艾索倫電力 (EXC) 2009 Q1 法說會逐字稿

Good morning, and welcome to the Constellation Energy's first-quarter 2009 earnings conference. At this time, all participants are in a listen-only mode. (Operator Instructions) Today's conference is being recorded. If you have any objections you may disconnect at this time.

I will now turn the meeting over to the Executive Director of Investor Relations for Constellation Energy, Mr. Carim Khouzami. Sir, you may begin.

Thank you. Welcome to our first-quarter earnings call. We appreciate you being with us this morning.

On slide two 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 is being webcast, and the slides are available on our web site, which you can access at www.constellation.com under Investor Relations. On slide three, you will notice we will use non-GAAP financial measures in this presentation to help you understand our operating performance. We have attached an appendix to the charts on the web site, reconciling non-GAAP measures to GAAP measures.

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

Thank you, Carim. Good morning, everyone. Thank you for joining us today. Let me begin by saying we are pleased with our Company's performance thus far in 2009. First-quarter adjusted earnings were strong across our core generation, customer supply, and regulated businesses. At the end of March, we successfully completed the sale of our international commodities business, and we ceased to have commodity price exposure to our Houston-based trading operations.

During the quarter we also made substantial progress in derisking and reducing the scale of our legacy commodities portfolio. In addition, we strengthened our liquidity position despite the headwinds from a declining commodities market. Our first-quarter adjusted earnings were $0.74 per share, importantly every one of our core businesses outperformed on a year-over-year quarterly basis. Jack will speak later in the presentation about the specific performance of each business.

During the quarter, in a challenging market environment, we announced the divestiture of the majority of our noncore operations, the most significant being our international commodities and Houston-based trading operations. Last year, we had announced our intent to divest these businesses with the purpose of increasing our cash position and reducing our collateral obligations. These actions had positive cash implications, but also resulted in noncash, GAAP EPS charges. On a cash basis, we expect to receive approximately $35 million of net proceeds from these collective strategic actions. More importantly, as we complete these transactions between the first and second quarters of this year, they will return approximately $1 billion of collateral. Applying this liquidity to support new business activity at our customer supply business should facilitate lower risk future profitability.

On a GAAP basis, our divestitures resulted in a first-quarter accounting loss of $0.93 per share. The bulk of which was related to the sale of our international commodities operations. In the second quarter, we expect GAAP earnings to be negatively impacted by an additional $0.33 per share, primarily related to the April 1st completion of the divestiture of our Houston-based trading operation. Jack will discuss these one-time earnings impacts in more detail later in the presentation.

During the quarter, we also recorded a loss of $0.23 per share associated with our efforts to close the nuclear joint venture with EDF and with our repayment of our MidAmerican senior note completing our obligations to MidAmerican. The remaining $0.20 per share of one-time items consists mainly of impairments related to our equity investment in Constellation Energy Partners and our nuclear decommissioning trust funds as well as work force reductions related to the divested businesses. Collectively, as a result of our divestitures and other nonrecurring losses, Constellation reported GAAP loss of $0.62 per share for the first quarter.

Now let's turn to slide five and review our Q1 highlights. We have made substantial progress in completing the strategic initiatives we articulated during our year-end 2008 earnings call. In particular, we have significantly reduced the size and scope of our legacy commodities trading portfolio. During our February earnings call, we highlighted the potential for a one-time cost of up to $0.50 per share related to exiting this portfolio. As a result of our efforts, we are now comfortable that our existing 2009 EPS guidance range of $2.90 to $3.20 per share can absorb any potential one-time losses associated with exiting these legacy positions.

As I commented on the last slide, in March and April, we closed the divestitures of our international commodities in Houston-based trading operations. These sales returned significant collateral to us and reduced our downgrade collateral requirements by approximately $400 million. As part of the sale of our Houston business, we entered into a gas supply agreement with the buyer, Macquarie Cook. This credit enhancing structure significantly reduces new energy gases, collateral, and working capital requirements and improves its return on capital.

While smaller in size, we also divested our Portland-based west trading operations an Alberta based power and gas customer supply business. We are in the process of exiting our Ontario operations and prospectively our new energy retail activities will focus exclusively on the US market. Our derisking efforts have meaningfully contributed to our improving liquidity balances. We estimate that our net available liquidity at the end of April was approximately $4 billion, significantly exceeding our current estimated downgrade collateral requirement of $1.5 billion. These liquidity enhancing actions are freeing up capital to be used in other critical areas.

As of this call, we have contributed approximately $300 million to our pension fund. With these contributions as of March 31, our pension was more than 80% funded using the calculation prescribed by the Pension Protection Act. We continue to make progress and remain on schedule to close the EDF transaction in the third quarter of 2009. Shortly after our February earnings call, we received the necessary approval from FERC. We are also pleased to announce that we received foreign investment clearance from the Federal National Security and Commercial Agencies known as Sythias.

In New York, home to three of our five nuclear generating units, clearance was received from the state's PSE last month. During the first quarter, the Maryland PSE began its review of the EDF transaction. The review process is scheduled to conclude in June. In the meantime, we will continue to work closely with the PSE and other interested parties to determine the appropriate next steps. And our C approval is also progressing as expected and is anticipated in the third quarter of this year.

Turning to slide six, through our derisking efforts and active risk management, we have significantly improved our liquidity in 2009. As you can see in this chart, our liquidity position at year end was $2.4 billion. As of April 30th, our risk management actions have resulted in a net increase in available liquidity of approximately $300 million. Shown here by the first green bar. Specific steps we took to improve liquidity included the restructuring and termination of existing transactions and amendments to credit agreements that led to lower working capital requirements and the reduced posting of initial margin. We were successful despite the countervailing impact of declining power prices on our customer supply business and liquidity position.

In addition to the sales of our international commodities in Houston-based trading operations during the first quarter, we also divested our Portland-based west trading operations and Alberta-based power and gas customer supply business. The majority of the contracts associated with these businesses have already been novated. As of the end of April, we have received more than $900 million of total collateral from all of our divestitures as shown in the second green bar on the slide. Combined with the incremental liquidity we gained from additional regulatory approvals related to the EDF put agreement shown in the third green bar, our estimated liquidity as of April 30th is approximately $4 billion.

So turning to slide seven and a discussion of risk, we use a number of metrics to measure risk in our Company. Of these we view economic value at risk as the most comprehensive measure of the Company's exposure to changing commodity prices. This metric measures the risk in our total portfolio encompassing all aspect of our merchant business over the five-year planning horizon. Looking at this slide, you can see that we have substantially reduced our total economic value at risk from approximately $179 million in September to $92 million at the end of March.

In the fourth quarter of 2008 we converted our generation length in 2009 to 2013 to heat rate length by selling natural gas forward. During the first quarter as commodity prices markedly declined, we benefited from this action. Reduced spread positions in our legacy portfolio and reduced market volatility have also contributed to the decrease in economic value at risk. In January, 2009, we bifurcated our trading portfolio into two new and distinct, portfolios. The first relates to our core business and includes our generation assets, customer supply positions, and associated hedges. This is not unlike other integrated utilities. This portfolio constitutes the bulk of our ongoing economic value at risk.

The second book created was the optimization portfolio which consists primarily of legacy trading positions. Since January, we have made significant progress exiting these positions and are actively managing those that remain. In January, approximately $14 million of the total $123 million economic value at risk was related to positions in the optimization portfolio. As of March 31st, this number was approximately $8 million, representing in a 43% reduction in risk from these positions.

If you turn to slide eight, some closing thoughts on our ongoing operations. We have refocused our strategy to target three core operations; generation, customer supply, and BGE. We have resized them and taken active steps to protect the earnings from these businesses in 2009 and 2010. In 2011 and beyond we are positioned to grow earnings from the strong base and leverage the risk management capabilities that have contributed to this quarter's strong performance. The importance of these capabilities is rarely apparent in volatile markets.

Within our generation business, we saw the potential for heightened earnings and liquidity risk due to declining commodity prices in the fourth quarter of 2008. Our high hedge ratios in 2009 and 2010 protected our future earnings during this difficult period. Importantly, while our hedges insulate 2009 and 2010, in 2011 and beyond we are well positioned to benefit from an economic recovery. Our hedge profile with respect to coal consumed and power generated by our fossil fleet preserves an open dark spread.

Lately we have seen dark spreads rebound, and we believe that future dark spreads will expand as the economy improves and reserve margins tighten. If this occurs, we expect to see earnings growth in 2011 and beyond. Our customer supply group is a strong complement to our generation business as it allows us to earn better margins from our generating units and reduces our exposure to price risk. Importantly, we are benefiting from our improved competitive position in this business, and we are maintaining our profitability with higher margins offsetting lower sales volumes. We continue to find merit in the customer supply groups annuity life earnings profile.

And after pricing in the full cost of credit, we are earning strong risk-adjusted returns on a newly contracted business. We are also actively pursuing structures to address the unique credit and liquidity aspects of the supply business. Our gas supply agreement with Macquarie is one example of such a structure. Over longer term, we have looked to add generation assets in markets where we currently have active load obligations aligning the relative sizes of these two business units.

At BGE, Maryland is one of the few states that's approved both electric and gas decoupling which separates customer sales volumes from delivery revenue. This regulatory approach insulates the utility from reduced consumption and represents BGE and the Maryland PSE's commitment to the implementation of conservation programs. We have for example advanced metering pilot programs already underway and plan to deploy incremental capital to support smart grid initiatives. Prospectively, we expect to significantly increase our capital expenditure program at the utility as we roll out these programs growing CapEx from approximately $450 million in 2009 to approximately $700 million in 2010.

In summary, we are well ahead of our internal expectations for our derisking efforts with a refocused executable strategy. We have reduced risk, improved liquidity, and retained the talent and capabilities that are important for our core businesses. Certainly time will be the judge of the durability of our turnaround, but as a management team we believe we have the opportunity to deliver significant value to shareholders in the years ahead.

With that I'll turn the presentation over to Jack Thayer to review the financial results.

Thank you, Mayo, and good morning, everyone. I'll start on slide ten with the review of our financials for the first quarter of 2009. As Mayo mentioned earlier in the presentation, our first-quarter adjusted earnings were $0.74 per share. Strong performances by each of our core businesses contributed to these positive results. BGE recorded earnings of $0.41 per share for the first quarter of 2009 as compared to $0.37 for the first quarter of 2008.

While BGE traditionally records approximately half of its annual earnings in the first quarter of the year on account of the seasonal demand for natural gas and electricity, the improvement was primarily due to the timing of expenses within the year. Offsetting these favorable items was an increase in bad debt expense. Our merchant segment recorded earnings $0.25 lower this quarter as compared to the first quarter of 2008. Despite this decline, our ongoing core merchant businesses delivered strong results. Within this segment, our generation operations recorded an $0.08 improvement due primarily to higher capacity revenue and fewer forced outages. Additionally, our customer supply earnings improved by $0.18 due primarily to improved margins in our wholesale customer supply business.

Offsetting the positive results in our core businesses was our global commodities group which recorded earnings approximately $0.22 lower than in the first quarter of 2008. This reduction in contributed earnings reflects our efforts to derisk and substantially reduce the scope of our commodity activities. It is largely in line with our beginning of quarter expectations. Other negative year-on-year quarterly impacts primarily consist of higher interest expense and dilution from incremental shares issued to MidAmerican at the end of 2008.

Now let me take a moment to describe the special items that reduce adjusted operating earnings of $0.74 per share to a GAAP loss of $0.62 per share. Special items for the quarter totaled a loss of $1.36 per share. As Mayo discussed, in the quarter we recognized a loss of $0.93 per share from our business divestitures. I'll walk you through the various divestiture-related accounting, earnings, and cash puts and takes on the next slide. First-quarter merger-related costs totaled a loss of $0.23 per share driven primarily by certain cost associated with repaying the MidAmerican senior note and the pending EDF transaction. Other special items including impairments of our nuclear decommissioning trust fund and other investments as well as work force reductions totaled $0.20 per share.

Turning to slide 11. As we have discussed, while the sales of our noncore businesses significantly increased our liquidity position and reduced our collateral postings, they resulted in a GAAP EPS losses at closing. On this slide you can see the divestiture's impact in the first quarter and projected impact in the second quarter of 2009. The primary driver of the loss during the first quarter was the sale of our international commodities business. And we expect the most significant GAAP impact in the second quarter to be the divestiture of the Houston-based trading operations.

Other divestitures that will impact the second quarter include the sales of our west trading operations and our international uranium business. In each case, the gain/loss on sale lines reflect the difference between the last book value of the operations sold and the cash paid or received. Underlying changes in commodity prices, perceived market risk, as well as the substantially reduced pool of buyers all contributed to the difference between book value at time of close and purchase price received. In addition, upon sale completion where we have applied hedge accounting for transactions that were part of the activities we sold, we must recognize hedge losses and gains in earnings that otherwise would have been deferred in accumulated other comprehensive income, or AOCI as it's known, until realization.

Let me take a moment to dig deeper into this hedge component and its impact on our international commodities divestiture. As you may recall, when we committed to selling this business in October of 2008, accounting rules required that we discontinue hedge accounting treatment for this business and instead begin using mark-to-market accounting to capture the change in fair value on these hedges going forward. Up until this point, the underlying transactions had appreciated in value while the hedges had declined in value. These hedge losses would have offset gains in the underlying transactions being hedged had we held them to delivery. With the difference representing our hedged economic margin.

However, since we had to cease hedge accounting, the market-to-market loss in the existing hedges was effectively locked in AOCI until we sold the operation. This value is reflected on the slide as negative $68.4 million of AOCI reclassification and was realized on transaction close. Furthermore beginning in October, the use of mark-to-market accounting to capture the change in fair value on these hedges resulted in positive earnings. These hedges largely hedges of coal sales appreciated in value as coal prices declined. This appreciation was recorded as positive mark-to-market earnings contributing $93 million to fourth-quarter earnings.

The underlying accrual transactions that were hedged nonderivative coal purchase contracts, declined in value over the same period impacting purchase price and correspondingly loss on sale. If we'd been able to continue hedge accounting up to the close of the sale, the AOCI amount would have switched from a sizable GAAP lost -- loss to a modest GAAP gain. Before leaving this slide and this accounting complexity, let me emphasize we made the strategic decision to divest these businesses for less than their book value to speed the return of the cash and collateral. In so doing we traded away future potential GAAP EPS to reduce risk and free up liquidity to support new business at our core operations.

On a cash basis we expect to receive net proceeds of approximately $35 million and as we complete the novations the return of approximately $1 billion of collateral. We're very pleased with this outcome which was achieved under the most trying of global economic conditions.

Turning to slide 12. The considerable steps we've taken to improve our liquidity position are working. We believe that we now maintain adequate liquidity to sustain our business activities under any economic cycle. As you can see on this slide, our net available liquidity improved from $2.4 billion at year end to approximately $2.6 billion as of March 31. These balances compare favorably to the estimated downgrade collateral requirement of approximately $1.8 billion at March 31st.

While quarter-end liquidity was in line with forecast we provided back in February, this understates our strong performance relative to plan. Year to date we've made contributions of approximately $300 million to the pension fund. Roughly $150 million more than our plan contemplated in February. During the first quarter, we also purchased approximately $120 million of LC-backed, tax-exempt bonds. Following the close of the asset's divestitures and the novation of the majority of the related contracts, we estimate that our net-available liquidity at the end of April was approximately $4 billion, and that our estimated downgrade collateral requirement was reduced to $1.5 billion.

Turning to slide 13 for review of projected liquidity. Looking at our updated first-quarter liquidity forecast, we see meaningful improvements to our plan across all quarters. Largely driven by our successful derisking activities. Specifically, we see a $700 million improvement in our projected 2009 year-end available liquidity.

Turning to slide 14. Let me close by taking a moment to discuss our earnings guidance. We expect operating earnings per share to be in the range of $2.90 to $3.20 in 2009 and $3.05 to $3.45 in 2010. This is consistent with what was shown during our year-end 2008 earnings call and now also includes any potential one-time costs associated with our portfolio derisking activities.

As you'll recall under the EDF agreement, we will be conveying on a present value basis $700 million of below-market value to the JV with the result being a $350 million MPV pretax cash benefit to Constellation. The agreement is specific as to what types of contracts, but not which contracts must be conveyed. The simple resolution to the complex issue of valuing and allocating existing hedges to the JV reflects the narrow timeframe in which the JV was created.

While we have commented in the past, the $700 million value transfer may take the form of a basket of below-market generation hedges, in the time since entering into the agreement, EDF and Constellation have been exploring other possible means of value transfer. These options include potentially entering into a new below-market power purchase agreement with the JV for the nuclear plant's output. An option which has certain efficiency benefits that may make it desirable. The accounting impact of the $700 million transfer on our future earnings will depend upon the specific form of the value transfer mechanism we select. In general, if we transfer existing contracts, presently receiving accrual accounting treatment, we will recognize an incremental increase in our future operating earnings for the difference between fair value and the contract's book value. This form of value transfer is articulated on the slide at the bottom as total adjusted EPS.

Alternatively, if we enter into a newly executed below-market power purchase agreement or convey existing underwater mark-to-market hedge contracts, these derivatives would be marked to fair value at close and result in a one-time GAAP gain on sale. In this instance, our reported operating GAAP earnings guidance would be consistent with the adjusted EPS pre-allocation estimates shown on the middle of the slide. In either form, the positive pretax cash and MPV benefit to Constellation is $350 million, and our cash flow will be largely the same no matter which option is ultimately enacted.

If for efficiency we choose to pursue the underwater PPA option, we will add the after-tax cash EPS impact to our pre-allocation EPS to arrive at a result comparable to our stated operating EPS guidance. To make this treatment transparent, we have broken out the 2009 and 2010 earnings contribution that we assumed would come from transferring below-market accrual contracts. As we get closer to closing the JV transaction, we expect to finalize the form and timing of this value transfer, and we'll update you accordingly.

Prospectively in what we believe to be a trough commodity price environment we project $3 of baseline earnings per share in 2011 and beyond. As prices return to historical norms, we would expect earnings to trend above this level. We continue to be comfortable with our exposure to dark spreads and heat rates. In 2012 as nuclear power purchase agreements roll off, we are increasingly sensitive to power prices. On the right side of the side, we show the sensitivity of Company earnings to dark spreads, heat rates, and power prices. We believe as reserve margins tighten prospectively, prices and profitability improvement off this base forecast will follow.

With that, I'd like to open the call to questions. Operator?

Thank you. (Operator Instructions). One moment please for the first question. The first question comes from Paul Fremont from Jefferies. Your line is open, sir.

Thank you. Really two questions. The first is on the customer supply side. I think the annual guidance showed a detriment of $74 million. But in the first quarter it looks like the gross margin increase was $81 million. So I just want to understand, number one, what -- what happened in the customer supply business, and how should we look at expectations for the year? The second question is really on the gross derivative asset side. I looked through your presentation on derivatives. But can you explain why the level of your gross derivative activity which I guess ended the first quarter around $50 billion is -- is so much higher than -- than any of your peers?

Paul this, is Jack. Why don't I start off with -- with a discussion of the customer supply business. And then we can dive into gross derivative assets. With respect to the customer supply business, I think it's fair to say that we have seen the competitive -- relative competitive position of that business be quite strong. That the margins that we've earned in that business relative to plan have come in stronger than anticipated, and that we continue to see prospectively the opportunity to use our liquidity to earn good risk adjusted returns in that business.

And that compares to the $614 million of annual guidance? Do you come in -- do you come in lower in the future quarters and, therefore, still maintain that gross margin guidance, or does that move up based on the stronger margins you're getting in the first quarter?

I -- what I would say is with this is given our move to reduce the $0.50 of projected, one-time gains or sorry, losses, that we would see in exiting the -- exiting the legacy trading positions, that improved margins in this business helps facilitate our absorbing the cost that we see in exiting that trading book and holding our guidance firm.

Okay. And on gross derivative assets?

With gross derivative assets, the -- and as you mentioned we put out a companion piece this morning that articulated what this is a measure of and -- and in effect what it's not a measure of. I -- what I would say is this -- our -- our gross derivative assets are higher than our peers largely because of the size and scope of our customer supply activities. We lock in economic hedges to support that business, and earn good risk-adjusted margins in that business. And we've experienced a significantly volatile pricing environment where we've seen prices decline markedly relative to the time in which those contracts were entered into. And that's reflected in the gross derivative assets.

As those contracts roll off, we would expect our relative gross derivative position to decline, and that plus the divestitures of our certain businesses should lead to a smaller gross derivative position on a go-forward basis. That said, I think this is not really a measure of risk for this -- for our business, it's merely a -- a quantitative measure of the price moves from the time we've entered into contracts until -- until their delivery point.

So is there a normalized level when all of the sort of the noise from the roll off of -- of the contracts is sort of out of the way? Is there a normalized level that we should expect out of the gross derivative asset position?

I guess what I'd say to that is -- it's our view that this is not a measure of risk so it's not -- it's not a measure that we're actively focused on managing. I think you will -- it's fair to say that we would not expect to see prospectively the -- the dramatic rise and decline in power and gas prices that we've seen in the last 12 months. So we -- as business contracts roll off, we would expect the number to come down. But again, I -- I think the -- this is not as Mayo mentioned in his piece a metric that we view as a measure of risk. We view economic value at risk as a -- as a far better measure of the size and direction of the risks in our business.

Yes, Paul, I might just add to that I mean it's really just a function of price volatility. So the aggregate amount of these positions, will come down relative to where we've been in the past. And we understand what the roll off is. But if you really thought about it as only a deviation from the point at which an origination transaction has been priced, that's what's going to cause up or down the increase in the gross derivative position. So if prices were in fact stable for the next two years, that gross derivative position would come way down. But you have to expect some volatility relative to the origination point. And that's what's really driving it up and down. It's not really that much more complicated than that.

Thank you.

Thank you. Our next question comes from David Frank with Catapult.

Hi, David.

Hi. Good morning, guys. Question for you on your -- your hedge slide. You show the percentages of prices and percentage -- I should say the prices and percentages of output it looks like hedged. I was wondering, could you tell us what percent of the capacity in the PJM fossil fleet and nuclear plants are hedged in those years. Do they correspond to the output hedged?

David, this is Jack. I think with respect to -- to the hedge statistics we provide, those are comprehensive. That would -- that would be -- that includes not just the power output, but all of the various ancillary and other value associated with those generation assets.

Okay. Great. That was pretty much my question. Thank you very much.

Thanks, David.

Thank you. Our next question comes from Gregg Orrill with Barclays Capital.

Hi, Greg.

Hi, good morning. Just wanted to come back to the -- to kind of clarify the $3 number you were talking about as a base for -- for 2011 and going forward. It -- is that -- is that earnings guidance for 2011? And-- and how could you maybe break that down into the categories on page 14? The segment contributions.

I think with respect to 2011, as you know it was a big step for us to provide two years of guidance. We're certainly not at a point where we're looking to provide three. That -- 2011 is a long way from here. I think what this was an attempt for us to provide is that looking at our internal -- in our internal plans and giving current forward prices, some contexts for what our earnings would be given the current forwards on the output of our generation fleet. And provide a base off which you can build your projections in 2011 and beyond so that you might -- so that you can use that for conducting MPV or TCF or other analyses.

And that would -- that would be on an open basis or -- and how would that include or exclude the hedge allocation from EDF?

That -- that $3 figure reflects our current hedge profile on those assets that we -- that we own. With respect to the EDF hedge allocation, that $3 figure would be consistent with the adjusted EPS pre-allocation line that you see on slide 14.

Okay. Thanks, Jack.

Thank you. Our next question comes from Paul Patterson with Glenrock Associates.

Good morning, guys.

Good morning, Paul.

On slide 20, just going through the cash flow statement. I just want to make sure I sort of understand this. It looks to me like working capital is about $600 million of a benefit. And it looks to me that there's a derivative power sale contract classified as financing which also comes out of the financing activity. I guess they balance each other off. If I exclude those two numbers, I'm coming up with about $89 million. How should we think about the cash flow for the quarter and the adjustments that I just talked about? Would there be something else would add to here to define benefit obligation, is that something that would that be seen as unusual, or how do we think about that?

What I would say with this and, Paul, what we've found with our divestitures is the accounting around this is -- is highly technical. And reasonably arcane. We entered into both with our sale of our international businesses to Goldman Sachs and our Houston trading operations to Macquarie, we entered into effectively with Goldman a total return swap and with Macquarie what we refer to as a mirror trade book. So effectively conveying the -- the economic exposure to the commodities positions to Macquarie in the first quarter. That resulted in some interesting outcomes that -- that you see here on the Q1 cash flow. And you'll see in our 10-Q when we file it on Friday. The net result of these is really accounting treatment that nets to roughly offset one another. It shows up in the investing and financing activities as well as -- as well as you see it here in the operating activities. We can certainly walk through that with you offline. But I don't think we want to -- we want to encumber everyone on the call with -- with the technical accounting aspects of --

Fair enough. I don't want to put everybody through that either. I guess what I'm sort of wondering is what should we think about as an operating cash flow number before working capital changes? I mean, I know that there are a lot of moving pieces here because you've got the divestiture and stuff like that. I guess I sort of -- maybe we can do that offline if you would like. But that's what I'm sort of getting at -- is there another number that you'd sort of like to give us, or should we just wait for --

I think what I'd say here is -- is in the first quarter, you see the benefits of certain actions that we took to reduce the working capital embedded in our business, whether it be through -- whether it be through transaction restructurings or, for example, the credit sleeving agreement with Macquarie. In that, through that credit sleeve, we reduced working capital in our gas -- new energy gas business from roughly $700 million to $150 million. So that is perhaps skewing the working capital and operating cash flow results you see here. But I think reflective of the -- of the dramatic steps we're taking to improve the working capital and collateral efficiency underpinning our business. With respect to diving further into the cash flow statement, happy to do that with you offline.

Okay. Thanks a lot, guys.

Thank you. Our next question comes from Angie Storozynski with Macquarie Capital.

Thank you. I have two questions. First is about the improvement in margins in your competitive retail business. I'm struggling a little bit to understand that because I understand that fewer competitors you might have increased your margins for new business. But how about existing contracts? We were seeing a lot of demand distraction. You procured power to serve these contracts in the past, so margins actually should be coming down. How can you explain this discrepancy?

Yes, why don't I have Kathi Hyle take a moment and explain that.

Hi, Andrea. So certainly for new business that we have been booking in the quarter we -- as we've articulated to you, we have seen significant increases in our margins. We've been judicious in the type of products that we're offering, the customer set that we are pursuing, and we have in fact been correctly capturing the cost of credit in our margins. So on a go-forward basis you would expect to see, as I think we've positioned for you, a little bit smaller business from a size standpoint, but much higher margins and absolute numbers that are improving. With respect to -- and maybe what you're asking is, the -- another -- let me ask you, are you questioning what we've actually realized in the customer supply business for the quarter where you see --

That's correct. The realized earnings, yes.

So, you've seen a year-over-year improvement. And obviously, as you've correctly point out, that's not necessarily from the new business. That-- that we've booked in the quarter. Really it's just -- it's more of a timing issue year over year. Most of that improvement was in the wholesale part of our business. We did have a loss in the wholesale part of the business in 2008. And so we don't -- we're not seeing that in 2009, and that's driving some -- some of the improvements.

We've actually, interestingly on the wholesale part of the business, we are seeing lower attrition rates in the wholesale part of the business. Which, is a positive to us. But that positive is offset by some of the demand destruction that we are seeing in fact in the retail business. And order of magnitude that demand destruction is about 3%, a little bit higher in some market, a little bit lower in others. But on average about 3%.

Does that help?

Yes. Thank you very much. And the second question is, I understand that the derivative assets and liabilities are not really a measure of risk associated with your trading book. But having divested from those large gastrating operations, how is it possible that your book hasn't shrank? I mean, I'm sure that there were a number of assets and liabilities that were transferred to new buyers along with the sale. With the sales of both businesses. Why -- why aren't we seeing any impact from the derivative asset and liabilities?

Andrea, this is Jack. While we -- while we closed on the sales of the businesses at the end of the first quarter for London and the beginning of the second quarter for Houston, the actual novations of contracts are -- have occurred -- or largely throughout the balance of April. Therefore that was -- the impact of those novations are not included in our Q1 gross derivatives number. Prospectively, we would absolutely expect the divestitures of those businesses to reduce the overall gross derivative asset position just as -- just as the roll off of -- of contracts that we've seen in the first and second quarter, we would prospectively given a largely sustained current pricing environment expect that gross derivative number to come down materially when we report in Q2.

Is there any -- could you give us any percentage of the book that was -- that is being divested.

Again, I think we're -- we're spending a lot of time, and we provided a very detailed explanation of what gross derivatives are and are not. And I think to belabor this with targets or guidance on roll off would be to convey to you that we use this as a measure of risk, and we do not.

Okay. And-- but economic value at risk is the metric that you're using as a reflection of the risk of your portfolio. And it -- it did come down since -- since September. But it didn't come down since you last reported in February. And why is that?

I think -- I think it largely reflects that we have -- we are at a level of economic value at risk that's consistent with our core operations. Importantly, it did come down 43% in the areas that we're exiting. While that's not a significant -- while it's not a significant nominal figure, it is a large percentage. And I think more importantly the $14 million actually reflected the substantial actions that we took during the fourth quarter of -- of 2008 to dramatically reduce risk.

On a going-forward basis, I would say this is largely where we would expect to be. Depending on what power prices do and -- and the input cost as well as the volatility in the market. We absolutely believe that this is durable and sustainable level of economic value at risk. If you looked at other businesses such as ours would -- would look very much akin to the risk levels that they would have in their businesses assuming they're in the customer supply business, as well. And while we would expect it to come down as we divest our upstream gas properties and we also divest other legacy positions, I think this is a -- this is a figure that our balance sheet and our liquidity more than amply can support.

Thank you so much.

Thank you. Our next question comes from Michael Goldenberg with Luminous Management.

Good morning.

Hi, Michael.

I have two questions that deal further with the derivative book. First of all, I'm trying to reconcile -- and I'm sure you've done this in the past; I apologize if I've forgotten how to do it. But looking at slide 28 and slide 29, the slide 29 mark-to-market derivative asset has total net of 1036 fair value. And then slide 28 has the net derivative position minus 1.237. What am I missing? Is it the qualifying hedges? Is there any relation between those two numbers, or are they completely unrelated?

With respect to -- to slide 28, that has hedges in it. With respect to 29, that does not reflect hedges.

So --

With respect to 29, the significant number that you see there is the 2009 $781.3 million. As you recall we had very strong GAAP earnings and operating earnings in 2008 during the second quarter that were noncash. That-- that reflects the -- that figure reflects the cash associated or the value associated with those gains. And the realization of that in 2009.

But how do I reconcile the minus 1.2 to the plus 0.1? Is the difference a little over $2 billion in qualifying hedges against you?

The -- I think it's important -- these are derivatives that offset our power plants and other contractual rights. So I -- I think it's really reflective of if anything if you go to slide 21, the -- we show the hedged EBITDA from the generation fleet would be the -- would be where you see that.

Wait. Hold on. But once again, going back to the minus 1.2 and the positive one, is there any relation between those numbers? Is there anyway to reconcile? Because I see the word derivative on slide 28. Derivative on slide 29 both seem to say net. The numbers are totally different. I'm trying to understand if they're talking about the same thing, and there's $2 billion of some number that I'm missing, or if they're talking about completely different things?

On 28, it's cash flow hedges we've incurred losses on. And 29, it's part of the -- the FR 61 disclosure where we show in our mark-to-market derivative assets the realization pattern of the value we'd expect to realize.

Okay. I guess I'll just take it offline to figure out how to reconcile them totally.

Yes -- Michael, with respect to that I would just say we have underlying gains in our accrual positions. You have offsetting losses in the -- in derivative assets. We can absolutely take it offline. But it -- it's accounting.

Appreciate it. The other question has to deal with VAR. I guess over the last six to eight months, there's been a fair amount of articles published as to sale of VAR to capture sales and thing like that. And especially like in very volatile environments how VAR doesn't always do the job because it -- it's completely lops off the tails and pretends that they don't even exist. Beside VAR, what other metric do you, not -- forget investors, what do you look at besides VAR to try to capture the tails and see what may happen in sales in an extreme scenario?

I think what we might do is ask Brenda Boultwood, our Chief Risk Officer, to address that.

Hi, Michael. We realize the limitations of VAR. We recognize it, though, as a -- as a fair measure, consistent measure of potential daily changes in earnings for the Company. However, internally, we supplement VAR with a broad array of other risk metrics. Most significantly stress testing, which we believe really captures better these tail events that you speak of. Also internally, when we speak of VAR, we speak of a for sigma-level VAR, recognizing really the volatility of commodity prices. So in addition to VAR and stress testing we have a full set of position limits as well as stop-loss limits that are very relevant, should large price changes occur in the portfolio.

Got you. So neither net book nor gross book is something that you look at? Or consider in detail? So it's more like derivative of what would happen numbers, not what are my current balance sheet numbers?

That's correct.

Got it. Okay, thank you very much.

Thanks, Michael.

Thank you. Our next question comes from Ameet Thakkar with Deutsche Bank.

Good morning. I don't want to belabor the point and I haven't had a chance to fully go through I guess the derivatives and risk management kind of presentation you guys have on the web site. I guess just -- just trying to understand, certainly understand that the gross derivatives and -- assets and liabilities don't necessarily reflect the potential impact on your P&L. I guess, it seems to me that a lot of the slides kind of use a case where you're transacting with the same counterparty. And to the extent that you guys are transacting through exchanges such as ICE or in the OTC market, do you necessarily have that ability to kind of pick and choose the same counterparty? In doing so -- if you transact with a different counterparties your net position might be offset, but from a collateral standpoint, you could stress the balance sheet?

Ameet, again, I've -- with respect to actively selecting counterparties we trade with, we're absolutely doing that. That's part of the improvement -- improvement that we've seen in our collateral posting. We've been -- become much more active managers of -- of our relative net exposure to various counterparties and managing that. Obviously in the gross derivative case, even if you have two -- two offsetting positions with a counterparty such as Goldman or Morgan Stanley, they show as both as an asset and liability in a gross basis. But I would say the working capital improvement that you've seen thus far is absolutely the reflection of our more actively managing counterparty selection.

And if I could just ask one quick followup question on the customer supply slide, on slide 26. On the retail margin for power, I think it's kind of consistent with what you guys had indicated during our last call that you held. And I think you guys mentioned that you're pricing credits into your transactions now. And that helps explain some of the I guess margin expansion relative to historical levels. Now I mean is this a case where you were -- are you necessarily targeting sub-optimal credits and charging them more? And kind of your -- I guess the make-up of your book from a credit standpoint is changing? Or -- or you've just kind of redone how you price these deals?

It's Brenda Boultwood again. I would say if anything our credit quality selection on new transactions has improved. We are selecting higher credit quality counterparties to transact with. But when we talk about pricing credit, we're talking really about two things. One is the underlying credit worthiness of the counterparty customer. And just ensuring that we're receiving adequate returns for their credit rating as well as the term of the transaction. Whether this is retail or wholesale load sales. And-- and we're doing that -- we've done that very effectively.

Okay. Thank you very much.

Oh, just a second component, I'm sorry, was contingent collateral. So we're also pricing potential collateral usage on these transactions depending on their term. So that has been another component of the pricing which we've successfully priced.

Great. Thank you, Michael. And thank you all today for attending the earnings call. And we'll look forward to hearing from you next quarter.

Thank you. This does conclude today's conference. You may disconnect at this time.