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| CEG > SEC Filings for CEG > Form 10-Q on 6-Nov-2009 | All Recent SEC Filings |
6-Nov-2009
Quarterly Report
Management's Discussion and Analysis of Financial Condition and Results of Operations
Introduction and Overview
Constellation Energy Group, Inc. (Constellation Energy) is an energy company that conducts its business through various subsidiaries including a merchant energy business and Baltimore Gas and Electric Company (BGE). We describe our operating segments in the Notes to Consolidated Financial Statements beginning on page 19.
This Quarterly Report on Form 10-Q is a combined report of Constellation Energy and BGE. References in this report to "we" and "our" are to Constellation Energy and its subsidiaries, collectively. References in this report to the "regulated business(es)" are to BGE. We discuss our business and strategy in more detail in Item 1-Business section of our 2008 Annual Report on Form 10-K and we discuss the risks affecting our business in Item 1A. Risk Factors section of our 2008 Annual Report on Form 10-K.
Our 2008 Annual Report on Form 10-K includes a detailed discussion of various items impacting our business, our results of operations, and our financial condition. These include:
º •
º Introduction and Overview section which provides a description of our
business segments,
º •
º Strategy section,
º •
º Business Environment section, including how recent events, regulation,
weather, and other factors affect our business, and
º •
º Critical Accounting Policies section.
Critical accounting policies are the accounting policies that are most important to the portrayal of our financial condition and results of operations and that require management's most difficult, subjective, or complex judgment. Our critical accounting policies include derivative accounting, evaluation of assets for impairment and other than temporary decline in value, and asset retirement obligations.
In this discussion and analysis, we explain the general financial condition and the results of operations for Constellation Energy and BGE including:
º •
º factors which affect our businesses,
º •
º our earnings and costs in the periods presented,
º •
º changes in earnings and costs between periods,
º •
º sources of earnings,
º •
º impact of these factors on our overall financial condition,
º •
º expected future expenditures for capital projects,
º •
º expected sources of cash for future capital expenditures, and
º •
º our net available liquidity and collateral requirements.
As you read this discussion and analysis, refer to our Consolidated Statements of Income (Loss) on page 3, which present the results of our operations for the quarters and nine months ended September 30, 2009 and 2008. We analyze and explain the differences between periods in the specific line items of the Consolidated Statements of Income (Loss).
We have organized our discussion and analysis as follows:
º •
º We describe changes to our business environment during the year.
º •
º We highlight significant events that occurred in 2009 that are
important to understanding our results of operations and financial
condition.
º •
º We review our results of operations beginning with an overview of our
total company results, followed by a more detailed review of those
results by operating segment.
º •
º We review our financial condition, addressing our sources and uses of
cash, capital resources, commitments, and liquidity.
º •
º We conclude with a discussion of our exposure to various market risks.
Business Environment
Various factors affect our financial results. We discuss these factors in the Forward Looking Statements section on page 78 and in Item 1A. Risk Factors section of our 2008 Annual Report on Form 10-K. We discuss our market risks in the Risk Management section beginning on page 72.
The volatility of the financial, credit and global energy markets impacts our liquidity and collateral requirements as well as our credit risk. We discuss our liquidity and collateral requirements in the Financial Condition section and our customer (counterparty) credit and other risks in more detail in the Risk Management section.
In this section, we discuss in more detail events which have impacted our business during 2009.
Federal Regulation
The United States Congress and the Commodity Futures Trading Commission are evaluating additional regulations for the derivatives markets, including position limits and eliminating hedge regulatory exemptions. We are unable to determine the final form any regulations may take, but such regulations could have a material effect on our business.
Maryland PSC Review of EDF Transaction
In June 2009, during Phase I of the EDF proceeding, the Maryland Public Service Commission (Maryland PSC) determined that EDF Group and related entities (EDF) would obtain the power to exercise substantial influence over the policies and actions of BGE under Constellation Energy's proposed transaction with EDF, and, therefore, that the Maryland PSC must review the transaction to determine that it is in the public interest with benefits and no harm to consumers.
Constellation Energy, BGE and EDF filed suit in the Baltimore City Circuit Court appealing the Maryland PSC's Phase I ruling that the Maryland PSC's review and approval was required for the EDF transaction. The Circuit Court dismissed the suit as premature, and Constellation Energy and BGE appealed the court's dismissal of the Phase I challenge to the Maryland Court of Special Appeals.
In Phase II of the EDF proceeding, EDF filed an application with the Maryland PSC in June 2009 and the Maryland PSC issued an order in Phase II on October 30, 2009. We discuss this Maryland PSC order and the EDF transaction in more detail in the Notes to Consolidated Financial Statements beginning on page 11.
Environmental Matters
Air Quality
Capital Expenditures
As discussed in our 2008 Annual Report on Form 10-K, we expect to incur additional environmental capital expenditures to comply with air quality laws and regulations. Based on updated information from vendors, we expect our estimated environmental capital requirements for these air quality projects to be approximately $345 million in 2009, $10 million in 2010, $20 million in 2011 and $30 million from 2012-2013.
Our estimates may change further as we implement our compliance plan. As discussed in our 2008 Annual Report on Form 10-K, our estimates of capital expenditures continue to be subject to significant uncertainties.
Global Climate Change
In September 2009, the Environmental Protection Agency proposed regulations to address greenhouse gas emissions under the Clean Air Act. The proposed regulations would require large facilities that emit at least 25,000 tons of greenhouse gases a year to obtain construction and operating permits covering these emissions. The proposed regulations would apply to many of our fossil fuel generating facilities. We are evaluating the potential impact of these regulations on our business should they be adopted. We could incur compliance costs that have a material impact on our financial results.
Accounting Standards Issued and Adopted
We discuss recently issued and adopted accounting standards in the Accounting Standards Issued and Accounting Standards Adopted sections of the Notes to Consolidated Financial Statements beginning on page 41.
Events of 2009
Acquisition
In July 2009, we acquired CLT Efficient Technologies Group (CLT), an energy services company. We discuss this acquisition in more detail in the Notes to Consolidated Financial Statements on page 16.
Divestitures
In January 2009, we entered into a definitive agreement to sell a majority of our international commodities operation. We completed this transaction in March 2009.
In February 2009, we entered into a definitive agreement to sell our gas trading operation. We transferred control of this operation in April 2009. Simultaneously, we entered into an agreement with the buyer of our Houston-based gas trading operation under which that company will provide us with the gas supply needed to support our retail gas customer supply business.
In June 2009, we completed the sale of a uranium market participant that provides marketing services to uranium producers, utilities and an investment fund in the North American and European markets.
In August 2009, we completed the sale of our equity investment in our shipping joint venture.
We discuss these divestitures and the gas supply agreement in more detail in the Notes to Consolidated Financial Statements beginning on page 16.
Merger Termination and Strategic Alternatives Costs
During the quarter and nine months ended September 30, 2009, we incurred merger termination and strategic alternatives costs related to the terminated merger with MidAmerican Energy Holdings Company (MidAmerican), the conversion of our Series A Preferred Stock, the transactions related to EDF, and other strategic alternatives costs. We discuss costs related to the mergers and strategic
alternatives in more detail on page 12 in Notes to Consolidated Financial Statements.
Impairment Losses and Other Costs
During the quarter and nine months ended September 30, 2009, we recorded impairment losses and other costs on certain of our equity method investments, investments in equity securities and other assets. We discuss these charges in more detail in the Notes to Consolidated Financial Statements beginning on page 14.
Workforce Reduction Costs
During the nine months ended September 30, 2009, we incurred workforce reduction costs primarily related to the divestiture of a majority of our international commodities operation as well as some smaller restructurings elsewhere in our organization. We recognized an $11.6 million pre-tax charge in 2009 related to the elimination of approximately 180 positions. We expect all of these restructurings will be completed within 12 months from the program's initiation. We discuss our workforce reduction costs in more detail in the Notes to Consolidated Financial Statements beginning on page 15.
Results of Operations for the Quarter and Nine Months Ended September 30, 2009 Compared with the Same Periods of 2008
In this section, we discuss our earnings and the factors affecting them. We begin with a general overview, then separately discuss earnings for our operating segments. Significant changes in other income and expense, fixed charges, and income taxes are discussed, as necessary, in the aggregate for all segments in the Consolidated Nonoperating Income and Expenses section on page 63.
Overview
Results
Nine Months
Quarter Ended Ended
September 30, September 30,
2009 2008 2009 2008
(In millions, after-tax)
Merchant energy $ 142.1 $ (246.0 ) $ (39.7 ) $ 106.7
Regulated electric 42.3 34.3 109.8 (31.2 )
Regulated gas (10.5 ) (11.5 ) 22.9 26.4
Other nonregulated (6.5 ) 1.1 (17.0 ) 0.4
Net Income (Loss) $ 167.4 $ (222.1 ) $ 76.0 $ 102.3
Net Income (Loss) attributable to common stock $ 137.6 $ (225.7 ) $ 22.2 $ 91.5
Change from prior year $ 363.3 $ (69.3 )
Other Items Included in Operations (after-tax)1:
International commodities operation and gas
trading operation2 $ (62.9 ) $ - $ (370.9 ) $ -
Impairment losses and other costs (9.0 ) (298.8 ) (85.4 ) (298.8 )
Impairment of nuclear decommissioning trust
assets (19.7 ) (15.3 ) (49.5 ) (21.5 )
Merger termination and strategic alternatives
costs (4.9 ) (37.3 ) (51.2 ) (37.3 )
Accrual of Maryland settlement credit - - - (125.3 )
BGE effective tax rate impact of Maryland
settlement agreement - 2.0 - 10.7
Emission allowance write-down, net - (22.8 ) - (36.2 )
Non-qualifying hedges - 12.0 - (57.3 )
Workforce reduction costs (1.6 ) (1.6 ) (7.0 ) (1.6 )
Credit facility amendment fees (8.2 ) - (17.1 ) -
Total Other Items $ (106.3 ) $ (361.8 ) $ (581.1 ) $ (567.3 )
Change from prior year $ 255.5 $ (13.8 )
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1 Amounts for the quarter ended September 30, 2009 include income tax adjustments relating to activity during the quarters ended March 31, 2009 and June 30, 2009 based on updated estimates of our 2009 annual effective tax rate.
2 These amounts include the losses on the sales of the international commodities and gas trading operations, the reclassification of losses on previously designated cash-flow hedges from Accumulated Other Comprehensive Loss because the forecasted transactions are probable of not occurring, and earnings that are no longer part of our core business. The impairment losses and other costs and workforce reduction costs line items also include amounts related to the operations we divested. Third quarter of 2009 activity is primarily due to the income tax adjustments referenced above.
Quarter and Nine Months Ended September 30, 2009
Our total net income attributable to common stock for the quarter ended
September 30, 2009 exceeded the net loss attributable to common stock for the
quarter ended September 30, 2008 and the net income attributable to common stock
for the nine months ended September 30, 2009 decreased from the net income
attributable to common stock for the nine months ended September 30, 2008
primarily due to the following:
Nine Months
Quarter Ended Ended
September 30, September 30,
2009 vs. 2008
(In millions, after-tax)
Generation gross margin $ (11 ) $ 62
Customer supply gross margin (8 ) 4
Global Commodities gross margin 169 (232 )
Hedge ineffectiveness 4 100
Absence of sale of upstream gas assets - (55 )
Absence of credit loss-coal supplier bankruptcy - 33
Merchant interest expense (24 ) (77 )
Regulated businesses, primarily related to
absence of Maryland settlement agreement credit 9 137
Other nonregulated businesses (8 ) (17 )
Total change in Other Items included in
operations per Overview-Results table 256 (14 )
All other changes (24 ) (10 )
Total Change $ 363 $ (69 )
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In the following sections, we discuss our net income by business segment in greater detail.
Merchant Energy Business
Background
Our merchant energy business is a competitive provider of energy solutions for various customers. We discuss the impact of deregulation on our merchant energy business in Item 1. Business-Competition section of our 2008 Annual Report on Form 10-K.
Our merchant energy business focuses on delivery of physical, customer-oriented products to producers and consumers, manages the risk and optimizes the value of our owned generation assets and customer supply activities, and uses our portfolio management and trading capabilities both to manage risk and to deploy risk capital.
Earlier this year, we outlined various strategic initiatives for our Global Commodities operation. We discuss our strategy in more detail in the Strategy section of our 2008 Annual Report on Form 10-K. As of the end of the third quarter of 2009, these initiatives are substantially complete.
While we have completed the sale of a majority of our international commodities operation, our gas trading operation, certain other trading operations, and a uranium market participant, the execution of our strategy in the future will be affected by continued uncertainty in global financial, credit, and commodities markets. Execution of our goals could have a substantial effect on the nature and mix of our business activities. In particular, the EDF transaction results in the deconsolidation of our subsidiary that owns our nuclear generation assets. In turn, this could affect our financial position, results of operations, and cash flows in material amounts, and these amounts could vary substantially from historical results. We discuss our asset and operation divestitures in more detail in the Notes to Consolidated Financial Statements beginning on page 16.
We record merchant energy revenues and expenses in our financial results in different periods depending upon which portion of our business they affect and based on the associated accounting policies. We discuss our revenue recognition policies in the Critical Accounting Policies section and in Note 1 of our 2008 Annual Report on Form 10-K.
As part of managing our total portfolio risk, we use economic value at risk. We view economic value at risk as the most comprehensive measure of our exposure to changing commodity prices. This metric measures the risk in our total portfolio, encompassing all aspects of our merchant energy business. We also use daily value at risk and stop loss limits and liquidity guidelines to restrict the level of risk in our portfolio.
Our Global Commodities operation actively transacts in energy and energy-related commodities in order to manage our portfolio of energy purchases and sales to customers through structured transactions. As part of these activities, we trade energy and energy-related commodities and deploy risk capital in the management of our portfolio in order to earn returns.
We discuss the impact of our economic value at risk and value at risk in more detail in the Mark-to-Market and Risk Management sections.
Results
Nine Months
Quarter Ended Ended
September 30, September 30,
2009 2008 2009 2008
(In millions)
Revenues $ 3,258.0 $ 4,492.6 $ 9,738.5 $ 12,719.7
Fuel and purchased energy expenses (2,268.7 ) (3,843.0 ) (7,285.3 ) (10,371.1 )
Operating expenses (396.8 ) (322.0 ) (1,214.0 ) (1,298.0 )
Merger termination and strategic
alternatives costs (4.9 ) (27.2 ) (51.2 ) (27.2 )
Impairment losses and other costs (7.5 ) (477.1 ) (96.6 ) (477.1 )
Workforce reduction costs (0.4 ) (2.2 ) (11.6 ) (2.2 )
Depreciation, depletion, and
amortization (69.7 ) (68.6 ) (198.3 ) (207.8 )
Accretion of asset retirement
obligations (18.5 ) (17.2 ) (54.6 ) (50.8 )
Taxes other than income taxes (29.2 ) (35.8 ) (85.3 ) (94.0 )
Net (loss) gain on divestitures (0.3 ) - (464.4 ) 91.5
Income (Loss) from Operations $ 462.0 $ (300.5 ) $ 277.2 $ 283.0
Net Income (Loss) $ 142.1 $ (246.0 ) $ (39.7 ) $ 106.7
Net Income (Loss) attributable to
common stock $ 116.0 $ (246.0 ) $ (83.1 ) $ 105.9
Other Items Included in Operations
(after-tax)1:
International commodities operation
and gas trading operation2 $ (62.9 ) $ - $ (370.9 ) $ -
Impairment losses and other costs (8.2 ) (298.8 ) (81.5 ) (298.8 )
Impairment of nuclear
decommissioning trust assets (19.7 ) (15.3 ) (49.5 ) (21.5 )
Merger termination and strategic
alternatives costs (4.9 ) (25.8 ) (51.2 ) (25.8 )
Emission allowance write-down, net - (22.8 ) - (36.2 )
Non-qualifying hedges - 12.0 - (57.3 )
Workforce reduction costs (1.6 ) (1.6 ) (7.0 ) (1.6 )
Credit facility amendment fees (8.2 ) - (17.1 ) -
Total Other Items $ (105.5 ) $ (352.3 ) $ (577.2 ) $ (441.2 )
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Above amounts include intercompany transactions eliminated in our Consolidated Financial Statements. The Information by Operating Segment section within the Notes to Consolidated Financial Statements on page 20 provides a reconciliation of operating results by segment to our Consolidated Financial Statements.
1 Amounts for the quarter ended September 30, 2009 include income tax adjustments relating to activity during the quarters ended March 31, 2009 and June 30, 2009 based on updated estimates of our 2009 annual effective tax rate.
2 These amounts include the losses on the sales of the international commodities and gas trading operations, the reclassification of losses on previously designated cash-flow hedges from Accumulated Other Comprehensive Loss because the forecasted transactions are probable of not occurring, and earnings that are no longer part of our core business. The impairment losses and other costs and workforce reduction costs line items also include amounts related to the operations we divested. Third quarter of 2009 activity is primarily due to the income tax adjustments referenced above.
Revenues and Fuel and Purchased Energy Expenses
Our merchant energy business manages the revenues we realize from the sale of energy and energy-related products to our customers and our costs of procuring fuel and energy. The difference between revenues and fuel and
purchased energy expenses, including all direct expenses, represents the gross margin of our merchant energy business, and this measure is a useful tool for assessing the profitability of our merchant energy business. Accordingly, we believe it is appropriate to discuss the operating results of our merchant energy business by analyzing the changes in gross margin between periods. In managing our portfolio, we may terminate, restructure, or acquire contracts primarily to reduce risk and/or improve our liquidity. Such transactions are within the normal course of managing our portfolio and may materially impact the timing of our recognition of revenues, fuel and purchased energy expenses, and cash flows.
We discuss our merchant energy revenues, fuel and purchased energy expenses, and gross margin below.
Revenues
Our merchant energy revenues decreased $1,234.6 million and $2,981.2 million
during the quarter and nine months ended September 30, 2009, respectively,
compared to the same periods in 2008 primarily due to the following:
Nine Months
Quarter Ended Ended
September 30, September 30,
2009 vs. 2008
(In millions)
Increase (decrease) in Global Commodities
mark-to-market revenues due to changes in power
and gas prices $ 205 $ (235 )
Decrease in volume of business primarily related
to our international coal and freight operation,
which we have divested (143 ) (652 )
Increase in contract prices and volume related to
our domestic coal operation 67 240
Realization of lower prices and volume of
business at our gas trading operation, which we
have divested, and absence of revenue due to the
sales of certain of our upstream gas properties
in 2008 (5 ) (218 )
Realization of lower volumes on wholesale and
retail load at our Customer Supply operation,
partially offset by higher contract prices (1,334 ) (2,097 )
All other (25 ) (19 )
Total decrease in merchant revenues $ (1,235 ) $ (2,981 )
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Fuel and Purchased Energy Expenses
Our merchant energy fuel and purchased energy expenses decreased
$1,574.3 million and $3,085.8 million during the quarter and nine months ended
September 30, 2009, respectively, compared to the same periods in 2008 primarily
due to the following:
Nine Months
Quarter Ended Ended
September 30, September 30,
2009 vs. 2008
(In millions)
Increase in Global Commodities mark-to-market
expenses related to the absence of international
coal purchase contracts due to divestiture of
operations and changes in prices $ 225 $ 333
Decrease in volume of business primarily related
to our international coal and freight operation,
which we have divested (123 ) (562 )
Increase in contract prices and volume related to
our domestic coal operation 87 207
Realization of lower volumes at our gas trading
operations, which we have divested (54 ) (197 )
. . .
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