Duke Energy earnings heat up; regulatory momentum cools

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Friday, August 6, 2010

With energy bills stuck in Congress, utility prepares for coming EPA regulation

Charlotte Business Journal - by John Downey Senior staff writer

Duke Energy Corp. reported better than expected earnings for the second quarter and has outperformed utility stock indexes since the start of 2009. But in the long term, this may prove the summer of Duke’s discontent.

Federal carbon regulation, which Chief Executive Jim Rogers pushed and on which Duke spent hundreds of thousands in lobbying costs, is dead. Come Jan. 2, the Environmental Protection Agency will impose limits on carbon, and Rogers acknowledges that will be more costly — to Duke and its customers — than the legislation he and Duke supported.

Duke and the industry as a whole have started running into resistance to smart-grid proposals. That digital upgrade to transmission and distribution systems holds considerable promise for energy efficiency and ultimately cutting customer use in a time of rising prices. But the costs of the conversion are giving some regulators pause.

Duke’s basic strategy for producing energy from renewable resources is being called into question in the Carolinas. And Duke continues to skirmish with regulators over treatment of payments under its Save-A-Watt initiative.

Rogers repeatedly says the power industry needs to know what the ground rules will be as it spends billions in the next 10 to 20 years to replace its aging coal plants, undertake nuclear construction, adopt renewable-energy sources and implement smart grid and other efficiency programs.

“We haven’t gotten clarity from the regulators. I don’t think we’ve got clarity from Congress,” he says. “But on some level that is predictable and it should be expected.”

Rogers describes himself as an optimist. The summer of 2010, at least, gives him a lot to be optimistic about.
Adjusted earnings of 34 cents per share reported this week for the second quarter beat analyst expectations by eight cents. While hot summer temperatures across the Southeast and Midwest played a role in that, Chief Financial Officer Lynn Good says it was led by a double-digit increase in industrial demand.

Industrial use is not yet back to pre-recession levels, she says. But when demand first jumped in the first quarter, Duke executives wondered whether that was a blip or the start of the trend. Duke’s industrial customers now say those demand levels are sustainable through 2010, Good says.

And Duke’s stock is performing well. Since January 2009, Duke’s stock has risen 20.6% to close at $17.37 a share at the beginning of this week. The Dow Jones Utility Index, by comparison, rose 4% over that period.

And last month, Duke Energy Indiana borrowed $500 million in the bond market at an unheard of rate of 3.75% for 10 years. “That’s the lowest coupon for utility companies since they started keeping records in 1962,” Rogers says.

So things are good now. But it’s hard to prepare for a future in which Rogers expects rising energy costs and constraints on carbon when rules and regulations have not caught up to the new realities.

While much of the power industry has resisted carbon regulation, Duke joined with other industrial giants and some major environmental groups to shape it. Duke wanted to minimize the impact on coal-dependent regions and utilities — and ultimately utility customers — while setting the rules replacing the existing fleet.
“We were successful beyond expectations with the Waxman-Markey bill (in the House) last year, and we were making progress with the Kerry-Lieberman bill in the Senate,” Rogers says. “We didn’t succeed (and) the failure to get across the goal line is bad news for our customers.”

That deal essentially fell apart in late April. Sen. Lindsay Graham was working on a bill with Sens. John Kerry and Joe Lieberman. But when Senate leaders announced they would push forward on immigration legislation, Graham objected and withdrew his support on energy. The bill never regained traction.

Duke won a big victory on smart grid this year by getting a $200 million federal grant to support a $900 million plan to install the system in Ohio and Indiana. Ohio regulators agreed. Indiana balked. Duke then scaled down its Indiana plan to a $22 million pilot program to install the technology for 40,000 customers.
Duke has yet to approach Carolinas regulators, who have often been less receptive than those in the Midwest on smart grid. “I view this part of the assignment as not a failure,” Rogers says. “I view it as a work in progress.”

Duke has also failed to get rulings in North Carolina that it wanted to clarify the treatment of payments for investing in efficiency under Save-A-Watt. And an issue before N.C. regulators threatens Duke’s plans to rely on wood as a biomass fuel to meet state requirements for renewable energy.

Rogers says he is not discouraged. “We’re meeting predictable, I believe, resistance to changing the model for our business and for our industry,” he says. “If people don’t understand what I’m trying to achieve, I’m failing in my explanation of it. I have more work to do.”

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