Q4 2008
Cash Flow Statement
HIGHLIGHTS industry’s free cash flow deficit increased to $37.4 billion in 2008 from $28.4 billion in 2007, driven down by an $11.5 billion or 36% drop in net income and a $10.1 billion or 36% jump in capital expenditures. ■mSeventy-two percent of shareholder-owned electric utilities increased capital spending in 2008 relative to 2007. OGE Energy (+112%), Great Plains Energy (+100%) and FirstEnergy (+77%) showed the largest percentage gains. In dollar terms, the industry’s year-toyear gains were led by Duke Energy (+$1.3 billion), FirstEnergy (+$1.3 billion) and PG&E (+$859 million). ■mMany companies made downward revisions to 2009 capex projections in late 2008 due to the financial crisis. About two-thirds of companies reduced their 2009 projection, with downward revisions ranging as high as 40%. The consolidated impact for 2009 is expected to be about a 10-15% decline from the $84.3 billion estimate published in EEI’s Spring 2008 capex survey.
■mThe
$ Billions
I. Free Cash Flow
U.S. Shareholder-Owned Electric Utilities
$ Billions 2002 Net Cash Provided by Operating Activities — Capital Expenditures — Dividends Paid to Common Shares Free Cash Flow 56.3 (49.0) (13.4) (6.0) 2003 57.0 (43.0) (12.3) 1.7 2004 58.1 (41.1) (13.2) 3.8 2005 2006 50.2 (48.4) (15.1) (13.2) 69.2 (59.9) (16.2) (6.6) 2007r 61.1 (74.1) (15.4) (28.4) 2008 63.3 (84.2) (16.5) (37.4)
Source: SNL Financial and EEI Finance Department / r = revised
II. Capital Spending — Trailing 12 months COMMENTARY
Net Cash Provided by Operating Activities
$ Billions
U.S. Shareholder-Owned Electric Utilities
“Net Cash Provided by Operating Activities” increased by $2.2 billion, or 3.7%, to $63.3 billion in 2008 from $61.1 billion in 2007. The measure increased for 55% of shareholderowned electric utilities. Prior to an increase in Q4 2008, it had fallen in six of the seven previous quarters. As shown in Table IV, the key drivers of the decline were a $7.1 billion increase in “Deferred Taxes and Investment Credits” and a positive $6.3 billion net change in “Other Operating Changes in Cash.” These offset an $11.5
1
Source: SNL Financial and EEI Finance Department
EEI Q4 2008 Financial Update
2
CASH FLOW STATEMENT
III. Net Change in Long-Term Debt
$ Billions
IV. Consolidated Cash Flow Statement
U.S. Shareholder-Owned Electric Utilities ($Millions) FY 2008 Cash Flows from Operating Activities: Net Income $ 20,754 Depreciation and Amortization 37,875 Deferred Taxes and Investment Credits 9,354 Operating Changes in AFUDC (730) Change in Working Capital (6,970) 3,017 Other Operating Changes in Cash Net Cash Provided by Operating Activities 63,300 Cash Flows from Investing Activities: Capital Expenditures (84,151) Asset Sales 25,140 (23,046) Asset Purchases Net Non-Operating Asset Sales and Purchases 2,094 Change in Nuclear Decommissioning Trust (802) Investing Changes in AFUDC 170 (733) Other Investing Changes in Cash Net Cash Used in Investing Activities (83,422) FY 2007r % Change $ 32,211 36,619 2,301 (466) (6,343) (3,261) 61,061 -35.6% 3.4 306.5 56.9 9.9 NM 3.7
U.S. Shareholder-Owned Electric Utilities
Source: SNL Financial and EEI Finance Department Note: Figures taken from Consolidated Balance Sheet
(74,064) 80,552 (88,120) (7,568) (289) 144 (2,279) (84,056)
13.6% -68.8% -73.8% NM 177.2 17.8 -67.8 -0.8
billion drop in “Net Income.” A big contributor to the drop in net income was Energy Future Holdings (EFH), whose earnings fell by $9.2 billion due to an $8.9 billion charge for impairment of goodwill from its buyout of TXU in October 2007. TXU was renamed EFH after it was taken private by investors led by Kohlberg Kravis Roberts and the Texas Pacific Group. The charge represents a best estimate of impairment pending finalization of fair value calculations, expected in early 2009. The total consists of an $8.0 billion impairment related to the Competitive Electric segment and $860 million related to the Regulated Delivery segment. The impairments were caused by the turmoil in the capital markets that erupted in late 2008, which drove credit spreads sharply wider along with the resulting discount rates used in estimating fair values, and the effect of related declines in the market value of debt and equity securities of comparable companies.
Cash Flows from Investing Activities
Cash Flows from Financing Activities: Net Change in Short-term Debt 8,678 Net Change in Long-term Debt 33,601 Proceeds from Issuance of Preferred Equity (323) Preferred Share Repurchases Net Change in Preferred Issues (323) Proceeds from Issuance of Common Equity 4,225 (2,384) Common Share Repurchases Net Change in Common Issues 1,841 Dividends Paid to Common Shareholders (16,511) Dividends Paid to Preferred Shareholders (80) (769) Other Dividends Dividends Paid to Shareholders (17,360) (383) Other Financing Changes in Cash Net Cash (Used in) Provided by Financing Activities Other Changes in Cash Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period Net increase (decrease) in cash and cash equivalents 26,054 (9) 10,295 16,218 5,923
2,633 (9,677) 490 (313) 177 4,813 (11,922) (7,110) (15,367) (86) (1,556) (17,009) 52,262 21,278 709 18,572 17,563 (1,009)
229.6 NM NM 3.3 NM -12.2 -80.0 NM 7.4 -7.6 -50.5 2.1 NM 22.4 NM -44.6 -7.7 NM
“Net Cash Used in Investing Activities” decreased 0.8%, falling from $84.1 billion in 2007 to $83.4 billion in 2008. The increase was due to a $9.7 billion increase in “Net NonOperating Asset Sales and Purchases” and a $1.5 billion decline in “Other Investing Changes in Cash”. These were offset by a $10.1 billion, or 13.6%, increase in “Capital Expenditures.” A substantial decrease in cash used for asset purchases can be traced to Energy Future Holdings, whose $32.7 billion decline related to its TXU acquisition in 2007. Duke Energy had a $16.0 billion decrease in asset purchases and a $17.2 billion decrease in asset sales, mostly relating to the purchase and sale of available-for-sale securities and the fair value accounting treatment for these investments.
Source: SNL Financial and EEI Finance Department / r= revised
Rising Capex
Seventy-two percent of shareholder-owned electric utilities increased capital spending in 2008 relative to 2007. OGE Energy (+112%), Great Plains Energy (+100%) and FirstEnergy (+77%) showed the largest percentage gains. In dollar
EEI Q4 2008 Financial Update
CASH FLOW STATEMENT
3
terms, the industry’s year-to-year gains were led by Duke Energy (+$1.3 billion), FirstEnergy (+$1.3 billion) and PG&E (+$859 million). Industry-wide capex began to rise in 2005, which showed the first significant full-year increase since the industry’s competitive generation build-out peaked in 2001 ($56.8 billion was spent on capex in 2001). The recent steady increase in capex is depicted in Table II. The $84.2 billion spent in 2008 is more than double the $40.2 billion spent during the 12-month period ending September 30, 2004, which marked the cyclical low following the competitive generation build-out. Companies have boosted spending in recent years on environmental compliance, transmission and distribution upgrades, and generation projects in many power markets to ensure adequate reserve margins over the long term. In addition to companies’ strategic decisions to boost capital spending, capex has also been impacted by construction material cost inflation.
Capex and the Financial Crisis
■ ■ ■
The downward revisions in 2009, which will also likely apply to 2010, are mostly postponements rather than cancellations. Revisions largely impacted growth-oriented not maintenance capex. Generation was most affected by the cuts, however transmission, distribution and environmental capex all received cuts/deferrals by at least some companies. Moreover, there was no general pattern of cuts across the industry, as each company made choices unique to its business strategy.
EEI’s 2008 study of industry capital spending (based on 2007 10K data, company presentations and discussions with companies) projected that: ■ Industry capex would reach approximately $86.5 billion in 2008, $84.3 billion in 2009 and $84.1 billion in 2010. Moreover, the 2008 and 2009 projections were revised sharply upward (+16% for 2008 and +11% for 2009) from the prior year’s study, which was completed in late spring 2007. All components of capex rose in dollar terms from 2007 to 2008. 2008’s total capital spending was allocated as follows: Generation, 36%; Distribution, 24%; Environmental, 14%; Transmission, 12%; Natural Gas-related, 9%, Other, 5%.
Although the cuts are significant, total capex remains very high by historical standards. Since it’s not possible to know when economic conditions will improve, the industry must balance prudent cost control with preparation for inevitable future demand growth when the economy recovers in an environment of already-low generation reserve margins, needed transmission development and an aging distribution system. A 2008 study by the Brattle Group projected that capital spending by the entire power industry (including public power and IPPs) could total $1.5 trillion from 2010-2030, and that’s without incorporating the effects of likely climate legislation.
Construction Cost Inflation
■ ■
However, many companies made downward revisions to their 2009 capex projections subsequent to the third quarter of 2008 due to the credit crisis and economic recession. About two-thirds of companies reduced their 2009 projection, with downward revisions ranging as high as 40%. The aggregate industry impact for 2009 is expected to be about a 10-15% decline from the projection shown above. The reduced availability and higher cost of capital along with reduced expectations for power demand growth given the weak economy drove these revisions. A closer look at the capex revisions made in late 2008 revealed the following:
It is hard to predict how the decline in global prices for many commodities in late 2008 will impact construction material costs and impact capex strategies. Construction costs, which had risen steadily in recent years, began a sharp decline in the second half of 2008. According to the latest Handy-Whitman Index of Public Utility Construction Costs, such costs increased by an average of 7.4% per year from 2000 through 2007 (a total of 59%) for transmission and 8.9% per year (a total of 71%) for distribution. The rise in announced deferrals/cancellations of planned new generation during the fourth quarter of 2008 may counterbalance rising spending in other areas. In total however, 2008 plant cancellations were relatively low at 4,956 MW (mostly coal and natural gas), well below the 16,577 MW of cancellations in 2007. Almost 61% more generation capacity was cancelled in 2007 than in 2006, with the majority (84%) being coalpowered. Cancellation totals over the last three calendar years are well below the levels of 2003 (27,110 MW) and 2005 (20,209 MW), which mostly consisted of natural gasfired generation.
Cash Flows from Financing Activities
“Net Cash Provided by Financing Activities” increased by $4.8 billion, or 22.4%, from $21.3 billion in 2007 to $26.1 billion in 2008. The increase was due to significantly higher debt levels, with net swings of $43.3 billion for long-term
EEI Q4 2008 Financial Update
CASH FLOW STATEMENT
debt and $6.0 billion for short-term debt, as well as a significant decline in common share repurchases. These were offset by a $52.6 billion negative net change in other financing changes in cash. The industry’s total short-term debt continued to rise in 2008, as it has in each year since 2004. This line item climbed $6.0 billion, or 230%, from a $2.6 billion rise in 2007 to a $8.7 billion rise in 2008, with 58% of companies showing a larger increase in short-term debt this year than last. The industry also saw accelerating growth in long-term debt ― adding a net change of $43.3 billion, from a negative $9.7 billion in 2007 to a positive $33.6 billion in 2008. Given the industry’s elevated capital spending, it is not surprising that long-term debt is also on the rise after the sizeable debt pay-downs from 2003 through mid-2006. Total long-term debt fell from $349.7 billion at the end of 2003 to $322.8 billion at June 30, 2006, and has since risen to $384.4 billion at December 31, 2008 (including securitized debt). Even though the back-to-basics story of “selling non-core assets and using the proceeds to pay down debt” is still in play for a handful of companies, most that needed to repair their balance sheet through debt reduction have done so. However, in a trend that developed in 2007 and continued
throughout 2008, more downgrades and credit watch situations (outlooks and watches) have involved the subject company’s ability to finance and manage the projected rise in capital expenditures. “Common Share Repurchases” decreased from $11.9 billion in 2007 to $2.4 billion in 2008, a $9.5 billion or 80.0% drop. Conversely, “Proceeds from the Issuance of Common Equity” fell by $588 million or 12.2%. Common equity issuance was steady throughout much of 2008, rising from $599 million in Q1 to $1.2 billion in Q2, $1.3 billion in Q3 and $1.2 billion in Q4 as companies sought the right balance to fund elevated capex. These decisions occurred against the backdrop of a rise in the cost of capital during 2008, as debt markets became much more expensive during the second half of the year and stock prices tumbled throughout the year (the EEI Index declined 25.9%). Common equity issuance fell by $5.2 billion, or 51.9%, in 2007 after surging the previous five years, from $5.0 billion and $5.6 billion in 2000 and 2001, respectively, to $13.1 billion in 2002 and averaging about $10 billion annually from 2003 through 2006. The industry’s strong stock performance over the period, in addition to a widespread desire to strengthen debt-tocapitalization ratios, drove the higher stock issuance. ■
EEI Q4 2008 Financial Update