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Home My WebLink Aboutkeybanc-Aug-31-2012.pdf.pdfI Energy Industry Research Electric Utilities Quarterly 2Q12 2Q12 Earnings Mostly Driven by Warm Spring and Hot June Weather Near Term, We Believe the Sector Provides Regulated Rate Base Growth and Stable Dividends, but Is Trading at a Historically High Valuation Long Term, We Believe the Sector Is Positioned for Stable Earnings Growth with Economic Recovery August 31, 2012 Paul T. Ridzon (216) 689-0270 pridzon@keybanccm.com Timothy Yee (216) 689-0385 tyee@keybanccm.com For important disclosures and certifications, please refer to page 65 of this document. KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 2 of 65 August 2012 Contents 2Q12 RESULTS — BY THE NUMBERS...........................................................................................................................................................................3 Earnings Comparison............................................................................................................................................................................4 Earnings Surprises ................................................................................................................................................................................4 Earnings Adjustments............................................................................................................................................................................4 Stock Price Performance.......................................................................................................................................................................5 Weather.................................................................................................................................................................................................6 2Q12 RATINGS, PRICE TARGET, AND RESEARCH COVERAGE CHANGES...............................................................................................................7 SECTOR OUTLOOK.........................................................................................................................................................................................................7 Historical Valuations Remain Inconclusive ..........................................................................................................................................11 GROUP INVESTMENT THESIS......................................................................................................................................................................................12 INDUSTRY THEMES ......................................................................................................................................................................................................13 Retreating Commodity Prices and Available Capacity Heat Up Competition.......................................................................................13 Heightened Importance of Regulatory Success...................................................................................................................................14 Comprehensive Energy Reform at an Impasse; EPA Emissions Rules Move Forward.......................................................................14 State Renewable Portfolio Standards..................................................................................................................................................15 Stock Performance Divergence Based on Commodity Exposure........................................................................................................17 Japan Nuclear Crisis Highlights Risks to Nuclear Power Industry.......................................................................................................18 New Generation / Transmission Build to Meet Load Growth ...............................................................................................................19 Cost Escalation in New Generation Build............................................................................................................................................19 Fifteen Percent Dividend Tax Rate Extension .....................................................................................................................................20 M&A ACTIVITY ON THE RISE .......................................................................................................................................................................................21 Possible Acquirees..............................................................................................................................................................................21 Possible Acquirers...............................................................................................................................................................................21 Recent M&A Activity Update................................................................................................................................................................21 SHORT INTEREST OVERVIEW .....................................................................................................................................................................................23 NEXTERA ENERGY, INC. (HOLD).................................................................................................................................................................................25 NEE – Quick Alert: Settles with Customer Groups in Florida Rate Case - reprinted from 08/16/2012 .....................................................................25 NORTHWESTERN CORPORATION ..............................................................................................................................................................................26 NWE: Recent Underperformance Unwarranted; Upgrading Shares - reprinted from 08/15/2012.............................................................................26 GREAT PLAINS ENERGY, INC......................................................................................................................................................................................28 GXP: Hot Weather Drives 2Q12; Raising 2012 Estimate - reprinted from 08/09/2012 ...............................................................................................28 AMERICAN ELECTRIC POWER COMPANY, INC. (BUY) .............................................................................................................................................30 AEP - Quick Alert: Ohio Regulators Approve AEP’s Modified ESP; Appears Balanced and Fair - reprinted from 08/08/2012 ..............................30 PEPCO HOLDINGS, INC................................................................................................................................................................................................31 POM: 2Q12 Below Views; Lowering 2012 Estimate - reprinted from 08/08/2012.......................................................................................................31 AVISTA CORPORATION................................................................................................................................................................................................33 AVA: Weather and Economy Weigh on EPS; Lowering Estimates - reprinted from 08/08/2012...............................................................................33 FIRSTENERGY CORP....................................................................................................................................................................................................35 FE: Lack of Clarity Drives Lack of Confidence - reprinted from 08/07/2012..............................................................................................................35 IDACORP, INC................................................................................................................................................................................................................37 IDA: Raising 2012 Estimate and Price Target - reprinted from 08/06/2012 ................................................................................................................37 DTE ENERGY COMPANY..............................................................................................................................................................................................39 DTE: 2Q12 Hot Weather Drives Beat; Raising 2012 Estimate - reprinted from 07/30/2012 .......................................................................................39 SOUTHERN COMPANY .................................................................................................................................................................................................41 SO: Adjusting 2012 Estimate Due to Weather - reprinted from 07/26/2012................................................................................................................41 ELECTRIC UTILITIES INDUSTRY:.................................................................................................................................................................................44 2Q12 Earnings Preview - reprinted from 07/20/2012 ...................................................................................................................................................44 NISOURCE, INC. (BUY)..................................................................................................................................................................................................50 NI – Quick Alert: Utica JV Announced, Awaiting Details - reprinted from 07/09/2012...............................................................................................50 IDACORP, INC. (BUY)....................................................................................................................................................................................................51 IDA – Quick Alert: Final Order on Langley Gulch Constructive - reprinted from 06/29/2012....................................................................................51 NV ENERGY, INC...........................................................................................................................................................................................................52 NVE: Initiating with a HOLD Rating - reprinted from 06/28/2012 ................................................................................................................................52 CMS ENERGY CORPORATION.....................................................................................................................................................................................56 CMS: Updating Price Target After Group Multiple Expansion - reprinted from 06/18/2012......................................................................................56 IDACORP, INC................................................................................................................................................................................................................57 IDA: Notes from Investor Meetings; Story Remains Intact - reprinted from 06/13/2012............................................................................................57 EXELON CORPORATION..............................................................................................................................................................................................59 EXC: Analyst Meeting Takeaways, Revising Estimates - reprinted from 06/11/2012................................................................................................59 DUKE ENERGY CORPORATION (HOLD) .....................................................................................................................................................................61 DUK – Quick Alert: FERC Merger Approval with Minor Conditions - reprinted from 06/11/2012..............................................................................61 APPENDIX......................................................................................................................................................................................................................62 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 3 of 65 August 2012 Electric Utilities Quarterly 2Q12 INDUSTRY UPDATE Paul T. Ridzon: (216) 689-0270 — pridzon@keybanccm.com Timothy Yee: (216) 689-0385 — tyee@keybanccm.com 2Q12 RESULTS — BY THE NUMBERS Table 1. Earnings Comparison Company Ticker 2Q12E 2Q12A 2Q11A 2Q Change 2012E 2013E Ameren Corp. AEE $0.67 $0.73 $0.59 23.7% $2.40 $1.95 American Electric Power, Inc. AEP $0.76 $0.77 $0.73 5.5% $3.05 $3.10 Avista Corp. AVA $0.44 $0.31 $0.39 (20.5)% $1.65 $1.80 CMS Energy, Inc. CMS $0.41 $0.40 $0.26 53.8% $1.55 $1.65 Cleco Corp. CNL $0.52 $0.64 $0.52 23.1% $2.40 $2.55 Consolidated Edison, Inc ED $0.61 $0.61 $0.57 7.0% $3.75 $3.85 DTE Energy Co. DTE $0.68 $0.86 $0.65 32.3% $3.85 $4.00 Dominion Resources, Inc. D $0.59 $0.59 $0.59 N/M $3.20 $3.40 Duke Energy Corp. a DUK $0.95 $1.02 $0.99 3.0% $4.25 $4.50 Entergy Corp. ETR $2.10 $2.11 $1.76 19.9% $5.25 $5.30 Exelon Corp. EXC $0.67 $0.61 $1.05 (41.9)% $2.85 $2.80 FirstEnergy Corp. b FE $0.62 $0.60 $0.70 (14.3)% $3.40 $3.25 Great Plains Energy, Inc. c GXP $0.35 $0.41 $0.31 32.3% $1.30 $1.60 IDACORP, Inc. IDA $0.54 $0.71 $0.42 69.0% $3.25 $3.20 MDU Resources Group, Inc. MDU $0.19 $0.19 $0.24 (20.8)% $1.20 $1.40 NV Energy, Inc. NVE $0.17 $0.29 $0.05 480.0% $1.20 $1.25 NextEra Energy, Inc. NEE $1.20 $1.26 $1.18 6.8% $4.50 $4.95 NiSource, Inc. NI $0.22 $0.24 $0.17 41.2% $1.45 $1.55 Northwestern Corp. NWE $0.27 $0.31 $0.30 3.3% $2.45 $2.55 Otter Tail Corp. d OTTR $0.22 $0.22 $0.16 37.5% $1.20 $1.25 PPL Corp. PPL $0.38 $0.51 $0.45 13.3% $2.35 $2.35 Pepco Holdings, Inc. POM $0.29 $0.25 $0.42 (40.5)% $1.15 $1.25 Pinnacle West Capital Corp. PNW $1.03 $1.12 $0.78 43.6% $3.40 $3.55 Southern Company SO $0.68 $0.69 $0.71 (2.8)% $2.65 $2.80 TECO Energy, Inc. TE $0.36 $0.34 $0.36 (5.6)% $1.30 $1.35 Wisconsin Energy Corp. WEC $0.44 $0.51 $0.41 24.4% $2.30 $2.40 Xcel Energy Inc. XEL $0.35 $0.38 $0.33 15.2% $1.75 $1.85 Average 10.5% a) DUK results on a stand-alone basis and do not include merged Progress Energy’s results. b) FE 2Q11A of $0.65 as originally reported was revised to adopt changes in pension/OPEB accounting methodology and a purchase accounting measurement adjustment. c) GXP earnings and estimates reported as GAAP net income. d) OTTR 2Q12A excludes DMI Industries, Inc. (DMI; wind energy segment) due to its pending sale by year-end 2012. Excluding only DMI asset impairment charge, 2Q12A from continuing operations (non-GAAP) would be $0.28 per share. Source: KeyBanc Capital Markets Inc. and Company reports KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 4 of 65 August 2012 EARNINGS COMPARISON Overall, companies within our electric utilities coverage universe mostly reported higher 2Q12 quarterly results, primarily driven by warm June weather. As indicated in Table 1, aggregate 2Q12 earnings for stocks in the KeyBanc Capital Markets Inc. Electric Utility Index were up 10.5% on average, compared to the same quarter a year ago. Based on our quarterly estimates, we had initially anticipated an average quarterly earnings increase of 4.1%, so 2Q12 results were above our expectations. EARNINGS SURPRISES On an individual company basis, there were two notable upside surprises and two notable downside surprises relative to our expectations for the quarter. On the upside, Cleco Corporation (CNL-NYSE; $0.64 vs. $0.52 in 2Q11; our estimate was $0.52, consensus was $0.56) beat our expectations as aggressive cost cutting lowering operating expenses and lower electric customer credits helped drive the upside surprise. PPL Corporation (PPL-NYSE; $0.51 vs. $0.45 in 2Q11; our estimate was $0.38, consensus was $0.41) also beat our expectations as the U.K. segment posted larger gains and the Supply segment saw an earnings reduction that was less than anticipated. On the downside, Avista Corporation (AVA-NYSE; $0.31 vs. $0.39 in 2Q11; our estimate was $0.44, consensus was $0.43) missed our earnings expectations as mild weather and continued economic weakness lowered gross margins and our estimate for improvement in its Energy Recovery Mechanism and O&M costs did not occur. At Pepco Holdings, Inc. (POM-NYSE; $0.25 vs. $0.42 in 2Q11; our estimate was $0.29, consensus was $0.31), higher O&M costs at the utilities mostly related to employee and customer support services costs drove earnings below our expectations. Additionally, we correctly called all three of our earnings surprises heading into the quarter in our 2Q12 earnings preview as Ameren Corporation (AEE-NYSE; $0.73 vs. $0.59 in 2Q11; our estimate was $0.67, consensus was $0.62) and CMS Energy Corporation (CMS-NYSE; $0.40 vs. $0.26 in 2Q11; our estimate was $0.41, consensus was $0.38) beat consensus views and FirstEnergy Corp. (FE-NYSE; $0.60 vs. $0.70 in 2Q11; our estimate was $0.62, consensus was $0.64) came in below consensus expectations. EARNINGS ADJUSTMENTS Heading into the 2Q12 earnings reporting season, we raised our 2012 estimates for Ameren Corporation (AEE-NYSE), Consolidated Edison (ED-NYSE) and Duke Energy Corporation (DUK-NYSE). Additionally, we raised our 2012 and 2013 estimates for Pinnacle West Capital Corporation (PNW-NYSE). We lowered our 2012 estimates for MDU Resources Group, Inc. (MDU-NYSE) and TECO Energy, Inc. We also lowered our 2013 earnings estimate for Otter Tail Corporation (OTTR-NASDAQ). For a summary on these estimate changes, please see page 44 for our July 20, 2012 published report titled “Electric Utilities Industry: 2Q12 Earnings Preview”. After digesting 2Q earnings reports, earnings conference calls and investor/analyst meetings, we raised our 2012 estimates for Great Plains Energy, Inc. (GXP-NSYE) to $1.30 from $1.25 per share, DTE Energy Company (DTE-NYSE) to $3.85 from $3.75 per share and IDACORP, Inc. (IDA-NYSE) to $3.25 from $3.10 per share, primarily due to strong 2Q results due to favorable weather. We lowered our 2012 estimate for Southern Company (SO-NYSE) to $2.65 from $2.70 per share due to unfavorable year-to-date weather impact and lowered our 2012 estimate for Pepco Holdings, Inc. (POM-NYSE) to $1.15 from $1.25 per share due to higher storm and operating expenses expected in 2H12. Lastly, for Avista Corporation (AVA-NYSE), we lowered our 2012 estimate to $1.65 from $1.75 per share for year-to-date weather, industrial customer outages and a sluggish economy, and also lowered our 2013 estimate to $1.80 from $1.85 per share for the slow economy. Please see pages 25-61 for our published reports on the above-mentioned estimate changes. Table 1 lists our current 2012 and 2013 earnings estimates for companies under coverage. KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 5 of 65 August 2012 STOCK PRICE PERFORMANCE As shown in Table 2, stock price performance during 2Q12 for current companies under coverage in the KeyBanc Capital Markets Inc. Electric Utility Index was positive, with the index showing a 9.9% price appreciation on average. Our coverage group’s performance was higher than the Philadelphia Utility Index (UTY), which was up 5.1% in 2Q12, outperforming the broader S&P 500 Index (SPX), which was down 3.3% for the quarter. 2012 year-to-date performance has recently seen the broader market (SPX) rally back to highs in the year up 12.8%, compared to a sector pullback to a 1.6% increase (UTY). We believe the recent strength in the broader market is attributable to increasing confidence in the likelihood of U.S. monetary policy easing and belief that Europe will resolve lingering sovereign debt concerns, despite signs of moderating growth in the United States. As such, we have seen investors risk appetite recently increase with sector rotation away from electric utilities. Table 2. Price Performance Price Price Price Price 2Q12 8/17/12 Company Ticker 12/30/11 3/30/12 6/30/12 8/17/12 Change YTD Change Ameren Corp. AEE 33.13 32.58 33.54 33.58 2.9% 1.4% American Electric Power, Inc. AEP 41.31 38.58 39.90 43.07 3.4% 4.3% Avista Corp. AVA 25.75 25.58 26.70 26.36 4.4% 2.4% CMS Energy, Inc. CMS 22.08 22.00 23.50 23.38 6.8% 5.9% Cleco Corp. CNL 38.10 39.65 41.83 42.46 5.5% 11.4% Consolidated Edison, Inc ED 62.03 58.42 62.19 61.68 6.5% (0.6)% DTE Energy Co. DTE 54.45 55.03 59.33 60.53 7.8% 11.2% Dominion Resources, Inc. D 53.08 51.21 54.00 53.92 5.4% 1.6% Duke Energy Corp. DUK 22.00 21.01 69.18 66.49 229.3% 202.2% Entergy Corp. ETR 73.05 67.20 67.89 69.48 1.0% (4.9)% Exelon Corp EXC 43.37 39.21 37.62 37.49 (4.1)% (13.6)% FirstEnergy Corp FE 44.30 45.59 49.19 45.87 7.9% 3.5% Great Plains Energy, Inc. GXP 21.78 20.27 21.41 21.71 5.6% (0.3)% IDACORP, Inc. IDA 42.41 41.12 42.08 42.57 2.3% 0.4% MDU Resources Group, Inc. MDU 21.46 22.39 21.61 22.54 (3.5)% 5.0% NV Energy, Inc. NVE 16.35 16.12 17.58 18.39 9.1% 12.5% NextEra Energy, Inc. NEE 60.88 61.08 68.81 69.60 12.7% 14.3% NiSource, Inc. NI 23.81 24.35 24.75 24.70 1.6% 3.7% Northwestern Corp. NWE 35.79 35.46 36.70 36.49 3.5% 2.0% Otter Tail Corp. OTTR 22.02 21.70 22.81 23.10 5.1% 4.9% PPL Corp. PPL 29.42 28.26 27.81 29.41 (1.6)% (0.0)% Pepco Holdings, Inc. POM 20.30 18.89 19.57 19.41 3.6% (4.4)% Pinnacle West Capital Corp. PNW 48.18 47.90 51.74 52.80 8.0% 9.6% Southern Company SO 46.29 44.93 46.30 46.08 3.0% (0.5)% TECO Energy, Inc. TE 19.14 17.55 18.06 17.88 2.9% (6.6)% Wisconsin Energy Corp. WEC 34.96 35.18 39.57 38.56 12.5% 10.3% Xcel Energy Inc. XEL 27.64 26.47 28.41 28.49 7.3% 3.1% KBCM Electric Utility Index Average 9.9% 7.4% Benchmarks: Philadelphia Utility Index UTY 481.45 469.09 493.01 489.19 5.1% 1.6% S&P 500 Index SPX 1257.60 1408.47 1362.16 1,418.16 (3.3)% 12.8% Note: Past results cannot and should not be viewed as indicators of future performance. Source: FactSet KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 6 of 65 August 2012 WEATHER According to the U.S. National Climatic Data Center, the contiguous (Lower-48) United States experienced its third warmest April and second warmest May on record. Temperatures in the second half of June contributed to record highs in many cities. Precipitation patterns were mixed across the country during the quarter, but about 56% of the nation was experiencing drought conditions. Given the record warm spring and early summer temperatures seen across the United States this quarter, we saw some meaningful 2Q12 weather earnings benefit when compared to 2Q11 weather degree days, primarily due to increased electric cooling load, helping to offset mild 1Q12 winter impacts earlier in the year and generally lower gas sales volumes due to the warm spring. Table 3 shows the impact of the weather temperatures (primarily on retail delivery) in the quarter compared to our predictions. Table 3. 2Q12 Weather Impact — Cooling Degree Days Company Ticker 2Q12 vs. Normal 2Q12 vs. 2Q11 Estimated Same Qtr YOY EPS Impact Actual Same Qtr YOY EPS Impact Ameren Corp. AEE 53.6 % 17.6 % $0.04 $0.03 American Electric Power, Inc. AEP 46.3 % 4.7 % $0.02 $0.00 CMS Energy Corp. CMS 80.5 % 117.8 % $0.05 $0.01 Cleco Corp. CNL 22.5 % (13.3) % ($0.03) ($0.02) DTE Energy Co. DTE 75.1% 38.0 % $0.05 $0.11 Dominion Resources, Inc. D 15.7 % (26.1) % ($0.04) ($0.06) Duke Energy, Inc. DUK 28.9 % (0.3) % $0.00 ($0.05) Entergy Corp. ETR 27.3 % (6.4) % n/e ($0.10) Exelon Corp. EXC 75.1 % 46.6 % $0.02 $0.00 Great Plains Energy GXP 60.5 % 29.3 % $0.03 $0.08 NV Energy, Inc. NVE 22.9 % 43.9 % n/e $0.11 Northwestern Corp.* NWE (15.3) % (28.8) % ($0.02) ($0.05) Pepco Holdings, Inc. POM 49.6 % (13.3) % ($0.01) $0.00 Pinnacle West Capital Corp. PNW 30.6 % 17.7 % $0.23 $0.23 Southern Company SO 27.1 % (9.7) % ($0.04) ($0.06) TECO Energy, Inc. TE 16.2 % (5.8) % ($0.01) ($0.03) Wisconsin Energy Corp. WEC 112.0 % 169.5 % $0.03 $0.06 Xcel Energy, Inc. XEL 74.7 % 70.7 % $0.03 $0.02 * Data is Heating Degree Days n/e – not estimated Source: National Oceanic and Atmospheric Administration (NOAA), Company data, KeyBanc Capital Markets Inc. estimates KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 7 of 65 August 2012 2Q12 RATINGS, PRICE TARGET AND RESEARCH COVERAGE CHANGES RATING CHANGES During 2Q12, we had no rating action changes for our coverage list. Since quarter end, we raised our rating on Northwestern Corporation (NWE-NYSE) to BUY from HOLD on August 16, 2012 (see page 26 for our published upgrade report titled “NWE: Recent Underperformance Unwarranted; Upgrading Shares”). Our current research for companies under coverage published since our previous Electric Utilities Quarterly through the date of this publication is provided on pages 25-61. PRICE TARGET CHANGES We regularly revisit and adjust our price targets on BUY-rated stocks given changes in peer group average P/E multiples and our business and economic outlook. Our current price targets on all of our BUY-rated stocks under coverage are outlined in Table 4. In conjunction with this issue, we are updating our price target for American Electric Power Company (AEP-NYSE) to $45.50 from $42.00 as recent Ohio Electric Security Plan approval appears to have relieved some regulatory uncertainty overhanging the stock. This valuation is based upon our view AEP should trade in line with the 2013 group average P/E ratio of 14.7x. We believe the primary risks to achieving this price target is persistent low power prices as a result of weak demand for electricity. Our price target represents a P/E multiple of 14.7x our 2013 estimate. Table 4. Price Target Changes Symbol Current Rating Current Target Previous Rating Previous Target Date Changed AEP BUY $45.50 BUY $42.00 08/31/2012 CMS BUY $25.50 BUY $23.00 06/18/2012 CNL BUY $44.00 BUY $42.00 05/24/2012 IDA BUY $46.00 BUY $44.00 08/06/2012 MDU BUY $24.00 BUY $26.50 02/07/2011 NI BUY $26.50 HOLD N/A 03/21/2012 NWE BUY $39.00 HOLD N/A 08/16/2012 Source: KeyBanc Capital Markets Inc. RESEARCH COVERAGE CHANGES During 2Q12, we initiated coverage of NV Energy, Inc. with a HOLD rating on June 28, 2012 (see page 52 for our published initiation note titled “NVE: Initiating with a HOLD Rating”). For additional research and investment analysis on NV Energy, Inc., please see our Basic Initiating Coverage Report published under separate cover. On June 28, 2012, following the merger closing of Gaz Metro Limited Partnership’s acquisition of Central Vermont Public Service Corporation (CV-NYSE delisted), we terminated coverage of CV. Effective upon termination of coverage, the last rating for this security (HOLD) should not be relied upon going forward. On July 3, 2012, following the merger closing between Duke Energy, Inc. (DUK-NYSE) and Progress Energy, Inc., (PGN-NYSE delisted), we terminated coverage of PGN. Effective upon termination of coverage, the last rating for this security (HOLD) should not be relied upon going forward. SECTOR OUTLOOK In the near term we expect utilities will face headwinds relative to the broad market. We believe both the regulated and commodity- focused subsets of companies face their own challenges. On the regulated side, a more positive sentiment around the overall economy (domestic and a calming of European concerns) will continue to move investors to “risk on” positions. Additionally, uncertainty on dividend taxation and continued concerns around ROE pressures from regulators are likely to weigh on shares. The commodity- focused names have come to offer some of the higher yields, leaving them vulnerable to dividend taxation concerns as well. While strict EPA regulations and weak power markets have driven plant retirement announcements, which should benefit this group, we believe the abundant natural gas supply brought about by horizontal drilling and hydrofracturing technology will continue to exert downward pressure on wholesale power prices. We believe lingering uncertainties around strength and sustainability of domestic and global economies could drive brief periods of outperformance for the group as a defensive safety play. KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 8 of 65 August 2012 A slow economy back in 2009 impacted electricity sales and pricing, as industrial customers saw reduced demand for their products and residential/commercial customer classes adjusted their spending accordingly. 2010 year-end results showed continued modest signs of the economy stabilizing with generally improving electricity sales comparables to the same periods a year ago, particularly for the industrial customer classes. 2011 continued the trend of flat to modest growth. We remain guarded in our near-term outlook, however, as earnings conference calls continue to caution slow to moderating load growth in 2012, given ongoing unemployment levels and the delicate state of the economy. On a less macro perspective, after starting the year off weakly from a weather perspective, with several companies’ 1Q12 results having been materially impacted by mild winter weather, a mild spring and hot June weather in 2Q12 has helped many companies reverse much of the negative weather year-to-date. In the intermediate to longer term, we believe the group will appeal to pockets of investors who seek relative yield, earnings stability and predictable steady growth opportunities around the meaningful capital the group will be spending. The spending opportunities we foresee include incremental generation capacity (which we envision as predominantly natural gas fired), rebuilding existing aged transmission, new transmission to more easily move power between regions that the existing transmission system never really contemplated under the previous more balkanized industry construct, and transmission to move renewable generation to market. Much of the intermediate to long-term growth in the sector is tied to large capital growth programs earning regulated returns. During a prior period of lofty valuations and easy credit, investors viewed these programs positively. Recent market performance has made the equity financing of these large projects less attractive. Names within our group of covered companies that have focused strategies on rate base growth (not including current projects) include: Ameren Corporation (AEE-NYSE); CMS Energy Corporation (CMS-NYSE); Dominion Resources, Inc. (D-NYSE); DTE Energy Company (DTE-NYSE); Duke Energy Corporation (DUK-NYSE); NorthWestern Corporation (NWE-NYSE); Pepco Holdings, Inc. (POM-NYSE); and Xcel Energy Inc. (XEL-NYSE). We continue to see a large number of new bond issuances, long-term refinancing and the terming out of higher cost short-term debt by utilities attempting to take advantage of record low long-term Treasury rates. Credit and liquidity concerns a few years ago drove many companies to revisit capital spending plans and reassess operational efficiencies. The primary response was generally to delay projects, as opposed to outright cancellation. Initially, reductions in capital programs were a function of lower growth, which eliminated the need for growth-related capital spending on items such as line extensions and new substations. However, as challenging economic conditions persisted, the cuts grew more extensive, with deferrals in non-core maintenance spending, re-evaluating the cost- effectiveness of running older inefficient power plants and pursuing company restructurings or mergers. Looking back, after outperforming the S&P 500 in the five years preceding 2009, the electric utility sector underperformed the market in 2009 and 2010. We believe the underperformance started with the 4Q08 earnings reporting season, as dividend cuts and conservative earnings guidance highlighted greater risk than was previously factored into the sector. Consumer electric conservation efforts and economic pressures affecting customer volumes and margins, low commodity pricing, increasingly populist regulatory sentiment and political uncertainty around carbon and taxes weighed on our sector throughout 2010. As fears of a double-dip recession were somewhat alleviated before the end of 2010, our industry appeared to fall out of favor as investors rotated out of the sector in early 2011 in pursuit of higher growth companies in a modestly improving economy. The group’s stock performance appeared to reflect optimistic economic recovery projections in the broader market, as our sector underperformed the S&P 500 in 1H11. The Japanese nuclear crisis in mid-March 2011 gave pause to investors in assessing the impact to the global economic recovery, leading to severe declines for both our sector and the broader market. As companies generally reported in line 1Q11 earnings with still sluggish economies, there appeared to be some movement in May 2011 back toward defensive industries, such as utilities. This pattern held true into July, with generally in line 2Q11 earnings reports for our sector prior to the entire market falling on fears again around a double-dip U.S. recession and European sovereign debt. As investors realized broader market recovery would be longer-dated, more challenged and subject to external shocks (as evidenced by Japan’s natural and nuclear disaster and European sovereign debt issues), 2H11 stock performance for our group appeared to be driven by investor attractiveness to the safe and defensive qualities and yield the utilities sector provided relative to the broader market, resulting in 2011 being another year of outperformance. For 2011, the sector index (UTY) recovered to a 14.1% gain, outperforming the 0.0% flat return in the broader market (SPX). We expect the group’s stock performance in 2012 will be a function of three primary drivers: commodity pricing; the economy; and environmental compliance costs/risks. Retreating high commodity prices weigh most heavily on unregulated generators with nuclear assets and coal-fired plants (with firm intermediate to long-term coal contracts). Low natural gas prices driven by low electric power demand and increasing shale gas supplies should continue to keep wholesale electricity prices at a depressed level, further exacerbating the margin woes for unregulated generators. In our view, the companies with the most leverage to unregulated commodity pricing are: American Electric Power Company, Inc.; Dominion Resources, Inc.; Entergy Corporation; Exelon Corporation; FirstEnergy Corp.; NextEra Energy, Inc.; and PPL Corporation. We believe any early indications for potentially improving natural gas pricing could eventually erase some of the negative sentiment around unregulated generators. However, for the time being, we await a stronger signal that natural gas pricing gains are sustainable and not merely a response to extremely hot weather across most of the country. Signs for longer-dated fundamental economic recovery, however, could lift earnings prospects and price multiples for our entire sector, as evidenced by a rebound for exposed stocks last year after PJM’s RPM base residual auction results for the 2014-2015 delivery year generally came in stronger than expected in the Western pricing zone. Weaker Eastern pricing appeared to have a dampening effect. KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 9 of 65 August 2012 Finally, EPA environmental regulations and the Japanese nuclear crisis have led to an increased focus on potential additional compliance costs. We believe how the power industry responds to new regulations with the public, regulators and politicians will drive stock movement, as well as tax policy and political election implications in 2012. Conversely, well-positioned unregulated generators (nuclear or clean baseload) stand to benefit from the EPA regulations as forced retirement of antiquated and high emitting plants will remove capacity and drive a tighter market. We expect the interplay of low natural gas prices and reduced capacity will be noteworthy. Chart 1. 2012 YTD Performance of UTY vs. SPX (December 30, 2011 – August 17, 2012) Ja n - 1 2 Fe b - 1 2 Ma r - 1 2 Ap r - 1 2 Ma y - 1 2 Ju n - 1 2 Ju l - 1 2 Au g - 1 2 -15-15 -10-10 -5-5 00 55 1010 1515 Re t u r n % Re t u r n % UTY vs. S&P 500 Indexed Price Performance - 2012 YTD S&P 500 (SPX) PHLX / Utility (UTY) Source: FactSet Year-to-date, Chart 1 shows the sector index (UTY) has risen by 1.6%, underperforming the 12.8% return in the broader market (SPX). From a 2013E P/E perspective, the group now trades at a 14.9x P/E multiple, compared to a 12.8x P/E multiple on the S&P 500 index. On a relative basis, the group is around a 17% premium to the S&P 500, compared to more historical discounts of 25-35% (prior to the Bush tax cuts). We believe our sector’s current premium valuation could rapidly converge even closer to or at a discount to the S&P 500 P/E multiple if investors have broader market confidence in a robust U.S. economy, driving investment into other sectors with greater potential upside in a more normal economy or if the Bush tax cuts on dividends are permitted to expire. Meanwhile, we attribute the pullback in the broader market this past spring to increased European sovereign debt concerns and signs of slowing growth in the United States. Continued concerns around Asia are likely to sustain the premium multiple given the yield support and perceived relative safety of the sector. More recently, we believe August recovery in the broader market is attributable to increasing confidence in the likelihood of U.S. monetary policy easing and belief that Europe will do what it takes to resolve lingering sovereign debt concerns, despite signs of moderating growth in the United States, thus driving “risk on” investor positions to rotate away from electric utilities. KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 10 of 65 August 2012 Chart 2. Price Performance of S&P Electric Companies and 30-Year Treasury Bond Yield (December 31, 1996 – August 17, 2012) Ja n - 9 7 Ap r - 9 7 Ju l - 9 7 Oc t - 9 7 Ja n - 9 8 Ap r - 9 8 Ju l - 9 8 Oc t - 9 8 Ja n - 9 9 Ap r - 9 9 Ju l - 9 9 Oc t - 9 9 Ja n - 0 0 Ap r - 0 0 Ju l - 0 0 Oc t - 0 0 Ja n - 0 1 Ap r - 0 1 Ju l - 0 1 Oc t - 0 1 Ja n - 0 2 Ap r - 0 2 Ju l - 0 2 Oc t - 0 2 Ja n - 0 3 Ap r - 0 3 Ju l - 0 3 Oc t - 0 3 Ja n - 0 4 Ap r - 0 4 Ju l - 0 4 Oc t - 0 4 Ja n - 0 5 Ap r - 0 5 Ju l - 0 5 Oc t - 0 5 Ja n - 0 6 Ap r - 0 6 Ju l - 0 6 Oc t - 0 6 Ja n - 0 7 Ap r - 0 7 Ju l - 0 7 Oc t - 0 7 Ja n - 0 8 Ap r - 0 8 Ju l - 0 8 Oc t - 0 8 Ja n - 0 9 Ap r - 0 9 Ju l - 0 9 Oc t - 0 9 Ja n - 1 0 Ap r - 1 0 Ju l - 1 0 Oc t - 1 0 Ja n - 1 1 Ap r - 1 1 Ju l - 1 1 Oc t - 1 1 Ja n - 1 2 Ap r - 1 2 Ju l - 1 2 2% 3% 4% 5% 6% 7% 8% 30 - Y r T - B o n d Y i e l d % -30% -20% -10% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 110% 120% 130% 140% 150% S& P E l e c t r i c U t i l i t y I n d e x R e t u r n % UTY vs. S&P 500 Indexed Price Performance S&P 500 / Electric Utilities -IND (UTY) United States Treasury Bond (30 Y) Yield Source: FactSet Chart 2 is provided to show historical price performance of S&P electric companies compared to the 30-year Treasury bond yield. Currently, the utilities sector offers an average dividend yield of 4.2% as compared to recent Treasury bond yields below 3%. This appears to support a more attractive safety play when needed. Our discussions with investors when there is talk of a potential “double- dip” seem to confirm this market dynamic and was evidenced in 2H11 when the broader market fell, while utilities were impacted to a much lesser extent. KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 11 of 65 August 2012 HISTORICAL VALUATIONS REMAIN INCONCLUSIVE Chart 3. P/E and Relative P/E of UTY vs. S&P 500 Indices (December 31, 2005 – August 17, 2012) . The two primary valuation metrics used for the group paint two contradictory pictures. From a relative (to the broad market) P/E standpoint, the group looks somewhat expensive, driven by outperformance of the more regulated subset of the utility sector (see Chart 3). We believe this outperformance is a flight to safety in response to heightened concerns about the domestic and global economies. We also note that earnings estimates for the S&P 500 have historically been somewhat volatile. Source: Bloomberg and KeyBanc Capital Markets Inc. research Chart 4. Yield Spread 10-Yr U.S. Treasury vs S&P Electric Utilities (June 1, 1993 – August 17, 2012) Alternatively, from a yield spread (vs. U.S. treasuries) perspective, the group continues to look rather attractive (see Chart 4). We believe this is a function of investor recognition and acceptance of the fact that these are truly extraordinary times and treasury yields are being held artificially and unsustainably low. We have been asked about the prospects for the group if yields started to rise. In our view, there would likely be a band of tolerance for treasury yields to rise before there was a corresponding sell-off of the utility group. In the near to intermediate term, we expect the current valuation metrics to remain somewhat unchanged as uncertainty continues in the markets. As we gain more clarity on stabilization (or further deterioration) in the European markets, we expect the group would become less range-bound and be revalued. Yield Spread Between 10 Year Treasury and S&P Electrics -400 -300 -200 -100 0 100 200 300 400 1- J u n - 1 9 9 3 1- J u n - 1 9 9 4 1- J u n - 1 9 9 5 31 - M a y - 1 9 9 6 1- J u n - 1 9 9 7 1- J u n - 1 9 9 8 1- J u n - 1 9 9 9 31 - M a y - 2 0 0 0 1- J u n - 2 0 0 1 1- J u n - 2 0 0 2 1- J u n - 2 0 0 3 31 - M a y - 2 0 0 4 1- J u n - 2 0 0 5 1- J u n - 2 0 0 6 1- J u n - 2 0 0 7 31 - M a y - 2 0 0 8 1- J u n - 2 0 0 9 1- J u n - 2 0 1 0 1- J u n - 2 0 1 1 31 - M a y - 2 0 1 2 Date Yi e l d S p r e a d ( b p ) 10 Yr Spread Average Spread P/E and Relative P/E of UTY vs. S&P 500 Indices 8.0x 9.0x 10.0x 11.0x 12.0x 13.0x 14.0x 15.0x 16.0x 17.0x 18.0x 19.0x 20.0x De c - 0 5 Ma r - 0 6 Ju n - 0 6 Se p - 0 6 De c - 0 6 Ma r - 0 7 Ju n - 0 7 Se p - 0 7 De c - 0 7 Ma r - 0 8 Ju n - 0 8 Se p - 0 8 De c - 0 8 Ma r - 0 9 Ju n - 0 9 Se p - 0 9 De c - 0 9 Ma r - 1 0 Ju n - 1 0 Se p - 1 0 De c - 1 0 Ma r - 1 1 Ju n - 1 1 Se p - 1 1 De c - 1 1 Ma r - 1 2 Ju n - 1 2 Se p - 1 2 Date 12 - m o F o r w a r d P / E 0.65 0.70 0.75 0.80 0.85 0.90 0.95 1.00 1.05 1.10 1.15 1.20 1.25 Re l a t i v e P / E UTY Index S&P500 Relative P/E KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 12 of 65 August 2012 GROUP INVESTMENT THESIS Broadly speaking, we believe the long-term fundamentals in the electric utility sector remain essentially intact, as opportunities exist in tight power markets (with an outlook for pricing to improve as the economy recovers and EPA regulations force some level of plant retirements and the potential to rate base needed capacity) needing to modernize aging transmission and distribution infrastructure, meet more environmentally friendly portfolio standards and serve growing demographics. We are generally more conservative in our long-term growth projections, as the sector historically lags and experiences lower demand growth compared to the broader market. In an industry that must continue to spend money to make money, regulatory risk is ever present as recovery of capital investment is never 100% assured and companies must seek advanced or later regulatory blessing on large capital expenses to ultimately recover their costs and earn a return on investment once the asset is placed into service. Our concern is that, at some point, rising electricity prices will draw enough public and political attention that regulators will be pressured to ease the sting on ratepayers, putting the shareholder at risk. We believe the levers in the regulatory toolbox that may be pulled to lower rates include reassessing allowable returns on equity, extending depreciation rates, reviewing costs of debt and reassessing appropriate capital structure. These negative regulatory outcomes had precedence in the 1970s, as high oil pricing and continued nuclear cost overruns prompted regulators to force shareholders to feel some of the pain. Additionally, U.S. nuclear energy is likely to be further impacted by increased scrutiny and inspections as a result of the recent Japan nuclear crisis. The confluence of several factors highlighted below leaves us concerned about increasing regulatory risk impacting the sector in the coming years. These factors include: · Potential for Populist Regulatory Sentiment. We believe investors must heighten awareness to political and regulatory risk as higher electricity (and overall energy) pricing becomes more scrutinized, especially during periods of a weak economy. We view electricity pricing as being far more exposed to local politics than the pricing of other energy commodities, and there are always risks to timely and fair recovery of investment dollars, despite prior precedents or assurances. · Environmental Capital Expenditures. On a consolidated basis, the sector must spend tens of billions of dollars to meet more stringent environmental regulations that can be subject to changing political winds. · Aggressive Rate Base Growth as an Earnings Driver. Given the low organic growth inherent in the sector, we believe some players may look for a tailwind by growing the rate base as aggressively as possible. · Additional Cost Pressure Driven by Inflation. We believe a weak dollar and long-term global competition for infrastructure materials have increased the rate risk on the proposed capital spend, as projects have an ever-escalating price tag. · Potential for Continued Low Interest Rates. We believe regulatory risk is increased by low treasury yields, as state regulatory commissions often use a spread over treasuries as an indicator of appropriate equity return levels. To some degree, our concerns are longer-dated as the confluence of regulatory risk factors highlighted above needs time to accumulate. In the short term, we believe that necessary infrastructure investments should and will be encouraged by regulators. More recently, however, the U.S. economic sluggishness has provided support for our more cautious view as evidenced by politicization of rate case proceedings in Maryland for Pepco Holdings, Inc. We emphasize that investors should monitor local regulation impacting investments for any move toward restrictive outcomes. Chart 5 illustrates the longer-term trend toward lower regulated utility equity returns authorized by state Commissions; average return on equity (ROE) for electric utilities was 12.7% in 1990 compared to 10.2% in 2011, and for gas utilities was 12.7% in 1990 compared to 9.9% in 2011. KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 13 of 65 August 2012 Chart 5. Average Authorized Equity Returns (January 1990 – June 2012) 9.00% 10.00% 11.00% 12.00% 13.00% 19 9 0 19 9 1 19 9 2 19 9 3 19 9 4 19 9 5 19 9 6 19 9 7 19 9 8 19 9 9 20 0 0 20 0 1 20 0 2 20 0 3 20 0 4 20 0 5 20 0 6 20 0 7 20 0 8 20 0 9 20 1 0 20 1 1 1H 1 2 Year RO E % Electric Gas , Source: Regulatory Research Associates, KeyBanc Capital Markets Inc. research INDUSTRY THEMES RETREATING COMMODITY PRICES AND AVAILABLE CAPACITY HEAT UP COMPETITION Natural gas pricing, remaining stubbornly in a thin trading band, continues to drive the marginal clearing price of power in wholesale markets (see Chart 6). Given available capacity and the sharp decline in wholesale power pricing as natural gas prices remain low, we remain vigilant over the potential for competitive marketers to undercut pricing in deregulated markets, such as Ohio and Pennsylvania, as utilities had previously procured supply during periods of significantly higher pricing. We believe competitive marketers could lock in supply at current low pricing to offer customers a more attractively priced alternative. Chart 6. Comparison of Spot, 12-Month and 24-Month Natural Gas Prices (December 31, 2004 – August 17, 2012) $1 $2 $3 $4 $5 $6 $7 $8 $9 $10 $11 $12 $13 $14 $15 $16 De c - 0 4 Ma r - 0 5 Ju n - 0 5 Se p - 0 5 De c - 0 5 Ma r - 0 6 Ju n - 0 6 Se p - 0 6 De c - 0 6 Ma r - 0 7 Ju n - 0 7 Se p - 0 7 De c - 0 7 Ma r - 0 8 Ju n - 0 8 Se p - 0 8 De c - 0 8 Ma r - 0 9 Ju n - 0 9 Se p - 0 9 De c - 0 9 Ma r - 1 0 Ju n - 1 0 Se p - 1 0 De c - 1 0 Ma r - 1 1 Ju n - 1 1 Se p - 1 1 De c - 1 1 Ma r - 1 2 Ju n - 1 2 Se p - 1 2 Date $/ M M B T U Spot 12 Mo 24 Mo Source: Bloomberg KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 14 of 65 August 2012 HEIGHTENED IMPORTANCE OF REGULATORY SUCCESS The major focus of many utilities over the past few years has been the “back-to-basics” approach, through which non-strategic businesses were divested or shuttered, and the business focus returned to the core utility operations. While this scenario has done a great deal to mitigate risk and exposure to volatile market conditions, future growth plans have also come into focus. In the past, companies had pursued diversified opportunities to provide additional growth to offset slower growth in the regulated business. In this new era of focus on the core regulated utility, the importance of regulatory success has come back to the forefront. Companies that are able to craft innovative solutions to issues, such as quick recovery of environmental expenditures, will likely set the stage for future growth of the regulated business. We believe the companies that currently have high levels of exposure to regulatory developments are Ameren, American Electric Power, CMS Energy, DTE Energy, Duke Energy, Exelon, IDACORP, Pepco Holdings and Xcel Energy. We believe a return of high fuel/commodity and construction materials pricing will likely increase regulatory risk, as regulators seek ways to minimize the increases in overall customer electric bills, even at the expense of the shareholder. COMPREHENSIVE ENERGY REFORM AT AN IMPASSE; EPA EMISSIONS RULES MOVE FORWARD Despite several legislative bills offered over the past several years, we believe that comprehensive energy reform [carbon cap-and- trade, climate change, federal Renewable Portfolio Standards (RPS), renewable energy qualifying sources and proposals such as offshore drilling to lessen the U.S. reliance on foreign oil] is unlikely to gain passage under the 2012 Congress in a presidential election year. An outlook for continued slow economic recovery is likely to prevent the issue from gaining traction over the next few years, in our view. We do believe there might be renewed attempts in Congress to legislate, restrict or delay EPA authority or funding to regulate greenhouse gases, including carbon, although overriding a Presidential veto would prove difficult. In the near term, EPA continues to advance its rules on a host of pollution criterion under the Clean Air Act and Clean Water Act. Legal challenges add uncertainty around timelines and how aggressively environmental regulations will be implemented, and we believe the dynamic of how a new Congress, the EPA and the industry work together post-election is something to watch. As recently as August 21, 2012, the District Court of Appeals for Washington, D.C. negated the Cross State Air Pollution Rule (CSAPR), as the Court ruled that the EPA exceeded its statutory authority in how the rules were crafted and applied to the states, regardless of the policy benefits. We believe this decision will only serve to further delay implementation of pollution controls intended to meet CSAPR requirements as the EPA reworks the rules and process to comply within its statutory authority. We feel it is still important for electric utility investors to become aware of the renewable energy resources available to each utility in each state, consider the business impact as to how an investor-owned utility would address any state mandates or renewable standards, and understand the possible implications (favorable and unfavorable) that a potential federal RPS, EPA mandate or other energy/climate-related (carbon) legislation, if enacted, may have on their utility investments. KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 15 of 65 August 2012 STATE RENEWABLE PORTFOLIO STANDARDS Thirty-six states and the District of Columbia have adopted state RPSs to foster electricity investments in efficiency and renewable resources. The result is a patchwork of different state standards on several factors, including: the ultimate amount or level to be targeted; how to measure the initiative (percent of capacity installed vs. generation output); timeline for implementation; balance between renewables usage vs. gains from efficiency; which renewable resources are to be included in the RPS; and even whether the targets being set are voluntary or mandatory. In Table 5, every state with a date listed has adopted an RPS into law. Six states (Indiana, North Dakota, South Dakota, Utah, Vermont and Virginia) have set voluntary renewable portfolio goals instead of a mandatory target. Since 2009, the Florida legislature has not yet ratified RPS draft rules for 20% renewable generation by 2020. Currently, Louisiana has a pilot renewable program targeting 350 MW of renewable capacity by the 2012-2013 time-frame. KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 16 of 65 August 2012 Table 5. State Renewable Portfolio Standards State original RPS law adoption date Amt Year Comments State original RPS law adoption date Amt Year Comments Arizona 2/26/06 15% 2025 2.5% of total electricity sold from renewable energy sources by 2010 and 15% by 2025. 5% of the renewables to come from solar power in 2007, and will ramp up to a 30% "distributed" energy technology requirement by 2011. Renewable energy from facilities installed before 1/1/1997 are not eligible. Nevada 3/15/07 25% 2025 SB 395 on 6/8/09 increased RPS to: 20% by 2015, at least 5% must be generated from solar energy. Utilities can also earn credit for up to 25% of the RPS through energy efficiency measures. Resources include biomass, fuel cells, geothermal, solar, hydro, and wind. On June 8, 2009 RPS was updated to 25% by 2025 (6% from solar by 2016). California 9/12/02 33% 2020 Renewable energy resources include biomass, solar thermal, photovoltaics, wind, geothermal, small hydropower, and ocean-generated power. On 9/15/09 the Governor signed an executive order increasing the original requirement of 20% by 2010 to 33% by 2020. On 3/29/11, the California Assembly passed Senate- approved bill X1-2 establishing the 33% by 2020 standard into law rather than relying on California Air Resources Board regulations. New Hampshire 5/11/07 25% 2025 25% of state's electricity from renewable resources by 2025 (includes wind, solar, geothermal, hydrogen fuels, methane gas, ocean-generated, biomass, and existing small hydroelectric sources). Colorado 11/2/04 30% 2020 On 3/22/10 HB 1001 increased the RPS standard to 30% by 2020. Requires large investor-owned utilities serving 40,000 or more customers to generate or purchase 12% of their retail electric sales from eligible renewable energy resources (solar, wind, geothermal, biomass, and small hydroelectric) by 2010, increasing to 20% by 2015, and 30% by 2020. 3% of these amounts must come from distributable solar- electric technologies. RECs may be used to satisfy standard New Jersey 2/9/99 22.5% 2021 AB 3520 on 1/17/10 required 5,316 MW to be generated from in-state solar generators by 2025. SB 2036 on 8/19/10 is nation's first carve-out offshore wind requirement calling for 1,000 MW of capacity, details TBD. Resources include solar, wind, wave, tidal, geothermal, landfill methane gas, fuel cells from renewable fuels, anaerobic digestion of food waste and sewage sludge at a biomass generating facility, and hydropower. Connecticut 7/1/98 27% 2020 On 6/4/07 HB 7432 increased the RPS standard to 20% renewables from "Class I" (solar, wind, sustainable biomass, ocean-generated, landfill gas, 5MW hydro), 3% from "Class I" or "Class II" (trash-to-energy, hydro facilities, and other biomass), and 4% from "Class III" (distributed heat, conservation, waste recovery programs). New Mexico 3/5/07 20% 2020 20% of an electric utility’s power must come from renewable sources. Resources include solar, wind, hydropower, geothermal, fuel cells from renewable fuels, and qualifying biomass. Performance-based financial or other incentives are used to encourage utilities to exceed annual standards. District of Columbia 1/19/05 11% 2022 Two-tiered system: "Tier 1" includes solar, wind, biomass, landfill gas, wastewater- treatment gas, geothermal, ocean-generating, and fuel cells from renewable fuels. "Tier 2" includes hydropower and municipal solid waste. Additional 0.386% of the district’s renewable energy to come from solar energy by 2022. On 7/2/10 DC Law 18-0223 amended the RPS so that municipal solid waste incineration may not be used to meet more than 20% of a Tier 2 requirement. Beginning 2013 municipal solid waste will no longer be eligible to generate Tier 2 RECs. New York 9/22/04 29% 2015 On 1/8/10 NY SPC increased RPS to 29% of renewables by 2015. 20.7% of target from existing facilities and 8.3% from new sources categorized into two-tiers. "Main Tier", roughly 93% of incremental renewables generation (biogas, biomass, liquid biofuel, fuel cells, hydroelectric, solar, ocean or tidal power, and wind). "Customer- Sited Tier" 7% of incremental renewables generation (fuel cells, solar, and wind resources). An additional 1% to come through voluntary power sales. Delaware 7/21/05 25% 2025 18% from renewable resources by 2019 (wind, ocean-generated, fuel cells from renewable fuels, 30MW hydroelectric facilities, sustainable biomass, anaerobic digestion, and landfill gas). 3.5% of state electricity supply from solar PV by 2025. North Carolina 8/20/07 12.5% 2021 By 2021, 12.5% of retail sales must come from renewable energy or energy efficiency for investor-owned utilities. 10% by 2018 for electric cooperatives and municipal utilities. Florida An Executive Order from July 13, 2007 directed the state commission to draft RPS rules. On Jan. 30, 2009 the Florida Public Service Commission proposed a RPS to the state Legislature requiring 20% generation from renewable resources by 2020. Other target dates: 7% by 2013, 12% by 2016 and 18% by 2019. The Florida Legislature did not act on or ratify the legislation in 2009 or 2010. North Dakota* 3/21/07 10% 2015 Voluntary RPS passed by legislature of 10% retail electricity sold to come from renewables by 2015. Hawaii 6/2/04 25% 2020 10% of net electricity sales to come from renewable sources by 2010, 15% by 2015 (wind, solar, ocean thermal, wave, and biomass). On June 25, 2009, RPS was increased to 25% by 2020 and 40% by 2030. 30% by 2030 to come from energy efficiency savings. Ohio 5/1/08 25% 2025 12.5% electricity sold in the state to come from renewables (wind, solar, hydropower, geothermal, or biomass), half of which must be generated in Ohio. Other 12.5% may come from alternative energy resources (nuclear power plants, fuel cells, energy-efficiency, and clean carbon capture technology). Utilities may buy, sell, and trade renewable energy credits to comply. 22.5% by 2025 to come from energy efficiency savings. Electric utilities must reduce peak energy demand 1% in 2009, and an additional 0.75% each year through 2018. Iowa 10/21/83 105 MW Not an official RPS, but 1983 Alternative Energy Production state law mandates two investor-owned utilities (Mid-American and Interstate Power/Light) to own or contract for 105 MW of renewable power (photovoltaics, landfill gas, wind, biomass, hydro, municipal solid waste, and anaerobic digestion). Voluntary goal of 1,000 MW of wind capacity by 2010. Oregon 6/6/07 25% 2025 25% of utility electric load from new renewable sources by 2025. Resources include wind, solar, wave, geothermal, biomass, new hydro or upgrades to existing hydro facilities. On 6/25/09 HB 3039 required 20 MW by 2020 to come from solar photovoltaic. Illinois 8/28/07 25% 2025 10% by 2015 and 25% by 2025. 75% of the electricity used to meet the RPS must come from wind power generation, 6% from new solar photovoltaic by 6/1/2015. Eligible renewables include solar, biomass, and existing hydropower. Utilities to implement energy efficiency standard to reduce electric usage by 2% of demand by 2015. Pennsylvania 12/16/04 18% 2020 Two-tiered resources to meet RPS: 8% from Tier 1 (wind, solar, coalmine methane, small hydropower, geothermal, and biomass), 10% from Tier 2 (waste coal, demand side management, large hydropower, municipal solid waste, and IGCC), and 0.5% must be solar-provided generation (part of Tier 1) by 2020. Indiana* 5/1/11 10% 2025 SB 251 sets a voluntary Clean Energy Portfolio Standard (CPS) program goal of 10% clean energy by 2025, based on 2010 levels. Qualifying electric utilities (public utilities) must apply to the Indiana Utility Regulatory Commission (IURC) to be eligible for incentives in order to pay for projects. 2013 - 2018: at least 4% average; 2019 - 2024: at least 7% average; 2025 - 2025: at least 10% average qualifying clean energy. Rhode Island 6/29/04 16% 2019 3% of retail electricity sales must come from renewable energy by 2006, increasing 1% a year through 2020. Existing renewables count for only 2% of RPS, the rest must be from new renewable production. Resources include direct solar radiation, wind, ocean-generated, the heat of the earth, small hydroelectric facilities, eligible biomass, and fuel cells using renewable fuels. The PUC will review/revise the schedule after 2013. Kansas 5/22/09 20% 2020 Generate or purchase renewable energy of 10% by 2011, 15% by 2016 and 20% by 2020 and beyond. Generated energy counts as 1.1 MW for each MW. Eligible sources include wind, solar thermal and photovoltaic, dedicated agricultural or plant waste, untreated wood, fuel cells, existing hydropower and new hydropower of 10 MW or less. South Dakota* 2/21/08 10% 2015 Voluntary RPS of 10% retail electricity sold to come from renewables by 2015. Maine 9/28/99 10% new 2017 Original standard of 30% by the year 2000. RPS was increased in June 2006 an additional 10% by 2017 for new renewable sources (fuel cells, tidal power, solar, wind, geothermal, hydro, biomass, or municipal solid waste recycling) placed into service after 9/1/05. Texas 6/18/1999 5,880 MW 2015 On 8/1/05 SB 20 increased RPS to 5,880 MW of new renewable generation to be built in state (about 5% of the state's electricity demand) by 2015. Goal of 10,000 MW in renewable generation capacity by 2025. 500 MW by 2025 from non-wind resources. Maryland 5/26/04 20% 2022 On 4/24/08 the RPS was accelerated to 20% of state’s electricity supply must come from renewable sources by 2022. At least 2% must come from solar sources and 7.5% from other renewable sources (wind, biomass, anaerobic digestion, landfill gas, geothermal, ocean-generated, fuel cells from renewable fuels, and small hydro) by 2022. Utah* 3/18/08 20% 2025 Voluntary RPS goal of 20% of adjusted retail sales by 2025. Utilities to pursue cost- effective renewable energy. Massachusetts 7/2/08 15% 2020 New law updates previous RPS of 4% in 2009 to 15% new renewable electricity generation by 2020 with 1% increase each subsequent year, with no set expiration. Renewables include solar, wind, ocean, fuel cells from renewable fuels, landfill gas, biomass, marine, and geothermal. Vermont* 6/14/05 10% 2013 Voluntary goal of 10% of 2005 total electric sales to be achieved by 2012, else RPS will become mandatory in 2013. Renewable resources include wind, solar, large hydropower, landfill methane gas, anaerobic digesters, and sewage-treatment facilities excluding municipal solid waste. Vermont utilities can build generation out of state to comply with RPS. On 3/20/08, new renewable goal of 25% by 2025 emphasizing use of Vermont's farms and forests. On 6/4/10 HB 781 required the PSB to considering changing state's RPS goals to a full-fledged RPS standard. PSB report due 10/1/11. Michigan 10/6/08 10% 2015 Qualifying sources include wind, solar, hydropower, landfill gas, waste combustion and cogeneration. Advanced fossil fuel technologies and efficiency measures may be used to cover some of a utility's obligation. Virginia* 4/11/07 15% 2025 Voluntary RPS goal (updated 4/2/10) of 15% of 2007 base year utility electricity sales (excluding average nuclear power supply) by 2025. Resources include solar, wind, geothermal, hydropower, wave, tidal, and biomass energy. Wind and solar receive a double credit toward RPS goals. Offshore wind receive a triple credit. Investor-owned utilities are incentivized with increased rate of return to procure a percentage of the power sold in VA from eligible renewable energy sources. Minnesota 2/22/07 25% 2025 Xcel Energy (generates about half of the state’s electricity) required to produce 30% from renewable sources by 2020. "Eligible Renewable Energy Technologies" include solar, wind, small (<100MW) hydroelectric, hydrogen from renewable resources, and biomass. Washington 11/7/06 15% 2020 All utilities in WA serving more than 25,000 people must produce 15% of their energy using renewable sources by 2020. Resources include water, wind, solar, geothermal, landfill gas, wave, ocean, tidal power, gas from sewage treatment facilities, biodiesel fuel not from deforested land and biomass. Missouri 11/4/08 15% 2021 Voters passed proposition C for state-wide RPS repealing current voluntary standard. Investor-owned utilities qualify with their own generation or renewable energy credits (2% from solar sources). 2% by 2011; 5% by 2014; 10% by 2018. West Virginia 6/17/09 25% 2025 10% by 2015 and 15% by 2020 from alternative or renewable energy sources. Eligible alternatives include advanced coal technology (e.g., carbon capture and storage, ultra/supercritical and pressurized fluidized bed technologies), coal bed methane, natural gas, coal gasification or liquefaction facility-produced fuel, synthetic gas, IGCC, waste coal, tire-derived fuel, pumped storage hydroelectric, and recycled energy. Eligible renewables are solar, wind, hydropower, geothermal, biomass, biofuels, and fuel cells. Montana 4/28/05 15% 2015 Utilities can meet the standard by entering into long-term purchase contracts for electricity bundled with renewable energy credits. The law includes cost caps that limit the additional cost utilities must pay for renewable energy. Resources include wind, solar, geothermal, existing hydro, landfill or farm-based methane gas, wastewater-treatment gas, nontoxic biomass, and fuel cells from renewable fuels. Wisconsin 10/27/99 10% 2015 On 3/17/06 RPS was increased to 10% by 2015. Qualifying renewables include tidal and wave action, fuel cells using renewable fuels, solar, wind, biomass, geothermal technology, and hydropower less than 60 MW. Renewable energy generated outside of Wisconsin is eligible. * Denotes states that have set voluntary goals for adopting renewable energy standards instead of mandatory targets. Sources: http://www.eere.energy.gov/states/maps/renewable_portfolio_states.cfm; http://www.pewclimate.org/what_s_being_done/in_the_states/rps.cfm Company data, KeyBanc Capital Markets Inc. research KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 17 of 65 August 2012 STOCK PERFORMANCE DIVERGENCE BASED ON COMMODITY EXPOSURE The strong (if not volatile) commodity cycle had for years been favorable for companies that have exposure to natural gas and/or coal, as they have typically outperformed the rest of the group, as depicted in Chart 7. Since 2009, the commodity subgroup has fared the worst in the economic downturn, as natural gas, coal and power prices have fallen with a sluggish economic outlook. Despite a brief period of outperformance in spring 2009, any investor enthusiasm in the commodity subgroup has remained somewhat muted. However, the unregulated generators had recently started to attract interest as investors started to weigh the impact of EPA regulations on the existing coal fleet. This enthusiasm has waned somewhat as economic concerns have intensified. We believe that the rapid and pronounced price declines were driven by several factors: the collapse of major banks likely drove forced liquidation of long commodity positions; reduced demand in light of a slowing global economy (especially China, which had been a major importer); volatility arising from marketplace assumptions on the effects of various government stimulus programs around the world; opening of new unconventional natural gas plays (with improving production technology) expanding gas supply; and investor realization that any economic recovery may be longer-dated and that demand is down due, in part, to a shift in changing consumer behaviors (conservation). Chart 7. Price Performance of Different Utility Subgroups (December 31, 2006 – August 17, 2012) -55% -50% -45% -40% -35% -30% -25% -20% -15% -10% -5% 0% 5% 10% 15% 20% 25% 30% 35% De c - 0 6 Ma r - 0 7 Ju n - 0 7 Se p - 0 7 De c - 0 7 Ma r - 0 8 Ju n - 0 8 Se p - 0 8 De c - 0 8 Ma r - 0 9 Ju n - 0 9 Se p - 0 9 De c - 0 9 Ma r - 1 0 Ju n - 1 0 Se p - 1 0 De c - 1 0 Ma r - 1 1 Ju n - 1 1 Se p - 1 1 De c - 1 1 Ma r - 1 2 Ju n - 1 2 Se p - 1 2 Date Re t u r n T&D Only Small Vertical Large Vertical S&P 500 Commodity Source: FactSet The 2011 performance for commodity-focused nuclear names took a severe drop in mid-March during the Japanese nuclear crisis as risk-averse investors avoided these generators. Commodity-focused names never truly recovered as weak power prices and global economic concerns continued throughout the year. Smaller vertically integrated names showed meaningful outperformance in 2011, which we attribute to any enthusiasm around M&A activity and the April and May announcements of the acquisitions of DPL and Central Vermont, respectively. Broader market index outperformance early in 2011 lost its ground against integrated utilities by year- end as investors took profits amid market turmoil and sought safety in our sector in names offering liquidity and yield while assessing the strength of global economic recovery. Early 2012 saw the broader market outperform all electric utility segments (see Chart 8) as investors gained confidence in broader market recovery, only to see that enthusiasm pull back mid-year due to reappearing European sovereign debt concerns and signs of slowing growth in the United States. A late summer broader market rally appears to be due to sector rotation away from utilities as investors hope for another round of quantitative easing by the Federal Reserve of the United States and that Europe will be able to finally resolve its sovereign debt issues, despite signs of slowing growth in the United States. KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 18 of 65 August 2012 Chart 8. Year-to-Date S&P 500 vs. KBCM Electric Utility Segment Performance (December 30, 2011 – August 17, 2012) -14% -12% -10% -8% -6% -4% -2% 0% 2% 4% 6% 8% 10% 12% 14% De c - 1 1 Ja n - 1 2 Fe b - 1 2 Ma r - 1 2 Ap r - 1 2 Ma y - 1 2 Ju n - 1 2 Ju l - 1 2 Au g - 1 2 Date Re t u r n S&P 500 Large Vertical Small Vertical Commodity T&D Only Source: FactSet JAPAN NUCLEAR CRISIS HIGHLIGHTS RISKS TO NUCLEAR POWER INDUSTRY A sharp decline occurred in mid-March 2011 for all equity segments, including the broader market, as concerns arose from the disaster at the Fukushima nuclear power complex in Japan that was severely damaged and leaking radiation due to the combination of an earthquake and tsunami. With 20% of U.S. power derived from nuclear energy, we do not envision a knee-jerk reaction in the United States to impact nuclear power. However, we do believe U.S. nuclear energy is likely to be impacted by increased scrutiny, inspections and considerations of specific reactor designs, as well as the sufficiency of backup systems in the event of station blackout conditions. The situation is also likely to fuel increased opposition to nuclear power, as did the Three Mile Island and Chernobyl incidents. Three Mile Island is considered to have been a major factor in the end of U.S. nuclear construction already hindered by construction delays and cost overruns. Existing plants on the public safety perception bubble (Vermont Yankee, for example) and others up for licensing renewals could face further public scrutiny. New nuclear construction, which has already been delayed by the recession, is likely to see higher opposition. Proponents of nuclear will argue that modern plants are simpler in design and designed to shut themselves down in emergencies. Opponents will cite another occurrence of an event that design redundancies would supposedly prevent from happening. The Japanese accident is likely to further drive incremental generation capacity decision making to favor natural gas, which could impact diversity and drive power pricing volatility. Public and political perceptions around nuclear energy will contribute to policy discussions. An August 23, 2011 earthquake on the U.S. East Coast drove a short-lived negative investor reaction as companies with nuclear exposure saw a brief sell-off. However, as news started to flow that the plants suffered no damage and all systems reacted as designed, market concerns were alleviated. Nuclear proponents touted the incident as an example of the safety of the U.S. nuclear fleet. On February 9, 2012, Southern Company’s combined construction and operating license for Vogtle 3 and 4 new nuclear units was approved by the U.S. Nuclear Regulatory Commission (NRC), clearing the way for the Company to proceed with full construction of major reactor components. In a four-to-one vote, dissenting former Chairman Gregory Jaczko favored safety enhancements be made at the plant as a result of lessons learned at Fukushima and in general feels that the implementation timeline for compliance for the nation’s nuclear plants in response to Fukushima should be sped up, particularly for seismic risks, which have the potential to be the most expensive and complicated of the changes. KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 19 of 65 August 2012 In March 2012, the NRC mandated new regulations for “lessons learned” from Fukushima, to be in effect by the end of 2016, that include reassessing the nuclear power industry for protections against earthquakes, floods or station blackout events, enhancing the safety of spent fuel pools and to improving venting systems in boiling-water reactors with General Electric Co. Mark I or Mark II containments. The full costs of compliance are yet undetermined. New Chairman Allison Macfarlane has re-emphasized the importance of nuclear plant safety and the storage of spent nuclear fuel. NEW GENERATION / TRANSMISSION BUILD TO MEET LOAD GROWTH On the supply side, the industry has worked off much of the capacity glut that resulted from a late 1990s building frenzy, which was fueled by cheap natural gas, robust economic growth and optimistic investors. Regionally, several parts of the country have recognized the fact that long construction lead times (particularly for baseload generation) suggest a sense of urgency around planning for new capacity. The recent economic slowdown, however, has temporarily slowed demand growth, while new capacity projects were already underway, thus improving load margins in the intermediate forecast term (see Chart 9). Chart 9. Historical and Forecasted U.S. Electric Supply and Demand (Summer) 0 100000 200000 300000 400000 500000 600000 700000 800000 900000 1000000 1100000 1200000 19 8 9 19 9 0 19 9 1 19 9 2 19 9 3 19 9 4 19 9 5 19 9 6 19 9 7 19 9 8 19 9 9 20 0 0 20 0 1 20 0 2 20 0 3 20 0 4 20 0 5 20 0 6 20 0 7 20 0 8 20 0 9 20 1 0 20 1 1 F 20 1 2 F 20 1 3 F 20 1 4 F 20 1 5 F 20 1 6 F Date Lo a d ( M W ) 0% 5% 10% 15% 20% 25% 30% Ma r g i n Demand Supply Margin Source: North American Electric Reliability Corp COST ESCALATION IN NEW GENERATION BUILD While recent prices have come off of their earlier highs due to the global economic crisis slowing construction demand, we believe the long-term trend of rising construction materials costs could resume as the global economy rebounds. The cost of building new generation remains a moving target, as worldwide demand for construction materials commodities (steel, concrete and copper), labor and components (turbines and boilers) would remain fundamentally strong, driven by a rebound in the U.S. and Chinese economies and required compliance with U.S. environmental regulations. We believe this presents challenges to both unregulated and regulated investment in new generation plants. In particular, on the regulated side, there exists a chicken-and-egg problem in that securing pricing without a regulatory buy-in is as difficult as receiving regulatory pre-approval without firm pricing. For example, in order to secure the project’s expected final approval, Southern Company subsidiary Mississippi Power agreed to a cost cap on its 582MW Kemper County IGCC plant at $2.88 billion to allow the Commission to protect and assure customers against uncontrolled cost increases from its original $2.7 billion estimate. In addition to this regulatory quagmire is uncertainty around the cost to achieve yet to be determined environmental controls to mitigate carbon output. Chart 10 illustrates the upward pressure on construction commodities, with the global economic slowdown affecting prices in the near term and showing recent indications of price stabilization and increases. As an example of longer-dated cost escalation on new generation build, Progress Energy had estimated the cost of building two new nuclear plants, with necessary transmission, at $17 billion, more than twice initial estimates. KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 20 of 65 August 2012 Chart 10. Construction Materials Indexed Pricing 80 90 100 110 120 130 140 150 160 170 180 190 200 210 220 230 240 250 260 270 280 290 1Q 0 5 2Q 0 5 3Q 0 5 4Q 0 5 1Q 0 6 2Q 0 6 3Q 0 6 4Q 0 6 1Q 0 7 2Q 0 7 3Q 0 7 4Q 0 7 1Q 0 8 2Q 0 8 3Q 0 8 4Q 0 8 1Q 0 9 2Q 0 9 3Q 0 9 4Q 0 9 1Q 1 0 2Q 1 0 3Q 1 0 4Q 1 0 1Q 1 1 2Q 1 1 3Q 1 1 4Q 1 1 1Q 1 2 2Q 1 2 3Q 1 2 E Date Re l a t i v e P r i c e % Steel Rebar Concrete Copper Source: Bureau of Labor Statistics; Steel Business Briefing (as of August 17, 2012). The long-term trend of rising costs increasingly necessitates the need for rate-making mechanisms, such as Construction Work In Progress (CWIP), to allow utilities to undertake construction without significantly weakening their balance sheet, cash flow and credit metrics. Additional cost pressures on ratepayers pose the risk of regulators authorizing lower ROEs in future rate proceedings to offer some rate relief. FIFTEEN PERCENT DIVIDEND TAX RATE EXTENSION A reduced 15% tax rate on corporate dividends (same as the long-term capital gains tax rate) provided a positive catalyst for continued investment in higher-yielding stocks when it was introduced in 2003 under former President Bush. As expiration of the Bush tax rates loomed toward the end of 2010, President Obama signed into law the Tax Relief Unemployment Insurance Reauthorization and Job Creation Act of 2010 on December 17 (after compromising with congressional Republican leaders), which extended the lower dividend and capital gains tax rates for two years through 2012. We believe our sector will remain particularly sensitive to news on dividend taxes as it is likely to again experience similar circumstances of political debate over lower dividend tax rate expiration in 2012. We expect current federal budget concerns and presidential election year politics will make the discussion more contentious than in the past. President Obama’s 2013 budget proposes letting the tax rate increase to 20% from 15% on long-term capital gains and to treat dividends as ordinary income for individuals making above $200,000 and for married couples making above $250,000 (subject to their pre-Bush tax cut top income tax rate of 39.6%). There would be no change in capital gains or dividend tax rates for those making below those thresholds. Without any Congressional action or by letting current Bush tax rates expire, the dividend tax would revert back to marginal income tax rates of up to 39.6% for the highest earners, in addition to a 3.8% passive income tax that was put in place with the Health Care and Education Affordability Reconciliation Act of 2010 (resulting in a stealth tax increase on dividends totaling up to 43.4% on highest income thresholds). We believe that 1.0-1.5x P/E multiple points of the group’s valuation expansion over the past years were attributable to these lower taxes and the 2010 extension prevented a negative catalyst for the utility group. Currently, our coverage universe averages a 4.2% dividend yield vs. 2.0% for the S&P 500 index. While our sector generally offers higher yields than the broad market, we expect that, on KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 21 of 65 August 2012 a relative basis, more highly regulated names with higher payout ratios and yields would underperform as income-focused investors started to discount expectations, lowering aftertax yields from these companies relative to opportunities in the bond market. M&A ACTIVITY ON THE RISE We expect that many utility executives are looking at the potential synergies of a strategic and well-executed merger with great interest, particularly with the recent pick-up in M&A activity (see Table 6). Companies with substantial unregulated operations would most likely be able to realize the greatest amount of synergies, as these savings are generally outside the reach of regulators. With balance sheets generally repaired (and the potential for all-stock deals to offer further improvement), we consider additional consolidation to be likely in the long term. The outlook for an extended period of low power prices may accelerate M&A to achieve cost synergies. We would expect larger players to look for opportunities to gain scale to endure weakened markets and capital needs through a greater unregulated presence or through the addition more stable regulated operations. On the regulated side, we believe smaller, single-state utilities make attractive targets. POSSIBLE ACQUIREES Cleco Corporation (CNL-NYSE) As a small, single-state regulated utility in Louisiana with a service territory next to Entergy, we believe Cleco Corporation is a potential acquisition target. We expect forecast free cash generation could be attractive to acquirers. NiSource, Inc. (NI-NYSE) We believe NiSource, Inc. is perceived as an acquisition target. The announced acquisition and bidding war for Southern Union Company (SUG-NYSE) has served to fuel this view. Recent (February 2012) rumors of an attractive cash offer have further stoked speculation. However, we believe a presence in several jurisdictions would present considerable risk of achieving reasonable approvals across the board. Further, we believe current management is keen to continue executing on its strategic initiatives. TECO Energy, Inc. (TE-NYSE) As a small, single-state regulated utility in Florida, we believe TECO Energy, Inc. is a potential acquisition target and an attractive candidate for a contiguous merger. TECO’s coal assets could make it an intriguing name as well. POSSIBLE ACQUIRERS Dominion Resources, Inc. (D-NYSE) Dominion was rumored to have been interested in acquiring Progress Energy away from Duke Energy. Since then, the Company has stated that it continues to focus on its organic growth plan and on achieving a 5-6% long-term earnings growth target. We believe that the Company would consider any opportunities that were accretive to earnings and shareholder value. RECENT M&A ACTIVITY UPDATE Duke Energy Corporation and Progress Energy, Inc. On July 2, 2012, Duke Energy Corporation (DUK-NYSE) and Progress Energy, Inc. (PGN) completed their merger to become the country’s largest utility, having about 57 GW of domestic generating capacity serving approximately 7.1 million electric customers in the six states of North Carolina, South Carolina, Florida, Indiana, Kentucky and Ohio. Immediately following the merger close, the new combined company Board (10 legacy DUK directors vs. five legacy PGN directors) voted out incoming Progress Energy CEO Bill Johnson and reinstalled outgoing Duke Energy CEO Jim Rogers as head of the combined company. The North Carolina Utilities Commission (NCUC) began investigative hearings into the post-merger CEO switch. Ultimately, we do not believe the NCUC would rescind its merger approval and understand that settlement talks are underway to resolve the matter; however, we feel the investigation could add increased regulatory risk to upcoming rate cases and that potential litigation and other employee issues could somewhat detract from the Company fully achieving merger synergies. We believe the situation bears watching as it unfolds. KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 22 of 65 August 2012 Table 6. Recent Utility M&A Activity Date Announced Acquirer Acquiree Consideration Offer Price per Share Implied Value at Announcement1 Premium at Announcement2 7/22/12 NRG Energy Inc. GenOn Energy Inc. 100% Stock 0.1216 shares $3.9 billion 20.6% 2/21/12 Fortis Inc. CH Energy Group 100% Cash $65.00 $1.5 billion 10.5% 7/12/11 Gaz Metro L.P Central Vermont Public Service Corp. 100% Cash $35.25 $704.1 million 44.9%4 4/28/11 Exelon Corporation Constellation Energy Group, Inc. 100% Stock 0.930 shares $10.6 billion 12.5% 4/20/11 AES Corporation DPL Inc. 100% Cash $30.00 $4.7 billion 8.7% 3/2/11 PPL Corporation Central Networks (from E.ON UK plc) 100% Cash N/A $6.40 billion N/A – Subsidiary 1/10/11 Duke Energy Corporation Progress Energy, Inc. 100% Stock 2.6125 shares $25.7 billion 3.9%; [6.4%] 3 12/7/10 AGL Resources Inc. Nicor Inc. 40% Cash and 60% Stock $21.20 and 0.8382 shares $3.1 billion 13.3% 10/18/10 Northeast Utilities NSTAR 100% Stock 1.312 shares $7.56 billion 1.9% 8/13/10 Blackstone Group, L.P. Dynegy Inc. 100% Cash (Failed) $4.50 at annc. ($5.00 final) $4.6 billion 61.8% 4/28/10 PPL Corporation E.ON U.S. (Louisville Gas & Electric and Kentucky Utilities) 100% Cash N/A $7.63 billion N/A - Private 4/21/10 Calpine Corporation Conectiv Energy Holding Co. 100% Cash N/A $1.65 billion N/A - Subsidiary 4/11/10 Mirant Corporation RRI Energy, Inc. 100% Stock 0.353 shares $1.63 billion 4.4% 2/11/10 FirstEnergy Corporation Allegheny Energy, Inc. 100% Stock 0.667 shares $8.5 billion 31.6% 10/20/08 Exelon Corporation NRG Energy, Inc. 100% Stock (Failed) 0.485 shares $6.15 billion 36.7% 10/26/07 Macquarie Consortium Puget Energy, Inc. 100% Cash $30.00 $7.4 billion 25.3% 6/25/07 Iberdrola SA Energy East Corporation 100% Cash $28.50 $8.50 billion 27.4% 2/26/07 KKR TXU Corp. 100% Cash $69.25 $44.16 billion 15.4% 2/7/07 Great Plains Energy Inc. Aquila Inc. 55% Cash and 45% Stock $1.80 and 0.0856 shares $2.8 billion -2.7% 7/8/06 MDU Resources Group Cascade Natural Gas Corp. 100% Cash $26.50 $471.2 million 23.5% 7/5/06 Macquarie Consortium Duquesne Light Holdings Inc. 100% Cash $20.00 $2.59 billion 21.7% 4/25/06 Babcock & Brown NorthWestern Corporation 100% Cash (Failed) $37.00 $2.23 billion 15.3% 12/19/05 FPL Group, Inc. Constellation Energy Group, Inc. 100% Stock (Failed) $62.02 $14.42 billion 0.65%; [15.0%] 3 Notes: Deals currently pending in italics 1) Deal transaction value (includes debt assumed) 2) 1-day closing stock price premium 3) [20-day average closing stock price premium] 4) Prior to previous agreement announced on May 30, 2011 Source: Company data, KeyBanc Capital Markets Inc. estimates KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 23 of 65 August 2012 SHORT INTEREST OVERVIEW Toward the end of 2010, sector concerns of a longer-dated U.S. economic recovery (dampening electric demand), weak initial outlooks by some companies heading into a new year, challenged power prices for merchant generators and questions around dividend security all contributed to the group trading at a discount to the S&P 500. We believe that many of these topics of concern were addressed by company managements during the 1H11 earnings seasons, leading to renewed confidence in the stability of our industry and subsequent sector outperformance in 2H11 (see Chart 11) as a defensive play amid broader market concern of a slower global economic recovery. A pick-up in M&A activity, double-dip U.S. recession fears and European sovereign debt issues appear to have dampened any enthusiasm for a quicker or stronger than expected economic recovery, and led to sharp broader market declines in July 2011. Chart 11. Forward P/E Comparison of KBCM Utility Coverage vs. S&P 500 (December 31, 2010 – August 17, 2012) 10.5x 11.0x 11.5x 12.0x 12.5x 13.0x 13.5x 14.0x 14.5x 15.0x 15.5x 16.0x De c - 1 0 Ja n - 1 1 Fe b - 1 1 Ma r - 1 1 Ap r - 1 1 Ma y - 1 1 Ju n - 1 1 Ju l - 1 1 Au g - 1 1 Se p - 1 1 Oc t - 1 1 No v - 1 1 De c - 1 1 Ja n - 1 2 Fe b - 1 2 Ma r - 1 2 Ap r - 1 2 Ma y - 1 2 Ju n - 1 2 Ju l - 1 2 Au g - 1 2 Date 12 m o F w d P / E 0.88 0.92 0.96 1.00 1.04 1.08 1.12 1.16 1.20 1.24 1.28 Re l a t i v e P / E KBCM Utility Index S&P500 Relative P/E Source: FactSet Historically, underperformance in our sector has provided opportunities for investors to cover their short positions. Short positions were built up in 2010 likely due to less optimistic views around merchant exposure, as a sluggish economy and sustained weakness in natural gas pricing appear to have dampened expectations around a recovery in power pricing. Arbitrage activity around M&A appeared to have also contributed to higher short interest in 2010. Heading into 2011, sector underperformance allowed investors to cover their short positions as evidenced by the declines through March 2011. Short interest modestly increased through 4Q11, likely from increased shares and positioning due to M&A related activity, as well as our sector having outperformed the broader market. The beginning of 2012 allowed investors to again cover their short positions, as our sector has underperformed while the broader market recovers based on renewed confidence of a U.S. economic recovery. The March 2012 uptick in total short position for our group was mostly due to an increased short position in Pepco Holdings, Inc. in connection with its March 5, 2012 forward sale agreement. Short interest has held mostly at steady levels since then (see Table 7), with the sharp July drop-off in short interest mostly due to the Duke Energy merger closing when there were some investor bets that the deal may not close. KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 24 of 65 August 2012 Table 7. Monthly Short Interest (days) (shares in millions) Shares Current 2012 2011 2010 Company Ticker Out Short Ratio Jull Jun May Apr Mar Feb Jan Dec Nov Oct Sep Aug Jul Jun May Apr Mar Feb Jan Dec Ameren Corp. AEE 242.6 2.3 2.4 2.9 3.9 4.3 4.7 3.5 3.2 3.7 4.7 4.6 7.2 5.5 4.2 5.1 5.5 6.0 5.5 7.4 9.1 7.7 American Electric Power Co. AEP 484.9 2.5 6.6 5.8 5.5 4.4 3.5 4.1 4.9 5.6 4.8 6.3 5.9 8.5 4.3 5.5 7.3 5.0 3.8 4.8 4.8 4.0 Avista Corp. AVA 58.8 10.9 2.0 2.3 2.3 2.2 1.9 1.9 2.2 2.4 2.1 2.0 2.4 2.5 2.1 1.9 1.6 1.5 1.5 1.4 1.3 1.5 CMS Energy Corp. CMS 265.0 2.3 4.5 5.1 5.9 4.2 9.4 10.1 13.5 11.4 13.5 17.6 15.0 15.8 16.6 13.0 12.5 17.1 10.4 13.2 11.3 13.9 Central Vermont Public Svc. Corp. CV 0.0 n/a 0.0 0.9 1.0 1.1 1.0 1.0 0.8 0.5 0.6 0.6 0.6 0.5 0.3 0.4 0.4 0.4 0.4 0.3 0.3 0.3 Cleco Corp. CNL 60.7 6.5 2.1 2.3 2.9 2.5 2.9 3.0 2.5 2.7 3.5 3.4 3.8 3.8 3.6 3.7 4.0 4.4 2.8 2.3 2.4 3.4 Consolidated Edison, Inc ED 292.9 5.4 7.3 7.1 7.2 7.0 8.0 7.2 8.2 11.3 10.7 11.2 11.9 13.5 14.1 13.1 11.8 9.5 7.3 7.7 7.2 7.0 DTE Energy Co. DTE 171.8 1.2 1.0 1.3 1.6 1.9 1.4 1.0 1.0 1.6 1.7 2.2 2.0 2.4 1.8 2.3 3.4 2.7 2.2 1.5 1.6 1.8 Dominion Resources, Inc. D 573.4 2.1 3.4 5.5 5.5 4.1 4.2 5.0 4.6 5.4 7.1 7.9 10.9 11.4 12.5 13.7 13.3 11.4 10.6 10.2 8.1 8.1 Duke Energy Corp. DUK 703.9 1.1 5.5 24.6 26.2 26.4 23.1 18.7 17.1 17.3 17.3 16.2 17.2 16.2 14.7 12.8 10.6 10.0 7.9 7.7 8.7 7.3 Entergy Corp. ETR 177.3 2.2 2.2 2.8 2.6 3.1 2.6 2.8 3.1 3.5 4.1 3.2 3.3 3.5 2.9 3.5 3.7 3.8 2.6 2.8 2.5 1.8 Exelon Corp. EXC 853.6 1.8 8.4 8.4 9.6 10.1 9.8 43.2 40.4 38.3 36.6 31.2 26.0 23.0 19.7 19.5 16.9 13.1 12.6 14.6 14.3 15.0 FirstEnergy Corp FE 418.2 2.3 5.9 5.8 7.7 7.4 6.7 5.9 7.4 4.0 3.7 4.1 5.2 4.4 3.1 4.4 4.7 7.5 5.8 30.1 30.4 30.4 Great Plains Energy, Inc. GXP 153.4 3.1 3.4 3.8 10.0 8.3 7.9 6.3 5.9 5.8 5.7 6.7 6.3 5.3 5.2 5.4 6.2 6.2 5.5 4.7 5.2 6.0 IDACORP, Inc. IDA 50.2 8.8 1.5 1.7 1.5 1.3 1.2 1.2 1.4 1.5 1.8 1.7 2.0 2.0 1.6 1.9 1.7 1.8 1.4 1.3 1.2 1.2 MDU Resources Group, Inc. MDU 188.8 2.6 2.9 2.8 3.1 2.4 2.0 2.7 1.9 1.8 1.8 1.4 1.3 1.6 1.8 2.3 2.7 2.3 2.1 1.1 1.5 1.2 NV Energy, Inc. NVE 236.0 0.5 1.3 1.6 2.3 2.4 2.7 4.8 1.2 2.2 2.8 4.3 3.5 4.4 4.5 4.7 3.5 4.4 3.2 3.0 3.5 5.8 NextEra Energy, Inc. NEE 422.8 5.5 8.5 8.2 9.9 6.9 5.8 6.1 8.1 11.2 7.1 6.0 5.6 5.6 5.1 4.9 4.4 5.0 3.9 3.9 4.3 3.3 NiSource, Inc. NI 284.9 1.0 3.1 3.4 4.1 4.9 4.9 6.6 4.1 4.5 5.0 3.9 4.4 6.1 8.1 6.1 8.0 5.6 5.2 6.2 5.9 5.1 NorthWestern Corp. NWE 37.2 6.4 1.1 1.1 1.2 0.9 0.9 0.8 1.0 1.1 1.4 1.6 1.7 1.8 1.7 1.5 1.4 1.1 1.0 0.9 0.9 0.9 Otter Tail Corp. OTTR 36.2 17.3 1.6 1.7 1.6 1.4 1.3 1.4 1.4 1.6 2.0 1.9 1.9 1.6 1.4 1.5 1.6 1.4 1.4 1.3 1.4 1.4 PPL Corp. PPL 580.7 4.6 18.9 18.4 19.3 17.4 8.2 8.6 8.1 9.8 12.9 14.6 16.5 14.6 14.1 12.2 13.4 14.5 7.9 7.1 7.1 5.4 Pepco Holdings, Inc. POM 228.9 12.8 22.8 23.0 22.6 22.9 23.1 8.8 8.6 9.0 9.2 8.1 9.9 11.4 11.5 12.0 14.1 10.4 13.2 11.7 11.6 10.4 Pinnacle West Capital Corp. PNW 109.5 1.5 1.3 1.9 1.9 1.1 0.8 1.0 1.1 1.4 1.9 1.8 1.9 2.2 1.9 1.7 1.2 1.3 1.1 1.2 1.5 1.6 Progress Energy, Inc. PGN 0.0 n/a 0.0 4.9 4.3 4.7 3.0 2.8 1.9 2.4 2.2 2.7 4.3 4.4 3.5 3.0 3.1 3.2 3.3 3.4 4.4 4.3 Southern Company SO 874.8 1.6 9.8 8.8 11.0 12.4 10.8 10.6 11.7 13.7 13.9 13.3 15.2 12.2 10.2 8.9 7.6 6.7 6.8 6.8 6.3 9.6 TECO Energy, Inc. TE 216.6 4.5 8.0 7.7 8.7 8.0 9.4 8.7 8.5 7.8 7.9 6.9 7.5 6.9 4.4 4.9 6.7 4.1 2.2 1.9 3.2 4.9 Wisconsin Energy Corp. WEC 230.5 4.8 7.6 7.3 7.4 6.0 6.2 4.1 4.3 5.9 6.4 6.5 7.1 7.2 7.0 5.5 5.0 5.5 5.7 5.4 6.9 6.2 Xcel Energy Inc. XEL 487.6 2.9 6.6 6.9 6.9 4.2 3.3 3.3 3.6 4.3 5.1 4.8 6.4 6.0 4.7 5.1 5.4 6.4 4.7 4.4 3.4 5.4 Total 8,441.1 149.7 178.0 197.7 183.9 170.6 185.4 181.9 191.7 197.3 196.6 206.9 204.1 186.4 180.6 181.5 172.2 141.9 168.2 170.3 174.9 Notes: 1) OTTR research coverage initiated January 17, 2012. Historical information provided for comparison purposes. 2) NVE research coverage initiated June 28, 2012. Historical information provided for comparison purposes. 3) PGN research coverage terminated July 3, 2012. Historical information provided for comparison purposes. 4) Historical share counts adjusted for WEC 2:1 stock split on March 1, 2011 Source: Bloomberg, as of August 17, 2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 25 of 65 August 2012 NEXTERA ENERGY, INC. NEE – Quick Alert: Settles with Customer Groups in Florida Rate Case - reprinted from 08/16/2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 26 of 65 August 2012 NORTHWESTERN CORPORATION NWE: Recent Underperformance Unwarranted; Upgrading Shares - reprinted from 08/16/2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 27 of 65 August 2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 28 of 65 August 2012 GREAT PLAINS ENERGY, INC. GXP: Hot Weather Drives 2Q12; Raising 2012 Estimate - reprinted from 08/09/2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 29 of 65 August 2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 30 of 65 August 2012 AMERICAN ELECTRIC POWER COMPANY, INC. AEP - Quick Alert: Ohio Regulators Approve AEP’s Modified ESP; Appears Balanced and Fair - reprinted from 08/08/2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 31 of 65 August 2012 PEPCO HOLDINGS, INC. POM: 2Q12 Below Views; Lowering 2012 Estimate - reprinted from 08/08/2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 32 of 65 August 2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 33 of 65 August 2012 AVISTA CORPORATION AVA: Weather and Economy Weigh on EPS; Lowering Estimates - reprinted from 08/08/2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 34 of 65 August 2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 35 of 65 August 2012 FIRSTENERGY CORP. FE: Lack of Clarity Drives Lack of Confidence - reprinted from 08/08/2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 36 of 65 August 2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 37 of 65 August 2012 IDACORP, INC. IDA: Raising 2012 Estimate and Price Target - reprinted from 08/06/2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 38 of 65 August 2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 39 of 65 August 2012 DTE ENERGY COMPANY DTE: 2Q12 Hot Weather Drives Beat; Raising 2012 Estimate - reprinted from 07/30/2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 40 of 65 August 2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 41 of 65 August 2012 SOUTHERN COMPANY SO: Adjusting 2012 Estimate Due to Weather - reprinted from 07/26/2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 42 of 65 August 2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 43 of 65 August 2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 44 of 65 August 2012 ELECTRIC UTILITIES INDUSTRY: 2Q12 Earnings Preview - reprinted from 07/20/2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 45 of 65 August 2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 46 of 65 August 2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 47 of 65 August 2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 48 of 65 August 2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 49 of 65 August 2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 50 of 65 August 2012 NISOURCE, INC. NI – Quick Alert: Utica JV Announced, Awaiting Details - reprinted from 07/09/2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 51 of 65 August 2012 IDACORP, INC. IDA – Quick Alert: Final Order on Langley Gulch Constructive - reprinted from 06/29/2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 52 of 65 August 2012 NV ENERGY, INC. NVE: Initiating with a HOLD Rating - reprinted from 06/28/2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 53 of 65 August 2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 54 of 65 August 2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 55 of 65 August 2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 56 of 65 August 2012 CMS ENERGY CORPORATION CMS: Updating Price Target After Group Multiple Expansion - reprinted from 06/18/2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 57 of 65 August 2012 IDACORP, INC. IDA: Notes from Investor Meetings; Story Remains Intact - reprinted from 06/13/2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 58 of 65 August 2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 59 of 65 August 2012 EXELON CORPORATION EXC: Analyst Meeting Takeaways, Revising Estimates - reprinted from 06/11/2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 60 of 65 August 2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 61 of 65 August 2012 DUKE ENERGY CORPORATION DUK – Quick Alert: FERC Merger Approval with Minor Conditions - reprinted from 06/11/2012 KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 62 of 65 August 2012 APPENDIX Table 8. Water Supply Forecast (% of Average) 2010 2011 2012 Runoff Period (April - Sept.) Jan Feb Mar Apr May Jun July Jan Feb Mar Apr May Jun July Jan Feb Mar Apr May Jun July Snowpack Idaho Upper Snake River Basin 56 63 57 56 58 87 NA 129 113 106 119 161 283 NA 73 86 89 83 64 63 NA Panhandle Region Basin 60 58 52 55 60 65 NA 91 95 105 112 142 200 NA 84 97 96 118 112 131 NA Oregon Upper John Day Basin 72 80 84 76 66 NA NA 143 98 79 125 217 NA NA 44 81 72 81 17 NA NA Upper Deschutes Basin 90 71 60 67 85 123 NA 149 101 109 137 164 273 NA 49 67 74 106 89 69 NA Washington Spokane River Basin 56 57 52 51 54 51 NA 91 89 96 114 167 277 NA 68 79 92 117 107 105 NA Precipitation Idaho Upper Snake River Basin 75 38 57 140 120 221 43 86 76 163 201 158 149 77 110 94 98 100 95 33 98 Panhandle Region Basin 64 43 85 133 134 197 63 126 107 165 244 138 107 40 95 96 230 141 98 263 115 Oregon Upper John Day Basin 102 59 59 109 169 222 50 85 87 160 135 208 138 35 117 62 150 123 61 143 125 Upper Deschutes Basin 81 53 83 129 127 234 47 76 84 169 141 144 356 107 140 78 183 101 92 180 38 Washington Spokane River Basin 64 46 78 139 139 207 52 140 110 167 241 147 125 28 101 108 215 139 100 253 89 Reservoir Storage Idaho Upper Snake River Basin 115 115 120 126 106 113 106 100 98 98 89 85 104 136 115 114 116 122 109 93 83 Panhandle Region Basin 103 106 111 118 105 102 101 121 113 111 91 77 105 102 80 71 108 148 89 100 100 Oregon Upper Deschutes Basin 110 107 106 105 102 109 106 112 111 106 108 113 121 132 121 114 113 113 114 120 124 Washington Spokane River Basin 47 41 55 73 85 101 100 182 60 105 81 155 97 104 43 57 179 196 76 97 99 Stream Flow Avista Corp. (AVA)* Clark Fork River (75%) - Whitehorse Rapids 77 70 64 60 61 66 74 102 108 113 124 140 157 159 86 88 98 108 110 97 NA Spokane River (25%) 83 57 53 52 55 65 76 101 101 109 126 151 170 176 99 108 133 143 139 161 160 Idacorp (IDA) Snake River-Brownlee Reservoir 60 56 49 51 52 61 72 112 99 91 115 133 159 153 84 83 102 99 86 89 90 Note: NA - not available. *AVA-owned hydroelectric generation is split approximately 75%/25% along Clark Fork/Spokane rivers. Sources: Northwest River Forecast Center (NRFC), National Water and Climate Center (NWCC), U.S. Dept. of Agriculture Natural Resources and Conservation Service (NRCS) as of August 17, 2012. Using observed and estimated sample data input into statistical regression models, a water supply forecast attempts to predict a volume of streamflow that might pass a point on a river stream, typically during the spring and summer seasons. In the western United States, snowfall accumulation (or snowpack) in the mountains during winter and early spring becomes the source of much of the water run-off into riverstreams during the spring and summer snowmelt season. On certain mountain slopes in the Cascades or Rocky Mountains, however, future precipitation may be a more dominant driver of actual streamflow than snowmelt, thus making forecasting more difficult. While no prediction or model is perfect, streamflow forecasts can be important to operational river users (such as hydroelectric dam operators, fishermen or even white-water rafters) who make decisions based on projected river conditions. As a service to our clients, we track the April through September streamflow forecast issued by the Northwest River Forecast Center for companies under coverage (Avista and IDACORP) that have large exposure to hydrological river conditions throughout the year. We believe investors may find incremental value in these forecasts as a possible variable of earnings for the year, offset by any fuel/power supply cost adjustment mechanisms each utility may have to address hydrology variability. The percent-of-average number listed in the table above is only a "probable" forecast within a forecasted range assuming unobstructed upstream influences to the natural seasonal flow of water. In reality, water is stored in reservoirs as it flows down the river basin, where the force of falling water is used to generate electricity. Unknown or unpredictable weather variables, uncertainty in the regression models, and unforeseen changes are other factors to consider that could affect the accuracy of the water supply forecast. KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 63 of 65 August 2012 Table 9. Domestic Generation Capacity for KBCM Utilities Coverage List Oper. Capacity Generating Plants by Fuel Type Capacity Company Ticker (MW) Coal Nuclear Gas Oil Hydro Wind Other Reported Owned: 59% 7% 27% 3% 4% 0% 0% 100% Ameren Corp. AEE 17,256 Used: 84% 12% 1% 0% 3% 0% 0% Owned: 65% 6% 26% 0% 2% 1% 0% 100% American Electric Power, Inc. AEP 38,427 Used: 77% 10% 11% 0% 1% 1% 0% Owned: 11% 0% 30% 0% 56% 0% 3% 100% Avista Corp. AVA 1,931 Used: 20% 0% 10% 0% 66% 0% 4% Owned: 41% 0% 44% 0% 14% 0% 1% 97% CMS Energy, Inc. CMS 7,851 Used: 73% 0% 19% 0% 7% 0% 1% Owned: 24% 0% 76% 0% 0% 0% 0% 100% Cleco Corp. CNL 4,624 Used: 64% 0% 36% 0% 0% 0% 0% Owned: 0% 0% 46% 54% 0% 0% 0% 97% Consolidated Edison, Inc ED 831 Used: 0% 0% 73% 27% 0% 0% 0% Owned: 60% 9% 20% 3% 8% 0% 0% 99% DTE Energy Co. DTE 12,346 Used: 77% 19% 1% 0% 3% 0% 0% Owned: 28% 21% 29% 13% 8% 1% 0% 100% Dominion Resources, Inc. D 27,841 Used: 32% 43% 19% 2% 3% 1% 0% Owned: 44% 14% 29% 2% 9% 2% 0% 98% Duke Energy Corp. DUK 38,554 Used: 57% 28% 10% 0% 3% 2% 0% Owned: 8% 33% 59% 0% 0% 0% 0% 99% Entergy Corp. ETR 31,440 Used: 12% 63% 25% 0% 0% 0% 0% Owned: 6% 70% 14% 7% 3% 1% 0% 96% Exelon Corp. EXC 26,085 Used: 3% 92% 1% 0% 3% 1% 0% Owned: 67% 18% 7% 1% 7% 0% 0% 97% FirstEnergy Corp FE 22,548 Used: 70% 28% 0% 0% 2% 0% 0% Owned: 57% 8% 25% 8% 0% 2% 0% 99% Great Plains Energy, Inc. GXP 6,757 Used: 83% 13% 1% 0% 0% 2% 0% Owned: 29% 0% 14% 0% 57% 0% 0% 99% IDACORP, Inc. IDA 3,537 Used: 33% 0% 1% 0% 66% 0% 0% Owned: 70% 0% 21% 0% 0% 9% 0% 99% MDU Resources Group, Inc. MDU 576 Used: 93% 0% 1% 0% 0% 6% 0% Owned: 14% 0% 86% 0% 0% 0% 0% 99% NV Energy, Inc. NVE 6,584 Used: 23% 0% 77% 0% 0% 0% 0% Owned: 2% 13% 51% 17% 0% 17% 0% 94% NextEra Energy, Inc. NEE 46,189 Used: 3% 24% 57% 4% 0% 12% 0% Owned: 77% 0% 23% 0% 0% 0% 0% 100% NiSource Inc. NI 3,334 Used: 85% 0% 15% 0% 0% 0% 0% Owned: 61% 0% 32% 7% 0% 0% 0% 100% Northwestern Corp. NWE 710 Used: 89% 0% 11% 0% 0% 0% 0% Owned: 72% 0% 6% 9% 1% 12% 0% 100% OtterTail Corp. OTTR 754 Used: 85% 0% 1% 0% 1% 13% 0% Owned: 54% 12% 21% 9% 4% 0% 0% 96% PPL Corp. PPL 19,566 Used: 72% 18% 5% 1% 4% 0% 0% Owned: 0% 0% 0% 100% 0% 0% 0% 98% Pepco Holdings, Inc. POM 803 Used: 0% 0% 0% 100% 0% 0% 0% Owned: 33% 16% 50% 0% 0% 0% 1% 100% Pinnacle West PNW 7,058 Used: 53% 29% 18% 0% 0% 0% 0% Owned: 47% 8% 34% 5% 6% 0% 0% 100% Southern Company SO 45,111 Used: 51% 16% 30% 0% 3% 0% 0% Owned: 38% 0% 61% 1% 0% 0% 0% 100% TECO Energy, Inc. TE 4,720 Used: 60% 0% 40% 0% 0% 0% 0% Owned: 60% 0% 29% 5% 1% 5% 0% 99% Wisconsin Energy Corp. WEC 6,867 Used: 86% 0% 11% 0% 1% 2% 0% Owned: 42% 9% 42% 1% 3% 2% 1% 100% Xcel Energy Inc. XEL 18,829 Used: 61% 16% 19% 0% 2% 1% 1% Owned: 40% 9% 33% 9% 7% 2% 0% Total Capacity & Fuel Mix Averages 401,130 Used: 54% 15% 18% 5% 6% 2% 0% Owned % = Operating Capacity (MW); Used % = Net Generation (MWh) Note: Data as of 2011 based on current ownership, rounded to nearest whole percentage. Totals may not sum to 100% due to rounding. Source: SNL Power; Company data, KeyBanc Capital Markets Inc. KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 64 of 65 August 2012 Table 10. Nuclear Outage Days by Company 2Q11 2Q12 Difference Company Ticker Units Total Units Total Units Total Ameren Corporation AEE 1 1.0 1 0.3 (0.7) American Electric Power Company, Inc. AEP 2 2.0 2 31.0 29.0 DTE Energy Company DTE 1 1.5 1 42.3 40.8 Dominion Resources, Inc. D 7 118.2 7 103.5 (14.7) Duke Energy Corporation DUK 7 132.5 7 90.5 (42.0) Entergy Corporation ETR 11 122.3 11 194.2 71.9 Exelon Corporation* EXC 17 157.7 22 159.0 5 1.4 First Energy Corp. FE 4 76.2 4 82.8 6.6 Great Plains Energy GXP 1 89.9 1 0.3 (89.5) NextEra Energy, Inc. NEE 8 238.4 8 164.2 (74.2) PPL Corporation PPL 2 131.5 2 99.0 (32.6) Pinnacle West Capital Corp. PNW 3 40.1 3 19.5 (20.6) Progress Energy, Inc. PGN 5 121.0 5 178.8 57.9 Southern Company SO 6 63.0 6 37.9 (25.1) Xcel Energy Inc. XEL 3 111.1 3 62.4 (48.7) Other Companies Not Covered -- 26 716.1 21 484.7 (5) (231.4) Total 104 2,122.4 104 1,750.3 0 (372.0) *On March 12, 2012, EXC completed its merger with Constellation Energy Group (CEG-NYSE; not covered) that owned 5 units. Source: U.S. Nuclear Regulatory Commission (as of June 30, 2012), KeyBanc Capital Markets Inc. estimates KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC Equity Research Page 65 of 65 August 2012 KeyBanc Capital Markets Inc. Disclosures and Certifications Important disclosures for the companies mentioned in this report can be found at https://key2.bluematrix.com/sellside/Disclosures.action. 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Please refer to the analysts' recently published reports for company-specific valuation and risks. Rating Disclosures Distribution of Ratings/IB Services Firmwide and by Sector KeyBanc Capital Markets IB Serv./Past 12 Mos. Rating Count Percent Count Percent BUY [BUY] 224 42.11 43 19.20 HOLD [HOLD] 294 55.26 44 14.97 SELL [UND] 14 2.63 4 28.57 ENERGY IB Serv./Past 12 Mos. Rating Count Percent Count Percent BUY [BUY] 39 49.37 16 41.03 HOLD [HOLD] 40 50.63 16 40.00 SELL [UND] 0 0.00 0 0.00