Executives
Mary Ann Arico - Director, Investor Relations
Ed Muller - Chairman and CEO
Jim Iaco - EVP and Chief Financial Officer
Bob Edgell - EVP and US Region Head
Bill Holden - SVP and Treasurer
John O'Neal - SVP and Chief Commercial Officer
Paul Gillespie - SVP, Tax
Analysts
Paul Patterson - Glenrock Associates
Andrew Levy - Brencourt
Reza Hatefi - Polygon Investments
Elizabeth Parrella - Merrill Lynch
Brian Russo - Ladenburg
Robert Howard - Prospector Partners
Jeff Coviello - Duquesne Capital
Clark Orsky - KDP Investment Advisors
Christopher Taylor - Evergreen Investments
Vikas Dwivedi - Morgan Stanley
Lee Cooperman - Omega Advisors
Gil Nathan - Restoration Capital
Brian Chin - Citigroup
Lasan Johong - RBC Capital Markets
Alex Mazier - Sandell Cap and Asset Management
Steve Moyer - TCP
Mirant Corp. (MIR) Q3 2007 Earnings Call November 9, 2007 9:00 AM ET
Operator
Good day, everyone and welcome to the Mirant Corporation'sThird Quarter Earnings Call. Today's call is being recorded.
For opening remarks and introductions, I would like to turnthe call over to Ms. Mary Ann Arico, Director of Investor Relations. Please goahead.
Mary Ann Arico
Good morning. And thank you for joining us today forMirant's third quarter earnings call. If you do not already have a copy, thepress release and second plus financial -- second quarter filings with the SECare available on our website at mirant.com.
The slide presentation is also available on our website. Areplay of our call will be available approximately two hours after we finish.
Speaking today will be Ed Muller, Mirant's Chairman andChief Executive Officer and Jim Iaco, Executive VP and Chief Financial Officer.Also in the room and available to answer questions are Bob Edgell, Executive VPand US Region Head, Bill Holden, Senior VP and Treasurer, John O'Neal, SeniorVP and Chief Commercial Officer and Paul Gillespie, Senior VP of Tax.
Moving to slide one, the Safe Harbor. During the call, wewill make forward-looking statements, which are subject to risks anduncertainties. Factors that could cause actual results to differ materiallyfrom management's projections, forecasts, estimates and expectations arediscussed in the company's SEC filings. I encourage you to read them.
Our slide presentation and discussion on this call mayinclude certain non-GAAP financial measures. Such measures are reconciled tothe most directly comparable GAAP measure and are available on our website orat the end of the slide presentation.
Now, I will turn it over to Ed Muller.
Ed Muller
Thanks Mary Ann and good morning, everyone. And as you cansee from the news release, we have a fair amount to discuss today. Let me beginon page three of the presentation. I will try and remember to tell you whatpage we are on and someone in the room can remind me if I forget to.
First, as we have announced this morning, we have completeda very thorough exploration of strategic alternatives for the company, which wehave been doing since April and looking at ways to enhance the value for ourstockholders. And as a result of that and having concluded it we have announcedtoday a plan to return cash to the stockholders.
We are also reinitiating guidance, the guidance for 2007,that is this year is $1 billion even of adjusted EBITDA and for next year $907million. Let me pause on the guidance. Jim Iaco later will give you more detailon this, but a couple of comments.
Our guidance for both years reflects increases in capacityrevenue offset by decreased plant availability. The decrease in plantavailability in 2007, that is this year, results both from extensions of thespring outage at unit one at Morgantown and limitations on our ability to runat Potomac River.
The decrease in plant availability in 2008 next year isprincipally because of limitations on our ability to run at Potomac River. Wehave also had some shifting of revenues, which Jim will go through from ourfuel oil management activities from 2007 to 2008.
Let me address the matters at both Morgantown and PotomacRiver. At Morgantown as part of our program of putting in environmentalcontrols we took a planned and extended spring outage for unit one to tie inconnect the SCR selective catalytic reduction equipment, which is designed toreduce emissions of nitrogen oxide.
Because we were taking an extended outage we also did avariety of other things to improve the performance of the plant such asupgrading all five of the pulverizers and upgrading of the controls.
I'm sorry to say, that the various contractors whom weengaged to do this work in a variety of ways let us down. And so we were latercoming back than we had planned and we had a variety of issues that arose evenwhen we came back and caused some trips and that had a negative impact. All ofthose problems are behind us now.
At Potomac River, as has been the case now for a number ofyears, we have various opponents of the plant who have been trying through avariety of means to make us go away. For example, the city of Alexandria a yearor two ago brought a case or attempted to zone us out of existence.
We ultimately took the matter to the Supreme Court ofVirginia and we won. These efforts have not stopped and the latest in theseefforts is an attempt by the Virginia Air Board to impose restrictions on usthat would limit our operations effectively to three units rather than the fiveunits that are at the plant.
It is our view strongly held that these efforts have nobasis either in science or in law. We are in litigation over them, as well as,discussions with the authorities in Virginia. We intend this in our legalrights and we will insist on them. Until, as we expect we prevail, we arelimited to running only three of the five units at Potomac River.
Continuing now on to the next item, as we previouslyannounced we closed the sale of our Caribbean business in August, whichcompleted the divestiture program that we began about one year before.
That was to sell our Philippine business, our Caribbeanbusiness and six natural gas-fired power plants in the United States, thatprogram is complete.
Also, as we have previously announced we made the electionunder L6 for the treatment of our pre-emergence NOLs. This had been an issue wehad been wrestling with ever since we emerged. We completed, as we have alsoannounced the settlement with Pepco, which put that long-standing set ofproblems behind us.
And -- now, let me move then to page four. As I said at thebeginning here, we have completed a thorough exploration of alternatives forthe company and have concluded that the best alternative at this time is toreturn excess cash to our stockholders.
In our divestiture program, which I just mentioned we hadtotal proceeds of $5.1 billion. Under the credit arrangements for Mirant NorthAmerica, we are required to take the proceeds from the sale of two of thenatural gas-fired plants Zeeland and Bosque and use them in the business ofMirant North America or retire debt.
That amounts to about $0.5 billion, subtracting the $0.5billion, which we are going to use and are using in the environmental CapExprogram in the Mid-Atlantic, leaves us with $4.6 billion and that is what wewill be returning to stockholders.
We also looked in sizing that at the following criteria thatare laid out on page four and that is, to maintain the credit profile of thecompany; to maintain adequate liquidity for our expected cash requirements,particularly the Maryland environmental CapEx program and to retain sufficientliquidity to handle fluctuations and commodities.
Turning to page five, our method for returning the $4.6 willbe as follows. We will do it in stages beginning today with $2 billion. $1billion in an advanced share repurchase program, which means we are delivering$1 billion to JP Morgan, which we will be handling this for us today and theywill be delivering to us approximately 24 million shares of Mirant stock.
And second, we will commence -- are commencing now openmarket purchases for another $1 billion. When we have completed, when JP Morganhas completed the advanced share repurchase program, which will not be longerthan six months. We will then determine how we will handle the return of theremaining $2.6 billion.
Turning to page six and our performance in the third quarterand in the first nine months of the year, we had very nice performance. As youcan see for the quarter, we are up 51% over last year in terms of adjustedEBITDA and for the nine months, we are up 62% compared to last year.
This is principally because of the implementation of RPM,the Reliability Pricing Model or capacity market in PJM, which is providinghigher capacity revenues to us.
In the marketplace, as we show there, lower on page six,long-term gas markets notwithstanding lots of gas in storage have remainedstrong at about $8 a million.
Electricity prices continue to rise as economics would tellus they should because of expanded heat rates in our major markets and again,referring to the capacity markets, capacity markets are reflecting the factthat there is substantial imbalance and growing imbalance between supply anddemand. That is the supply is by and large not growing, and the demandcontinues to grow. So as basic economics teaches, prices are going to tend to rise(inaudible) as well to the capacity prices.
Further to the point about supply and demand, we have put inon page seven some charts that show what is happening to reserve margins. Youcan see in all of the markets in which we do business in the United States,reserve margins are falling.
And they are falling to levels that, in terms of ensuringthat we -- the industry, the electricity industry of the United States meetsour obligations to society to have electricity available, we are reaching apoint and are heading to a point that should give all of us concern.
We all live in this country together and we can debate howwe should go about producing electricity, and how much we need and so on. Butmeanwhile, we are in inexorably marching into an area that gives us concern.
In terms of prices, for somebody like us who produces a lotof our electricity with coal, this is a positive. Because we have more and moreinstances where, with rising heat rates, natural gas is the setting the pricein the market and we are a beneficiary of that.
These rising heat rates are also benefiting our intermediateand peaking units and in general, as I said previously, they are leading tohigher capacity prices.
This is particularly the case in the area of Southwest MAAC,which is where our Mid-Atlantic plants are located. There is a significantdeficiency of generating capacity in Southwest MAAC.
Even if the new transmission projects that are on theplanning boards get built, these problems don't go away. New generation isneeded. But as we all I think know, getting new generation built is verydifficult and will be very expensive.
And even these new capacity prices which we are seeing orthese rising capacity prices are certainly heading in the right direction.
But to get new capacity built, we need first of all to seeprices that are at or slightly higher than where they have been, given what thecosts of new construction are, and second, for somebody who, like us and ourindustry, has to contemplate large capital investments, the returns on whichare earned over many years, we need to have a sense of sustainability, andseeing what happens one year or in one auction is not enough to give us allthat comfort.
We are looking at this, we continue to look at it, but weall have to recognize that these are not pinpoint decisions. These aredecisions that will have an effect for decades in terms of the capitalcommitted.
Page eight, as we have in the past, here you can see ourhedge levels, and we are heavily hedged in terms of our baseload coal for nextyear and coming well along in 2009. You should expect that you’d see morehedging from us in the not too distant future.
Turning to page nine, our Mid-Atlantic, again if you lookdown on the lower left, you will realize gross margin, you can see that in thethird quarter we are up 29% compared to last year, up 35% for the first ninemonths and again principally because of the revenues coming in, in the capacitymarkets in PJM.
An update on the environmental CapEx program to which I havereferred several times already. This is the program that requires us underMaryland law to scrub our plants, to reduce massively the emissions of sulfurdioxide, and to put in controls to limit nitrogen oxide emissions, all of whichwe have underway.
And that was the SCR, for example, at unit one, which wehave now tied in and which is performing extremely well. That program we haveforecast will cost result in expenditures of about $1.6 billion.
We remain on schedule. We remain on budget. We have expendedthrough the end of the third quarter $357 million of our expected expenditures.I referred earlier to Potomac River.
We are operating on three units. We continue to be inlitigation and discussions in Virginia. That may continue until for some time,until we reach an appropriate resolution as the law and science both dictate.
On page 10, you can see the results, which are alreadypublic of the capacity markets we cleared in Southwest MAAC. So those are thenumbers applicable to us there. You can see the $237.33 a megawatt day.
There are more auctions to come. The schedule is down below.There are questions raised, understandably about whether these capacity marketsare working.
I think in terms -- you can -- there is evidence that theyare. The evidence is that the things that can be done on a relativelyshort-term because you are not investing gobs of capital as required to addcapacity, is that we have seen clear demand response, 900 megawatts in PJM inthe last auction.
And we have seen the deferral of retirements at existingunits, again because of these capacity prices, 3,000 megawatts in PJM in thelast auction. So they are working. The third leg of that stool which is newcapacity requires, as I said, a sense by us and those situated like us that wehave a sustainable environment in a pricing regime that justifies the largeexpenditures of capital that we would make.
On page 11, you can see the results in the Northeast for us.The key message here is that higher capacity prices in New York and New Englandoffset the revenues that we lost because we shut down Lovett's Units three andfour.
We'd note that the New York capacity market is looking atagain the CONE or the Cost of New Entrant to see if in their formula in orderto be adjusted upward to reflect the fact that the cost of new construction isin fact higher than -- well across the country, prices are rising. InCalifornia, nothing particular to report.
You can see the numbers there on page 12. On page 13, as wehave said before, we emphasize the declining reserve margins that we depictedearlier in this presentation continue to demonstrate the need for new capacityin the markets.
An extremely efficient way to do that is to do it atexisting sites, whether repowering or through Brownfield Development and wecontinue to have a variety of efforts underway to do just that.
We're also looking or in connection with that, we're lookingat adding new capacity in our, excuse me, at our California sites. PG&E,Pacific Gas & Electric, is somewhere in the process of putting out arequest for offers as is common in our industry. It has been delayed some. Andso we haven't responded yet, but we are prepared to respond and we willrespond.
Page 14, a chart that we have used before, but I remind youthat we have -- we are located in the United States in major load centers allwith declining reserve margins. All with some -- many cases with worrisomelevels of declining reserve margins.
And we have room and the ability to add capacity at thosesites. There's certain inevitability in my mind to saying that new capacitywill be added at those sites it is a question of when we will do so. We wouldbe pleased to do so. We work on doing so. But we will do so only if it makesfinancial sense.
With that, turning to page 15, I will turn this over to JimIaco.
Jim Iaco
Thank you, Ed. Good morning. As Ed mentioned, we had astrong third quarter with a 51% increase in adjusted EBITDA from continuingoperations as compared to the third quarter of 2006.
In addition, due to the fact that we have completed theexploration of strategic alternatives to enhance stockholder value, we arereinitiating guidance for 2007 and 2008. I will talk more on that in a moment.
As shown on slide 15, net income from continuing operationsfor the third quarter of 2007 was $642 million as compared to $248 million forthe 2006 period. The $394 million improvement is principally driven by fourfactors.
The first factor is a $379 million gain related to the Pepcosettlement, which is principally comprised of $341 million representing thefair value of the price risk management liability that was reversed as a resultof the rejection of the back-to-back agreement. And $36 million refunded byPepco for payments made under the back-to-back agreement for periods subsequentto May 31, 2006.
The second factor is due to 2006 results includingimpairment losses of $396 million related to the US natural gas plant assetssold in 2007. And $120 million related to the construction and development costfor the suspended Bowline combined cycle unit.
The third factor is an increase in realized gross margin of$89 million, principally due to higher capacity revenues as a result of theimplementation of the RPM capacity market in PJM during 2007.
And the fourth factor, which partially offsets the firstthree factors is a $215 million decrease in unrealized gross margin as a resultof mark-to-market accounting related to our hedging activities. Our hedgingactivities reduce our exposure to commodity price fluctuations and allow us toachieve more predictable adjusted EBITDA results.
Turning to the nine months ended September 30, 2007 netincome from continuing operations was $426 million as compared to $778 millionfor the 2006 period. The $352 million difference is again due to a number offactors.
The first factor is a $1.21 billion decrease in unrealizedgross margin. The second factor is a $175 million impairment taken in thesecond quarter of 2007 related to the Lovett generating facility.
These two factors are partially offset by impairment lossesin 2006 totaling $516 million comprised of the $396 million related to the USnatural gas plant assets sold in 2007 and again a $120 million related to theconstruction and development costs associated with the suspended Bowlinecombined cycle unit.
And finally, a $273 million increase in realized grossmargin due to higher capacity revenues as a result of the implementation of theRPM capacity market; favorable fuel oil management activities; higher electricenergy prices; and lower emission allowance cost. I will cover this in moredetail on the next slide.
Adjusted net income from continuing operations is net incomefrom continuing operations excluding unrealized gains or losses from our hedgingactivities, $362 million of the gain in 2007 related to the Pepco settlement.
The $175 million impairment in 2007 related to the Lovettgenerating facility. The $120 million impairment in 2006 related toconstruction and development costs for the suspended Bowline unit and othernon-recurring items.
Adjusted EBITDA, the best metric for measuring theperformance of our business is adjusted net income or loss excluding interest,taxes and depreciation and amortization. Additional data is provided in the appendixreconciling for all periods presented net income to adjusted net income andfurther to adjusted EBITDA.
Adjusted EBITDA from continuing operations for the thirdquarter of 2007 was $323 million as compared to $214 million for the 2006period and $774 million for the nine months ended September 30, 2007, ascompared to $478 million for the 2006 period. The increase for the quarter wasprincipally due to higher capacity revenues as a result of the implementationof the RPM capacity market.
For the year-to-date period in addition to the highercapacity revenues, this increase was also due to favorable fuel oil managementactivities; higher electric energy prices and lower emission allowance costs.
Our average diluted share count is lower in the 2007 periodas compared to the 2006 period due to share repurchases during the latter partof 2006, partially offset by an increase in assumed diluted shares for optionsand warrants due to additional grants and increases in our stock price.
And finally, our adjusted earnings per share from continuingoperations was $1.14 for the third quarter of 2007 as compared to $0.44 for thecomparable 2006 period and $2.17 per share for the nine months ended September30, 2007 as compared to $0.72 for the comparable 2006 period.
Now turning to slide 16, this slide displays the componentsof the Company's realized gross margin from continuing operations for the thirdquarter and year-to-date periods.
Energy, shown as the light blue bar in the graph, representsgross margin from the generation of electricity at market prices, sales andpurchases of emission allowances, fuel sales, purchasing and handling of fuel,steam sales and our proprietary trading and fuel oil management activities.
The quarter-to-quarter comparison is relatively flat, whileon a year-to-date basis energy gross margin is higher by $124 million due tofavorable fuel oil management activities, higher electric energy prices, andlower emissions cost.
Contracted and capacity, the dark blue bar represents revenuereceived through reliability must-run contracts and other installed capacityarrangements; revenues from ancillary services and revenue from theback-to-back agreement, which was terminated in August of this year pursuant tothe Pepco settlement.
The quarter-to-quarter and year-to-date increases areprincipally due to increases in capacity revenue in the Mid-Atlantic and theNortheast and to refunds related to the Pepco settlement.
And finally, the incremental realized value of hedges, theyellow bar, reflects the actual incremental margin realized in excess of marketprices upon the settlement of our power and fuel hedging contracts.
Turning now to slide 17, let's take a look at our free cashflow from continuing operations for the third quarter of 2007 and theyear-to-date period.
Taking net cash provided by operating activities andreducing it for bankruptcy payments results in adjusted net cash provided byoperating activities of $312 million for the third quarter of 2007, as comparedto $399 million for the third quarter of 2006.
And $689 million for nine months ended September 30, 2007,as compared to $781 million for the 2006 period.
Reducing these amounts further for all capital expendituresresults in free cash flow of $105 million for the third quarter of 2006 and$304 million for the 2007 year-to-date period.
We believe that a more meaningful apples-to-applescomparison is using free cash flow adjusted for extraordinary environmentalCapEx such as the cost of compliance with the Maryland Healthy Air Act.
Accordingly adding back in the non-recurring MarylandHealthy Air Act capital expenditures for all periods presented results in anadjusted free cash flow of $283 million or $1 per share for the third quarterof 2007, as compared to $385 million or $1.29 per share for the third quarterof 2006.
And $283 million or $2.05 per share for the nine monthsended September 30, 2007, as compared to $305 million or $2.39 per share forthe 2006 year-to-date period.
Turning to slide 18, this slide presents our debt andliquidity as of September 30, 2007 and December 31, 2006. The $138 milliondecrease in debt is principally due to repayments at Mirant North America.
After subtracting restricted and reserve cash our availablecash-and-cash equivalents including amounts available under the Mirant NorthAmerica revolver and synthetic letter of credit facility amounted to $7.030billion at September 30, 2007.
Let me take a moment and discuss the cash balances at MirantNorth America and Mirant Mid-Atlantic. Mirant North America's ability to paydividends is restricted under the terms of its debt agreements.
At September 30, 2007 Mirant North America had distributedto its parent all available cash that was permitted to be distributed under theterms of its debt agreements leaving approximately $946 million at Mirant NorthAmerica and its subsidiaries.
Approximately $100 -- excuse me, $251 million of such amountwas held by Mirant Mid-Atlantic, which as of September 30, 2007, met the ratiotest under the leveraged lease documents for distribution to its parent MirantNorth America.
After taking into account the financial results of MirantNorth America for the nine months ended September 30, 2007. We expect MirantNorth America will be able to distribute to its parent approximately $166million in November.
Turning to slide 19, as I indicated earlier we arereinitiating our guidance for 2007 and 2008. Our 2007 adjusted EBITDA guidancefor continuing operations has been updated to $1 billion and our 2008 adjustedEBITDA guidance has been updated to $907 million.
I will address the changes from our previous guidance andchanges in realized gross margin in the coming slides.
Deducting projected net interest expenditures and incometaxes and factoring in projected changes in working capital. Cash flow fromoperations is $984 million and $769 million for 2007 and 2008 respectively.
Reducing cash flow from operations by projected totalcapital expenditures of $711 million and $913 million for 2007 and 2008respectively. Derives free cash flow of $273 million for 2007 and a free cashflow deficit of $144 million for 2008.
Adding back in the Maryland Healthy Air Act CapEx for 2007and 2008 results in an adjusted free cash flow of $730 million for 2007 and $509million for 2008. Our hedged gross margin for 2007 is $1.523 billion or 91% ofour projected realized gross margin.
For 2008, our hedge gross margin is $1.181 billion or 74% ofour projected realized gross margin. Hedge gross margin is defined as hedgedmerchant generation and other contracted capacity, which would includereliability must-run agreements and other installed capacity arrangements.
Finally hedged adjusted EBITDA, which is defined as hedgegross margin reduced by our projected operating expenses for a full calendaryear, is $847 million or 85% of our projected adjusted EBITDA for 2007. And$488 million or 54% of our projected adjusted EBITDA for 2008.
Turning now to slide 20, this slide presents the componentsof projected realized gross margin included in our guidance for 2007 and 2008.Realized gross margin is projected to decrease from $1.676 billion in 2007 toan even $1.6 billion in 2008.
The $76 million decrease is comprised of a $273 milliondecrease in the incremental realized value of hedges, partially offset by a$120 million increase in contracted and capacity realized gross margins and a$77 million increase in energy realized gross margins.
The increase in contracted and capacity realized grossmargins is due to a full year of RPM capacity revenues for 2008, as compared toseven months for 2007, as well as, higher prices for the RPM plan year '08,'09, as compared to the RPM plan year '07, '08.
The $77 million increase in energy realized gross margins isdue to higher prices and an increase in plant availability, partially offset bya decrease in anticipated revenues from fuel oil management activities.
Turning now to slide 21, this slide presents a comparison ofour current and previous adjusted EBITDA guidance. Our previous adjusted EBITDAguidance given on March 5, 2007, was $1,089 billion for 2007 and $914 millionfor 2008.
The decline in adjusted EBITDA guidance for both years isdue to a decrease in plant availability including Potomac River and unfavorableenergy market price movements, partially offset by higher capacity prices,lower operating expenses and the termination of the Pepco back-to-backagreement.
In addition, due to oil price increases 2007 revenues fromfuel oil management activities were lower, while 2008 revenues from suchactivities were favorably affected by a similar amount.
Turning to slide 22, let's address some of the keysensitivities regarding the guidance for 2007 and 2008 that we are providingtoday. NYMEX strip prices utilized in our guidance are as of October 16, andare $7.65 per MMBtu for the balance of 2007 and $8.12 per MMBtu for 2008.
Based upon our unhedged adjusted EBITDA for 2007 and 2008, a$1 price move in natural gas will result in a change in adjusted EBITDA ofapproximately $2 million for the balance of '07 and $30 million for all of2008.
Power price changes due to heat rate movements of 500 BTUsper kilowatt-hour will result in a change in adjusted EBITDA of approximately$2 million for the balance of '07 and $37 million for all of 2008.
The heat rates shown are 7x24 Pepco Forward Implied MarketHeat Rates. Again to emphasize these sensitivities based upon our currentunhedged adjusted EBITDA.
Turning to slide 23, this slide presents a breakdown of ourprojected capital expenditures for 2007 through 2010. Our normalizedmaintenance CapEx, which approximates about $90 million a year is expected tobe higher in the earlier years of our Maryland environmental CapEx program dueto upgrades that will be timed in conjunction with our environmental retrofits.
As Ed mentioned earlier, the total estimated cost forcompliance with the Maryland Healthy Air Act remains at approximately $1.6billion. We have expended $357 million through September 30, 2007.
As I mentioned earlier, at September 30, 2007 Mirant NorthAmerica had distributed all available cash that was permitted to be distributedunder the terms of its debt agreements, leaving approximately $946 million atMirant North America and its subsidiaries.
After the anticipated $166 million distribution in November,Mirant North America and its subsidiaries will have approximately $780 millionof cash and cash equivalents which will be available for future expendituresfor the cost of compliance with the Maryland Healthy Air Act.
Turning to slide 24, upon the filing of our 2006 federal taxreturn on September 15, 2007, we elected section 382(l)(6) treatment for ourpre-emergence NOLs.
The election of treatment under section 382(l)(6), ascompared to section 382(l)(5), preserves $1.1 billion of NOLs that would havebeen lost under a section 382(l)(5) election and avoids the potentialforfeiture of the unused NOLs under section 382(l)(5) if we were to have achange of ownership prior to January 4, 2008.
However, the election under section 382(l)(6) subjectspre-emergence NOLs to an annual use limitation. As a result of finalizing our2006 federal tax return our estimated NOL balance at September 30, 2007, is$3.4 billion for pre-emergence NOLs and $150 million for post-emergence NOLs.
And finally, our balance sheet does not reflect thepotential value our NOLs because they are fully reserved under GenerallyAccepted Accounting Principles.
And with that, I will turn it back to Ed, who wrap up andopen up the presentation for questions. Ed?
Ed Muller
Thanks, Jim, I appreciate it. Turning to page 25 tosummarize, as I said earlier we have completed a very thorough exploration ofstrategic alternatives and decided that the best thing to do at this time is toreturn $4.6 billion of cash to our stockholders.
We will do so in stages with the first stage being $1billion advance share repurchase program commencing today and a $1 billionrather open market purchase program commencing today.
And we have reinitiated guidance. Jim has just gone throughit. Adjusted EBITDA for the third quarter was up sharply 51%, principallybecause of the implementation of the capacity markets in PJM. We have completedthe divestiture program as promised and on the schedule we promised.
As Jim just described, we collected L6 treatment for ourNOLs, which we think enhances the big position tax-wise. Our operations remainlocated in US markets with significantly declining reserve margins.
This provides for the Company earnings growth for thefuture, because of those market conditions. It also societally raises pro-fundconcerns about reliability in the system.
And because of all that we look forward, when it makesfinancial sense for the Company, to adding Brownfield capacity and re-poweringand redeveloping our existing assets, which are located in urban centers withthese declining reserve margins and where we have ample room to add.
So with that, Mary Ann I think we are ready for questions.
Mary Ann Arico
Steve, we will turn it over to you to manage the Q&A.
Question-and-Answer Session
Operator
(Operator Instructions) And we will go to Paul Patterson,Glenrock Associates.
Paul Patterson - Glenrock Associates
Good morning. Can you hear me?
Ed Muller
Absolutely. Good morning, Paul. How are you?
Paul Patterson - Glenrock Associates
All right. I wanted to sort of get a clarification on thebifurcation of the open market purchase and the accelerated repurchase. Andwhen we might think those things might conclude and when you might be lookingat the $2.5 billion that's sort of left over there.
And is there any potential that the $2.5 billion might gointo investments, because you're saying that you're seeing all these reservemargin decreases and what have you -- versus actually coming back toshareholders? Just anything you could elaborate on that.
Ed Muller
Sure. First as to the timing, we -- the advance sharerepurchase program will be completed within six months. And once it iscompleted, we'll address the next phase.
Second, while the needs to which I referred are great andthey are profound and we would look forward to meeting those needs, the realityis that until we have a societal sense that we know where we are going as asociety in meeting the need for new capacity, I don't see -- and I think it isunfortunate, the ability to move rapidly forward.
So while, I think it would be great to report to ourinvestors that we are able to deploy in a way that is financially prudent someof this capital into new capacity or revised capacity, I don't think it isrealistic in this time frame.
So I would expect and we are planning to return theremainder of the $4.6 billion and to talk about how we will move forward on theremaining $2.6 billion after we have completed this first advance sharerepurchase.
Paul Patterson - Glenrock Associates
Okay. And those two repurchases are happening concurrently Ican sounds like, I mean the open market will be happening at the same time asthe accelerated repurchases?
Ed Muller
That is exactly correct.
Paul Patterson - Glenrock Associates
Okay. Thank you very much.
Ed Muller
Sure.
Operator
We go next to Andrew Levy with Brencourt.
Andrew Levy - Brencourt
Hey, Ed. How are you?
Ed Muller
I'm fine, how are you?
Andrew Levy - Brencourt
I'm all right. I just want to get to your thinking on whyyou guys didn't do a Dutch auction versus an open market. You know, stock isgetting pretty badly hurt right now. So I think most shareholders wereexpecting a Dutch auction, so just kind of want to see what you are thinking ison that.
Ed Muller
Well, our thinking in looking at all of the various meansfor returning cash is to find -- to move forward in a way that is mostefficient for the value that will remain for the long-term holders of thestock.
And so we have weighed all of the various possibilities withthat in mind and we think the method we have chosen is most likely to enhancethe value for those who will be long-term holders of the stock.
Andrew Levy - Brencourt
Why is that?
Ed Muller
I'm not going to go beyond that.
Andrew Levy - Brencourt
Well, you should be. I mean, I am a shareholder of thestock, so are many people on the call. I mean I would want to know what yourthinking is on the decision process. I mean it is $6 billion or $5 billion,whatever it is.
And you know it doesn't seem that the market is reactingfavorably to your decision. So I think it's important that you explain yourselfon why you decided this versus another method.
Ed Muller
I appreciate that.
Andrew Levy - Brencourt
So you are not going to answer it?
Ed Muller
Okay. Thank you.
Operator
We'll go next to Reza Hatefi with Polygon Investments.
Reza Hatefi - Polygon Investments
Thank you. If I look at slide 27, where you have yourgeneration, expected generation guidance, it looks like the base load coalguidance for 2008 is about 17 terawatt-hours, which is consistent with theslide from Q4 2006, where you guys initiated '08 guidance.
It looks like I guess gas and oil are down about 4terawatt-hours, because the total expected generation is 20 versus 24. Is thatdecline in 4 terawatt-hours on the gas-oil side causing the offset to theincreased heat rates as well as the capacity upside that we sort of expected?
Ed Muller
John, do you want to take this?
John O'Neal
Sure. The drop in expected generation in 2008 really is afunction of the changing gas-oil spread for our generation assets in theNortheastern part of the United States, where we have a significant amount ofoil-fired generation.
So given the current gas-oil spread, where oil prices havemoved up or resin prices -- which is in fact what we burn -- since they havemoved up quite considerably, we see less expected generation in 2008 than wedid previously.
However, that does not affect our expected capacity revenue.Because as you know, you get paid for capacity on your installed capacity, sowe will continue to earn capacity payments from those units, although we doforecast and include in our guidance a slightly lower energy revenue for nextyear because of that changing gas-oil spread.
Reza Hatefi - Polygon Investments
But I guess is it fair to assume that this decline or this-- what you just mentioned is basically offsetting any upside to capacity thatyou could have had or is that you have had through the auctions, as well as aheat rate upside?
I mean, looking at slide 22 the calendar '08 heat rate isnow 8100 and looking at the same slide from the fourth quarter it was 7500 witha sensitivity of every 500 causing $95 million improvement in EBITDA.
So going from 7500 to 8100 I would have thought that wouldbe about 90 or $100 million EBITDA improvement in addition to capacity EBITDAimprovement. So is that drop in oil, gas generation totally offsetting that? Isthat the right way to think about it?
John O'Neal
Well, partly. I mean, again the capacity revenues don'tchange by our changing forecast of how much we expect to generate. Becauseagain you're getting paid on the capacity based on the installed capacity notin fact how much it in fact generates.
Reza Hatefi - Polygon Investments
Right.
John O'Neal
On the heat rate upside, the heat rates we give to you onthis page are with respect to the Mid-Atlantic. And so to the extent we areunhedged, there has been substantial increase in the value of the portfolio asheat rates have expanded, in markets where we are not hedged and particularlyin the Northeast, you would expect heat rate expansion to generally benefit ourportfolio and it generally does.
However, if we see in the case of the oil units, oil pricesrise higher than heat rates have moved up, you would expect some deterioration.In fact, that is what we have seen in 2008 for our oil units.
Reza Hatefi - Polygon Investments
Thank you. Just finally, the Potomac issues, how much EBITDAdetriment is that causing in '08 versus your previous guidance?
Ed Muller
We do not break it out by plant and so I'm afraid we won'tanswer that question.
Reza Hatefi - Polygon Investments
Thank you very much.
Operator
We will go next to Elizabeth Parrella with Merrill Lynch.
Elizabeth Parrella - Merrill Lynch
Yes. Thank you. You are now, I think, showing that some ofthe Maryland expenditures sort of extend into 2010. Just wondering if you cangive us an update on when you see the timing of the outages to put thescrubbers on the three Maryland coal plants.
Ed Muller
We are planning all three of the plants will tie in on theirscrubbers in '09. The reason you have expenditures is that even though theprogram is done, you don't pay out all the contractors and so on as you arefinishing (inaudible) completed, right? You have holdbacks, et cetera. So it isjust how the cash flows. But the program will be done in '09.
Elizabeth Parrella - Merrill Lynch
Okay. Similar to Morgantown, are there any kind of FCR, anyother big outages other than the scrubber outages in '09 coming up over thenext couple of years? I mean other than the limitations at Potomac River.
Ed Muller
No
Elizabeth Parrella - Merrill Lynch
Just -- thinking of.
Ed Muller
No. We will be tying in the SCR at Unit 2 of Morgantown inan outage, we will take starting in February. Then we will be doing thescrubbers, the three scrubbers in '09.
Elizabeth Parrella - Merrill Lynch
Okay. A question for Jim on the guidance. If I remembercorrectly, in the '07 guidance you had a $140 million, maybe I will call it ahedging gain related to fuel oil management activities that I think wasintended to be a positive versus '06?
And I'm just wondering how much of that has been realized sofar in the first nine months? Is that still a good number for this year? And isthat sort of a natural decline in '08? Could you just walk us through thatagain?
Jim Iaco
John, why don't you? You've got that number.
John O'Neal
Yes. Elizabeth, in general the way I think about it isessentially at the time we forecast it, earlier in the year, we had anexpectation given where oil prices were, how much of that would realize in thisyear versus how much would realize in 2008.
As the shape of the curve has changed over the year, therealized earnings have moved also. In fact, we will see less realized earningsthis year from that activity and an increase in realized earnings for nextyear.
So in total I expect that in 2007 it will be roughly around$80 million which is about what we expected, which is lower than what weoriginally forecast, but almost all of that reduction has been offset byincreases in 2008.
Elizabeth Parrella - Merrill Lynch
So we should think about it as that roughly $60 millionpickup in '08 related to this? You just basically realize it over the twoyears. Is that the right way to think about it?
John O'Neal
Yes. I think that is correct.
Elizabeth Parrella - Merrill Lynch
Okay. Then just one other question in terms of how youtreated the Pepco settlement. I think it was a $362 million impact on EBITDA,which I think you kind of removed from adjusted EBITDA.
Jim Iaco
Yes.
Elizabeth Parrella - Merrill Lynch
How much of that is for the -- I think you mentioned at theoutset a number related to the reimbursement by Pepco back to May '06. How muchof it is in total? And does any of that relate to '07 that we might want tosort of treat as recurring in this particular year?
Jim Iaco
Yes. Elizabeth, the total that was refunded for paymentssubsequent to May 31, 2006, was $36 million, $19 million of that referred,applied to payments made from May 31, 2006, to the end of the year of 2006, and$17 million were payments made in 2007.
Elizabeth Parrella - Merrill Lynch
Okay. Thanks very much.
Operator
We'll go next to Brian Russo with Ladenburg.
Brian Russo - Ladenburg
Could you give us a sense of the timing on the Potomac Riverlitigation? Any calendar of events we can watch for?
Ed Muller
You know, we have I think currently pending four pieces oflitigation. The process of litigation doesn't lend itself to being able to layfull out that kind of timeline. I would like it all to move forward as rapidlyas possible and we will seek to do so, but litigation takes its own course.
Brian Russo - Ladenburg
So it is quite possible that litigation could push out into2009?
Ed Muller
I would doubt it. It's possible. But I would doubt it.
Brian Russo - Ladenburg
Okay. My last question is can you tell us how much capacityyou submitted to the latest 2009-2010 capacity auction at PJM?
Ed Muller
Yes. We do not disclose that number for earnings interest.
Brian Russo - Ladenburg
Okay. Thank you.
Operator
We will go next to Robert Howard with Prospector Partners.
Robert Howard - Prospector Partners
Good morning.
Ed Muller
Good morning.
Robert Howard - Prospector Partners
Just wanted to ask a little bit about the NOLs on the slidehere. You talked about the post-emergence NOLs was about $150 million and lastquarter when you were talking about the Pepco settlement, you talked about a$600 million tax deduction.
And I just was kind of wondering, can I look at that $600million from before as sort of creating $600 million of NOLs? And if that isthe case, sort of how did we move from that $600 million to this $150 million?
Ed Muller
Paul. Do you want to take that, please?
Paul Gillespie
Okay. The $150 million basically represents the netoperating loss for tax purposes for 2006 for the Company. The Pepco transactionarose in 2007 and it has generated for us a $700 million tax deduction thatwill happen in 2007.
That will not necessarily result in an equivalent netoperating loss because we also have taxable income in 2007, which we will usethe deduction to offset.
Robert Howard - Prospector Partners
Okay. All right. So that is another piece of value againstit that is impacting the taxes that hasn't been reflected in this slide?
Paul Gillespie
Yes. That's correct.
Robert Howard - Prospector Partners
Okay. Great. And another thing, you were talking about thePepco creating a gain and the benefit for income for the quarter but then atthe same time, we are also talking about this tax deduction and that just seemsa little counterintuitive. I was just wondering if you could explain how you couldhave a gain but then also get a tax benefit?
Paul Gillespie
Okay. For book purposes the contracts, which were thesubject of the Pepco settlement, were booked as a liability. So the gainresulted from the relief of that liability. For tax purposes, those contractswere treated as executory, meaning that we did not create a liability.
So the effect of the settlement for tax purposes wasessentially to accelerate all of our future obligations into 2007. Thoseobligations are deductible so the accelerated amount is deductible.
Robert Howard - Prospector Partners
Okay. All right. And then lastly, in the last guidance thatyou guys had given earlier in the year, just looking at the CapEx, I think youhad about $800 million or so for '08 and right now you are talking about aCapEx estimate for '08 of about $913 million. So I was just wondering what isdriving the increase there.
Ed Muller
Jim?
Jim Iaco
Yes. It is basically just a shift in the timing of theexpenditures, predominantly related to the Maryland Healthy Air Act. There isreally no overall increase, it is just a timing shift.
Robert Howard - Prospector Partners
And was the timing moving '07 stuff back or moving like '09stuff forward?
Jim Iaco
A little of both but some of the '07 expenditures moved into'08 and it is just a combination of a lot of factors.
Robert Howard - Prospector Partners
Okay. Great. Thanks.
Operator
We will go next to Jeff Coviello with Duquesne Capital.
Jeff Coviello - Duquesne Capital
Hi. Good morning.
Ed Mueller
Good morning Jeff.
Jeff Coviello - Duquesne Capital
I was going to ask the same question, I guess, about PotomacRiver. And just, I guess the recap, maybe you could recap what happened at theAir Board. I believe there was a board composed of citizens that ruled on theoperating order and kind of tweaked it a bit, that made it hard to operate morethan three units.
If you could elaborate on I guess what the most -- if thereis a most important course of recourse against that Board, where that is, andwhat your argument is?
Ed Muller
Well. We have as you, in the world of litigation, which is aworld I prefer not to be in but we are not going to have our rights ignored.
As you can imagine there are a variety of arguments and Idon't think it useful or appropriate in the course of the litigation to belaying out here how we are thinking about the litigation other than to tell youwe are litigating and intend to until we get what is the appropriate result.
Jeff Coviello - Duquesne Capital
Can you talk about what the capacity factor was on the plantyear-to-date, '07 Potomac River?
Ed Muller
I don't think we lay that out and so I think the way tothink about it in general, as I said before, is that the Potomac River has fiveunits and the restrictions that have been placed on us at the plant limit useffectively to running three units.
Jeff Coviello - Duquesne Capital
Okay. I guess my final question, just going forward, lookingat strategic opportunities and the brownfield sites, California is pretty clearthere is an RFP. As far as the Northeast and Mid-Atlantic go, what should we bewatching for?
What should we be waiting for to know when the time might beright to explore some of those opportunities, are there some one-off stuff thatis almost able to be explored now or are you still waiting for the market tomature and the political will to emerge?
Ed Muller
Yes. I think there are two factors, Jeff. The biggest one iswhat you just referred to, which is the political will or I think of it more associety coming to a conclusion on what it is prepared to do and willing to do.
Another factor is we have a variety of technical things weare looking at but it's premature to know whether they would work with all kindof things and so on.
Jeff Coviello - Duquesne Capital
And I guess just finally on the, are there any (inaudible)was there an operational review that took place during the strategic review, isthere going to be as a, moving forward as a stand-alone entity, will there bean operational review just in terms of optimizing the value and the operationsof the assets going forward?
Ed Muller
You know, the operations and how we operate were not part ofthe strategic evaluation that we did. But we do what you just described all thetime that is a continuous process for us.
And it was before April of this year and it will be aftertoday, I mean, it is the nature of being in this activity.
Jeff Coviello - Duquesne Capital
Okay. Thank you very much.
Ed Muller
Sure.
Operator
We’ll go next to Clark Orsky with KDP Investment Advisors.
Clark Orsky - KDP Investment Advisors
Hi. I just had a quick question, Jim, on the $0.5 billion ofrequired reinvestment or debt repurchase at Mirant North America what yourplans are there?
Jim Iaco
Well, the $0.5 million, I think you are referring to thecash from the asset sales proceeds that was tied to the Zeeland and Bosquesale. That cash again, is dedicated to Mirant North America operations but Ithink the more relevant number is the cash balances that are there today.
Again as I had mentioned during the webcast at September 30,2007, there's two $946 million at Mirant North America and the subs and weanticipate doing a distribution of $166 million in November.
So what is left is approximately about $780 million and as Imentioned on a webcast, that cash is restricted to Mirant North America andit's available for the future expenditures for the cost of compliance with theMaryland Healthy Air Act.
Clark Orsky - KDP Investment Advisors
Okay. So it’s not just sitting sort of at M&A or you candownstream it to Maryland to the Maryland Act?
Jim Iaco
That's correct.
Clark Orsky - KDP Investment Advisors
Okay.
Jim Iaco
That's correct.
Clark Orsky - KDP Investment Advisors
Okay. Thank you.
Jim Iaco
You’re welcome.
Operator
We’ll go next to Christopher Taylor with EvergreenInvestments.
Christopher Taylor - Evergreen Investments
Thanks. Something doesn't connect to me you've got expandingheat rates. You've got a forward gas curve, which has actually improvedslightly. You've got in PJM very good capacity payments.
Yet your EBITDA guidance is down, is this hedge related orcan you leaving aside the hedges just your pure gross margin before any hedgingimpact, what is the trend there or why is your gross margin guidance down withall these favorable factors?
Ed Muller
Well, I can probably take that. I mean the guidance is downas I indicated on the gross, when you say on the gross margin it was down about$76 million for '07, compared to '08.
But pull out the hedging activities and it is really upbecause both the energy component, which is up and the contracted and capacityrevenue component is up. The energy component is up $77 million and thecontracting and capacity, excuse me, component is up $120 million.
So what is driving it down is predominantly this incrementalmargin on our hedging activities and the reason that is down is the 2007 -- thehedges that we realized in 2007 were set at market prices that were higher thanthe market prices at the date of settlement. And for 2008, obviously thatfactor is not as prevalent and also we have lower hedge volume in 2008 than wehad in 2007.
Christopher Taylor - Evergreen Investments
So what should we look for in 2009 when the PJM capacitypayments fully kick in, should we be looking for a big increase?
Ed Muller
We're not giving any guidance for 2009 at this point.
Christopher Taylor - Evergreen Investments
Well, then the second question I wanted to ask was in termsof -- where do you guys go from here? If you had strategic buyers look at youwith all these favorable trends, restricted capacity issues, heat rateexpansion, blah blah blah; but yet a strategic buyer was not willing to pay a10 times multiple, why should we as public investors have faith if strategicbuyers didn't have faith? It is like, what is this Company's future?
Ed Muller
Well, first, you have assumed what occurred during thisprocess; and I don't want to leave the notion that your description is accurateor inaccurate. I don't intend and we don't intend to comment further than tosay we did a very thorough evaluation and concluded that returning the cash atthis time was the best way forward.
The Company is healthy, is viable and is well positioned. Weintend to run it and maximize its value and look to the future.
Christopher Taylor - Evergreen Investments
Well, I've misphrased my question then. I wasn't implyingthat a specific strategic buyer there. But in general, you were on the marketfor six months. So presumably any strategic buyer at least gave a quick glanceand they decided to take a pass. So post this $4 billion, where is the value inthis Company?
What is your long-term future? You have sent a very strongmessage that being independent is not part of your future and now you havechanged course. I'm just confused where this Company will be in three years.
Ed Muller
Well, first of all, again your question assumes whatoccurred during this evaluation and I'm not going to comment further on it.Second, you referred to $4 billion. We are going to return $4.6 billion. Idon't want to ignore the $600 million.
Christopher Taylor - Evergreen Investments
Fair enough.
Ed Muller
And third, we sent a message that we are focused ondelivering value to our owners and there are different paths to do that. Thereis not just one. We have evaluated a variety of ways to do that.
At this time, we see the return of cash as the best pathforward. And where will be in three years will be -- depends on a variety ofthings, but certainly can include running a business in a market that hasrising demand and needs more capacity, where prices should be rising. That is anice business to be in.
Christopher Taylor - Evergreen Investments
But then if it is a nice business to be in, how come all thebuyers out there took a pass? I guess that's what I'm trying to understand.
Ed Muller
Now, as I said, I am not going to comment on what went onduring this process. And we are -- we have told you what we are going to do andI think on that probably enough said.
Operator
And we'll go next Vikas Dwivedi with Morgan Stanley.
Vikas Dwivedi - Morgan Stanley
Good morning.
Ed Muller
Good morning.
Vikas Dwivedi - Morgan Stanley
Just wanted to make sure I understood the resid to gasspread drivers. I guess resid is up strong on the back of crude. But it seemslike the resid to gas relationship, I'm sorry the resid the crude relationshipitself has gotten even stronger. And when I look at the low-por or thehigh-por, low sulfur resid it is in the $13 per MMBtu range.
What kind of spread -- I mean, I guess in you all'smodeling, how do you look at that, I mean does crude have to come back into the55 or 60 range, if gas is static on the forward curve? Or is this a driverthat's going to be potentially, if crude stays where it is, just not going tocome back your way for quite some time?
Ed Muller
John, do want you take that it?
John O'Neal
Sure.
Ed Muller
I'm sorry. I didn't mean to cut you off. Hang on, John.
Vikas Dwivedi - Morgan Stanley
No, that's was I guess the question. I mean, can you guyssee -- first of all, I would be curious, who is buying resid? Is it the freightmarket that's got it bid up even versus its normal relationship to crude?
John O'Neal
Vikas, this is John O'Neal. I won't comment on the broadermarket question about who's in the market and what they're up to. With respectto how it affects Mirant. You know in our Canal station those units burnprimarily resid although one of the units does have some dual-fuel capabilityto burn natural gas.
So primarily those units are resid units. And so in the veryhigh-priced environment that you describe those units are certainly as we seeit on a forward basis, less economic now than they have been in the past.
And so, you're right it would take some change either in theoil complex or the natural gas complex for us to see those units be as economicin the future as they have been in the past.
However, and as I pointed out earlier, those units continueto earn very steady capacity payments because the capacity payments are not atall linked to how economic they are on an energy basis. And so that's how I'dsee Canal.
With respect to our other large oil-burning units at ChalkPoint in Maryland and at Bowline in New York those units have the benefit ofbeing able to burn either oil or natural gas.
And so while, we have seen they are relatively less economicon oil, they are when they do or called on to run in times of high demand, I'mable to run on natural gas. So in general, I would say the rise in oil pricesrelative to gas is a net negative for us on those oil units, but it is offsetsomewhat by increased gas runs on those units that can burn natural gas.
Vikas Dwivedi - Morgan Stanley
Got it. Okay. Thank you.
Operator
We'll go next to Lee Cooperman with Omega Advisors.
Lee Cooperman - Omega Advisors
Thank you very much. You know, this is kind of a strangecall in a sense because you're very forthcoming on all the analytics about thebusiness, very thorough, very complimentary but very vague about the process?
So let me just tell you how I kind of react to the fact.Frankly, I think you should be forthcoming because you don't want to be tradingagainst your shareholders. So I am assuming basically what happens is that thestrategic or financial buyers weren't prepared to pay a price that you felt thebusiness was worth.
Okay. And then you had to then take your next step. I amassuming and this is a very important question to me and I hope you will beforthcoming that if you felt that you were not creating value for thoseshareholders that are holding on, you would not be buying back stock but ratherjust resort to a cash dividend and let the shareholders take their money and dowhat they want with it.
But by virtue of buying back stock, you think that youcreate additional value, assuming you buy it at appropriate prices for thoseshareholders that intend to hold on. Is that interpretation reasonable?
Ed Muller
Well. Lee, let me answer this way. First, I don't want to --by not commenting on it agree with the various assumptions you have made aboutwhat has transpired. So please don't take that conclusion.
But as I said, we're going about returning cash in a waythat we think will deliver value to the long-term holders of the Company and Ithink in that sense, the answer to your question is yes.
Lee Cooperman - Omega Advisors
Exactly. In other words, you would not be buying back sharesunless you felt you would be leveraging your return to the investors that arepatient enough to hold on. Because you got a rogue's gallery of shareholders, abunch of hedge funds -- not there is anything wrong with hedge funds since I amone of them but basically we tend to have a longer-term horizon.
If you felt the value was very full and that the sharesdidn't offer long-term attraction, you would resort to paying us a dividend andsay, go on and take that money and do what you like with it.
As opposed to saying, well, if you trust us, we think thatwe can create more value for you by us doing it the way we are doing it. Ithink you have answer to that question.
Ed Muller
Well. Yes. I have. But I will -- I have to take exception,Lee, to the notion that we have a Rogue's gallery of shareholders.
Lee Cooperman - Omega Advisors
I was including myself in that Rogues' gallery. How's that?Self-depreciation. All right. It's okay. I have a good feeling about myself. Ihave a good feeling about you, actually. All the best and I think you haveanswered my question.
Ed Muller
Thanks Lee.
Lee Cooperman - Omega Advisors
Thank you and all the best.
Ed Muller
Thank you. You too.
Operator
We'll go next to [Gil Nathan] with Restoration Capital.
Gil Nathan - Restoration Capital
Yes. Hi, guys. Can you hear me?
Ed Muller
Absolutely. Go ahead, Gil.
Gil Nathan - Restoration Capital
You know, on the back of what Leon just said, you didn'twant to discuss obviously the process and we are not asking for that. But I waswondering with the share buyback, does it have to do with the NOLs? Is that thebest use? Or was there a tax implication here? Is that something you can answerfor us?
Ed Muller
There is not a tax implication.
Gil Nathan - Restoration Capital
So that had nothing to do with it. Okay. So on your guidancefor '08, obviously, you have talked a little bit about why it is down thehedges are. Can you attribute how much it is affected by the outages or howmuch it is affected by three of the five plants running at Potomac?
Ed Muller
As I have said before, we are not prepared to start goingunit by unit. We obviously described to you the major elements. So when youlook at the numbers, you can draw that general conclusion but I don't want togo beyond that.
Gil Nathan - Restoration Capital
Okay. And your slightly free cash flow is negative next yearbecause of your CapEx. How much of that cash -- I know you have the restrictedcash at North America. How much of that cash is going to be used at MirantNorth America?
Ed Muller
Well. Jim or Bill can help me but the point -- thus wehaven't done as good as job as we ought on this. But here is our basic point.We have a $1.6 billion program. We have expended as of September 30, $357million of the $1.6 billion and even after the $166 million dividend that wewill be authorized to withdraw from Mirant North America, we will have north of700 -- north of $0.75 billion in Mirant North America and we will use all ofthose funds for the Maryland Healthy Air Act expenditure.
So if you assumed that it took all of the $1.6 billion andyou subtracted the $357 million, you would have $1.25 billion and we have $0.75billion sitting in Mirant North America available plus we will be generatingmore cash.
So in the great scheme of things, we will use all of thecash that is there. We will generate more cash and to the extent we are shortwithin Mirant North America, we will inject the remaining cash in.
Gil Nathan - Restoration Capital
Okay. And on the share buyback, I guess I am a littleconfused about the JP Morgan purchase. Can you explain the workings of that? Imean you guys are giving them the cash today, I suppose and they're able --they have their own discretion to buy it over six months? How does it work?
Ed Muller
Bill Holden, why don't you address this question?
Bill Holden
The way that the ASR will work is we will pay JP Morgan $1billion. They will actually borrow Mirant shares in the market. The number ofshares that they borrow, we estimate it at 24 million but the actual numberthat they will borrow and deliver to us will be based on the closing pricetoday.
So it will be $1 billion divided by today's closing price.The settlement for those shares will be on Tuesday of next week. So we willtake delivery of the shares, we will pay JP Morgan $1 billion. They will thenbuy shares in Mirant stock over a period of up to six months to cover theirposition.
And then at the end of that period, when they have boughtall the shares to cover the position, there will be a true-up based on avolume-weighted average price of Mirant shares over the period minus a setdiscount that we have agreed with JP Morgan.
Gil Nathan - Restoration Capital
And are you prepared to make that discount public?
Bill Holden
No. We’ve agreed with them to keep that confidential.
Gil Nathan - Restoration Capital
Okay. And I guess, I am just a little confused as to howthis is beneficial to shareholders overall versus a Dutch auction. I mean witha discount and there it sounds like you're at the beck and call of JP Morgan,so?
Bill Holden
I think as Ed mentioned.
Gil Nathan - Restoration Capital
As opposed to a $2 billion share repurchase in the openmarket by yourself?
Bill Holden
Again, I would offer a couple things. I think as Edmentioned, we look at a variety of alternatives and we believe that this whatwe have outlined is the most efficient way to execute the return of capital toshareholders.
The only other point I would note with the ASR, theaccelerated share repurchase contract does qualify for equity accountingtreatment. So our share count will be reduced immediately upon the delivery ofthe borrowed shares from JP Morgan to Mirant. And then any subsequent true-upwould just be an adjustment to the equity account when the true-up occurred.
Gil Nathan - Restoration Capital
And can you guys repurchase warrants in this also, becausethose if your attempt is to buy shares back cheaper it would be more accretiveright, if the long-term -- to improve long-term value?
Bill Holden
The warrants are not part of the accelerated sharerepurchase.
Gil Nathan - Restoration Capital
Okay. Thank you very much.
Operator
We’ll go next to Brian Chin with Citigroup. Brain your lineis open, please go ahead.
Brian Chin - Citigroup
Hi. This is Brian Chin. Quick question for you, do you guyshave any opinions against a Dutch tender for the remaining portion of thebuyback on the tail end?
Ed Muller
Brian, it is Ed. How we will go about, how we will proceedafter the advance share repurchase is completed. We will announce when we areready to announce it.
Brian Chin - Citigroup
So you don't have any opposition to a tender on the tailend?
Ed Muller
All of the various means for returning cash including thatwould be things that we will evaluate at the time.
Brian Chin - Citigroup
Thank you.
Operator
We’ll go next to Lasan Johong with RBC Capital Markets.
Lasan Johong - RBC Capital Markets
Yes. Good morning. Wanted to kind of get your thoughts onwhy 2010 has power hedged out but no fuel associated with it. In general, kindof how you approach the hedging in terms of a philosophical approach.
Do you look at it as opportunistically trying to lock ingood -- what you feel is good prices or is this kind of varying it as over timekind of on a scheduled basis where regardless of price you are going to lock insome amount of power and fuel?
Ed Muller
Well, it is this. I think we have to step back and ask whatwe're seeking to do in terms of a philosophy and that is, we seek to havestability and smooth out the vagaries of the market so that we can run thebusiness including knowing how much cash we need.
That said, when we choose to make each decision we assessbased on what we, our experience in the market. We are active in these marketsdaily, hourly and so, we don't have necessarily all of the decisions made oneach element at the same time.
Lasan Johong - RBC Capital Markets
So, are you going to be opportunistically hedging based onwhat you think is an appropriate price?
Ed Muller
Yes. Sure.
Lasan Johong - RBC Capital Markets
Okay. Then in 2010, why the 20% baseload coal hedge on thepower side but no accompanying fuel, are you assuming that some of the fuelfrom '08 and '09 are going to be passed down to 2010?
Ed Muller
John, why don't you address this?
John O'Neal
I mean, in general we are, as Ed described, we opportunityto look -- we look at the market and time our hedges when we think it makes themost sense. We look at our coal hedges slightly differently.
And we are in the market quite frankly conducting RFPs andmaking other market purchases to secure our coal on a longer-term basis.Oftentimes, those things don't line up exactly but in general, we would seek tohedge out our coal consistent with our power hedge.
You're assumption is correct, the way we look at it while weare somewhat unhedged in 2010, we are overhedged relative to our power sales in'08 and '09. So we look at that as a relatively flat position. But in generalwe are in the coal markets looking to lay off our coal hedges two, three, fouryears out.
Lasan Johong - RBC Capital Markets
Okay. So it is not like you're taking a negative positionand making a bet on power price in 2010?
John O'Neal
That's correct.
Lasan Johong - RBC Capital Markets
Okay. I understand. Thank you very much.
Operator
We’ll go next to Alex Mazier with Sandell Cap and AssetManagement.
Alex Mazier - Sandell Cap and Asset Management
Hi. It's Alex Mazier from Sandell. Two questions, one, whatwas your availability assumption back in April when you first issued guidanceand what is it now?
And the second question is could you give us your point ofview with respect to any development in capacity markets for California, whatsort of framework could be possible in that time frame?
Ed Muller
Jim, why don't you address the first?
Jim Iaco
On the availability, I don't think we are breaking it downin a percentage what our commercial availability is. So I can't answer thatsecond and I think on the third regarding California, it is probably…
Ed Muller
I will take it. It is early stage. We obviously spend a lotof time given the assets we have there on the subject, but it is premature tohave views. And there are lots of very sophisticated parties and entitiesaddressing this subject.
And it will evolve, but our internal views; I don't think ourworth that much for you right now other than that they are ours. Nor, do wewant to be laying them out, as we are a participant and how this market willevolve.
Operator
And due to time constraints, we will take our final questionfrom Steve Moyer with TCP.
Steve Moyer - TCP
Hi, guys. Thanks.
Ed Muller
Sure.
Steve Moyer - TCP
Two sort of cleanup things, perhaps one, on the large NOL,what would be the circumstances that would allow the reserve to be looked at,so it would be recognized on the balance sheet and what other GAAP implicationswould there be from that?
Ed Muller
Paul or Jim, how do you want to do that?
Paul Gillespie
Well, we -- quarterly we reviewed the issue of whether ornot the evaluation reserve will be removed. The reason it has not been removedto date is our lack of history of net income.
Now, obviously as we move out over time our history becomesbetter in that respect. Now, if the valuation allowance is removed there willbe a substantial non-cash increase in our net income.
Steve Moyer - TCP
Second issue, there appears to have been some developmentsin Maryland on the proposed system for allocating emission allowances goingforward. Could you comment on the possible impact to your business from those?
Ed Muller
Sure, let me try. I take it to make sure we are all on thesame page. You're referring to RGGI?
Steve Moyer - TCP
Yes.
Ed Muller
The Regional Greenhouse Gas Initiative and I take it you arereferring to whether and to what degree any of the emissions credits would beallocated rather then auctioned.
Steve Moyer - TCP
And I might correct that the current proposal at least is toauction 100%.
Ed Muller
That is our understanding of the proposal. I think -- and ofcourse this is still all very much in flux, recognizing that Maryland isdealing with a variety of questions and issues and trying to think through howto address electricity in policy.
But, I think a couple of things are worth noting. To theextent that, as is the case coal sets price on the margin in Maryland abouthalf the time, to the extent that the coal units are in Maryland and havetherefore borne the costs for this -- however, the cost is calculated, youwould expect to see it in prices.
And that's the way the world works. To the extent gas setsthe price and it is gas in Maryland. Then the cost borne by the gas-firedgeneration you would expect to see in the price. And for that it is importantto recognize what the carbon dioxide content per unit of electricity generatedby gas is compared to that generated by coal.
And the answer is somewhere around 60%. That is gas -- likeany other hydrocarbon will cause when it's burned the release of carbondioxide. And it is 60% to two-thirds of the carbon dioxide comes out bygenerating with gas compared to coal. So there would be some cost impact onsomeone like us, because if we wouldn't have a full inclusion in the pricingthere.
But, the notion that all of this somehow ends up sitting atthe generator's table is incorrect. Now, to the extent that price is set at avery low-priced time by power coming from non RGGI states transmitted into thezone, then you would have the situation where they would not have those costsand how their pricing would not include those costs.
So you could imagine in their pricing and their thinkingabout how they are bidding to come into the market their recognition that thenative load -- the native generating capacity rather in Maryland has to bearthis cost. So how much of it can they get?
So the question in thinking about this, and I think it'simportant not just for investors thinking about it and us thinking about, butit's also very important for policymakers thinking about it is there is no freelunch. And for us, when we think about the costs and we would expect there tobe some cost based on how we're seeing this evolve, we are thinking about it interms of the net cost.
Because there will be a cost and there will be a headlinenumber and it will blast around somewhere on the headline in the press and whathave you. But then there will be the question of how much of that cost ends upgoing to the ultimate consumer.
I mean, the reality is, as I think is probably fairlyevident a cap and trade program, which is what this is, if you go forward, ifthey go forward with RGGI -- is an indirect tax.
And the question is, where does the tax the incidence oftaxation land? And the one thing that is clear as we think about it is 100% ofit does not land on the generator. And so now, that -- from there you come to anet number.
And I think, as people go forward on all this, policymakerswill have to think about the impact of that. The voters ultimately are going tobear the overwhelming bulk of this cost.
Steve Moyer - TCP
Got it. Thank you for the insight.
Mary Ann Arico
Thank you. Steve Moyer. And I will be available thisafternoon to answer any further questions you have, Steve on the conferencecall. Thank you.
Operator
Thank you. This does conclude today's conference. Thank youall for your participation. You may now disconnect.
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