Calpine (CPN) Thad Hill on Q4 2015 Results - Earnings Call Transcript

| About: Calpine Corporation (CPN)

Calpine Corp. (NYSE:CPN)

Q4 2015 Earnings Call

February 12, 2016 10:00 am ET

Executives

W. Bryan Kimzey - Vice President, Investor Relations & Financial Planning

Thad Hill - President, Chief Executive Officer & Director

W.G. Griggs, III - Chief Commercial Officer & Executive Vice President

Zamir Rauf - Chief Financial Officer & Executive Vice President

W. Thaddeus Miller - Chief Legal Officer, Executive Vice President & Secretary

Andrew Novotny - Senior Vice President, Commercial Operations

Analysts

Neel Mitra - Tudor, Pickering, Holt & Co. Securities, Inc.

Julien Dumoulin-Smith - UBS Securities LLC

Stephen Calder Byrd - Morgan Stanley & Co. LLC

Brian J. Chin - Bank of America Merrill Lynch

Abe C. Azar - Deutsche Bank Securities, Inc.

Michael Lapides - Goldman Sachs & Co.

Praful Mehta - Citigroup Global Markets, Inc. (Broker)

Operator

Good morning and welcome to the Fourth Quarter 2015 Earnings Conference Call. My name is Brandon and I will be your operator for today. Please note this conference is being recorded. And I will now turn it over to Mr. Bryan Kimzey, Vice President of Investor Relations & Financial Planning. You may begin, sir.

W. Bryan Kimzey - Vice President, Investor Relations & Financial Planning

Thank you, operator, and good morning, everyone. I'd like to welcome you to Calpine's investor update conference call covering our fourth quarter and full year 2015 results. Today's call is being broadcast live over the phone and via webcast, which can be found on our website at www.calpine.com. You can access the webcast and a copy of the accompanying presentation materials in the Investor Relations section of our website.

Joining me for this morning's call are Thad Hill, our President and Chief Executive Officer; Trey Griggs, our Chief Commercial Officer; and Zamir Rauf, our Chief Financial Officer. In addition, Thad Miller, our Chief Legal Officer; and Andrew Novotny, SVP, Commercial Operations, are also with us to address any questions you may have on legal, regulatory or detailed commercial issues.

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

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

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

Thad Hill - President, Chief Executive Officer & Director

Thank you, Bryan. Good morning to all of you on the call and thank you for your interest in Calpine. We are living in interesting times. Very low gas prices, increasing renewable integration, tighter EPA rules, the financial peril of traditional base load generation, and now high yield debt markets that are demanding high returns for certain businesses.

In the midst of all of this, we at Calpine are heads down and continuing to execute our plan and we believe that many of these dynamics actually help our business over the medium term. In fact, over the course of today's call, we hope to remind investors the many ways we are very different from our peers: our assets, our capital allocation approach, and our focus on customers, and why we expect those differences to uniquely position us to outperform.

With that context, I'm pleased to report that in 2015 Calpine delivered record adjusted EBITDA and free cash flow per share and that today we are reaffirming our 2016 guidance. For 2015, we achieved adjusted EBITDA of $1.976 billion and adjusted free cash flow per share of $2.31, despite bearing the burden of a cumulative $36 million impact from the September wildfire at the Geysers. We generated almost 115 million megawatt hours of electricity in a reliable and safe way as we continue to serve our customers. Despite mild weather, low commodity prices, and the wildfire at our Geysers facilities, the men and women of the Calpine team stayed focused and delivered.

Since our third quarter call, we've continued to make progress on several other fronts as well. One of the things that sets us apart from our competition is our active portfolio management. Last week, we were excited to close on our purchase of Granite Ridge in New England. We've also recently made some tougher choices. In Texas, we have mothballed one unit at our Clear Lake Energy Center that was not economic to repair.

And much more meaningfully, in California, we have announced the suspension of operations at our Sutter Energy Center. Sutter is a well-run modern and flexible plant. It faces certain locational challenges that portended a negative cash flow period for some time, so we elected to remove it from service. Trey will discuss our California business in more detail since it has attracted some real investor attention as of late. But rest assured, Sutter was a unique case without read-through to the rest of our business there.

Another thing that sets us apart is our focus on customers. Last year, we entered the retail market in a meaningful way with our purchase of Champion Energy. Meanwhile, we continued our focus on wholesale customers as well, particularly but not exclusively public power. Today we announced three notable new customer transactions.

Our Morgan plant in Alabama has signed a 10-year contract with the TVA that commenced this month. We have signed a 10-year multi-hundred megawatt extension of our contract beyond 2021 with the South Texas Electric Cooperative, a customer that we've been serving for some time. Finally, we have continued our progress with community choice aggregation in California and are happy to announce a new three-year contract with the City of San Francisco.

Meanwhile, Zamir, Stacey and the finance team have remained busy as well. Since our last call, as we've announced today, we've extended the maturity of our revolver by two years and added $178 million of incremental capacity into 2018. We have closed a $550 million term loan at very attractive pricing. We paid down $120 million of almost 8% debt, and we restructured part of our Pasadena lease in a delevering transaction. Hats off to the team in a very difficult environment for high-yield issuers, we have been continuing to strengthen and evolve our balance sheet to position ourselves even better.

These efforts have given us momentum into 2016, and I'd like to address briefly our plans this year for capital allocation and our to-do list on the next slide. We expect 2016 to be a year full of action, marking continued progress against our aggressive agenda to grow adjusted free cash flow per share in a balanced way. At a high level, looking ahead to 2016, we will be investing almost $800 million in growth, split between our Granite Ridge acquisition and organic growth, most notably our York 2 facility in Pennsylvania.

We will be paying off, at a minimum, almost $450 million of debt. There are various attractive options to do so, which Zamir will cover. This will leave us with roughly $0.5 billion of remaining capital to deploy, although most of this cash will come in during the second half of the year. I'm sure there is probably a lot of interest in how we're thinking more broadly about go-forward capital allocation at this juncture, including our plans for the roughly $0.5 billion that we'll accumulate by year-end.

Yes, we believe our stock is cheap. We're also mindful that the turbulent environment could give rise to other opportunities. As we have in the past, we will seek to be balanced in our allocation with multiple objectives: maintain a balance sheet with strength and flexibility that gives our investors confidence; seek to take advantage of market disruptions to create value; return money to our shareholders, which is the yardstick by which we measure all other investments; and to be clear, we continue to believe our stock represents a real opportunity.

As the year progresses and we meet our current growth and debt pay-down commitments and the deployable cash balances begin to build, we will be making decisions on how best to deploy it. Beyond discussing capital allocation, I also want to describe what you should expect from us more broadly this year. As you have come to expect, our key focus is to remain the premier power generation operating company. Our focus on the plants, the safety of our employees, and maintaining a lean cost structure has served us well and defines who we are as a team.

We will also continue our focus on portfolio management. Of course, our first job here is to close the sale of our Osprey plant in Florida to Duke at the end of the year. Beyond that, we still believe that there are plants in our portfolio that others value more than our shareholders do. While progress has been a little slower here than we'd like, given the external environment, rest assured, we're continuing our work.

There could also be opportunities to grow. But for any capital we deploy towards growth, we'll have to believe it will create more value than buying our own stock. And as I just mentioned, that is a high hurdle. We will maintain our momentum on the customer side. Champion continues on a nice track, and we are working to build upon our industry-leading wholesale origination efforts.

Zamir and team will continue to look for opportunities to improve our balance sheet. And finally, we will continue to be very active in defending competitive wholesale power markets through our advocacy efforts. As you can see, there's a lot to do in 2016, and we will not be standing still.

On the next slide, I'd like to close the way I opened by highlighting how different we are from really any other unregulated energy business much less power businesses and how beneficial these differences are to us in today's market. Our assets are the best there are. Our combined-cycle gas turbine fleet with an average age of 12 years has decades of useful life remaining. And they've demonstrated this year how important flexibility is in markets with more and more intermittent renewables.

There are also no encroaching environmental concerns at all for us. And despite the Supreme Court stay of the Clean Power Plan, coal generators still must comply with MATS, a number of coal ash disposal issues, and in Texas the regional haze rule.

We think a couple of specific transactions in PJM in the fourth quarter of 2015 highlighted the premium value of our fleet compared to traditional base load generation. A combined-cycle gas turbine sold for nearly six times what a coal plant sold for on a $1 per KW basis, and this coal plant was fully controlled. I pointed this out because this distinction matters a lot, and the private market has done a better job so far in realizing it.

As a company, unlike most other energy-producing companies, we're relatively immune to shocks from any one commodity. Although longer-term gas prices certainly impact our competitive environment, our units have demonstrated the ability to make money in both high and low gas price environments.

Our balance sheet is solid. The recent upsize and extension of our revolver by the banks that know us best demonstrates this. We have a high debt service coverage ratio and no near-term maturities, nor do we have subsidiaries that could be distressed.

Our cash flow as a percent of our EBITDA is the highest of our peers and above that of companies in other comparable sectors. Because of our modern fleet takes less maintenance dollars, has no environmental CapEx requirements or legacy liabilities to fund, and because of our tax net operating loss positions, $1 of EBITDA means more than $0.40 of free cash flow available to pay down debt, return to shareholders or fund growth.

And finally, we think we've differentiated ourselves on capital allocation, not just buying plants, although we do that and like it when we get a good deal, but also selling plants when someone values them more and making the hard choice to lay up plants that are losing money.

Yes, gas prices are low, the EPA is active beyond the Clean Power Plan and more renewables are coming. But our fleet and we think the way we operate it, truly set us apart and uniquely position us to take advantage of the evolving landscape and outperform. I'm very excited about what the next several years hold for Calpine.

With that, I'll turn it over to Trey.

W.G. Griggs, III - Chief Commercial Officer & Executive Vice President

Thank you, Thad, and good morning to everyone joining the call. As Thad just described, Calpine stands apart from the crowd in many respects. Among them is our dedication to operational excellence as evidenced by the statistics on the slide.

Once again, our safety performance lies well within the top quartile. Our 2015 forced outage factor, excluding the impact of the Geysers wildfire, was just above 2%, an outstanding performance by industry standards. The honor roll of plants with exemplary performance in these areas is included in our appendix. As always, our sincere thanks and congratulations go out to those teams.

In addition, let me also extend my thanks to the continued efforts of our team at the Geysers, where we are now back to 80% of our pre-wildfire generation levels, and expect to be fully restored by the end of the third quarter. Yet another way in which Calpine is distinguished from its peers is its resilience in a low gas priced environment, which is based in part upon our ability to increase generation volumes given low fuel prices. In particular, generation in Texas and the East increased in 2015 as a result of low natural gas prices, even after adjusting for portfolio changes in both periods. Meanwhile, in the West, generation volumes from our gas fleet increased as a result of low hydro generation in 2015.

Moving to the chart in the bottom right, it's worth noting that this is our first earnings call with a full quarter of operations from our retail platform, Champion Energy. At Champion, we met our goal of serving more than 22 million megawatt hours of load in 2015. That's a 24% increase over the prior year. Similarly, we have extended the weighted average deal tenor from 22 months in 2014, to 28 months in 2015, a 27% improvement. Put simply, the Champion investment is absolutely delivering. In the four months since we acquired Champion, I've been impressed by the caliber of the people and the growth the team has delivered. It really is a remarkable and profitable liquidity platform.

Speaking of liquidity and the market Champion provides for megawatts generated off of our fleet, on the next slide, I will address our other two sources of market liquidity, contract origination and forward markets. In fact, our origination efforts are yet another way that we further differentiate ourselves from our peers. You'll see in the upper right corner of the slide a summary of some of the new contracts we've added since our last call; activity across the fleet with a variety of customers, including a government agency in the East, public power in Texas, and a community choice aggregator in California. We continue to identify opportunities to serve all types of customers in many different ways.

Looking at our disclosures, you'll see that we have added to our hedge positions in all three years, most notably in 2016. The increases in 2017 and 2018 are primarily related to the addition of a 10-year contract at Morgan, as well as some additional financial hedging in 2017. Across all years, we are more highly hedged today than we were for the equivalent periods on last year's fourth quarter call. We've been opportunistic where possible, yet are still open enough to benefit from recovery in our markets.

As for 2016, lower spark spreads as shown in the table on the lower right are clearly a challenge, as is the return of normal hydro conditions in the West, which we think could reduce our gas-fired generation by 5 million or more megawatt hours year-over-year.

However, we were highly hedged this winter, positioning us well for the first quarter despite mild weather early on. In addition, we are 80% hedged for the remainder of this year, including the benefit of the Morgan contract which was effective immediately.

Before moving on, let me mention that for the first time this quarter, we are presenting the New England or NEPOOL spark spreads on this slide on a clean basis, incorporating the costs of environmental credits associated with the Regional Greenhouse Gas Initiative, just as we do with the Northern California or NP-15 spark spreads, which similarly account for AB32 allowances. You'll note a similar update in our modeling tips in the appendix.

Speaking of California, let's turn to the following slide, where we outline the prospects for our fleet in what is quite possibly the nation's most rapidly evolving power market. The goal of this slide is to provide absolute clarity with respect to Calpine's position in the state. Today, our renewable Geysers assets and our contracted natural gas-fired fleet collectively account for approximate 95% of our free cash in California, as shown by the chart in the top left. Before going into further detail, please note that free cash, as presented here, is not directly comparable to the consolidated free cash flow for which we give guidance. The cash flows on this slide do not include any allocations of corporate overhead costs or corporate interest.

As you can see from this chart, a large portion of our California fleet, about 3,500 megawatts is currently composed of merchant capacity, operating under RA contracts of varying tenor. All told, this capacity contributes quite little in terms of free cash, yet acts as an option on future market conditions. More on that in a moment.

Within the merchant capacity bucket, you can see that the last segment of the orange area on the chart takes a turn downward. This circled area represents our Sutter plant north of Sacramento. Due to its unique isolation from the CAISO, Sutter is disadvantaged by burdensome transmission charges and the receipt of system, not local, resource adequacy payments. These factors have weighed on the economic outlook for Sutter, leading us to take the swift and decisive action of suspending operations at the plant. We do believe that Sutter offers many features that will be important to California over the longer term, but we will not continue to operate it at a loss while we wait for the market to recognize and appropriately reward these characteristics. The chart on the bottom left provides a plant-by-plant summary of the contracts for capacity and energy that drive the economics depicted by the chart above it.

A few key messages worth highlighting. As I introduced on our third quarter call, we are deliberately transitioning our Geysers indexed contracts to fixed price agreements. You'll see that over the next couple of years, we materially shift to the balance of these positions.

With respect to our three largest contracted gas assets, Otay Mesa has a put-call option at the end of its PPA that we expect will, at a minimum, fully retire the project debt associated with that plant. In addition, Russell City and Los Esteros have nearly $800 million of project-level debt that fully amortizes by the end of their respective contracts.

As a result, as we consider the potential risks associated with roll-off of the contracts in the blue bucket, we note that nearly half of the cash flows are satisfying debt amortizations, and thus, the net downside exposure is limited. The culmination of all of these items means that we have relatively limited merchant exposure through 2023 and limited risk to corporate cash flow beyond that.

I cannot predict the future, but I can say with absolute confidence that the California market of the future will look nothing like the market today. No matter what that future looks like, further penetration of renewables and retirements of once-through cooling units and possibly other capacity, lead us to believe that our fleet will play a necessary role. As you can see from the chart in the upper right, we believe our assets will be needed more and more as the afternoon peaks continue and gas remains an important part of the solution.

In sum, as we think about our California position in the middle of the next decade, I take the view that our existing merchant assets represent minimal downside exposure from today's economics while offering real option value. These plants are already playing an important role in meeting the state's reliability needs while advancing its goal of increased renewable penetration and will continue to do so into the future. And I believe that our contracted assets are of such a nature that whether due to the unmatched flexibility of our peakers, or the locationally significant contributions of Russell City and Los Esteros, we will be able to capture meaningful value in the future.

I'll wrap up my remarks on the following slide with some comments on the Texas and East markets. In Texas, after our last earnings call, ERCOT published its most recent report on system supply and demand conditions. This report paints a picture much different from the reality we believe exists in the market.

In order to more accurately represent market conditions, we have prepared what we call an economic reserve margin or the margin after which incremental load will price at scarcity prices of $1,000 a megawatt hour or higher, all the way to the system-wide offer cap of $9,000 a megawatt hour.

To calculate the economic reserve margin, we first add back the load that is served by the resources that trigger these scarcity prices when deployed, which includes reserves, emergency response, and load management resources. Next, we adjust the projected incremental fossil capacity to remove projects that currently are unlikely as they are not yet under construction and lack funding, something that we believe will be hard to come by from rational investors in the current market. This adjustment accounts for the removal of approximately 4,500 megawatts in 2019.

Meanwhile, we also make adjustments to account for the two Exelon projects that are currently under construction. We accelerate the plant that is currently in the CDR into 2017 to be consistent with Exelon's public remarks about projected start date, and we add their second plant in 2018 that was not included in the CDR.

Lastly, we reduced the contributions of solar-installed capacity to account for typical output coincident with peak demand. The result of all of these adjustments paints a much tighter picture than the CDR as published. And it should not go without notice that the CDR does not contemplate any future retirements of assets which we believe are very real prospects. In fact, the entire economic reserve margin in 2019 is roughly equivalent in size to the amount of coal capacity impacted by regional haze compliance obligations that could trigger retirement decisions. We remain positive in our outlook for Texas and that market moving forward, particularly given ongoing discussions about ORDC reform.

In the East, we continue to see margin shift from energy to capacity markets. Incremental newbuilds and PJM are driving backwardated forward energy curves. However, the capacity markets continue to evolve favorably as we progress toward a 100% capacity performance requirement over the next two auctions. On the demand response front, the recent Supreme Court decision will have relatively limited impact in our view. In fact, we welcome DR as a market participant now that it is competing on an even playing field.

Where capacity markets are concerned, DR participation has already likely been muted by the introduction of the CP product. And where energy markets are concerned, DR actually sets the price when called upon during scarcity, which would be favorable. Where the recent ruling has more interesting implications is as a potential read-through for federal jurisdiction. And whether that bears any weight on the outstanding Maryland case, the anti-competitive contracts in Ohio, or even national net energy metering policies. Stay tuned.

In New England, the auction for 2019, 2020 concluded this week. The results were consistent with the auction two years ago, but below last year's results. Nonetheless, we continue to view this constrained market favorably and expect future year auction results will remain at or above this level for some time.

With that, thank you all again for your time this morning, and I'll now turn it over to Zamir.

Zamir Rauf - Chief Financial Officer & Executive Vice President

Thank you, Trey, and good morning everyone. I'm proud to say that in 2015, the Calpine team rose to the occasion to face the challenges that Thad and Trey mentioned earlier, enabling us to successfully deliver on our financial commitments, and in the process, set the Calpine record for adjusted EBITDA, adjusted free cash flow and adjusted free cash flow per share.

Our focus on operational excellence, particularly given increased generation levels, our ability to effectively hedge, including through our new retail platform, Champion Energy, and our ongoing portfolio management efforts, resulted in a $27 million increase in adjusted EBITDA year-over-year, which clearly speaks to the resilience of our business and our people. We were able to achieve these results despite a mild summer in the East, only to be followed by the warmest winter on record in both Texas and the East, and the tragic wildfire in Northern California that alone resulted in a $36 million negative adjusted EBITDA impact in 2015.

The economic impact of the Geysers wildfire is now essentially behind us in 2015, although for this year, we may experience some timing differences for insurance proceeds. I am pleased that our continued execution of operational excellence, effective hedging and customer origination are keeping us on track to once again deliver on our commitments for 2016.

On the following slide, let's briefly review our adjusted EBITDA performance for the fourth quarter, including the primary year-over-year drivers summarized on the chart in the upper left. During the fourth quarter, we incurred $29 million of the $36 million 2015 impact from the Geysers wildfire, driven by a combination of repairs and revenue losses.

Regulatory capacity payments resulted in a year-over-year improvement of $25 million, driven primarily by higher PJM capacity revenues. And lastly, we benefited in the fourth quarter from hedges across all three regions, including retail hedging with the addition of Champion in the fourth quarter. In all, we achieved $45 million of quarter-over-quarter adjusted EBITDA growth.

Our 2015 commercial and operational performance was matched by our continued success at derisking the balance sheet and actively managing our capital structure. On the following slide, we provide an overview of our most recent achievements in this area. Amongst many significant transactions, we are pleased to announce an upsize and two-year extension of our $1.5 billion corporate revolver. We extended the maturity from June of 2018 to June of 2020 with an upsize of $178 million through the original maturity date of June 2018.

The culmination of these efforts is clear. We have no near-term debt maturities, almost $2 billion of liquidity and three times interest coverage. As always, we are actively allocating our capital in a very accretive and balanced way. As Thad mentioned earlier, we have committed to growth via our Granite Ridge acquisition along with the ongoing construction of York 2.

We will also be paying off a minimum of $435 million of debt in 2016. This will occur through a combination of regular amortizations of approximately $210 million and the application of $225 million from the excess proceeds of our 2023 first lien term loans. We have already committed to buying back $50 million of our high interest rate capital lease on our Pasadena plant.

As for the balance, we are considering a variety of other available options which could include; paying down high interest rate project level debt, redeeming our 2023 notes, of which $120 million is callable in the fourth quarter of this year with the remaining balance of $453 million becoming callable next January, or paying down other corporate debt. Beyond these commitments, we continue to evaluate our options to further reduce debt and extend our maturity, all while continuing to make disciplined decisions on capital deployment that will preserve flexibility, while maintaining the strength of our balance sheet.

Wrapping up on the following slide, you've heard a lot today about how Calpine stands tall above the crowd. From my vantage point, our key differentiators are our people, stable financial positioning and premium asset quality. We have no near-term debt maturities. Our strong liquidity is supported by consistently strong free cash flow that translates into the highest EBITDA conversion rate in the sector, and our customer origination and hedging activities continue to further reinforce the stability of our financial performance.

We have the right assets to sustain the stability moving forward. Unlike others, our modern, clean and efficient fleet is not answering questions about longevity of livelihood, environmental retrofits, and competitiveness against low-priced natural gas.

Calpine's strong financial footing, modern fleet and insulation from commodity shocks leaves us uniquely positioned to weather the current environment, which we will do through continued operational excellence, effective hedging, and balanced and disciplined capital allocation.

With that, let me thank you once again for your time this morning. Operator, please open the lines for Q&A.

Question-and-Answer Session

Operator

Thank you, sir. And from Tudor, Pickering & Holt, we have Neel Mitra on line. Please go ahead.

Neel Mitra - Tudor, Pickering, Holt & Co. Securities, Inc.

Hi. Good morning.

Thad Hill - President, Chief Executive Officer & Director

Good morning, Neel.

Neel Mitra - Tudor, Pickering, Holt & Co. Securities, Inc.

I had a question on maybe growth CapEx or acquisitions. Obviously, there's now a push to deleverage within your space. When you look at potential acquisitions, are there additional hurdles that you normally didn't have to look at before that you are looking at now to justify an investment specifically does something have to be credit-accretive as well as equity-accretive for you to pursue it?

Thad Hill - President, Chief Executive Officer & Director

Yeah, Neel. That's a good question. The way we have always looked at the deals that we have done is that they are free cash flow accretive to us because we typically have done deals with kind of this balance sheet leverage, we've always tried to make sure they're also credit-accretive. And so I would say those same two hurdles remain in place for us, which is we find opportunities most interesting there about free cash and credit-accretive. And I don't think anything has changed from that. We'll continue to hold ourselves to that standard.

Neel Mitra - Tudor, Pickering, Holt & Co. Securities, Inc.

Okay. Great. And then I just wanted maybe get some additional color on the slide where you guys are noting that the DR decision may have a read-through to the Ohio PPAs and the Maryland and New Jersey subsidies. Could you maybe go in a more detail on what those read-throughs could be?

W. Thaddeus Miller - Chief Legal Officer, Executive Vice President & Secretary

Hi, Neel. It's Thad Miller. Sure. 745 in our reading of it really had a pretty broad interpretation of FERC jurisdiction. We know there were some bits in there that suggested in some aspects in our jurisdiction. But our read on balance is that it was broader jurisdictions. So if we look at it on a read-through for Maryland, we think that the four federal courts have already ruled in favor of the preemption mandate there. We think that it was a surprise that the Supreme Court accepted it, but we still think that the Supreme Court would be disposed under that broad interpretation of FERC jurisdiction to uphold the lower courts.

I think the important thing to remember about that also is that the impact on the market will be minimal because since those cases started the New Jersey and the Maryland contracts were entered into, in PJM, they instituted a MOPR, a Minimum Offer Price Rule that's been FERC-approved that would effectively undermine the ability of the states to do what they propose to do in the first instance there.

In terms of Ohio, the broad FERC jurisdiction is important there. But I think perhaps more importantly in terms of any challenges at the federal level to what they're proposing to do in Ohio is that we see this as a potential violation of the utility affiliate self-dealing rule that FERC has in place. And we would expect it to be challenged if in fact the PUC approves the proposed settlement. We would expect it to be reviewed by FERC.

Maybe just to back up less on the FERC jurisdictional aspect of what's going on in Ohio, we think it's crazy what they're doing in Ohio because effectively the proposal saddles ratepayers was somewhere between $2.5 billion and $4 billion of additional costs over the next eight years. And the market can serve that load much more economically. So we're hopeful that as these facts have come to light after the settlement was reached that the PUC itself will have the fortitude to overrule it. But if they don't, we would expect to challenge it in state court, and as I mentioned, in the federal court. But again, in a similar way to what we talked about with respect to Maryland, we don't expect it to have a meaningful impact on the market because even if they bid in those units to PJM, they'd have to bid them in a cost and we would expect that those costs would not include the benefit of the subsidies that are being proposed.

Neel Mitra - Tudor, Pickering, Holt & Co. Securities, Inc.

Right. Okay. Great. Thank you.

Operator

From UBS, we have Julien Dumoulin-Smith. Please go ahead.

Julien Dumoulin-Smith - UBS Securities LLC

Hi. Good morning.

Thad Hill - President, Chief Executive Officer & Director

Hey. Good morning, Julien.

Julien Dumoulin-Smith - UBS Securities LLC

So, perhaps, just to follow up a little bit on the deleveraging theme. Can you talk about any new targets, if any? I mean, how are you thinking about what you previously laid out? Is there a need to reevaluate those targets more structurally? And then I suppose in tandem with that, how are you thinking about liquidity needs? I know you kind of talked about like a $1 billion threshold kind of informally and historically, but is that kind of still standard? Is there kind of a new thought on liquidity?

Zamir Rauf - Chief Financial Officer & Executive Vice President

Sure. Hey, Julien. This is Zamir. Julien, as you know, we've talked about a leverage target of between 4.5 times to 5.5 times. And while we are towards the top end of that today. I am incredibly comfortable with where we are. As you know, right leverage is a combination of debt and EBITDA. We have talked on this call about paying off almost $0.5 billion of debt this year alone. We're also evaluating other high interest rate projects and corporate debt and we have the 2023s and that will be callable in January of 2017, and that's about $450 million.

So, with that, with the fact that we have incredibly strong liquidity, no near-term maturities, very high interest coverage, strong free cash flow conversions, Julien, I'm very comfortable where we are today. So I don't think we need to evaluate the range. I think we just need to make sure that we are very prudent with how we move forward over here.

In terms of liquidity, $1 billion has always been our target. That's probably a little higher than we need, but we are conservative. We upsized the revolver, as you know, $178 million through the middle of 2018 and then extended it through 2020. And so we have more than ample liquidity to run the business and also to be opportunistic, if the need were to arise. So I'm incredibly comfortable, Julien, with where we are today.

Julien Dumoulin-Smith - UBS Securities LLC

And let me actually run with your last comment there, being opportunistic, and maybe this is the question for the broader team. How do you see an opportunity to be opportunistic given the current market environment? Obviously, there's a lot of distress out there. Is there an ability to take advantage of this and capitalize on it?

Thad Hill - President, Chief Executive Officer & Director

Julien, we just have to understand the opportunities that present themselves over time. Clearly, some valuations will come down and, clearly, there will be some folks that are in a strong financially as we are and there may be opportunities. But beyond that, I don't think we can really get more specific, but we're going to pay attention to see if there's opportunity in this type of environment. And if there is, as Zamir said, we're well positioned to take advantage of it certainly. And we think our – the way our balance sheet is positioned and trading is an advantage to others.

Julien Dumoulin-Smith - UBS Securities LLC

Great. Thank you, guys.

Operator

From Morgan Stanley, we have Stephen Byrd on line. Please go ahead.

Stephen Calder Byrd - Morgan Stanley & Co. LLC

Hi. Good morning.

Thad Hill - President, Chief Executive Officer & Director

Good morning, Stephen.

Stephen Calder Byrd - Morgan Stanley & Co. LLC

Wanted to discuss the market environment for sales of assets. This is something that a number of companies have been talking about for some time. From your perspective, broadly, do we have a sufficiently robust buyer universe relative to the amount of supply in the sense of number of assets that are available for sale. Do you believe there is differential in terms of contracted versus merchant in terms of market appetite? Where do you sort of see the opportunity and is there really a sufficiently a large enough buyer universe?

Thad Hill - President, Chief Executive Officer & Director

Yeah. Julien, that's a great question. I'm sorry, Stephen. I apologize. Great question. We have a set of assets that we do think could be more valued by others. But it's not every asset and it's not in all circumstances. There continue to be, in some places, utility interest in an asset, which could be put in rate base, and that's equivalent to what we did at Duke. With Duke, with their Osprey plant in Florida, which as you know we'll close on the end of the year. There are also some assets that do have contract to cash flows where they can support high-quality project debt or where there's already project debt in place where there could still be value or you're not being held captive by the current high-yield markets. And so we're going to continue to explore that, as we always have. And so we'll see if something makes sense or not. And so – but I wouldn't say that there's been any stepped up effort on our part. It's something that we've done all along and we'll continue to do. If somebody values it more than we do, they ultimately can own it.

Stephen Calder Byrd - Morgan Stanley & Co. LLC

Understood. Understood. And turning to California, we were happy to see the San Francisco contract. And you did talk about the locational challenges around Sutter, but can you talk a little bit further about how to distinguish Sutter from the rest of the fleet? And also, we do get questions from investors about the ability to not just have the assets physically survived and be in the market, but actually to thrive, i.e., to create significant positive margin in terms of contracts, et cetera, any color you can provide around the outlook. And there clearly seems to be a need for gas assets in the market, yet there is a lot of skepticism on ability to turn that into real margin. Could you speak to the environment in California?

W.G. Griggs, III - Chief Commercial Officer & Executive Vice President

Sure. Well, specifically with respect to your question around Sutter, it has a uniquely disadvantaged position with respect to transmission. And so, I wouldn't read through our decision to lay up Sutter through to other assets. It's a fine modern flexible plant but had a unique transmission issue.

With respect to the rest of the fleet, ignoring for the moment the contracted natural gas assets and our Geysers asset, the nature of your question seems to suggest the value of our merchant fleet. And on slide 10, we point out in the bottom right graph that as you suggest, natural gas is necessary to the California landscape for a long time to come. And our fleet, we think as I said in my prepared remarks, represents real option value. On the top right of that same slide, you note the steepening ramps. Other generation sources are not as flexible as ours and unable to respond to that steep ramp the way that ours can. And so as those ramps steepen, our merchant fleet becomes more valuable.

Thad Hill - President, Chief Executive Officer & Director

Yeah and, Stephen, I point to probably five separate indications, so just to kind of give a list that are all kind of ongoing in California. And any one of these doesn't change the world, but all of them I think are pretty constructive. First, there is the new FlexiRamp product at the Cal ISO, which could pay assets for flexibility. Secondly, there are a lot of once-through cooling units that could retire. Third, there is a nuclear plant where there is always to question on new licensing. So, we'll see how that goes. Fourth, the PUC is actually looking at what they consider effective load carrying capacity for solar, which is whether or not how much solar can you account towards capacity. There is an overdue situation and we think there'll be some news on that relatively soon.

And finally, there's the discussion about the expansion of the California market. Today for power to leave California, there's a fee, and there is not to come the other way. And the expansion of the Western markets that could remove that could also be a fairly – show some upside. So again, none of these individually, that's a laundry list matter. But I would say taken together, we think the fundamentals are only going to get better from here.

Stephen Calder Byrd - Morgan Stanley & Co. LLC

That's super helpful. I just wanted to follow up on the San Francisco contract. And is there any, I imagine the specifics are confidential, but is there any color you can give in terms of margin potential just because that is a new contract in terms of evidence of being able to generate margin from new contracts?

Thad Hill - President, Chief Executive Officer & Director

No, we can't speak to the specifics of the commercial terms of the transaction. But what we can say is that there has been a growing community choice aggregation effort in the state of California and our team, our origination efforts are very focused on capturing more than our fair share of that market. And we've been incredibly successful to-date.

Stephen Calder Byrd - Morgan Stanley & Co. LLC

Great. Thank you very much.

Operator

From Merrill Lynch, we have Brian Chin online. Please go ahead.

Brian J. Chin - Bank of America Merrill Lynch

Hi. Good morning.

Thad Hill - President, Chief Executive Officer & Director

Good morning, Brian.

Brian J. Chin - Bank of America Merrill Lynch

Just to be clear piggybacking off Stephen's question. So I guess, what we're saying then is when we look at that bottom left chart on slide 10 and we see Metcalf, Delta, Pastoria, Gilroy, Los Medanos, what we're saying is that as those contracts roll off, they won't go the same way as Sutter, that the fundamental backdrop for California still looks constructive, and we're not going to be in this position of hearing about other plants potentially going the way of Sutter in another one, two, three years, right? That's what we're saying?

Thad Hill - President, Chief Executive Officer & Director

Yeah. So yes, that is absolutely true with all of our large combined cycles. So those plants that are in locally constrained areas that pull gas off of the backbone and that are important to reliability are in good shape. So there are some smaller plants that we'll have concede, but we're not anticipating anything else that looks like Sutter.

Brian J. Chin - Bank of America Merrill Lynch

Okay. Great. And then, just one question going back to capacity markets in the East Coast. One of your peers yesterday said that they had cleared a project in this year's auction that didn't clear in the prior years, and that was largely due to bonus D&A. Should we expect a similar type of behavior in PJM's capacity market this upcoming year where bonus D&A may change bidding behavior this year versus last year?

W.G. Griggs, III - Chief Commercial Officer & Executive Vice President

Yeah. This is Trey. So I'm certainly not a tax expert or an accountant. But my appreciation for the bonus depreciation rules is that phase-down occurs materially in 2018, disappears entirely after 2019. And so if there is any effect, I would expect it to be limited. Notably, the New England auction process ensures a seven-year capacity lock, unlike PJM, where that lock does not exist. Also worth noting is the project that cleared or at least a couple of the projects that cleared belong to strategics. And my read of the pipeline of new opportunities or potential capacity additions in PJM suggests that it's a lot of smaller development shops, who I would argue would have a difficult time financing new projects in the current environment.

Thad Hill - President, Chief Executive Officer & Director

And I would just add to that. Everybody is doing the math, and we've done the math in our own model. And we came out with something approaching a couple of dollars a kilowatt-month as the advantage that are provided in New England. But given the lower pricing in PJM and the lack of the longer term, I agree with Trey, I think it's very hard for it to be a read-through.

Just on this New England auction, we obviously would have liked to see a higher price. We actually had a unit that could have been a newbuild that we would have contracted. But as you all know, we just closed on Granite Ridge last week, and we've done our best to reconstruct the economics. And we're proud of our financial discipline, and we've tried to be very firm about that. And to us, when we look at Granite Ridge versus a newbuild in New England, we think that there's a several turn of EBITDA multiple if you kind of view these as kind of EBITDA in first full year, you're avoiding construction risk, and we own assets for $450 a KW cheaper.

So several turns the EBITDA less, a lot less risk, the benefits begin accruing immediately and it's at a 40%-plus discount. So for us, we are constructive in New England, particularly next year, this comes back, new capacity will be needed. And we think that in that market, the buy versus build has been a more appropriate way to play it.

Brian J. Chin - Bank of America Merrill Lynch

Thank you very much. That's helpful.

Operator

And from Deutsche Bank, we have Abe Azar on line. Please go ahead.

Abe C. Azar - Deutsche Bank Securities, Inc.

Good morning.

Thad Hill - President, Chief Executive Officer & Director

Good morning, Abe.

Abe C. Azar - Deutsche Bank Securities, Inc.

Can you guys discuss why the Mid-Atlantic generation was down year-over-year in Q4? It seems to be a reversal of the trend we've seen for most of the year. So, could you discuss that a little bit, maybe there were maintenance outages at play there?

Andrew Novotny - Senior Vice President, Commercial Operations

Yeah, sure. This is Andrew. Yes. One item that you alluded to was some amount of maintenance of our power plants. Additionally to that, there was maintenance on the Transco pipeline as they got ready to bring on new production in the Leidy area, and this is part of the Leidy Southeast project. That for that temporary period boosted gas prices to our power plants in the Mid-Atlantic. We actually are seeing the reversal distance that project has come on and expect very, very low gas prices for 2016. So, when we look at what happened in the fourth quarter, we say it is an anomalous event. It's probably not going to be repeated in the current year.

Abe C. Azar - Deutsche Bank Securities, Inc.

Thank you. That's helpful. That's all I have for now.

Thad Hill - President, Chief Executive Officer & Director

Thanks, Abe.

Operator

From Goldman Sachs, we have Michael Lapides on line. Please go ahead.

Michael Lapides - Goldman Sachs & Co.

Hey, guys. Real quick question on capital allocation. Your capital allocation policies have been very consistent over a number of years. I give you guys credit in terms of being opportunistic buyers and sellers of assets. But do you worry that your capital allocation policies haven't changed with the market enough? Meaning, you allocate a little bit to buybacks, a little bit to debt reduction, a little bit to growth pretty much most every year using your free cash flow. It seems that the market, clearly, is less comfortable with 5 times EBITDA as you are. It also seems as if the market is valuing the IPP sector very differently than the owners of those assets do. And it also seems in some places the market may be very robustly valuing generation assets and in other places they may be dramatically undervaluing.

Do you think or is there a discussion within Calpine about revising the capital allocation process to take more of a view, whether that is a view of dramatically increase the amount of deleveraging you do, given the market's view across the entire commodities and cyclical complex about companies with 5 times debt to EBITDA? Or is it a dramatically tilt much more to buying back stock if you believe your stock is that cheap? Or using that for asset M&A, meaning, a much more tilt rather than kind of a more equal balance across those three buckets?

Thad Hill - President, Chief Executive Officer & Director

Yeah. Michael, we have not set out to be prescriptive every year in our capital allocation. Rather, it's been driven by really two things. One is the availability of cash in a particular period. And the second thing being what the opportunity set looks like in a particular period. And we've always said that if there's a great opportunity, we may use all the available cash and the opportunity. And if our stock is cheap and debt markets are free and then there's an opportunity, and there are no great other opportunities, you buy back more stock. So, I would say, our philosophy hasn't changed.

The market environment continues to change and we'll obviously react to the market environment that our philosophy is putting our cash towards the direction where we see the most value won't change. And so, we haven't set out over the last several years to kind of pro rata hit all three, the debt reduction, the share buyback, and the growth. Rather, there have been years in which one has been up and the other has been down based on the opportunity set and this just kind of played out on a more equal basis.

So what I'd say is, I think, our view of the world, which is to be balanced, but take advantage of whatever provides the most value at the time based on our best read of the environment is what we're going to continue to do.

Michael Lapides - Goldman Sachs & Co.

Got it. And one follow-up question, just a little bit of a read across from the New England capacity auction from this week and this is probably one for either Trey or Andrew. Just curious about the read across from the increased amounts of demand response that cleared year-over-year in New England despite a lower price. What do you think that means; A, for future New England auctions; but B, for capacity auctions elsewhere, especially in markets like PJM?

W.G. Griggs, III - Chief Commercial Officer & Executive Vice President

Yeah, Michael. I mean, this is Trey. I didn't see the same increased clearance in demand response. There certainly was a healthy element of demand response, but it was consistent with prior years and expectations. And so, it's not exactly the case that you get perfect clarity and their press release is on exactly what happened, but that's my read of it. And as I mentioned in my prepared remarks with respect to PJM, the same applies with respect to New England, demand response does not frighten us. In fact, it is, given where it clears often times very helpful.

Michael Lapides - Goldman Sachs & Co.

Got it. Thanks, guys. Much appreciated.

Operator

And our last question from Citigroup, we have Praful Mehta on the line. Please go ahead.

Praful Mehta - Citigroup Global Markets, Inc. (Broker)

Hi, guys. I wanted to touch on the Calpine smile a little bit. With this current low gas price environment, it's no surprise that your generation went up, makes sense. But I don't see the increase in EBITDA guidance as in, is it that the spark spreads haven't held up, or the coal-to-gas switching isn't as high as you would have expected? What is driving, I guess, the Calpine smile? Is it working? Is it not working? Because I would think this is probably the best environment for that to work.

W.G. Griggs, III - Chief Commercial Officer & Executive Vice President

Yeah. So, from a macro standpoint, you're absolutely right. Let's just – high level, we buy gas. Gas prices gets cheaper relative to other feed stocks, and we're going to run more. Calpine smile is absolutely intact as you see from our generation statistics that we disclosed on the past quarter.

Andrew Novotny - Senior Vice President, Commercial Operations

Yeah. I mean, and in terms of jumping into some of your detailed points, if you go region by region, there are certain dynamics at play. Certainly, in PJM, we have seen an increase in spark spreads. The low gas equals the left hot side of the smile and we've seen PJM let that spark spread to record levels. In Texas, we haven't really quite gone to the kink of the smile as the price of coal has been a little bit lower than where the market is, but we may see that now as we head into spring, and gas prices are sub-$2.

That being said, one thing that we've mentioned before is we're somewhat gas price agnostic and then there are other factors at play in terms of the total EBITDA. Scarcity during summer, Texas spark spreads, scarcity in PJM and whether demand response hits the market, those are all things that are very meaningful factors. So in conclusion, yes, the Calpine smile is still intact. Certainly, relative to any of our peers we're incredibly gas price agnostic. And you can see from our results from 2015 that we generated 115 million megawatt hours in a low gas price environment.

Praful Mehta - Citigroup Global Markets, Inc. (Broker)

I got you. Okay, that's helpful color. So, I guess, Texas, the kink is probably different from where it is in PJM, given the price of coal is lower or has been lowered in Texas. Is that fair?

W. Thaddeus Miller - Chief Legal Officer, Executive Vice President & Secretary

Yeah, I think that's fair for a variety of reasons. The kink is lower in Texas than it is in PJM.

Praful Mehta - Citigroup Global Markets, Inc. (Broker)

I got you. So just one final question on Texas again. On the ORDC curve review, I know that's a big driver and all the work that you've kind of shown here around the reserve margins, clearly, the ORDC curve needs to work for that to show up in terms of gas margins or spark spreads. Is there any update on where that stands or how you see that playing out, or if it will kick in for this summer?

W. Thaddeus Miller - Chief Legal Officer, Executive Vice President & Secretary

Sure. This is Thad Miller again. As you know, there's been a ERCOT stakeholder process that has looked at it. And at yesterday's meeting, the PUC in Texas actually briefly discussed it. They are very much occupied these days with the Oncor approval and therefore did not have time to deal with it in detail and deferred it until the April meeting. But our expectation is they see – we hope what we see, which is that the CDR, the ERCOT CDR really belies that Texas is getting tighter as we look forward and that now is the time to modify the ORDC, so it does reflect the scarcity pricing and sends the right price signals to the market. So, we expect that there'd be a workshop or some equivalent to that in the spring of this year with the commission taking action sometime this year. While we'd be hopeful that it would be by this summer, we can't say that it will be, but we certainly feel that they're going to deal with it in earnest over the next few months.

Praful Mehta - Citigroup Global Markets, Inc. (Broker)

I got you. Well, thank you so much, guys.

Operator

Thank you. We will now turn it back to Thad Hill for closing comments.

Thad Hill - President, Chief Executive Officer & Director

Great. Well, thanks, everyone, for your interest in Calpine and your time in the call today. I do want to reemphasize the primary messages or the theme of today's call. We are doing very well. There is a environment out there, which has created on a lot of disruption, but we are keeping our heads down. We are executing according to our plan. We're delivering on our numbers. And we feel very confident in our business. We've always been conservative in the way we manage our business, and we can continue to be that way.

As the year goes on, we will have a fair amount of cash to deploy. And our capital allocation philosophy remains intact. We definitely want to make sure we have a strong balance sheet, and that is very important to us. As you can see, there's some debt pay-down that's occurring this year. We also think our stock price is cheap.

So, we're going to continue to operate, be conservative and take advantage of the opportunities that lie before us. And we think, certainly, at the current trading levels of Calpine, this is a great point of entry for investors. So, again, thank you for your time and attention.

Operator

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

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