艾索倫電力 (EXC) 2006 Q4 法說會逐字稿

Good morning, everyone, I am Kevin Hadlock, Vice President of Investor Relations of Constellation Energy.

Welcome to our 2007 analyst presentation and fourth quarter earnings call. I'm glad that so many of you could join us here in New York today and on the phone.

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

Thank you, Kevin.

Good morning, everybody. I want to welcome all of you who have joined us here in New York and those who are participating via telephone and webcast. We're glad that so many of you have joined this morning.

So here's our agenda for this morning. First, I am going to provide an industry and company overview. After that, Tom Brooks, who was recently named President of our Integrated Merchant Businesses, will provide an overview of our competitive businesses and then Follin Smith, our CFO and Chief Administrative Officer, will cover our financials. After Follin, we will have plenty of time for questions.

So let's begin on slide 5.

This management team is sharply focused on delivering results and, in 2006, we had another outstanding year. We grew earnings by almost 25% and generated adjusted earnings of $3.61 a share. This performance exceeded management's 2006 guidance given at the beginning of the year of $3.30 to -- $3 to $3.30. And our more recent adjusted guidance range of $3.30 to $3.45 per share. Our earnings growth rate outpaced the S&P Electric Utility Index and the S&P 500 by more than 8 percentage points. I'm very proud of this management team and all of the employees for their accomplishments.

Our success in delivering such strong earnings also translated into significant total return for shareholders. Considering both stock price appreciation and dividends, we drove total shareholder return of nearly 23% in 2006, following the 35% total shareholder return realized in 2005.

During 2006, we continued to reinforce the foundation to support future growth of our business. The successful sale of our gas-fired generation plants demonstrated our capital discipline to sell assets when the market value exceeds our internal valuation. Proceeds from the plant sale have enabled us to achieve our balance sheet targets and we will redeploy the balance to attractive investment opportunities in generation, competitive supply, transmission, and distribution.

Finally, the creation of Constellation Energy Partners and the evaluation of new nuclear options are just two examples of how we are demonstrating our industry leadership position.

In summary, we continued to deliver superior earnings growth and to drive strong total shareholder return for our investors in 2006. As you'll see throughout the presentation, we are poised to continue our success in 2007 and beyond.

So today, I want to talk about our businesses in a way that may be a little different than how we have discussed them in the past. I'll focus more on the types of business activities that occur in the Company rather than the organizational sticks and boxes some of you might be accustomed to seeing.

On a high level, this chart shows how we think about the businesses we have created. Constellation is built on a solid foundation of physical supply assets. We also have a regulated transmission and distribution business, Baltimore Gas and Electric. These two businesses represent what most of you think of as an integrated utility.

In load-serving, we act as an intermediary between suppliers and consumers of energy. Effectively we are selling insurance products to producers of energy, who want to manage their risk as they sell their output, and to consumers of energy, who want to manage their price risk. We have built this franchise into the industry-leading platform that has a substantial lead on our competitors. While each of these businesses are independently valuable, we are leveraging their value by integrating them into a single platform. Scale, extensive knowledge of physical logistics, focus on customer needs, and a disciplined risk management approach give us a strong competitive edge. This year, we are in a position to leverage this scale and market expertise by realigning our merchant platform, which will drive our long-term profitability. The realignment of all of our merchant businesses allows us to leverage our world class capabilities in risk management and portfolio management across our leading industry platform. Tom Brooks will talk more about this in his presentation.

So turning to slide 7.

As we look at the energy sector, industry fundamentals are attractive for increasing investment in physical supply assets. There's a clear and growing need for significant infrastructure investment throughout the sector. Electricity demand is outpacing supply additions in most regions across the country. In certain areas of PJM, where we have a significant physical asset presence, reserve margins are expected to decline and to signal the need for new investment. The growing demand for natural gas will also create a need for additional investment in supply assets.

The evolving debate on energy policy will also drive additional investment. Coal plants are requiring billions of dollars of investment in emissions abatement equipment over the next decade to meet environmental compliance standards. Carbon restrictions are on the horizon and will increase the industry focus on alternative energy investment. Following a year of debate around rising commodity prices, expiring rate caps and election year politicking, the regulatory environment is stabilizing and becoming more supportive of new investment. The desire for enhanced load management will drive the need for advanced metering and demand response initiatives. These areas will provide opportunities for transmission and distribution utilities to invest capital and earn a regulated rate of return.

So how do we take advantage of these trends?

Turning to slide 8.

Because we own high-quality generation assets in high-value markets, Constellation should benefit from the need for more physical supply asset investment. Deregulation should cause scarcity pricing signals to be sent to the market, and encourage the build of new generation capacity when necessary. As this happens, incumbent generators will be advantaged. In the near term, Constellation will benefit from capacity market reform in PJM. When new capacity is required,Constellation will be well-positioned for future generation development at existing sites in constrained zones.

Finally, our strong merchant platform has set the stage for further investment and growth. We expect to leverage our successful growth in the gas business. The completed IPO of Constellation Energy Partners provides a low-cost funding partner to further our growth in this business. Constellation believes it is imperative to slow, then stop, and eventually reverse the growth of greenhouse gases going into the atmosphere and is working with state and federal policymakers to that end. The effective solution set must be market oriented, economy wide, equitable among industries, and very important national and then international in scope. We also believe that the benefits of efficiency and innovation driven by competition are crucial to addressing global climate change. Our cap and trade program in the power sector with lessons learned from the European Union experience should and likely will become a feature of national climate policy in the near term. The details of such a program are impossible to predict today and may take years to enact into law. But it is worth noting that Constellation is well positioned for the future development of this market.

Our commodities trading experience and position in and knowledge of the wholesale markets will be highly leverageable in an emissions trading marketplace. We have one of the lowest carbon-emitting generation fleets in the country, with 60% of our megawatt hours coming from zero emitting sources, nuclear and hydro. The electric industry will struggle to formulate consistent positions on global warming, and there will be challenges for some players as individual states race ahead of Washington. But we believe the accelerating pace of discussions is healthy for everyone concerned, and gives us reason to be optimistic about our own future.

Turning to slide 10.

We are also cautiously optimistic about the future for new nuclear generation capacity in the United States. We believe that the debate around environmental policy and U.S. energy security are very supportive of a new nuclear renaissance. However, there are a number of significant obstacles and risks between where we stand today and where we need to go for this new nuclear capacity to be built.

Our approach to this opportunity is the same as what other opportunities we evaluate. First, we try to leverage our existing skills to identify an area of market opportunity. Second, we try to thoroughly understand the risks involved. Third, we mitigate or eliminate the unwanted risks. And fourth, we apply a gated risk management approach that allows for multiple offramps before we commit large amounts of capital.

Our approach to new nuclear is the same. In the near term, our focus will be developing the option to pursue the new nuclear opportunity. We expect to keep capital investment relatively modest over the next couple of years as we work to remove the obstacles and mitigate the risks. We believe our unique business model, the alignment with AREVA, with Bechtel and with EDF, and strong nuclear operating experience position us well to take advantage of a potentially large developing opportunity. Further, we are working with several parties similarly interested in new nuclear plants who share our perspective and are teaming with us in their approach.

Turning to slide 7-- or slide 11.

Over the years, we have been strong proponents of competitive markets, not only because it benefits our business model, but because it's also good public policy. Competition in energy markets is woven into the fabric of the U.S. economy and its benefits are well-documented. A SERA study found that competition has resulted in $34 billion worth of savings to residential customers nationwide. Another study found that fuel adjusted prices in PJM declined by one-third between 1998 and 2003. In markets with well-structured retail choice options, approximately 90% of large customers and almost 50% of medium-sized customers have switched to competitive suppliers. These facts support the notion that customers continue to benefit from well-functioning competitive markets. Last year, the confluence of expiring rate caps, rising commodity prices and election year politicking increased the noise and drama surrounding deregulation and caused someone to question electricity market restructuring.

However, competition continued to progress in the face of these challenges. For example, Illinois successfully completed first-time wholesale auctions, Pennsylvania is beginning to address the transition to market prices for residential customers, and commercial and industrial customers petitioned the California commission to lift the suspension on customer choice. Our projections contemplate the state of competitive markets, as they stand today, including existing plans in some states for continued migration towards competitive markets. It does not contemplate new opening of additional markets. But should other states begin the deregulation discussion, we are clearly positioned to benefit. Federal support for deregulation and substantial evidence of customer savings will continue to push deregulation forward. The scale and cost advantage of our competitive businesses leave us well positioned to deliver more growth in future years.

On slide 12. The confluence of events that led to the political drama in Maryland in 2006 is unlikely to repeat in the future. The current political and regulatory environment appears to be stabilizing, and succession in the Public Service Commission is now proceeding. Looking through the noise of last year, it is important to understand the facts that transpired. Full recovery of BGE's cost was assured by the legislation passed in the special session last summer. Securitization of rate deferrals has been approved and customers are scheduled to transition to market rates this year with an interim opt-in plan to be approved by the Public Service Commission in the coming months.

I have spent time with the new Governor and the presiding officers over the past few weeks. I believe we do have a constructive dialogue and that will continue in the coming months, and I also expect that there will be a few bumps in the road as we transition to market prices. I know many of you are focused on the environmental regulations and capital requirements for compliance. And Follin will address this a little bit more later. We now have legislation that clarifies the rules and provides defined targets and time lines. We have specific plans in place to become fully compliant and expect to meet the deadlines as required.

Turning to page 13.

Looking to the future, Constellation's long-term growth prospects remain very bright. The long-term commodity price outlook has favorable implications for the value of the fleet. We tend to hedge out 2 to 4 years in the future. When below-market hedges established in lower commodity environments, lower-priced commodity environments roll off, we replace them with new hedges. Consequently our gross margin will continue to grow for several years as we benefit from the high levels of commodity prices. We offer a superior customer value proposition as an intermediary in wholesale and retail competitive supply, which should drive continued growth.

Our productivity initiatives are working and have proven sustainable. We've executed our plan as promised, and have added $97 million pretax annually to our bottom line since we began our productivity initiatives in 2003. This means we've grown earnings by more than 10% since 2003 through streamlining our processes and investing capital to increase the output of our existing plants. We have laid the ground work in 2006 to achieve our productivity results in 2007 through reducing Nine Mile Point workforce costs and completing a 17% capacity upgrade at Ginna. We generate strong cash flow, and now plan to take advantage of capital investment opportunities for the future benefit of our shareholders.

Turning to slide 14.

I do realize that when you invest in Constellation, you put your confidence in this management team's ability to execute. Let me put into perspective how successful this management team has been over the last 5 years. Since November 1st, 2001, Constellation Energy has delivered stock price appreciation of 208%, verses the S&P Electric Utility index of 61%. Over the same period, the S&P 500 rose 34%. In 2001, we owned a moderately sized utility and generation assets that had limited exposure to rising commodity prices because the bulk of our generation fleet was hedged through long-term contracts. Industry players were running from the competitive supply business model. And while we had a small competitive supply business, we had few natural advantages.

At that point, the future looked challenging at best, but we made the best of what we had. First, we took a joint venture with Goldman Sachs to the industry-leading wholesale intermediary; then we went from having no presence in the retail supply business to become the biggest player in the market by a wide margin. We moved from an average single site nuclear operator to an industry thought leader with a fleet of 5 units. We also made several moderately sized, highly successful acquisitions to fill in our portfolio and solidify our position as an industry leader. Our competitive supply capabilities and generating plant operational expertise leave us poised as a management team who will take advantage of the opportunities that this industry offers.

Turning to slide 15, to me the most important.

We drove the success by investing in projects that delivered above hurdle rate returns. We employ rigorous analysis and discipline to ensure that we make investments that exceed the appropriate cost of capital. Over the past several years, we've driven our return on invested capital from a subpar ROIC to one that is superior relative to our cost of capital and others in the industry. We've gotten there through taking market share in our competitive supply businesses, driving productivity gains from our assets, making smart investments, and by eliminating sub-earners from our portfolio. As we project forward, the return to profitability of our mid-Atlantic fleet as below-market hedges roll off will accelerate the improvements we have made to ROIC. The ability we have demonstrated in driving returns will hold us in good stead as we launch the next phase of growth for this Company.

On page 16, Constellation is entering a new era of growth and capital investment. Spending for environmental compliance through 2010 will be significant. With our success to date in the upstream gas business, we are placing more focus on expanding our physical asset base. We are also increasing investment in BGE for reliability. We could also see incremental investment opportunities to fuel future BGE earnings growth later in the decade. As I discussed, spending for new nuclear will remain modest over the next couple of years. Looking forward, we can believe we can deliver 15% dividend growth and continue to grow future earnings.

Now moving to slide 17 and our earnings guidance and outlook.

Our long-term outlook continues to strengthen. And as you will continue to see throughout this presentation, the drivers are highly visible. We are reaffirming our guidance for 2007 and 2008 and looking out to 2009. We expect EPS growth of 10% over 2008.

With that, I'd like to turn the time over to Tom Brooks to discuss the outlook for the competitive businesses. Tom?

Thanks, Mayo, and good morning, everyone, and thanks for joining us.

I'm going to provide an overview of our competitive businesses. As Mayo mentioned, we're in the process of combining several units into an integrated merchant organization. The purpose of this realignment is to enable us to capture maximum leverage across our operations. In the last 5 years, we've been intently focused on broadening and strengthening our customer relationships, enhancing our capabilities in competitive markets and operating our facilities more efficiently. Given our success in building the generation, wholesale, and retail components of our business, we're now turning our focus to creating value by leveraging across their activities. We think this will drive top line growth and enable better operating efficiency. And we intend to go after both. We will be developing and implementing detailed plans for this throughout 2007.

Looking forward to this realignment, I'll provide a strategic overview of our competitive operations. As you'll see, this will not conform to our current reporting approach, but will highlight key economic drivers and present some thinking on returns.

Turning to slide 19.

Our competitive market portfolio includes three categories of investment and commercial activity, our physical asset base, our customer load-serving businesses and our risk management and investing activities. First, our physical asset base is comprised of 8,700 megawatts of mostly base load plants located in central New York and southeast PJM. Our operations teams focus on maximizing the contribution from these units by making operational improvements that increase output and gross margin or create O&M savings. We've also consistently hedged price risks to reduce uncertainty in our earnings. Accordingly, we expect to see significant improvement in our fleets results over the next 5 years as historic hedge pricing transitions to current market levels. For 2007, we forecast unhedged EBITDA of about $1.9 billion and hedged EBITDA of about $1 billion. We expect hedged EBITDA to increase by a compound annual growth rate of 11% through 2011, adding about $1.19 of EPS.

Second, our customer load serving businesses are the clear market leader in providing electricity and natural gas risk management products to a growing base of wholesale and retail customers across North America. These businesses have reached a critical level of scale, which we expect to leverage as we integrate across the platform. We expect 2007 EBITDA of $402 million from our customer load serving businesses.

Third, our risk management and investing activities have produced consistently strong performance over the last 5 years. Managing our own risks effectively is core to our strategy, but this is not just a defensive tool. It has also enabled us to identify and execute on a range of opportunities to deploy capital at very attractive returns, extending the scope of our customer businesses. We expect EBITDA of $342 million from these activities in 2007.

Turning to slide 20.

Let me now talk in more detail about each area, turning first to our physical asset base starting on slide 21.

Our generation fleet is mostly low variable cost base load plants in high-value markets with good long-term prospects. Over the past 5 years, we've significantly improved our fleet's operating efficiency, driving toward top quartile performance at our fossil fleets, and top decile on the nuclear side. We've made good progress, but there's more to come. As we continue to sharpen our execution, driving and sustaining both top line productivity and operating efficiency, we expect more operational up side, complementing the market up side we see over the next several years.

We've been selective and successful in our new investments and generating assets. For instance, Nine Mile Point and Ginna were very effectively integrated into our fleet model and are yielding attractive returns. The completion, start-up, and management of our legacy gas plants through a tough period in the capacity cycle was also well executed. As you know, we recently sold most of our gas-fired generation and certainly this reflects something important about our investment philosophy. Power plants are complex facilities with substantial employee bases. You don't buy and sell them like NYMEX gas contracts. On the other hand, we do focus intently on returns and value. So we're not reluctant to realize value and redeploy the proceeds at higher returns when compelling opportunities arise.

In the future, we expect to continue to be active but selective investors in generating assets. For instance, our efforts to establish a new nuclear platform have been fairly visible. Less visible, but equally important, is our intent to respond to the need for new generation close to home in southeastern PJM over the next several years. Additionally, as the progression of the capacity cycle yields opportunities, we do expect to pursue acquisitions of existing fossil and nuclear facilities, continuing our selective approach.

Turning to slide 22.

We plan to provide increasing visibility into the value of our generation fleet on a hedged and unhedged basis. To this end, I'm going to discuss the fundamental economic drivers to our fleet's results and the hedging effects separately. Given that our fleet is comprised largely of base load assets, only a few factors explain most of the potential variability in our unhedged EBITDA. These are, first, our fleet's production, both in energy and capacity products, principally driven by our planned outage performance and forced outage rate. Second, our ability to achieve operational efficiencies and sustain productivity as we drive towards top quartile performance at our fossil fleet and top decile on the nuclear side. Third, the price of energy at the liquid hub, which will obviously be driven by a number of market factors. Fourth, basis differential between the hub and the actual location of our plants. With about half of our capacity located in the relatively constrained southeastern PJM, we tend to benefit from our plants' locations relative to the hub price. Fifth, capacity pricing, which has become increasingly important with the enhancement of capacity markets in New York and PJM. And sixth, delivered fuel prices, which are subject to varying costs for the commodity, quality variability, transportation method, and emissions. These are the most important factors that we focus on in forecasting and managing realized value.

Turning to slide 23.

Shifting from the drivers of results before hedging to a discussion of our hedging approach, we follow that consistent practice of forward hedging to the value of our fleet's output to enable more predictable earnings. We've done this to support our financial strength over the whole commodity price cycle, and the approach contributed to the steady trend in our earnings and improvement in our balance sheet over the last 5 years. At this point in the commodity cycle, after a 4-year upward price trend, our hedge portfolio is naturally out of the money. So historic hedging somewhat masks the fundamental value of our fleet, an effect that will diminish over the next few years.

Turning to slide 24.

The gap between our results before and after hedging will diminish significantly as hedged EBITDA increases over the next 5 years, which you see here as the narrowing of the yellow wedge. We forecasted unhedged EBITDA based on prevailing forward prices in mid-December. So the forecasted decline in unhedged EBITDA over the 2008 to 2011 period that you see here is simply a reflection of the shape of today's backward-dated forward curve. Of course this effect could ultimately play out differently if declining reserve margins cause power prices to increase in the future relative to current forward market levels.

As with any portfolio managed with a consistent hedge program not biased towards trying to predict future prices, we would expect our average realized price per megawatt hour after hedging to lag market prices, after the rising prices that we've experienced over the last 4 years. Conversely, we would expect that the average realized price of our portfolio would outperform market prices after an extended period of declining prices. Most importantly, over the long-term, we would expect our results, after hedging, to yield a realized average price in line with the market over the full cycle, implying a long run average value of our hedge portfolio of about zero.

Turning to slide 25.

Looking forward, there may be additional up side to our outlook, due to declining reserve margins and their impact on regulatory policy. These factors could create upward pressure on either capacity or energy prices. In PJM a new approach to locational capacity markets has been recently approved, though subject to rehearing by the FERC. We cannot yet project capacity prices with any precision, given that the rules implementing the RPM program have yet to be developed. However, southeastern PJM, the location of about half of our capacity, is supply constrained and has a number of units that may require capital upgrades to meet new environmental standards. As a result, we think there may be upward pressure on the clearing price of southeastern PJM capacity, since under the RPM program supplier offers are capped at a level that is in part driven by incremental capital investment.

We forecasted capacity prices based on the prevailing forwards in late December. For instance, about $40 a megawatt day in PJM and $90 a megawatt day in New York for 2007. Therefore, over the next 5 years, there could be upward pressure on capacity prices from our forecasted level if capital upgrades are made to enable older plants to continue operating or if older plants are replaced by new ones. If we do not see new investments driving the near term price of capacity upward, then energy prices may trend upward as reserve margins decline.

Like any ISO, PJM is a heavily regulated market. There are a number of features of this regulation that effectively suppress energy prices at times of actual scarcity. Offer price caps, market dispatch rules and realtime price mitigation. In the last several years, generation reserve margins have been declining with little announced new investment. In the long run, regulatory policy may need to adjust to allow actual scarcity to be reflected in energy prices, if the new capacity market alone proves insufficient to attract new investment. If this policy transition were to happen, our fleet would likely benefit in the long run.

Turning to slide 26.

Let me now turn to our customer load serving activities, starting on slide 27. Our customer load serving operations provide risk management products to wholesale and retail consumers of electricity and natural gas. Our customers value our services because energy prices are an important cost component and managing the range of risks associated with procuring a load following product is highly complex. Our customers recognize that it is more efficient to purchase these risk management services from us than to self-provide. Our success in serving our customers depends on the effectiveness of our risk management approach, the quality of our presence in several customer sales channels, our focus on customer service, and our scale. We've built an edge in all four areas by investing heavily in people and technology. Over the last 10 years, we've assembled the top team in the business, a team that competes confidently with both large energy companies and financial players of several types. On the technology side, we've spent 10 years developing the infrastructure that supports a competitive advantage in mining and managing information resources. Together, the combination of people and technology supports a culture of excellence.

We've become the clear market leader in a substantial business and we believe we can extend our advantage. Over the last 5 years, aggregating scale and driving the top line have been our prime directives. Given our success in building scale, we believe we can now drive further growth to top and bottom line by integrating across our platforms. This will put better tools and information in the hands of our salespeople who provide risk management solutions to our customers, and enable better back office functionality at a lower cost. We're still quantifying the benefits, but we're confident that this can have a meaningful impact. By combining people, scale, and information with better products, better risk management, and more operational leverage, we believe we can continue to lead the market and drive growth.

Turning to slide 28.

Focusing on key indicators of our market performance, we've been providing risk management products to load serving customers for 10 years. So we have a good understanding of customer needs and market dynamics as well as a long history to inform our projections of future performance. Here's a summary of our last three years of market performance as to sales volumes and unit margins.

We've experienced steady growth in volumes; key drivers include our success in utility load auctions where our lower cost to manage risk across a big portfolio allows us to compete very effectively; high renewal rates of 70% to 95% in our retail channels; and our ability to continue growing our current market share of nearly 25% in a fragmented market, particularly as retail switching rates increase. As to margins, we've been able to increase unit margins in natural gas by transitioning our mix towards higher value risk management products. On the power side, we've seen some cyclicality driven by competitor behavior and market conditions. But we've also found that by maintaining strict pricing discipline, we've been able to maintain attractive returns under varying conditions.

Turning to slide 29.

Given our market leading position and steady demand, our customer load serving operations have experienced strong growth. We project EBITDA of $402 million in 2007, an increase of 18% over 2006. And we see meaningful longer term growth based on adding market share, further penetrating the unswitched retail market and capturing more efficiency by integrating across our load serving platform.

Our customer load serving activities have also generated very attractive returns on investment. Anticipating the upcoming realignment of our merchant organization, we've made an initial cut at the proportion of Constellation's current equity capital that would be required to support a combined wholesale and retail customer load-serving business. On this preliminary basis, the combined platforms' requirements would be in the range of $600 million to $800 million. Based on this pro forma equity requirement and our 2006 EBITDA of $341 million, we earned a return on equity of 26% to 34% in 2006. Our return outlook for 2007 is higher. Since this is just a preliminary look at the combined equity requirement, we will be refining our assessment as part of planning and implementing the realignment.

Moving to slide 30.

Let me turn to a discussion of our risk management and investing activities starting on slide 31.

Our risk management and investing activities have been crucial to our success for two reasons. First, our commercial approach is built on thoroughness and identifying, analyzing, and managing risks. The predictability of our results in volatile markets resulted in part from the strong performance in this area. And intense focus on risk management runs right through our culture and we think it sets us apart.

In addition, this capability has been a source of opportunities to invest capital at very attractive returns and has allowed us to incubate opportunities that have broadened our platform and driven growth. These investment areas include, first, our customer businesses in non-load serving power products, upstream and downstream natural gas, and coal and freight services; second, the portfolio management associated with all of our wholesale activities; and third, trading and related activities.

Anticipating the realignment of our merchant segment, we also carried out a preliminary assessment of the equity capital supporting our risk management and investing activities. On a preliminary basis, the range is $900 million to $1.1 billion. In 2006, we earned $553 million in EBITDA from these activities, implying a return on equity range of 30% to 37%. While we don't expect to match those results every year, we have earned consistently attractive returns in the past and we expect this pattern to continue in the future. We know that this category of activity, unlike our physical asset fleet and load serving, is challenging to model from the outside, but it has been a steady earner and the underlying capability is a key differentiator that has been critical to our success. Since we've been an active investor in natural gas production in the last year, let me turn to that area since it provides a good example of the approach we employ within our risk management and investing operations.

Turning to slide 32.

We follow a very structured, targeted approach to investing in natural gas production. First, we identify investment opportunities that are strategically aligned with our broader business objectives and core competencies tending toward lower production risk, longer-lived reserves where our commodity price management expertise is important. We partner with companies experienced at reserve development and extraction who can benefit from our risk management expertise and we combine our own internal valuation capability with external expertise to evaluate and structure investments. After we invest, we focus on maximizing the value of the assets within our portfolio by improving hedging approaches, development strategies, and operations. Finally, we look for opportunities to realize returns by monetizing investment after enhancing their value.

As many of you are aware, we recently spun off a tax advantage vehicle with our IPO of Constellation Energy Partners. CEP is structurally similar to the NLPs that are prevalent in the mid-stream business. The IPO enabled us to harvest cash for future investment while retaining a stake in CEP, which would help support our targeted natural gas strategy. The two companies have a complementary investment focus that allows us to pursue joint acquisitions of properties and provides Constellation with a ready partner for certain types of properties after we've improved them, which should allow us to efficiently monetize investments in the future through drop down sales to CEP.

When we see attractive opportunities that fit our targeted strategy, we expect to continue investing in natural gas production. We've made 9 acquisitions over the past 4 years, investing about $500 million at attractive returns. Given our track record of success and the advantage of the CEP relationship, we expect more success from this focused approach.

Turning to slide 33.

To summarize, our competitive businesses are built on a foundation of three key elements.

First our valuable base load generation assets in attractive markets that we've operated efficiently and will continue improving. Second, our market-leading load serving businesses, with strong track record, deep customer relationships and good growth prospects. And third, our proven return oriented risk management approach. Over 10 years, we've built meaningful competitive advantages in our load-serving businesses based on the quality of our team, our technology infrastructure, and our scale. We believe that this edge will support continued market leadership. Our competitive businesses have generated attractive returns on capital, which we expect to improve as hedge price levels transition to current prices -- market prices, and we continue to build on our successful track record in load serving and risk management and investing. As we realign our merchant platform, we'll go after opportunities to drive top line growth as well as operating efficiencies. And as we look forward to growth opportunities, we'll maintain our constant focus on generating attractive returns on capital.

Now I'll turn things over to Follin.

Thank you, Mr. Brooks.

Good morning, everyone, thanks for joining us.

I'll start this morning on chart 35 taking a look at our financial results for the fourth quarter of last year and for the full year and then we'll focus on the 2007 and 2008 outlook and finally, then we'll look at capital spending, cash flow and the balance sheet. And finally I'll give you some insight into our earnings outlook beyond 2008 and some thoughts around valuation.

Starting with chart 36.

Fourth quarter GAAP earnings were $2.22 per share. After special items our fourth quarter adjusted EPS was $1.08 versus the guidance range of $0.75 to $0.90. Full-year, GAAP earnings were $5.16 per share. We back out $1.55 per share, including the gain on the sale of the gas plants, a reclass of High Desert's earnings to discontinued operations, gains on nonqualifying economic hedges, and synfuel earnings to arrive at EPS of $3.61. This adjusted EPS is $0.16 higher than the guidance we gave you in October of $3.30 to $3.45, and $0.31 higher than the guidance we provided at the beginning of the year.

Turning to slide 37.

Now looking at management results by segment. The merchant earned $0.88, well above our guidance range of $0.55 to $0.70 per share, due to outperformance by wholesale competitive supply, primarily portfolio management and trading and by new energy. Compared to last year, EPS was up 24%, primarily due to growth in competitive supply, both wholesale and retail, commercial, and industrial, offset by lower earnings at BGE due to weather and higher costs.

Now turning to slide 38.

For the full year, adjusted earnings were $3.61, up $0.72 or 25% from last year and $0.31 above the top end of guidance range provided in October of $3.00 to $3.30 excluding High Desert. That was guidance provided at the beginning of the year. The merchant segment achieved EPS growth of $0.81. Earnings benefited from $1 per share of growth in wholesale competitive supply both in new business originated during the year and backlog realized. New energy performance improved $0.28 driven by better electric rates, and lower costs to serve load. The fleet was down $0.39 for the year due to the end of the competitive transition charge collections in Maryland, longer planned nuclear outages primarily due to the Calvert Cliffs reactor vessel head replacement and due to inflation. These negatives were partially offset by fleet price improvements and productivity gains. Finally we had an aggregation of smaller unfavorable items that cost us $0.08. The utilities earnings were down $0.14 compared to 2005 due to mild weather and higher operating expenses partially offset by benefits of the gas rate case which took effect in mid December 2005.

Turning to slide 39.

This is the waterfall projection for 2006 compared to 2005 that we shared with you last January. The bottom of the chart compares our actual performance to what we told you to expect a year ago. We told you we would grow in competitive supply in bioproductivity and that the end of the competitive transition charge would create a headwind. And that's what played out. With better performance by competitive supply, partially offset by longer planned outages as we hit some difficulties in the Calvert Cliffs reactor vessel head replacement and then accumulation of other smaller negative variances. We executed our plan for the fifth straight year with outperformance in some areas offsetting challenges in others; this is what good management teams do. They deliver what they say they will.

And moving to slide 40, I'll start with an outlook on 2007 and 2008 earnings.

The most significant driver to 2007 and 2008 earnings growth will be the return of the mid-Atlantic fleet to profitability as below market revenues hedges are replaced with later vintage hedges. As Tom mentioned, in effect, we're realizing 2004 power prices in 2007 earnings. And we'll recognize today's higher power prices later in the decade.

Another key theme is the inclusion in the forecast of moderating growth assumptions for competitive supply. We are forecasting lower wholesale portfolio management and trading results following an exceptional performance in 2006; wholesale and retail power we are assuming will see a return to more normal conditions from the very favorable 2006 environment. On the other hand, we have a strong backlog and we'd expect good growth in the wholesale and retail gas businesses.

Next, productivity's been a big story for us over the past several years. Our productivity initiatives at generation and headquarters are on track. In addition, efficiency initiatives at NewEnergy will drive a lower cost per megawatt hour sold, and generally our gross margin will grow faster than our cost base as we benefit from scale with our growth. A new theme in 2007 will be a step up in capital spending. The drivers are environmental spending, higher spending on transmission and reliability programs at BGE and a place holder for investments in our successful upstream gas business in 2007. Finally, return on invested capital will continue to improve as our mid-Atlantic fleet returns to profitability as below market hedges roll off and as we continue to make smart investments.

And turning to slide 42.

For 2007, our guidance range is $4.30 to $4.65 per share, which represents 19% to 29% growth over a very successful 2006. We expect the merchant segment will be up 34% to 44% and BGE will be down 14% to 25%. Slide 43 walks you through the factors that will contribute to our 2007 earnings growth. Generation profits will grow by $0.92 in 2007, primarily driven by the $0.83 per share effect of the improvement in fleet price and the $0.20 impact of fewer planned nuclear outage days in 2007. These positives will be partially offset by the negative $0.14 impact of the end of the competitive transition charge.

Our competitive supply businesses are forecast to be down $0.19 in 2007, with a decrease in the wholesale profits to be partially offset by an increase in NewEnergy's profits. First we're forecasting a significant decrease in wholesale portfolio management and trading, which had a banner year in 2006. Second, at wholesale power, a monetized contract added to profits in 2006 and, in general, we saw very robust new business conditions in wholesale power. Accordingly, we're assuming 2007 power results will be down with the assumption of a more normalized environment. On the other hand, wholesale backlog is $150 million higher going into 2007 than it was going into 2006, and we expect to see good new business growth in gas.

With respect to retail, EBIT will be up as the gas business projects an increase of about 1 percentage point in market share with about 74% of planned volumes already contracted. The retail electric business picks up volume in markets transitioning at the beginning of 2007, mainly Illinois, Connecticut, and Pennsylvania. 66% of the electric plan volume is already contracted, slightly ahead of where we were this time last year.

Now, the profit impact of the electric volume impact will be offset by an assumption that we trend back to normalized unit margins after a very favorable 2006 environment. Continued productivity gains of $0.22 in 2007 will be partially offset by $0.08 of inflationary cost increases resulting in a net earnings increase of $0.14. BGE's earnings will be down $0.17. The main drivers are associated with last year's Maryland legislative action, which in aggregate cost us $0.09, and $0.15 for an accumulation of smaller items. These negatives will be partially offset by $0.07 favorable due to our forecast assumption of return to normal weather. In other, the primary drivers are lower interest expense, partially offset by the absence of the gas plant earnings, excluding High Desert.

Now turning to slide 44.

As Tom pointed out, a consistently applied hedge approach will mean some years hedges are in the money and some years hedges are out of the money, but over time should not cost shareholders anything. The reason we maintain a highly hedged portfolio is to create visibility for our investors and our employees as we manage to our competitive supply and productivity growth targets. In a rising price environment, the upshot is a delayed gross margin uplift and the converse will hold true in a declining price environment.

This graph represents gross margin per megawatt hour from our mid-Atlantic fleet from 2004 through 2009. Our gross margin from the fleet was declining through 2006 with a significant proportion of our revenues hedged in 2001 in conjunction with Maryland deregulation while fuel costs were not locked in in 2001. So early in the decade, our coal prices went up while our revenues were fixed, squeezing our margins. Going forward, gross margin per megawatt hour will improve as our below market hedges roll off and our mid Atlantic fleet returns to appropriate earnings. This gross margin is highly hedged through 2008, which provides significant visibility into our future earnings.

Moving to slide 45, this slide divides our wholesale and retail competitive supply results into 3 categories. In the dark blue, you see that wholesale competitive supply before portfolio management and trading has achieved steady growth by taking market share and power load serving and developing complementary gas and coal businesses. In the light blue, you see the growth in NewEnergy, our power and gas business which serves commercial and industrial customers. The combination of wholesale power, gas and coal and commercial and industrial power and gas has grown at a compound rate of 30% per year from 2003 through 2006.

For 2007, we're forecasting a moderating growth rate in this grouping of competitive supply activities. We have strong backlogs and expect good gas growth, but we're assuming a return to a more normalized power market condition after a robust 2006. The green portion of the bars represents wholesale portfolio management and trading. Including portfolio management and trading, our 2003 to 2006 competitive supply growth rate was 42% per year. As the size of our portfolio increases, we're finding more opportunities to generate portfolio management and trading earnings. However, we think it's prudent to project lower year-over-year portfolio management and trading earnings following our exceptional performance in 2006.

In total, we're forecasting competitive supply to be slightly lower in 2007. In essence, growth in the combined backlog in gas businesses will be more than offset by an assumption that portfolio management and trading and power will not repeat the incredibly strong 2006 performances.

Now, turning to slide 46.

In addition to our strategy to leverage our leadership position as commodity intermediaries, we focus intensely on driving productivity each year by developing specific targets and detailed plans and then crisply executing to what we've outlined. As you'll recall in 2004, we promised that 2008 pre-tax earnings would be $150 million to $180 million higher than 2003's due to our generation and staff productivity initiatives. This chart shows our cumulative gains as a result of our productivity initiatives. 2007 productivity gains will be largely the result of already completed 2006 initiatives. We have lower labor costs from a 2006 workforce realignment at Nine Mile Point helping to drive $30 million to $35 million in 2007 productivity and the successful 2006 implementation of an 83 megawatt up rate at Ginna will drive another $19 million in 2007. On average permanent productivity gains at generation and headquarters will have driven approximately 2 percentage points per year of our EPS growth from 2004 through 2008.

And moving to slide 47, not only is our bottom line benefiting from explicit productivity initiatives in generation and headquarters, which we talked to you most frequently about, we are benefiting from scale as we leverage our fixed cost in systems and in people. This chart illustrates how we've driven productivity and scale to increase EBIT. In 2004, our expenses were 72% of gross margin. The green line here represents holding cost as a percentage of gross margin constant at 72%. Now with generation and staff productivity and with NewEnergy's efforts to reduce SG&A per megawatt hours sold, and as gross margin growth outpaces costs, our bottom line is benefiting.

The blue line represents actual and forecast cost. In 2007, we expect costs to be 65% of gross margin and that 7 percentage point improvement from 2004 represents an increase in EBIT of $284 million due to productivity and scale benefits.

And moving to slide 48.

To recap our 2007 growth story, the underpinning for our strong 2007 earnings growth are in place, making our 2007 earnings highly visible. First our 2007 portfolio is highly hedged as to price risk. We currently have hedged 96% of our 2007 power and 91% of 2007 fuel. That means the value of the wholesale backlog at $0.83 per share of earnings growth from fleet price improvement should not vary much due to changes in market prices.

Second, our 2007 projection for wholesale and retail competitive supply includes significantly lower portfolio management and trading results and lower power new business than what we achieved in 2006. Finally, the underpinnings of $60 million to $65 million in productivity were in place at the end of last year. We need to crisply execute on a number of initiatives in order to achieve our 2007 projections, but the basis for our projections is very sound.

Turning to slide 49.

Before I move to 2008, let me provide first quarter 2007 guidance. We expect first quarter earnings to be $0.80 to $1 per share, which is up significantly from the $0.61 of EPS we earned in the first quarter of last year. In the merchant, we're projecting EPS of $0.42 to $0.62, versus $0.22 in the first quarter last year. Generation will be up year-over-year as the mid-Atlantic fleet returns to profitability as below market hedges roll off. NewEnergy will be up primarily due to higher volume. And these positives will be partially offset by wholesale competitive supply, which we're forecasting to be down year-over-year compared to an exceptionally strong portfolio management and trading performance in the first quarter of last year.

We expect BGE EPS of $0.30 to $0.35 compared to $0.38 last year, consistent with our full-year expectations for BGE.

And moving to slide 50 and 2008 EPS.

We are projecting 2008 EPS of $5.25 to $5.75, up 23% versus the midpoint of our 2007 guidance. The generation fleet will contribute $0.79 of earnings growth and the biggest driver will be the profitability of the mid-Atlantic fleet as below market hedges are replaced with later vintage hedges. We projected $0.33 of earnings growth from competitive supply. Given an already healthy backlog in wholesale competitive supply, we do not need any growth in our rate of new business origination for 2008 to achieve these numbers. NewEnergy is forecasting moderate share gains. The impact of spending on reliability improvements and inflationary costs at BGE effect a $0.07 decline in earnings. We expect it will be time to proceed with a BGE electric distribution rate case no later than 2008, which will favorably effect 2009 earnings.

Turning to slide 51, you'll note that our 2008 guidance range is $0.50 wide. One notable area of uncertainty is capacity market reform in PJM. Capacity markets have been enhanced significantly over the last several years; with the FERC's recent order in December to the PJM ISO to implement the RPM construct, we expect that higher capacity revenues may add to the revenue from generation plants in PJM. Giving the growing importance of capacity as a revenue source, we will provide information on our capacity position with the similar levels of transparency as to what we've provided relative to our energy position in the last several years. As with energy, we've sold capacity to many load-serving customers and bought capacity from numerous generators over the last several years. Given competitive dynamics, we cannot provide the details of our positions in every location, but as we've done with energy, we want to help you understand our net capacity position and potential variability on the open amount. Our total fleet in PJM and New York produces about 3 million megawatt days of capacity annually. Over the next 3 years our hedge ratios on this capacity position are 90% in 2007, 66% in 2008, and 36% in 2009.

As to capacity pricing, we forecasted the value of our open capacity position at prevailing forward market prices, just as we've done over the last several years for energy. The forward price we assumed for our open position in 2007 is $40 per megawatt day. For 2008, capacity markets are still somewhat illiquid, but our best guidance is that it could range between $50 per megawatt day and $100 per megawatt day.

Turning to slide 52. Taking 2007 and 2008 together, we expect earnings growth of 22% to 26% per year from 2005 to 2008. Several of you have asked if we will provide a point estimate for 2009 EPS. As you'll recall two years ago we provided you with an EPS guidance range over a forward 3-year period. With the substantial earnings increase driven by the roll-off of below market hedges, we felt it was very important to communicate our embedded growth by extending our guidance horizon out to 3 years. Now that this phenomenon is understood, we think a sounder practice is to focus more generally on long-term growth rates.

Now looking beyond 2008, our best guidance to you is 2009 EPS growth should be about 10% over 2008. In Tom's section, we provided an estimate of fleet EBITDA growing from $1.27 billion in 2008 to $1.44 billion in 2009. That alone is about $0.45 per share or 8 percentage points of EPS growth. For 2009, we're hedged 79% on power and 56% on fuel, so we have greater exposure to changing commodity prices than we do in 2007 and 2008. On the other hand, modest growth expectations for competitive supply make an all-in EPS growth expectation of 10% seem very reasonable.

Moving to slide 53.

Our growth rates will be very high over the next 3 years, and yet we have tremendous visibility on the earnings growth drivers. The dark blue on the bottom reflects the solid base of utility earnings at BGE, the royal blue section above BGE represents EBITDA from our generation fleet, which is now moderately hedged and balanced as to commodity price exposure through 2009. Fleet EBITDA will grow from 32% of Constellation's total 2006 EBITDA to 48% in 2008. The area above the generation fleet is NewEnergy. For 2007, over 65% of NewEnergy's projected gross margin is already contracted. NewEnergy has high customer retention rates, that is, a good track record of retaining customers whose contracts expire, which bodes well for winning new business. The light blue segment shows the strong commodities group backlog of already originated transactions to be realized in future earnings. About 45% of projected 2007 wholesale competitive supply gross margin is already contracted. Adding it together, earnings streams with high visibility represented by blue here are 87% of our 2007 EBITDA and 82% of 2008 EBITDA.

Now let me turn to capital spending, cash flow, and the balance sheet on slide 55. This chart represents the capital spending projections in our business plan. As you'll recall, we give you a capital spending forecast that includes only known or reasonably likely investments. We do not include unknown mergers and acquisitions, for instance, so accordingly, what you have here is essentially an organic business plan. Our current plan is to spend $1.9 billion in 2007 and $1.7 billion in 2008. The increases in our capital forecast are driven by environmental capital spending related to the Maryland Healthy Air Act, higher merchant capital spending driven by our investment in our successful upstream gas business, and utility spending driven by the need to add transmission capacity to bring power into the region and replacing and upgrading substation equipment like transformers and switches and running new feeders to accommodate growth in the City of Baltimore.

Turning to slide 56, this chart shows you the break out of our projected environmental capital spending for Brandon Shores, Wagner and Crane to comply with the Maryland Healthy Air Act by 2010 as well as our share of spending at the Keystone plant in Pennsylvania. Last January we projected environmental spending of 740 million through 2010. Maryland's Healthy Air Act was finalized in 2006 and the Clean Power Rule was finalized in early 2007. Maryland's rules, which exceed federal standards, have required that we add additional equipment resulting in cost increases. In addition, like many companies, our costs also have gone up as market, labor, and material costs are increasing. We currently expect spending of $1.1 billion over the 2007 to 2010 period.

Turning to slide 57.

With each category of upcoming investments, we see a clear linkage to future earnings benefits. With our environmental spending, we expect to see offsetting capacity revenue as investments by ourselves and others put upward pressure on capacity prices in Southeast PJM. We've currently modeled the impact conservatively in our forecast; as the implementation becomes more clear, we will better understand the full impact to our growth. In upstream gas, we're pleased with the success to date of this business and we have a place holder for investments in 2007 of about $225 million higher than in 2006. We modeled the earnings on the upstream gas business conservatively, assuming that we hold each investment for its entire life cycle. However, we actually expect to harvest investments as proven reserve levels begin to rise, which should lower the net investment in this business. This business, of course is different from launching a project like the Brandon Shores scrubber where we will have committed to and launched a sizable program.

With the gas business, each discrete investment is smaller. We evaluate each one carefully and if lucrative opportunities do not present themselves, we will not spend the capital.

Finally our investments in utility reliability and infrastructure will yield future benefits. Our 2007 BGE capital program will be up $80 million over 2006 levels, $50 million of this is in transmission projects, which are subject to formula rates which allow us to start earning a return when the capital is spent. The remainder is traditional electric distribution spending to increase reliability of the sort never challenged in any jurisdiction in the U.S. This spending supports construction for increased load growth in the area and also supports the replacement of aging infrastructure through increased reliability.

As I mentioned, we've assumed that we will file an electric distribution rate case no later than 2008, and BGE will start to see returns on this capital in 2009. Not included in our projects -- not included in these projections are initiatives we are evaluating in advanced metering and demand response, which we would undertake if Maryland regulators are supportive. These are initiatives which we think are the right thing to do and which would provide a fair return to shareholders. We will tell you more about these if Maryland is supportive. All of these opportunities -- environmental spend in PJM, BGE transmission and distribution spending, and new gas provide a foundation for meaningful earnings growth after the 2007 and 2008 period.

Now, turning to slide 58.

Bringing the capital and the earnings picture together. As you see on the operating cash flow line in the middle of the chart, in 2007 we expect operating cash flows to be a use of $700 million. Additionally we'll see a use of $234 million related to the continuation of the Senate bill on rate stabilization plan deferrals for BGE, which will be funded by a securitization later this year. After dividends, our cash flow will be $1.3 billion negative reflecting our investment in the business combined with a payment of about $300 million in dividends.

In 2008, with earnings growth and moderating net capital spending, operating cash flow is neutral. With dividends, free cash flow will be negative. By 2009, the environmental capital compliance program at Brandon is nearing completion. Earnings will be up, and we expect free cash flow to be positive.

Turning to slide 59.

Net debt to total capital at the end of 2006 was 35%, significantly below the year end 2005 level of 43%. The key driver behind this decrease was the receipt of cash proceeds generated from the sale of six gas fired plants in December for $1.6 billion in proceeds. Now, as we mentioned before, these proceeds will be used to repay approximately $700 million of debt that will be maturing in early 2007. Additionally, the strong cash balance provides us the liquidity to fund our 2007 capital plan. Net debt to capital will rise in 2007 and 2008 as we execute our capital program, pay healthy dividends, assumed in our projections to grow by 15% per year. We've mentioned in the past that the 40% net debt to total capital target is a proxy for a number of credit metrics that we and the rating agencies monitor. For those of you who focused on the S&P upgrade of Constellation's debt to BBB+ will have noted a target funds flow from operations to debt ratio of between 25% to 30% to sustain this rating. FFO, of course, includes net income plus depreciation and amortization, deferred taxes and other non-cash items. S&P also imputes debt for structured contracts and capital leases. In 2007, we will be in the lower half of that 25% to 30% targeted FFO to debt range, and debt to capital will be in the targeted 40% area. Accordingly, we have achieved our balance sheet objective and will be able to maintain this strong position over the next two years.

Now, turning to slide 61, let me reflect on the sources of growth at Constellation and the implication for our valuation.

For the 7-year period from 2002 to 2009, we expect to grow adjusted EPS at 13% per year. That's a level rarely seen for such a sustained period in the business world. We will have achieved this by executing on multiple fronts in each area of the business. In competitive supply we have been and will continue to take market share in load serving and structured commodity transactions and to take market share in the gas business by providing capital and services to customers who are somewhat underserved.

We expect to benefit from continued focus on leveraging the cost structure at NewEnergy. As we realign our merchant segment, we expect opportunities to leverage the infrastructure and processes across the wholesale and retail load serving businesses to further grow earnings. Our generation activities will present opportunities to leverage the wholesale commodities and generation interface. We have seen and expect to see benefits from generation productivity initiatives. The impact of rising commodity prices will benefit our earnings over the next several years as we experience the roll-off of earlier vintage hedges and realize higher market prices.

Later in the decade, we project earnings growth will be driven by upward pressure on PJM capacity prices due to environmental capital investments that plant owners are making over the next several years. Finally, we're evaluating the viability of building new nuclear plants, which would manifest returns in the next decade. At BGE, we're making investments now to improve the infrastructure of the utility. We're also exploring up side opportunities for investments to support energy conservation, which is the right thing to do and would provide a return to our shareholders. Together we have a healthy array of sound growth initiatives to be executed by a management team with a proven track record.

Turning to page 62, we realize that because the sources of our growth are meaningfully different from others in the industry, we speak to many of you directly on a regular basis and we recently concluded an investor perception study. One of the consistent themes that we have heard from you is a desire for us to provide our thoughts on how to value the merchant. Now while I realize that providing valuation thoughts is somewhat unconventional, quite literally, you asked for it. We've grouped our merchants earnings into three business activities that Tom used, generation, load serving, and risk management and investing.

Load serving comprises NewEnergy, which serves retail and gas, electric load, and wholesale load serving. The remaining businesses in wholesale competitive supply, including portfolio management and trading and the up stream gas and coal logistics businesses are grouped into risk management and investing.

And turning to slide 63.

For generation we think the EBITDA multiples of other merchant generators make a good comparable. However, because different merchants began the practice of hedging at different points in history, we think it's necessary to determine the relevant multiple applied to the unhedged EBITDA of our comparables output. So for each merchant genco comparable, we made an estimate of the after tax net present value in or out of the moneyness of their hedges. We subtracted that from their enterprise value to arrive at an unhedged enterprise value. Separately, we estimated EBITDA from their output at today's market prices. So we divided this unhedged EBITDA into the adjusted enterprise value to arrive at an unhedged EBITDA multiple. We apply that multiple to our unhedged EBITDA and then we subtract the after tax net present value of the hedge contracts from that value.

For the load serving business, there are no publicly traded comparables. So what we tried to do is think about businesses which provide conceptually similar services, and which have similar value drivers as the load serving business. We think specialty insurance is a good analogy. In load serving as in specialty insurance, we are absorbing risks which are not yet commoditized from a loss experience data perspective. We step in between the buyers and sellers of energy to accept and manage their risk with a profit margin adequate to provide an attractive return on the capital we put at risk. Risk management expertise, portfolio management and optimization are key success factors in this business as in the insurance business. The discipline to throttle back on growth rather than assume inappropriate levels of risk when competitors are driving deal pricing to unsustainable levels is important in our business as to good insurers. And we are a human capital and a systems intensive business.

Lastly, in choosing comparables for our risk management and investing, we concluded that many types of businesses performed portfolio management functions, but that merchant banks are more closely aligned to our portfolio management and trading operations. In the risk management and investing business, just as a merchant bank does, we provide extensive portfolio management activities to optimize the return on the portfolio. We trade proprietary positions, our infrastructure is powerful, human capital and complex systems and we actively hedge our internal risk. This grouping of businesses risk management and investing also includes the gas and coal services businesses. We have not attempted a separate valuation metric given their relatively smaller size.

Page 64 details the components of a sum of the parts valuation using the referenced comparables. If you want to look at this analysis further, you will find a list of the comparables that we used in this appendix to identify this comparable multiple range. I'll note that in the perception study, a number of you teased us that we are sandbaggers in providing earnings projections. And we truly do work to develop projections that we will meet or beat, not just consistently beat. Of course, if you do believe that our projections are conservative, that would imply the application of the low upward end of the valuation ranges.

Now I'll leave it to you to do the math and to evaluate the validity of this valuation approach. I think if you do that, you will conclude that even at the low end of the indicated valuation ranges, an investment in Constellation appears to offer significant opportunity.

On that note, I will turn the podium back over to Mayo.

Great, thanks, Follin.

So throughout the morning, you've heard me, Tom, and Follin all describe the outlook for Constellation. So let me just quickly restate the key themes.

First, our earnings will grow substantially over the next 3 years based on clear drivers, primarily the return of the mid-Atlantic fleet to profitability as below market hedges roll off, we are projecting 22% to 26% compound annual earnings growth from 2005 to 2008. Second, this management team has been a very effective steward of your capital. As you look back over the last five years, our stock prices outperformed through a variety of market conditions. We have delivered total shareholder return of 28% per annum since this management team came together in late 2001. And third, as we look to the future, we feel that we are just getting started. Today we have a solid foundation built on a well managed, high quality asset base, market-leading customer franchises, and a very strong balance sheet.

So today's starting point is far better than where we were 5 years ago. We believe the market environment is very attractive and that our team is well positioned to capture the opportunity.

And that includes our formal remarks. I'll point out that we brought our entire senior management team with us today and I will serve as moderator for any questions and all of the management team are perfectly willing to dive into this. So I know it's a long presentation with lots of information, but we're happy to clarify or answer anything you might have.

[OPERATOR INSTRUCTIONS]

See if we can get that mike turned on for you.

Can you hear me?

Yeah.

Two questions. The first would be could you provide any thoughts on the 2009 capacity market in your part of PJM? I think you gave $1.50-$3.00 kW/month per guidance for '08 and maybe at least directionally you can help us out for '09. And then the second question would be on the directional guide down on wholesale competitive supply for 2007, just what it is about the business that's changed. Is it your focus or opportunities? Maybe some granularity around that. Thanks.

Great. Just I'm going to have Tom Brooks answer the questions.

I might just refer, again, back to your second question that the outperformance in 2006 has an awful lot to do with the conservatism to the 2007 estimate on portfolio management and trading. But Tom, you want to address question one?

Sure, Mayo.

As to the value of capacity in 2008, I'd say a couple of things. One, the $50 megawatt day to that Follin cited, I would characterize that more as the range of outcomes upon which our forecast has been constructed as opposed to necessarily a forecast on our part of the potential price. And then looking forward to 2009, I would say -- I would say probably even more uncertainty as to the outcome. Uncertainty for a couple of reasons. One, the rules implementing the RPM program in PJM have not yet been fully developed. As a matter of fact the RPM settlement is subject to a rehearing in front of the FERC. And the details of the implementation of the business rules are going to be important. So frankly I don't think we have a particularly clear view of what the price of capacity will be. I would say that we see a number of factors that could exert upward pressure on capacity prices, but on this stage of the game, I think it would be too early to hazard a guess.

Turning to, turning to your question of wholesale competitive supply, which I think was kind of how do we compare our 2007 outlook to our 2006 performance. Really the key -- the key difference that I think you're highlighting is that in 2006 as Follin pointed out, we had very strong performance from our portfolio management and trading area. The -- our portfolio management trading teams really -- really performed very, very well, though I would say not flawlessly. So I don't think that this is a flash in the pan, but I also don't think we're going to forecast in 2007 continued performance.

In terms of where the performance came from, just quickly, one, a basic market theme, which was, fundamentally, declining prices of energy commodities across the year. And in that declining -- declining price environment, we performed very well in a couple of areas. Number one, dynamic management of our load portfolio. When we enter into a year, as you know, we're -- we tend to be highly hedged as to forward prices. On the other hand with the load business, there is a fair amount of variability due to customer demand, principally driven by weather but also driven by the potential for customer attrition, customers leaving standard offer service from our utility customers. So in the face of that decline in price environment we were able to very effective live dynamically manage our load portfolio and effectively reduce our cost to serve load. And then secondly, we do have a very broad portfolio including both own generation, contractually controlled generation and in a broad load business, load-serving business. This gives us very good access to information, particularly on the power side. And in 2006, we were able to leverage that knowledge advantage to do related position taking of various types that perform pretty well.

So again, good performance in 2006, not a flash in the pan. We've performed very steadily in portfolio management and trading over a period of years. So I don't exactly regard that as a one-time event, but I would say we're not going to, we don't anticipate outstanding performance to be repeated year-over-year.

[OPERATOR INSTRUCTIONS]

Just a couple of points of clarification on the mid-Atlantic fleet. When you talk about the unhedged EBITDA, does that include the benefit of the capacity price estimates that you're talking about the 50-100 in '08?

Yes, it does.

Okay. So at least to some extent you are factoring in tightening reserve margins and the increasing value of capacity into those numbers?

Yes, effectively as we have always done. We forecasted the value of the open or unhedged position at prevailing forward in late December. Not a lot of clarity, frankly in terms of forward prices of capacity in '08 and beyond. But effectively mechanically we follow the same approach.

In 2010 you showed sort of a drop off in the unhedged EBITDA from the mid-Atlantic fleet. You're down to, I think 36% hedged in capacity in 2009, is there a further offset with those capacity hedges either dropping off completely. In other words, i guess what would the 2010 capacity hedge number be, and would there be potential offset to the decline in the unhedged EBITDA?

Well, let's -- let me answer it in two parts and I'll answer the first part. As to unhedged EBITDA, effectively what we did mechanically is just forecast unhedged EBITDA at the prevailing forward prices in late December. So prevailing forward prices for '08 and beyond for energy are backward aided, so that declining unhedged EBITDA is simply a reflection of the backward aided forward curve. If you believe margins may tighten and may cause capacity and/or energy prices to go up, obviously that unhedged EBITDA shape could be differently.

In terms of the proportion of our capacity beyond --

2009 -- 2009 -- we have not decided that data.

And last question, would be on the competitive supply side with no new standard offers seeming to take place. Would it be safe to assume that all the growth in that business would have to come from expanding your market share in existing markets?

A couple of different areas. One, one certainly we compete pretty effectively. And we do expect to, we have grown our share substantially over the last few years. Reasonable to expect we may be able to continue that.

But a couple of other important areas. Number one, the base of potential retail customers that have switched to competitive suppliers is growing. And so fundamentally there's growth implicit in just, overall nationwide increase of the rate of retail switching to competitive suppliers. And then, secondly, we think that there's opportunity for us to leverage more operational efficiency across our whole load serving platform. Power, gas, wholesale, retail in the future.

I think generally just to expand a little bit on that, as we've cited before, when we got into the retail business on both the electric and gas side, the strategy was very much to get feet on the ground, get position to gain as much market share we could get to a point where we had the type of leverage that would allow us actually to manage the margins and our cost positions more aggressively because of the scales. I think the market was not particularly competitive for the number of years in which we both grew organically and added through the acquisition of several corporate entities. And we're now really very well poised to seek the operational leverage that one would expect from a company that had gone through that big growth spurt.

In looking at some of the nonenvironmental CapEx increases, largely in the commodities group, when do you expect to see the returns in the accretion from those investments?

You start to see some returns some growth in 2007 in the gas business. It's relatively modest, it's $0.07 in 2007 and then you'll see it play out in '08 and '09.

And as far as beyond '09, does any of that CapEx help drive or sustain either up side to '09 or that same type of growth beyond '09?

The -- if you step back and you look at the CapEx, you have three major pieces, you have the environmental capital spending, which we talked about, that is something, of course that is not optional. But the way that PJM, RPM is designed as various operators begin to make those capital spendings that should drive offsetting revenue benefit. The BG & E transmission and distribution spending will go into formula rates and transmission and will be reflected in rate case benefits starting in 2009. And the gas CapEx we've just spoken about. As you make the investments, you will see it play out in earnings and subsequent years.

Thank you. And then on BGE, what -- or can you tell us what ROE, or what realized ROE you're assuming in the '09, '10 percent growth rate?

I'll pull that up for you in just a second. We're assuming that we will trend towards national ROE levels. I'll pull that up for you in just a second.

Thank you.

I just had a few quick questions on the environmental spending and how it's supposed to drive capacity values. I assume that lowers, I guess capacity. That's why I'm assuming it as the reason that drives the value. Can you give us a quantitative feel as to what the new environmental spending will do in terms of reducing potential capacity is what's driving that? Or why is that increasing the value of capacity? Do you see what I'm saying?

So that the RPM program is designed to provide an incentive for new investment either to enable existing facilities to continue operating or obviously for new facilities to be built. So those two categories of investment, that's motivating those two categories of investment is the whole intent of the program. You have a demand curve, effectively simple microeconomics demand curve, that's administratively determined and part of the program. And a supply curve, which is established by supplier offer prices and supplier offers are capped. And capped at a level that's driven by a couple of factors, but one of them is incremental capital investment required to maintain reliability. So if, in fact, environmental or other reasons power plants -- not just in southeastern PJM but throughout the pool, power plants are required to invest incremental capital to stay online, they are able to increase their offer prices accordingly.

Okay and how much does the cap go up as a result of that? Is what I was wondering. What are you guys projecting in that?

And I guess to follow up on the scarcities. You mentioned that RPM may be enough to get people invest in these capacities. Doesn't look like from your CapEx projections that you're planning on building any new plants. I didn't hear anything about that. If you aren't planning on building them under the current environment, what kind of pricing environment do you see under which Constellation would build new plants? What kind of pricing would you need? You mentioned scarcity pricing, perhaps, which I guess that might mean price caps being removed, I don't know. Would you give us a little bit more of a feeling for that? What do you guys see in terms of when you guys will actually start to invest, how high prices have to go for you to do that?

We, as I mentioned some of my remarks. I think we anticipate ourselves of building new power plants in our home, particularly in our home area in southeastern PJM. When precisely will we do that? I don't, I don't want to indicate that we have a clear plan in mind. The spread between the cost of fuel and the price of power needs to go up in order to, in order to signal return on investment. But given declining reserve margins, we think it's pretty reasonable to expect that there will come a time in the not too distant future when we see the opportunity to invest capital and attractive returns.

Can you give us a general idea?

Let me also comment that I think that there are a number of exogenous factors that have to clarify themselves too. And not only within the environment of market pricing, but observing the implementation of RPM, observing the evolution of what happens with carbon. We have a multitude of issues that will clarify themselves over the course of the next two to three years, with respects of the prospects of new nuclear, dealing with the base load issue. And they're also factors specific to location and reliability in our zone that may lead us to make decisions that are prudent with respect to the overall reliability issues within the zone.

So I think -- I think directionally what we're suggesting to you is, yes, we think we're going to build new capacity, but a lot of these other factors as they play themselves out will dictate what kind of capacity and where in addition to the -- the technical question that you're asking, which is at what price would you build what?

Follin, let me ask that question that John asked, maybe a little bit of a different way. When you look at the earnings guidance for '07, the net income earnings per share range for BG & E given the rate base you're projecting, what ROE is that? Do you know that number?

Kathy, what's the book and the regulated ROE for BGE in 2007? I'll pull up in just a --

I remember --

We think it's time for a electric distribution rate case in later than 2008.

I think you were asked the question on your third quarter call on what type of ROEs you were earning in '06, and they were just between 10% and 12%, but if we start to see these types of net income decline, why would you wait for '08 to file a rate case?

Because you have to have an ROE. Ken, do you want to comment on the ROE?

This is Ken DeFontes, the CEO of BG&E.

At the end of 06, the actual ROE earned for BGE for regulator was about 10%. But it would probably be upwards of 10.9 if you adjust for weather, because we had mild weather. You'll see an ROE in '07 somewhat less than that, but you can't look for the total earnings because the offsets for the nuclear decommissioning givebacks can't be factored into that. That was outside of the regulated returns.

Sort of answering the other question earlier, we already have baked into the formula rates 10.8% return on equity for the formula rates with a potential for an additional 50 basis points up side should we get incentive rates and we'll be working to apply for that this year on the transmission side. The last gas rate case that we had we were awarded an 11% ROE based on a 48% capital structure. The returns that had been offered in most rate cases around the nation are running about 10.4. So in our projections, we're assuming something in the 10-10.5% range for a traditional case in 08.

And do you presume that the lost decommissioning revenues, which basically taken, in my opinion, in perpetuity, or are you expecting to get that back? Maybe that's a question for Mayo?

Yeah, I think, Greg, we don't know the answer to that yet. As you know, we have a stand still agreement on those issues related to the SB1 so-called takings. And I think that we -- we put that issues under the context of all legislative matters occuring in Annapolis during the course of the year.

And I think we'll use our best judgment as to, how to resolve those issues to the satisfaction of a quieter legislative and regulatory environment and to the in the best interest of the company in its own earnings prospects. So it's -- it's a balanced issue but one very much in the dialogue as we talk to people in Annapolis now.

Mayo, yesterday the chairman of the Maryland Public Service Commission who was at odds with the Democratic majority resigned, so I guess you didn't have time to update your handout to mention that, but what do you see in terms of the makeup going forward? What's your relationship with the new Governor? and what are your strategic goals for the company taking that into account over the next 2-3 years?

Well, actually there was obviously an overly subtle reference to that succession that is now in place with respect to the Commission. But I think we've been obviously, as a regulated entity, the one thing we as noisy as everything was, the one thing we did not engage in was any commentary about specific commissioners and so forth. On the other hand, we have been very encouraging to the legislative presiding officers and the Governor that we needed stability, number one, and the regulatory regime. And we also reminded them and encouraged them. And I think that they are fully supportive of the notion after a very complicated year of discussions that there's a reason that there's a PSC and that it's a very complicated subject. And although my impression from the last few weeks worth of meetings is that they're very pleased with the outcome of SB1 as complicated as the issue was to be introduced into a legislative session and a special one at that, I think at the end this is going to end up being okay from the standpoint of the evolution of how to migrate the customers in Maryland to market rates.

We had one step, we now have an opt-in plan that's coming into play that we've now filed with the PSC. I think that from the accounts that we hear and from our own discussions, we think that order will be restored by virtue of new commissioner appointments. There are now two vacancies and a retirement coming up shortly. So the Governor will have the opportunity to in effect put in a new commissioner that he thinks and that the administration thinks are up to what is a very difficult task and fully qualified. And we have a lot of confidence that he's going to do exactly that. And I think that he appreciates and I think all of Annapolis appreciates the fact that the instability that occurred last year was not just a harmful to us as a company, but to the industry and to the other industries that are regulated. And there's been pretty much of a concerted effort on the part of the, of the companies that have been, that are regulated by the PSC to seek out this stability. And our sense even from the article that was written in the Baltimore Sun this morning. They're very positive remarks being made, particularly by the legislators about how the PSC has to be constituted with people who understand and the interests of ratepayers on one side and of good business sense on the other. We're encouraged now by what we hear in the marketplace.

I guess, going back to slide 23, which is nonhedged and hedged EBITDA. You mentioned you used the curves middle of December. Could you just highlight what those prices were as going forward we kind of value the capacity, the carbon and all that? Things will be moving around, but can you just, I was looking to the appendix, I couldn't see it unless it's somewhere in the appendix. Is there some base you could give us? What those prices are based on which these things are calculated so we can follow them as the year progresses on.

Frankly off the top of my head, I cannot cite to you the prices in mid December. Since then, of course, prices fell off a bit and then came back up. The -- in terms of I guess the the specific market pricing factors to bear in mind, I think they're relatively simple. For instance, relatively long-term forward market. But I guess as the -- I'm not sure if you're asking sort of precisely what were the year-over-year prices --

Yeah -- I guess what you're saying is the best, I guess right now is just to follow the PJM prices. That would be a good --

That's right. And as I laid out, of course on 22, of course the basis between PJM west and the location of our various plants is an important issue, as well. That's different for different of the plants.

On average, do you know what that could be?

I don't off the top of my head know what average basis was built into our forecast.

And then if I can just end with one more question. This is on appendix slide 215, which is basically giving the 2007 gross margin for the mid-Atlantic fleet. I guess what I'm the price remains the same for the 34 terawatt hours, but there's a huge drop off in the expense side from '06 to '07 and oil, gas, and other 2.61 going down to 82, which is driving the margin at the mid-Atlantic fleets. I'm trying to understand if you can just elaborate.

Think about what happened in 2001. And I know you've been following the company for a number of years. So as you'll recall, in the context of deregulation in Maryland, we entered into a 6 year fixed price revenue contract. The revenues were flat and then commodity prices began to rise. We had not hedged out full prices. So not only is the relationship between power and coal improving somewhat in the last 6 years, but we had an artificial squeeze on our relationship between our power prices and our coal prices. So if you look at coal, that's very influential on the change in the gross margin per megawatt hour.

Okay.

Yes?

Could you comment on the re-regulation debate taking across some states either taking a full step back or a partial step in terms of allowing the PND to [indiscernible] generation? One, how does that impact your competitive supply business? And second, how do you see that debate playing out in Maryland?

Well, I think as I alluded to earlier that we are very confident in the policy direction of competitive markets and the sense that it is the right direction for states to head in. We're completely cognizant given where rates have headed post storms and so forth that the advantages of competitive markets, we believe, are temporarily obscured by this rate debate and particularly the fuel inputs that lead to higher pricing. But as active as that debate is, as you look state by state, I think there's a certain degree of intellectual honesty that goes into understanding that competitive markets lead to lower prices over longer periods of time.

And with 60 studies in hand that describe the fact that a lot of money has been saved in particular states and in certain ISOs, which far outweigh the sort of unsubstantive rhetoric that we've heard in the last year about how today's current rates have actually been driven by the competitive markets, which we believe is absolutely untrue. So I think that we are in for more debate about this issue for sure, particularly in Maryland. But we're actually optimistic that putting that debate into the hands of a new PSC and they've been instructed to review certain aspects of their deregulated bill; it's exactly where we would want this debate to be because we have complete confidence that in the end, when they review the review the evidence so to speak and the analysis behind what has transpired, there are many, many examples of this.

And I will anecdotally look at the nuclear industry as an example of what has happened to their capacity factor since states deregulated and my guess, Mike, is that capacity factors have moved from high 70s/low80s up into the 90s, 94%. There are plenty of examples of employees at coal plants numbering 300 who are now at 38, and how suppliers to the industry, in fact have now been driven to supply equipment at much lower costs and not in gold plated fashion in order to drive costs of production down. There are thousands of these many examples to justify why competition is good for this industry. And I suspect that that debate will continue over the course of the year, as evidence develops, but that good reason will prevail here. And it may seem like we are "stuck in the middle" at the moment, but there are, certainly from our standpoint, as we operate in 22 competitive states, in several cases we continue to see the migration to more open free choice markets.

We think we're very well-poised, as the leading provider there, to continue to take advantage of that, and obviously to help shape that debate, which I think we're very much involved in.

And on the competitive supply business, the unit margins have fluctuated widely in the last two years, what's your assumption embedded in the 07 guidance for unit margins for wholesale as well as retail?

Retail is a realized margin of 376 in 2007 and 356 in 2008, and that's trending down from margins of 450 in 2006. As you'll recall, we've been saying that 350 feels like a sustainable margin, and 2006 was a very favorable environment. Wholesale, we continue to operate in the $2.00-$4.00 per megawatt hour range.

4 to 450 in 06, how much is ex-Texas?

I'm sorry?

How much is that excluding taxes in the 450 for 06 in retail?

Margins excluding Texas, I don't know what it is excluding Texas.

[Off microphone] Texas was not a drag on 2006 as it was on 2005, so it would not have been that significantly different from the total, but we can try to calculate something. Thank you.

So that's -- one more question, or is that it? Great. Well, I want to thank everyone for sticking with what is our annual event and loaded full of information, but we thank you for your patience and your interest this morning. I'll see you at the end of the next quarter. Thanks.