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Executives

Edward Muller – Chief Executive Officer

William Holden – Chief Financial Officer

Robert Gaudette – Chief Commercial Officer

Dennis Barber – Investor Relations

Analysts

Jon Cohen – ISI Group

Ted Durbin – Goldman Sachs

Ameet Thakkar – Bank of America Merrill Lynch

Brandon Blossman – Tudor, Pickering & Holt

Jonathan Arnold – Deutsche Bank

Ali Agha – SunTrust

Julien Dumoulin-Smith – UBS

Brian Russo – Ladenburg Thalmann

GenOn Energy Inc. (GEN) Q3 2011 Earnings Call November 9, 2011 9:00 AM ET

Operator

Greetings and welcome to the GenOn Energy Third Quarter 2011 Earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star, zero on your telephone keypad. As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Dennis Barber with GenOn Energy. Thank you, Mr. Barber. You may begin.

Dennis Barber

Thank you, Claudia, and good morning everyone. Thank you for participating in GenOn’s conference call. Leading the call this morning are Ed Muller, our Chairman and CEO, and Bill Holden, our Chief Financial Officer. Following our prepared remarks, we will have a question and answer session. Also in the room and available to answer questions are Rob Gaudette, our Chief Commercial Officer, and Gary Garcia, our Treasurer.

The earnings release as well as the slide presentation we’re using today is available on our website at www.GenOn.com in the Investor Relations section. A replay of this call will also be available on the website approximately two hours after the call is completed.

Turning to Slide 2, any projections or forward-looking statements made today are based on our current expectations and are subject to the Safe Harbors contained in this slide. Actual results may differ materially from our projections or forward-looking statements as a result of many factors, including those described in this slide and in our SEC filings. We’re also using non-GAAP measures to provide additional insight into the operating results and guidance, and reconciliations of the non-GAAP measures to GAAP figure are also available on the website or in the back of this presentation.

I’ll now turn the call over to Ed.

Edward Muller

Thanks, Dennis, and good morning everyone. I’ll start on Slide 4 of the presentation with several updates. First, I’m very pleased to report that our integration since the merger 11 months ago continues to proceed well. As we stated publicly in September, we expect we’ll save $160 million per year in costs starting in January. Second, I’m pleased to report that the construction of Marsh Landing in northern California remains on schedule to be completed by mid-2013 and remains on budget. And third, as we publicly announced recently, we expect to retire the Potomac River station in October 2012. Upon its retirement, we will receive $32 million that is escrowed for environmental improvements at the station.

Turning to Slide 5, I’ll address the impact of two EPA rules. The first, HAPS-MACT, is scheduled to be issued on December 16. Assuming the rule is issued as it was proposed, we expect it to be very positive for GenOn starting in the second half of this decade. The second EPA rule is CSAPR, which was promulgated in August. CSAPR is currently having a negative impact on our guidance for 2012, which I’ll address in a moment. I say currently because CSAPR allowances have to date been very thinly traded and their prices have been very volatile. In what we think are significant legal flaws in CSAPR, we, like many others, have petitioned the United States Court of Appeals in Washington, DC to stay and vacate the rule.

One final point on CSAPR and HAPS-MACT – HAPS-MACT as proposed will take effect in 2015. Once it takes effect, we expect it will mitigate the impact of CSAPR because with the sharp drop in emissions there will be less demand for CSAPR allowances.

Turning to Slide 6, we’ve laid out our updated guidance for adjusted EBITDA for each of 2011 and 2012, as well as guidance for 2012 which we’re initiating today. As you can see, our guidance is $607 million for 2011. It then drops to $496 million for 2012 and rises to $761 million for 2013. We’ve initiated guidance for 2013 one quarter earlier than usual because we don’t think 2012 is indicative of GenOn’s ongoing earnings power. We think 2013 is more indicative of the Company’s earnings power until HAPS-MACT as proposed is implemented.

I’ll now address each of the three years starting on Slide 7. There you’ll see that our guidance for 2011 has come down $14 million from the guidance we gave in August. The reduction is largely because of lower energy margins offset by higher contracted in capacity and higher results from our energy marketing segment. On Slide 8, you’ll see that for 2012 we’re reducing our guidance by $112 million to $496 million. This large decrease results from two things: first, lower power prices; second, reduced generation and higher costs associated with CSAPR. Though we expect to have excess CSAPR allowances, we plan to carry them forward to future years to optimize their value given the shape of the forward curves and transactions costs. Those reductions are somewhat offset by higher realized value of hedges and higher contribution from our energy marketing segment.

Turning to Slide 9, we compare our guidance for 2013 to our guidance for 2012. It’s an increase of $265 million. The large improvement results from three things: first, higher contracting and capacity; second, higher energy margins; and third, higher realized value of hedges. As for 2012, we plan in 2013 to carry forward excess CSAPR allowances to optimize their value. Bill Holden will provide more of the details in our guidance for each of the three years shortly.

On Slide 10, we show for SO2 allowances why it’s been very challenging to figure out the near-term impact of CSAPR. The bid ask was very wide initially and the curve was falling or backwardated. Three things helped narrow the bid ask spread and make the curve rising or contango: first, time for the marketplace to start coming to grips with CSAPR; second, the proposal by the EPA in October to eliminate for 2012 and 2013 a severe penalty for exceeding statewide budgets; and third, the proposal by the EPA in October to increase the number of allowances to be allocated.

On Slide 11, we show our hedges as of October 6 both for the fleet and for our base-load coal. We show our hedges as of October 6 because we use curves as of that date for our guidance for 2011, 2012 and 2013. Our strategy remains to hedge our output to reduce volatility in our realized gross margin. Our hedged position increased from July 12 largely because our expected generation declined as a result of CSAPR.

On Slide 12, we show our hedges as of October 31, which have increased since October 6. We’ve been adding hedges now that we are more comfortable with what our expected generation will be with CSAPR.

Let’s turn to Slide 13 and discuss HAPS-MACT. As I said earlier, we expect HAPS-MACT as currently proposed to be very positive for GenOn starting in the second half of this decade. As currently proposed, HAPS-MACT will result in four things: first, retirements, including of some GenOn units; second, reduced supply; third, higher prices; fourth, capital expenditures for environmental controls. We expect the overall impact to be higher earnings from price increases which will more than offset reduced earnings from units that GenOn retires.

On Slide 14, we address how much we’ll invest in environmental controls. We will only invest if our expected returns exceed our cost of capital. Based on current forward prices for 2015 when HAPS-MACT as proposed would take effect, we would invest less than $285 million in environmental controls. We expect, however, that as a result of industry retirements, prices will be higher than current forward prices for 2015. With those higher prices, we expect we would invest between 565 and $700 million for environmental controls over the next nine years. If market prices increase even more than we currently expect, additional investments could become economic.

Given that based on current forward prices for 2015 we would not invest more than 285 million, valuing GenOn using current forward prices and assuming capital expenditures of between 565 and $700 million is a mid-snatch and undervalues GenOn. We wouldn’t invest 565 to $700 million at current forward prices.

With that, I’ll turn things over to Bill Holden to walk you through the numbers. Bill?

William Holden

Thanks, Ed, and good morning everyone. I’ll start on Slide 16 where you can see that adjusted EBITDA for the quarter was $256 million, a decrease of $159 million from pro forma results for Q3 2010. For the year-to-date, adjusted EBITDA was 565 million, a decrease of $203 million from pro forma results for the same period last year. As a reminder, pro forma results for the 2010 period adjust the reported Mirant results for the 2010 period to show the combined results from Mirant and RI adjusted for merger-related items.

Adjusted EBITDA for the quarter and year-to-date was lower principally because of lower adjusted energy gross margin and lower contracted and capacity revenue partially offset by lower adjusted operating and other expenses. The $141 million reduction in energy gross margin for the quarter reflects lower energy gross margin from generation principally from PJM. The $53 million reduction in contracted and capacity revenue for the quarter principally resulted from lower capacity revenues in PJM. The $31 million lower adjusted operating and other expenses for the quarter primarily reflects merger-related cost savings.

Slide 17 summarizes debt and liquidity for GenOn at September 30. Total debt outstanding was approximately $4.1 billion. Total cash and cash equivalents was about 1.7 billion, of which 1.6 billion was held at GenOn or at subsidiaries other than GenOn Mid Atlantic or REMA. I would note that at September 30, 62 million of cash at REMA was not available for distribution because REMA did not satisfy the ratio required in its operating leases to permit distributions. And in addition, based on the results for the quarter, GenOn did not satisfy the ratio required by the GenOn senior notes to allow distributions of cash above the $250 million basket. We do not expect either of these restrictions to affect operations.

Including availability under the revolving credit facility, total available liquidity was just under $2.3 billion. Funds on deposit at September 30 were just over $600 million. Note that cash collateral for energy trading and marketing activities will be returned to GenOn upon settlement of the underlying transactions. The cash collateral to support the Marsh Landing project will be returned to GenOn by mid-2013 when the project achieves commercial operations; and the GenOn Mid Atlantic restricted cash has been removed from cash and cash equivalents and set aside to fund payments for the scrubbers at our Maryland plants.

Slide 18 provides details around the updated guidance for 2011 and 2012, and the guidance that we are initiating for 2013. First as noted on the slide, our guidance is based on forward commodity prices as of October 6, 2011. Also note that our guidance for 2012 and 2013 now incorporates the reduced generation and higher cost expected to result from the cross-state air pollution rule. The guidance does not incorporate any forecasted sales of excess CSAPR allowances because carrying them forward to future periods optimizes their value.

As Ed described, we are reducing our adjusted EBITDA guidance to $607 million for 2011 and $496 million for 2012. In addition, we are providing guidance of $761 million for 2013. I’ll provide additional detail on adjusted gross margin and a comparison to prior guidance for 2011 and 2012 as well as a bridge from 2012 guidance to 2013 guidance on the next few slides.

Starting with adjusted EBITDA and deducting cash interest paid and income taxes paid and adjusted for working capital and other changes in cash, arrives at net cash provided by operating activities of 69 million expected for 2011, 65 million projected for 2012, and 403 million projected for 2013. Deducting projected capital expenditures to be paid from cash for each year arrives at adjusted free cash flow deficits of $217 million projected for 2011, $122 million projected for 2012, and adjusted free cash flow of $159 million for 2013.

As noted on the slide, capital expenditures to be paid from cash exclude the amounts for Marsh Landing that will be funded by Project Finance Debt and also exclude the remaining Maryland Healthy Air Act capital expenditures that will be paid from funds on deposit.

Adjusting for the Marsh Landing working capital and equity contributions and payment of merger-related costs results in adjusted free cash flow deficits excluding these items of $39 million projected for 2011, $148 million projected for 2012, and adjusted free cash flow excluding these items of $92 million projected for 2013.

Finally, hedged gross margin which includes energy gross margin that is hedged plus contracted and capacity revenues, for which prices have been set, is approximately 1.71 billion in 2011 or about 95% of projected 2011 adjusted gross margin; just under 1.3 billion in 2012 or about 79% of projected 2012 adjusted gross margin, and approximately 1.43 billion in 2013 or about 75% of projected 2013 adjusted gross margin. Deducting the full-year forecast for adjusted operating and other expenses arrives at hedged adjusted EBITDA of $515 million for 2011, 150 million for 2012, and 284 million for 2013.

Turning to Slide 19, this slide presents the components of adjusted gross margin that are contained in our guidance for 2011, ’12 and ’13. Contracted and capacity, the lower bar, represents gross margin received from capacity sold in ISO and RTO-administered capacity markets, through PPAs and tolling agreements, and from ancillary services. Contracted and capacity comprises roughly half of our adjusted gross margin in all three years. Prices have already been set for over 95% of these amounts in all three years. The decrease of 69 million from 2011 to 2012 principally results from lower RPM auction prices partially offset by higher contracted prices in California, while the increase of 147 million from 2012 to 2013 is driven primarily by higher RPM auction prices in 2013.

Energy, shown as the middle bar, represents gross margin from the generation of electricity at market prices, fuel sales and purchases at market prices, fuel handling, steam sales, our proprietary trading and fuel management activity, and natural gas transportation and storage activities. The decrease of 19 million from 2011 to 2012 is principally driven by the effects of CSAPR which more than offset higher market prices. The increase of 101 million from 2012 to 2013 results principally from higher market prices.

And finally, realized value of hedges, the top bar, reflects the actual margin upon settlement of our power and fuel hedging contracts and the difference between market prices and contract costs for fuel that we have purchased under long-term agreements. Power hedging contracts include sales of both power and natural gas used to hedge power prices as well as hedges to capture the incremental value related to the geographic location of our physical assets. The decrease of $69 million from 2011 to 2012 is driven principally by a lower hedge percentage of our expected generation in 2012 as compared to 2011, while the increase of 16 million from 2012 to 2013 reflects higher hedge margins partially offset by a lower hedge percentage of our expected generation in 2013.

Turning to Slide 20, this slide reconciles our previous adjusted EBITDA guidance to our updated guidance. Our updated 2011 guidance is $14 million lower than our previous adjusted EBITDA guidance for 2011. This decrease is comprised of a $27 million decrease related to market price and generation changes principally resulting from lower power prices in PJM. This decrease was partially offset by relatively small increases from higher contracted and capacity revenue, a higher contribution from energy marketing, higher realized value of hedges, and a decrease in operating and other expenses.

Our updated 2012 adjusted EBITDA guidance is $112 million lower than our previous guidance for 2012. This decrease is comprised of the following: first, an $88 million decrease in energy gross margin resulting from lower power prices and generation, principally in PJM; second, an $85 million decrease resulting from the effects of CSAPR. Of this total,$46 million results from our expectation that excess emission allowances will be carried forward to future periods to optimize their value. Third, there is a small increase in operating and other expenses. These items were partially offset by a $51 million increase from realized value of hedges, an $11 million increase in the contribution from energy marketing, and a $1 million increase in forecasted contracted and capacity revenues.

Turning to Slide 21, our 2013 adjusted EBITDA guidance is $265 million higher than adjusted EBITDA guidance for 2012. This increase is comprised of the following: first, a $147 million increase in contracted and capacity principally related to higher capacity prices in PJM; second, a $105 million increase in energy gross margin principally driven by higher prices in PJM; third, 16 million higher realized value of hedges which results from higher hedge margins in 2013 compared to 2012, and a $1 million reduction in operating and other expenses. These items are partially offset by $5 million lower contribution from energy marketing.

Turning to Slide 22, this slide provides details on our CSAPR emissions position for 2012 and 2013, showing our expected allocations, expected emissions, and the amounts carried forward. Based on forward price curves as of October 6, 2011, we expect to be net long emissions in 2012 resulting in emissions allowances being carried forward to 2013. Based on our expected allocations and expected emissions for 2013, we expect our net long emissions position to increase during 2013 to the amount shown in the table after the caption, carry forward to 2014.

The bottom section of the table shows 2014 emissions prices in dollars per ton and also shows the value of the emissions position carried forward to 2014. The total value in 2014 is $98 million. As noted earlier, we assume we will carry forward our excess emissions allowances from 2012 and 2013 to optimize their value.

Turning to Slide 23, this slide shows sensitivities around our guidance. The guidance for all three years is based on commodity prices at October 6, 2011. The NYMEX natural gas price and market implied heat rate for 2011 are for the period from November through December. Also note that the natural gas sensitivities assume market implied heat rates and generation volumes are held constant, while market implied heat rate sensitivities assume fuel price and generation volumes are held constant. The sensitivities are greater as we move out in time because we are less hedged in the later years.

Finally turning to Slide 24, this slide presents a breakdown of our projected capital expenditures for 2011 through 2013. We expect normalized maintenance capital expenditures to be approximately $115 million per year. The total projected cost for compliance with the Maryland Healthy Air Act remains at 1.674 billion. A total of 155 million is expected to be paid in 2011, of which 71 million has already been paid. As I noted earlier, the funds to satisfy the remaining payments are held as restricted cash to GenOn Mid Atlantic and have been moved from cash and cash equivalents to funds on deposit on the balance sheet.

Other environmental expenditures are estimated at $30 million this year, 57 million next year and 76 million for 2013. Construction expenditures include the estimated amounts for the construction of our Marsh Landing generating facility, which will commence operations in mid-2013. Other construction expenditures are primarily for the ash beneficiation project at our Morgantown plant.

And with that, I’ll turn the call back over to Ed who will wrap up and open the call for your questions.

Edward Muller

Thank you, Bill. I’ll turn to Slide 25 and sum up. First, we are on track to achieve annual merger savings of $160 million starting this January. Second, we expect HAPS-MACT as proposed to be very positive for GenOn starting in the second half of this decade. We expect higher earnings from price increases resulting from industry retirements will more than offset reduced earnings from the retirement of some GenOn units. And third, CSAPR currently is having a significant negative impact on our adjusted EBITDA guidance for 2012 and 2013. HAPS-MACT, as proposed, will mitigate that impact.

And now Claudia, we’re ready to take questions.

Question and Answer Session

Operator

Thank you. Ladies and gentlemen, we will now be conducting the question and answer session. If you would like to ask a question, please press star, one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star, two if you’d like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Once again, if you would like to ask a question, please press star, one on your telephone keypad.

Our first question is coming from the line of Jon Cohen with ISI Group. Please state your question.

Jon Cohen – ISI Group

Hey, good morning. I know we’re not looking out to 2014 yet, but when I look at the EPA allocations, it looks like they take a pretty meaningful step down from ’12 and ’13 to ’14. So this surplus that you’re building up, isn’t that going to change into a short position starting in 2014? And I take your point that HAPS-MACT should reduce total emissions, but that’s not until ’15, ’16; so how should we think about 2014?

Edward Muller

Well first of all, we are not giving guidance for ’14. We are giving guidance only through ’13; and second, as you can see we are currently, based on current curves and current pricing, expecting that we will optimize the value of our excess allowances for each of ’12 and ’13 by carrying them forward. Beyond that, I’m not going to start to go through the particulars.

Jon Cohen – ISI Group

Okay, thank you.

Operator

Our next question is coming from the line of Ted Durbin of Goldman Sachs. Please state your question.

Ted Durbin – Goldman Sachs

Thanks. First one is I’m a little confused on your Slides 11 and 12. You’ve got two different hedge levels. Can you just walk us through where guidance would be directionally if you implemented the October 31 hedge levels?

Edward Muller

Well, I’ll let Bill walk you through the sensitivities. We provided both ’11 and ’12 only because the changes have been fairly significant. During the time we were trying to assess in the market what the impact of CSAPR would be on our generation, we were—we paused somewhat in our normal program of adding hedges because we didn’t want to hedge beyond our expected generation. That’s reflected largely in what we show on Slide 11 as of October 6. Now that we have a clearer sense of what we expect our expected generation to be, we’ve gone back into our normal program, and that’s reflected in what we show on October 31 on Slide 12—before October 31 on Slide 12. However, all of our guidance is based on October 6 curves including—on the October 6 hedge levels, and then has the sensitivities that are laid out; and I’ll let Bill augment there.

William Holden

I think the only thing I would add there – I don’t have an update on how the October 31 hedge positions would affect guidance, but I think the way to think about that is the objective of the hedging program is to reduce the variability around adjusted EBITDA in future periods, and so that’s what the higher hedge positions accomplish.

Ted Durbin – Goldman Sachs

Okay, great. And then if I can just ask specifically about Portland, we’ve got some new news here around specific emission limits. I guess first, it sounds like you may be able to blend there to reduce some of your emissions. How are you thinking about how much you can blend? And then as we go forward, thinking about environmental controls for that plant specifically?

Edward Muller

Okay. For Portland, the rule as it has been issued would require us to reduce emissions of sulfur dioxide starting in January 2013 by about 60%, and then in January 2015 by around 80%. We have a variety of things we’ve been and continue to explore on how we can meet the first period – that is January ’13 through January ’15 – and that is reflected in the guidance we have given today. And it can involve things like blending, like using lower sulfur coal, and how we operate the two coals units there. In January ’15, the 80%, to achieve that would almost certainly require environmental controls being added to the units, and there we will – as we will for all of our coal units that don’t have the full suite of environmental controls – look and see whether it makes economic sense to put on the controls. And I won’t go more specifically on Portland, but we would not invest unless we were comfortable that we could earn more than our cost of capital, and we would be looking not at a specific rule or this rule under 126 but rather everything that we see on the horizon – all rules and all prices.

Ted Durbin – Goldman Sachs

Okay, thank you. And my last question is just on I guess we’ve still got some liens outstanding with the Stone Wester litigation – it sounds like 165 million. When do you expect resolution of that? Is there anything there in your guidance - are you’re going to hold some cash back there if that potentially is triggered?

Edward Muller

Well as we’ve disclosed and for some time, we are in litigation with Stone Wester, and litigation always has a life all its own; but we remain comfortable with our expected expenditures under that contract, which was to install scrubbers to meet the requirements of the Maryland Healthy Air Act.

William Holden

And if I could just augment, you asked the question about what’s in the guidance. We’ve got all of the remaining capital expenditures. If you look at the capital expenditure table on Slide 24, we’ve got all the remaining capital expenditures for the Maryland Healthy Air Act assumed by the end of this year. If that doesn’t happen, obviously they would carry forward into next year.

Ted Durbin – Goldman Sachs

Right. Okay, great. That’s it for me. Thanks, guys.

Edward Muller

Thank you.

Operator

Our next question is coming from the line of Ameet Thakkar with Bank of America Merrill Lynch. Please state your question.

Ameet Thakkar – Bank of America Merrill Lynch

Good morning. Was just looking at the capacity—contracted and capacity revenue slide on Slide 29, and it looks like relative to disclosure you gave last time, it looks like you’ve made some progress on contracting some additional capacity in California, or certainly the green bars are a little bit larger now. Can you walk us through what’s driving that, and is there potential for more to be done in that area?

Edward Muller

Rob, why don’t you take that, please?

Robert Gaudette

Sure. As you know, SoCal Edison runs an RFO basically annually, looking for RA capacity out through the term. We participate in that with our southern California assets. We participated this time. I think what the numbers reflect is that we won some stuff there. I think as you look forward, you could expect that we would continue to participate and we continue to have the ability to participate. So we’ve got—we have more capacity out there. I don’t really want to talk about how much or where, but we will always be looking to sell capacity off our California assets, and one of the best ways to do that is through the RFO. We also in the shorter term provide the customers RA capacity for their needs.

Does that answer your question?

Ameet Thakkar – Bank of America Merrill Lynch

Yes, thank you. And then Ed, again kind of going back to Slide 6 when you were kind of discussing—I guess giving ’13 guidance here a little bit early, and it can be viewed as more of indicative look of what the Company’s performance should look in ’13 and ’14 versus ’12. Again, understanding that you just gave us ’13 and I’m not asking you to give guidance beyond that, but I just want to make sure I’m clear that you think that relative to ’13 and ’14, that is MACT comes into place as proposed, then there should be upside relative to what you have shown us in ’13?

Edward Muller

Well, I don’t want to give you directions, but let me reiterate. We see HAPS-MACT as its proposed, assuming it comes out on that basis or something similar, as very positive for GenOn once it comes in, and we see 2013 generally as indicative of the earnings power of the company going forward whereas we don’t see 2012 as being indicative of the earnings power, which is why we are giving the guidance a quarter earlier for ’13 than we normally would.

Ameet Thakkar – Bank of America Merrill Lynch

Okay. And then just finally on the economic decision to not include any benefit or revenues from potential sales of emissions in ’12 and ’13 and carrying that forward to ’14, can you just kind of walk us through directionally where prices would have to go on an emissions prices from, I guess, what you’ve embedded in your guidance for—how is that going to work? I mean, I guess that’s going to be kind of dynamic. I mean, if things change around, you might make the decision to include that going forward?

Edward Muller

Well, let’s take a look at Slide 10, which is for SO2 emissions; and notice what’s happened if you look from July 12 to August 16 to October 6. On the first two – on July and August – the curve was backwardated, that is if you could sell an allowance that was excess today, you could buy it back when you needed it for a lower price, being simplistic. Whereas on October 6, you can see the curve is rising so that if you sell it today – take that gain – you’ve got to buy it back figuratively tomorrow at a higher price. That’s not economic.

Now these curves and prices have been moving around. That’s why we put in Slide 10 – look initially how large, how wide the bid-ask spread was, whereas it’s come in quite a bit. But this is still moving around, and emissions allowances are a commodity and they will, in all likelihood, lose some more; and we will take the actions that will optimize their value for GenOn. And if that means that we don’t sell them because that’s the best economic decision, that’s what we’ll do. If on the other hand the curves were to sling back to where they were earlier, we could go the other way. We will simply do at any time what will deliver the most value for this company.

Ameet Thakkar – Bank of America Merrill Lynch

Thank you very much.

Operator

Our next question is coming from the line of Brandon Blossman from Tudor, Pickering & Holt. Please state your question.

Brandon Blossman – Tudor, Pickering & Holt

Good morning, guys.

Edward Muller

Good morning, Brandon.

Brandon Blossman – Tudor, Pickering & Holt

Hey Ed, I’ll take a stab at this, and I’m guessing there won’t be much of an answer but worth the try. You mentioned that you saw some significant legal flaws in CSAPR. Any chance that you’d care to detail what those flaws are and what your thoughts around those flaws are?

Edward Muller

You know, it’s a good try. We’ve got a lot of excellent lawyers working on this. Our filings are public. We are not alone, of course, in challenging this. There are many states challenging it. There are other companies challenging it, and there are unions challenging it, including the United Mine Workers. And I think while I could generally summarize the positions, I think it is far better to let the pleadings speak for themselves.

Brandon Blossman – Tudor, Pickering & Holt

Okay, fair enough. Detail question – you said $285 million worth of environmental CAPEX given the forward curves. Is that, one, incremental to what you have in your ’12 and ’13 guidance for environmental CAPEX? And then, two, care to give any detail around what those projects might be under the $285 million?

Edward Muller

As to the detail on which projects, no, we will not provide that. This is, as you can see based on our valuation of various price scenarios going forward, fluid. We will only, as I’ve said before, invest when it’s economic, so we’re looking at various price curves. The 285 million is based on the forward prices for 2015. Our own internal work tells us those prices will be higher and we will therefore invest more.

That said, on the timing of the capital, let me turn to Bill.

William Holden

Yeah, most of that 285 million would be incremental to what’s shown on the slide for other environmental investments. There may be a little bit of preparation for some of them, but the number would be very small.

Brandon Blossman – Tudor, Pickering & Holt

Okay, thanks. That’s it for me.

Operator

Our next question is coming from Jonathan Arnold with Deutsche Bank. Please state your question.

Jonathan Arnold – Deutsche Bank

Good morning. Sorry, guys – had the mute on.

Edward Muller

That’s okay. Good morning.

Jonathan Arnold – Deutsche Bank

My question is somewhat following up on where Brandon was there. As you decide whether to invest incremental CAPEX beyond the 285, obviously that will be dependent on price; but what if prices are slow to react to where you think they should be, given whatever comes out finally on MACT? How will you react and sort of time your decisions? Is it possible we could have plants out of the picture for a bit and then coming back? Maybe speak to that.

Edward Muller

Sure. I think if prices are slow to react, we will be slow to react. I think we’re talking serious dollars here. We will not invest them cavalierly. Our expectation, as I’ve said, is that we will be investing substantial amounts because we expect prices to move; but if we don’t see those indications in the market, we will wait.

Jonathan Arnold – Deutsche Bank

So prices need to come first, basically, then?

Edward Muller

Prices and clarity in the rules need to come first, and I would suspect that if we didn’t see clarity in the prices it would be for one of two reasons, or both. One would be lack of clarity in the rules, and the second would be economic conditions.

Jonathan Arnold – Deutsche Bank

And I guess picking up on that, how confident are you that you’re going to see clarity on the rules in this sort of mid-December time frame, and does the rule going final kind of constitute clarity in your mind?

Edward Muller

We are quite confident based on how things have played out that the EPA will issue its rule on December 16, given that it just went to the U.S. Court of Appeals with other groups and sought that extension. It would seem highly unlikely to us that they would not issue the rule. What the rule will say, of course we don’t know. In all of our remarks here, we are addressing the rule as it has been proposed. It can be different, of course.

And second, based on how its proposed, we think this is very positive for GenOn. We know that there are other participants in the industry who see it differently, so we would expect that there would be some challenges; and if there are, we would have to assess at the time how much clarity that give us. We are telling you what we think we’re going to do with CSAPR, that we are ourselves participating in a significant challenge to CSAPR.

Jonathan Arnold – Deutsche Bank

Okay. Thank you. If I may on just one other topic – does your environmental capital investment range include any kind of numbers around retirement costs of the assets you don’t expect to run, and is there a netting that goes on as this number moves?

Edward Muller

No, it does not include anything for retiring assets. As a general matter, retiring assets does not involve significant amounts of capital. There is no requirement to, for example, dismantle the facilities, and we wouldn’t. We would obviously keep them safe in terms of the public and fence them in and provide guard services. But until we see another use for the property, either ourselves or someone else, we would expect not to be expending any capital that’s worth talking about.

Jonathan Arnold – Deutsche Bank

Okay, thanks a lot.

Operator

Our next question is coming from the line of Ali Agha with SunTrust. Please state your question.

Ali Agha – SunTrust

Thank you. Good morning.

Edward Muller

Good morning, Ali.

Ali Agha – SunTrust

First, just a couple of clarifying points. The impact of carrying forward the emission allowances in ’12, the negative impact, is that triggered because previously you had assumed sale of those allowances, because I know when you originally gave ’12 you guys, if I recall, had said you had factored in CSAPR but were not very specific. So just to be clear, what is causing the negative hit from carrying forward the allowances versus your prior guidance?

Edward Muller

Bill, why don’t you walk through this?

William Holden

Yeah. When we spoke last on the Q2 call, we had not incorporated CSAPR into the guidance but what we said at the time was that we expected it would be a modest negative impact, and the reason for that was a function of where power prices were and where the emissions allowances prices were. I would note that at the time, we expected that we would monetize excess allowances based on the shape of the price curve, and so the net effect of that is what would have been the modest negative effect.

As we see now, the shape of the curve has changed and we find that in order to optimize the value of the allowances, we would carry them forward to future years; and what we’ve done here on the details around the guidance is shown you the effect of the expectation that we’ll carry the allowances forward.

Ali Agha – SunTrust

I get it. Another clarifying question, Bill, for you – your O&M expense in the third quarter, anything unusual in there which kept it so low, because if I look at your full-year guidance and your nine-month numbers, it implies a pretty big ramp-up in the fourth quarter for O&M versus the third quarter.

William Holden

Yeah, I think the only there is just the timing of outages and projects within the year, I think is the biggest item.

Ali Agha – SunTrust

I see. And Ed, to you – your liquidity needs as you look forward, I know you guys do the stress test and constantly view that downside case. But as you look at the forward curves, et cetera, would you still say that your current liquidity is what you need to hold, or is there any opportunity that you see to free up some of that cash to use it for other means?

Edward Muller

I’m going to let Bill remind everyone of how we address this, but we think we have adequate liquidity for the company. We’re very comfortable with that, but we don’t think we have meaningful excess liquidity in the company.

William Holden

Right. And the only thing I would just add to that is that’s based on the same framework that we’ve been using where we look at what the outlook for the business is and the current environment. But we really set our liquidity requirements based on a stress case where we look at the possibility of a spike in commodity prices but also a prolonged downturn in commodity prices from current price levels.

Ali Agha – SunTrust

And last question for Ed, to you – looking at the market, looking at the trends, given your size and scope, to maximize shareholder value in your opinion, is the strategy to hunker down and wait for that turn that you expect will come, or is there something else – perhaps another transaction to make the company larger and stronger balance sheet – that may be required to really maximize the full value for GenOn shareholders? How are you thinking given the environment that we’re in?

Edward Muller

Well, I think this, Ali – whatever environment we’re in, this market place, boom times, whatever it is, something in between, it is incumbent on us to always examine all possibilities for enhancing the value of the company. But beyond that, I wouldn’t say anything. Nothing has changed today from yesterday, and we’ll do that tomorrow. That is our job.

Ali Agha – SunTrust

Okay, thank you.

Operator

Our next question is coming from the line of Julien Dumoulin-Smith with UBS. Please state your question.

Julien Dumoulin-Smith – UBS

Good morning.

Edward Muller

Good morning.

Julien Dumoulin-Smith – UBS

First question – you mentioned in the release and presentation regarding state implementation plans and those not changing per your guidance. How do you see that panning out? When do you think we’ll get some clarity around that? And as you see the cards right now, is there a bias one way or another, for or against you, in terms of potential changes from the current allocations?

Edward Muller

Well, the current allocation which is the federal implementation plan, covers 2012. Quite a few of the states that are relevant to us have elected to take on the plan for 2013. As we say in our materials here, we expect given the time and the time necessary to get approvals for changes and indications from the EPA of what it thinks ought to be the case for 2013, that 2013 will be very similar to—or virtually identical to 2012. Thereafter, we are unsure. The Clean Air Act program provides that the states should figure out how to do this, and how they will go about it, we’ll know more as we go forward. But remember, the rule was issued or promulgated in August, having been proposed early in the year, and it calls for going into effect in January. So just as this has left the industry, including us, having to move quickly to figure all this out in a very fast-moving environment where prices are moving around and the bid-ask is large and so on, the same is true for the states. So while we are in contact with them and working with them on this, I think it is just premature to say how we think it’s going to come out post-2013.

Julien Dumoulin-Smith – UBS

Great. Second question here relating to the need for baghouses. I know we’re prior to the issuance of the final rules here, but as it stands today for the Maryland portfolio, is there any chance that there would be the need for further, call it particulate matter CAPEX to comply with the MACTS rules?

Edward Muller

We don’t expect so.

Julien Dumoulin-Smith – UBS

Great. Looking at the 2014 CSAPR pricing, clearly in contango now, but does it adequately reflect your expectation? Maybe you could expand that to ’12 and ’13, and then more so, is that currently in power forwards?

Edward Muller

I’m going to let Rob take this. It’s hard to know exactly what’s in the forwards. We certainly think some of it is in, but exactly how much, we’re not certain. How the market will evolve, we’re also uncertain. We do think that the shift here reflects the fact of proposed changes by the EPA made last month. When I say this is fluid, it is fluid – promulgated in August to take effect in January, and proposed modifications by the EPA in October on which comments are still going in. Those two things that the EPA proposed last month are more allocations to go out and the elimination of a severe penalty structure for ’12 and ’13 when state budgets are exceeded. So we think the market has responded logically, but how exactly it will come from here, we’re not prepared to say.

Rob, anything that I missed there, or did I get it?

Robert Gaudette

No, I think you nailed it.

Edward Muller

Okay.

Julien Dumoulin-Smith – UBS

Great. Finally, third question – this is more of call it a revenue number. The capacity revenue for PJM in ’15 ticked down a little bit. Are we just to take that’s just sort of the normal ebbs and flows of your hedging philosophy, or is that sort of representative of incremental thoughts around retirements at all?

Edward Muller

You know, we do not, Julien, discuss what we do unit-by-unit in the capacity auctions, but with everything going on, we assess where we think things are going and what our position is, and we do seek through our commercial organization to maximize the value for us. So you can assume that that’s what that reflects.

Julien Dumoulin-Smith – UBS

Great. Actually perhaps just a last quick one here – working capital benefits and cash flow for ’11 and ’12 seem to have seen a nice uptick. Any kind of reason behind that in particular?

William Holden

You’re referring to the working capital and other line on the guidance slide?

Julien Dumoulin-Smith – UBS

Yes.

William Holden

You know, the biggest changes from 2011 – in the prior guidance, we had the return of funds on deposit for the Maryland Healthy Air Act classified as a return of working capital. For this quarter, we’ve re-classed that to investing activity. That’s offset—so it no longer appears as an inflow in ’11. That’s offset by the timing of some payments being pushed to ’12, which largely explains the change in 2012.

Julien Dumoulin-Smith – UBS

Great, thank you.

Dennis Barber

Claudia, I think we’ll have time for maybe one more question.

Operator

Okay. Our last question is coming from the line of Brian Russo with Ladenburg Thalmann. Please state your question.

Brian Russo – Ladenburg Thalmann

Hi, good morning. Most of my questions have been asked and answered, but just curious if you could maybe elaborate on the assumptions of how much higher the 2015 forward curve needs to be to move from the 285 million CAPEX up to the 565 to 700?

Edward Muller

Yeah, Brian, I’m not going to give you anything with specificity, but it’s obviously more than a hair and we expect it to move that way. Logic tells us that. There are, of course, a variety of factors, not least of which is the state of the economy then; but it would move up meaningfully is our expectation before we would justify the incremental capital.

Brian Russo – Ladenburg Thalmann

Okay, thanks.

Operator

Mr. Barber, there are no further questions at this time. I’ll now turn the floor back over to you for any closing comments.

Dennis Barber

Thank you, Claudia. Thank you everyone for participating in our call this morning. A replay will be available in about two hours. Hope you have a great day.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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