Large Capital Projects: What are the Risks and Who Should Bear Them? Mark Agnew, Edison Electric Institute NARUC Accounting/Finance Meeting Lexington, KY October 13, 2008

Table of Contents Regulatory Compact – The Key Players Industry’s Soaring Capital Expenditures Risks Facing the Industry Demand Financing, Credit Regulatory Execution, Inflation Specific businesses (Transmission, Generation) EEI’s Outreach Activities

Who Shares the Risks? Management Duty to manage utility/projects prudently Shareholders Receive an adequate return on investment for risks taken on behalf of ratepayers Ratepayers Receive reliable service at just and reasonable rates Not responsible for mismanagement by utilities Good regulation tries to achieve a fair balance of all interests

Soaring Capital Expenditures

Increasing Electricity Demand

Industry Capex Continues to Rise

Capex Projected to Top $86 Billion in 2008 P = projected

Industry Capital Expenditures Industry committed to reliability and making needed investments in generation, transmission, distribution and the environment Capex 2006 totaled $59.9 billion (+24%) 2007 totaled $69.1 billion (+16%) 2008 projected $86.5 billion (+25%) Dollar growth in all categories from last year 2008 (+16%) and 2009 (+12%) projections revised sharply upward from last year’s study Increased spending expected to continue Total capex for ~ $1.5 trillion* U.S. Shareholder-Owned Electric Utilities * The Brattle Group, preliminary findings from The Edison Foundation presentation titled Transforming America’s Power Industry. Represents the entire Power sector.

Overall Infrastructure Investment Needs $1.5 trillion will be required over the 2010 – 2030 period doubling existing net plant in service Distribution - $675 billion Transmission - $233 billion Generation - $560 billion Represents the entire power industry IOUs, Cooperatives, Municipals, IPPs Carbon Legislation would enhance overall projection Source: Transforming America’s Power Industry: The Investment Challenge (Preliminary Findings), The Brattle Group, April 2008

About 2/3 of Industry is State Regulated

Demand Risk

Energy Efficiency Decoupling and other EE measures How much will this impact future revenues? Brattle’s latest projections on this impact Required generation could fall by 17% from , under a reasonable EE scenario Price Elasticity Consumer reaction to rising gas prices (‘08 v ‘07) Risk – Management/SH – EE & price elas. Ratepayers - energy efficiency

Financing and Credit Risks

Financing Risk Financing decisions that don’t impair: Financial strength, Credit Rating Tighter Credit Markets Overall trend, magnified by recent financial crisis Eventual Rise in Interest Rates? Rates still at historical lows Strong correlation to awarded ROEs Dividends – frozen or cut? borrowing to pay? Risk – Ratepayers - Int rates & gen cap trends Management/SH – all the above

Credit Ratings Risk Taking on too much debt without timely cost recovery impairs credit metrics may lead to downgrades Increases financing costs Capex plans & related debt mentioned in most ratings actions/outlooks in Risk – Management/Shareholders

Industry Leverage Beginning to Rise

Credit Quality Starting to Slide in ‘08 Downgrades outpacing upgrades in 2008 First time since 2004

Average Credit Rating Has Declined

Regulatory Risk

Timely recovery of large capex is crucial CWIP Large capex cycles tend to put downward pressure on realized ROEs Regulatory lag Risk – Management/Shareholders Ratepayers Quality of cost recovery affects all.

Regulatory Lag is Retu rning Note: Figures reflect Lehman Brothers utility coverage scaled up by a factor of 1.11x to reflect companies not in the Lehman Brothers coverage universe Source: FactSet and Lehman Brothers estimates 10

Rate Cases on the Rise

Execution and Inflation Risks

Execution Risk Delays in completing the project Cost overruns Other delays (licensing, environmental opposition, etc.) Risk – Management/Shareholders

Construction material costs have soared in recent years. Labor also on the rise Inflation clauses required by builders Risk – Ratepayers, Management/Shareholders Cost Inflation Risk

Raw Materials Price Indexes

Risks by Business Activity

Transmission - Risk Largely regulated, less financing risk Political (siting) challenges Communities, landowners, environmentalists Enormous long-term planning Generation Planning risk – when will transmission be in place? Risk – Management/Shareholders

Generation - Risk General Risks Project management, fuel choice Regulated Cost Risk - Management/Shareholders Ratepayers Overruns (retroactive disallowance) – Mgmt/SH Merchant Risk – Management/Shareholders

31 Margins Projected to Fall Below Minimum Target Levels TRE (ERCOT) 2009/2016+ New England 2009/2009 RFC (MISO)* 2008/2008 AZ/NM/SNV 2009/2011 California 2009/2012 Rocky Mtn 2008/2011 SPP 2015/2016+ MRO 2009/2009 (US) New York 2011/2016+ RFC (PJM) 2012/2014 *Excludes MISO resources outside the RFC boundary Source: NERC 2007 Long Term Reliability Assessment

Coal-Fired Generation - Risk Most companies delaying construction starts Proposed capacity fell 11% from Feb to Aug ’08 Large capital outlays, long build time Carbon regulation How expensive will coal generation be? What model used?......Price of CO2 allowances? Environmental opposition

Natural Gas-Fired Generation – Risk Lower capital costs - less financing risk Shorter construction time - less project management risk. “Bridge” fuel pending nuclear and clean coal Proposed capacity rose 20% from Feb to Aug ’08 Least risky for continuous power

Nuclear Generation - Risk Financing risk is largest risk Capturing financing cost in rates is key Considerable project management risks No nuclear built in decades Majority of in-service dates targeting Proposed capacity rose 70% from Feb to Aug ’08 Fuel disposal? Risk – Management/Shareholders Ratepayers (built in rate base)

Renewables - Risk Financing risks are less Government incentives ….but higher KW hour costs than fossil fuels Intermittent, RPS driven Low political risk Political and cultural popularity “Transmission access” risk associated with prime wind and solar areas Proposed Wind capacity +69% from Feb to Aug ’08 Majority of proposed build by IPPs and foreign utils.

EEI’s Outreach Activities

Opinion Leader Outreach “Get Energy Smart – Get Energy Active” Internet campaign to help educate consumers about the key issues facing the electric power industry today 1.8 million visits to Web site since launch Keeping the Lights On—Our National Challenge: Conference in New York focused on industry’s infrastructure needs and the role of energy efficiency

State Capital Road Shows 38 April 16-17, 2008  Fargo and Bismarck, ND October 22, 2007  Santa Fe, NM March 17-18, 2008  Topeka, KS June 11, 2008  Albany, NY May 13-14, 2008  Sioux Falls-Rapid City, SD

Wall Street Outreach EEI’s State-of-the-Industry address to Wall Street EEI Leadership Wall Street Visit Wall Street-Regulator Dialogues Nearly 20 dialogues to date Wall Street-Utility Leadership Forums 2 forums on climate issues Pre-NARUC Convention Discussion of Market Conditions (November ‘08) Energy Policy Leadership Forum (Dec. '08)

EEI Financial Publications

Contact Information Mark Agnew Manager, Financial Analysis Edison Electric Institute (202)