Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Max Kuniansky - EVP of IR & Corporate Communications

Paul Evanson - Chairman, President and CEO

Phil Goulding - CFO

Analysts

Dan Eggers - Credit Suisse

Greg Gordon - Citi

Reza Hatefi - Polygon Investment

Lasan Johong - RBC Capital Markets

Steve Fleishman

Brian Russo - Ladenburg

Ashar Khan - SAC Capital

Daniele Seitz - Dahlman Rose

Allegheny Energy, Inc. (AYE) Q3 2007 Earnings Call October 26, 2007 8:30 AM ET

Operator

Good morning. My name is Casina, and I will be yourconference operator today. At this time, I would like to welcome everyone tothe Allegheny Third Quarter Earnings Call.

All lines have been placed on mute to prevent any backgroundnoise. After the speakers' remarks, there will be a question-and-answersession. (Operator Instructions) Thank you.

Mr. Kuniansky, you may begin your conference.

Max Kuniansky

Good morning, everyone, and thanks for joining us. If youhave to leave the call before it's over, you can listen to the taped replay,which is available until midnight onNovember 2nd. You can listen to it by telephone, on our website, or by podcast.

Some of our statements will be forward-looking. Thesestatements involve risks and uncertainties and are based on currently availableinformation. Actual results may differ significantly from the results in theoutlook we discuss today.

Please refer to our earnings news release and our SECfilings regarding factors that may cause actual results to differ from theforward-looking statements made on this call. Our presentation includes somenon-GAAP financial measures. On our website you will find the reconciliationsrequired under the SEC's Regulation G.

After our prepared remarks, we'll take your questions. Weask that you try to limit your questions to two each, so we have time to get toas many of you as possible.

And now, let me introduce Paul Evanson, Chairman, Presidentand Chief Executive Officer of Allegheny Energy.

Paul Evanson

Good morning, everyone, and thanks for joining us. I ampleased to report that Allegheny had strong earnings growth in the thirdquarter. Earnings were $0.67 per share, up from the $0.56 of adjusted earningsreported a year ago.

Higher market prices in PJM and higher generation rates in Pennsylvania,as well as increased retail sales at Allegheny Power, were the majorcontributors to earnings. Availability at our super critical power plants was87% during the third quarter, versus 89% in last year's quarter.

As I mentioned on the last analyst call in July, weexperienced a number of unplanned outages at the end of June that continuedinto the first half of July. Since then, and through today, the plants havebeen operating at expected levels.

Now, let's look at the progress we've been making on ourmain objectives for the year. In September, Moody's raised our credit rating toinvestment grade. Standard and Poor's had, previously, upgraded us in May.

I've always said we would reinstate the dividend once webecame investment grade, so in early October the board declared a quarterlycash dividend of $0.15 per share, payable on December 17th. We have set thepayout at a level that gives us room not only to grow the dividend in thefuture, but also to fully complete our announced capital spending programs, andcontinue to strengthen our financial condition.

A second objective is the expansion of our transmissionsystem to improve reliability throughout PJM. The approval process for the500-kV Trans-Allegheny Interstate Line, or TrAIL, continues to move forward.

Public hearings in West Virginia,the third and final state to hold them, will conclude next week. Evidentiaryhearings are scheduled in Pennsylvania,Virginia, and West Virginia during the first quarter of 2008, and weanticipate final Commission decisions by mid-year.

A second project, the Potomac Appalachian TransmissionHighline--or PATH, as we call it--is gearing up. We finalized the joint venturewith American Electric Power in August, and we expect to file with the FERClater this year for incentive rates, and then with state regulators, forapprovals in the second half of next year.

Both lines are within the National Interest ElectricTransmission Corridor, recently designated by the U.S. Department of Energy.The DOE designation further underscores the importance of transmissionexpansion to improve reliability in our region.

Turning, now, to key regulatory issues. In September, wefiled for a modified rate increase in Virginia.In the request, we are asking for recovery of purchase power costs to supplythe portion of our Virginia loadin excess of the 367 megawatts that we had transferred out of rate base in2000. The Commission has set a hearing in the matter for December 4th.

In Pennsylvania,the legislature has been meeting in special session since September on energyissues. Allegheny supports Governor Rendell's efforts to address criticalenergy issues for the state. And we welcome the opportunity to work with theGovernor, the General Assembly, the Public Utility Commission, and otherinterested parties, to develop effective energy policies including thetransition to market-based rates.

More generally, energy conservation and efficiency programshave risen to the forefront of the utility industry in recent months. Alleghenyhas embraced this movement through a series of initiatives that we call, WattWatchers.

We kicked this program off in Marylandwith a distribution of compact fluorescent light bulbs to our 220,000 customersthere. You will be seeing many other programs implemented throughout our serviceterritory in the future.

Now, in other news, I am pleased to report that the U.S.Second Circuit Court of Appeals ruled in our favor in the Merrill Lynch case.The court reversed the award to Merrill of $115 million, plus interest,reinstated our counterclaims for fraud, and remanded to the District Court forreconsideration. A very positive development.

Earlier this month, PJM completed its third capacity auction--thisone for the 2009-10 planning year. The market clearing price was $191 per megawattday in the MAAC+AP zone, and $102 in the rest of the market.

Allegheny has about 2,400 megawatts of capacity in excess ofour obligation for that fiscal year, 1500 megawatts in the MACC+AP zone, and900 in the rest of the market. The next auction will take place in January, forthe 2010-11 fiscal year. While our excess capacity will be significantly higherin that period, that capacity will no longer be groups in the MAAC zone, butwill be in several zones--principally in the APS zone.

Allegheny Power continues to win top rankings for itscustomer satisfaction. Just last week, the TQS survey of large commercial andindustrial customers put us number one in the Northeast, and number nine in thenation. You'll note on this slide, our steady improvement in satisfaction overthe last three years. And on the environmental front, our scrubber projectsremain on schedule and on budget for service in 2009.

Before closing, I must also share the sad news that we losta valued member of our senior management team, with the passing of JoeRichardson, at the end of September. Joe had been diagnosed with cancer just afew weeks earlier, and died from complications resulting from major surgery.

Professionally, I can't say enough about Joe's capabilitiesand leadership. He joined us in August '03, as President of Allegheny Power andin June '06, became Chief Operating Officer of the generation business.

On a personal level, Joe was just simply a wonderful person,beloved by everyone who came in contact with him. He will be sorely missed byhis family and all of us who worked with him. Until we fill his position, Iwill be overseeing the operations of the generation business.

In closing, 2007 continues to be a year of solidaccomplishment and strong earnings growth for Allegheny and we expect thatgrowth to continue into 2008.

Finally, I look forward to seeing many of you at the EEIConference in Orlando, in a week orso.

Now, let me turn the call over to Phil.

Phil Goulding

Thank you, Paul. Good morning. I will begin with our GAAPbasis results. Yesterday, we reported net income of a $115 million for thethird quarter of 2007, compared to a $110 million for the third quarter a yearago. Earnings per share increased to $0.67, up from $0.65 in the same period ayear ago.

There were no adjustments to net income for the thirdquarter of 2007. Last year's adjusted income of $94 million excludes a $17million benefit associated with the change in Pennsylvaniatax law, and a small loss from discontinued operations.

On an adjusted basis, our earnings per share of $0.67 thisquarter is up from $0.56 per share a year ago. For the nine months endedSeptember 30th, earnings increased to a $1.78 per share, up $0.32, compared toadjusted EPS for the same period a year ago.

Before I go through each line of the income statement, Iwould like to summarize the key factors that impacted the quarter-over-quarterchange in adjusted earnings per share. The net effect of market prices,marketing contracts, and hedging activities, increased EPS by $0.08. Prices inour zone averaged $56 per megawatt hour, an increase of $2 per megawatt hourover the third quarter of 2006.

Higher generation rates in Pennsylvaniacontributed $0.05 to EPS. Our Pennsylvaniageneration rates increased 8% on January 1st of this year. This was the secondin a series of annual increases scheduled through 2010.

T&D revenues, excluding the effects of the West Virginia rate case, increased EPS by $0.03. Loadgrowth and weather contributed to this increase. Cooling degree days were 10%higher than the same quarter a year ago, and about 19% higher than normal. Theexpiration of the Marylandcustomer choice credit in early 2007 further contributed to the T&D revenueincrease.

Higher coal prices reduced EPS by $0.05. Our fully deliveredcoal price per ton increased from $37.49, in the third quarter of last year, to$40.66 per ton in the third quarter of 2007. This increase is in line with our2007 earnings drivers.

Decreased generation output reduced earnings by $0.04 pershare. As Paul mentioned, output was impacted by higher forced outage rates atour coal-fired stations.

Higher O&M reduced EPS by $0.02 per share. Reducedinterest expense, excluding securitized interest, which is recovered in rates,added $0.04 per share. Other factors, which include a La Paz real estate transaction, increased earnings pershare by $0.02. In total, earnings per share increased $0.11.

Now, I would like to discuss the quarter-to-quarter changesin each of the primary lines of the income statement. There were no adjustmentsto pretax income from continuing operations in either period, so the numbersshown here are the same on a GAAP and adjusted basis.

Beginning with the top line, revenues increased by $30million. Let me summarize the key factors that contributed to this change. Theincrease in Pennsylvaniageneration rates provided $13 million of increased revenues, compared to thethird quarter a year ago.

Load growth and weather increased T&D revenues by $5million. Retail electricity sales were 11.2 million megawatt hours in the thirdquarter of 2007, a 1.3% increase over the same period last year. The expirationof the Maryland customer choicecredit increased revenues by $4 million.

Market prices, including marketing and hedging activities,improved revenues by $8 million quarter-over-quarter. Revenues from increasedmarket prices were partially offset by a decrease in revenue from theexpiration of the Ohio purchasepower agreement with AEP.

The Fort Martinscrubbers securitization surcharge added $6 million in revenues. Decreasedplant output reduced revenues by $8 million, and all other factors increasedquarterly revenues by about $2 million.

Moving from revenues to expenses. Fuel costs increased by$15 million, period-to-period. Higher coal prices and increased gas consumptionwere offset by lower generation output. Other fuel items include a coalinventory adjustment, and increased emission allowance costs.

Purchase power costs decreased by $8 million in the thirdquarter of 2007, due primarily to the expiration of the AEP agreement. Thesedecreases were partially offset by higher Virginiapurchase power costs.

Deferred energy costs relating to Marylandand West Virginia increasedexpenses by $4 million. O&M expenses increased $4 millionquarter-over-quarter, reflecting the payment of a contingent consulting fee.

Moving down the income statement, depreciation andamortization expense was lower by $2 million, due to the West Virginia rate order, which increased the useful livesof our regulated generating plants. The depreciation expense reduction waspartially offset by increased investments in our businesses.

Other income increased $7 million, primarily due to a gainon a La Paz real estate transaction,which was an exchange of land for water rights.

Interest expense for the third quarter of this year was down$7 million. Debt reduction, increased capitalized interest, and thediscontinuing of further interest accruals related to our Merrill Lynch lawsuit,reduced interest expense by $12 million.

These reductions were offset by a $5 million increase insecuritized interest costs, which were recovered in rates. Our average debtbalance, excluded securitized debt, was $3.3 billion, down $236 million fromthe same period last year. The net result of all of these items was a $31million improvement in pretax income.

Our tax rate was about 37% this quarter. Our tax rate willfluctuate somewhat, period-to-period. However, we still expect the tax rate forthe full-year 2007 to be about 38%.

That concludes my discussion of the income statement.

Moving on to cash flow. Net cash flow from operations was$321 million in the third quarter of 2007, a $24 million increase from the sameperiod a year ago. Capital expenditures increased by a $125 million, primarilydue to the Hatfield and Fort Martin scrubber projects and TrAIL.

Free cash flow, excluding the capital expenditures for the Fort Martin scrubbers, was a $115million. We expect free cash flow for the year, excluding the capital expendituresfor the Fort Martinscrubbers, to be about zero after the payment of our dividend in December.

As Paul mentioned, Moody's recently joined S&P inupgrading our corporate credit rating to investment grade. Our credit metricscontinue to improve. Our debt-to-EBITDA ratio is now 3.0 and EBITDA is fivetimes interest expense, when excluding securitized debt and interest.

Before we cover the outlook for next year, I would like tobriefly comment on the fourth quarter of this year. We expect fourth quarterresults to reflect many of the same factors that drove our performancethroughout the year. The fourth quarter and full year should be consistent withthe 2007 earnings growth drivers we shared with you on the last call.

Turning now to outlook for 2008. Here is an overview of thekey drivers for 2008, as compared with 2007. I will offer the same caveat thatwe've given in the past. This list is not complete, there will, undoubtedly, besome impacts, both positive and negative, that we haven't addressed here, but Ithink it's useful framework for thinking about the coming year.

First, improved super critical plant availability should addabout $70 million to 2008 earnings, based on achieving our 2008 goal of 91%. Weexpect availability in 2007 to average about 84%. So our goal for next yearrepresents an improvement of 7 percentage points.

We expect a $10 million benefit for each percentage pointimprovement in availability. Increasing rates in Pennsylvaniashould add $40 million. This reflects our scheduled 8% increase in generationrates, offset by the negative impact of a Pennsylvaniastranded cost recovery surcharge, which expires in June of 2008.

Transmission expansion projects, including the TrAILproject, other PJM-directed projects, and, to a lesser extent, PATH, areexpected to help income by about $20 million in 2008. The exact level ofbenefit will depend on the return on equity allowed by the FERC, and the 2008capital spending levels, which depend on the timing of state approvals.

Higher RPM capacity prices should result in a $20 millionbenefit. We expect to have about 1100 megawatts of excess capacity in 2008.

Interest expense, excluding the effects of securitizationand transmission debt, both of which have offsetting revenues, should be lowerby $20 million. We have executed marketing contracts and hedges on about 5million megawatt hours of generation, that will result in a market pricebenefit of about $20 million in 2008.

We do not forecast market price benefits for unhedged generation,but I will provide you with some information to make it easier for you todevelop your own forecast. At this point, we have about 5 million megawatthours of unhedged generation in 2008, so each dollar change in price versus2007 would impact us by about $5 million.

As a reference point, 2008 Western hub forward prices arecurrently averaging $63 per megawatt hour, which is $4 higher than theequivalent 2007 prices, including the effects of 2007 marketing contracts andhedges.

We are choosing not to include any impacts from the Virginiarate case scheduled for hearing in December. As Paul mentioned, we haverequested recovery of $45 million of additional purchase power expense.

We will continue to focus on controlling O&M costs. Weexpect O&M to increase by about $20 million, due to planned reliabilityimprovements in our utility businesses. This estimate excludes O&M relatedto our transmission expansion projects, and other customer programs, that willbe recovered in revenues through formula rates.

We expect emission allowance expense at Allegheny Energy Supplyto increase by about $30 million, and higher coal prices to impact supply by$40 million. Allowance in coal expenses associated with our regulated West Virginia generation are included in the fuel clause,and therefore, should not impact earnings.

Other factors, such as weather and customer growth, willundoubtedly affect our results in 2008, but, as in the past, we haven'tattempted to quantify these impacts.

And with that, let me turn it back to the operator forquestions.

Question-and-AnswerSession

Operator

(Operator Instructions) We'll pause for just a moment tocompile the Q&A roster. Your first question comes from the line of DanEggers with Credit Suisse.

Dan Eggers - CreditSuisse

Good morning.

Paul Evanson

Hey, good morning, Dan.

Phil Goulding

Good morning, Dan.

Dan Eggers - CreditSuisse

A first question. Now, you guys have filed the Pennsylvaniaprocurement plan.Ccan you just give us the timeline of the process for approvalson the plan, and maybe a little bit of thoughts behind why you guys rolled itout, now, in the middle of the Pennsylvanialegislative process?

Paul Evanson

Well, we've been working on it for some time, and I think wealways said we'd file it in the fall, and that kind of fit more appropriatelywith how we're going out in terms of the procurement of the power. So, I mean,the legislative session is ongoing, but I think this is really independent ofit.

And, it basically follows the PUC's guidelines that theylaid out in May, so there's nothing extraordinary in it. It's laddered contractdurations, the multiple procurements, different procurement strategies by rateclass, and I would expect it, maybe, in about six months, we would get thefinal decision by the PUC on completing this.

Dan Eggers - CreditSuisse

Okay. And then looking at the delivery earnings for thequarter… kind of the pretty meaningful for year-on-year decline at delivery,from an EPS perspective. Can you just talk a little bit about the fuel costincrease for Virginia and West Virginia; how we should think about that goingforward, and how much of that was picked up by having more generation for youto sell on the generation side of the business?

Paul Evanson

Well, in West Virginia,now we have the fuel clause, so that gets passed through any changes goingforward. So we're covered on that piece. Virginiais a different situation. As you know, we filed for recovery of all of purchasepower cost increases that we would be experiencing when our contract, theoriginal contract, ended with them in June of this year, and the Commissiondenied that. We are appealing that in the State Court, which is now pending.

And we filed a rate request, on kind of a limited basis, forthat excess over 367 megawatts. And we did that, Dan, because in theCommission's opinion, denying the rate increase that we had requested, they hada little suggestion that said, well, you know, if you had come in and asked forpurchase power only on the excess of what you transferred out, we might havegranted it. So, we're seeing if that suggestion will work well with them, nowthat we've actually asked them for that.

And in the third quarter, which was a high -- probably thepeak period, the difference, the purchase power or the loss, really, was about$35 million excess purchase power cost in Virginia. It should run on anannualized basis of probably $90 million-$100 million.

And when they went out on bid to get that, about 11/12ths ofthat is coming from our own supply business. So you might say there's an offsetthere, and 1/12th is coming from a third party, and that's part of the reasonwhy we had an increase in purchase power when Phil went through his analysis.

Dan Eggers - CreditSuisse

Just to clarify on that, Paul, the excess would be coveredover 367 megawatts… how much of that $90 million-$100 million increase wouldget picked up, if that were to go well in Virginia?

Paul Evanson

That's about $45 million, Dan. So, it's about half of it.

Dan Eggers - CreditSuisse

Okay. I'll let somebody else ask questions. Thank you.

Paul Evanson

Okay, thanks, Dan. Next question, operator?

Operator

Your next question comes from the line of Greg Gordon withCiti.

Greg Gordon - Citi

Thanks. Good morning, gentlemen. A couple of questions. One,to just piggyback on the answer to that last question. If you were to getfavorable treatment from Virginiaon the capacity in excess of what was frozen, that $45 million, what's theearliest you would expect a decision on that next year?

Paul Evanson

Well, we've asked for, and we would certainly appreciate,expedited hearing, given the losses we're sustaining in the company. So I'mhopeful that the Commission might decide it by the end of the year, but I'd saythat'd be a best case.

Greg Gordon - Citi

End of this year?

Paul Evanson

End of this year. That would be the best case.

Greg Gordon - Citi

And the worst case?

Paul Evanson

And the worst case is, it kind of drags out; it's hard tosay. There's not a specific time limitation where they need to take action.

So, you never know where we could go, but I'm hopefulbecause of, you know, they know the issue. They've considered itthoroughly--our original request--so I don't think there's much new here that'sgoing to require a lot of work and effort on their part.

Greg Gordon - Citi

Okay. Great. Second question, and I apologize if you coveredit at the beginning, because I missed the first couple minutes of the call. Iskimmed through your filing, it looks like you're asking for the approval to gointo a series of laddered auctions, beginning in June of '08, to cover yourpost 2011 power needs. Is that correct?

Paul Evanson

Yes, exactly.

Greg Gordon - Citi

And Phil, can you give us an update similar to what you didon the last quarter's call--what the sort of realized revenue per megawatt hourwould be to Allegheny, if you sort of simulated an auction today, similar towhat you did in terms of an apples-to-apples comparison to PPL on the lastquarter?

Phil Goulding

Well, I'll do the same analogy, versus predict our own. PPLdid release some additional auction results recently. Results were in the rangeof a $105 per megawatt hour. Those prices do reflect gross receipts tax andline losses.

So, backing that back to the generator by removing the grossreceipts, tax and line losses--which is about a 13% adjustment--gets you to $91per megawatt hour. But that's at the PPL zone, so you also have to adjust thatdown for any locational differences between PPL and Allegheny, and that's about$10. So that would get you to $81, or so, per megawatt hour, using thatanalogy.

Greg Gordon - Citi

Great.

Phil Goulding

Of course, there's all kinds of uncertainties in that,including what the locational difference would be, what the capacity marketsmight be in 2011, but notionally that's…

Greg Gordon - Citi

That's just a snapshot in time.

Phil Goulding

Exactly. With a lot of assumptions. And, of course, that'swell above the $52.50 that our rates are set at, in 2010.

Greg Gordon - Citi

But we would start to get some visibility on that withactual contract bids in June of next year, if your proposal is accepted by thePennsylvania Commission?

Phil Goulding

Correct.

Paul Evanson

Exactly.

Greg Gordon - Citi

And that could be positively affected, also, by if yourtransmission lines get built and come in on time, I would presume, in terms oflevelizing some of that basis differential?

Phil Goulding

I wouldn't want to speculate too much on that.

Greg Gordon - Citi

Okay. And can you talk a little bit about the specifics ofthe problems you had with forced outages in the quarter? This is my lastquestion.

Paul Evanson

Yes, most of the problem really happened in June-Julyperiod, Greg, and I think I mentioned a little bit of that in the last call,. But,we had some typical issues, like boiler tube leaks--but we had a few atypicalthings, for example, at Fort Martin.We had problems with our air conditioning system for the control equipment thatforced a shutdown in both units at that station.

The Pleasant station--Pleasants 1--had a little vibration inthe bearings of the turbines, that we had to take them off for that. That'sbeen somewhat of a recurring problem, and we have the extended outage going onnow at Pleasants 1, and Siemens is working diligently on that issue. So,hopefully, we'll get that behind us.

So the quarter, as a whole, was not terribly good. But as Isaid in the formal comments, from that period on through today, we've beendoing pretty well. So I'm pleased with where we're at, and where we're headed.

Greg Gordon - Citi

Thank you.

Operator

Thank you. Your next question comes from the line of RezaHatefi with Polygon Investments.

Reza Hatefi - PolygonInvestments

Thank you. I kind of missed some of the details, Phil, whenyou were going through some of the earnings drivers for 2008. You mentioned Pennsylvania$40 million…something was offsetting that. Can you repeat the details on that?

Phil Goulding

Sure. I'll provide a little clarification. Two things arehappening to our Pennsylvaniarates next year. We've got the 8% generation rate increase associated with thedeal we cut a number of years ago, and have talked about regularly, and areaffecting our '07 growth drivers, also. And we've also got the completion of astranded cost recovery surcharge that went in place 10 years ago, and has beencoming through our results for the last 10 years.

And that surcharge has been resulting in some positiveincome. And the reason for that, is we were unable to impair--when we got thestranded cost recovery--we were unable to impair all of the generation, due toaccounting rules, and so there was a realized gain that we had to take over theperiod of time of revenue collection. We couldn't take the gain prior to therevenues being received.

That is about a half year impact in 2008. So the net of the8% generation rate increase, and the stranded cost recovery benefits, stoppingfrom an income perspective, is a $40 million plus.

Reza Hatefi - PolygonInvestments

So the stranded cost piece was about $20 million, or so, for2008 effect?

Phil Goulding

Yes. It was about $20 million. And, obviously, there will bea 2009 effect, also, as the second half of that rolls off.

Reza Hatefi - PolygonInvestments

Another $20 million. And the plant availability, the $70million…what's the percentage increase in plant availability, again, from '07to '08?

Phil Goulding

We're estimating that at 7%. We think we'll come in at 84%,and we're targeting 91%.

Reza Hatefi - PolygonInvestments

Wow, 7% improvement. And just, finally, the SO2 allowancecost detriment of $30 million. Should we assume--or how much should we assume--goesaway in 2009 or ‘10, once all your scrubbers are online? Hello?

Phil Goulding

Hello. Did you hear us?

Reza Hatefi - PolygonInvestments

It cut out, I think, for a while after the question.

Phil Goulding

The answer was all of the short position should go away inthe '09-'10 timeframe at Allegheny Energy Supply.

Reza Hatefi - PolygonInvestments

So would that be a pick up of $30 million, or a larger pickup, because this is incremental versus '07?

Phil Goulding

Well, it would be a larger pick up, but you also have torecognize for that to happen, the scrubbers have to get completed at Hatfield,and that will, in turn, result in a new depreciation charge and some additionalinterest expense.

Reza Hatefi - PolygonInvestments

Okay.

Phil Goulding

We'll get to that when we get to nine. I'm still working oneight.

Reza Hatefi - PolygonInvestments

Okay, great. Thank you.

Operator

Thank you. Your next question comes from the line of LasanJohong with RBC Capital Markets.

Lasan Johong - RBCCapital Markets

Good morning. I want to see if I can attack this question oftransmission leveling a little different way. Obviously, Paul, you hadmentioned there were about 14 transmission projects that are being proposed,and PJM--almost all of them, if not all of them--are going through Alleghenyservice territory. That's obviously going to have some impact on capacityprices going forward.

So, a couple of questions. One, what is your expectations,or do you have an update on your expectations, for how many transmissions linemay get built? I think last time you mentioned, maybe, half was possible. And,if we do get to that kind of level, obviously the capacity prices between therest of market and MAAC APS is going to levelize out. Do you have anyexpectations as to where that might settle down?

And then, just quickly, on natural gas--Phil, you hadmentioned your costs went up in natural gas. Is that due to consumption orprice? And if it's due to consumption, is that due to because you're runningthe peakers more, and if so, how much more were you running them?

Paul Evanson

Okay. Well, starting on the transmission, Lasan, I mean therehave been a number of lines that PJM transmission group has been evaluating andthe ones they have approved to-date that I'm aware of is our TrAIL, PATH and Ibelieve Pepco has about a $1 billion or $2 billion project in their territory.The TrAIL, I think I've said in the past, probably opens up about 3800megawatts of capacity and PATH will obviously open up some more.

That gets factored into both the capacity markets and,obviously, into PJM prices--generally,east, western region. We've never really made an estimate as to what theimpact of that would be; people can do some analysis on their own on that. Butwe haven't made it, so we're just focused totally on getting those lines builtto meet that reliability need, which is a paramount reason that they're beingbuilt.

So ,our focus has been on both of those and beyond that, Ireally wouldn't want to say at this point, other than it has an impact.

Lasan Johong - RBCCapital Markets

Fair enough.

Phil Goulding

And on your natural gas question…yes, the natural gas is upabout 150,000-megawatt hours for the quarter. Recognize that that's not a hugeprofitability opportunity. We're certainly not losing on running them, but wereally get paid the spark spread, which isn't that large. So, as an earningsgrowth driver, it's not a very big event, but it does affect revenues and fuelcosts.

Lasan Johong - RBCCapital Markets

How much increase was there in terms of percentage?

Phil Goulding

Well, it's a big percentage increase--67%. But it's a bigpercent increase on a very small number.

Lasan Johong - RBCCapital Markets

Yes. Understood. Great. Thank you very much.

Paul Evanson

Great, thank you.

Operator

Thank you. Your next question comes from the line of SteveFleishman. Mr. Fleishman, your line is open. Please go ahead with yourquestion.

Steve Fleishman

I'm sorry. Can you hear me?

Paul Evanson

Yes.

Steve Fleishman

Hi, Paul.

Paul Evanson

Yeah. Delighted to have you on the call, Steve. It's been along time.

Steve Fleishman

Thank you. I know.

Paul Evanson

Now that you've lost that empire--I would have said evilempire--but I'm sitting next to our general counsel, so I can't clarify now.

Steve Fleishman

Okay. Well, don't put them down when they're down, right?

Paul Evanson

Agreed.

Steve Fleishman

Paul, could you just give us some context. I know some ofthe proposals in Pennsylvaniahave different things on future procurement plans, some of the legislativeproposals do. How is your plan kind of in the context of what some theseproposals are saying?

Paul Evanson

Well, there's a whole variety of Bills and legislationthat's being proposed in Pennsylvaniaby a whole number of people. We still haven't seen the formal proposal from theGovernor. I mean, the Republicans do have a proposal out there.

I would say when it comes to procuring power in the process,there's not major changes in most of those legislations. So I think ours kindof just follows almost exactly what we did in Maryland, and what Maryland approved,and what the Pennsylvania PUC has suggested and recommended back in May, andwhat PPL has been doing. So, I think we're right in the mainstream, and it maychange with legislation, but I don't think that part of it's going to changedramatically, Steve.

Steve Fleishman

Yeah. Okay. One other question. When PJM, in this nextauction, breaks out the Allegheny zone out of MAAC APS, are the supply demanddynamics materially different for the Allegheny zone, versus kind of looking atall MAAC APS?

Phil Goulding

I would say, Steve, that they are materially different; thatthe Allegheny zone is much more comparable to the rest of the, and so thebreakout will reduce in less tight reserve margins for our capacity.

Steve Fleishman

Okay. Thank you.

Paul Evanson

Okay. Nice having you back with us, Steve.

Steve Fleishman

Thanks, Paul.

Operator

Thank you. Your next question comes from the line of BrianRusso with Ladenburg.

Brian Russo -Ladenburg

Good morning.

Paul Evanson

Good morning.

Phil Goulding

Good morning.

Brian Russo -Ladenburg

Could you maybe quantify a favorable resolution on theMerrill Lynch litigation, and maybe a timeline of events that might unfold?

Paul Evanson

Well, the Appellate Court sent it back to the DistrictCourt, remanded it to the District Court. The District Court is really in theprocess of deciding how to proceed from here--whether they need an entirely newtrial, whether they can base it, in large part or totally, on the trial thattook place earlier. So, that's somewhat-- it's still open, at this point.

So, depending on how it goes, it could move quickly, or at amuch slower pace. And basically, we're back--I wouldn't say to ground zero, butpretty close, in terms of the issues here. The Appellate Court said--the keything was the Appellate Court set a different legal standard and measure forthe District Court to apply. So that's going to be the key issue.

Brian Russo -Ladenburg

Okay. I'm sorry.

Paul Evanson

Go right ahead.

Brian Russo -Ladenburg

Okay. And then just on O&M expense. If you back out thatconsulting fee, it looks like quarter-over-quarter the O&M is flat. I'mjust wondering if you could, maybe, comment on initiatives that may have offsetany escalating costs on the forced outages, and so forth?

Phil Goulding

Well, special maintenance across the quarter is reasonablyflat. So the way we're maintaining flat is primarily through vigilant costcontrol.

Brian Russo -Ladenburg

Okay. Thank you.

Paul Evanson

Okay.

Operator

Thank you. Your next question comes from the line of AsharKhan with SAC Capital.

Ashar Khan - SACCapital

Good morning.

Paul Evanson

Good morning.

Ashar Khan - SACCapital

Phil, can you just take us through the math; how 1% increasein availability leads to $10 million?

Phil Goulding

I could do that. I'd rather not do that on the call. It'sabout 10 steps of math.

Ashar Khan - SACCapital

Okay.

Phil Goulding

But I'd be happy to do that, if you want to set up a littletime on that.

Ashar Khan - SACCapital

Because I was trying to figure out, I mean, that delta wasgiven two or three years ago, and prices have gone up substantially, and I'mtrying to understand how 1% still remains $10 million. In my view it should behigher. But I'm trying to understand whether some costs came in, or somethingwhich offset it?

Phil Goulding

Well, a few things to think about. First of all, $10 million--justwhat we're using to estimate. I'm not saying it's the precise, exact number. Secondof all, it's based on '07 prices. That $70 million estimate is based on '07prices, because we're picking up the benefit of prices in our market price lineas we go forward.

I guess, third, is for it to come through income, it has tobe at Allegheny Energy Supply now, because any improvements in availabilitywill go through the fuel clause in our West Virginiageneration.

Ashar Khan - SACCapital

Okay.

Phil Goulding

So, if you take all those factors into account, you get to anumber that's 10 to something, but $10 million is a reasonable estimate.

Ashar Khan - SACCapital

Okay. And then could you just mention to us the $20 millionin transmission increase; what kind of CapEx is that associated with? So if CapEx comes out more or the same, we can kind of monitor what the earnings levelshould be on the transmission side?

Phil Goulding

We did that estimate based on the CapEx that's in the K.

Ashar Khan - SACCapital

So it's the same Cap Ex in the K.

Phil Goulding

In the K. And we also use our as-filed ROE.

Ashar Khan - SACCapital

Okay. Thank you very much.

Phil Goulding

Okay.

Operator

Thank you. (Operator Instructions) Please hold for your nextquestion. Your next question comes from the line of Daniele Seitz with DahlmanRose.

Daniele Seitz -Dahlman Rose

Thank you. Most of my questions have been answered. But Iwas wondering, is there any uncertainty as to the timing of all of theauthorizations for the transmission lines, in terms of right-of-ways and, Imean, technical type of potential delays?

Paul Evanson

I'd say we're going through that formal process, and it'spretty well laid out. The last public hearings in the three states are beingheld now in West Virginia, and then the formal evidentiary hearing, which isthe key thing that really goes to the PSC, begins in January, in Pennsylvania,February in Virginia, and February in West Virginia.

Daniele Seitz -Dahlman Rose

So you don't anticipate any snags of several months, andalso, what do you expect of the milestones for the first line, for example?

Paul Evanson

Well, you never know on these; this is a major project. It's250 miles through three states, and there is, as you'd expect, more than thenormal opposition to it. People who hate transmission don't want the linesbuilt near them. And, of course, you get federal, state issues, and eminentdomain, cost allocations rules, environmental. We've had a lawsuit that's beenfiled in Pennsylvania by peoplethat have given easements in the past. We're expecting to stay on that schedule,but there are no guarantees on this.

Daniele Seitz -Dahlman Rose

And when most of these issues should be cleared, and thenyou are going to the construction phase?

Paul Evanson

Well, we're doing sighting already, but what we would liketo do is get all the approvals by summer of '08. That's really the target thatwe've always had and we've been working toward, but it kind of ebbs and flows. Butsummer of '08 is when we hope to get all the certificates from all of the threestates so that physical construction can begin.

Daniele Seitz -Dahlman Rose

Okay. So you would hope for the construction to start insummer of '08?

Paul Evanson

Right. Although, as I say, we're doing a lot of the sightingwork already, and spending some money that way, and trying to line up materialcontracts etcetera, already.

Daniele Seitz -Dahlman Rose

Great. Thanks.

Paul Evanson

Thank you, Daniele.

Operator

Thank you. (Operator Instructions) At this time, there areno further questions. Will there be any closing remarks?

Paul Evanson

Well, just thank, everyone, for joining us on the call. AndPhil and I and MAAC certainly look forward to seeing everyone at EEI coming upand spend some real quality time with you all. Thank you.

Operator

Thank you for participating in today's third quarterearnings conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Allegheny Energy Q3 2007 Earnings Call Transcript
This Transcript
All Transcripts