美國電力 (AEP) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the third-quarter 2007 earnings conference call. (Operator Instructions). As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Ms. Julie Sloat, Vice President of Investor Relations and Strategic Initiatives. Please go ahead.

Thanks, Lois. Good morning and thank you for joining us today to discuss AEP's 2007 third-quarter earnings. If you have not seen the press release issued earlier today, it is available on our web page at AEP.com, and a podcast will be available on our web page at the conclusion of this call. In addition to the financial schedules included in the press release package, the webcast of this call will include visuals of charts and graphics referred to by AEP management during the call. An investor information packet is also available at AEP.com that includes the consolidated balance sheet and statement of cash flows, as well as full income statements for our utility operations, MEMCO operations, generation and marketing, and corporate and all other.

The earnings release and other matters that may be discussed on the call today contain forward-looking statements and estimates that are subject to various risks and uncertainties. Please refer to the SEC filings, including the most recent Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q, for a discussion of the factors that may cause results to differ from management projections, forecasts, estimates and expectations.

Also on the call, we will discuss some measures about Company performance, that is ongoing earnings versus reported earnings, that differ from those recognized by generally accepted accounting principles, or GAAP. You can find the reconciliation of these non-GAAP measures on our Investor Relations website at AEP.com.

I will now turn the proceedings over to Mike Morris, Chairman, President and CEO of the Company, to lead an opening presentation, and then there will be time for your questions. Mike?

Julie, thanks a lot. That was a mouthful, to say the least, but I know there are many things you have to touch on, and we're always happy to be introduced that way.

Thank you much for being on the phone with us to discuss what we think is an excellent quarter. Most typically, I'm worried that you have a very full day and I'm not certain how long you'll be able to stay with us, but as I understand it, we're the only utility reporting today. So we are happy to have you all, and I'm sure we'll have a good opportunity to address your questions as we go.

As I said and Julie said as well in the press release highlights for you, we are really pleased with the quarter performance. Pretty much everything that could go correct for us this quarter did. We are happy with the way that the utilities have performed. MEMCO's performance is much more back on target with what our hopes had been for the quarter, and even catching up somewhat on the year, and everything else seems to be moving along swiftly.

I really want to spike out and I will talk at greater detail about this. Mike Miller and Janet Henry, two of our lawyers who some of you have been exposed to, who did an excellent job in bringing what we think is a very, very creative resolution to the New Source Performance lawsuit -- I must tell you I was quite displeased with the leak out of the Department of Justice and the EPA, which I thought was extremely sophomoric. There was an agreement to confidentiality until all press releases came forth. And obviously, somebody felt it was important to say what they said.

However, as you know from S&P, the Journal and others who reported more balanced on the way this unfolded, it in fact was an extremely creative settlement that resolved all those issues and will allow us to do what we think are some very important and creative things going forward with our fleet without the intervention day in, day out of whether we're in compliance or not with New Source Review. So we are quite pleased with those results.

Let me turn to the dollar facts. We are $1.16 a share ongoing earnings. The impact of that settlement, however, did affect GAAP earnings, down to $1.02. We're very comfortable with that, and again, as I said, pleased about all of that. For the year, we are at $2.48 a share on an ongoing basis. And that leads us well on our way to performing within our '07 range, as we shared with you just a few weeks ago with a major presentation in New York. And as you know, we tightened our range there, and we feel very comfortable that we are going to be within that range.

If you turn to the second slide on regulatory update, I would like to give you some granularity on the way that we saw some of those outcomes. As you know, coming into '07, we had a stack of $338 million of regulatory accomplishments that we hoped to achieve. And I'm happy to report that that was a successful endeavor.

As you know, going forward, '08 through 2010 is also dependent very much on appropriate and balanced regulatory treatment, and I think '07, like '06, '05 and '04 before that, have demonstrated that the American Electric Power team continues to focus on the relationship, to focus on the balance between investors' needs and customers' ability to pay, capital allocation where it is important and necessary. That frequently yields solid returns and not major impacts on the price of the products sold.

As I think you know, the Ohio rate stabilization plan allows for the Company to petition for and recover additional costs incurred for events not contemplated by the RFP as submitted by Ohio Power Company and Columbus Southern. We received a very supportive order by the commission in this quarter to that event and feel comfortable about the way that that was handled.

You're very familiar with what we call the I&M depreciation case, very impactive in Indiana, but equally so in Michigan. And the Michigan Public Service Commission approved a change in the depreciation rates as they pertain to the I&M activities in Michigan. That was a very positive event for us as well.

Public Service of Oklahoma, the rate case, although some wrote stories about it that seemed as though we might be disappointed, we weren't disappointed to a great degree, because much of what we had expected to happen in PSO rate-wise did. We continue to have the opportunity to pursue additional tracker adjustments in the overall rates to improve customer service and reliability in Oklahoma. We're very comfortable with that approach.

And equally important and almost unnoticed is that also in the most recent quarter, a number of orders came out by the commission which solved many open issues as to past fuel recovery cases. In fact, in Oklahoma today, all of our fuel issues through '01, '02, '03 and '04 are solved without any disallowances, and we're very encouraged by that balanced and fair treatment.

I would tell you that we're disappointed by the Red Rock decision. There continues to be an unnecessary onslaught on the activity of coal going forward. As you know from our many presentations, coal is essential not only to American Electric Power and its current demands, but to its future demands, but equally important and in an overarching sense really more important to this country as we continue to be faced with ever-growing demands on the 24/7 power plant production capacity in this country.

We will continue to push forward. I think we were invited for a couple of very important things in the Red Rock decision and the rate case decision -- one, give us another view of other generating facilities because we do in fact know and in fact concluded that you needed to add to the generation fleet in Oklahoma; and secondly, in the rate case itself, an invitation to come forward with some of our GridSMART activities that we shared with you most recently when we were in New York earlier this month.

Very, very satisfied with the Texas Central case handled by the PUCT, appropriate treatment, what we think is probably one of the best rate results that the old Central Southwest as well as AEP team ever experienced in Texas. It was fair, balanced. Rates of return weren't where we thought they ought to be. But nonetheless, we were very satisfied with the way that the ultimate outcome of the TCC rate case went.

I can't say quite the same for Electric Transmission Texas. We were in fact gratified that the PUCT determined that we were an in-state utility in that sense, transmission focus. However, we and our partners were disappointed by the 9.96 rate of return on equity.

When one thinks about a larger transmission play, and you know that's very important not only to us, but to MidAmerican, you can see rates of return north of 11% in other jurisdictions. And that puts a great deal of pressure on the whole notion of continuing with big-time investments to satisfy the Texas needs, and we will continue to work on that issue. But we were satisfied that it was designated as a PUCT organization, not an FERC requirement. But we will continue to work on that rate of return on equity, because that simply is insufficient to continue to attack the investments that are needed, transmission-wise, in all of Texas.

As to the Southwestern Electric Power Company and the Turk plant, hearings concluded earlier this week in Arkansas, with support from in excess of 100 folks living in and around the general area who took the time to come to Little Rock for the closing arguments that were made in that case.

I'm very pleased with the way that our team handled themselves throughout that entire undertaking. I think the ultra-supercritical environmental plusses speak for themselves. The only detractor of the Turk case was in fact some folks who are near the site and have a hunting lodge, and at the end of the day, through the hearing process, what we all came to learn was that it isn't a coal plant, it's any plant that they don't want in their backyard.

We would hope and have every confidence to believe that Arkansas, Louisiana and ultimately Texas will come forward and support an, again, much-needed coal-based ultra-supercritical plant for our SWEPCO facilities.

Let me move now to a couple of other events that I know you are all very, very interested in, and they are on the third slide, key activities. Ohio, post-2008, I know that many of you have worked very diligently to determine exactly what is going to happen in Ohio. I would share with you that we are equally working diligently to find the answer to that question.

We expect that this Thursday, the Senate will enter a substitute bill. I think that is general knowledge. We, of course, like you, have no additional understanding of what might be in there, but we do hope that we will get more definition around how one might establish the market price option, which the governor provided for in his submitted bill. We also would hope that there is some definition of how one would establish the principal value to begin negotiating from if a company were to choose the electric security plan option as laid out in the governor's proposal.

With clarity on both of those issues and the opportunity to negotiate reasonable moving-forward rates to benefit our investors because of the value of the generating assets, as well as benefit our customers by not going to some rate shock undertaking, we feel there is still a high potential for a very solid answer here in Ohio.

As to the New Source Review settlement itself, I've already said a few comments about it. We found it to be extremely creative. The activities that we committed to do at the Rockport station, probably the most eye-opening of some of the numbers involved. But nonetheless, Rockport on our schedule was intended to go to the SCRs and FGDs in the mid to late next decade anyway. We may have moved those up by maybe one year in each event.

Our experiences of late, and I would expect our experiences then, will be that the sooner you do those things, the cheaper they ultimately are. And of course those are all recoverable as they are capital investments required to satisfy federal statutory requirements.

The whole notion of making environmental contributions of $60 million was an important point because it's part of what American Electric Power believes in. We will continue to make investments in those kinds of activities, notwithstanding whether they are associated with something like this or just exactly the right thing for us to do.

We would hope and as we shared with you before that some of those dollars have the potential to flow back to us by way of environmental improvements that we will make on our transportation fleet or that we might make in different operations inside of our own environmental portfolio. I think those were very creative subsets of the settlement that we reached, and it is very nice to have that behind us.

As you know, there is a chance to up-rate the output capacity of our entire fleet, and we can now go forward and make some of those energy efficiency changes to reduce the BTU heat content in, as well as to increase the megawatt-hour generation out, without the overarching concern of whether it was or wasn't violative or requiring a New Source Review undertaking.

Very pleased with our partnership with Allegheny on the first phase of what you have heard us many times call the I-765 project. The PATH, as it is now more commonly referred to, is well underway. We did receive, very importantly, the NETC final designation from the Department of Energy. And although I know there are many concerned citizens along that route as we go forward and receive the final alignments, I'm sure that all of those issues will be fully addressed and hopefully satisfied as we go.

But at the end of the day, all of us here in this country need to understand that the infrastructure needs to be upgraded, it needs to be enhanced, it needs to be improved. And the whole notion of the American not-in-my-backyard concept simply is not sustainable in the long term if we intend to continue to have an economy that is based on electricity.

Lastly, PJM activities -- we feel very comfortable with our off-system sales results for the quarter, very satisfied with the way that the RPM self-supplying activity has benefited our customers to the tune of about $11 million just in the most recent auction for the '08 and '09 numbers, and very happy with the auction results both last and this time as they stayed about the same and demonstrated some additional capacity tightness in certain pockets further east of us.

If one were to build all the transmission that would satisfy those demands, you would see those capacity prices fall more in line with the numbers that you see in the western side of the PJM.

I will, however, tell you that we continue to be dissatisfied with a few things at the PJM, most importantly, the socialization of the existing 765 grid as one looks at cost recovery on the overall benefit that that grid yields to customers throughout the PJM, both east and west, and of course, what we believe to be an inequitable way that the marginal loss implementation has been brought forward.

There are simple solutions to that. We think that we of course have the opportunity to recover those costs, both -- at the state level, but we will address that issue before the FERC because we think that there are inequities associated with the marginal loss implementation.

With that, I will turn the podium over to Holly, who will give you much more granularity on the specifics of the numbers in the third quarter, and then I look forward to your questions. Holly?

Thanks, Mike. Referring now to page 6 of what's up on your website, there is a tremendous amount of financial detail, so I will just touch on a few of the high points for the quarter.

As you can see, the third quarter demonstrated continuing strong earnings performance. Weather favorably impacted by $0.03, $16 million in total. Slightly better than normal weather year on year. We're also up $0.03.

Rate relief was another key component, $66 million quarter on quarter. In our east regulated utilities, it was about $30 million, related to rate increases at our Appalachian Power Company, half of which came from Virginia, the other half from West Virginia. Our Ohio companies were up $15 million on the quarter year on year.

West integrated utilities, our PSO rate increase contributed $5 million, and our Texas wires had a rate increase of $15 million, tallying up to the $66 million total.

We are also experiencing continued positive load growth. As we have mentioned in the past, our east utilities added a new wholesale customer in Indiana, Wabash. And our Ohio utilities added Ormet. Both of those customers came on in January of this year, contributing to our strong 4% positive load growth year on year.

Increased off-system sales of $36 million is demonstration of a continued strong generation performance, as well as successful market activity by our commercial operations group.

You'll see on line 6 our substantial decrease in our net transmission revenue, a decrease of $58 million. This is due to the addition of marginal losses that Mike has just mentioned. I should point out, however, that these marginal loss costs of $71 million are offset by lower fuel expense in both our eastern integrated utilities as well as our Ohio companies, and partially offset by increased off-system sales.

O&M decreased by $8 million, predominantly associated with the absence this year of the earnings drag associated with our Dow Plaquemine facility, which closed or was sold in the fourth quarter of last year.

As you would expect, interest expense is up $53 million year on year, associated with increased long-term debt outstanding. Other income and deductions have changed due to increased carrying costs and decreased stranded carrying costs in Texas.

The decrease in our effective tax rate is predominantly attributed to the change in depreciation rates in those states where we flow through the benefits of accelerated depreciation.

Turning now to the year-to-date performance, once again it is very strong year on year, and we remain on track. Weather continues to be a favorable factor, $83 million year on year. Increased rate relief of $167 million is driven majorly by our Ohio companies; $84 million of it is in Ohio. The balance, our east regulated utilities, $51 million associated with rate increases in Appalachian Power, which I just discussed, as well as Kentucky Power.

Our West integrated utilities, we're seeing a continuing increase of our PSO rate increase, $9 million on a year-to-date basis. And Texas wires are up $23 million. Load growth is positive -- $168 million, net of weather, which is about 4.5%. Off-system sales, also positive year on year, due to the same factors which I have just discussed.

Transmission revenue, once again we're seeing the full effect of the marginal losses. It is higher than the third quarter because marginal losses started in June.

Other operating income has increased by $35 million due to increased TCC securitization, offset by a decrease in work for third parties.

O&M has increased by $77 million on a year-to-date comparison. It has to do with increased distribution costs associated with ice storm and increased vegetation and storm restoration work.

We have seen a reduction in depreciation expense of $62 million in total. This is driven in major part by an increase in the amortization of our TCC securitization revenues.

Interest expense is up due to long-term debt outstanding. We have seen a decrease in other income and deductions, in major part due to a decrease in the Centrica sharing revenue, which, as you will recall, this was the final year of those payments from Centrica. And, once again, the decrease in effective tax rates is due to our change in depreciation.

Turning now to cash flows, once again, we remain on track and in line with what we were expecting. Changes in working capital were driven in major part by changes in accrued taxes and accounts receivable. Our investing activities, our cash outlays for the year, are $2.6 billion, associated with capital investments. And the primary asset sale proceeds, our Centrica sharing, as I just mentioned, is down, and we have in addition completed the sale of [Oakley] Union in the year 2007.

Our other investing activities are related to the purchase of nuclear fuel and contributions to the nuclear trust, and our financing activities of $1.2 billion year to date are related to the net issuance of long-term debt of just over $1 billion, short-term debt of $0.5 billion and increase in the proceeds from common share issuances due to stock options exercised as well as the continuation of the dividend reinvestment program.

Finally, turning to capitalization, as you know, we ended the quarter at a 60.6% debt to cap on a GAAP basis and 58.4% on a credit-adjusted basis. Our goal is to maintain a debt to cap on an adjusted basis in the 60% or below range.

The adjustments that we make to arrive at our reported numbers on an adjusted basis are shown in the bottom half of this schedule. We adjust the debt to add back the $1.16 billion Rockport lease and subtract out the debt associated with our Texas securitization bonds, since they are serviced by Texas customers. We also remove the nuclear spent fuel trust, since it is fully funded with cash that is not available to the Company.

With that, we have covered the numbers, and we will open it up for questions.

(Operator Instructions). Greg Gordon, Citigroup.

Would you mind talking in a little bit more detail about what your next steps will be in determining whether you intend to move forward in Texas, given the PUC decision, and could you give us an update on the probability of success in getting regulatory approvals for your IGCC initiatives in Ohio and West Virginia?

Sure, Greg. On the Texas issue, we still feel very committed to the concept of building out transmission in Texas. And as you know, the partnership at ETT will take a hard look at the magnitude of the projects that we intended to build going forward.

We think that the 9.96, of course, is very close to the 10 on equity or the 10.25 we were looking for, but still sends a signal to anyone who intends to build transmission in Texas that you might do better in other regions. You know that we like the regulatory swiftness with which capital investment turns into revenue streams as compared to maybe a longer regulatory lag period elsewhere. And we'll continue to try to explain those issues to the commissioners in Texas.

I would expect that we and MidAmerican will continue to review our hole cards, if you will, to see what the conclusion will be, and we'll probably share that with the outside world in the not-too-distant future. We very much would like to go forward. However, this is a bit of a roadblock.

As to the regulatory activities for integrated gas combined cycle, arguments were made before the Ohio Supreme Court as recently as a couple of weeks ago. As Jack Keane, our General Counsel, always reminds, never read too much into the Qs and As that you hear from the bench. But I would argue that it didn't go as well as we wished that it would've, because there were a lot of questions that said, well, it seems to me that deregulation from the 1990s Senate Bill 3 segregated generation from distribution, and here it would appear as though, under this provider of last resort, you're trying to pass through what clearly are generation costs on a distribution rate.

That was struggling for some of the jurists, and we will just have to wait and see how they come forward. As you know, in the Ohio legislative activities to date, that issue is high on the governor's agenda. It's high on our agenda. And we do have a chance to perfect the legislation going forward to ensure that if one wanted to build a more traditional rate of return power plant in Ohio, they could go ahead and do that. We would expect that to be an important part of whatever legislation comes out of this current cycle here in Ohio.

As to the integrated gas plant in Appalachian Power, it is before both the West Virginia and Virginia commissions. There doesn't seem to be a great deal of consternation over that. As you know, in Virginia, it qualifies for the enhanced rate of return on equity, and it was so filed. And the hearings will commence in the not-too-distant future. And we'll see how that goes.

You know, maybe the underlying part of your question really circles around the whole notion that coal plants of late across the country, including our Red Rock, have not done well. And that is truly disquieting and unfortunate. I was quite pleased to see that the Ohio Power Siting Counsel, as well as the Ohio EPA, just issued the air permits for the Meigs County AMP-Ohio project, and in fact, there is a story in Columbus Dispatch where the leader of the Ohio EPA said, we need to go forward and build generation to satisfy the needs of the growing economy here in Ohio and not be overly concerned about the carbon footprint associated with that, because at the end of the day, that will ultimately become a federally controlled issue. And AMP-Ohio, American Electric Power through Ohio Power Company or Columbus Southern, will comply with whatever those federal standards are.

It really demands almost that we get some answer out of the federal government on this issue as clearly as we can, because these plants do in fact need to be built, or as you know, Greg, because you and I have had many hours to chat about this, we will be taking the U.S. economy into an economic brownout that will cause the politicians more pain than worrying a bit about how to handle the carbon and the carbon issue.

Ashar Khan, SAC Capital.

Could you just mention a little bit on Ohio, I guess, where things stand? I guess we were expecting an amended bill. Is that the next step in the Senate committee? And just trying to get a sense as to what is happening there.

Yes, I would think -- Ashar, I think the testimony has been as you would expect it to be. The industrials would like energy to be free. I don't blame them, but it isn't. There was some very interesting testimony yesterday on the renewables by an environmental group who were seeking a little more clarity around what the benefit of renewables might be in a state like Ohio, where in fact it doesn't -- the wind doesn't blow very frequently, nor does the sun shine. In fact, we are all sitting here in a very gray day, about the fifth in a row. I would hate to be counting on my solar machine today.

But at any rate, I think the testimony has been enlightening. I think the senators have been deeply engaged. I think they have learned about the complexities of the undertaking. And I think that there has been some headway made on the notion that elected officials need to create the energy policy for the state of Ohio and they simply can't abdicate that over to an administrative agency to sort all of that out.

So I would hope that in fact, as we understand, tomorrow there will be a substitute bill brought into the Senate, and I would hope that it addresses, as you've heard us say many times before, a little more clarity about how one would establish the market price and an equal clarity about how one would establish the base of the value negotiating point, if you will, if one were to go forward on an electric security plan, which are the two options that the governor laid out in his bill.

So I would say that it's going reasonably well in that sense. It surely is not confrontational in any way. I think, again, the questioners and the answers given have been reasonable and to the point. We, at the end of the day, we understand from the President of the Senate that they would like to get something out before the end of the month, which is a very heavy task for them. And then it will be taken up by the House.

Yesterday, the Speaker of the House made mention, and as reported in the local media here, that if the bill comes out of the Senate without any problems, it might move along swiftly in the House. However, if there are problems, and I don't know what that means, then the House will do its deliberation to make certain that we aren't overreacting and creating a situation that may be worse than anyone intended.

Remember, when we did Senate Bill 3, it was the industrials who drove the bus trying to get to what they thought was the freedom of an open market. And today, it's the same people who have the bus in reverse, which at least is somewhat entertaining.

But I expect that this will all unfold and we will have an opportunity to be successful. And as you have heard us say before, if we could simply define the upper boundary of the market price, the lower boundary of the value proposition, I am comfortable that American Electric Power can negotiate a resolution to this issue that would be good not only for our investors, but our customers, and equally important, the economy of Ohio.

Mike, do you expect the substitute bill tomorrow to incorporate what you're looking for?

I would hope that it addresses those two very important issues as to a little more flesh on the political bones of here is a market option that the commission will divine, and here is a value proposition that the commission will divine. That is the way the governor's bill reads today. I hope that there is a little more clarity about the how as we go forward with the substitute bill.

And if I can just ask one question to Holly, Holly, I'm just trying to -- the variances on the off-system sales margin and the transmission revenue, they have been, like, off from I guess the predictions. The off-system sales margin are doing much better than what you forecast. And then the transmission revenue is low. And I'm just trying to look forward to '08 guidance and then trying to see how should I look at -- '07 is coming off in totally different ways than what you had initially forecasted.

So how should we look at '08? Are the discrepancies going to reverse, that the margin is going to go lower on the off-system side and the transmission revenues are going to pick up next year? Or how should we look at '08 versus '07 historical results?

The numbers will be recast for you in January, and the principal difference for '08 from what we rolled out on October 4 is the location, or how we're showing the impact of marginal losses. For this quarter, on both a quarter and year-to-date basis, the gross amount of marginal losses were reflected in line 6, transmission revenue. That is not the case in what you're looking at for '08, and we will provide that update in January.

I think to the specific question on the margins, as you know, we try to be conservative about our view of the market going forward as we lay that out. And your observation about '07 is that the margins are coming in considerably higher than we thought that they would as we started the year.

I would hope for the same kind of result, because as you know, the margins that we gain on off-system sales are shared both with our customers by way of credits to the retail cost of service and some are rightfully retained for our shareholders. So we never want to go in with a an extremely bold forecast of what we think market prices will be, but it would be very difficult for one to fathom how market prices would go down as fuel prices go up, cost of maintenance goes up, cost of natural gas goes up. I don't know how the market prices will come down.

Anthony Crowdell, Jefferies.

I have a question on the rate relief slide on page 16. At the analyst conference, you spoke about the 2009 rate relief includes some benefit from Ohio. But you wouldn't quantify it. My question is, the version you gave out before the analyst conference or last year's version had rate relief in '09 of about $400 million less. Does that include any benefit from Ohio generation other than the 3% to 7% pickup?

Anthony, I'm not sure I am following the granularity of your question. What we gave you -- what we have in the package today is, I think, comparable to what we shared with you on our October 4. It may be different than the '09 number you have seen from years earlier because we had the 3% and 7% in that, and we really haven't built that into the '09 stack that you're looking at on page 16, if -- I think that's the question.

Right, so the previous version didn't -- just included the 3% and 7% pickup in Ohio, whereas the one you guys just gave out or the one you gave out at the analyst conference included a different pickup in Ohio generation.

I think that's accurate, yes, sir.

Paul Patterson, Glenrock.

I know you're not contemplating your question that deeply.

I'm sorry, can you hear me?

Yes, we can hear you fine now, Paul.

Sorry about that. Favorable fuel reconciliations -- I was wondering what is driving that. It was mentioned in the press release, and if you could just give us a little more flavor on that.

Holly?

In terms of our fuel prices for the year, they are coming in more favorable than we anticipated at the beginning of the year. We expect to see a coal cost up about 4% to 5% on the year versus the 7% to 9% that we had previously anticipated.

One of the biggest drivers is a continuation of synfuel credits. As you know, they will expire the end of this year. But that's nearly $70 million or about $1 a ton. In addition, we had good performance under some contracts that are very favorably priced, and we haven't encountered some logistical challenges that we have in years past. Real rates have remained in line with expectation. We're going to play a bit of catch-up next year, as you will recall, Paul. We talked about 13% of an increase for '08.

Okay, that's right. And then MEMCO, the weaker conditions that you guys were able to offset, was that because of contracting? And what is the outlook, I guess, as we go into 2008 with respect to these weaker -- these weaker spot market rates would indicate that maybe -- what are you expecting to happen there, I guess, with MEMCO? I see that you guys have got about $10 million less. I guess what I'm saying is, what contracting impact do we see, I guess, and going forward, what do you see as being sort of a normalized number for MEMCO?

I think a couple of things are happening. As to the third quarter and what we would expect for the rest of calendar year '07, the incredible grain harvest, which was intended to go to ethanol machines which have yet to be built, is now going to the export market. And as you know, MEMCO is a forward contract hire on the Mississippi River and is seeing some very, very high utilization rates and some very good spot market bid rates as well.

When we go on a forward-looking basis to '08 and '09 through the 2010 numbers that we shared with you before, we still look at consolidation on the rivers, we still look at some of the smaller folks dropping out of the equation, and we still build into our MEMCO view a continuation and an upgrade in our facilities. In fact, we just had our Board down in New Orleans the last couple of days to take them through MEMCO facilities, and we're kind of bullish on where we are.

The overall contract rates should escalate some, should surely accommodate the notion of increased costs for new equipment purchased, as well as increases in fuel. So we see the margins holding up relatively well.

Our goal there, quite honestly, Paul, is to continue the AEP tradition of being the lowest-cost provider on the river. We think that will attract a tremendous amount of business and provide for some significant yield deltas in an earnings sense for our investors.

We don't expect it will expand much beyond that footprint. We would love, to during that 2008 to 2010 horizon, maybe move into some liquid transportation, which we don't do yet. We see that as maybe being a potential growth opportunity for us there, but really aren't that interested in getting into the big-time marine shipping or any of the out of the Gulf of Mexico kind of transportation.

But we're pleased with what MEMCO is doing. And as you know, one of the great aces in the hole about MEMCO is our ability to move fuel in a moment's notice to the stations that need it to ensure that we have adequate generation, not only to satisfy our customers' needs, but to take full advantage of the market demands in the PJM.

John Kiani, Deutsche Bank.

Can you talk a little bit more about the potential amendments and kind of what you expect from the substitute bill tomorrow? I know you touched on it a little bit, but I'm actually looking for more color on what happened to the language that had a provision for not requiring PUCO approval to transfer or sell your Ohio generating assets.

I'm not sure if that will be addressed specifically in a substitute bill. Again, we've raised that issue, that there is a fairness requirement here that all utilities be in the same spot. Some would argue that we all are, that whatever our friends north did, they in fact may try to legislatively reverse.

The whole notion, as we see it, John, unfolding is let's not get driven on the side by arguments that would simply lead to all kinds of legal ramifications. Let's see if we can't get some definitional clarity around the two major points that are important to all utilities in the state and find some reason to compromise in between on an ESP. And if you can't get an ESP, then you implement the market process, presuming that the market process is a bit more defined than simply allowing the commission to decide if and when one would go about doing that.

Okay, that's helpful. And then can you talk a little about the benefit that the peaking assets you had acquired had on the third quarter?

Well, we surely can. They came to play, as you know, from conversations we've had before, not only in the RPM capacity uptick, but also, in fact, came to play frequently during the quarter with energy placed into the market. So we have been quite pleased with those asset acquisitions. And not only did they allow us continue to be a free agent, if you will, in the RPM world to satisfy our customers' needs with the savings that I spiked out earlier on, but it also has proven to be a benefit to our customers and our shareholders by putting that capacity and energy into the PJM market, where, as you know, the off-system sales revenues are shared between shareholders and customers.

So it's really been a plus-plus for us, and I'm happy that my team encouraged me to buy those machines when I didn't think that was the brightest thing in the world to do.

Dan Eggers, Credit Suisse.

Just thinking about the challenges with the coal build situation, and given the load obligations that you have within your service territories, plus probably a couple of years, realistically, until we get a federal decision on CO2, how are you guys thinking about some contingency planning as far as generation resources are concerned? And how quickly could you effectively shift gears away from coal, maybe into gas or something like that, as you look at Oklahoma and some of the other projects?

Well, Dan, as you know, you'll see a shift in Oklahoma very quickly to the gas. That was one of the directions. It is interesting that Chairman [Cloud] also suggested we might want to look at nuclear for the benefit of Oklahoma and that region. He may have forgotten that we actually have the Black Fox site. We wouldn't mind going to a nuclear station in Oklahoma, but that won't fit the near-term profile of what our needs are.

You'll see a shift to natural gas if we're going to put assets on the ground. But you'll see us continue to push very, very hard for the ultimate approval of these coal stations because, you've heard me say many times before, an 18, 19 trillion foot supply cannot continue to satisfy a 22, 23 growing supply demand.

Not to dig into a conspiracy theory here or anything, but on slide 3, the earnings guidance you guys showed only covers '07 and '08. Is there -- we shouldn't read anything in about '09 and '10 guidance, should we?

Absolutely not. No conspiracy theory, not before, not now, or not ever.

Just wanted to make sure. And then the last one, on the RPM auction, color on the amount of capacity that was bid into the auction this time versus last time.

I think that, again, there were areas that demonstrated the RPM has worked reasonably well. If you look at the far west side of the PJM, where much of our activity is based, there's been capacity additions, and that's what the RPM is supposed to do.

However, because in some regions, particularly in the east of the PJM or the more classic PJM, and no one wants anything in their backyard, and they're paying mightily for the lack of capacity being there. And some of those numbers were up in the mid-200s for megawatt-days, which is -- maybe if you can afford to pay it, you don't want to see a power plant in your neighborhood, that's your choice. But at least you ought to want to have a transmission asset somewhere near your neighborhood so that American Electric Power can bring you very cost-effective capacity and energy.

Vikas Dwivedi, Morgan Stanley.

Actually, this is Rudy Tolentino. I think Dan was asking you, how much capacity did you guys bid into the auction that just completed?

1300.

As you know, we're capped out at that number.

Earlier on the call, you mentioned in your opening remarks that with this New Source Review settlement done that you will be able to do capacity up-rates. Can you quantify, like, the amount of capacity up-rates that you could potentially do and maybe, like, give an idea of the timing?

The timing will be in keeping with the capital allocation that we have on the system to make certain that we hold our debt/equity ratios the way that we have before. And I would just as soon not share with you exactly what we think the megawatts might be because it could be premature and we wouldn't get there. And as you know, our mantra is to share with you exactly the facts as we know them. And then, if we can outperform that a little bit, we're fine. But rather than tell you X and deliver X-minus, I would rather avoid that.

Paul Ridzon, KeyBanc.

Just a question on O&M year to date. Are we going to have a particularly heavy quarter in the fourth quarter or is some going to slip into 2008? It just seems like we're pretty light relative to your forecast.

We are a little light relative to forecast. But we do play catch-up. And as you know, the fourth quarter is when those unpredictable storms come along, and that can obviously move O&M quite a bit. I think we are on track. I wouldn't look to that as being a major contributor to anything.

Yes I would only add to that that the last weekend, there were a series of storms that originated in the far southwest that came entirely across our footprint, which are the storms we hate the most. But, much credit to the operating companies and our structure in that we held up well, customer outages were not that dramatic, which means that the tree trimming and the rehabilitation that we have done in those jurisdictions where we don't have idiotic rate freezes really added to the benefit of reliability for our customers, and we'll continue to try to make those adjustments where we can.

The results speak for themselves. Give us a tree trimming rider, we put the money to work, and reliability goes up. Sit in the middle of a rate freeze, where people argue over a $0.02 a month per customer increase, and your reliability goes down. It's really that simple.

And just can you comment on the trajectory that you've seen on new build costs? What does the slope of the trajectory look like? Is it slowing down? Is it continuing to increase?

It isn't slowing down. I don't know that it's running further apace, but I would tell you this, Paul, that any station that you would hope to build in 2012 that you build in 2013 or '14 will cost more, unless you're able to lock in the prices, which of course AEP has done in a very traditional sense. That has led to our environmental buildout of SCRs and FGD across the fleet to be cheaper on a megawatt basis than I think almost anybody else.

And of course, the real benefit of the Turk plant currently in front of the regulators in our western system scream to that end -- there are some beautiful fixed-price contracts, guaranteed performances built into the current contracts, and we hope that that clarity rings true in the ear of the regulator to take full advantage for the customer of those capped prices.

So year over year continues to increase. It isn't running out of control. But as you know, much of that is controlled by the world energy demand because the United States continues to find itself in a let's not build anything now and hope tomorrow we won't need to. How that's ever going to play out is beyond me.

I think if you saw yesterday's Journal, there was quite an intriguing story about the 20% renewable requirements in California, which will yield some 3600 megawatts of wind or solar and require 12,600 megawatts of other generation to satisfy the lack of solar and wind being capacity-real. There is an equation going on here that's just absolutely idiotic.

We at American Electric Power will continue to speak out on that issue, not only in our footprint, but beyond, because this not in my backyard is going to take us into an economic brownout that will make everybody sorry that we didn't build what needed to be built in a timely sense. 34 nuclear stations being built around the world, none in the United States. Coal plants being built everyday around the world, none but for co-ops and munis in the United States. It's just really silly. I'll jump off my soapbox here real quick.

Thank you.

Elizabeth Parrella, Merrill Lynch.

A couple of questions for you. One is I wanted to follow up on one of Ashar's questions on this transmission marginal loss impact. If I understand it correctly, the impact on gross margin in the quarter on a net basis was about $20 million negative and $5 million negative in the second quarter.

Well, you are in the range. I would say $15 million to $20 million on the quarter, so, yes.

Okay, so how should we be thinking about the annual impact or let's say a full-year impact on gross margin from this decision by PJM?

It's safe to say you should not multiply this quarter by four, because we have a series of regulatory recovery strategies that we'll provide more detail around in January, when we spell out our strategy at both the state and federal level, getting these costs recovered.

We know how good you are at multiply by four, but it really would be a mistake in this regard, and not only because of what Holly said at the state level on the recoverability of the delta. But we really think there's just an inequity in the implementation of the whole notion, and we hope to redress that at the FERC, because when you charge it on generation and flow it back on load, you've just got a mismatch.

You ought to do -- either you ought to sectionalize it, as they have done with the capacity regions, or you ought to simply just flow the revenues, the overcollections, back from those who paid them on a one-for-one basis. There's a very easy remedy here. But the inequities are starting to pop up, and that just simply needs to be resolved.

So in terms of the '08 guidance, is that sort of post this decision, or is it post this decision with your assumption on to what degree you recover this at the state and federal levels? And what kind of assumptions did you put into the '08 numbers?

We built into '08 our view of this. It may not have been spot-on, but this doesn't change our view of the '08 guidance at all.

All you will see is a change in geography in terms of the amounts on the lines, but the total is going to remain the same, Elizabeth.

The way you presented it right now on 2008, it's kind of the pre -- in terms of the transmission line, that line 6, it's previous decision, I think, if I understood your answer to the question before.

I think that's accurate.

Exactly.

If I could just ask one other question, could you just remind us -- the Michigan depreciation decision, what is the annual impact of that, and when did you start booking that?

It was a $10 million depreciation number, and the change in it will happen in this quarter.

Okay, in the third quarter. So there's no second-quarter impact for it. Excuse me, it happened in the fourth quarter and there was no third-quarter impact for it.

Exactly.

Thanks a lot, everybody, for joining us today. As I said at the outset, we're very pleased with the quarter and have every reason to believe that the year will end up well within the guidance range.

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