公共服務電力與天然氣 (PEG) 2005 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Public Service Enterprise Group third Quarter 2005 earnings conference call and webcast. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session for members of the financial community. [OPERATOR INSTRUCTIONS]

As a reminder, this conference is being recorded Friday October 28th, 2005 and will be available for telephone replay for 24 hours beginning at 1:00 Eastern time today until 1:00 Eastern time on October 29th, 2005. It will also be available as an audio webcast on the PSEG's corporate web site at www.pseg.com.

I would now like to turn the conference over to Sue Carson. Please go ahead.

Thank you and good morning. We appreciate your listening in today either by telephone or over our website. I'll be turning the call over to Tom O'Flynn, PSEG's Chief Financial Officer, for a review of our third quarterly 2005 results and a discussion of key issues. Bur first I need to make a few quick points.

We issued our earnings release this morning. In case you have not seen it, a copy is posted on our website, www.pseg.com. We expect to file our 10-Q with the Securities and Exchange Commission later today, which will contain additional information.

In today's webcast, Tom will discuss our future outlook in his remarks, and so I must refer you to our forward-looking disclaimer. Although we believe that our expectations are based on reasonable assumptions, we can give no assurance they will be achieved. The results or events forecast in our statements today may differ materially from actual results or events. The last word on any of our businesses is contained in the various reports that we file with the SEC.

Recent SEC actions have created a hightened sensitivity to confirmation and/or changes in forward-looking information, in particular, earnings guidance. Our guidance speaks as of the date it is issued. Any confirmation or update in guidance will only be done in a public manner, generally in the form of a press release, a webcast such as this, or an 8-K or other SEC filing.

PSEG may or man not confirm or update guidance with every press release. As a matter of corporate policy, we will not comment on questions regarding guidance during one-on-one meetings or individual phone calls.

As a reminder, Tom will be using the term "operating earnings" to describe both quarterly and year-to-date results for this year. Operating earnings exclude merger-related costs and is our standard for comparing 2005 results to both 2004 and 2006. This term should not be confused with the GAAP term "income from continuing operations."

We also show net income, which includes the impact of the sale of Waterford as discontinued operations. We exclude the merger-related costs so that we can better compare our current period results with prior and future periods. By excluding the merger-related costs, our results and guidance are consistent with the way Epsilon is treating their merger-related costs.

The attachments to the press release provide the required reconciliations between the GAAP term "income from continuing operations" and "operating earnings."

Finally, Tom will take your questions at the conclusion of the prepared remarks. In order to accomplish this effectively, we'd appreciate it in you'd limit yourself to one question and one follow-up.

Thank you, and I will now turn the call over to Tom.

Thanks, Sue. Good morning all. Thanks for joining us. I hope you've had a chance to review the release we put out this morning.

On this call, I'll briefly go over our results for the quarter, put some perspective on our expectations for the full year as well. I'll also make some comments on the current market environment, particularly for natural gas and electricity and their impacts on our business goes forward. Then I'll add some color to the 2006 guidance we announced this morning.

Briefly, operating earnings for PSEG were 270 million for the quarter, excluding 10 million of after-tax merger-related costs, an increase of 18 million from the prior year. PSE&G, our regulated utility, reported operating earnings of 114 million, a $22 million improvement from the prior year. Power reported operating earnings of 135 million, slightly below last year's results of 139 million. Finally, Energy Holdings reported operating earnings of 39 million, up 6 million from last year.

As I go through the three major businesses, I just to remind you that I'll be using pre-tax numbers to describe the various impacts unless otherwise indicated.

At Power, improvements in the operation of the three nuclear units in New Jersey continued. For the quarter, the three units had a combined capacity factor of 96.5%, an improvement of 4.5% over the third quarter of last year. Both Salem units ran well, with Salem Unit 1 at full capacity for the entire quarter. As mentioned in the release, Hope Creek was out for seven days in late August, at a time when prices reached $150 per megawatt hour. Replacement power cost for the seven days averaged about $2.5 million per day, far exceeding the amount we generally see of about $1 million a day tor the plant.

Year-to-date, the capacity factor of the five-unit nuclear fleet is 89%, just slightly ahead of last year, which was 87.3 at the end of the third quarter.

When the impact of Hope Creek's being out for most of January is excluded, the performance from all five units has been exceptional this year. For the full year, Power is anticipating a five-unit capacity factor of about 88%, an improvement of 6% over last year. For just the New Jersey units, Power is looking at the potential for 12% improvement year-over-year.

On October 11th, Salem 1 started its 17th refueling outage, which includes the replacement of the reactor vessel head. This outage marked the end of 152 days of simultaneous continuous operation for the two Salem units, a new record, surpassing the previous mark of 148 days set in 1991.

In the spring, Salem 2 completed the refueling of a head replacement in a record 36 days. By applying the experience gained from the Salem 2 outage, the teams at the site are confident that the Salem 1 outage will meet or better the safety, radiation exposure, and outage duration performance established during the Salem 2 outage.

In other nuclear news, we continue to make progress with our safety conscious work environment efforts. Our metrics, along with the self-assessment we recently completed, indicate we're making progress in a lot of areas. For example, we set aggressive goals for reducing our corrective maintenance this year and in most instances have already met our year-end targets.

Turning now to the fossil fleet. Year-to-date, it's produced about 10% more megawatt hours than last year. The New Jersey coal plants have seen a 27% improvement in their availability year-over-year and a 21% increase in the capacity factor. Unfortunately, similar to Hope Creek, prices were high when Hudson experienced unplanned outages, costing us about 18 million compared to last year.

As you know, Power enters into four contracts for natural gas and electricity, a modest number of which require mark to market accounting. During the quarter, Power reported unrealized losses on support contracts of about 15 million or $0.04 per share. These losses will reverse in future periods.

This quarter the Nuclear Decommissioning Trust, or NDT, made a sizable contribution to our bottom line as a result of the continued restructuring of the underlying assets. For the quarter, net realized gains of 38 million or $0.09 per share were reported. On both a year-to-date and full-year basis, the NDT contribution is expected to be comparable to last year.

Summing up Power's results for the quarter, operating earnings were 135 million or $0.55 per share, compared to 139 million or $0.58 per share last year. Year-to-date, Power reported 313 million or $1.29 per share compared to 319 million or $1.34 per share last year. As you'll recall, the fourth quarter of last year was marked by the extended Hope Creek outage. With the improved operations we've seen at our New Jersey units, the fourth quarter results for Power should be a meaningful improvement over last year.

Now to PSE&G. Weather was a dominant event at PSE&G for the third quarter, providing a benefit of 16 million or $0.04 over last year. For commercial and industrial customers, demand revenues, which are based on the highest demand by the customer during each monthly billing cycle, were also up. Higher demand revenues, coupled with some additional volume, contribute an additional 16 million or $0.04 per share for the quarter.

On our last call I talked about some slippage in demand revenues and speculated that perhaps there was greater impact from the loss of a few large industrial customers. Looking at demand revenues for the second and third quarters combined, we were able to eliminate timing differences in the billing cycles and determine that, for the year, electric demand revenues are consistent with last year. In a few minutes, I'll talk about what we may see on the gas side during the upcoming heating season, but for now we continue to see modest growth on the electric side.

To summarize for the quarter, PSE&G earned 114 million or $0.47 per share compared to 92 million or $0.39 per share last year. For the first 9 months, PSE&G has earned 279 million or $1.15 per share, just slightly ahead of last year, with reported earnings of 278 million or 1.17 per share.

Turning now to energy holdings, at PSEG Global, [time] continues to be a significant contributor to holdings' 2005 results. For the quarter, the two combined cycle plants contributed 24 million more than last year. This upswing in earnings is the result of increased demand in Texas, partly due to weather and the dramatic increase in spark spreads in the region.

Recently the PSEG board approved a domestic reinvestment plan under the job [inaudible] that provides for lower tax rate on foreign earnings repatriated to the U.S. during 2005. We have approximately 182 million that was repatriated, 140 million of which is eligible for the reduced tax rate. We did record a related tax expense of 9 million, or $0.04 for the quarter on this transaction. For the balance of the year, we're projecting an additional 50 million of cash eligible for repatriation.

At Resources, results for the quarter for in line with last year. Recent bankruptcy announcements by Northwest and Delta are not expected to impact Resource's airline investments, which have a total value of 36 million. Resources believes the underlying asset value, as well as other structures within the leases, will provide substantially full recovery of the investments.

To round out the quarterly results, Holdings reported earnings of 39 million or $0.16 per share, a 6 million or $0.02 improvement over last year. Year-to-date, Holdings has earned 137 million or $0.56 per share, a favorable comparison to the 92 million or $0.39 per share reported last year. Year-to-date results for Holdings are already within the full year guidance provided earlier this year, so Holdings may end up the year above the earnings range originally established.

From a financing cash flow perspective, we were fairly active in the capital markets during the quarter. Two series of trust preferred securities, with rates of 7.25% and 7.44% were called, for a total of 375 million [inaudible] 375 million floating rate issue called at par after a year.

At PSE&G, 250 million of 5.25% 30-year notes were issued in July to redeem 125 million of 9 and 1/8% bonds and to reduce short-term debt,

In September, the long-awaited securitization of the year 4 BGS deferral took place. The 103 million issuance was used to reduce short-term debt.

Finishing up on '05, I want to reaffirm our full year projections of $3.15 to $3.35 per share, excluding merger related costs. As a reminder, the earnings ranges for each company are as follows: Power, 335 to 385 million, currently at 313; PSE&G, 325 to345 million, currently at 279; Holdings, 135 to 155, currently at 137; and PSEG, the parent, 65 to 70 million estimated cost, currently at 50.

That pretty much covers '05 from an earnings perspective. I'd like to spend a few minutes on the '06 guidance of $3.45 to $3.75 per share that was provided this morning.

10% increase in earnings next year is largely driven by Power, which will see significant upsize, reflecting our expectation of continued operational improvements and an increase in the price of our electric forward sales contracts. Power continues to maintain an objective of hedging up 75% or more of its expected generation output over an 18 to 24-month period. For the first time, year by year hedge amounts have been provided in our release, which should give you some indication of how we gained more comfort around Power's earnings growth potential beyond our '06 guidance.

For 2006, we've secured attractive margins through contracting for 85 to 90% of our expected coal and nuclear output. As you know, our coal and nuclear units generate over 80% of our output and a larger percentage of our margins. These contract levels, coupled with the ongoing operational improvements with our fleet, should dampen the impact of commodity price fluctuations during 2006.

For example, $1 MMBTU change in natural gas prices moves our earnings about a penny. A $5 a-megawatt hour change in round the clock PJM West energy prices has a potential to move earnings about $0.05, assuming a full-year impact on our current open positions.

Our projected nuclear capacity factor for next year is just over 91%, a 2 to 3% improvement over this year's expected capacity factor.

Also in '06, PSE&G is expected to benefit from reasonable outcomes of the two filings that are pending: The expiration of the 64 million depreciation credit, and the 133 million gas base rate case.

For Holdings, continued strong performance from Texas and South America should provide a stable earnings base in '06. Our guidance does not include any impacts from potential asset sales at Global.

Looking beyond 2006, we've been fairly active in our hedging. We've seen steadily increasing underlying energy prices as part of the BGS auction process. These can be seen in the PJM West round-the-clock one-year forward prices at the time of each auction. For example, over the next three years, contracts with underlying round-the-clock prices were between $32 and $47, and these are rolling off.

Current round-the-clock forward prices are above $70 per megawatt hour for the 1 year forward, trending down to about $55 per megawatt hour over a three-year period. When you consider that over 80% of our projected output is from nuclear and coal, it's not hard to understand the earnings potential for Power beyond 2006.

We've been hedging our 2007 and 2008 coal and nuclear output. We now stand about 65 to 75% hedged in 2007 and about 35 to 50% hedged in 2008.

We've indicated a 10% growth in our earnings from 2005 to 2006. Given the rising commodity environment in the level of our forward contracts, our expectations for 2007 and 2008 are annual growth rates that are meaningfully above the 2006 rate. Of course, good operations of our plants continues to be a key element to our financial success.

As you'll see later today in our 10-Q, considerable amount of detail about the various impacts higher gas prices have had on our business. Overall, we continue to believe that higher commodity prices are beneficial for Power. However, the near term impacts on our balance sheet need to be understood.

Unlike the modest number of contracts that are marked direct earnings, a significant amount of our contracts are marked to balance sheet through Other comprehensive income or loss, a component of equity. Since the beginning of the year, there has been a 370 million increase in other comprehensive loss. That's a portion of Power's equity related to the marks on these contracts. As with the unrealized losses recorded in earnings, these will reverse out as the contracts mature, with about half rolling off over the next 12 months.

Power is subject to collateral calls related to commodity contracts regardless of how the mark to market. Collateral requirements in the form of cash and letters of credit have increased with the significant increase in prices, as well as the increased duration of our book. As of September 30th, Power had posted cash margins of about 250 million and issued letters of credit totaling over 700 million.

To support these increase margin requirements, PSE&G and Power have increased their credit lines by 500 million, and we are comfortable that we can secure additional liquidity on reasonable terms if necessary. As of today we have almost 2.1 billion of liquidity available on our various credit facilities.

The combination of the increased collateral requirements and the reduction in equity through other comprehensive loss has increased PSEG's debt ratio to just over 60%. The issuance of 416 million of equity in connection with our mandatory convert in mid-November will reduce that number.

For customers of PSE&G, the immediate impact of higher gas prices is going to be on their heating bills. PSE&G was granted a 10.6% increase in gas rates effective September 1st. However, this increase is not expected to cover the actual cost of the gas during the heating season. PSE&G and other gas distribution companies in the state have received authorization from the Board of Public Utilities for two 5% self-implementing increases, if necessary, one in December, the other in February. Even with two 5% increases, the deferred gas balance related to this winter could exceed 100 million by September, 2006.

The New Jersey BPU recently established a board staff fuel cost team to work with the gas companies in New Jersey to further analyze the impact of wholesale natural gas prices and to explore options for dealing with these high prices.

While customers will be paying higher prices, they will also benefit from the successful hedging program and gas storage capabilities Power provides under the BTSS contract. As a result of the BTSS contract with Power, hedging contracts and deliveries to storage were entered into at a time when prices, while higher than historic levels, were considerably lower than today's prevailing prices.

Residential customers of PSE&G are currently paying between 8 and $9 per decatherm for gas this heating season, admittedly a significant increase over last year but overall about 35% less than the current market prices for this winter.

Commercial and industrial customers pay a monthly market based rate, so they'll be subject to the higher prices on the commodity portion of their bills. PSE&G is actively promoting energy savings tips to all customers in the attempt to reduce the overall cost of heating, with the likely result of reduced demand.

An increase in electricity prices for residential and small industrial customers, a result of the higher forward prices, will not occur until next June, when the rates established at the February, 2006 EGS auction will be effective. Even then, the impact on customers' monthly bills will be mitigated because of the three-year nature of the contracts and the favorable rates in the 2004 and 2005 auctions that remain in effect.

Finally, just a brief update on our pending merger. In September, PECO filed a settlement with the Pennsylvania public utilities commission that addressed most of the issues raised by the state related to the merger. In addition to rate discounts and caps through 2010, the settlement provided for substantial funding for alternative energy and environmental projects, economic development, and expanded outreach and assistance for low income customers. It's anticipated that the administrative law judge in the case may issue an initial decision earlier than the original mid December date. And the full Pennsylvania PUC will vote on the case, possibly before the end of the year.

Earlier this month, PSEG requested modifications to the procedural schedule in New Jersey that maintains the March 30th initial decision date and the May 15th BPU decision and final order. The request moves the hearings into early January, and the initial filing of direct testimony by the ratepayer advocate, BPU staff, and other intervenors into mid November. The revised schedule provides for some windows for settlement discussions later this year, end of January.

Exelon and PSEG expect that, assuming all the of the conditions for the merger are satisfied, the merger should be completed in the first quarter of 2006, assuming successful settlements in both Pennsylvania and New Jersey. If early settlements are not reached and approved, the merger is likely to close in the second quarter of '06.

That concludes my remarks. And now I will open it up for questions, Operator.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from the line of Steve Fleishman from Merrill Lynch. Please proceed.

Hi, Tom. I wanted to ask some questions about the New Jersey approval of the merger.

Yes.

And thoughts on that. First of all, there has been a lot of vocal opposition from other parties. I guess a group of other parties. What's your take on, given that vocal opposition, the likelihood that settlement talks could be successful, and how can you address some of their issues? Just your take on that.

Sure. There was a group of citizens, businesses, and labor group that surfaced a few weeks ago. A number of those parties are folks who have intervened and voiced issues in the past in various rate proceedings that we've had.

I think in general, Steve, the schedule has been moving along. There's been a great deal of discovery discussion, deposition of the staff, the BPU and all their consultants are doing an extremely thorough job, and we're doing our best to open our doors and make all information available.

In general, mid-November is the time when the direct testimony is filed. The intervenors kind of in late November file their -- I'm sorry. The consultants file their testimony at a later point. There are a couple of windows for potential settlement discussions from mid December. One potentially in January.

It's hard to -- it's hard to handicap these things. I would say, though, that we continue to think that the merger provides a number of benefits on the operating, financial, and some synergy sharing side. We saw a reasonable settlement in Pennsylvania, and we think it's the right thing to do for the State.

And then, how much, being in New Jersey, has the Exelon/Illinois situation potentially become an issue that might need to be resolved for New Jersey approvals? Obviously it's a totally different state, but has that been brought up as an issue at the commission?

And then I guess, on that topic, just while I'm asking, just what is PEG E's take on the material adverse change risk of what's happened in Illinois.

Okay. Clearly the financial integrity of PSE&G is critical. I, Jim Ferland, John Young, and other people have been deposed before the BPU. But the importance of PSE&G financial integrity, I think we've demonstrated that very clearly in the past and need to continue to get the BPU and others comfortable that that will continue.

In general, Exelon's credit metrics scale, breadth, diversity, those are all longer term credit positives, so obviously the Commonwealth Edison issue puts a wrinkle short-term in that. I think, Steve, what it leads is to go through the process and as we go through settlement discussions, the BPU is going to want to be comfortable that PSE&G will continue to be a stand-alone strong company. We've done that without structural things around the Company. We would hope to continue to do that, but if there are structural things we need to consider, those are obviously things that will be a part of the discussion. But I think we can get folks comfortable.

If you look at the way we've run the company, PSE&G, it has truly, through the various ups and downs of our other businesses, I think it's done well. Now the capital structure, given policy et cetera, has been extremely stable at PSE&G, and that's the way we're going to keep on running that business.

The ComEd, we're clearly mindful of the situation. The Exelon folks are good to keep us quite well-informed, and we are keeping our board informed. In terms of the [MAC], we're not seriously evaluating it as a [MAC] at this point. From our standpoint, the merger is going quite well. The Exelon team is running the nukes in a very responsible, valuable fashion. It's quite an impressive group that's down there, and we spent a fair amount of time with them. All of the pieces of the integration, from people, from values, synergies, et cetera, all those are looking very strong. We continue to think the overall themes are good.

There's obviously some tough issues that John and the folks have to deal with out there. They've got a lot of experience in terms of dealing successfully with things, and we have comfort that they'll be able to do that.

Okay. And then a question on some of your guidance. The assumptions for '06 on the PGM capacity prices, $3 per kilowatt year: does that reflect what they are right now?

Yes. They're in that range.

Okay. And what is some of the data that you've shown to the degree that like RPM were implemented that those capacity prices could go to? In some of the models that have been --

If you look at the PJAM stuff, when you get to numbers that would begin to -- they have a kind of sliding demand scale from 25% reserve margins down to 15. I think under 15 it becomes a bit of an alarm bell where you get a premium. But I believe numbers are in the 30 to 50 kind of range when you get to those levels, so they're certainly quite meaningful.

So, 30 to 50dollars per what?

Kilowatt year. Even those would not incent new build.

But you're assuming pretty much $3 in your numbers.

Near-term. Longer term with the expectations that the RPM will be adopted and will be quite --

When you talked about this kind of over 10% growth, '07, '08 ', are you including the RPM improvement? Or are you just --

We are including some modest RPM improvement, but it's largely driven by energy prices that are locked in pursuant to the hedge ratios and the open position of [inaudible].

Okay. And then just one other question on your power hedges.

Yes.

When you're showing this hedge data for your Power, are you -- particularly on the call where you've had some margin hit, are you kind of locking in the call at the same time so that's really kind of a hedged margin, almost, we should think about?

It's very close. Yes. Certainly for '06 and '07, for '08 largely.

Great. Thank you.

Our next question comes from the line of Josh Levin from Lord Abbot.

Good morning. I know last January when the merger was announced or right after it I saw that PEG E signed an operations agreement which allowed Exelon to go ahead and manage and hopefully improve the performance of your nukes For whatever reason, the merger didn't take place. What happened to that contract?

Contract can be there. We thought about that. Obviously, stability of a team is very important, it's important to us and it's important, frankly, to the Exelon team that's down there. They're down there, they've got a job, they're doing it, they want to make sure that they're there for a sustained period of time.

So the agreement has -- in the event the merger is terminated, the nuclear operating services agreement can extend for 2 years and for an additional third year at our option. So essentially we've got three years to find a transition in the event the merger was terminated.

Just to be clear, if the merger was terminated, the agreement definitely survived?

Yes. Definitely. That was very -- that was a requirement. We all agreed. To run a plant, you've got to make sure the team is going to be there for a sustained period of time.

Okay. And also on a separate note, as part of the approval process, I know you've been talking quite a bit with the staff of the DPU. How would you characterize your relationship with the DPU staff now? Is it as amicable as it's always been? Has it taken a turn for the worse, given the opposition in the state?

No, I think it's reasonable. They've got a job to do. We have a job to do. They have added some resources recently that I think will help them, just in terms of volume of work to do, especially a senior resource that will be helpful to get through it all. We've obviously been in this state 101 years, I believe it is. It is customary for us, if you look back at us, to have long and thorough discussions on things. For the most part, we've managed to have amicable settlement discussions at the end, albeit, of a fairly extensive process.

Okay. Thank you.

[OPERATOR INSTRUCTIONS] Our next question comes from the line of Paul Raymond from Jefferies. Please proceed.

Thank you. The RPM proposal was finally filed by PJM. Given the delays that have taken place in LICAP, can you give us a sense of what you think the time line would be? And yesterday I think the chairman of the Ohio Commission speaking in New York said he was skeptical that FERC would move forward with either LICAP or RPM. Any comment on that?

Yes. Obviously, the PJM has filed at FERC and tried to get something implemented by the start of '06. There has been some significant comments and intervention. We wouldn't be surprised to see some delay, and I think our financials would have some expectation of that. Clearly for '06, in our numbers for the next couple of years, we don't have any B material RPM input. But we ought to see Exelon support, so we think it's a must-do to get incremental build in. You're going to need incremental build. And so there may be some delay, but we believe it's hopefully going to happen.

The same in Connecticut. We're obviously interested up there. We do have a contract with one of the utilities up there that goes through '06, so it's not an '06 issue for us. It does become an '07 issue for us. There's a significant amount of debate also up there, but we think having some implementation during '07 would still be doable.

And any comment on the Ohio commissioner and his comments that he was skeptical that FERC would actually go ahead and approve either LICAP or RPM?

Yes, Paul, I'm not sure I'd want to make comment -- I haven't seen all the detailed comments made by that commissioner. I wouldn't want to make -- obviously, there's been a lot of comments on both sides and we've been fairly -- quite consistent and quite open. We think this is the right way to encourage capacity built on a reasonable, steady basis. Some may see that this would cause higher capacity prices in the near term, but we would say, if you don't do it, you're going to have a crisis and then there's going to be a problem and capacity is going to be at very high prices. This is a reasonable way to gradually step up into reasonable capacity prices.

Thank you.

Our next question comes from the line of Gregory Gordon from Citigroup Global Markets. Please proceed.

Hey, Tom.

Hey, Greg.

Just wanted to make sure I understand the connect-the-dots on your guidance. You're saying -- you gave explicit earnings guidance range for '07, and that translates into -- sorry, to '06. And that translates into earnings growth of approximately -- in the mid-teens type range?

Wait -- '05 and '06, just take it in the middle of each range, about 10%. 10.2 or something. We're saying that will do meaningfully better than that in each of '06, '07 and '07 to '08.

Great. I wanted to make sure I heard that correctly.

Yes.

You feel pretty comfortable with that because you've materially hedged out through those -- through that period?

Yes.

When it comes to a little bit more specificity, we sort of -- we know that you're in different markets. One of the smaller markets you're in is Connecticut.

Yes.

You've got some power plants? You've got a little over 3 million-megawatt hours of production annually there. And you're selling that power right now under a standard offer of service. Correct?

Correct.

And there's another auction in '07?

Well, we have a three-year contract from '04 to '06. And hopefully that entity will go through some sort of process toward the end of the year to secure power in '07 and beyond. I don't think they've made it public what they're going to do, but presumably we'll a player in that.

Okay. So that particular piece of your business, it's your expectation that they will hedge through participating in some incremental procurement process?

Well, before they had a process. They had an RP. We won the RP in, I don't know, fall of '03 that took us '04 ' to '06. So that contract period. So presumably, they will do something similar. I don't believe they've made if public whether that will be a one-year deal, two-year deal, three-year deal -- there will be other folks up there.

There are obviously -- the New England market has moved up quite well. It's a gas driven market, so that's lifted prices. We've got 400 megawatts of coal, Bridge Park Harbor is running fine. That's a very attractive asset up there. The value of that asset is in particular -- we bought 1000 megawatts three years ago or so, and the value of that coal asset there is quite attractive.

I guess my point is, when I look at that particular contract -- I think it's about a $50 contract, and the spot is almost double that right now.

Yes.

And you're telling me that that particular asset portfolio is not hedged because there's going to be a procurement process later next year?

No. I'd say -- no. I'd say we've -- I don't want to give away hedge numbers specifically, region by region. In the denominator of what I gave you, that would be there in terms of expected megawatt hour generations. We would generally look to hedge some but also leave ourselves able to play in upcoming auctions. Just like in the PJM numbers, we have hedged forward some in the general markets, but we'd also leave ourselves open enough to be able to play the BGS.

Okay, Tom. Thank you.

Our next question comes from the line of Kit Konolige from Morgan Stanley. Please proceed.

Hello?

Hey, Kit.

Just to follow a little more again on the hedging, it would appear, if it's not stated directly here, that you were extremely active in the third quarter in putting a lot of these sort of second and third year hedges in place.

I'd say -- yes. I mean, in general, some in the second quarter, some in the third quarter, we tried a dollar cost average, not thinking that -- absent a strong view in the market. I'd say it's been -- it's been a steadier process. I think we felt it was -- we felt it was helpful to give longer term ratios to get a little more clarity beyond our -- the disclosure we've given for now a couple of years of 75% or more.

We have a little -- I would say, if you think about where we were a year ago when we had our offset and we showed a graph at the Short Hills process, we've got a little more in year 3 than we would normally have. Year 1 and year 2 may not be meaningfully different.

Okay. I guess I was sort of jumping off from the -- I think you indicated the total collateral you have now is about approaching $1 billion. 950 million.

Yes.

And you say here that is 700 million increase in margin requirements during the third quarter.

Yes. Part of that, Kit, was in incremental contract. Part of that was just existing contracts we had. Price went up a lot.

Right. Exactly.

Probably even have some margin with your buddies.

I'll walk across the hall here and ask them. They won't tell me, but I could ask.

For the forward years, as you note, the open market prices, the around-the-clock prices are significantly higher than they were when you put your existing hedges into place, the ones that are running off now.

Correct.

I guess we'll sit down after this and do some backing out about 10% plus and see what we come up with, but just generally speaking, I mean, are you -- are you able to hedge at prices above those around-the-clock prices, given the existence of the BGS which provides a very substantial premium? Or how should we look at that, that you have some sort of phased-in average price if we go back over the last couple of quarters?

Yes. A couple comments here. In general, the market around-the-clock prices, definitely higher. We said for '06 they're about 70 bucks, backwardated like the GAF curve, so in '08 they're about 55 and I think they're in between in '07.

And that's for PJM East?

West. That's kind of the baseline. If you look at the benchmark, there's a benchmark to follow, and BGS includes a lot of stuff. I think as you and other people have pointed out in your writings, BGS has sometimes been one and a half times -- we're probably constant premium about 20 bucks over the round-the-clock PJM West. And what's in that, we said, Kit, that we think that's generally reasonable payment for all the stuff that's in there, i.e., it's not market profit, but if you look at transmission, you look at ancillary services, which have been quite good for us, you look at some of the load shaping issues, congestion, which is West/East, which is running pretty high -- West/East is up meaningfully. It's been 5 to 7 bucks over most of this year. Risk premium and a little bit of money for capacity, maybe a buck if you're lucky. You add all that up and you sort of get numbers that are the differential between round-the-clock PJM West and you add about 20 bucks, which is the list of the stuff I rattled off, and you get to a general BGS number.

So if you want to think about the numbers for the forward BGS, who knows what's going to happen in February, but the one that's rolling off out of our book is one that was priced at 32 to 33 bucks around the clock. This was back in '03, so --

So plus 20.

Yes. I think it's a 52, 53. That's the one that's rolling off. It's kind of the benchmark if you think that the 20 bucks is relatively stable. Then the way to get some understanding of how that might move is to look at what that 32, 33 bucks, you know 3 has compared to the current 3-year forward strip. And now it's probably low to mid 60s on a three-year forward strip.

Right. But of course we can't tell from what you've given us here at what -- I mean, that's been running up consistently over the last year and more, so we can't really tell at what point you put those hedges into place.

No, you can't. But what we'd say is that we are what we are. And given the hedge ratios we have and the current prices in the market -- we threw out I think a number of 69 for '06. Given those prices, that's where we see our '06 guidance and then we see the growth rate for '07 and '08 as being better than 10%.

Fair enough. Thank you.

We're turning over some of the cards, Kit. Not all of them.

Right. It's that one in the middle that makes all the difference. Right?

[Laughter] Okay.

Thank you.

Our next question comes from the line of Paul Ridzon from Key McDonald. Please proceed.

Tom, you threw out a range in response to Steve Fleishman's question -- packets of 25% and 15% reserve margins. Did you give up a payment for the 25% end?

It's on the PJM website. On the 25% end, it was modest. On the 15 to 17, that's when -- that's the range. It's in the mid to high teens when PJM is looking to incent build. When you get under, I believe it's 15, then I believe you get some premium prices, because there may be some emergency building required. I think in the mid to high teens, it's in the 30 to 50, 60 buck range. Even then, if you look at the map to build new capacity, it's got to be above those numbers. So I'm being conservative just because it's been low for a few years here.

But it's all on the PJM website, so I wouldn't want to go too far explaining the stuff that they've put out.

And how would you handicap RPM implementation?

We think it's going to happen. There's certainly a lot of discussion about when it's going to happen. But we think with some general increase in demand that there will be new facilities required to be built, and we think that's by far the best way to do it.

Thank you very much.

Our next question comes from the line of Clark Orsky from KDP Asset Management. Please proceed.

I had a couple questions about holding. Any update on the IRS tax investigation?

Yes. We continue to -- you know, we have a reasonable amount of [LILOs] and [SILOs]. Probably the update, and it will be in our Q, is that we are -- the IRS has been looking at our audit for -- I believe it's the '97 to 2000 timeframe. They have sent us a note that they are proposing to disallow a number of the deductions under those transactions. Obviously, we continue to think that our structures are solid. We got good opinions, and they give economic substance.

Nevertheless, I think our Q will say that -- as we look at all the deferred taxes taken up until the filing of the Q, September 30th, there's 650 million of deferred tax liabilities that have been recorded under these structures, and there's also about another $80 million of after-tax in the event penalties were assessed. So it's a little more -- it's consistent with the disclosure we've put in before in our K and proxy and Qs, but that would be an update. It will be in our Q that we'll have out hopefully at the end of the day.

Okay. And have they sort of given you a number?

No.

In terms of which one of those they're going after?

No. No. This is in the middle -- it's in the midst of the audit, so it's -- They've told us that there's a number of the structures that they're proposing to disallow. We have the opportunity to assert our viewpoint, and it will be a fairly lengthy process.

I want to make sure I said it. So, what it will be in our Q, it will be 650 of deferred tax liability that could be subject to these. We obviously think that's the worst case kind of number, but that will be there. And the $80 million is interest. I'm sorry. I think I may have said penalties. It's on interest.

One other question. Any updated thoughts on sort of what you might do with holdings, given sort of what you said about not putting any more money about it and it doesn't seem like Exelon is all that interested in it?

Yes, what I'd say is, holdings are doing fine if you can keep by the numbers. We expect them to be above their guidance range that we put out about a year ago. Specifically, Texas is doing well. Latin America is doing quite well. If you look at the -- we provide in one of our exhibits here, if you look at EBIT contribution from North America and South America, they're up nicely.

On a stand-alone basis, we will continue to look for opportunities to monetize the value of assets. Those are things that we tend to look for and not talk about them until we're very comfortable that there's near term visibility on something. That would be, in general, I think on our own basis, it would be a multi-year kind of process. I think Exelon has said that their horizon may be shorter, so after the closing there may be some acceleration of things. We're obviously thinking about some of those things as part of the integration process, so know if those things are really in the planning stage at this point.

I appreciate the update.

Yes.

Our next question comes from the line of Michael Goldenberg from Luminous Management. Please proceed.

Good morning, guys. Sorry, I missed most of the call. Just wanted to ask about the New Jersey BPU proceedings. In terms of the way the discussions are being held, between PSE&G and Exelon, who particularly is in charge of these discussions? And maybe you can say specifically what PSE&G is doing to kind of bring the guys from Illinois into the fold and alleviate whatever concerns may be within BPU, given that you've known them for so long.

Sure. I think the discussions are really quarterbacked by Ralph Izzo, President of PSE&G, and he's going to be responsible for the three T&E utilities, post-merger. Obviously, there's a number of other people, from a legal standpoint, Mr. Ferland's obviously focused on it also.

We integrate with the Exelon folks, John [inaudible] Betsy, obviously is very active in all the regulatory thinking around those kind of subjects. So it's really, I think, led by Izzo with a very integrated effort.

What are you specifically doing to --

I think we're -- the specific tasks are really on all fronts, dealing with a number of discussions with the BPU, more than a couple thousand questions have come forth, dealing with the consultants, both ourselves from a business financial -- all around the areas, both ourselves and some of the folks at Exelon. Having some discussions with other constituents around the state, but obviously the BPU is the leader of the process.

We're trying to hit on all cylinders. We're working through it, but it's a big issue. But we continue to be comfortable that it's the right thing to do and there's benefits for the State.

Okay. And my other question is -- I think Steve Fleishman might have touched upon it early in the call, but like I said, but I missed a big part of it. In terms of a lot of parties being involved in settlement discussions, do you see specific parties without which a settlement cannot take place? Obviously you will not be able to get every single party, but would you be able to name three or four or five parties without which a settlement is just not feasible?

I think you have to look back at past records of who we've had settlements with. I don't think it's fair to single out any one party at this point.

Fair enough.

We should go, and I think we'll allow maybe one last question.

One more caller. Operator, is there one final question?

We have a question from Steve Fleishman from Merrill Lynch. Please proceed.

Hi, again. Tom, do you have any sense that you might be able to provide on the assets that are being considered for divestiture as part of the merger? Just -- I know they're mainly your assets and some mix of coal and gas. I think mainly gas.

It's really a balance of -- there's eight meaningful ones. Some of our coal, some of their coal, some of our joint coal, like Keystone Conemaugh.

Right.

And then I guess a new combined cycle facility. So It is a balance. We're obviously working through it actively. The major issue is DOJ. We've been through, FERC, they've got a fairly prescriptive formula of how they look at market concentration. We are working with DOJ. They have the same themes, but look at it in slightly different ways and we're frankly, both our team and the Exelon team are working actively to help them think through whether there's any suggestions, modifications, whatever.

I think after that process, we will then go to the market with a set of assets that could be all those assets, all those large eight assets plus peakers or it could be a reduced group of assets. We'll just have to see.

In terms of timing for that, we would expect to -- we would hope to get enough input from DOJ this year such that we could then start a process.

Okay. Thank you.

Mr. O'Flynn, there are no further questions at this time.

Thanks, all, for listening. Hopefully we'll see a lot of people at the EEI. Once again, we're pleased that we're going the right direction this year, and we think over a longer 2 to 3-year time period we've got a business model that effectively balances earnings growth with some prudent risk management. Thanks, all, for joining.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Have a great day, everybody.