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FPL Group, Inc. (FPL-OLD)

Q4 2006 Earnings Call

January 26, 2007 9:00 am ET

Executives

Jim von Riesemann - Director, IR

Moray Dewhurst - CFO, VP-Finance

Analysts

John Kiani - Deutsche Bank

Ashar Khan - SAC Capital

Steven Ranzlow - Saturn Capital

Paul Patterson - Glenrock Associates

Paul Ridzon - KeyBanc

Reza Hatefi - Polygon Investment

Annie Tsao - AllianceBernstein

Andrew Levy - Brencourt

Scott Engstrom - Satellite Asset Management

Shalini Mahajan - UBS

Jesse Laudon - Zimmer Lucas

Presentation

Operator

Good day, everyone, and welcome to the FPL Group Fourth Quarter Earnings Call. Today’s conference is being recorded. At this time, for opening remarks, I would like to turn the call over to Mr. Jim von Riesemann, Director of Investor Relations. Please go ahead, sir.

Jim von Riesemann

Thank you. Good morning, and welcome to our 2006 fourth quarter earnings conference call. Moray Dewhurst, Chief Financial Officer of FPL Group will provide an overview of our performance for the fourth quarter and 2006 as a whole. Also with us this morning are Lew Hay, FPL Group's Chairman and Chief Executive Officer; Jim Robo, President and Chief Operating Officer of FPL Group; Armando Olivera, President of Florida Power & Light Company, and Mitch Davidson, President of FPL Energy.

Following Moray’s remarks, our senior management team will be available to take your questions. Let me remind you that our comments today will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Any statements made here-in about future operating results or other future events are forward-looking statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from such forward-looking statements. A discussion of factors that could cause actual results or events to vary is contained in the appendix here-in and our SEC filings, and in the investor section of our website www.fplgroup.com.

And now I would like to turn the call over Moray Dewhurst. Moray?

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Moray Dewhurst

Thank you Jim, good morning everyone. Before giving you an over view of the year, I would like to start by highlighting some key developments that occurred in the fourth quarter and then may perhaps make analysis of our results that are a bit complicated. We had a number of significant unusual items, some positive to get results, some negative, as well as some difference in our operating performance relative to our expectation for the quarter.

Overall the fourth quarter continued the trends of the earlier months of the year. Florida Power & Light performed about as we expected and FPL Energy did a little bit than we had expected. Our adjusted results look a little better than this statement might lead to expect, because of some favorable factors affecting the fourth quarter that won’t necessarily carry over in to future period. Our outlook for 2007 and 2008 remains about where we indicated on our third quarter call.

When we spoke to you last October we indicated that fourth and full year results would likely be affected by recognition of a gain on resolution of outstanding litigation surrounding an Indonesian geothermal project, as well as a change in accounting methodology for major maintenance. Both of these in fact occurred, and in addition after completing a review of our FiberNet business, prompted by changes we have been observing in the competitive landscape, we concluded that it was appropriate to write down the value of the metro assets in that business and that write down is reflected in our fourth quarter results.

Both the settlement gain and the asset impairment charge are reflected in our adjusted results, although of course they are not indicative of the operating performance in the quarter. From an operating perspective the fourth quarter was a good one, although not quite as good as adjusted results might suggest largely because of some favorable fact side that I will discuss later one. Florida Power & Light showed good customer growth offset by weaker usage growth, while FPL Energy continued to outperform our expectations, despite a weak finish to the year from wind resource availability.

Both our GAAP and adjusted results include the impact of changing the method we use for recording major maintenance expenses at FPL Energy and the slides to this presentation contain a footnote quantifying the impact of the change. Without going in to too much detail here, let me note that the practical effect is that under the new methodology earnings in 2004 and 2005 are a few pennies higher than we previously reported. While somewhere near the end of the projects' lives in the future, they will be slightly lower than we would have reported under the old methodology. For 2006, the impact is immaterial and we expect it to be immaterial in 2007 and 2008 as well.

Let me now try and give you a summary of the year as we see it. On balance, 2006 was an excellent year for FPL Group, led by the outstanding performance at FPL Energy. Setting aside the fourth quarter gain on the Indonesian dispute and the impact of the accounting change, FPL Energy’s adjusted earning grew by about 50% with new wind projects, the addition of Duane Arnold to the nuclear fleet, strong contributions from the existing merchant fleet, and growth in our full requirements and retail businesses.

Our ability to deliver outstanding financial results was founded upon excellent operating performance, and both the fossil and nuclear fleet of FPL Energy had exceptional years.

Relative to our original expectations above the only disappointments whether for the full year, the wind resources was a bit below long-term expectations, but well within the bounds of statistical expectations and the availability of the wind assets did not live up to our high expectations.

At Florida Power & Light, we knew that 2006 would be a challenging year and a year of uncertainties. Yet with one exception, we ended the year roughly in line with our original expectations. Customer growth dropped off in the early part of the year, but stabilized and in the last few months has increased modestly. Usage was weak as a result price elasticity effects. Good cost performance overall allowed us to fund the initial efforts of our Storm Secure program and still stay within our expectations. Unfortunately, we were not quite as successful in our storm cost recovery proceedings as we had hoped and it was the disallowances resulting from these proceedings that caused us to fall short of our original expectations. Nevertheless, Florida Power & Light had a solid year and remains well-positioned for future growth.

During the year, we continued to work on positioning ourselves for the future growth of the company. We announced our agreement to acquire the Point Beach Nuclear Power facility from a subsidiary of Wisconsin Energy and we continued to expand our wind program. With the recent one-year extension of the production tax credit through 2008, we look forward to building on our 2007 development backlog and expect to add at least 1500 megawatts of new wind projects over the 2007 and 2008 timeframe. We also made good progress in re-hedging our portfolio at attractive forward prices.

Finally, last October we shared with you our initial expectations for 2007 and 2008. The developments of the fourth quarter have not significantly changed our view of the next two years and we reaffirm those expectations today. For 2007, we expect adjusted EPS to be in the range of 335 to 345, the corresponding figure for 2008 is 360 to 380. While adjusted EPS growth further out necessarily becomes more speculative, we believe the extension of the production tax credit through 2008 positions us well to deliver continued earnings growth into 2009. As a reminder, each year's wind program tends to have most of its initial earnings impact not in that year, but in the following one. So, the reinforcement of the prospects for the 2008 wind program boards well for our 2009 earnings expectations. While we were disappointed that we could not bring the proposed merger with Constellation Energy Group to a successful conclusion, we continue to feel very comfortable with our standalone growth path.

As a reminder, when we discuss FPL Group's earnings expectations we assume normal weather and mark our currently open positions to the current forward curves. We also exclude the effect of adopting new accounting standards, if any, and the mark-to-market effect of non-qualifying hedges, neither of which can be determined at this time.

Now let’s look at the results for the fourth quarter and full year 2006. In the fourth quarter of 2006, FPL Group’s GAAP results were $268 million or $0.67 per share, compared to $209 million or $0.54 per share during the 2005 fourth quarter. FPL Group's adjusted 2006 fourth quarter net income and EPS were $254 million or $0.63 respectively, compared with a $182 million or $0.47 per share in 2005.

Our adjusted results exclude the mark-to-market effect of non-qualifying hedges and merger-related costs. Please refer to the appendix of the presentation for a complete reconciliation of GAAP results to adjusted earnings.

FPL Group's management uses adjusted earnings internally for financial planning, for analysis of performance, for reporting of results to the Board of Directors, and as input to the company’s employee incentive compensation plan. FPL Group also uses earnings expressed in this fashion when communicating its earnings outlook to analysts and investors.

FPL Group management believes that adjusted earnings provide a more meaningful representation of FPL Group's fundamental earnings power. For the full year, FPL Group’s 2006 net income was $1.281 billion or $3.23 per share, compared to $901 million or $2.34 per share in 2005.

Excluding the mark-to-market effect of non-qualifying hedges and merger-related costs, FPL Group’s 2006 adjusted earnings were $1.203 billion or $3.04 per share, compared to $1.013 billion or $2.63 per share in 2005.

Again, please refer to the appendix presentation for s reconciliation of GAAP results to adjusted earnings.

Turning now to Florida Power and Light; our full-year financial results were very consistent with our original expectations with the exception of the $0.07 negative impact of the unexpected storm cost disallowance loan that we have previously discussed. 2006 was the first year under the 2005 rate agreement, which implemented new depreciation and decommissioning rights, which in turn allowed us to offset other trends of increase in cost. Comparisons with 2005 were also aided by the relative absence of tropical storm activity. We had expected 2006 to be a challenging year for Florida Power and Light on the revenue front and it was. Customer growth for the full year was about what we expected, but usage was weak late in the year as I'll discuss in a moment.

With a large rise in prices caused by rise in fuel cost, we had expected some price elasticity effect, but we were uncertain how significant it would be. In addition, the weather impact for the full year was a little below normal than 2005 levels. On the other hand, we benefited from some favorable cost effects, which allowed us to fund the initial impact of our Storm Secure program, which we introduced early in the year, while still maintaining acceptable overall cost performance. Other cost mostly driven by growth in an asset base, such as interest and property taxes, increased about inline with expectations.

For the fourth quarter, Florida Power and Light reported net income of $170 million, compared with $124 million in last year's fourth quarter. The corresponding contributions to EPS were $0.43 this year, compared to $0.32 last year. As a reminder, 2005 fourth quarter results had a significantly negative impact from the effect of Hurricane Wilma, making quarter-to-quarter growth not particularly meaningful.

For the full year Florida Power and Light reported net income of $802 million, compared with $748 million in 2005. Earnings per share for 2006 were $2.02 versus $1.94 in the comparable period a year ago.

For the full year, customer growth ended up about where we had expected at 2% for the number of customer accounts increased by 88,000. The first half of the year saw customer growth rates steadily decrease reaching a low in August. September saw an up-tick and the growth rate has increased each month since then. For the fourth quarter, the growth rate was 2.2%, equivalent to an annual rate of about 95,000. Some part of the fluctuations in growth rate we believe simply reflects the ripple impact of the 2005 hurricane season. In effect, the 2005 storms caused some people to differ our moves into Florida and we are now seeing some catch up effects. For this reason, we do not expect the 2.2% rate to continue through 2007. Instead, we are anticipating about 2% customer growth again for the full year.

Unfortunately the usage during the fourth quarter was not so good. Overall, retail kilowatt hour sales increased 3.9% during the quarter, but this was heavily affected by the fact that the 2005 fourth quarter saw depressed sales owing to hurricane Wilma. Factoring out the estimated impact of this driver kilowatt hour sales actually fell about 0.8%. We estimate that underlying usage and mix effects i.e. that portion of usage, which cannot be attributed to weather were a negative 2.6%.

For the full year, retail kilowatt hour sales were up 1.6%, customer growth was a positive 2% in the absence hurricane effects on usage provided a positive 1.3% comparison, usage per customer fell 1.7% for the full year consisting 0.7% weather related usage and a negative 1% in underlying usage growth and mix.

Last January, we indicated to you that we expected weather adjusted usage per customer to be about flat with price elasticity effects roughly offsetting the typical 1% growth in underlying usage. We also indicated that there was a significant degree of uncertainty surrounding our estimate of elasticity.

Through the first three quarters, weather adjusted usage was running a little below expectations, but not significantly so. However, the fourth quarter saw a significant drop off in usage, particularly in November. December was also down, but not as much. We are still analyzing the data to understand the patterns, but there is no obvious single explanation at this point.

We know that the declines are concentrated in the residential customer class, but there is not an obvious correlation with factors such as income or usage. For the moment, we believe the prudent thing to do is to assume that we are seeing both a price and an income elasticity effect with disposable income is being squeezed by such factors as steep increases in insurance rates and that this is exacerbating the normal reaction to price.

As a consequence, even though our rates are decreasing in 2007 with a lower fuel charge, we are not expecting a proportion of reversal of this year's elasticity effect. Instead, we are continuing to use our existing elasticity assumptions. Nevertheless, this should still lead to a return to positive usage growth for the full year 2007.

Many of you have read about the housing slowdown in the media and have asked what impact it may have on FPL's projected customer growth rates. The accompanying chart shows monthly housing starts dating back to early 2000. You can clearly see the bubble that emerged in 2004 and 2005 and the very sharp drop off in 2006. However, it's worth noting that there was a slight up-tick in November, and the absolute level still remains very healthy and consistent with rates of growth of 80,000 to 90,000 new customers in FPL's service territory. Nevertheless, it is unclear where the decline will settle out and we will keep you updated as new data becomes available. We continue to believe that the Florida markets will need to work through an excess supply in the condo market, but we are also confident that the underlying demand for new housing will continue to be strong as long as Florida's economic and employment environment remain strong.

For the fourth quarter, FPL's 2006 O&M expense was $350 million, essentially flat with the year ago figures. Comparisons with the 2005 fourth quarter are favored by the elimination of the storm reserve accrual as well as lower nuclear maintenance costs. This was largely offset by continued cost pressures in other areas of the business. Employee benefits, customer care, distribution costs all increase relative to the 2005 fourth quarter.

For the full year, FPL's O&M expense was $1.374 billion, up from $1.307 billion in 2005. Higher operating costs in distribution, customer care, and nuclear drove O&M expenses as well as cost associated with Storm Secure and employee benefits. Productivity improvements in the absence of the $20 million storm reserve accrual helped mitigate these O&M increases.

Looking forward, Florida Power & Light expects cost increases in employee benefits, fossil generation, customer service, and insurance to be partially offset by continued productivity gains elsewhere. As we indicated last October, a key to our O&M trend in 2007 will be our Storm Secure initiative. In simple terms, this program will absorb all of our expected net O&M productivity improvement this year and still leave us with greater than normal O&M growth. For the next few years, we expect to spend about $40 million to $50 million of incremental O&M per year in support of our storm hardening initiatives. In addition, we expect to commit a $100 million to $200 million per year in incremental capital.

Depreciation in the fourth quarter declined to $199 million from $243 million in the same period a year ago. For the full year, depreciation fell to $787 million from $951 million. As you may recall, a key outcome of the 2005 rate negotiations was the implementation of new depreciation rates and new decommissioning contributions. With our license extension at the four nuclear units as well as the benefit of continued success in extending the economically useful lives of all the fossil units, we were able to decrease depreciation substantially and to eliminate for some years to come contributions to the well-funded nuclear decommissioning funds.

Depreciation for the full year was partially offset by the introduction of the Martin and Manatee units, which went into service in June 2005 and underlying growth in transmission and distribution plant.

The table shown here summarizes the drivers of the earnings growth for Florida Power & Light for both the quarter and year. In the interest of time, I would not read each number for you, for those you without immediate access to the slides they will be available in the investor section of our website www.fplgroup.com. In total, the quarterly comparison increased to $0.11 per share and the increase in the comparative annual figure is $0.08 per share.

FPL Energy had another excellent quarter and an outstanding year overall. Setting aside the gain on litigation resolution, the fourth quarter showed good growth despite the presence of the Seabrook outage this year, while the full year growth and adjusted results was exceptional.

Driving growth for the year were strong contributions from new assets, primarily new wind projects and Duane Arnold, as well as margin expansion at existing assets, good hydro conditions and growth in our retail and full requirements businesses. Wind resources were better than last year, though slightly below the long-term average, operational performance was outstanding with the fossil and nuclear plants collectively having there best year ever for a liability and the financial results reflect incremental G&A expenditures primarily for new wind development that we expect will help us continue to drive growth into the future. Also important for our future prospects Seabrook Nuclear facility we completed the second portion of the two part upgrade that we have previously discussed providing additional capacity that supports our expectations for this year and beyond. Our portion of Seabrook's output now amounts to approximately 1,098 megawatts.

We took advantage of the volatility of the underlying fuel prices and moved early in the year to lock in favorable pricing on additional 2007 and 2008 hedges. For both years, we are more heavily hedged at this point and has been typical for us in the past. For 2007, we are essentially fully hedged to the first order impacts of natural gas prices and very significantly hedged against other price movements, including spark spreads.

Over 90% of our expected 2007 equivalent gross margin is protected against commodity price volatility. For 2008, the comparable figure is 80%. I will discuss our hedging position in greater detail later. Our wind development continues to make excellent progress that we finished the year having added just over 800 megawatts in new wind capacity, including new projects and acquisitions. This is more than we had originally expected but opportunity is to acquire additional wind assets presented themselves during the year.

As I noted earlier, we expect to add at least 1500 megawatts in new wind capacity over the 2007 and 2008 timeframe. Our confidence in our 2008 program was reinforces by the recent one year extension of the production tax credit.

The combination of new wind projects, the expected increased and contributions from our merchant assets as all the hedges were locked and are replaced by sales of higher prices, are the primary drivers a growth in 2007 at FPL Energy, while 2008's growth profile will be more weighted to new development, which will be a function of the success in completing our 2007 program in a timely manner. In addition the acquisition of Point Beach Nuclear Facility will help our earnings in 2008 and beyond.

FPL Energy's 2006 fourth quarter reported results were $148 million or $0.37 per share compared with $89 million or $0.23 per share in the prior period results. Adjusted earnings for 2006, which exclude the effect on non-qualifying hedges were $133 million or $0.33 per share compared to $62 million or $0.16 per share.

To repeat, this year's fourth quarter adjusted results included litigation gain amounting to $0.15 for the quarter and the $0.16 in the full year which I referred to in my earlier comments. Excluded from the adjusted results, are the effective transactions in the non-qualifying hedge category.

During the quarter, forward prices at the front end of the curve continued to retreat from their peaks with gas coming down particularly hard. As a result, we saw gains overall in the non-qualifying hedge category. These gains were offset by equivalent losses in the value of the underlying physical asset positions, which are not mark-to-market under GAAP. By chance, at the end of the year approximately $1.5 million of net gains in the non-qualifying hedge category remained on the balance sheet.

Looking back, since the beginning of 2001, when we introduced this concept and at which point there were $7 million of cumulative losses on the balance sheet. We have had 14 quarters in which the NQH category has shown gains and 10 quarters in which it shown losses. The sum total of the gains and losses is a gain of $8.5 million, thus reconciling to the $1.5 million which is on the balance sheet at the end of 2006. However, gains and losses in individual quarters have ranged from a high of $74 million in the third quarter of 2006 to a low of negative $56 million in the third quarter 2005. As we had frequently noted the purposes of analyzing our reported results excluding the impact of non-qualifying hedges, is to get a better perspective on our economics in the current quarter.

All the time the effects of the NQH category will necessarily washout, but any particularly quarters results can be dramatically affected by the inherent mismatch between the transactions which are mark-to-market on the Generally Accepted Accounting Principles. And economically equivalent asset positions which are not mark-to-market. We continue to believe that it is more useful when analyzing FPL energies current period of results to exclude the impact of the non-qualifying hedge category whether positive or negative.

For the full year FPL Energy's reported earnings were $610 million or $1.54 per share, compared with $203 million or $0.53 per share in 2005. Adjusted earnings were 518 million or $1.31 per share versus $315 million or $0.82 last year. The full year impact of a non-qualifying hedge category was a positive $92 million, reflecting a large decline in 2007 forward prices that we observed over the course of the year.

FPL Energy's fourth quarter adjusted EPS growth more than doubled from the prior year period driven to a great extent by the one-time gain on resolution of litigation. New asset contributions namely wind and Duane Arnold accounted for $0.08 improvement; compared with the fourth quarter of 2005, the 2006 fourth quarter benefited from approximately 1066 megawatts of additional wind capacity. The existing portfolio was down $0.05 in the quarter, driven by the refueling and uprate outage at Seabrook. Most of the other parts of the existing portfolio were up slightly. Asset optimization and trading activities increased by one penny, and restructuring activities were roughly flat with the 2005 fourth quarter.

In that quarter we had a gain from the sale of three small projects, in 2006 we had a $0.03 gain from the sale of certain development rights which we felt the counter party was better positioned to take advantage of than we were. All other factors were in negative penny including additional interest expense and overhead partially offset by favorable state tax rate comparisons. For the full year, FPL Energy's adjusted net earnings per share growth was [$0.49], of this $0.16 is attributable to the litigation resolution. Setting aside this impact, as well as the retrospective adjustment of 2005 results of the change in accounting, FPL Energy's contribution to adjusted EPS grew by about 50%.

New project additions contributed $0.28. FPL Energy's 2006 wind program included new projects in Texas, Minnesota and North Dakota as well as the purchase of existing assets in Texas, California and Minnesota. In all FPL Energy added more than 800 megawatts to its wind portfolio and now owns 416 net megawatts of wind. In addition, the January 2006 acquisition of a 70% interest in the Duane Arnold Nuclear facility accounted for 415 megawatts of new capacity and the Duane Arnold team exceeded our expectations for their first year of operations in the FPL Group nuclear portfolio. The full year contributions from the existing investment improved by $0.14 per share due to better pricing, strong hydro conditions in Maine, and improved wind conditions overall, all supported by strong reliability.

Price volatility provided good opportunities for buying back and resetting hedges against some of our higher heat rate assets. Natural resource availability for the full year was mixed, 2006 was a very good year for the main hydro assets without roughly 30% about normal and 4% above 2005. Wind resource across the existing portfolio was up relative to 2005, but was still below long-term averages. The wind indexes for the fourth quarter and full year were 99 and 97 respectively. Relative to normal, the wind resource represented a drag of approximately $0.02 per share for the year, reflecting the large size of the wind portfolio and its importance in FPL Energy’s economics. Please refer to the appendix representation for additional detail on the wind index.

Asset optimization and trading activities added $0.06 per share, while the year-over-year net effective restructuring activities were a negative $0.05. All other activities contributed negative $0.10 to the year-over-year comparison, increased interest expense accounting for $0.07 and higher overhead accounting for $0.04. All other items added a penny. As I mentioned earlier, FPL Energy is highly hedged for 2007. So changes in 2007 forward prices at this stage has only modest implications for our expected results assuming continued, strong operational performance. While 2008 is also well hedged, we continue have some open positions and thus changes in 2008 market forwards may be of some interest. During the quarter, as this chart shows, there was little net change to key forward prices with spark spreads continuing to trade at attractive levels.

As you all know there has been a lot of movement in 2007 for gas prices, during the fourth quarter of 2006, the 2007 calendar strip declined from about $8 to about $7, equivalent declines have not been seen in the out years. As this chart shows, 2008 gas prices remained around $8 or about $0.50 below where they were as far back in the fall of 2005. Certainly the 10 years strip, while it remains quiet volatile and has declined from its extreme peak of January of last year, remains robust at around $7. We continue to believe that longer term fundamental supports strong gas prices. Furthermore any move towards a nationwide carbon emission control framework which we believe will happen in do course, will likely increase pressure on gas prices. Accordingly we remain very optimistic about the future earnings potential of FBL Energy.

I mentioned in October that we would be revising the way in which we present information concerning our hedging activities at FPL Energy. As the business evolves and grows more complex, it becomes too much of a simplification to think solely in terms of megawatts sold or unsold. Over the past couple of months we have been working to find a new form of disclosure that helps provide useful information on the degree of exposure we have to fluctuations in commodity prices, while also remaining reasonably simple. The result is shown here and on the following chart and focuses on the percent of expected equivalent gross margin, a term I will define in a moment; that is hedged or otherwise insulated from commodity price fluctuations. Let me stress that this chart only deals with commodity price exposure, and of course there are many other sources of variability in the FPL Energy earnings profile. We encourage you also to review the old plus and minus charts in the appendix, which provide rough estimates of the likely response of earnings to some of the more common sources of variability.

This chart also introduces a slightly different segmentation we have previously employed. In 2007, we expect about 93% or so of our equivalent gross margin to come from business that is directly tied to our physical assets. The remaining 7% or so will come from businesses such as full requirements or retail, which while they benefit from the support of the assets, are not directly tied to them and in any case have very different competitive characteristics and margin drivers. For this small portion, we believe it is more useful to think in terms of margin that is associated with contracts already executed, for which we use the shorthand backlog versus margin associated with contracts that are yet to be originated. So, for 2007, roughly half of the margin we expect from these kinds of activities is already in the backlog. For 2008, the figure is not surprisingly smaller, at 20%.

The upper part of the table deals with the 93% or so of expected equivalent gross margin that is directly asset based. Here we have broken the portfolio up mostly by type of commodity exposure with some additional cuts such as geography as well. In particular, for NEPOOL, ERCOT, and other, which include PJM in California, we have distinguished between assets, for which the primary commodity dependency is spark spread and other assets for which the primary dependency is the absolute value of power price often highly correlated with the price of natural gas.

In NEPOOL, for example our spark spread driven assets includes the combined cycle unit in Rhode Island and the oil-fired assets in Maine. While the NEPOOL other segment includes Seabrook and the Maine hydro assets. For each line of the chart, we have provided a rough range of the expected equivalent gross margin and the percent of that margin that is hedged against variability in the primary underlying commodity driver. Substantively, you will see that we are very tightly hedged for 2007 with roughly 90% of our expected margin protected. You will also note that the major open positions are generally with the spark spread driven assets. These positions are disproportionately the off-peak hours, particularly for 2007.

It is a mark of how much of the markets have changed in the last few years that these now have significant the economic value. However, they are, of course, less profitable hours than the on-peak hours in general and they tend to show more volatility. As you know, we always like to keep some portion of our capacity available to take advantage of volatility and these positions represent a good way of doing so in the current market environment.

Also, of note, in this chart is the new additions line, which for these purposes represents additions that will be considered new as of January 1, 2007. This is, of course, the 2007 to 2008 wind program and you can see that for 2007 nearly 74% of the equivalent gross margin we expect from these new projects is alright -- already identified in the form of fix price contracts or other commodity hedges against known projects. The equivalent figure for 2008 is 58%.

I mentioned the term expected equivalent gross margins several times. This is a measurement concept designed specifically to support this chart and to enable you to think about all our assets on an economically equivalent basis. It includes the expected gross margin for all our consolidated projects as well as our share of expected revenues net of fuel cost for equity method investments plus the value of production tax credits grossed up to a pretax equivalent value. Thus, the economic importance of our wind projects and our non-consolidated projects are properly reflected in their equivalent gross margins impact. Of course, this figure is not one that will appear in one place in our income statement, but we think you'll find to helpful in analyzing the economics of FPL energies operations.

Before moving on, let me note that this disclosure is still something of a work in progress and we look forward to feedback from the analyst community. This chart provides the same information as the previous one, except that it represents the 2008 position. As you can see, about 80% of our expected equivalent gross margin is hedged. As with 2007, the more significant opened positions are with spark spread sensitive assets. And as you would expect, there is more potential for variability around the contributions from new assets and from non-asset based business that would likely be originated later this year or in 2008. I should also note that these 2008 numbers do not yet reflect the impact of Point Beach.

To summarize the 2006 fourth quarter; on an adjusted basis, FPL contributed $0.43, FPL energy contributed $0.33, and corporate and other was a negative $0.13 contribution. That is a total $0.63 compared to $0.47 in the 2005 fourth quarter on an adjusted basis.

The corporate and other comparison is driven by the $0.15 impairment charge taken against FPL FiberNet's metro assets. Excluding this item, corporate and other benefited from favorable tax effects, mostly reductions in deferred state tax liability occasioned by the rapid growth in FPL Energy. Included in the numbers is about the $0.07 favorable effect that we would not expect to carry over into future years.

For the full-year 2006, again on adjusted basis, FPL contributed $2.02, FPL Energy contributed $1.31, and corporate and contributed a negative $0.29, that is a total of $3.04 a share, an increase of $0.41 over the same period in 2005.

Setting aside the various unusual items, I have mentioned, which lead to a positive impact, we finished the year a few pennies better than the high-end of the 280 to 290 range that we set out in October of 2005. It was an excellent year for FPL group.

Turning to 2007 and 2008, we discussed our initial views of EPS expectations for these years and the drivers behind them on our third quarter call. Since then, although commodity markets have remained volatile and as I've described the front end of the forward curve has declined, there has been no developments that would cause us to change our expectations significantly.

For 2007, we continue to see an adjusted EPS range of $3.35 to $3.45, and for 2008, we see a range of $3.60 to $3.80. We have not changed the 2008 range to reflect the addition Point Beach at this stage, although we expect it to contribute a few pennies to that year. Point Beach's major accretive impact will come in the years beyond 2008.

We continue to expect very strong growth from FPL Energy, driven both by contributions from new investment as well as the roll over of existing hedges to new values more closely approximating current market conditions. Florida Power & Light faces a more challenging year with significant impact from the Storm Secure program and uncertainty around revenue growth, but we still look for modest growth from that business.

In terms of the pattern of earnings over the year, it may be worth noting that a significant portion of FPL Energy's growth will most likely be concentrated in the fourth quarter since we do not have a refueling outage plan and of course all of the extra output available will be sold at new higher prices in comparison to 2006. By contrast, the first quarter will probably show the least growth, as it would be difficult for the existing portfolio to improve much upon the exceptional performance it delivered in the first quarter of 2006.

Many of you have begun to ask how we will finance our 2008 wind programs now that PTC program has been extended as well as the pending acquisition of the Point Beach Nuclear Plant. As you know, we evaluate all of your investments at FPL Energy with an appropriate mix of debt and equity, while the actual determination of any need to come to the market for new equity is made at the enterprise level taking into account our total investment opportunity set. While no final decision has yet been made, it seems like the total investment we will deploy this year we will be greater than we are comfortable funding at internally.

On the financing side, we were very pleased with the market reception of our hybrid security issuance last year and we believe there is more room in the capital structure for instruments of this general type. We've had good success with project financing to wind projects once they are at or near completion and we will likely continue this approach. We have the flexibility to fund development and instruction on balance sheet and then structure the projects for efficient financing. In this way, we have been able to extract equity dollars for recycling into new projects while still retaining the upside and while conserving our strong corporate credit.

Consequently, we will be reassessing our net need for external equity later in 2007 when we have more visibility on both our investment opportunities and our financing possibilities. If we do need to come to the market for additional equity, most likely it will be not be until late in 2007 or early in 2008. Of course, we have the flexibility to close on Point Beach independent of any decision on equity issuance.

Also, I should note that we expect the Board to revisit and carefully consider FPL Group's dividend policy in conjunction with its February Board meeting. To conclude therefore, we are pleased with the overall performance we have been able to deliver in 2006, while we were challenged in a number of areas and not able to achieve every single one of our goals, the net results came nevertheless strong, and we have clear visibility into an attractive growth profile for the next several years at least. We look forward to another good year in 2007.

And now, we'll be happy to take questions.

Question-and-Answer Session

Operator

(Operator Instructions). And we'll go first to John Kiani, Deutsche Bank

John Kiani - Deutsche Bank

Good morning.

Moray Dewhurst

Good morning, John.

John Kiani - Deutsche Bank

You mentioned earlier Moray and then in the appendix you showed that a $2 per MMBTU change in commodity prices affects '07 EPS by about $0.01 to $0.02 a share. And you indicated that obviously because the hedge profile is a little bit less in a way to that it's going to be different. Can you give us a sense for what that sensitivity looks like in '08?

Moray Dewhurst

I am not going to give you a number of the top of my head. I have something that might be wrong. We'll get you that number.

John Kiani - Deutsche Bank

Okay. Can we assume that its -- order of magnitude obviously it's going to be a little bit greater, but probably anywhere in the pennies range?

Moray Dewhurst

Yeah, it will still be in the pennies range. It's certainly greater, but as you can see from the hedging chart, the assets that are natural gas sensitive or absolute power price sensitive tend to be very heavily hedged in 2008 as well. But the principal open positions for 2008 are bound to spread out.

John Kiani - Deutsche Bank

Great. And then, one other question, I saw that you recently launched $700 million financing for the 605 or 606 megawatt Lone Star wind portfolio. Can you talk about what the debt-to-cap or the percentage of leverage was that was used for that portfolio?

Moray Dewhurst

We don't generally talk about the leverage on specific transactions because the way that we structure a particular -- which projects we put together, how we structure the thing could have a big impact on that. I will tell you that in general across the collection of project financings that we've done on the wind assets, we typically reached 65% to 70% leverage. So, that's definitely much higher than the standard 50-50 assumption that we think of as the average for FPL Energy.

John Kiani - Deutsche Bank

Okay. So, if that project was levered 70% with that $700 million financing then the enterprise value would be about $1 billion, is that safe to say?

Moray Dewhurst

That’s correct, that’s a reasonable way to think about it.

John Kiani - Deutsche Bank

Okay. Thank you.

Operator

Thank you. And we will go next to Ashar Khan, SAC Capital.

Ashar Khan - SAC Capital

Hi, good morning.

Moray Dewhurst

Good morning, Ashar.

Ashar Khan - SAC Capital

Moray, you mentioned regarding financing, could you just elaborate little bit what the size could be and will then that impact your forecast for '08? I guess it's not in the '08 forecast, I just want to …

Moray Dewhurst

Yeah, let me be clear. When we consider new projects and let's take Point Beach as an illustration. It is safe to assume that when we are doing the pro forma economics, we build into those economics the assumption of a certain amount of equity that we believe is appropriate to support that particular investment. So that’s kind of in the economics. So, then if we say that such an asset is going to be x cents accretive in a particular year, we are saying it’s net of that implied incremental equity. So, anything that we have into 2008, for example, based on incremental new wind that we would be doing includes a presumption of an appropriate amount of new equity to go along with that new investment. However, the actual choice of how and when to conduct financings is done sort of separately at the enterprise level, and really what we try and do there is look ahead a couple of years and manage our overall risk profile and credit statistics so that we can maintain a good strong corporate credit position, and then the specific transactions that are needed to support that almost kind of drop out subject to whatever the market opportunities are. So, as a particle matter, we may be in a sense able to do a little better than the accretion numbers that are presumed in any given forward-looking statement, once we fine tune the actual financing plan.

Ashar Khan - SAC Capital

Okay.

Moray Dewhurst

It’s a kind of a long wind that explanation was, what we do.

Ashar Khan - SAC Capital

And then if I can just follow-up on this chart that you gave on the margins, the hedging chart 21 and 22 for 2007 and 2008. And I am just trying to -- the way I am reading and tell me if I am right or wrong. As you show the 800-wind that you are going to do in ’07, the expected margin for that for the year is 50 to 70, midpoint being 60. And then the next slide shows, when its 1550, the midpoint is somewhere approximately around 300, so you pick up something like $240 million or so. What that would imply, and I am just trying to go to 2009, is that the wind that you developed during the year contributes just like 30% or 20% or 25% of the margin that year, and like 70% of the margin or 70% or 75% of the margin comes in the following year. Is that a good way to say, hey then like 75% of the margin, if you develop 800 megawatts or 750 megawatts of the wind in 2008, that wind is going to show up in 2009?

Moray Dewhurst

Ashar, you have the basic dynamics, correct because the -- any given years wind program tends to be sort of back-end loaded. There is relatively smaller impact in the given year. Obviously, however it depends upon the specific profile of when assets come in to service in a particular year. It so happens that we are and have been now for several years for historical reasons the way the PTC program is, sort of, in a pattern where our in service days tend to cluster in the later part of the year, so as I rule of thumb I think that sort of one quarter to one third impact in the current year and the reminder in the following year is not a bad one but be aware that if we have a year where new winds comes in relatively earlier in the year that ratio would change.

Ashar Khan - SAC Capital

Okay. And if I think just end up, I don’t know just as you said comments on this would be nice because if I look at it just going back again to this chart 21, the expected gross margin is I guess mid-point would be like 2.6 and then if I am right FPL's energy's are going to like $0.6 billion and that would be nice if you can some how in the next time I don’t know if you can take us from the gross margin to the net income, it would be helpful

Moray Dewhurst

Okay.

Ashar Khan - SAC Capital

See as to -- what happens I don’t know if you can elaborate on it today?

Moray Dewhurst

Ashar, let me -- I certainly mean when I said about inviting you comments, however in the interest of allowing other people to ask questions on today stop. Can I ask everybody to sort of thinking about the backend and funnel those through Investor Relations subsequent to the call, but I take your input and we will think about it.

Ashar Khan - SAC Capital

Thanks.

Moray Dewhurst

Thanks.

Operator

Thank you. We'll go next to [Steven Ranzlow from Saturn Capital].

Steven Ranzlow - Saturn Capital

Hi good morning, I guess.

Moray Dewhurst

Good morning.

Steven Ranzlow - Saturn Capital

A follow up on the hedging question, if I go from the mid-point of '07 expected equivalent gross margin to the mid-point of '08, that’s roughly if I just tax effect that’s $0.40 a share. Can you give us some kind of bridge between that and what the expected growth in the EPS is from FPL Energy from '07 to '08?

Moray Dewhurst

Okay I will mark that down as further input, the answer to this specific question is, no, I can't give you that here today.

Steven Ranzlow - Saturn Capital

Okay.

Operator

Thank you, we will go next to Paul Patterson, Glenrock Associates.

Paul Patterson - Glenrock Associates

Hi, how are you doing?

Moray Dewhurst

Good morning.

Paul Patterson - Glenrock Associates

Just want to clarify something, the tax impact was $0.07 for the quarter with respect to the state deferred, the state tax benefits that you guys saw, is that correct?

Moray Dewhurst

No, that’s not correct and the $0.07 is quite frankly my personal estimate of kind of how much of the net fourth quarter tax -- we always do a sort of tax catch-up and reconciliation in the fourth quarter, and as I look at those numbers -- and it's a judgment call, but I look at them and say I would think about $0.07 of that is tough, it really is just one-time catch-up. And if nothing changes in my assumptions looking forward, I would not expect to see that continue on unto subsequent years. So I just flagged that, so don't expect that to be something that shows up every year here after, but it's frankly my judgment call.

Paul Patterson - Glenrock Associates

Okay. And what's your expectation for the tax rate going forward for just on a corporate wide basis? Is that applicable with all the production tax credits that you are getting from the [revenue]?

Moray Dewhurst

Yeah. You've highlighted probably the single biggest driver of variability there. Depending upon in essence the proportion of our group net income that comes from wind projects, effective tax rate will vary. So for next year by coincidence, I think, a fair number to use for sort of forecasting purposes is actually our current effective tax rate, but it consists of two offsetting changes, one is a slight uptick in the underlying rate because we had these non-continuing favorable effects in 2006, but that happens by coincidence to be roughly offset by a slightly higher proportion on next year's income coming from wind assets and therefore, slightly higher beneficial effect on the effective tax rate from PTCs. Again, long-winded explanation, but the answer is for forecasting purposes what we are expecting right now is about this year's effective tax rate.

Paul Patterson - Glenrock Associates

Okay great. Thanks a lot.

Moray Dewhurst

Thanks.

Operator

Thank you. We go next to Paul Ridzon with KeyBanc.

Paul Ridzon - KeyBanc

Moray, could you just clarify your need for financing, did you say that any external financing would probably be hybrids?

Moray Dewhurst

No, I am not saying that any external financing will be hybrids, but I think that there is a – we will have to take a look a little closer. There is a good possibility that we will be doing an additional transaction of that nature and the last one we did was really an unexceptional transaction when you look at it sort of net after tax cost of capital, and I think there is a little room in the capital structure for more. How much more I don’t know. We will have to go through and work the numbers, but at this stage, I would say that’s probably close to on my list. Obviously, we will continue to do project level financing on the wind. And then, so actually coming to the market for incremental new equity would be fallout out of how much, I think, we can do of those and balancing the credit risk.

Paul Ridzon - KeyBanc

And then, you’d mentioned the potential to address dividend policy. Is that a change in policy or is that just--

Moray Dewhurst

No, I just I wanted to flag for everybody that it is standard for our Board to consider dividend policy each February and obviously, we've had some significant changes and the outlook is very strong so that will be taking a very close look at the upcoming February board meeting.

Paul Ridzon - KeyBanc

So, we'll like to see a potential change in the dividend level as a result to that meeting?

Moray Dewhurst

Well, each of the past years, they have voted an increase in the dividend. But at this stage, I am not going to try and guess how the Board is going to come out on the actual decision in February.

Paul Ridzon - KeyBanc

And then, lastly just sorry to go back to the issue, but the tax item was the fourth quarter a catch-up of quarters 1, 2, and 3 or was it just quiet unusual?

Moray Dewhurst

No. it's -- unusual and usual. Let me see if I can try and do this briefly without taking three hours over it. Since all tax issues seem to be fairly detailed, but broadly speaking this relates primarily to state taxes. Many state taxes are done on a unitary basis and therefore, depend upon the proportions of business activity being done in that state versus other states. And therefore, in order to record state taxes as we go along through for the year, we have to be making some assumptions about what those portions in fact are or will be. Obviously, we do that on the best available information at the time. However, those do change and for us they can change quite significantly because the rapid growth of FPL Energy in a number of different states. So in the fourth quarter when we have completed the actual tax filings for the prior year, we obviously have better and newer information of what those portions in fact are. So, we then use those newer proportions of factors to update our estimates of what the taxes should be. That’s fine and it's usually a small number, except for the fact that we’ve previously booked state deferred taxes. So, on the balance sheet is a fairly significant amount of state deferred taxes and we therefore have to, in a sense, true-up that balance to what we now believe the apportionment factors would be, and that creates what I think up is a little bit of a one-time catch up effect. So, if I true those deferred taxes up, it's a correct adjustment for that period, but it's not one I would necessarily expect to continue on into the future. If the apportionment factors will not change in the future, it would clearly not change. So, that's really what's going on. And that -- please that is a very simplified explanation. There is a lot more to the tax reconciliations to go on, but that's the key driver here.

Paul Ridzon - KeyBanc

Okay. I guess this killed that topic .Thank you.

Operator

Thank you. We'll go next to Reza Hatefi with Polygon Investment.

Reza Hatefi - Polygon Investment

Good morning. Thank you.

Moray Dewhurst

Good morning.

Reza Hatefi - Polygon Investment

On slide 21 and 22 for the wind, what is the capacity factor that's hidden in those margin numbers?

Moray Dewhurst

The capacity factor that we assume for when setting expectations of financial planning is the natural capacity factor for each individual project. So, when we invest in these projects and we develop a wind date or we make an estimate of what we expect the average capacity factor to be. We may then in -- after some years of operation, we may tweak that based on actual input, but it doesn't change that much. So, if that number is then used going forward, I would always assuming normal weather looking forward. So, we use the normal expected capacity factor each project. We weight average those out and that comes out to the portfolio average, which typically has been in the low 30s. Individual project factors range from the high 20s to the mid 40s. An extremely good wind project would have a capacity factor of 45, but the portfolio average has been somewhere around 32 to 33.

Reza Hatefi - Polygon Investment

32? Great. And the ERCOT and other, is that the remaining winds in addition to the contracted wind above?

Moray Dewhurst

Yeah, yes. Yeah that's primary wind, but it was Taxes wind.

Reza Hatefi - Polygon Investment

And can you give us CapEx guidance for '07 and '08 broken down by FPL Utility and FPL Energy?

Moray Dewhurst

For FPL for '07, the numbers goes up to about $2.2 billion and for FPL Energy excluding Point Beech it's about $1.3.

Reza Hatefi - Polygon Investment

And how about 2008?

Moray Dewhurst

I don’t have those immediately to have. I think for the next few years at FPL, you can expect on the order of $2 billion or so with some fluctuations depending upon the profiles of the generation projects. For FPL Energy for 2008, it would be on the same order of magnitude, again plus the -- all of these are exclusive of Point Beach where Point Beach ends up being in '07 or '08, may be a little -- little higher for FPL Energy for the next year.

Reza Hatefi - Polygon Investment

Thank you very much.

Operator

And we'll go next Annie Tsao with AllianceBernstein

Annie Tsao - AllianceBernstein

Good morning.

Moray Dewhurst

Good morning, Annie.

Annie Tsao - AllianceBernstein

Yeah. I've just got one addition question, for the usage growth per customer, what kind of a function do you use in your'07 and '08 guidance?

Moray Dewhurst

We run the same -- the normal model, which has inputs is like -- what we expect the basic growth in for capital income to be and the change in our prices and we are assuming the regular level of price elasticity. So, since the rates have come down a little bit, we get a positive effect from price elasticity and a positive effect from assumed income growth. And as a result, we are -- then we sort of normalize for weather. So, on that basis, I think the weather normalized growth that we are looking for is a little less than 2%.

Annie Tsao - AllianceBernstein

For customer growth, is your housing starts when you include that chart came down. Do you have -- do you think any of your assumptions over there for the…?

Moray Dewhurst

As I said in the prepared remarks, the current level of housing starts is very consistent with annual customer growth for us in the 80,000 to 90,000 range. So, unless it drops off really a whole lot more, I don't see any reason why the 2% level isn't quite realistic. Obviously, there is some uncertainty about that and as I indicated we'll watch the -- we do watch the housing starts closely and we'll update you on those. But I think that's a reasonable assumption at the moment. The other point that I made in the prepared remarks is that ultimately the -- our customer growth rate is driven by the state of the economy. So, as long as employment growth and the underlying economy of Florida remain good, which they obviously have been for some time then we will see good customer growth. If that starts to change then we'll have to revise our view.

Annie Tsao - AllianceBernstein

Thank you.

Operator

Thank you. We'll go next [Andrew Levy] with Brencourt.

Andrew Levy - Brencourt

Hey guys.

Moray Dewhurst

Good morning.

Andrew Levy - Brencourt

Just back on your dividends thing, I guess what your payout ratio, if you kind of look at consensus for '07 based on your guidance is about 44%. Can you give us any guidance on what you think the appropriate payout ratio is or the range of payout ratio is for a company with your profile?

Moray Dewhurst

Well we have kind of struggled with, that we have never been able to come up with a specific number or target range. Just as a reminder, our -- kind of historical, the policy that the balance that the Board has tried to strike is to have a what we call a not uncompetitive yield balanced with recognition of the fact that we have much more significant growth opportunities hence much higher CapEx needs than many others have -- compared to companies and therefore we would never be in the 70% to 80% payout range. What that has in fact just meant is the balance has been struck in below 50s. So I think we will be looking at that with the board and providing them input on that. But clearly the acceleration of the earnings growth profile provides some opportunity for increasing dividend.

Andrew Levy - Brencourt

And so beyond just to give the payout ratio I guess yield relative to the -- it appears your group is also something else you will be looking at?

Moray Dewhurst

Yeah that’s something that we take in to account. For example a couple of years ago, I can't remember exactly which year it was now. We looked -- that was one of the factors that the Board looked at, and the conclusion was that we were really slipping down to well below the bottom of the comparative group that we look at, and so the Board made a mid-year increase and that was really the motivation there. So that’s definitely something that they look at.

Andrew Levy - Brencourt

And then I guess clearly now you are below average too so. Okay, great. Thank you very much.

Operator

Thank you, we will go next to Scott Engstrom with Satellite Asset Management.

Scott Engstrom - Satellite Asset Management

Good morning.

Moray Dewhurst

Good morning Scot.

Scott Engstrom - Satellite Asset Management

Question about FPL and the earnings thresholds to refund. Did you guys get in that zone at the base level? And then a follow-up would be, what – as you roll that 10 year average forward to next year, what would be the growth for the increase in the threshold?

Moray Dewhurst

The answer to the first question is unfortunately no. Under the rate agreement the thresholds escalate at a predefined rate that’s based on sort of historical growth. So they kind of keep going with the -- in tune with the expansion of the business. So its design sort of a head room that you have before you hit the first break point is kind of proportionately the same in each year of the agreement. So unfortunately no, the revenue performance has not been at the level that would warrant that.

Scott Engstrom - Satellite Asset Management

With – so where that threshold, is it like 2.9% and that it will increase in ’06 or ’05 is that the right range?

Moray Dewhurst

Yeah, I don’t know that 2.9 is the exactly the right number, but it’s around 3%.

Scott Engstrom - Satellite Asset Management

Okay, great. Thanks.

Operator

Thank you. We go next to Shalini Mahajan with UBS.

Shalini Mahajan - UBS

Good morning.

Moray Dewhurst

Good morning.

Shalini Mahajan - UBS

I just wanted to follow up on the customer usage question. You indicated that ’07 EPS guidance assumes less than 2% growth in the underlying usage. Now can we look at your 2006 results of $0.04 simply because you did not give it in your variance drivers that every 1% decline in underlying usage is a $0.07 drive in earnings, will that be a fair assumption?

Moray Dewhurst

Hang on one second, let me make sure -- Shalini, let me get back to you and rather than mistake to do the mental arithmetic incorrectly.

Shalini Mahajan - UBS

Okay, okay.

Moray Dewhurst

That’s one we can easily provide.

Shalini Mahajan - UBS

Okay. And just on the chart on 21. Would you be able to give -- I expect an equivalent gross margin for 2006 or it was and kind of a similar bottom line number as '07?

Moray Dewhurst

Okay. I will put that in sort of the same category as it shows.

Shalini Mahajan - UBS

Okay, alright.

Moray Dewhurst

Thank you.

Shalini Mahajan - UBS

Okay, thank you.

Operator

And we'll go next to Jesse Laudon with Zimmer Lucas

Jesse Laudon - Zimmer Lucas

Hi, good morning.

Moray Dewhurst

Good morning.

Jesse Laudon - Zimmer Lucas

Just a quick question on what you kind of are assuming in NEPOOL for some of the capacity markets, now that there has been some progress made there. Is that impacting your margins or is that more because of hedging going to impact us beyond '08?

Moray Dewhurst

Yeah, clearly that’s a positive driver for NEPOOL portfolio. If recollection serves correctly, the next couple of years are essentially sort of preset in terms of the capacity rates, and so those amounts are built into expectations. So what happens beyond 2009, well obviously market forces are going to take over. But if you look at the underlying fundamentals for that market, you certainly have to be at this stage pretty optimistic about the further trend in capacity values?

Jesse Laudon - Zimmer Lucas

So we should assume that that -- in your numbers, those gross margins numbers that you're putting out, that would be considered an unhedged revenue?

Moray Dewhurst

That would in this -- for these two years we would consider that hedge revenue because the values are preset by the way the rules are written. As we go out into the future and we roll to a pure market rate construction, then it would depend upon whether we head contractual arrangements to lock in the capacity of the value. Obviously, you can -- through the market you can engage forward transactions for the capacity too. But to the specific answer to your question, in those charts that is assumed as hedge margins because those are fixed values according to the market rules.

Jesse Laudon - Zimmer Lucas

Great. Thank you.

Moray Dewhurst

Thank you.

Operator

And with no further questions, I'll turn the conference back over the Mr. Jim von Riesemann for additional or closing remarks.

Jim von Riesemann

That concludes our conference call today. Thank you for joining us.

Operator

Thank you once again. That will conclude today's call. We thank you for your participation and you may disconnect at this time.

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