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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 your conference operator today. At this time, I would like to welcome everyone to the Allegheny Third Quarter Earnings Call.

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

Mr. Kuniansky, you may begin your conference.

Max Kuniansky

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

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

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

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

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

Paul Evanson

Good morning, everyone, and thanks for joining us. I am pleased to report that Allegheny had strong earnings growth in the third quarter. Earnings were $0.67 per share, up from the $0.56 of adjusted earnings reported 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 major contributors to earnings. Availability at our super critical power plants was 87% during the third quarter, versus 89% in last year's quarter.

As I mentioned on the last analyst call in July, we experienced a number of unplanned outages at the end of June that continued into the first half of July. Since then, and through today, the plants have been operating at expected levels.

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

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

A second objective is the expansion of our transmission system to improve reliability throughout PJM. The approval process for the 500-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. Evidentiary hearings are scheduled in Pennsylvania, Virginia, and West Virginia during the first quarter of 2008, and we anticipate final Commission decisions by mid-year.

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

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

Turning, now, to key regulatory issues. In September, we filed for a modified rate increase in Virginia. In the request, we are asking for recovery of purchase power costs to supply the portion of our Virginia load in excess of the 367 megawatts that we had transferred out of rate base in 2000. 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 energy issues. Allegheny supports Governor Rendell's efforts to address critical energy issues for the state. And we welcome the opportunity to work with the Governor, the General Assembly, the Public Utility Commission, and other interested parties, to develop effective energy policies including the transition to market-based rates.

More generally, energy conservation and efficiency programs have risen to the forefront of the utility industry in recent months. Allegheny has embraced this movement through a series of initiatives that we call, Watt Watchers.

We kicked this program off in Maryland with a distribution of compact fluorescent light bulbs to our 220,000 customers there. You will be seeing many other programs implemented throughout our service territory 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 for reconsideration. A very positive development.

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

Allegheny has about 2,400 megawatts of capacity in excess of our obligation for that fiscal year, 1500 megawatts in the MACC+AP zone, and 900 in the rest of the market. The next auction will take place in January, for the 2010-11 fiscal year. While our excess capacity will be significantly higher in that period, that capacity will no longer be groups in the MAAC zone, but will be in several zones--principally in the APS zone.

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

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

Professionally, I can't say enough about Joe's capabilities and leadership. He joined us in August '03, as President of Allegheny Power and in 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 by his family and all of us who worked with him. Until we fill his position, I will be overseeing the operations of the generation business.

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

Finally, I look forward to seeing many of you at the EEI Conference in Orlando, in a week or so.

Now, let me turn the call over to Phil.

Phil Goulding

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

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

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

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

Higher generation rates in Pennsylvania contributed $0.05 to EPS. Our Pennsylvania generation rates increased 8% on January 1st of this year. This was the second in 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. Load growth 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. The expiration of the Maryland customer choice credit in early 2007 further contributed to the T&D revenue increase.

Higher coal prices reduced EPS by $0.05. Our fully delivered coal 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 our 2007 earnings drivers.

Decreased generation output reduced earnings by $0.04 per share. As Paul mentioned, output was impacted by higher forced outage rates at our coal-fired stations.

Higher O&M reduced EPS by $0.02 per share. Reduced interest 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 per share by $0.02. In total, earnings per share increased $0.11.

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

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

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

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

The Fort Martin scrubbers securitization surcharge added $6 million in revenues. Decreased plant output reduced revenues by $8 million, and all other factors increased quarterly 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 consumption were offset by lower generation output. Other fuel items include a coal inventory adjustment, and increased emission allowance costs.

Purchase power costs decreased by $8 million in the third quarter of 2007, due primarily to the expiration of the AEP agreement. These decreases were partially offset by higher Virginia purchase power costs.

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

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

Other income increased $7 million, primarily due to a gain on 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 the discontinuing 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 in securitized interest costs, which were recovered in rates. Our average debt balance, excluded securitized debt, was $3.3 billion, down $236 million from the same period last year. The net result of all of these items was a $31 million improvement in pretax income.

Our tax rate was about 37% this quarter. Our tax rate will fluctuate somewhat, period-to-period. However, we still expect the tax rate for the 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 same period a year ago. Capital expenditures increased by a $125 million, primarily due to the Hatfield and Fort Martin scrubber projects and TrAIL.

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

As Paul mentioned, Moody's recently joined S&P in upgrading our corporate credit rating to investment grade. Our credit metrics continue to improve. Our debt-to-EBITDA ratio is now 3.0 and EBITDA is five times interest expense, when excluding securitized debt and interest.

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

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

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

We expect a $10 million benefit for each percentage point improvement in availability. Increasing rates in Pennsylvania should add $40 million. This reflects our scheduled 8% increase in generation rates, offset by the negative impact of a Pennsylvania stranded cost recovery surcharge, which expires in June of 2008.

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

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

Interest expense, excluding the effects of securitization and transmission debt, both of which have offsetting revenues, should be lower by $20 million. We have executed marketing contracts and hedges on about 5 million megawatt hours of generation, that will result in a market price benefit 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 to develop your own forecast. At this point, we have about 5 million megawatt hours of unhedged generation in 2008, so each dollar change in price versus 2007 would impact us by about $5 million.

As a reference point, 2008 Western hub forward prices are currently averaging $63 per megawatt hour, which is $4 higher than the equivalent 2007 prices, including the effects of 2007 marketing contracts and hedges.

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

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

We expect emission allowance expense at Allegheny Energy Supply to 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, will undoubtedly affect our results in 2008, but, as in the past, we haven't attempted to quantify these impacts.

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

Question-and-Answer Session

Operator

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

Dan Eggers - Credit Suisse

Good morning.

Paul Evanson

Hey, good morning, Dan.

Phil Goulding

Good morning, Dan.

Dan Eggers - Credit Suisse

A first question. Now, you guys have filed the Pennsylvania procurement plan.Ccan you just give us the timeline of the process for approvals on the plan, and maybe a little bit of thoughts behind why you guys rolled it out, now, in the middle of the Pennsylvania legislative process?

Paul Evanson

Well, we've been working on it for some time, and I think we always said we'd file it in the fall, and that kind of fit more appropriately with 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 of it.

And, it basically follows the PUC's guidelines that they laid out in May, so there's nothing extraordinary in it. It's laddered contract durations, the multiple procurements, different procurement strategies by rate class, and I would expect it, maybe, in about six months, we would get the final decision by the PUC on completing this.

Dan Eggers - Credit Suisse

Okay. And then looking at the delivery earnings for the quarter… 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 cost increase for Virginia and West Virginia; how we should think about that going forward, and how much of that was picked up by having more generation for you to 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 going forward. So we're covered on that piece. Virginia is a different situation. As you know, we filed for recovery of all of purchase power cost increases that we would be experiencing when our contract, the original contract, ended with them in June of this year, and the Commission denied 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, for that excess over 367 megawatts. And we did that, Dan, because in the Commission's opinion, denying the rate increase that we had requested, they had a little suggestion that said, well, you know, if you had come in and asked for purchase power only on the excess of what you transferred out, we might have granted it. So, we're seeing if that suggestion will work well with them, now that we've actually asked them for that.

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

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

Dan Eggers - Credit Suisse

Just to clarify on that, Paul, the excess would be covered over 367 megawatts… how much of that $90 million-$100 million increase would get 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 - Credit Suisse

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 with Citi.

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 get favorable treatment from Virginia on the capacity in excess of what was frozen, that $45 million, what's the earliest 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'm hopeful that the Commission might decide it by the end of the year, but I'd say that'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 to say. There's not a specific time limitation where they need to take action.

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

Greg Gordon - Citi

Okay. Great. Second question, and I apologize if you covered it at the beginning, because I missed the first couple minutes of the call. I skimmed through your filing, it looks like you're asking for the approval to go into a series of laddered auctions, beginning in June of '08, to cover your post 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 did on the last quarter's call--what the sort of realized revenue per megawatt hour would be to Allegheny, if you sort of simulated an auction today, similar to what you did in terms of an apples-to-apples comparison to PPL on the last quarter?

Phil Goulding

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

So, backing that back to the generator by removing the gross receipts, tax and line losses--which is about a 13% adjustment--gets you to $91 per megawatt hour. But that's at the PPL zone, so you also have to adjust that down 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 that analogy.

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 markets might 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's well 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 with actual contract bids in June of next year, if your proposal is accepted by the Pennsylvania Commission?

Phil Goulding

Correct.

Paul Evanson

Exactly.

Greg Gordon - Citi

And that could be positively affected, also, by if your transmission lines get built and come in on time, I would presume, in terms of levelizing 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 of the problems you had with forced outages in the quarter? This is my last question.

Paul Evanson

Yes, most of the problem really happened in June-July period, 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 atypical things, for example, at Fort Martin. We had problems with our air conditioning system for the control equipment that forced a shutdown in both units at that station.

The Pleasant station--Pleasants 1--had a little vibration in the bearings of the turbines, that we had to take them off for that. That's been somewhat of a recurring problem, and we have the extended outage going on now 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 I said in the formal comments, from that period on through today, we've been doing 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 Reza Hatefi with Polygon Investments.

Reza Hatefi - Polygon Investments

Thank you. I kind of missed some of the details, Phil, when you 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 are happening to our Pennsylvania rates next year. We've got the 8% generation rate increase associated with the deal we cut a number of years ago, and have talked about regularly, and are affecting our '07 growth drivers, also. And we've also got the completion of a stranded cost recovery surcharge that went in place 10 years ago, and has been coming through our results for the last 10 years.

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

That is about a half year impact in 2008. So the net of the 8% generation rate increase, and the stranded cost recovery benefits, stopping from an income perspective, is a $40 million plus.

Reza Hatefi - Polygon Investments

So the stranded cost piece was about $20 million, or so, for 2008 effect?

Phil Goulding

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

Reza Hatefi - Polygon Investments

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

Phil Goulding

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

Reza Hatefi - Polygon Investments

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

Phil Goulding

Hello. Did you hear us?

Reza Hatefi - Polygon Investments

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

Phil Goulding

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

Reza Hatefi - Polygon Investments

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

Phil Goulding

Well, it would be a larger pick up, but you also have to recognize 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 additional interest expense.

Reza Hatefi - Polygon Investments

Okay.

Phil Goulding

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

Reza Hatefi - Polygon Investments

Okay, great. Thank you.

Operator

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

Lasan Johong - RBC Capital Markets

Good morning. I want to see if I can attack this question of transmission leveling a little different way. Obviously, Paul, you had mentioned there were about 14 transmission projects that are being proposed, and PJM--almost all of them, if not all of them--are going through Allegheny service territory. That's obviously going to have some impact on capacity prices 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 line may 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 the rest of market and MAAC APS is going to levelize out. Do you have any expectations as to where that might settle down?

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

Paul Evanson

Okay. Well, starting on the transmission, Lasan, I mean there have been a number of lines that PJM transmission group has been evaluating and the ones they have approved to-date that I'm aware of is our TrAIL, PATH and I believe 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 3800 megawatts 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 the impact of that would be; people can do some analysis on their own on that. But we haven't made it, so we're just focused totally on getting those lines built to meet that reliability need, which is a paramount reason that they're being built.

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

Lasan Johong - RBC Capital Markets

Fair enough.

Phil Goulding

And on your natural gas question…yes, the natural gas is up about 150,000-megawatt hours for the quarter. Recognize that that's not a huge profitability opportunity. We're certainly not losing on running them, but we really get paid the spark spread, which isn't that large. So, as an earnings growth driver, it's not a very big event, but it does affect revenues and fuel costs.

Lasan Johong - RBC Capital Markets

How much increase was there in terms of percentage?

Phil Goulding

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

Lasan Johong - RBC Capital Markets

Yes. Understood. Great. Thank you very much.

Paul Evanson

Great, thank you.

Operator

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

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 a long time.

Steve Fleishman

Thank you. I know.

Paul Evanson

Now that you've lost that empire--I would have said evil empire--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 of the proposals in Pennsylvania have different things on future procurement plans, some of the legislative proposals do. How is your plan kind of in the context of what some these proposals are saying?

Paul Evanson

Well, there's a whole variety of Bills and legislation that's being proposed in Pennsylvania by a whole number of people. We still haven't seen the formal proposal from the Governor. 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 kind of 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, and what PPL has been doing. So, I think we're right in the mainstream, and it may change with legislation, but I don't think that part of it's going to change dramatically, Steve.

Steve Fleishman

Yeah. Okay. One other question. When PJM, in this next auction, breaks out the Allegheny zone out of MAAC APS, are the supply demand dynamics materially different for the Allegheny zone, versus kind of looking at all MAAC APS?

Phil Goulding

I would say, Steve, that they are materially different; that the Allegheny zone is much more comparable to the rest of the, and so the breakout 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 Brian Russo 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 the Merrill Lynch litigation, and maybe a timeline of events that might unfold?

Paul Evanson

Well, the Appellate Court sent it back to the District Court, remanded it to the District Court. The District Court is really in the process of deciding how to proceed from here--whether they need an entirely new trial, whether they can base it, in large part or totally, on the trial that took 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 a much slower pace. And basically, we're back--I wouldn't say to ground zero, but pretty close, in terms of the issues here. The Appellate Court said--the key thing was the Appellate Court set a different legal standard and measure for the 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 that consulting fee, it looks like quarter-over-quarter the O&M is flat. I'm just wondering if you could, maybe, comment on initiatives that may have offset any escalating costs on the forced outages, and so forth?

Phil Goulding

Well, special maintenance across the quarter is reasonably flat. So the way we're maintaining flat is primarily through vigilant cost control.

Brian Russo - Ladenburg

Okay. Thank you.

Paul Evanson

Okay.

Operator

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

Ashar Khan - SAC Capital

Good morning.

Paul Evanson

Good morning.

Ashar Khan - SAC Capital

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

Phil Goulding

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

Ashar Khan - SAC Capital

Okay.

Phil Goulding

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

Ashar Khan - SAC Capital

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

Phil Goulding

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

I guess, third, is for it to come through income, it has to be at Allegheny Energy Supply now, because any improvements in availability will go through the fuel clause in our West Virginia generation.

Ashar Khan - SAC Capital

Okay.

Phil Goulding

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

Ashar Khan - SAC Capital

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

Phil Goulding

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

Ashar Khan - SAC Capital

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 - SAC Capital

Okay. Thank you very much.

Phil Goulding

Okay.

Operator

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

Daniele Seitz - Dahlman Rose

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

Paul Evanson

I'd say we're going through that formal process, and it's pretty well laid out. The last public hearings in the three states are being held now in West Virginia, and then the formal evidentiary hearing, which is the 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, and also, 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's 250 miles through three states, and there is, as you'd expect, more than the normal opposition to it. People who hate transmission don't want the lines built near them. And, of course, you get federal, state issues, and eminent domain, cost allocations rules, environmental. We've had a lawsuit that's been filed in Pennsylvania by people that 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 then you are going to the construction phase?

Paul Evanson

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

Daniele Seitz - Dahlman Rose

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

Paul Evanson

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

Daniele Seitz - Dahlman Rose

Great. Thanks.

Paul Evanson

Thank you, Daniele.

Operator

Thank you. (Operator Instructions) At this time, there are no further questions. Will there be any closing remarks?

Paul Evanson

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

Operator

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

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Source: Allegheny Energy Q3 2007 Earnings Call Transcript
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