Duke Energy's CEO Discusses Q2 2011 Results - Earnings Call Transcript

| About: Duke Energy (DUK)

Duke Energy (NYSE:DUK)

Q2 2011 Earnings Call

August 02, 2011 10:00 am ET

Executives

B. Trent - President of Commercial Businesses and Group Executive

Lynn Good - Chief Financial Officer and Group Executive Officer

Stephen De May - Head of Investor Relations, Senior Vice President and Treasurer

James Rogers - Chairman, Chief Executive Officer and President

Analysts

Michael Lapides - Goldman Sachs Group Inc.

Dan Eggers - Crédit Suisse AG

Jonathan Arnold - Deutsche Bank AG

Greg Gordon - ISI Group Inc.

James von Riesemann - UBS Investment Bank

Hugh Wynne - Sanford C. Bernstein & Co., Inc.

Steven Fleishman - BofA Merrill Lynch

Operator

Good day, everyone and welcome to the Duke Energy Second Quarter Earnings Conference Call. Today's call is being recorded. At this time for opening remarks, I would like to turn the call over to Mr. Stephen De May, Senior Vice President of the Investor Relations and Treasurer. Please go ahead, sir.

Stephen De May

Thank you, Kelly. Good morning, everyone and welcome to Duke Energy's second quarter 2011 earnings review and business update. Leading our discussion today are Jim Rogers, Chairman, President and Chief Executive Officer; and Lynn Good, Group Executive and Chief Financial Officer. Jim and Lynn will review our first quarter results and provide an update on our key priority. After these prepared remarks, we will take your questions.

Today's discussion will include forward-looking information and the use of non-GAAP financial measures. You should refer to the information in our 2010 10-K and other SEC filings concerning factors that could cause future results to differ from this forward-looking information. A reconciliation of non-GAAP financial measures can be found on our website and in today's materials. Note that the appendix to the presentation materials includes additional disclosures to help you analyze the company's performance.

Now I'll turn the call over to Jim Rogers.

James Rogers

Thank you, Stephen. Good morning, everyone, and thank you all for joining us today. We appreciate your interest and investment in Duke Energy. During today's call, we will provide you review of our quarterly earnings followed by an update of one, our pending merger with Progress Energy; two, our major construction program; three, our proposed Electric Security Plan in Ohio; and four, our base rate case filings in the Carolinas. These initiatives are positioning the company for long-term stability and earnings growth in the future.

I will also update you on Edwardsport and discuss a proposal we filed with the Indiana Commission in April. It is an equitable proposal and provides a path forward on this important project. Finally, I will end the call with some observations on the most recent EPA ruling and the NRC Task Force review of the events at Fukushima.

Today, we reported second quarter 2011 adjusted diluted earnings per share of $0.33. That compares to $0.34 in the prior year's quarter. With the second quarter, we continued our positive momentum from the first quarter. The company's largest business segment, U.S. Franchised Electric and Gas, achieved solid performance due in part to its new generation investments in the Carolinas and Indiana. This helped offset less favorable weather and higher operations and maintenance costs primarily related to storm restorations. Duke Energy International delivered strong results, as did Commercial Power despite the financial impact of 2010 customer switching in Ohio.

For the year, we are well on track to achieve our guidance range of $1.35 to $1.40 in adjusted diluted earnings per share. And as you all may recall, our third quarter is typically the most significant of the year. I am very pleased with our second quarter performance. We were well-positioned to execute on our business and financial plans for the remainder of the year. Now, I'll turn it over to Lynn, who will give more detail on our financial results for the quarter.

Lynn Good

Thank you, Jim. Slide 6 outlines the adjusted earnings drivers for each of our business segments for the quarter. For U.S. Franchised Electric and Gas, quarterly adjusted segment EBIT decreased from the prior year. While we benefited from weather, this quarter, it was less favorable than the second quarter of 2010.

In addition, we incurred significant storm restoration costs. Both of these were offset by the continued earnings contribution from our new generation investments. Destructive storms have been a theme in the first half of 2011. Storm costs for the quarter were approximately $53 million higher than the prior year quarter. In April, wind storms in the Carolinas and Indiana caused significant outages requiring extensive repairs. In May, severe thunderstorms in Ohio brought damaging winds, hail and tornadoes. According to estimates from the Ohio Insurance Institute, it was the third most expensive natural disaster in the state's history.

As they have in the past, our employees acted quickly to restore power. In fact, after the Carolinas windstorm in April, we restored service within 24 hours to about 70% of the 250,000 customers who lost power. We appreciate our customers' patience and are grateful for the dedication of our employees and those from our neighboring utilities. Storm restoration costs in both the first and second quarter will challenge us to keep the increase in the total company O&M costs within our targeted range of 3% to 4%, net of deferrals and cost recovery riders. However, we continue to work actively to mitigate these unexpected expenses.

In Commercial Power, the quarter's adjusted segment EBIT was lower than the prior quarter, primarily due to the annualized margin impact of 2010 customer switching in Ohio, which we will further discuss in a moment. Our nonregulated Midwest gas split continue to perform very well, supported by strong energy margins and higher dispatch. The gas split [ph] dispatched about 1,100 gigawatt hours more than the 2010 second quarter, consistent with the trend we saw in the first quarter this year.

Also during the quarter, we entered into an agreement to transfer our 75% interest in the nonregulated Vermillion gas plant to Duke Energy Indiana and Wabash Valley Power Association. Pending regulatory approval, Duke Energy Indiana will hold a 62.5% interest in the plant, with Wabash Valley owning the remaining 37.5%. As a result of the transaction, which is expected to close in the first quarter of 2012, we recognized an approximate $9 million pre-tax impairment during the quarter.

Duke Energy International continued the strong performance we saw in the first quarter. Higher prices and volumes in Central America and higher average contract prices in Brazil contributed to the increase in the segment's adjusted EBIT. More favorable average foreign exchange rates and higher earnings from our equity investment in National Methanol also contributed to the increase.

In our other category, we recorded second quarter 2011 net expense from continuing operations of $52 million compared to $39 million in the second quarter of 2010, primarily due to higher captive insurance losses. Finally, we continue to anticipate a 2011 effective tax rate of approximately 32%. Please note that a discussion of our GAAP reported results for each quarter is included in today's press release.

Turning to Slide 7, I'll spend a few minutes on our customer volume trends for the quarter and the economic conditions within our service territories. Overall for the quarter, our weather-normalized volumes were slightly favorable, led by increase of residential volumes. As you will recall last quarter, we experienced the downturn in our weather-normalized residential volumes, a trend we have been monitoring closely. During the second quarter, however, we saw an increase in residential volumes of 1.6% on a weather-normalized basis. As you see from the chart in the upper left-hand section of the slide, quarterly residential activity has been volatile since 2010. We attribute the volatility to the continued pressure of the soft economy, as well as the energy efficiency efforts from our customers. Importantly though, we continue to experience modest retail customer growth in both the Carolinas and the Midwest, though not at the levels we were experiencing pre-recession.

In our commercial customer class, the decline we saw beginning late last year has continued, as quarterly commercial volumes were 0.7% lower than the prior year quarter. Although our service territories have experienced relative stability in office vacancy rates, retail sales activity has recently slowed.

Industrial customer volumes for the quarter were flat, but they are around 2% higher on a year-to-date basis than the prior year. During the quarter, industrial volumes remained strong in the Carolinas, offset by softness in the Midwest. Favorable industrial activity in the Carolinas continue to be broad-based across several sectors. However, it was especially supported by strong activity in the automotive and textiles sectors. In fact, most of our textile customers continue to operate at or near full capacity level. The Midwest experienced declines in the primary metals and related sectors, as the overall economy and lack of rebound in the construction market has reduced demand. Sourcing issues in the automotive sector that resulted from the earthquake and tsunami in Japan also had temporary effects during the quarter.

Overall, the outlook from manufacturing activity across our service territories remains positive. We have found that our primary industrial customers are generally optimistic, but believe the recovery will be slow. A majority of them expect the remainder of 2011 will be favorable compared to 2010 and that this favorable trend will continue into 2012. Yesterday's announcement of the July ISM manufacturing Index, which fell to a level just above the expansion threshold, demonstrates the negligible growth being experienced by the economy. Until we see more consistent and sustainable growth, our economic outlook will remain cautious.

As a reminder, our 2011 guidance assumes we would see weather-normalized volume increases of about 1%, driven by growth of approximately 2% in the industrial class and less than 1% in the commercial and residential classes. Given the modest softness we had seen in the commercial and residential customer classes during 2011, we may be slightly below this overall 1% weather-normal volume increase for the year. We will continue to monitor customer volume trends and update our assumptions as we progress through the remainder of the year.

I'll now discuss in more details in the competitive environment in Ohio, including the level of customer switching. A chart showing the trend in customer switching since December of 2009 is on Slide 8. As displayed by the light blue and red bars on the graph, you can see that switching has remained relatively stable for the past year. As of June 30, approximately 67% of our native load customers have switched to other generation providers as compared to approximately 65% at December 31. Our competitive retail arm in Ohio, Duke Energy Retail, continues to serve approximately 60% of our Ohio switch load, helping to preserve margin. As a result, Duke Energy entities are providing generation services to approximately 72% of the customers in our Ohio service territory. For the balance of this year, we do not expect to see significant financial impact from additional customer switching.

In a moment, Jim will discuss our recently proposed ESP filing in Ohio. We are working towards resolution of this filing by the end of 2011. However, if we do not receive a commission order by the end of this year, our current ESP will continue. As you know, Commercial Power's financial results in 2012, are dependent upon the timing and resolution of this ESP proceeding, and we will continue to update you on our progress over the course of the year.

In summary, we are very pleased with our execution of financial results for the first half of 2011. Our regulated businesses continue to realize the financial benefits from our new construction projects as well as the benefits from favorable weather, a trend that continued into July. This has helped us mitigate the impacts of considerable storm costs across all of our service territories. Additionally, our Commercial Power and International segments have performed exceptionally well, and we expect the financial impact of customer switching in Ohio in the back half of the year to be insignificant.

The strength of our balance sheet and continued earnings growth supported our ability to increase the quarterly dividend from $0.245 to $0.25 effective with the September dividend payment. Additionally, our financial strength allows us to avoid equity issuances including those through our internal DRIP plans, based upon our present business plan.

We are well-positioned to achieve our targeted 4% to 6% long-term growth in adjusted diluted earnings per share, as well as our current year earnings guidance range of $1.35 to $1.40. Our focus for the remaining months of this year will be on effective costs control, operational efficiencies and advancing our strategic initiatives. I'll now turn it over to Jim.

James Rogers

Thank you, Lynn. Let's take a look at Slide 9, which contains our merger scorecard. As you see, we have completed all of our required regulatory filings for merger approval. Our S-4 was declared effective by the SEC on July 7, and our joint proxy statement was mailed to shareholders the week of July 11. Duke and Progress have scheduled special shareholder meetings for August 23 to vote on merger-related matters. The Boards of both companies have unanimously recommended approval of the merger to shareholders. We're also working to advance merger approval in the states of North Carolina, South Carolina and Kentucky. In North Carolina, we have filed testimonial support of the merger, and hearings have been scheduled for September 20, intervenor and staff testimony is due on August 26. We're awaiting a procedural schedule from the South Carolina Commission.

In Kentucky, Duke and the Attorney General have filed a settlement agreement with the Kentucky Public Service Commission. Hearings were held in July and we expect an order soon. In April, applications for approval were also filed with the Federal Energy Regulatory Commission, and we expect a ruling by early October. Last week, the FCC approved the transfer of the Progress Energy licenses. And as we highlighted in our first quarter earnings call, the waiting period into the Hart-Scott-Rodino Act has expired.

We continue to move forward with merger integration planning. Integration teams have completed the analysis phase of their work and have begun the process of designing the organizational structure and policies for the combined company. The second tier of the new Duke Energy organizational structure has been developed, and we expect to name leaders of each of these functions by mid-September. Although the merger is expected to result in headcount reduction, our goal remains to minimize the number of job losses through a combination of normal attrition and retirements. To begin achieving the necessary reductions, we plan to offer voluntary severance benefits to certain employee groups by year-end.

All in all, we have accomplished a tremendous amount in just over 6 months. We continue to target a merger closing date by the end of the year. The combination of Duke Energy and Progress Energy will provide the scale and strength necessary to manage future environmental compliance and to build or replace needed capacity. Our greater regulatory and earnings diversity will enhance growth opportunities and reduce our risk profile. And with stable cash flows and a healthy balance sheet, the combined company will continue to support the growth in our dividend.

Next, let me update you on the status of our major construction projects outlined on Slide 10. We continue to move forward with our 4 projects: The Cliffside, Buck and Dan River projects in North Carolina and the Edwardsport IGCC project in Indiana. These projects represent a total investment of approximately $7 billion and about 2,700 megawatts of capacity. They are the cornerstone of our strategy to replace and retire older, less-efficient coal units in anticipation of more stringent environmental regulations. Buck is expected to be in service later this year. Edwardsport, Cliffside and Dan River are all scheduled to be in service in 2012.

Let me now spend a few moments discussing the Edwardsport project, which is about 90% complete. As you all are aware, earlier this year, we filed a proposal with the Indiana Commission to cap the costs of the Edwardsport plant at $2.72 billion, excluding financing cost. This cap, along with other provisions, mitigates near-term customer rate increases associated with cost we incur above $2.35 billion.

This project remains the best solution for our customers, as we replace existing generation and ensure the energy future of Indiana. The average age of Duke Energy's coal-fired plants in Indiana is more than 40 years old. Edwardsport is the first-phase load plant to be built by Duke Energy Indiana in the past 30 years, and is the centerpiece of our fleet modernization strategy in the state and will allow us to close older, less-efficient coal generation and to comply with more stringent EPA regulations. When the plant is completed, Indiana will have one of the cleanest coal-fired facilities ever built in the industry.

As a reminder, the commission has separated our cost increase proceeding into 2 separate phases. The first phase, for which we have the burden of proof, is for approval to recover the $530 million increase in the estimated cost of the project from the currently approved amount of $2.35 billion. The second phase, of which the intervenors have the burden of proof, is related to allegations of fraud, gross mismanagement and concealment related to the project. Hearings on both phases -- Phase 1 are scheduled to begin October 26, while hearings on Phase 2 will begin on November 3. We expect the commission decision on both phases by early 2012. Intervenors have recently filed testimony under both phases of the proceeding. For Phase 1, they are recommending the commission not approve the requested cost increase due to alleged imprudence. For Phase 2 of the proceeding, intervenors contend that Duke should only recover the project's original cost estimate of approximately $2 billion. Our rebuttal testimony to Phase 1 of the proceeding will be filed tomorrow, and our response to intervenor allegation in Phase 2, will be filed on September 9. Our testimony will demonstrate that intervenor allegations are unfounded. We have diligently and prudently managed the Edwardsport project.

Slide 11 summarizes the key elements in our recently proposed ESP filing in Ohio. As you all may recall, our current ESP agreement expires at end of this year. In developing our proposal, we saw a long-term solution for the State of Ohio. It balances the needs and objectives of our customers and our investors. It also recognizes the diversity of the regulatory models in this state. We have threaded the needle between the first energy approach and AEP's proposed proposal. Our plan creates long-term stability and certainty for both Duke Ohio and its customers. At the same time, it enhances customer choice and competition for energy. Our filing addresses our expectation that more stringent environmental regulations, increased demand and the need to replace aging generation facilities will lead to higher and more volatile electricity prices in the future. Most importantly, our plan is designed to mitigate price volatility and offer customers price stability over the longer term. This longer-term certainly enables Duke Energy Ohio to earn a fair and reasonable return on its generating assets and provide a structure that will permit long-term utility investments. Additionally, it would help to attract industry, generate jobs and spur economic investment in Southwest Ohio.

The plan also supports competition by preserving customer choice and incorporating competitive energy options. Of course we have proposed options to cure all of our customers' energy needs, our generation will be available to sell into the wholesale market when it is economic to do so. In exchange for recovery in capacity charges on the none but passable bases, our plan proposes to return to all customers a majority share of net profits earned through the output of our generating assets.

In the near term, our proposed ESP will result in rates that are modestly higher than the rates that would be expected under a market rate offer. However, and most importantly, over the plan's 9.5-year term, energy and capacity prices are expected to rise substantially, which causes our proposed plan to be significantly more favorable to customers than the expected results into the MRO. In fact, we estimate that the ESP is lower on average, by about 8%, resulting in a present value benefit to customers of approximately $1 billion. Hearings on our ESP are currently scheduled for September 20, preceded by intervenor's testimony on September 7 and staff testimony on September 14. We are targeting revised rates to go into effect on January 1, 2012.

Turning to Slide 12, I will update you on recent regulatory activities in the Carolinas. On July 1, Duke Energy Carolinas filed a base rate increase with the Northern Carolina Utilities Commission. We requested approval of a $646 million. This translates into approximately 15% average increase to customer rate. Our request proposes an allowed return on common equity of 11.5% with a 53% common equity component. This rate case reflects the need for additional rate increases, as we continue to modernize our plants and system. Almost 3/4 of the proposed increase is due to recovery of capital investment such as the Cliffside coal plant, the Buck natural gas plant, investments in our T&D system and upgrades to our nuclear units. These investments will ensure our continued ability to deliver affordable, reliable and increasingly clean energy to our customers in light of more stringent state and federal environmental regulations.

Knowing that customer rate increase pressures were on the horizon, we have worked diligently over the last several years to manage our costs. In fact, 2010 represented the fourth straight year we were able to hold our total company O&M costs, net of deferrals and cost recovery riders essentially flat. Hearings have been scheduled from November 28, and revised rates are expected to be in effect in February 2012. Within the next week, we plan to file similar base rate case in South Carolina.

Next, I will update you on 2 key industry issues: The finalization environmental regulations from the EPA and the preliminary findings from the NRC's Task Force review of the events at Fukushima.

First, the EPA ruling. As we have frequently discussed, the U.S. EPA continues to work to finalize new, more stringent environmental regulations, which will significantly impact coal generation. In early July, the EPA finalized 1 of these rules -- a Cross State Air Pollution Rule or CSAPR. All states in Duke's service territory are affected by this new version of the Clean Air Transport rule. Even though CSAPR is more restrictive and the compliance periods are more aggressive than originally proposed, the provisions are within our long-term planning assumptions. Over the short term, these environmental regulations would require curtailment of certain generating units and increase costs such as purchasing additional emission allowances for purchased power.

However, the anticipation of more stringent environmental regulations has long been part of our long-term strategic planning process. Over the past decade, we have invested approximately $5 billion to install equipment that comply with state and federal environmental requirements, leaving our coal-generating fleet well-controlled for both sulfur dioxide and nitrogen oxide. Additionally, when our new construction programs and related retirements are completed, approximately 90% of our coal generation capacity will have scrubbers in operation. As we look forward, based of when our current plan and assumptions, we expect approximately $5 billion to $6 billion in additional capital expenditures over the next decade to comply with the portfolio of regulations. We will continue to adjust and refine these planning assumptions as the EPA finalizes the remaining pending regulations.

Our plans for compliance with existing environmental permit commitments and the new EPA regulations assume we have retired -- and we will retire almost 3,500 megawatts of coal generation or about 20% of our existing coal fleet system-wide by 2015. This coal generation consists of older, less efficient units, for which it is not economically feasible to install advanced environmental equipment. For example, we recently announced the retirement by 2015 of the 862 megawatts of coal-fired generation capacity at the WC Beckjord Station in Ohio as well as 163 megawatts at Miami Fort Unit 6.

We do expect the finalization of CSAPR rules to have some financial impacts. Since the provisions of CSAPR replace the previous Clean Air Interstate Rules, the SO2 emission allowances we hold for CAIR compliance will no longer be needed beginning in 2012. These allowances were recorded as intangible assets at fair value in connection with purchase accounting related to the Duke's Energy merger transaction in April 2006. As a result, we expect to record an approximate $80 million pretax impairment charge at Commercial Power in the third quarter of 2011. This noncash charge will be recognized as a special item and therefore will be excluded from our adjusted diluted earnings per share for the year.

Before I close, I'll comment on the Nuclear Regulatory Commission's report on the Fukushima crisis and update you on our nuclear development plans. As you all know, the report from the NRC Japan Task Force did not suggest risks associated with the current safety of U.S. plants, spent fuel storage or disaster planning. Neither did it raise any potential issues that would preclude licensing new plants and are relicensing existing ones. In fact since March, the NRC has continued licensing work, including its reviews of new plant licenses and issuing license extensions for several existing plants.

After Fukushima, Duke Energy took immediate action to affirm our plants are ready to respond quickly to extreme conditions, whether natural or man-made. As a company, we regularly reexamine our processes and procedures to ensure the highest level of safety in our nuclear operations. This is part of our safety and continuous improvement culture. Over the years, we have made numerous modification upgrades to further enhance the ability of our plants to withstand devastating events. We are continuing to carefully review the NRC report and are working cooperatively with the industry to identify any additional safety enhancements we should make for the long term. We expect there may be some new oversight requirement, as the NRC identifies additional lessons learned from the events in Japan. But until there has been a more detailed analysis of the task force recommendation and the process that will follow, it is too early to speculate on any final regulations and the timing or costs associated with them. We believe strongly that nuclear energy will be an important source of carbon-free generation in the years ahead.

Consistent with our long-range plans, we continue to explore regional generation opportunities to meet future load requirements. In July, we signed the letter of intent with Santee Cooper that provides the framework for Duke to take a 5% to 10% interest in the new nuclear reactors at V.C. Summer in South Carolina. Once we have completed a number of important steps and the NRC issues the Summer Combined Construction and Operating License, the letter of intent allows us to buy an interest in the project if we so choose.

Also recently, the South Carolina Commission gave us authorization to spend an additional $120 million through June of 2012 on developing activities for the Lee Nuclear Station. We are awaiting a similar decision for North Carolina and remain on track to receive our COL in the 2013 time frame. As we've noted before, a significant investment in new nuclear by Duke Energy is dependent upon the passage of legislation in North Carolina that provides assurances of timely recovery of financing costs on nuclear investments during the construction period.

Slide 15 lists the key priorities we presented to you in February. I am very pleased with our progress to date. We are on track to achieve our financial objectives and recently increased the quarterly dividend to our shareholders. We continue to advance on our strategic objectives to provide our customers with affordable, reliable, clean and safe energy over the long term. The proposed merger with Progress Energy, targeted to be closed by year end, will create a combined company with the size, scale and diversity to be very successfully positioned for the future. Now, let's open up the phone lines for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go ahead and take our first question from Daniel Eggers with Crédit Suisse.

Dan Eggers - Crédit Suisse AG

Jim, I guess kind of the focus today seems to be on Ohio right now with the potential for AEP to come to some sort of settlement announcement this week for the staff hearing [ph] on Friday. What bearing do you think the settlement could have on what you guys have proposed recently? And what's been the conversation you've had since you guys put out your new plan in the same [ph]?

James Rogers

I think historically, the Ohio Commission has structured different plans for each of the companies of the state. And there is one that's been designed for FirstEnergy, for instance, Dayton. And now they're in the process of working on a plan for AEP. We have presented a plan that in my judgment as I said during our prepared remarks that really threads the needle between the FirstEnergy plan and AEP's proposed plan. And we believe it's in the best interest of our customers over the long term. And I think that is very important, as we look at the forward curves on power in the region. And again, it's about providing affordable, reliable, clean and safe electricity over the long term. We believe we have a proposal that works for our customers over the long term. So again, it's important to watch what happens with the developments of AEP, and we are, of course. But I would urge you to remember that historically, there have been very different plans for each utility in the state.

Dan Eggers - Crédit Suisse AG

And Jim can you remind me when you guys need to have an agreement done if you want to have the auctions in place for effective 1/1/12 rate implementation?

James Rogers

My belief is that we probably need approval in the October-November time frame to be able to do that. But in the event that we don't get it until later, as you know, we keep our existing plan in place until we're able to implement the new proposal.

Dan Eggers - Crédit Suisse AG

Okay. And I guess with the changes at the commission and one more seat to be filled, are you guys comfortable that you can get through a settlement agreement and get the commission to sign off in a timely fashion? Or do you think it's going to be a little more drawn out given the changes?

James Rogers

I believe that this commission has acted timely. There has already been a significant transition of new commissioners, new chairman. But I don't think they've missed a beat in terms of addressing issues before them. So we are confident that they will act in a timely manner.

Operator

And we'll take our next question from Greg Gordon with ISI Group.

Greg Gordon - ISI Group Inc.

When I look at the -- a couple of questions. First, when I look at the Ohio assets that are still within the regulated umbrella, and I look at the incremental impact that declining gross margins from shopping have had, it looks to me like from a practical perspective, you're not really making any meaningful return on assets on those assets currently. At least if I run out, if I assume the gross margins you're earning today annualized for the impact of shopping, you're really not earning a reasonable return on those assets, maybe not earning any return on those assets. Is that a fair analysis or unfair?

Lynn Good

Yes, Greg, I think it's fair that the returns are under pressure for the Ohio business. The one specific data point I would point you to is the seat filing for 2010 for all of Ohio, which would include generation and T&D would adjust above 7%. And so we would project to be below that in 2011. That's why as we think about constructing something in Ohio, we're very focused on ensuring that the returns that we earn are putting our proposal forward that puts us in a position to earn returns commensurate [ph] with the investments at stake.

Greg Gordon - ISI Group Inc.

Right. Well if the average return is 7% and your distribution returns are sensibly more stable, that would mean that your generation returns are even -- are below that average number, correct?

Lynn Good

That's correct.

Greg Gordon - ISI Group Inc.

Right, so in some way, shape or form [ph], what's happening is the retail entrants are basically getting a free ride on the back of your capacity and are unable to undercut you on energy without paying what a reasonable return would be to backstop on a capacity backstop. I'm not -- that's what you're attempting to resolve with this filing.

James Rogers

Right. And based on your statement, is it possible you could testify?

Greg Gordon - ISI Group Inc.

Maybe in my next career. So my second question is in North Carolina, the base rate increase you've asked for is obviously justified by the investments you made. But it is a very substantial customer increase. Is there anything happening on the fuel side or are there pass-through costs that would mitigate the impact of that when it gets implemented?

James Rogers

I think first and foremost, 74% of the rate increase is really tied to our capital program that's been preapproved by the commission. And that is really a very important statistic with respect to kind of the recovery. And I would suggest that this merger that we had proposed, when it goes into effect and we had joint dispatch, that will mitigate some of this increase that we're expecting up from the approval of the rate increase in North Carolina.

Greg Gordon - ISI Group Inc.

Okay. But on a stand-alone basis, there's no big offsetting cost savings that you can point to that would substantially mitigate it?

James Rogers

I guess the only point I'd make is, is that as we went into this rate case in the test year, we had basically have kept our O&M cost flat for 4 years, as I said earlier, in anticipation of this case. So we're able to demonstrate to the commission that we have acted very prudently during this period of holding our costs down, knowing there's going to be at a rate increase coming. And even prior to that, we went to the commission to get approval, so we can invest in energy efficiency so that we could help our customers reduce their usage as prices go up. So again, we've been very sensitive to our customers because they are at the heart of our business. And we want to make sure that we're doing these increases in a way that allows them to handle them comfortably, as comfortably as they can during this period of modernization of our generation and distribution system.

Greg Gordon - ISI Group Inc.

Final question, as you look at the impact of the Crystal River 3 delamination event at Progress both in terms of the exposure to replacement power costs and the uncertainty regarding the claim at NEIL, how do you access the impact that might have on Duke shareholders vis-à-vis the combination?

James Rogers

I think what's important to know is that Progress has provided updates to the NRC and the Florida PSC on status of Crystal River 3. More detailed engineering and construction and analysis needs to be completed by Progress, and they are currently undertaking those responsibilities. The Florida PSC is working to establish the proposed hearing schedule. We'll continue to monitor all of this very closely. And this is an issue that is very important that Progress, and ultimately the new Duke Energy, addresses in an appropriate way. And I have every confidence that we will, balancing the interests of our customers in Florida as well as our investors in the new Duke Energy.

Operator

We'll take our next question from Steve Fleishman with Bank of America.

Steven Fleishman - BofA Merrill Lynch

A couple questions. In the -- first of all, with the DOJ looking like they effectively approved the merger, I assume that means the market power issues are not -- are resolved, if there were any?

James Rogers

I would say the conclusion to draw is if the period expired, and so the DOJ has no opposition to this. And I'm certain that the FERC, in their deliberations may have their own specific tests that they undergo, will take notice of the fact that, that period has expired in their own deliberations.

Steven Fleishman - BofA Merrill Lynch

Okay. In the Carolinas, looks like we're going to get intervenors and staff in late August and then hearing in September. If you were to be in a position to attempt to settle the merger case in the Carolinas, where would the kind of typical timing be for that in the process?

James Rogers

I think that -- we're working on settlement today, both with respect to the merger application as well as starting conversations with our customers with respect to the rate case. And so it's difficult for me to predict kind of the timing of when we're able to kind of bring those 2 cases to a constructive close through a negotiated settlement. But clearly, that's our objective going forward.

Operator

And we'll take our next question from Hugh Wynne with Sanford Bernstein.

Hugh Wynne - Sanford C. Bernstein & Co., Inc.

I have a question regarding the Ohio ESP, which by the way I think is very, very clever and I very much hope it's approved, but my question is this, my understanding, and please correct me if I'm wrong, is that you're proposing to provide the capacity of your coal-fired units in return for a capacity charge and at the same time, to procure energy for your retail load in the marketplace. The nature of the energy that you're procuring, as I understand, is for requirements load following retail electricity whatever is needed to supply the load at Duke Ohio. Have I got that right so far?

James Rogers

Yes, you're on track.

Hugh Wynne - Sanford C. Bernstein & Co., Inc.

The difficulty that I have with the plan conceptually is this, it would seem to me that in procuring full requirements, retail electricity to supply load, you'll be basically requiring the winning bidders in that reverse auction to procure capacity themselves. They will have to have the backup capacity to ensure that they can supply the energy required during peak hours. And yet, on the other hand, you're seeking compensation for your capacity in a separate charge. And my question is how to reconcile those 2 things. Would the commission view that as causing the customers of Duke Ohio to pay for their capacity requirements twice?

James Rogers

Well, I think the important thing is, if the auction is going to be around energy, and people would bid in to that energy auction. And they, in all likelihood, will not back it up with capacity, and that the capacity that we have in our capacity charge will basically be the backstop in the event they can't deliver the energy in a timely manner.

Hugh Wynne - Sanford C. Bernstein & Co., Inc.

Would you supply, say, peak requirements from your fleet or procure peak requirements in the marketplace from others, if the energy suppliers chose not to do so? Or would you expect energy suppliers to meet the full requirements load of your customers?

James Rogers

We would expect the energy suppliers to supply the entire load even on the peak and...

Hugh Wynne - Sanford C. Bernstein & Co., Inc.

But again it requires that they need to have the capacity to do so.

James Rogers

No, it just means I have to go to market and meet they're requirements that they've committed to us. And quite frankly, as you talk to the various suppliers, they all say they have the capability to provide load following energy without lining up capacity.

Operator

And we'll take our next question from Michael Lapides from Goldman Sachs.

Michael Lapides - Goldman Sachs Group Inc.

Real quick, the announcement of the voluntary severance plan and kind of thoughts on O&M, how big of an impact, just trying to think about it in terms of what it means for 2012. And also when do you expect to get a full year's impact from it?

Lynn Good

Michael, we are -- we have just begun some preliminary disclosure around the voluntary offering. We've informed employees that we will offer a voluntary program, the specifics of which will be communicated later in the year. We will then identify which pockets of the company will be eligible for the plan that will occur later in the year. So this is part of kind of preparing the company for the merger. And we'll have more specifics around expectations for '12, which will include O&M and the other moving parts to our numbers after the first of the year, as the company comes together.

Michael Lapides - Goldman Sachs Group Inc.

Got it. The other -- when I kind of think about the Indiana and Edwardsport -- kind of changing topics here a little bit. What is the earliest do you think you could see the net-agreed-upon rate increase for Edwardsport actually put in the rates?

James Rogers

Well, based on the current status of the case, we believe that the pending request that we have with respect to quip will be resolved when the commission acts on Phase 1 and Phase 2 of the procedural schedule, which in all likelihood is the first quarter of next year.

Michael Lapides - Goldman Sachs Group Inc.

So you're saying you would have new rates at the beginning of next year or at the beginning of second quarter next year? And that's just on IGCC 4, which is under review. That's not dealing with 5, 6 or 7.

Lynn Good

Michael, we have hearing dates for 5, 6 and 7 scheduled in November and December. I guess our planning expectation is that the commission would move through Phase 1, Phase 2 and then move through the IGCC trackers within the time frame that Jim just discussed. So it's probably early '12 for resolution of all of these matters.

Operator

And we'll take our next question from Jonathan Arnold with Deutsche Bank.

Jonathan Arnold - Deutsche Bank AG

Jim, I wanted to make sure I just not -- didn't miss you just saying you're talking about the settlement to the time table on North Carolina. And it sounded like you were suggesting it's possible that the rate case and the merger could somehow be settled kind of together. Were you going that far?

James Rogers

No, no, that's -- appreciate the question. We view these as on 2 separate tracks. And basically, we would push back against any effort to try to tie these 2 together going forward.

Jonathan Arnold - Deutsche Bank AG

But you did say you're sort of beginning settlement discussions on the rate case or at least talking to the parties?

James Rogers

We are talking to the parties. Again, this is a what I call a rate-based case, with such almost 3/4 of it tied to actual capital expenditures that have been preapproved by the commission. So this is, in many senses in the word, there's not many moving parts, and it's pretty straightforward. And the debate will probably, in all likelihood, be around the return on equity. That's where the debate will be because virtually everything else is straightforward and speaks for itself.

Jonathan Arnold - Deutsche Bank AG

And when you say you'll push back on efforts to the link for 2 cases of those, are there kind of tangible assets already underway to do that? Or is that more a conceptual statement?

James Rogers

We have seen no effort by anyone to attempt to tie these 2 together.

Jonathan Arnold - Deutsche Bank AG

And then on -- can you just clarify those reasonably meaningful movement in Central America during the quarter we weren't expecting. What was -- can you be a little more specific what drove that? And is this a recurring type of item or is it a one off or something unusual --

Lynn Good

All right. I'll take that one. Jonathan, we've had a good experience over the years at DEI, experiencing diversification among the countries. And in this instance, Central America has actually had a dry season with thermal plants in the country and have experienced both higher volumes and higher margins. So it's the portfolio that worked this quarter.

Jonathan Arnold - Deutsche Bank AG

Okay. Great. Thank you -- one other, just clarifying, I was following up on the Ohio questions. If there were a customer or customers that were, say, being served under a contract that would have a life on it that went beyond your current ESP, I'm not sure how many that might be, but I believe there are some who are effectively paying for capacity under that contract. How would you kind of avoid the situation with that sort of customer ended up paying twice, at least until that current contract with the supplier ends? Is there some provision for dealing with a situation like that in the ESP or...

James Rogers

Let me ask Keith Trent, who leads our Commercial business, to address that question.

B. Trent

Thanks for the question, Jonathan. First of all, I think you're right that there are not a lot of customers who would be in that situation. Now most of the customers who have switched or are using other providers, their contracts expire at the end of this year. But to the extent that there are customers that have contracts beyond this year, I think it's going to be on a contract-by-contract basis to look at that. Some of those contracts, I think, will have express out that would allow them to, for example, if they're paying capacity today, to get out of paying the capacity in the event they're starting to have to pay capacity under our plan. Another way of looking at that though, is at this point in time, anyone who is entering into an agreement beyond this end of our term, we’re taking on some regulatory risks. And so that's certainly an issue that they, I'm assuming took into account, as they entered into contracts beyond the year. But I think for the most part, those situations can be handled via the contracts they entered into.

Operator

And we'll take our last question from Jim von Riesemann UBS.

James von Riesemann - UBS Investment Bank

A couple of questions here. One is -- the first one I guess is following up on Jonathan's questions on Latin America. Can you talk a little bit about some of these recent news articles that suggested that you might be interested in selling the Brazilian assets?

James Rogers

I think, first, I've seen the articles but I've been seeing them for 5 years about every 3 to 6 months. One pops up and says we're selling this to that. But quite frankly, DEI has really saved our bacon in the first 2 quarters in terms of hitting our earnings targets. And there -- it is been a very successful operation, and we're not currently entertaining any offers or any discussions with respect to the purchase of those assets. They proved this year the value of diversity in earnings streams and has really allowed us to meet our earnings target because they have successfully stepped up and delivered.

James von Riesemann - UBS Investment Bank

And the second question, switching topics, is on this letter of intent agreement on Santee Cooper. Well, maybe I know you're in negotiations, but hoping that you could still provide a little bit more color and maybe talk about some of the mechanics. From your prepared remarks, it sounds to me like there's a chicken-and-egg situation going on. Maybe you might actually execute an agreement to buy the minority stake shortly after the COL is issued but before you have enabling legislation in Carolina, North Carolina. Is that correct?

James Rogers

That's correct.

James von Riesemann - UBS Investment Bank

Okay. And could you talk or frame some of the economic considerations in terms of what you might expect to pay for? And how comfortable you are in taking a minority stake in the facility without presumably any operational control or say --

James Rogers

That's a very -- it's actually a very good question, and actually, it's one of our concerns. As we evaluate the potential of taking a 5% to 10% interest, we've always said that we really need, and we continue to believe we need legislation in North Carolina that would allow us to try quip on a periodic basis. So that's kind of been -- and that's obviously, as you might imagine, part of one of the conditions that we put forward in making the offer and starting down the road that we've started down with them. But again and without any -- we've not done any true due diligence. We don't really know kind of what we would be buying into. We're working hard to avoid buying and pegging a poke, and we've structured it that way. And so my hope is, is that we can diligently work through this and see if there's an opportunity that really makes sense for our customers as well as for our investors. But more to come on all that, it's really too early to give you any more color on the current negotiation.

James von Riesemann - UBS Investment Bank

Okay. And now -- just my understanding is that the folks at SCANA have a say in all this at the end of the day as well. Is that true?

James Rogers

It's not totally clear to us. We're negotiating with Santee Cooper. And we have not, as I said earlier, we have not stepped into the due diligence process to know what the contractual relationship is between Santee Cooper and SCANA.

Lynn Good

The only thing I would add to it is we have long been supporters of regional generation. This is an opportunity for regional generation in our service territory. This is a framework for us to look at taking an interest in the due diligence. It's something we'll be focused on over the next couple of months and have more clarity around that step, as we complete that work.

Operator

And that does concludes the question-and-answer session. At this time, Mr. De May, I will turn the conference back over to you for any additional closing remarks.

Stephen De May

Thank you, Kelly, and thank you, everyone, for joining us today. And as always, the Investor Relations team is available for any follow-up questions. Have a great day.

Operator

And that does conclude today's conference. We thank you for your participation.

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