賓州電力 (PPL) 2018 Q4 法說會逐字稿

Good morning, and welcome to the PPL Corporation Fourth Quarter Earnings Conference Call.

(Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Andy Ludwig, Director of Investor Relations.

Please go ahead.

Thank you, Phil.

Good morning, everyone, and thank you for joining the PPL conference call on fourth quarter and year-end 2018 financial results.

We have provided slides for this presentation and our earnings release issued this morning on the Investors section of our website.

Our presentation and earnings release, which we'll discuss during today's call, contain forward-looking statements about our future operating results or other future events.

Actual results may differ materially from these forward-looking statements.

Please refer to the appendix of this presentation and PPL's SEC filings for a discussion of factors that could cause actual results to differ from the forward-looking statements.

We will also refer to earnings from ongoing operations or ongoing earnings, a non-GAAP measure on this call.

For reconciliations to the GAAP measure, you should refer to the appendix of this presentation and our earnings release.

I'll now turn the call over to Bill Spence, PPL Chairman, President and CEO.

Thank you, Andy, and good morning, everyone.

We're pleased that you've joined us for our 2018 year-end earnings call.

With me on the call today are Vince Sorgi, PPL's Chief Financial Officer; Greg Dudkin and Paul Thompson, the Heads of our U.S. Utility Businesses; and Phil Swift, who was recently named Chief Executive of Western Power Distribution in the U.K. following the unfortunate passing of Robert Symons in November.

While we are deeply saddened by Robert's passing and he will be sorely missed, we are very fortunate to have Phil, who has a wealth of experience with over 25 years at WPD.

I have great confidence in Phil's ability to lead our tremendous team there and to continue the company's proven track record of outstanding execution established by Robert over the past 20 years.

Moving to Slide 3. Our agenda this morning begins with a brief overview of 2018 results and PPL's business outlook for 2019.

I'll also provide a brief update on key regulatory developments.

Vince will then provide a more detailed financial review of 2018 and 2019 and the discussion on our earnings guidance for 2021.

As always, we'll leave ample time to answer your questions.

Turning to Slide 4. 2018 marked another successful year for PPL as we delivered on our strategy of best-in-sector operational performance, investing in a sustainable energy future, maintaining a strong financial foundation, and engaging and developing our people.

We closed the year with strong operational and financial results.

As announced earlier today, we achieved the high end of our 2018 ongoing earnings forecast range or $2.40 per share.

2018 was the ninth consecutive year that we exceeded the midpoint of our guidance.

It was the second straight year that we achieved the high end of our forecast.

We're very proud of this track record of financial performance.

It reflects our emphasis on execution and operational excellence across the regulated businesses, which included minimizing regulatory lag and achieving the allowed returns set by each regulatory jurisdiction, which we accomplished in 2018.

This was paramount in delivering a 7% increase in ongoing earnings from 2017 results while also strengthening the balance sheet post-tax reform.

Focused on maintaining a strong financial foundation, we completed a $1.7 billion equity forward to mitigate tax reform impacts, strengthen future credit metrics and support our solid investment-grade credit rating.

As for investing in a sustainable energy future, we successfully completed about $3.5 billion of infrastructure improvements in 2018.

In Pennsylvania, we installed approximately 1.2 million new meters, keeping us well on pace to conclude our advanced metering project in 2019.

We also continued to strengthen our transmission system to improve grid security and resiliency.

In Kentucky, we continue to make progress on a multiyear project to cap and close ash ponds at our coal-fired power plants.

We ramped up the investment in Smart Grid technology on our distribution and transmission systems to more quickly detect outages and restore power.

And we put the finishing touches on the modernization project at our Ohio Falls hydroelectric facility, increasing the generating capacity from 80 to 100 megawatts.

In the U.K., we have executed on our asset replacement and fault management plans.

We continue to incorporate more automation on our networks and advance numerous low carbon network projects to enable increased adoption of distributed energy resources.

In addition to delivering strong financial results through our infrastructure investments, we continue to make progress in pursuit of our strategy to deliver best-in-sector operational performance.

Our utilities remained among the very best for customer satisfaction in the regions we serve.

Both PPL Electric Utilities and Kentucky Utilities received J.D. Power awards for residential customer satisfaction, achieving the highest overall marks in their respective categories and regions based on customer surveys.

These achievements represent the 46th and 47th J.D. Power awards earned by our domestic utilities.

Meanwhile, our 4 U.K. distribution network operating companies remained the top 4 performers in Ofgem's broad measure of customer satisfaction for the regulatory year ended March of 2018.

WPD also ranked best among U.K. operators in stakeholder engagement and addressing vulnerable customers, which are important areas for Ofgem, and they did this for the seventh straight year.

At the same time, safety and reliability across our businesses remained strong in 2018.

All 3 of our domestic utility companies were recognized as top quartile of public utilities nationwide in limiting the average number of outages per customer.

In addition and for the second straight year, PPL Electric posted its best year ever for safety.

These achievements reflect the common purpose and desire across our businesses to deliver without fail for our customers, to exceed their expectations and to improve performance each and every day.

On the regulatory front, I'd like to highlight our efforts in Pennsylvania in establishing a means for alternative ratemaking for state utilities.

We view this as a very important piece of legislation as it grants the ability to develop additional regulatory mechanisms such as decoupling and incentive-based rates.

Also in 2018, we continue to invest in our employees, developing the pipeline of future leaders and fostering a more inclusive and encouraging innovation among our employees.

While we need to continuously focus attention in this area, I'm proud to report that PPL was recognized by Forbes Magazine as one of America's best employers in 2018.

Our Pennsylvania operations were also recognized as Best Places to Work for Disability Inclusion and received a perfect score of 100% on the Human Rights Campaign Foundation's Corporate Equality Index.

Turning to our 2019 outlook on Slide 5. Today, we initiated formal 2019 earnings guidance of $2.30 a share to $2.50 a share.

Vince will take you through a detailed walk of 2018 actual to the 2019 forecast earnings later in his remarks.

Our projected 2019 results keep us firmly on track to achieve the 5% to 6% growth target for ongoing EPS through 2020, which we reaffirm today.

We also initiated a projected earnings guidance range of $2.50 to $2.80 per share for 2021.

Turning to our dividend.

Today, we announced we are raising the annualized dividend to $1.65 per share.

PPL has paid a dividend in every quarter since 1946.

In addition, the company has increased its dividend 17x over the past 18 years.

We remain committed to dividend growth as it is an important piece of our overall shareowner return proposition.

We will continue to assess the rate at which we grow the dividend in the context of our yield and payout ratio relative to peers.

In terms of network investment for 2019, we plan to put another $3.3 billion into our utilities, which we will continue to support the efforts to improve the customer experience and resiliency of the grid.

As reflected in our 2018 results, our investments are driving better operational performance.

We expect this trend to continue as we make these additional investments.

Finally, we will remain focused on achieving balanced regulatory outcomes that will benefit our customers and our shareowners.

In Kentucky, our rate review, which takes a combined revenue increase of $172 million, continues to proceed as scheduled before the Kentucky Public Service Commission.

Our rate requests are being made to support additional capital investments to make the grid smarter, stronger and more resilient, to replace aging natural gas lines and to support additional power plant performance and reliability improvements.

All these investments are expected to further improve service to our customers.

In the U.K., we continue to work with Ofgem to develop the rules that may be used to shape the framework for the next price control, which begins in 2023 for electric distribution utilities.

Turning to Slide 6. We wanted to clarify and outline some observations about Ofgem's recent RIIO-2 consultation document that pertains to the electric transmission and gas subsectors.

That consultation document, which was issued in December, does not apply to the electricity distribution network operators, including our U.K. company, Western Power Distribution or WPD.

In addition, it does not impact WPD's current business plans that extend through March of 2023 or it does not impact WPD's operations.

It is important to note that this is a consultation, and Ofgem is seeking comment from a wide variety of stakeholders to ensure the best outcome.

The comment period on that consultation ends March 14, 2019, with the decision expected by Ofgem in May.

In that consultation document, the proposed returns for gas and transmission were lower than we expected.

They are based on current market conditions and other proposed methodologies on which Ofgem is seeking input and comments.

Also in that document, Ofgem proposes to index the cost of equity to risk-free rates, which are currently negative in the U.K. Given we are years away from settling our tariffs or setting them for the electric distribution sector and market rates are currently near record lows, we believe there is potential upside from current market conditions in terms of the cost of equity that we will be receiving in RIIO-ED2.

We also expect that incentives will play a significant role in RIIO-2 based on the subsector consultation.

We recognize that this will be an area of key debate as it represents a significant opportunity in driving operational efficiency and returns.

While it's not clear how incentives will be structured for electric distribution networks at this time, we expect that Ofgem will be more focused on differentiating returns and provide substantial opportunities for the top performers.

WPD is well-positioned with its strong track record of superior customer service and reliability.

Further, we see ample opportunity for continued RAV growth through RIIO-2 to support replacement of aging infrastructure and the investment demands of U.K. electrification and carbon reduction initiatives.

PPL and WPD will continue to monitor Ofgem's RIIO-2 consultation process and provide input and engage with Ofgem to ensure the best outcomes for all stakeholders.

Lastly, even though the current consultation for transmission and gas does not apply to WPD, we would still encourage our investors and others to provide their feedback and views to Ofgem on this consultation.

It is critically important that Ofgem hears from all stakeholders during the consultation.

With that, I'll now turn the call over to Vince for a more detailed financial overview.

Vince?

Thank you, Bill, and good morning, everyone.

Let's move to Slide 8 for a brief financial overview before I get into the details.

Regarding 2018, I'll focus my prepared remarks this morning on the full year results.

Please refer to the news release for additional details on the fourth quarter results.

Today, we announced 2018 reported earnings of $2.58 per share compared to $1.64 per share a year ago.

2018 reported earnings reflect net special item benefits of $0.18 per share, primarily due to unrealized foreign currency economic hedges.

2017 reported results reflect net special item expenses of $0.61 per share, primarily due to the impact of U.S. tax reform and the unrealized foreign currency economic hedges.

Adjusting for these special items, 2018 earnings from ongoing operations were $2.40 per share compared to $2.25 per share a year ago.

The solid execution of our business plan and benefits from weather during the year enabled us to achieve the high end of our ongoing earnings guidance range.

Looking at 2019, as Bill indicated, we announced formal guidance of $2.30 to $2.50 per share.

As you may recall, we accelerated the timing of some planned equity issuances into 2018 and 2019 as a result of U.S. tax reform to support our credit metrics and significant capital investment program.

While this results in higher dilution in 2018 and 2019, we continue to expect 5% to 6% compound annual EPS growth through 2020 based on the 2018 original ongoing earnings guidance midpoint of $2.30 per share.

In addition, we continue to project growth through 2021 and have initiated a guidance range of $2.50 to $2.80 per share, which I will discuss in detail in a few moments.

Turning to Slide 9 for a detailed review of 2018 financial results.

Overall, we continue to deliver strong year-over-year earnings growth at each of our operating companies, driven by our substantial investment and ability to earn our allowed returns.

Excluding the $0.07 per share impact from dilution, 2018 financial results grew nearly 10% from 2017 results.

The primary drivers for the year-over-year increase are higher adjusted gross margins, the higher foreign currency translation rate and higher pension income for the U.K. segment.

The positive drivers were partially offset by higher income taxes, higher O&M, higher depreciation and higher financing cost.

A portion of the adjusted gross margin increase was driven by higher sales volumes due to weather, was about $0.11 per share, primarily at our domestic utilities.

Turning to the individual segment drivers, starting with the U.K. Our U.K. Regulated segment earned $1.36 per share, a $0.12 year-over-year increase excluding dilution.

This increase was primarily due to higher adjusted gross margins driven by the April 1, 2018 price increase, higher foreign currency exchange rates in 2018 compared to 2017 of $0.13, and other primarily due to an increase in expected pension asset returns on higher asset balances.

These positive drivers were partially offset by higher O&M and higher income taxes, primarily due to higher U.S. income taxes as a result of a 2017 U.S. tax benefit from accelerated pension contributions and the reduction in tax benefits on holding company interest expense due to the lower federal tax rate resulting from U.S. tax reform.

In Pennsylvania, we earned $0.62 per share, a $0.13 year-over-year increase excluding dilution.

This increase was primarily due to higher adjusted gross margins of $0.15 per share, primarily resulting from results on additional transmission capital investments, higher distribution sales volumes, including $0.03 due to weather, and higher zonal peak load.

Note that adjusted gross margins for both Pennsylvania and Kentucky reflect the impact of lower collected taxes and revenues, which is offset in taxes in driving the significant tax benefit reflected on the slide.

Higher adjusted gross margins in Pennsylvania were partially offset by higher depreciation expense due to asset additions and higher financing costs.

Turning to our Kentucky Regulated segment, we earned $0.59 per share in 2018, a $0.04 year-over-year increase from 2017 excluding the impact of dilution.

This increase was primarily driven by higher adjusted gross margins of $0.16 per share, excluding the effect of tax reform that has offset taxes.

The increase in gross margins was driven by higher sales volumes, primarily due to favorable weather of $0.06, higher base electricity and gas rates effective July 1, 2017, and returns on additional environment capital investments.

This was partially offset by higher O&M expense and higher depreciation expense due to asset additions.

Turning to Corporate and Other, we experienced a $0.07 decrease, driven by higher taxes due to reduced tax benefits as a result of lower tax shield on holding company interest expense and higher financing costs.

Moving to our 2019 outlook on Slide 10.

We began with our strong 2018 results and adjust for the significant weather benefits experienced this past year, which results in 2018 weather normalized ongoing earnings of $2.32 per share.

I'll use that as a base in explaining the year-over-year drivers for comparability purposes.

From that base, we project earnings per share growth at each of our segments, excluding $0.13 of dilution as a result of settling the remaining 43 million shares of common stock under our forward equity sales agreements that we completed in May of 2018.

You'll see on the slide that we detailed the $0.13 of dilution by segment.

Looking at the operational drivers, excluding the dilution, in the U.K. segment, we expect to deliver higher earnings of $0.13 per share compared to 2018.

This increase is expected to result from higher gross margins, primarily driven by an April 1, 2019 price increase, higher foreign currency exchange rate and other primarily due to pensions.

This is partially offset by higher interest expense from incremental debt issuances and higher income taxes.

In Pennsylvania, we are projecting higher earnings of $0.02 per share.

Higher transmission margins and lower O&M expenses are expected to be partially offset by higher depreciation due to continued capital investment.

In Kentucky, we are projecting a $0.04 increase in earnings per share.

This is expected to be driven by higher adjusted gross margins, primarily driven by higher base electricity and gas rates, and return on additional environmental capital investments.

This is partially offset by higher O&M expenses, higher depreciation and higher interest expense due to planned debt issuances.

Turning to Slide 11.

Today, we initiated a guidance range for 2021 of $2.50 to $2.80 per share.

Our high-level underlying assumptions are reflected on this slide, which begin with our rate base and returns.

Rate base continues to grow at a steady pace of 5% to 6%, given the substantial investment opportunities we have in each of the utilities.

In terms of ROEs, our terms have -- our teams have done an excellent job of maintaining strong returns at or near their allowed levels through cost management, utilization of favorable recovery mechanisms and achieving performance incentives.

We are confident that we will continue to execute at that high level as we have demonstrated consistently.

We've also updated our assumptions regarding U.K. pensions, interest under-recovery and various other true-up mechanisms under the U.K. regulatory framework.

In total, we are projecting these adjustments to impact 2021 earnings in the range of negative $0.05 to negative $0.10 per share compared to 2020's estimated earnings.

In terms of foreign currency for 2021, we are using a range of $1.35 on the low side and $1.60 on the high side.

$1.35 represents forward rates in the low end of our bank forecast for 2021.

$1.60 reflects the higher end of the bank forecast for '21 and the historical average for the GBP rate.

I'll touch on our foreign currency hedging status in a few moments.

Overall, our sensitivity on a fully opened position remains at about $0.01 change in the currency rate equaling a $0.01 change in EPS.

Moving to Slide 12.

Our planned capital expenditures for 2019 through 2023 are detailed on the slide, with infrastructure investment totaling $14.5 billion over the period.

In the U.K., we are projecting over $5.5 billion of capital investment over the next 5 years.

There have not been significant changes to our U.K. capital plans as those have already been accepted by Ofgem through the end of RIIO-ED1.

As we think about future spending beyond the current price control period, the electric distribution sector will have significant opportunities to deploy incremental capital, given the U.K.'s electrification initiatives.

Turning to Pennsylvania, we are projecting about $4.5 billion of investment over the next 5 years, with the majority of the investment in transmission as we continue our focus on grid resiliency and modernization.

There are also no significant changes to report in our Pennsylvania capital plan, with a slight increase driven by additional reliability in other projects in providing our electric service to our customers.

Finally, in Kentucky, we are projecting more than $4.5 billion of investment over that period.

We made a few changes to the Kentucky capital plan in this update.

First, we included some incremental infrastructure projects and some environmental spending related to compliance with effluent limitation guidelines.

In total, this was about $425 million of incremental capital.

However, we also updated the Kentucky capital plan to remove about $275 million for the advanced metering system project.

We continue to believe the AMS project will benefit our customers, and we expect to continue to seek approval from the KPSC for this project.

Similar to prior years, we only include identified projects with a high probability of certainty in our capital plan.

We will update our capital plan at the appropriate time per normal course, along with any additional capital spending opportunities across our utilities as we often identify projects during the execution of our plan.

Let's move to Slide 13 to close with a discussion on our foreign currency strategy.

As we outlined at the beginning of 2018, our foreign currency hedge percentages are back within the rolling 36-month targeted ranges established under our risk management framework.

As a reminder, those hedge ranges are as follows: 70% to 100% hedged for the next 12 months; 30% to 70% for the second 12 months; and 0% to 30% hedged for the third 12 months.

We remain fully hedged through 2019 and about 50% hedged for 2020 at hedge rates well above current market rates, which should support our earnings translation through the volatile periods surrounding Brexit.

We continue to believe that there will be upside to the current rates as we move past the political uncertainty in the U.K. We will continue to be opportunistic in our hedging execution as we have done historically.

You can see on the right side of the page that most bank forecast remain above the current forwards, especially for 2021.

We continue to maintain our budgeted rate for open positions at $1.40 per GBP 1 for 2020.

And as I mentioned earlier, we are using a range of $1.35 to $1.60 per GBP 1 for the low and high ranges of our 2021 guidance.

That concludes my prepared remarks.

I'll turn the call back over to Bill for the question-and-answer period.

Well, thanks, Vince.

In closing, PPL delivered another strong performance in 2018 as we continued to execute on our strategy for growth and operational excellence.

Once again, we delivered strong financial results.

We executed on our financing plan and positioned the company well post-tax reform.

We provided award-winning customer service and reliability to our more than 10 million customers.

With an eye towards the future, we invested in infrastructure to make the grid smarter, more reliable and more resilient and to advance a cleaner energy future.

We continue to deliver on our commitments to customers and shareowners, and we will continue to deliver long-term value for those who invest in PPL.

That concludes our prepared remarks.

Operator, let's open the call up for questions, please.

(Operator Instructions) The first question comes from Ali Agha with SunTrust.

My first question comes back to the assumption -- one of the assumptions you've made for 2021, which has U.K. pension income and a couple of other factors, just wanted to get a sense of how much U.K. pension income are you currently booking?

And that negative $0.05 to $0.10 you assumed in '21, is that primarily pension income reduction or is it the other factors driving it?

And also, when will you know for certain what the pension income will be for 2021?

Sure.

Let me start and then I'll turn part of this over to Vince.

We are expecting a negative -- about a negative $0.05 impact from the pension deficit in our base case.

So that is the number that's really associated directly with the pension deficit.

As you noted, there are some other drivers, which are some other true-ups that could impact it, but that's the primary amount and the $0.05 is what's built into the base case for now.

Relative to the amount that we're collecting, it's about $180 million of revenue that we're collecting in pension deficit funding.

Based on the current assumptions and as Vince noted, the lower asset returns and balances, we believe, are still going to require continued deficit funding certainly over the next several years.

So just for sensitivity purposes, as we noted, we stressed it, another $0.05 in the low case.

So the primary drivers to the high and low guidance range that we gave are the FX and the U.K. pension and other true-ups, which we discussed.

Relative to the more detailed question, I'll turn that over to Vince.

Sure.

So Ali, when we think about the timing of when we'll know what's going to happen with the pension deficit, we will be setting our tariffs for '21, '22 actually at the end of this year.

That will require us to make an estimate of what we think the pension deficit requirements will be, really, for the remainder of ED1.

So by the end of this year, we will know what the revenues for the calendar year '21 will be, but they will be subject to true-up once we get through the full triennial review with the trustees and then with the pension regulator and then ultimately, with Ofgem, which we had indicated would be completed at the end of 2020.

So any true-up that would be required there would be trued up in the '23-'24 timeframe.

So that just gives you a sense of how this process and how these adjustments will play out.

And I guess just to kind of conclude the thought here on the pension deficit, we're not expecting that the entire amount of the pension deficit would go away through the ED1 process.

So we think there could be the negative impacts, some reductions, but certainly don't believe at this point that the majority of it would go away.

Got you.

Second question, Vince, just looking at the -- or Bill, for that matter, the dividend increase, when I compare it to the last couple of years, was much more modest.

Just again, wanted to get a sense of your thinking on the dividend and what brought it to a substantially lower growth rate than what we've been seeing the last couple of years.

Sure.

I think it's not just one factor.

There's a couple of factors.

Maybe the first is we look at the dividend in the context of the overall total return that we expect to deliver to the shareowners.

And currently, with the 5.5% EPS growth and the almost 5.5% dividend growth, we're looking at about an 11% total return per shareowners, which we think puts us in the top quartile of the peer group.

So we think that that's competitive overall with the peer group.

The second factor that we typically look at is the payout ratio compared to our peer group.

And we're currently at nearly 70% payout.

So that's on the high end of the peer group.

So we'd like to work that down more in line with the peers over time.

So those are 2 of several factors that go into our thought process.

Got you.

Last question, Bill, again to you.

As it currently relates to the U.K. assets, I'm just wondering, are there any other proactive strategic options still left on the table worth looking at?

Or is it more a sense of just keep executing, hunkering down and letting the uncertainties play themselves out over time?

As I previously have mentioned, we continuously look for opportunities to create shareowner value as we've really done over the past decade.

And if there is a clear and compelling path that we can take to drive additional value for the shareowners, we are certainly going to consider it.

And I think our track record has clearly demonstrated that.

So I think we continue to operate exceptionally well and believe the current business mix and plan is going to generate long-term shareowner value.

And certainly, I believe we have a very strong business plan with significant rate base and earnings growth and a very competitive dividend.

So I don't think we're compelled to react hastily to political or regulatory aspects that, quite frankly, are out of our control that -- and take options that might destroy shareowner value, not create it.

So we continue to look at that.

But at the moment, nothing clear and compelling to drive additional value for shareowners.

The next question comes from Greg Gordon with Evercore ISI.

I think you've answered the question on the pension pretty well.

But when you look at the drivers that the overall -- the set of drivers that cause that $0.05 to $0.10 range, are there other offsetting things in there that are actually positives, like thinking about the level of negative delta associated with interest?

So I know people tend to be hyper-focused on like this, oh, we could lose $0.20 on the pension.

But like, are there other things going from '20 to '21 in that driver basket that actually could be positive drivers that mitigate that?

Sure.

Good point and...

Apart from just having less of a pension deficit.

Sorry.

Yes, no, excellent point.

So a couple of things I would point to.

One is, and you kind of alluded to it, is inflation to the extent that inflation is driving the RPI or CPI in the U.K. upwards, which it has been.

That's actually a positive because that creates incremental revenue for us.

So -- and certainly, we've seen some benefit from that here lately.

I think also incremental cost efficiency, we've done an excellent job both in the U.K. and in the domestic utilities to really try to take cost out wherever we can.

And that's certainly an area that we're going to continue to look at.

I think the other things are customer and load growth.

I think you see that with our year-end 2018 on a weather-adjusted basis, we did see some uptick in load growth.

I'm not sure that that's indicative of what we're going to see going forward, but built into our plan is actually slightly negative load growth.

So certainly anything flat to positive will be upside to the current plan.

And then, of course, regulatory outcomes could always, whether it be in Kentucky or Pennsylvania, could help lift earnings higher as well.

So those are just some of the other ones that I would add.

And potentially, incremental CapEx towards the back end of the plan.

As Vince mentioned, our CapEx plan is really just based on kind of specific projects that we already know about and have high confidence that we can execute on.

But I'm sure that there will be additional incremental CapEx as we look towards the back end of the plan.

Cool.

And my next question goes to the attestations you're making with regard to your views on the trajectory of what the negotiation with Ofgem will look like on RIIO-ED2, differences between the way distribution will be -- might be treated versus the way it appears at least at the outset transmission and gas are being treated.

When you look at where this sort of -- this 3% number that they're attesting to starting at in terms of ROE, how do you think about walking that up to what you think you'll really be, what the real earnings opportunity is going to look like?

Because I think in prior conversations, you've talked about how that really masks an opportunity when you add everything up to get back to the types of returns on equity, they're kind of consistent with what we earn here in the U.S.

Sure, sure.

So starting from that base, number one would be probably an expectation that we're not going to be in a negative risk-free return environment by the time our ROE is actually set.

So that would be probably point number one.

Point number two would be the upside potential from incentive revenue that we've had a long history of doing very, very well at.

The third element would probably be the shift from fast pot to slow pot, putting more of our revenue into the -- if you want to call it the fast pot, the operating and maintenance kind of bucket and a little bit less than the CapEx for slow pot bucket.

And I believe that was about 100 -- would have been about $140 million had we shifted at about 10% in the current RIIO-ED1 regulatory process.

Other potential upsides, we are not -- we know that Ofgem is going to have a keen focus on how do they incentivize the electric distribution companies to meet some of the clean energy objectives, policy objectives in the U.K. And we believe that's going to result in some other opportunities, whether that be CapEx or otherwise.

But also in our case, the one element that we do have that we mentioned earlier on the pension deficit funding that's about $180 million that could be converted from arguably less quality earnings to more higher quality earnings through additional CapEx that we could spend and still not raise customer rates.

Because of that reduction coming off the pension deficit, we can replace it with something that's going to be, longer term, an earnings driver.

So those are, I would say, the major drivers as we look to RIIO-ED2, which again doesn't start for us until April of 2023.

Bill, maybe just a couple additional comments.

So Greg, when you look at the expected ROREs, which are the real returns in the gas sector, they are projected to be close to 11%; for the electric distribution sector, it's projected to be under 9.5%.

So I don't think you're necessarily going to see the same level of adjustment for the electric distribution companies as what's being contemplated for gas.

We've -- in our conversations with Ofgem, and they've made it clear in the consultation that this does not apply to electric distribution, they've reaffirmed that to us in our direct conversations with them.

And as Bill said, I think we all agree that there will be additional capital requirements going into electric distribution in RIIO-2 as compared to RIIO-1 to meet all of the electrification needs.

And so again, our sense is that Ofgem will, ultimately, for the electric distribution companies, come out with their returns to incentivize that investment.

The next question comes from Jonathan Arnold with Deutsche Bank.

I think most of my questions have been answered.

But I'm just curious, in your comments on your approach to hedging and the currency, how long will you wait before you start locking in some more of 2020 and start on 2021?

How much flexibility do you have within the policy?

Sure.

We do have quite a bit of flexibility, but Vince, maybe you can give some color around that?

Yes.

Our current projection would suggest that we would need to start layering it around April to be -- to remain compliant with the policy.

April of '19?

Yes, correct, for hedges beginning in the back end of 2020.

(Operator Instructions) The next question comes from Michael Lapides with Goldman Sachs.

Just a little confused about the 2021 guidance, and then have a question about rate base and cash flow.

On the '21 guidance, your range includes an FX range that, honestly, we haven't seen in a couple of years, right?

We haven't seen that since the middle of 2016.

So if I were to just say, let's use current today, you'd be at the very low end of the guidance range.

Is that the right way to think about it?

Or are there other move -- kind of puts and takes in there?

Go ahead, Vince, I'll let you take that one.

I would -- I mean, I think that if you just adjust that assumption on its own, it would suggest that, Michael, but I would be hesitant to confirm that conclusion because of all the items that Bill talked about before.

So the regulatory outcomes in Kentucky could come out better than what we're projecting.

Again, we use pretty conservative assumptions when we model some of this base stuff out.

And so customer and load growth were flat for Kentucky, slightly negative for PA.

If we determine that, the solid sales growth that we're seeing in 2018 is not just a weather anomaly, and that actually continues going forward, that would provide some upside to that base number.

Again, we talked about the additional capital investment.

As we go through the plan, none of that is built into the low end of the range.

So of course, we have O&M and inflation assumptions in there.

So I wouldn't necessarily say that if it stayed at $1.35, we would only be at $2.50 in 2021.

But clearly, that's the assumption we put into that low end of the range.

And I would say, just to make sure that I put a point on this, the $1.35, we've certainly seen that number in the forwards for post-Brexit.

So I think you were probably, Michael, referring to the $1.60, the high end we haven't seen since Brexit.

So I just want to be clear.

And that number is really informed by 2 things: one is some bank forecast that we've seen; and the second is that had been, prior to Brexit, kind of I think around the 10-year average, actually, I think the 10-year average is slightly higher, maybe around $1.65.

So I think it has some basis for our forecast in reality, assuming that Brexit is behind us by the time we get to 2021.

Got it.

Okay.

And then a question on rate base and cash flow.

It seems that you're moderating your rate base growth a little bit as you extend forward a year versus what you gave out at EEI.

Is it right to think about 1 of 2 things is happening, a, there's just not that much clarity on the back end of the forecast, meaning 4 or 5 years is a long way out, CapEx could change a lot between now and then; and two, would that imply that, hey, even if rate base growth does slow, it means cash flow would pick up, and if so, how would you utilize that extra cash?

Sure.

Go ahead, Vince.

You want to take that?

Yes.

So actually, under the existing capital plan that we've presented, we become free cash flow positive in the back end of the plan, to your point, Michael.

And so really, that additional cash is reducing the amount of debt and equity that we need to fund the CapEx plan.

So at this point, that cash would still be utilized to feed the capital.

Meaning it would be utilized to feed -- to fund the CapEx and potentially to delever up top with the holding company?

Correct.

The next question comes from Praful Mehta with Citigroup.

I just wanted to follow up on the strategic question that was addressed earlier around WPD.

You had mentioned that you always look at strategic options as you've done in the past.

Just wanted to check, the key constraint always seem to be the tax angle, right, the tax leakage that was related with any strategic transaction around WPD.

Has anything changed around that?

Or are there new options that have come up that may limit the tax leakage, in which case, there are more options to consider?

Or is it status quo around the tax leakage point?

On the tax leakage, it's pretty much status quo.

We have investigated many times different structures and alternatives that would significantly reduce the tax leakage, and none of those to date, at least, have made it still shareowner positive, meaning we're not destroying shareowner value.

The other item that we talked about on one of the previous calls was that credit impact of the sale -- potential sale of WPD as being negative as well.

So there'd be both a tax and a credit impact that we'd have to overcome to make this shareowner accretive or benefit for the shareowners.

Got you.

And so no such solution exists at this point based on your review?

Correct, not at this point.

Got you.

Okay, that's super helpful.

And then secondly, on the rate base side, you have -- we were just comparing the rate base at EEI or the guidance on the rate base at EEI versus rate base guidance in your presentation today, and it looks like it's lowered a little bit.

Is that -- firstly, is there anything specific on the reason driving it?

Is it just timing of CapEx?

Or is there something else that we should be thinking about around the rate base projections going forward?

There's not really anything major or specific other than I would say, I believe we've taken out the advanced metering project in Kentucky.

So that was a fairly sizable one and maybe some of the other projects that were probably lower probability projects that could come back into the plan.

But I think it's just, as we roll forward, it's just refining the numbers that we presented at EEI.

And since EEI, we've had more planning done, and we've presented our CapEx to our Board of Directors and had the latest numbers approved.

So it's really kind of an update, a more specific update than we had at EEI.

Yes, Praful, it's really just the math of dropping off at $3.5 billion a year and adding a $2.5 billion a year at the back end until we identify additional capital to be spent out there.

So it's really just that.

Okay, thank you.

Well, thanks, everyone, for joining today's call, and we look forward to talking with you on the first quarter call.

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