艾索倫電力 (EXC) 2008 Q2 法說會逐字稿

Good morning, and welcome to Constellation Energy second quarter 2008, conference call. (OPERATOR INSTRUCTIONS)

I will now turn the meeting over to vice president of Investor Relations and financial planning analyst for Constellation Energy, Mr. Kevin Hadlock. Sir, you may begin.

Thank you, and good morning. Welcome to our second quarter 2008 earnings call. Glad you could join 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. On Slide 3, you will notice we will use non-GAAP financial measures in this presentation to help you understand our operating performance. We've 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, President and CEO of Constellation Energy.

Thank you, Kevin. Good morning, everyone, and thank you for joining us today for the second quarter of 2008, we recorded adjusted earnings of $1.82 per share, $1.18 above the adjusted $0.64 per share earned during the second quarter of last year. As we mentioned at our annual meeting of shareholders, these results significantly exceeded our expectations reflecting strong execution at each of our operating divisions, with particularly strong performance at our global commodities group. We are also reaffirming earnings guidance for 2008 of $5.25 to $5.75 per share. Now let's turn to Slide 5 for a review of the second quarter's operational highlights. Our nuclear generation fleet continued its excellent operating performance in the second quarter. We successfully completed the Ginna and Nine-Mile Point Unit 2 nuclear refueling outages while maintaining a very low forced outage rate across the nuclear fleet. We are proud of our three refueling outages that resulted in the first, third and 11th shortest durations out of the 42 units refueled in the first half of the year. In addition, we expanded our existing fleet by 300-megawatts through the acquisition of the West Valley facility in Utah and the refurbishment of our Gould Street plant in Baltimore.

Our global commodities group delivered strong new business results, as rising commodities prices benefited our strategies in power, natural gas and coal markets. We continue to execute our invest, develop, harvest strategy with the sale of gas assets in Arkansas. With the purchase Nufcore, we acquired specialized uranium capabilities and expanded our risk management services. At BGE, our Smart Energy Savers program is moving forward with very successful results. Our peak rewards program launched earlier this summer, and we just began a pilot program of advanced metering and dynamic pricing. The PSC also authorized last year a limited number of energy efficiency programs, and we are now working towards approval of a broader portfolio of conservation initiatives. The combined potential of the programs, including smart thermostats, advanced meters, dynamic pricing and energy efficiency is between 1500 and 1700-megawatts. To put that into context, our two-unit Calvert Cliffs plan produces 1735-megawatts, so these plans are roughly equivalent to a large nuclear facility. The gains we can make with demand response are extraordinary. It represents one of the most encouraging developments for BGE customers in the energy sector overall.

Turning to Slide 6, as you can see from the chart on this slide, energy commodity prices in the second quarter escalated even faster than in the first quarter of this year. Through the second quarter, powered PJM has risen 33% in 2008, while coal has jumped an unprecedented 153%. Market liquidity appeared to improve in the second quarter, though activity remains well below 2007 levels. As you have seen from our past performance, volatile markets typically result in success for our businesses. We started the quarter with a fundamentally bullish outlook on commodity prices, and as shown here, all energy commodity markets moved dramatically higher.

As a merchant supplier, we are able to identify opportunities to serve customers, which provides the insight to acquire assets and deploy risk capital at the right time. As I said at our annual shareholders meeting earlier this month, the effects of the current rising commodity cycle have been and will continue to be significantly exacerbated by a host of environmental and reliability issues. And investment in energy infrastructure, is almost by definition, an investment in the environment. We are today making more than $1 billion of investment in air quality control systems for our coal plants in Maryland, while also investing in efficiency, conservation, and demand response programs at BGE. We are finding commercial opportunities to meet the growing customer interest in solar and other renewable technologies. Meanwhile, there is intense pressure to hold down electric prices, despite the expectation that reserve margins should grow and be met only with cleaner resources.

Turning to Slide 7, the big picture is that we are witnessing the inevitable and appropriate convergence of energy policy with environmental policy, and this is especially apparent in terms of greenhouse gas regulation. These environmental and energy policy dynamics appear to be paving the way for new nuclear plants to be built. Therefore, I would like to provide you with an update on our new nuclear initiatives and a potential for a third unit at Calvert Cliffs. As you know, while we haven't made the decision to begin early site works for Calvert Cliffs Unit three, we continue to actively develop our options that we can be in the best position to quickly move forward with the project economics, including affordable financing, tax and other incentives, encourage us to do so.

To that end, on June 30, the DOE issued the solicitation for loan guarantee applications. The solicitation lays out a time line that suggests that we will not know until next year in our project has been selected to begin a financing discussion. Financing certainty through an affordable structure is critical to our build decision. We're pleased to finally see the loan guarantee solicitation. However, the proposed approach and the approval process still presents many challenging issues that must be satisfactorily addressed. We are working through the application process and expect to submit Part 1 of the loan application next week. Although precise timing is difficult to predict, the loan guarantee process pushes our decision to begin early site work into next year.

The other major factor, of course, is cost. Putting a price on carbon emissions is of central importance and despite a stalled federal debate, we will begin to see carbon pricing later this year when the first auctions take place under the regional greenhouse gas initiative. Whatever the price implications of carbon regulation, all signs point to energy costs continuing to trend upward in the years ahead. We have also seen tremendous escalation and near record prices for steel, cement and other construction materials. Many of the materials and components of a new reactor will come from abroad, as the US abandon its nuclear manufacturing base many years ago, all of this will drive the cost of new plants higher. However, we believe that we benefit from the knowledge and experience of our partners, Areva, Bechtel, Austin, and especially EDF, who is currently building in [Flamenville], France.

As we observe the cost estimates of other single-unit plants, we are seeing current overnight costs in the 4500 to 6000-per kilowatt range. Our own estimate for the cost of a third unit at Calvert Cliffs is in the mid upper end of this range, due to the added security and safety features of the USEPR. The impact of rising cost for new generation and the availability of attractive financing are significant drivers in their decision process and timing to pursue building a new unit at Calvert Cliffs. The primary objective has been to develop the strategic option to pursue new nuclear, when we continue on that path. At every step of the way, balance sheet exposure and cost management have been key areas of focus and will continue to be managed with great care.

Turning to Slide 8, in closing, I am especially pleased with the strong performance of the company during the second quarter and we are confident we can achieve our guidance range for 2008. Therefore, we are reaffirming our 2008 earnings guidance of $5.25 to $5.75. For 2009, we continue to forecast earnings growth of 15 to 20% over 2008. Over the five-year planning horizon, we continue to project an average growth rate of greater than 10%. With that, I'll turn the presentation over to John to review the financial results.

Thank you, Mayo, and good morning, everyone. Let's begin on Slide 10.

Second quarter GAAP earnings were $0.95 per share. After special items, adjusted earnings were $1.82 per share. Let's walk through the major adjustments to GAAP earnings. As expected, we recorded a negative $0.69 special item at BGE related to the $188 million customer credit that was accrued in April and will be applied to customers' bills in September. The credit also causes a reduction in BGE's full year effective tax rate, which impacts all four quarters. In addition to classifying the $188 million credit as a special item in the second quarter, the impact of the lower effective tax rate on normal earnings will be classified as a special item in each quarter. We had a $0.19 loss on economic nonqualifying hedges. The loss in the second quarter was related primarily to gas transportation.

Looking at our segment performance in the second quarter compared to last year, the merchant was up $1.18 per share. Utility was up $0.01. And other nonregulated was down $0.01. Overall, adjusted earnings were up $1.18 per share. I will speak to the segment results in more detail on the next few slides.

Turning to Slide 11, compared to the prior year, BGE was up $0.01 on an adjusted basis due to higher electric transmission revenue and the benefits from the Maryland settlement, which was partially offset by higher storm expenses. BGE's second quarter 2008 adjusted earnings of $0.09 per share were just over the upper end of the second quarter guidance range of $0.04 to $0.08 per share. Turning to Slide 12, compared to the second quarter of last year, merchant adjusted earnings were up $1.18 per share. On the positive side, global commodities was favorable $1.20 per share driven by strong new business results and an increased backlog realization compared to a relatively weak second quarter 2007, and customer supply was favorable $0.14 per share, primarily driven by favorable mark-to-market results in retail gas versus the second quarter of last year. I will cover the drivers to customer supply and global commodities in a moment. Lastly, generation was unfavorable. $.19 per share, primarily driven by the differences in planned refueling outages at our nuclear plants as compared to the same quarter last year, higher costs to improve Fossil peaking unit reliability in response to PGM's RPM capacity market and unplanned outages at our Baltimore coal plants.

Turning to Slide 13, this chart provides an update on how changes in market forward prices and hedging activity affect generation EBITDA. For 2008, we are forecasting unhedged EBITDA of $3.1 billion. Netting the hedging impact of approximately $2.1 billion, our hedged EBITDA is forecast to be about $1.1 billion this year. As Mayo mentioned, the Regional Greenhouse Gas Initiative takes effect January 1, 2009. This is earlier than we initially assumed and has the result of reducing our current hedged EBITDA forecast for 2009. Over the last quarter, the power curve and forecasted coal prices have risen. We currently forecast unhedged EBITDA of $2.8 billion by 2011. This is approximately $1.5 billion higher than what we shared with you in April.

Turning to Slide 14, as you see in the chart on the top of the slide, during the quarter, customer supply realized gross margin of $277 million. This was in line with our second quarter expectations. Year-over-year, on a comparable basis, gross margin is up $66 million, or 30%. The difference is primarily due to increased new business at retail gas. The retail power retention rate, including the customers that remain on a month to month basis increased to 76%, consistent with last year's rate. Of the customers we retained, a significant portion remained on short-term contracts due to the high priced energy environment that persisted through the second quarter. In the second quarter, as-priced margins were $2.49 per megawatt hour, down from the $3.01 level of the second quarter 2007, primarily reflecting increased competition, especially in Texas and New England. Additionally, our product mix in the second quarter was more weighted towards lower margin products compared to the same period last year. Retail gas retention rates remain strong at 95% and realized margins improved by $0.10 over last year, partially driven by our Midwest acquisition of Cornerstone Energy. In summary, our customer supply business, wholesale power, retail power, and retail gas are on track to achieve their 2008 earnings targets.

Turning to Slide 15, taking a look at the customer supply group backlog, we have filled 2008 backlog through the second quarter that represents about 91% of the gross margin we expected to realize when we talked to you in January. For 2009, we have increased our backlog by $65 million, driven by both retail and wholesale power. However, in retail power, we have not seen evidence of the cyclical recovery and subsequent increase in customers entering into long-term contracts that we discussed in January. Consequently, we are behind where we expected to be in creating backlog for next year.

Moving to Slide 16, now turning to the global commodities group, as you can see in the column on the left, total contribution margin during the quarter was $486 million, including backlog of $47 million and $439 million of new business. Backlogged realization in the second quarter was up $50 million versus the same period last year. New business in the second quarter was $386 million higher versus last year's second quarter, driven primarily by an increase in portfolio, management and trading of $346 million. As Mayo stated, we entered the second quarter bullish on energy commodities and certain price relationships among commodities and locations, given what we observed in the first quarter. We benefited in our power, gas and coal businesses from what turned out to be a rapidly rising market, even while maintaining risk levels comparable to the first quarter.

In addition, energy investments was up year-over-year, driven by a $76 million gain on the sale of a certain gas assets in Arkansas. As Mayo mentioned, this is the continued execution of our upstream gas strategy of invest, develop and harvest. Looking at the bottom portion of the chart, you can see that we have generated $465 million of new business year to date. These results are driven by strong year-over-year performance in all three areas. Energy investments, structured products, and portfolio management and trading.

Turning to Slide 17, as we told you in January, we expected to be in the Capital Markets in 2008 and in the second quarter, we raised $1.1 billion of capital. As previously discussed, our $2.4 billion 2008 capital expenditures plan primarily consists of environmental projects, projects which improve plant reliability, investments in BGE's infrastructure and conservation programs, and investments in strategic opportunities. Overall, 2008 capital spending is approximately $800 million higher than our 2007 capital expenditures program. Through the end of the second quarter, $1.2 billion has been spent of our $2.4 billion capital program. In addition to capital expenditures, BGE has $300 million of debt maturities this year, which we planned to refinance. In June, we also added an additional $1.1 billion of credit facilities to support the continued growth of the business and to maintain an adequate liquidity position.

Now let's turn to Slide 18 to discuss liquidity. At the end of June, our net available liquidity was $2.9 billion compared to $3.1 billion at the end of March. We have normalized our net available liquidity presented on this page to exclude certain transitional liquidity items that were not intended to support normal operations. During the second quarter, we added an additional $1.1 billion in credit facilities to address the significant increase in energy commodity prices, which resulted in the issuance of an additional $1.75 billion in letters of credit to support our risk management and hedging activities.

Turning to Slide 19, as in the first quarter, we are using the same format to report cash flow that is more closely aligned with our GAAP cash flow statement. Adjusted cash flow from operating activities was a positive $262 million during the second quarter. Adjusting for investing activities, free cash flow was a use of $466 million, primarily driven by capital expenditures. Cash flow from financing activities, which primarily reflects the debt issuances during the quarter, was a positive $1 billion, resulting in a change in net cash of $568 million in the second quarter. Looking at each segment, merchant generated approximately $450 million in cash flow from operations, excluding changes in working capital. Increases in working capital were driven primarily by $400 million of additional initial margin requirements under new exchange rules. Additionally, BGE generated $187 million of adjusted operating cash flow this quarter. While BGE's GAAP net income was negative due to the one-time customer credit associated with the Maryland settlement, actual cash flows for the settlement will occur later this year.

Turning to Slide 20, we continued to maintain a strong balance sheet. Total debt outstanding increased to $5.6 billion in the quarter, reflecting the new issuances previously noted. Price changes and hedging contract expirations running through our accumulated other comprehensive income were a major contributor to the increase in equity. These changes caused the net debt to total capital metric to improve by roughly 100 basis points in the quarter. Adjusting for third party collateral held and adjustments to equity from changes in accumulated other comprehensive income, adjusted net debt to adjusted total capital increased to 42% during the second quarter. As you will recall, all of these metrics exclude the impact of the BGE securitization debt.

Turning to Slide 21, let me wrap up with a brief review of our third quarter outlook. Consistent with the approach we introduced in January for the first quarter of 2008, we are providing a few key operating and financial metrics to help you understand our expectations for the third quarter. First, we are providing a BGE earnings range of $0.13 to $0.17 per share. This compares to our third quarter 2007 earnings of $0.14 per share. For generation, we are providing a hedged EBITDA forecast of $437 million, which is $127 million higher than the hedged EBITDA of $310 million earned in the third quarter of 2007, driven mainly by the continued rolloff of below-market hedges and higher capacity prices. Customer supply backlog is expected to be $113 million in the third quarter of 2008. Because we did not measure 2007 backlog in a manner comparable to today, we are not providing an estimate for the third quarter last year. However, as a point of reference, total realized gross margin in the third quarter of 2007 was $163 million.

To wrap up, we wanted to provide you some thoughts on our expected earnings pattern for the remainder of 2008. Today, we affirmed guidance of $5.25 to $5.75 per share for 2008. We expect roughly a third of the balance of the year earnings to occur in the third quarter and two thirds to occur in the fourth. That concludes my remarks. I will turn the call back over to Mayo for concluding comments and questions and answers.

Thanks, John. Before we take your questions, I wanted to comment briefly on our business outlook and future investment for growth. Midway through the year, we are pleased that our overall operating performance. While we've experienced greater variability in our quarterly results, which was a major driver for our decision to discontinue quarterly guidance, we think our second quarter results speak to the strength of our operating model and our focus on execution. We remain very confident in our long-term outlook given market fundamentals that are supportive of the value of our underlying assets. This is particularly true in our generation business, which we see as a significant driver of shareholder value over the next several years.

While we are pleased with the overall operating performance of the company, we understand that the recent performance of our stock does not reflect the underlying value of our assets. While some of this is directly related to the tough economic and market environment, we believe that our current stock price significantly undervalues the company and we intend to take strategic steps to address this valuation gap. In addition to continuing to execute on our basic business plan, we are focused on two additional drivers of shareholder value. First, optimizing our business mix as it relates to our allocation of capital, and, second, driving long-term growth by continuing to make investments to grow our physical asset base.

Focusing on our current business mix, we are actively assessing the ongoing capital requirements of our global commodities business. In that regard, we are considering various strategic alternatives for our commodities business. These alternatives may involve various approaches, including possible partnership arrangements. We have had a very successful first half of the year and our performance demonstrates the strength of our business model. As we look to the future, we will remain focused on maximizing shareholder value by executing in our plan, while optimizing our business mix and pursuing additional growth through investment in our physical asset base.

And now we would be pleased to answer your questions. As usual, we have the management team here to assist. Operator?

(OPERATOR INSTRUCTIONS) John Kiani with Deutsche Bank, you may ask your question.

Good morning.

Good morning, John.

Can you talk a little bit, Mayo, about some of your comments toward the end of the call, perhaps how far along you are, have you made any progress in discussions, you mentioned potential partnership structures, and just kind of give us a flavor for, is this very early stage or is this something that you all have done a lot of work on thus far?

John, I think it's fair that we've, we've considered the issue for for a reasonable amount of time and we've worked on various approaches. The obvious reason to be not more completely disclosed is that we're not at the end game on this by any means. We have a number of options. We want to be very thoughtful about it. Obviously the objective is to release the value that seems to be underappreciated in the context of how the market reacts to our business mix, earnings performance, et cetera. And I think that we have heard from shareholders along the way that they expect us to work on this issue and that's exactly what we're doing. So we're -- we would expect to be moving down this path during the remainder of the year and come up with some answers.

Okay, great. So is the right way to think about it that you'll continue to look at these alternatives and that we'll have an answer closer to the end of the year?

Yeah, I mean I think the best way to look at it is that the timing will reflect our own judgment about just maximizing the value of the assets, the businesses that we have. And of course we have to consider market forces and so forth. But we are working on it. We understand what the issue is. We understand what shareholders are telling us about this issue and as a consequence, we'll get on it and react to what we see and how the market is behaving at the time.

And if I could ask one more question perhaps, when you talked about the partnership interest, is something similar to what Semper did with Royal Bank of Scotland, what you were referring to? Or could we get a little more clarity on what some of the alternatives are?

Yeah, certainly the concept of third party capital would be put into that mix.

Okay, great. Thanks, Mayo.

Thanks, John.

Gregg Orrill with Lehman Brothers, you may ask your question.

Thanks very much. I was wondering if you could comment on kind of the balance sheet and it looked like you didn't buy back stock in the quarter. Wondering your thoughts on needs to raise equity down the road and also if you could comment on '08 earnings range I think in the first quarter call, you said you felt like there was a -- I can't remember your exact wording, but weren't as confident that you would be in the higher end of the range or something to that effect. Where do you sit now? Thank you.

Well, Greg, on the point on the balance sheet and buying back stock, we have not pursued any more stock repurchases at this point in time. We don't believe that this is the right market environment to be repurchasing stock, although the stock price is very attractive to repurchase. Given the overall market volatility and where the overall Capital Markets sit at this point in time and the financial system in general, we believe it's best to be prudent and maintain a very strong balance sheet and manage the company conservatively at this point in time in this type of market cycle. With regards to 2008 earnings outlook, we did say at the end of the first quarter we were less confident in the mid to upper end of the guidance range. What we're still saying today is that we're confident of hitting the $5.25 to $5.75 share range.

So the commentary on the balance sheet is such that you don't believe you need to raise equity -- even without a capital infusion for trading, you don't believe you need to raise equity?

Well, I think the discussion about the need to raise equity will depend upon how we deploy capital in the future and the capital requirements to the business and we do have growing capital requirements and so what we're going to have to do is manage them prudently to invest the capital we see the best risk adjusted returns.

Okay. Thanks.

Michael Goldenberg with Luminous Management, you may ask your question.

Good morning, gentlemen.

Good morning.

Excellent quarter.

Thank you.

Wanted to ask a couple of questions. First, this new business originated and realized in the Q2 of $453 million, I'm sorry, $439 million, if I understand correctly, that was business that came about in Q2 and you made money right away in Q2. Can you talk a little bit about how you made money, what it was on, whatever you can disclose?

Michael, Tom Brooks. As I think John alluded to, the biggest chunk of that was certainly from our -- came from our portfolio management and trading efforts and certainly our portfolio management trading teams perform very well. As you know, we are -- our portfolio management and training business is fundamentally focused on three basic markets, power in North America, natural gas in North America, and coal and freight globally. And given market conditions at the start of the quarter, given our view of fundamentals, I think we really entered the quarter as both Mayo and John alluded to, fundamentally bullish in each of those three markets. And particularly bullish, price relationships, either between commodities or between locations that we saw at the time.

And I think as you would expect, you know, we're not in a position to talk about the details of our positions during the quarter, in part for competitive reasons and in part because, of course, we manage our books quite dynamically so the positions changed significantly over the course of the quarter. But I guess what I would tell you in general is in terms of our strategies in each of those three areas, fundamentally, we batted 1000 and really things went very well in each area, so on the one hand, we don't exactly expect to bat 1000 every quarter. This quarter things went very well, but probably exceeded our expectations. On the other hand, I would say over a period of years we have done very well in portfolio management and trading, so we don't exactly view, the occasional outperformance as a flash in the pan.

Got you. Very glad to hear that. One other question I just wanted to understand, your Q2 2008 cash flow, you had acquisitions and divestitures. Acquisitions are as the two gas power plants you've bought, just wanted to confirm that. Is that the case?

The acquisitions, Michael, this is John. You know, in the second quarter were both -- was primarily West Valley, But if you looked year to date, the acquisitions would include three. It would include our Hillabee facility in Alabama, West Valley in Utah, and Nufcor, which is the uranium marketing business that we bought, too, and that actually was a second quarter transaction, too. So the two second quarter transactions were West Valley and Nufcor and the divestiture were the gas assets in Arkansas.

Okay, okay. Got it. On those gas assets in Arkansas, did you -- I must have missed that. Did you record a gain on that?

It was a $76 million gain during the quarter.

So, Michael, this is Tom again. I probably failed to mention that one in characterizing our new business, but that was, that was an important piece of it as well.

Okay, got it. And just so I understand on the acquisitions, Nufcor, was that a large acquisition of the 156 or relatively insignificant?

Nufcor was a moderate size acquisition. It's a uranium marketing business and it's roughly $65 million.

Okay. And I'm sorry, just one more question. John, what you were saying about the $5.25 to $5.75, are you removing at this time the lower end of the range from the statement basically saying it's just like it was before Q1, or--

No, we have not removed the lower ends. We're just reaffirming between 5.25 and 5.75.

Okay, got it. All right. Thank you very much. Excellent numbers. Good luck.

Thank you. Rudy Tolentino with Morgan Stanley, you may ask your question.

Hi, just wanted to just make sure I understand. On the already-originated business, I take it that that's margin from deals that when you take it to physical, you are realizing margin, or is that changes in the value of existing business? Or existing contracts?

Well, I think the new business that we originate during the quarter was primarily related to portfolio management and trading, and, you know, so it -- all the activities that falls within that bucket, absent what we talked about with the energy investments, which was $76 million.

So it's some of, it's some of both in a sense, it's activities that are accounted for on a mark-to-market basis are in that bucket and then of course activities accounted for in an accrual basis as they realize are also in that bucket.

Okay, and then I probably missed it, in slide 7, you mentioned that material escalation is a driver to higher project estimates. Did you give out your project estimates for the new Calvert Cliffs, how much that's going to cost roughly?

Yes, the language we used was that the current range of costs actually seen by others and ourselves is 4500 to 6000 per kilowatt, and we are likely to be in the mid to upper end of that range because of the certain safety and security aspects associated with our design.

Okay. So you'll be at the mid to upper end of that range?

Yes.

Okay. Thank you very much.

Thank you.

Shalini Mahajan with UBS.

Thank you, and good morning. Just a follow-up on the notion of taking a partnership of your global commodities group. Now, your motion business pretty integrated with portfolio management and just management across your generation customers supply and global commodities groups. I'm just trying to understand a little bit better, what's the partnership going to entail since it's very difficult to extract value for pure risk management, which is so integrated with other businesses? If you could just provide us some color on that.

I think as Mayo, as Mayo characterized previously, you know, at this point in the process, I don't think we're really ready to talk in detail about potential structures. I think the -- some of the key messages that Mayo hit on, one, our focus on shareholder value and, two, our view that the potential to bring third party capital might well have some benefit here. I mean certainly those are the two key themes that we're focused upon. In terms of how we might execute, I think as Mayo indicated, it's probably too early in the process to really get into the details there.

Okay, and secondly, Tom, just would like to hear your views on on the PGM market, the -- did collapse a lot in the first quarter, have not come back as much. So if you could provide any commentary and especially around demand, if you're seeing any price elasticity or slowdown taking its toll there.

Sure. A couple of comments. A couple of comments on heat rates. One, of course, in the first quarter we, we talked about heat rate movement, which we found to be sort of somewhat counter to our expectations in the first quarter. And we do that really to explain some of our hedge ineffectiveness, going to the breakdown in the historic relationships between gas and power pursuant to the rules of FAS 133. We had some -- a larger than typical amount of hedging effectiveness in the first quarter and a good piece of that was due to heat rate movement. And we wanted to just give some sense of the driver to that. So Andrew -- in the first quarter, I believe we reported $63 million of hedging effectiveness and about two-thirds of that roughly resulted from the heat rate movement. So really we discussed this issue in the first quarter for a somewhat narrow and specific reason.

In terms of the further movement in the second quarter, a little bit more of a mixed bag in various markets. In some markets, heat rates increased. In some markets, heat rates were about flat. And in other markets, heat rates declined, and the PJM market, as you point to, the, you know, the heat rate did decline a little bit further in the second quarter. And its impact is, you know, is -- that decline's impact fundamentally as in the first, so we do have them embedded in our new business results, some hedging effectiveness in the second quarter, not, not to the -- smaller than the first quarter, but it's fundamentally part of the total reported results. And then in terms of just overall market conditions, I don't know, George Persky, do you want to add anything further there?

I guess just in terms of some of the markets we operate where heat rates had changed over Q2 or not changed, I think what we said in Q1, we probably continue to see is that there's the persistence of differential liquidity in the gas markets and the power market still seems to be an issue driving forward heat rates. So, you know, as Mayo mentioned in his remarks, we saw some liquidity come back in Q2, but it's still pretty far behind where we saw it last year. So I wouldn't discount that as a potential driver to, you know, some of the forward heat rates that we're currently seeing in some of those markets.

Okay, great. And just one last question on Slide 23 as I look at the -- income statement. What's driving the operations and maintenance? There's a big jump from the same quarter last year?

Well, primarily being driven by having additional outages at our nuclear power plants. We had two -- in the second quarter, we had both Nine Mile Point unit 2 and our Ginna outages and last year we would have had our Nine-Mile point one outage and ga nay, to remind you, is an 18-month fueling cycle as opposed to a 24-month refueling cycle, so that impacts different quarters differently. We also had some increased O and M expenses related to our Baltimore combustion reliability fleet program in order to respond to the RPM capacity markets we've invested additional capital in our combustion turbine fleet in Baltimore to reflect, you know, better reliability of those units.

Would you be able to break out the amounts for the outages and the CT investment?

I don't have that right at the tip, but Kevin can probably get with you later on that.

Okay, great. Thanks so much.

Ashar Khan with SAC Capital, you may ask your question.

Good morning and congrats. If I look at the hedging changes on Slide 13, is it fair to assume that you are more hedged in 10 and 11 than the first quarter, or no?

I mean--

As a percentage

Yeah, I guess I would probably point you back into the additional modeling information where we give you some earning sensitivity on the generation fleet. I don't have, I don't have those from Q1 in front of me, but that was probably a better comparison to look at in terms of assessing a change in our hedge profile. The changes in the hedge EBITDA on Page 13 are really more a reflection of what happened with market prices of the various components, both for power output and fuel inputs to our fleet over the second quarter.

Yeah, this is where I'm a little bit -- I don't know if you can talk about this. -- there's a change of about a million or so in '10, but the fuel variance has gone huge. The fuel variance was like minus 0.5 in the first quarter and minus -- while the few variance has gone up so much from the first quarter.

Yeah, I'm sorry. I don't have the Q1 numbers in front of me. We can probably get back to you on that later.

Okay, and then I just wanted to, going back to the comments on the quarter, second half of the year, if I'm right, you know, if you add the first two quarters to get to the upper end of the range, there's another $3 to go. I'm just trying to do it simplifying myself. I heard John say one third is going to come in the third quarter and two-thirds in the fourth quarter. Is that correct?

That is correct. That's what we think the earnings pattern will look like.

And so, John, we know that we are flat right now on EBITDA for the fixed generation and that's going to show in the third quarter slides. What should we expect -- our expectation is that the other businesses are going to be going down, that that would be the assumption, right?

I think number one, and Tom Brooks can add some more detail to this, but in the third quarter at least, you know, we try to give a little context around customer supply. You know, in 2007 to remind you, it was a very strong year for our customer supply business. We do not expect as strong a results in customer supply year-over-year in the third quarter and for that matter in the fourth quarter, and then we also, have had very strong year to date performance in our global commodities business. We don't expect necessarily as strong results as we move forward, but Tom can comment on that in a little bit more detail.

A couple other thoughts. One, you know, as both John and Mayo have indicated, obviously we're confident in the outlook for the year, wanted to give you a little bit more visibility given that we're midway through the year into the proportionality of the two remaining quarters, and in terms of the relationship of Q3 versus Q4, there are a couple of factors sort of embedded in the portfolio and the timing of the way it rolls out over each of the next two quarters that sort of affect that one third/two-thirds relationship. And just to highlight a couple of items for you, one, in the first quarter as you recall, we realized some gains out of our coal portfolio, coal prices ran up very significantly in the first quarter and we thought it prudent to realize some of those gains through various sales transactions, which we did do. That had the impact of reducing our risk and benefiting Q1 results. It does slightly somewhat negatively impact Q3 results. That negative impact is obviously built into the outlook that John articulated, but that's one item. A second item is, you know, sort of Texas overall, much has been talked about the Texas situation given various market dynamics there. As you know, we serve a fair amount of load, both at wholesale and retail in Texas.

Through the first quarter, two quarters, actually our portfolio management teams have been able to manage some of those market issues in Texas very well, and it didn't have a big impact on us, on our results in the first two quarters. On a forward basis, actually Texas market dynamics reduced the Q3 outlook a little bit relative to, relative to what we would have thought at the beginning of the year and then finally, just overall our, given the way market prices have moved in PJM and given our overall hedging approach over the course of the year, principally relative to the fleet, but to a lesser extent relative just to the load business in the Mid-Atlantic region, we have an impact over the balance of the year where Q3 is down somewhat and Q4 is down somewhat.

So the totality of those three items -- I'm sorry, Q4 up somewhat. The total of those three items relative to the outlook for Q3 is down about 200 to $250 million, rough proportionality would be about 30% of that due to the impact of the coal sales from the first quarter, 20% roughly due to the Texas situation and the balance, just sort of the shape of our hedging profile in terms of what falls in Q3 and what falls in Q4 over the balance of the year. So in some ways, all of that is a little bit mechanics. The basic point is that we're confident in the overall outlook, but just given a market environment where prices have gone down and up and down again quite a bit, that's somewhat influenced the timing of when we expect to realize earnings over the third and fourth quarters of the year.

I really appreciate it. Thanks for the details.

(OPERATOR INSTRUCTIONS) Paul Patterson with Glenrock Associates.

Good morning, guys.

Good morning.

Just wanted to sort of clarify the slides and everything. The 439 million that we see on Slide 16, the 439, that is realized. That's the actual cash impact of what actually -- that new business realized was actual cash that you guys got as a result of this, it wasn't a mark-to-market benefit?

Well, Paul, as you're aware, so the accounting of how that would work is mark-to-market clearly would show up as income. As you're aware, send on the risk capital deployment side, the PMT side of the business, we're fundamentally margined -- either through exchange or bilateral contracts with margining, so you get a mark-to-market benefit and you're getting the cash realization of that mark-to-market benefit either next day with the exchange or next day cash margin with the counter party. So I guess -- to get a total picture on the global commodities business, how much was it impacted by noncash revenue items?

Well, I think we showed you that, Paul, in the cash flow page. Let me just flip the page.

19.

So the $279 million is actual cash, there's no noncash revenue recognition in there?

Well, no, Paul. I think as you're aware, when we do these cash flows, we start with the net income and then we walk you through large adjustments of either noncash earnings or cash that doesn't show up in earnings, so depreciation and amortization and then the items you're talking about. So the adjustment in mark-to-market assets, the net asset derivative and the adjustment in, say, third party cash collateral would show up in the working capital change. Okay, so it's -- the mark-to-market stuff was a -- is essentially very short-term in nature and so therefore it's more of a working capital item?

Well, Paul, why don't we -- we can get into some of these.

Okay.

Why don't we do this offline and we'll get into some of those details with you.

Fair enough. And the impact of Nufcor, was there any impact at all?

There was really no impact in the second quarter, as it was really closed right at the end of the quarter.

Okay. And going forward, any thoughts about what that might bring about from a net income perspective?

Well, we haven't disclosed that, but it will depend on how it finally grows and integrates in the business. But relatively small, given the size of the acquisition.

Okay. Thanks a lot, guys.

Charles Sharett with Credit Suisse, you may ask your question.

Hi, good morning. Could you talk about your LC usage during the quarter, you said it went up by 1.5 billion. A little more detail about that and how we should think about that going forward?

Well, I think we need to step back when we have this conversation, discuss what the collateral is used for. And as you know, we are a very large hedger of our customer supply group, and when we go out and hedge that business, that business, wholesale and retail customer supply consume about 150 million-megawatt hours a year, which is pretty much about five times the amount of generation that we actually have available to manage that business. So we do a lot of forward hedging and during the second quarter, we saw a very large run-ups in prices that caused us to post collateral against those positions. And obviously our collateral, our collateral will fluctuate depending on how prices move and the other components of the hedging activity relate to our fleet as well. So it just depends on the absolute movement and market prices, what it does to collateral. I will tell you what we strive to do is always ensure that we have sufficient liquidity to meet market moves to protect our hedge positions.

With respect to letters of credit, I think we also saw a larger phenomenon that was larger in prior quarters where people are posting letters of credit to us and unlike cash, we can't then assign that back over to our counter parties who we may sit on the other side of a roughly flat position and so that has the effect of we now have to post LCs out. If you think of LCs posted into us and LCs out on that, that's about a $900 million increase in the use of LC. Again, roughly related to the higher level commodity prices.

Great. We have time for one more question.

Andrew Levi with Brencourt, you may ask your question.

Hi, guys. Good morning. I got a couple questions, but guess I can't ask them all. I guess just getting back to Paul's question on working capital, negative 350, can you give us a breakdown of that?

Well, it's primarily driven by higher initial margin requirements. It's where we clear products on the exchange and that was roughly $400 million of it.

Okay, and--

Due to their changed rules. As you are aware, they changed rules --

As volatility and prices went up, they increased the amount of initial margin you have to post for your position.

So it sounds -- just getting off that, but staying on the trading side, sounds like you had a very good quarter trading. I guess that's fair to say, and from your comments, I guess you probably were long certain commodities that did very well. I'm just wondering, and I know you can't really tell us about the third quarter, but obviously there's a big reversal in that and you seem to be having lower earnings in the third quarter on a kind of mixed basis. I guess last year, third quarter was up 50/50 as far as the remaining earnings. Now -- I don't know if you can answer this, but I'm just wondering, are you giving anything back in the third quarter from what you made in the second quarter trade? I know I gave some back.

So in terms of the, again, back to sort of the Q3 versus Q4 outlook, as John characterized the proportionality we expect one third/two-thirds or as compared to last year in terms of the year on year difference for Q3. I went over 200 to $250 million of sort of timing factors within the portfolio, and that's the most significant driver to sort of -- where we stand in Q3 or what our outlook is for Q3 versus Q4.

Probably fair to point out that while backlog's up in the commodities group year-over-year, we had a very strong Q3 '07 and for business originated and realized inside the quarter, and we're simply not projecting as strong a quarter out of some.

Okay, and then the last question's a very simple question and then we'll let you guys go. Just -- there was some reference, I guess John Kiani -- partnership on the trading side -- John, did and I guess I'm just wondering, in this environment, are there actually people out there who can actually pay you and be interested in this environment? Obviously the energy environment's good, but the financial environment's not good.

Yeah, I think that we're confident that there are a number of options that we can develop to address some of the issues I think many of you have brought up over the course of the first half of the year. So I think the answer to that is that, yes, there are options and we're, you know, we're pursuing them.

Great. Thank you very much.

Well, thank you all very much. Have an enjoyable summer and we'll see you after the next quarter.