艾索倫電力 (EXC) 2008 Q3 法說會逐字稿

Good morning, and welcome to Constellation Energy's third quarter 2008 earnings call. (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 the Vice President of Investor Relations and Financial Planning and Analysis for Constellation Energy, Mr. Kevin Hadlock. Sir, you may begin.

Thank you. Welcome to our third quarter earnings call. We appreciate you being with us this morning. On Slide 2, 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 that 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.

On Slide 3, Constellation Energy has filed with the Securities and Exchange Commission a preliminary proxy statement and other relevant documents regarding the proposed transaction with MidAmerican Energy Holdings Company. A definitive proxy statement will be sent to security holders of Constellation Energy seeking approval for the proposed transaction. We urge investors to read the definitive proxy statement and other relative documents when they become available, because they will contain important information about Constellation Energy and the proposed transaction. With that, I'd like to turn the call over to Mayo Shattuck, Chairman, President and CEO or Constellation Energy.

Thank you, Kevin, and good morning, everyone. I would like to begin today with an overview of the last few months, so you're looking only at the first slide with my name on it at this point. The shock to the financial system in the past several months is still being digested and analyzed. And although we have our differing macro theories about its causes, I can at least provide some perspective on its effects. Companies like ours are dependent on access to capital in two fundamental ways. First, for fulfilling its capital expenditure programs; and second, for the liquidity capital required to operate and support its commercial businesses. In 2008, we had planned for a CapEx program of $2.4 billion, a substantial increase over prior years, primarily because of the environmental upgrades required on our coal plant.

Since this program was larger than our planned cash generation for the year, we had anticipated going to the market to raise capital during the year; and during the first and second quarter of 2008 we raised $1.1 billion in new debt and hybrid securities as part of this program. Our liquidity capital requirements are funded by lines of credit and cash. The main drivers of the use of liquidity capital in our case has been hedging the generation fleet, hedging the customer supply business in both power and gas, and hedging our international coal business. We will describe this in much detail today. But it is important to note that our approach is to lock in economic value by hedging our exposures to the extent possible. In this way, we have been able to reasonably able to forecast the economic exposure and long-term cash flows from our fleet based on our hedge ratios, and also reasonably lock in a spread in our commercial businesses over the life of the contracts. This formula worked well for many years while access to liquidity capital was available and the cost of that capital was reasonable. We managed to total liquidity capital requirements by comparing our liquidity resources to the requirements if we were to be downgraded by the ratings agencies.

When we entered into the famed -- infamous week of September 15th when Lehman and AIG failed and when the other major investment banks altered their strategic courses through mergers or bank charters, we were threatened by a downgrade of the rating agencies after they witnessed violent moves in our stock price and CDS spreads. To avoid the downgrade and the potential restriction of our access to credit resources, we engaged in an immediate capital infusion by MidAmerican in the amount of $1 billion. We also agreed to merge into MidAmerican for a price of $26.50 per share. The tumultuous nature of the markets that week cause a tremendous amount of uncertainty how our counter-parties would react if given any signal that a downgrade was possible. As a result, it was imperative that we receive the capital commitment by the end of that Friday. This issue explains why a last minute proposal by EDF and certain private equity firms on Friday was not accepted, and that it did not address the immediate financing need on that day nor did it spell out immediate issues such as ownership structure and financing sources, both of which are so important in assessing the probability of a transaction closing.

The merger agreement was signed, the markets worsened; and specifically for power companies, a declining power price environment has caused all companies in our space to decline in price significantly. This has given us an even stronger perspective that a merger partner like MidAmerican has important near and long-term advantages in terms of our access to capital. We also believe that the merger is a compelling proposition to a number of our constituencies, particularly the State of Maryland which must look to the benefit that such a merger has to BGE rate payors. In addition, the history of MidAmerican's management approach of keeping its subsidiaries as autonomous units provides some of the qualitative benefits that employees and other stakeholders always examine in these circumstances. While we have been diligently working on the transaction process with MidAmerican, we have also been hard at work to reduce risk in collateral requirements to adjust to a new environment where prices have declined, markets are liquid and credit is scarce. We will discuss today our efforts on all fronts. Risk is being reduced through the pursuit of sales of certain businesses and the overall lowering and flattening of our book of business. Collateral requirements are also being reduced through these actions. Since the merger announcement, we have changed the focus of our commodities business to prioritize risk and collateral reduction over the near-term realization of profits.

In practical terms, this means that we have spent in the third quarter, and will spend in the fourth quarter, some money to achieve a lower risk in collateral profile. We were making these decisions with the full concurrence of MidAmerican, such that we have the business appropriately right sized to fit its long-term strategy. We are in the midst of our five year planning process and our assessing how the impact of the current market environment and expected execution of our strategic initiatives will affect our 2009 earnings and cash flow. Our planning efforts are focused on generation, BGE, customer supply and activities in the global commodities group that will either be in a wind down bucket or ongoing bucket. Obviously, many of the strategic decisions made over the last few months, including those activities we expect to divest, combined with the current economic environment, introduced a degree of uncertainty around earnings expectations for the balance of 2008 and 2009. As such, we were not in a position to affirm our previously stated guidance. That said, Jack will outline our fourth quarter expectations for BGE, generation and customer supply backlog as we customarily do each quarter; and I do expect that we will be able to provide an outlook for 2009 by the time of the shareholder vote in late December or January.

Let me take a moment to review our credit sources. This morning, we announced that we anticipate the close approximately $1.2 billion of the previously announced credit facilities as early as next week. In addition, MidAmerican has committed to provide Constellation up to $350 million in additional liquidity resources. Jack will be providing more specific information on our liquidity position in a moment. Finally, I've asked Brenda Boultwood, our Chief Risk Officer, to speak this morning about how we are managing risk. It is important to note that the interrelationships between risk, credit support and earnings are complex; but we will attempt to describe some the most significant moving parts. As an example, the asymmetry that exists in the margin requirements of some of our businesses have been a major driver of collateral use. When coal prices soared earlier this year, we were required to post collateral to our customers while receiving none from our suppliers. More recently, as power prices dropped, we were required to post collateral to our suppliers while getting none from our load serving customers. And as volatility in all commodities has increased, the exchanges in ISOs had a generally increased the credit requirements to conduct business through them. Most market participants, including ourselves, have adjusted their pricing models to account for the significant increases in the cost of doing business in this credit environment, and we have actually seen the market accept these increased credit costs in our origination businesses.

So if you turn to Slide 6, let me turn now to some specific initiatives that we have recently undertaken. In light of the changed environment I just described, we are managing our business appropriately. We believe that this is prudent business practice, irrespective of the pending transaction with MidAmerican. Specifically, we are targeting a reduction in our capital consumption consistent with our $4.2 billion of long-term bank facilities, primarily by curtailing risk and collateral exposure. In addition, we are right sizing the customer facing businesses as part of our long-term planning process. As I mentioned, we are increasing the cost of capital in our models to be consistent with our marginal cost of capital and in alignment with changes in the industry's pricing methodology. We are also reducing the scale and scope of global commodities, and are pursuing the sale of our Houston downstream gas trading operations. In addition, we are focused on reducing portfolio management activities to a size appropriate to support hedging at generation and customer supply group. Our goal is to position Constellation's business to earn reasonable, risk-adjustment returns on capital while reducing earnings risk and variability. Turning to Slide 7, I would like to update you on the initiatives described to you at our August analyst meeting.

We have made significant progress on our announced strategic divestitures. On our international business, we received a high level of interest from potential buyers and have completed the second phase of the bidding. We are currently in the process of negotiating final terms and would expect to sign definitive documentation in the next two weeks. While we cannot predict the certainty of timing of the closing around the sale of this business, as it depends on the receipt of any required approvals and consents, we are committed to close as quickly as possible, and are targeting a closing prior to year end. We also continue to move forward with the sale of the upstream gas assets. We expect to have bids on certain properties this week and proceed with the process with a targeted closing date by year end. We have also initiated the sales process for our Houston gas business, which focuses on gas supply activities to wholesale customers and on gas trading activities. While this has been and continues to be an attractive business, we do not see it as a core strategic fit as we move forward with our strategic business realignment. We have seen strong initial interest in this business and are currently making management presentations to interested buyers. Following the management presentations, we expect to identify the leading bidders and begin negotiations. Our current schedule is to negotiate and sign a purchase and sale agreement by the middle of December.

Let me take minute to update you on the status of the transaction with MidAmerican. We are pleased to report that we have completed all required filings for the transaction. We are focused on two key approvals in particular, the Maryland Public Service Commission, and the SEC's approval of the preliminary proxy statement. By statute, the Maryland PSC has 180 days, with an option to extend by 45 days to rule on the transaction. We are also awaiting the SEC's comments on the preliminary proxy statement that was filed on October 17. We have not yet set a date for the shareholder meeting until we have more visibility into the time associated with receiving and responding to the SEC's comments on the preliminary proxy. However, currently we estimate the vote may take place in late December or January, and we remain on track for a second quarter 2009 close, subject to necessary approval. We continue to execute and develop the strategic transformation that we outlined in the analyst meeting in August. However, as you can imagine, our operating objectives are different under the merger agreement, and we are working with MidAmerican as the transformation evolves. Unfortunately, our activities have impacted our third quarter results as we actively reduce risk in our business at the expense of earnings.

Turning to Slide 9, in summary, we are actively working to reduce risk in our merchant business. We are reducing volatility of cash flows, the reduction in the size of the portfolio and shifting the composition of the portfolio. We are also working towards building liquidity to support the businesses. While the majority of our time is spent operating and right sizing the business, we also continue to prepare for the transaction with MidAmerican. As indicated in our third quarter results, earnings were impacted by these initiatives, and we expect this to continue at least through the fourth quarter. While we were not in a position to provide detail around 2009, we expect that earnings will not include those activities we expect to divest, such as upstream and downstream gas, and international coal and freight. With that, I will turn the call over to Brenda Boultwood, Constellation's Chief Risk Officer. Brenda?

Thank you, Mayo, and good morning. Before we begin the risk management update, we would like to revisit the impact that the market environment has had on Constellation. Commodity prices climbed steadily through the first half of 2008 and were near annual highs at the end of June. On August 27, we discussed the consequences of higher commodity prices as higher collateral requirements, higher gross derivative asset values and increased credit exposures. This trend can reverse during the third quarter as power, natural gas and coal prices drop sharply by over 30%. Given our generation fleet, we are generally long power. Thus, this reduction in power prices affected our portfolio value. Further, the fallen commodity prices have also impacted our collateral requirements and decreased the size of our gross derivative positions and credit exposures. In addition, our challenges in the credit markets in August and September forced us to increase collateral postings by almost $750 million.

As Mayo discussed, credit markets are perhaps the most challenged in decades. From access to short-term commercial paper markets to the availability of longer term debt facilities, credit products are available to some but at high prices. This is impacted Constellation's access to short-term financing sources and our cost of capital; most importantly, affecting the capital needed to fund collateral requirements on our economic hedges of generation and customer supply. In addition, power market liquidity has challenged our flexibility and hedging, as we have been impacted by the withdrawal of investor funds from commodity markets and the loss of some market participants. Today, we will show that Constellation has substantially reduced its economic exposure to directional commodity price risk in reaction to these market challenges. We accomplished this by reducing position sizes and overall length in our portfolio.

Furthermore, we are actively managing the liquidity needs of our business by reducing the variability of our collateral requirements. Finally, the collateral we are required to post in a credit rating downgrade scenario has decreased as result of our management actions, as well as declining prices. Earlier, Mayo provide an update on our strategic focus. And on Page 3 we lay out -- excuse me, Page 12 -- we lay out specific steps taken in our business to reduce economic risk and liquidity requirements. In our generation business, objectives remain unchanged. In the customer supply group, we revised our pricing to reflect the increased cost of capital. We have also purchased financial and physical swaps to reduce physical shorts at the regional power independent system operators, reducing our working capital requirement for this business. We are currently in the process of identifying load contracts that can be sold along with their derivative hedges to further reduce margining requirements. In the global commodities business, we continue to focus on the strategic portfolio divestitures that Mayo discussed earlier. Additionally, we are now focused on reducing the risk in our portfolio by reducing positions where economic opportunity exists and market liquidity permits; reducing geographic and time spreads as market liquidity permits; and reducing the variability of our collateral requirements by flattening our book of margin positions.

Turning to Page 13, here we discuss actions taken to reduce the size of our economic positions across our global commodities business. The impact of this position reduction is a decrease in overall portfolio risk through 2013. As a power Company, we have generally maintained a highly hedged portfolio. Specifically, we have typically hedged out three years of our generation length, with a highest hedge ratio in the near year and declining through year three. In the customer supply group we have hedged retail and wholesale load obligations at their inception in order to lock in the margin on our transactions. And finally, in the global commodities group, we have largely transacted commodity, location and calendar spreads. Recently in the global commodities business, we have deviated significantly from these objectives in an effort to minimize the impact of sharp market moves on collateral. Specifically, we have sold financial power lengths to flatten ourselves both economically and in terms of our collateralized position in order to reduce the volatility of our collateral posting requirements. Between June 30 and October 31, we reduced power positions 29 million megawatt hours or 35%.

Earnings at risk is used to reflect the risk level of our total portfolio. Earnings at risk is a one-day, 95% confidence interval measure of the change in economic value of our portfolio across all accrual and mark to market asset and hedge positions through 2013. On June 30, earnings at risk was $202 million, $141 million from our generation fleet and its hedges, and $61 million from the global commodities group. By September 30, overall risk had dropped 25%, despite an increase in the cost of a unit measure of earnings at risk during this period. Through a continued outright position reduction, flattening of the economic risk and reduced market volatility, the overall risk level was reduced to $137 million by October 31. Since June 30, we reduced the overall portfolio risk by $65 million or 32%, primarily by reducing non-generation financial power positions and converting power lengths into heat rate options by selling gas. This is consistent with our change in business strategy. In your additional modeling material, we have included an update on average disclosed market value risk -- value at risk levels for the overall mark to market book and the mark to market trading book.

Recent portfolio actions have substantially reduced mark to market bar levels in October. However, during the third quarter we saw an increase in mark to market bar levels as a result of the increase in unit bar and the break down in correlations underlying certain location and calendar spread positions. This break down in correlations has been caused by the turnaround in commodity prices at the end of the second quarter, causing dislocations in various commodity, geographic and location spread relationships as prices for various products declined at different rates. Turning to Page 14. On this page, we take a slightly different view of our portfolio by focusing on positions that require collateral. Converting power, gas and coal positions to a megawatt hour equivalent, we show that we have flattened the position in order to minimize the volatility of our daily price-driven collateral posting requirements. This reduction in volatility has helped us manage our collateral requirements during this period of volatile prices and constrained capital. While our overall margin position has been reduced, we are still long power and are vulnerable to further liquidity needs should power prices continue to fall. In fact, our collateral posting requirements are more sensitive to price decreases.

Recent collateral stress results indicate that our collateral posting requirements for a commodity price decline requires approximately twice the incremental collateral posting as the same price increase. Constellation's use of liquidity to collateralize hedge positions can be explained simply as stemming from our desire to remain economically hedged across our generation customer supply and coal businesses in order to lock in margins to reduce earnings variability. Many of our hedges may be financial contracts on exchanges or with OTC counter parties that require collateral. Here are some details about how Constellation uses capital to collateralize our economic hedges and trading positions. First, there are business driven collateral asymetries. For example, our coal portfolio is asymmetrical with respect to collateral, and that coal producers don't post collateral on their fixed price contracts while our hedges require collateral. As a result, we as posting collateral as coal prices rise, and having collateral returned as coal prices fall.

Also, customer supply load sales of power and gas are typically not collateralized, while our purchase power hedges are typically collateralized. Generation power length is not collateralized, while forward power sales are typically collateralized. In addition to these business-driven collateral asymetries, collateral is consumed by exchange positions with cash postings to meet variation margin requirements that may be hedged with OTC positions collateralized with letters of credit Collateral received in the form of letters of credit provides excellent credit protection, but provides no liquidity benefit; while collateral posted in the form of letters and cash has capital costs. What begins as desire to remain economically hedged across our business results in an aggregate portfolio of collateralized positions that demand significant collateral capital. Between June 30 and October 31, overall collateral requirements have increased $1 billion due to falling collateral prices and the need to meet incremental collateral requirements of our August and September event.

Turning to Page 15. Here we update you on downgrade collateral numbers. As of October 17, the additional collateral required when downgraded by two notches to a BB-plus is $2.2 billion. As you see, the downgrade collateral requirement has declined significantly from June 30 number of $4.6 billion. This is mainly attributed to four key factors. First, there have been significant price decreases across all commodities since June 30. Second, the reduction in position size of our overall non-generation portfolio. Third, there has been incremental adequate assurance collateral postings of approximately $260 million between September 15 and September 30. And finally, line reductions of $480 million in the third quarter. Based on estimates of an allocation of collateral to businesses consistent with the way we run the business, downgrade collateral could be reduced by over a $1 billion as a result of executing both the sale of the London business and the Houston gas treating operation. This is a critical fact in sizing our future liquidity requirements. We turn this now over to Jack Thayer, our CFO, to provide a liquidity balance sheet and earnings update.

Thank you, Brenda, and good morning, everyone. Before diving into the specifics of Constellation's third quarter liquidity and earnings performance, I think it's important to take a step back and provide financial context for what transpired in September. An essential part of this history is the discussion of key sources and uses of cash and liquidity during the first three quarters of 2008, given the importance of liquidity to our viability. At the end of 2007, Constellation held approximately $3.8 billion of available cash and lines of credit to support its business operations. Heading into the year, we anticipated significant capital spending related to environmental CapEx, BG initiatives and generation investments. To fund this activity, we planned to both deploy funds from operations and proceeds from financings and asset sales. Accordingly, we believe we approached the year from a solid financial foundation. What we did not anticipate were several seismic changes stemming from volatile commodity prices that increased the contingent capital needs of the business, including the significant increase in margin requirements to support merchant participation in exchanges and ISOs; the sizable incremental posting of cash and LC collateral to maintain economic hedges supporting our merchant business; and incremental collateral posting requirements related to a ratings downgrade.

The effects have been compounded by asymetries in the collateral posting relationship between our assets and contractual hedges and our merchant activities and the adverse impact this relationship has had on our liquidity position. Exacerbating these issues further were several additional issues, including the shift in orientation of our merchant earnings from the anticipated cash earnings to a greater than expected percentage of non-cash mark to market earnings; an unprecedented tightening in the previously liquid credit markets; and the impact of volatile commodities markets on the scale of our incremental downgrade collateral posting exposure. The net result of all these forces was a net use of $1.5 billion of cash and LC collateral through the third quarter. This is despite raising more than $1.7 billion in lines of credit, $1 billion of preferred equity from MidAmerican and $1.1 billion of debt. Importantly, the bulk of this outflow is working capital related, and the timing of its return will primarily occur in 2009 and 2010.

So with that long history behind us, now let me turn to a more detailed discussion of our third quarter liquidity, cash flow and earnings results. Turning to Slide 17 and a discussion of our Q3 change in liquidity. As you can see, this slide details the third quarter changes in net availability liquidity comprised of cash and unused credit facilities. Starting at the left bar, we began the quarter with net available liquidity of approximately $2.9 billion. Moving to the right, reductions of portfolio positions amid declining power prices, together with calls for adequate assurance and reductions in implied credit lines from counter parties required the posting of an incremental $746 million in cash and LC collateral during the quarter. Subcomponents of this $746 million include the posting of $860 million of cash collateral and $235 million of variation margin. Definitionally, variation margin is the cash settlement of daily changes in the valuation of certain exchange-traded positions. This use of liquidity was offset by a $349 million reduction in posted letters of credit.

In total, the net increase in cash posted for collateral was primarily due to the return of cash posted to us by counter parties earlier in the year as power prices declined. Capital expenditures were another material use of cash liquidity. We invested $491 million in PP&E, primarily related to BGE, environmental spend at our plants and nuclear fuel during the quarter. Capital expenditures, together with all other operating and investing activity excluding collateral and margin, collectively use $643 million of cash during the quarter. Cash outflows required for operating and investing activities were funded primarily through financing activities, which you see labeled on the slide. In conjunction with our merger agreement, we issued $1 billion in preferred stock to MidAmerican during the quarter. We raised additional cash totaling $1.1 billion in the form of short-term debt through the net issuance of $354 million in commercial paper; and later in the quarter, the drawdown of $750 million from our credit facilities.

We drew on our facilities in the wake of turmoil in the financial markets in order to secure funds in advance of commercial paper maturities and other near term obligations. The issuance of commercial paper and drawdown on facilities increased cash but decreased availability facilities, as our lines serve as backstops for these activities. The overall impact on our availability liquidity was neutral. Turning to Slide 18 for a review of projected liquidity, as you saw in the prior slide, we ended the third quarter with net available liquidity of approximately $2.3 billion. Since then, liquidity has declined by an estimated $463 million to $1.9 billion as of October 31. Primary drivers of this reduction include dividend and interest payments, as well as the partial impact of the BGE rate settlement. As you will recall, we extended $170 rate credits to our customers in September, and this is impacting cash receipts and cash flow primarily in October.

Looking forward to the remainder of 2008, we anticipate closing in November on approximately $1.2 billion in credit facilities. We've also agreed to terms on a $350 million alternative financing with MidAmerican which allows us to sell our Safe Harbor and West Valley generation units to them in a prearranged price. We anticipate finalizing this arrangement next week. Collectively, these two financings more than offset the maturity of approximately $1.4 billion in credit lines which expire at the end of the year. In addition, our planned strategic divestitures have the potential to raise an incremental $1.7 billion in available liquidity through a combination of net proceeds and the return of underlying collateral. Importantly, these divestitures, if successful, would also further reduce our downgrade collateral requirements by an estimated $1.1 billion using our October 17th calculations. These collective efforts, which we anticipate will supplement ongoing initiatives we are currently undertaking to derisk our merchant business, give us a measure of confidence in our current and prospective liquidity position.

Turning to Slide 19. Beyond 2008, it's important to note that the majority of our collateral usage is related to hedging our generation fleet, our customer supply activities and our international coal and freight business. The majority of these activities and related hedges are short-dated. Accordingly, as you can see on the slide, we expect a return of this collateral in the near term with the expected roll off of letters of credit and cash collateral posted to support our current portfolio of contracts. Assuming a static book, current price curves, no new positions added, market curves realizing at -- as projected today, and current positions rolling off as they mature, we anticipate that approximately 39% of our letters of credit and cash collateral currently posted is returning during 2009. Further improvement is anticipated in 2010. This expected collateral roll off trend should help facilitate a reduction in the liquidity requirements of our business prospectively.

Now let's turn to a discussion of the balance sheet on Slide 20. We exited the third quarter with a debt-to-total capital ratio of 42%, which is a market deterioration compared to the 36% we reported at the end of the second quarter. Total debt increased in the quarter as we expanded our short-term borrowings by issuing an additional $354 million of commercial paper and drawing $750 million on our credit facilities. More impactful was the negative impact to equity related to special items and certain unrealized losses on our hedge portfolio. The special items reduced retained earnings, while the hedge losses are realized in accumulated other comprehensive income, or AOCI. As you will recall, when we experience gains or losses on our cash flow hedge portfolio, those unrealized value changes are not recognized on the income statement. Rather, they are recorded in AOCI on the balance sheet. With the recent drop in power prices, certain of our cash flow hedges are in a net loss position. This has created a quarter over quarter reduction in equity of approximately $1.2 billion.

Finally, offsetting this negative, our equity capitalization was improved by the $1 billion convertible note issued to MidAmerican as part of the merger agreement. We treat this as equity for management reporting purposes, while GAAP recognition would record it as debt. Adjusting out the AOCI losses and a small amount of third party collateral posted to us by counter parties, quarter-ending adjusted net debt to adjusted total capital and improves to 39%. As you will recall, all of these metrics exclude the impact of the BGE securitization debt. Turning to the next slide. We'll now turn to the earnings portion of the presentation and quickly discuss our results on a consolidated basis and by business segment. Turning to Slide 22. Third quarter GAAP results were a loss of $1.27 per share. After special items adjusted earnings were $0.76 per share. Let's walk through the major adjustments to GAAP earnings. A variety of special items net to a loss of $2.10 per share.

During the third quarter, we recognized $1.76 of impairment charges related to merchant goodwill, our upstream gas properties, and our ownership in Constellation Energy partners. We also recorded additional charges related to declines in the value of our nuclear decommissioning trust investments and the settlement of Fly Ash Environmental litigation. We had an after tax charge of $0.21 related to merger and strategic alternative costs. Finally, we had a $0.13 write down of emissions allowance inventory, partially offset by mark to market emissions derivative gains related to the vacation of care. We had a $0.07 gain on economic nonqualifying hedges related primarily to gas transportation contracts. Looking at our segment performance in the third quarter compared to last year, the merchant was down $0.72 and the utility was up $0.02. Overall, adjusted earnings were down $0.69 per share.

Turning to Slide 23, BGE turned in a solid third quarter performance. Compared to the prior year, BGE was up $0.02 on an adjusted basis due to benefits from the Maryland settlement, which were partially offset by higher bad debt expense and interest expense. Turning to Slide 24 and a discussion of the merchant results. Compared to the third quarter of last year, merchant adjusted earnings were down $0.72 per share. Year-over-year variances were primarily due to the following: Generation was a favorable $0.39, primarily due to improved energy and capacity pricing; global commodities was an unfavorable $1.08 per share, driven by lower new business results in portfolio management and trading; customer supply was an unfavorable $0.07 per share, primarily driven by unfavorable mark to market results in retail gas and lower rates in volumes at retail power. A strong performance at wholesale power, driven by favorable variable load risk, partially offset this negative. Other merchant items were up $0.04 per share versus the same period last year, primarily due to lower costs, partially offset by higher interest expense.

Drilling further into the segment, I will cover the drivers to customer supply and global commodities. Let's start with global commodities on Slide 25. As you can see on the column on the left, total contribution margin from the global commodities business during the quarter was a negative $148 million, including backlog of $99 million and new business of negative $247 million. Backlog realization in the third quarter was up $49 million versus the same period last year. New business in the third quarter was $477 million lower than last year's very strong third quarter, driven primarily by a decrease in portfolio management and trading of $472 million. Of the negative $247 million in new business realized in the third quarter, we expected 200 to $250 million going into the quarter. As we described in the second quarter earnings call, the coal sales we executed in the first quarter reduced our Q3 backlog.

The Texas market dynamics from earlier this year served to increase our cost to serve load and our hedging approach to our load and generation portfolios, combined with market price shifts in PGM, led us to project the negative results. In addition, offsetting this expected negative during the third quarter, we originated $100 million of new business which we realized during the quarter, and our portfolio management results were $100 million positive excluding the items previously mentioned. Offsetting these increases were trading losses of $210 million, primarily due to power positions. Approximately one-third of this was due to our activities to reduced risk.

Please turn to Slide 26. As you can see in the chart at the top of the Slide, during the quarter, customer supply realized gross margin of $119 million. This was in line with our third quarter expectations. Year-over-year on a comparable basis, gross margin is down $82 million or 50%. The difference is primarily driven by retail gas mark to market results. The retail power retention rate, including the customers that remain on a month-to-month basis, increased to 88%, which is in line with last year's rate of 89%. During the quarter, customers that had previously been on month-to-month contracts began locking in fixed rates due to favorable market prices in the third quarter, as price margins were $3.46 per megawatt hour, up from the third quarter of 2007. This was primarily driven by our sales force incorporating higher cost of capital into their pricing. Retail gas retention rates remained strong at 94%, and realized margins improved by $0.10 over last year, in part due to our acquisition of Cornerstone Energy.

Turning to Slide 27. As you see, 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 $2.4 billion. Netting the hedging impacts of approximately $1.3 billion are hedged EBITDAs forecast to be about $1 billion. Over the last quarter, the power curve and forecasted coal prices have fallen. We currently forecast hedged EBITDA of $1.5 billion in 2011. This is $600 million lower than what we shared with you in July.

Turning to Slide 28 and our Q4 outlook. Let me wrap up with a brief review of our fourth quarter outlook. Consistent with the approach we introduced in January, for the fourth quarter of 2008 we are providing a few key operating and financial metrics to help you understand our expectations. First, we are providing a BGE earnings range of $0.20 to $0.24 per share. This compares to fourth quarter 2007 earnings of $0.17 per share. The year over year variance is primarily driven by the impact of the Maryland settlement and lower costs. For generation, we are providing a hedged EBITDA forecast of $244 million. This is a $53 million improvement relative to EBITDA of $191 million earned in the fourth quarter of 2007. This is driven mainly by the continued roll off of low market hedges and higher capacity prices.

Our customer supply backlog is expected to be $210 million in the fourth quarter of 2008. Because we did not measure 2007 backlog in a manner comparable to today, we're not providing a comparable metric for the fourth quarter of last year. And with that, I'd like to turn the call over to the operator for Q&A.

(OPERATOR INSTRUCTIONS). Our first question comes from Dan Eggers with Credit Suisse. Your line is open.

Hey, good morning. Thanks for all of the detail today. May I just make sure I have this right? The shareholder vote is expected late December or sometime in January. You have all expectations of having 2009 guidance provided before the shareholder vote?

Yes, that is our expectation. And the -- really, the gating item associated with the shareholder vote is the -- both SEC timing of their response and our ability to turnaround whatever questions they have. So we will turn that around as quickly as possible; and if it's feasible to set the date in late December, we would do that. Otherwise, probably early January. But we would expect be providing investors with more visibility on the 2009 break down.

And the expectation, I guess, also from a timetable perspective, would be that the asset sales would -- or divestments would all be done by the time the shareholder vote comes, it sounds like also?

Probably not, Dan. But we would have visibility hopefully on the make up and terms associated with what we have done. But the closing of those transactions could easily slip into January. But our intention is to try to get those done as quickly as possible, both in terms of announced transactions as well as closings. So we will be working on those expeditiously.

Okay, and then when I -- I'm sorry?

Go ahead.

When look at the liquidity changes for December '08, the $300 million, is that the expected proceeds from the sale of the EMPS wholesale? The $0.3 billion?

I think that's -- Dan, that's a -- I think the range we'd expect. The slide you see -- the proceeds that would net against our liquidity.

Okay.

So given the nature of the credit lines that we are negotiating with the banks, we would expect to retain for ourselves a percentage of those proceeds, and certain of those proceeds would net against the existing lines.

So the $1.2 billion has net provisions in it as well?

From assets proceeds -- from sales proceeds, yes.

Okay. All right. Thank you, guys.

Thanks, Dan.

Our next question comes from Leslie Rich with Columbia Management. Your line is open.

I wondered if I could go back to Slide 25, global commodities. New business realized during the third quarter was a negative $247 million. And I'm sorry, I just couldn't follow exactly what was going on there. You said there were trading losses of $210 million, but what all else is in that bucket?

Leslie, I think -- this is Jack. The -- during the second quarter call, I think we went to some length to articulate that we expected 200 to $250 million of a shift in effective earnings between -- or expected earnings between Q3 and Q4. As we -- in our projection, this was a 200 to $250 million negative. As we realized through the year, we originate -- or through the quarter, sorry -- we originated $100 million of new business that offset this; and our portfolio management group also had $100 million positive results, which in effect would have satisfied a good portion of that 200 to $250 million negative that we expected going into the quarter. Importantly, on top of this, there were trading losses of $210 million. And the (inaudible) of this was related to power positions that we had on. Approximately one-third of that loss was related to our activities to reduce risk.

Okay, so you said $472 million was from lower portfolio management and trading. Was that year to date?

That's year-over-year.

Oh, year-over-year. Okay. And then --

If I could just clarify one thing. The 200 to 250 is not all a shift between Q3 and Q4. A portion of the 200 to 250 was due to a hedging strategy in the way prices had moved which created a downtick -- reduced earnings in Q3 and increased earnings -- you know, as we said at the beginning of Q3 looking forward. The rest was related to the coal sales in the first quarter and to market dynamics in Texas, which is increased our cost to serve load in that market.

Okay. And then going to Slide 20 on the balance sheet, your equity position reduced by $1.6 billion. Could you just walk through what that was again? You said AOCI reduced because of mark to market?

Right, so we had -- during the quarter, we issued an additional $354 million in commercial paper. We drew $750 million on our lines. Special items reduced retained earnings by approximately $296 million. And -- sorry, unrealized value changes in hedges that were recorded in AOCI in the balance sheet resulted in an approximate decrease of values to our equity balance of approximately 1.3 billion.

Okay, and you said those would be realized over 2009, 2010?

It's for all of our -- the majority, yes. But it reflects all of our hedged positions.

Okay, great. Thank you.

Our next question comes from Michael Goldenberg with Luminous Management. Your line is open.

Good morning.

Good morning, Michael.

I wanted to get a better understanding about the credit facility that you are trying to close, and how firm the commitment is -- I guess, first, it's been down say from 2 billion to 1.25. What assurances do you have that banks will not come back next week and say, sorry, we can't do 1.25. It is going to be much, much less. How firm is it?

Let me comment on that. We have an extension from the banks. We believe that where we will size out this facility is about 1.2. Given now what we know today, we are supplementing that with a liquidity resource facility from MidAmerican. We are trying to balance the size of this facility against both its costs and also the projected strategic -- the effects of the strategic transformations we are making. So as we look back, recall that in August we thought what we needed was $2 billion. We raised $1 billion in preferred at that time. In our discussion with the rating agencies and given the tremendous uncertainty in the marketplace and not really being able to define exactly what the impact of the strategic moves would be on collateral and credit requirements, at that time agreed with Moody's that we would go back to two. Since that time, we have had more information to us.

We obviously have more sense of the market and more sense of the cost of credit, and we think the right balance here is the program that we are putting in place, and we think this gets us to a reasonably good place, particularly with respect to dealing with the maturity in December. So we have just had some time to fine tune this a little bit more in a very difficult credit environment, and we think that during the course of the next seven to ten days, we are going to get this thing closed up.

Okay. But my question is still not what it is that you are trying to do. My question is what it is that banks are trying to do. If the banks that have committed the facility to you, if they decide to reduce the commitment, do they have the ability to do that? And I wanted to get a better understanding of what that flexibility is on that.

Well, I can speak from -- I can only really speak for myself. We talk to them every day, and we believe in the outcome that we just -- that I just described to you.

But should the banks change their minds? What legal ramifications do they have?

Michael, this is Jack. The firm underwritten commitment from UBS and RBS remains in place, and it remains in place through the 27th. I'm sorry, -- the 26th.

So the --

Hold on.

Go ahead.

The nature of that commitment enables them to use a number of areas to satisfy that commitment. Certain of that can be funded through a combination of incremental flex. Some of it can be satisfied by funded debt or the issuance of debt -- of incremental debt instruments. I think as Mayo discussed, we obviously have much more information now. We have taken significant steps to derisk our business. And I think what you see in the decision and the anticipation of closing on 1.2 billion next week is more a reflection of our perspective, when added to the $350 million additional liquidity we are receiving -- or we anticipate receiving from MidAmerican -- that we have a sufficient amount of liquidity to execute our business plans at an appropriate cost. Could we go out and secure the full 2 billion? I think the answer is -- I think the answer is yes. The composition of that, however -- and remember, this is meant to be insurance -- it is not anticipated that we would draw these lines, would have a level of permanency and cost that would not be reflective of the insurance that it's meant to be.

Okay. So if I understand you correctly, the reduction commitment was fully Constellation's idea?

I think it's fair to say that it's the result of our trying to navigate the appropriate level of liquidity, permanency of liquidity, funded nature of that liquidity and cost of that liquidity.

Okay, got it. Thank you.

Our next question comes from Ashar Khan with SAC Capital. Your line is open.

Hi, good morning. Mayo, could you just -- if you look at the way you describe the business today, it seems like that MidAmerican, the things that they put up in the deal that the business conditions deteriorate by "X" amount, they can walk off. Seeing this presentation today clearly implies that conditions have deteriorated since the start. So could you tell us what's happening on that level that they had indicated? What was that level when they redid the affirmed and negotiations? What is that level in your mind right now? I just want to get a better sense as to what is happening on that condition -- that a business conditions deteriorate by -- if I remember, it was 200 million -- I could be wrong. Where do we stand on that number as you regard between the two parties?

Yes, Ashar, I think the way to describe that, first technically, in the merger agreement there is a $400 million threshold that exists. Now it did start out at 200 during their due diligence period, and they released that covenant for now underneath the $400 million; and that essentially is a number, as in most merger agreements, that help characterize what a material adverse condition might be. As you know, those thresholds are often put in these agreements, but are also somewhat subjective in its interpretation. So we have very much made it an active part of our deliberations about managing the business to have MidAmerican in concurrence with what we are doing. And so some of these actions steps that we have taken, virtually from day one, have been with MidAmerican at our side. We obviously want to deliver a company that looks like the company they want it to be during the time when we closed this transaction. And obviously, they were have been showing a tremendous amount of support with respect to backing up the Company and participating in particular a back up facility of $350 million. So I think that these things ultimately are a little bit subjective. But I think that we are satisfied that with the active involvement with MidAmerican and the way things are progressing, that they have every intent to close and we have every intent to close.

Okay. And then if I could go back to the Slide 18, the way I understand it is that after -- is this -- this is pro forma or December '08. Is this pro forma for all transactions? That is, the coal, upstream and the downstream? Is that what the liquidity would stand, that we would have about 2.2 billion available and the downgrade would be like a 1.1 billion? Is that a fair representation for all transactions, if it's a pro forma for all transactions as contemplated right now?

That's correct, Ashar. So we have called out the incremental approximately $1.6 billion in liquidity facilities that we would expect to enter into in November, as well as the potential impact of the proceeds related to the sale of our upstream gas operations, as well as the potential divestiture of our London operations as well as our Houston gas trading operations.

Okay. And if I could just end up, Mayo, reading the proxy statement, if I understand the fairness opinion provided by Morgan Stanley. I mean, they didn't do any comps or anything. They just said, hey, the condition was either we are going bankrupt or to accept this 2650. Could you just elaborate a little bit, you know, why the bankruptcy -- according to you, I think -- why were we getting bankrupt? If we had gone bankrupt, according to you the value would have been substantially less than the 2650. Could you just highlight a little bit more on that valuation as to how we are reaching bankruptcy and the valuation would have been substantially lower?

Ashar, I am going to largely let the proxy speak for itself on that front. Obviously, we got a fairness opinion from Morgan Stanley, and that was an element of their evaluation. But I think that anyone can take a look at the components of value. In that determination, there had to be an evaluation of -- obviously the cost of bankruptcy -- in the direct cost of bankruptcy in the outright, as well as estimations about realizations of value. And Morgan Stanley made their conclusion and provided their opinion on that analysis.

Will that analysis -- it will be every made public to us, or no?

I do not believe that beyond what you see in the proxy that there will be any further disclosure on that.

Okay. Thank you, sir.

Thank you.

(OPERATOR INSTRUCTIONS). Our next question comes from Paul Fremont with Jefferies. Your line is open.

Thank you very much. If you look at Slide 18, there is discussion there that the 350 million facility allows for Constellation to sell certain assets to MidAmerican subject to FERC approval. Can you give us an idea of what types of assets are involved in that?

Paul, it's a -- yes, it's a put arrangement. It has two assets in it, one of which is a hydro facility and one of which is a gas plant. And again, much like the credit lines, we expect that this facility is an insurance policy. And so we would hope not to be in a position to exercise that put. But like the other facilities, it's there to provide the backstop relative to the downgrade collateral table. And the circularity associated with those requires that we -- you know, we want to have sufficient liquidity provide comfort to the marketplace. I guess we have time for one more question.

Well, does that work like collateral on a loan? Or is it an actual -- is it an actual sale and agreement to sell those assets?

Yes, it would end -- it exercised, it would end up being, in fact, cash back to the Company. It would be a sale.

Thank you.

Can we have one more question, please, operator.

Our last question comes comes from David Frank with Catapult Management. Your line is open.

Hi, good morning, guys.

Hi, David.

Just going back to the Slide 18, which Ashar pointed to briefly. It looks like if you don't execute any of the transactions -- the sales transactions you talked about -- you stand at a liquidity -- but you do close on the 1.2 billion. You stand at a liquidity of about $1.8 billion. Is that right? Available net liquidity?

Yes, that -- if you add the anticipated 1.6 billion of incremental liquidity and take existing anticipated liquidity at the end of the year, we would stand just south of $2 billion there.

And -- but your downgrade collateral requirements, if you were to be junked, would be a 2.2? Is that it?

David, think it's important to note that's as of calculations conducted on October 17.

Right.

We are actively taking steps to reduce the size and scale of our portfolio, as well as to reduce -- as Brenda discussed -- the margins positions that we have in our portfolio. As you see, we have had a pretty steady trend of that downgrade collateral target declining. And I think we would anticipate that trend continuing through the remainder of the year.

So it would be a safe bet that if you are able to complete some portion, if not all, or these transactions, you would have -- your coverage to collateral requirement in a downgrade would be maybe two or three times. So I guess my question to Mayo would be, I mean, this sounds great. Wouldn't this then (inaudible) the purpose and the need for the merger with MidAmerican?

Well, David, I think you get to the fundamental point, obviously, where we intend to -- we intend to merge with MidAmerican. We are proceeding down all that path. We also have the obligation as an independent Company right now to operate ourselves prudently. So yes, we are going down both paths, so to speak; but we also think there is alignment between the two and it's important that we manage the Company that way. In this kind of environment, the type of moves that we would be taking and are taking to reduce risk and divest ourselves of the businesses that we would hope to close by the end of the year are really consistent with what we would be doing independently anyway.

Right. And I understand your comments with regard to the merger you basically have to say. But I also know you wouldn't willingly want to sell this this Company at less than two times trough EBITDA. So I guess as a shareholder in the Company, if you are successful in executing on all of these plans, I would hope -- I would certainly vote against this deal, and I hope that we get a resounding no, because your Company is certainly worth far more stand alone than it is under this price.

Well, David, it's perfect to leave you with leave a concluding comment there, but I would say there are a lot of moving part to this. The markets are very volatile. We have a good merger partner. And we're taking -- going down that course, and my expectations is that when people get to see the information that we hope to provide in the context of people making votes, where we look at 2009 earnings, people will make their judgment on that, and we completely expect the people will see the advantages of merging with MidAmerican. So with that as concluding remark, we will look forward to seeing you as we talk about the merger more specifically in December. Thanks very much.

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