Annual Report — Form 10-K Filing Table of Contents
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phi10k-2008
2: EX-4.3 Pepco Supplemental Indenture Dated March 31, 2008 HTML 27K
14: EX-4.3 Courtesy Copy of Pepco Supplemental Indenture PDF 18K
Dated March 31, 2008 -- ex4-3
5: EX-10.10 Conectiv Supplemental Executive Retirement Plan HTML 115K
17: EX-10.10 Courtesy Copy of Conectiv Supplemental Executive PDF 68K
Retirement Plan -- ex10-10
6: EX-10.21 Non-Management Directors Compensation Plan HTML 32K
18: EX-10.21 Courtesy Copy of Non-Management Directors PDF 19K
Compensation Plan -- ex10-21
7: EX-10.22 Annual Executive Incentive Compensation Plan HTML 44K
19: EX-10.22 Courtesy Copy of Annual Executive Incentive PDF 32K
Compensation Plan -- ex10-22
8: EX-10.25 Change-In-Control Severance Plan HTML 72K
20: EX-10.25 Courtesy Copy of Change-In-Control Severance Plan PDF 50K
-- ex10-25
9: EX-10.28 Phi Combined Executive Retirement Plan HTML 70K
21: EX-10.28 Courtesy Copy of Phi Combined Executive Retirement PDF 55K
Plan -- ex10-28
10: EX-10.30 Phi Named Executive Officer 2009 Compensation HTML 29K
Determinations
22: EX-10.30 Courtesy Copy of Phi Named Executive Officer 2009 PDF 19K
Compensation Determinations -- ex10-30
11: EX-10.36 Amendment to Employment Agreement of W. T. HTML 21K
Torgerson
23: EX-10.36 Courtesy Copy of Amendment to Employment Agreement PDF 16K
of W. T. Torgerson -- ex10-36
12: EX-10.37 Credit Agreement Dated November 7, 2008 HTML 445K
24: EX-10.37 Courtesy Copy of Credit Agreement Dated November PDF 305K
7, 2008 -- ex10-37
3: EX-10.5 Phi Long-Term Incentive Plan HTML 102K
15: EX-10.5 Courtesy Copy of Phi Long-Term Incentive Plan -- PDF 65K
ex10-5
4: EX-10.6 Phi Executive and Director Deferred Compensation HTML 72K
Plan
16: EX-10.6 Courtesy Copy of Phi Executive and Director PDF 48K
Deferred Compensation Plan -- ex10-6
Securities
registered pursuant to Section 12(b) of the Act:
Registrant
Title
of Each Class
Name
of Each Exchange
on
Which
Registered
Pepco
Holdings
Common
Stock, $.01 par value
New
York Stock
Exchange
Securities
registered pursuant to Section 12(g) of the Act:
Registrant
Title
of Each Class
Pepco
Common
Stock, $.01 par value
DPL
Common
Stock, $2.25 par value
ACE
Common
Stock, $3.00 par value
Indicate by check mark if the
registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act.
Pepco
Holdings
Yes
X
No
Pepco
Yes
No
X
DPL
Yes
No
X
ACE
Yes
No
X
Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or Section
15(d) of the Act.
Pepco
Holdings
Yes
No
X
Pepco
Yes
No
X
DPL
Yes
No
X
ACE
Yes
No
X
Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12 months and (2)
has been subject to such filing requirements for the past 90 days.
Pepco
Holdings
Yes
X
No
Pepco
Yes
X
No
DPL
Yes
X
No
ACE
Yes
X
No
Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of Regulation S-K is not contained
herein, and will not be contained, to the best of registrant’s knowledge, in the
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K (applicable to Pepco
Holdings only). X
Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer or a
non-accelerated filer. See definition of “accelerated filer and
larger accelerated filer” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
Accelerated Filer
Non-Accelerated Filer
Pepco
Holdings
X
Pepco
X
DPL
X
ACE
X
Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the
Act).
Pepco
Holdings
Yes
No
X
Pepco
Yes
No
X
DPL
Yes
No
X
ACE
Yes
No
X
Pepco, DPL, and ACE meet the
conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K
and are therefore filing this Form 10-K with the reduced disclosure format
specified in General Instruction I(2) of Form 10-K.
Registrant
Aggregate
Market Value of Voting and Non-Voting Common Equity Held by Non-Affiliates
of the Registrant at June 30, 2008
Number
of Shares of Common Stock of the Registrant Outstanding at
February 2, 2009
Pepco
Holdings
$5.2
billion
219,115,048
($.01
par value)
Pepco
None (a)
100
($.01
par value)
DPL
None (b)
1,000
($2.25
par value)
ACE
None
(b)
8,546,017
($3.00
par value)
(a)
All
voting and non-voting common equity is owned by Pepco
Holdings.
(b)
All
voting and non-voting common equity is owned by Conectiv, a wholly owned
subsidiary of Pepco Holdings.
THIS COMBINED FORM 10-K IS SEPARATELY
FILED BY PEPCO HOLDINGS, PEPCO, DPL AND ACE. INFORMATION CONTAINED
HEREIN RELATING TO ANY INDIVIDUAL REGISTRANT IS FILED BY SUCH REGISTRANT ON ITS
OWN BEHALF. EACH REGISTRANT MAKES NO REPRESENTATION AS TO INFORMATION
RELATING TO THE OTHER REGISTRANTS.
Portions of the Pepco Holdings, Inc.
definitive proxy statement for the 2009 Annual Meeting of Shareholders to be
filed with the Securities and Exchange Commission on or about March 26, 2009 are
incorporated by reference into Part III of this report.
TABLE
OF CONTENTS
Page
-
Glossary
of Terms
i
PART
I
Item
1.
-
Business
1
Item
1A.
-
Risk
Factors
21
Item
1B.
-
Unresolved
Staff Comments
31
Item
2.
-
Properties
32
Item
3.
-
Legal
Proceedings
33
Item
4.
-
Submission
of Matters to a Vote of Security Holders
34
PART
II
Item
5.
-
Market
for Registrant’s Common Equity, Related
Stockholder
Matters and Issuer Purchases of
Equity
Securities
35
Item
6.
-
Selected
Financial Data
38
Item
7.
-
Management’s
Discussion and Analysis of
Financial
Condition and Results of Operations
39
Item
7A.
-
Quantitative
and Qualitative Disclosures
About
Market Risk
140
Item
8.
-
Financial
Statements and Supplementary Data
145
Item
9.
-
Changes
in and Disagreements With Accountants
on
Accounting and Financial Disclosure
361
Item
9A.
-
Controls
and Procedures
361
Item
9A(T).
-
Controls
and Procedures
361
Item
9B.
-
Other
Information
363
PART
III
Item
10.
-
Directors,
Executive Officers and Corporate Governance
364
Item
11.
-
Executive
Compensation
366
Item
12.
-
Security
Ownership of Certain Beneficial Owners and
Management
and Related Stockholder Matters
367
Item
13.
-
Certain
Relationships and Related Transactions, and
Director
Independence
368
Item
14.
-
Principal
Accounting Fees and Services
368
PART
IV
Item
15.
-
Exhibits,
Financial Statement Schedules
369
Financial
Statements
Included
in Part II, Item 8
369
Schedule
I -
Condensed
Financial Information of Parent Company
370
Schedule
II
-
Valuation
and Qualifying Accounts
373
Exhibit
12
-
Statements
Re: Computation of Ratios
389
Exhibit
21
-
Subsidiaries
of the Registrant
393
Exhibit
23
-
Consents
of Independent Registered Public Accounting Firm
395
Exhibits
31.1 - 31.8
Rule
13a-14a/15d-14(a) Certifications
399
Exhibits
32.1 - 32.4
Section
1350 Certifications
407
Signatures
411
i
GLOSSARY
OF TERMS
Term
Definition
2007
Maryland Rate Orders
The
MPSC orders approving new electric service distribution base rates for
Pepco and DPL in Maryland, each effective June 16,2007.
A&N
A&N
Electric Cooperative, purchaser of DPL’s retail electric distribution
assets in Virginia
ABO
Accumulated
benefit obligation
ACE
Atlantic
City Electric Company
ACE
Funding
Atlantic
City Electric Transition Funding LLC
ADITC
Accumulated
deferred investment tax credits
AFUDC
Allowance
for Funds Used During Construction
AMI
Advanced
Metering Infrastructure
Ancillary
services
Generally,
electricity generation reserves and reliability
services
APIC
Additional
paid-in capital
APIC
pool
A
computation that establishes the beginning balance of the
APIC
Appeals
Office
The
Appeals Office of the IRS
Bankruptcy
Funds
$13 million
from the Bankruptcy Settlement to accomplish the remediation of the Metal
Bank/Cottman Avenue site
Bankruptcy
Settlement
The
bankruptcy settlement among the parties concerning the environmental
proceedings at the Metal Bank/Cottman Avenue site
BGS
Basic
Generation Service (the supply of electricity by ACE to retail customers
in New Jersey who have not elected to purchase electricity from a
competitive supplier)
BGS-FP
BGS-Fixed
Price service
BGS-CIEP
BGS-Commercial
and Industrial Energy Price service
Bondable
Transition Property
Right
to collect a non-bypassable transition bond charge from ACE customers
pursuant to bondable stranded costs rate orders issued by the
NJBPU
BSA
Bill
Stabilization Adjustment
CAA
Federal
Clean Air Act
CAIR
EPA’s
Clean Air Interstate rule
CAMR
EPA’s
Clean Air Mercury rule
CERCLA
Comprehensive
Environmental Response, Compensation, and Liability Act of
1980
Citgo
Citgo
Asphalt Refining Company
CO2
Carbon
dioxide
Conectiv
A
wholly owned subsidiary of PHI which is a holding company under PUHCA 2005
and the parent of DPL and ACE
Conectiv
Energy
Conectiv
Energy Holding Company and its subsidiaries
Conectiv
Group
Conectiv
and certain of its subsidiaries that were involved in a like-kind exchange
transaction under examination by the IRS
Cooling
Degree Days
Daily
difference in degrees by which the mean (high and low divided by 2) dry
bulb temperature is above a base of 65 degrees
Fahrenheit
CRMC
PHI’s
Corporate Risk Management Committee
CWA
Federal
Clean Water Act
D.
C. Circuit
United
States Court of Appeals for the District of Columbia
Circuit
DC
OPC
District
of Columbia Office of People’s Counsel
DCPSC
District
of Columbia Public Service Commission
ii
Term
Definition
Default
Electricity
Supply
The
supply of electricity by PHI’s electric utility subsidiaries at regulated
rates to retail customers who do not elect to purchase electricity from a
competitive supplier, and which, depending on the jurisdiction and period,
is also known as SOS or BGS service
Default
Supply Revenue
Revenue
received for Default Electricity Supply
Delaware
District Court
United
States District Court for the District of Delaware
Delta
Project
Conectiv
Energy’s 545 megawatt natural gas and oil-fired combined-cycle electricity
generation plant located in Peach Bottom Township,
Pennsylvania
DNREC
Delaware
Department of Natural Resources and Environmental
Control
DPL
Delmarva
Power & Light Company
DPSC
Delaware
Public Service Commission
DRP
PHI’s
Shareholder Dividend Reinvestment Plan
DSM
Demand
Side Management
EDIT
Excess
Deferred Income Taxes
EITF
Emerging
Issues Task Force
EPA
United
States Environmental Protection Agency
EPS
Earnings
per share
ERISA
Employee
Retirement Income Security Act of 1974
Exchange
Act
Securities
Exchange Act of 1934, as amended
FAS
Financial
Accounting Standards
FASB
Financial
Accounting Standards Board
FERC
Federal
Energy Regulatory Commission
FHACA
Flood
Hazard Area Control Act
FIFO
First
in first out
FIN
FASB
Interpretation Number
FPA
Federal
Power Act
FSP
FASB
Staff Position
FSP
AUG AIR-1
FSP
American Institute of Certified Public Accountants Industry Audit Guide,
Audits of Airlines — “Accounting for Planned Major Maintenance
Activities”
FWPA
Freshwater
Wetlands Protection Act
GAAP
Accounting
principles generally accepted in the United States of
America
GCR
Gas
Cost Recovery
GWh
Gigawatt
hour
Heating
Degree Days
Daily
difference in degrees by which the mean (high and low divided by 2) dry
bulb temperature is below a base of 65 degrees
Fahrenheit.
HEDD
High
electric demand day
HPS
Hourly
Priced Service DPL is obligated to provide to its largest
customers
IRC
Internal
Revenue Code
IRS
Internal
Revenue Service
ISO
Independent
system operator
ISONE
Independent
System Operator - New England
ITC
Investment
Tax Credit
LTIP
Pepco
Holdings’ Long-Term Incentive Plan
MAPP
Mid-Atlantic
Power Pathway
Maryland
OPC
Maryland
Office of People’s Counsel
Mcf
One
thousand cubic feet
Medicare
Act
Medicare
Prescription Drug, Improvement and Modernization Act of
2003
Mirant
Mirant
Corporation
MPSC
Maryland
Public Service Commission
NERC
North
American Electric Reliability
Corporation
iii
Term
Definition
NFA
No
Further Action letter issued by the NJDEP
NJBPU
New
Jersey Board of Public Utilities
NJDEP
New
Jersey Department of Environmental Protection
NJPDES
New
Jersey Pollutant Discharge Elimination System
Normalization
provisions
Sections
of the IRC and related regulations that dictate how excess deferred income
taxes resulting from the corporate income tax rate reduction enacted by
the Tax Reform Act of 1986 and accumulated deferred investment tax credits
should be treated for ratemaking purposes
NOx
Nitrogen
oxide
NPDES
National
Pollutant Discharge Elimination System
NUGs
Non-utility
generators
NYDEC
New
York Department of Environmental Conservation
ODEC
Old
Dominion Electric Cooperative, purchaser of DPL’s wholesale transmission
business in Virginia
Panda
Panda-Brandywine,
L.P.
Panda
PPA
PPA
between Pepco and Panda
PARS
Performance
Accelerated Restricted Stock
PBO
Projected
benefit obligation
PCI
Potomac
Capital Investment Corporation and its subsidiaries
Pepco
Potomac
Electric Power Company
Pepco
Energy Services
Pepco
Energy Services, Inc. and its subsidiaries
Pepco
Holdings or PHI
Pepco
Holdings, Inc.
PHI
Parties
The
PHI Retirement Plan, PHI and Conectiv, parties to cash balance plan
litigation brought by three management employees of PHI Service
Company
PHI
Retirement Plan
PHI’s
noncontributory retirement plan
PJM
PJM
Interconnection, LLC
Power
Delivery
PHI’s
Power Delivery Business
PPA
Power
Purchase Agreement
PRP
Potentially
responsible party
PUHCA
2005
Public
Utility Holding Company Act of 2005, which became effective February 8,2006
RAR
IRS
revenue agent’s report
RARM
Reasonable
Allowance for Retail Margin
RC
Cape May
RC
Cape May Holdings, LLC, an affiliate of Rockland Capital Energy
Investments, LLC, and the purchaser of the B.L. England generating
facility
RECs
Renewable
energy credits
Recoverable
stranded
costs
The
portion of stranded costs that is recoverable from ratepayers as approved
by regulatory authorities
Regulated
T&D Electric
Revenue
Revenue
from the transmission and the delivery of electricity to PHI’s customers
within its service territories at regulated rates
Revenue
Decoupling
Adjustment
A
negative adjustment equal to the amount by which revenue from such
distribution sales exceeds the revenue that Pepco and DPL are entitled to
earn based on the approved distribution charge per
customer
RGGI
Regional
Greenhouse Gas Initiative
ROE
Return
on equity
RPM
Reliability
Pricing Model
SEC
Securities
and Exchange Commission
Sempra
Sempra
Energy Trading LLP
SFAS
Statement
of Financial Accounting Standards
SILO
Sale-in/lease-out
SNCR
Selective
Non-Catalytic Reduction
iv
Term
Definition
SO2
Sulfur
dioxide
SOS
Standard
Offer Service (the supply of electricity by Pepco in the District of
Columbia, by Pepco and DPL in Maryland and by DPL in Delaware on and after
May 1, 2006, to retail customers who have not elected to purchase
electricity from a competitive supplier)
Spark
spread
The
market price for electricity less the product of the cost of fuel times
the unit heat rate. It is used to estimate the relative
profitability of a generation unit.
SPCC
Spill
Prevention, Control, and Countermeasure plan required by
EPA
Spot
Commodities
market in which goods are sold for cash and delivered
immediately
Standard
Offer Service
revenue
or SOS revenue
Revenue
Pepco and DPL, respectively, receive for the procurement of energy for its
SOS customers
Starpower
Starpower
Communications, LLC
Stranded
costs
Costs
incurred by a utility in connection with providing service which would be
unrecoverable in a competitive or restructured market. Such
costs may include costs for generation assets, purchased power costs, and
regulatory assets and liabilities, such as accumulated deferred income
taxes.
T&D
Transmission
and distribution
Tolling
agreement
A
physical or financial contract where one party delivers fuel to a specific
generating station in exchange for the power output
Transition
Bond Charge
Revenue
ACE receives, and pays to ACE Funding, to fund the principal and interest
payments on Transition Bonds and related taxes, expenses and
fees
Transition
Bonds
Transition
bonds issued by ACE Funding
Treasury
lock
A
hedging transaction that allows a company to “lock-in” a specific interest
rate corresponding to the rate of a designated Treasury bond for a
determined period of time
VaR
Value
at Risk
VIE
Variable
interest entity
VRDBs
Variable
Rate Demand Bonds
v
THIS
PAGE LEFT INTENTIONALLY BLANK.
Item
1. BUSINESS
OVERVIEW
Pepco Holdings, Inc. (PHI or Pepco
Holdings), a Delaware corporation incorporated in 2001, is a diversified energy
company that, through its operating subsidiaries, is engaged primarily in two
businesses:
·
The
distribution, transmission and default supply of electricity and the
delivery and supply of natural gas (Power Delivery), conducted through the
following regulated public utility
companies:
o
Potomac
Electric Power Company (Pepco), which was incorporated in Washington, D.C.
in 1896 and became a domestic Virginia corporation in
1949,
o
Delmarva
Power & Light Company (DPL), which was incorporated in Delaware in
1909 and became a domestic Virginia corporation in 1979,
and
o
Atlantic
City Electric Company (ACE), which was incorporated in New Jersey in
1924.
·
Competitive
energy generation, marketing and supply (Competitive Energy) conducted
through subsidiaries of Conectiv Energy Holding Company (collectively
Conectiv Energy) and Pepco Energy Services, Inc. and its subsidiaries
(collectively Pepco Energy
Services).
The following chart shows, in
simplified form, the corporate structure of PHI and its principal
subsidiaries.
1
Conectiv
is solely a holding company with no business operations. The
activities of Potomac Capital Investment Corporation (PCI) are described
below under the heading “Other Business Operations.”
PHI Service Company, a subsidiary
service company of PHI, provides a variety of support services, including legal,
accounting, treasury, tax, purchasing and information technology services to PHI
and its operating subsidiaries. These services are provided pursuant
to a service agreement among PHI, PHI Service Company, and the participating
operating subsidiaries. The expenses of PHI Service Company are
charged to PHI and the participating operating subsidiaries in accordance with
costing methodologies set forth in the service agreement.
Pepco
Holdings’ management has identified its operating segments at December 31, 2008
as Power Delivery, Conectiv Energy, Pepco Energy Services, and Other
Non-Regulated.For financial information relating to PHI’s segments, see Note
(5), “Segment Information” to the consolidated financial statements of PHI set
forth in Part II, Item 8. Each of Pepco, DPL and ACE has one
operating segment.
Investor
Information
Each of PHI, Pepco, DPL and ACE files
reports under the Securities Exchange Act of 1934, as amended. The
Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current
Reports on Form 8-K, and all amendments to those reports, of each of the
companies are made available free of charge on PHI’s internet Web site as soon
as reasonably practicable after such documents are electronically
filed with or furnished to the Securities and Exchange Commission
(SEC). These reports may be found at http://www.pepcoholdings.com/investors.
Description of
Business
The following is a description of each
of PHI’s two principal business operations.
Power Delivery
The largest component of PHI’s business
is Power Delivery, which consists of the transmission, distribution and default
supply of electricity and the delivery and supply of natural gas. In
2008, 2007 and 2006, respectively, PHI’s Power Delivery operations produced 51%,
56%, and 61% of PHI’s consolidated operating revenues (including revenue from
intercompany transactions) and 72%, 66%, and 67% of PHI’s consolidated operating
income (including income from intercompany transactions).
Each of
Pepco, DPL and ACE is a regulated public utility in the jurisdictions that
comprise its service territory. Each company owns and operates a
network of wires, substations and other equipment that is classified either as
transmission or distribution facilities. Transmission facilities are
high-voltage systems that carry wholesale electricity into, or across, the
utility’s service territory. Distribution facilities are low-voltage
systems that carry electricity to end-use customers in the utility’s service
territory.
2
Delivery of Electricity, Natural Gas
and Default Electricity Supply
The Power Delivery business is
conducted by PHI’s three utility subsidiaries: Pepco, DPL and
ACE. Each company is responsible for the delivery of electricity and,
in the case of DPL, also natural gas in its service territory, for which it is
paid tariff rates established by the applicable local public service
commission. Each company also supplies electricity at regulated rates
to retail customers in its service territory who do not elect to purchase
electricity from a competitive energy supplier. The regulatory term
for this supply service varies by jurisdiction as follows:
Delaware
Standard
Offer Service (SOS)
District
of Columbia
SOS
Maryland
SOS
New
Jersey
Basic
Generation Service (BGS)
Effective January 2, 2008, DPL sold its
retail electric distribution assets and its wholesale electric transmission
assets in Virginia. This sale terminated DPL’s obligations as a
supplier of electricity to retail customers in its Virginia service territory
who do not elect to purchase electricity from a competitive
supplier.
In this Form 10-K, the supply service
obligations of the respective utility subsidiaries are referred to generally as
Default Electricity Supply.
In the aggregate, the Power Delivery
business delivers electricity to more than 1.8 million customers in the
mid-Atlantic region and distributes natural gas to approximately 122,000
customers in Delaware.
Transmission of Electricity and
Relationship with PJM
The transmission facilities owned by
Pepco, DPL and ACE are interconnected with the transmission facilities of
contiguous utilities and are part of an interstate power transmission grid over
which electricity is transmitted throughout the mid-Atlantic portion of the
United States and parts of the Midwest. The Federal Energy Regulatory
Commission (FERC) has designated a number of regional transmission organizations
to coordinate the operation and planning of portions of the interstate
transmission grid. Pepco, DPL and ACE are members of the PJM Regional
Transmission Organization (PJM RTO). In 1997, FERC approved PJM
Interconnection, LLC (PJM) as the provider of transmission service in the PJM
RTO region, which currently consists of all or parts of Delaware, Illinois,
Indiana, Kentucky, Maryland, Michigan, New Jersey, North Carolina, Ohio,
Pennsylvania, Tennessee, Virginia, West Virginia and the District of
Columbia. As the independent grid operator, PJM coordinates the
electric power market and the movement of electricity within the PJM RTO
region. Any entity that wishes to have electricity delivered at any
point in the PJM RTO region must obtain transmission services from PJM, at rates
approved by FERC. In accordance with FERC-approved rules, Pepco, DPL,
ACE and the other transmission-owning utilities in the region make their
transmission facilities available to the PJM RTO and PJM directs and controls
the operation of these transmission facilities. Transmission rates
are proposed by the transmission owner and
3
approved
by FERC. PJM provides billing and settlement services, collects
transmission service revenue from transmission service customers and distributes
the revenue to the transmission owners. PJM also directs the regional
transmission planning process within the PJM RTO region. The PJM
Board of Managers reviews and approves each PJM regional transmission expansion
plan.
Distribution of Electricity and
Deregulation
Historically, electric utilities,
including Pepco, DPL and ACE, were vertically integrated businesses that
generated all or a substantial portion of the electric power supply that they
delivered to customers in their service territories over their own distribution
facilities. Customers were charged a bundled rate approved by the
applicable regulatory authority that covered both the supply and delivery
components of the retail electric service. However, legislative and
regulatory actions in each of the service territories in which Pepco, DPL and
ACE operate have resulted in the “unbundling” of the supply and delivery
components of retail electric service and in the opening of the supply component
to competition from non-regulated providers. Accordingly, while
Pepco, DPL and ACE continue to be responsible for the distribution of
electricity in their respective service territories, as the result of
deregulation, customers in those service territories now are permitted to choose
their electricity supplier from among a number of non-regulated, competitive
suppliers. Customers who do not choose a competitive supplier receive
Default Electricity Supply on terms that vary depending on the service
territory, as described more fully below.
In connection with the deregulation of
electric power supply, Pepco, DPL and ACE have divested all of their respective
generation assets, by either selling them to third parties or transferring them
to the non-regulated affiliates of PHI that comprise PHI’s Competitive Energy
businesses. Accordingly, Pepco, DPL and ACE are no longer engaged in
generation operations.
Seasonality
Power Delivery’s operating results
historically have been seasonal, generally producing higher revenue and income
in the warmest and coldest periods of the year. In Maryland, however,
the decoupling of distribution revenue for a given reporting period from the
amount of power delivered during the period, as the result of the adoption in
2007 by the Maryland Public Service Commission (MPSC) of a bill stabilization
adjustment mechanism for retail customers, has had the effect of eliminating
changes in customer usage due to weather conditions or other reasons as a factor
having an impact on revenue and income.
Regulation
The retail operations of PHI’s utility
subsidiaries, including the rates they are permitted to charge customers for the
delivery and transmission of electricity and, in the case of DPL, also the
distribution and transportation of natural gas, are subject to regulation by
governmental agencies in the jurisdictions in which they provide utility service
as follows:
o
Pepco’s
electricity delivery operations are regulated in Maryland by the MPSC and
in Washington, D.C. by the District of Columbia Public Service Commission
(DCPSC).
o
DPL’s
electricity delivery operations are regulated in Maryland by the MPSC and
in Delaware by the Delaware Public Service Commission (DPSC) and, until
the sale of
4
its
Virginia assets on January 2, 2008, were regulated in Virginia by the
Virginia State Corporation Commission.
o
DPL’s
natural gas distribution and intrastate transportation operations in
Delaware are regulated by the DPSC.
o
ACE’s
electricity delivery operations are regulated by the New Jersey Board of
Public Utilities (NJBPU).
o
The
transmission and wholesale sale of electricity by each of PHI’s utility
subsidiaries are regulated by FERC.
o
The
interstate transportation and wholesale sale of natural gas by DPL is
regulated by FERC.
Pepco
Pepco is engaged in the transmission,
distribution and default supply of electricity in Washington, D.C. and major
portions of Prince George’s County and Montgomery County in suburban
Maryland. Pepco’s service territory covers approximately 640 square
miles and has a population of approximately 2.1 million. As of
December 31, 2008, Pepco delivered electricity to 767,000 customers (of which
247,000 were located in the District of Columbia and 520,000 were located in
Maryland), as compared to 760,000 customers as of December 31, 2007 (of which
241,800 were located in the District of Columbia and 518,200 were located in
Maryland).
In 2008, Pepco delivered a total of
26,863,000 megawatt hours of electricity, of which 29% was delivered to
residential customers, 51% to commercial customers, and 20% to United States and
District of Columbia government customers. In 2007, Pepco delivered a
total of 27,451,000 megawatt hours of electricity, of which 30% was delivered to
residential customers, 50% to commercial customers, and 20% to United States and
District of Columbia government customers.
Pepco has been providing market-based
SOS in Maryland since July 2004. Pursuant to an order issued by the
MPSC in November 2006, Pepco will continue to be obligated to provide SOS to
residential and small commercial customers indefinitely, until further action of
the Maryland General Assembly, and to medium-sized commercial customers through
May 2010. Pepco purchases the power supply required to satisfy its
SOS obligation from wholesale suppliers under contracts entered into pursuant to
competitive bid procedures approved and supervised by the MPSC. Pepco
also has an on-going obligation to provide SOS service, known as Hourly Priced
Service (HPS), for the largest customers. Power to supply the SOS HPS
customers is acquired in next-day and other short-term PJM RTO
markets. Pepco is entitled to recover from its SOS customers the cost
of the SOS supply plus an average margin of $.001651 per
kilowatt-hour. Because margins vary by customer class, the actual
average margin over any given time period depends on the number of Maryland SOS
customers from each customer class and the load taken by such customers over the
time period. Pepco is paid tariff delivery rates for the delivery of
electricity over its transmission and distribution facilities to all electricity
customers in its Maryland service territory regardless of whether the customer
receives SOS or purchases electricity from another energy supplier.
5
Pepco has been providing market-based
SOS in the District of Columbia since February 2005. Pursuant to
orders issued by the DCPSC, Pepco will continue to be obligated to provide SOS
to residential and small and large commercial customers indefinitely, pending
investigation by the DCPSC of other alternatives, including the selection of
another party to administer the SOS franchise. Pepco purchases the
power supply required to satisfy its SOS obligation from wholesale suppliers
under contracts entered into pursuant to a competitive bid procedure approved by
the DCPSC. Pepco is entitled to recover from its SOS customers the
costs associated with the acquisition of the SOS supply, plus administrative
charges that are intended to allow Pepco to recover the administrative costs
incurred to provide the SOS. These administrative charges include an
average margin for Pepco of $.002151 per kilowatt-hour. Because
margins vary by customer class, the actual average margin over any given time
period depends on the number of District of Columbia SOS customers from each
customer class and the load taken by such customers over the time
period. Pepco is paid tariff delivery rates for the delivery of
electricity over its transmission and distribution facilities to all electricity
customers in its District of Columbia service territory regardless of whether
the customer receives SOS or purchases electricity from another energy
supplier.
For the year ended December 31, 2008,
50% of Pepco’s Maryland distribution sales (measured by megawatt hours) were to
SOS customers, as compared to 51% in 2007, and 33% of its District of Columbia
distribution sales were to SOS customers in 2008, as compared to 35% in
2007.
DPL
DPL is engaged in the transmission,
distribution and default supply of electricity in Delaware and portions of
Maryland. In northern Delaware, DPL also supplies and distributes natural gas to
retail customers and provides transportation-only services to retail customers
that purchase natural gas from other suppliers.
Transmission and Distribution of
Electricity
In Delaware, electricity service is
provided in the counties of Kent, New Castle, and Sussex and in Maryland in the
counties of Caroline, Cecil, Dorchester, Harford, Kent, Queen Anne’s, Somerset,
Talbot, Wicomico and Worchester. Prior to January 2, 2008, DPL also
provided transmission and distribution of electricity in Accomack and
Northampton counties in Virginia. As discussed below, under the
heading “Sale of Virginia Retail Electric Distribution and Wholesale
Transmission Assets,” DPL, on January 2, 2008, completed the sale of
substantially all of its Virginia retail electric distribution and wholesale
electric transmission assets.
DPL’s electricity distribution service
territory covers approximately 5,000 square miles and has a population of
approximately 1.3 million. As of December 31, 2008, DPL delivered
electricity to 498,000 customers (of which 299,000 were located in Delaware and
199,000 were located in Maryland), as compared to 519,000 electricity customers
as of December 31, 2007 (of which 298,000 were located in Delaware, 198,000
were located in Maryland, and 23,000 were located in Virginia).
In 2008, DPL delivered a total of
13,015,000 megawatt hours of electricity to its customers, of which 39% was
delivered to residential customers, 41% to commercial customers
6
and 20%
to industrial customers. In 2007, DPL delivered a total of 13,680,000
megawatt hours of electricity, of which 39% was delivered to residential
customers, 40% to commercial customers and 21% to industrial
customers.
DPL has been providing market-based SOS
in Delaware since May 2006. Pursuant to orders issued by the DPSC,
DPL will continue to be obligated to provide fixed-price SOS to residential,
small commercial and industrial customers through May 2012 and to medium, large
and general service commercial customers through May 2010. DPL
purchases the power supply required to satisfy its fixed-price SOS obligation
from wholesale suppliers under contracts entered into pursuant to competitive
bid procedures approved by the DPSC. DPL also has an obligation to
provide SOS service, known as HPS for the largest customers. Power to
supply the HPS customers is acquired on next-day and other short-term PJM RTO
markets. DPL’s rates for supplying fixed-price SOS and HPS reflect
the associated capacity, energy, transmission, and ancillary services costs and
a Reasonable Allowance for Retail Margin (RARM). Components of the
RARM include a fixed annual margin of approximately $3 million, plus estimated
incremental expenses, a cash working capital allowance, and recovery with a
return over five years of the capitalized costs of the billing system used for
billing HPS customers. DPL is paid tariff delivery rates for the
delivery of electricity over its transmission and distribution facilities to all
electricity customers in its Delaware service territory regardless of whether
the customer receives SOS or purchases electricity from another energy
supplier.
In Delaware, DPL distribution sales to
SOS customers represented 55% of total distribution sales (measured by megawatt
hours) for the year ended December 31, 2008, as compared to 54% in
2007.
DPL
has been providing market-based SOS in Maryland since June
2004. Pursuant to an order issued by the MPSC in November 2006, DPL
will continue to be obligated to provide SOS to residential and small commercial
customers indefinitely until further action of the Maryland General Assembly,
and to medium-sized commercial customers through May 2010. DPL
purchases the power supply required to satisfy its SOS obligation from wholesale
suppliers under contracts entered into pursuant to competitive bid procedures
approved and supervised by the MPSC. DPL also has an on-going
obligation to provide SOS service, known as HPS, for the largest
customers. Power to supply the SOS HPS customers is acquired in
next-day and other short-term PJM RTO markets. DPL purchases the
power supply required to satisfy its SOS obligation from wholesale suppliers
under contracts entered into pursuant to competitive bid procedures approved and
supervised by the MPSC. DPL is entitled to recover from its SOS
customers the costs of the SOS supply plus an average margin of $.001630 per
kilowatt-hour. Because margins vary by customer class, the actual
average margin over any given time period depends on the number of Maryland SOS
customers from each customer class and the load taken by such customers over the
time period. DPL is paid tariff delivery rates for the delivery of
electricity over its transmission and distribution facilities to all electricity
customers in its Maryland service territory regardless of whether the customer
receives SOS or purchases electricity from another energy supplier.
In Maryland, DPL distribution sales to
SOS customers represented 65% of total distribution sales (measured by megawatt
hours) for the year ended December 31, 2008, as compared to 67% in
2007.
7
DPL provided Default Service in
Virginia from March 2004 until the sale of its Virginia retail electric
distribution and wholesale transmission assets on January 2,2008. DPL was paid tariff delivery rates for the delivery of
electricity over its transmission and distribution facilities to all electricity
customers in its Virginia service territory regardless of whether the customer
received Default Service or purchased electricity from another energy
supplier.
In Virginia, DPL distribution sales to
Default Service customers represented 94% of total distribution sales (measured
by megawatt hours) for the year ended December 31, 2007.
Sale
of Virginia Retail Electric Distribution and Wholesale Transmission
Assets
In
January 2008, DPL completed (i) the sale of its retail electric
distribution assets on the Eastern Shore of Virginia to A&N Electric
Cooperative and (ii) the sale of its wholesale electric transmission assets
located on the Eastern Shore of Virginia to Old Dominion Electric
Cooperative.
Natural
Gas Distribution
DPL provides regulated natural gas
supply and distribution service to customers in a service territory consisting
of a major portion of New Castle County in Delaware. This service
territory covers approximately 275 square miles and has a population of
approximately 500,000. Large volume commercial, institutional, or industrial
natural gas customers may purchase natural gas either from DPL or from other
suppliers. DPL uses its natural gas distribution facilities to
transport natural gas for customers that choose to purchase natural gas from
other suppliers. Intrastate transportation customers pay DPL
distribution service rates approved by the DPSC. DPL purchases
natural gas supplies for resale to its retail service customers from marketers
and producers through a combination of long-term agreements and next-day
delivery arrangements. For the twelve months ended December 31, 2008,
DPL supplied 65% of the natural gas that it delivered, compared to 67% in
2007.
DPL distributed natural gas to 122,000
customers as of December 31, 2008 and 2007. In 2008, DPL
distributed 20,300,000 Mcf (thousand cubic feet) of natural gas to customers in
its Delaware service territory, of which 38% were sales to residential
customers, 24% to commercial customers, 3% to industrial customers, and 35% to
customers receiving a transportation-only service. In 2007, DPL
delivered 20,700,000 Mcf of natural gas, of which 38% were sales to residential
customers, 25% were sales to commercial customers, 4% were to industrial
customers, and 33% were sales to customers receiving a transportation-only
service.
ACE
ACE is primarily engaged in the
transmission, distribution and default supply of electricity in a service
territory consisting of Gloucester, Camden, Burlington, Ocean, Atlantic, Cape
May, Cumberland and Salem counties in southern New Jersey. ACE’s
service territory covers approximately 2,700 square miles and has a population
of approximately 1.1 million. As of December 31, 2008, ACE
delivered electricity to 547,000 customers in its service territory, as compared
to 544,000 customers as of December 31, 2007. In 2008, ACE delivered
a total of 10,089,000 megawatt hours of electricity to its customers, of which
44% was delivered to residential customers, 44% to commercial customers and 12%
to industrial customers. In 2007, ACE delivered a total of 10,187,000
megawatt hours of electricity to its customers, of which
8
44% was
delivered to residential customers, 44% to commercial customers, and 12% to
industrial customers.
Electric customers in New Jersey who do
not choose another supplier receive BGS from their electric distribution
company. New Jersey’s electric distribution companies, including ACE,
jointly procure the supply to meet their BGS obligations from competitive
suppliers selected through auctions authorized by the NJBPU for New Jersey’s
total BGS requirements. The winning bidders in the auction are
required to supply a specified portion of the BGS customer load with full
requirements service, consisting of power supply and transmission
service.
ACE
provides two types of BGS:
·
BGS-Fixed
Price (BGS-FP), which is supplied to smaller commercial and residential
customers at seasonally-adjusted fixed prices. BGS-FP rates
change annually on June 1 and are based on the average BGS price obtained
at auction in the current year and the two prior years. ACE’s
BGS-FP load is approximately 2,198 megawatts, which represents
approximately 99% of ACE’s total BGS load. Approximately
one-third of this total load is auctioned off each year for a three-year
term.
·
BGS-Commercial
and Industrial Energy Price (BGS-CIEP), which is supplied to larger
customers at hourly PJM RTO real-time market prices for a term of 12
months. ACE’s BGS-CIEP load is approximately 33 megawatts, which
represents approximately 1% of ACE’s BGS load. This total load
is auctioned off each year for a one-year
term.
ACE is paid tariff rates established by
the NJBPU that compensate it for the cost of obtaining the BGS
supply. ACE does not make any profit or incur any loss on the supply
component of the BGS it provides to customers.
ACE is paid tariff delivery rates for
the delivery of electricity over its transmission and distribution facilities to
all electricity customers in its New Jersey service territory regardless of
whether the customer receives BGS or purchases electricity from another energy
supplier.
ACE distribution sales to BGS customers
represented 78% of total distribution sales (measured by megawatt hours) for the
year ended December 31, 2008, as compared to 80% in 2007.
In February 2007, ACE completed the
sale of its B.L. England generating facility, which is reflected as discontinued
operations on ACE’s consolidated statements of earnings for the years ended
December 31, 2007 and 2006. ACE’s sale of its interests in the Keystone and
Conemaugh generating facilities in September 2006 is also reflected as
discontinued operations on the consolidated statement of earnings for the year
ended December 31, 2006 of ACE.
ACE has several contracts with
non-utility generators (NUGs) under which ACE purchased 3.8 million megawatt
hours of power in 2008. ACE sells the electricity purchased under the
contracts with NUGs into the wholesale market administered by PJM.
9
In 2001, ACE established Atlantic City
Electric Transition Funding LLC (ACE Funding) solely for the purpose of
securitizing authorized portions of ACE’s recoverable stranded costs through the
issuance and sale of bonds (Transition Bonds). The proceeds of the
sale of each series of Transition Bonds have been transferred to ACE in exchange
for the transfer by ACE to ACE Funding of the right to collect a non-bypassable
transition bond charge from ACE customers pursuant to bondable stranded costs
rate orders issued by the NJBPU in an amount sufficient to fund the principal
and interest payments on the Transition Bonds and related taxes, expenses and
fees (Bondable Transition Property). The assets of ACE Funding,
including the Bondable Transition Property, and the Transition Bond charges
collected from ACE’s customers, are not available to creditors of
ACE. The holders of Transition Bonds have recourse only to the assets
of ACE Funding.
Competitive Energy
The Competitive Energy businesses
provide competitive generation, marketing and supply of electricity and natural
gas, and related energy management services primarily in the mid-Atlantic
region. These operations are conducted through subsidiaries of Conectiv Energy
and Pepco Energy Services. For the years ended December 31, 2008, 2007 and 2006,
PHI’s Competitive Energy operations produced 53%, 48%, and 43%, respectively, of
PHI’s consolidated operating revenues and 36%, 26%, and 20%, respectively, of
PHI’s consolidated operating income.
Conectiv
Energy
Conectiv Energy divides its activities
into two operational categories: (i) Merchant Generation & Load
Service and (ii) Energy Marketing.
Merchant Generation & Load
Service
Conectiv Energy provides wholesale
electric power, capacity and ancillary services in the wholesale markets and
also supplies electricity to other wholesale market participants under long- and
short-term bilateral contracts. Conectiv Energy supplies electric
power to Pepco, DPL and ACE to satisfy a portion of their Default Electricity
Supply load, as well as the default electricity supply load shares of other
utilities within the PJM RTO and Independent System Operator - New England
wholesale markets. Conectiv Energy obtains the electricity required
to meet its Merchant Generation & Load Service power supply obligations from
its own generation plants, tolling agreements, bilateral contract purchases from
other wholesale market participants and purchases in the wholesale
market. Conectiv Energy’s primary fuel source for its generation
plants is natural gas. Conectiv Energy manages its natural gas supply
using a portfolio of long-term, firm storage and transportation contracts, and a
variety of derivative instruments.
Conectiv Energy’s generation capacity
is concentrated in mid-merit plants, which due to their operating flexibility
and multi-fuel capability can quickly change their output level on an economic
basis. Like “peak-load” plants, mid-merit plants generally operate
during times when demand for electricity rises and prices are
higher. However, mid-merit plants usually operate more frequently and
for longer periods of time than peak-load plants because of better heat
rates. As of December 31, 2008, Conectiv Energy owned and operated
mid-merit plants with a combined 2,778 megawatts of capacity, peak-load plants
with a combined 639 megawatts of capacity and base-load generating plants with a
combined 340 megawatts of capacity. See
10
Item 2
“Properties” of this Form 10-K. In addition to the generation plants
it owns, Conectiv Energy controls another 500 megawatts of capacity through
tolling agreements.
Conectiv Energy is constructing a 545
megawatt natural gas and oil-fired combined-cycle electricity generation plant
located in Peach Bottom Township, Pennsylvania known as the Delta
Project. The plant will be owned and operated as part of Conectiv
Energy and is expected to go into commercial operation in
2011. Conectiv Energy has entered into a six-year tolling agreement
with an unaffiliated energy company under which Conectiv Energy will sell the
energy, capacity and most of the ancillary services from the plant for the
period June 2011 through May 2017 to the other party. Under
the terms of the tolling agreement, Conectiv Energy will be responsible for the
operation and maintenance of the plant, subject to the other party’s control
over the dispatch of the plant’s output. The other party will be
responsible for the purchase and scheduling of the fuel to operate the plant and
all required emissions allowances.
Energy Marketing
Conectiv Energy also sells natural gas
and fuel oil to very large end-users and to wholesale market participants under
bilateral agreements. Conectiv Energy obtains the natural gas and
fuel oil required to meet its supply obligations through market purchases for
next day delivery and under long- and short-term bilateral contracts with other
market participants. In addition, Conectiv Energy operates a
short-term power desk, which generates margin by identifying and capturing price
differences between power pools and locational and timing differences within a
power pool. Conectiv Energy also engages in power origination
activities, which primarily represent the fixed margin component of structured
power transactions such as default supply service. Conectiv Energy
refers to these operations collectively as Energy Marketing.
Pepco Energy
Services
Pepco Energy Services provides retail
energy supply and energy services primarily to commercial, industrial, and
government customers. Pepco Energy Services sells electricity,
including electricity from renewable resources, to customers located primarily
in the mid-Atlantic and northeastern regions of the U.S., Texas and the Chicago,
Illinois areas. As of December 31, 2008, Pepco Energy Services’
estimated retail electricity backlog was approximately 33 million megawatts for
delivery through 2014, an increase of approximately 1 million megawatts over
December 31, 2007. Pepco Energy Services also sells natural gas to
customers located primarily in the mid-Atlantic region.
Pepco Energy Services also provides
energy savings performance contracting services principally to federal, state
and local government customers, owns and operates two district energy systems
and designs, constructs, and operates combined heat and power and central energy
plants.
Pepco Energy Services owns three
landfill gas-fired electricity plants that have a total generating capacity
rating of 10 megawatts and the output of these plants is sold into the wholesale
market administered by PJM and a solar photovoltaic plant that has a generating
capacity rating of 2 megawatts and the output of this plant is sold to its host
facility.
11
Pepco Energy Services provides high
voltage construction and maintenance services to customers throughout the United
States and low voltage electric construction and maintenance services and
streetlight construction and asset management services to utilities,
municipalities and other customers in the Washington, D.C. area.
Pepco Energy Services owns and operates
two oil-fired power plants. The power plants are located in
Washington, D.C. and have a generating capacity rating of approximately 790
megawatts. See Item 2 “Properties” of this Form
10-K. Pepco Energy Services sells the output of these plants into the
wholesale market administered by PJM. In February 2007, Pepco Energy
Services provided notice to PJM of its intention to deactivate these
plants. In May 2007, Pepco Energy Services deactivated one combustion
turbine at its Buzzard Point facility with a generating capacity of
approximately 16 megawatts. Pepco Energy Services currently plans to
deactivate the balance of both plants by May 2012. PJM has informed
Pepco Energy Services that these facilities are not expected to be needed for
reliability after that time, but that its evaluation is dependent on the
completion of transmission and distribution upgrades. Pepco Energy
Services’ timing for deactivation of these units, in whole or in part, may be
accelerated or delayed based on the operating condition of the units, economic
conditions, and reliability considerations. Deactivation will not
have a material impact on PHI’s financial condition, results of operations or
cash flows.
Derivatives and Risk
Management
PHI’s
Competitive Energy businesses use derivative instruments primarily to reduce
their financial exposure to changes in the value of their assets and obligations
due to commodity price fluctuations. The derivative instruments used
by the Competitive Energy businesses include forward contracts, futures, swaps,
and exchange-traded and over-the-counter options. In addition, the
Competitive Energy businesses also manage commodity risk with contracts that are
not classified as derivatives. The two primary risk management
objectives are (1) to manage the spread between the cost of fuel used to operate
electric generation plants and the revenue received from the sale of the power
produced by those plants, and (2) to manage the spread between retail sales
commitments and the cost of supply used to service those commitments to ensure
stable cash flows, and lock in favorable prices and margins when they become
available.
Conectiv Energy’s goal is to manage the
risk associated with the expected power output of its generation facilities and
their fuel requirements. The risk management goals are approved by
PHI’s Corporate Risk Management Committee and may change from time to time based
on market conditions. The actual level of coverage may vary depending
on the extent to which Conectiv Energy is successful in implementing its risk
management strategies. For additional discussion of Conectiv Energy’s
risk management Activities, see Item 7A “Quantitative and Qualitative
Disclosures About Market Risk” set forth in Part II of this Form
10-K.
PJM Capacity
Markets
A source of revenue for the Competitive
Energy businesses is the sale of capacity by Conectiv Energy and Pepco Energy
Services associated with their respective generating facilities. The
wholesale market for capacity in PJM is administered by PJM which is responsible
for ensuring that within the transmission control area there is sufficient
generating capability available to meet the load requirements plus a reserve
margin. In accordance with PJM requirements, retail sellers of
electricity in the PJM market are required to maintain
12
capacity
from generating facilities within the control area or generating facilities
outside the control area, which have firm transmission rights into the control
area that correspond to their load service obligations. This capacity
can be obtained through the ownership of generation facilities, entry into
bilateral contracts or the purchase of capacity credits in the auctions
administered by PJM. All of the generating facilities owned by the Competitive
Energy businesses are located in the transmission control area administered by
PJM. The capacity of a generating unit is determined based on the
demonstrated generating capacity of the unit and its forced outage
rate.
Beginning on June 1, 2007, PJM replaced
its former capacity market rules with a forward capacity auction procedure known
as the Reliability Pricing Model (RPM), which provides for differentiation in
capacity prices between “locational deliverability areas.” One of the
primary objectives of RPM is to encourage the development of new generation
sources, particularly in constrained areas.
Under RPM, PJM has held five auctions,
each covering capacity to be supplied over consecutive 12-month periods, with
the most recent auction covering the 12-month period beginning June 1,2011. Auctions of capacity for each subsequent 12-month delivery
period will be held 36 months ahead of the scheduled delivery year. The next
auction, for the period June 2012 through May 2013, will take place in May
2009. The Competitive Energy businesses are exposed to certain
deficiency charges payable to PJM if their generation units fail to meet certain
reliability levels. Some deficiency charges may be reduced by
purchasing capacity from PJM or third parties.
In addition to participating in the PJM
auctions, the Competitive Energy businesses participate in the forward capacity
market as both sellers and buyers in accordance with PHI’s risk management
policy, and accordingly, prices realized in the PJM capacity auctions may not be
indicative of gross margin that PHI earns in respect to its capacity purchases
and sales during a given period.
Competition
The unregulated energy generation,
supply and marketing businesses located primarily in the mid-Atlantic region are
characterized by intense competition at both the wholesale and retail
levels. At the wholesale level, Conectiv Energy and Pepco Energy
Services compete with numerous non-utility generators, independent power
producers, wholesale power marketers and brokers, and traditional utilities that
continue to operate generation assets. In the retail energy supply
market and in providing energy management services, Pepco Energy Services
competes with numerous competitive energy marketers and other service
providers. Competition in both the wholesale and retail markets for
energy and energy management services is based primarily on price and, to a
lesser extent, the range and quality of services offered to
customers.
Seasonality
The power generation, supply and
marketing businesses are seasonal and weather patterns can have a material
impact on operating performance. Demand for electricity generally is
higher in the summer months associated with cooling and demand for electricity
and natural gas generally is higher in the winter months associated with
heating, as compared to other times of the year. Historically, the
competitive energy operations of Conectiv Energy and Pepco
13
Energy
Services have generated less revenue when temperatures are milder than normal in
the winter and cooler than normal in the summer. Milder weather can
also negatively impact income from these operations. The energy
management services of Pepco Energy Services generally are not
seasonal.
Other Business Operations
Through its subsidiary PCI, PHI
maintains a portfolio of cross-border energy sale-leaseback transactions, with a
book value at December 31, 2008 of approximately $1.3
billion. For additional information concerning these cross-border
lease transactions, see Note (16), “Commitments and Contingencies” to the
consolidated financial statements of PHI set forth in Item 8 “Financial
Statements and Supplementary Data” of the Form 10-K. This activity
constitutes a separate operating segment for financial reporting purposes, which
is designated “Other Non-Regulated.”
EMPLOYEES
At December 31, 2008, PHI had 5,474
employees, including 1,343 employed by Pepco, 898 employed by DPL, 523 employed
by ACE and 1,893 employed by PHI Service Company. The remaining were
employed by PHI’s Competitive Energy and other non-regulated
businesses. Approximately 2,896 employees (including 1,047 employed
by Pepco, 727 employed by DPL, 378 employed by ACE, 341 employed by PHI Service
Company, and 403 employed by the Competitive Energy businesses) are covered by
collective bargaining agreements with various locals of the International
Brotherhood of Electrical Workers.
ENVIRONMENTAL
MATTERS
PHI,
through its subsidiaries, is subject to regulation by various federal, regional,
state, and local authorities with respect to the environmental effects of its
operations, including air and water quality control, solid and hazardous waste
disposal, and limitations on land use. In addition, federal and state
statutes authorize governmental agencies to compel responsible parties to clean
up certain abandoned or unremediated hazardous waste sites. PHI’s
subsidiaries may incur costs to clean up currently or formerly owned facilities
or sites found to be contaminated, as well as other facilities or sites that may
have been contaminated due to past disposal practices.
PHI’s subsidiaries’ currently projected
capital expenditures plan for the replacement of existing or installation of new
environmental control facilities that are necessary for compliance with
environmental laws, rules or agency orders are expected to be approximately
$37 million in 2009 and $32 million in 2010. These expenditures
include $18 million and $11 million, respectively, to comply with
multi-pollutant regulations adopted by the Delaware Department of Natural
Resources and Environmental Control (DNREC), as more fully discussed
below. The actual costs of environmental compliance may be materially
different from this capital expenditures plan depending on the outcome of the
matters addressed below or as a result of the imposition of additional
environmental requirements or new or different interpretations of existing
environmental laws, rules and agency orders.
14
Air Quality
Regulation
The generating facilities and
operations of PHI’s subsidiaries are subject to federal, state and local laws
and regulations, including the Federal Clean Air Act (CAA), which limit
emissions of air pollutants, require permits for operation of facilities and
impose recordkeeping and reporting requirements.
Sulfur Dioxide, Nitrogen Oxide, Mercury
and Nickel Emissions
The acid rain provisions of the CAA
regulate total sulfur dioxide (SO2) emissions
from affected generating units and allocate “allowances” to each affected unit
that permit the unit to emit a specified amount of SO2. The
generating facilities of PHI’s subsidiaries that require SO2 allowances
use allocated allowances or allowances acquired, as necessary, in the open
market to satisfy the applicable regulatory requirements. Also under
current regulations implementing CAA standards, each of the states in which PHI
subsidiaries own and operate generating units regulate nitrogen oxide (NOx)
emissions from generating units and allocate NOx allowances. Most of
the generating units operated by PHI subsidiaries are subject to NOx emission
limits. These units use allocated allowances or allowances acquired,
as necessary, in the open market to maintain compliance with the regulatory
requirements during the calendar year and during the ozone season (May 1 to
September 30).
In 2005, the United States
Environmental Protection Agency (EPA) issued its Clean Air Interstate Rule
(CAIR), which imposes further reductions of SO2 and NOx
emissions from electric generating units in 28 eastern states and the District
of Columbia, including each of the states in which PHI subsidiaries own and
operate generating units. CAIR uses an allowance system to cap
state-wide emissions of SO2 and NOx in
two stages beginning in 2009 for NOx and in 2010 for SO2. States
may implement CAIR by adopting EPA’s trading program or through regulations that
at a minimum achieve the level of reductions that would be achieved through
implementation of EPA’s program. Each state covered by CAIR may
determine independently which emission sources to control and which control
measures to adopt. CAIR includes model rules for multi-state cap and
trade programs for power plants that states may choose to adopt to meet the
required emissions reductions. Generating units are permitted to
satisfy the CAIR requirements through the use of allocated allowances or
allowances acquired in the open market, through the installation of pollution
control devices or through fuel modifications.
In July 2008, the United States Court
of Appeals for the District of Columbia Circuit (the D.C. Circuit) vacated CAIR
and remanded the rule to the EPA for further rulemaking to address the flaws it
found with the rule, including EPA’s (1) failure to ensure that CAIR
emission reductions from upwind states would assist downwind states in meeting
air quality standards, (2) method for allocating SO2 and NOx
emission caps among the states and (3) efforts to terminate or limit acid
rain SO2
allowances. In December 2008, the D.C. Circuit held that CAIR
nevertheless would remain in effect pending such rulemaking.
The states in which PHI subsidiaries
own and operate generating units have either adopted regulations to implement
CAIR or will require compliance with the federal CAIR program. In
either case, the regulatory programs will require, beginning in 2009, the
surrender of one NOx annual allowance for each ton of NOx emitted during the
year and one NOx ozone season allowance for each ton of NOx emitted during the
ozone season; and between 2010 and
15
2014, the
surrender of one SO2 annual
allowance for each 0.5 ton of SO2 emitted
during the year and beginning in 2015, one SO2 allowance
for each 0.35 ton of SO2 emitted
during the year. To implement CAIR, the New Jersey Department of
Environmental Protection (NJDEP) adopted a new NOx trading program to replace
its prior NOx trading program. This new trading program allocates NOx
annual and NOx ozone season allowances to Conectiv Energy’s Carll’s Corner,
Cedar, Cumberland, Deepwater, Middle, Mickleton, and Sherman generating units,
and will operate in a manner similar to NJDEP’s prior NOx trading
program. Conectiv Energy’s Edge Moor, Christiana and Hay Road
generating units in Delaware will be subject to federal CAIR for NOx and SO2. Pennsylvania
promulgated CAIR regulations in 2008 that are applicable to Conectiv Energy’s
Bethlehem generating units and the generating units being constructed in Peach
Bottom Township, Pennsylvania. Virginia is implementing CAIR by
participating in EPA’s cap and trade program making Conectiv Energy’s Tasley
peaking unit subject to federal CAIR for NOx and SO2. Conectiv
Energy’s Crisfield generating units in Maryland, Bayview units in Virginia, Edge
Moor 10, Delaware City 10 and West 10 units in Delaware, and Missouri Avenue
generating units in New Jersey produce fewer megawatts than CAIR’s applicability
threshold and therefore are not subject to CAIR.
Pepco Energy Services’ Benning Road
generating units located in the District of Columbia are subject to CAIR
requirements. Pepco Energy Services’ Buzzard Point generating units
and its landfill gas generating units produce fewer megawatts than CAIR’s
applicability threshold and therefore are not subject to CAIR.
Conectiv Energy and Pepco Energy
Services units use NOx annual, NOx ozone season and SO2 allowances
allocated or acquired, as necessary, in the open market to comply with
CAIR. Although implementation of CAIR will increase costs for
Conectiv Energy and Pepco Energy Services units, PHI currently does not
anticipate that CAIR will have a significant impact on the financial results of
its business.
In August 2008, NJDEP proposed
amendments to its air pollution control regulations applicable to generating
units in New Jersey to implement a multi-pollutant strategy to reduce fine
particulate matter, SO2 and NOx
emissions from coal-fired boilers serving electric generating units and NOx
emissions from high electric demand day (HEDD) units, which are units capable of
generating 15 or more megawatts and which are operated less than or equal to an
average of 50 percent of the time during the ozone season. The units
that will be subject to NJDEP’s multi-pollutant regulations when promulgated
also are subject to CAIR requirements, and accordingly, must hold sufficient NOx
and SO2 allowances to cover their NOx and SO2
emissions. The proposed multi-pollutant regulations may require the
installation of pollution control equipment at the Deepwater generating station
in order to comply with the more stringent maximum allowable emission
rates. For the period 2009 through 2014, the proposed HEDD
regulations do not impose specific emission limits at any specific source, but
require reductions from HEDD units that Conectiv Energy chooses to operate in
accordance with a protocol submitted to NJDEP. Beginning in May 2015,
the proposed regulations establish specific maximum allowable emissions rates
for HEDD units. NJDEP’s regulations are expected to become final in
May 2009. Conectiv Energy is evaluating its options for complying
with the proposed regulations.
In 2005, EPA finalized its Clean Air
Mercury Rule (CAMR), which established mercury emissions standards for new or
modified sources and capped state-wide emissions of mercury beginning in
2010. The regulations, which permitted states to implement CAMR by
adopting
16
EPA’s
market-based cap-and trade allowance program for coal-fired utility boilers or
through regulations that at a minimum achieve the reductions that would be
achieved through EPA’s program, were vacated by the United States Court of
Appeals for the District of Columbia Circuit in February 2008.
In December 2004, NJDEP published final
rules regulating mercury emissions from power plants and industrial facilities
in New Jersey that impose standards, effective December 15, 2007, that are
significantly stricter than EPA’s now vacated federal CAMR for coal-fired
plants. Conectiv Energy has confirmed, based upon the monitoring of
mercury emissions at the Deepwater generating facility, that its only coal-fired
generating plant in New Jersey is in compliance with the mercury emissions limit
without the need for the installation of additional pollution control
equipment.
In November 2006, DNREC adopted
multi-pollutant regulations to require large coal-fired and residual oil-fired
electric generating units to develop control strategies to address air quality
in Delaware. These control strategies are intended to assure
attainment of ambient air quality standards for ozone and fine particulate
matter, address local scale fine particulate emission problems, reduce mercury
emissions, satisfy the now vacated federal CAMR rule, improve visibility and
help satisfy Delaware’s regional haze obligations. For Conectiv
Energy’s Edge Moor coal-fired units, these regulations establish stringent
short-term limits for emissions of NOx, SO2 and
mercury, and for Edge Moor’s residual oil-fired generating unit, impose more
stringent sulfur in fuel oil limits and establish stringent short-term limits
for NOx emissions. The regulations also cap annual mass emissions of
NOx and SO2 from Edge
Moor’s coal-fired and residual oil-fired units, and mercury from Edge Moor’s
coal-fired units. In December 2006, Conectiv Energy filed a complaint
with the Delaware Superior Court seeking review of the adoption of the new
regulations. In December 2008, Conectiv Energy reached a settlement
with DNREC. Under the terms of the settlement agreement, Conectiv
Energy will comply with the NOx, SO2 and
mercury emission reduction requirements by the regulatory compliance dates,
except that it will comply with the Phase II mercury emission limit by January1, 2012, which is one year earlier than the regulatory compliance
date. In addition, DNREC has agreed to increase the annual SO2 mass
emission limit as it relates to the Edge Moor residual oil-fired generating
unit. Conectiv Energy is installing new pollution control equipment
and/or enhancing existing equipment to comply with the multi-pollutant
regulations. Conectiv Energy currently estimates that it will cost up
to $81 million over a period of six years to install the control equipment
necessary to comply with the regulations. These estimated costs do
not include increased costs associated with operating control
equipment.
Conectiv Energy is installing water
injection pollution control equipment on its five stationary combustion turbines
in Delaware (Christiana 11 and 14, Edge Moor 10, Delaware City 10 and West 10)
to comply with new ozone season NOx emission limits. Conectiv Energy
estimates that the cost of compliance will be approximately
$3 million.
In a March 2005 rulemaking, EPA removed
coal- and oil-fired units from the list of source categories requiring Maximum
Achievable Control Technology for hazardous air pollutants such as mercury and
nickel under CAA Section 112, thus, for the time being, eliminating the
possibility that control devices would be required under this section of the CAA
to reduce nickel emissions from the oil-fired unit at Conectiv Energy’s Edge
Moor generating facility. In the decision issued on February 8,2008, the U.S. Court of Appeals for the District of
17
Columbia
Circuit determined that the delisting of coal- and oil-fired units from
regulation under CAA Section 112 was unlawful.
Carbon Dioxide Emissions
Delaware, Maryland and New Jersey
(along with Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island,
Vermont and New York) are signatories to the Regional Greenhouse Gas Initiative
(RGGI), a cooperative effort by ten Northeast and mid-Atlantic states to first
stabilize and then beginning in 2015 incrementally reduce carbon dioxide
(CO2)
emissions with the goal of achieving an overall 10% reduction from baseline by
2018. Under RGGI, each of the participating states has adopted
legislation or regulations to implement a regional CO2 budget and
an allowance trading program to regulate emissions from fossil fuel-fired
electric generating units rated at 25 megawatts or greater. Under the
program each covered fossil fuel-fired electric generating unit is required,
commencing January 1, 2009, to hold allocated CO2
allowances, or and allowances acquired in the open market equivalent to its
CO2
emissions during specified compliance periods. Beginning in 2009, all
covered CO2 sources
must have an approved plan to monitor tons of CO2
emitted. The Maryland and New Jersey CO2 allowance
trading programs each provides for auction of substantially all of the
allowances allocated to the state by RGGI. Delaware’s program, in
2009, will auction 60% of allowances and allocate 40% of allowances to existing
CO2
sources. For each year after 2009, Delaware will increase the
percentage of allowances for auction by 8%, such that 100% of allowances will be
auctioned in 2014. The first compliance period is the three-year
period from 2009 to 2011. The period may be extended to four years if
a safety-valve mechanism is triggered by meeting certain market price
targets. In early 2012, each source will be required to surrender one
CO2
allowance for each ton of CO2 emitted
during the period. Conectiv Energy participated in the September and
December 2008 RGGI auctions and anticipates participating in subsequent RGGI
auctions as necessary.
In February 2007, the New Jersey
Governor signed an Executive Order that requires New Jersey to stabilize its
statewide greenhouse gas emissions at 1990 levels by 2020, and to reduce
statewide greenhouse gas emissions to 80% below 2006 levels by
2050. The Executive Order requires NJDEP to coordinate with NJBPU,
New Jersey’s Department of Transportation, New Jersey’s Department of Community
Affairs and other interested parties to evaluate policies and measures that will
enable New Jersey to achieve the statewide greenhouse gas emissions reduction
levels set forth in the Executive Order. In July 2007, New Jersey
enacted legislation requiring NJDEP to promulgate regulations by July 1, 2009
that establish a statewide greenhouse gas emissions monitoring and reporting
program covering all sources within the state to evaluate progress toward the
2020 and 2050 greenhouse gas limits. These programs are in addition
to New Jersey’s participation in RGGI for electric generating
units.
Water Quality
Regulation
Provisions of the federal Water
Pollution Control Act, also known as the Clean Water Act (CWA), establish the
basic legal structure for regulating the discharge of pollutants from point
sources to surface waters of the United States. Among other things, the CWA
requires that any person wishing to discharge pollutants from a point source
(generally a confined, discrete conveyance such as a pipe) obtain a National
Pollutant Discharge Elimination System (NPDES) permit issued by EPA or by a
state agency under a federally authorized state program. Each
of
18
the steam
generating facilities operated by PHI’s subsidiaries has a NPDES permit
authorizing pollutant discharges, which is subject to periodic
renewal.
In July 2004, EPA issued final
regulations under Section 316(b) of the CWA that are intended to minimize
potential adverse environmental impacts from power plant cooling water intake
structures on aquatic resources by establishing performance-based standards for
the operation of these structures at large existing electric generating plants,
including Conectiv Energy’s Deepwater and Edge Moor generating
facilities. These regulations may require changes to cooling water
intake structures as part of the NPDES permit renewal process. In
January 2007, the U.S. Court of Appeals for the Second Circuit issued a decision
in Riverkeeper, Inc. v. United
States Environmental Protection Agency (commonly known as the Riverkeeper II decision),
that remanded to EPA for additional rulemaking substantial portions of these
regulations for large existing electric generating plants. In April
2008, the U.S. Supreme Court agreed to review the Riverkeeper II
decision. Briefing and oral argument before the Court have been
completed, but no decision has been rendered. Regardless of the
outcome of the pending judicial proceedings, additional EPA rulemaking is
expected, and the capital expenditures, if any, that may be needed as a
consequence of such new regulations will not be known until the rulemaking
process is concluded and each affected facility completes additional studies and
addresses related permit requirements.
EPA has delegated authority to
administer the NPDES program to a number of state agencies including
DNREC. The NPDES permit for Conectiv Energy’s Edge Moor generating
facility expired on October 30, 2003, but has been administratively extended
until DNREC issues a renewal permit. Conectiv Energy submitted a
renewal application to the DNREC in April 2003. Studies required
under the existing permit to determine the impact on aquatic organisms of the
plant’s cooling water intake structures were completed in
2002. Site-specific alternative technologies and operational measures
have been evaluated and discussed with DNREC. DNREC, however, has not
announced how it intends to address Section 316(b) requirements in the renewal
NPDES permit in light of Riverkeeper II and the remand
of substantial portions of the federal regulations.
Under the New Jersey Water Pollution
Control Act, NJDEP implements regulations, administers the New Jersey Pollutant
Discharge Elimination System (NJPDES) program with EPA oversight, and issues and
enforces NJPDES permits. In June 2007, Conectiv Energy filed a timely
application for renewal of the NJPDES permit for the Deepwater generating
facility, which administratively extended the existing permit. The
existing NJPDES permit for Deepwater requires that Conectiv Energy perform
several studies to determine whether or not Deepwater’s cooling water intake
structures satisfy applicable requirements for protection of the
environment. While those study requirements were consistent with
requirements under EPA’s regulations implementing CWA Section 316(b), the result
of the Riverkeeper II
decision and any subsequent EPA rulemaking may require reevaluation of the
design and operational measures that Conectiv Energy anticipated using for
future compliance with Section 316(b) at Deepwater. In view of the
uncertainty associated with Riverkeeper II, NJDEP, at
Conectiv Energy’s request, has agreed to stay a cooling water intake structure
design upgrade requirement in Deepwater’s existing NJPDES
permit. NJDEP is preparing a renewal permit for Deepwater, which will
be published as a draft NJPDES renewal permit together with a request for public
comments.
Pepco and a subsidiary of Pepco Energy
Services discharge water from a steam generating plant and service center
located in the District of Columbia under a NPDES permit
19
issued by
EPA in November 2000. Pepco filed a petition with EPA’s Environmental
Appeals Board seeking review and reconsideration of certain provisions of EPA’s
permit determination. In May 2001, Pepco and EPA reached a settlement
on Pepco’s petition, under which EPA withdrew certain contested provisions and
agreed to issue a revised draft permit for public comment. A timely
renewal application was filed in May 2005 and the companies are operating under
the November 2000 permit, excluding the withdrawn conditions, in accordance with
the settlement agreement. In June 2008, EPA issued a draft
permit. Pepco filed comments on the draft permit in January
2009. In February 2009, EPA issued the final draft permit and
initiated a 30-day public comment period, closing on March 16,2009. The capital expenditures, if any, that may be needed as a
consequence of new permit conditions, will not be known until the permit process
is concluded.
In November 2007, NJDEP adopted
amendments to the agency’s regulations under the Flood Hazard Area Control Act
(FHACA) to minimize damage to life and property from flooding caused by
development in flood plains. The amended regulations, which took
effect November 5, 2007, impose a new regulatory program to mitigate flooding
and related environmental impacts from a broad range of construction and
development activities, including electric utility transmission and distribution
construction that was previously unregulated under the FHACA and that is
otherwise regulated under a number of other state and federal
programs. ACE filed an appeal of these regulations with the Appellate
Division of the Superior Court of New Jersey on November 3, 2008. PHI
cannot predict at this time the costs of complying with the FHACA regulations
due, among other things, to the potential for additional rulemaking as a result
of the appeal, as well as the possibility that NJDEP will issue exemptions from
the new regulations.
On October 6, 2008, NJDEP adopted
amendments to the agency’s regulations under the Freshwater Wetlands Protection
Act (FWPA). PHI believes that the amended FWPA regulations
unnecessarily restrict, among other things, various types of electric
transmission and distribution system maintenance and construction activity and
PHI is evaluating whether to appeal the FWPA regulations to the Appellate
Division of the Superior Court of New Jersey. PHI cannot predict at
this time the costs of complying with the amendments to the FWPA regulations due
to the potential for additional rulemaking if an appeal is filed, as well as the
possibility that NJDEP may issue exemptions from certain aspects of the new
regulations.
In 2002, EPA amended its oil pollution
prevention regulations to require facilities that, because of their location,
could reasonably be expected to discharge oil in quantities that may be harmful
to the environment, to implement and amend Spill Prevention, Control, and
Countermeasure (SPCC) Plans. PHI facilities subject to the
regulations must now comply with these regulatory requirements by July 1,2009. In December 2008, EPA published a final rule to clarify its
regulations and streamline certain requirements. In a February 3,2009 Federal Register notice, EPA delayed until April 4, 2009 the effective date
of the December 2008 final rule and indicated that it is reviewing the dates by
which facilities must prepare or amend SPCC Plans and implement those
plans. PHI continues to analyze its facilities to identify equipment
and sites for which physical modifications may be necessary to reduce the risk
of a release of oil and comply with EPA’s SPCC regulations. As
provided in EPA’s regulations, SPCC Plans for PHI facilities for which the
installation of structures or equipment is not practicable include an oil spill
contingency plan and a written commitment of manpower, equipment and materials
to respond to a discharge of oil. PHI anticipates that compliance
with the EPA regulations will require physical modification of certain
facilities through the construction of containment
20
structures
or replacement of oil-filled equipment with non-oil-filled equipment at a total
anticipated cost to ACE, DPL and Pepco of approximately
$50 million.
Hazardous Substance
Regulation
The Comprehensive Environmental
Response, Compensation, and Liability Act of 1980 (CERCLA) authorizes EPA, and
comparable state laws authorize state environmental authorities, to issue orders
and bring enforcement actions to compel responsible parties to investigate and
take remedial actions at any site that is determined to present an actual or
potential threat to human health or the environment because of an actual or
threatened release of one or more hazardous substances. Parties that
generated or transported hazardous substances to such sites, as well as the
owners and operators of such sites, may be deemed liable under CERCLA or
comparable state laws. Pepco, DPL and ACE each has been named by EPA
or a state environmental agency as a potentially responsible party in pending
proceedings involving certain contaminated sites. See
(i) Item 7 “Management’s Discussion and Analysis of Financial
Condition and Results of Operations – Capital Resources and Liquidity – Capital
Requirements – Environmental Remediation Obligations,” and (ii) Note (16),
“Commitments and Contingencies – Legal Proceedings – Environmental Litigation”
to the consolidated financial statements of PHI set forth in Part II, Item 8 of
this Form 10-K.
Item
1A. RISK
FACTORS
The businesses of PHI, Pepco, DPL and
ACE are subject to numerous risks and uncertainties, including the events or
conditions identified below. The occurrence of one or more of these
events or conditions could have an adverse effect on the business of any one or
more of the companies, including, depending on the circumstances, its financial
condition, results of operations and cash flows. Unless otherwise
noted, each risk factor set forth below applies to each of PHI, Pepco, DPL and
ACE.
PHI
and its subsidiaries are subject to substantial governmental regulation, and
unfavorable regulatory treatment could have a negative effect.
The regulated utilities that
compose PHI’s
Power Delivery businesses are subject to regulation by various federal, state
and local regulatory agencies that significantly affects their
operations. Each of Pepco, DPL and ACE is regulated by state
regulatory agencies in its service territories, with respect to, among other
things, the rates it can charge retail customers for the supply and distribution
of electricity (and additionally for DPL the supply and distribution of natural
gas). In addition, the rates that the companies can charge for
electricity transmission are regulated by FERC, and DPL’s natural gas
transportation is regulated by FERC. The companies cannot change
supply, distribution, or transmission rates without approval by the applicable
regulatory authority. While the approved distribution and
transmission rates are intended to permit the companies to recover their costs
of service and earn a reasonable rate of return, the profitability of the
companies is affected by the rates they are able to charge. In
addition, if the costs incurred by any of the companies in operating its
transmission and distribution facilities exceed the allowed amounts for costs
included in the approved rates, the financial results of that company, and
correspondingly, PHI, will be adversely affected.
PHI’s subsidiaries also are required to
have numerous permits, approvals and certificates from governmental agencies
that regulate their businesses. PHI believes that each of its
21
subsidiaries
has, and each of Pepco, DPL and ACE believes it has, obtained or sought renewal
of the material permits, approvals and certificates necessary for its existing
operations and that its business is conducted in accordance with applicable
laws; however, none of the companies is able to predict the impact of future
regulatory activities of any of these agencies on its
business. Changes in or reinterpretations of existing laws or
regulations, or the imposition of new laws or regulations, may require any one
or more of PHI’s subsidiaries to incur additional expenses or significant
capital expenditures or to change the way it conducts its
operations.
Pepco
may be required to make additional divestiture proceeds gain-sharing payments to
customers in the District of Columbia and Maryland. (PHI and Pepco
only)
Pepco currently is involved in
regulatory proceedings in Maryland and the District of Columbia related to the
sharing of the net proceeds from the sale of its generation-related
assets. The principal issue in the proceedings is whether Pepco
should be required to share with customers the excess deferred income taxes and
accumulated deferred investment tax credits associated with the sold assets and,
if so, whether such sharing would violate the normalization provisions of the
Internal Revenue Code and its implementing regulations. Depending on
the outcome of the proceedings, Pepco could be required to make additional
gain-sharing payments to customers and payments to the Internal Revenue Service
(IRS) in the amount of the associated accumulated deferred investment tax
credits, and Pepco might be unable to use accelerated depreciation on District
of Columbia and Maryland allocated or assigned property. See
Item 7 “Management’s Discussion and Analysis of Financial Condition and
Results of Operations — Regulatory and Other Matters — Divestiture Cases” for
additional information.
The
operating results of the Power Delivery business and the Competitive Energy
businesses fluctuate on a seasonal basis and can be adversely affected by
changes in weather.
The Power Delivery business
historically has been seasonal and weather patterns have had a material impact
on its operating performance. Demand for electricity is generally
higher in the summer months associated with cooling and demand for electricity
and natural gas is generally higher in the winter months associated with heating
as compared to other times of the year. Accordingly, each of PHI,
Pepco, DPL and ACE historically has generated less revenue and income when
temperatures are warmer than normal in the winter and cooler than normal in the
summer. In Maryland, the adoption in 2007 of a bill stabilization
adjustment mechanism for retail customers of Pepco and DPL, which decouples
distribution revenue for a given reporting period from the amount of power
delivered during the period, has had the effect of eliminating changes in the
use of electricity by such retail customers due to weather conditions or for
other reasons as a factor having an impact on reported revenue and
income.
Historically, the competitive energy
operations of Conectiv Energy and Pepco Energy Services also have produced less
revenue when weather conditions are milder than normal, which can negatively
impact PHI’s income from these operations. The energy management
services business of Pepco Energy Services is not seasonal.
22
Facilities
may not operate as planned or may require significant maintenance expenditures,
which could decrease revenues or increase expenses.
Operation of the Pepco, DPL and ACE
transmission and distribution facilities and the Competitive Energy businesses’
generation facilities involves many risks, including the breakdown or failure of
equipment, accidents, labor disputes and performance below expected
levels. Older facilities and equipment, even if maintained in
accordance with sound engineering practices, may require significant capital
expenditures for additions or upgrades to keep them operating at peak
efficiency, to comply with changing environmental requirements, or to provide
reliable operations. Natural disasters and weather-related incidents,
including tornadoes, hurricanes and snow and ice storms, also can disrupt
generation, transmission and distribution delivery systems. Operation
of generation, transmission and distribution facilities below expected capacity
levels can reduce revenues and result in the incurrence of additional expenses
that may not be recoverable from customers or through insurance, including
deficiency charges imposed by PJM on generation facilities at a rate of up to
two times the capacity payment that the generation facility
receives. Furthermore, the generation and transmission facilities of
the PHI companies that are defined as elements of the Bulk Electric System,
which is defined by the North American Electric Reliability Corporation (NERC)
as transmission facilities operating at a voltage of 100 kilovolts and above,
are subject to mandatory compliance with the reliability standards established
by the NERC and the Reliability First Regional Entity, which is the
NERC-designated regional entity with jurisdiction in the PJM
region. Failure to comply with the standards may result in
substantial monetary penalties and reflect poorly on the public image of
PHI.
The
transmission facilities of the Power Delivery business are interconnected with
the facilities of other transmission facility owners whose actions could have a
negative impact on operations.
The electricity transmission facilities
of Pepco, DPL and ACE are directly interconnected with the transmission
facilities of contiguous utilities and, as such, are part of an interstate power
transmission grid. FERC has designated a number of regional
transmission organizations to coordinate the operation of portions of the
interstate transmission grid. Pepco, DPL and ACE are members of the
PJM RTO. In 1997, FERC approved PJM as the provider of transmission
service in the PJM RTO region, which currently consists of all or parts of
Delaware, Illinois, Indiana, Kentucky, Maryland, Michigan, New Jersey, North
Carolina, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia and the
District of Columbia. Pepco, DPL and ACE operate their transmission
facilities under the direction and control of PJM. PJM RTO and the
other regional transmission organizations have established sophisticated systems
that are designed to ensure the reliability of the operation of transmission
facilities and prevent the operations of one utility from having an adverse
impact on the operations of the other utilities. However, the systems
put in place by PJM RTO and the other regional transmission organizations may
not always be adequate to prevent problems at other utilities from causing
service interruptions in the transmission facilities of Pepco, DPL or
ACE. If any of Pepco, DPL or ACE were to suffer such a service
interruption, it could have a negative impact on it and on PHI.
23
The
cost of compliance with environmental laws, including laws relating to emissions
of greenhouse gases, is significant and new environmental laws may increase
expenses.
The operations of PHI’s subsidiaries,
including Pepco, DPL and ACE, are subject to extensive federal, state and local
environmental laws, rules and regulations relating to air quality, water
quality, spill prevention, waste management, natural resources, site
remediation, and health and safety. These laws and regulations can
require significant capital and other expenditures to, among other things, meet
emissions and effluent standards, conduct site remediation and perform
environmental monitoring. If a company fails to comply with
applicable environmental laws and regulations, even if caused by factors beyond
its control, such failure could result in the assessment of civil or criminal
penalties and liabilities and the need to expend significant sums to come into
compliance.
In addition, PHI’s subsidiaries are
required to obtain and comply with a variety of environmental permits, licenses,
inspections and other approvals. If there is a delay in obtaining any
required environmental regulatory approval, or if there is a failure to obtain,
maintain or comply with any such approval, operations at affected facilities
could be halted or subjected to additional costs.
There is growing concern at the federal
and state levels about CO2 and other
greenhouse gas emissions. As a result, it is possible that, in
addition to RGGI, state and federal regulations will be developed that will
impose more stringent limitations on emissions than are currently in effect. Any
of these factors could result in increased capital expenditures and/or operating
costs for one or more generating plants operated by PHI’s Conectiv Energy and
Pepco Energy Services businesses. Until specific regulations are
promulgated, the impact that any new environmental regulations, voluntary
compliance guidelines, enforcement initiatives or legislation may have on the
results of operations, financial position or liquidity of PHI and its
subsidiaries is not determinable. PHI, Pepco, DPL and ACE each
continues to monitor federal and state activity related to environmental matters
in order to analyze their potential operational and cost
implications.
New environmental laws and regulations,
or new interpretations of existing laws and regulations, could impose more
stringent limitations on the operations of PHI’s subsidiaries or require them to
incur significant additional costs. Current compliance strategies may
not successfully address the relevant standards and interpretations of the
future.
Failure
to retain and attract key skilled professional and technical employees could
have an adverse effect on operations.
The ability of each of PHI and its
subsidiaries, including Pepco, DPL and ACE, to implement its business strategy
is dependent on its ability to recruit, retain and motivate employees.
Competition for skilled employees in some areas is high and the inability
to retain and attract these employees could adversely affect the company’s
business, operations and financial condition.
PHI’s
Competitive Energy businesses are highly competitive. (PHI
only)
The unregulated energy generation,
supply and marketing businesses primarily in the mid-Atlantic region are
characterized by intense competition at both the wholesale and retail
levels. PHI’s Competitive Energy businesses compete with numerous
non-utility generators,
24
independent
power producers, wholesale and retail energy marketers, and traditional
utilities. This competition generally has the effect of reducing
margins and requires a continual focus on controlling costs.
PHI’s
Competitive Energy businesses rely on some generation, transmission, storage,
and distribution assets that they do not own or control to deliver wholesale and
retail electricity and natural gas and to obtain fuel for their generation
facilities. (PHI only)
PHI’s Competitive Energy businesses
depend on electric generation and transmission facilities, natural gas
pipelines, and natural gas storage facilities owned and operated by
others. The operation of their generation facilities also depends on
coal, natural gas or diesel fuel supplied by others. If electric
generation or transmission, natural gas pipelines, or natural gas storage are
disrupted or capacity is inadequate or unavailable, the Competitive Energy
businesses’ ability to buy and receive and/or sell and deliver wholesale and
retail power and natural gas, and therefore to fulfill their contractual
obligations, could be adversely affected. Similarly, if the fuel
supply to one or more of their generation plants is disrupted and storage or
other alternative sources of supply are not available, the Competitive Energy
businesses’ ability to operate their generating facilities could be adversely
affected.
Changes
in technology may adversely affect the Power Delivery business and the
Competitive Energy businesses.
Research and development activities are
ongoing to improve alternative technologies to produce electricity, including
fuel cells, wind energy, micro turbines and photovoltaic (solar)
cells. It is possible that advances in these or other alternative
technologies will reduce the costs of electricity production from these
technologies, thereby making the generating facilities of the Competitive Energy
businesses less competitive. In addition, increased conservation
efforts and advances in technology could reduce demand for electricity supply
and distribution, which could adversely affect the Power Delivery businesses of
Pepco, DPL and ACE and the Competitive Energy businesses. Changes in
technology also could alter the channels through which retail electricity is
distributed to customers which could adversely affect the Power Delivery
businesses of Pepco, DPL and ACE.
PHI’s
risk management procedures may not prevent losses in the operation of its
Competitive Energy businesses. (PHI only)
The operations of PHI’s Competitive
Energy businesses are conducted in accordance with sophisticated risk management
systems that are designed to quantify risk. However, actual results
sometimes deviate from modeled expectations. In particular, risks in
PHI’s energy commodity activities are measured and monitored utilizing
value-at-risk models to determine the effects of potential one-day favorable or
unfavorable price movements. These estimates are based on historical
price volatility and assume a normal distribution of price changes and a 95%
probability of occurrence. Consequently, if prices significantly
deviate from historical prices, PHI’s risk management systems, including
assumptions supporting risk limits, may not protect PHI from significant
losses. In addition, adverse changes in energy prices may result in
economic losses in PHI’s earnings and cash flows and reductions in the value of
assets on its balance sheet under applicable accounting rules.
25
The
commodity hedging procedures used by the Competitive Energy businesses may not
protect them from significant losses caused by volatile commodity
prices. (PHI only)
To lower the financial exposure related
to commodity price fluctuations, PHI’s Competitive Energy businesses routinely
enter into contracts to hedge the value of their assets and operations. As part
of this strategy, PHI’s Competitive Energy businesses utilize fixed-price,
forward, physical purchase and sales contracts, tolling agreements, futures,
financial swaps and option contracts traded in the over-the-counter markets or
on exchanges. Each of these various hedge instruments can present a
unique set of risks in its application to PHI’s energy assets. PHI
must apply judgment in determining the application and effectiveness of each
hedge instrument. Changes in accounting rules, or revised
interpretations to existing rules, may cause hedges to be deemed ineffective as
an accounting matter. This could have material earnings implications
for the period or periods in question. Conectiv Energy’s objective is
to hedge a portion of the expected power output of its generation facilities and
the costs of fuel used to operate those facilities so it is not completely
exposed to energy price movements. Hedge targets are approved by
PHI’s Corporate Risk Management Committee and may change from time to time based
on market conditions. Conectiv Energy generally establishes hedge
targets annually for the next three succeeding 12-month
periods. Within a given 12-month horizon, the actual hedged
positioning in any month may be outside of the targeted range, even if the
average for a 12-month period falls within the stated
range. Management exercises judgment in determining which months
present the most significant risk, or opportunity, and hedge levels are adjusted
accordingly. Since energy markets can move significantly in a short
period of time, hedge levels may also be adjusted to reflect revised
assumptions. Such factors may include, but are not limited to,
changes in projected plant output, revisions to fuel requirements, transmission
constraints, prices of alternate fuels, and improving or deteriorating supply
and demand conditions. In addition, short-term occurrences, such as
abnormal weather, operational events, or intra-month commodity price volatility
may also cause the actual level of hedging coverage to vary from the established
hedge targets. These events can cause fluctuations in PHI’s earnings
from period to period. Due to the high heat rate of the Pepco Energy
Services generating facilities, Pepco Energy Services generally does not enter
into wholesale contracts to lock in the forward value of its
plants. To the extent that PHI’s Competitive Energy businesses have
unhedged positions or their hedging procedures do not work as planned,
fluctuating commodity prices could result in significant
losses. Conversely, by engaging in hedging activities, PHI may not
realize gains that otherwise could result from fluctuating commodity
prices.
The
operations of the Competitive Energy businesses can give rise to significant
collateral requirements. The inability to fund those requirements may
prevent the businesses from hedging associated price risks or may require
curtailment of their operations. (PHI only)
A substantial portion of Pepco Energy
Services’ business is the sale of electricity and natural gas to retail
customers. In conducting this business Pepco Energy Services
typically enters into electricity and natural gas sale contracts under which it
is committed to supply the electricity or natural gas requirements of its retail
customers over a specified period at agreed upon prices. To acquire
this energy, Pepco Energy Services enters into wholesale purchase contracts for
electricity and natural gas. These contracts typically impose
collateral requirements on each party designed to protect the other party
against the risk of nonperformance between the date the contract is entered into
and the date the energy is paid for. The collateral required to be
posted can be of varying forms, including cash, letters of credit and
guarantees. When energy market prices decrease relative to the
supplier contract prices, Pepco Energy Service’s collateral
26
obligations
increase. In addition, Conectiv Energy and Pepco Energy Services each
enter into contracts to buy and sell electricity, various fuels, and related
products, including derivative instruments, to reduce its financial exposure to
changes in the value of its assets and obligations due to energy price
fluctuations. These contracts usually require the posting of
collateral. Under various contracts entered into by both businesses,
the required collateral is provided in the form of an investment grade guaranty
issued by PHI. Under these contracts, a reduction in PHI’s credit
rating can also trigger a requirement to post additional
collateral. To satisfy these obligations when required, PHI and its
non-utility subsidiaries rely primarily on cash balances, access to the capital
markets and existing credit facilities.
Particularly
in periods of energy market price volatility, the collateral obligations
associated with the Competitive Energy businesses can be substantial. These
collateral demands negatively affect PHI’s liquidity by requiring PHI to draw on
its capacity under its credit facilities and other financing
sources. The inability of PHI to maintain the necessary liquidity
also could have an adverse effect on PHI’s results of operations and financial
condition by requiring the Competitive Energy businesses to forego new business
opportunities, by requiring the businesses to curtail their hedging activity,
thereby increasing their exposure to energy market price changes or by rendering
them unable to meet their collateral obligations to counterparties.
PHI
and its subsidiaries have significant exposure to counterparty risk. (PHI
only)
Both
Conectiv Energy and Pepco Energy Services enter into transactions with numerous
counterparties. These include both commercial transactions for the
purchase and sale of electricity and natural gas and derivative and other
transactions to manage the risk of commodity price
fluctuations. Under these arrangements, the Competitive Energy
businesses are exposed to the risk that the counterparty may fail to perform its
obligation to make or take delivery under the contract, fail to make a required
payment or fail to return collateral posted by the Competitive Energy businesses
when no longer required. Under many of these contracts,
Conectiv Energy and Pepco Energy Services are entitled to receive collateral or
other types of performance assurance from the counterparty, which may be in the
form of cash, letters of credit or parent guarantees, to protect against
performance and credit risk. Even where collateral is provided,
capital market disruptions can prevent the counterparty from meeting its
collateral obligations or could degrade the value of letters of credit and
guarantees as a result of the lowered rating or insolvency of the issuer or
guarantor. In the event of a bankruptcy of a counterparty, bankruptcy
law, in some circumstances, could require Conectiv Energy and Pepco Energy
Services to surrender collateral held or payments received. In
addition, Conectiv Energy and Pepco Energy Services are participants in the
wholesale electric markets administered by various independent system operators
(ISOs), and in particular PJM. If an ISO incurs losses due to
counterparty nonperformance, those losses are allocated to and borne by other
market participants in the ISO. Such defaults could adversely affect
PHI’s results of operations, liquidity or financial condition. These
risks are increased during periods of significant commodity price fluctuations,
tightened credit and ratings downgrades.
Business
operations could be adversely affected by terrorism.
The threat of, or actual acts of,
terrorism may affect the operations of PHI or any of its subsidiaries in
unpredictable ways and may cause changes in the insurance markets, force an
increase in security measures and cause disruptions of fuel supplies and
markets. If any of its
27
infrastructure
facilities, such as its electric generation, fuel storage, transmission or
distribution facilities, were to be a direct target, or an indirect casualty, of
an act of terrorism, the operations of PHI, Pepco, DPL or ACE could be adversely
affected. Corresponding instability in the financial markets as a
result of terrorism also could adversely affect the ability to raise needed
capital.
Insurance
coverage may not be sufficient to cover all casualty losses that the companies
might incur.
PHI and its subsidiaries, including
Pepco, DPL and ACE, currently have insurance coverage for their facilities and
operations in amounts and with deductibles that they consider
appropriate. However, there is no assurance that such insurance
coverage will be available in the future on commercially reasonable
terms. In addition, some risks, such as weather related casualties,
may not be insurable. In the case of loss or damage to property,
plant or equipment, there is no assurance that the insurance proceeds, if any,
received will be sufficient to cover the entire cost of replacement or
repair.
Revenues,
profits and cash flows may be adversely affected by economic
conditions.
Periods of slowed economic activity
generally result in decreased demand for power, particularly by industrial and
large commercial customers. As a consequence, recessions or other
downturns in the economy may result in decreased revenues and cash flows for the
Power Delivery businesses of Pepco, DPL and ACE and the Competitive Energy
businesses.
The
IRS challenge to cross-border energy sale and lease-back transactions entered
into by a PHI subsidiary could result in loss of prior and future tax benefits.
(PHI only)
PCI
maintains a portfolio of eight cross-border energy lease investments, which as
of December 31, 2008, had an equity value of approximately $1.3 billion and from
which PHI currently derives approximately $56 million per year in tax benefits
in the form of interest and depreciation deductions in excess of rental
income. In 2005, the Treasury Department and IRS issued a notice
identifying sale-leaseback transactions with certain attributes entered into
with tax-indifferent parties as tax avoidance transactions, and the IRS
announced its intention to disallow the associated tax benefits claimed by the
investors in these transactions. PHI’s cross-border energy lease
investments, each of which is with a tax-indifferent party, have been under
examination by the IRS as part of the normal PHI federal income tax
audits. In connection with the audit of PHI’s 2001 and 2002 income
tax returns, the IRS disallowed the depreciation and interest deductions in
excess of rental income claimed by PHI with respect to six of its cross-border
energy lease investments. In addition, the IRS has sought to
recharacterize the leases as loan transactions as to which PHI would be subject
to original issue discount income.
PHI believes that its tax position with
regard to its cross-border energy lease investments is appropriate based on
applicable statutes, regulations and case law and is protesting the IRS
adjustments and the unresolved audit issues have been forwarded to the Appeals
Office of the IRS. In the event that PHI were not to prevail and were
to suffer a total disallowance of the tax benefits and incur imputed original
issue discount income due to the recharacterization of the leases as loans, as
of December 31, 2008, PHI would have been obligated to pay approximately $520
million in additional federal and state taxes and $83 million of
interest. In addition, the IRS could require PHI to pay a penalty of
up to 20% on the amount of additional taxes due. PHI
28
anticipates,
however that any additional taxes that it would be required to pay as
a result of the disallowance of prior deductions or a recharacterization of
leases as loans would be recoverable in the form of lower taxes over the
remaining term of the investments.
For further discussion of this matter
see Item 7 “Management’s Discussion and Analysis of Financial Condition and
Results of Operations — Regulatory and Other Matters — Federal Tax Treatment of
Cross-Border Leases” of this Form 10-K.
PHI
and its subsidiaries are dependent on their ability to successfully access
capital markets. An inability to access capital may adversely affect
their businesses.
PHI, Pepco, DPL and ACE all rely on
access to both short-term money markets and long-term capital markets as sources
of liquidity and to satisfy their capital requirements that are not met by cash
flow from their operations. Capital market disruptions, or a
downgrade in their respective credit ratings, could increase the cost of
borrowing or could prevent the companies from accessing one or more financial
markets. Factors that could affect the ability of PHI and its
subsidiaries to access one or more financial markets could include, but are not
limited to:
· recession
or an economic slowdown;
· the
bankruptcy of one or more energy companies or financial
institutions;
· significant
changes in energy prices;
· a
terrorist attack or threatened attacks; or
· a
significant transmission failure.
In accordance with the requirements of
the Sarbanes-Oxley Act of 2002 and the SEC rules thereunder, PHI’s management is
responsible for establishing and maintaining internal control over financial
reporting and is required to assess annually the effectiveness of these
controls. The inability to certify the effectiveness of these
controls due to the identification of one or more material weaknesses in these
controls also could increase financing costs or could adversely affect the
ability to access one or more financial markets.
The
funding of future defined benefit pension plan and post-retirement benefit plan
obligations is based on assumptions regarding the valuation of future benefit
obligations and the performance of plan assets. If market performance
decreases plan assets or changes in assumptions regarding the valuation of
benefit obligations increase our liabilities, PHI, Pepco, DPL or ACE may be
required to make significant unplanned cash contributions to fund these
plans.
PHI holds
assets in trust to meet its obligations under the PHI Retirement Plan (a defined
benefit pension plan) and its postretirement benefit plan. The
amounts that PHI is required to contribute (including the amounts for which
Pepco, DPL and ACE are responsible) to fund the trusts are determined based on
assumptions made as to the valuation of future benefit obligations, and the
investment performance of the plan assets. Accordingly, the
performance of the capital markets will affect the value of plan
assets. A decline in the market value of plan
29
assets
may increase the plan funding requirements to meet the future benefit
obligations. In addition, changes in interest rates affect the
valuation of the liabilities of the plans. As interest rates
decrease, the liabilities increase, potentially requiring additional
funding. Demographic changes, such as a change in the expected timing
of retirements or changes in life expectancy assumptions, also may increase the
funding requirements of the plans. A need for significant additional
funding of the plans could have a material adverse effect on the cash flow of
PHI, Pepco, DPL and ACE. Future increases in pension plan and other
post-retirement plan costs, to the extent they are not recoverable in the base
rates of PHI’s utility subsidiaries, could have a material adverse effect on
results of operations and financial condition of PHI, Pepco, DPL and
ACE.
PHI’s
cash flow, ability to pay dividends and ability to satisfy debt obligations
depend on the performance of its operating subsidiaries. PHI’s
unsecured obligations are effectively subordinated to the liabilities and the
outstanding preferred stock of its subsidiaries. (PHI
only)
PHI is a holding company that conducts
its operations entirely through its subsidiaries, and all of PHI’s consolidated
operating assets are held by its subsidiaries. Accordingly, PHI’s
cash flow, its ability to satisfy its obligations to creditors and its ability
to pay dividends on its common stock are dependent upon the earnings of the
subsidiaries and the distribution of such earnings to PHI in the form of
dividends. The subsidiaries are separate legal entities and have no
obligation to pay any amounts due on any debt or equity securities issued by PHI
or to make any funds available for such payment. Because the claims
of the creditors of PHI’s subsidiaries and the preferred stockholders of ACE are
superior to PHI’s entitlement to dividends, the unsecured debt and obligations
of PHI are effectively subordinated to all existing and future liabilities of
its subsidiaries and to the rights of the holders of ACE’s preferred stock to
receive dividend payments.
Energy
companies are subject to adverse publicity which makes them vulnerable to
negative regulatory and litigation outcomes.
The energy sector has been among the
sectors of the economy that have been the subject of highly publicized
allegations of misconduct in recent years. In addition, many utility
companies have been publicly criticized for their performance during natural
disasters and weather related incidents. Adverse publicity of this
nature may render legislatures, regulatory authorities, and other government
officials less likely to view energy companies such as PHI and its subsidiaries
in a favorable light, and may cause PHI and its subsidiaries to be susceptible
to adverse outcomes with respect to decisions by such bodies.
Provisions
of the Delaware General Corporation Law may discourage an acquisition of
PHI. (PHI only)
As a Delaware corporation, PHI is
subject to the business combination law set forth in Section 203 of the Delaware
General Corporation Law, which could have the effect of delaying, discouraging
or preventing an acquisition of PHI.
30
Because
Pepco is a wholly owned subsidiary of PHI, and each of DPL and ACE is an
indirect wholly owned subsidiary of PHI, PHI can exercise substantial control
over their dividend policies and businesses and operations. (Pepco,
DPL and ACE only)
All of the members of each of Pepco’s,
DPL’s and ACE’s board of directors, as well as many of Pepco’s, DPL’s and ACE’s
executive officers, are officers of PHI or an affiliate of PHI. Among
other decisions, each of Pepco’s, DPL’s and ACE’s board is responsible for
decisions regarding payment of dividends, financing and capital raising
activities, and acquisition and disposition of assets. Within the
limitations of applicable law, and subject to the financial covenants under each
company’s respective outstanding debt instruments, each of Pepco’s, DPL’s and
ACE’s board of directors will base its decisions concerning the amount and
timing of dividends, and other business decisions, on the company’s respective
earnings, cash flow and capital structure, but may also take into account the
business plans and financial requirements of PHI and its other
subsidiaries.
Item
1B. UNRESOLVED STAFF
COMMENTS
Pepco
Holdings
None.
Pepco
None.
DPL
None.
ACE
None.
31
Item
2. PROPERTIES
Generation
Facilities
The following table identifies the
electric generating facilities owned by PHI’s subsidiaries at December 31,2008.
Electric Generating
Facilities
Location
Owner
Generating
Capacity (kilowatts)
Coal-Fired Units
Edge
Moor Units 3 and 4
Wilmington,
DE
Conectiv
Energya
260,000
Deepwater
Unit 6
Pennsville,
NJ
Conectiv
Energya
80,000
340,000
Oil Fired Units
Benning
Road
Washington,
DC
Pepco
Energy Servicesb
550,000
Edge
Moor Unit 5
Wilmington,
DE
Conectiv
Energya
450,000
1,000,000
Combustion Turbines/Combined Cycle
Units
Hay
Road Units 1-4
Wilmington,
DE
Conectiv
Energya
555,300
Hay
Road Units 5-8
Wilmington,
DE
Conectiv
Energya
565,000
Bethlehem
Units 1-8
Bethlehem,
PA
Conectiv
Energya
1,130,000
Buzzard
Point
Washington,
DC
Pepco
Energy Servicesb
240,000
Cumberland
Millville,
NJ
Conectiv
Energya
84,000
Sherman
Avenue
Vineland,
NJ
Conectiv
Energya
81,000
Middle
Rio
Grande, NJ
Conectiv
Energya
77,000
Carll’s
Corner
Upper
Deerfield Twp., NJ
Conectiv
Energya
73,000
Cedar
Cedar
Run, NJ
Conectiv
Energya
68,000
Missouri
Avenue
Atlantic
City, NJ
Conectiv
Energya
60,000
Mickleton
Mickleton,
NJ
Conectiv
Energya
59,000
Christiana
Wilmington,
DE
Conectiv
Energya
45,000
Edge
Moor Unit 10
Wilmington,
DE
Conectiv
Energya
13,000
West
Marshallton,
DE
Conectiv
Energya
15,000
Delaware
City
Delaware
City, DE
Conectiv
Energya
16,000
Tasley
Tasley,
VA
Conectiv
Energya
26,000
3,107,300
Landfill Gas-Fired Units
Fauquier
Landfill Project
Fauquier
County, VA
Pepco
Energy Servicesb
2,000
Eastern
Landfill Project
Baltimore
County, MD
Pepco
Energy Servicesd
3,000
Bethlehem
Landfill Project
Northampton,
PA
Pepco
Energy Servicesc
5,000
10,000
Solar Photovoltaic
Atlantic
City Convention Center
Atlantic
City, NJ
Pepco
Energy Servicese
2,000
Other Natural Gas Fired
Units
Deepwater
Unit 1
Pennsville,
NJ
Conectiv
Energya
78,000
Diesel Units
Crisfield
Crisfield,
MD
Conectiv
Energya
10,000
Bayview
Bayview,
VA
Conectiv
Energya
12,000
22,000
Total
Electric Generating Capacity
4,559,300
a
All
holdings of Conectiv Energy are owned by its various
subsidiaries.
b
These
facilities are owned by a subsidiary of Pepco Energy
Services.
c
This
facility is owned by Bethlehem Renewable Energy LLC, of which Pepco Energy
Services holds a 80% membership
interest.
d
This
facility is owned by Eastern Landfill Gas, LLC, of which Pepco Energy
Services holds a 75% membership
interest.
e
This
facility is owned by Pepco Energy Services,
Inc.
32
The
preceding table sets forth the net summer electric generating capacity of the
electric generating plants owned by Pepco Holdings’
subsidiaries. Although the generating capacity of these facilities
may be higher during the winter months, the plants operated by PHI’s
subsidiaries are used to meet summer peak loads that are generally higher than
winter peak loads. Accordingly, the summer generating capacity more
accurately reflects the operational capability of the plants.
Transmission and
Distribution Systems
On a combined basis, the electric
transmission and distribution systems owned by Pepco, DPL and ACE at December31, 2008, taking into account the sale by DPL of its Virginia retail electric
distribution and wholesale electric transmission assets in January 2008,
consisted of approximately 3,200 transmission circuit miles of overhead lines,
300 transmission circuit miles of underground cables, 18,200 distribution
circuit miles of overhead lines, and 15,500 distribution circuit miles of
underground cables, primarily in their respective service
territories. DPL and ACE own and operate distribution
system control centers in New Castle, Delaware and Mays Landing, New Jersey,
respectively. Pepco also operates a distribution system control
center in Maryland. The computer equipment and systems contained in
Pepco’s control center are financed through a sale and leaseback
transaction.
DPL has a liquefied natural gas plant
located in Wilmington, Delaware, with a storage capacity of approximately 3
million gallons and an emergency sendout capability of 48,210 Mcf per
day. DPL owns eight natural gas city gate stations at various
locations in New Castle County, Delaware. These stations have a total
sendout capacity of 255,500 Mcf per day. DPL also owns approximately
111 pipeline miles of natural gas transmission mains, 1,802 pipeline miles of
natural gas distribution mains, and 1,301 natural gas pipeline miles of service
lines. The natural gas transmission mains include approximately 7
miles of pipeline, 10% of which is owned and used by DPL for natural gas
operations, and 90% of which is owned and used by Conectiv Energy for delivery
of natural gas to electric generation facilities.
Substantially all of the transmission
and distribution property, plant and equipment owned by each of Pepco, DPL and
ACE is subject to the liens of the respective mortgages under which the
companies issue First Mortgage Bonds. See Note (11), “Debt” to the
consolidated financial statements of PHI set forth in Item 8 of this Form
10-K.
Item
3. LEGAL
PROCEEDINGS
Pepco
Holdings
Other than litigation incidental to PHI
and its subsidiaries’ business, PHI is not a party to, and PHI and its
subsidiaries’ property is not subject to, any material pending legal proceedings
except as described in Note (16), “Commitments and Contingencies—Legal
Proceedings” to the consolidated financial statements of PHI set forth in Item 8
of this Form 10-K.
Pepco
Other than litigation incidental to its
business, Pepco is not a party to, and its property is not subject to, any
material pending legal proceedings except as described in Note (13),
“Commitments and Contingencies—Legal Proceedings” to the financial statements of
Pepco set forth in Item 8 of this Form 10-K.
33
DPL
Other than litigation incidental to its
business, DPL is not a party to, and its property is not subject to, any
material pending legal proceedings except as described in Note (14),
“Commitments and Contingencies—Legal Proceedings” to the financial statements of
DPL set forth in Item 8 of this Form 10-K.
ACE
Other than litigation incidental to its
business, ACE is not a party to, and its property is not subject to, any
material pending legal proceedings except as described in Note (14),
“Commitments and Contingencies—Legal Proceedings” to the financial statements of
ACE set forth in Item 8 of this Form 10-K.
Item
4. SUBMISSION OF MATTERS TO A
VOTE OF SECURITY HOLDERS
Pepco
Holdings
None.
INFORMATION
FOR THIS ITEM IS NOT REQUIRED FOR PEPCO, DPL, AND ACE AS THEY MEET THE
CONDITIONS SET FORTH IN GENERAL INSTRUCTIONS I(1)(a) AND (b) OF FORM 10-K AND
THEREFORE ARE FILING THIS FORM WITH THE REDUCED FILING FORMAT.
34
Part II
Item
5.
MARKET FOR
REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY
SECURITIES
The New York Stock Exchange is the
principal market on which Pepco Holdings common stock is traded. The
following table presents the dividends declared per share on the Pepco Holdings
common stock and the high and low sales prices for the common stock based on
composite trading as reported by the New York Stock Exchange during each quarter
in the last two fiscal years.
Period
Dividends
Price
Range
Per Share
High
Low
2008:
First
Quarter
$
.27
$
29.640
$
23.800
Second
Quarter
.27
27.385
24.010
Third
Quarter
.27
26.160
21.610
Fourth
Quarter
.27
23.930
15.270
$
1.08
2007:
First
Quarter
$
.26
$
29.280
$
24.890
Second
Quarter
.26
30.710
26.890
Third
Quarter
.26
29.280
24.200
Fourth
Quarter
.26
30.100
25.730
$
1.04
See Item 7, “Management’s Discussion
and Analysis of Financial Condition and Results of Operations — Capital
Resources and Liquidity — Capital Requirements — Dividends” of this Form 10-K
for information regarding restrictions on the ability of PHI and its
subsidiaries to pay dividends.
At December 31, 2008, there were
approximately 61,347 holders of record of Pepco Holdings common
stock.
All of the common equity of Pepco, DPL
and ACE is owned directly or indirectly by PHI. Pepco, DPL and ACE
each customarily pays dividends on its common stock on a quarterly basis based
on its earnings, cash flow and capital structure, and after taking into account
the business plans and financial requirements of PHI and its other
subsidiaries.
35
Pepco
All of Pepco’s common stock is held by
Pepco Holdings. The table below presents the aggregate amount of
common stock dividends paid by Pepco to PHI during each quarter in the last two
fiscal years.
Period
Aggregate
Dividends
2008:
First
Quarter
$
20,000,000
Second
Quarter
-
Third
Quarter
44,000,000
Fourth
Quarter
25,000,000
$
89,000,000
2007:
First
Quarter
$
15,000,000
Second
Quarter
14,000,000
Third
Quarter
45,000,000
Fourth
Quarter
12,000,000
$
86,000,000
DPL
All of DPL’s common stock is held by
Conectiv. The table below presents the aggregate amount of common
stock dividends paid by DPL to Conectiv during each quarter in the last two
fiscal years. Dividends received by Conectiv were used to pay down
short-term debt owed to PHI.
Period
Aggregate
Dividends
2008:
First
Quarter
$
27,000,000
Second
Quarter
15,000,000
Third
Quarter
-
Fourth
Quarter
10,000,000
$
52,000,000
2007:
First
Quarter
$
8,000,000
Second
Quarter
19,000,000
Third
Quarter
-
Fourth
Quarter
12,000,000
$
39,000,000
36
ACE
All of ACE’s common stock is held by
Conectiv. The table below presents the aggregate amount of common
stock dividends paid by ACE to Conectiv during each quarter in the last two
fiscal years. Dividends received by Conectiv were used to pay down short-term
debt owed to PHI.
Period
Aggregate
Dividends
2008:
First
Quarter
$
-
Second
Quarter
31,000,000
Third
Quarter
-
Fourth
Quarter
15,000,000
$
46,000,000
2007:
First
Quarter
$
20,000,000
Second
Quarter
10,000,000
Third
Quarter
20,000,000
Fourth
Quarter
-
$
50,000,000
Recent
Sales of Unregistered Equity Securities
Pepco
Holdings
None.
Pepco
None.
DPL
None.
ACE
None.
Purchases
of Equity Securities by the Issuer and Affiliated Purchasers.
Pepco
Holdings
None.
Pepco
None.
DPL
None.
ACE
None.
37
Item
6 SELECTED FINANCIAL
DATA
PEPCO
HOLDINGS CONSOLIDATED FINANCIAL HIGHLIGHTS
2008
2007
2006
2005
2004
(in
millions, except per share data)
Consolidated Operating
Results
Total
Operating Revenue
$
10,700
(a)
$
9,366
$
8,363
$
8,066
$
7,223
Total
Operating Expenses
9,932
8,560
(c)
7,670
(e)
7,160
(g)(h)(i)
6,451
Operating
Income
768
806
693
906
772
Other
Expenses
300
284
283
(f)
286
341
Preferred
Stock Dividend
Requirements
of Subsidiaries
-
-
1
3
3
Income
Before Income Tax Expense
and
Extraordinary Item
468
522
409
617
428
Income
Tax Expense
168
(a)(b)
188
(d)
161
255
(j)
167
(k)
Income
Before Extraordinary Item
300
334
248
362
261
Extraordinary
Item
-
-
-
9
-
Net
Income
300
334
248
371
261
Earnings
Available for
Common
Stock
300
334
248
371
261
Common Stock Information
Basic
Earnings Per Share of Common
Stock
Before Extraordinary Item
$
1.47
$
1.72
$
1.30
$
1.91
$
1.48
Basic
- Extraordinary Item Per
Share
of Common Stock
-
-
-
.05
-
Basic
Earnings Per Share
of
Common Stock
1.47
1.72
1.30
1.96
1.48
Diluted
Earnings Per Share
of
Common Stock Before
Extraordinary
Item
1.47
1.72
1.30
1.91
1.48
Diluted
- Extraordinary Item Per
Share
of Common Stock
-
-
-
.05
-
Diluted
Earnings Per Share
of
Common Stock
1.47
1.72
1.30
1.96
1.48
Cash
Dividends Per Share
of
Common Stock
1.08
1.04
1.04
1.00
1.00
Year-End
Stock Price
17.76
29.33
26.01
22.37
21.32
Net
Book Value per Common Share
19.14
20.04
18.82
18.88
17.74
Weighted
Average Shares Outstanding
204
194
191
189
177
Other Information
Investment
in Property, Plant
and
Equipment
$
12,926
$
12,307
$
11,820
$
11,441
$
11,109
Net
Investment in Property, Plant
and
Equipment
8,314
7,877
7,577
7,369
7,152
Total
Assets
16,475
15,111
14,244
14,039
13,375
Capitalization
Short-term
Debt
$
465
$
289
$
350
$
156
$
320
Long-term
Debt
4,859
4,175
3,769
4,203
4,362
Current
Maturities of Long-Term Debt
and
Project Funding
85
332
858
470
516
Transition
Bonds issued by ACE
Funding
401
434
464
494
523
Capital
Lease Obligations due within one year
6
6
6
5
5
Capital
Lease Obligations
99
105
111
117
122
Long-Term
Project Funding
19
21
23
26
65
Minority
Interest
6
6
24
46
55
Common
Shareholders’ Equity
4,190
4,018
3,612
3,584
3,339
Total
Capitalization
$
10,130
$
9,386
$
9,217
$
9,101
$
9,307
(a)
Includes
a pre-tax charge of $124 million ($86 million after-tax) related to the
adjustment to the equity value of cross-border energy lease investments,
and included in Income Taxes is a $7 million after-tax charge for the
additional interest accrued on the related tax
obligation.
(b)
Includes
$23 million of after-tax net interest income on uncertain and effectively
settled tax positions (primarily associated with the reversal of
previously accrued interest payable resulting from the final and tentative
settlements, respectively, with the IRS on the like-kind exchange and
mixed service cost issues and a claim made with the IRS related to the tax
reporting for fuel over- and under-recoveries) and a benefit of $8 million
(including a $3 million correction of prior period errors) related
to additional analysis of deferred tax balances completed in
2008.
(c)
Includes
$33 million ($20 million after-tax) from settlement of Mirant bankruptcy
claims.
(d)
Includes
$20 million ($18 million net of fees) benefit related to Maryland income
tax settlement.
(e)
Includes
$19 million of impairment losses ($14 million after-tax) related to
certain energy services business assets.
(f)
Includes
$12 million gain ($8 million after-tax) on the sale of Conectiv Energy’s
equity interest in a joint venture which owns a wood burning cogeneration
facility.
(g)
Includes
$68 million ($41 million after-tax) gain from sale of non-utility land
owned by Pepco at Buzzard Point.
(h)
Includes
$71 million ($42 million after-tax) gain (net of customer sharing) from
settlement of Mirant bankruptcy claims.
(i)
Includes
$13 million ($9 million after-tax) related to PCI’s liquidation of a
financial investment that was written off in 2001.
(j)
Includes
$11 million in income tax expense related to the mixed service cost issue
under IRS Revenue Ruling 2005-53.
(k)
Includes a $20
million charge related to an IRS settlement. Also includes $13
million tax benefit related to issuance of a local jurisdiction’s final
consolidated tax return
regulations.
38
INFORMATION FOR THIS ITEM IS NOT
REQUIRED FOR PEPCO, DPL, AND ACE AS THEY MEET THE CONDITIONS SET FORTH IN
GENERAL INSTRUCTIONS I(1)(a) AND (b) OF FORM 10-K AND THEREFORE ARE FILING THIS
FORM WITH THE REDUCED FILING FORMAT.
Item 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The information required by this item
is contained herein, as follows:
Registrants
Page
No.
Pepco
Holdings
41
Pepco
104
DPL
116
ACE
129
39
THIS
PAGE LEFT INTENTIONALLY BLANK.
40
PEPCO
HOLDINGS
MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF
OPERATIONS
PEPCO
HOLDINGS, INC.
GENERAL
OVERVIEW
In 2008, 2007 and 2006, respectively,
PHI’s Power Delivery operations produced 51%, 56%, and 61% of PHI’s consolidated
operating revenues (including revenues from intercompany transactions) and 72%,
66%, and 67% of PHI’s consolidated operating income (including income from
intercompany transactions).
The Power Delivery business consists
primarily of the transmission, distribution and default supply of electricity,
which for 2008, 2007, and 2006, was responsible for 94%, 94%, and 95%,
respectively, of Power Delivery’s operating revenues. The
distribution of natural gas contributed 6%, 6% and 5% of Power Delivery’s
operating revenues in 2008, 2007 and 2006, respectively. Power
Delivery represents one operating segment for financial reporting
purposes.
The Power Delivery business is
conducted by PHI’s three utility subsidiaries: Potomac Electric Power
Company (Pepco), Delmarva Power & Light Company (DPL) and Atlantic City
Electric Company (ACE). Each of these companies is a regulated public
utility in the jurisdictions that comprise its service
territory. Each company is responsible for the delivery of
electricity and, in the case of DPL, natural gas in its service territory, for
which it is paid tariff rates established by the applicable local public service
commission. Each company also supplies electricity at regulated rates
to retail customers in its service territory who do not elect to purchase
electricity from a competitive energy supplier. The regulatory term
for this supply service varies by jurisdiction as follows:
Delaware
Standard
Offer Service (SOS)
District
of Columbia
SOS
Maryland
SOS
New
Jersey
Basic
Generation Service (BGS)
Effective
January 2, 2008, DPL sold its retail electric distribution assets and its
wholesale electric transmission assets in Virginia. Prior to that
date, DPL supplied electricity at regulated rates to retail customers in its
service territory who did not elect to purchase electricity from a competitive
energy supplier, which is referred to in Virginia as Default
Service.
In this Form 10-K, the supply service
obligations of the respective utility subsidiaries are referred to generally as
Default Electricity Supply.
Pepco, DPL and ACE are also responsible
for the transmission of wholesale electricity into and across their service
territories. The rates each company is permitted to charge for the
wholesale transmission of electricity are regulated by the Federal Energy
Regulatory Commission (FERC). Transmission rates are updated annually
based on a FERC-approved formula methodology.
41
PEPCO
HOLDINGS
The profitability of the Power Delivery
business depends on its ability to recover costs and earn a reasonable return on
its capital investments through the rates it is permitted to
charge. The Power Delivery operating results historically have been
seasonal, generally producing higher revenue and income in the warmest and
coldest periods of the year. Operating results also can be affected
by economic conditions, energy prices and the impact of energy efficiency
measures on customer usage of electricity.
In connection with its approval of new
electric service distribution base rates for Pepco and DPL in Maryland,
effective in June 2007 (the 2007 Maryland Rate Orders), the Maryland Public
Service Commission (MPSC) approved a bill stabilization adjustment mechanism
(BSA) for retail customers. For customers to which the BSA applies, Pepco and
DPL recognize distribution revenue based on an approved distribution charge per
customer. From a revenue recognition standpoint, the BSA thus
decouples the distribution revenue recognized in a reporting period from the
amount of power delivered during the period. This change in the
reporting of distribution revenue has the effect of eliminating changes in
retail customer usage (whether due to weather conditions, energy prices, energy
efficiency programs or other reasons) as a factor having an impact on reported
revenue. As a consequence, the only factors that will cause
distribution revenue from retail customers in Maryland to fluctuate from period
to period are changes in the number of customers and changes in the approved
distribution charge per customer.
The Competitive Energy businesses
provide competitive generation, marketing and supply of electricity and gas, and
related energy management services primarily in the mid-Atlantic
region. These operations are conducted through:
·
Subsidiaries
of Conectiv Energy Holding Company (collectively, Conectiv Energy), which
engage primarily in the generation and wholesale supply and marketing of
electricity and gas within the PJM Interconnection, LLC (PJM) and
Independent System Operator - New England (ISONE)
wholesale markets
·
Pepco
Energy Services, Inc. and its subsidiaries (collectively, Pepco Energy
Services), which provides retail energy supply and energy services
primarily to commercial, industrial, and governmental
customers.
Each of Conectiv Energy and Pepco
Energy Services is a separate operating segment for financial reporting
purposes. For the years ended December 31, 2008, 2007 and 2006,
the operating
revenues of the Competitive Energy businesses (including revenue from
intercompany transactions) were equal to 53%, 48%, and 43%, respectively, of
PHI’s consolidated operating revenues, and the operating income of the
Competitive Energy businesses (including operating income from intercompany
transactions) was 36%, 26%, and 20% of PHI’s consolidated operating income for
the years ended December 31, 2008, 2007 and 2006,
respectively. For the years ended December 31, 2008, 2007 and 2006,
amounts equal to 7%, 10%, and 13% respectively, of the operating revenues of the
Competitive Energy businesses were attributable to electric energy and capacity,
and natural gas sold to the Power Delivery segment.
Conectiv Energy’s primary objective is
to maximize the value of its generation fleet by leveraging its operational and
fuel flexibilities. Pepco Energy Services’ primary objective is to
capture retail energy supply and service opportunities predominantly in the
mid-Atlantic region.
42
PEPCO
HOLDINGS
The
financial results of the Competitive Energy business can be significantly
affected by wholesale and retail energy prices, the cost of fuel and gas to
operate the Conectiv Energy plants, and the cost of purchased energy necessary
to meet its power and gas supply obligations.
The Competitive Energy businesses, like
the Power Delivery business, are seasonal, and therefore weather patterns can
have a material impact on operating results.
Through its subsidiary Potomac Capital
Investment Corporation (PCI), PHI maintains a portfolio of cross-border energy
sale-leaseback transactions with a book value at December 31, 2008 of
approximately $1.3 billion. This activity constitutes a fourth
operating segment, which is designated as “Other Non-Regulated,” for financial
reporting purposes. For a discussion of PHI’s cross-border leasing
transactions, see “Regulatory and Other Matters — PHI’s Cross-Border Energy
Lease Investments” in this Management’s Discussion and Analysis.
IMPACT
OF THE CURRENT CAPITAL AND CREDIT MARKET DISRUPTIONS
The
recent disruptions in the capital and credit markets, combined with the
volatility of energy prices, have had an impact on several aspects of PHI’s
businesses. While these conditions have required PHI and its
subsidiaries to make certain adjustments in their financial management
activities, PHI believes that it and its subsidiaries currently have sufficient
liquidity to fund their operations and meet their financial
obligations. These market conditions, should they continue, could
have a negative effect on PHI’s financial condition, results of operations and
cash flows.
Liquidity
Requirements
PHI and its subsidiaries depend on
access to the capital and credit markets to meet their liquidity and capital
requirements. To meet their liquidity requirements, PHI’s utility
subsidiaries and its Competitive Energy businesses historically have relied on
the issuance of commercial paper and short-term notes and on bank lines of
credit to supplement internally generated cash from operations. PHI’s
primary credit source is its $1.5 billion syndicated credit facility, which can
be used by PHI and its utility subsidiaries to borrow funds, obtain letters of
credit and support the issuance of commercial paper. This facility is
in effect until May 2012 and consists of commitments from 17 lenders, no one of
which is responsible for more than 8.5% of the total $1.5 billion
commitment. The terms and conditions of the facility are more fully
described below under the heading “Capital Resources and Liquidity ¾ Credit
Facilities.”
Due to the capital and credit market
disruptions, the market for commercial paper in the latter part of 2008 was
severely restricted for most companies. As a result, PHI and its
subsidiaries have not been able to issue commercial paper on a day-to-day basis
either in amounts or with maturities that they have typically required for cash
management purposes. To address the challenges posed by the current
capital and credit market environment and to ensure that PHI and its
subsidiaries will continue to have sufficient access to cash to meet their
liquidity needs, PHI and its subsidiaries have undertaken a number of actions,
including the following:
·
PHI
has conducted a review to identify cash and liquidity conservation
measures, including opportunities to reduce collateral obligations and to
defer capital expenditures due to lower than anticipated
growth. Several measures to
reduce
43
PEPCO
HOLDINGS
collateral
obligations and expenditures have been taken. Additional measures
could be undertaken if conditions warrant.
·
PHI
issued an additional 16.1 million shares of the Company’s common stock at
a price per share of $16.50 in November 2008, for net proceeds of $255
million.
·
PHI
added a 364-day $400 million credit facility in November
2008.
·
In
November 2008, ACE issued $250 million of First Mortgage Bonds, 7.75%
Series due November 15, 2018.
·
In
November 2008, DPL issued $250 million of First Mortgage Bonds, 6.40%
Series due December 1, 2013.
·
In
December 2008, Pepco issued $250 million of First Mortgage Bonds, 7.90%
Series due December 15, 2038.
At
December 31, 2008, the amount of cash, plus borrowing capacity under the
syndicated credit facility and PHI’s new 364-day credit facility, available to
meet the liquidity needs of PHI on a consolidated basis totaled $1.5 billion, of
which $843 million consisted of the combined cash and borrowing capacity of
PHI’s utility subsidiaries. During the months of January and February
2009, the average daily amount of the combined cash and borrowing capacity of
PHI on a consolidated basis was $1.4 billion, and of its utility subsidiaries
was $831 million. This decrease in liquidity of PHI on a consolidated
basis was primarily due to increased collateral requirements of the Competitive
Energy businesses. During the months of January and February 2009,
the combined cash and borrowing capacity of PHI’s utility subsidiaries ranged
from a low of $673 million to a high of $1 billion.
Collateral
Requirements of the Competitive Energy Businesses
In conducting its retail energy sales
business, Pepco Energy Services typically enters into electricity and natural
gas sales contracts under which it is committed to supply the electricity or
natural gas requirements of its retail customers over a specified period at
agreed upon prices. Generally, Pepco Energy Services acquires the
energy to serve this load by entering into wholesale purchase
contracts. To protect the respective parties against the risk of
nonperformance by the other party, these wholesale purchase contracts typically
impose collateral requirements that are tied to changes in the price of the
contract commodity. In periods of energy market price volatility,
these collateral obligations can fluctuate materially on a day-to-day
basis.
Pepco Energy Services’ practice of
offsetting its retail energy sale obligations with corresponding wholesale
purchases of energy has the effect of substantially reducing the exposure of its
margins to energy price fluctuations. In addition, the
non-performance risks associated with its retail energy sales are relatively low
due to the inclusion of governmental entities among its customers and the
purchase of insurance on a significant portion of its commercial and other
accounts receivable. However, because its retail energy sales
contracts typically do not have collateral obligations, during periods of
declining energy prices Pepco Energy Services is exposed to the asymmetrical
risk of having to post collateral under its
44
PEPCO
HOLDINGS
wholesale
purchase contracts without receiving a corresponding amount of collateral from
its retail customers. In the second half of 2008, the decrease in
energy prices has caused a significant increase in the collateral obligations of
Pepco Energy Services.
In addition, Conectiv Energy and Pepco
Energy Services in the ordinary course of business enter into various contracts
to buy and sell electricity, fuels and related products, including derivative
instruments, designed to reduce their financial exposure to changes in the value
of their assets and obligations due to energy price
fluctuations. These contracts also typically have collateral
requirements.
Depending on the contract terms, the
collateral required to be posted by Pepco Energy Services and Conectiv Energy
can be of varying forms, including cash and letters of credit. As of
December 31, 2008, the Competitive Energy businesses had posted net cash
collateral of $331 million and letters of credit of $558 million.
At
December 31, 2008, the amount of cash, plus borrowing capacity under the
syndicated credit facility and PHI’s new 364-day credit facility, available to
meet the liquidity needs of the Competitive Energy businesses on a consolidated
basis totaled $684 million. During the months of January and February
2009, the combined cash and borrowing capacity available to PHI’s Competitive
Energy businesses ranged from a low of $378 million to a high of $757
million.
Ongoing
Monitoring of Financial and Market Conditions
PHI monitors its liquidity position on
a daily basis and routinely conducts stress testing to assess the impact of
changes in commodity prices on its collateral requirements. Stress
testing conducted over the months of January and February 2009, based on
contractual rights and obligations in effect at the time, indicated that a 1%
change in forward prices corresponding to the periods under the various
contractual arrangements with respect to which collateral was required would
have caused an estimated change of approximately $6 million in Conectiv Energy’s
net collateral requirements and a change of approximately $17 million in Pepco
Energy Services’ net collateral requirements. PHI’s net collateral
obligations decrease when forward prices increase and increase when forward
prices decrease.
PHI also closely monitors its credit
ratings and outlooks and those of its rated subsidiaries, and computes the
hypothetical effect that changes in credit ratings would have on collateral
requirements and the cost of capital. Based on contractual provisions
in effect at December 31, 2008, a one-level downgrade in the unsecured debt
credit ratings of PHI and each of its rated subsidiaries, which would decrease
ratings to below “investment grade,” would increase the collateral obligations
of PHI and its subsidiaries by up to $462 million.
Counterparty
Credit Risk
PHI is exposed to the risk that the
counterparties to contracts may fail to meet their contractual payment
obligations or may fail to deliver purchased commodities or services at the
contracted price. PHI attempts to minimize these risks through, among other
things, formal credit policies, regular assessments of counterparty
creditworthiness, and the establishment of a credit limit for each
counterparty.
45
PEPCO
HOLDINGS
Pension
and Postretirement Benefit Plans
PHI and
its subsidiaries sponsor pension and postretirement benefit plans for their
employees. While the plans have not experienced any significant
impact in terms of liquidity or counterparty exposure due to the disruption of
the capital and credit markets, the stock market declines have caused a decrease
in the market value of benefit plan assets over the twelve months ended December31, 2008. The negative return did not have an impact on PHI’s results
of operations for 2008; however, this reduction in benefit plan assets will
result in increased pension and postretirement benefit costs in future
years.
PHI
currently estimates that its net periodic pension benefit cost will be
approximately $85 million in 2009, as compared to $24 million in 2008. The utility
subsidiaries are generally responsible for approximately 80% to 85% of the total
PHI net periodic pension benefit cost. Approximately 30% of net
periodic pension benefit cost is capitalized.
PHI
expects to make a discretionary tax deductible contribution to the pension plan
in 2009 of approximately $300 million. The utility subsidiaries will
be responsible for funding their share of the contribution of approximately $170
million for Pepco, $10 million for DPL and $60 million for ACE. PHI
Service Company is responsible to fund the remaining share of the
contribution. PHI will monitor the markets and evaluate any
additional discretionary funding needs later in the year. See Note
(10), “Pensions and Other Postretirement Benefits,” to the consolidated
financial statements of PHI set forth in Item 8 of this Form 10-K.
BUSINESS
STRATEGY
PHI’s business strategy is to remain a
mid-Atlantic regional diversified energy delivery utility and competitive energy
services company focused on value creation and operational
excellence. The components of this strategy include:
·
Achieving
earnings growth in the Power Delivery business by focusing on transmission
and distribution infrastructure investments and constructive regulatory
outcomes, while maintaining a high level of operational
excellence.
·
Supplementing
PHI’s utility earnings through competitive energy businesses that focus on
serving the competitive wholesale and retail markets primarily within the
PJM Regional Transmission Organization (PJM RTO)
market.
·
Pursuing
technologies and practices that promote energy efficiency, energy
conservation and the reduction of greenhouse gas
emissions.
To further this business strategy, PHI
may from time to time examine a variety of transactions involving its existing
businesses, including the entry into joint ventures or the disposition of one or
more businesses, as well as possible acquisitions. PHI also may
reassess or refine the components of its business strategy as it deems necessary
or appropriate in response to a wide variety of factors, including the
requirements of its businesses, competitive conditions and regulatory
requirements.
46
PEPCO
HOLDINGS
Strategic
Analysis of Pepco Energy Services’ Retail Energy Supply Business
Over the past several months, PHI has
been conducting a strategic analysis of the retail energy supply business of
Pepco Energy Services. This review has included, among other things, the
evaluation of potential alternative supply arrangements to reduce collateral
requirements or a possible restructuring, sale or wind down of the business.
As discussed above under the heading, “Impact of Current Capital and
Credit Market Disruption -- Collateral Requirements of the Competitive Energy
Businesses,” as energy prices have declined in the second half of 2008, the
collateral that Pepco Energy Services has been required to post to secure its
obligations under its wholesale energy purchase contracts has increased
substantially. Among the factors being considered is the return PHI
earns by investing capital in the retail energy supply business as compared to
alternative investments. PHI expects the retail energy supply
business to remain profitable based on its existing contract backlog and the
margins that have been locked in with corresponding wholesale energy purchase
contracts. The increased cost of capital associated with its collateral
obligations has been factored into its retail pricing and, as a consequence, PES
is experiencing reduced retail customer retention levels and reduced levels of
new retail customer acquisitions.
PHI’s net income for the year ended
December 31, 2008 was $300 million, or $1.47 per share, compared to $334
million, or $1.72 per share, for the year ended December 31, 2007.
Net
income for the year ended December 31, 2008, included the charges set forth
below in the Other Non-Regulated operating segment, which are presented net of
federal and state income taxes and are in millions of dollars:
Adjustment
to the equity value of cross-border energy lease investments to reflect
the impact of a change in assumptions regarding the estimated timing of
the tax benefits
$
(86)
Additional
interest accrued under Financial Accounting Standards Board Interpretation
No. 48 (FIN 48) related to the estimated federal and state income tax
obligations from the change in assumptions regarding the estimated timing
of the tax benefits on cross-border energy lease
investments
$
(7)
Net
income for the year ended December 31, 2007, included the credits set forth
below in the Power Delivery operating segment, which are presented net of
federal and state income taxes and are in millions of dollars.
Excluding the items listed above, net
income would have been $393 million, or $1.93 per share, in 2008 and $296
million, or $1.53 per share, in 2007.
47
PEPCO
HOLDINGS
PHI’s net
income for the years ended December 31, 2008 and 2007, by operating segment, is
set forth in the table below (in millions of dollars):
2008
2007
Change
Power
Delivery
$
250
$
232
$
18
Conectiv
Energy
122
73
49
Pepco
Energy Services
39
38
1
Other
Non-Regulated
(59)
46
(105)
Corp.
& Other
(52)
(55)
3
Total
PHI Net Income
$
300
$
334
$
(34)
Discussion
of Operating Segment Net Income Variances:
Power Delivery’s $18 million increase
in earnings is primarily due to the following:
·
$38
million increase due to the impact of the distribution base rate orders
($23 million related to Maryland, which became effective in June 2007 for
Pepco and DPL, and $15 million related to the District of Columbia, which
became effective in February 2008 for
Pepco).
·
$23
million increase due to favorable income tax adjustments primarily related
to FIN 48 interest impact.
·
$15
million increase due to FERC network transmission service rate changes in
June 2007 and 2008.
·
$20
million decrease due to the Mirant bankruptcy damage claims settlement in
2007.
·
$18
million decrease due to the Maryland tax settlement, net of fees in
2007.
·
$16
million decrease primarily due to lower sales (primarily decreased
customer usage, including an unfavorable impact of weather compared to
2007).
·
$5
million decrease due to higher operating and maintenance costs (primarily
higher employee-related costs and bad-debt
expense).
Conectiv Energy’s $49 million increase
in earnings is primarily due to the following:
·
$43
million increase in Merchant Generation & Load Service primarily due
to:
(i)
an
increase of $22 million primarily due to short-term sales of firm natural
gas and natural gas transportation and storage rights, the dual-fuel
capability of the combined cycle mid-merit units (fuel switching),
cross-commodity hedging (use of natural gas to hedge power positions), and
the opportunities created by the mid-merit combined cycle units’ operating
flexibility (option value) in conjunction with short-term power and fuel
price volatility,
(ii)
an
increase of $28 million due to higher PJM capacity prices net of capacity
hedges,
48
PEPCO
HOLDINGS
(iii)
an
increase of $11 million due to the application of fair value accounting
treatment and associated settlements with respect to excess coal hedges
accounted for at fair value,
(iv)
a
decrease of $9 million due to a lower of cost or market adjustment to the
value of oil inventory held at the power plants at year-end 2008,
and
(v)
a
decrease of $9 million due to lower sales of emissions
allowances.
·
$9
million increase in Energy Marketing primarily due to increased short-term
power desk margins, and new default electricity supply
contracts.
·
$5
million increase due to favorable income tax adjustments primarily due to
the reversal of FIN 48 interest
accruals.
·
$10
million decrease primarily due to higher plant
maintenance.
Pepco Energy Services’ $1 million
increase in earnings is primarily due to the following:
·
$6
million increase resulting from higher volumes due to growth in the retail
gas supply business.
·
$2
million increase in the retail electricity business due to more favorable
congestion costs; partially offset by higher cost of electricity and other
electricity supply costs.
·
$2
million increase resulting from favorable income tax adjustments related
to deferred income taxes.
·
$9
million decrease for the generation plants primarily due to Reliability
Pricing Model (RPM) related
charges.
Other Non-Regulated’s $105 million
decrease in earnings is primarily due to the following:
·
$86
million after-tax charge resulting from a $124 million adjustment to the
equity value of PHI’s cross-border energy lease
investments.
·
$7
million after-tax charge for interest accrued under FIN 48 related to
estimated federal and state income tax obligations for the period from
January 1, 2001 through June 30, 2008 resulting from the change in
assumptions regarding the estimated timing of the tax benefits of PHI’s
cross-border energy lease
investments.
·
$9
million decrease primarily due to favorable valuation adjustments to
certain other PCI portfolio investments in 2007; partially offset by lower
interest expense.
Corporate
and Other’s $3 million increase in earnings is primarily due to lower interest
expense and corporate governance costs.
49
PEPCO
HOLDINGS
CONSOLIDATED
RESULTS OF OPERATIONS
The following results of operations
discussion compares the year ended December 31, 2008, to the year ended
December 31, 2007. All amounts in the tables (except sales and
customers) are in millions.
Operating
Revenue
A detail of the components of PHI’s
consolidated operating revenue is as follows:
2008
2007
Change
Power
Delivery
$
5,487
$
5,244
$
243
Conectiv
Energy
3,047
2,206
841
Pepco
Energy Services
2,648
2,309
339
Other
Non-Regulated
(60)
76
(136)
Corp.
& Other
(422)
(469)
47
Total
Operating Revenue
$
10,700
$
9,366
$
1,334
Power
Delivery
The following table categorizes Power
Delivery’s operating revenue by type of revenue.
2008
2007
Change
Regulated
T&D Electric Revenue
$
1,690
$
1,592
$
98
Default
Supply Revenue
3,413
3,295
118
Other
Electric Revenue
66
66
-
Total
Electric Operating Revenue
5,169
4,953
216
Regulated
Gas Revenue
204
211
(7)
Other
Gas Revenue
114
80
34
Total
Gas Operating Revenue
318
291
27
Total
Power Delivery Operating Revenue
$
5,487
$
5,244
$
243
Regulated
Transmission and Distribution (T&D) Electric Revenue includes revenue from
the delivery of electricity, including the delivery of Default Electricity
Supply, by PHI’s utility subsidiaries to customers within their service
territories at regulated rates. Regulated T&D Electric Revenue
also includes transmission service revenue that PHI’s utility subsidiaries
receive as transmission owners from PJM.
Default Supply Revenue is the revenue
received for Default Electricity Supply. The costs related to Default
Electricity Supply are included in Fuel and Purchased Energy and Other Services
Cost of Sales. Default Supply Revenue also includes revenue from
transition bond charges and other restructuring related revenues.
Other Electric Revenue includes work
and services performed on behalf of customers, including other utilities, which
is not subject to price regulation. Work and services
includes
50
PEPCO
HOLDINGS
mutual
assistance to other utilities, highway relocation, rentals of pole attachments,
late payment fees, and collection fees.
Regulated Gas Revenue consists of
revenues from on-system natural gas sales and the transportation of natural gas
for customers by DPL within its service territories at regulated
rates.
Other Gas Revenue consists of DPL’s
off-system natural gas sales and the sale of excess system
capacity.
In response to an order issued by the
New Jersey Board of Public Utilities (NJBPU) regarding changes to ACE’s retail
transmission rates, ACE has established deferred accounting treatment for the
difference between the rates that ACE is authorized to charge its customers for
the transmission of Default Electricity Supply and the cost that ACE
incurs. Under the deferral arrangement, any over or under recovery is
deferred as part of Deferred Electric Service Costs pending an adjustment of
retail rates in a future proceeding. As a consequence of the order,
effective January 1, 2008, ACE’s retail transmission revenue is being
recorded as Default Supply Revenue, rather than as Regulated T&D Electric
Revenue, thereby conforming to the practice of PHI’s other utility subsidiaries,
which previously established deferred accounting treatment for any over or under
recovery of retail transmission rates relative to the cost incurred. ACE’s
retail transmission revenue for the period prior to January 1, 2008 has
been reclassified to Default Supply Revenue in order to conform to the current
period presentation.
Electric Operating Revenue
Regulated
T&D Electric Revenue
2008
2007
Change
Residential
$
580
$
579
$
1
Commercial
746
720
26
Industrial
29
26
3
Other
335
267
68
Total
Regulated T&D Electric Revenue
$
1,690
$
1,592
$
98
Other Regulated T&D Electric
Revenue consists primarily of (i) transmission service revenue, (ii) revenue
from the resale of energy and capacity under power purchase agreements between
Pepco and unaffiliated third parties in the PJM RTO market, and (iii) either (a)
a positive adjustment equal to the amount by which revenue from Maryland retail
distribution sales falls short of the revenue that Pepco and DPL are entitled to
earn based on the distribution charge per customer approved in the 2007 Maryland
Rate Orders or (b) a negative adjustment equal to the amount by which revenue
from such distribution sales exceeds the revenue that Pepco and DPL are entitled
to earn based on the approved distribution charge per customer (a Revenue
Decoupling Adjustment).
51
PEPCO
HOLDINGS
Regulated
T&D Electric Sales (Gigawatt hours (GWh))
2008
2007
Change
Residential
17,186
17,946
(760)
Commercial
28,739
29,137
(398)
Industrial
3,781
3,974
(193)
Other
261
261
-
Total
Regulated T&D Electric Sales
49,967
51,318
(1,351)
Regulated
T&D Electric Customers (in thousands)
2008
2007
Change
Residential
1,612
1,622
(10)
Commercial
196
197
(1)
Industrial
2
2
-
Other
2
2
-
Total
Regulated T&D Electric Customers
1,812
1,823
(11)
Due to
the sale of DPL’s Virginia retail electric distribution assets in
January 2008, the numbers of Regulated T&D Electric Customers listed
above include a decrease of approximately 19,000 residential customers and 3,000
commercial customers.
The Pepco, DPL and ACE service
territories are located within a corridor extending from Washington, D.C. to
southern New Jersey. These service territories are economically
diverse and include key industries that contribute to the regional economic
base.
·
Commercial
activity in the region includes banking and other professional services,
government, insurance, real estate, shopping malls, casinos, stand alone
construction, and tourism.
·
Industrial
activity in the region includes automotive, chemical, glass,
pharmaceutical, steel manufacturing, food processing, and oil
refining.
Regulated T&D Electric Revenue
increased by $98 million primarily due to:
·
An
increase of $28 million due to a distribution rate change under the 2007
Maryland Rate Orders that became effective in June 2007, including a
positive $19 million Revenue Decoupling
Adjustment.
·
An
increase of $24 million due to a distribution rate change in the District
of Columbia that became effective in February
2008.
·
An
increase of $24 million due to a distribution rate change as part of a
higher New Jersey Societal Benefit Charge that became effective in June
2008 (substantially offset in Deferred Electric Service
Costs).
·
An
increase of $24 million in transmission service revenue primarily due to
transmission rate changes in June 2008 and
2007.
52
PEPCO
HOLDINGS
·
An
increase of $24 million in Other Regulated T&D Electric Revenue from
the resale of energy and capacity purchased under the power purchase
agreement between Panda-Brandywine, L.P. (Panda) and Pepco (the Panda PPA)
(offset in Fuel and Purchased Energy and Other Services Cost of
Sales.
·
An
increase of $4 million due to customer growth of 1% in 2008 (excluding
customers associated with the sale of DPL’s Virginia retail electric
distribution and wholesale transmission assets in January
2008).
The
aggregate amount of these increases was partially offset by:
·
A
decrease of $20 million due to lower weather-related sales (a 2% decrease
in Heating Degree Days and a 10% decrease in Cooling Degree
Days).
·
A
decrease of $12 million due to the sale of DPL’s Virginia retail electric
distribution and wholesale transmission assets in January
2008.
Default Electricity Supply
Default
Supply Revenue
2008
2007
Change
Residential
$
1,882
$
1,843
$
39
Commercial
1,125
1,073
52
Industrial
75
94
(19)
Other
331
285
46
Total
Default Supply Revenue
$
3,413
$
3,295
$
118
Other Default Supply Revenue consists
primarily of revenue from the resale of energy and capacity purchased under
non-utility generating contracts (NUGs) in the PJM RTO market.
Default
Electricity Supply Sales (GWh)
2008
2007
Change
Residential
16,621
17,469
(848)
Commercial
9,564
9,910
(346)
Industrial
640
914
(274)
Other
101
131
(30)
Total
Default Electricity Supply Sales
26,926
28,424
(1,498)
Default
Electricity Supply Customers (in thousands)
2008
2007
Change
Residential
1,572
1,585
(13)
Commercial
166
166
-
Industrial
1
1
-
Other
2
2
-
Total
Default Electricity Supply Customers
1,741
1,754
(13)
53
PEPCO
HOLDINGS
Due to
the sale of DPL’s Virginia retail electric distribution assets in January 2008,
the number of Default Electricity Supply Customers listed above includes a
decrease of approximately 19,000 residential customers and 3,000 commercial
customers.
Default Supply Revenue, which is
substantially offset in Fuel and Purchased Energy and Other Services Cost of
Sales and Deferred Electric Service Costs, increased by $118 million primarily
due to:
·
An
increase of $202 million in market-based Default Electricity Supply
rates.
·
An
increase of $48 million in wholesale energy revenues due to the sale in
PJM RTO at higher market prices of electricity purchased from
NUGs.
The aggregate amount of these increases
was partially offset by:
·
A
decrease of $55 million due to lower weather-related sales (a 2% decrease
in Heating Degree Days and a 10% decrease in Cooling Degree
Days).
·
A
decrease of $33 million primarily due to existing commercial and
industrial customers electing to purchase electricity from competitive
suppliers.
·
A
decrease of $32 million due to the sale of DPL’s Virginia retail electric
distribution and wholesale transmission assets in January
2008.
·
A
decrease of $12 million due to differences in consumption among the
various customer rate classes.
Gas Operating Revenue
Regulated
Gas Revenue
2008
2007
Change
Residential
$
121
$
124
$
(3)
Commercial
69
73
(4)
Industrial
6
8
(2)
Transportation
and Other
8
6
2
Total
Regulated Gas Revenue
$
204
$
211
$
(7)
Regulated
Gas Sales (billion cubic feet)
2008
2007
Change
Residential
7
8
(1)
Commercial
5
5
-
Industrial
1
1
-
Transportation
and Other
7
7
-
Total
Regulated Gas Sales
20
21
(1)
54
PEPCO
HOLDINGS
Regulated
Gas Customers (in thousands)
2008
2007
Change
Residential
113
112
1
Commercial
9
10
(1)
Industrial
-
-
-
Transportation
and Other
-
-
-
Total
Regulated Gas Customers
122
122
-
DPL’s natural gas service territory is
located in New Castle County, Delaware. Several key industries
contribute to the economic base as well as to growth.
·
Commercial
activity in the region includes banking and other professional services,
government, insurance, real estate, shopping malls, stand alone
construction and tourism.
·
Industrial
activity in the region includes automotive, chemical and
pharmaceutical.
Regulated Gas Revenue decreased by $7
million primarily due to:
·
A
decrease of $4 million due to differences in consumption among the various
customer rate classes.
·
A
decrease of $3 million due to lower weather-related sales (a 3% decrease
in Heating Degree Days).
·
A
decrease of $2 million primarily due to Gas Cost Rate changes effective
April 2007, November 2007 and November
2008.
The
aggregate amount of these decreases was partially offset
by:
·
An
increase of $2 million due to a distribution base rate change effective
April 2007.
Other Gas Revenue
Other Gas Revenue, which is
substantially offset in Fuel and Purchased Energy and Other Services Cost of
Sales, increased by $34 million primarily due to revenue from higher off-system
sales, the result of an increase in market prices. Off-system sales
are made possible due to available pipeline capacity that results from low
demand for natural gas from regulated customers.
Conectiv
Energy
The impact of Operating Revenue changes
and Fuel and Purchased Energy and Other Services Cost of Sales changes with
respect to the Conectiv Energy component of the Competitive Energy business are
encompassed within the discussion that follows.
55
PEPCO
HOLDINGS
Operating Revenues of the Conectiv
Energy segment are derived primarily from the sale of
electricity. The primary components of its costs of sales are fuel
and purchased power. Because fuel and electricity prices tend to move
in tandem, price changes in these commodities from period to period can have a
significant impact on Operating Revenue and Costs of Sales without signifying
any change in the performance of the Conectiv Energy
segment. Conectiv Energy also uses a number of and various types of
derivative contracts to lock in sales margins, and to economically hedge its
power and fuel purchases and sales. Gains and losses on derivative
contracts are netted in revenue and Cost of Sales as appropriate under the
applicable accounting rules. For these reasons, PHI from a managerial
standpoint focuses on gross margin as a measure of performance.
Conectiv Energy Gross
Margin
Merchant Generation & Load Service
consists primarily of electric power, capacity and ancillary services sales from
Conectiv Energy’s generating plants; tolling arrangements entered into to sell
energy and other products from Conectiv Energy’s generating plants and to
purchase energy and other products from generating plants of other companies;
hedges of power, capacity, fuel and load; the sale of excess fuel (primarily
natural gas); natural gas transportation and storage; emission allowances;
electric power, capacity, and ancillary services sales pursuant to competitively
bid contracts entered into with affiliated and non-affiliated companies to
fulfill their default electricity supply obligations; and fuel switching
activities made possible by the multi-fuel capabilities of some of Conectiv
Energy’s power plants.
Energy Marketing activities consist
primarily of wholesale natural gas and fuel oil marketing, the activities of the
short-term power desk, which generates margin by capturing price differences
between power pools and locational and timing differences within a power pool,
and power origination activities, which primarily represent the fixed margin
component of structured power transactions such as default supply
service.
Generation Fuel and Purchased
Power Expenses ($ millions) 3:
Generation
Fuel Expenses 4,5
Natural
Gas
$
223
$
268
$
(45)
Coal
57
62
(5)
Oil
46
34
12
Other6
2
2
-
Total
Generation Fuel Expenses
$
328
$
366
$
(38)
Purchased
Power Expenses 5
$
992
$
480
$
512
Statistics:
2008
2007
Change
Generation
Output (MWh):
Base-Load
7
1,710,916
2,232,499
(521,583)
Mid-Merit
(Combined Cycle) 8
2,625,668
3,341,716
(716,048)
Mid-Merit
(Other) 9
74,254
190,253
(115,999)
Peaking
78,450
146,486
(68,036)
Tolled
Generation
116,776
160,755
(43,979)
Total
4,606,064
6,071,709
(1,465,645)
Load
Service Volume (MWh) 10
10,629,905
7,075,743
3,554,162
Average
Power Sales Price
11($/MWh):
Generation
Sales 4
$
109.71
$
82.19
$
27.52
Non-Generation
Sales 12
$
92.02
$
70.43
$
21.59
Total
$
96.92
$
74.34
$
22.58
Average
on-peak spot power price at PJM East Hub ($/MWh) 13
$
91.73
$
77.85
$
13.88
Average
around-the-clock spot power price at PJM East Hub ($/MWh) 13
$
77.15
$
63.92
$
13.23
Average
spot natural gas price at market area M3 ($/MMBtu)14
$
9.83
$
7.76
$
2.07
Weather
(degree days at Philadelphia Airport): 15
Heating
degree days
4,403
4,560
(157)
Cooling
degree days
1,354
1,513
(159)
1
Includes
$397 million and $442 million of affiliate transactions for 2008 and 2007,
respectively.
2
Includes
$6 million and $7 million of affiliate transactions for 2008 and 2007,
respectively. Also, excludes depreciation and amortization
expense of $37 million and $38 million,
respectively.
3
Consists
solely of Merchant Generation & Load Service expenses; does not
include the cost of fuel not consumed by the power plants and intercompany
tolling expenses.
4
Includes
tolled generation.
5
Includes
associated hedging gains and
losses.
6
Includes
emissions expenses, fuel additives, and other fuel-related
costs.
7
Edge
Moor Units 3 and 4 and Deepwater Unit
6.
8
Hay
Road and Bethlehem, all units.
9
Edge
Moor Unit 5 and Deepwater Unit 1.
10
Consists
of all default electricity supply sales; does not include standard product
hedge volumes.
11
Calculated
from data reported in Conectiv Energy’s Electric Quarterly Report (EQR)
filed with the FERC; does not include capacity or ancillary services
revenue.
12
Consists
of default electricity supply sales, standard product power sales, and
spot power sales other than merchant generation as reported in Conectiv
Energy’s EQR.
Source: Average
delivered natural gas price at Tetco Zone M3 as published in Gas
Daily.
15
Source:
National Oceanic and Atmospheric Administration National Weather Service
data.
57
PEPCO
HOLDINGS
Conectiv
Energy’s revenue and cost of sales are higher in 2008 primarily due to increased
default electricity supply volumes and higher energy commodity
prices. In 2008, Conectiv Energy expanded its default electricity
supply business into ISONE.
Conectiv Energy’s margins were
favorably impacted by higher energy commodity prices in the first half of 2008,
and unfavorably impacted by the decrease in prices and spark spreads during the
second half of the year. Volatile commodity prices contributed to
significant movements in the value of transactions accounted for at fair
value.
Merchant Generation & Load Service
gross margin increased approximately $73 million primarily due to:
·
An
increase of approximately $37 million primarily due to short-term sales of
firm natural gas, and natural gas transportation and storage rights, the
dual-fuel capability of the combined cycle mid-merit units (fuel
switching), cross-commodity hedging (use of natural gas to hedge power
positions), and the opportunities created by the mid-merit combined cycle
units’ operating flexibility (option value) in conjunction with short-term
power and fuel price volatility. This combination of strategies
positioned Conectiv Energy to realize the upside potential of its overall
portfolio during the winter period. The magnitude of gain was
due partly to significant fuel price increases in conjunction with less
significant increases in power
prices.
·
An
increase of approximately $46 million due to higher PJM capacity prices
net of capacity hedges.
·
An
increase of approximately $18 million due to the application of fair value
accounting treatment and associated settlements with respect to excess
coal hedges.
·
A
decrease of approximately $15 million due to a lower of cost or market
adjustment to the value of oil inventory held at the power plants at
year-end 2008.
·
A
decrease of approximately $15 million due to lower sales of emissions
allowances.
Energy
Marketing gross margin increased approximately $15 million primarily due
to:
·
An
increase of approximately $9 million in short-term power desk margins in
2008.
·
An
increase of approximately $9 million due to additional default electricity
supply contracts in 2008.
·
A
decrease of approximately $4 million due to lower wholesale gas
margins.
Pepco Energy
Services
Pepco
Energy Services’ operating revenue increased by $339 million to $2,648 million
in 2008 from $2,309 million in 2007 primarily due to:
58
PEPCO
HOLDINGS
·
An
increase of $259 million due to higher volumes of retail electric load
served due to customer acquisitions and higher prices in
2008,
·
An
increase of $64 million due to higher natural gas volumes driven by
customer acquisitions and higher prices in
2008,
·
An
increase of $26 million due to increased construction activities in
2008;
The
aggregate amount of these increases was partially offset by:
·
A
decrease of $11 million due to RPM-related charges that lowered capacity
revenues for the generation plants.
Other
Non-regulated
Other Non-Regulated operating revenue
decreased by $136 million primarily due to:
·
A
non-cash charge of $124 million was recorded during 2008 as a result of
revised assumptions regarding the estimated timing of tax benefits from
PCI’s cross-border energy lease investments. In accordance with
Financial Accounting Standards Board Staff Position 13-2, this charge was
recorded as a reduction to lease revenue from these transactions, which is
included in Other Non-Regulated
revenues.
Operating
Expenses
Fuel and Purchased Energy and Other
Services Cost of Sales
A detail of PHI’s consolidated Fuel and
Purchased Energy and Other Services Cost of Sales is as follows:
2008
2007
Change
Power
Delivery
$
3,578
$
3,360
$
218
Conectiv
Energy
2,640
1,887
753
Pepco
Energy Services
2,489
2,161
328
Corp.
& Other
(418)
(465)
47
Total
$
8,289
$
6,943
$
1,346
Power
Delivery
Power
Delivery’s Fuel and Purchased Energy and Other Services Cost of Sales, which is
primarily associated with Default Electricity Supply sales, increased by $218
million primarily due to:
·
An
increase of $333 million in average energy costs, the result of new
Default Electricity Supply
contracts.
59
PEPCO
HOLDINGS
·
An
increase of $32 million in gas purchases for off-system sales, the result
of higher average gas costs.
·
An
increase of $24 million for energy and capacity purchased under the Panda
PPA.
The
aggregate amount of these increases was partially offset by:
·
A
decrease of $61 million primarily due to commercial and industrial
customers electing to purchase electricity from competitive
suppliers.
·
A
decrease of $60 million due to lower weather-related
sales.
·
A
decrease of $45 million due to the sale of Virginia retail electric
distribution and wholesale transmission assets in January
2008.
Fuel and
Purchased Energy expense is substantially offset in Regulated T&D Electric
Revenue, Default Supply Revenue, Regulated Gas Revenue and Other Gas
Revenue.
Conectiv
Energy
The impact of Fuel and Purchased Energy
and Other Services Cost of Sales changes with respect to the Conectiv Energy
component of the Competitive Energy business are encompassed within the prior
discussion under the heading “Conectiv Energy Gross Margin.”
Pepco Energy
Services
Pepco
Energy Services’ Fuel and Purchased Energy and Other Services Cost of Sales
increased $328 million primarily due to:
·
An
increase of $236 million due to higher volumes of electricity purchased at
higher prices in 2008 to serve increased retail customer
load.
·
An
increase of $65 million due to higher volumes of natural gas purchased at
higher prices in 2008 to serve increased retail customer
load.
·
An
increase of $15 million due to increased construction activities in
2008.
·
An
increase of $12 million for the generation plants primarily due to
capacity costs related to RPM.
60
PEPCO
HOLDINGS
Other Operation and
Maintenance
A detail of PHI’s other operation and
maintenance expense is as follows:
2008
2007
Change
Power
Delivery
$
702
$
667
$
35
Conectiv
Energy
143
127
16
Pepco
Energy Services
87
74
13
Other
Non-Regulated
2
3
(1)
Corp.
& Other
(17)
(13)
(4)
Total
$
917
$
858
$
59
Other Operation and Maintenance
expenses of the Power Delivery segment increased by $35 million; however,
excluding $3 million resulting from the operation of ACE’s B.L. England electric
generating facility prior to its sale in February 2007, Other Operation and
Maintenance expenses increased by $38 million. The $38 million increase was
primarily due to:
·
An
increase of $17 million in deferred administrative expenses associated
with Default Electricity Supply (offset in Default Supply Revenue) due to
(i) the inclusion of $10 million of customer late payment fees in the
calculation of the deferral and (ii) a higher rate of recovery of bad debt
and administrative expenses as a result of an increase in Default
Electricity Supply revenue rates. See the discussion below
regarding a 2008 correction of errors in recording customer late payment
fees, including $6 million related to prior
periods.
·
An
increase of $11 million due to higher bad debt expenses associated with
distribution and Default Electricity Supply customers, of which
approximately $6 million was
deferred.
·
An
increase of $9 million in employee-related costs primarily due to the
recording of additional stock-based compensation expense as discussed
below, including $6 million related to prior
periods.
·
An
increase of $3 million in Demand Side Management program costs (offset in
Deferred Electric Service Costs).
·
An
increase of $3 million in legal
expenses.
The aggregate amount of these increases
was partially offset by:
·
A
decrease of $3 million in corrective and preventative maintenance and
emergency restoration costs.
·
A
decrease of $4 million in regulatory expenses primarily due to higher
expenses in 2007 relating to the District of Columbia distribution rate
case.
·
A
decrease of $3 million due to higher construction project write-offs in
2007 related to customer requested
work.
61
PEPCO
HOLDINGS
·
A
decrease of $2 million in accounting services related to tax consulting
fees.
Other Operation and Maintenance expense
for Conectiv Energy increased by $16 million primarily due to increased planned
maintenance at its power plants.
Other
Operation and Maintenance expense for Pepco Energy Services increased by $13
million due to increased compensation, benefit, outside contractor and
regulatory costs related to growth in its businesses.
During
2008, PHI recorded adjustments, on a consolidated basis, to correct errors
in Other Operation and Maintenance expenses for prior periods dating back to
February 2005 during which (i) customer late payment fees were incorrectly
recognized and (ii) stock-based compensation expense related to certain
restricted stock awards granted under the Long-Term Incentive Plan was
understated. The late payment fees and stock-based compensation
adjustments resulted in increases in Other Operation and Maintenance expenses
for the year ended December 31, 2008 of $6 million and $9 million,
respectively.
Depreciation
and Amortization
Depreciation
and Amortization expenses increased by $11 million to $377 million in 2008
from $366 million in 2007. The increase was primarily due
to:
·
An
increase of $21 million due to higher amortization by ACE of stranded
costs as a result of an October 2007 Transition Bond Charge rate increase
(offset in Default Supply Revenue)
·
An
increase of $7 million due to utility plant
additions.
The
aggregate amount of these increases was partially offset by:
·
A
decrease of $15 million due to a change in depreciation rates in
accordance with the 2007 Maryland Rate
Orders.
Deferred
Electric Service Costs
Deferred
Electric Service Costs, which relate only to ACE, decreased by $77 million
to income of $9 million in 2008 from an expense of $68 million in
2007. The decrease was primarily due to:
·
A
decrease of $46 million due to a lower rate of recovery associated with
deferred energy costs.
·
A
decrease of $29 million due to a lower rate of recovery of costs
associated with energy and capacity purchased under the
NUGs.
·
A
decrease of $17 million due to a lower rate of recovery associated with
deferred transmission costs.
62
PEPCO
HOLDINGS
The
aggregate amount of these decreases was partially offset
by:
·
An
increase of $15 million primarily due to a higher rate of recovery
associated with Demand Side Management program
costs.
Deferred
Electric Service Costs are substantially offset in Regulated T&D Electric
Revenue and Other Operation and Maintenance.
Impairment
Losses
During
2008, Pepco Holdings recorded pre-tax impairment losses of $2 million ($1
million after-tax) related to a joint-venture investment owned by Conectiv
Energy. During 2007, Pepco Holdings recorded pre-tax impairment
losses of $2 million ($1 million after-tax) related to certain energy services
business assets owned by Pepco Energy Services.
Effect of Settlement of Mirant
Bankruptcy Claims
The Effect of Settlement of Mirant
Bankruptcy Claims reflects the recovery in 2007 of $33 million in operating
expenses and certain other costs as damages in the Mirant bankruptcy
settlement. See “Capital Resources and Liquidity — Cash Flow Activity
— Proceeds from Settlement of Mirant Bankruptcy Claims” herein.
Other
Income (Expenses)
Other
Expenses (which are net of Other Income) increased by $16 million to a net
expense of $300 million in 2008 from a net expense of $284 million in 2007 due
to:
·
A
decrease of $15 million in income from equity
investments.
·
A
decrease of $5 million in Contribution in Aid of Construction tax gross-up
income.
The aggregate amount of these decreases in income was partially offset
by:
·
A
net decrease of $10 million in interest
expense.
Income
Tax Expense
PHI’s effective tax rates for the years
ended December 31, 2008 and 2007 were 35.9% and 36.0%, respectively. While the
change in the effective rate between 2008 and 2007 was minimal, the effective
rate in each year was impacted by certain non-recurring items. In
2008, PHI recorded certain tax benefits that reduced its overall effective tax
rate, primarily representing net interest income accrued on effectively settled
and uncertain tax positions (including interest related to the tentative
settlements with the IRS on the mixed service cost and like-kind exchange issues
discussed below and a claim made with the IRS related to ACE’s tax
reporting of fuel over- and under-recoveries), interest income received in 2008
on the Maryland state tax refund referred to below, and deferred tax adjustments
related to additional analysis of its deferred tax balances completed in
2008. These benefits were partially offset by limited federal and
state tax benefits related to the charge taken on the cross-border energy lease
investments in the second
63
PEPCO
HOLDINGS
quarter
of 2008. In 2007, PHI recorded the receipt of Pepco’s Maryland state
tax refund in the third quarter of 2007 as a reduction in income tax
expense.
During
the second quarter 2008, PHI reached a tentative settlement with the IRS
concerning the treatment by Pepco, DPL and ACE of mixed service construction
costs for income tax purposes during the period 2001 to 2004. On the
basis of the tentative settlement, PHI updated its estimated liability related
to mixed service costs and, as a result, recorded a net reduction in its
liability for unrecognized tax benefits of $19 million and recognized after-tax
interest income of $7 million in the second quarter of 2008. See Note
(16), “Commitments and Contingencies—Regulatory and Other Matters — IRS Mixed
Service Cost Issue,” to the consolidated financial statements of PHI set forth
in Item 8 of this Form 10-K.
During
the fourth quarter of 2008, PHI reached a final settlement with the IRS
concerning a transaction between Conectiv and an unaffiliated third party that
was treated by Conectiv as a “like-kind exchange” under Internal Revenue Code
Section 1031. PHI’s reserve for this issue was more conservative than
the actual settlement and resulted in the reversal of a total of $5 million
(after-tax) in excess accrued interest related to this matter in the fourth
quarter of 2008. See Note (16), “Commitments and Contingencies —
Regulatory and Other Matters — IRS Examination of Like-Kind Exchange
Transaction” to the consolidated financial statements of PHI set forth in Item 8
of this Form 10-K.
The following results of operations
discussion compares the year ended December 31, 2007, to the year ended
December 31, 2006. All amounts in the tables (except sales and
customers) are in millions.
Operating
Revenue
A detail of the components of PHI’s
consolidated operating revenue is as follows:
2007
2006
Change
Power
Delivery
$
5,244
$
5,119
$
125
Conectiv
Energy
2,206
1,964
242
Pepco
Energy Services
2,309
1,669
640
Other
Non-Regulated
76
91
(15)
Corp.
& Other
(469)
(480)
11
Total
Operating Revenue
$
9,366
$
8,363
$
1,003
64
PEPCO
HOLDINGS
Power
Delivery
The following table categorizes Power
Delivery’s operating revenue by type of revenue.
2007
2006
Change
Regulated
T&D Electric Revenue
$
1,592
$
1,496
$
96
Default
Supply Revenue
3,295
3,309
(14)
Other
Electric Revenue
66
58
8
Total
Electric Operating Revenue
4,953
4,863
90
Regulated
Gas Revenue
211
205
6
Other
Gas Revenue
80
51
29
Total
Gas Operating Revenue
291
256
35
Total
Power Delivery Operating Revenue
$
5,244
$
5,119
$
125
Regulated Transmission and Distribution
(T&D) Electric Revenue includes revenue from the delivery of electricity,
including the delivery of Default Electricity Supply, by PHI’s utility
subsidiaries to customers within their service territories at regulated
rates. Regulated T&D Electric Revenue also includes transmission
service revenue that PHI’s utility subsidiaries receive as transmission owners
from PJM.
Default Supply Revenue is the revenue
received for Default Electricity Supply. The costs related to Default
Electricity Supply are included in Fuel and Purchased Energy and Other Services
Cost of Sales. Default Supply Revenue also includes revenue from
transition bond charges and other restructuring related revenues.
Other Electric Revenue includes work
and services performed on behalf of customers, including other utilities, which
is not subject to price regulation. Work and services includes mutual
assistance to other utilities, highway relocation, rentals of pole attachments,
late payment fees, and collection fees.
Regulated Gas Revenue consists of
revenues for on-system natural gas sales and the transportation of natural gas
for customers by DPL within its service territories at regulated
rates.
Other Gas Revenue consists of DPL’s
off-system natural gas sales and the sale of excess system
capacity.
In response to an order issued by the
NJBPU regarding changes to ACE’s retail transmission rates, ACE has established
deferred accounting treatment for the difference between the rates that ACE is
authorized to charge its customers for the transmission of default electricity
supply and the cost that ACE incurs. Under the deferral arrangement,
any over or under recovery is deferred as part of Deferred Electric Service
Costs pending an adjustment of retail rates in a future
proceeding. As a consequence of the order, effective January 1,2008, ACE’s retail transmission revenue is being recorded as Default Supply
Revenue, rather than as Regulated T&D Electric Revenue, thereby conforming
to the practice of PHI’s other utility subsidiaries, which previously
established deferred accounting treatment for any over or under
65
PEPCO
HOLDINGS
recovery
of retail transmission rates relative to the cost incurred. In
addition, ACE’s retail transmission revenue for the period prior to
January 1, 2008 has been reclassified to Default Supply Revenue in order to
conform to the current period presentation.
Electric Operating Revenue
Regulated
T&D Electric Revenue
2007
2006
Change
Residential
$
579
$
550
$
29
Commercial
720
689
31
Industrial
26
27
(1)
Other
267
230
37
Total
Regulated T&D Electric Revenue
$
1,592
$
1,496
$
96
Other Regulated T&D Electric
Revenue consists primarily of (i) transmission service revenue, (ii) revenue
from the resale of energy and capacity under power purchase agreements between
Pepco and unaffiliated third parties in the PJM RTO market, and (iii) any
necessary Revenue Decoupling Adjustments.
Regulated
T&D Electric Sales (GWh)
2007
2006
Change
Residential
17,946
17,139
807
Commercial
29,137
28,378
759
Industrial
3,974
4,119
(145)
Other
261
260
1
Total
Regulated T&D Electric Sales
51,318
49,896
1,422
Regulated
T&D Electric Customers (in thousands)
2007
2006
Change
Residential
1,622
1,605
17
Commercial
197
196
1
Industrial
2
2
-
Other
2
2
-
Total
Regulated T&D Electric Customers
1,823
1,805
18
Regulated T&D Electric Revenue
increased by $96 million primarily due to:
·
An
increase of $43 million in sales due to higher weather-related sales (a
17% increase in Cooling Degree Days and a 12% increase in Heating Degree
Days).
·
An
increase of $29 million in Other Regulated T&D Electric Revenue from
the resale of energy and capacity purchased under the Panda PPA, (offset
in Fuel and Purchased Energy and Other Services Cost of
Sales).
66
PEPCO
HOLDINGS
·
An
increase of $20 million due to a distribution rate change under the 2007
Maryland Rate Orders that became effective in June 2007, including a
positive $5 million Revenue Decoupling
Adjustment.
·
An
increase of $12 million due to higher pass-through revenue primarily
resulting from tax rate increases in the District of Columbia (primarily
offset in Other Taxes).
·
An
increase of $5 million due to customer growth of 1% in
2007.
The aggregate amount of these increases
was partially offset by:
·
A
decrease of $10 million due to a change in the Delaware rate structure
effective May 1, 2006, which shifted revenue from Regulated T&D
Electric Revenue to Default Supply
Revenue.
·
`A
decrease of $4 million due to a Delaware base rate reduction effective May1, 2006.
Default Electricity Supply
Default
Supply Revenue
2007
2006
Change
Residential
$
1,843
$
1,508
$
335
Commercial
1,073
1,363
(290)
Industrial
94
110
(16)
Other
285
328
(43)
Total
Default Supply Revenue
$
3,295
$
3,309
$
(14)
Other Default Supply Revenue consists
primarily of revenue from the resale of energy and capacity purchased under NUGs
in the PJM RTO market.
Default
Electricity Supply Sales (GWh)
2007
2006
Change
Residential
17,469
16,698
771
Commercial
9,910
14,799
(4,889)
Industrial
914
1,379
(465)
Other
131
129
2
Total
Default Electricity Supply Sales
28,424
33,005
(4,581)
67
PEPCO
HOLDINGS
Default
Electricity Supply Customers (in thousands)
2007
2006
Change
Residential
1,585
1,575
10
Commercial
166
170
(4)
Industrial
1
1
-
Other
2
2
-
Total
Default Electricity Supply Customers
1,754
1,748
6
Default Supply Revenue, which is
partially offset in Fuel and Purchased Energy and Other Services Cost of Sales,
decreased by $14 million primarily due to:
·
A
decrease of $346 million primarily due to commercial and industrial
customers electing to purchase electricity from competitive
suppliers.
·
A
decrease of $95 million due to differences in consumption among the
various customer rate classes.
·
A
decrease of $46 million in wholesale energy revenue primarily the result
of the sales by ACE of its Keystone and Conemaugh interests and the B.L.
England generating facilities.
·
A
decrease of $4 million due to a DPL adjustment to reclassify market-priced
supply revenue from Regulated T&D Electric Revenue in
2006.
The aggregate amount of these decreases
was partially offset by:
·
An
increase of $379 million due to annual increases in market-based Default
Electricity Supply rates.
·
An
increase of $87 million due to higher weather-related sales (a 17%
increase in Cooling Degree Days and a 12% increase in Heating Degree
Days).
·
An
increase of $10 million due to a change in Delaware rate structure
effective May 1, 2006 that shifted revenue from Regulated T&D
Electric Revenue to Default Supply
Revenue.
Other Electric Revenue
Other Electric Revenue increased $8
million to $66 million in 2007 from $58 million in 2006 primarily due to
increases in revenue related to pole rentals and late payment fees.
68
PEPCO
HOLDINGS
Gas Operating Revenue
Regulated
Gas Revenue
2007
2006
Change
Residential
$
124
$
116
$
8
Commercial
73
73
-
Industrial
8
10
(2)
Transportation
and Other
6
6
-
Total
Regulated Gas Revenue
$
211
$
205
$
6
Regulated
Gas Sales (billion cubic feet)
2007
2006
Change
Residential
8
7
1
Commercial
5
5
-
Industrial
1
1
-
Transportation
and Other
7
5
2
Total
Regulated Gas Sales
21
18
3
Regulated
Gas Customers (in thousands)
2007
2006
Change
Residential
112
112
-
Commercial
10
9
1
Industrial
-
-
-
Transportation
and Other
-
-
-
Total
Regulated Gas Customers
122
121
1
Regulated Gas Revenue increased by $6
million primarily due to:
·
An
increase of $12 million due to colder weather (a 15% increase in Heating
Degree Days).
·
An
increase of $6 million due to base rate increases effective in November
2006 and April 2007.
·
An
increase of $5 million due to differences in consumption among the various
customer rate classes.
·
An
increase of $3 million due to customer growth of 1% in
2007.
The aggregate amount of these increases
was partially offset by:
69
PEPCO
HOLDINGS
·
A
decrease of $18 million due to Gas Cost Rate decreases effective November
2006, April 2007 and November 2007 resulting from lower natural gas
commodity costs (offset in Fuel and Purchased Energy and Other Services
Cost of Sales).
Other Gas Revenue
Other Gas Revenue increased by $29
million to $80 million in 2007 from $51 million in 2006 primarily due to higher
off-system sales (partially offset in Fuel and Purchased Energy and Other
Services Cost of Sales). The gas sold off-system resulted from
increased demand from unaffiliated third party electric generators during
periods of low customer demand for natural gas.
Conectiv
Energy
Conectiv Energy Gross
Margin
Merchant Generation & Load Service
consists primarily of electric power, capacity and ancillary services sales from
Conectiv Energy’s generating plants; tolling arrangements entered into to sell
energy and other products from Conectiv Energy’s generating plants and to
purchase energy and other products from generating plants of other companies;
hedges of power, capacity, fuel and load; the sale of excess fuel (primarily
natural gas); natural gas transportation and storage; emission allowances;
electric power, capacity, and ancillary services sales pursuant to competitively
bid contracts entered into with affiliated and non-affiliated companies to
fulfill their default electricity supply obligations; and fuel switching
activities made possible by the multi-fuel capabilities of some of Conectiv
Energy’s power plants.
Energy Marketing activities consist
primarily of wholesale natural gas and fuel oil marketing, the activities of the
short-term power desk, which generates margin by capturing price differences
between power pools and locational and timing differences within a power pool,
and power origination activities, which primarily represent the fixed margin
component of structured power transactions such as default supply
service.
Generation Fuel
and Purchased Power Expenses ($ millions) 3:
Generation Fuel Expenses 4,5
Natural Gas6
$
268
$
175
$
93
Coal
62
53
9
Oil
34
27
7
Other7
2
4
(2)
Total
Generation Fuel Expenses
$
366
$
259
$
107
Purchased Power Expenses 5
$
480
$
431
$
49
Statistics:
2007
2006
Change
Generation
Output (MWh):
Base-Load 8
2,232,499
1,814,517
417,982
Mid-Merit (Combined Cycle) 9
3,341,716
2,081,873
1,259,843
Mid-Merit (Other) 10
190,253
115,120
75,133
Peaking
146,486
131,930
14,556
Tolled
Generation
160,755
94,064
66,691
Total
6,071,709
4,237,504
1,834,205
Load Service Volume (MWh) 11
7,075,743
8,514,719
(1,438,976)
Average
Power Sales Price
12($/MWh):
Generation Sales 4
$
82.19
$
77.69
$
4.50
Non-Generation Sales 13
$
70.43
$
58.49
$
11.94
Total
$
74.34
$
62.54
$
11.80
Average on-peak spot power price at PJM East Hub
($/MWh) 14
$
77.85
$
65.29
$
12.56
Average around-the-clock spot power price at PJM
East Hub ($/MWh) 14
$
63.92
$
53.07
$
10.85
Average spot natural gas price at market area M3
($/MMBtu)15
$
7.76
$
7.31
$
0.45
Weather (degree days at Philadelphia Airport):
16
Heating
degree days
4,560
4,205
355
Cooling
degree days
1,513
1,136
377
1
Includes
$442 million and $471 million of affiliate transactions for 2007 and 2006,
respectively. The 2006 amount has been reclassified to exclude
$193 million of intra-affiliate transactions that were reported gross in
2006 at the segment
level.
2
Includes
$7 million and $5 million of affiliate transactions for 2007 and 2006,
respectively. The 2006 amount has been reclassified to exclude
$193 million of intra-affiliate transactions that were reported gross in
2006 at the segment level. Also, excludes depreciation and
amortization expense of $38 million and $36 million,
respectively.
3
Consists
solely of Merchant Generation & Load Service expenses; does not
include the cost of fuel not consumed by the power plants and intercompany
tolling expenses.
4
Includes
tolled generation.
5
Includes
associated hedging gains and
losses.
6
Includes
adjusted 2006 amount related to change in natural gas hedge allocation
methodology.
7
Includes
emissions expenses, fuel additives, and other fuel-related
costs.
8
Edge
Moor Units 3 and 4 and Deepwater Unit
6.
9
Hay
Road and Bethlehem, all units.
10
Edge
Moor Unit 5 and Deepwater Unit 1. Generation output for these units was
negative for the first and fourth quarters of 2006 because of station
service consumption.
11
Consists
of all default electricity supply sales; does not include standard product
hedge volumes.
12
Calculated
from data reported in Conectiv Energy’s Electric Quarterly Report (EQR)
filed with the FERC; does not include capacity or ancillary services
revenue.
13
Consists
of default electricity supply sales, standard product power sales, and
spot power sales other than merchant generation as reported in Conectiv
Energy’s EQR.
Source: Average
delivered natural gas price at Tetco Zone M3 as published in Gas
Daily.
16
Source: National Oceanic and Atmospheric
Administration National Weather Service
data.
71
PEPCO
HOLDINGS
Merchant Generation & Load Service
gross margin increased $69 million primarily due to:
·
An
increase of approximately $77 million primarily due to 43% higher
generation output attributable to more favorable weather and improved
availability at the Hay Road and Deepwater generating plants and improved
spark spreads.
·
An
increase of approximately $26 million due to higher capacity prices due to
the implementation of the PJM Reliability Pricing
Model.
·
A
decrease of $33 million due to less favorable natural gas fuel hedges, and
the expiration, in 2006, of an agreement with an international investment
banking firm to hedge approximately 50% of the commodity price risk of
Conectiv Energy’s generation and Default Electricity Supply commitment to
DPL.
Energy Marketing gross margin decreased
$5 million primarily due to:
·
A
decrease of $5 million due to lower margins in oil
marketing.
·
A
decrease of $4 million due to lower margins in natural gas
marketing.
·
An
increase of $3 million for adjustments related to an unaffiliated
generation operating services agreement that expired in
2006.
Pepco Energy
Services
Pepco Energy Services’ operating
revenue increased $640 million to $2,309 million in 2007 from $1,669 million in
2006 primarily due to:
·
An
increase of $646 million due to higher volumes of retail electric load
served at higher prices in 2007 driven by customer
acquisitions.
·
An
increase of $27 million due to higher volumes of wholesale natural gas
sales in 2007 that resulted from increased natural gas supply transactions
to deliver gas to retail customers.
The aggregate amount of these increases
was partially offset by:
·
A
decrease of $32 million due primarily to lower construction activity in
2007 and to the sale of five construction businesses in
2006.
Other
Non-Regulated
Other Non-Regulated operating revenue
decreased $15 million to $76 million in 2007 from $91 million in
2006. The operating revenue of this segment primarily consists of
lease earnings recognized under Statement of Financial Accounting Standards No.
13, “Accounting for Leases.” The revenue decrease is primarily due
to:
72
PEPCO
HOLDINGS
·
A
change in state income tax lease assumptions that resulted in increased
revenue in 2006 as compared to
2007.
Operating
Expenses
Fuel and Purchased Energy and Other
Services Cost of Sales
A detail of PHI’s consolidated Fuel and
Purchased Energy and Other Services Cost of Sales is as follows:
2007
2006
Change
Power
Delivery
$
3,360
$
3,304
$
56
Conectiv
Energy
1,887
1,709
178
Pepco
Energy Services
2,161
1,531
630
Corp.
& Other
(465)
(478)
13
Total
$
6,943
$
6,066
$
877
Power
Delivery
Power Delivery’s Fuel and Purchased
Energy and Other Services Cost of Sales, which is primarily associated with
Default Electricity Supply sales, increased by $56 million primarily due
to:
·
An
increase of $445 million in average energy costs, the result of new
Default Electricity Supply
contracts.
·
An
increase of $93 million due to higher weather-related
sales.
·
An
increase of $29 million for energy and capacity purchased under the Panda
PPA.
The aggregate amount of these increases
was partially offset by:
·
A
decrease of $472 million primarily due to commercial and industrial
customers electing to purchase an increased amount of electricity from
competitive suppliers.
·
A
decrease of $36 million in the Default Electricity Supply deferral
balance.
·
Fuel
and Purchased Energy expense is primarily offset in Regulated T&D
Electric Revenue, Default Supply Revenue, Regulated Gas Revenue or Other
Gas Revenue.
73
PEPCO
HOLDINGS
Conectiv
Energy
The impact of Fuel and Purchased Energy
and Other Services Cost of Sales changes with respect to the Conectiv Energy
component of the Competitive Energy business are encompassed within the prior
discussion under the heading “Conectiv Energy Gross Margin.”
Pepco Energy
Services
Pepco Energy Services’ Fuel and
Purchased Energy and Other Services Cost of Sales increased $630 million
primarily due to:
·
An
increase of $636 million due to higher volumes of purchased electricity at
higher prices in 2007 to serve increased retail customer
load.
·
An
increase of $40 million due to higher volumes of wholesale natural gas
sales in 2007 that resulted from increased natural gas supply transactions
to deliver gas to retail customers.
The
aggregate amount of these increases was partially offset by:
·
A
decrease of $45 million due primarily to lower construction activity in
2007 and to the sale of five construction businesses in
2006.
Other
Operation and Maintenance
A detail
of PHI’s other operation and maintenance expense is as follows:
2007
2006
Change
Power
Delivery
$
667
$
640
$
27
Conectiv
Energy
127
116
11
Pepco
Energy Services
74
68
6
Other
Non-Regulated
3
4
(1)
Corp.
& Other
(13)
(20)
7
Total
$
858
$
808
$
50
Other
Operation and Maintenance expense of the Power Delivery segment increased by $27
million; however, excluding the favorable variance of $34 million primarily
resulting from ACE’s sale of the B.L. England electric generating facility in
February 2007, Other Operation and Maintenance expenses increased by $61
million. The $61 million increase was primarily due to:
·
An
increase of $16 million in employee-related
costs.
·
An
increase of $11 million in preventative maintenance and system operation
costs.
·
An
increase of $7 million in customer service operation
expenses.
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PEPCO
HOLDINGS
·
An
increase of $4 million in costs associated with Default Electricity Supply
(primarily deferred and
recoverable).
·
An
increase of $4 million in regulatory
expenses.
·
An
increase of $4 million in accounting service
expenses.
·
An
increase of $3 million due to various construction project write-offs
related to customer requested work.
·
An
increase of $3 million in Demand Side Management program costs (offset in
Deferred Electric Service Costs).
·
An
increase of $3 million due to higher bad debt
expenses.
Other Operation and Maintenance expense
for Conectiv Energy increased by $11 million primarily due to:
·
Higher
plant maintenance costs due to more scheduled outages in 2007 and higher
costs of materials and labor.
Other Operation and Maintenance expense
for Pepco Energy Services increased by $6 million due to:
·
Higher
retail electric and gas operating costs to support the growth in the
retail business in 2007.
Other Operation and Maintenance expense
for Corporate & Other increased by $7 million due to:
·
An
increase in employee-related costs.
Depreciation and
Amortization
Depreciation and Amortization
expenses decreased by $47 million to $366 million in 2007 from $413 million
in 2006. The decrease is primarily due to:
·
A
decrease of $31 million in ACE’s regulatory asset amortization resulting
primarily from the 2006 sale of ACE’s interests in Keystone and
Conemaugh.
·
A
decrease of $19 million in depreciation due to a change in depreciation
rates in accordance with the 2007 Maryland Rate
Order.
Other Taxes
Other Taxes increased by $14 million to
$357 million in 2007 from $343 million in 2006. The increase was
primarily due to:
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PEPCO
HOLDINGS
·
An
increase in pass-throughs resulting from tax rate increases (partially
offset in Regulated T&D Electric
Revenue).
Deferred Electric Service
Costs
Deferred Electric Service Costs, which
relate only to ACE, increased by $46 million to $68 million in 2007 from $22
million in 2006. The increase is primarily due to:
·
An
increase of $38 million due to a higher rate of recovery associated with
energy and capacity purchased under the
NUGs.
·
An
increase of $12 million due to a higher rate of recovery associated with
deferred energy costs.
The aggregate amount of these increases
was partially offset by:
·
A
decrease of $3 million due to a lower rate of recovery associated with
Demand Side Management program
costs.
Deferred
Electric Service Costs are substantially offset in Regulated T&D Electric
Revenue and Other Operation and Maintenance.
Impairment
Losses
During 2007, Pepco Holdings recorded
pre-tax impairment losses of $2 million ($1 million after-tax) related to
certain energy services business assets owned by Pepco Energy
Services. During 2006, Pepco Holdings recorded pre-tax impairment
losses of $19 million ($14 million after-tax) related to certain energy services
business assets owned by Pepco Energy Services.
Effect of Settlement of Mirant
Bankruptcy Claims
The Effect of Settlement of Mirant
Bankruptcy Claims reflects the recovery in 2007 of $33 million in operating
expenses and certain other costs as damages in the Mirant bankruptcy
settlement. See “Capital Resources and Liquidity — Proceeds from
Settlement of Mirant Bankruptcy Claims” herein.
Income
Tax Expense
PHI’s effective tax rates for the years
ended December 31, 2007 and 2006 were 36.0% and 39.3%, respectively. The
decrease in the effective tax rate in 2007 was primarily the result of a 2007
Maryland state income tax refund. The refund was due to an increase
in the tax basis of certain assets sold in 2000, and as a result, PHI’s 2007
income tax expense was reduced by approximately $20 million, with a
corresponding decrease to the effective tax rate of 3.7%.
CAPITAL
RESOURCES AND LIQUIDITY
This section discusses Pepco Holdings’
working capital, cash flow activity, capital requirements and other uses and
sources of capital.
76
PEPCO
HOLDINGS
Working
Capital
At December 31, 2008, Pepco Holdings’
current assets on a consolidated basis totaled $2.6 billion and its current
liabilities totaled $2 billion. At December 31, 2007, Pepco Holdings’
current assets on a consolidated basis totaled $2 billion and its current
liabilities totaled $2 billion. The increase in working capital from December31, 2007 to December 31, 2008 is primarily due to an increase in cash as a
result of the issuance of long-term debt during the fourth quarter of
2008.
At December 31, 2008, Pepco Holdings’
cash and current cash equivalents totaled $384 million, of which $343 million
was invested in money market funds that invest in U.S. Treasury obligations, and
the balance was held as cash and uncollected funds. Current restricted cash
(cash that is available to be used only for designated purposes) totaled $10
million. At December 31, 2007, Pepco Holdings’ cash and current
cash equivalents totaled $55 million and its current restricted cash totaled $15
million. See “Capital Requirements — Contractual Arrangements with Credit Rating
Triggers or Margining Rights” herein for additional information.
A detail of PHI’s short-term debt
balance and its current maturities of long-term debt and project funding balance
follows.
PHI,
Pepco, DPL and ACE maintain a credit facility to provide for their respective
short-term liquidity needs. The aggregate borrowing limit under this
primary credit facility is $1.5 billion, all or any portion of which may be used
to obtain loans or to issue letters of credit. PHI’s credit limit
under the facility is $875 million. The credit limit of each of
Pepco, DPL and ACE is the lesser of $500 million and the maximum amount of debt
the company is permitted to have outstanding by its regulatory authorities,
except that the aggregate amount of credit used by Pepco, DPL and ACE at any
given time collectively may not exceed $625 million. The interest
rate payable by each company on utilized funds is, at the borrowing company’s
election, (i) the greater of the prevailing prime rate and the federal funds
effective rate plus 0.5% or (ii) the prevailing Eurodollar rate, plus a margin
that varies according to the credit rating of the borrower. The
facility also includes a “swingline loan sub-facility” pursuant to which each
company may make same day borrowings in an aggregate amount not to exceed $150
million. Any swingline loan must be repaid by the borrower within
seven days of receipt thereof. All indebtedness incurred under the
facility is unsecured.
The facility commitment expiration date
is May 5, 2012, with each company having the right to elect to have 100% of
the principal balance of the loans outstanding on the expiration date continued
as non-revolving term loans for a period of one year from such expiration
date.
The
facility is intended to serve primarily as a source of liquidity to support the
commercial paper programs of the respective companies. The companies also are
permitted to use the facility to borrow funds for general corporate purposes and
issue letters of credit. In order for a borrower to use the facility, certain
representations and warranties must be true and correct, and the borrower must
be in compliance with specified covenants, including (i) the requirement that
each borrowing company maintain a ratio of total indebtedness to total
capitalization of 65% or less, computed in accordance with the terms of the
credit agreement, which calculation excludes from the definition of total
indebtedness certain trust preferred securities and deferrable interest
subordinated debt (not to exceed 15% of total capitalization), (ii) a
restriction on sales or other dispositions of assets, other than certain sales
and dispositions, and (iii) a restriction on the incurrence of liens on the
assets of a borrower or any of its significant subsidiaries other than permitted
liens. The absence of a material adverse change in the borrower’s
business, property, and results of operations or financial condition is not a
condition to the availability of credit under the facility. The facility does
not include any rating triggers.
In
November 2008, PHI entered into a second credit facility in the amount of $400
million with a syndicate of nine lenders. Under the facility, PHI may
obtain revolving loans and swingline loans over the term of the facility, which
expires on November 6, 2009. The facility does not provide for the issuance of
letters of credit. All indebtedness incurred under the facility is
unsecured. The interest rate payable on funds borrowed under the facility is, at
PHI’s election, based on either (a) the prevailing Eurodollar rate or (b) the
highest of (i) the prevailing prime rate, (ii) the federal funds effective rate
plus 0.5% or (iii) the one-month Eurodollar rate plus 1.0%, plus a margin that
varies according to the credit rating of PHI. Under the swingline loan
sub-facility, PHI may obtain loans for up to seven days in an aggregate
principal amount which does not exceed 10% of the aggregate borrowing limit
under the facility. In order to obtain loans under the facility, PHI must be in
compliance with the same covenants and conditions that it is required to satisfy
for utilization of the primary credit facility. The absence of a material
adverse
78
PEPCO
HOLDINGS
change in
PHI’s business, property, and results of operations or financial condition is
not a condition to the availability of credit under the facility. The facility
does not include any ratings triggers.
Typically,
PHI and its utility subsidiaries issue commercial paper if required to meet
their short-term working capital requirements. Given the recent lack
of liquidity in the commercial paper markets, however, the companies have
borrowed under the primary credit facility to maintain sufficient cash on hand
to meet daily short-term operating needs. As of December 31,2008, PHI had an outstanding loan of $50 million and Pepco had an outstanding
loan of $100 million under the facility. In January 2009, PHI borrowed an
additional $150 million under the facility.
Cash
and cash equivalents reported on the Balance Sheet total $384 million,
which includes the $343 million invested in money market funds and $41
million held in cash and uncollected
funds.
During
the months of January and February 2009, the total cash and credit facilities
available to PHI on a consolidated basis ranged from a low of $1.1 billion to a
high of $1.7 billion, and averaged $1.4 billion. The total cash and
credit facilities available to the utility subsidiaries collectively ranged from
a low of $673 million to a high of $1 billion, and averaged $831
million.
Cash
Flow Activity
PHI’s cash flows for 2008, 2007, and
2006 are summarized below.
Cash
Source (Use)
2008
2007
2006
(Millions
of dollars)
Operating
Activities
$
413
$
795
$
203
Investing
Activities
(714)
(582)
(230)
Financing
Activities
630
(207)
(46)
Net
increase (decrease) in cash and cash equivalents
$
329
$
6
$
(73)
79
PEPCO
HOLDINGS
Operating Activities
Cash flows from operating activities
are summarized below for 2008, 2007, and 2006.
Cash
Source (Use)
2008
2007
2006
(Millions
of dollars)
Net
Income
$
300
$
334
$
248
Non-cash
adjustments to net income
1,073
382
613
Changes
in working capital
(960)
79
(658)
Net
cash from operating activities
$
413
$
795
$
203
Net cash from operating activities was
$382 million lower for the year ended December 31, 2008 compared to the
year ended December 31, 2007. In addition to a $34 million decrease
in net income, the primary contributor was a $336 million increase in cash
collateral requirements associated with Competitive Energy
activities. The cash collateral requirements of the Competitive
Energy businesses fluctuate significantly based on changes in energy market
prices.
As of December 31, 2008 and 2007,
the combined net cash collateral positions of the Pepco Energy Services and
Conectiv Energy businesses were net cash posted of $331 million and $90 million,
respectively. As energy prices have declined in the second half of
2008, the collateral that the Competitive Energy businesses have been required
to post has increased substantially.
In addition, the transfer by Pepco of
the Panda PPA to Sempra Energy Trading LLC had an impact on 2008 cash flows from
operating activities. Non-cash adjustments to net income reflect the
change in restricted cash equivalents used to make the payment and changes in
working capital include the reduction in the regulatory liability established to
help offset future above-market capacity and energy purchase costs.
Net cash from operating activities in
2007 was $592 million higher than in 2006. In addition to an increase
in net income, the factors that primarily contributed to the increase
were: (i) a decrease of $203 million in taxes paid in 2007, partially
attributable to a tax payment of $121 million made in February 2006 in
connection with an unresolved tax matter (see Note (16), “Commitments and
Contingencies ¾
Regulatory and Other Matters — IRS Mixed Service Cost Issue” to the consolidated
financial statements of PHI set forth in Item 8 of this Form 10-K), (ii) a
decrease in cash collateral requirements associated with Competitive Energy
activities, and (iii) the receipt of the proceeds of the Mirant bankruptcy
settlement, of which $399 million was designated as operating cash flows and $15
million was designated as investing cash flows.
80
PEPCO
HOLDINGS
Investing Activities
Cash flows used by investing activities
during 2008, 2007, and 2006 are summarized below.
Cash
(Use) Source
2008
2007
2006
(Millions
of dollars)
Construction
expenditures
$
(781)
$
(623)
$
(475)
Cash
proceeds from sale of other assets
56
11
182
All
other investing cash flows, net
11
30
63
Net
cash used by investing activities
$
(714)
$
(582)
$
(230)
Net cash used by investing activities
increased $132 million for the year ended December 31, 2008 compared to the
year ended December 31, 2007. The increase was due primarily to (i)
$158 million increase in capital expenditures, of which $96 million was
attributable to Conectiv Energy and $33 million was attributable to Power
Delivery, and (ii) the receipt by Pepco in 2007 of the proceeds of the Mirant
bankruptcy settlement of which $15 million was designated as a reimbursement of
certain investments in property, plant and equipment, offset by (iii) an
increase of $45 million in cash proceeds from the sale of assets. The
increase in Conectiv Energy capital expenditures was primarily due to the
construction of new generation plants. The increase in Power Delivery capital
expenditures was primarily attributable to capital costs associated with new
customer services, distribution reliability, and transmission. The proceeds from
the sale of assets in 2008 consisted primarily of $54 million received from
DPL’s sale of its Virginia retail electric distribution assets and wholesale
electric transmission assets. Proceeds from the sale of assets in
2007 consisted primarily of $9 million received from the sale by ACE of the B.L.
England generating facility.
Net cash used by investing activities
in 2007 was $352 million higher than in 2006 primarily due to: (i) a
$148 million increase in capital expenditures, $107 million of which relates to
Power Delivery, and (ii) a decrease of $171 million in cash proceeds from the
sale of property. The increase in Power Delivery capital expenditures
is primarily due to major transmission projects and new substations for Pepco
and ACE. The proceeds from the sale of other assets in 2006 consisted
primarily of $175 million from the sale of ACE’s interest in the Keystone and
Conemaugh generating facilities. Proceeds from the sale of other
assets in 2007 consisted primarily of $9 million received from the sale of the
B.L. England generating facility. Cash flows from investing
activities in 2007 also include $15 million of the net settlement proceeds
received by Pepco in the Mirant bankruptcy settlement that were specifically
designated as a reimbursement of certain investments in property, plant and
equipment.
81
PEPCO
HOLDINGS
Financing Activities
Cash flows used by financing activities
during 2008, 2007 and 2006 are summarized below.
Cash
(Use) Source
2008
2007
2006
(Millions
of dollars)
Dividends
paid on common and preferred stock
$
(222)
$
(203)
$
(199)
Common
stock issued through the Dividend
Reinvestment
Plan (DRP)
29
28
30
Issuance
of common stock
287
200
17
Redemption
of preferred stock of subsidiaries
-
(18)
(22)
Issuances
of long-term debt
1,150
704
515
Reacquisition
of long-term debt
(590)
(855)
(578)
Issuances
(repayments) of short-term debt, net
26
(61)
193
Cost
of issuances
(30)
(7)
(6)
All
other financing cash flows, net
(20)
5
4
Net
cash provided by (used by) financing activities
$
630
$
(207)
$
(46)
Net cash provided by financing
activities in 2008 was $837 million higher than in 2007. Net cash
used by financing activities in 2007 was $161 million higher than in
2006.
Common
Stock Dividends
Common stock dividend payments were
$222 million in 2008, $203 million in 2007, and $198 million in
2006. The increase in common dividends paid in 2008 was the result of
additional shares outstanding (primarily from PHI’s sale of 6.5 million shares
of common stock in November 2007) and a quarterly dividend increase from 26
cents per share to 27 cents per share beginning in the first quarter of 2008.
The increase in common dividends paid in 2007 was due to the issuance of the
additional shares under the DRP.
Changes
in Outstanding Common Stock
In
November 2008, PHI sold 16.1 million shares of common stock in a registered
offering at a price per share of $16.50, resulting in gross proceeds of $265
million. In November 2007, PHI sold 6.5 million shares of common
stock in a registered offering at a price per share of $27.00, resulting in
gross proceeds of $176 million.
Under the
DRP, PHI issued approximately 1.3 million shares of common stock in 2008,
approximately 1 million shares of common stock in 2007 and approximately 1.2
million shares of common stock in 2006.
Changes in Outstanding Preferred
Stock
Cash flows from the redemption of
preferred stock in 2008, 2007 and 2006 are summarized in the chart
below.
82
PEPCO
HOLDINGS
Preferred
Stock Redemptions
Redemption
Price
Shares
Redeemed
Aggregate
Redemption Costs for years ended December 31,
