艾索倫電力 (EXC) 2005 Q3 法說會逐字稿

Good morning, and welcome to Constellation Energy's third quarter earnings call. At this time, all participants are in a listen-only mode. [OPERATOR INSTRUCTIONS] Today's conference is being recorded. If anyone has any objections, you may disconnect at this time. I will now turn the meeting over to the Chairman, President and CEO of Constellation Energy, Mr. Mayo Shattuck. You may begin.

Thank you, and good morning, everyone. Welcome to our third quarter 2005 earnings call. Before we begin our presentation, let me remind you that our comments today will include forward-looking statements which are subject to certain risks and uncertainties. For a complete discussion of these risks, we encourage you to read our documents on file with the SEC. Our presentation today is being webcast and the slides are available on our website, which you can access at constellation.com under investor relations. We will use non-GAAP financial measures in this presentation to help you understand our operating performance. We have attached an appendix to the charts on the website reconciling non-GAAP measures to GAAP measures.

So turning to page four, we delivered strong financial results despite a third quarter in which hot weather in many regions drove strong load demand and gulf coast hurricanes fueled a significant rise in commodity prices. We once again demonstrated that our strong risk management capabilities enable us to succeed in this type of environment. Adjusted earnings per share for the third quarter were $1.16 per share at the high end of management's guidance change of $1.02 to 1.17. Compared to the third quarter of last year, adjusted earnings were $0.04 lower. This is the 16th straight quarter where we were able to meet or beat our guidance.

Our reported GAAP earnings per share include the impact of certain economic hedges, which do not qualify for hedge accounting. You are all familiar with this issue from companies with similar circumstances where the accounting rules often make economic hedges mark to market while the underlying positions are accrual. As our commodities group grows we expect we'll have to call out this sort of thing. Our promise is to do in a transparent way that makes it easy for you to follow what we are calling out.

Let's review the drivers of the third quarter performance on slide five. BGE delivered solid results in the quarter. Earnings were up due primarily to warm weather in Maryland, which was the third warmest since BGE kept keeping records in 1950. The same hot weather, which drove strong earnings at BGE created variable load cost in our power load serving businesses. As in several past quarters of high load demand, we have benefited as our total business was positioned relatively neutrally to temperature-sensitive load and commodity price changes.

The competitive supply business is doing a great job of building for the future, with success and power, as well as the new gas and coal businesses. We had forecasted they would originate 236 [million] of backlog in all of 2005 and they have already booked 322 million in backlog through three quarters. That's great momentum. We also delivered incremental productivity and remain on track to reach our 2005 productivity charges.

In the third quarter, we reached an agreement to sell our Panama operations. The transaction closed on October 3rd and will drive a gain of $0.08 per share in the fourth quarter which we will treat as a special item.

Turning to Slide six, with the passage of the energy policy act of 2005, we believe the time is right to build new nuclear plants in America. Together with AREVA, we announced in the third quarter the formation of Uni Star nuclear, a joint enterprise to develop and deploy the first fleet of advanced nuclear power plans. Uni Star plans to perform joint ventures for each nuclear power plant, and we expect that Constellation would operate the proposed fleet of nuclear power plants and hold the plant operating licenses. Yesterday, Uni Star nuclear announced that it plans to submit a combined construction and operating license with the NRC. Constellation identified Calvert Cliffs and Nine mile point as among the potential sites for consideration. We'll be spending an amount in 2005 and 2006, which is modest in the context of our earnings forecast. Commitments for significant project funding will only be made once we have better visibility on investment partners, costs, and revenue.

Turning to Slide seven, with three quarters complete, I want to affirm our 2005 guidance range of 3.35 to 3.60 of adjusted earnings per share. We also remain confident in our ability to deliver on our 2007 outlook of 4.75 to $5.00 per share and incremental 10% growth in 2008. Because the fleet is highly hedged, the attainment of this longer-term outlook hinges on our execution of competitive supply growth, productivity and cash flow generation. As has been our practice, we will provide a guidance range for 2006 in January when we have completed our business planning process. With that, I would like to turn the call over to Follin to cover the financials.

Thanks, Mayo. Good morning, everyone, and thanks for joining us today. Let's start on Page nine. Adjusted EPS of $1.16 per share was at the top of our $1.02 to $1.17 per share guidance range and down $0.04 compared to $1.20 per share last year. Overall we delivered another strong performance in the face of rising commodity prices, and extreme weather. As you'll recall, our guidance for the third quarter EPS was to be down year-over-year due to the wind down of our competitive transition charge to all Maryland BGE customers, inflationary costs increases and the absence of favorable 2004 customer bankruptcy settlements for new energy.

Moving to Slide ten, BGE earned $0.24 per share in the third quarter, which was above the top end of our guidance range by $0.07 and exceeded our third quarter 2004 EPS by $0.08 As Mayo mentioned, the increased earnings were driven primarily by hot weather in the quarter.

Moving to Slide 11, the merchant segments adjusted earnings were $0.92 per share within our guidance range of $0.88 to $1.03 per share. This was $0.14 lower than the $1.06 per share recorded in the third quarter last year. Looking at the year-over-year variance we delivered $0.03 of incremental productivity in the third quarter pushing us closer to our 2005 productivity target.

While weather-driven demand benefited BGE, it cost the load-serving businesses as customers consumed more fixed price power. New energy was down $0.05 due to this phenomenon. As in several past quarters of high load demand, the total business benefited in the third quarter, and we were positioned relatively neutrally to temperature sensitive load and commodity price changes.

As we said would be the case on our call with you in July, the rolloff of the CTC hurt the year-over-year comparison by $0.03 as a number of commercial customers completed their CTC obligations. We also saw a $0.09 negative year-over-year variance that reflects a combination of factors including generation outages falling in the third quarter, inflationary cost increases, and the absence of favorable third quarter 2004 new energy bankruptcy settlements.

The merchant segment realized 647 million of gross margin in the third quarter of 2005, excluding the impact of economic nonqualifying hedges. This was down 54 million from the third quarter of 2004. Gross margin from the Mid-Atlantic fleet was down 30 million. The largest item is lower CTC revenue. The remainder of the decrease is primarily a function of generation outages falling in the third quarter. Performance of our plants with PP A's and qualifying facilities were approximately in line with last year's results.

Now let's drill down on competitive supply gross margin, starting on page 13 with wholesale competitive supply. Wholesale competitive supply realized contribution margin of a dollar ---- $115 million, down 7 million from the 122 million recognized in the same period last year. As you'll recall from our last earnings call, we told you already originated business would be up in this quarter. Realization of backlog transaction originated in prior years with 16 million higher year-over-year. New business originated this year and realized in the quarter of 23 million was 2 million higher than in the same period last year. Portfolio management and trading of 32 million was 25 million lower than strong results in the third quarter of last year. While we experienced higher costs to serve load in the face of rising commodity prices and extreme weather in the third quarter, the overall portfolio was positioned to perform well.

Moving to slide 14, this chart gets an update on wholesale competitive supply origination versus the targets we provided at the beginning of the year. In the box on the center of the page, you see through three quarters of the year we've completed 75% of the current year margin target compared to 89% at the same time last year. On the bottom line of the chart, you see that including backlog transactions to be realized in future years, 104% of our total new business target is complete, with only three quarters of the year behind us. As we mentioned last quarter, we've been building out the gas business faster than initially planned. This is adding current year cost to build for the future and we're seeing good success in growing the backlog.

Moving to slide 15, this chart provides an update of the backlog for wholesale competitive supply. These accrual earnings provide significant visibility into future periods earnings. As you know, the portfolio's highly hedged as to price risk; on an ongoing basis we actively manage risk such as the basis risk between regions, or counter party performance risks. In total, we've added 84 million to the 2006 backlog and 91 million to the 2007 backlog through strong strong new business origination year to date. We expect this pattern of creating margin for future years to continue, thereby building our backlog of future earnings.

Turning to slide 16, before I leave wholesale competitive supply, let me elaborate on the economic nonqualifying hedges Mayo mentioned. There are two classes of nonqualifying hedges, which are distorting GAAP results this quarter. Fuel adjustment clauses or FACs, and gas transport contracts. These economic hedges do not qualify for hedge accounting and are required to be mark to market. The underlying positions are accrual. This different accounting treatment creates a timing mismatch of earnings between the hedges, which are mark to market and [hints like changing commodity] prices immediately and the underlying transactions, which are accounted for on an accrual basis and on which the impact of changing commodity market prices is recognized over time.

In the environment we just went through of rapidly rising prices, the FAC hedges, for example, moved significantly out of the money and the associated FACs became more valuable. We recognized the mark to market hedge losses now and the FAC accrual earnings come in the future. We expect the offsetting accrual earnings to come about ratably over the next four years for the FACs, and for the gas transport contracts to resolve about one third in the fourth quarter and the balance next year. You see that the mark to market on nonqualifying hedges has been $0.19 year to date. If gas and fuel prices didn't change at all in the fourth quarter, about $0.02 of this would resolve in the fourth quarter gas transport contract realization for net calendar year impact of $0.17. Special items for the year will include an $0.08 gain from the sale of our Panama business earlier this month, bringing special items to a favorable of about $0.11 for the year. The net of special items and nonqualifying hedges that we call out will probably be a relatively small addition to GAAP/ EPS to arrive at adjusted EPS for 2005.

Turning to slide 17, new energy's peak megawatts served and market share up significantly compared to the third quarter of last year. For the quarter excluding the impact of favorable 2004 bankruptcy settlements, third quarter 2005 gross margin of 52 million was 10 million less than the third quarter of last year. Essentially, higher volumes were more than offset by higher costs to serve load due to a combination of higher wholesale prices and increased customer usage due to hot weather. We provide for this kind of load cost variability in the guidance we provide you.

Let me pause to discuss the selling environment, which remains strong and where we benefit from our national footprint, which provides a degree of diversification. In some markets, utilities are required to provide a default service rate to commercial and industrial customers that resets over a period of time. In periods of rapidly rising wholesale power prices, new energy may be temporarily disadvantaged versus the local utility default service where there's not a frequent rate reset. Markets like New York where customers see day ahead or realtime market prices, and Massachusetts, where default rates are reset frequently, thereby reflecting current market prices, are better for our retail business. We saw evidence of the impact of rapidly rising prices on retention rates in the third quarter, whereas new energy planned for the renewal of 75% of expiring contracts, it actually saw a retention rate of 65% in the quarter. When we exclude customers who went back to the local utility, new energy's retention rates were approximately 85%, indicating they are not losing ground to other competitive players, but are experiencing an expected cyclical phenomenon associated with rapidly rising market prices. The majority of the contracts coming up in the fourth quarter are in markets with favorable retail structures. As a consequence, we expect to grow our market share and do not expect this issue to significantly effect the fourth quarter.

Moving to slide 18 and looking at new energy's volume backlog, as of the end of the third quarter we had 63 million-megawatt hours either delivered or contracted for 2005, which matches our beginning of the year target. We were also successful in adding to our future backlog and have about 33 million-megawatt hours contracted for 2006.

Moving to slide 19, our philosophy of hedging out over the intermediate timeframe provides significant visibility into our earnings through 2008. As you can see, we're substantially hedged through 2008, with balance in our power and fuel position. As to the unhedged position, as long as the spread between power and fuel stays relatively constant, price changes should not materially change our outlook for 2008.

Moving to slide 20, looking at productivity, we've delivered about 72 million, or 90% of our 2005 productivity target of 80 million, which is primarily driven by our generation group. As you can see, we're delivering on our promise that 2008 pretax earnings will be 150 million to 180 million higher than 2003's [via] productivity. These gains will create a higher profitability structure, which is an annuity for our shareholders in our deregulated environment and which increases the return on your investment in Constellation.

Turning to slide 21, year to date cash flow for debt reduction was 743 million. The most notable new news since our second quarter call is a $500 million influx in the third quarter of cash collateral from counter parties due to rising commodity prices. If we turn to slide 22, we see the balance sheet implication. Reported net debt to capital at quarter end was 37.9%. If you exclude other people's money held as cash collateral, we are at net debt to capital of 42%. We project net debt to capital excluding other people's collateral to end the year at about 41%, consistent with the forecast we provide order our July call. We remain on track to reach our 40% net debt to capital target in 2006.

Moving to Slide 23 and looking to the future, we've told you we expect 2007 EPS will be 4.75 to $5.00. In August, we indicated that our hedges for 2008, initiatives for productivity, and a building wholesale competitive supply backlog give us comfort that 2008 should be another 10% growth year. The biggest growth drivers will be wholesale competitive supply, productivity, and the impact of higher market power prices on our Mid-Atlantic fleet. Nothing that happened in the third quarter market prices changed to this outlook.

Looking beyond 2008, I know several of you are trying to understand the implications of higher power prices on our fleet's gross margin. We're reluctant to share detailed EPS guidance that far out into the future, but we'll try to provide more insight in January. In the interim, a few key facts may provide some perspective on the impact of higher commodity prices. First, the PPA on the 609-megawatt Nine mile point unit one plant, from which we're currently selling power at roughly $35.00 per megawatt hour will expire in August 2009. At current forward prices this, would add gross margin of 30 million in 2009 and another 100 million in 2010.

Now, separately you've asked us when our Mid-Atlantic fleet becomes substantially unhedged, and what gross margin looks like in the unhedged state, considering current market prices. The Mid-Atlantic fleet reaches a relatively unhedged state in 2011. At current forwards we expect gross margin would be about 200 million higher in 2011 compared to 2008.

Now, let me wrap up with fourth quarter guidance on slide 24. We expect adjusted fourth quarter earnings of $0.81 to $1.06 per share compared to $0.71 per share in the fourth quarter of 2004. We expect the merchant's adjusted earnings to range between $0.60 and $0.85 per share compared to $0.56 of adjusted EPS in the fourth quarter of last year. Compared to last year's fourth quarter, the merchant will benefit from $0.09 higher wholesale competitive supply backlog recognition, and expected higher new business. We expect BGE to deliver $0.17 to $0.22 per share, flat to slightly up from last year; similarly we expect other non-regulated to be flat to slightly up from last year.

That concludes our prepared remarks. We'll now turn the call over to the operator for questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Dan Eggers of CSFB. You may ask your question.

Good morning, Dan.

---- before, how much of it has to do with the fact that you're able to lock in more hedge on the commodity exposure versus confidence in productivity and the other pieces?

Dan, we sort of missed the beginning of your question. Could you just review it again?

Sure. You guys seem to have more confidence in 2008 than I think I've ever heard out of you. I was just curious how much of that confidence is a function of having established more meaningful hedges for 2008 on the commodity side in the quarter relative to other places where you could lock in opportunity.

Dan, I would say in 2008, the hedge position has not changed significantly since what we shared with you in early August. I would say we're making terrific progress on building a backlog of future earnings at wholesale competitive supply to be recognized in 2008.

Okay. On the new energy and the wholesale side, could you give a little more color about what margins looked like in this quarter relative to prior quarters?

Good morning, Dan. This is Tom Brady. I'll address the new energy piece of that. The third quarter margins, I think as Follin indicated, were impacted by the low growth and the heat and some of the volatility in pricing. I would say that our margins actually achieved in Q3 with about $1.00 below target. The good news on the margin side is that we continue to contract business and contract at a 6% increase in business Q3 '05 versus '04, and the terms continue to be 16 months and the margins should be realized over $3.00. So we're seeing no degradation in the contracted margins. It was simply the cost incurred in Q3.

Dan, why we don't we have George comment on the wholesale side.

On the wholesale side, as you know, most sort of new load auctions with respect to our power business occur in Q4 and Q1. But the opportunities that we saw to generate new business in Q3, margins were roughly consistent with the range that we've said in the past, 2 to $4.00, and margins in our gas and coal business were also about in line with plan.

Got it. I guess, Tom, going back to a bit of slippage in margin at new energy, that was just a function of volumes being kind of a step changeout of what you would normally expect because of the weather, and that's what would have compressed them a little bit, is that right?

Yes, that's correct, Dan. When we enter into contracts, we try to keep our books as flat as possible region by region, and in certain areas where you're seeing rapid volume growth because of growth in the business, it's a little more difficult to do, so we try to balance that out at corporate level. The combination of the very hot weather and heavy consumption right after a big sales quarter, we sold 5000 megawatts back in Q2. When you get into that type of situation and the fact that we-- there is always some superpeak shaping risk that you either cannot hedge or it's not economic to hedge. We put-- we take some risk on that, put a premium in the price. When you have the type of weather we had throughout all the regions, be it New England, New York, Mid-Atlantic, Texas, you would expect to see some degradation of margins and that's pretty much what happened this time.

And one last one, Follin. What was the net cash you guys are going take out of Panama and is there any stranded cash that you're going to bring home with this sale?

No, it's 75 million is the net proceeds. It's about 40 million debt that will be terminated and 35 million cash. That's approximately the breakdown between debt reduction and cash that comes through the door.

Great. Thank you, guys.

Steve Fleishman of Merrill Lynch, you may ask your question.

Yes, hi.

Hey, Steve.

Couple questions. First, somewhat the same issue, but maybe you could give a little more color on how you managed against the high load high prices, particularly since it continued well into September. Maybe not just retail, but maybe on the wholesale side, because in theory, this probably would have been one of your tougher environments.

Sure, Steve. It's George. I guess in terms-- on the wholesale side, you know, as in previous quarters with extreme weather and commodity price volatility, we position the overall portfolio with an eye to insuring that we wouldn't feel the full effect of an increase in sort of VLR costs, and with the broad portfolio that we have along with tools that we sort of explained before in addition to just owning power, weather and temperature swaps, contractual ability to dispatch power plants, we were able to position the portfolio in a way that we didn't really feel the full effect of the increase in costs.

Okay. You mentioned generation outages in the Mid-Atlantic. Which -- is it a particular plant?

Steve, this is Mike Wallace. We had an outage at our Brandon Shores unit that came at a particularly poor time when prices were high that required us to be off for several days, and then in addition, the high temperatures affected Calvert Cliffs and as the high temperatures affect the efficiency of the plant and we lose megawatts, they also affect the biologics of the bay, which puts sea grass coming into the intake structure and that also has a drive to cause us to downpower the plant a little bit. So in balance, we lost some megawatt hours at Calvert Cliffs due to temperatures and the biologics and we lost megawatts at Brandon Shores due to a forced outage.

So, Steve, when we plan for the year, we plan for a certain level of unplanned outages for the plants over the course of the year. And the plants are going to hit the unplanned outage levels in terms of reliability, capacity, factors that we had planned for the year. What happened is there was a bit more that fell into the third quarter at an inopportune time of high prices, so compared to our plan for the year, it maybe cost us $0.02.

Okay. The Nine mile two guidance you gave for '09 '10, does that include any sharing that you might have to give back to I guess the old Niagara Mohawk?

That is all for us. It's on Nine Mile Point one. Nine Mile Point two is what has the sharing arrangement.

Okay, and you didn't include that sharing arrangement when you gave those numbers?

This, this is about Nine Mile Point one, which the contract terminates on in 2009. The Nine Mile Point two contract terminates in 2011.

Right, okay. And one final thing, could you just update us on how you are tracking on the coal and gas margin targets that you gave back in January?

Yes, this is Felix. In general, I would say that the progress both on building out the commercial capability, sort of expanding qualitative or commercial functions has been good. From an earnings standpoint, we're about in line with what we expected, just to refresh everybody's memory, we gave pretty modest gross margin forecasts for,--- for the upstream gas business, the downstream gas business and the coal business at the beginning of the year, and as Mayo and Follin both mentioned, the forward progress of those businesses has been faster than we originally anticipated when we set those targets. So at this point we feel pretty comfortable that we'll, we're in a position to meet or exceed those for the year.

Okay. Thank you very much.

Greg Gordon of Citigroup, you may ask your question.

Thanks. First, a qualitative question. As you look at, across all your businesses, the impact of hot weather across all the regions, rapidly rising commodity prices, the impact on the ability to both contract new business, serve business, and run your plants, I mean as we look back over the past sort of couple quarters since -- as we look back at 2002 since new management team took over the business, how would you rate this quarter in terms of the challenges you faced? Is this the most challenging quarter you faced? Is this the most difficult operating environment, or is this something that we should expect to see on a normal course?

Well, I would say, Greg, that first of all, just point out that we were at the upper end of guidance, so it wasn't a quarter that I would characterize as anything other than a good execution, the model played itself out in a way that we had expected. You know, certainly it -- there are probably more moving parts, but, again, in running a balanced portfolio to deal with volatility in our fuel input is really what the Company is all about, and if you took a look at new energy specifically, there are some forces that retard growth and hurt margin in a risingly --- rising commodity price environment. That will reverse itself when, if and when prices ever go back in the other direction.

Nonetheless, I think that there's increased validation of the Constellation new energy model in this kind of environment because customers increasingly realize that they can in fact hedge against whatever budget exposures they might have by focusing on their energy costs and working with a provider like Constellation new energy to hedge their positions.

So there's still a lot of origination activity, new sales activity and an environment where you might not actually not expect it new energy. So I think we're encouraged that the competitive model continues to be proven out and the way in which we manage our positions, I think, is in this kind of commodity environment, is --- manifests itself in another solid earnings quarter.

Mayo, I think you misconstrued my question. I mean, the numbers were a little bit light, but all things considered, the operating environment, it could have been much worse. I guess my point is in terms of execution of managing the risk in your portfolio, was this one of the more challenging quarters you faced?

Absolutely, I mean absolutely, Greg. You said difficult environment. If by that you meant the temperature load price environment, absolutely. I know Felix and George went back to sort of the temperature load price distributions they had done late last year in the context of their strategic plan for this year's third quarter. This was a 99.6 percentile compared to what they would have expected in a distribution of temperature and load.

Thanks. And one other question. I don't want to take up too much time. The 1.1 billion of cash that you have on the balance sheet, how much of that is actually shareholder's cash? When we subtract out collateral and working capital?

700 million of that is collateral from other companies and that other companies' collateral had been running at about 200 million for a long time and we received 500 million this quarter.

Thank you.

Paul Fremont of Jefferies, you may ask your question.

Really, if we think about new energy and the fact that you're looking at a heavily backward gated gas curve, shouldn't the new energy business on a going forward basis benefit significantly, assuming that the lower future gas prices translate to lower future electricity prices? In other words, shouldn't that, just as it worked against you in terms of a rising price environment, shouldn't that work in your favor on a going-forward basis?

This is Tom Brady, and clearly, if you get into a declining wholesale price environment, okay, that would be favorable to new energy and especially in the environments where the default rates, the backoff rates have been set at the higher wholesale price. So, yes, you would expect a decline in environment to help them out, I guess, on a near-term basis. I would point out that we have been in a rising price environment now for probably at least 24 months, and we have been able to double the size of new energy during that rising price environment, and in fact, even after you incur some of the costs that we did in Q3, which we understand, that's a part of doing this business, that's part of what people pay us for, to have that type of risk insurance from the customer's perspective.

You go back over that two-year period, we've grown our gross margin in Q3 9% a year on a compounded basis. So it's-- we've been able to work our way through the high price environment, but if your point is if we do see a decline in wholesale price environment, that would be advantageous for an immediate period of time.

And then the other question that I have relates to sort of merchant generation. In terms of, in terms of nuclear, what would you see sort of as the earliest opportunity to have the potential to build a new facility?

This is Mike Wallace. The time line for a new nuclear plant is pretty well held consensus around the industry to be 2014 or 2015 before the first plant could go online, and it's driven principally by the regulatory process. An estimated four years to go through the approvals to get a license, followed by four and a half or five years to construct the plant. So 2014 would be the earliest. 2015, perhaps more likely.

Thank you.

Greg Orrill of Lehman Brothers, you may ask your question.

Thanks very much. I was wondering if you could talk about kind of the options for using strong balance sheet that you're going to-- that you have and are building into next year --- how you're thinking about stock buybacks, acquisitions, get through either [exelon] divestitures or other things. I know we've seen a bit [for drax] and I guess there's also potential to continue growing the trading franchise.

Greg, I'll talk a little bit about mechanically how we think about it, which I think you understand, but I'll just make sure. In our projections, we are assuming that once we have taken debt down to the 40% debt to capital level, in our business plan, which is essentially an organic business plan, we aren't assuming any major acquisitions or major gas investments in our business plan. So what we assume is things we have an organic line of site on, and then of course we're very cash generative. We assume that excess cash goes to prorata, buying back debt and stock to keep to capital at 40%, debit capital, that's of course very accretive.

What we are working towards, and you've alluded to some specific opportunities, is to find value accretive investments which are strategically connected to the things that we're very good at and, that exceed the appropriate hurdle rates for the investment in question. So it's quite possible, right, there would be no stock repurchases this next year if we're successful when finding value additive investments. Mayo, do you want to talk about--

Yes, and I think as everyone knows who's followed the Company in, any given year, we have dozens and dozens of opportunities in the acquisition realm, whether it be in generation or in gas or in contract restructuring, and I think we try to remain thoughtful to being balanced in our approach as we build out the businesses, secondly, strategic in terms of buying assets that link to something else that we're doing, and we continue to see a very active stream of those things, and certain parts of that world are more competitive from time to time than others. But I think that we're not at a loss for opportunity and I think you should expect to us sort of continue down that path.

Okay. Thanks.

Paul Patterson of Glenrock Associates, you may ask your question.

Good morning, guys.

Good morning.

I wanted to sort of touch base with you on the nonqualifying hedges. What were-- what was the total amount of the nonqualifying hedges for 2004, the total year?

It was a few hundred thousand dollars --- $1 million?

Okay. And, is that the reason why-- because it looks--

But--

-- weren't impacted by this in the past so that's why you guys are now, or at least not that much--

If you go back over the last, you know, the quarter since EITF 023 was implemented, Paul, what you'll see is that we've -- quarter by quarter, as a variance item, we have been identifying nonqualifying hedges as well as ineffective hedges. The biggest issue for us since EITF 023 has been implemented has been these FAC transactions; or these FAC hedges, which when EITF 023 was implemented, the underlying position, FAC itself became an accrual position. The hedges did not qualify for hedge accounting, a number of hedges, and were mark to market.

So we've been calling that out for you period to period. What happened this quarter is that the impact became quite large and quite significant and was distorting the comparison between periods, so we thought it was important to call it out of the key operating EPS number so that you would have something you could compare period to period.

Okay. That's great. And a lot of other companies do it that way as well. Let me just ask you, what was the total mark to market that doesn't fall into this category --- this category? What was the impact on-- what was the adjusted-- what was the impact of mark to market gains on the adjusted number, if you follow me, absent this stuff?

Absent this stuff, what you'll see in the 10-Q will be mark to market of 108 million. We think about that as mark to market of 80 million because they are direct expenses and the emissions cost, which go against that.

Okay, and that's just for the quarter?

Yes.

And for year to date, what would it be for year to date?

Let me pull that up.

And while I've got you here, the portfolio management, I'm sorry if I missed this, what happened there, if you could just elaborate a little bit more what happened this quarter on that?

Yes, mark to market year to date has been 170 million, and I don't have that -- that's the number that's in the Q. I don't have it at my fingertips what it is after you pull out direct expenses and emissions costs.

Okay. And portfolio management, I notice that was sort of down a little bit. I was just wondering if you could elaborate a little bit more on that.

Paul, it's George, so portfolio management and trading versus last time this year, I think was down 25 million. We have a big, broad portfolio and embedded in that portfolio is our load businesses and our accrual gas and coal businesses, as well as our gas and power trading businesses, and we really look to manage the whole, wholesale competitive supply risk position in portfolio management.

So quarter other over quarter versus last year, we did have some additional costs with respect to serving load, but performance versus -- performance versus plan for the year has been strong and we think that sort of demonstrates our ability to sort of manage through very volatile and difficult times like we had this quarter.

Sure, and the sea grass, is that a relatively new thing, or -- I just don't remember it before. What -- I'm sorry. What was that exactly?

Well, it's not a new phenomenon. This is Mike Wallace, but the extreme temperatures we had in the bay caused it to be exasperated and effectively what happened is grasses are sloughed off by the bay. They then get entrained in our in-take structure, can clog up the condensors and drive down the efficiency of the plant.

When that happens, we need to drop power temporarily. We don't come off line, and then clean the sea grasses off of our intake structure and out of our condensors and then go back and resume normal operation. The high temperatures, very, very high temperatures in the bay just created more extreme conditions in that regard than we normally see.

Okay, and how much more would you say that lowered your capacity factor?

Well, I can't tell you that exactly, but I would -- in the context of lost megawatt hours, perhaps the equivalent of about one day.

Okay.

Combination of temperatures being higher and those effects.

Okay. Appreciate it.

[Inaudible] of Talon capital, you may ask your question.

Good morning, everyone.

Good morning.

I wanted to see if you could give us a EPS impact of weather on BGE and also on the wholesale business specifically.

It was $0.08 at BGE. Do you want to take the -- weather-- what you see in portfolio management and trading is the net impact of a pure, unhedged temperature load and price cost net of the hedges we had put on and the macro positioning of the wholesale competitive supply business going into that environment. And so what you saw is net-net, wholesale competitive supply performed very well going through that because it was well positioned.

But in terms of additional megawatt hours that were demanded because of hotter weather and the cost of providing those megawatt hours to get to a sort of total impact, do you have something like that?

I mean this is George. It's difficult to characterize exactly in an EPS sort of number, but in aggregate, the portfolio as a whole benefited slightly from the conditions that we saw in Q3 across all the commodity markets.

But there was a negative impact of weather, right, on the wholesale business? I mean--

In terms of serving load, what you're alluding to is higher-- higher than expected volumes on their load serving contracts that are at fixed prices and those megawatt hours having to come from a higher priced environment. So certainly against-- for that discreet cost item, costs would have been higher. Now, we don't have that broken out as a line item convertible into EPS, but as George was describing, that net portfolio was positioned in a way that that, the effect of the high temperatures driving prices higher, as well as fuel prices driving prices higher benefited from that on balance.

Got it. So in sort of a normal weather year, you wouldn't see much of an impact either way from what you did this quarter on wholesale, at least?

Steve, when we do-- maybe we can-- we'll be glad to go off line and spend some time walking you through like how we think about a load serving contract, how we price it, how we manage the portfolio. When we charge a customer for a load serving contract, we are charging him essentially -- if it's a fixed price customer, we are charging him for the value of the option we're giving him to be able to call power away from us in an extreme environment. And much of that, right, if you were just hedging one specific contract, you could put a series-- we could buy a series of calls and puts to explicitly manage away that option we've given our customer. We tend to manage it in a portfolio way, so that's why it's hard for us to call out exactly what the cost of, was of that option we gave the customer over the course of the quarter. But we'll be glad to spend some time with you explaining to you how we price it, how we manage it.

Yes, that would be helpful, I guess that on an overall portfolio level, you're saying there wasn't much of an impact either way because it was offset by other pieces in the portfolio?

Exactly.

Okay. Then on the trading side, or the kind of risk management side, if you just look at the net assets mark to market and risk management assets, net of the liabilities this quarter, they were roughly positive 530 million, where they were negative 260 as of the last quarter. So those have gone up dramatically. Can you give us a little color around that? I know your VARs went up, almost doubled. That can be explained maybe by commodity prices. Your hedge position has actually fallen on percentage, on a percentage basis. So can you give us a little bit of color on the inflation in the trading assets, and the hedge position percentages going down? Are they linked? What's kind of the story behind all of that?

Well, rapidly -- market prices changed very rapidly for power and for fuel in the quarter, and for a portfolio that is highly hedged, that means that, for example, with the load serving contract, your obligation to serve the customer moves significantly out of the money. The generation you have procured from a third party, perhaps, has moved significantly in the money and it tends to increase the value of both your assets and your liabilities.

I guess I was surprised to see that the net assets increasing so much from quarter to quarter, if that hedged -- if you are, as you said, fully hedged on both sides, you notice that last quarter it was a negative balance and it increased by, by about $800 million quarter over quarter, and I guess I'm trying to understand that in the context of the hedge.

If, if it is a qualifying hedge, right, the way that the accounting works is that the mark to market on the hedge goes through other comprehensive income. So that's now down in the equity section, right, and that's why a difference rises. Are you with me?

Yes, okay. So if I net off that OCI, then--

Exactly.

-- roughly only a $300 million increase rather than a 500. But I see, the impact is much less.

Exactly.

And in terms of the hedge position percentages being lower this quarter versus last quarter?

On the asset fleet, is that what you're-- is that the question you're asking?

There is a slide in terms of the commodity sensitivity, and I noticed that --- it's Slide 19, like just for example last quarter power hedges were at 95% for '06 and this quarter they are at 91%.

So I guess during the, during periods of price changes, obviously we're trying to hedge dollar price neutrality in the portfolio rather than volume necessarily, so periodically from quarter to quarter you may see small changes in the hedged percentages as we try to adjust the hedges to achieve sort of dollar price neutrality rather than volume neutrality.

Got it. Okay. That makes sense. And then one last question on new energy, I notice that the peak load that you served was actually lower than Q2 even though the megawatt hours were up, were up significantly quarter to quarter, just given the weather and the time of the year. Is there an easy explanation for that?

This is Tom Brady. I think it was down 25 megawatts between where it was at the end of Q2 and where it's at the end of Q3. We talked about Q3 having some lower retention rates. It is a -- as I explained earlier, a relatively low quarter with regard to sales. I would say that that largely that's just the noise around the relatively slow quarter. We continue to be load wise somewhat above where we thought we would be at year end. Our original plan had us getting to about 15,000 megawatts at the end of the year. So no concern there.

Was it just that you are seeing-- I guess if you had-- I guess you would expect to see a higher peak load, right, assuming hotter than normal weather, you would assume to see higher peak load, but is it the case where you are serving maybe less customers, but more megawatts per customer? How does that--

No, no, I think that you're thinking in terms of the actual sales we did in the quarter and the peak being up because of temperature, and we disclosed that number. Okay? That is simply the peak load that we have contracted through all of our customers across the region. That's the size of our load serving business. So you would not necessarily tie in that minor decline with what you would expect to be a rising peak with respect to the warm temperatures.

Okay. I think I got that. Thank you.

Andrew Levi of Bear Wagner, you may ask your question.

I'm all set. Thank you.

One moment. Ashar Khan of SAC Capital, you may ask your question.

I have been answered. Thanks.

Thanks, Ashar. Maybe one more question.

David Frank of Pequot Capital, you may ask your question.

Yes, hi, good morning. Just wanted to thank you guys for providing such insight into the future potential gross margin upside. That was new. But I do have a question. If I look at the -- Follin, I think you said roughly 300 million based on today's power prices through 2011--

330, yes.

330 between 2008, 2011. If I do simple arithmetic and just tax effect that and add it to your earnings and look at where potentially your earnings could be for '08, assuming you have another 10% growth year in '08 versus 2007, I mean it looks like you have an average annual growth rate in earnings of about 10% now through 2011, assuming no growth in any of your other businesses. If that's the case, why aren't you guys out there buying stock today? [Laughter]

Good push, David. [Laughter]

Well, given the balance sheet and the cash you have, it may not be a bad idea.

We'll take that on advisement, Mr. Frank. We've got to make sure that we meet the commitments that we've laid out to the rating agencies. We're pretty darn close and we think the right thing to do is to stay steady here.

Okay. All right. Well, I mean I know the quarter wasn't as strong as some people would have liked, but I guess given the difficulties, maybe understandable. Otherwise, this margin sounds very interesting. Thanks for the insight.

All right. Thank you, and thank you, all, for attending the third quarter, and we will look forward to the January presentation. Thanks again.

Thank you, and this concludes today's call. You may disconnect at this time.