked in the rhetoric.

Instead of focusing on these sound fundamentals, the market appears to be grappling with the current year's mild summer. Compared to the trailing 10-year average, we have experienced well below normal cooling degree days each month, which has depressed power prices. Fortunately, as you saw on our last earnings call, we were fairly well-hedged coming into the summer, so our exposure to the weak weather has been mitigated.

As a result of this year's continued mild weather, the forwards have also recently come under significant pressure, further widening the deficit between the curves and the spark spreads needed to economically incentivize new build. However, we believe that the market fundamentals remain intact and that they will ultimately prove out the tightness in the market, given the current lack of appropriate investment signals and increasing potential for market volatility.

Turing to the following slide, let's wrap up our market overview with California, where despite all the rhetoric, we feel confident in our ability to preserve the value of our assets. California's unwavering pursuit of a low carbon energy policy has led to a substantial and growing supply of intermittent renewable resources, advantaged by federal and state subsidies and above-market contracts.

And while backup generation is needed to support this market construct, there is currently no meaningful mechanism to adequately compensate this supply. Given these dynamics, the task before us in California is not without its challenges. However, we believe that the Calpine fleet has a number of distinct advantages that position us well.

Today, we're providing new disclosures that are intended to illustrate these features and dispel recent concerns about the effects of renewable penetration on our business. First, while representing just over 10% of our California generation capacity, our Geysers geothermal assets make up more than 40% of the commodity margin we earned in the state.

As the world's largest complex of geothermal power plants, the Geysers is a crown jewel among low carbon resources. Not only does it produce power with minimal greenhouse gas emissions, it does so reliably, featuring a 97% average availability factor for the past 10 years. And with none of the cost typically associated with renewable integration.

As you can see on the chart, at today's level of solar penetration, geothermal power is a compelling low carbon resource. As solar penetration continues to rise, the marginal economic value of solar will continue to decline, whereas geothermal will remain consistent. As a result of its compelling features, we believe the Geysers will play a vital role in ensuring California's low carbon future.

Along those lines, we are pleased to announce that we have entered into a 10-year contract with SCE for 225 megawatts from our Geysers, beginning in 2017, subject to CPUC approval. We believe, we will have the opportunity to continue to secure contracts that reflect the importance of this resource going forward.

The balance of California's commodity margin is earned by our natural gas-fired fleet. Nearly half of the total California commodity margin is represented by gas-fired plants that operate under contracts for power and/or capacity products. In general, these modern and efficient plants feature attributes that will be essential for California to successfully support intermittent renewable resource.

First, there is a need for reliable resources that can consistently provide voltage support, grid regulation and other ancillary services. Second, there is a need for flexible resources to support daily ramping needs. The ISO and PUC recognize the need for these reliable, fast ramping resources, which is further heightened by the fact that several thousand megawatts of dispatchable fossil resources will retire over the next five years without equivalent replacement.

There are several regulatory processes currently underway to address these needs, and the dialog is constructive. Whether or not the market ultimately assigns pricing premiums for flexible products, we can at least see a clear need for our assets. With opportunities to continue securing contracts that sufficiently compensate our fleet for its role in preserving the reliability of a grid, that is growing increasingly dependent upon intermittent renewable resources.

The remainder of our California commodity margin, less than 10% or approximately $100 million, comes from merchant energy sales, probably a much smaller portion than most people appreciate. And while they impact on-peak block prices from increased solar generation is likely to be meaningful. There are several mitigating factors to consider.

First, price formation improvements are underway that are specifically designed to address renewable integration issues and may provide ancillary service opportunities that currently don't exist in the market. Second, there is a potential upside in the market from higher natural gas and CO2 prices, should they emerge. And finally, there has already been an increased amount of intraday volatility, which we expect to expand as even more solar comes online.

Our flexible fleet benefits from volatility. The chart at the bottom of the slide depicts what we've already seen in Northern California this year. You will recall that most of our assets are located in the North, while the bulk of the solar build out is occurring in the South.

In sum, we remain positive about our position in California, despite increased solar penetration. We believe we will successfully maintain a stable platform by capturing the distinct value that our unique low-carbon Geysers assets and our flexible efficient gas-fired assets are able to provide to the market.

The following slide concludes with an update to our standard hedge disclosures. As a reminder, these disclosures reflect the sale of six plants in the Southeast that closed on July 3.

Starting with the hedge percentages on the left, you will note that we remain highly hedged in 2014, although it appears from the disclosure as though we've become more open than we were on our last call. The primary driver behind this variance is an increase in our expected volume since our last disclosure, primarily as a result of declining gas prices and the related impacts on our power plants in the Eastern U.S.

The portion that remains open is primarily off-peak and non-summer generation. We remain highly hedged for the summer and for the on-peak. You will also see that we have added hedges in 2015, that we still remain fairly well open, and are very open for 2016.

Before leaving this slide, as you see from the table in top right, we are continuing to demonstrate commercial progress, with the signing of several new term contracts.

In addition to the new contract for the Geysers, we have added a 235-megawatt peaking contract in MISO to be served from our RockGen plant and two load-serving contracts totaling nearly 90-megawatts for our Texas fleet with public power agencies. We remain focused on identifying opportunities like these that reflect our views on the various market fundamentals I have just described.

With that, let me now turn it over to Zamir for his financial review.

Zamir Rauf

Thank you, Steve, and good morning everyone. As you've already seen we continue to deliver strong results and create shareholder value through effective capital allocation and balance sheet management.

The chart in the upper right shows the primary drivers for the second quarter year-over-year improvement in adjusted EBITDA. As you can see the impact from the expiration of the Delta contract in the West was offset by higher regulatory capacity payments in PJM.

Portfolio changes also added to the positive variance with a full quarter's benefit from the addition of Russell City, Los Esteros and Guadalupe and to a lesser extent, a half month of operations at the Deer Park and Channel expansions that were completed in June.

Lastly, and as you will see on the following slide, effective hedging and stronger market conditions in the West and Texas added to the increase in adjusted EBITDA. As such, we continue to demonstrate the benefits of a geographically diversified fleet.

Given our continuous strong performance this year, we are reaffirming our full year 2014 guidance despite the Southeast Six Pack sale and mild weather so far this summer.

The chart in the lower right details the balance-of-year drivers for adjusted EBITDA. After accounting for our year-to-date performance, the rest of the year will continue to benefit from the previously mentioned portfolio changes. Partially offsetting these increases are the Southeast asset sale, lower regulatory capacity payments in PJM in the second half of this year, and contract expirations primarily at the Delta Energy Center in California.

The next slide takes a closer look at the second quarter results from a regional perspective. As previously mentioned, portfolio changes in the West and Texas were a material driver for the quarter. Please also note that the July 3 sale of our Southeast plant did not impact our second quarter results.

Other material drivers that contributed to the second quarter performance were the positive impacts from higher spark spreads resulting from stronger market conditions in our West and Texas regions, particularly in April and May.

We also benefited from higher contributions from hedges in Texas, along with higher RPM capacity prices in PJM, offset in part by the contract expiration in the West.

Our year-to-date results reflect similar variance drivers as shown here, with a notable addition of the strong first quarter. We included the year-to-date comparative slide in the appendix for further reference.

Before leaving this slide, I wanted to remind you that this will be the last time you will see our financial results broken out into the four regions shown here.

With the close of the Southeast transaction in July, going forward we will have three regions. The remaining plants in the Southeast will be combined with our plants in the North region to form the new East Region. The Texas and West regions will remain unchanged. You will see these changes when we report our third quarter results.

The next slide provides a more detailed look at the transformational refinancing we recently complete and what it means for our capital structure. In July, we took advantage of favorable capital markets to enhance our financial flexibility by intruding unsecured debt. We issued two tranches of unsecured senior notes totaling $2.8 billion at a blended rate of 5.58%, maturing in 2023 and 2025.

The proceeds were used to retire an equal amount of senior secured bonds that were at a blended rate of 7.68% with maturities in 2019, 2020, and 2021. As a result of this refinancing, we not only decreased interest expense by $60 million annually, we also extended the maturities of this debt by approximately 3.5 years.

The pro forma effect of our debt maturity profile is illustrated in the top right chart. As part of this transaction, we also took the opportunity to increase our corporate revolver by $500 million to a total of $1.5 billion. This refinancing was truly a historic event for Calpine as the transaction significantly improves our liquidity and strategic flexibility, while providing material interest savings. The transaction was also well received by the rating agencies, who had viewed it as credit positive.

Turning to the last slide. I'd like to end with a more detailed update on capital allocation. As Thad mentioned, since our first quarter call, we have been aggressively putting our excess cash to work. We've repurchased over a $0.5 billion of our stock, increased the authorization amount, and as you can see from the chart in the lower right, we still have $566 million of remaining authorization. We definitely continue to see our stock as a strong investment opportunity.

In addition to investing in our stock, we have also deployed excess cash towards strengthening our balance sheet. As part of the recent $2.8 billion refinancing, we kept leverage neutral by deploying approximately $350 million of cash towards early retirement premiums and fees that will ultimately translate into $60 million in annual interest savings.

Along these same lines, you should expect us to call an additional $120 million of debt at 103% towards the end of the year. This debt is currently at an interest rate of slightly under 8%.

Finally, with the announcement our York 2 Energy Center in PJM, we will be investing an incremental $100 million this year in accretive growth. We are excited about this addition to the Calpine fleet and the attractive returns we expect it to generate.

Even after allocating more than a $1 billion of capital since May, and not taking into account the incremental capital we will be investing between now and December 31, we expect to end the year with over $1.3 billion of excess cash. As our track record shows, we have been proactive in managing our business and taking advantage of opportunities to create value when presented.

As we allocate capital, we remain focused on driving adjusted free cash flow per share growth that will ultimately increase the per share value for each of our shareholders.

With that, I would like to thank you once again for your time this morning. Operator, please open the lines for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) From Tudor, Pickering, Holt, we have Neel Mitra on line.

Neel Mitra - Tudor, Pickering, Holt

I had a question on the York brownfield development. I know you are building it at a substantial discount to true greenfield costs. But could you kind of describe how you look at maybe what kind of capacity price you need over the long-term for it to be economic, if you look at where forward spark spreads are right now in PJM?

Thad Hill

Neel, the current market and the current capacity pricing in the market are sufficient to get us a great return on capital based on what we think our all-in cost will be there. So that asset is going to perform well for us at the current market, including the most recent trend on capacity market. We do expect there was upside on that, but we're comfortable kind of in the current conditions. It's a good returning project.

Neel Mitra - Tudor, Pickering, Holt

And then second on Texas, obviously, there is some new wind capacity. We've had mild weather. The ORDC doesn't seem to be adding a lot of value to current prices. What do you see as maybe turning the tide for ERCOT prices? And with 38% hedged in 2015, how are you looking at hedging that portfolio out? What are you looking for in terms of pricing to maybe close that portfolio before the end of the year?

Thad Hill

So Neel, I'm going to turn it over to Steve to answer that question, although I wouldn't expect him to provide you any detailed hedging on plans. Steve?

Steven Pruett

No detail hedging plans here, Neel. Sorry about that. We don't do that. In Texas, I mean what's going to turn the corner is, is basically the fundamentals of the market, the supply and demand. Load is growing. The all indications are we're probably in 3% to 4% range in growth itself from external sources and some observations.

So in the supply side, things that have been announced, we're not sure there is any financing closed on those recently. Now, we do believe that probably something will get build eventually in Texas. But the current projects have been announced, we don't think they have financing behind them. So we're not sure where the supply is going to come from to meet the load growth. So we think the fundamentals are ultimately going to pan out.

The second thing you asked about is ORDC. This summer it hasn't mattered. There is two things that they're doing there. One, any price formations things inside that where they add units at mid-gen and they don't count it, and then let it go into the how they calculate it's hard to see, they will fix that, we believe. And in this fall, they are actually going to relook at that ORDC to see if they need to change the slope of the curve. And those will be beneficial to us moving forward.

Operator

From Goldman Sachs, we have Michael Lapides on line.

Michael Lapides - Goldman Sachs

A handful of questions. First of all, when you look across the balance sheet, Zamir, do you see other opportunities for significant debt refinancing? And can you give a little bit of an overview of what the refinancing you just did means in terms of covenants and ability to deploy capital?

Zamir Rauf

Sure. As we look forward, we have really just got one maturity in 2023, the one that we are going to call 10% on, and there will be 840 of it remaining at yearend. That's close to 8% at 778. So there is definitely an opportunity there, although the make-whole on that, that is still pretty high. I mean in addition to that, I think there is a lot of opportunity to further move maturities out in time and continue to derisk the balance sheet. But what this really means for us is, is a couple of things.

So one, it allows us to have more balanced capital structure in terms of secured versus unsecured. In the past, we were 100% secured and that was a little bit of a legacy. But now with this structure, we are able to do things like increase our corporate revolver. It gives us some flexibility in terms of -- we don't really have any restricted covenants. I think I have always said that that our covenants are pretty much investment grade.

So it doesn't really change a whole lot there. It does give us a little bit of secured debt capacity in case we ever need it, which is always good to have, which we didn't have in the past. So all-in, I think it's very positive for us. And this whole transaction has allowed us to increase liquidity by $0.5 billion, which I think some times get lost in the message here.

Michael Lapides - Goldman Sachs

Want to change topics a little bit. Thad, you touched on Demand Response, and Steve, you touched on some of the uncertainty around Demand Response. Kind of want to turn to the read-across from the court decision that came out in late May and ask you how that -- I know that court decision was really directed towards how Demand Response or could Demand Response bid into the energy markets. But given that capacity is just an obligation to provide energy at a certain point, do you think that same ruling would apply that whether Demand Response could legally bid into capacity markets in places like PJM and New England?

Thad Hill

Michael, Thad Miller will take a crack at that.

Thaddeus Miller

Yes. I mean that is, Michael, as you know, a debated issue, legal issue, and there is good arguments on either side. We tend to believe that at its base, it is a FERC jurisdictional issue, whether it is an energy or capacity product. But that said, as Steve implied before, we think that ultimately, while there will be a transition period, if the DR energy comes out of the market, and then the DR capacity comes out of the market, that other solutions will develop for the DR product.

Thad Hill

So in sum, we think DR will be a part of the mix in the mid-Atlantic. I mean there could be some near-term upside, and certainly rule changes on how it plays could be helpful, but we think it will continue to be a part of the mix.

Operator

From Merrill Lynch, we have a Brian Chin on the line.

Brian Chin - Merrill Lynch

Question for you on the external asset market. One of the trends over the last year has been the emergence of these yieldcos. And we hear from different pockets of the utilities and renewable power space that asset valuations are rising because of the cost of capital advantage claimed by yieldcos.

Just as an observer of the markets, are you seeing asset valuations rise? And I know that you guys have stated in the past that a yieldco really isn't something you guys are looking at. But is there a set of conditions under which you might want to reconsider that position, if you could talk about that a little bit.

Thad Hill

Sure, Brian. On the yieldco that is not something, as you've been clear -- as you said, we've been pretty clear, that that we don't think that makes sense for Calpine right now. We did a transaction this summer, as you know where we sold plants, and we sold a $100 million-ish of EBITDA for over $1.5 billion.

And when you look at the multiples at which others have dropped assets, particular fossil assets, down into yieldcos, we've gotten to much higher multiple, much higher value for the assets by selling them to a third-party than by having to drop them down into a yieldco, where you end up with all kinds of conflicts in figuring it out. So I would say, I think we've done better than yieldco on our asset dispositions in this market.

Now, that said, never say never, I mean if there is a compelling strategic reason for us to consider it. But I think the real answer is, is we're not going to do financial engineering. We have said that. There are growth treadmills out there, there is high interest rate risk, and so that is, it's not part of our plans.

Brian Chin - Merrill Lynch

And then with regards to the external asset market are you seeing asset valuations continue to rise as a result of yieldcos?

Thad Hill

Well, certainly, anything to contract is getting a premium right now. And so there was no doubt about it, there is money seeking yield.

Operator

From Wolfe Research, we have Steven Fleishman on line.

Steven Fleishman - Wolfe Research

A couple questions. First on York, does that facility have any preferred natural gas access and/or firm access? Can you get cheap gas there?

Steven Pruett

Steven, this is Steve. It's in a good spot from a gas supply standpoint. So it will definitely prevail upon Marcellus gas in a very efficient way.

Steven Fleishman - Wolfe Research

And could you give us a sense like what price point we should look at for it?

Zamir Rauf

You can use TETCO M3 as a proxy, but that plant in particular probably will be even a little better than that, but it's a proxy, its M3, TETCO M3.

Steven Fleishman - Wolfe Research

And then just on ERCOT wind, could you give us a sense in your thinking on that? Does the market currently reflect the ERCOT wind that you are expecting? Or do things need to kind of get worse before we can see things get better for your generation? Just how are you thinking whether the ERCOT wind is reflected in the market yet or not?

Steven Pruett

I think it's probably, fair to say it's in. We have probably only got another 3,000 to 4,000 to come on here in the near future. Obviously, that subject could change if the tax credit situation changes. And most of that's in the West. So the pressure is going to be more off-peak in spring, I think Steven, and more in the West zone. So it depends on how congested we get.

I think it's going to put a lot of pressure on the fossil generation during those times, because of the wind, especially if they add more. But as we showed on our chart we are already cycled-down and we cycle, so it's not really that much more of an issue for us in the marketplace. But the market seems to, I think pretty much reflect that on a forward basis.

Thad Hill

And Steven, I would probably just add that I think our outlook is for higher on-peak, lower off-peak pricing, in which our ability to stop and start everyday is a good thing. And maybe the final policy comment on this is that this transmission lines are getting close to full with this latest push.

And we think that it is not a done deal that Texas will build more transmission capacity. In fact, we think there is probably a bit of a push against that kind of investment occurring as it has occurred in the past. So we'll see how it plays out. But I think we're feeling pretty good about the net impact on our fleet.

Steven Fleishman - Wolfe Research

One last question just on the new Geyser contract. Any sense on that you can give us on pricing of that? Is that tied to where current REC pricing would be for that period or how does it compare to the contract that rolls off?

Zamir Rauf

I mean I think the way I need to answer that right now, Steven, is that it's significantly reduces our exposure, our open exposure on Geysers. And I'd refer back to Page 11, where Geysers is around 43% of the total EBITDA. We think that the values are going to, we think are going to maintain in there.

Steven Pruett

Commodity margin will maintain there.

Operator

From Morgan Stanley, we have Stephen Byrd on the line.

Stephen Byrd - Morgan Stanley

I just wanted to talk a little bit further about capital allocations. You put quite a bit of capital to work, both buying back shares and also looking at organic growth. As you look out, I know you've already done a lot, but the question is where do we go from here?

When you look out at opportunities organically versus your own share price, are you generally seeing significant organic internal growth opportunities or do you think you're likely to be biased more towards deploying via share buyback? What's generally your sense for as you look going forward at what's likely to be the most attractive use of your capital?

Thad Hill

Stephen, in my comments, I said, and I think this holds true, over the last several years we have been roughly half-and-half, not because that was any given plan, but because of the opportunities stacked up and the way it demands our stock price, that's kind of where the capital allocation decisions shook out based on the relative economics.

We obviously don't know what's in front of us, but we do have a good pipeline of internal opportunities, some contracted, some that are low dollar-per-kW merchant expansions. We also have a very high view of the value of our own equity. So the best guidance I can give right now is that kind of roughly balanced go-forward allocation is probably a pretty good rule of thumb.

Now, if there is a great opportunity, one way or the other, we'll certainly do whatever makes the most sense. So we're not going to be dogmatic about it. But when we look at the capital coming off in our pipeline of opportunities, we think there will be continue to be room to do both in a balanced way.

Stephen Byrd - Morgan Stanley

And just to add on to Brian's question just on the value of contracted assets, you do have several assets that have high-quality contracts. And it does seem like the cost of capital that's out there broadly is significantly lower than the effective cost of capital that investors are putting on Calpine. Do you see real opportunities and are you relatively interested in finding ways to monetize some of those assets that have longer-duration contracts?

Steven Pruett

Behind every asset there is a story. A great example of that is our Mankato asset that has, I believe, 14 years left on a contract, but we're actively working to actually get that asset further contracted on. And so there is a strategy there, and hey, we're the right owner of the asset right now.

There are other assets that are in California, which I think you've mentioned. In California, we operate in integrated business out there. And our customers view us as an integrated business there as well. So I would say that anything is for sale at the right price, but we have to consider the overall integration of our business when we make decisions. So look, we'll continue to do what makes sense economically. That's probably the best answer I can give you today.

Stephen Byrd - Morgan Stanley

But maybe just when you think about the integrated business, meaning, you have a significant presence in a region, is that the general concept there?

Steven Pruett

What I meant by an integrated business is that, we have different products and services we offer in some of our markets, and where relative scale is important as well as being able to serve customers in different ways. And so you have to look at each individual. You can look at individual asset just by itself, so you have to look at the overall whole.

Operator

From UBS, we have Julien Dumoulin-Smith on the line.

Julien Dumoulin-Smith - UBS

So following-up a little bit on the last question, I'd be interested, what your latest views on the Northeast and specifically PJM as far as further expansion? Obviously, you've announced organic expansion in the market. How do you balance the view of new entrant economics and the thought about the attractiveness of further upside, both from an M&A perspective and from broader market participants getting involved as well? What's your view of new entrants ultimately and what's your view of additional M&A entry into that market?

Thad Hill

Julien, more broadly on the markets, I mean we're very positive Texas, we're positive PJM, we're positive New England from here. We're probably a little more indifferent about MISO and New York. And clearly, we've broadly, if not totally exited the Southeast. So we continue to like particularly those three markets I mentioned. But it's all about price.

And whether we're just seeing up a cost at which we can do something organically or whether it's the cost of the market. And we've been pretty financially disciplined then and we'll continue to be financially disciplined. So I can tell you the markets where we think there is upside from here, our ability to enter or not, or change our mix or not, is going to depend on pricing. We're going to be very financially disciplined about it. So it's impossible to call from here what next steps may look like.

Julien Dumoulin-Smith - UBS

And do you have a dollar per kW sense, just to kind of back into a little bit?

Thad Hill

Our overall construction cost for that asset, it will be somewhere between $500 million and $600 million.

Julien Dumoulin-Smith - UBS

And then going back to Texas, you mentioned environmental rules, CSAPR. Do you think if it were to be implemented once again next year, it would have a material impact or even under the Phase 2 of CSAPR at this point? Or do we really need to see a rewrite of those rules ultimately to really have a more meaningful impact?

Thad Hill

Julien, I'm going to let Steve and Thad Miller answer that.

Thaddeus Miller

Julien, on the market impact, yes, we think there will be an impact in the marketplace, because they're going to have to comply with it. The expectation to our analysis is more that it's probably spring and off-peak that it effects in the off-season spring and fall, because then it's going to lead to mothball potentially to meet the reductions that they need to do. We don't think it will affect the summer as much, because they're going to figure out how to cut other time to do it. But we do think it will have a positive impact on pricing.

Julien Dumoulin-Smith - UBS

Even as soon as next year, just by math.

Thaddeus Miller

That's correct.

Operator

From Macquarie Capital, we have Angie Storozynski on the line.

Angie Storozynski - Macquarie Capital

I wanted to actually ask a question about Texas and your portfolio there. So when I look at your disclosures, you run your assets around 50% of the time. So meaning, all day during the day and you turn them off at nights. Then you're bearish gas. Okay. So you are not going to make money off-peak. There is no upside on-peak to volume. So what does offset my weakness in spark spread and the impact of those lower gas prices on your earnings in Texas?

Thad Hill

Well, I'll take a crack at what I think was the core of your question. So, yes, our capacity factor typically, although we do have a limited amount of run through the night, where we have cogens, so somebody else is pain free. So typically our assets run during the day and not off-peak, which is our point, earlier on the wind question about not having a lot of exposure there.

As far as on-peak, we talked about our view, which is a near-term view on natural gas, not necessarily long-term view on natural gas. In fact, if I had to describe it longer term, I think we're more constructive from natural gas in the Gulf Coast, although certainly I would say it'd be opposite view of gas in the Marcellus.

Finally, and most importantly, I think that our view is that the differential upside for our fleet in Texas, while it certainly gets some upside, if there is natural gas expansion on the Gulf Coast, which I said I think we think is a reasonable guess, but that we're actually subject to heat rate expansion more than necessarily gas price. And we think that heat rates in Texas, particularly on-peak heat rates will continue to rise and we'll benefit from that.

Angie Storozynski - Macquarie Capital

But do you think it's a near-term phenomenon? Because you keep adding assets, right, to your regions, to ERCOT, to PJM, while also pitching the tightening of supply demand fundamentals. And I know that there could be a mismatch in the scale of new build versus retirements and maybe in Texas via the locals. But it does seem like your growth plans undermines the improvements in these markets.

Thad Hill

Well, Angie, I'll say, in the last year-and-a-half or two years, we've added 2,200 megawatts in Texas, 400 of those megawatts have been from adding new capacity, the other 1,800 megawatts have been done M&A, where we bought assets at $0.50 to $0.60 on the $1. Load in Texas, if it is 3%, is growing at 2,000 megawatts a year. And while there will certainly be new capacity added, there has been no new project financing close that we're aware of at least in the last year.

So again, new capacity will be added, but we think there is a room for at least 2,000 megawatts to keep the market balanced. We also see there's going to be some retirements. So we're going to be very prudent on and be financially disciplined about where we add capacity.

Angie Storozynski - Macquarie Capital

And lastly on California, could you tell us roughly what's the expiration of existing tolls or capacity contracts in general for your gas plant? So for instance, is there any offset to that new contract for the Geysers in '17 from expiration of any CCGT tolls?

Thad Hill

Angie, we have made a public and we have in prior disclosures all of our gas plant contracts, the termination determined to contracts and we don't have it as part of this package, but we can follow-up afterwards and make sure we get it to you. It's staged over time. There are some contracts that expire in a couple of years or some that expire at the end of the decade, and some that expire in the middle part of next decade. So we'll get you those disclosures. We have them and they're public. We just don't have in this package.

Operator

From Barclays, we have Gregg Orrill on line.

Gregg Orrill - Barclays

You have bought back a lot of stock already this year, and you also mentioned that you still have an expectation of having $1.3 billion of cash by the end of the year excess. If you don't see anything more come to fruition in the M&A market over the next few months, do you expect to see to come back and kind of update us on even more buybacks on the third quarter call?

Thad Hill

Gregg, we've got $566 million left on our authorization. We think our stock is a great buy. As we've talked about we have some good organic growth opportunities. But I fully expect that we'll continue to be returning money to shareholders on over time in a robust way as far as when and how and what announcements we might make on the next quarter call or whatever else it is, we're just going to have to wait.

Gregg Orrill - Barclays

And then just on Texas, how do you generally think about your approach to hedging that market, given kind of the disconnect in fundamentals and forwards in gas?

Steven Pruett

Gregg, this is Steve. I mean the hedging is done, when we think its appropriate time to do it. We have our analysis of where we think the fundamentals are what we see in the marketplace, because obviously we're talking to everyone in the marketplace trying to see where the interest is coming from. So we make those decisions on that. We just look for the right time to do the value to it. And there is no other better explanation other than we hedge, when we find the right value than time to hedge.

Gregg Orrill - Barclays

And with the low hedge levels, I guess you don't see the value.

Thad Hill

I will just maybe add one to that. We typically manage our power book one year out in Texas. So I would expect, unless there is a fantastic bilateral deal. We've done some of those that we think fairly represents fundamentals in the long-term. I think what Steve is talking about is generally kind of managing the next year. Longer dated, we rely on our fundamental view before we make any sort of long-dated contracting decisions.

Operator

From ISI Group, we have Jon Cohen on the line.

Jon Cohen - ISI Group

I think most of my questions have been answered. Just one on the balance sheet repositioning though. Should we, the freeing up of the senior capacity and the revolver, should we be reading anything into that? I mean would you say there are more strategic opportunities out there now that you want to be positioned to take advantage than previously or is this just the cost, interest rate, and other things?

Zamir Rauf

Sure. No, look, it definitely gives us more strategic flexibility no doubt. We don't have any plans to use that capacity. It's just nice to have, if you know the opportunity were to present itself, the plan is actually to move to a more unsecured capital structure. But we've been a tremendous allocator of capital, if you just look at how much capital we've been putting to work here. And adding $500 million, $0.5 billion of additional liquidity can only enhance the capital allocation strategy overall. So I think you can read into that and that we have more liquidity now than we did in the past.

And as we look at the excess cash, I mean we use to keep $1 billion on the balance sheet just to run the business, and we still do. But out of that $1 billion we have some LCs under the revolver, so we actually have $760 million of revolver and $249 million of cash. And so a lot of cash gets freed up here. So the long of saying it is, we've got much more flexibility more dollars for capital allocation and that's good. We expect that to be positive going forward here.

Jon Cohen - ISI Group

And then, Thad, I'm just asking a prior question slightly differently, are you at all concerned that new build will eventually put downward pressure on spark spreads and capacity prices? I mean logically, one would think that Calpine is not the only company that has these opportunities available to build the discounts to greenfield replacement cost. So at what point do you see that sort of impacting the market, especially PJM?

Thad Hill

Look, it's a fair question, obviously prices will not go up forever. But we do believe that there remains and we will get kind of the long lead time builds on what actually has been constructed, and the change in the asset mix in PJM, a lot more volatility between here and there and a lot of upside.

Ultimately, the orders growing, our assets are retiring, new build does have to occur. I think that we've been fairly unique in some of the creative ways we've been able to use our existing asset base in our existing sites, to keep cost down using prior-owned equipment, mothballed equipment, that kind of thing.

So I am not sure that others are getting it done for our price, nor do I think they will. But ultimately new entry will happen, but until we think it's going to meet the demand need, we think there are several years of some pretty interesting times ahead of us.

Operator

From SunTrust, we have Ali Agha on the line.

Ali Agha - SunTrust

Earlier on I think, Thad or Steve, you alluded to the fact that your hedging disclosure had moved around in '14, primarily because of more production assumptions. So given where the forward curves are for gas, can you just give us some sense for modeling purposes what roughly production levels should we be assuming for 2014?

Thad Hill

We have that laid out in the tips; correct, Bryan? To kind of give that indication and I don't have it in front of me.

Bryan Kimzey

Ali, we can work with you offline just to work through the modeling tips, which will kind of get you in the -- which are intended to get you in the ballpark.

Ali Agha - SunTrust

No, I see the range and so on. I was just wondering was that a substantial change from your previous outlook?

Thad Hill

Not that I am aware of, no.

Ali Agha - SunTrust

And then second, Thad, given the volatility around pricing as you alluded to, the weather gets mild, forward curves fall down, and everything sort of gets more bearish. What's your philosophy overall looking forward as far as contracting and hedging is concerned? Are you more inclined to do that? And along with that vein of thought, having a retail marketing business, do you think to hedge out your output, would that make strategic sense for Calpine?

Thad Hill

On hedging, as I think Steven and I both said, we pretty actively manage on the first couple of years, particularly the first during the power markets, probably the first three years in the gas market, based upon our view of the new term fundamentals and weather patterns, and the light. When we get beyond the first year or so, we rely deeply on our fundamental view of the market of how things will play out over time.

And there's not a market to hedge with, but there are bilateral contracting opportunities. And we use the same curves, we used to make any kind of decision, whether it is buying an asset or selling an asset or on building new asset or buying stock, we use the same curves as we make our hedging or our long-term contracting decision. So we're consistent that way.

As far as the retail business goes, we had stuck to staying a pure-play generator. It doesn't mean that we aren't spending more time getting closer toward though -- Steve Pruett talked about a couple of different load deals in Texas. And I think you can expect more, us to be closer to load. I'm not willing to say today that we're going to be a retailer though. But we were spending a lot of time getting closer to those [to do on-load].

Operator

Thank you. We will now turn it back to Mr. Bryan Kimzey for closing remarks.

Bryan Kimzey

Thank you. Thanks to everyone for participating in our call today. For those of you that joined late, an archived recording of the call will be made available for a limited time on our website. If you have any further questions, please don't hesitate to call Investor Relations. Thanks again for you interest in Calpine Corporation.

Operator

Ladies and gentlemen, this concludes today's conference. Thank you for joining. You may now disconnect.

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Source: Calpine's (CPN) CEO Thad Hill on Q2 2014 Results - Earnings Call Transcript
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