American Electric Power Company Inc. (NYSE:AEP) Q3 2016 Results, Analyst & Investor Meeting Conference Call November 1, 2016 8:00 AM ET
Nick Akins - Chairman, President and CEO
Brian Tierney - EVP and CFO
Robert Powers - EVP and COO
Charles Zebula - EVP, Energy Supply
Lisa Barton - EVP, Transmission
Andrew Levi - Avon Capital
Julien Dumoulin-Smith - UBS
Michael Weinstein - Crédit Suisse
Michael Lapides - Goldman Sachs
Jonathan Arnold - Deutsche Bank
Praful Mehta - Citigroup
Ali Agha - SunTrust
Steve Fleishman - Wolfe research
Greg Gordon - Evercore Finance
Paul Patterson - Glenrock Associates
Anthony Crowdell - Jefferies
Gregg Orrill - Barclays Capital
Will Zhang - LNZ Capital
Jim von Riesemann - Mizuho Securities
Good morning, everyone, and welcome to today's Analyst Day. AEP really thought about the approach that we'll be taking during this Analyst Day, and it really is focused on the future. As you've probably seen from the two press releases this morning, those press releases are very much focused on, not only our Third Quarter Results, but also focused on the future in terms of where we plan on taking this company, so very happy to be able to focus on that further today.
Obviously, our story's around growth and innovation, focused on infrastructure development, and the customer experience, which we’ve talked about previously, but also very much so consistency and quality of our earnings. And I think you're going to see, in the process, we really focused this company on the firm foundation, a firm financial foundation, which continues to exist, and also being able to invest in the right things, as you see from the capital plan, that's going to be extremely important for us in the future to deliver consistency and quality of earnings to our shareholders.
Some I'm going to do the clicker here, and everyone's familiar with the safe harbor statements, so you could read that at your leisure if you like. But also, as we look at the program today, we wanted to take a look at several areas, and we have some executives here today that focus on specific areas of growth and expectations of the company going forward. We'll have those leaders here today to answer questions that you may have about the future in terms of their parts of the business, but obviously it's a change for AEP to be able to address these types of issues as opposed to focusing on some of the concerns that we’ve had to deal with in the past. And I'll get into that a little bit later where we've addressed those concerns and really repositioned AEP for a positive future.
So we'll have Brian Tierney. Obviously, he'll be up, as CFO, to talk about the third quarter results and also talk about some of the capital allocation plans that we have and expectations around credit metrics and those types of things to show that we do have a very, very firm foundation, one that really is positioned for growth. And as he gets into the details of some of those activities, particularly around capital allocation, you're going to see, we are very much focusing our investment on those things that will produce that consistency and quality of earnings. Lisa Barton will be up here as well. She leads our transmission area. And everyone has questions about transmission. I think one of the things that we talked about today in the release, $17.3 billion of investment over the next 3 years, and over 50% of that investment is in the transmission area.
So you might think of AEP as a transmission company that has several distribution companies and ability to grow indigenously that others don't have, and I think that's a unique quality about AEP that we'll be talking about today. And then, Bob Powers, our Chief Operating Officer, who heads up all of the utilities as well. He'll be talking about the investments we're making at the utilities and the focus that we have on delivering expectations from a jurisdictional standpoint, to ensure that we are spending on the right things that customers actually value in those jurisdictions. And then Chuck Zebula will be up here. You all know Chuck. Chuck has done a masterful job of running our energy supply business. He's been responsible for the disposition of our unregulated generation assets. So he'll talk about that and answer any questions you may have. But I think as far as the future is concerned, we're very much focused on the
adoption of renewables, focused on that part of the business, and as well delivering customer experience levels of operations that really focus on what customers truly want, and he will be talking about that as well.
Here is -- there’s a famous quote, I think it’s unknown in terms of origin, but it says a lot about the releases that we just did. And it says, when you stop chasing the wrong things, you give the right things a chance to catch you. And I think when you look at AEP, we have been very much focused on trying to issue -- trying to really focus on the issues that have hampered us in the past, and what you’re seeing today in the releases that have occurred, in the actions that we’ve taken, we’ve de-risked the corporation dramatically and really put processes in place to ensure that we’re able to invest in the right things and invest in those areas that can produce that consistency and quality of earnings. So I’m very happy with where the company is positioned today and where we’re going to be going in the future. There’s no question that we have a firm foundation and the ability to invest in those things that make a lot of sense to the future of not only American Electric Power, but the industry as well.
So as I look at our previous statement about, and we’ve heard it repeated several times from investor analysts as well, being the next premier regulated energy company; that’s been what we've been focused on for years now, actually. For the last four years, we’ve been taking steps one at a time to really focus on being that next premier regulated energy company that you can really invest in and ensure that consistency and quality of earnings.
Well, I’m going to go through some of the steps that we’ve taken, and we’re changing the notion from here going forward. And that is, we’re going to be -- let me go back here, the premier regulated energy company, because I think we’re there today. Now that we’ve really refocused our business, focused on de-risking components of the business that people have had concerns about, we’re now in a position with a firm foundation to make those investments and really be able to adjust as we go along because the mechanisms we have in place today have been borne out of the challenges we’ve had in the past, but has made us better in terms of allocation of capital, in terms of all those areas to be able to adjust and that’s why we’ve been able to provide consistency and quality of earnings over the last four years even during turbulent times. I can’t imagine what we’ll be able to do without the overhang of some of these issues in the future as we go through and make the investments that we truly want to make and investing in the future and investment in technology, investment in the customer experience that we believe is very valuable.
So let me just go over some of things that we said we would do and it was really focused around three areas. Obviously, we had a lot of questions about the strategic review of the competitive assets. We have gone through a process, a systematic process, and I know it’s been slower than some had expected, but there had to be conditions in place that were conducive for us to be able to achieve the objectives, and we’ve taken our time doing it, but we’ve done it in a way that we thought was as expeditious as possible given the conditions we were dealing with, and we’ve actually gone through the process in a very disciplined way not only in terms of the River Operations area that we sold a couple of years ago, now we are in the process of selling a part of the unregulated generation that we’re very happy to be almost through with that strategic process, associated with those resources, and as well as you know, this morning, we took an impairment on the remaining resources, and I'll get into that in a little detail as well. But as we look at those investments, those -- the remaining overhang investments that had the volatility associated with the business, the exposure to the capacity in energy markets, those are areas that we wanted to make sure that we minimize as much as we could and as quickly as we could. So we've actually, I think we've done a great job of adjusting to that.
Now let me talk a little bit about the restructuring issues in Ohio. Those remaining unregulated assets still remain in the Ohio footprint. And those are things that we're trying to achieve a more forward-looking view. From an Ohio perspective, we really see a limitation on the ability for utilities like us who are focused on long-term sustainability and the ability to invest for the long-term to have those pricing signals so that we can invest in new types of generation, whether it's natural gas in the state, the governor's obviously very focused on developing natural gas and as well focused on renewables in the state. And for our utility to being best, we're really positioning this in terms of not reregulation in Ohio, but restructuring in Ohio. And that restructuring is focused on the forward view of being able to invest in the resources of the future within the state.
There's no question, there's probably 3 or 4 natural gas units being built in the state of Ohio today. There should be double that, at least double that being built. And that's something that I think we have to really focus on in terms of not only development of those particular resources, but the pipelines associated with it, the transmission associated with it, so that we can continue to invest and by virtue of all that, the economic development activities within the state would be further enhanced.
The Ohio Business Roundtable has certainly recognized that, and that's something that we're very focused on working with the governor, their staff and as well the legislators during the next legislative session to get resolved. So as we look at restructuring, it's all around that position of our forward-looking view. And that enables us to continue to invest. Otherwise, we're essentially a wires utility in the state and we really do want to focus on the ability to invest in new generation resources, but we have to have a mechanism to do that.
So we will continue to work on the legislative front associated with the restructuring. And as far as the impairment is concerned, we looked at it and obviously, with the sale of assets that have occurred that gave a market value on some of those assets, and as well looking through some of the likelihood of getting any potential excess costs over market or any kind of recovery associated with that, it's probably going to be difficult. And I think it's a much cleaner discussion with the state when you focus on a forward-looking view to replace the earnings that could be incremental to the plan that we've put forward with you. So very, very much focused on that, and we're getting a lot of positive feedback along those lines.
As far as reinvesting the proceeds wisely, we've reinvested and we're in the process of reinvesting the proceeds of these transactions. I'll talk a little bit about that a little bit later. But as we look at the reinvestment, it's unique in AEP's ability to be able to reinvest the magnitude of the new cash capital coming in and to look at another 2, over $2 billion, whether it’s through proceeds of the sale or bonus depreciation or whatever the case may be, we’ve been able to have a plan to reinvest indigenously and certainly, transmission's a big part of that, but also the regulated utilities are as well. I think we’re in a unique position from that perspective. And we’re very proud of what we've been able to put together in terms of a plan that we feel like is very firm, it’s known projects as we’ve talked about previously, it’s not something that's an aspiration in terms of our ability to reinvest this additional capital that’s coming in, and we’re very focused on doing that over the next 3 years. And then of course, we continue to grow our regulated business, but now, we repositioned the company to take advantage of that growth.
We have a really hard growth when it comes to investments in our regulated companies, and you’ll see that with our adjustment to the cone going forward from a growth rate perspective.
So AEP going forward, we’re well positioned as a regulated business, there’s no question from our perspective. We see our ability to invest, invest in the regulated companies, invest in regulated infrastructure and as well focused on long-term purchase power arrangements for the expansion of renewables. Those are very positive things from our perspective as long as we can invest, invest for the long term and understand what the return components are going to look like, we’ll be in great shape.
Earnings growth rate, further enhanced, we were at 4% to 6% growth rate, we’re now at 5% to 7%. So we’ve increased that growth trajectory, and we see that continuing on out as well. So really, it’s one of the stories of getting smaller to get larger and we’ve really focused on the ability to reposition the company, show the how our growth profile that fully reflects the regulated business and our investments that are being made.
So let’s take a closer look at some of the concerns that you’ve had in the past, and I’ll talk a little bit about how we’ve addressed those. So the first concern, number one was our investor focus on the competitive generating assets. Obviously, as we said in the past, we don’t like spending 90% of our time talking about 5% to 10% of the business, and that’s what’s happened over the last four years.
Now we don’t have to talk about that anymore. The volatile earnings associated with the competitive generation from the capacity and the energy markets are no longer a concern. So we are very definitely in a position where we feel like we’ve resolved our competitive asset concerns. We’ve resolved that by the sale of River Ops, the sale of the unregulated generation and as well the impairment de-risk of the financial aspects associated with continuing to own that generation until we do go through the process strategically of determining what the future of that generation looks like.
Second issue, questions about the use of proceeds, we – I know there’s a little bit of disappointment that we didn’t talk about the use of proceeds after the last quarter, but keep in mind, with the magnitude of the capital being deployed. We want to make sure we had an absolutely firm plan that we could reassure you that we could take those dollars, reinvest them and really focus on growth for our company going forward.
So we will be using all the proceeds from these transactions. And that really is to refocus and redeploy that capital on parts of the business that we find particularly attractive. And the majority of that was reinvested in the transition area. We've said time and time again, we have a long runway when it comes to transition. We have the magnitude of a project management to be able to support the investment in transmission, and that's something, I think that is unique to AEP, that we're able to invest in transmission. And that really has the ability to adjust on an order of magnitude that many others just don't have, so very happy about that.
As I said earlier, over 50% of that capital is going to transmission. And keep in mind, when you think about the breadth of AEP transmission, the largest transmission system in North America, 14% of all the transmission investment in this country is occurring at AEP. So if you really want to look at a transmission company, AEP certainly is that. As we look at some of the other areas of concern, and as I mentioned earlier, we've increased investment in transmission. On the renewables side of things, we are looking at long-term renewables. I always ask the question how many states does AEP have operations in, most people say 11 states. If you ask the transmission people, they'll say 13 states because we are also in Kansas and Missouri. The truth is, if we had Chuck's business as well, we're in 30 states. And with those states, we're really focused on those kinds of long-term purchase power arrangements whether it's solar, whether its wind, other forms of renewables, whether it's specific relationships with large customers. That's a great thing for us to be involved with. We have the ability now with that firm foundation that I've talked about earlier to really invest in those types of businesses.
We've actually decided to use deferral accounting for that so it continues to be a part of our business as opposed to trying to feed the monster on a continual basis. But keep in mind, our primary motivation is the focus on our regulated companies and our transmission infrastructure and to an extent, generation in regulated jurisdictions that makes sense as well, but also augmented by our ability to focus on these other aspects of the business that Chuck is overseeing at this point. So I think it's really important to see not that a central part of our business, but one that we can be selective and be very focused on enhancing the earnings profile of the company going forward.
Next issue. Regulated, non-regulated business mix. There's no question that as we looked at our unregulated business mix, it was definitely an issue for us going forward. We had with the unregulated piece of the business, we had volatility in terms of our forecasting. We certainly had issues with the capacity markets, the energy markets and so forth. So it's been a great opportunity for us to de-risk the company from that perspective. And today, you look at our regulated business, 100% of the capital is being invested in the regulated business, 97% of our earnings will come from the regulated business. So when you look at what's occurring with this company, it definitely is a repositioning that takes out the volatility that focuses on the discipline and the execution around investing in the right things that customers truly value. Customers, and I've said this several times, it's very difficult for customers to value a scrubber or an SCR being built at a coal plant, but they do value investment in transmission, investment in distribution, investment in technology to be able to deploy from the customer experience perspective. Those are things that customers will value. And if customers value it, regulators will value it, and our shareholders will benefit from that.
And the final issue is the earnings volatility itself. Our main focus of derisking the corporation has been focused on the consistency and quality of earnings. And we recognized the volatility of waiting for the next capacity market to actually come to fruition what that value would be, what the energy markets do on a regular basis, what happens to the ability to invest in some of this generation that we have to make much harder decisions about from an environmental standpoint and so forth. We really do have to be able to de-risk the business from that perspective, and we've been able to do that. I think when you look at the company going forward, there's going to be predictable earnings and a higher growth rate, and that's exactly what our investors have been -- has been asking for. I can't reiterate enough though that the capital spend is real. It's not something that is aspirational. It's projects that we know and understand and are going to execute over that time period. So we look at the forecast as very solid, very conservative, but that's what AEP does, we want to make sure that we deliver on the expectations and we will certainly do that as time goes on.
So this is really the money slide, where we are moving from 4% to 6% growth rate to 5% to 7% growth rate and that’s really says a lot about how we have repositioned the company. When you think about the rebates, everyone wouldn't know what the rebates was, and now you know this as 365 and that we have a growth trajectory on top of that, that goes to 5% to 7%. In the third year, that cone overlaps the 4% to 6% cone. But here's the real story is, the 5% to 7% CAGR continues to grow. So for long-term investors in our shares of stock, it's important to understand that this is a repositioning of the company that if you are long-term investor, you're in great shape going forward. And then secondly, for investors today, it's an opportunity to buy into that 5% to 7% CAGR.
So I think it's just an amazing component of AEP going forward because when you think of AEP, you have the 5% to 7% growth rate, you have the investment in, in particular, wires and regulated parts of the business, and you have the ability to adjust as we go along, which we normally do with our capital forecasting and all the changes that we make along the way. So I would say that this repositioning, you can see down below, the operating earnings guidance range, we took the midpoint of the cone for the operation -- for the guidance range, and I think it's a very certainly while conservative, it's still an area that we're very comfortable with. So a lot of progress has been made from that perspective.
Now attached to that with the earnings growth associated with it, our board has been consistent with focusing on that dividend range of 60% to 70% and we're well within that range. This shows the past in terms of the 4.9% dividend growth that's occurred. Our board recently approved additional increase in the dividend. We will continue to have the policy of having our dividend growth be commensurate with our earnings growth. So as we look at 5% to 7% CAGR on earnings, I think we can look forward to our dividends to be consistent with that approach as well. So it is a very positive story for our long-term investors as we look forward to the future, but even more so it’s about what we’re spending on and it’s about the quality of the $17.3 billion of capital that we have focused on for the next three years. When you look at that, we’re not spending on a large central station generation facility or anything like that, we’re spending on projects, multiple projects, that we can manage from here on out, so in a very, very good position.
So as I lead up to Brian coming up, this is a story of AEP, the new story of AEP, the premier regulated energy company, it’s around higher growth, higher dividends, more regulated and more certainty. So from a shareholder perspective, it should be just an excellent story for investment going forward.
So now, I’m going to turn it over to Brian to give some more detail of not only the third quarter results, but also in terms of the other issues we’ve talked about. So, Brian, you’re up?
Thank you, Nick and good morning, everyone. I’m going to focus a little bit on the past and then I’m going to try and catch up with my CEO and talk about the future a little bit as well, but I need to clear some things out of the way before we can get there.
Let’s start with the asset impairment that we announced today. This morning AEP announced a third quarter pretax impairment of $2.3 billion. This is $1.5 billion after-tax, and on a per share basis, it’s $2.98. Fortunately, AEPs strong balance sheet can withstand this type of impairment. This moves our debt to total cap to 55% and doesn’t come close to bringing in the question any covenants or credit events.
The vast majority of this impairment is associated with generating units, some of which serve regulated customers in Ohio for more than 4 decades. We were required to conduct the asset impairment test due to the reduced likelihood of cost recovery in Ohio that Nick mentioned earlier, declining prices for capacity and energy and the market intelligence that we have gained in the recent sale process of other generating assets. There will be no cash tax savings from this impairment until the units are either sold or retired. However, coincident with the impairment, we – the capital budget for these plants was reduced by approximately $400 million over the remaining life of the plants. These are dollars that will be reinvested in our regulated or contracted businesses. This asset impairment, combined with previously announced sale of our other Ohio generating assets, puts the financial impact of the costly Ohio deregulation debacle squarely behind us.
To be clear, we now have a significantly smaller financial footprint in Ohio, but we also have wires companies that in the state are in very attractive returns.
This morning, we did release our traditional earnings presentation and press release on our website. But let me briefly take you through the highlights of the third quarter and year-to-date results. Most of the difference between GAAP and operating earnings for both periods is driven by the impairment that we just discussed. However, there are other items for you to be aware of, and they are found in the reconciling detail in the presentation and release.
For 2016, third quarter operating earnings, AEP earned $640 million or $1.30 per share compared to $1.06 per share or $521 million in 2015. We experienced growth in each of our regulated segments with the major drivers for the earnings being weather, which added $0.07 per share and rate changes in lower O&M expenses, each of which added $0.09 per share. Generation & Marketing was down $0.03 per share for the quarter and corporate and other was down $0.02, partially reflecting the sale of River Operations.
Turning to year-to-date results. Again, most of the difference between GAAP and operating earnings is attributable to the asset impairment. 2016 year-to-date operating earnings were $1.61 billion or $3.27 per share compared to $3.21 per share or $1.58 billion earned in 2015. Similar to the quarterly comparison, all the related segments were up year-to-date, partially offset by declines in a our regulated businesses, in our competitive businesses, I'm sorry. On the regulated side, rate changes added $0.18 per share and reduced O&M expense added $0.09 per share, partially offset by unfavorable weather of $0.05. In addition, the Transmission Holdco segment, added $0.12 per share, reflecting increased investment and recovery in that business.
On the competitive side, Generation & Marketing was down $0.33 per share, largely due to increased, decreased capacity revenues and lower energy margins, down $0.19 and $0.10, respectively. And corporate and other, the sale of River Ops was a negative $0.03 per share. Given the strength of our regulated businesses and some of the help we've seen from warmer weather in the third quarter, we are confident in raising and narrowing our operating earnings guidance range for 2016 to $3.75 to $3.85 per share. Let me now take you through asset sale details, where we get the money from and then on the next slide, we'll talk about where we reinvest those proceeds to. In September of this year, we announced the sale of 5,200 megawatts of competitive generation. This transaction is expected to close in the first quarter of 2017. And we, at that time, we expect to record a gain of approximately 151, $150 million. The sales price was $2.2 billion.
And after you account for debt retirement and taxes, we'll have net proceeds of about $1.2 billion, which we can then lever up to about $2.2 billion to reinvest in our regulated businesses. When we lever this up, we're taking dollars that had been trapped in a competitive business and directly transferring it to our regulated businesses, which offer a steadier and more stable growth profile. Let's go through some of the specifics where the use of that proceeds will go. For the years 2017 through 2019, AEP had planned to spend about $15.1 billion in capital expenditures. Now for the same period, we have the additional capacity to put the 2.1, $2.2 billion of levered sales proceeds to work in our regulated and contracted businesses. Let's talk specifics. Due to the previously discussed sale and impairment of assets as well as the refinement of our regulated generating plants, we were able to reduce our base combined generation CapEx by about $800 million.
In the next three years, we will be able to invest an incremental $1.6 billion in our regulated transmission business, further improving resiliency and reliability for our customers. Our business model, including regulated Transcos, JVs and our integrated utility companies, as well as our extensive transmission and network, allow us to deploy this amount of capital effectively and efficiently. Our customers benefit in the near-term and the capital is put to work with very little regulatory lag and attractive rates. Lisa Barton, who heads this business for AEP, will provide more detail on how we will do this later in the presentation.
We also have plans to invest about $400 million in renewable wind at our vertically integrated utilities. The pending expiration of the production tax credit makes renewable wind investments very timely for companies that had planned to invest in this space between now and the early 2020s. Bob Powers, AEP's Chief Operating Officer, will show the incredible position of renewables in our regulated companies' integrated resource plants later in the presentation.
Finally, we believe that contracted renewables offer a regulated like risk profile with attractive returns. When will look to the future, we believe that renewables will play an increasingly important part in the country's energy mix, regardless of what happens to the Clean Power Plan. We believe this is a channel for us to serve customers who want renewable resources and for us to earn a reasonable return doing so at relatively low risk. We plan to invest about $1 billion or about 6% of our capital budget in this space over the next 3 years. We will be using the deferral method for recognition of the investment tax credit so there will not be an earnings clip associated with this activity. Chuck Zebula and his team have formed AEP OnSite Partners and AEP Renewables to serve customers in this area, and you'll hear more from Chuck later in the presentation about our plans in this area.
When you look at the reduction in CapEx in businesses that we've sold or impaired and where we're reinvesting the levered proceeds from those sales, a truly attractive picture of future capital allocation starts to appear. Bob and Nick will highlight for you later how dramatically and in such a short period of time, the composition of our net plant has shifted to more weighted and wires, and our earnings profile has shifted from hybrid to regulated. Those shifts are a result of asset divestitures and careful capital allocation overtime.
This pinwheel highlights a few key points. Our forecasted capital for the next 3 years, 94% of this is in regulated businesses, represented by the blue and green bars on the pinwheel. 74% of the forecast is allocated to the regulated wires business, and investors know why this is so important. If you consider contracted renewables as being regulated like, and I think you probably should, then fully 100% of our CapEx over the next 3 years is in regulated and regulated like businesses while we maintain the 74% allocation to the wires business. The careful capital allocation demonstrated by this slide is what drives the dramatic changes in business composition that Bob and Nick will highlight later in the presentation.
Given the very robust capital investment forecast, the next obvious question is, can AEP afford it? And the answer is yes. Our capital forecast is not predicated on equity issuances and none are planned at this time. We believe that our cash flows from operations support credit metrics in the BBB+ and BAA1 range. We will have significant debt capital markets needs, but we've seen strong appetite from investors in our regulated and wires oriented paper.
Finally, we've been asked about share buybacks. Our ability to quickly reinvest proceeds from asset sales into our regulated businesses, offer a superior total return proposition. As such, no share buybacks are planned at this time.
We've explained the use of proceeds in our capital forecast and discussed that AEP can afford it, let's talk now about what this means to our rate base. The 5% to 7% earnings growth rate that Nick described is predicated on investing in our regulated properties for the benefit of our customers and then getting that investment reflected in rates. This slide shows it for our forecasted plan, our compound annual growth rate for rate base will be 7.7% from 2015 through 2019. That is, we will grow rate base from $32.8 billion to $44.2 billion. The top 2 bars, T&D Utilities and Transcos source, which account for about 72% of the rate base of growth, had very efficient mechanisms for putting investment into rates and allowing recovery. Vertically Integrated Utilities, the remaining 28% of investment, offer the same opportunity for recovery and to earn on the investment, just generally, with more lag. This lag contributes to the difference between the 5% to 7% earnings growth and the 7.7% growth in rate base.
Let's take a look now at the waterfall, the current 2016 operating earnings guidance, to 2017. Looking at 2017, the midpoint of our operating earnings guidance is $3.65 per share compared to $3.80 in 2016. Generally, the decrease in earnings is driven by the expected decline in the Generation & Marketing segments due to the sale of the assets and the assumed return to normal weather in 2017. These unfavorable drivers were partially offset by rate changes and increased earnings from AEP's Transmission Holdco segment. Earnings for the Vertically Integrated Utilities segments are expected to be $1.85 per share, down $0.09 for 2017. The segments' major variances include increased interest expense and lower AFUDC, a return to normal weather, an increased depreciation expense not yet reflected in rates. Each of which will cost with the comparison $0.06 per share. These negatives were partially offset by a recovery of incremental investment to serve our customers and increase in normal load, which together add $0.09 per share to the comparison.
The Transmission & Distribution Utilities segment are expected to earn $1.08 per share, up $0.16 over 2016's $0.92 per share. This segment's major variance is due to rate changes and regulatory provisions, which are projected to be higher by $0.14.
Our AEP Transmission Holdco segment continues to grow and expects 2017 earnings to be $0.59 per share compared to 2016's earnings of $0.55. The growth in earnings reflects our return on incremental investment. Net plant, less deferred taxes is expected to grow by $1.3 billion between 2016 and 2017, an increase of 31%. The Generation & Marketing segment is expected to earn $0.19 per share compared to 2016 earnings of $0.50 per share. The 31% decline is due to the sale of the assets. Corporate and others is expected to be higher by $0.05 per share and should be driven by lower O&M.
Now let's take a look at the normalized load trends that are supporting the forecast. We expect to end this year with a modest 0.2% growth, followed by a slight recovery of 0.6% in 2017. This is consistent with a modest economic recovery expected for AEP service territory as energy prices recover. The strongest growth in 2017 is expected to come from our Transmission & Distribution Utilities in Ohio and Texas. For the period 2017 through 2019, we are only anticipating growth in the range of 0.1% to 0.5%.
Let's take a look at normalized load growth by class. Starting in the upper left quadrant, our residential sales are expected to fall by 0.3% in 2017, after growing by 0.4% in 2016. Residential customer class counts are expected to grow only 0.2% in 2017. If you exclude AEP Texas, residential customer accounts are expected to be essentially flat. Normalized residential usage is projected to decline by 0.005% due to the impact of energy efficiency and price elasticity. In the upper right, commercial sales are expected to increase by 1% in 2016 and remain relatively flat in 2017.
Finally, in the lower left quadrant, you see a significant recovery in the industrial class, up 2% in 2017. Industrial sales have been held back in 2016 by low energy prices, strong dollar and weak global demand. We expect the number of industrial expansions to come online next year. Most of these are in the oil and gas sectors, but also include metals, transportation and plastics.
In addition to capital allocation, we’ve also been very disciplined about operations and maintenance expense. Since 2011, we have kept O&M, excluding trackers and riders between $2.8 billion and $3.1 billion, by implementing continuous improvement and procurement initiatives. This has enabled us to absorb network, IT security issues and other emergent work increases. We will continue to proactively manage our costs so as to keep O&M flat at approximately $3 billion over the forecast period.
Let me briefly summarize before I turn the presentation over to Lisa Barton. In a very short period of time, we have changed this company’s risk and earnings profile from a hybrid model to a very regulated model. And we’ve done it primarily through two methods: The first is through asset divestitures and the second is through careful allocation of capital. Our strong balance sheet and credit metrics will allow us to continue to do this into the foreseeable future. When you take AEP’s dividend yield of 3.5% to 4%, add it to AEP’s earnings growth of 5% to 7%, AEP represents a total shareholder return proposition of between 9% and 11%. We believe that’s significant for a business of this regulated risk profile.
Transmission is a large part of that growth story, and I’ll now turn it over to Lisa Barton to provide you details on that. Thank you.
Well, good morning. It’s a pleasure to be here with you today and talk about our Transmission business. As Nick mentioned, AEP owns, operates and maintains the largest transmission network in North America. From a transmission business unit standpoint, we have 2,600 employees located in over 90 offices across the system for 11 states. From these offices, we basically maintain the assets of our seven operating companies, our six Transcos and our five joint ventures. This is a portfolio that provides tremendous geographic as well as project diversity. And that has been and will continue to be key to our execution in the future.
I want to talk a little bit about Transmission Holding Company and to point you to our net plant figures that you see on the screen here. Our Transmission Holding Company assets are fairly new. Underneath these companies, we have our joint ventures as well as we have our AEP Transmission Company and AEP Transmission recently secured Moody's rating of A2, with a stable outlook and S&P family rating of BBB+. In that issuance, they also mentioned the fact that if it was a stand-alone company, that AEP Transmission Company would get an A+ rating. These strong ratings reflect the strength of transmission-only businesses in our portfolio. By contrast, assets held in our operating companies are older. You can see that we have about $10 billion of net plants and used assets. And that reflects about 37,000 miles of line and 3,000 substations. AEP Transmission Holdco is created in 2011 with 2 FERC formula rates.
Since that time, we've been putting dollars to work in support of good reliability and furtherance of that effort. Diversity has been our key in terms of our execution from a project portfolio standpoint and a geographic standpoint. It has enabled us year-over-year to reach not only our base case CapEx plans, but again, year-over-year, our high-case targets. The forecast that you see in front of you continues to focus on known projects, as Nick mentioned. It excludes large RTO projects that we think may be approved over the next coming years. Our current plan is to invest $3 billion a year, with respect to our Transmission business. We continue to anticipate the $3 billion will be evenly split between our operating companies and our Transcos on a going-forward basis. As you've known from me speaking in the past as well as Nick and Brian, we've talked about the fact that we have needed to invest a tremendous amount in terms of regional reliability upgrades.
These are projects that are needed to support the regional infrastructure. We've needed these to interconnect wind projects in the West and to accommodate the retirement of our generation assets in the East, not only our assets but the assets of many other utilities in our Eastern footprint. Our next wave is going to focus more on local reliability projects and on replacing our assets that are aging. This is actually one of my favorite slides. We operate a system of transmission assets from 23 kV to 765 kV, and I will spend a little time on this slide here. We've got about 40,000 miles across our footprint and thousands of substations. The number one question that I get asked is how long is this runway. And this is one of two slides that attempts to give a little bit more perspective around that answer.
Generally speaking, there are three significant asset types in the transmission space: lines, transformers and breakers. What you see here is the asset age profile of both our transmission lines as well as our transformers. Suffice it to say, the more you have, the older it is, the more you need to invest. If you take a look at those gray bands that you see here in the center, this reflects the life expectancy of our transmission lines and our transformers, respectively. Like any long-lived asset, there is not one date that these assets sale on, it is more or less a range and that gray band is reflecting of that range. If you look at the red bands, the red bands, left of the gray, shows the assets that are beyond their life expectancy. These are assets that are typically fully depreciated and require significant O&M. These are the assets that we need to focus on going forward. The other thing that I'd like to point out to you is as you look at, and I know it's difficult to see here on the screen, but if you look at the years as to when these assets were placed and serviced.
The assets on the far left, the assets that are basically in red and quite frankly, a number of the ones in the gray are assets that are 138 kV and below. Our 345 kV build out took place between the '40s to '60s, and our 765 kV builds out took place in the '60s and '70s. When you think about the cost of replacing these assets, it starts to go up overtime. 345 is usually about twice the investment that you would have in a 130 kV investment and 765 is about 3 times the investment that you would have in a 138 kV investment. So as you can see, we have a long runway in front of us.
Putting these numbers together in a different way, if you take a look at our system 10 years out, you will see that over 12,000 miles of line will be beyond their useful life, over 2,000 transformers and over 4,000 breakers. These are the types of investments that improve the reliability, resiliency and efficiency of the grid.
So now on to my second most asked question, and that is, what is the average size of our projects? And as you've known in the past, it's been a difficult question to answer. With a system as large as ours, there really is no one average size project. We have thousands of projects going on at any given point in time and we're going to continue to in support of the $3 billion CapEx that we have per year in front of us for the next 3 years. But I wanted to show you a couple of examples. This is one of my favorite ones, and I like talking about this, this time of year because as there are leaves falling on the ground, there are transmission projects going into service. This is the time of year that we commission transmission projects. And so every day, basically, I'm getting an email talking about another line or another transformer being, going into service. So it's an exciting time of the year for the transmission shop at AEP.
So this project is in McDowell County. Welcome to McDowell County, West Virginia. This project represents $143 million investment, where we're basically retiring our 88 kV system. In the past, you've heard me talk about the 88 kV system. It is an obsolete voltage class and one that we're seeking to basically eliminate across the system. It's very inefficient and it has several reliability problems. So this project is really designed to improve the local reliability in the West Virginia and Western Virginia footprint. In essence, it will bring a 138 kV source to the area, looping it and replacing these 2 stations. And I wanted to talk a little bit about these 2 stations. If you were to go there today, and I actually went there about a month or so ago, and the station manager who is in charge of the reconstruction here in this area gave me these two photos, which I thought were particularly pertinent to show. So I don't know if you can see the car on the far left. I do not know the age of the car, but I do know that, that is one old substation. And you can see the building that's there as well. That is back in the day when we man substations, where people actually were they were paid to be there 24 hours a day in order to open the breakers and so forth on the system. And if you also see the I want to go back a little bit here. If you look at the landscape, you'll see that it's been completely defoliated. This is a vibrant forest now today. And so these are the kinds of investments that are really helping to improve reliability in the future. Both of these substations, basically, will be leveled and it will be replaced by one substation, thereby dramatically increasing efficiency in the area.
Okay, Cloverdale Station, Virginia. This is another one of my favorite projects. And this is one actually that went into service the 530 to 345 kV bank went into service last week. This is a project that was directed by PJM, and this was needed to support regional reliability. This reflects about $189 million investment and this picture really does not do this project justice. I was out there at the Cloverdale site, and this is probably about six months or so ago. And I stood on a hill that overlooked the station. And if you go from your far left, all the way and pan to the right, probably looking at about 120 degrees, you will see nothing but substation. This one station basically has resulted in us needing to put 25,000 truckloads to fill, 1,000 truckloads of concrete, 32 miles of ground grid, and it's taking over 600,000 man-hours to complete this project. In essence, it is a new 500 kV source feeding into the 345 kV system and required us to relocate 10 different transmission lines into this area. And this is really one of three stations in the area, so it'll all be linked together. This station is unique in the sense that it is a major point of interconnection between our system and the Eastern 500 system. It is one that has every voltage class that AEP has on the system in this station.
On to a smaller project, this is a $40 million project. And this is the Marcellus Area Improvement Project. It's a small project with a big local impact. This is basically bringing in a new 138 kV loop with two distribution stations, and it enables shale gas development. This is an area that was underserved by transmission in the sense that it had a very old 69 kV system. We had new shale gas customers who were coming online and they needed additional capacity in order to operate. So we have put in a skid station to provide them with temporary service. And now that this line is going into service, they will be able to have full output of their facility.
Again, back to some of our larger projects and out to the West. This is the Lower Rio Grande Valley, 345 kV project. It reflects a 156-mile line that's coming from North Edinburgh to Laredo. It's an investment of about $330 million. This is a project that has enabled multiple wind farms to be able to interconnect in our system and has dramatically improved the reliability to one of the fastest growing areas in the U.S. It was commissioned and put into service in May of this past year.
So recent FERC filing. I'm sure everybody would like to hear a little bit about this today. We hit a 206 filing that is a request to adjust our rates from 10.99 to 8.32. This was filed by AMP and a number of other companies. Suffice it to say, we significantly disagree, with the ask that is -- than put in place there. After short a comment period, they will recommend a settlement period then we will go into settlement. We will be filing our response within the next 20 days. Concurrently, with this filing, we will be submitting a 205 filing. And I want to talk a little bit about what that 205 formula rate adjustment filing is seeking to do.
Today, we have a partial historic, partial forward-looking rate. And so what ends up happening is in the summer, that rate gets adjusted each year. We have historical O&M and historical property taxes. Basically, this 205 filing would allow us to earn our authorized return going forward and it would be using projected plant and service, projected O&M and projected property tax. This would very much be in line with the rates that are in place for our PJM peers.
So we talked about the opportunities in this space but in the end, it’s all about execution. The Transmission business is filled with a number of first, we were the first investor-owned utility to move forward and delve into the competitive transmission space because we felt that it was important to be relevant in that space. We have developed a number of joint ventures that has enabled us to expand our system to 15 states and increase our investment opportunities beyond our traditional borders. We’ve created Grid Assurance to adjust the need for large power equipment spares and we have our asset health center, which helps us manage and prioritize the equipment replaces -- replacements that are going to be needed in order for us to make this $3 billion CapEx investment.
As the largest developer of transmission projects in the country, we’re experienced and we’re well positioned to execute the $3 billion entrusted to us to improve the reliability, resiliency and the efficiency of the grid. Thank you for your time.
Well, good morning, and thanks, Lisa. What a great investment story. And I’m pleased to be able to have some time this morning to share with you the regulated properties are well positioned to put that capital investment and other capital investment to work for our shareholders. And I’d also like to share with you how the capital allocation and a resource mix in AEP is changing based on crisp capital allocation, plant sales and unit retirements that’s all leading to a lower environmental and lower overall business risk. So let’s take a look.
So Nick graciously allowed me to take his favorite slide, the equalizer slide, it’s something you've all seen every quarter, and talk about how the regulated operations are doing. You’ve seen it before, we have a variation in performance across the 11 states. But overall, I’m pleased to report at the end of the third quarter, the regulated ROEs for these companies were 10.5%. We had some nice uplift from weather. But overall, the properties are performing at a rate of about 10%, like we performed over the last three to four years.
Quickly going from left to right, to give you a perspective of what’s going on. Obviously, Ohio is leading the ROE race here. It’s now a wires company, smaller, and Nick had talked a little bit initially and will talk some more about some opportunities for investment in Ohio. But – and of the ROE at 13.2% is actually on a book basis, about 140 basis points higher. We’ve discounted this number for some of the regulatory proceedings that gave us WAC, improved WAC recovery on fuel and the seed cap. So we’ve removed that and this reflects more the ongoing earning power of AEP Ohio.
APCo is now our largest operating company based on invested capital. It's navigating the Virginia base rate case freeze very well. We've obviously had improved performance on the West Virginia side of that business, and it's operating at a nice 10.1% ROE. Kentucky Power. All I can tell you, it's vastly improved from a year ago. It's at 7.2% ROE, benefiting from a $45 million rate case that was concluded last year. That will improve over time, but that property is struggling with load growth. And so we'll make appropriate adjustments, both in terms of our plan for additional rate case filings and, as Brian and I go around and look at invested capital, likely make adjustments to O&M and capital on that property as well.
I&M is a very constructive regulatory environment, operating at about 11.2%, had good load this year. It's got a good environment overall and a good load forecast going forward. PSO has a rate case pending. We've put rates, $75 million of rates in effect, pending that final determination by the commission. We do have a growing backlog of invested capital in PSO that are outside the test year that's represented in that rate case. So we'll be looking at an opportunity to invest in PSO going forward again. SWEPCO at 7.2%. You do recall that, that property is somewhat handicapped by the 88 megawatts of Turk that is still not in rate base. However, it has constructive regulatory circumstance in other regards. And going forward, we'll be looking at recovering environmental investment in the Texas part of SWEPCO. We have formula rate proceedings in Louisiana that are also pending.
So we're looking for some improvement in the SWEPCO performance as well. AEP Texas is a great wireless investment opportunity. Mechanisms to keep regulatory lag at a minimum, operating at about 10.3% ROE. And again, that with TCOS and DCOS opportunities in Texas, that's just a great investment story there. And the AEP Transmission Holdco company coming in a little bit better than forecast based on some improved lag performance in that particular area. So overall, I can represent to you that the regulated operations are well-positioned to take the capital that Lisa's putting to work, the capital that's going in the distribution and the remaining capital in generation to work. We've achieved about a 9.8% ROE overall in this business from 2014 to 2016. We're forecasting 9.9% in 2017, and we absolutely expect it during the period of 2017 to 2019. These properties will operate at about a 10% ROE. So pretty good. And I should say that my team is very effective at knowing how to deal with these circumstances.
We know how to file rate cases and be successful in them. Brian and I are pretty good at making sure that a level of capital beyond the fundamental obligation to serve is directed to those operating companies that are performing well and restricted in those that are struggling. And we also take a hard look at O&M in the process. So overall, I think a pretty good story. Let's take a look at where some of the investment in these properties is going. And this next slide is an integrated view of the IRPs for the operating companies. And it's a summary. It's a snapshot as well. This will change based on fuel prices, or change based on technology cost, or change based on load. But at the end of the day, I think this story is much about what you don't see is what you see on this chart. You see over the forecast period, no new coal. You see no large nuclear generation projects. You see a limited amount of gas projects, and you see a lot of solar and wind.
Now this is a much greener portfolio, obviously, than the traditional AEP coal by wire that you've known over the past years. These projects have been picked by the IRP process on the cost of the projects. But I also want to tell you that there's a lot of discipline that's been engrained in the analyzing team, discipline regarding future change in law, discipline regarding sober and realistic depreciation periods for competing assets as the planning process goes on. So all in all, this is a process that, at the moment, is delivering a much, much greener portfolio going forward. I think this is part of the story of AEP's change over the rapid change that Brian pointed out, and the change that will continue going forward.
So what are the good consequences, the appropriate consequences of that change in resource portfolio? Well, taking a look at where our nameplate capacity exists, past and present and future, you can see that there's been a dramatic change in the generation portfolio for AEP. Back in '99, 68% coal on a 37,000 plus megawatt base. Flashing forward to 2017, 47% coal on a 30,000 megawatt base. Increases in the contribution in natural gas. Nuclear remains about the same. Increases in hydro, pump storage, wind, solar and the like and, obviously, increases also in energy efficiency and demand response. This is a changing portfolio. Unit retirements, sales, capital allocation are all driving a change to AEP. And let me share with you some of the environmental results that occur because of this.
This gives you some idea of the dramatic, the very dramatic decreases in environmental emissions profile for the AEP fleet. From 1990 to 2015, 88% reduction in SO2, 87% reduction in NOx, 73% reduction in mercury. And as we look forward to the completion of the asset sales, Gavin plant will be removed. We see that goes up to over 94%, 93% for NOx, 89% for mercury. Just a great, great, great reduction in the environmental risk profile for AEP. And if you're wondering about CO2, well, that pesky little critter, you go back to year 2000, 167 million tons of CO2.
You can see that by the end of 2017 will be about half of that, it's at 89 million tons. 46% reduction in CO2 at the time by the time we look at ultimate retirement or disposal of our Conesville and Zimmer and Stewart units. You're talking about over a 50% reduction in CO2 emissions from the AEP fleet, a dramatically changed risk profile from an environmental prospective.
So let's take a look at a tale of 2 decades, as described here. Nick and I sort of changed jobs in 2006. I was the EVP of Generation. He came in as the EVP of Generation. Mike sent me off to get some experience in the utility business. So this is what I handed to Nick in 2006. 64% of the capital is being directed towards generation. A small Lisa, your business was just, I guess, a gleam in somebody's eye, right? And distribution, about 23%. Flash forward to 2016, okay, 58% of the capital budget is heading towards -- this is actually for the period of 2017 to 2019, but 58% in transmission, only 18% in generation and 24% in distribution. We have changed where capital goes in this business dramatically. In 2006, I sat down with Nick and said, "It's all about environmental retrofits, scrubbers and SCRs and the like." And transmission was just starting. Now the focus is on wires. Lisa, you're putting more than $9 billion to work over the period of time in transmission. So just a dramatic change.
Also look at the net plant profile, differences between 2006 and 2016. We are a different company. In 2006, 45% of the rate base was in generation, 20% in transmission and 35% in distribution. Look at the more distributed, reduced risk in generation on the 2016 chart, down to 32% in generation, 34% in transmission and 34% in distribution. And as we put 74% of our capital on an annual basis to work in distribution and transmission, okay, that pie chart on the right-hand side is going to continue to improve going forward.
We also have an opportunity, going forward, to take a look at where new technology applies in this space. Columbus, Ohio was just recently picked as a smart city, big focus on electric transportation. But believe it or not, AEP was one of the biggest reasons that Columbus achieved that smart city grant from the Department of Transportation and Department of Energy. And what they liked was the vision that AEP could bring to the table regarding renewables, regarding smart distribution equipment, regarding micro grids, regarding technological use of batteries. And those are all opportunities that AEP is well-positioned to adopt strategically and in a focused manner going forward as that world continues to evolve.
So let me now turn the presentation over to a guy that we all know as the coal guy, Mr. Coal, Chuck Zebula. And this is just going to really highlight to you the fact that AEP will be a greener company going forward.
Thanks Bob, and good morning everyone. My good friend, Brian Tierney, often reminds me of an award I achieved in 2006, which was the Ohio Coal Man of The Year, and often take a ribbing for that. It's interesting to me that 10 years later, here speaking about our entrée into the renewable energy space from a contracted basis. And so time does change a lot of things in our industry. And no question, 10 years from now, I'm sure there'll be someone up here, someone else up here talking about some other transformational opportunity in our industry.
So we've had a very busy year in the competitive space. On November 12 of last year, 2015, we sold AEP River Operations to ACBL. That was a very successful transaction. And immediately, after that, we began working diligently on the divestiture of the 4 power plants that we sold in September, the Gavin plant, Lawrenceburg plant, Waterford and Darby. We announced that transaction in mid-September.
As Brian and Nick had addressed earlier, all the regulatory filings are in for that transaction. We expect first quarter close for that, the teams at AEP are very busy, as well as the buyer of the assets transitioning, working on a number of work streams to enable a smooth transition. And all that work is on path, and it looks like we’re on schedule for a first quarter close.
A lot of people wonder, what takes so long for something like that occur? The due diligence process for gas plants is much different than it is for a coal plant. As you know, a coal plant was a big part of that sale, 2,600 megawatts at the Gavin plant. Throughout the process, we’ve logged all the questions that we had to answer in the due diligence process. The due diligence teams, either finance, operational, environmental, legal answered over 6,000 submitted questions from the bidders on who were buying those assets. Very extensive due diligence, very good work, it actually makes the transitional efforts very easy as we go forward.
So besides being very busy with those two processes, there has been time and effort spent on looking at the renewable space and what is changing out there in the industry. Early in 2016, we decided to enter that space because it gave us the ability to invest, gave us the ability to grow our company, provide solutions to customers, which are largely technology-based, and ultimately to provide a cleaner emission profile for them as well.
So a very positive sign for us with being in the business for less than a year, become very active and very welcome. And since we are very purposeful in our commitment in how we spend capital, we can actually choose the projects that we want to participate in, those that balance the risk and reward profiles that we’re looking for as a company. And as Brian mentioned earlier, over the next three years, we plan to commit about $1 billion in this area, and I’ll describe to you how we plan to achieve that goal.
So we formed two subsidiaries earlier this year, one called AEP OnSite Partners, the other AEP Renewables. Let’s first talk about AEP OnSite Partners. This primary purpose of this company is to work with large end-use customers on solutions and projects, helping them to achieve their specific goals, whether that would be applying a technology, reducing emissions or lowering their cost and energy profile. In this company, AEP is providing an asset to the customer, which is ultimately backed by a 20 to 25 year power purchase agreement. So far, the projects we’ve invested in have been solar mostly. There have been some other technologies that are part of the portfolio, size of the solar projects between one and five 5 megawatts and costs generally between $2 million and $15 million.
Again, we’ve been very successful in a very short period of time, committing to about 21 projects this year in eight different states, with capital investment close to $75 million. These opportunities are created through our ability to cross-sell from our subsidiaries, AEP Energy and AEP Energy Partners, our wholesale and retail affiliates as well as our relationships with developers, customers and technology providers in the industry. Without a doubt, distributed renewable resources are a growing trend, and our participation has been successful and welcome.
On the AEP Renewables side, the scope of this company is to participate in the long-term power purchase arrangements that are backed by wind and solar assets to serve utilities, municipalities and corporations. These projects are, of course, larger scale, require more capital, require a bigger tax appetite, but they also provide compelling cash return economics. In this space, we are largely purchasing projects from developers, which of course are backed by 20 to 25-year power purchase arrangements with creditworthy entities. So let's take a look at the next slide and look at a couple of the sample projects that we're doing in this area. On the left side of this slide is a example project for AEP OnSite Partners. In June of this year, we put this 3.6-megawatt solar project in operation for the city of Clyde, which is located in Northwestern Ohio. It's backed by a 25-year PPA. This project came about because the city wanted to do a solar project.
AEP had an existing wholesale relationship with the city of Clyde providing them power. And due to that relationship, we were able to explore the opportunity to build this solar plant for them. Project was built on time, on budget, operating within the expectations that we had set for ourselves. A win-win relationship for AEP, for the client, and it's our inaugural project in the OnSite Partners space. It's also representative of the kinds of projects AEP OnSite Partners will do, providing behind-the-meter distributed technologies to customers who desire these kinds of solutions. On the right side of the slide is an example project from AEP Renewables. It's called Pavant Solar III. It's located in Utah. It's a 20-megawatt AC solar plant, backed by a 20-year PPA with PacifiCorp. Now there are two other projects located adjacent to Pavant III, Pavant I and Pavant II, which are owned by Dominion and PSEG.
Our project's currently under construction, being constructed by JSI Construction, which is a division of juwi. We expect this project to be operational before year's end, and are excited about this kind of opportunity. It demonstrates our commitment to this space. It demonstrates our willingness and delight in working with a reputable strong utility, such as PacifiCorp. And it demonstrates to developers that we are a real player in this market and are willing to take on projects as we look at the wind and solar opportunities here going forward. So when we look at the outlook, we do see a strong pipeline of opportunities. As you look and attend to other utility meetings here this week and at EEI, you might wonder, wow, lots of people are chasing all these opportunities. How does it all stack up? The reality is, some of this is stimulated by the desires of customers, right? Some of it's by regulatory policy, tax policy, declining technology cost. This stuff is real, and it's happening. Our investments in this area will be disciplined, focused on the long-term PPAs backed by the asset and will be supported by significant efforts from our development, marketing and due diligence teams, which were have built with internal hires, but also external hires here over the past 9 months.
Ideally, we're looking for investments that balance the wind and solar profile. We're not webbed to either technology in a sense because they complement each other from an earnings and financial profile, and they provide both strong cash returns due to their tax benefits. Regarding the $1 billion that we plan to spend, we already have letters of intent in place for about 30% of that $1 billion that we plan to spend over the next 3 years. And we're in the due diligence phase for that 30%.
So in summary, we're very pleased about our entrée into this marketplace. It leverages our existing customer businesses to provide them asset backed opportunities. Again, we are a welcomed to partner due to our strong financial position, our relationships and our proven participation. I'm very confident that we can invest this $1 billion in a way that balances the risk and rewards that we are seeking in the renewables area.
That's all I have for today. I'm going to turn it over to Nick, who will summarize this eventful day for AEP. Thank you.
As you can see, there's a great degree of enthusiasm about where this company is going in the future. I know some say that AEP really should be a boring regulated utility, but it's anything but that. It's actually, I think for me, personally, it's the most exciting time that I've ever experienced in my career working for a company that's really focused on the future. It doesn't have the baggage that we used to have, and is really clear to focus and make those decisions that are going to be important for our customers in the future. So as I, let me go one more slide here. We've gotten pretty good at doing these before and after slides to get our point across. But if you look at 2014, 79% of our earnings were from the regulated side. Afterwards, today, 97% of our earnings will be from the regulated operations. So clearly, clearly, a substantial change has occurred. And you heard Bob mention, this is really the exciting part. To me, I get carried away. I know Bette Jo doesn't want me to talk about technology a lot, but that will be for the next Investor Analyst Day. But clearly, we're in a position now where we have a firm foundation to be able to grow and make decisions about how we want to address the customer experience in the future. And that's done through infrastructure development, blocking and tackling associated with these projects. When you tell Lisa Barton, "Hey, guess what? You have another $1.6 billion you need to spend over 3 years." And she said, "Yes, we can do that." And that shows the incredible agility of what we have relative to our projects, the project flow, the project management, all those types of activities to support the investment that's being made. I'm very proud of our entire executive team and the team at AEP that really is focused on not only advancing the strategic aspects of what we're trying to achieve in the future, but also dealing with those areas of cost containment, optimization, continuous improvement mechanisms. All those types of things are occurring and that's what helps us reach the earnings targets when you see O&M expenses consistent for years. So it really is a tremendous time, where everyone's on deck to make sure that we are focused on the future.
So when I look at again, I will resurrect the slide I used earlier. As we move closer to the presidential election time, I am going to make my pitch about AEP, and I will sort of be like a candidate with a parting message. But if you look at the premier regulated energy company, AEP, it's a vote for higher growth, a vote for higher dividends, a vote for more regulated, a vote for more certainty. And I can't imagine anything that's better for the shareholders of the future, and that's American Electric Power.
So thank you very much, and we'll take questions now. Brian, do you want to come up to the other podium.
A - Lisa Barton
For the purpose of the webcast, if you could state your name.
Hi, it's Andrew Levi from Avon Capital. Just a couple of questions. 2018, 2019, what gets you to the high end of your guidance?
Load recovery and rate improvements. It's really a recovering economy.
On the plant impairments, on those 4 plants that you have out there, are they losing money in '17, 18 and '19 in your forecast? Or how does that work?
They're going to be about cash flat.
No, but earnings-wise?
Flat? Okay. So if you were to sell or shut them, there wouldn't be any earnings incurred one way or the other?
Yes, just think about what we need to do relative to those assets. I mean, some of them are multiple owners. So we've got to resolve some of those issues. So there's really our own strategic review around those sets of assets to determine, can there be consolidation? Would you package them together? How do you deal with the variances associated with those particular plants as opposed to the non-PPA plants?
Well, I guess, 1 or 2 of them, if they were, let's say, Dynegy's co-owner on them? I guess, they probably could run them cheaper than you guys? Do you feel that?
We're in talks with people who might be interested in buying those. And obviously, co-owners might be ways that we could settle that fairly easily. But there are others who are interested in those as well.
Okay. And then my last question, and I'll let somebody else go, on the 205 filing that you made, is that in your guidance that you get that? Or is it your guidance basically incorporates how you have it today?
Lisa, do you have a microphone?
Thanks. So the 205 filing, we have one, we have not filed it yet. We anticipate doing so in the next 30 days. The guidance that you see basically is reflective of the ROE before the 206 complaint, as well as not having the 205. The two in ‘17 will likely cancel out each other. When you look at – for example, we have O&M expenses, property taxes, and the impact of bifurcated plant in service, if you look at over the past three years that’s been about 119 basis point delta.
And Andy, the net – the net that keeps us in the range.
The question is, would it be a one-year pop; and yes, it would be a one-year pop. And what we have seen in the past is on an average, has been about 119 basis points.
Back here. Julien Dumoulin-Smith, UBS. Just a couple of quick questions. Well done on the transition regulated. Let’s turn it back to that 3% unregulated for a quick second. Can you talk about what the future is of that 3%? What is there? Is it sustainable? And then also, where are you reflecting the renewables pieces? In that 3%, I mean, obviously, there’s probably not a ton in there. How does that grow over time? And then perhaps a second one, if I can throw it out there. What is a good rule of thumb in terms of levered IRR, earned ROE or just in general, 100 megawatts of x contributes x cents?
Yes. So we’ll make sure Chuck gets a microphone here as well, if there’s a microphone. We’ll get back to all the questions. Don’t worry about it. But part of that is the energy supply business, the retail business, and I have been a proponent of maintaining that retail business because, and Chuck talked about this a little bit, it’s a relationship, it’s a channel growth opportunity. As you long as you stay disciplined around the execution and can find the risk of that business, it can be a very good business. Now we’re not a huge retail energy provider in this country. I mean, obviously, we don’t intend to be that. We are – we have about 500,000 customers in that part of the business spread out in various states. And it gives us eyes and ears in terms of what customers truly want in those various areas, and it gives us an opportunity to expand in other areas as well. So Brian, I don’t know if you have additional comments? We’ll get to Chuck as well.
Yes. So just to add to that right, the contribution or lack of contribution, if you will from the PPA plants right would be also represented in that 3% area. So again, it’s the retail business, the wholesale business, and the contracted renewables. All of those businesses are fully hedged, either backline asset or some other hedging mechanism right through our risk management procedures. And in terms of – as we look at investing in contracted renewables, if you kind of stack up the IRR kind of possibilities in orders of preference financially, we’d prefer a win, it also comes with more risk, right? Secondly, we prefer the OnSite Partner opportunities because those smaller projects often have an ability to get a higher IRR. And then lastly, the universal solar is providing kind of the least opportunity in terms of IRR and equity as we stack up what we want to do in pursuing that business.
I also see the retail business as a hedge from a structural part of the industry going forward because you know, I mean you’re seeing in Nevada and other states the potential for some form of restructuring. If that were to occur, we want to make absolutely sure we have the foundation ready to advance from that perspective. And we've done a nice job of it so far.
But just to clarify, call it, diamond of earnings from the retail business, that should be ongoing? And renewables should be incremental to that number?
Got it. Okay. Excellent. And then just if I can follow up real quickly, separate related subject. Why not do renewables via kind of a more traditional rate-based approach? Why bother with the contracted PPA approach at all?
We're going to do that as well. And that was the $400 million that we talked about for the use of proceeds. That was in vertically integrated utilities.
And keep in mind, too, a lot of things that Chuck is doing in his part of the business around the relationships with customers, whether it's micro grids, whether it's solar, wind, battery technologies. We're also working to advance the regulatory structural mechanisms in place to support or regulate utilities to make those same type of investments, because that's important to provide universal access to everyone as opposed to individual customers with those tailored needs.
Hi. Mike Weinstein from Crédit Suisse. Just to follow up on Julien's question. Can you quantify the IRR, ROEs that you expect to get from the renewables business?
That's competitive information, I'd hate to be able to throw that out there in the space and offer my competitors the ability to know where AEP's doing business. There's very active projects we're participating in right now. Would not be a wise thing to do to.
And one, just one follow-up on...
Let me just to add that, though. We talked a lot about the threshold level that's acceptable to us. And that when Chuck was talking about being selective in the process, we're managing the discipline around that from a financial perspective.
Just one follow-up on the transmission forecast. The EPS forecast looks a little bit lower than the EEI presentation from last year. I'm just wondering what drives that.
It is, basically, it's bonus depreciation is the most significant contributor in 2015. We did not assume extension of bonus depreciation. Also, this past year, our network system peak will change from summer to winter peaking. And that results in a lag that would be remedied with the 205 filing.
Michael Lapides of Goldman. Two questions, one, a little bit of housekeeping, and one more kind of strategic or longer term. On the housekeeping, Brian, one of the slides, Slide seven shows that you actually do have earnings contributions from the generating business in 2017. I think it's $0.09 from the remaining assets and $0.09 from the soon-to-be divested ones?
It's until the sale, Michael.
Yes. So $0.09 from the generating, and I apologize. That's until we sell it, then we don't have that. And then it's about $0.09, $0.10 for what's left.
Got it. So like if I were to rebase '17, it's really that $3.47 you're talking about?
Okay. My second question is more thinking about the generation portfolio at the regulated subsidiaries. And you've done a great job as a company overall of reducing emissions, putting controls on existing coal plants. We've seen some of your peers among the larger utilities be more proactive in terms of fleet transformation at the regulated subs, meaning whether building and owning gas-fired generation within the regulated business. And I know you can't really do that right now in Ohio. You've got a lot of other regulated subs that own generation. But you've not build a lot of gas fired generation in rate base. We've seen other companies, including ones that are in states that don't have renewables standards. So states in the Southeast neighboring some of yours that built renewables in rate base. And I know, Brian, you touched on you're going to spend $400 million or so. Back of the envelope map, that's not even 300 megawatts. For a company your size, it's kind of a rounding error. So just curious how you're thinking about fleet transformation at the regulated subsidiaries within the AEP asset ownership profile versus other owners? Or is this a conscious move where AEP becomes less of an owner of the generation that serves its customers?
Yes. So as far as regulated generation is concerned, we'll still be an owner of that generation. I think when you going back to Bob's slide of the future and what we're showing, it's all renewables and natural gas. Now keep in mind, our Western territories already have a lot of natural gas. And but we made decisions, and you can expect decisions to be made very differently about the investments that were made, particularly as it relates to coal fired generation, and whether the mechanisms we can work through to ensure that we reinforce the transition occurring. We just retired a wells unit, one of the wells units, and that was in the context of adding renewables as well. You're going to see more of the trade off being made of natural gas and renewables against coal fired generation to really focus on balancing out that fleet perspective.
So the units we have left are fully controlled, but the issue still remains. When you look at huge, new investments being made and what you have to invest in those plans in the future versus making a change here during a transformation cycle, that's an opportunity that we have with all of our regulated jurisdictions to go through, through the integrated resource planning process. And we intend on doing that. I think you're seeing, like I said, very, very different decisions being made about not only depreciation, but also in terms of investment and where you focus on the plant actually being retired.
In the past, it was run these plants as long as you can. Today, it's really bound to financial decisions around what the options are, which are very different today, versus trying to achieve that transformation as quickly as possible. So Brian?
Yes, Michael, the only thing I'd add to that is we're not in a position of having to add large central station generation right now. Remember, given what happened with Ohio deregulation, there were states that wanted access to Amos and Mitchell that they've had for many years. And we were able to transfer those assets at book value and cover up a lot of those company central station needs for a long period of time. In addition, in the West, we also have Turk that was recently added to the portfolio there. And so there hasn't been large central station needs in the Western part of our system as well.
And keep in mind, too, just the overall investment thesis is, all of our investments are smaller, whether generation smaller capacity segments or smaller in terms of transmission investments, things that we can turn on and off in a very fluid fashion as opposed to being half built on a $1 billion scrubber or in the middle of a large central station facility. We're not doing that. We're going to be focused on investments that we can make to have the agility that's required to provide that consistent earnings profile. That's what we're doing across the board.
Brian, first, on O&M, the slide shows $3 billion flat through 2017. I think you might have said something about beyond? But could you just clarify what we should be thinking about within the guidance for O&M out to '17.
Our goal is to keep it at that level for the foreseeable future. And there's been a transition on that as well, Jonathan. Some of that, as you know, as we've sold some of the generation or shut down some of the generation, the generation has gone down. And some of the things that we've been spending on emerging costs, like IT and security, have actually increased over time. But our goal is through continuous improvement initiatives and procurement initiatives to stay at that $3 billion level for the foreseeable future.
Safe to say that's what's in the guidance?
And then separately, you sounded like you might be at least somewhat optimistic you could still sell the PPA assets. I think, Nick, you described the restructuring as being thinking about the future. And I was just curious whether that precludes some sort of arrangement around those existing assets or just handicapping which way you that'll likely to go and how likely you are to be out of them.
Yes. We definitely want to be able to neutralize the financial impact of those units. In the restructuring discussion, I really believe that we have, hugely, a much better chance of going through restructuring with a forward view of what we can do for Ohio. When you look at those assets, and particularly when you're thinking about in the excess cost of market recovery that's being transferred back to the wires company, that really -- while it potentially could be done as a challenge, and it encumbers the ability to really get that forward view of the investment potential that's available in Ohio for us. So I tend to look at it more from a forward perspective than looking back. That may have impacts on others, obviously. But from an AEP perspective, after all, you get -- you can only beat your head against the wall so many times. And it really is a difficult message to say, we want excess cost over market. And that becomes the headline as opposed to a true forward-looking view of enhancing the earnings capability of the company going forward. If we're able to move forward and have Ohio in a position where the utilities can invest in new generation, then that's also an earnings positive for us that's not in the plan, and that's something that we're really focused on.
And level of optimism on selling the assets?
I mean, so we've had third parties who were interested in examining those assets, and we've had a team that's been focused on selling a different set of assets. And as that comes to a close, we're going to explore conversations with those folks.
Hi guys, Praful Mehta from Citi. So a quick question, just to clarify again on the 2017 earnings. The $0.09 we get, that is the assets that are being sold. The other $0.09, is that the other assets, the PPA assets, effectively? And is that earnings neutral or is that $0.09 that other assets?
The $0.09 is everything else that's in Chuck's business, but we don't anticipate much contribution from the -- what we used to call the PPA assets.
Got you. And so if you look at the trajectory then going forward, the 5% to 7%, given if Chuck’s business, effectively the other $0.09, what contribution, I guess, is the renewable component going forward? So if you look at, let’s say, 2019, apart from the utility business, which we can see in the growth profile, what is the renewables business, I guess, add up to as a proportion of the total by 2019?
So you should think of it – next year, in the $0.09, we have a favorable hedge position by which is contributing, right to the benefit of that $0.09, right? As that rolls off, if we sell the generation, that number is going to come down and it’s going to be replaced, right, by the growing renewable business. So you should consider that $0.09 to be somewhat slow-growing through the period, not at the 5% to 7%.
Fair enough. And then, finally, just to – Chuck you said a number of people are going after renewable businesses, and this seems to be the new kind of theme to kind of seek growth right now in the utility space. I guess, just to test that thesis, if you don’t get the IRRs that you’re looking for because it is becoming more competitive to buy contracted renewable assets, is there a backup plan B? As in, if you’re not able to deploy the $1 billion of capital, do you have a Plan B? Or is that – what I guess is, is if you don’t get the ability to invest, what do you do?
Yes, I think I’d be a lot more concerned if we just laid out a $3 billion or $4 billion plan over the next 3 years. Because in reality, I think with the $1 billion plan, we can high grade that opportunity and choose the projects that we want to participate in. If I was to win everything that I’ve have got a bid out on, I’d be well over $1 billion right now. And I already 25% of it in letter of intent phase that I – that basically we’re going through the due diligence to make sure everything is set on that. So the reality is I’m very comfortable at $1 billion because it allows me to choose what I want to do. If things fall through the bottom, we’ll return the capital to the company, right and the company will deploy that in a different fashion that provides the return right that you were seeking as a shareholder.
Got you. But there's no plan ever to move into the development side. It’s always buying developed assets is the goal?
Yes. There could be a few exceptions AEP owns some property that has renewable development potential. So that would be the exception. But the rule is more stepping in, right, behind the developers, already incurred those expenses and purchasing the projects. You could strand up a lot of cost, right through developing projects. And so therefore, we’re playing a much lesser role in the true development phase. We are more development in the OnSite partner part though, because you’re specifically working with a customer.
Keep in mind, your premise was around plan B. Chuck gives the plan B. Plan A is to focus on our transmission and regulated investment. And when we look at what Chuck is doing, Chuck is some form of high grading, but certainly that is occurring because we have that optionality. But it’s not – is not the way we’re trying to grow his business at an inordinate standpoint when we have the forecast out there. We want to forecast that Chuck is completely comfortable with as opposed to something, again, that's aspirational that may or may not occur or could occur with low returns. So we have that ability and I think that's the huge part of the message here today. As Chuck said, if you can't do it at the threshold level that we set on the return expectations, we're also constantly looking at our own business, including transmission, including the regulated operations, to see what we can make those investments in. And with the growing areas of security, resiliency of the grid, technology deployment around the customer experience, those are also growth areas that will be occurring on that side. So this is not set in stone. This is what we know today. And as we look at the future, that process will continue and we'll continue to look for even further growth. We're not stopping there.
Ali Agha, SunTrust. First question, the $2.2 billion that you've invested or plan to invest over the next three years. Just to be clear, for planning purposes, in total, what kind of return have you assumed on that? Is that the 10% roughly that you've been looking at on the regulatory side?
Okay. And then second question. In your chart, when you look at the 5% to 7% growth, you have a section beyond '19 kind of the future, if you will, what is your line of sight right now? How far is your visibility when you look at the transmission projects that Lisa has or other investments that gives you comfort that this continues how far beyond '19?
I think that's what Lisa was trying to lay out and showing age of system, the type of projects that she's investing in. We see a run way going out 10 years in that business for ample opportunity to invest, whether it's aging infrastructure, local reliability, regional reliability. One of the things that we haven't seen yet and we should have opportunity to invest upwards of $1 billion associated with retirements that happened in 2015, there is likely another set of retirements that are coming about associated with the affluent standards of what we, in effect in the early 2020s. So that's not even in our numbers yet on top of what we have just on our own system.
And Brian, as you look at those investment opportunities even beyond '19, when at the earliest do you think equity issuance comes to the table for AEP?
I just, I don't see it in our plan right now. That's not to say that we wouldn't do that for the right opportunity. But we haven't had to do that since 2009, and I don't see it in our plan currently.
We even cut off the DRIP.
Last question, Nick. There is ongoing consolidation going on in the space, electric as well as gas. Maybe not the next three years, but strategically, is there an interest for you now that you are 100% focused regulated company to seek out opportunities for growth?
Absolutely, we're always looking at opportunities. But, and you know the story, we have to be positioned to do that. I think we are positioned to do that. But there again, the things we talk about today, the indigenous growth potentials that we have within our service territory, the ability to invest, it's a higher threshold for us. So it's going to have to be something that's truly strategic, truly something that's additive to the issues that we've brought up today. And we'll continue to looking at that. But I think we are in a much better position to do that kind of thing strategically. But our focus is making sure that we are wise in the capital deployment that we have, that we're efficient for investors and as long as we will only be paying premiums, if it's of true strategic value going forward. Right now, we're making a lot of investments with no premiums.
But the organic opportunities keep you at that 5% to 7% threshold?
Absolutely. And actually, on that graph, we even talked about how it will end. I mean because, you show the cone going out and you cut it off for the year. The logical question is what happens after that? And we purposely said, no it continues on. We're in a great position in that.
Steve Fleishman. Couple of related questions. Just overall, in your plan, kind of what is the impact on customer rates? Are you kind of close to inflation on average crusher system? Also, are there any kind of key rate cases coming up that we should watch? And then, lastly, in the Ohio ESP outcome, there was the grid mod and renewables that you were allowed to do. Is that in the plan? Is that part of the mix here?
So let me start with the rate changes. Over the forecast period, we're anticipating average rate increases in the 3% range.
In regarding Ohio, I'm reasonably optimistic that some of the issues, Steve, that you highlighted will get resolved in the near term, which would represent investment opportunity and enhanced DIR. Again, I think the smart city decision in Columbus has got the attention of the Public Utility Commission of Ohio from a positive standpoint. As far as rate cases you should watch, we're watching the pending decision by the Oklahoma Commission in PSO. Obviously, we put $75 million of rates at risk on that decision. If for whatever reason that doesn't mean our expectation, we'll be looking to refile in Oklahoma shortly after.
Yes. Certainly, Steve, I wouldn't want to undervalue the importance of issues like the smart city challenge, that was one. We already had proposals before the Ohio Commission focused on smart city type of applications. And it's important to not only the entire area of Central Ohio, but important to many leaders, including the commission, to focus on the ability for us to invest in those smart technologies of the future. And so we see that as an important framework for the expansion in other areas of our service territory. That's the, and with those particular riders that are applied for, we expect the commission to be very supportive of those applications because that is AEP's avenue for growth in Ohio, that along with the restructuring.
And I think we've probably registered the importance of AEP's position in Ohio is driven by our ability to invest in new technologies, new generation, but also focus on the strategic aspects of smart cities and those types of applications, whether it's micro grid technologies, energy storage, those kinds of devices that can be deployed to support transportation or other types of activity. So that is a central part of the theme going forward for Ohio.
Greg Gordon. Just on Pages 19 and Page 37, you talk about the current earned ROEs, expected earned ROEs, and you talked about in your guidance that the difference between the 7.7% CAGR on rate base and the 5.7% earnings growth target is regulatory lag. So can you kind of walk through the algebra of that? Because I think that would presume that your ROEs are going down over time when, theoretically, you should be trying to make them go up.
Very good. There's a couple of things going on there that add to that lag as well. One is the fact that we have $0.09 in for a business that we're going to sell in 2017, and that, of course, goes away. And so we need to make up that piece as well. And I think taking that out, you can do the algebra and you'll get very close to the 7.7%. You'll also see that the remaining piece, the $0.09 that we had talked about that Chuck described doesn't grow as fast as the 7.7% as well. So those 2 factors, combined with the lag, will get you to the reconciliation between the 5% to 7% growth rate and the CAGR of 7.7%.
Okay. So you do think that in the core business, when we do that, sort of the big -- the layer cake here, that the ROEs are stable.
You'll end up right on top of it.
Paul Patterson, Glenrock Associates. Just -- I guess, for Lisa, FERC Order 1000, just sort of competitive issues they are developing also with smaller -- potential smaller projects and what have you, just sort of what your outlook is on that.
And then also, just in terms of O&M and you're investing -- you're replacing 100-year-old stuff and what have you, it sounded to me that the 205 complaint sort of suggested that there was actually regulatory lag with respect to O&M. I was wondering, how is O&M trending, given that you're putting that much CapEx in the business? Just intuitively, I would think that would mean your O&M might go down. So I just was wondering if you could elaborate on those 2 things.
Sure. Both great questions. With respect to Order 1000, we won two of the two competitive projects in PJM. I think that the RTOs are still struggling with the process. I don't think the RTOs like the process of moving forward with Order 1000. That being said, I think it's very difficult for folks to argue against there being some level of competition in that space and that is what FERC has continued to say. So we continue to be well positioned in that space. So we look within our borders as well as outside our borders. And we firmly believe that your best defense is a strong offense. And so by virtue of actually participating on these, we've actually identified a lot of projects that benefit our customers that we'd move forward on, whether it be investments of our operating companies or our Transcos. So even though it shows really a couple of smaller projects in that space, it's allowed us a strong defense as well.
With respect to O&M, yes, we are reducing some of that O&M, but you have to kind of take a look at the overall system. We still have 37,000 miles of line and over 3,000 substations that are older. So it will take quite some time before you'll see significant savings on the O&M side of that piece. As you mentioned, with respect to the 205 filing, that 205 filing that we make is going to allow us to fix to -- fix our formula rates that is completely forward-looking. As you know, in the past, we've had one that's a bit of a hybrid. We have been reticent to move forward on that 205 because as soon as you move forward on the 205, you're triggering an ROE review. And so this actually provides us that opportunity to address that on a going-forward basis. And it will allow us to also remedy the network system, peak load adjustment that would have been a one year hit for us into '17 as well.
The nice thing about the 205 is it positions us also in those outer years to actually achieve our authorized ROE, whatever that might be. What we have had in the past is you’ve always seen on the slide that has the – what our ROE has been, like the 12.2%, that is always reflective of the true-up. And so that true-up would go away and it would also – it would be forecasted.
And then just on the 3% rate increase, in fact, is that the entire bill? Or is that just the rate base? I mean, is that the entire bill that we’re talking about that you’re seeing in that – in annual numbers?
Brian X. Tierney
Entire bill average across the system.
Anthony Crowdell, Jefferies. Two quick questions. I guess, one, to Chuck, when I look at that $0.09 we’re all talking about, on Slide 20, you show renewables as $0.01. So then is the other $0.08 all generation on marketing? Is that a good way to look at that?
Yes, yeah, for ‘17.
Great. That was easy. Question for Bob, I guess, and a little to Jonathan’s question earlier about Ohio restructuring. I mean, if we think of the potential outcomes that could come about, whether it’s full regulation – or reregulation of the state or some stranded cost recovery, I mean, what are the kind of options you think are possible coming out of Ohio?
Well, as Nick handicap things and I would agree since our team is kind of reporting out to Nick, I don’t think a total restructuring is, if you were to handicap that, you’d have to get some pretty long odds to take that bet. As far as stranded cost recovery, maybe not as much of a galvanizing issue as total restructuring, but still difficult. I think you got to look at it more from a going-forward standpoint. It is clear at least to the commission there’s been some very positive support for renewables. So you are aware that the state currently has its renewables standards on hold, legislatively, there’s a lot to talk about what should be done there. But part of that smart city commitment on the part of AEP or proposal was the fact that 900 megawatts of renewable that was in the stipulation associated with the PPA, we did not pull down. So there’s every opportunity for the commission to endorse both from a supportive restructuring standpoint that renewable. And that was split between solar and wind, about 500 and 400, if I remember. I mean, the other thing that’s out there is clearly Marcellus and Utica Shale gas. I mean, there is clear a desire from a standpoint of growing the state’s economy to build out the infrastructure associated with – in supporting infrastructure like a combined cycle gas plant. So we’d like to think that from of structuring standpoint that Ohio could work to make a development-related opportunity for Utica part of that whole restructuring process. That’s the way I’d kind of handicap it.
There’s a clarity of message here because it started out with a focus of reregulation, which meant customers didn’t have a choice. All of the generation would be slammed back into the wires company, those kinds of connotations. We really refocused it on restructuring, which our customers would continue to have some level of choice. We would potentially transfer assets back into the wires company, but that remains to be seen. We don’t want to encumber the forward view and the ability to invest in resources of the future in Ohio and for the headline to be trying to put coal plants back into AEP Ohio rate base. And so it is a tradeoff that's occurring there. We're obviously going to continue to try to find a home for those assets, but it'll be strategically reviewed just like the other assets. But we don't want to be, we want to be very clear and consistent in the message to legislators and so forth about the future of AEP in Ohio is driven by the outcome of restructuring and the commission's view of where we're trying to get to in terms of movement toward resource of the future and the technology deployment associated with these riders in clean city and all that kind of stuff. So we want to make sure that the message remains very clear on that.
Gregg Orrill, Barclays. Just a clarifying question on the Ohio Electric Security Plan. Is that in the guidance, the extension there, including the distribution rider? And also, do think you'll be able to spend the targeted amounts in that plant?
Yes and yes.
Yes. So I think if it gets you there is, yes, it's included in the plan in its present form. But if this really takes off like it should, then there's additional opportunities available there as well.
On the restructuring?
On the restructuring, but also on the investment in the grid itself.
Will Zhang with LNZ Capital. On slide 26, what's driving the $0.20 of higher growth in 2018 as compared to the $0.13 of growth in the other years?
So let's say, sorry, you're on 26?
So what you're seeing with respect to '17 because I think that's really where the big difference is, that's where you're seeing some of the impact of bonus depreciation. You're seeing that actually in all years, but the network system, peak load delta as well as O&M is hitting in '17 and that's resolved in '18.
By flowing through the formula rate, right?
And just the acceleration of earnings from the projects that are being put in place as well.
Thank you very much for the three year look forward on earnings. Just by segment, how much of this capital, how firm is this capital? And how confident are you that there's not going to be some snags at being able to deploy it? And then, secondly, I appreciate you didn't buy back stock because you do have these opportunities out there and you've probably downside, asymmetric downside, list to, on cost of capital going forward here. So how should we think about the balance sheet for the next 3 years? Are you just going to run underlevered and then grow into that leverage as you deploy the capital? And then, I guess, just one follow-up. What's the status on when you're going to start spending money on smart meters in Ohio?
Bob, you can address the smart meter question. We're going to do that first and then we'll do it soon.
That application has been in for a long time, and again, I offered by optimism that there's been constructive dialogue with staff on a number of issues including that grid smart, smart meter deployment along with self-healing circuits and Volt-VAR optimization. So we're very optimistic that we'll see some of it from the commission soon. Can we spend in '16? Can we spend in '16? I'd like to have an order first.
In terms of the as far as the capital deployment in each area, we're very confident of the capital that's being managed in that plan. Those plans exist, and certainly, we want to make absolutely sure and we wanted to make sure that when we gave the new cone of 5% to 7%, that it wasn't aspirational, that it was focused on existing projects and existing confirmation of what we felt like we can achieve. And I think Chuck gave you a little bit of insight, too, in his messaging of we could have done more. But we wanted to stay conservative in our approach about the expansion of that part of the business. And of course, when you tell Lisa you got another $1.6 billion you need to spend, you have to get the engine going to address that. The fact that she could is a great testament. But as time goes on, certainly, the ability to take on even more projects may became prevalent. Lisa, you may want to respond to that.
So it's known that there'll probably be a bit of cash out there for a little bit of time. So from a transition standpoint, we've been preparing for that. We're basically scoping about $3.5 billion worth of projects, and that's really to make sure that projects are ready to go on a going forward basis. So across the system, that's what we're doing. We're also being very aggressive with our RTOs and talking about needed projects that are there. Those numbers are not in the forecast that you see.
In terms of the balance sheet, yes, our planned spend was to consume some of that capacity that we have. Also, what you saw the board do with the increase in the dividend in the middle part of the payout range starts to consume some of the capital that we have. And we had anticipated becoming a cash taxpayer in 2018, which we haven't been for some time now. If the sale of the assets go through, we'll be very fortunate to have the opportunity to pay some cash taxes in 2017.
So when we step out of this room and its ongoing now, but it's focused on execution around the plan we put together for you today, but also it's about expanding the additional earnings capability of the company going forward through not only Chuck's business, but channel growth associated with our customers. And that really goes to a lot of the smart meter applications, but also all those activities around optimization of the grid and so forth. So there's some great investment potential out there strategically, but we'll have to execute in the meantime and that's why that plan exists.
Jim von Riesemann
Jim von Riesemann from Mizuho. Two questions. The first question is on actual trends. It's following up to Paul's question. How much can you actually invest a year in transmission? Meaning, what are the structural impediments in terms of people, man hours, etcetera, to do transmission? And the second question is different. Is there anything in the financing plan that we need to think about from a tax, like tax equity section 174, credits under pilot programs or something, to help you with the financing?
Yes, certainly. Lisa, you can address the transmission piece. But I think one of the challenges that and I ask the same question of Lisa quite frequently and a lot of it is just plain and simple of getting the outages to be able to put this equipment in place. And you had a massive reinvestment that's occurring in our part of the grid. So it's really focused on optimizing those outages to ensure that we are able to expand and grow and invest. But at the same time, you have the very real issues of resources deployed, project management to be able to deploy that many projects. But Lisa, you may want to expand on that.
Sure. Thanks, Nick. We're very comfortable wit the $3 billion and that's why it's $3 billion out there as opposed to a different number. With respect to how we're positioning ourselves, I mentioned that we're targeting to have more projects scoped than the $3 billion. That's gives us a little bit of a cushion. We always have to be concerned, as Nick mentioned, with respect to outages and so forth. And that's why having more projects in the pipeline helps us adjust and be flexible with respect to those outages. We have been very aggressive in terms of making sure that we have locked in engineering resources. Over the next several years, we have a relationship with a number of Tier 1 engineering companies as well as engineering and construction companies to make this happen. Because we're the largest developer of transmission in the company -- in the country, excuse me, we have those relationships with labor. We have those relationships with our suppliers, which helps us set forward that plan of execution.
Unless my colleagues are aware of the response to the tax question, we'll have to get back to you on that.
Next question. We have a full circle.
It's Andy Levi again of Avon Capital. So the question has got to do with M&A, but I just -- before I get into that, I just want to compare and contrast before you answer it. So if you look at the Analyst Day we went to a lot of us went to yesterday, Southern Company where, obviously, they've been on a buying binge. The reality is that their core utility is only growing 2% organically and that's why they went on this buying binge. And a lot of the growth that they're seeing is through acquisition and they paid up for that acquisition. Then we look at your story where you're growing actually much more than them, 5% to 7% versus 5%. And all your growth is organic and which is obviously what we prefer as investors. And so I think the story is a very good story going forward. But as well, you kind of opened the door a little bit to potentially looking at an M&A transaction. And where prices are today, I think it would be kind of crazy for you to do that. And then I said...
I'm not buying back my stock.
But your stock would be actually a lot less and it would pay 25 times earnings. I just want to make sure that we're very clear that you're not out there shopping and that you're focused on the organic growth and that you have this really good growth story and that there's no need for that. I just want to make sure that you answer the question.
Okay, great question. So the way we look at it is this, and I repeatedly said over the years, it has been a process of ours to become more regulated to see the multiple expansion, to improve our currency value, to give us optionally around M&A type of activity. But I'll say I mean and Chuck said this when he looked when he's talking about the investment from a renewables perspective being very selective. We've defined a threshold level, and that threshold level is centered on our ability to indigenously invest in our own company. And you look at the amount to depreciations occurring versus the amount of investment, we're buying a company every year, but we're doing it without a premium. And that's the way that we look at it.
So unless there is some – and you never want to say no, because unless there’s some strategic opportunity that really is beneficial to what we’re trying to achieve for the future, it’s going to have to measure against our threshold level, which is very high. Now I’m not going to comment on other companies and where they’re at. They're investing because they need to invest to grow and they’re investing in different things. We don’t have to do that. That’s why I keep saying AEP is unique from that perspective, because we do have the indigenous growth. We have the ability to invest in transmissions, by the way, that’s more than our customers within our indigenous territory that pay for the transmission. So that’s a real opportunity for us to continue to invest from that perspective. So I’m just saying that you never say never, but there’s a very high threshold. In that high threshold, we thoroughly understand the point that you’re making.
Nick, Brian, Michael Lapides of Goldman. Thank you for allowing the follow-ups. Two questions. One, Brian, can you just give for ‘17, ‘18 and ‘19, the expectation for bonus D&A. And I want to make sure I understand because your CapEx is going up so your bonus D&A should be going up and yet you’re commenting about being a federal cash taxpayer?
Yeah. So we’re going to be a modest taxpayer in 2017 if we end up closing the transaction that’s been announced. And then we will slowly become an increasing taxpayer over the next several years it’s a significant number approaching $1 billion of cash taxes on an annual basis. The assumptions that you would expect for bonus depreciation, given the CapEx that we have, are – as bonus depreciation decreases, we factor that into our capital plans.
Got it. So in other words, bonus D&A lowers rate base but you don’t get the corresponding benefit of not being a cash taxpayer in the interim?
We start becoming a cash taxpayer.
Okay. Nick, on Ohio, the wires business, I kind of like to think of things in a normal operating environment, kind of think about what’s a normal earnings power. You’re earning 13% ROEs in Ohio, that’s healthy. How do you think investors should kind of value that? Should they capitalize that number? Is that kind of a normal operating environment? Should they assume, hey, you have that for x number of years and if so, what’s your kind of view of how long? And then eventually, that changes. Just curious about how you kind of think about what normal in Ohio wires is?
Well, I think, generally, from the wires perspective, we have a very, very positive relationship with the commission that’s focused on addressing what everyone believes, including our customers, of what the advancement of the system should be. Our transmission business is very robust in Ohio as well. So I don’t see any reason for that to let up because, again, we’re spending on the right things in Ohio from wires a perspective. We’re spending on augmented by transmission from the Transco perspective in Ohio. So I feel good about that part of the business from an Ohio perspective. What needs work is and to further enhance that earnings capability is to be able to invest in generation in Ohio, and of course, the new applications, the smart city type of applications. But I think the commission's on board with that. I fully expect a positive result on that. But I really, they see the future we see in terms of investment in the grid, investment in the quality of customer service. Those are areas where you just can't go wrong. From a resource perspective, there's no question that customers are expecting a cleaner energy future, and right now, there's no way to invest in renewables in Ohio. And that has to be fixed. And along with that, everyone wants to see expansion from a natural gas perspective and the infrastructure and the economic development, the jobs, taxes, and that's not going to happen. It'll happen in the tempered sense. I mean, obviously, there are investors that will come in on a spec and build some, but not near about what should be getting built in Ohio to provide that energy future. So I just see upside from an Ohio perspective at this point.
So we have time for two more questions here.
This is for Lisa. Just to clarify on the 205 and 206, the 206 was filed on AEP East, I think you said. And then, the 205, is that also just on AP East? Is that broader? And how should we think about the West within this whole framework?
Yes, just on the East. And in terms of the West, I mean, it's the same question, I guess, that's out there tomorrow, which was there yesterday.
And what's the current allowed on the West? Is it the same or is it different? I should know.
What's the allowed ROE kind of...
11.2% and that includes the 50 basis point adder.
I'll close out by coming full circle here about that. Julien, UBS. So perhaps going back to Andy's question a little bit but trying to tie in rate cases as well, you own probably the smaller utilities in a number of other states, let's call it minority position. Does that actually make you more of a seller of certain assets to a certain extent? Like, for instance, to tie it back to your strategy in Kentucky. I heard some ambiguity as to what exactly you do, value a wide range of things. What do you do, for instance, in Kentucky or with respect to Arkansas?
So everybody likes to pick on Kentucky. I call it the little engine that could, because it's our first plant transfer that occurred there from Ohio. It has the first cyber-related rider. But that being said, now that we're fully regulated, there's probably a lot more optionally around decisions to optimize any portfolio. I'm not saying we're selling. I'm not saying we're buying. What I'm saying is, is that we position ourselves where we can be much more comfortable and objective about the decisions being made. We're fully regulated. We intend on staying fully regulated. What that means in terms of buys or sales says that we're going to be fully regulated. And so we now look at the individual jurisdictions through the equalizer chart.
We know exactly where each state stands, each jurisdiction. We know the investment potential associated with that jurisdiction. Some may lag for some period of time because of the investment that's occurring. But as long as the average works out where we're, that utility rate of return of 10% or so forth, I think that's what we're after. The fact of the matter is, though, that we can more objectively look at that. So if there's a jurisdiction that's an underachiever for a long period of time and we can't see a view towards it getting better, then it more easily falls in the category of making those kinds of decisions than it did before because we had unregulated sitting out there. And if we sold any regulated, we'd become more unregulated and that's not the direction that we were going.
So today, I'm just saying we can be very objective with a high threshold of what those changes can be. It's really a great position to be in from my opinion. Any other question? Okay, well, thank you very much for attending today.
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