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American Electric Power (NYSE:AEP)

Q2 2011 Earnings Call

July 29, 2011 10:00 am ET

Executives

Brian Tierney - Chief Financial Officer and Executive Vice President

Charles Zebula - Senior Vice President and Treasurer

Michael Morris - Chairman, Chief Executive Officer, Chairman of Executive Committee, Member of Policy Committee, Chairman of American Electric Power Service Corporation, Chairman of Appalachian Power Company, Chairman of Ohio Power Company, Chairman of Southwestern Electric Power Company, Chief Executive Officer of American Electric Power Service Corporation, Chief Executive Officer of Appalachian Power Company, Chief Executive Officer of Ohio Power Company, Chief Executive Officer of Southwestern Electric Power

Analysts

Michael Lapides - Goldman Sachs Group Inc.

Dan Eggers - Crédit Suisse AG

Anthony Crowdell - Jefferies & Company, Inc.

Paul Ridzon - KeyBanc Capital Markets Inc.

Paul Patterson - Glenrock Associates

Jonathan Arnold - Deutsche Bank AG

Justin McCann - S&P Equity Research

Greg Gordon - ISI Group Inc.

Ali Agha - SunTrust Robinson Humphrey, Inc.

Unknown Analyst -

Steven Fleishman - BofA Merrill Lynch

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the AEP Second Quarter 2011 Earnings Conference Call. [Operator Instructions] And as a reminder, today's call is being recorded. Now with that being said, I'll turn the conference over to Mr. Chuck Zebula. Please go ahead, sir.

Charles Zebula

Thank you, John. Good morning and welcome to the Second Quarter 2011 Earnings Webcast of American Electric Power. Our earnings release presentation slides and related financial information are available on our website, aep.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors.

Joining me this morning are Mike Morris, our Chairman and Chief Executive Officer; and Brian Tierney, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Mike.

Michael Morris

Thanks a lot, Chuck, and good morning, everyone. Thanks for being here with us for the update on the second quarter activities at American Electric Power Company.

I'd move you to Page 3, the second quarter 2011 highlights and try to get some granularity about these small statements. First, we're really quite satisfied with where we are through the second quarter of 2011. We really got up to a bit of a slow start in kilowatt-hour usage as you may remember early in the year, but things have improved in our entire footprint since then.

Clearly, stronger in the West than in the East, but acceptable in both of those areas. Commercial sales in the East still are lagging from what we had forecasted they might be, but we're really seeing very strong industrial sales throughout our Eastern footprint.

In fact, if you remove the impact of Century Aluminum still being offline, we're at about 95-plus percent of the overall industrial send-outs that we saw in the prerecession time. And that really stays in line with the things that we talked to you about during 2008 and 2009.

Clearly, different from the recessions that we saw in our Eastern footprint back in the 80s and 90s, where plants actually were shut, and shut forever. What we suggested in the 2008, 2009 timeline was that people were laying their plants up for the intent to come back and clearly, that has come to be the case.

We are seeing additional shopping in Ohio beyond what we had forecast for our retail customers, but as you might imagine, American Electric Power retail operations have been successful, not only in AEP Ohio's footprint, but in the other opportunities that present themselves here in Ohio.

And of course, any gigawatt-hour sale that doesn't go to the retail market does go to the off-system market. And I think you know from our press release that off-system sales results have been quite solid.

So when we look at the net-net of the effect of switching in Ohio, we've always been an advocate for that. We didn't think that it would affect us quite as deeply as it has, but we're reacting to it in a very constructive way. And net-net, the impact is acceptable and we are satisfied with where we are with AEP retail and some of the things that we see.

So based on all that we look at throughout these first 2 quarters, we feel very comfortable with our $3 to $3.20 range, and reaffirm our earning strength forecast for calendar year 2011.

We have a couple of interesting litigation developments to talk about. We couldn't be happier with the way that the Texas Supreme Court ruling came out just a couple of weeks ago. I know that many of you had a chance to digest that, and of course, many of you have seen the impact that it had on CenterPoint and continues to have for them, as they go through the remand cycle of what the Texas Supreme Court has decided.

For us, as you know, it justifies the way that we went about auctioning off our assets, the way that we characterized stranded costs going forward, and it has great potential upside for, us not only in a one-time event, which we'll talk about or Brian will talk about a little bit more here in 2011, but on an ongoing basis as well.

And one of the things that you may not have appreciated, and we surely do, about the Texas Supreme Court decision, is that it also removed potential downsides that were argued by other petitioners in the case and made it quite clear that the approaches that AEP Texas took to that endeavor were exactly in compliance with the law, and we're very satisfied with that, as you might imagine.

We're also over-the-top satisfied with the ability to remove a number of the litigants in the overall activities in Arkansas as they pertain to the John W. Turk Plant. We are grateful that our team at SWEPCO was able to bring resolution with the hunt club folks as well, as well many of the other interveners in that case. And I can assure you that the political folks in Arkansas, as well as many of the judges that we reported the settlement to, were quite pleased with what they had come to learn about those activities.

As you know, there are 2 NGOs who did not participate in the overall dialogue, although invited. And that is interesting, and we'll continue to carry on our dialogues with them to see if we can find some resolution.

But more importantly, the underlying environmental issues that those parties have raised were addressed in the overall settlement with the other parties, so we think that we have the potential to bear fruit in those discussions with the 2 NGOs and we'll continue to do that.

When we look at our regulatory plan, as you know, where we've already had some success in calendar year 2011, $220 million of our overall rate stack already accomplished. There are a few cats and dogs out there that may help us get there, but we're in pretty solid shape the way that we see it.

And the open proceedings in Ohio, Virginia and Michigan are there. Some may be resolved yet this year, and they'll have a constructive effect, we would hope, in that sense.

So let's spend a few minutes talking about Ohio because surely, as you know, we have a number of open cases in front of this jurisdiction, all of which are important to us, all of which are important to our customers and clearly, all of which are very important to the economy here in Ohio.

We continue to have what we believe to be constructive dialogue with the many parties to the cases, including the Commission staff. We will continue to work toward that end on all of these outstanding matters. As you know, the merger case has been approved by the FERC. We would hope that, that will come through here in Ohio in the not-too-distant future.

A couple of important filings to be made in the not-too-distant future, obviously, today, we expect that the staff will file their testimony in the overall ESP case. Like all staff testimonies, or the testimony filed by any party, it will have some parts that we agree with, there will be some other parts that I'm sure we don't agree with.

Net-net, testimony is never the end result of where a case may end up but nonetheless, we, like you, look forward to reading that, and hopefully, we'll find a few things in there that will be encouraging for us. But I'm well aware that we may read things in there that we don't necessarily agree with as, well.

At the end of the day, we feel very comfortable about our position in Ohio. We feel comfortable, as I mentioned, about the dialogue that we've had with the parties to the cases. This is a new and different Commission, surely up to the task of resolving these many cases, and we would hope that, that happens. We also will be filing our view of the 2010 review of the SEET activity, pursuant to Senate Bill 221. As before, we think Ohio Power is in the Safe Harbor zone. And based on the way that the staff dealt with the activities at Columbus and Southern in the 2009 review SEET activities, we feel comfortable that we will not be impacted at all by the SEET activities in the review that will go on.

Like all my other colleagues, let me move into the environmental update, I should say, all my other colleagues who are coal-centric producers. I know that you had a pretty good walk-through the way that we all see the impact of the things the Environmental Protection Agency continues to do.

Casper came out, the industry spoke in a solid voice of -- we understand the end game here. We think that we can get there efficiently, financially and electrically, if the dates would be extended from 2014 to 2016. Much to our dismay and others, they moved those dates from 2014 to 2012. And of course, as you surely read frequently, the state of Texas was included for the very first time in the final rule that came out, now called Casper.

Notwithstanding that, we feel pretty comfortable at American Electric Power with our overall view of what we think the EPA's rulings, not only that which are issued, but those which will be issued, will have on our overall system. We stay committed to the notion that we'll be shuttering 6,000 megawatts prematurely. I know there's always been some confusion whether they were part of an overall settlement on New Source Review and New Source performance review some years back.

About 700 of those megawatts were included in those timelines, however, the rest of them have all been moved forward because of the current activities going on at the EPA.

Closing some of those facilities over time will, of course, have an effect on our ability to have gigawatt hours available for us in the off-system sales market. But throughout the footprints where we are very active with off-system sales, we expect other facilities will be shut as well. And that clearly will have not only a constructive impact on the capacity fees that we receive going forward, but it will also increase the amount of money recognized on gigawatt hours of energy put into the marketplace. And it doesn't take much of an uptick in those 2 numbers to compensate for the megawatts that will be coming offline because, as you all can imagine, those were higher-price plants at the top of the stack, which didn't dispatch as early as those on the lower cost portion.

So we feel as though there will be some impact, it surely won't be a devastating impact. Nonetheless, we will continue to do what we can politically, as well as in the general dialogue with the EPA to try to put greater rationality in what it is that they're trying to accomplish. I know that some of the more principled NGOs are concerned about the approaches that we have taken to this, particularly in the legislative arena.

But our position, we think, is reasonable. It gets us to the same environmental footprint by 2020 instead of 2016 or 2017, and it's not in a much more financially and electrically rational and beneficial way. So we will continue to put as much pressure on the EPA as we can. I'm happy to see that today, they decided to put another cap on oil and gas drilling. That will bring some additional folks in the fray of trying to discuss about the incredible aggressiveness that the EPA is taking, all in keeping with what they think is their challenge, but nonetheless, in our view, unnecessarily over-the-top and a bit aggressive. I don't think there's a corporation in America that doesn't want to get to the right place, it's just a matter of trying to get there in a cost-effective and energy-effective way.

Lastly, let me talk a minute about some disappointment for us, anyways, from the carbon capturing storage project layup at our Mountaineer station in New Haven, West Virginia. I know that many of you had the opportunity to be there. You know how amazingly impressive it was that we were able to capture and store the only integrated project anywhere in the world with a coal-fired power plant.

But going forward, without a carbon legislation or without an appropriate approach to carbon and its impact, it was simply not able for us to go forward and continue that project. It has been completed or will be completed through the base in engineering drawings and activities and laid up for another day.

We're encouraged by what we saw, we're clearly impressed with what we learned, and we feel that we've demonstrated, to a certainty, that carbon capture and storage is in fact a viable technology for the United States, and quite honestly, for the rest of the world going forward.

So with that, let me simply close by saying we, as I mentioned at the outset, reaffirm our view of our earnings strength in 2011 and, of course, stand by our $3.25 forecast for 2012.

With that, I'll turn the microphone over to Brian.

Brian Tierney

Thank you, Mike. This morning I'll review quarterly and year-to-date reconciliations through the second quarter, discuss low trends, review customer switching data and provide an update on the company's capitalization and liquidity. Then we will get to your questions as quickly as possible.

On Slide 4, you'll see that second quarter earnings for this year was $352 million or $0.73 per share, which was $3 million less than last year's second quarter results of $355 million or $0.74 per share.

Here are some of the highlights for the quarter-on-quarter comparison: Operations and maintenance expense net of offsets was unfavorable by $56 million or $0.08 per share. This number is largely explained by an increase in storms expense of $52 million. Much of this variance is attributable to Appalachian Power when in the second quarter of 2010, they were able to defer $25 million related to a 2009 storm.

This year, Appalachian Power had storm costs totaling $17 million for the quarter. Other costs, net, accounted for negative $0.04 per share or $34 million, and primarily consisted of a decrease of $10 million net of tax from the sale of shares of the Intercontinental Exchange in 2010 and year-on-year increases in other taxes.

Customer switching accounted for an unfavorable quarterly comparison of $24 million or $0.04 per share. We will discuss this in more detail on Slide 7. Rate changes accounted for positive $66 million or $0.09 per share and came from multiple jurisdictions.

Off-system sales net of sharing were positive $37 million or $0.05 per share. This result was driven by a significant increase in physical volumes and the widening of spark and dark spreads. Physical volumes were up 81% due to an 11% reduction in planned and unplanned outages, and the fact that more of our units were in the money since around the clock prices were up 14%, while natural gas prices were only up 1% and delivered prices for coal were only up 3%.

Weather accounted for a positive $0.01 per share, a $5 million improvement over last year, and was favorable $47 million versus normal weather. Driving this result for the quarter was the fact that our Western service territories experienced the hottest June in the last 30 years.

Turning to Slide 5, you will see that for year-to-date 2011, AEP earned $744 million or $1.55 per share, which is $24 million more than last year's $720 million or $1.50 per share.

Highlights include operations and maintenance expense, net of offsets, which compared negatively to last year by $30 million or $0.04 per share, so with the quarterly comparison, this difference was largely driven by an increase in storm costs of $36 million.

Other costs net decreased $0.05 per share or $35 million, and similar to quarterly comparison, was primarily driven by the absence of the $10 million net of tax gain on ICE shares and from higher other taxes.

Customer switching was the difference of $43 million or negative $0.06 per share, and again, we'll discuss this in more detail later.

On the positive side, rate changes were responsible for a year-to-date gain of $110 million or $0.15 per share versus 2010. Again, these rate increases were for multiple jurisdictions.

Off-system sales, net of sharing, accounted for a positive comparison to last year of $49 million or $0.07 per share year-to-date. The story here is similar to the quarterly explanation, but it's not as dramatic. Physical volumes were up 45% and spark and dark spreads widened with around the clock prices for electricity increase in 5%, while natural gas prices were actually down 10% and delivered prices for coal increased 1.4%.

Finally, in contrast to the quarterly comparison, weather was a negative variance to last year for the year-to-date period. Although unfavorable by $0.02 per share or $15 million to last year, this year was actually favorable $67 million when compared to normal weather.

Turning to Slide 6, we will take a look at the normalized load trends as promised. It's important to remember that this data has been adjusted to exclude the effect of weather and represents our total connected load.

In the bottom right-hand side of the slide, you will see that total normalized retail sales were up 1.9% for the quarter and are running at a positive 2.2% for the year-to-date. This improvement is primarily in the residential and industrial classes.

Although the residential class is up 4.4% for the quarter, it is up 9/10 of a percent year-to-date, which we believe is more indicative of growth in the class. Economic recovery for our commercial class of customer remains slow.

The improvement in the industrial class has been aided by the return to full production of one of our large aluminum customers. Mike mentioned that with the exception of another aluminum customer who remains closed, our industrial sales volumes now stand at 95% of the prerecession levels.

Slide 19 in the appendix provides more detail on our top 5 industrial sectors. Finally, all customer classes have benefited by the Valley Electric Membership Corporation acquisition in our SWEPCO operating unit.

As a reminder, as part of our guidance for 2011, we were expecting sales volumes to exceed the prior-year by 1.7%. Although the mix of customer sales continues to shift somewhat between the classes, we remain confident that our original guidance remains sound. On Slide 7, we can examine AEP Ohio customer switching.

For clarity, let me describe the graph. The bars show us the 2011 cumulative percentage of load lost as to compared to AEP Ohio's total load. The line shows us how much generation margin was lost associated with the customer switching, $46 million in total.

At the bottom of the page, you can see how this activity is split between our 2 Ohio operating units for the quarter-to-date and year-to-date periods. As we have previously discussed, the more significant activity is occurring in Columbus and Southern Power.

In aggregate, about 7% of 2011 total AEP Ohio load has switched through the end of June. The level of switching, to date, is running ahead of the pace assumed in our guidance, and we expect that to continue for the remainder of 2011.

It is important to note that we are experiencing positive, offsetting margins associated with the freed-up energy and capacity through off-system sales and capacity sales to competitive retail suppliers.

Given the net effects of increased switching and positive margin offsets, we remain confident with the 2011 earnings guidance.

Finally, on Slide 8, I would like to update you on our balance sheet and renewal of our recent credit facilities. You'll see that AEP's debt to total capitalization stands at 56.6%. This is the lowest level for this ratio in the last 5 years and reflects the commitment by the company to maintain a strong balance sheet and solidly BBB credit ratings.

Our cost reduction initiatives from last year and our capital expenditure discipline reflect that commitment and are direct reasons for the strength of our balance sheet. Also, on Wednesday, we issued an 8-K which contained important announcements about our 2 core credit facilities. On July 26, we renewed and upsized the $1.45 billion facility that was due to expire in April of 2012 with a $1.75 billion facility that will expire in 5 years.

In addition, we were able to extend the $1.5 billion facility that was due to expire at the end of June of '13 by 2 years, now with an expiration in June of '15. We were also able to reprice that facility to reflect current, more favorable pricing. These assumptions improve the capacity of our credit facilities by nearly $300 million to $3.25 billion, and extend the tenure of these facilities considerably.

Also, as Mike mentioned earlier, we are pleased with the decision of the Texas Supreme Court to reverse the PUCT's decision to deny recovery related to the capacity options and to remand the issue back to the PUCT.

As a result, TCC will be entitled to recover $420 million plus carrying costs dating back to 2002. We expect the total to be about $900 million. This capital infusion will further strengthen the balance sheet of the company.

In summary, the company is in a strong credit and liquidity position as we enter the next several years, where the company will see increased demands for capital investment for environmental, maintenance and reliability needs.

As Mike mentioned, we are affirming our guidance for 2011 and 2012. As you know, our point estimate guidance for 2012 is $3.25 per share. This guidance assumes a reasonable outcome in Ohio, manageable impact to off-system sales from the Casper rules and continued growth in our Transmission business.

In the coming months, as the Ohio and EPA pictures become clearer, we will be able to provide more specific guidance than the point estimate we affirm today.

We appreciate your time today, and I'll turn the call now over to the operator for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And first, we'll go to the line of Greg Gordon with ISI Group.

Greg Gordon - ISI Group Inc.

So when we look at -- when looking at the numbers, clearly, as you explicitly stated, the switching numbers are tracking ahead of what you had told us your budget was for this year, but you're also at 70% of the target of gross margin for the year in your off-system sales business and we're not even in the third quarter yet. So is there some way, maybe in the future, you could give us what the net impact to margins is by sort of carving out the benefits that are accruing to the OS, off-system sales margins as energy and capacity move from the retail bucket to the wholesale bucket?

Michael Morris

We'll surely try to crack something like that, Greg, to give you guys at least some directional view. The offsetting positive effects, as you already mentioned, showing where we are with off-system sales with just 2 quarters moving into what, as you know, is usually the most productive quarter. We feel very, very comfortable about where we are. And as you know, inside of the ESP, there are some great design issues, as they pertain to the commercial rate class, which is the high-impact class at Columbus Southern, we expect will get resolved. And so going forward, some of the off-system benefits will continue to be there and some of the on-system switching might slow down a bit, but we'll try to give you a better picture of that so you can get a feel for it. But rest assured, we feel extremely comfortable of where we are. We're capturing about 25% of our own market share and that ascends to AEP retail having success. And the other areas, both FE -- all 3, really, FE, Dayton and Cincinnati. So switching in Ohio was interesting. I think we've reacted to it in a constructive way and the impact on it, although, more than we had expected, has been very tolerable.

Greg Gordon - ISI Group Inc.

And the Casper rule, some of the other companies that reported yesterday indicated they thought there was a chance that the implementation could be delayed by the courts. Are you presuming that happens or are you presuming that doesn't happen? And when you look at the amount of credits you've been allocated, are they sufficient to mitigate the potential increase in customer builds or do you have enough credits to mitigate having to increase what you charge in the system agreements? So when you look at the balance of sort of your long-short position, how does that play out in terms of where those credits get allocated? And is that going to be a '12 impact or do you think perhaps, it will be delayed?

Michael Morris

Well, like everybody else, we'll continue to push for a delay, because there's just no way in the world you can make a rule final in November of 2011 and expect people to comply with it on January 2012. It's as close to lunacy as you can get. But having said that, we'll continue to plan to address those issues. We continue to look at the options that are available to us. Your question on the credit is interesting. We're long in some jurisdictions, short in other jurisdictions. Some of the controlled trading will allow us to address much of it, but maybe not all of it, and we're going about the process of trying to satisfy that shortage as we go. But as you know, in a regulated world, those kinds of activities are recoverable from our customers and is going to have some unfortunate dislocation. When you think about Casper and the timelines, we'll all be able to manage our way through it. If we end up spending a certain amount of money in the regulated footprint, as you know, that will turn into earnings as we go. The really devastating effect though, will be in those communities where plants are prematurely closed, jobs are lost, property tax bases are affected. And in many of those regions, Greg, as you know, we're the only game in town. So when the power plants go, so go the communities. And that is truly the unfortunate impact that no one on the coast cares about, and I understand that, whether it's East or West Coast. But we care a great deal about that in our footprint, we sure do.

Greg Gordon - ISI Group Inc.

The final question, on the $900 million in pretax cash you'll hopefully be getting some time next year. Is there -- do you know what the use to that cash are going to look like at this point?

Brian Tierney

Yes, we do, Greg. We're going to obviously take some of that and resecuritize TCT [ph] by retiring some debts. And just there are going to be some requirements that we're going to have in Texas to retire that and refinance that company. But there will be a component of that, where that should be a significant dividend up to the parent. And, of course, we'll use that for the other capital needs that we have and we've sort of laid some of those out for you, the environmental needs that we have building the transmission business and others.

Operator

Our next question is from Paul Patterson with Glenrock Associates.

Paul Patterson - Glenrock Associates

First on the tax rate for the quarter, I'm sorry if I missed this, but it did seem a little bit lower than I think normal. Could you tell us what happened there and if there's any change or opportunity for lowering your tax rate on a go forward basis?

Michael Morris

I'm trying to end up looking like Jeff Himmel [ph], but I'll let Brian answer that question.

Brian Tierney

Tax rate for the ongoing, the AEP total -- each segment was about 33.27% compared to the prior year, and about 35.5%. And it was lower as a result of lower pretax booked income and larger favorable flow-through and permanent book-to-tax differences. We're always looking for opportunities to try and get that down as low as we possibly can and we're engaged in a number of tax-planning activities to try and get that as low as possible. We're pleased that it's below what we had in the guidance, above 35% range for the quarter and the year, but we're always planning and trying to find ways to reduce that tax burden as much as we possibly can.

Paul Patterson - Glenrock Associates

You now to have changed the -- we should change your outlook on the tax situation going forward, right?

Brian Tierney

I think it's always wise for you to assume a 35% rate. And if we come in lower than that, that's a benefit to our shareholders.

Paul Patterson - Glenrock Associates

Okay. With respect to -- [indiscernible] switching, I guess, Greg asked this question. You guys are not providing any -- I mean, that's the gross margin that you always had on that slide as opposed to the net margin. Could you just give us a little bit of a flavor as to what you think the net margin would be, roughly speaking?

Michael Morris

I'd rather give you some accurate data as best we can down the road. Paul, again, I will tell you that it's considerably smaller than the gross margin impact.

Paul Patterson - Glenrock Associates

Okay. The Ohio situation, we've seen the interveners file their testimony and it was all over the map, I guess, different industrials or different positions and what have you and the OCC and what have you. Is there any possibility that we're going to be getting a settlement? I know that others have suggested that, like Duke. And I'm just wondering whether or not -- what do you see the -- I mean, this is going to be a fully litigated case and that's just what we should expect?

Michael Morris

Well, I would hope not. As I mentioned in my opening comments, we continue to have what we think to be constructive dialogues. As you know, and I mentioned this as well, people file testimony to lay out what they think is their most preferred position, frequently knowing that they'll never get there, but nonetheless, they do. And each and every time people do that, it does have an effect on settlement discussions. So -- but I have every reason to believe, based on what we're hearing in the give and take discussions with folks, that these cases lend themselves to settlement and we'll continue to work diligently toward that end.

Paul Patterson - Glenrock Associates

And then just finally on the staff, you mentioned that it's coming out today. And with the old ESP, it came out and it didn't really say much. It sounds like you guys are expecting them to give a more defined position as to where they're actually -- what the sort of full ESP format should sort of be you like? Is that what you guys are sort of sensing?

Michael Morris

Not necessarily. What I tried to say in my comments was just if you see something there that looks draconian, you can react to it as you'd like. But again, that won't be the endgame. And the dialogue with the parties, so staff included, have been constructive. I think we're better than Congress at debt ceilings and cost reductions. But some of the conversations every now and again get a little worrisome, so we'll see what we'll see. I don't think it'll be a crystal-clear path of here is what we think the commission ought to do. It will lay out some of their positions and various issues, some that may be more aggressive than we would like and others that may be more supportive, and the others would've thought the staff would've been. So it's really hard to forecast. I assure you, they're not sharing with us any drafts of what it is they intend to file. We'll get it the same time you get it.

Operator

Next, we'll go to Daniel Eggers with Crédit Suisse.

Dan Eggers - Crédit Suisse AG

Mike, I just wondered if you could give us your thoughts kind of on the -- you've added a big plan for the capital spending for environmental and kind of the plans for retirement versus keeping. Can you share a little color on what's the regulatory response and the stakeholder response to investment and closure decisions by states and whether you're going to see any changes or inducements maybe to change that plan?

Michael Morris

That's an interesting question, Dan, because the granularity that we provided has allowed us to be on the point and to catch any one of the number of arrows coming our way. Now I will tell you this, we have not had a meeting with anyone in any of the states and/or in Washington, including the EPA, where there wasn't serious thanks for telling us exactly what your picture looks like. You can rest assure that the state level, the governors and the House and Senate members, as well as the local community folks, are eager to see us change the plans. I had an opportunity to speak to about 500 people at the Kentucky chamber, where the Speaker of the House of the State, the Commonwealth of Kentucky, who serves our big sandy areas, stood up and said, "Whatever you do, don't shut big sandy down." Go about whatever it is you need to do, whether you're going to retrofit it, which would be their preference, and/or convert it to gas, and they'll be with us as we go to the PSC in Kentucky to adjust the rates accordingly. I think what we're seeing in our Eastern footprint, for the most part, are state leaders who are suggesting that they do not want to be at the whim of the market, nor do they want to be a net energy importer, because each of those 7 governors have already staked out their jobs and economic development are the plans for their success. So we should -- a great deal of encouragement. I must tell you, I had meetings with the FERC, with the Department of Energy's electricity group, with the EPA, with the various NERC players and the RTOs, the NAIRU folks, everyone is saying thanks for the granularity and the honesty of your data, and we can see what you mean by there may be pockets of reliability impacts. And someone really needs to aggregate all that data so that you can see that going forward and, as you know, the Energy Commerce Committee in the House of Representatives has suggested in the TRAIN Act that, that's exactly what the government does. So this is far from over with. It really is. And again, we are not in any way, shape or form, although I know many NGOs don't agree with us in this regard. We're not trying to change the environment nor affect the environment in a negative way. We're trying to balance the environmental benefit that will come from retrofitting and changing the generation fleet here in the United States with the economy of the United States, which we think is every bit as important.

Dan Eggers - Crédit Suisse AG

I guess, here's another question. If you look at the usage patterns in the quarter, it looks like residential kind of had a pretty nice pot relative to where trend had been coming out of the recession. Was there something unique to the quarter? Was there some weather adjustment data that makes them all swirly? Are you actually seeing a real change in usage out of that customer class?

Michael Morris

Well, you've heard us say this in the first quarter. Well, one of the few things that is, in a constructive sense, their heating bills went down a lot because natural gas prices continued to dampen, compared to what they saw a year ago and the cost of transportation went down some. So I think that they probably were turning on some of the lights that they had turned off in the first quarter.

Operator

Your next question is for from Paul Ridzon with KeyBanc.

Paul Ridzon - KeyBanc Capital Markets Inc.

How should we think about the tax rate on the securitization proceeds?

Brian Tierney

We are going to be setting up a tax deferral associated with that. So we're going to take -- at the time that we recognize the transaction, we're going to take the $420 million plus the applicable interest and the debt only portion, and we'll record that as a regulatory asset with the related deferred tax expense of about 35%. And then, of course, as the reg assets amortize, the deferred taxes will be amortized to match the current income tax expense. And the equity portion that we'll be realizing will be recognized as the amortization happens, as well. And we anticipate over the 14-year securitization period, the equity carrying cost of between $20 million and $185 million to be recognized in current period earnings.

Paul Ridzon - KeyBanc Capital Markets Inc.

On the $0.04 to customer shopping in the quarter, is that net of what you might have picked up? Where do you -- where does your retail margin as you go and competitively shop your power, where does that show up -- where does the margin on that show up?

Michael Morris

Well, that is not a net number. That's the actual impact of those who have chosen other suppliers. As you might imagine, the retail margins on sales from AEP retail are less than the margin you'd see, had those customers stayed on the system. Brian, where exactly...

Brian Tierney

In terms of the EEI line, on Pages 11 and 13, it's Line 18, Generation & Marketing.

Operator

Next, we'll go to Anthony Crowdell with the Jefferies & Company.

Anthony Crowdell - Jefferies & Company, Inc.

Just some more question on customer switching. What customer class, I guess, had the most switching? And my assumption is commercial, I guess. Where would the loss of gross margin go if you saw all your Columbus Southern commercial customers switched?

Brian Tierney

That is right, it is the commercial class of customers. And primarily, at Columbus and Southern Power Company and the place where you would see that margin occurring is in the Ohio companies, Line 2 on Pages 11 and 13.

Michael Morris

And I think it's almost inconceivable to imagine that the entirety of the commercial load at Columbus Southern would move away from us. And as I mentioned before, as you know, inside of ESP, a lot of the activity has to do with the arcane concept known as rate skewing. Our commercial customers typically pay more than the cost to serve them, and in the filings that we made inside the ESP, one of the things that actually is getting some pretty solid support is adjusting that rate skewing to better balance customer bills to customer costs. So there are some self-correcting activities that will go forward in that sense.

Anthony Crowdell - Jefferies & Company, Inc.

What percentage of commercial customers have switched already?

Brian Tierney

It's -- I don't have the percent of total commercial customers that have switched. We can get that for you.

Operator

And we'll go to Michael Lapides with Goldman Sachs.

Michael Lapides - Goldman Sachs Group Inc.

Few questions, first of all, system sales, second quarter levels, the new normals when we start thinking about the same quarter for next year? Or is it something slightly different?

Brian Tierney

It's hard to say at this point, Michael, because of the impact of what Casper might have on that. I would obviously, expect that people might have less volume to go in the shoulder periods and will be trying to optimize what they have available to go in the winter and southern months as load and pricing is higher. So it's really hard for us to tell what the new normal's going to be when we have the situation changing as much as it's going to under the Casper issue.

Michael Lapides - Goldman Sachs Group Inc.

Got it. Second, O&M, I know up to the quarter, you've given the storm costs. What are you assuming in '11 guidance and in '12 guidance, meaning back end, second half of '11 and in your $3.25 for '12 in terms of O&M growth?

Brian Tierney

Second half of '11, we anticipate being very similar to the first half, being burn close to flat, consistent with what our guidance is. And I'd anticipate that although we haven't come out with '12, we're going to be very conservative on O&M growth there as well. Really, the bulk of what we're trying to show in any growth at all in O&M is trying to have as much of that as possible picked up in trackers, and as little of that as possible flowing through as a net against revenue hitting the bottom line.

Michael Morris

I think that's an important point, Michael, that Brian makes. I think and it doesn't -- it surely isn't missed by you or your colleagues. The fact of the matter is some of the increase in O&M has to do with the magnitude of the storms that we've experienced so far this year. They don't hit that threshold that you go in for recovery in the normal course of business in the various jurisdictions. And the other part of it is simply, O&M authorities that have been granted to us by various commissions where you're recovering dollar for dollar for the increase in O&M. As you know, we've been very aggressive to try to build more trackers and riders in our cases. So take Indiana as a perfect example, or I guess PSO may be a better example. They gave us a certain amount of money to underground activities so that the Tulsa region didn't see the same amount of interruptions on the system, and every single dollar that they authorized to be spent, it was spent for that goal as you would expect us to do. So net-net, the O&M discipline at American Electric Power continues to be strong. The headcount numbers continue to be right where we thought that they would be, so we keep a very, very close eye on that as we go forward. So when you see those increases, I want to make sure, and your question has given us the opportunity to put some granularity to what's driving them.

Michael Lapides - Goldman Sachs Group Inc.

Got it. Last question, just in terms of rate filings, rate cases underway, I mean, I think we're up-to-date on the ones that are underway now. But in terms of what you expect to file in the back end of 2011 for future rate increases, either in 2012 or beyond?

Michael Morris

So when we look at -- there probably aren't any more that we would file yet this year in an impact of this year, but there will be a few and we'll give you some granularity on that. There will be some active cases, as you might imagine. As you know, the Virginia case will mature in '12, the Michigan case will mature in '12, although it has a potential to settle in '11. So we'll see how it goes. We've got cases, probably in Indiana as well, and other jurisdictions. But net-net, we'll let you know what else we're looking at in the back of the year.

Operator

And we'll go to Jonathan Arnold with Deutsche Bank.

Jonathan Arnold - Deutsche Bank AG

Quick question on as we look at your baseline, historical emissions of the fleet in let's say, 2010, is that a reasonable proxy for where you are or where you're operating your existing controls as much as you could? Could we get somewhere else on fuel switching? Just something -- should we think of that as a static starting point or not?

Michael Morris

Well, that would probably be inappropriate. We will begin to operate the fleet a bit differently. We're looking at some fuel selection differences. As you know, we're -- although not by a tremendous amount, because we're getting more gassy. But at American Electric Power, because of the size of our coal fleet, adding the gas facilities that we have will have some impact. We've moved Dresden up in a much more aggressive construction cycle. It will come to play in 2012, so it's probably inappropriate to use that as your base because the mix will change, the fuels will change and the footprint will go down some. Having said that, and I know there's been some concern about how scrubbers are operating across the U.S. fleet. We're really operating at peak performance, 98%, 99% capture, so we're quite satisfied. We're looking at remedial action and changes to some of those scrubbers as we go, and that's all working out quite well, as well.

Jonathan Arnold - Deutsche Bank AG

So you -- in terms of what, how the scrubbers are performing, 2010, you'd consider to be a good base?

Michael Morris

Oh, we do indeed.

Jonathan Arnold - Deutsche Bank AG

And then I know you said you're studying the Casper rule and the impacts, is there any expectation that you will update your compliance plan just sometime later this year as you work more on studying? Or are we -- what's the timeframe if we think about a change?

Michael Morris

Well, I think what we did earlier on is pretty accurate. The only difference that we may see is that we are taking a real hard look at the dry sorbent approach to it rather than the major capital investments that we thought we might have to put on. But I think that, as you know, what we get on HAPs MACT is going to have probably a much larger effect. So we don't want to get too granular about what we're going to do yet knowing that, that's coming out in November.

Operator

And our next question's from Ali Agha with SunTrust.

Ali Agha - SunTrust Robinson Humphrey, Inc.

Mike, as you mentioned, there's a lot of activity going on in Ohio. Could you also give us a quick update and remind us where you stand on the remand proceedings that are going on there and also the distribution rate case?

Michael Morris

Well, they're all moving along at pace. The discussions that we're having on the ESP, of course, include the magnitude of all of the filings, so the merger docket, the remand case, as well as the overall distribution rate case. So they're all there, they all have schedules established for the most part. And the Commission staff and the Commission, as well as the parties, are looking through all of them as quickly as we can. I don't know -- I don't want to leave you with the impression that there's some overall global settlement concept that may wrap them all up. If that were doable, we'd be happy to do it. But there are uniquenesses to each of the cases, and some of the interveners would rather see -- some of them process to their conclusion, while others of them may yield a better opportunity to settle.

Ali Agha - SunTrust Robinson Humphrey, Inc.

Okay. But on the remand, as far as I recall, Mike, there were hearings held. And then was that a base step for a decision or is that still an open item?

Michael Morris

Still an open item.

Ali Agha - SunTrust Robinson Humphrey, Inc.

Okay. And separate question, as I recall, when you have laid out your plan, your big environmental plan, had you assumed that there could be some delays in these proposals coming down the pipe from the EPA or was that based on where the existing proposals were playing out? Can you just remind us of that?

Michael Morris

Yes, it was based exactly as the proposals were. And to the only update, again, as I've mentioned, we're looking at different technologies in response to the opportunity to address Casper. So we've not built any delay in there. What we tried to do was show a straightforward, verifiable view of the effect of the draft rules as they stood at the time and the rules that we think will come out over time and the effect that they'd have on our fleet.

Ali Agha - SunTrust Robinson Humphrey, Inc.

Okay. And the last question, Mike, in the past, you folks have -- in the recent past, I should say, there have been rumblings, musings from AEP. You're looking at your entire portfolio and there may be opportunities to monetize some of the assets if it makes more sense. Could you just give us an update on your current thinking there? And could we expect something before the year is up?

Michael Morris

No, I would think not. As we always do, we look at the assets and the opportunities that are in front of us. A couple of the jurisdictions continue to lag from what we'd like to see them do, but they're catching up in a hurry and we're encouraged by that. We're equally encouraged by the activities that we see from the FERC on their transmission Final Rule 1000. I don't want to take too much time on this call, but I must say that Susan Tomasky, who has headed that transmission group for us for the last handful of years, was instrumental in pulling together the comments that American Electric Power made to the FERC, and a number of those comments were very much evident in the Final Rule as it was brought forth. So I'm encouraged by what we see in transmission, the opportunity to do that. Lisa Barton, who has managed many of our negotiations with our joint venture partners in transmission will take Susan's role. We'll miss Susan a great deal, but the whole notion of having her responsible for transmission during that period of time worked out exactly as we had hoped that it would. So we see a lot of investment opportunities with the assets that we have, but we'll always look at monetizing anything if it seems better in the hands of another player.

Operator

Our next question's from Steve Fleishman with Bank of America.

Steven Fleishman - BofA Merrill Lynch

A couple questions. First, I believe most of your states have fuel clauses that would cover emission allowances. So if Casper brings these back, are you able to pass through emission allowances in your fuel clauses?

Michael Morris

Every one of the states, yes, that's correct.

Steven Fleishman - BofA Merrill Lynch

Okay. And then, secondly, in Ohio, I guess, one potential outcome given that it's kind of -- it seems like it's almost happened with Duke, is that they just don't get a plan done by the end of this year, what happens then? And if you just kind of kept your current plan and had your fuel clause and et cetera, is that really -- how big a problem is that or not?

Michael Morris

I don't think that would be a big issue at all if that's the way it ends up. I appreciate the point you make about Duke because they've kind of gone from one footprint, one approach to another, and then kind of morphed in with a hybrid of the 2, and that may be a bit troubling. But we have every reason to believe that we'll come to some resolution before the end of the year. I think everyone knows that the executive administration of the State of Ohio is in different hands, very aggressive hands. Governorate Kasich is a let's-get-it-done kind of person. I expect we'll see an order before the end of the year, one way, shape or form. If that doesn't happen, we'll just continue on what's -- where we are, and that's not a bad news story for us at all.

Operator

And we'll go to Justin McCann with Standard & Poor's.

Justin McCann - S&P Equity Research

If after the 2012 election, a political scenario plays out in which a Climate Bill was passed in say, 2013 or '14, and you were able to get regulatory approval for CCS gross recovery. How long would it take to pick up from where you left off and complete the remaining 3 phases needed to realize commercial operation?

Michael Morris

Quite honestly, not that long of a period of time because again, as I mentioned, we're taking it to the original engineering design. Now that would have to be brought up to date. Austin and around the world, there is still a couple of projects going forward. As you know, Southern Company is looking on some of O&M technology down in Mississippi, I believe. So we all continue to look at that as a constructive undertaking. But you've asked a very important question. Having spent a great deal of time in the international dialogue on these issues to a number of facilities that the American Electric Power is involved with, it would appear to me that a carbon intensity plan is about as far as you're going to see China or India go. And so if we had legislation that really was driven toward carbon intensity in the United States going forward, that may cause some of the carbon capture and storage projects to go forward. We always thought we could get the final design in about a year or less, bid and construct in a year or more, so it would stay on those kinds of timelines. What we thought originally was a 2014, '15 date, if you had a piece of legislation by 2013, you may be looking more to 2017 or '18 timeline.

Operator

And next, we'll go to Ashar Kahn [ph] with Visium Capital Management [ph].

Unknown Analyst -

I just wanted to get a -- I guess you mentioned, what would be the use of proceeds? You said it would be all for debt reduction, is that what I heard?

Brian Tierney

No, there'll be some debt reduction at TCC, and perhaps, in rebalancing of the capital structure of that company. But there will be a considerable dividend up to the parent.

Unknown Analyst -

And so what will the parent do with the dividend then?

Brian Tierney

We have some significant capital needs that we're going to be embarking on as we've talked about our capital plan and what we need to do in terms of environmental retrofits and the like. And we have some pretty significant needs for that capital on our Transmission business as well, in addition to our underlying utility businesses. So we have plenty of uses to put that capital to work and have it earning for the shareholders of the company.

Michael Morris

But I think if there's anyone who had concern over one-time equity issuances at the parent, I think that these kinds of activities surely lay those over.

Unknown Analyst -

You have not baked that in into your point estimate, am I correct? It's the -- I guess, the benefit of lower interest expense, that's the way I look at it. That's not really baked into the $325 million, is that a fair conclusion or no?

Brian Tierney

Yes, this was not incorporated in our point estimate when we came out with it. We've since incorporated that in there, and there've been a number of ins and outs. And so I wouldn't just assume that there's some significant upside associated with the capital infusion.

Unknown Analyst -

Okay. So you're saying there's some -- the positive has been -- from this has been, there've been some negatives. So it's like matched even and the $325 million does incorporate this outlook now.

Brian Tierney

It does. John, we have time for one more question.

Operator

And that will be Paul Ridzon with KeyBanc.

Paul Ridzon - KeyBanc Capital Markets Inc.

You mentioned DSI. Southern Company, obviously, another big coal burner, has some doubts about whether DSI is really kind of the silver bullet that a lot of people claim it is. But what are your concerns around DSI?

Michael Morris

Well, I don't want to misrepresent, because the EPA laid that out as the ultimate silver bullet that would make life go on without anyone ever having to pass away. It isn't quite that good. What we're saying is that when we' look at particularly some of our Western plants, we may be able to use that technology there with a combination of some fuel blending in our Western stations. And that will have an effect of one, maybe being able to do it more rapidly than we thought because they aren't as massive a construction project and two, not as expensive because they aren't as massive a construction project. But we, like Southern Company, actually see these things very much the same. They kind of -- we lay on top of each other with understanding the impact. And we don't think that it's a silver bullet, but we do think it's a technology that may lend itself to use. And our engineers are pretty far along the line with those conclusions. And in fairness, as you might expect, we and Southern Company do dialogue on these issues frequently. So we will share with them what we think we see, but of course, as you know, they don't have the same lignite base fleet that we do out West.

Paul Ridzon - KeyBanc Capital Markets Inc.

So that would tend to trust your southern combustion engineers more than EPA?

Michael Morris

As would I. Well, they'll probably pay more than we do, Paul.

Paul Ridzon - KeyBanc Capital Markets Inc.

Going back to Ali Agha's question about M&A, could we expect you to seem to get smaller before you got bigger?

Michael Morris

No. No, I don't think so.

Good, we'd like to thank everyone for their time and for joining us on today's call. As always, always our IR team will be available to answer any additional questions you may have. John, can you please give the replay information.

Operator

Ladies and gentlemen, this replay starts today at 12:00 p.m. Eastern time and will last until August 5 at midnight. You may access the replay at any time by dialing (800) 475-6701 or (320) 365-3844. The access code is 209105. That does conclude your conference for today. Thank you for your participation. You may now disconnect.

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