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| PEG > SEC Filings for PEG > Form 10-Q on 4-Aug-2008 | All Recent SEC Filings |
4-Aug-2008
Quarterly Report
PSEG, Power and PSE&G
This combined MD&A is separately filed by Public Service Enterprise Group Incorporated (PSEG), PSEG Power LLC (Power) and Public Service Electric and Gas Company (PSE&G). Information contained herein relating to any individual company is filed by such company on its own behalf. Power and PSE&G each make representations only as to itself and make no representations whatsoever as to any other company.
The following discussion relates to the markets in which PSEG and its subsidiaries compete, the corporate strategy for the conduct of PSEG's businesses within these markets, significant events that have occurred during 2008 and the future outlook for Power, PSE&G and PSEG Energy Holdings L.L.C. (Energy Holdings), as well as the key factors that will drive the future performance of these businesses. This discussion includes significant changes in or additions to information reported in the 2007 Annual Report on Form 10-K and refers to the Condensed Consolidated Financial Statements (Statements) and the related Notes to Condensed Consolidated Financial Statements (Notes). This information should be read in conjunction with such Statements, Notes and the 2007 Annual Report on Form 10-K.
PSEG's business consists of four reportable segments, which are Power, PSE&G and the two direct subsidiaries of Energy Holdings: PSEG Global L.L.C. (Global) and PSEG Resources L.L.C. (Resources).
Power
Power is an electric generation and wholesale energy marketing and trading company that is focused on generation markets in the Northeast and Mid Atlantic U.S. Through its subsidiaries, Power seeks to produce low-cost energy through efficient operations of its nuclear, coal and gas-fired generation facilities. Power seeks to balance this generation production with its fuel requirements and supply obligations through energy portfolio management. In addition to the electric generation business, Power's revenues also include gas supply sales under the Basic Gas Supply Service (BGSS) contract with PSE&G and to other customers.
PSE&G
PSE&G operates as an electric and gas public utility in New Jersey under cost-based regulation by the New Jersey Board of Public Utilities (BPU) for its distribution operations and under regulation by the Federal Energy Regulatory Commission (FERC) for its electric transmission and wholesale sales operations. Consequently, the earnings of PSE&G are largely determined by the regulation of its rates by those agencies.
Global
Domestically, Global has investments in power producers that own and operate electric generation in Texas, California and Hawaii, with smaller investments in New Hampshire and Pennsylvania. Global has reduced its international risk by monetizing most of its international investments.
Resources
Resources primarily has invested in energy-related leveraged leases. Resources is focused on maintaining its current investment portfolio and does not expect to make any new investments.
Overview of 2008
Financial Results
PSEG, Power and PSE&G
PSEG had a Loss from Continuing Operations of $(166) million or $(0.32) per share for the quarter ended June 30, 2008, as compared to Income from Continuing Operations of $281 million, or $0.55 per share for the same quarter in 2007. PSEG had a Net Loss for the quarter ended June 30, 2008 of $(150) million or $(0.29) per share, as compared to Net Income of $275 million or 0.54 per share for the second quarter of 2007. PSEG had Income from Continuing Operations of $268 million, or $0.53 per share for the six months
The quarter-over-quarter and six-month over six-month changes in PSEG's Income from Continuing Operations and Net Income reflect improved earnings principally at Power which was more than offset by after-tax charges of $490 million recorded in June 2008 at Resources associated with deductions taken for tax purposes on certain types of leveraged lease transactions that are being challenged by the IRS. Earnings were also slightly lower at PSE&G. As of June 30, 2008, Resources had a total gross investment of $1.0 billion in such transactions. See Note 5. Commitments and Contingent Liabilities for additional information.
The primary reasons for the quarter and year-to-date increases over the prior year periods at Power were higher prices and sales volumes, higher prices realized from recontracted Basic Generation Service (BGS) and higher mark-to-market (MTM) gains in 2008 as compared to 2007. The increases were somewhat offset by higher generation costs, largely due to increased prices for natural gas and coal purchases, higher Operation and Maintenance costs related to outages at certain of Fossil's facilities and the recognition of $19 million and $47 million in the second quarter and first half of 2008, respectively, of additional other-than-temporary impairments on certain securities in the Nuclear Decommissioning Trust Funds.
During 2008, commodity prices increased significantly, resulting in a material increase in Power's Accumulated Other Comprehensive Loss of $(619) million for the six months ended June 30, 2008 mainly related to the derivative transactions entered into to hedge forecasted energy sales from its generation stations. Power's required margin postings for sales contracts entered into in the normal course of business also significantly increased due to the increased commodity prices. Should commodity prices rise further, additional margin calls may be necessary relative to existing power sales contracts.
Business Developments
PSEG, Power and PSE&G
In January 2008, PSEG's Board of Directors approved a two-for-one stock split of PSEG's outstanding shares of common stock. Also in January 2008, April 2008 and July 2008, PSEG's Board of Directors approved a $0.3225 per share dividend for each of the first three quarters of 2008, reflecting an indicated annual dividend rate of $1.29 per share.
In January 2008, PSE&G, ER&T, Power Connecticut, Fossil and Nuclear submitted market-based rate (MBR) filings to FERC in which they asserted that they either lack market power or, that market power is being effectively mitigated in various markets. In April 2008, FERC issued a decision that eliminates the need for these companies to conduct a market power analysis within the Northern PSEG sub-market. In June 2008, PJM filed a revised transmission capability study, potentially impacting the MBR analysis. In an order issued July 17, 2008, FERC clarified how MBR sellers should calculate transmission capability in their respective market areas. As a result, PSE&G, ER&T, Power Connecticut, Fossil and Nuclear expect to file a revised MBR analysis based on these recent orders by September 2, 2008. The outcome of this proceeding cannot be predicted.
In February 2008, the BPU approved the results of New Jersey's annual BGS-Fixed Price (FP) and BGS-Commercial and Industrial Energy Price auctions and PSE&G successfully secured contracts to provide the anticipated electricity requirements for its customers. As a result of the February 2008 auction, new BGS-FP rates increased the average residential customer's bill by approximately 12% effective June 2008.
In March 2008, FERC approved the classification of new 69 kV facilities as transmission rather than distribution which PSE&G expects to result in improvements in reliability and more expeditious rate treatment for these facilities.
In March 2008, the U.S. Department of Treasury issued final regulations regarding Investment Tax Credit (ITC) normalization, referring to deferred tax balances that were to be refunded to utility customers but were terminated upon New Jersey's electric industry deregulation in 1999. The ruling confirmed that none of the generation-related ITC could be passed to utility customers without violating the normalization rules.
In April 2008, the U.S. Supreme Court granted the request of industry petitioners, including Power, to review the question of whether Section 316(b) of the Federal Water Pollution Control Act allows the U.S. Environmental Protection Agency (EPA) to compare costs with benefits in determining the "best technology
In April 2008, New Jersey issued a draft Energy Master Plan (EMP). A final report is expected to be available later in 2008. The EMP proposes a number of actions to improve energy efficiency and increase the use of renewable resources and clean central station power for addressing climate change.
In April 2008, the BPU approved a settlement agreement allowing PSE&G to invest approximately $105 million in a solar energy pilot program, designed to spur investment in solar power in New Jersey and meet energy goals under the EMP. PSE&G will provide loans to customers in its electric service territory for the installation of solar photovoltaic systems on the customers' premises. The program is open to commercial, industrial and residential customers. As of June 30, 2008, PSE&G has received applications for approximately 38.5% of the 30 MW program.
In April 2008, FERC approved incentive rate treatment for PSE&G's Susquehanna-Roseland transmission line project, which will enable PSE&G to earn an adequate return on investment, full recovery of construction costs and the authority to transfer certain incentives to affiliates that are members of Regional Transmission Organizations (RTOs).
In May 2008, several state commissions, including the BPU and consumer advocacy agencies, as well as customer groups and certain federal agencies filed a complaint with FERC with respect to PJM's Reliability Pricing Model (RPM) on the grounds that the capacity prices set in the first three RPM auctions were not just and reasonable. If granted by FERC, this complaint would have a material adverse impact on Power's revenues. For additional information relating to this complaint and PJM's evaluation of ways to improve the RPM process, see Item 5. Other Information.
In May 2008, PSE&G submitted a request to the BPU for an increase in annual BGSS revenues of $376 million to be effective October 1, 2008, representing approximately a 20% increase on a typical residential gas customer's bill.
In June 2008, Power completed projects at Hope Creek and Salem Unit 2 anticipating increasing its nuclear generating capacity at those facilities by 125 MW and 15 MW, respectively. Phase I of the Hope Creek turbine replacement project increased the nominal capacity of the unit by 10 MW in 2005. Initial testing indicates that Phase II added approximately 125 MW of nominal capacity in the second quarter of 2008. Final performance testing will be conducted later this year. Phase I of the Salem Unit 2 turbine upgrade increased Power's share of the nominal capacity by 14 MW in 2003. Phase II was completed and put in operation in the second quarter of 2008, concurrent with steam generator replacement and increased Power's share of the nominal capacity by approximately 11 MW. Final performance testing will be conducted later this year. Power's total expenditures for these projects were $212 million (including Interest Capitalized During Construction of $24 million).
In June 2008, as a result of the recent court decisions regarding certain types of leveraged lease transactions, PSEG evaluated its unrecognized tax benefits under FIN 48, "Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement 109" (FIN 48), and recorded an after-tax increase to the interest reserve of $135 million in the second quarter of 2008. This charge is recorded in Income Tax Expense in PSEG's Condensed Consolidated Statements of Operations. PSEG also recorded a charge of $355 million under FSP 13-2, "Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction." This charge is reflected as a reduction in Operating Revenues of $485 million with a partially offsetting reduction in Income Tax Expense of $130 million in PSEG's Condensed Consolidated Statements of Operations. As the tax benefits associated with these lease transactions are timing differences, total cash flows and net income in a leveraged lease transaction remain the same after a change in the timing of the cash flows. The charges related to FSP 13-2 will therefore be recognized as income over the remaining terms of the affected leases.
In July 2008, PSE&G filed a petition with FERC to implement a cost of service formula rate for its existing and future transmission investment. The request is based on a proposed ROE of 11.68% and, if approved, would allow PSE&G to update its transmission rates annually based on forecasted Operation and Maintenance and capital expenditures for the coming year, with no lag of recovery, and would provide for a true-up to actual expenditures in the subsequent year. PSE&G has requested an effective date of October 1, 2008.
In July 2008, the Board of Directors of PSEG authorized the repurchase of up to $750 million of PSEG Common Stock to be executed over 18 months beginning August 1, 2008. PSEG is not obligated to acquire any specific number of shares and may suspend or terminate its share repurchases at any time. The amount and timing of any stock repurchases would be based on various factors such as management's assessment of PSEG's capital structure and liquidity, the market price of PSEG's common stock and the opportunity to grow the business if investments are available.
In July 2008, Global closed on the sale of its investment in the SAESA Group for a total purchase price of approximately $1.3 billion, including the assumption of approximately $413 million of the consolidated debt of the group. The sale resulted in an after-tax gain of approximately $180 million. Net cash proceeds, after Chilean and US taxes of approximately $275 million, were approximately $600 million.
For additional information, see Item 5 Other Information and Note 5. Commitments and Contingent Liabilities.
Future Outlook
PSEG, Power and PSE&G
PSEG's future success will depend on the ability of Power, PSE&G and Energy Holdings to achieve their respective objectives and earnings expectations, as well as the successful completion of various construction projects and their respective growth initiatives, discussed below.
There is no guarantee that such initiatives will be achieved since many issues need to be considered, such as system reliability concerns, regulatory approvals and construction or development costs.
In general, PSEG believes it has growth opportunities in the following three key areas:
• responding to climate change and continuing to improve environmental performance through investments in energy efficiency, renewables and clean central station power;
• upgrading critical energy infrastructure; and
• providing new energy supplies.
Power
A key factor for success is Power's ability to operate its nuclear and fossil stations at sufficient capacity factors to limit the need to purchase higher-priced electricity to satisfy its obligations. Historically, Power's nuclear and coal-fired facilities have produced over 50% and 25% of Power's production, respectively. Power seeks to sell a portion of this anticipated low-cost nuclear and coal-fired generation over a multi-year forward horizon, normally over a period of two to four years. With the vast majority of its power sourced from these lower-cost units, rising electric prices have yielded higher margins for Power. Over a longer-term horizon, if prices are sustained at levels reflective of what the current forward markets indicate, Power would have an attractive environment in which to contract for the sale of its anticipated output, allowing for potentially sustained higher profitability than recognized in prior years. However, with an increase in competition and market complexity and constantly changing forward prices, there is no assurance that Power will be able to contract its output at attractive prices. While recent higher forward prices may have a potentially significant beneficial impact on margins, they could also raise any replacement power costs that Power may incur in the event of unanticipated outages, and could also further increase liquidity requirements as a result of contract obligations. For additional information on liquidity requirements, see Liquidity and Capital Resources.
Power contracts for the future delivery of nuclear fuel and coal to support its contracted sales. Power's estimated fuel needs are subject to change based upon the level of its operations as well as upon market demands for and on the price of coal, both of which have increased recently. Earlier in the year, Power revised the pricing for one of its coal supply agreements for the Mercer station through 2008. A second supplier for about 15% of Mercer's coal requirements has declared a force majeure and has reduced
Power could be impacted by a number of events, including regulatory or legislative actions favoring non-competitive markets, energy efficiency initiatives and regulatory policies favoring the construction of rate-based transmission that may result in increased imports of power, which may be subject to less stringent environmental regulation, into areas served by Power's generation assets. Further, some of the market-based mechanisms in which Power participates, including BGS auctions and the RPM capacity payments, are at times the subject of review or discussion by some of the participants in the New Jersey and federal regulatory and political arenas, including FERC and the BPU, and the PJM market monitor. Accordingly, Power can provide no assurance that any or all of these mechanisms will continue to exist in their current form. For additional information, see Item 5. Other Information-Regulatory Issues.
In addition, Power must be able to effectively manage its construction projects and continue to economically operate its generation facilities under increasingly stringent environmental requirements, including legislation, regulation and voluntary restrictions that address:
• the control of carbon dioxide emissions to reduce the effects of global climate change and greenhouse gas;
• other emissions such as NOx, SO2 and mercury; and
• the potential need for significant upgrades to existing water intake structures and cooling systems at its larger once-through cooled plants, including Salem, Hudson, Mercer, Sewaren, New Haven and Bridgeport.
Power recently completed two projects to increase the generating capacity of its Hope Creek and Salem Unit 2 facilities and has several other projects included in its forecasted capital expenditures.
Power has two large environmental back-end technology projects underway at its Mercer and Hudson coal plants scheduled to be completed by the end of 2010. Power is focused on completing these projects on schedule and within the established budgets, but faces many risks typically involved in managing large construction projects.
Power has been selected by the Connecticut Department of Public Utility Control in a regulatory process to build 130 MW of gas-fired peaking capacity. Power estimates the cost of these generating units to be $130 million to $140 million.
Power has initiated planning activities with respect to the construction of new gas-fired peaking capacity. Power's final decision whether or not to proceed with construction of these units would depend on numerous items, including estimated capital and interconnection costs, available siting and Power's ability to meet environmental permitting requirements. Power is also currently exploring the potential to build new nuclear generation and in addition may also seek growth from acquisition opportunities.
PSE&G
PSE&G's results primarily depend on the treatment of the various rate and other issues by the BPU and FERC, as well as other state and federal regulatory agencies. Therefore, PSE&G's success will depend on its ability to:
• attain an adequate return on the investments it plans to make in its electric and gas transmission and distribution system;
• continue cost containment initiatives;
• maintain system reliability and safety levels; and
• continue recovery of the regulatory assets it has deferred.
PSE&G's results will also be impacted by the level of recovery of distribution revenues in light of customer demand and conservation efforts.
Moreover, PSE&G has made a request to the BPU for an increase in annual BGSS revenues of $376 million to be effective October 1, 2008.
Under the terms of the settlement of PSE&G's most recent electric and gas base rate cases, it is required to file joint electric and gas petitions for future base rate increases and no base rate changes may become effective before November 15, 2009.
PSE&G has also proposed various initiatives to meet energy goals under the EMP. As discussed above, PSE&G has received BPU approval allowing PSE&G to invest approximately $105 million over two years to help finance the installation of solar energy systems throughout its service area. PSE&G will be allowed to earn a return on and of its investment and partially recover its administrative costs to implement the Solar Energy Program through regulated rates. The program will support 30 MW of solar power in the next two years, fulfilling approximately 50% of the BPU's Renewal Portfolio Standard requirements of 57 MW in PSE&G's service area by May 2009 and May 2010.
In order to meet the growing demand for electricity in the region in a safe, reliable and economically efficient manner, PJM has identified the need for several transmission projects as part of its Regional Transmission Expansion Plan (RTEP). One project is the Susquehanna-Roseland 500 kV transmission project that was approved by PJM and is currently in the permitting and siting phase with construction expected to begin in the spring of 2009 to meet the 2012 in-service date. PSE&G has the responsibility to build and own a portion of this transmission line and has been granted incentive rate treatment for this project. PSE&G will also be responsible for constructing and owning a portion of the Mid-Atlantic Pathway Project (MAPP), another 500 kV transmission line. The in-service date has not been finalized. There are several other 500 kV transmission projects, as well as 230 kV transmission project options, actively under consideration by PJM to address future reliability criteria violations in the PJM region. These projects have not yet been approved by PJM. For additional information, see Item 5. Other Information.
Energy Holdings
Energy Holdings' earnings are primarily comprised of the results of operations at Global and Resources. As a merchant generation business with a load-following asset profile, Global's largest domestic investment is in two generating facilities in Texas, and, as such, its success will be driven by the efficient operation of those plants and by changes in market conditions, particularly projected market heat rates and weather. Resources maintains a portfolio of investments which is designed to provide a fixed rate of return. However, its future performance is subject to tax risks, such as the impacts of changes to uncertain tax positions as determined by changes in substantive tax law and tax audit results, including resolution of significant tax audit claims associated with its leveraged lease transactions. See Note 5. Commitments and Contingent Liabilities for further discussion.
In March 2008, a subsidiary of Global, together with Winergy Power Holdings, an unaffiliated New York-based private developer, submitted a proposal to the New Jersey Office of Clean Energy (OCE) to build a 350 MW wind farm approximately 16 miles off the shore of southern New Jersey. If the proposal is accepted by the OCE, subject to required permits, feasibility and environmental studies, financing and other conditions, the wind farm could be fully operational in 2013.
PSEG, Power and PSE&G
PSEG expects that continued strong cash from operations will be sufficient to fund dividends and support its capital expenditure program. This operating cash flow is expected to be generated primarily at Power with modest contributions from PSE&G and Energy Holdings. When combined with funds from asset sales and potential additional financing capacity, PSEG expects that it could have $2.5 billion of discretionary cash through the end of 2011 for incremental growth initiatives or to pursue its stock repurchase program. This discretionary cash currently assumes:
• Potential payments totaling approximately $900 million to $950 million to address significant income tax claims related to certain leveraged lease transactions at Energy Holdings, discussed in Note 5.
• A forecast that includes greater levels of growth capital than included in the capital expenditures forecast included in the 2007 Form 10-K, but which remains under review as . . .
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