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

Exelon Corp. (EXC)

Q3 2007 Earnings Call

October 26, 2007, 11:00 AM ET

Executives

Chaka Patterson - VP, IR

John F. Young - EVP, Finance and Markets, and CFO

John W. Rowe - Chairman President and CEO

Christopher M. Crane - EVP and COO

Ian P. McLean - President, Exelon Power Team; EVP, Exelon Corporation

Analysts

John Kiani - Deutsche Bank

Paul Ridzon - Keybanc

Hugh Wynne - Sanford Bernstein

Jonathan Arnold - Merrill Lynch

Rudy Tolentino - Morgan Stanley

Paul Paterson - Glenrock Associates

Paul Fremont - Jefferies & Co

Nathan Judge - Atlantic Equities

Presentation

Operator

Good morning. My name is Jennifer, and I'll be you conference operator today. At this time I like to welcome everyone to the Exelon Third Quarter 2007 Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. [Operator Instructions]. Thank you.

It is now my pleasure to turn the floor over to your host, Chaka Patterson, Vice President of Investor Relations. Ma'am, you may begin your conference.

Chaka Patterson - Vice President, Investor Relations

Thank you, it's sir but that's okay. Good morning, and welcome to Exelon third quarter 2007 earnings review and conference call update. Thank you for joining us today. We issued our earnings release this morning. The release also contains a slide presentation that will accompany John Young's remarks. The slides can be found at the end of the earnings release package. If you haven't receive it, the release is available on the Exelon website, at www.exeloncorp.com, or you can all Dolaras Modia [ph] at 312-394-5222, and she will fax or email the release to you.

This call is being recorded and will be available through November 9th by dialing 877-519-4471. International call in number is 973-341-3080. The confirmation code is 9302966. In addition, the call will be archived on the Exelon website. Before we begin today's discussion, let me remind you that the earnings release and other matters we discuss in today's call contains forward-looking statements and estimates that are subject to various risks and uncertainties.

Please refer to our SEC filings for discussions of factors that may cause results to differ from management's projections, forecast and expectations. In our press release and during this call, we will discuss adjusted non-GAAP operating earnings that exclude the earnings impact of mark-to-market adjustments from economic hedging activities. Significant impairments of intangible assets, including goodwill, significant changes in decommissioning obligation estimates, investments in synthetic fuel producing facilities, cost associated with the Illinois Electric Rate settlement including ComEd's previously announced customer rate relief, certain costs associated with the terminated merger with PSEG for 2006 only, severance charges for 2006 only, gain or losses on the State Line and Tenaska transactions, and other unusual items including significant future changes to GAAP.

We believe these adjusted operating earnings are representative of the underlying operational results of the company. In today's earnings release, we provided a reconciliation between reported GAAP earnings and adjusted non-GAAP operating earnings.

With me today are John Rowe, Exelon's Chairman, President, and CEO; John Young, Exelon's Executive Vice President, Finance and Markets and Chief Financial Officer; other member of Exelon Senior Management Team; members of the Generation Company's Senior Management Team; ComEd's Senior Management Team; and PECO Senior Management Team: who will be available to answer your question.

Because we will see many of you at Edison Electric Institute Financial Conference, the first week in November, today's call will focus primarily on third quarter 2007 financial and operational results. At EEI we will expand on our outlook for the remainder of 2007, discuss operational and financial drivers for 2008 and the next five years and provide a more detailed view of the key issues facing the Company.

We have scheduled an hour for this call, we will spend about 30 minutes on prepared remarks and use the remaining time for Q&A. In order to effectively manage this call, we would appreciate if you would limit yourself to only one question.

I will now turn the call over to John Young who will discuss our financial results for the quarter.

John F. Young - Executive Vice President, Finance and Markets, and Chief Financial Officer

Thank you, Chaka. Good morning, everyone. As part of our earnings release package, we include slides that I will refer to during my remarks. These slides highlight, both, the earnings for the quarter and year-to-date. My remarks, as they usually do, will focus on the quarter and our outlook for the balance of the year.

Beginning with slide 3, Exelon announced third quarter 2007 adjusted non-GAAP operating earnings of $823 million or $1.21 per diluted share, an increase from third quarter 2006 operating earnings of $690 million or $1.02 per diluted share. On a GAAP basis, Exelon reported consolidated earnings of $780 million or $1.15 per share for the third quarter of 2007. One of the main differences between GAAP and non-GAAP operating earnings during the quarter was the $0.12 charge related to the cost associated with the Illinois settlement.

As I mentioned on the second quarter call, we believe these costs reflect a one-time event associated with Illinois' transition to a competitive market, and we plan to exclude these cost for future operating earning. These costs would be expensed as credits are issued to customers over time.

For a complete reconciliation of GAAP and non-GAAP earnings, please refer to the tables that accompanied the earnings release.

Consistent with the first half of the year, Exelon strong performance for the third quarter was driven primarily by increased earnings in Exelon Generation which were partially offset by the extent of decrease in ComEd's earnings. PECO's earnings during the quarter were also up compared to the last year.

Turning the slide 4, Exelon Generation contributed $0.90 of operating earning per diluted Exelon share in the third quarter of 2007 compared to $0.51 for the same period in 2006. The major driver of Generation operating earnings growth during the quarter was higher wholesale margins as a result of tree items: the end of the below market PPA with ComEd, a contractual price increase associated with the PECO PPA, and favorable portfolio and market conditions, including higher realized market prices and capacity revenues.

As I indicated in the second quarter earnings call, the benefit associated with capacity revenues were partially offset by the negative impact of marginal loss pricing by PJM. We estimate that marginal loss pricing add about $10 million to $15 million pretax impact per month on Generation revenues. This is about a $0.01 to $0.015 per share each month. I'll remind you that marginal loss pricing was implemented by PJM on June 1, 2007; therefore, Generation was not impacted by marginal losses during the first five months of the year.

During the third quarter Generation also benefited from one less nuclear refueling outage compared to the same period last year. This positive impact can be seen, both, in higher margins, as a result of higher nuclear volumes, and in lower outage cost during the quarter. These benefits were partially offset by lower hydro generation due to the limited rainfall in Mid-Atlantic... The affects of labor-related inflation and nuclear plant development cost associated with our construction and operating license application in Texas.

While it did not yet impact third quarter earnings, I will spend a movement on the termination of the State Line purchase power agreement that we announced last week. Under the terms of the PPA, Exelon Generation purchased the output from State Line, a 515 megawatt coal-fired facility located near Hammond, Indiana through 2012. Upon close of the termination agreement, Exelon Generation will receive $233 million in cash and will no longer receive the output associated with State Line, which is roughly 3 million to 3.5 million megawatt hours a year, depending on operational performance.

The PPA is a non-strategic asset in Generation's portfolio and termination will provide us with immediate cash flow. We expect to record an after-tax gain of around $130 million during the fourth quarter of this year. This gain will be excluded from our operating earnings. Although, we have not provided earnings guidance beyond 2007, we expect a negative after-tax earnings impact of about $30 million to $35 million beginning in 2008 extending through the end of the original contract term of 2012. That's roughly $0.05 per year.

Turning now to ComEd on slide 5; in the third quarter of 2007, ComEd contributed $0.10 per Exelon share compared to $0.33 during the same period of 2006. ComEd's decrease in earnings was expected and was due primarily to the impact of the end of the regulatory transition period in Illinois. The company also experienced higher storm costs during the quarter, as a result of devastating thunderstorms that hit the ComEd service territory late in August. These storms were some of the worst on record for the company. John Rowe will talk more about ComEd's response and restoration efforts in a moment.

On the positive side, ComEd benefited from warmer weather during quarter, an increase revenues associated with ComEd's delivery service rate case that was concluded in December of '06 and an increase in revenues associated with the Company's 2007 transmission rate case.

Weather, during the third quarter of 2007, was $0.01 favorable to ComEd's earnings compared to the third quarter of 2006 but about $0.02 favorable to normal level.

On slide 6 and 7, we provide a summary of ComEd's transmission case settlement agreement that was filed with FERC earlier this month. FERC's approval of a formula-based transmission rate would establish a reasonable framework for timely recovery of transmission investment on an annual basis, in the step one of ComEd's regulatory recovery plan.

And second, and even more important, step of this plan is ComEd's recent distribution rate filing with the older recoveries commission. In this rate filing, ComEd requested an increase of $361 million in its annual revenue requirement to allow for continued expansion upgrades to its distribution system to meet the growing demand for electricity in the ComEd service territory.

Additional details on ComEd's distribution rate filing and tentative schedule are provided on slide 8 and 9. ComEd's ability to deliver reliable service is dependent on being able to recover its cost through fair and reasonable rating. ComEd's 2007 earned return on equity is projected to be between 3.5% and 4.5%, which is substantially below the allowed ROE by the ITC, or ComEd's distribution business and the FERC... or ComEd's transmission business.

Primary reason for the difference in the earned versus allowed return is regulatory lag or the availability to recover current year costs. ComEd's operating costs and rate base have increased substantially over 2004 cost which was the test year for... and pro forma capital adjustments through 2005 that was used in the last rate case.

ComEd's current rate case before the ITC is based on the 2006 test year plus planned capital investment through the third quarter of 2008. In addition, ComEd is seeking approval of riders that will allow for faster recovery of certain expenditures. A combination of these should be a step in the right direction towards minimizing regulatory lag and improving ComEd's financial condition.

We will talk more about ComEd's regulatory recovery plan and ETR.

Now turning to PECO on slide no 10, PECO's contribution to operating earnings for the third quarter of 2007 was $0.25 per Exelon share compared to $0.21 during the same period of 2006. During the quarter PECO benefited from slow growth, a reduction in reserves for PURTA property taxes and the absence of storm costs as compared to last year. Recall that numerous storms hit PECO's service territory last summer, including the worst summer storm in PECO's history mid-July... during mid-July of 2006.

At the corporate level, ComEd storm costs for this quarter were more than offset by the absence of the 2006 PECO storm costs. Impact of PECO's favorable earnings drivers was offset primarily by scheduled increase in PECO's CTC amortization and the absence of a 2006 favorable tax settlement. The impacts of weather at PECO during the third quarter of 2007 were flat when compared to the same period of 2006, and were about $0.01 favorable to normal weather.

Please refer to the tables that accompany the earnings release for additional detail regarding our third quarter results.

Coming to slide 11 and our outlook for 2007, with three quarter of strong financial and operating performance behind us, we are reaffirming Exelon's non-GAAP operating earnings guidance ranges for 2007 at $4.15 to $4.30 per share, which represents the top half of the range of our original 2007 guidance.

We are also reaffirming operating earnings guidance for each of the operating purposes. The ranges are provided on the slide. We are revising our GAAP earnings guidance to $3.90 to $4.20 per share from $3.70 to $4 per share, primarily to reflect the gain from State Line. Both Exelon's operating earnings and GAAP earnings guidance are based on the assumption of normal weather for the balance of the year.

Moving to slide 12, where we summarize the results of the third RPM auction. Our 9500 megawatts of capacity in Eastern MAAC are committed to serve our load obligations including the PECO load obligation and will not benefit from these capacity prices. However, our uncommitted paid capacity in the Midwest where we see primarily the rest of market capacity price for the auction beginning on June 1,, 2009.

The majority of our Midwest capacity in uncommitted, only a limited portion of our Midwest capacity was committed through the underlying load auction through the end of May 2006. Given our large low cost, low emissions and exceptionally well run nuclear fleet, Exelon is in a unique position to benefit from improving power market fundamentals, driven by rising capacity values and higher usage. We plan to talk more about this at EEI when we update our 2008 un-hedged or open EBITDA position.

Before I turn the call over to John Rowe, I will remind you that our annual investor conference will be on December 19th in New York at the [indiscernible]. Additional details on this issue will be coming out from Investor Relations soon. At this meeting, we plan to provide overall 2008 earnings guidance by operating company, 2008 sources and uses of cash, regulatory and operational updates as well as our strategic outlook.

With that I will turn the call over to John Rowe; I look forward to seeing many of you at EEI in Orlando.

John W. Rowe - Chairman President and Chief Executive Officer

Good morning, everyone, and thank you, John. As Chuck has told you we intend to talk about the future at EEI in very short time, so I am going to confine most of what I say to the third quarter in this year.

At EEI we will try to give you the best picture we can as to next year and the longer term. We had a very strong quarter with year-over-year operating earnings up from $1.02 to $1.21 per share. As John said, we are reaffirming our operating earnings guidance $1.30 [ph] per share and we are delighted to be able to revise the GAAP guidance upward to $3.90 - $4.20 per share.

We are very pleased that all of the characteristics that made up this operating performance. Personally, however, I am even more pleased that this has been a quarter when we have been able to commit to complete a wide variety of commitments too.

We told you at the end of the second quarter that we expected our Illinois transaction to be confirmed in legislation. It was. Thanks to the hard work of Frank Clark, Darryl Bradford and the majority in their team.

We told you at the end of the second quarter that the financial swap that we had entered into was a fairly valued transaction. I know many of you were concerned that that might not be so. Well, [Indiscernible] and their team work this contract out very favorably and we now have the numbers to illustrate that.

We promised you that we were going to implement our value return policy and in August the Board approved it and we have executed that policy as is set forth in the press release. So, to me, the third quarter is not only a superb quarter operating wise, it's a superb quarter in the larger context of protecting the value which you all [indiscernible].

We are very proud of the work that Chris Crane, Chip Pardee and the Nuclear Group did. They achieved a capacity factor of 97% during the quarter. I don't think there is too many more percent left that you can get out of Chris. Mark Schiavoni and his Power Group excelled in operating our Fossil and Hydro Group: a commercial availability of 91.6% for fossil and an equivalent availability of 19.2% for hydro. And as usual, the Ian McLean, Jim [indiscernible] their whole team capitalized on our operating capabilities with their careful and sound behavior, in our mind. They also successfully managed our participation.

At the Distribution company level, I can genuinely say that this is one of the best performances for ComEd that we have ever seen. Greg, Barry Mitchell and their operating team performed spectacularly in the face of one of the worst performance ComEd has experienced. ComEd reestablish service through approximately 634,000 customers, within five days bringing back 75% of those affected in the first day and 90% within 48 hours.

This was a brief demonstration of ComEd's commitment to its customers, a brief demonstration of the improving capabilities of the ComEd operating management team. All of that work, we've been doing the last five years is starting to show at ComEd.

Thousands of employees from throughout the company were engaged in this firm recovery, working 16 hours shifts to deploy service. I want to thank all of them for what they did. They also were helped by crews from utilities in six states: Missouri, Michigan, Texas, Tennessee, Kentucky, Pennsylvania. We appreciate the help, but in terms of management, I think, Barry Mitchell and John Costello did in recognizing the size of the problem quickly and calling for help quickly, really saved a day or two for our customers.

John has already described ComEd, a settlement with the State of Illinois on July 24, 2007 which General Assembly approved on July 26, 2007 and the Government signed on August 28, 2007. Pursuant to the settlement agreement, ComEd has started nailing bills irregularly credit to customers. ComEd pushed to have energy efficiency standards and investments in the renewable energy part of the Illinois settlement.

And we feel that these things have to be done, to the policies stated by the Governor as well as the larger needs of the state, and we wanted to make certain, we had proper cost recovery provisions in the legislation when it passed. Greenfield is a place where we have to go fairly often, but we don't choose to go all that long, pursuant to the settlement agreement ComEd will file its energy efficiency plan.

During the third quarter ComEd launched its One Million Compact Fluorescent Lights Discount Program. To-date customers have already purchased about half of that supply. This discount CFL program is part of the ComEd care initiative. And it is the largest privately funded energy efficient lighting program. ComEd made a filing with the ICC seeking to have customers with demand of 100 kilowatts to 400 kilowatts, very competitive. This follow a statutory declaration that customers above 400 kilowatts were competitive as part of the Illinois settlement.

The ICC recently approved the ComEd filing, what that means is that all customers whose demand is above 100 kilowatts are now declared competitive. A large portion Ian, I am sure, can give you the exact number of our customers now shopped regularly. This is a major action for us. Finally with the Illinois settlement and the ComEd was the first step for regulatory approval.

As John described, ComEd reached a proposed settlement of its transmission rate case at the FERC and filed its Distribution case with Illinois Commerce Commission. We're pleased with the proposed FERC settlement and are optimistic about a positive outcome. Of course, I cannot overemphasize the importance of fair regulatory for ComEd. Over the years of the rate case and even now, we have invested an enormous amount of money in ComEd's distribution. We continue to do so, in order to handle the increased demand from customers and ensure reliable... an adverse regulatory decision will significantly impact additional investment...

Turning to PECO, PECO's management has been engaged on all fronts. They have worked extraordinarily hard to manage extreme on this, PECO saw its electric demand peak at 6,525 megawatts, which is all time high. It experience 9 of its top 15 all time peak days this past summer. With extreme weather and the amazing response by both ComEd [indiscernible] proven as an example of why we have to make and continue to make substantial...

PECO has currently been busy trying to manage the political situation as well. Earlier this year, Governor Edward Rendell announced an energy independence strategy that include proposed legislation to address potential rate increases and a variety of environmental agenda items. On September 17th the Pennsylvania State Legislature through a special session to consider elements of Governor Rendell's energy package. Special session run concurrently with the regular legislative session which is scheduled to be assessed in December.

Last month PECO announced programs that it is prepared to implement and support Governor Rendell's and the General Assembly's commission addressing critical energy. This includes energy efficiency and price management, local resource development.

The company is supporting a variety of steps to ease the transition to comparative markets and at the same time post positive energy policy. PECO supports the development of a legislative package to help customer manage rising energy prices and increasing environmentally friendly alternative power sources. Negotiation with the Rendell administration... are ongoing.

I would like to point out that part of what is going on here is that the efforts of Exelon company to protect the value that we have created require us to be at active and public policy oriented course including changing energy needs of our state.

We can't simply sit on what we have. We have to help, to solve the problem. That is what caused us to improve the efficiency program in the Illinois package, that is what motivates Dennis O'Brien, Rick Scottsville [ph] and their team to be working so closely with the [indiscernible].

In summary the generation and distribution companies have performed very well as... I believe, if you look at the whole array of what we have done in the past three months. We have delivered on a whole lot of things. And with that, we will continue to do so, in the forthcoming quarter.

We'll now take questions.

Question And Answer

Operator

[Operator Instructions]. Your first question comes from John Kiani of Deutsche Bank.

John Kiani - Deutsche Bank

Good morning. We've heard the company talk about M&A recently and I'm trying to better understand the value proposition, do you think Exelon has the currency to do a larger deal when the stock isn't placing in the '11 uplift or carbon at this point? Can you talk through how you see that value proposition working?

John W. Rowe - Chairman President and Chief Executive Officer

Sure, John. We can't give a value proposition unless and until we have a proposal, you are not going to do something that we think distract from the value we created here. We understand as keenly as you do the value that we can add in 2011 and 2012. Protecting and getting something for it is at the heart at what we do around here. And so, obviously, you just don't stay... we'll see the currency is pretty good let's spend it, we are not made that way.

On the other hand, we continue to believe that this industry is slowly and painfully consolidating. We think there are possibilities that will increase the robustness of our value and we keep looking at them. But we are not going to just give away that value that you just described. So, I can't tell you our transaction when I don't have a transaction to describe to you, I mean, I... I'm not good enough to sell something that I don't have to give you at the moment.

Now, you know our basic policy on anything specific when we are looking at lest all the lawyers in the room rise up and strangle me is that we don't talk about it until and unless we have something specific to tell you about, and then we will respond to your questions about the value proposition.

John we are simply not going to do something that we don't think capitalizes on that value in 2011 and 2012. I mean, I've been... I've lived for value now for damn near 24 years running utility, so I not see now, I didn't throw it away in some kind of old man's ego.

John Kiani - Deutsche Bank

Thanks, John.

Chaka Patterson - Vice President, Investor Relations

Next question, please.

Operator

Your next question comes from Paul Ridzon of Keybanc.

Paul Ridzon - Keybanc

Given your view that forwards aren't adequately reflecting rising heat rates and capacity values, are there any steps you could... in the financial engineering or contract renegotiations that you could implement to try to capture some of that value you see relative to your... what would be below market contracts?

John W. Rowe - Chairman President and Chief Executive Officer

While the answer is, of course, sure, the issue is all those other financial engineering is a wise thing to do. I mean the financial engineering in my view is largely an up to date term for what we call leverage in our use. And we are well aware that we have the capability to increase the leverage on our balance sheet. The issue is whether it's a good idea and increases your real value to do that sort of thing and we keep looking at different ways that might make worth while to do so.

But remember there is a swirl of things going on here, there is, of course, rising heat rates, we just given a presentation on that to our Board. There is the issue of what natural gas prices are going to do in the next several years, and strangely we tend to be a little more bullish on that than some of the public forecast. But nonetheless it isn't real until it happens.

We have given you our value return policy, we mean it. We will be looking at when and what the next increments of that policy should be between now and the end of the year, you can of course expect there is more roll up in the dividend as it normally does this time of year. We will have to look at what the right share buyback kinds of decisions for next year are as we get there, if we can't we'll give you a little better insights into that down EEI but these tend to be decisions that you get... you must have a grasp if the Board [ph] makes specific one.

Philosophically, I look at this as increasingly a commodity price driven company. And I spend a fair amount of time studying how companies in the commodity business behave, and the ones who survive and do well for their investors in the long run tend not to be people who leverage themselves to the help every time the commodity looses grip. And in our case, you have not only the different factors affecting the commodity prices, you have constant need to deal with the political and regulatory issues that affect your value. So, that's why I used words like resilience and robust, I want this to be a company that you can count on.

Chaka Patterson - Vice President, Investor Relations

Next question please.

Operator

Your next question comes from Hugh Wynne of Sanford Bernstein.

Hugh Wynne - Sanford Bernstein

Hi, I wanted to ask a question or kind of a treasury sort. I was looking at the cash flow statement for the nine months --

Chaka Patterson - Vice President, Investor Relations

People I advise that we are not on video, how far your treasury source... on treasury resource?

Hugh Wynne - Sanford Bernstein

Good. The question is this, the cash from operations, excluding changes in working capital has increased enormously this year as a result of the growth in revenues in Illinois by about $850 million. Cash flow from operating activities is actually down a tad, because of the accumulation of investment or working capital, primarily related to collateral assets and liabilities and then also accounts receivable. And I was wondering if I could just get a little bit a light about what those very large cash movements mean, and when they will be reversed as I assume these collateral assets are associated with hedges?

John W. Rowe - Chairman President and Chief Executive Officer

Yes, and Hugh I don't know if I can give you all the details, I might have to look at that and get back to you, but I think in general you're right that basic cash from operations is much stronger and higher than last year driven by... the same things that are driving earnings higher, meaning on the Generation side as result of the higher revenues from Generation margins and the expiration of the ComEd EPA.

As far as the overall cash position it can also swing around a lot due to margining of cash in and out, and when we had hedges on the books and prices go up we're being margin, and that can move us $400 million, $500 million in either direction because we have quite a bit of volumes that we sell into the wholesale market bilaterally. So my presumption and we can go check that if that's the result of cash, margin cash out of the company, as a result the agreements with counterparties.

Hugh Wynne - Sanford Bernstein

Okay. As a result of that we would expect these cash flows to revert to positive as it begin to benefit from those higher prices on your sales, is that right?

John W. Rowe - Chairman President and Chief Executive Officer

Yes.

Hugh Wynne - Sanford Bernstein

Okay, thank you.

Chaka Patterson - Vice President, Investor Relations

Next question please.

Operator

Your next question comes from Jonathan Arnold of Merrill Lynch.

Jonathan Arnold - Merrill Lynch

Good morning.

John W. Rowe - Chairman President and Chief Executive Officer

Good morning, Jon.

Jonathan Arnold - Merrill Lynch

Can, I ask you guys to just comment a little on the specifics of the Carbon Bill that was recently put before congress and what in that you find to be acceptable and I know you have generally been in support of a lot of the proposed legislation but how could that be improved to be a better bill in your opinion?

John W. Rowe - Chairman President and Chief Executive Officer

Well there are pieces of that Bill that we like and pieces that we... I am troubled. And we would like... the fact is one more step towards comprehensively dealing with the problem because we think comprehensive gap and trade carbon legislation, we will deal with this problem more effectively and at less cost than simply throwing money at every new renewable is some obvious like. We do not think ethanol is the only scandal with [Indiscernible] in this book. So, we strongly like the gap in trade approach.

We like the fact that the, people in Water Bill doesn't just give all the allocations away for free. We had no wish to place unnecessary burdens on states or companies that are more coal dependent than we are, but at the same time our investors and our customers have learned the burdens of a relatively clean fleet for a great many years and we don't think somebody else is entitled to permanently lower prices because they put more stuff up in the air.

So, we like the way that we've been learning our dealing with partners. Our biggest questions on this bill involve this sort of new Federal Reserve Bank NOI that they put in place of the kind of safety valve that the Bigham Inspector [ph] Bill has. We are strong supporters of the safety bill concept. We do not think the nation's economy can afford, we do not think the utility industry can afford, to have a bill where the price impacts in the early years are just utterly unknown.

So, I don't suppose given the dynamics of the Senate at the moment that the Bigham Inspector safety bill provision will just get added into the Liberman-Warner, I think there will be some complicated set of guidelines. But this sort of Federal Reserve Bank concept won't work unless the legislation contains some guidelines on how this new entity should use floors of ceilings to make certain that carbon is priced into the market in an orderly way and not in a chaotic way.

That maybe more than you wanted to know about Liberman-Warner, the bill is of course very long very complicated in that and that there is infinite number of things about it that I don't understand yet. But that's my view as of the moment.

Jonathan Arnold - Merrill Lynch

Thank you, John.

Operator

Your next question comes from Rudy Tolentino from Morgan Stanley. Sorry about that.

Rudy Tolentino - Morgan Stanley

Hi. In your press release, higher labor costs were account for Nickel determent to earnings, can you comment on whether or not it's from your existing employee base or just a reflection of higher contract labor costs and if it is due to higher craft labor, can you give me an idea of how that's trending.

John F. Young - Executive Vice President, Finance and Markets, and Chief Financial Officer

John Young, I think the answer I yes, yes and yes. But John --

John W. Rowe - Chairman President and Chief Executive Officer

And I think and I'll have go back to look at the table that you are referring to but yes to all of the questions but last year we had an offset in ONM expenses related to some one-time recoveries as of DST case that we attributed to last year. So you have a... an increase that looks bigger than the otherwise would look, but yes we are seeing normal kind of inflation related labor cost increases year-over-year, that are in the 3 percentage point ranges.

Rudy Tolentino - Morgan Stanley

It's just more on your, for your... the employee end or just more on the craft labor end, for outages?

John W. Rowe - Chairman President and Chief Executive Officer

It's actually booked. Obviously we have that built into our labor contracts and then... and maybe Chris Crane, might want to talk to the outage cost of labor specifically.

Christopher M. Crane - Executive Vice President and Chief Operating Officer

The outage labor costs are standard or average escalation is 3.5% to 4% a year. Our material cost has been a little bit higher, they've been averaging about 7% a year. But year-over-year we have adjustment in work scopes based off of cycles that the reactors are in. If we are on a ten-year cycle like we are, a PWRs right now we are doing more extensive inspections that will drive our costs and they'll balance out over the period.

Rudy Tolentino - Morgan Stanley

Okay, so the higher outage costs for this year is looked to the ten year reactor inspections do you think?

Christopher M. Crane - Executive Vice President and Chief Operating Officer

That's partially is with escalations coming in on inflation as it's grown to.

Rudy Tolentino - Morgan Stanley

Okay. Thanks very much.

John W. Rowe - Chairman President and Chief Executive Officer

As you look at cost of almost everything in facility does... then it is true for oil refineries and anybody else building these complex things. All of the input for amateurs: labor, concrete, steel, engineering, forging are all up, that's why every time you look at a cost estimate for a new power plant anywhere, it tends to be higher than the estimate was six months ago and we just reviewed with our board the way those numbers have changed for different kinds of facilities. This is going to create a lot of pressure on our entire industry because in the rate regulated situations our delivery companies, the entire company in the case of Integrated... when you have rising costs it's harder and harder to get with our normally fair returns.

Chaka Patterson - Vice President, Investor Relations

Next question please.

Operator

Your next question comes from Paul Paterson of Glenrock Associates.

John W. Rowe - Chairman President and Chief Executive Officer

Good morning, Paul.

Paul Paterson - Glenrock Associates

Good morning, guys. I want to touch, based with you on the announcement that public service made with respect to, I think, it]s about 400 megawatts that they think that they are likely, I guess, to announce building because of the higher RPM prices. And just in general, I mean, you are looking at robust market and everything that you just mentioned, what are your thoughts on that and the potential for you guys to make maybe a similar announcement or something like that, just what are your thoughts about the new entrants with respect to the RPM price difference and what have you?

John W. Rowe - Chairman President and Chief Executive Officer

Well, I'll invite John in the end to chip in, after I finish my opening here, but first we think the BSEG announcement is a constructive thing. New Jersey is just playing short on capacity and on something redundant in that space. Second, we are fortunately better off in Pennsylvania and Illinois but we keep looking at those same factors, that's partly why I said we just can't camp on what we have. We have to keep looking at what needs to be done. Now, my basic point of view and this is actually quite consistent with these actions is that the current prices are high enough to support peaking in some commitments that are not high enough to support new base-load.

Maybe, Ian, would say that most of PJM is still not high enough to support seeking commitments too. But the ones have to stay on, have to make the market broader, and PECO will to have the kind of stake in these markets that we do, after we do that as well.

I think this is what Governor Rendell is most concerned about, Pennsylvania, we want to make certain that the state is going to enough... to have it in a greener way, and to do it without prices just skyrocketing, and Dennis O'Brien and our Genco [ph] people haven't stayed with that too, but we don't have any big surprise announcement for you. We are looking very diligently at our possible two nuclear units in Texas. We think that the particularly attractive markets for base-load proposal, we ardently commented the Bush administration on what it's done to implement the Energy Act several years ago and putting out a Loan Guarantee Program that really works because without that, I don think, even we consider merchant nuclear plants at the present time, but with it, it just might work. So, we are looking at those very hard, that's our principal project. But I think, you will see us constantly trying to lead with our energy efficiency program, do the renewals, where they are required by public policy, and they will peak as...where that's needed to keep the lights on. Fortunately, we have a little more time than they do in New Jersey.

Paul Paterson - Glenrock Associates

How much more time?

John W. Rowe - Chairman President and Chief Executive Officer

Well, I don't think, we need them in Illinois a lot, 12 or 13, John, and Pennsylvania perhaps a little sooner. Ian, do you want to tell me, when you think Pennsylvania just has to have more capacity.

Ian P. McLean - President, Exelon Power Team; Executive Vice President, Exelon Corporation

Yes, I think, early part after 2010, 2011. And what I would just add to what you said is that. Right now, what's happening is, we've got the prices to the point where people are reinvesting in the older plants and keeping them going. We have done that ourselves, I think that the prices aren't quite yet where we would go and build some new PECO's. But we certainly would like to send the price signal, at what cost, we do that. And I think that right now PJM is looking at CONE. The cost of new entrant and then they may even be announcing it today, to raise that. And I think once you get that confidence, and I really do think you start to get some new iron in the ground.

Paul Paterson - Glenrock Associates

Okay thanks.

Chaka Patterson - Vice President, Investor Relations

Next question please.

Operator

Your next question comes from Paul Fremont of Jefferies.

Paul Fremont - Jefferies & Co

Thank you, I guess you mentioned in the presentation that the State Line transaction is expected to result in a $0.05 dilution going forward. Can you elaborate on what you see as the benefits of that buyout? And can you also discuss Kinkade and whether you would consider a buyout of that contract?

John W. Rowe - Chairman President and Chief Executive Officer

Well, there are several benefits here. First, we are getting a nice lot of cash and based on our valuation model we are getting, at least a fair price for the buyout of the contract. Second, State Line is a plant where Dominion needs to make a lot of decisions about how it's going to run the plant and how much it's going to invest in the plant. We don't think they would make those decisions on, as plane and rational basis, if they are confined by the contract with us, as they will, when they have, both the expenditure and the output side.

So, State Line is a little different then Kinkade, where it's both bigger and our team has more interest in its loan following capability. But that said, we are interested in value and we can afford to deal with a little volatility in earnings if we get more value and it wouldn't shock me, if we would end up looking at Kinkade. But I don't have something to tell you about it, at the moment. But it is, for us it's pure value and with this volatility we need to keep the lights on, Ian do you want to supplement that.

Ian P. McLean - President, Exelon Power Team; Executive Vice President, Exelon Corporation

Yes, I think simply put it was a transaction where we got more in cash than we valued the plant at, I mean it was that simple, and that's why we did the transaction.

Chaka Patterson - Vice President, Investor Relations

Next question please.

Operator

Your final question comes from Nathan Judge of Atlantic Equities.

Nathan Judge - Atlantic Equities

Good morning, I wanted to follow up on the question on Carbon Bill. If prices were to rise significantly, following on some type of carbon legislation on the Federal level. What repercussions... could states do anything to change, what impact it has on their customers in the states and would there be any risk of repercussions to utilities and generators in the state.

John W. Rowe - Chairman President and Chief Executive Officer

I would like to say not with my lawyers. But even with the best lawyers around. After what you have seen in Illinois and Pennsylvania, the answer to that is pretty obviously, yes, repercussions abound. I mean let's put it very simple, we believe that with what's going on in natural gas markets over the next decade, where most new capacity will still be gas. Because it's what's you can build, we believe that with what's going on in carbon. We believe that with what's going on in capacity shortfall, we are absolutely and uniquely well positioned to benefit. But if those prices go up too much, we will have more than our share of problems.

I just finished at our Directors retreat, showing our Board, a three nice photograph of commodore orders Gunboats [ph] going under the guns in Pittsburg, and I said, it must seem to you that somebody is always shooting at us. And the answer is that they are, and they will continue to do so as long as has we have the most valuable platform in the business. And I intend that we shall continue to have the most valuable platform in the business. But that's one of the reasons we support a safety valve on the carbon legislation.

The old axiom, bulls make money, bears make money and pigs get slaughtered probably applies to Exelon carbon, we need to make certain move that when carbon legislation come, it's both efficacious and practical. And practical means not shocking this economy with huge cost, all at once, that's why we push the bill. We also defend the safety valve which ought to be of more interest to our core marine brethren.

I believe that carbon legislation will create, very major long term value for Exelon shareholders. But it only does that, if we make certain, that it doesn't hurt our customers unnecessarily, and that's what we're setting out to do. We need to show that Exelon is at the forefront of viewing this environmental issue, because this one is real and this one is bigger than any of the others.

There is no cheap, one way out of the carbon problem, as the old Star Trek movie says, we are carbon-based organisms and we live in a carbon-based society, and it's going to be very expensive and very long term to deal with this problem. We are well positioned to benefit from it, if we aren't sinking... but if you have huge pricing increases all at once, then you just have to assume, we will have to share more than we might want to share. So, we are looking at how we can help the public most with the environmental problem, and at the same time keep the most we can of our value for all of you.

Nathan Judge - Atlantic Equities

Thank you very much.

Operator

I will now turn the floor over to John Rowe for any finishing remarks.

John W. Rowe - Chairman President and Chief Executive Officer

I just made them. This is going to be a really tough business in the next decade. And Exelon has better opportunities and more armor on its boat than anybody else. Thank you.

Operator

Thank you. That concludes today's Exelon 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: Exelon Corp. Q3 2007 Earnings Call Transcript
This Transcript
All Transcripts