Table of Contents

1. Large Capital Projects: What are the Risks and Who Should Bear Them? Mark Agnew, Edison Electric InstituteNARUC Accounting/Finance MeetingLexington, KY October 13, 2008

2. 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

3. 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

4. Soaring Capital Expenditures

5. Increasing Electricity Demand

6. Industry Capex Continues to Rise

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

8. 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 2010-2030 ~ $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.

9. 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

10. About 2/3 of Industry is State Regulated

11. Demand Risk

12. 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 2010-2030, 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

13. Financing and Credit Risks

14. 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

15. 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 2007-08. • Risk – Management/Shareholders

16. Industry Leverage Beginning to Rise

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

18. Average Credit Rating Has Declined

19. Regulatory Risk

20. 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.

21. Regulatory Lag is Returning Note: Figures reflect Lehman Brothers utility coverage scaled up by a factor of 1.11x to reflect companies not in the Lehman Brothers coverage universeSource: FactSet and Lehman Brothers estimates 10

22. Rate Cases on the Rise

24. Execution and Inflation Risks

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

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

27. Raw Materials Price Indexes

28. Risks by Business Activity

29. 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

30. 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 RFC (MISO)* 2008/2008 MRO 2009/2009(US) RFC (PJM) 2012/2014 NewYork 2011/2016+ Rocky Mtn 2008/2011 New England 2009/2009 California 2009/2012 AZ/NM/SNV 2009/2011 SPP 2015/2016+ *Excludes MISO resources outside the RFC boundary TRE (ERCOT) 2009/2016+ Source: NERC 2007 Long Term Reliability Assessment 31

32. 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

33. 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

34. 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 2015-2020 • Proposed capacity rose 70% from Feb to Aug ’08 • Fuel disposal? • Risk – Management/Shareholders Ratepayers (built in rate base)

35. 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.

36. EEI’s Outreach Activities

37. 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

38. State Capital Road Shows 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 April 16-17, 2008  Fargo and Bismarck, ND

39. 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)

40. EEI Financial Publications

41. Contact Information Mark Agnew Manager, Financial Analysis Edison Electric Institute (202)508-5049 magnew@eei.org