Jul 28, 2011
Executives
Laura Mountcastle – VP and Treasurer John Russell – President and CEO Thomas Webb – EVP and CFO
Analysts
Daniel Eggers – Credit Suisse Greg Gordon – ISI Group Ali Agha – SunTrust Mark Barnett – Morningstar Paul Ridzon – KeyBanc Brian Russo – Ladenburg Mark Segal – Canaccord Genuity Jonathan Arnold – Deutsche Bank
Operator
Good morning, everyone and welcome to the CMS Energy 2011 Second Quarter Results and Outlook Call. This call is being recorded.
Just a reminder, there will be a rebroadcast of this conference call today beginning at noon Eastern Time running through August 5th. This presentation is also being webcast and is available on CMS Energy’s website in the Investor Relations section.
At this time, I would like to turn the call over to Ms. Laura Mountcastle, Vice President and Treasurer.
Please go ahead.
Laura Mountcastle
Thank you. Good morning and thank you for joining us today.
With me are John Russell, President and Chief Executive Officer; and Tom Webb, Executive Vice President and Chief Financial Officer. Our earnings press release issued earlier today and the presentation used in this webcast are available on our website.
This presentation contains forward-looking statements. These statements are subject to risks and uncertainties and should be read in conjunction with our Form 10-Ks and 10-Qs.
The forward-looking statements and information and risk factors sections discuss important factors that could cause results to differ materially from those anticipated in such statements. This presentation also includes non-GAAP measures.
A reconciliation of each of these measures to the most directly comparable GAAP measure is included in the appendix and posted in the investor section of our website. Reported earnings could vary because of several factors, such as legacy issues associated with prior asset sales.
Because of those uncertainties, the company isn’t providing reported earnings guidance. Now I’ll turn the call over to John.
John Russell
Thanks, Laura and good morning everyone. I appreciate you joining us today for our second quarter earnings call.
I’ll begin the presentation with a few brief comments about the quarter before turning the call over to Tom for a more detailed discussion on the financial results and the outlook for the remainder of the year. Then we will close with Q&A.
Second quarter adjusted earnings per share was $0.26, the same as last year. The benefit from electric and gas rate relief was offset by higher rate base investment cost, storm restoration cost and accelerated investments in system reliability.
The first half adjusted earnings per share was $0.77, up $0.13 or 20% over last year, primarily reflecting a rate relief and favorable first quarter weather. Tom will review the details with you in a few minutes.
We remain on track to achieve our adjusted earnings per share guidance of a $1.44 a share. Let me give you an update on the Michigan Public Service Commission before I talk about our regulatory agenda.
Commissioner Monica Martinez’s term officially ended July 2. However, she has agreed to remain a Commissioner for a while.
The governor has been interviewing several candidates, but I can’t comment on the timing of the appointment, it’s his decision. Moving to the Regulatory Agenda.
There are several important orders and filings during the second quarter. In June, we filed a new electric rate case requesting a $195 million increase based on a 10.7% return on equity.
I’ll review the details of this filing on the next slide. The Commission approved the reconciliation of our energy optimization plan cost for 2009 and approved a $6 million incentive for exceeding the plan targets.
We also requested approval to collect an $8 million incentive for exceeding the 2010 targets. More than 200,000 customers have participated in our energy efficiency programs.
Also in June, the Commission approved our amended renewable energy plan authorizing us to reduce the surcharge by $54 million annually. This will provide headroom to minimize the customer rates going forward.
On the gas side of the business, the Commission approved a rate case settlement authorizing us to increase our natural gas rates by $31 million effective May 27th based on 10.5 return on equity. We anticipate filing a new gas rate case in the third quarter of this year.
In keeping with our plan, we filed a new electric rate case on June 10th. The request seeks to recover new investments in system reliability and environmental compliance.
We’ve lowered our O&M cost by $31 million to reflect employee benefit plan changes and increased productivity. This was partially offset by a proposed $13 million increase and forestry expense and a projected $14 million increase in uncollectable accounts due to the expected reduction in funding.
We also adjusted our sales forecast to reflect a higher level of sales to retail up and access customers. We plan to sales implement a rate increase in December with a final order in June of next year.
From our customer’s perspective, the renewable energy surcharge reduction and the DoEs settlement refund which Tom will discuss in a few minutes are expected to provide over $75 million to help offset the impact of this case. Let me give you an update on some recent operational highlights.
We received a favorable vote on our special land use permit for our first wind park, the 100 megawatt Lake Winds energy park. Construction of this $232 million project is planned for the start – this plant is start to this fall.
By the end of 2012 about 8% of our power will come from renewable energy resources developed in Michigan. State Environmental Regulators approved an 18 month extension of our air permit for the construction of the 830 megawatt clean coal power plant in our current wet out generating complex.
This extension keeps open an option to meet further future customer demand. The recent cross state air pollution rule will require us to meet a federal mandate to reduce emissions starting in 2012.
Our plan includes installing FDR scrubbers and fabric filters at our large coal-fired plant as part of our $1.5 billion environmental CapEx plan. We’re still analyzing the impact of the rule on our plan as it relates to our older, smaller coal-fired plants.
We expect recovery of all environmental investments. On the operational front, our Campbell 2 coal plant set a new record for a continuous run of 325 days in counting, a notable achievement for a plant that is over 40 years old.
Safety is something that we work on every day, it’s our number one priority and I am pleased that consumers energy received the American Gas Association 2010 Safe Driving Award. Our employees drove more than 40 million miles in 2010.
Another significant safety milestone was achieved at Dearborn industrial generation complex. The employees completed five years without any recordable incidents.
We’ve incurred a significant number of storm related outages and cost during the first half of this year. Our crews have done a great job restoring service on nine different occasions to over 800,000 customers.
In the first six months there were 219 severe weather warnings almost twice as much as last year. The frequency and wide spread damage lead to a 60% increase in customer outage minutes compared to the first half of 2010.
Despite our efforts to harden the system, there is little we can do to prevent damaging incurred by ice, tornadoes and wind storms. And as you would expect the storms had an impact on earnings reducing earnings per share by $0.07 in the first half, five more than last year.
Everyone has been talking about the extreme temperatures across the nation over the past couple of weeks. Although this is not a second quarter event, I do want to talk about how our electric system performed last week.
On July 21st, we set a new peak load record of 8,885 megawatts, slightly greater than our previous peak of 8,883 megawatts setback in August of 2006. As you can see on the slide, the annual peak drop during the recession.
Our generation and distribution systems performed very well last week. We had a 50% reduction in heat related customer outages, on this year’s peak day compared to 2006.
And the customers who did lose power 99.5% were restored within eight hours. The doubling of our capital investment in our electric distribution reliability systems since 2007 has made a difference.
It allowed us to meet the highest level of customer demand in our history with a fewest number of interruptions. The infrastructure investments are paying off for our customers and our investors.
Now I’d like to turn the call over to Tom to discuss the results further.
Thomas Webb
Thanks, John. I’m delighted to add my welcome to everyone on the call this morning.
I know it’s a very busy morning and some of you are just now dialing in, so thank you for that. Second quarter results were solid with reported GAAP earnings at $0.38 a share up $0.06 from last year, primarily for a one-time non-cash state income tax benefit of $0.12 offset partly by a one-time insurance benefit in 2010.
Excluding the one-time favorable news in both years, adjusted EPS was $0.26 in each year. For the first half, as John mentioned, earnings were up 20% from last year and this is our best first half result in almost a decade.
In May, Governor Schneider signed in to a new Michigan Corporate Income Tax in the law to improve the attractiveness of Michigan business. The overall future implications to us were minimal, the new law did not however continue our provision in the old Michigan business tax, that permitted the tax impacts of timing differences between cumulative book expenses and tax deductions to be recorded on balance sheet.
Specifically for us, this results in a utility liability of $134 million that will be recorded as a regulatory asset for recovery later. Outside the utility, this tax results in a $32 million tax benefit, again we recognized in this quarter.
As you can see on this slide, adjusted earnings were equivalent to last year despite unusually severe storms that John just described to you. Recall that in the first quarter results were substantially better than planned.
We used some of this space to increase our efforts to further improve customer reliability, we’re still on course to do this, but with a little bit smaller step up in order to address the severity of the recent storms. Now as many have, we’ve been seeing a bit of slowing in the economic recovery late in the second quarter, but overall growth for the year is still good.
It’s clear now that some of our customers suffered from the supply issues associated with the tsunami in Japan. This in the desire by automakers to accelerate some of their model changeovers resulted in the little slower industrial electric sales growth than we anticipated.
Still, industrial sales were up 3% on top of the 12% growth in the second quarter of last year and that’s a stronger growth in the second quarter of this year than we saw in the first quarter. Residential sales growth continued at about 1%, commercial sales, however, were down 3%.
The Federal Deficit Debate in Washington and gas prices also appeared to be dampening consumer confidence, how that plays in the sales is always hard to predict. For the year, we anticipate weather adjusted electric sales to be up about 2%, a little softer than the 2.5% that we shared in our last call.
We anticipate returning to prerecession industrial sales this year and for total sales we expect to be back to prerecession level next year. This forecast reflects a recovery at less than half the amount experienced after the big recession in the early 1980.
We continue to plan in a conservative manner. Now let’s recap the storm and weather impacts for the first half.
In 2011 storms were unfavorable at our electric business impacting earnings by $0.07 of share, offset partly by favorable weather at our gas business. Total, storms and weather were unfavorable by $0.02 so far this year.
Last year however storms $0.02, mild weather was adverse was $0.04. Altogether, weather and storms hurt 2011 earnings by $0.02, we’ve managed this in our total plan.
Last year weather and storm hurt $0.06 leaving a favorable year-to-year comparison. In July it’s been hot and it was pretty hot in July of 2010.
We are over 400 Gigawatt hours ahead of the forecast so far in July. This certainly will help us continue to reinvest in actions that improve reliability.
So for first half of the year earnings were up $0.13 or 20% and that’s well ahead of our plan. With the exception of storms, our cost plans are as expected.
We continue to take advantage of favorable overall results to accelerate work to make meaningful improvements in reliability for our customers. Now looking ahead, most of our rate increases for the second half were already in place from existing orders, coupled with scheduled investments that keeps us right on plan to deliver earnings at $1.44 a share and that’s up 6% from last year.
In July, we completed settlement of Spent Nuclear Fuel Obligations with the Department of Energy. First, we paid off loan of $44 million plus interest of $119 million to close out any obligations remaining for spent nuclear fuel prior to 1983.
Second, as shown on this slide, the DoE satisfied its financial obligation for 1983 and beyond with a payment of $120 million. This resulted in proceeds of $35 million in excess of book value.
A portion of this 35 million could be provided as a refund to customers. We proposed that 23 million be shared with customers and about 12 million with investors through earnings.
This latter portion represents recovery of cost that we’ve incurred over the years. In the near future, we’ll file this proposal with our Public Service Commission another step toward meaningful rate mitigation, we expect an order sometime in 2012.
Our 2011 cash flow metrics both for the parent and the utility are on target as well. Financing plans for the year are complete including a new continuous equity program that we initiated in June.
We raised $15 million from this program and do not plan to issue more this year. This is one of the tools we said that we might use to supplement our drift in our direct stock purchase plan.
Combined these programs provided about $29 million a year. We still have no plans to issue large blocks of equity during the next five years.
At the utility you can see the $44 million prepayment of our pre1983 DoE loan net of the post 1983 DoE payment to Consumers Energy. Now stepping back you can see here on this slide that we have strong liquidity with a level well over a third of our market value, peers average about 20%.
Today we have $2.5 billion of capacity with about half of this in the form of long-term revolvers and about 40% in cash. As of the end of the first half of the year $2.3 billion of this capacity was available.
Here’s list of items that provide you the opportunity to assess possible changes against our earnings in cash flow. We’re comfortable with our outlook and guidance, but like many of you we constantly measure performance in a manner to deal with issues should pay a rise.
Our earnings growth rate has been 8%. Over the last several years we continue to project future earnings growth in the 5% to 7% range along with a healthy dividend payout.
Now here is our 2011 report card. Earnings, cash flow and capital structure metrics continue to be strong all on or better than target.
So thanks again on this very busy day for dialing in to our call, we appreciate your interest and support. And John and I would be happy to take your questions at this time.
Operator
Thank you very much, Mr. Webb.
(Operator Instructions) Our first question comes from the line of Daniel Eggers with Credit Suisse. Please proceed.
Daniel Eggers – Credit Suisse
Hi, good morning, guys, this is Kevin.
John Russell
Good morning.
Thomas Webb
Good morning.
Daniel Eggers – Credit Suisse
Good morning. And so with your – with the rate case filing, what is your expected volumes for 2012?
John Russell
Sales volumes delivery?
Daniel Eggers – Credit Suisse
Correct, correct, yeah.
John Russell
We are planning on something that’s really just (inaudible) kind of in the ball park of what we’re talking to you about now, let’s see if we can get you some of that volume number here hold on just a second. So we are looking in that case it’s something that would show about 2% growth year-over-year if you think of that as ‘11 over ‘10 and that will apply that towards next year.
Daniel Eggers – Credit Suisse
Okay. And then what are you think about the change in decoupling?
When we will greater insight from the commission and the staff with regards to moving rate from the 10% cap in choice? I mean –
Thomas Webb
I think that’s a great question. And the first answer will come when we get sort of what I call the second part of the gas rate case after this settlement.
The commissions do some time within this next month to talk to us a little bit about how they would handle decoupling. I think there we will see a signal when that direction comes out as to whether they want to modify the process a little bit going forward and we’ll just wait and see.
I know there are different views in the States about how the decoupling should be handled, some people feel that it will be better just to make it energy efficiency and others like us feel that we like the more full decoupling approach for the economy, as well as the weather, but let’s all wait and see what happens.
Daniel Eggers – Credit Suisse
Okay. And then my last question with regards to your dividend.
It still looks like you are below your target dividend average of 65% to 70%, how – would you like to step that up an one big increase at the end of this year, beginning of the next year or would you like to do it till several years?
Thomas Webb
Okay, let me take that one. We’ve not given guidance on our payout ratio.
We know we’re below the peers in that, we grow a little bit faster than our peers and our payout ratio are better a little bit than last. But that’s something we look at on an annual basis compared to the industry and say we need to be competitive with our peers and satisfy our shareholders.
Daniel Eggers – Credit Suisse
Okay. Thank you.
Take care.
Thomas Webb
Thank you.
John Russell
Thanks, Kevin.
Operator
Your next question comes from the line of Greg Gordon with ISI Group. Please proceed.
Greg Gordon – ISI Group
Good morning, gentlemen.
John Russell
Hi, Greg.
Thomas Webb
Good morning.
Greg Gordon – ISI Group
So can you – you might have touched on this and I missed it in your scripted comments, but you clearly had a lot more expenses related to storms than you’ve had planned for, but you are still on track to hit your targeted earnings for the year. So what’s – what have you done to modify your operating budget to afford just to stay on track?
Thomas Webb
Yeah, a couple of things. (Inaudible) is common on both – what we’ve done is we’ve accelerated expenses above and beyond the rate case levels this year.
One of the key areas is forestry expense. Our focus is to improve the reliability to our customers, so what we’ve been able to do because of the success in the first half of this year continue to accelerate investment.
Some of those investments so we will slow down a little bit based on the storms that we’ve had and paying for the storms and the recovery of those storms. So we’re in position pretty well to do that and as I mentioned earlier, we did have some favorable weather early in the year in the gas business to offset some of those storm cost.
And what’s not in there now, but Tom covered is how hard it is in July.
John Russell
And let me give you a little color on the tree trimming to help everybody because I know that’s one area that we’re able to do things effectively in short-term. So our plans for this year at nearly $10 million increase in tree trimming.
After the first quarter we’re so good, we moved that up substantially by around another $10 million and we pulled that back just a little bit, not a lot and with this very hot July that John just mentioned we may not need to pull that back much at all. So the important message here I think is not only through tree trimming but through their entire business, we manage our cost to fit what our business needs.
And so we work with reliability and we work the results as well.
Greg Gordon – ISI Group
Okay. So the storm costs are really, functionally been offset by a strong first quarter and what looks like a strong third quarter in terms of top line.
And then you’ve been able to sort of flux your reliability spending as well?
John Russell
(Inaudible) wouldn’t even think too much about the third quarter. We’ve been able to flux through the first year, first year-to-date to handle it.
Greg Gordon – ISI Group
Great. At a $1.44 share for the year, if we isolate just the electric utility, are you earning at your authorized return or below your authorized return?
Where do you think that puts you?
John Russell
When you look at the data you’re going to see us up a little bit for the trailing 13 months. And don’t let that coming get in the way, little bit of that may be a weather adjustment, but over the year we anticipate to be fairly close to those authorized levels, both electric and gas.
And I can’t predict it could be a tenth or so above or tenth so under, but in that range.
Greg Gordon – ISI Group
Great. Thank you guys.
Thomas Webb
Thank you.
Operator
Your next question comes from the line of Ali Agha with SunTrust. Please proceed.
Ali Agha – SunTrust
Thank you, good morning.
John Russell
Good morning.
Ali Agha – SunTrust
I wanted to get, John, a sense from you. There were some rumblings in Michigan about a bill that was going to be introduced to support more retail open access for schools and you continue to have marketers and others talk about a push towards retail open access beyond the current limit.
Can you just provide us the latest of what you’re gathering in terms of focus on that issue?
John Russell
Yeah, sure. There has been a bill that has been introduced, but it’s not going anywhere and it’s to provide in exception to the 10% cap for schools only.
There is – what we see is no traction in the bill, very little interest in the bill. But you said it right, Ali, it was promoted by out of states third-party marketers and there seems to be little interest in the legislature to move forward with that.
Ali Agha – SunTrust
Okay. And nothing else from the Governor’s office any other anecdotal data point that gives you added comfort on this issue recently?
John Russell
Yeah, I mean we’ve met with the Governor several times and he’s made some public statement, he is very supportive of the law, he likes the law the way it is. He doesn’t have any plans to change the law, we’ve – I don’t think the Senate or the House Energy Committee Chairman’s have mentioned it, but they’ve talked to us about it, they like the fact that we’re into a couple of years in the law as you know it only started in 2008.
We’ve been making significant investments or partnering with the state the latest one that we combined with the DTE and Huntington bank to do the pure Michigan connect. The administration – this administration see us more as an economic development partner to help grow Michigan, make investments and move the state and business forward.
So I’m very pleased to help and it’s what we want to do.
Ali Agha – SunTrust
And secondly, I think, I heard you, John, say that the plan would be to file the next gas rate case in the third quarter. You also pointed out on a trailing 13-month average gas auto of 12.6% was obviously significantly above authorized.
Are you comfortable that looking at the future plans that you get back to or below authorized levels or would that third-quarter filing be potentially push back a bit?
Thomas Webb
Ali, that’s a good question and I would answer get to the end and say, no. We think the timing is right for the filing, but the 12.6 % that you see from the trail through June 30th, if you whether adjust that right away you get to 11.5%.
But then when you look at our full-year plans for the next six months, we’re in that pretty close to the zone of the authorized level of the 10.5%. So we feel really comfortable that what we’re doing is bringing our investment programs forward and then asking to get the recovery of those and rates in working too hard to keep our O&M down.
So those are things that are received pretty well up in lancing.
John Russell
And I’ll take a look at what I mentioned in the electric business. I mean that case that we filed there all capital spent with a reduction in O&M and that’s a good way to look at.
We talked before about we’re trying to keep our base rates, we anticipate to keep our base rates at or below the rate of inflation going forward. And the way to do that is to go in to rate cases where you actually have reduction or very small increase in your O&M.
Ali Agha – SunTrust
Okay. And last question.
Tom, I think you mentioned no financial major block of equity, but fair to say for planning purposes between drift and perhaps more periodic equity about around 15 million a year or so is that a good rule of thumb to think about?
Thomas Webb
No, I tell you should look at our cash flow schedule we show you and if you put those together, I would – you think between $25 million and $30 million a year. The continuous equity being around $15 million and then the drift in the rest there, so that’s about the number to use $25 million to $30 million, you see $29 million forecast for this year.
Ali Agha – SunTrust
Got it. Thank you.
Thomas Webb
You’re welcome.
Operator
Your next question comes from the line of Mark Barnett with Morningstar. Please proceed.
Mark Barnett – Morningstar
Hey, good morning, guys.
John Russell
Good morning.
Mark Barnett – Morningstar
Couple of quick questions. You gave a lot of detail on the OpEx impact from those storms.
Could you maybe talk a little bit about the internal CapEx from your plan that you may have incurred? And how those expenses are going to be recovered?
Thomas Webb
Yeah, the capital when you think of storms like that, we’ve shown you there is the impact on earnings. Usually a storm is split, but depends on the type of storm.
Ice storm will be majority of capital, a little bit of less in O&M, most of the recovery outages based on wind and others will be the majority of O&M. So for planning purposes think of the split.
The capital that we spent for restoration for the customers is in the plan. We’ve got the capital for that, it was the O&M that exceeded what our targets were for the first half of the year.
Mark Barnett – Morningstar
Okay. That’s good.
And then second, I guess more of a general economic question. Through the first six months given adjusted for weather you had a 2% increase in residential usage, permitting as far as correctly.
Would you think is a similar factors that are driving that improvement?
Thomas Webb
Yeah, I’d tell you the way to look at that and what you’re seeing on that slide is full-year, just to relate that a little bit to help you on your questions that the residential side for the first half is up about 1% compared to our two-year and trending up. Commercials been down and flat and the industrial is what continues to grow for us.
So what we’ve seen for the last year and half is the industrial recovery is driving substantially the rest of the state for us, the rest of our service territory. We’re watching the first quarter with good growth particularly on top of the 12% increase a year ago, the second quarter with good growth compared to the 12% a year ago increase.
And so we see the industrial side leaning the way out where consumer confidence comes back and the residential is already turning around. So we see that being up about 2% for the year following that industrial up about 5% for the year, but the commercial side is lagging.
And candidly that simply confidence people going back to the commercial sector for things that they need whether its haircuts or whatever it maybe and that part is coming around slower than the rest, I suspect we’ll see that turn up a little bit next year, not this year.
John Russell
And one thing to just to add to that Michigan has got a reputation for the high-end employment, but if you think about two years ago, we were at 14.5% unemployment rate, we’re down to 10.5% which is the significant reduction. We’re still about a point above the national average, but we’re starting to see the employment at Michigan comeback and some of the autos comeback and start to hire different shares, and particularly when you think about the bolt on and some other things that are being produced here.
We’re starting to see that unemployment number come down, which I also think maybe having a little impact on residential sales account.
Mark Barnett – Morningstar
Okay. That’s a good detail.
And just one more quick question, if I can. Yesterday on a call I had a mention of another legal challenge to your casper or even that have snapped back in the D.
C. Circuit Court sometime this year.
I was wondering if you heard anything about that, and how that might proceed if that – what are going to happen.
John Russell
Yeah, I’ve not heard about it, it’s not unexpected though, I expect that. Everything that comes out of the EPA recently and probably in the near future will be challenged by somebody.
So we’re looking at, we are – our planning purposes looks that what the order says, what the regulation requires and then we look at what the reality is, that what we expect through lawsuits and through fights to get this through. Our point is as we think at the end of the day that regulation will probably be delayed about a year, that’s where we’re looking at.
Mark Barnett – Morningstar
Okay. Thanks.
I appreciate it, guys.
Operator
Your next question comes from the line of Paul Ridzon with KeyBanc. Please proceed.
Paul Ridzon – KeyBanc
Which regulation that we’re talking about being delayed a year?
John Russell
That was casper.
Paul Ridzon – KeyBanc
And what about (inaudible)?
John Russell
No.
Paul Ridzon – KeyBanc
No to that?
John Russell
No, I mean that will be fought in courts, but the one that we are looking at right now that affects us most is casper.
Paul Ridzon – KeyBanc
And then just take you back in all these questions? Schools, except for the schools, there is really nothing effort that could change the ROE?
Thomas Webb
No, that doesn’t seem to be much interest, Paul. I mean, people – I hear it from analysts and I hear it from outside energy providers, but they’re just doesn’t seem to be the interest here.
And the reason is the administration looks it up with being the second largest investor in the state, the seventh largest employer in the state, we spent $2 billion a year on goods and services with the state that support 2700 companies in Michigan. So when they looked us, they would think, wow, this is a pretty important company to the success for the state of Michigan.
Paul Ridzon – KeyBanc
Sounds good. Thank you.
Thomas Webb
You’re welcome.
John Russell
Thanks, Paul.
Operator
Your next question comes from the line of Brian Russo with Ladenburg. Please proceed.
Brian Russo – Ladenburg
Hi, good morning.
John Russell
Good morning.
Thomas Webb
Good morning.
Brian Russo – Ladenburg
Can you just maybe elaborate a little bit on the coal plant air permit expansion, remind us of the decision to delay that initially and is there a new kind of a time line for new base load needs and is there a greater amount of appetite for a clean coal plant in Michigan.
Thomas Webb
Yeah, great question. I will say just publicly, it was much easier to get the extension than it was the original air permit.
But now that we have it at the end of the day the fundamental principles of why – why we went? Why we delayed it in the first place still whole through.
The gas price is continue to be low, we believe that shale gas is real, it’s going to keep prices, gas prices low in the future. Despite the fact that we’re seeing an increase in customer demand, it’s not enough to justify a new plant and there is still uncertainty of what we’re going to do about our older small coal-fired unit.
I mean those plants despite the fact that they are old they are dispatched at a high rate, nearly 70 % capacity factors. So nothing has really changed from that standpoint, but we thought it was in our best interest to request the extension just to provide an option for us in the future.
Brian Russo – Ladenburg
Okay. And also just can you remind us how the decoupling mechanism works on the electric side, I thought it was a full decoupling and therefore a favorable margin variance is relative to favorable weathers somewhat mitigated.
So how does that play out with strong expectations for the third quarter given the July weather?
Thomas Webb
That’s a very good question. On the electric side, you’re exactly right.
It is full decoupling which includes the economy, includes the weather and energy efficiency. On the gas side we don’t have the weather offsets and decoupling.
However, remember the mechanism reverses the levels in a rate case and it’s not really perfect. So when you get a very hot summer, you will get a little believe through of that good news and if you had a very mild summer by the way, you’ll get a believe through of that news the other way.
So it’s not a 100% in the method that the decoupling is done when it’s done by average customers. So you’ll see pretty good coverage on that with decoupling, but you’ll see depending on the amount of heat in the summer month, some of that will flow through.
But remember if it was very mild it can also go the other way. So it’s not a perfect mechanism.
Brian Russo – Ladenburg
Understood. Thank you.
John Russell
Thank you.
Operator
Your next question comes from the line of Mr. Mark Segal with Canaccord Genuity.
Please proceed.
Mark Segal – Canaccord Genuity
Hi, good morning. I was just wondering if you could provide an update on your activities surrounding smart metering.
John Russell
Yeah. We’re moving forward with it albeit slowly.
We have a plan in place to move forward with smart grid when the pilots are complete. We’re looking at a very incremental approach to this beginning with the electric business, beginning on the west side of the state near Grand Rapids.
And then working its way around the state. We’ve eliminated the gas business, we don’t see a positive business case for changing for gas customers except those that are combination customers.
But the business case today is sound with our operational cost reductions and with the investments that we make in smart grid we should be able to see or we will see a payoff for customers on a net present value basis.
Mark Segal – Canaccord Genuity
Okay. And have you guys come to a determination yet over how long the project might stand from a commercial roll out standpoint?
John Russell
It’s a pretty long roll out about six or seven years as I recall. Starts in at about 12 and should be done around 16 and something like that.
So it’s scheduled, it’s done by geographic territory, so we can get the benefits of those areas, evaluate the customer profiles, are they actually reacting to smart grid and then move around to the other areas. So since we first proposed the if you followed us for a while we first proposed it, we’ve reduced the amount of investment about $125 million in that range, we’ve extended the timeframe for the implementation of it, and we’ve eliminated the gas only customers in the plan.
Mark Segal – Canaccord Genuity
Okay. And has the technology validation from the pilot has that all been successfully concluded?
And it’s just to go now in the 12 timeframe?
John Russell
Yeah. Actually we made the affect that we’re kind of the followers of the pack, may be good for us as far as vendors and who we can secure for this.
Mark Segal – Canaccord Genuity
Understood. Thanks for the great detail.
John Russell
Thank you.
Operator
Your next question comes from the line of Jonathan Arnold with Deutsche Bank. Please proceed.
Jonathan Arnold – Deutsche Bank
Good morning, guys.
John Russell
Good morning.
Thomas Webb
Good morning.
Jonathan Arnold – Deutsche Bank
I would ask a quick question on the cash per rule and – he said, John I think that your assumption is – that it’s going to be delayed a year?
John Russell
Yeah.
Jonathan Arnold – Deutsche Bank
What would happen if it is not? And I guess, even if it is you can have to make some interim changes in your dispatch practices, what might be the rate impacts on the fewer side of doing that giving the time line, and I guess the slight delay the time line on some of your complaints effort?
Thomas Webb
To the big five it really will have limited impact. We may have to accelerate slightly some investments, but I don’t have the exact number right now what we do.
If it moves to 2012, so that on that too concerned about the impact it would be what happens with the smaller coal-fired units. But I think as we talked before those units we think our most impacted by the Mercury rule already established in Michigan.
So that would be – when the mercury rule goes into effect in 2015 in Michigan that would determine the fate, if you will, of those smaller plants. And as for us what happens to the viability of the customers and so forth, if the rule goes force in 2012, I do believe that you’re going to see a quicker closure of some of the coal plants then probably what people are anticipating, which in turn of those plants are competitive could raise rates for customers.
And I know that’s the case with our seven smaller units which are competitive today, but based on the rules that the EPA has come up with, I don’t think it’s likely that we would put the controls into those plants because of their age and the ultimate cost that’s required.
Jonathan Arnold – Deutsche Bank
Since we are clear that’s a rule content question rather than the timing?
John Russell
Yeah.
Jonathan Arnold – Deutsche Bank
So based on that you’re saying, you’re likelihood is that though you don’t comply on those units unless something changes in the content of the rule?
John Russell
Exactly. And the smaller units can just to make clear those smaller units can run right now till about 2015 not for say round purposes.
Then we have a couple of options, one is to put the controls in and run them though we need to make to those decisions later this year or next year so that we are prepared for the 2015 target date. If we don’t put controls on them we could retire them or third option which is most likely right now but we haven’t looked at the rule in detail yet is to mothball.
I mean, we can mothball them up for three years.
Jonathan Arnold – Deutsche Bank
And does (inaudible) affect those units?
John Russell
That’s what we’re evaluating right now Jonathan. I want to make sure I fully understand what though the impact is of (inaudible).
Jonathan Arnold – Deutsche Bank
Okay. It sounds like your anticipating giving clarity little later this year.
John Russell
Later this year or early next year, between those. Because, look we need to make a decision on what we’re going to do on so you know, probably at the end of this year or early next year.
Jonathan Arnold – Deutsche Bank
And how would you view in the even to that you do involve (inaudible) or after procure (inaudible) otherwise? Any recent indications what that might do versus your plan of keeping these rates within the rate of inflation?
John Russell
Shouldn’t affect it. And end of the day if we close them down, we want have any (inaudible) associated with those plants.
So that would keep our rates lower. If we do invest in it, that would bring some capital but the only reason we had invest the capital in the smaller plants is if those plans would be competitive in the market which overall would save customers money.
Jonathan Arnold – Deutsche Bank
All right. That’s taken enough time.
Thank you John.
John Russell
Thanks Jonathan. I appreciate it.
Operator
We have no further questions in the queue.
John Russell
All right let me wrap up today if we can. First of all, as Tom said I know it’s a busy day some of you are flying between calls, so let me thank you for joining us again.
We had another good quarter both operationally and financially. First half earnings were up 20% and that’s really a lot as we talked about to accelerate reliability spending and cover our storm restoration expense.
One thing I want to highlight too we’ve eliminated all nuclear fuel risk with a DoE settlement. Jim Pruner and his team did a great job getting that one done and we remain committed to provide value to our customers and our shareholders.
So thanks for joining us today and good luck with the rest of your calls.
Operator
This concludes today’s conference. We thank everyone for your participation.