American Electric Power Company Inc. (NYSE:AEP) Q1 2009 Earnings Call April 24, 2009 8:30 AM ET
Mike Morris - Chairman, President & Chief Executive Officer
Holly Koeppel - Executive Vice President & Chief Financial Officer
Charles Zebula - Treasurer & Vice President of Investor Relations
Good morning everybody and thank you very much for being here. This is a combined American Electric Power update, as well as a first quarter earnings call of unique nature. In all of our quarters with American Electric Power we’ve never done this. We’re typically removed from you and in Wisconsinite in our own conference room and waiting for your probing questions. So, today we’ll be able to do that simultaneously and get a chance to see you as you ask those questions about our plans, and our dreams, and our performance.
You know as well as I that all of this is as straight forward as we can make it, but it is futuristic; some of its optimistic; some of it’s realistic and I know that all of you will decide for between the pluses and the minuses and come up with your own conclusions, which for some reason you always have a tendency to do.
When you look at AEP and the highlights of what’s going on in our space, we continue to believe and I would hope, we demonstrated to you now over the significant number of years that this really is a great utility platform, with a lots of opportunity for upside, tremendous place for us to continue with capital work and to lead this industry in any one of the number of ways, in any one number of places. We’re still very satisfied with the footprint, the capital investment opportunity, and all-in-all as the economy rebounds, we think we’re uniquely positioned to take full advantage of those upside potentials.
The second bullet here is one that is near and dear to my heart, and you have heard me speak about this now probably more than you like, but I have frequently heard the equation of my calc and anyone manage their way through eleven stage jurisdictions and I would argue that if you look and I’ll share with you later to four to five, my view of this world, that the regulatory treatment that American Electric Power receives, has received, and I would argue, will continue to receive, has been nothing short of phenomenal.
What we always intend to do is build a respectable relationship with the regulator, cultivate that relationship and put capital to work in the things that are important to them. So, retrofitting the fleet early on as we did for SOx and NOx on an average cost of about $250 to $300 a kilowatt installed, better than any other utility in the country, embraced by the regulators with rate approvals and rate adjustments, is exactly the same kind of path that we’ll continue to follow.
When you see people talk about upgrading the intellect of the system; when again you look at the size of the American Electric Power system, you’ll see the opportunities that that provide to us. So in jurisdictions, where we have been invited to go forward and do what we call grid smart and most others called smart grid, we’re doing it in Texas, we’re doing it Indiana, we’re going to do a little bit over in Ohio that was approved by the commission. We’ve made filings in every other jurisdiction to go forward with those undertakings and as soon as we get the authorities to do it, we’ll do it.
The transmission play which we have now talked about for an extended period of time, is beginning to come together in any one of a number of ways and I’ll give you some granularity about that a few slides down the highway here, but most importantly and I had this conversation while we were having a few moments together out in the lobby, the political will and the political need and the political recognition of what we have called I-765 for a long time, again is growing.
Senators Reid, Dorgan, Bingaman, all now believe that we need to go forward with those endeavors. I had the opportunity to be at a session with the last two administrations ago and not long ago, where Senator Reid made those comments quite clearly.
As you know we joined my old friend Boone Pickens with the Pickens plan, because it helps support our concept of an interstate transmission play and even Al Gore, god bless him. He was in full flight and in full agreement with building out a transmission play. Of course he and to a lesser degree Senator Reid believed that you can do that for green power only; at the end of the day that will not happen it will be for all power.
The American Electric Power as the largest transmitter of electricity in the country, with the largest transmission footprint will be uniquely station to take full advantage of that opportunity. It would be silly for me not to make special mention of this last bullet and give what credit is due to our incredibly talented financial team, led by Holly Koeppel, who’ll follow me here at the podium with Chuck Zebula and others.
We have been one step ahead of the financial game over the last couple of years in every way that you can be. I already mentioned the early moving on retrofitting the system, but I want to make sure you appreciate that we’re also an early mover in pulling down lines of credit through the later half of 2008, fully fearful that the marketplace may dry up in commercial paper for A-2/P-2 rated companies, it did and we were well taken care by pulling down those lines of credit at very, very low cost profile rates.
I think you all know, within the last few weeks we went through what was really a very enjoyable exercise and many of you were with us in that endeavor, in the equity offering. I know that some were surprised by the size of the equity offering. There’s no question that an equity infusion was required.
When the question was asked to me, again were we reacting to pressure from the outside or were we acting in a preemptive way? And it really was some pressure from Moody’s no question; some pressure from S&P, no question; all of which we felt could have been managed for in a period of time, depending on how long that would have needed to be.
We were always waiting for a resolution of Ohio and we’ll surely talk about that in a short period of time. Within 10 days we were in the equity market incredibly successfully. Many of you had an opportunity to participate in it and we thank you for doing that. It worked out really, really well as far as we’re concerned.
Some years ago, at consumers’ power after we’d spent a lot of money on our system, we ran some full page ads coming into the summer months, and so we were more prepared than Noah was for the great rain; and then a storm rode through and we had a half a million customers out for about a month. So I’m a little nervous about telling you what I’m about to tell you, but I would argue that financially we’re as sound as we can be, and we would hope that we can ride the rapids, no matter how long the water stays tuned up as we go forward.
The equity offering itself, and of course this is always fun because you get this from the managers. They’re falling all over each other telling us how great this was, how big it was, how everything it was. Of course they were getting paid a ton of money to tell us that and that always there is a unique way to go about things, but at the end of the day it does speak for itself. It gives us all of the things that we think that we needed and want it did most importantly, is the later half of the slide. It really did solidify the balance sheet, solidify the requirements.
Coupled with the capital reductions that we’ve announced, again we think that it puts American Electric Power in an incredibly unique space going forward. Some of our challenges that we constantly hear about, are things that are of great interest to you, of great interest to us and things that we are deeply participating in.
The first one here is the current debate in Washington, mostly on house side, because the Senate seems very calm about all of this, even though the Senate leader, Senator Reid speaks in terms of taking a sub sometime in the summer or fall. The fact of the matter as we feel that the carbon program that comes out of Washington eventually, and I would sometime 2010 not 2009, will be reasonably flat. It will be somewhat similar to what came out in the Clear and Clean Air Act in the 70s, 80s and 90s.
In early days it will be an offset, an allowance that is allocated with our cost, which will benefit our customers and our fleet particularly so, and then ultimately will move into the demonstration, development, deployment of the carbon capture in storage hardware, which will add to the overall earning strength of the company as we go forward.
We always hear that companies like American Electric Power should be very sensitive to the potential impact of that and we are and we have always focused our needs towards the balancing of our shareholders’ requirement, as well as the impact of that program, if [Inaudible] can have on our customers.
When the President came out with his auction 100% of the credits, to put $1 trillion down payment on the healthcare plan that he’s yet to announce, we were early and loud in our opposition and merely within weeks, not because of us, but because others joined us, the President said “Well, maybe that’s not exactly the way we ought to do it.”
You know, when Congressmen Markey and Waxman came out with their bill, I guess their discussion well lasted a couple of weeks ago. They left auctions and allocations alone, because they know it’s a lightening rod. We have been in constant discussions with them and other members of the House committee and Subcommittees and feel comfortable at the end of the day that that too will come out and look very similar to what the Clean Air Act was before with allocations to the utilities, to be utilized to the benefit of the customers.
One of the things that we don’t talk a lot about, but we are surely proud of is that we’re big believers in renewable energy as well. We continue to move forward in the wind development. We are just south of 1,000 megawatts and continuing to head north in that direction. There are areas within our service territory where wind plays well. We also believe that wind was a enabler for us to continue with the transmission build out plans, that we feel so strongly about and I’ll talk about as go forward.
Lastly, it’s impossible having said what I said about the regulatory relation that we’re trying to build; not to believe in energy efficiency wholeheartedly and not to move forward and do all that we can to get into demand response programs, ultimately distributor generation, some micro generation, all of things that are on the very top shelf issue for our in state regulators.
So the last bill that tells you that in the last the few years we put on almost 5,000 megawatts of gas, we hear that owning a gas would be $3.30 yesterday? I’m glad that got a lot; that makes me feel better. The fact of the matter is, the price of gas is unique and it’s having some very interesting impacts on the marketplace and we’ll take about that in a moment as well.
I think a very interesting, more granular view of the Co2 cost recovery strategy, at American Electric Power, is something that we will need to continue to develop with you, than get your pushback and have you help us think this bill is to make certain that we do see it in the light that is reasonable to you and reasonable to us. These pin roles will demonstrate to you something that we think is interesting; something that I know, you know when you look at our fleet.
We are more carbon intensive in the Eastern footprint. We are much more comfortable in knowing in the Eastern footprint, particular in Ohio where the ESP has already covered recovery of carbon cost, whatever they might be in the fuel adjustment clause and we would expect the same treatment in coal heavy West Virginia for our Appalachian operations as well.
So, if you look at the far less a bubble here 163 million tons; much of it centered in the Ohio operating companies, as well as Appalachian Power and we think again that that will work out quite well for us as we go forward. Clearly, the two pin roles to the middle and right of the side demonstrate what we hope you’ll see as a very successful portrait of how we manage the Clean Air Act as it pertained to SOx and NOx. As I said earlier on, I expect that carbon will play the same way as you know.
In September of this year, at our mountaineers’ station in West Virginia, we will be the first utility in the United States to actually demonstrate carbon capture and storage. The wires have been drilled, the pipes have been laid. The capture machine is being built and I’ll share with some of you, because when you say 20 megawatts stream of the fuel gas, you think that this must be a bread box size operation; let me assure you that it is different from that.
It is a peace of the equipment that is as big as this room, four stories high, with 150 foot stack that about 12 of those arm-to-arm could hug. This is a very important demonstration of a technology that we feel is very comfortable when there was a time, when we and other utilities thought that that kind of hardware on the back-up facility could be parasitic to the 20% to 30% of the overall output of the plant.
We’re now comfortable in thinking that it maybe more in the order of 10% to 15% and as we continue to work on the power block side of the plants to upgrade the output potential of those facilities, we feel comfortable about how carbon will play out in American Electric Power.
Every bill, that has come through the house for the Senate, has included what I think is one of the more creative things that our Washington team came up with, realizing as we had talked for the longest while that this is a global issue. This isn’t an American Electric Power issue and it isn’t an United States issue; it’s called global warming for the reason.
The unions have joined us after that, to make sure that the other side of the isle doesn’t run away with a very green view of let’s do for America, what America ought to do and let’s have a blind eye toward what China, India, Russia, South America and Indonesian countries do. If that were to be the case, we will have only dampened the U.S. economy and we will have not effected the environment in any constructive way.
So, what is known as the IBEW, AEP global approach to global warming has been included in every piece of legislation, including Waxman and Markey. We feel good about that and I really do feel that at the end of the day this will unfold toward an advantage ultimately, not only to our customers, to the environment, to the communities we serve, but to our shareholders as well.
Now, being one of the lowest cost providers of course, it always helps to me feel a little bit better about that. I think again a lot about the regulated utility that we represent; it is outlined for you here graphically.
I always enjoyed the center column and I particularly enjoy talking about it when you are in a city like New York, because years ago when there used to be a number of investment bankers, they were all number one in everything and here in generation between David Ratcliffe and Jim Rogers and myself, we continue to battle over who is number one. So, I found a way to bump us up above Jimmy, because I know on occasion Jimmy expands the facts of Duke Energy as he sees them, but he moved us in at number two and I feel good about that.
When we have of 20 year contracts about wind, off of wind farms, I think that’s generation under our control. I’m sure Jim will come up with some creative way and we’ll continue to stumble over each other.
The lower left hand side of this slide I think demonstrates something else that I’ve talk to you about since my arrival in 2004. That being the lowest cost providers gives us tremendous opportunity to increase the rate based earnings strength of this company; while maintaining that low cost position in every of the jurisdictions where we do business; and that in fact has happened and we feel very comfortable about that as well.
The reason that has happened is demonstrated to you on this slide, and again this is something that I guess I’d probably get a bit emotional about. I mentioned it a few moments ago with the broad foot for regulatory challenge and the uniqueness of the multiple regulators and the structures of the regulators in each of those 11 states. I think this slide screams at me and I hope at you, that we got the right process figured out.
It’s a matter of building things that are important to the regulator; it’s a matter of respecting the regulator for the jobs that they do and they do very well; and it’s a matter of making sure that we spend a great deal of time with our customers trying to explain the benefits that they see from the capital that we’ve invested on the system to their advantage.
Rate increases, already approved that will flow through the year 2011, $2.1 billion, a few rate cases to go. I’m most impressed with 2009 and when we get more into the first quarter update, it overwhelms me to think about the first quarter of 2009, but for the economic downturn, with the rate activity that we went into the year hoping to secure versus the rate activity that has already been addressed in the constructive way before the end of the first quarter. We have a GAAP in rate recoveries yet to be concluded in ’09 of only $53 million.
On the right side of this slide, if you look under pending rate release, you can add up the APCo, SWEPCo Texas requirements and you’ll find that $88 million of rate applications in front of the commissions, meeting $53 million of treatment and we feel very comfortable about that.
On the bottom right side of this slide, as you know we have continued to work on with success, and reducing regulatory lag by putting in automatic rate adjustments by making sure that rate based when invested, moves into the rate recovery scheme as rapidly as it can. Trackers and automatic adjusters are very important tools for us and you will see that we will continue to work on those and relationship building with the instate regulator continues to be a primary concern of all of us and its done with a great deal of respect and that respect has been paid back, we would argue very comfortably.
If you breakdown the various operating companies and as you know we have seven of the companies in the 11 states, because a couple of them are multi state servers or multi state regulated. You can see that all the series of viewers, the rates of returns have continued to improve with many, and are still lagging in some, which will be addressed in the very near term.
You can see that the net income by operating company on the bottom side of the slide, tells you that where we have an opportunity in the largest amount of capital invested, our jurisdictions where we are receiving what we would consider to be as the most rewarding rates of return and actual realized rates of return on the capital investments.
That also comes to play very much when you look at the cash flow from operations as well as the capital investment opportunities that we see in a going forward basis, and you can see that we continue to invest strongly in those jurisdictions, where the rates of return are reasonable and we continue to be very wise about the capital invested in those jurisdictions where rates of return are not as handsome.
We think that that’s a very appropriate way to manage this portfolio of assets and we need to continue the work on those places where we see substandard returns on the capital invested, and as I know you are very familiar, we continue to do that with the certain degree of success.
Looking at the potential of the economic downturn being somewhat longer term than maybe others see it, we have asked the operating team at American Electric Power to do something that is not the easiest thing for them to do and that’s to travel back to capital investment in a very substantial.
You know as we came into 2009, looking at the tail of 2008, we decided that traveling back by three quarter of $1 billion would be the right thing to do and now as we look at 2010 and 2011, we’re full prepared to throttle our capital investments back to $1.8 billion going forward and put that money to work in the places that are demonstrated on the block slides here at the far right. Again I think it demonstrate something that we shared with you for a number of years as we were building the by way of up from ‘05 through ’08.
You continue to ask a very honest question of (a) how much capital can you put to work? (b) If things get tough, will you be able to stop the capital investment machine? We’ve always told you that we could; we’ve always told you that we would and in fact we’ve demonstrated in this year to my own satisfaction at $2.5 billion and probably end up spending a bit less than that; and going forward in 2010, 2011 that we will again demonstrate our ability to do that.
We depreciated at $1.2 billion a year, so even at one-eighth capital investment; we are growing the overall strength and earnings base of the company by about $600 million a year. If you look at the three year cycle that we’re talking about there, you can see that you’ll be growing the earnings strength of the company by $1 billion or more as we go forward.
We talked a bit about the transmission play and we’ve been talking about this for an incredibly long period of time. It is surely one more slowly than I would have ever thought that it was going to go, but remember that we’re really trying to sell an extremely important, yet very difficult emotionally issue.
What we are trying to convince people to do at the state regulatory level, is to give up some of the rights of control as they see it. What we’re trying to convince people to do at the state level is to allow the federal government to have eminent domain authority; to condemn properties to see toward that and the inter-state electric transmission grid is developed to it’s fullest exempt, and that always sounds good to an elected official until you go to build a project and we began to get letters from your constituency.
With the backup authority that we were able to create in the 2005 Energy Policy Act signed by then President Bush, we probably fought in seven or eight different committees in the House and the Senate, individual elected officials, either Congressmen or members of the U.S. Senate who were trying to undo the backup authority.
Ultimately what we need and I think ultimately what we’ll get, because now is the time, with primary federal energy regulatory commission authority; with primary first stage eminent domain authority and equally important if not more important, the ability the cost allocate over the entirety of the grid that the line is intended to serve.
So, ultimately asset that are about to serve our Southwest power approval, the cost of that facility will be allocated to all of the gig watt hours in the Southwest power approval, because all of them would receive benefit from the capital investment. That kind of legislation is difficult to accomplish, but the time has never been better. As I mentioned earlier on; Senators Reid, Dorgan and Bingaman have all addressed the issue and I feel comfortable that sometime if not this calendar year, clearly in 2010 we’ll probably receive that kind of authority.
Having said that; inside of the current envelope of regulatory authority and back stop authority and regional planning undertakings, we have wrapped an amount of potential capital to be invested in the transmission play. We usually feel comfortable about the way that we do it. We partner up not only with the capital partner and a very solid intellectual partner with mid American for many of them, but we also partner up with local players in most of these projects as well; for the benefit that a local player brings in a debate where the local commission is still with a very strong will to play.
So, if you look on the left side of this column, you can see active projects, you can see potential dates where they go into service. If you look to the right side of the column, you can see an extended expansion of capital investment opportunities. As we were doing the road show, some of you were with us and certainly learned that the potential capital investment could be as big as $15 billion, again parceled out to partners over a series of years, over a series of projects.
So, at the end of the day, we see an opportunity to continue to grow the earnings strength of this company when the economy does rebound and I would hope that to be sooner than later and I surely hope that it visits itself upon the U.S. economy someday. I expect that we’re all in.
I would truly be happy to receive any of your forecast for when that’s going to happen, but at the end of the day it will happen, and we’ll go from a classic 2% to 4% regulative utility growth model, back to a 4% to 8% of very productive regulated utility, very productivity transmission investment opportunity utility as we go and we feel comfortable about what all of that will yield for our shareholders as we look at that.
One of the issue that’s important and came up frequently while doing the road show is well, how about we shareholders, what about us, what about your dividend plans, where are you? I think the first line here is incredible when we think about 395 consecutive quarterly dividends I paid to our shareholders. $1.64 a share, appropriate yield we think in these markets, an incredibly attractive yield, just north of 6% and inside of a dividend payout ratio that we feel comfortable about being able of maintain.
Other’s who were at a higher payout ratios than us on the far your left side of the slide, on the lower left hand box, tell me that I don’t know that they can sustain that going forward, but we’re comfortable that we surely can. So, when we get down to the bottom line, the things I have been saying since 2004 remain very similar. I know this is probably a bit boring of the story for you, but it is a successful story and it’s something that the men and women of American Electric Power are very proud of is something that I’m equally proud of.
Almost everything that we see says “This is a great place to invest nearer term.” If you’re just worried about the risk profile of your capital investment, enjoy the dividends while they’re there. We’ll grow slowly in the near term, grow more robustly as the marketplace picks up and then continue to have substantial upside as the transmission play ultimately develops and we’re sure that it well.
So with that, I would invite Holly Koeppel to the podium to take you through the first quarter production. Holly.
Thanks Mike. I’d like to start off by going over the component parts of our 2009 guidance; give you a feel for how the U.S. is expected to shapeup. Looking at the far left slide, you can see we ended last year at $1.3 billion, adjusting for known increases in interest expense and depreciation expense of approximately $200 million, as well as the tremendous success in the regulatory arena already achieve to-date, would put us at a run rate borrowing the impact of the economic environment of approximately $1.6 billion.
So if conditions were normal, things would look substantially better. There are two major factors that are closing a drag on our earnings this year. The first is a reduction in industrial load and derived margins from those customers and the second and far more dramatic is the loss of off system sales margins, due to both the decline in volumes, as well as a dramatic compression in margin. Taking these factors into account, we end up right back where we started with expected earnings for the year 2009 of $1.3 billion, which is bracketed by our guidance range of $2.75 to $3.05.
Touching on retail load, as you can see we are experiencing and expecting a decline predominantly in industrial load. Residential and commercial volumes are expected to remain relatively flat and in fact that is what we have seen in the first quarter. Industrial on the hand as Mike mentioned, we have experienced a decline quarter-on-quarter ’08 to ’09 of approximately 16%. We are forecasting a decline of 10% for the full year of 2009 as we started to see a drop off in the later half of the year.
It’s important to note however, that due to the tariff structure or how we price sales to industrial customers, the drop off in revenue and margin is not linear or directly correlated with the drop off in load. That’s because a very large majority of our payments from these industrial customers are in a fixed charge or demand basis and a relatively modest amount is actually recovered through a volume metric or commodity rate.
Therefore as you can see in the bottom left hand side of the chart, our expected retail revenues from industrial customers will be essentially flat year-on-year. This is what result’s in a relatively modest impact, as a consequence of an anticipated decline in load of nearly 5% of cost of system.
Turning to off-system sales, as I mentioned this is a much larger impact on expected earnings and guidance for 2009, driven by two factors. First, fuel volume sold into the market; second, much lower margins realized on the sale. This is a function of the collapse in the dark spread or the relationship between a very low gas price and a coal price at AEP that is finally approaching market.
As you know we are a very successful and large coal purchaser and have traditionally had our prices well below market. We’re gradually approaching market crisis and as our prices narrows toward market and as gas market price come in, you see the phenomena on the right hand portion of that chart, the narrow dark spread which translates into the drop that you can see on an all in realized margin forecasted for the year of only $11.40.
I’d like to give you a little color around what makes up off-system sales, to help explain how challenging it is to arrive at the margin. There are three component parts off-system sales; first is by the fiscal volumes that we sell into the market. That’s the number that you typically see; that’s the denominator of the correlation that we give you to translate into off-system sales. The revenue from sales to the wholesale market has declined and we expect it to decline year-on-year by over $600 million. Last year it was over $700 million, this year it will be just over $100 million.
Second component, is the fixed payment regulated by the Texas Public Utility Commission from our energy partners, wholesale or cut marketing activity, to our Texas North subsidiary for the use of the Oklaunion capacity. So this payment is fixed and known. Then the final component is the revenue derived from our marketing, trading activities, predominantly in our Eastern footprint; again, a fairly stable and relatively modest scale. I should also add that this component also includes the proceeds from our participation in wholesale power market option.
As you can see, for this year we are forecasting pretty stable performance in our marketing, trading and auction activities. A very stable predictable and regulated performance for the Oklaunion payment and the entirety of the decline is associated with lower volumes and lower margins into the market.
Moving on to how our capital funding plan is looking for the year, as Mike mentioned you can see that we have reduced our capital budget year-on-year substantially. We’ve also reduced it from our earlier forecast that we had provided you with and we will be at a level of just under $2.6 billion. We also plan and will precede with equity contributions to our transmission joint ventures; predominately the electricity transmission Texas venture of just under $50 million.
The dividend line shown has been adjusted for our recent equity issuance. You can see that our cash forces and uses, that our cash from operations is remaining relative flat. The proceeds from sale of asset sales, I wouldn’t want to mislead you and have you think we’re selling assets that are reflective of the payments from partners associated with the Turk Power Plant construction at SWEPCo, as well as the payments received for contribution of assets into ETT transmission asset. Finally, you see our common stock proceeds as well as our change in debt. We expect end of the year with the cash balance of $200 million, consistent with past years.
Moving onto the quarter end, our first quarter 2009 GAAP earnings were $0.89 per share. There were non-ongoing earnings adjustments in this first quarter, but when compared to last year’s ongoing earnings, our GAAP earnings were $163 million higher than ongoing related to the settlement with Tractebel Energy Marketing.
So ongoing earnings from utility operations decreased quarter-on-quarter by $66 million and we ended the quarter at $0.89 per share. The primary drivers on our first quarter lines are retail rate release, primarily at Appalachian Power and Ohio companies, as well as to west at PSO.
As I mentioned earlier, we have substantially reduced off-system sales, which resulted in reduced off-system sales sharing or contribution back approximately $50 million. We also last year had a favorable variance related to a coal contract amendment of $58 million. It’s important to point out that our load contraction resulted in only about a $6 million impact from industrial load, primarily in our Eastern footprints at I&M and our Ohio companies. Weather was not a factor year-on-year in the quarter.
Turning to Off-System Sales, the total decrease of $136 million is entirely due to lower fiscal volumes and much lower margins. Our trading and marketing activities were up $10 million quarter-on-quarter and therefore our volume metric decrease was nearly $150 million on the quarter. The volumes were lower by nearly 70%; margins were lower by nearly 80%. Other operating revenue is substantially higher, due almost entirely to the accidental outage insurance payment, associated with our Cook Nuclear Plant outage.
It’s important to note here that the team successfully resolved the extent to which a portion of this payment is attributed to customers of Indiana Michigan Power, in order to offset higher fuel costs that they’ve incurred. This matter was settled in the first quarter. We now can proceed with certainty. 40% of this amount is credited to customers in the fuel cost, 30% is retained by the company, so a net, approximately $30 million of the $54 million of proceeds received in the first quarter will flow through as pre-tax earnings.
O&M, a fairly modest increase, due almost entirely to the treatment of storm cost. As you will recall last year, we received a very favorable rate treatment in Oklahoma. The ability to defer and amortize over $70 million of storm costs. This year we had another storm in Oklahoma and that cost us nearly $40 million and the net of the two is more than the $56 million increase in the quarter.
Moving on to interest expense and preferred dividend; we see an $11 million increase nearly sue as you would expect to increase long term debt outstanding and a slightly up tick in the rate that we’re currently paying. Operating income and deductions is $10 million lower due to a decrease related to an income tax refund from the IRF.
Moving down to the green box, our River Operations; the bulk of the change of $4 million, the improvement is associated with the sales of two turbots. We are seeing reduced volumes and slight pressure on freight rates that has been offset essentially entirely by reduced fuel cost and so it’s a steady to go with there.
Finally, the effective tax rate was slightly lower. The first quarter of 2009 was 32.9%; last year it was 33.6%. This is due in major part to the migrations of FIN18, which is the recording of estimates for tax purposes; and last but not the least, shares outstanding in the quarter increased by $6 million. Our weighted average shares outstanding in the first quarter of last year were 401, this quarter 407.
Moving on, this provides you a snapshot of where the balance sheet looked at the end of the quarter. The last bar showing a debt to total capital of 63.1% and on a pro forma basis, after reflecting the effect of the equity issuance, assuming all proceeds for used to offset debt, which results in a debt to total cap of less than 58%.
On the right hand side of the page, you can see liquidity is strong. At the end of the quarter we had cash and cash investment of $1.1 billion. The draw on the credit facilities remaining was down to just under $1 billion and as Mike mentioned earlier, we are using the proceeds to retire debt. Our value liquidity at the end of the quarter remains strong at $3.2 billion.
With that, I’d like to open it up for question. Thanks.
Thanks Holly. Now you’ll get to see how we typically hand all these Q-and-A things. Because we’re recording this, put your hand up, we’ll get you a microphone and we’ll go from there.
Hey Mike, I know I need to ask this question because it’s hard enough to get you not to spend money, but how do you think about prioritizing capital for ‘10 and ’11 if you guys see a recovery as far as how you put money to work above the $1.8 billion? What markets look most compiling and how do you think about pursuing additional investment?
I want to make sure I understood the question. The $8 billion has got a couple of projects in it that we is incredible important, because they do a number of very important things not only for our customer, but for our company. So we’re continuing to build out the installed plant; we’re continuing to build out the Turk station.
The Turk station is an ultra super critical plant. The first one being built in America, we think it’s very important technology advancements. So, the three states Texas, Louisiana, Arkansas, are all in agreement with going forward and undertaking that activity.
We are also continuing to fully fund the carbon capture and storage activities at our mountaineer station in West Virginia for the obvious reason that we think no matter what might come out of Washington, someone has to demonstrate the integrated concept of capturing storage and we think that’s clearly us. We’re in that space and we’re going to do it.
All of the other capital is typically dedicated towards interestingly enough, even though the U.S. economy is flat and even though you don’t see population numbers in some of areas where we do business, you’re still seeing our service territories expand. So our minimal build on the outskirts of the town like Tulsa needs to have an extension of the fiscal facilities to get that done. So almost every dollar of capital investment going forward in 2010, 2011 are dedicated toward projects that we know need to be funded and activities that are being driven by the desires of the instate regulator.
Should the economies improve? The list of projects that we have to go back into the investment mode is substantial. Should the economy continue to rock along and we need to cut back further? Well we might face those difficult issues of delaying the final construction of one of the operating power plants and that’s a realty that we talked about and a realty that we’re prepared to adjust to if we need to.
I guess maybe the question is that, if you see an economy recovery and you think about putting more capital back to work, how do you prioritize where that capital goes in other jurisdictions where the returns mechanism are more compelling to forecast.
Yes, our whole capital plan is typical driven towards that; to the jurisdictions where we receive better rates of return; to jurisdictions where the regulatory lag is less dramatic. So I expect what you would see is we will continue aggressively on some of the environmental build outs on the various plant inside of that eastern footprint, where that treatment has been very, very solid.
Now my question regarding page 10 and 11 of your presentation which has the earned ROE’s and the CapEx by operating company. By looking at page 10, it appears that the earned ROE’s at Texas Wires, PSO, SWEPCo, Kentucky Power, Appalachian Power, are all below 10%, sometimes significantly so; but when we look at page 11, I see that you’re investing in 2010 after the CapEx cuts about $1 billion of incremental CapEx into those operating companies.
Now, we just raised $1.7 billion of the P/E multiple about eight, earnings yield about 12, you’re putting a bowing into these companies that are earning less than 10; isn’t this just going to destroy shareholder values as long as that continues?
Sure, as long as it continues that would be the case. So where are we with the major capital investments at SWEPCo; it has to do with the power plant that I just spoke to. There are in all of those jurisdictions, the wind treatment process have ultimately weighing that capital into the rate base with an earnings cycle on it, that’s why SWEPCo substandard earnings.
The same is true with Appalachian Power. There it’s the Virginia law that we and Dominion put in place a few years back, that will allow for a substantial up-tick in calendar year 2010 for the Virginia side of the Appalachian Power. So you’ll see here that those returns on equity should bounce back into the zone that tells you why would we be putting capital into those particular undertaking.
In fact in Virginia we’re allowed to look forward and is a fully forecasted test here including an anticipated return on those expected investment.
You may remember that the Virginia regulatory model is such that your returns on equity are pretty much pre-forecasted in a basket of equity returns by enabling utilities. So I think you’re going to see some pretty reasonable rates of return on equity at Appalachian, Virginia.
I just wanted to sort of follow-up on the P/E ENEC case in West Virginia. It’s a fuel case; you think it would be pretty straight forward by the time it’s going to be all that straight forward. Is that just because of the environment and the fact of the prices going up a lot or is there anything else and is there a possibility of maybe a settlement there or kind of just touch a little bit on what’s going on there?
Sure, so the ENEC case in West Virginia, Appalachian is [Inaudible] and that its happened year-to-year, it’s pretty much in automatic adjustment. The conversations with the West Virginia regulator are quite straight forward.
You know that we can even smooth it out ourselves, rather than trying to recover all in a single step and when we would typically implement that in the not to distant future, they said, “Let’s weigh a while, so we can get our arms around all of the pieces to make sure that your math is right; that these were cost that you had incurred or will incur as we make that ENEC adjustment.”
I don’t think you’ll find any difficult with that at the end of the day. It’ll happen a little later than we thought that it would, but I think it’ll be implemented to the entirety of what was filed. There is no major push back; it’s just the regulator saying, “Wow, this is a really big number. We need more time to make sure we’re comfortable with it.”
Then on the off-system sales, I’m a little bit not completely clear why volume is down, is it because the price is down and they have got dispatch or is it DC Cook or…
It’s an interesting event and as you know, we got this up last year as Cook station was offline. It has very little of anything to do with the off-system sales. The off-system sales has everything to do with the United States economy. We were talking about at it this morning. If you look back at 2002, it was the last time the natural gas prices were in fact lower than they are today and our coal fleet dispatch just fine thank you.
In this cycle our coal plant is not dispatching and quite honestly, combined cycles, a well priced gas supply, gas plants aren’t dispatching the off-system market either. So it just is a volume downturn throughout the entire Eastern quarter of the United States that we serve and have served as you know goes on and off-system for a long, long time.
Then just the forecasted 2009 industrial sale, that includes GM shutting down, that includes all the ancillary impact. I mean just sort of what’s in that forecast if you could just be little bit more..
We spend an enormous amount of time in the plants of our industrial customers, because of the volume that they require and it gives us a pretty good look at what the overall demand on system will be, which also put into our marketing group kind of a portfolio of opportunities on what the volume is for our system sale. So we got in there, the reality that our customers if shared with us.
When we look at the yesterday GM announcement, we sold one Hummer facility that obviously will be impacted by that. I was encourage to hear the GM equal announcement yesterday at the Singapore, Auto Show; that they’ve comes up with a new engine modification that put in the Hummer, they quickly will start getting Hummers with a hybrid electric at 400 mile range and about 40 miles a gallon. So, you might still be able to buy your Hummer three, which they make at that plant that we serve and feel better about your gas mileage. That will be a 2010 or 2011 event.
The point I’m trying to make Paul, is that we spent a great deal of time in it; not that it matters to you, but it does matter to me. Year-after-year-after-year we win the Edison Electric Institute award for customer satisfaction in our commercial industrial space.
We never got away from that interface of in the field people working with customers at the point of consumption and its pay dividends for self. I’m not Gilbert who does that work for us in a very macro sense. If you look back and I believe that we didn’t see the downturn that we’re seeing now; but if you look back over the year’s that I forecast, they have always been inside of a 1% range. So I think we feel pretty comfortable about the numbers that we put in front of you for the spread that we’ve got on guidance for 2009.
Thank you, Mike. Given the downturn in the economy and lower expected load growth, have you changed you coal inventory strategy at all?
I’ve never changed my coal inventory strategy too much, but the fact of the matter is with some of the downturn, as you expect us to do we’re going back on the relationship that we’ve built over a number of years and saying to our suppliers “Everybody calm down here. We’re going to have to theorize and work on a mutual agreed to, going forward plan for the next so many months, while this downturn is out there.”
We’ll take an opportunity if we get one to put coal in the marketplace and the most importantly we’re just simply working with the very same producers who came to us at a $150 a ton and said, “Hey we can deliver as much to you, because we’re going to deliver a lot to the market.” We allowed some of that to happen back then and the mutual relationship that we’ve always build with out supplier and we’re going to get the benefit of that other turn on.
Can you refresh us on the quest process in Texas, more importantly what your view is of how much just broadly, not just for AEP, how much broadly get build over the next five to six years, whether it’s actually conceivable given permitting process, for the participants to get that done in that time frame and what your total expected investment over the next four or five years in cress project; whether it’s at the actual sub or whether it’s at the JV?
I would expect that when you say “could I update you on the cress process,” I chuckled a bit, because I don’t think anybody could. Maybe the chairman could, but it’s been a long and difficult undertaking, but I would argue that it’s conclusion which really came out with finality just about a week ago.
It looks like $6 billion where the team gets built; about $1 billion of it will be ours; about $800 million of that will be inside of the ETT partnership and ultimately, we expect the $200 million or so that’s assigned to our two operating Texas companies will be transferred to that partnership.
I think the other players when you follow it, maybe not all of them, but clearly this is a pretty serious investment opportunity and permitting in Texas is really pretty straight forward. So I think you’re going to see some of that happen in a very short period of time. Holly you might want to add to that if you got any.
Yes, it pretty much covers the water front. The important thing is the preemption authority vested with the utility in Texas makes that easy to get it done. They have the regulatory regime that makes it work.
Mike and Holly, in the presentation you show quarter earnings growth of 2% to 4% and you talk about a net $600 million rate base investing and if I just do kind of the simple calculation and assume for the timely recovery, that’s about $0.06 or 2%. So what bridges is the gap between the low end of that growth forecast and the upper end?
Well David, if you look how net P&E has grown. The property plant and equipment rate base has grown as you see about in the slide, 10.7%. Our earnings growth rate has been 6.9%, so as Mike alluded to earlier, we have bio waves, some reasonably anticipated rate release. As you pointed out those returns will come up and it will allow earnings to grow, just earning a return, the appropriate return on what’s already been invested, as well as the incremental investments that yield for 2%.
So, it’s the true up of previous investments you had?
That goes back to the question that you asked. If you look at slides 10 and 11, most typically the driver for a rate case is are you earning your authorized rates of return or not. So inside of that envelope we’ll make filings in cases where we’ve not put a lot of capital work; just simply because we think its time to up-tick the overall rate of return that you’re earning inside of that jurisdictions. So, those are the ranges that you’ll see between the two to four.
The economy comes back when you see the much wider range of four to eight, which is driven by again a more robust price profile in the on-system market, as well as demand profile in the on-system market, as well as a recovery in industrial sales inside the regulated envelope.
If I could take a moment, housekeeping matter. For those of you on the phone, if you would like to ask a question on the webcast, please click on the Q-and-A link above the slide window.
I just wanted to talk about the OSS for a second and just follow-up, thinking about going forward and trying to forecast that a little bit, any metrics, any hubs, any way to think about it broadly for ’09 and ‘10. I mean you guys clearly related out now, but should the gas markets recover, power markets I mean, any guidance?
I’ll point you to how you may want to take a view on the widening of the dark spread and our leverage to that. Based on the data here, you can look back to what we stated as our underlying coal cost infused AEP’s in prior dark spreads are historic years. Volume metrically we’ve given you a view on how many megawatts will clear the market and I’ll let you form your own view as to the forward curve, but mathematically that would be a reasonably sound approach. So it’s all about the dark spreads and a multiplication.
Then just one second question with regards to the cash flow deferrals. I mean clearly you can’t touch on it too much at this point, but any sense of a range? You gave at 2011 cumulative, but for perhaps 2009, 2010, maybe at APCo; I mean just can you give maybe a little more granularity there?
Yes, I believe publicly we have stated that our Appalachian deferrals could be in excess or we expect them to be in excess of $400 million. The Ohio deferrals, I believe there is a chart in the back of your package, but there will be nearly a quarter billion dollars this year and they will grow over the period through 2011 to just under $500 million, and for Ohio I’d refer you the page 30.
I’m just trying to get a general sense that I know your retail demand is down, but we have some auctions happening and your other service territory to the south taking a pretty high rate versus you. There’s no chance that you can sell into those auctions to get some of those customers, the way you are situated.
I think you all have seen the outline of the requirements for the AEP auction which will happen in the not to distant future. If we were to participate and if we were to be successful, we can talk to you about that our May 18 and up until that time, we can’t tell you whether we intend to or don’t intend to, nor can we tell you whether we think or don’t think we’ll be successful, but as they say in advertising, watch the space.
But that is not included in your forecast, is that correct?
There would be nothing build into our forecast that we don’t feel comfortable about being accurate and as you know we’re relative conservative people.
Do you guys or maybe Turk or someone have any thoughts on where an auction might clearly have a range, a sense of where the price might be…?
Yes, of course we do. We’re now wondering about the share review or anyone else.
You had a few things that can come up after you gave your revised guidance. I don’t know if you had factored in this deferral in Virginia, the Century Aluminum in West Virginia, I guess and also I think this coal issue you mentioned, that maybe you’re going to be reselling coal at a price below what you paid for it?
Obviously we won’t sell anything at a price below what we paid for; no you can’t make that up in volume.
Do you have any sense of where your guidance will fallout this year; will it be towards the upper end, lower end…?
Well, one of the views of our guidance is that; they taught me this when I was a little boy at a catholic school, that if you have two numbers together and divide by two you get right in the middle of it. You can do that I bet.
So listen, as we always say at the end of these things, we appreciate your time, particularly in a day like today. We appreciate the physical opportunity to see you. This maybe a new model that we may want to try on a couple of occasions, because this is most enjoyable to feel the questions than more of them just in oral sense. Thanks for being here and thanks a lot for your time, your attention and your investments.
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