艾索倫電力 (EXC) 2007 Q2 法說會逐字稿

Good morning, and welcome to Constellation Energy's second quarter 2007 earnings call. At this time, all participants are in a listen-only mode. (OPERATOR INSTRUCTIONS) Today's conference is being recorded. If you have any objections, you may disconnect at this time.

I will now turn the meeting over to Vice President of Investor Relations for Constellation Energy, Mr. Kevin Hadlock. Sir, you may begin.

Good morning, everyone. I'm Kevin Hadlock, Vice President of Investor Relations for Constellation Energy. Welcome to our second quarter 2007 earnings call. Thank you for joining us today. 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 would like to turn the time over to Mayo Shattuck, Chairman, President and CEO of Constellation Energy.

Thank you, Kevin. Good morning, everyone, and thank you for joining us today. Our reported earnings were in line with our expectations, and our underlying fundamental performance was even stronger. We recorded adjusted earnings of $0.64 per share, in line with our guidance range of $0.55 to $0.75 per share, and $0.19 above the second quarter of 2006. Earnings include a loss of $0.14 per share due to the timing impact of qualifying hedges that were required to be mark to market in the quarter. These hedge losses are expected to reverse in future periods, with a significant portion reversing during the balance of 2007. Adding back the timing impact of the mark to market losses associated with the hedges, our second quarter results would have exceeded the upper end of our guidance range, reflecting continued strong performance from our Merchant business.

Turning to slide five. I want to take this opportunity today to talk about Constellation's perspective regarding climate change and evolving environmental policy. It is increasingly clear that most of the significant business decisions we face, and many of the greatest opportunities we see in the future, are affected by the probability of greenhouse gas controls. We are taking an active stance in the policy debates occuring at the state, federal, and international levels. We believe it is imperative to slow, stop, then reverse the growth of greenhouse gas emissions. We support mandatory economy-wide controls and a cap on carbon emissions that would create a global market for carbon trading. Today, we have a relatively advantageous carbon footprint. We own about 8, 700 megawatts of generation capacity, with more than 60% of the output coming from nuclear and hydro. As the price for carbon begins to be reflected in the market through voluntary compliance or a cap and trade program, we will be well-positioned.

With the expanded focus on environmental stewardship, we see substantial opportunities to assist our large customer base in achieving their sustainability objectives. Many of our customers are seeking products to manage their carbon exposure or to meet other renewable energy objectives. While still in its formative stage, we are providing products to our customers to help them meaningfully reduce their demand and tap into green energy products. The fact that we have a wide array of businesses and assets, high quality low emitting generation plants, industry-leading customer-focussed competitive supply businesses and a regulated utility, provides a strong platform for Constellation Energy to offer an expansive set of environmentally friendly energy products to our customers. While we are excited by these customer opportunities, perhaps the most significant contribution Constellation can make would be to deploy the first standardized fleet of new nuclear power plants in almost three decades. We took a significant step towards this objective last week with the announcement of the strategic joint venture with EDF, which I'll talk about in a few minutes.

Turning to slide six. Today our businesses are environmentally sensitive and we are proactively moving to improve our position. We are proud to have one of the the lowest emitting generation fleets, with more than 60% of our megawatt hours coming from ultra-low emitting nuclear and hydro sources. In the second quarter, we announced the start of construction on the Brandon Shores scrubber, that will substantially reduce SO2 and mercury emissions from the plant. Looking to the future, our generation fleet is strategically positioned in location and fuel type to benefit from the changing environment. Our customer focused businesses are actively engaged on the demand side. Our retail businesses are seeing increasing demand for sustainability products, and we are modifying our product offerings to meet these needs. At the Commodities Group, we are active in emissions trading in CO2, SO2, and NOx, and in providing emissions products to our customers, including emissions credits and low emissions coal. We are contracting with renewable energy providers to secure renewable energy credits to supply our customers. Earlier this week, we announced the signing of an 18-year renewable energy power purchase agreement for about 200 megawatts with a wind project to be constructed in Illinois. This project should help Illinois meet its recently announced wind energy goals, and provides us with an attractive long-term green commodity resource.

At Constellation Energy Projects and Services, we operate several large renewable energy projects and are developing more than 20 additional projects, including solar, geothermal, biomass, and wind resources. At BGE, we are fast-tracking a Smart Energy Savers program to provide our customers with the tools and incentives to better understand their energy usage through advanced metering and conservation programs, and to reduce demand in times of peak load. By leveraging our large customer base and understanding their requirements, we expect to capitalize on the evolution of the market.

Moving to slide seven. This chart quantifies some of the sustainable energy metrics we follow. We believe demand response is more than just a reliability product, because it reduces energy consumption and the associated greenhouse gas emissions. Wei estimate we will serve over 700 megawatts of demand response during 2007, an increase of 68% over 2006. In 2007, we expect to deliver more than 3.8 million renewable energy credits to wholesale and retail customers, and we see significant potential growth due to new programs in states like Illinois, as well as increasing interest in voluntary offsets in other states. We believe this is just the beginning, and expect our role of providing sustainable energy solutions to customers will increase significantly in the coming years.

Turning to slide eight. We are increasingly excited about the potential customer opportunity presented by the move to a sustainable energy marketplace. However, we believe the most significant contribution we can make is to pursue the option to deploy a fleet of new nuclear plants in the United States. We recognized years ago that Constellation had an opportunity to assume a leadership position in new nuclear technology. As many of you are aware, last week we announced a 50/50 joint venture that we are forming with EDF, the world's largest nuclear plant operator, solidifying our leadership position. The new company, UniStar Nuclear Energy, will focus on the potential development and deployment of the first fleet of new nuclear power plants in the United States and Canada in nearly three decades.

Initially, EDF with invest $350 million in UniStar Nuclear Energy and Constellation will contribute the UniStar line of businesses we have developed over the past two years. Upon reaching certain milestones, EDF will contribute up to an additional $275 million. In connection with this strategic alliance, EDF may purchase up to 9.9% of Constellation's outstanding common stock in the open market during the next five years, with a limit of 5% ownership during the first 12 months of the agreement. Our partnership with EDF is a big step in furthering Constellation's ability to drive a potential nuclear renaissance in North America, a goal we have been working towards with Areva. Adding EDF's knowledge and capabilities to the business model will solidify UniStar Nuclear Energy's position as the leading new nuclear development team in the U.S. Lastly, this relationship manages and reduces Constellation Energy's financial risks associated with licensing and developing new nuclear plants.

Turning to slide nine. Before I turn the call over to John, let me summarize the investment thesis in Constellation Energy. First, we see clear and substantial earnings growth in the coming years. We are reaffirming guidance for 2008 of $5.25 to $5.75 per share, representing 21% to 26% compound annual earnings growth from 2006 through 2008. We are forecasting 2009 earnings growth of more than 10% over projected 2008 earnings. Second, we believe this market environment is very attractive, and our team is well-positioned to capture the opportunities presented by the market. Constellation's management team has delivered superior results over the past five years. We have predictably and consistently delivered on earnings guidance through a variety of market conditions. Our disciplined focus on managing through the full commodity cycle has allowed us to perform well in both up and down commodity price environments and has held the Company in good stead.

Third, as we look to the future, we feel like we are just getting started. Today we have a solid foundation built upon a well-managed high-quality asset base. Our focus on customers and market-leading position in power, and our strong position in gas and coal markets continue to give us an information edge and scale advantage over our competitors. Our industry-leading risk management capabilities and our disciplined investment approach help us to make sound investments and optimize their value. Finally, our strong balance sheet provides us the financial flexibility to act quickly to capture opportunities.

Before I hand off to John Collins, I want to note that John has been participating in these earnings calls with me for six years, but he's now being handed the microphone as our CFO for the first time. For the past six years, John has been our Chief Risk Officer, and previously he was the Principal Financial Officer for our Commodities Group. We're very proud of the risk management systems which John has been instrumental in constructing, and equally proud of the finance organization which Follin Smith built, and which John inherits. One of the hallmarks of this Company is its disciplined approach to the allocation and management of its capital base, and we are pleased to have someone of John's caliber to continue that commitment. So with that, John, I'll hand it over to you.

Thank you, Mayo, and good morning, everyone. Let's begin on slide 11. We had a strong second quarter, marked by continued earnings growth in the Merchant business. The generation fleet performed well, as we continue to transition to current market prices. During the quarter, most of BGE's residential electric customers in Maryland transitioned to market rates. Earlier this year, the Maryland Public Service Commission approved an opt-in plan for customers to defer the transition to full market rates until January 1, 2008. Only 4% of BGE's residential electric customers opted into this plan, while the remaining 96% moved to full market rates on June 1st. This is consistent with the results of other Maryland utilities that have transitioned to market prices, and whose rates are comparable to BGE's residential customers rates.

In addition, we completed the securitization for the initial rate stabilization plan, approved by the PSC last year. We issued $623 million in rate stabilization bonds that are supported by a non-bypassable charge on customers' bills over a ten-year period. We're also moving forward with the planned environmental upgrades on our coal-fired power plants. In connection with these projects, we expect to spend approximately $1.1 billion through 2010, consistent with previous estimates. Last month, we began construction on the Brandon Shores scrubber project. This project illustrates our continued commitment to invest in the latest clean air technology, and significantly reduces our SO2 and mercury emissions.

Turning to slide 12. For the second quarter, our adjusted earnings were $0.64 per share, including the earnings timing issued relating to qualifying hedges we were required to mark to market in the quarter. This is in the middle of our guidance range of $0.55 to $0.75 per share. GAAP earnings per share was $0.64. Let me walk you through the adjustments to GAAP in the second quarter of 2007. We had $0.08 related to special items. Included in this amount was a $0.07 charge related to a wind investment in western Maryland that we acquired from FPL in connection with the merger termination. We decided not to pursue this project as an equity investor. We also had a $0.01 special item related to the workforce reduction at Nine Mile Point. We had a $0.01 gain on economic nonqualifying hedges associated with gas transport, which we subtract from GAAP EPS. Lastly, synfuel earnings per share was $0.07 in the quarter. As you'll recall, we call out synfuel earnings separately, since the synfuel tax credit program expires at the end of this year, and the fact that synfuel earnings vary with oil prices. Overall, adjusted earnings per share were up $0.19 year-over-year. The Merchant was up $0.24 more, utility was down $0.03, and other nonregulated was down $0.02.

Turning to slide 13. BGE earned $0.08 of adjusted EPS in the quarter, down $0.03 per share from the second quarter of 2006, driven by the loss of nuclear decommissioning revenues due to Senate Bill 1 and other inflationary costs, partially offset by higher electric volumes due to customer growth, and a return to more normal weather after a mild second quarter in 2006.

Moving to slide 14. The Merchant segment's adjusted earnings were $0.56 per share compared to our guidance range of $0.50 to $0.70 per share. Compared to the second quarter of last year, the Merchant segment was up $0.24 per share. The generation fleet drove an increase of $0.31 per share, as it continues to transition to current market prices. Wholesale competitive supply increased $0.13 per share due to higher backlog realization. Net interest expense was down $0.11 per share due to lower net debt following the sale of our gas-fired generation plants in December 2006. Second quarter results include $0.18 per share of losses associated with qualifying hedges that were required to be mark to market, of which approximately $0.14 is pure timing. These hedge losses are expected to reverse in future periods, with a significant portion reversing in the second half of 2007. Adding back the timing impact of these losses, the Merchant segment would have exceeded the top end of the guidance range. In addition, retail competitive supply results declined $0.05 per share, in part due to mark to market losses on economic hedges of accrual positions. The $0.05 loss of competitive transition charge collections in Maryland, and $0.03 of other costs also created a negative year-over-year variance.

Turning to slide 15. In Wholesale Competitive Supply, we completed the acquisition of the Progress Ventures portfolio and received cash proceeds of $346 million. In the transaction, the Commodities group assumed full requirements contracts to serve electric cooperatives in Georgia and assumed tolling contracts that support the load. The transaction represents an opportunity for us to grow the Wholesale Competitive business in the Southeast, where we have had good initial success to date and where we see additional opportunities. We also continued to execute on our natural gas strategy. Year-to-date, the Commodities group has acquired 103 billion cubic feet equivalent approved reserves for $212 million, and Constellation Energy Partners, where we have an equity ownership of about 30%, has acquired 136 billion cubic feet equivalent approved reserves for $355 million. We continue to look for opportunities to harvest and deploy capital in upstream gas at attractive returns.

As we've told you previously, our objective is to build a portfolio of strategically connected gas-producing assets that leverage our risk management and valuation capabilities. Our focus is on properties primarily in early-stage development, where we can develop the assets for future opportunities to harvest the properties and redeploy the capital. As we move forward, we will continue to pursue attractive economic opportunities in our upstream gas business. At the same time, we will look for opportunities to realize returns from the portfolio by monetizing investments after enhancing their value, including pursuing possible opportunities with CEP, as properties mature and have a production profile more suitable for an MLP.

Moving to slide 16. As you see in the column on the left, Wholesale Competitive Supply booked a contribution margin of $206 million, including realization of $120 million of backlog and $86 million of new business in the quarter. Backlog realization in the second quarter was up $48 million versus the same period last year, an increase of 67%. New business in the second quarter was $88 million lower versus last year's second quarter, driven primarily by a decrease in portfolio management and trading of $98 million. As you'll recall from our last earnings call, we mentioned that portfolio management and trading results were exceptionally strong in 2006, and that we were not forecasting to repeat that same level of high performance in 2007.

Moving to slide 17. This chart gives you the full picture of Wholesale Competitive Supply performance, because it shows the earnings added to the backlog during the quarter. We add backlog when we originate new transactions or restructure existing ones. We also reflect the value of actions taken to increase the future value of coal and downstream gas transactions in our portfolio. Of the total originated line in the center of the chart, you see that the Commodities group originated new business gross margin of $308 million in the second quarter, compared to $309 million for the same period last year. Looking at the components, we originated $122 million of business to be realized this year versus $196 million in last year's second quarter. We also originated $186 million to be realized in future years versus $113 million in the second quarter last year. For the first half of 2007, we have originated new business gross margin of $798 million compared to $707 million for the first half of last year. As highlighted in this chart, Wholesale Competitive Supply is having a strong year, with 49% of our current year plan and 78% of our total year origination plan achieved through the end of June.

Moving to slide 18. This chart provides an update of the backlog we've created this year in our Wholesale Competitive Supply portfolio. These accrual earnings provide significant visibility into future periods' earnings. On an ongoing basis, we actually manage risks, such as basis risk between regions, customers' variable usage risk, supply risk, and counterparty performance risk. Of the $567 million of future contribution margin originated in the first half of 2007, we have added $134 million to the 2008 backlog and $114 million to the 2009 backlog. Wholesale Competitive Supply continues to perform well, and the future year backlog provides a highly visible stream of future earnings already originated as a solid base from which to build.

Turning to slide 19. In the second quarter, NewEnergy Electric delivered over 18 million megawatt hours, which was up about 7% compared to last year. For the second quarter of 2007, NewEnergy benefited from lower cost to serve load, resulting in realized gross margin of $5.42 per megawatt hour. Based on year-to-date performance, we expect unit margins to average about $4.50 per megawatt hour this year. Longer term, we still expect margins to trend towards the $3.50 per megawatt hour range. Retention rates were 64% in the second quarter of 2007, consistent with the 65% experienced in the second quarter of last year. On the gas side, NewEnergy Gas delivered about 82 billion cubic feet in the second quarter, which is about flat compared to the second quarter last year. NewEnergy Gas also completed the Cornerstone acquisition for approximately $100 million. This acquisition will add over 100 BCF annually and has further expanded NewEnergy's geographic footprint.

Moving to slide 20. In NewEnergy backlog, we have 70 million megawatt hours either delivered or contracted for 2007, which accounts for about 85% of the full year target, and is in line with the pace set last year. We also added to future backlog. We currently have 37 million megawatt hours contracted for 2008, providing a solid foundation for next year, which represents 39% of our 2008 planned volumes in comparison to 34% last year for 2007 volumes.

Turning to slide 21. Free cash flow for the quarter was a positive $102 million. Capital spending is tracking slightly below planned for the year. Working capital was a use of $113 million, as we posted approximately $50 million more cash collateral than at the end of the first quarter. The $346 million of cash received from the Progress portfolio is in the contract restructuring line, and is offset by the amortization of other contract restructurings we have completed in the past. We also funded the last of Senate Bill 1 rate deferrals at BGE of $90 million. We continue to purchase shares in the open market to satisfy employee benefit obligations, rather than issue new shares, resulting in a use of $20 million for the quarter.

Turning to slide 22. In our first quarter presentation, we provided you with our capacity hedge positions for our total New York and PJM portfolios. As with energy, we have sold capacity to load-serving customers and bought capacity from numerous generators over the last several years. Together with our own generation capacity, we have a large portfolio of capacity positions throughout New York and PJM. Given competitive dynamics, we do not provide the details of our positions in each location. In mid July, PJM released the 2008-2009 planning year auction results. Compared to the price levels we saw in April for the '07, '08 planning year, clearing prices increased for Rest of Pool and Southwest MAAC, and decreased for Eastern MAAC. As of the end of June, our hedge ratios on our total capacity position in New York and PJM were 87% in 2008, and 42% in 2009.

These recent capacity auction results suggest that scarcity pricing signals are beginning to be reflected in the energy market, which should help encourage the build of new generation capacity. The combination of higher energy and capacity prices is creating potential investment opportunities for Constellation. We are responding to these price signals in several ways, many of which we would not consider in the absence of the RPM framework and related positive price signals. We are evaluating the potential to reopen 175 megawatts of retired generation assets in Maryland. In addition, we continue to make steady progress at our feasibility study for building new gas-fired generation capacity at existing sites, although we've not yet committed to build.

Turning to slide 23. Let me turn to our third quarter guidance. We expect third quarter earnings to be $1.35 to $1.55 per share, compared to adjusted earnings per share of $1.46 in the third quarter of last year. In the Merchant, we are projecting earnings per share of $1.25 to $1.45, versus $1.24 per share adjusted earnings in the third quarter last year, driven primarily by improved earnings in the generation fleet as we continue to transition to current market prices, higher Wholesale Competitive Supply backlog realization, and lower interest expense. These positives will be offset by the absence of revenue from the gas plants that were sold in 2006 and higher costs to support growth. We expect BGE to earn $0.08 to $0.12 per share in the third quarter, down from the $0.20 of adjusted earnings per share earned in the third quarter last year, due to the loss of revenue as a result of Senate Bill 1 residential electric credit for nuclear decommissioning revenue, and the loss of residential polar return and other inflationary costs.

Now let me wrap up on slide 24. I will wrap up with our 2007 to 2009 outlook. Given the favorable fundamental outlook of the energy markets, with strong global demand, continued strong power and fuel prices, and tightening reserve margins in many markets, we have increased confidence in our long-term outlook. We are reaffirming our 2007 guidance of $4.30 to $4.65 per share, and we have a higher level of confidence in 2008 that moves us to the mid to high-end, or a $5.25 to $5.75 per share guidance range. Looking out further to 2009, we expect earnings growth of more than 10% over 2008. Beyond 2009, we believe the underlying fundamentals in the energy markets have positive implications for longer term growth. That concludes our prepared remarks. We'll now turn the call over to the operator for questions.

(OPERATOR INSTRUCTIONS) John Kiani, Deutsche Bank.

John, actually your comments at the very end of your script and also in the press release, it looks like the language there and in the presentation for 2009 earnings growth, expectations changed from approximately 10% that you were using in the past, to more than 10% of earnings growth, which you're using today. And as you mentioned, it sounds like you have increased confidence in the longer term earnings growth profile of the Company. Can you give us some color around what those better earnings drivers are, and what we might be able to see in '09?

Well, obviously we have not gone through the whole planning cycle yet. So we can't give you any specific -- point to any specific portion. But the confidence is really being driven by our outlook of the marketplace, both the energy prices that we see going out the curve, and the fundamentals that we think will continue to support those energy prices, as well as the increased capacity prices that we've seen in the auctions cleared so far. Especially with the '08-'09 auction that just cleared, and the price signals it sent. So those are really the two drivers. I would add that we also think that given the competitive supply platform that we have on both the wholesale and retail side of the business, we continue to see very positive outlook for that side of the business, as well.

That's helpful. And then also I notice that in '09 your capacity hedge percentage decreased from 52% last time to 42% this time. Can you talk about that a little bit?

John, this is George. Obviously, we have positions that are outside of just our asset fleet. So we have physical assets in Maryland, physical assets in New York. We also have a portfolio of contractual supply and delivery commitments for that capacity. And based on transactions that took place in the quarter or changes that we see in the market, you should not always expect our hedge positions to go up quarter-to-quarter.

That's helpful. And just one last question, maybe for Mayo. Can you talk a little bit about the customer rate credits that the BGE customers are getting and compare those to what we saw in the Illinois settlement earlier this week?

Well, I think maybe you could argue that the Maryland customer got a better deal than the Illinois customer on average. Obviously, there are a lot more aspects to the settlement in Illinois. And I'd point out that it was a settlement, as opposed to a piece of legislation, which is what we had here in Maryland that dictated the $386 million that have gone -- or is in the process of going back to our customers here. But net net, I would say that financially, probably the Maryland customer got a better deal. On the other hand, we had, I think, a reasonable settlement, or I should say a reasonable outcome with respect to the legislation. It is leading to a number of other conversations taking place and examinations of the competitive market here that have potentially other ramifications, which we've talked about a bit in the past, and that's probably going to unfold over the next year or two. We have to stay tuned on that front.

Okay. That's helpful. So it sounds like it's safe to say that in your view, if you look at it maybe on like a dollar per customer basis or something like that, the BGE customers actually made out pretty well.

Yes.

Thanks.

Dan Eggers, Credit Suisse.

Looking at the EDF transaction, can you just give a little history on how that came about? And then what kind of numbers we should be thinking about you guys not having to spend from a CapEx or from an operating expense perspective over the next couple of years, given their commitments to do some of that cash funding?

Sure. We have Mike Wallace on the line. He's not here physically, but I might ask Mike to start off on that.

Sure. Right after we announced the formation of UniStar with Areva in September '05, we began very early discussions with EDF. And they are individuals and a company that many of us have worked with for almost 20 years as nuclear operators around the globe collaborate. Those discussions moved to the point where in July of '06, we entered into a memorandum of understanding of about how we could benefit from use of their technical experience. That evolved until in February, we signed a technology assistance agreement. And then with that formalizing how we would exchange technical information, we then were approached by EDF for their interest in pursuing an even broader engagement with us in March of this year. And the discussions then took place from March until the point where we announced the deal yesterday, or rather last week. And fundamentally what that does for Constellation Energy with the cash infusion to the joint venture by EDF, until such time as those funds are expended in deploying the joint venture business plan, Constellation Energy will not have a need for any other capital infusion. And so we project that that will take care of Constellation's capital through the rest of '07 and '08. And it will be sometime in '09 before we're in a position to once again be putting capital into new nuclear activity.

How much money have you set aside or were you expecting to spend for '07, '08, and into '09? I guess just how much more cash does Constellation have because of this?

Well, the way we've been pursuing our new nuclear activity is in a very disciplined risk managed approach. And so we looked forward on select items of activity that would go out associated with licensing to the end of the licensing period, which was 2010. And that funding was rather minimal. We were then very clear on what the funding requirements would be through '07. And our plan as it had been every year, was to address at the end of this year in December with our Board what the cash requirements might need to be going forward. And as our plans have unfolded, we don't have a need for a cash requirement of a significant amount outside of '07. And what we had funded '08 through '10 was rather minimal.

If I could just add a couple things. Just so -- as Mike said, we have been managing the process with the new nuclear development activities in a very risk managed approach. And so we were always looking at offramps and decision points along the process before we would invest large amounts of new capital. So when you take a look at our five-year plan today, what we have out there, our plan beyond '07 had really nothing in there for CapEx or earnings related to the new nuclear UniStar development activities. So as we adjust our plans going forward, and we go through our '08 planning cycle, we will be getting more firm numbers around this as we work with EDF to develop the whole UniStar business plan model going forward.

Okay. You guys made note of your Demand Response business, which is something you haven't spoken much about, and given the fact there are some market participants who have gotten a lot of attention for a similar business model, can you give just a quick overview of what that business is, and kind of the trajectory of growth you see as we look forward?

I'd say that both our Demand Response efforts and really our overall green product marketing efforts are on the one hand at very, very early stages. On the other hand, we see very significant potential going forward. So what are we doing right now? Providing load response capability to certain of our commercial industrial retail customers, as well as at BGE to a block of BGE customers. And you there is -- you see the statistics in the presentation in terms of how much load response we're providing today. In terms of the outlook, we think it's very strong. So we've put a significant increased focus on these activities in the last year, and we expect to continue that. And I think the one key thing that we'd highlight in terms of our business model, is given the very broad base of customers that we serve, as demand response programs and technologies develop, and as demand for green products develop, we think we're very well-positioned to provide these sorts of solutions to our customer base.

Ken DeFontes might also comment from BGE side.

Yes, we announced our Smart Energy Savers program in January, and we're out now testing some new Smart thermostats and new two-way switches for air-conditioning. We believe we can triple in the next say, five or six years, the amount of demand response just from that alone, from about 200 megawatts to about 600 megawatts. And we also believe there's more Demand Response capability that will come as a result of competitive peak pricing that would be a part of our advance metering infrastructure.

Got it. Thank you.

Michael Goldenberg, Luminous Management.

Good quarter. Had a couple of questions. I guess, first of all I was wondering if you could update us on your open EBITDA position given the higher than expected capacity prices that we've seen in the PJM region, and I guess for some movement in gas, as well.

Michael, John Collins. We are not prepared at this time to update our open EBITDA position. So it's something that we will look at as we go through our planning process, and likely update you all on the January presentation at that time.

Well, maybe you can talk about the -- in your original numbers, what was the expected PJM -- I'm sorry RPM capacity pricing?

Well, when we did our plan last year, the '07 plan, the five-year plan, we were assuming RPM capacity prices of $50 to $100 per megawatt day.

That's true for all the years, right? 2007 through '11?

Yes.

Okay. Got it. Thank you very much.

Michael, let me just clarify. We didn't talk about it past '08, but for '07 and '08, we had $50 to $100 per megawatt day.

Understood. Thank you.

[Josh Levin], Citigroup.

John, you said you were considering unretiring 175 megawatts of generation. What kind of generation is that?

I'll ask Tom Brooks to answer the question.

Sure. Just to answer the question slightly more broadly, I'd say we're actively engaged in development efforts for new generation capacity in several ways, several types that are short, medium, and long-term. In terms of the factors that will drive our ultimate investment decisions, of course, to put it very simply, of course you have the costs to construct and construction costs have increased, of course, for any type of infrastructure asset very significantly over the last several years. For instance, the construction costs for new combined cycle power plants has arguably more than doubled over the last five years. So cost to construct obviously a significant factor. And then market conditions. In terms of new gas fire generation capacity in most locations today, energy prices alone are not sufficient to justify adequate returns on new capital. But new capacity pricing approaches in several regions look like they have the potential to get one close to a remunerative return on investment. So on the basis of these new capacity signals, we're actively engaged in several ways. In terms of the sort of the short-term opportunities that you referred to, we see capacity expansion potential at a number of our existing facilities. In the Mid-Atlantic region, these are principally gas-fired generation opportunities that we're evaluating. They're attractive because given the high construction costs, these appear to be new capacity opportunities that would yield moderate amounts of new capacity at relatively attractive prices.

On an intermediate term basis, we're also focussed on new development, development of new facilities at some of our existing sites in the Mid-Atlantic region. We recently applied to the PJM for transmission interconnection study for such a facility. And the real attractiveness there from our point of view, is speed. We feel like we can move quickly at some of our existing sites, if and when market conditions would indicate attractive returns. And then finally as Mayo and Mike Wallace have talked about, on a longer term basis, we're of course actively involved in new nuclear development, as well. So I think we're actively engaged in a variety of types of new generation capacity. And stating the obvious, sort of the combination of our view on construction costs and market conditions will dictate for each type when we see the appropriate time to invest.

Okay. On a separate note, the Maryland PSC is currently looking at the structure for power markets and thinking about the future of those power markets. Can you give us a sense of what to expect over the next few months in regards to a time line or milestones?

I'm going to have Tom Brady talk about that.

Yes. There's a lot of activity going on in Maryland right now, including today, but over last three days there has been a -- currently a planning conference by the Public Service Commission that's largely looking at demand growth and conservation demand response initiatives, as well as new generation. There was an energy summit that I would say, the broader focus on that was really looking at conservation-type measures. And up to this point, everything that has went on there has been quite constructive. Probably the larger activity centers around Senate Bill 400, which if you recall was passed this year in the General Assembly. And it, in fact, was an amendment to Senate Bill 1 that was passed in the prior year. Senate Bill 1 passed in 2006, required certain studies to be performed by the Public Service Commission. And in 2007, Senate Bill 400 extended the timeframe. And the Public Service Commission has issued a request for proposal to consultants. And they're largely going to look at the restructuring status. They obviously are going to look at utility ownership of plants, probably specifically peakers. They'll look into the implementation of the 1999 restructuring law and several follow-up issues related to Case 99, which was the case decided in May that took the Baltimore Gas and Electric customers to market rates. And items that seem to fall out of that would be structuring of the wholesale markets to make sure there's a better understanding of how it's done, as well as some transmission and generation issues. Overall, we expect that process to take place during November.

And under Senate Bill 400, the Public Service Commission needs to have an interim report by December 2007, and a final report by December 2008. And I would say that the way to distinguish between the two of them are get as much of this completed by the end of this year to report to the General Assembly, with the balance to be reported the following year. And I guess the one other thing that has emerged, is during the decision where the BGE customers went to market rates in May, there were some questions being raised about the affiliate relationships. And there are, as I think you're aware, some pretty strong code of conduct and affiliate rules that we have within the Company. But the Public Service Commission has decided they really would like to take a look at that relationship. And although they have not set a date, the Governor has encouraged them to look at this in the month of September 2007.

Okay. Thanks, guys.

Steve Fleishman, Catapult Partners.

My questions have been answered. Thank you.

Gregg Orrill, Lehman Brothers.

Is it possible to provide a sensitivity to -- an earnings sensitivity to where your unhedged position was on '09 capacity back at June 30th?

We're not prepared to do that at this time. What we've tried to give you was the percent of hedges that we have out there. And we try to give you a little bit of the building blocks, but we're not prepared to give you a sensitivity at this point in time.

Okay. Also, Mayo, the Governor of Maryland has been fairly outspoken about the topic of separating BG&E from the rest of the Company. What have you heard from other constituents in Maryland?

Well, I think given the political firestorm of last year, I think it's reasonable to have expected that they're going to turn over every rock. And I think that is really what's going on right now. I think the rhetoric around, particularly the affiliate rule issue, is there something between parent and subsidiary that needs to be examined, is probably a pretty reasonable one given everything that's happened. We have complete confidence in our procedures and compliance with the affiliate rules. So it's not -- to that extent, we welcome the examination if there's some lack of understanding of those affiliate rules. Let's make them as transparent as possible.

I think that secondarily there's the anxiety that's going on in every state as to whether the outcome of all of these processes that we're in, auctions, et cetera, lead to what people refer to as a just and reasonable rate, or just and reasonable outcome on rates. As you saw in the Illinois case, that issue was more or less resolved through the settlement. It has, however in the last 48 hours been brought up as a question mark about the PJM marketplace. Obviously, given our long standing advocacy of the competitive markets and PJM's reputation as the premiere wholesale market in the country, if the not the world, I highly doubt whether the FERC is going to come to any conclusion other than the position they've had for many, many years about the development of these markets. And as I think everyone on this call knows, the rates in Maryland are pretty much equivalent to the rates all the way up the coast and in many states. So with respect to Maryland's specific inquiry into that issue, I can't imagine an outcome where the FERC processes and the way in which the competitive markets work lead to anything that is particularly dramatic.

We do expect tinkering with the -- of some fashion like we saw in SB1, with respect to the construction of the way the market works in Maryland. Probably the most notable in SB1 was the suggestion that perhaps BGE should build a plant or should perhaps procure in a somewhat different way, a blended way, a portfolio approach, whatever. That's really what is on the table now. And I think that there may well be -- if you took as an example the issue as to whether BGE should build a peaker or not, I think it actually is probably reasonable for people to ask the question whether Constellation would be motivated one way or the other to build a peaker at BGE or at the parent. And it's those types of questions that I think lead the Governor's inquiry and the others to ask, let's make sure we understand what the motivations are. And you could see how we might assume that some further separation of the parent from the subsidiary might be put on the table in that respect, if they felt the motivations weren't consistent with providing the lowest possible cost to Maryland rate payers.

We happen to think, we've been advocates for many, many years on this, that the competitive markets work. That despite what's happened since Katrina with the escalation of rates, people understand the fundamental reasons for that. But also in Maryland, we always have to keep in mind that we're coming off a six-year rate freeze, just at that time, which creates the drama around the change. So I think there's a lot to discuss. I think so far it's been pretty constructive. Yes, I would say that some people have a hypothesis about this issue with respect to the parent and its subsidiary. But we're just going to have to let it play itself out and participate in that debate with as much information as we can provide. But you will -- you should expect us to continue to be very strong advocates for the way in which competitive markets work. And we believe the PJM has about the best construction in the world.

Thanks.

Shalini Mahajan, UBS.

Following up on the last question, Mayo, what are your current thoughts on separation of BG&E? Do you think the timing is right for Constellation to pursue that? Would you rather wait for the outcome of the PSC study?

Consistent with my last remark, I think we have to wait to see how these studies come out. BGE is a very valued component of our Company. It's got a great history, it's got tremendous employees. We feel at every level of this Company the collective responsibility towards Maryland customers. So it's certainly not an examination that we would take lightly. And I think that the hearings and the examination by the PSC that will be going on in the course of the next six to 12 months will help all constituencies understand potentially what the optimal outcome would be. And so, I don't really want to prejudge that process. It's not our top of mind concern right now. I think that we obviously have an appreciation for the fact that BGE looks to some as credit dilutive to the parent at the moment. I don't for a minute think that that's going to last that long, shouldn't last that long. We have now transitioned to market rates. But keeping in mind that that's been something like 26 days now, as people have transitioned to market rates, you can imagine that the public debate around rates is pretty intense. And I think we need to have this play itself out. Sooner or later, people will realize that the BGE customers are now paying actually even a little bit less than the rest of the Maryland customers, and a little bit less than many of our surrounding states. So I just think it's the change that's obviously raised the intensity of that debate right now.

And Mayo, could you also comment on your current views on M&A in the space? We've seen political risk elevated, we saw what happened in Illinois, we've seen the Northwestern deal fall apart. So would love to get your thoughts on that.

Well, as you can probably appreciate, M&A is not top of my mind right at the moment. I think that the environment is very tough for M&A activity. We are seeing transactions getting done. As you can imagine, in our case, it was a single state transaction. You can imagine how complex multiple state transactions are. You're asking for an awful lot to go through these processes in this kind of environment. So I think that it will probably remain a little bit stagnant for the time being until -- particularly until many of these states that are still going through their restructuring and deregulatory processes, we still have Pennsylvania, to sort of go through its complete evolution. I think that you'll see a calm in the markets for a while. Obviously, the other issues that are going on in the debt markets right now probably also will tend to retard any aggressive activities in that respect. Although I do think it's probably to our advantage that the markets are sort of coming back to some realm of normalcy. So strategic players in this marketplace, which many have felt have lost some of their position relative to the financial buyers, that's probably going to fix itself here pretty soon. So, but the big M&A stuff, my guess is maybe we should wait a year or two before you see a lot of activity there again.

Thanks, Mayo. And separately on page 17, the origination in the Wholesale Competitive Supply, you guys have done 49% in first half of this year, which is tracking below last year's level. Just curious to know the market conditions which are leading due to this variance?

I'll just answer, and then I'll turn it over to George Persky. But I think you just have to keep in mind last year that we had very strong portfolio managing and training results in the first six months of the year. And we told everybody when we published our 2007 plan that we did not expect to see that same type of strong results in 2007 versus 2006. So as a result, that's one of the reasons behind why we're tracking below last year, just was an extremely strong performance of last year. And I'll turn it over to George to talk about the market conditions.

Yes, mainly that year-over-year change that you see on page 16 in the Portfolio Management and Trading line, is driving a significant portion of the sort of year-over-year change in the percentage completed. I would also say we had lower amounts of risk capital in the markets this Q2 than we did last Q2, as well as I think John and Mayo both mentioned the $0.14 on the hedges that are embedded in that Portfolio Management and Trading number on page 16.

Okay. Great. (inaudible) And lastly, kind of just thinking about your UniStar strategy you guys have already signed on three to four customers there. Curious to know, what's the criteria that you're looking for before you take on a customer?

Mike?

Yes, fundamentally, we're looking for partners in the marketplace who have land, water, and transmission access, the ability to move the offtake, and who want to be part of the UniStar fleet of standardized units. And so with those criteria, we have been talking with a broad range of partners, evidence we've been very public with Amarillo, at one end of the spectrum, and Ameren at the other end of the spectrum. A new entrant with a greenfield site in Amarillo. And in Ameren's case, a very accomplished nuclear operator themselves, with an existing nuclear plant, choosing to expand on the same footprint. So we are open and are in discussions with a wide range of people.

Thanks, Mike.

I think we have time for one more question.

Paul Fremont, Jefferies.

I'm a little puzzled with respect to NewEnergy. It looks like there was about $1.47 improvement in the realized margin, a 1.2 million megawatt hour improvement. And yet, you're down $20 million. And in the first quarter, with less margin improvement and less volume improvement, you achieved a $47 million increase. So what exactly happened to result in sort of -- in a lower number? And just on the margins and volumes, I'm coming up with about a $30 million sort of improvement that I would calculate.

Yes, I mean in looking at that, and Tom Brooks may want to comment when I'm done, is that when you take a look at the second quarter results, when we're talking about this here, that's the total retail competitive supply, which is the combination of NewEnergy Electric and NewEnergy Gas. NewEnergy Electric is up year-over-year in the second quarter because of the high margins and the increased volumes they had. However, NewEnergy Gas is down relative to their plan, just because of the current market conditions related to the gas market in the first half of the year, were not as favorable as they were in the first half of the year last year. In addition, we had roughly $13 million or so of hedges of accrual transactions that were mark to market that drove a $13 million loss in that business during the quarter.

So it's mainly margins on the gas side then, plus the hedges?

Yes. It was slightly higher expenses. But -- .

Okay.

And that $13 million, just so we understand, it should be a timing issue because again, those are valid hedges. Their just (inaudible) mark to market (inaudible) that we would expect to get back in future periods.

Just a bit of an overall characterization of the retail businesses performance to date, on the electric side, basically volumes are up about 10% year-on-year, roughly. That's a bit under plan. But let's see, 5% to 10% under plan. On the other hand, on the margin side, margins are -- unit margins are 30% to 40% above plan and above last year. So in net, the basic sales and risk management engine on the power side is doing quite well, and tracking above plan for the full year. On the gas side, we're probably tracking a bit below plan on -- for some of the reasons that John highlighted. But we feel pretty positive about the outlook for the gas business, as well. Although year-to-date it's tracking a little bit less favorably than the power side. But overall, we're feeling pretty good about the performance of our retail businesses.

Great. Thank you, all, very much for joining us today. And we'll look forward to seeing you next quarter.