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Duke Energy Ohio "Leaning" Towards Market Rate Offer

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October 29, 2010

Duke Energy is "leaning" towards filing for a Market Rate Offer (MRO) to govern the provision and pricing of Standard Service Offer supplies for non-shopping customers in the Duke Energy Ohio territory beyond 2011, CEO James Rogers said during an earnings call. Rogers said that an ultimate decision and filing with PUCO is expected in mid-November.

Because Duke Energy Ohio owns ratebased generation, any MRO would require at least a five-year transition period to full market rates, under which rates from the current electric security plan (ESP), subject to potential adjustment by PUCO, would be blended with market rates. Statute requires that no more than 10% of supply be bid competitively under market rates in the first year of the MRO, with the percent potentially increasing up to 10 percentage points each subsequent year in a five-year transition. The distribution company would have the ability to seek to bid out less than the capped amounts of market-priced load each year, and PUCO would set the final percentages.

"I think the way to put the stage is to say for the past nine years, the customers have benefited from a five-year rate freeze and a negotiated rate that was below the market price for four years," Rogers said. "It worked for both customers and investors during that period. Today, the situation is very different. Prices have dropped dramatically in PJM, and we've experienced significant switching, to the benefit of consumers, but not investors. At the heart of the problem, in my judgment, is that customers have a free option. Said another way, they have the ability to get the lower of market price or a negotiated rate. And the commission has been unwilling to permit a nonbypassable charge for standing ready to serve our customers when they return. As you know so well, in truly competitive markets, there are no free options. Consequently, the way I view the situation in Ohio, we are neither regulated or allowed to completely to market today. So we are taking a very close look at the MRO, because that is a way to transition to market. It seems to be emerging in our analysis as the appropriate way forward, with respect to getting the appropriate returns for investors and continuing to provide to our customers reliable and affordable service. The way I would say it is, is that we're continuing to think our way through this. We're continuing to examine the pluses and minuses of the ESP approach that's been so beneficial to customers and investors in the past. And we're continuing to drill down on all of the implications of the MRO. As you know, FirstEnergy's MRO request was rejected several years ago, and we've looked closely at the basis for its rejection. And if we go that route, we will make sure that we address the issues that were raised by the commission there. So on balance, we believe that we have to make a very difficult decision between now and mid-November. But if you had to say, well, where are you leaning? I would say we're leaning toward the MRO at this point, but that's not a final decision. We have more work to do," Rogers said.

"The MRO’s feature, which is in my judgment could be a positive, is the way you're permitted to blend your existing generation with purchases in the market to come up with a negotiated price for your customers. So the amount of the blend from your existing generation or from the market is something that would be negotiated as you go down the MRO path," Rogers added.

CFO Lynn Good added that the blending, "does give you an opportunity to keep the prices at a higher level than what a strict reduction to market would result."

Rogers also said that even with the MRO, there will be a commitment of Duke Energy Ohio capacity to retail load. "So the issue of hedging out the capacity is not an issue that's in front of us in the short or medium term. I think that's a longer-term consideration," Rogers said.

"In the near term, the ESP regulatory framework under which we operate today in Ohio, creates more downside risk than potential for upside in today's markets. This framework makes it difficult for us to earn consistent and appropriate risk-adjusted returns for investment," Rogers said.

Duke's Commercial Power unit recorded lower adjusted EBIT of $155 million for the quarter, down from $182 million a year ago. The impact of customer migration in Ohio, net of customers retained by Duke Energy Retail Sales, negatively impacted Commercial Power earnings by $41 million. Reported EBIT for Commercial Power was $188 million versus a loss of $234 million a year ago. Prior-year reported results were impacted by non-cash impairment charges of $413 million primarily related to goodwill associated with non-regulated generation operations.

Gross customer switching at Duke Energy Ohio is 64%, but the net impact of switching, net of customers retained by Duke Energy Retail Sales, is only 26%. In other words, Duke is serving through its combined subsidiaries about 74% of retail load in the Duke Energy Ohio territory, versus 77% as of the end of the second quarter.

Duke Energy Retail Sales acquired approximately 60% of migrated load, or 38% of total load. Non-affiliated suppliers serve 26% of total load.

"The competitive environment in Ohio continues to be challenging, but we are extremely pleased with the efforts of our competitive retail arm, Duke Energy Retail, in defending and capturing margins," Good said.

Good also said that, "switching pressures in Ohio have stabilized."

Duke reiterated its prior forecast of an annual negative impact from migration of $52-92 million, though it said that the impact will likely be in the upper end of that range. For 2011, Duke is still forecasting an additional $66 million incremental negative impact from migration on top of the 2010 impact.

Good said that Duke Energy Retail Sales remains concentrated on the Ohio market, both in its affiliated service area and other service areas. Any offerings outside of Ohio are still expected to be limited to serving Ohio customers' accounts in other states, as previously reported. As only noted in Matters, Duke Energy Retail Sales has a pending supplier application in Pennsylvania (9/17).

"[S]trategically, we're not trying to build a national footprint or even a super-regional footprint on retail," Good said.

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