Constellation Energy Group, Inc. Q2 2008 Earnings Call

Constellation Energy Group Inc. (CEG)

Q2 FY08 Earnings Call

July 31, 2008, 08:30 AM ET

Executives

Kevin Hadlock - Vice Prezsident of IR and Financial Planning and Analyst

Mayo A. Shattuck III - Chairman, President and CEO

John R. Collins - EVP and CFO

Thomas V. Brooks - President, Constellation Energy Resources, and EVP

George E. Persky - Co-Chief Commercial Officer of Constellation Energy Resources

Analysts

John Kiani - Deutsche Bank

Gregg Orrill - Lehman Brothers

Rudy Tolentino - Morgan Stanley

Shalini Mahajan - UBS

Ashar Khan - SAC Capital

Paul Patterson - Glenrock Associates

Presentation

Operator

Good morning and welcome to Constellation Energy's Second Quarter 2008 Earnings Call. At this time, all participants are in a listen-only mode. [Operator Instructions] Today's conference is being recorded. If you have any objections, you may disconnect at this time.

I will now turn the meeting over to the Vice President of Investor Relations and Financial Planning and Analyst for Constellation Energy, Mr. Kevin Hadlock. Sir, you may begin.

Kevin Hadlock - Vice Prezsident of Investor Relations and Financial Planning and Analyst

Thank you and good morning. Welcome to our second quarter 2008 earnings call. I am glad you could join us today.

Before we begin our presentation, let me remind you that our comments toady will include forward-looking statements which are subject to certain risks and uncertainties. For a complete discussion of these risks, we encourage you to read our documents on file with the SEC. Our presentation today is being webcast and the slides are available on our website, which you can access at constellation.com under Investor Relations.

On slide 3 you'll notice we will use non-GAAP financial measures in this presentation to help you understand our operating performance. We've attached an appendix to the charts on the website reconciling non-GAAP measures to GAAP measures.

With that, I would like to turn the time over to Mayo Shattuck, Chairman, President and CEO of Constellation Energy.

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Thank you, Kevin. Good morning everyone and thank you for joining us today. For the second quarter of 2008, we recorded adjusted earnings of $1.82 per share, a $1.18 above the adjusted $0.64 per share earned during the second quarter of last year.

As we mentioned at our annual meeting of shareholders, these results significantly exceeded our exceptions, reflecting strong execution at each of our operating divisions, with particularly strong performance at our Global Commodities Group. We are also reaffirming earnings guidance for 2008 of $5.25 to $5.75 per share.

Now let's turn to slide 5 for a review of the second quarter's operational highlights. Our nuclear generation fleet continued its excellent operating performance in the second quarter. We successfully completed the Ginna and Nine Mile Point Unit 2 nuclear refueling outages while maintaining a very low forced outage rate across the nuclear fleet. We are proud of our three refueling outages that resulted in the first, third and 11th shortest durations out of 42 units refueled in the first half of the year.

In addition, we expanded our existing fleet by 300 megawatts through the acquisition of the West Valley facility in Utah and the refurbishment of our Gould Street Plant in Baltimore.

Our Global Commodities Group delivered strong new business results as rising commodities prices benefited our strategies in power, natural gas and coal markets. We continued to execute our Invest-Develop-Harvest strategy with the sale of gas assets in Arkansas.

With the purchase of Nufcor, we acquired specialized Uranium capabilities and expanded our risk management services.

At BGE, our Smart Energy Savers program is moving forward with a very successful results. Our peak rewards program launched earlier this summer, and we just began a pilot program of advanced metering and dynamic pricing.

The PSC also authorized last year unlimited number of energy efficiency programs and we are now working towards approval of a broader portfolio of conservation initiatives. The combined potential of the programs, including smart thermostats, advanced meters, dynamic pricing and energy efficiency, is between 1500 and 1700 megawatts.

To put that into context, our two-unit Calvert Cliffs plant produces 1735 megawatts. So these plants are roughly equivalent to a large nuclear facility. The gains we can make with demand response are extraordinary. It represents one of the most encouraging developments for BGE customers in the energy sector overall.

Turning to slide 6. As you can see from the chart on this slide, energy commodity prices in the second quarter escalated even faster than in the first quarter of this year. Through the second quarter power and PJM has risen 33% in 2008 while coal has jumped an unprecedented 153%. Market liquidity appeared to improve in the second quarter, though activity remains well below 2007 levels.

As you've seen from our past performance, volatile markets typically result in success for our businesses. We started the quarter with the fundamentally bullish outlook on commodity prices and, as shown here, all energy commodity markets move dramatically higher. As a merchant supplier, we are able to identify opportunities to serve customers which provide an insight to acquire assets and deploy risk capital at the right time.

As I said in our annual shareholders meeting earlier this month, the effects of the current rising commodity cycle have been and will continue to be significantly exacerbated by host of environmental and reliability issues. And investment in energy infrastructure is almost, by definition, an investment in the environment.

We are today making more that a $1 billion of investment in air quality control systems for our coal plants in Maryland while also investing in efficiency, conservation and demand response programs at BGE. We are finding commercial opportunities to meet the growing customer interest in solar and other renewable technologies.

Meanwhile, there is intense pressure to hold down electric prices, despite the expectation that reserved margin should grow and be met only with cleaner resources.

Turning to slide 7, the big picture is that we are witnessing the inevitable and appropriate convergence of energy policy with environmental policy, and this is especially apparent in terms of greenhouse gas regulation. These environmental and energy policy dynamics appear to be paving the way for new nuclear plants to be built. Therefore, I'd like to provide you with an update on our new nuclear initiatives and the potential for our third unit at Calvert Cliffs.

As you know, while we haven't made a decision to begin early site work for Calvert Cliffs unit 3, we continue to actively develop our options so that we can be in the best position to quickly move forward if the project economics, including affordable financing tax and other incentives, encourage us to do so.

To that end on June 30, the DOE issued the solicitation for loan guarantee applications. The solicitation lays out a timeline that suggests that we will not know until next year if our project has been selected to begin a financing discussion.

Financing, certainly through an affordable structure is critical to our build decision. We're pleased to finally see the loan guarantee solicitation. However, the proposed approach and the approval process still presents many challenging issues that must be satisfactorily addressed. We're working through the application process and expect to submit part 1 of the loan application next week. Although, precise timing is difficult to predict, the loan guarantee process pushes our decision to begin early site work into next year.

The other major factor, of course, is cost. Putting a price on carbon emissions is of central importance, and despite a stalled federal debate, we will begin to see carbon pricing later this year when the first auctions take place under the Regional Greenhouse Gas Initiative.

Whatever the price implications of carbon regulation all signs point to energy costs continuing to trend upward in the years ahead. We have also seen tremendous escalation in near record prices for steel, cement and other construction materials. Many of the materials and components of a new reactor will come from abroad as U.S. abandoned its nuclear manufacturing base many years ago. All of this will drive the cost of new plants higher.

However, we believe that we benefit from the knowledge and experience of our partners Areva, Bechtel, Austin, and especially EDF who is currently building in Flamanville, France. As we observe the cost estimates of other single unit plants, we are seeing current

overnight cost in the 4500 to 6000 per kilowatt range.

Our own estimate for the cost of a third unit at Calvert Cliffs is in the mid upper end of this range, due to the added security and safety features of the USEPR. The impact of rising costs for new generation and the availability of attractive financing are significant drivers in our decision process and timing to pursue building a new unit at Calvert Cliffs.

The primary objective has been to develop the strategic option to pursue new nuclear and we continue on that path. At ever step of the way, balance sheet exposure and cost management have been key areas of focus and will continue to be managed with great care.

Turning to slide 8, in closing, I am especially pleased with the strong performance of the company during the second quarter, and we're confident we can achieve our guidance range for 2008. Therefore, we are re-affirming our 2008 earnings guidance of $5.25 to $5.75. For 2009 we continue to forecast earnings growth of 15% to 20% over 2008. Over the five year planning horizon we continue to project an average growth rate of greater than 10%.

With that, I will turn the presentation over to John to review the financial results.

John R. Collins - Executive Vice President and Chief Financial Officer

Thank you Mayo, and good morning everyone.

Let's begin on slide 10. Second quarter GAAP earnings were $0.95 per share. After special items, adjusted earnings were $1.82 per share. Let's walk through the major adjustments to GAAP earnings.

As expected, we recorded a negative $0.59 special item at BGE related to the $188 million customer credit that was included in April and will be applied to customer's bill in September. The credit also causes a reduction in BGE's full year effective tax rate which impacts all four quarters.

In addition to classifying the $188 million credit as a special item in the second quarter, the impact of the lower effective tax rate on normal earnings would be classified as a special item in each quarter. We had a $0.19 loss on economic non-qualifying hedges. The loss in the second quarter was related primarily to gas transportation.

Looking at our segment performance in the second quarter compared to last year, the merchant was up $1.18 per share, utility was up $0.01 and other non-regulated was down a penny. Overall, adjusted earnings were up $1.18 per share. I will speak to the segment results in more detail on the next few slides.

Turning to slide 11. Compared to prior year, BGE was up $0.01 on adjusted basis due to higher electric transmission revenue and the benefit from the Maryland settlement, which was partially offset by higher storm expenses. BGE's second quarter 2008 adjusted earnings of $0.09 per share was just over the upper end of the second quarter guidance range of $0.04 to $0.08 per share.

Turning to slide 12. Compared to the second quarter of last year Merchant adjusted earnings were up $1.18 per share. On the positive side, Global Commodities was favorable $1.20 per share driven by strong new business results and an increased backlog realization, compared to a relatively weak second quarter 2007. And Customer Supply was favorable $0.14 per share, primarily driven by favorable mark-to-market results in retail gas versus the second quarter of last year.

I will cover the drivers to Customer Supply and Global Commodities in a moment. Lastly, generation was unfavorable $0.19 per share, primarily driven by the differences in plant refilling outages at our nuclear plants, as compared to the same quarter of last year. Higher costs to improve fossil peaking unit liability in response to PJM's RPM capacity market and unplanned outages at our Baltimore coal plant.

Turning to slide 13. This chart provides an update on how changes in market forward prices and hedging activities affect generation EBITDA. For 2008 we are forecasting un-hedged EBITDA of $3.1 billion. Netting the hedging impact of approximately $2.1 billion, our hedged EBITDA is forecast to be about $1.1 billion this year.

As Mayo mentioned, regional Greenhouse Gas Initiative takes effect January 1, 2009. This is earlier than we initially assumed and has the result of reducing our current hedge EBITDA forecast for 2009.

Over the last quarter, the power curve and forecasted coal prices have risen. We currently forecast un-hedged EBITDA of $2.8 billion by 2011. This is approximately $1.5 billion higher than what we shared with you in April.

Turning to slide 14. As you see in the chart on the top of the slide, during the quarter, Customer Supply realized gross margin of $277 million. This was in line with our second quarter expectation. Year-over-year, on a comparable basis, gross margin is up $66 million or 30%. The difference is primarily due to increased new business at retail gas.

The retail power retention rates, including the customers that remain on a month-to-month basis, increased to 76%, consistent with last year's rate. Of the customers we've retained, a significant remained on short term contracts due to the high price energy environment that persisted through the second quarter. In the second quarter, gas price margins were $2.49 per megawatt hour, down from the $3.01 level of the second quarter 2007, primarily reflecting increased competition, especially in Texas and New England.

Additionally, our product mix in the second quarter was more weighted towards lower margin products, compared to the same period last year. Retail Gas retention rate remained strong at 95% and realized margins improved by $0.10 over last year, partially driven by our Midwest acquisition of Cornerstone Energy.

In summary, our Customer Supply businesses, Wholesale Power, Retail Power, and Retail Gas are on track to achieve their 2008 earnings targets.

Turning to slide 15. Taking a look at the Customer Supply group backlog, we have built 2008 backlog to the second quarter that represents about 91% of the gross margin we expected to realize, when we talked to you in January.

For 2009, we've increased our backlog by $55 million, driven by both Retail and Wholesale Power. However, in Retail Power, we have not seen evidence of the cyclical recovery and subsequent increase in customers entering into long-term contracts that we discussed in January. Consequently we're behind where we expected to be in creating backlog for next year.

Moving to slide 16. Now, turning to the Global Commodities group, as you can see in the column on the left, total contribution margin during the quarter was $486 million, including backlog of $47 million and $439 million of new business.

Backlog realization in the second quarter was up $15 million versus the same period last year. New business in the second quarter was $386 million higher versus last year's second quarter, driven primarily by an increase in portfolio, management and trading of $346 million. As Mayo stated, we entered the second quarter bullish on energy commodities and certain price relationships among commodities and locations given of what we observed in the first quarter.

We benefited in our power, gas and coal businesses from what turned out to be a rapidly rising market, even while maintaining risk levels comparable to the fist quarter. In addition, energy investments was up year-over-year driven by a $76 million gain on the sale of certain gas assets in Arkansas.

As Mayo mentioned, this is the continued execution of our upstream back gas [ph] strategy of invest, develop and harvest. Looking at the bottom portion of the chart, you can see that we have generated $465 million of new business year-to-date. These results are driven by strong year-over-year performance in all three areas, energy investments, structured products and portfolio management and trading.

Turning to slide 17. As we told you in January, we expected to be in the capital markets in 2008 and in the second quarter, we raised $1.1 billion of capital. As previously discussed, our $2.4 billion 2008 capital expenditure plan primarily consists of environmental projects, projects which improve plant reliability, investments in BGE's infrastructure and conservation programs, and investments in strategic opportunities.

Overall, 2008 capital spending is approximately $800 million higher than our 2007 capital expenditure program.

Through the end of the second quarter, $1.2 billion has been spent of our $2.4 billion capital program. In addition to capital expenditures, BGE has $300 million of debt maturities this year, which we plan to re-finance.

In June, we also added an additional $1.1 billion of credit facilities to support the continued growth of the business and to maintain an adequate liquidity position.

Now let's turn to slide 18 to discuss liquidity. At the end of June, our net available liquidity was $2.9 billion compared to 3.1 billion at the end of March. We have normalized our net available liquidity presented on this page to exclude certain transitional liquidity items that were not intended to support normal operations.

During the second quarter, we added an additional $1.1 billion in credit facilities to address the significant increase in energy commodity prices, which resulted in the issuance of an additional $1.75 billion in letters of credit to support our risk management and hedging activities.

Turning to slide 19. As in the first quarter, we are using the same format to report cash flow so it is more closely aligned with our GAAP cash flow statement. Adjusted cash flow from operating activities was a positive $262 million during the second quarter.

Adjusting for investing activities, free cash flow was a use of $466 million primarily driven by capital expenditures. Cash flow from financing activities, which primarily reflects the debt insurances during the quarter, was a positive $1 billion resulting in a change in net cash of $568 million in the second quarter.

Looking at each segment, Merchant generated approximately $450 million in cash flow from operations, excluding changes in working capital. Increases in working capital were driven primarily by $400 million of additional initial margin requirements under new exchange rules.

Additionally, BGE generated $187 million of adjusted operating cash flow this quarter. While BGE's GAAP net income was negative due to the one-time customer credit associated with the Maryland settlement, actual cash flows for the settlement will occur later this year.

Turning to slide 20. We continue to maintain a strong balance sheet. Total debt outstanding increased to $5.6 billion in the quarter, reflecting the new issuances previously noted. Price changes and hedging contract expirations running through our accumulated other comprehensive income, were major contributor to the increase in equity. These changes caused the net debt to total capital metric to improve by roughly 100 basis points in the quarter.

Adjusting for third party collateral held and adjustments to equity from changes and accumulated other comprehensive income, adjusted net debt to adjusted total capital increased to 42% during the second quarter. As you will recall, all of these metrics exclude the impact of the BGE securitization debt.

Turning to slide 21. Let me wrap up with a brief review of our third quarter outlook. Consistent with the approach we introduced in January for the first quarter of 2008, we are providing a few key operating and financial metrics to help you understand our expectations for the third quarter.

First, we are providing a BGE earnings range of $0.13 to $0.17 per share. This compares to our third quarter of 2007 earnings of $0.14 per share. For generation, we are providing a hedged EBITDA forecast of $437 million which is $127 million higher than the hedged EBITDA of $310 million earned in the third quarter of 2007, driven mainly by the continued roll-off of below market hedges and higher capacity prices.

Customer Supply backlog is expected to be $113 million in the third quarter of 2008 because we did not measure 2007 backlog in a manner comparable to today, we are not providing an estimate for the third quarter last year. However, as a point of reference, total realized Customer Supply gross margin in the third quarter of 2007 was $163 million.

To wrap up, we wanted to provide you some thoughts on our expected earning pattern for the remainder of 2008. Today, we affirm guidance of $5.25 to $5.75 per share for 2008. We expect roughly a third of the balance of the year earnings to occur in the third quarter and two thirds to occur in the fourth.

That concludes my remarks. I will turn the call back over to Mayo for concluding comments and question and answers.

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Thanks John. Before we take your questions, I wanted to comment briefly on our business outlook and future investment for growth.

Mid-way through the year we're pleased with our overall operating performance. While we've experienced greater variability in our quarterly results, which was a major driver for our decision to discontinue quarterly guidance, we think our second quarter results speak to the strength of our operating model and our focus on execution. We remain very confidence in our long-term outlook given market fundamentals that are supportive of the value of our underlying assets. This is particularly true in our generation business which we see as a significant driver of shareholder value over the next several years.

While we're pleased with the overall operating performance of the company, we understand that the recent performance of our stock does not reflect the underlying value of our assets. While some of this is directly related to the tough economic and market environment, we believe that our current stock price significantly undervalues the company and we intend to take strategic steps to address this valuation gap.

In addition to continuing to execute on our basic business plan, we are focused on two additional drivers of shareholder value. First, optimizing our business mix as it relates to our allocation of capital, and second, driving long-term growth by continuing to make investments to grow our physical asset base.

Focusing on our current business mix, we're actively assessing the ongoing capital requirements of our Global Commodities business. In that regard, we're considering various strategic alternatives for our commodities business. These alternatives may involve various approaches including possible partnership arrangements.

We have had a very successful first half of the year and our performance demonstrates the strength of our business model. As we look to the future we will remain focused on maximizing shareholder value by executing in our plan while optimizing our business mix and pursuing additional growth through investment in our physical asset base.

And now we'll be pleased to answer your questions. As usual we have the management team here to assist. Operator?

Question And Answer

Operator

Thank you. [Operator Instructions]. John Kiani with Deutsche Bank, you may ask your question.

John Kiani - Deutsche Bank

Good morning.

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Good morning, John.

John Kiani - Deutsche Bank

Can you talk a little bit Mayo, about some of your comments towards the call. Perhaps how far along you are, have you made any progress in discussions? You mentioned potential partnership structures and just kind of give us a flavor for, is this a very early stage or is this something that you all have done a lot of work on thus far?

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

John I think it's fair that we've considered the issue for reasonable amount of time and we've worked on various approaches, obvious reasons to be not more completely disclosed, is that we are not at the end game on this by any means. So, we have a number of options. We want to be very powerful about it. Obviously, the objective is to release the value that seems to be under appreciated in the context of how the market reacts to our business mix, earnings performance, et cetera. And I think that we've heard from shareholders along the way that they expect us to work on this issue and that's exactly what we're doing. So we're... we would expect to be moving down this path during the remainder of the year and come up with some answers.

John Kiani - Deutsche Bank

Okay great. So then it is the right way to think about it that you'll continue to look at these alternatives and that we'll have an answer closer to the end of the year?

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Yes I mean, I think the best way to look at it is that the timing will reflect our own judgment about just maximizing the value of the asset... the businesses that we have. And of course, we have to consider market forces and so forth. But we are working on it. We understand what the issue is. We understand what shareholders are telling us about this issue. And as a consequence, we'll get on it and react to what we see and how the market is behaving at the time.

John Kiani - Deutsche Bank

And if I can ask just one more question, perhaps when you talked about partnership interest, is it something similar to what Semper did with Royal Bank of Scotland what you're referring to or can we get a little more clarity on what some of the alternatives are?

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Yes certainly, the concept of third party capital would be put into that mix.

John Kiani - Deutsche Bank

Okay great. Thanks Mayo.

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Thanks John.

Operator

Gregg Orrill with Lehman Brothers, you may ask your question.

Gregg Orrill - Lehman Brothers

Thanks very much. I was wondering if you could comment on kind of the balance sheet, and it looked like you didn't buy back stock in the quarter. Wondering your thoughts on needs raise equity down the road. And also if you can comment on '08 earnings range, I think in the first quarter call, you said you felt like there was a... can't remember your exact wording but one is confident that you would be in the higher end of range or something to that effect, where do you sit now? Thank you.

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Gregg, on the point on the balance sheet and buying back stock we have not pursued any more stock repurchases at this point in time. We don't believe that this is the right market environment to be repurchasing stock although the stock price is very attractive to repurchase, given the overall market productivity and where the overall capital markets sit at this point in time and the financial system in general, we believe it's to be prudent and maintain a very strong balance sheet and manage the company conservatively at this point in time and in this type of market cycle.

With regards to 2008 earnings outlook, we did say at the end of first quarter we were less confident in the mid to upper end of the guidance range. What we are still saying today is we are confident of hitting the $5.25 to $5.75 per share rate.

Gregg Orrill - Lehman Brothers

Okay. And so the commentary on the balance sheet is such that, you don't believe you need to raise equity if... even without a capital infusion for trading, you don't believe you need to raise equity?

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Well I think the discussion about the need to raise equity will depend upon how we deploy capital in the future and the capital requirements to the business. And we do have growing capital requirements. And so, what we are going to have to do is manage them prudently to invest the capital we see the best risk adjusted returns.

Gregg Orrill - Lehman Brothers

Okay. Thanks.

Operator

Michael Goldenberg with Luminous [ph] Management. You may ask your question.

Unidentified Analyst

Good morning gentlemen.

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Morning

Unidentified Analyst

Excellent quarter.

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Thank you.

Unidentified Analyst

Wanted to ask a couple of questions. First, this new business originated and realized in the Q2 of 453 million would you... I'm sorry $439 million. If I understand correctly that was a business that came about in Q2 and you made money right away in Q2. Can you just talk a little bit about that, how you made money whether was on... whatever you can disclose?

Thomas V. Brooks - President, Constellation Energy Resources, and Executive Vice President

Michael, Tom Brooks. As I think John alluded to, the biggest chunk of that was certainly from our... came from our portfolio management and trading efforts and certainly our portfolio management trading teams performed very well. As you know, our portfolio management and trading business is fundamentally focused on three basic markets, power in North America, natural gas in North America and coal and freight globally. And given market conditions at the start of the quarter, given our view of fundamentals, I think we really entered the quarter as both Mayo and John alluded to fundamentally bullish in each of those three markets.

And particularly bullish to price relationships, either between commodities or between locations that we saw at the time. And I think as you'd expect we are not in a position to talk about the details of our positions during the quarter in part for competitive reasons and in part, because of course we manage our books quite dynamically. So the positions change significantly over the course of the quarter. But I guess what I'd tell you in general is in terms of our strategies in each of those three areas, fundamentally we've battered a thousand. And really things went very well in each area. So on the one hand... we don't exactly expect to batter a thousand every quarter, this... we are pleased that this quarter went very well but probably exceeded our expectations.

On the other hand, I would say over a period of years we have done very well in portfolio management and trading. So we don't exactly view the occasional out-performance as a flesh in the pan.

Unidentified Analyst

Got you. Very glad to hear that. One other question I would just wanted to understand your Q2 2008 cash flow you had acquisitions and divestitures. The acquisitions are the two gas pipelines you've bought, just wanted to confirm that. Is that the case?

John R. Collins - Executive Vice President and Chief Financial Officer

The acquisitions... Michael, this is John. In the second quarter, were both was primarily West Valley but if you look year-to-date the acquisitions will include three, will include our Hillabee facility in Alabama, West Valley in Utah and Nufcor which is the Uranium marketing business that we bought too and that actually was a second quarter transaction too. So the two second quarter transactions were West Valley and Nufcor and the divestiture were the gas assets in Arkansas.

Unidentified Analyst

Okay, okay I got it. On those gas assets in Arkansas, did you... I must have missed that. Did you record a gain on that?

John R. Collins - Executive Vice President and Chief Financial Officer

It was a $76 million gain during the quarter.

Thomas V. Brooks - President, Constellation Energy Resources, and Executive Vice President

Sorry, I might... Michael I probably, this is Tom again. I probably failed to mention that one in characterizing our new business but that was an important piece of it as well.

Unidentified Analyst

Okay, got it. And just so I understand on the acquisition Nufcor, was that a large acquisition over the 156 or relatively insignificant?

John R. Collins - Executive Vice President and Chief Financial Officer

I mean Nufcor was a moderate size acquisition, it's a uranium marketing business and it's roughly $65 million.

Unidentified Analyst

Okay. And, I'm sorry, just one more question. John, what you were saying about the $5.25 to $5.75, are you removing at this time the lower end of range from the statement basically saying it's just like it was before Q1 or?

John R. Collins - Executive Vice President and Chief Financial Officer

No we have not removed the lower range, we are just reaffirming between $5.25 and $5.75.

Unidentified Analyst

Okay, got it. All right, thank you very much, excellent numbers. Good luck.

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Thank you.

Operator

Rudy Tolentino with Morgan Stanley, you may ask your question.

Rudy Tolentino - Morgan Stanley

Hi, just wanted to, just make sure that I understand. And originated business, I take it, that's margin from deals that when you take to physical, you're realizing margin or is that changes in the value of existing business, or existing contracts?

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Well I think the new business that we originated during the quarter was primarily related to portfolio management and trading. And the so all the activities that falls within that bucket asset what we talked about with the energy investments which was $76 million.

Thomas V. Brooks - President, Constellation Energy Resources, and Executive Vice President

So it's sum of both in a sense, it's activities that are accounted for on the mark-to-market basis, are in that bucket, and then of course activity carried for in an accrual basis, as they realized are also in that bucket.

Rudy Tolentino - Morgan Stanley

Okay. And then apologies if I missed it, in slide 7 you mentioned that material escalation is the driver of the higher project estimate. Did you give about your project estimate for Calvert Cliffs... the new Calvert Cliffs unit, sounds like that's going to cost roughly?

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Yes, the language we used was at the current range of cost actually seen by others and ourselves is 4500 to 6000 per kilowatt. And we are likely to be in the mid upper end of that range because of the certain safety and security aspect associated with our design.

Rudy Tolentino - Morgan Stanley

Okay. So you'll be at the mid to upper end of that range.

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Yes

Rudy Tolentino - Morgan Stanley

Okay. Thank you very much

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Thank you

Operator

Shalini Mahajan with UBS.

Shalini Mahajan - UBS

Thanks and good morning. Just a follow-up on the notion of checking a partnership for your Global Commodities group. Now your Merchant businesses are truly integrated with portfolio management and risk management over laying across your generation, Customer Supply and Global Commodities group. But I am just trying to understand a little bit better if... what's the partnership going to entail that it is very difficult to extract value for pure risk management which is still sort of deviated with other businesses if you could just provide some color on that?

Thomas V. Brooks - President, Constellation Energy Resources, and Executive Vice President

I think, as Mayo characterized previously on it, at this point in the process, I don't think we're really ready to talk in detail about potential structures. I think some of the key messages that Mayo hit on, one, our focus on shareholder value and two; our view that the potential to bring third party capital might well have some benefit here. I mean certainly those are the two key themes that we're focused upon.

In terms of how we might execute, I think as Mayo indicated it's probably too early in the process to really get into the details there.

Shalini Mahajan - UBS

Okay. And secondly Tom, just would like to hear your views on the PGM market, the heat rates that collapsed a lot in the first quarter, have not come back as much. So, if you could provide any commentary and especially around also demand if you've seen any price elasticity or slowdown taking its toll there?

Thomas V. Brooks - President, Constellation Energy Resources, and Executive Vice President

Sure a couple of comments on heat rates. One of course in the first quarter we talked about heat rate movement which we found to be sort of somewhat counter to our expectations in the first quarter. And we did that really to explain some of our hedging effectiveness, going to the breakdown in the historic relationships between gas and power, pursuant to the rules of FAS 133 we had some... a larger than typical amount of hedging effectiveness in the first quarter. And a good piece of that was due to heat rate movement. And we wanted to just give some sense of the driver to that.

So in regard... John will correct me if I get the numbers a little bit off. But in the first quarter, I believe we reported $63 million of hedging effectiveness and about two thirds of that roughly resulted from the heat rate movement. So really we discussed this issue in the first quarter for a somewhat narrow and specific reason.

In terms of the further movement in the second quarter, little bit of more a big mix bag in various markets. In some market, heat rates increased, in some markets heat rates were about flat and then in other markets heat rates declined. And the PJM market as you point to, the heat rate did decline a little bit further in the second quarter. And its impact is... to that decline impact is fundamentally in the same direction as the first. So we do have embedded in our new business results, some hedging effectiveness in the second quarter, not to be smaller than the first quarter. But it's fundamentally part of the total reported results. And then in terms of just overall market conditions I know, George Persky, do you want to add anything further there?

George E. Persky - Co-Chief Commercial Officer of Constellation Energy Resources

I guess just in terms of across some of the markets that we operate in where heat rates have changed over the Q2 or not changed, I think what we said in Q1 we probably continue to see is that there is the persistence of differential liquidity in the gas markets, and the power market still seems to be an issue driving forward heat rate.

So, as Mayo mentioned in his remarks, we saw some liquidity comeback in Q2 but it's still pretty far behind where we saw last year. So I wouldn't discount that as a potential driver to some of the forward heat rates that we're currently seeing in some of those markets.

Shalini Mahajan - UBS

Okay great. And, just one last question on slide 23, if I look at the Merchant income statement. What's driving the operations and maintenance, there's a big jump from same quarter last year?

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Primarily being driven by having additional outages that are nuclear power plants. We had two in the second quarter, we had both Nine Mile Point Unit 2 and our Ginna outages, and last year we would... had our Nine Mile Point Unit 1 outage, and Ginna, just to remind you is an 18 months refueling cycle, as opposed to a 24 month refueling cycle. So that impacts different quarters differently. We also have some increased O&M expenses related to our Baltimore combustion turbine fleet reliability program in order to respond to the RPM capacity markets. We've invested additional capital in our combustion turbine fleet in Baltimore, to reflect better reliability of those units.

Shalini Mahajan - UBS

Would you be able to break out the amounts of the outages and the BT investment?

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

I don't have that right at tip, but I think we can... Kevin can probably get with you later on that.

Shalini Mahajan - UBS

Okay, great. Thanks, so much.

Operator

Ashar Khan with SAC Capital. You may ask your question.

Ashar Khan - SAC Capital

Good morning and congrats.

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Thank you.

Ashar Khan - SAC Capital

All right. Just kind of question... if I look at the hedging changes on the slide 13. Is it fair to assume that you are more hedged in 10 and 11 than the first quarter or no?

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

I mean, I would..

Ashar Khan - SAC Capital

As a percentage.

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Yes I would... I guess I would probably point you back into the additional modeling information where we give some earnings sensitivity on the generation fleet. I don't have those from Q1 in front of me but that is probably a better comparison to look at in terms of assessing a change in our hedge profile. The changes in the hedge EBITDA on page 13 are really a more reflection of what happened with market prices of the various components both for power output and fuel inputs to our fleet over the second quarter.

Ashar Khan - SAC Capital

Yes this is where I am a little bit... I don't know if you can talk it on this if I look at the first quarter you don't have it. There is a change of about a million or so in 10 [ph] but the fuel variance has gone huge, the fuel variance was like minus 0.5 in the first quarter and its like 5.2 million now. And so that was my follow up question why the fuel variance has gone up so much from the first quarter?

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Yeah I am sorry I don't have the Q1 numbers in front of me, we can probably get back to you on that later.

Ashar Khan - SAC Capital

Okay, and then I just want to... going back to the comments on the quarter, second-half of the year, if I'm right, if we add the first two quarters to get to the upper end of the range there is another $3 to go. I'm just trying to do it simplifying myself and If I heard John said one-third is going to come in the third quarter and two-thirds in the fourth quarter, is that correct?

John R. Collins - Executive Vice President and Chief Financial Officer

That is correct. That's what we think the earnings pattern will look like.

Ashar Khan - SAC Capital

And so John, we know that we are flat right now in EBITDA for the fixed generation and that's going to improve as you show in the third quarter slide. So what should we expect... we should expect to be... your expectation is that the other businesses are going to... be going down, that would be the assumption right?

John R. Collins - Executive Vice President and Chief Financial Officer

I think number one, and Tom Brooks can add some more detail to this but in the third quarter at least we tried to give a little context around Customer Supply. In 2007 to remind you it was a very strong year for our Customer Supply business. We do not expect a stronger results in customer supply year-over-year in the third quarter and for that matter in the fourth quarter. And then we also had very strong year-to-date performance in our Global Commodities business, we don't expect this necessary a strong result as we move forward but Tom can comment on that a little more detail.

Thomas V. Brooks - President, Constellation Energy Resources, and Executive Vice President

A couple of thoughts, one, as both John and Mayo have indicated obviously we're confident in the outlook for the year. Wanted to give you a little bit more visibility given that we are mid way through the year and the proportionality between the two remaining quarters. And in terms the relationship of Q3 versus Q4, there are a couple of factors sort of embedded in the portfolio and the timing of the way it rolls out over each in the next two quarters that sort of effect that one-third, two-thirds relationship.

And just a highlight of couple of items for you. One, in the first quarter as you recall, we realized some gains out of our coal portfolio, coal prices ran up very significantly in the first quarter. And we thought it prudent to realize some of those gains through various sales transactions which we did do, that had the impact of reducing our risk and benefiting Q1 results. It does slightly somewhat negatively impact Q3 results. That negative impact is obviously built into the outlook that John articulated but that's one item.

Second item is sort of Texas overall much has been... we talked about the Texas situation given various market dynamics there, as you know we serve a fair amount of load, both at wholesale and retail in Texas. Through the first quarter, two quarters actually our portfolio management teams have been able to manage some of those market issues in Texas very well, and it didn't have a big impact on us... on our results in the first two quarters.

On a forward basis, actually Texas market dynamics reduced the Q3 outlook a little bit relative to what we would have thought at the beginning of the year. And then finally, just overall, our given the way market prices have moved in PJM and given our overall hedging approach over the course of the year, principally relative to the fleet, but to a lesser extent relative just to the load business in the Mid-Atlantic region. We have an impact over the balance of the year where Q3 is down somewhat and Q4 is down somewhat.

So that totality of those three items... again, sorry, Q4 up somewhat, the total of those three items relative to the outlook for Q3 is down about $200 million or $250 million, a rough proportionality would be about 30% of that due to the impact of the coal sales in the first quarter, 20% roughly due to the Texas situation and the balance just of the shape of our hedging profile in terms of what falls in Q3 and what falls in Q4 over the balance of the year.

So, in some ways all of that is a little bit, mechanics of the basic point is that we are confident in the overall outlook which is given a market environment where prices is gone down and up and down again quite a bit, that's somewhat influenced the timing of when we expect to realize earnings over the third and fourth quarters of the year.

Ashar Khan - SAC Capital

I really appreciate, thanks for the details.

Operator

[Operator Instructions] Paul Patterson with Glenrock Associates.

Paul Patterson - Glenrock Associates

Good morning guys.

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Good morning.

Paul Patterson - Glenrock Associates

Just wanted to sort of clarify the slides and everything. The $439 million that we see on slide 16, the 439 that is realized, that's the actual cash impact of what actually... that new business realize was actual cash that you guys got as a result of this, it wasn't a mark-to-market benefit?

John R. Collins - Executive Vice President and Chief Financial Officer

Well Paul, I mean as you're aware right, so the accounting of how that would work is mark-to-market clearly would show up as income. As you're aware, certainly on the risk capital deployment side, PM&T side of business, we're fundamentally margin, cash margin, these are through exchange or through bilateral contracts, with margining. So you get a mark-to-market benefit and you are getting the cash realization of that mark-to-market benefit either next day with the exchange or next day via cash margin with the counterparty.

Paul Patterson - Glenrock Associates

Okay, so I guess this is sort of to get a total picture on the Global Commodities business, how much was it impacted by non-cash revenue item?

John R. Collins - Executive Vice President and Chief Financial Officer

I think we showed you that Paul in the cash flow page, when we just flip to page 19.

Paul Patterson - Glenrock Associates

So that $239 million is actual cash, there is no non-0cash reorganization in there?

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

No Paul, as you are aware right, when we do cash flows we start with the net income and then we walk you through the large adjustments of either non-cash earnings or cash that doesn't show up in earnings but the depreciation and amort. And then the item that you are talking about. So the adjustment and mark-to-market assets, the net assets derivative and the adjustment in say third party cash collateral which show up in the working capital change.

Paul Patterson - Glenrock Associates

Okay. The mark-to-market stuff was a... is essentially very short term in nature and therefore it's more of a working capital item?

John R. Collins - Executive Vice President and Chief Financial Officer

Paul why don't we... we can't get into some of these, this is a little detail for us.

Paul Patterson - Glenrock Associates

Okay

John R. Collins - Executive Vice President and Chief Financial Officer

Why don't we do this offline, and we'll get through in some of those details with you.

Paul Patterson - Glenrock Associates

Fair enough. And then just... the impact of Nufcor was there an impact at all?

John R. Collins - Executive Vice President and Chief Financial Officer

There was no real impact in the second quarter as it was really closed right at the end of the quarter.

Paul Patterson - Glenrock Associates

Okay and going forward? Any thoughts about what that might bring about from a net income perspective?

John R. Collins - Executive Vice President and Chief Financial Officer

Well we haven't disclosed that but it will depend on how it finally grows and integrate into the business but relatively small given the size of the acquisition.

Paul Patterson - Glenrock Associates

Okay. Thanks, a lot guys.

Operator

Charles Sharett [ph] with Credit Suisse. You may ask your question.

Unidentified Analyst

Hi, good morning. Could you talk about your LC usage during the quarter? You said it went up by $1.5 billion, a little more detail about that and also how we should think about that going forward?

John R. Collins - Executive Vice President and Chief Financial Officer

Well I think we need to step back when we have this conversation the stuff, what the collateral is used for. And as you know we are a very large hedger of our Customer Supply group. And when we go out and hedge that business, that business, wholesale and retail, customer supply consume about 150 million megawatt hours a year which is pretty much about five times the amount of generation that we actually have available to manage that business. So we do a lot of forward hedging and during the second quarter, we saw very large run ups in prices that caused us to post collateral against those positions.

And obviously our collateral will fluctuate depending on how prices move and the other components of the hedging activity relate to our fleet as well. So, it just depends on the absolute movement in market prices what it does to collateral. I will tell you, what we strive to do is always ensure that we have sufficient liquidity to meet the market moves to protect our hedge positions.

Thomas V. Brooks - President, Constellation Energy Resources, and Executive Vice President

With perspective to letters of credit, I think we also saw a larger phenomenon that was larger than we have seen in prior quarters where people are posting letters of credit to us. And unlike cash we can't, then assign that back over to our counterparties who may sit on the other side of a roughly flat position. And so that has the effect of... we know have to post LCs out. If you think of LC posted in to us and LCs out on that, it's about $900 million increase in the use of LCs again roughly related to the higher level of commodity prices.

Thomas V. Brooks - President, Constellation Energy Resources, and Executive Vice President

We have time for one more question.

Operator

Andrew Levi [ph] with Brencourt, you may ask your question.

Unidentified Analyst

Hi guys good morning.

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Good morning.

Unidentified Analyst

I got a couple of questions but I guess can't ask them all. I guess just getting back to Paul's question on working capital, the negative 350, can you give us a breakdown of that or ?

John R. Collins - Executive Vice President and Chief Financial Officer

Well it's primarily driven by higher initial margin requirements and it's where we clear products on the exchange and that was roughly $400 million of it.

Unidentified Analyst

Okay. And...

Thomas V. Brooks - President, Constellation Energy Resources, and Executive Vice President

Due to their changed rule, they've already changed the rule for margin posting inside the quarter.

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

As volatility the prices went up, they increased the amount of an initial margin you have to post for your position.

Unidentified Analyst

So, it sounds... I mean just getting off that but staying on trading side, sounds like you had a very good quarter of trading, I guess that's fair to say. And from your comments I guess you probably were long serving commodities that did very well. I'm just wondering and I know you can't really tell us about the third quarter but obviously there's been a big reversal in that and you seem to be having lower earnings in the third quarter on a kind of mix basis. I guess last year third and fourth quarter was up 50:50 as far as the remaining earnings value thing [ph], one third, two thirds. I don't know if you can answer this but I'm just wondering have you given anything back in the third quarter from what you made in the second quarter trading. I know I gave some back so?

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

So in terms of the, getting back to the sort of Q3 versus Q4 outlook as John characterized, proportionality we expect one-thirds two-thirds or as compared to last year, in terms of the year-on-year difference for Q3. I went over $200 million to $250 million of sort of timing factors within the portfolio. And that's the most significant driver to sort of where we stand in Q3 or what our outlook is for Q3 versus Q4?

Thomas V. Brooks - President, Constellation Energy Resources, and Executive Vice President

And probably it is fair to point out that while backlog is up in the Commodities Group year-over-year we had a very strong Q3 '07 and for business originated and realized inside the quarter and we're simply not projecting a strong a quarter out of some --

Unidentified Analyst

Okay. And then the last question, is very simple question and then I'll let you guys go. There was some reference, I guess, John Kiani mentioned like you might do... And I guess you mentioned that too, there might be some type of partnership on the trading side, RBS [ph], here is RBS John did. And I guess I'm just wondering in this environment, are there actually people out there who can actually pay you and the interest in this environment, obviously the energy environment driven financial environment?

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Yes, I think that we are confident that there are a number of options that we can develop to address some of the issues I think many of you have brought up over the course of the first half of the year. So I think the answer to that is that yes there are options and we're pursuing them.

Unidentified Analyst

Great, thank you very much.

Mayo A. Shattuck III - Chairman, President and Chief Executive Officer

Wellthank you all very much. Have an enjoyable summer. We will see after the next quarter.

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