May 2, 2008
Executives
R. Sean Trauschke - Sr.
VP, IR and Financial Planning James E. Rogers - Chairman, President and CEO David L.
Hauser - Group Executive and CFO Lynn J. Good - Group Executive and President, Commercial Businesses James L.
Turner - Group Executive; President and COO, U.S. Franchised Electric and Gas
Analysts
Daniel Eggers - Credit Suisse Jonathan Arnold - Merrill Lynch Paul Patterson - Glenrock Associates Paul Fremont - Jefferies & Co. Lasan Johong - RBC Capital Markets Nathan Judge - Atlantic Equities Michael Lapides - Goldman Sachs Ashar Khan - SAC Capital Shalini Mahajan - UBS
Operator
Good day everyone and welcome to the Duke Energy First Quarter Earnings Conference Call. Today's call is being recorded.
At this time for opening remarks I'd like to turn the call over to Mr. Sean Trauschke.
Please go ahead sir.
R. Sean Trauschke - Senior Vice President, Investor Relations and Financial Planning
Good morning, and welcome to Duke Energy's first quarter 2008 earnings review. Leading our discussion today are Jim Rogers, Chairman, President and Chief Executive Officer; David Hauser, Group Executive and Chief Financial Officer; and Lynn Good, Group Executive and President, Commercial Businesses.
Jim will begin today's presentation by providing a general overview of the quarter's results then David will provide more detail in context around the quarter's results from each of our businesses. That portion of the call will include an update Lynn Good on the Commercial Businesses.
Following Lynn, Jim will update you on some of our major growth and regulatory initiatives. After our prepared remarks we'll open the lines up for your questions.
Before we begin, let me take a moment to remind you that some of the things we'll discuss today concern future company performance and include forward-looking statements within the meanings of the securities laws. Actual results may materially differ from those discussed in these forward-looking statements, and you should refer to the additional information contained in Duke Energy's 2007 Form 10-K filed with the SEC and our other SEC filings concerning factors that could cause those results to be different than contemplated in today's discussion.
In addition today's discussion includes certain non-GAAP financial measures as defined under SEC Regulation G. A reconciliation of those measures to the most directly comparable GAAP measures is available on our Investor Relations website at www.duke-energy.com.
As you saw in our news release early this morning, prior to the first quarter 2008, we presented ongoing earnings, which excluded the impacts of special items and discontinued operations. Starting with today's quarterly release, we are reporting an adjusted earnings, which exclude mark-to-market impacts of economic hedges in the Commercial Power segment as well as special items in discontinued operations.
David will explain why we made this change in his discussion. With that, I'll turn the call over to Jim.
James E. Rogers - Chairman, President and Chief Executive Officer
Thank you, Sean. Good morning everyone, and thank you for joining us today.
Most importantly thanks you for your interest and investment in Duke Energy. We had a strong first quarter.
We're making good progress in resolving regulatory uncertainty while pursuing major capital projects to insure that we provide our customers with clean, affordable and reliable electric and gas services. As we said in our new release this morning, we reported adjusted diluted earnings per share of $0.35 for the first quarter of '08 versus $0.30 in the first quarter last year.
These results reflect continued strong contributions from each of our three largest business units; Franchised Electric and Gas, Commercial Power and Duke Energy International. One quarter doesn't make a year, but with this solid performance we are on track to achieve our 2008 employee incentive target of $1.27 per share on an adjusted diluted basis.
Now I'll ask David to give you more specifics about each segments results.
David L. Hauser - Group Executive and Chief Financial Officer
Thank you, Jim. I'll begin my review of our first quarter 2008 business segment results with US Franchised Electric and Gas, our largest business segment.
That segment reported first quarter 2008 segment EBIT of $637 million an increase of $63 million over last years first quarter. The quarter-over-quarter improvement in segment EBIT was primarily driven by the conclusion of clean air amortization and the substantial completion of merger related rate reductions in 2007.
Favorable weather also drove the increase in the segments EBIT. As a result of the 2007 North Carolina rate case, we will no longer amortize our clean air expenditures.
The unamortized expenditures of approximately $800 million will be included in rate base as they are completed. In the first quarter of 2007, we recorded clean air amortization for North Carolina's clean air program of approximately $56 million.
Merger related rate reductions also ended in 2007, with the exception of a small amount, that we will continue to share with our customers in Kentucky over the next several years. In the first quarter of 2007 merger related rate reductions were approximately $51 million.
The segment's results were also positively impacted by favorable weather conditions. Heating degree days for the first quarter 2008 were approximately 5% higher than in the same period n 2007 in both the Carolinas and the Midwest.
The improvement in weather contributed approximately$32 million to the segment's quarter-over-quarter improvement. Franchised Electric and Gas's results were also impacted by $18 million of higher equity allowance for funds used during construction.
These favorable impacts to EBIT were partially offset by lower retail rates of approximately $25 million resulting largely from last year's North Carolina rate review. Higher operation and maintenance costs primarily due to nuclear plant maintenance and outages and decreased both Power Marketing sales and that of sharing.
For the quarter the EBIT contribution for both Power Marketing was approximately $26 million net of sharing, a reduction of $18 million when compared to the same quarter in 2007. The year-over-year increase was also impacted by a favorable settlement with the Department of Energy that resulted in the recognition of $26 million of EBIT in the first quarter of last year.
Our regulated customer base continued to grow approximately 41,500 customers were added in the Carolinas since the first quarter of 2007, a 1.8% increase. Approximately 13,000 customers were added in the Midwest in that same time period, a 0.6% increase.
Though we continue to add customers for all of U.S. Franchised Electric and Gas, kilowatt hour sales are affected by market conditions including the general decline in the textile industry.
Next, I will review Commercial Power; adjusted segment EBIT was $99 million, an increase of approximately $60 million over the first quarter of 2007. This segments improved adjusted EBIT was driven was reduced net purchase accounting expenses of $49 million, gains on the sale of emission allowances of $12 million, and a $10 million improvement at our Midwest gas-fired assets.
The quarter's positive drivers were slightly offset by higher operation and maintenance resulting from plant outages. We continue to be pleased by the operational performance of our Midwest gas-fired plants.
Increased generation and higher capacity revenues continue to improve the results of those assets. For the quarter, these plants had adjusted EBIT losses of approximately $4 million.
We now expect these assets to be EBIT positive by 2009, on an adjusted basis. Over the past year, we have highlighted the mark-to-market impact on our financial results, but continued our practice of including unrealized mark-to-market gains and losses as part of ongoing earnings.
Starting with this quarter, we will begin to exclude the mark-to-market impact and present adjusted earnings. Let me give you a little background.
Most of the output from our generation in Ohio is sold to our native load customers. We economically hedge the remaining output by selling the power forward and buying the associated inputs of coal and emission allowances.
Certain transactions, that we use to execute this hedging strategy received mark-to-market treatment under the accounting rules. We believe that by excluding the impact of mark-to-market changes from adjusted earnings until the settlement of these economic hedges, we are better matching the financial impact of the derivatives with the underlying assets.
Ultimately, we will recognize the effect of the economic hedges in adjusted earnings, when the contracts settle. Now let's turn to our International Business.
For the first quarter of 2008, Duke Energy International reported segment EBIT of approximately $114 million, an increase of 20 million over the last year's first quarter. DEIs improvements were primarily driven by higher results at National Methanol of $21 million and favorable foreign exchange rates of 10 million.
These drivers were partially offset by less favorable hydrology in Latin America. As you will recall, our earnings impact of changes to foreign exchange rates is reduced by the local currency Brazilian debt that affects interest expense.
We continue to be pleased with the overall contribution of International. Next is, Crescent Resources and Other.
For Crescent segment earnings were $2 million in the first quarter of 2008, which is flat with 2007. You will not be surprised that the real estate business continues to be challenge.
Our Other category primarily includes cost associated with corporate governance and Duke Energy's captive insurance company. For the first quarter of 2008, other adjusted net expense was $67 million compared to $52 million in the prior year's quarter.
The increase in other's adjusted net expense was driven impart by increased captive insurance cost. Now, I will focus on a few important non-operating items.
Our overall liquidity and access to the capital markets remain strong. As of March 31st, we had $642 million of cash and cash equivalents on hand.
We have increased the size of our credit facility by $550 million to $3.2 billion. And through April 2008, we have issued approximately $1.9 billion in new debt including the refunding of a $100 million of our auction rate debt.
I am sure you are aware of the recent liquidity issues in the auction rate security market. We have debt securities outstanding as well as investments in these auction rate securities.
As of December 31, 2007, we had approximately $880 million of auction rate debt outstanding. As I have just mentioned a $100 million of this balance, which had a maximum rate of 12% was refunded in April.
The failed auction interest rate for the remainder of the debt is at most 1.75 times one-month LIBOR. So, the impact is not as severe as you have seen elsewhere.
As we continue to review the capital markets, we may reconsider issuing hybrids and/or moving the dividend reinvestment plan to new issues rather than open market purchases sooner than anticipated. Related to our investments, as of March 31st, we have classified $300 million of auction rate securities as non-current assets due to a liquid markets.
Since, we don't need these auction rate securities for near-term liquidity, we can continue to hold these investments until the credit markets regain liquidity and in the mean time earn a higher interest rate. Interest expense from continuing operations for the three months ended March 31st, increased $19 million compared to the same period in 2007.
This increase was due primarily to higher debt balances as well as our foreign exchange rate impacts on Brazilian denominated debt. Offsetting this was a $3 million increase in AFUDC debt and capitalized interest over the same quarter last year.
The total AFUDC debt and capitalized interest was approximately $18 million during the quarter. The effective tax rate for the quarter was approximately 32% compared to 29% for the same period last year.
Our tax rate was lower in 2007 as a result of the reduction in 2007 in the unitary state tax rate due to the spin-off of Spectra Energy. We continue to feel comfortable about our forecasted compound annual growth rate through 2012.
Our teams will continue the focus on improving our returns in our regulatory jurisdictions. If we can earn within 50 basis points of our allowed return on equity on our projected rate base and our Midwest gas assets continue to improve, our growth rate will be closer to 6% from our results in 2007.
With that I will turn it over to Lynn Good who will discuss our commercial businesses.
Lynn J. Good - Group Executive and President, Commercial Businesses
Thank you, David. I wanted to spend a few minutes updating you on our commercial businesses and what we see as future growth opportunities.
For today's discussion I will frame our commercial businesses, the Commercial Power segments and Duke Energy International as a single business, a diversified generation asset business operating in North and South America. You will recall that the Commercial Power segment includes our Ohio coal assets, Midwest gas fleet and our wind business.
To understand how we are looking at future growth opportunities, it is important to understand the scale and contribution of our combined commercial businesses. Our combined commercial businesses are expected to contribute nearly 25% of Duke Energy's 2008 adjusted total segment EBIT, and own and operate approximately 12,000 megawatts of generation, 60% of which is from lower carbon sources; hydro, gas and wind.
The capital expenditure plan for Commercial Power and DEI that we shared with you in September included the following strategic objectives. First, an expected compound annual growth rate of 8% to 10% from 2007 to 2012, measured and adjusted EBIT before considering the benefits of expected production tax credits.
Second, an improvement in the performance of our Midwest gas fleet. Third, the continued investment in renewable energy sources, and fourth, the projected investment of $1 billion in Latin America funded by Duke Energy Internationals operating cash flow.
We are on track for achieving these strategic objectives and in fact we see market conditions improving and industry trends developing in a way that creates more opportunity for growth. Let me touch briefly on three primary growth areas; our Midwest generation, renewables and Latin America.
First, Midwest generation; our Midwest generation portfolio includes approximately 7,600 megawatts of generation with approximately 4,000 megawatts devoted to serving load in Ohio, and 3,600 megawatts of gas fired generation. Over the last year, as reserve margins have tightened we have seen an improvement in the value of these assets and an improvement in the earnings contribution from our gas assets.
During Jim's closing remarks he will discuss the recent legislative activity in Ohio. He will also review our expectations of the impact of the legislation on the earnings from our assets serving customers in Ohio.
For our gas assets, we continue to see improvement in margins due to both capacity payments and energy margins. PJM Capacity prices have increased significantly.
In 2008 capacity revenues will be $50 million and we expect that to grow to approximately $170 for the 2010, 2011 planning year. As you know, the PJM auction for planning year 2011 to 2012 will occur later this month and we expect to bid 3,100 megawatts into the auction.
At the same time, our energy margins are improving, as megawatt hour production continues to increase. In 2007, we saw a 70% increase in megawatt hour production year-over-year.
In the first quarter of 2008, our megawatt hour production increased 53% over the prior year. With market pressure against building coal assets, the potential for retirements of aging coal plants and the long development cycle for nuclear.
We see continued improvement in value and contribution from our Midwest gas assets. As David mentioned, we now expect the results of these assets to be EBIT positive by 2009 on an adjusted basis.
Next renewables, almost a year ago we acquired a wind development business and presently have 240 megawatts under construction with a 180 megawatts expected to come on line later this year. Our pipeline of development projects has grown from 1,000 megawatts to over 3,000 megawatts and we have the potential to grow at a pace of 200 megawatts to 300 megawatts of wind generation annually.
Since we initiated our renewables business about a year ago, public policy and support of low carbon generation and rising fuel prices have confirmed our belief that renewables are an important part of generation next. Strong valuations of wind portfolios have also been confirmed by recent transactions in the market.
We will continue to look for opportunities to add to our wind portfolio and to pursue other renewable energy projects including solar and biomass projects. Lastly Latin America, given the strong macro economic trends and solid power sector fundamentals in Latin America, our 4,000 megawatts of primarily based load generation is very well positioned to deliver continued earnings growth.
Power demand growth rates of 5% to 10% coupled with tight supply margins are pushing prices higher and driving the need for significant capacity additions. Solid [ph] ratings have also improved as evidenced by Peru's recent upgrade by Fitch and Brazil's recent upgrade by S&P to investment grade.
All of these factors are not only driving up the value of our existing portfolio, but have created an environment for new investments. To-date we have committed $300 million of capital to growth projects in Central and South America.
Our bias has been toward greenfield and brownfield generation projects and we have a pipeline of additional growth opportunities that we are pursuing including acquisitions where it makes sense to do so. In summary we offered a valuable and diversified mix of profitable generation assets in the Americas.
The value of these assets is increasing and attractive growth opportunities exist in the markets we serve. Under our present plan we believe 8% to 10% compound annual growth is achievable.
To capture the additional growth opportunities that I have spoken about, as well as confirm the value we see in our portfolio of assets. We are looking at creative ways to bring additional capital into our commercial business including partnerships or joint venture relationships.
Now let me turn it back over to Jim.
James E. Rogers - Chairman, President and Chief Executive Officer
Thank you, Lynn. Let me now update you on Ohio and our new generation initiatives.
We are pleased that Governor Strickland signed the new Ohio Energy Bill yesterday. It is an important first step in resolving the uncertainty we face with the expiration of our rate stabilization plan at the end of this year.
The next step is for the commission to issue new regulations for the implementation of the two options we will have. An Electric Security Plan or ESP, and...
or a Market Rate Option or MRO. We have long believed in a RSP type approach in Ohio, is best for our customers and our investors.
Therefore it is our intent to pursue the ESP option as early as possible under the new law and that appears to be in late summer. Obviously our desire to pursue the ESP option depends on the regulations that the Public Utility Commission will issue later this year.
There are many aspects of the new law, such as the excessive earnings test that will need to be more explicitly defined. We will have the opportunity to comment on these rules when they are proposed.
Additionally, we also plan to file in June for an increase in our distribution and transmission rates in Ohio. It is our opinion that the ESP option is very similar to our existing rate stabilization plan.
For instance, it provides for the mechanisms that allow us to recover periodically our fuel cost and incremental environmental CapEx. Under the ESP option, we can also seek to recovery automatically other distribution costs.
We realized that PUCO has a full schedule for the rest of this year. In the event, the commission is unable to act on our ESP filing by year end under the new law, we will have the ability to continue to operate under our existing RSP.
We believe the risk profile for our Ohio operations and our earnings projection for 2009 will not change under either scenario. On April 23rd, we filed an Exempt Wholesale Generator or (EWG) application for 7600 megawatts, which are currently owned by Duke Energy Ohio.
All of these assets are unregulated. As you may recall, about 4000 of these of megawatts were deregulated buy the Ohio legislature in 2000.
So, remaining generating assets have never served our Ohio customers under the prior regulatory regime or under our existing RSP. Unfortunately, the timing of our filing has created some concern by certain parties in Ohio.
The primary purpose of our EWG filing was to transfer these assets to a separate corporation to gain greater financial flexibility. We made the filing pursuant to and consistent with prior Ohio commission orders in our corporate separation plan filed and approved under the existing law.
As I said earlier, depending on the commissions regulations being consistent with our understanding of the new law, we intend to commit the 4000 megawatts, which are committed to our Ohio customers today under the RSP to our customers, under the new ESP to be effective in 2009. Now let me turn to our new generation plant projects.
First, the Edwardsport, Indiana IGCC plant. Yesterday, Duke Energy Indiana filed a cost update along with our request to initiate the CWIP rider for its IGCC plant in Indiana.
The filing also request approval for studies related to carbon capture and sequestration of the plant. The filing was made pursuant to the IURC's order approving the 630 megawatt plant in November 2007.
Our revised estimate of the project is approximately $2.35 billion including AFUDC. The prior estimate was approximately $2 billion and was developed over a year ago and was the basis of the commission's decision last year.
The cost increases that we now project are inline with the increases experienced in the past several years by other building, generating plants around the world. We are in the process of finalizing the contractual arrangements with our major project vendors.
These efforts include procurement of long lead time equipment. We began this step shortly after receiving the commission's order approving the plan.
In its CPCN order last November, the commission discussed the possibility of cost increases, but refused to implement a cost cap at some parties that urged. Of course we will need to demonstrate the fees increased cost are wanted, and doing so we will show the commission, that we continue to believe this is the best base load option to meet the needs of our customers, while at the same time minimizing our environmental emissions footprint.
We will also show, that this plant provides a commercial platform for the development of carbon capture sequestration at that side and important step in our efforts to decarbonize our fleet. Equally important, it allows us to shutdown older, inefficient and high admitting coal units in Indiana.
We are asking the commission for expertise review of our filing. Let me now briefly discuss the Lee Nuclear plant and Cliffside unit.
A construction and operating application from the Lee plant was filed with the NRC in 2007 and it has been accepted by the agency. After completing our projected cost analysis of the proposed three 200 megawatt plant, we will be filing for state approvals in the fourth quarter of this year.
The Cliffside plant is off to a great start. Since receiving the air permit in January we have been excavating for the power build...
boiler building and pouring concrete for the scrubber chimney's foundation. We have a formal ground breaking in March, at which time we announce that the IRS approve the full $125 million in federal tax credits for the project.
To wrap this up, I again want to emphasize our value proposition for investors. I won't go through it, other than just say that we had a great quarter and we see no reason, why we won't achieve our strategic and financial objectives.
Let's open the lines for your questions. Question and Answer
Operator
Thank you. [Operator Instructions].
We'll take our first question from Dan Eggers from Credit Suisse.
Daniel Eggers - Credit Suisse
Hey, good morning.
James E. Rogers - Chairman, President and Chief Executive Officer
Good morning, Dan and welcome.
Daniel Eggers - Credit Suisse
Thank you. Hey, Jim, can you just help explain a little bit more the thought process behind the Ohio generation separation I guess from a timing perspective and then if you add a little more color on your thoughts and what the financial flexibility improvements would be through the process?
James E. Rogers - Chairman, President and Chief Executive Officer
Sure, I'd be delighted to do that. We have been contemplating filing the EWG for a period of time and we've been working to put the filing together and quite frankly we waited to see, what the final statutory language would look like to see if would require any other modifications to our application.
And once that legislation was finalized, we then file with the FERC. Its our judgment that, that the primary purpose of that filing is to take those assets that are currently in Duke Energy of Ohio put them in a separate corporation and quite frankly that gives us a lot of flexibility and you heard Lynn talked a little bit about that, in terms of how we finance it, it gives us flexibility in terms of the potential brining in a joint venture partner.
So, it all opens up for us a series of opportunities that will allow us to fund the growth in our Commercial Business.
Daniel Eggers - Credit Suisse
So, are you thinking about this potentially being a true, floated spin-off or is this something that stays core to Duke and you are just looking in a way that gets some more scale out of it?
James E. Rogers - Chairman, President and Chief Executive Officer
We don't contemplate a spin off. It's primarily just again a way to either finance it or bring in partners because we believe this is a core business that we want to grow and develop and this just gives us more financial flexibility.
Daniel Eggers - Credit Suisse
Okay. And then on the IGCC cost inflation I guess from last year, can you…do you have a feel for how much the rate impacts will be to the customers with that plant coming in to service and when you look at it relative to say the CCGT option, how the cost differential looks right now.
James E. Rogers - Chairman, President and Chief Executive Officer
Sure. As you know, Dan we are in a commodity market boom, I mean you look at steel prices just in the last year they are up 70%.
If you look at the component parts of building generation, boilers, turbines, tubing, all of these costs are up rather dramatically over the last several years. This increase, roughly $350 million is roughly 18% increase.
As we look at it when the plant is fully in service, it will translate into roughly a 2% increase in prices for consumers over the existing estimate. So, again it's a modest increase and part of that is tied as you know to the fact that we didn't start finalizing our arrangements with our major vendors until we actually receive the certificate from the commission in November, and that the original estimate, and this is an important point, was developed over a year ago based on numbers that were developed during the prior year.
So, again, in this commodity boom, we expected that there might be some increases and as we went to the finalization of the contracts, and in fact there were, and so we are now in the process of presenting those to the commission and under Indiana law, the commission will review this over the next several months.
Daniel Eggers - Credit Suisse
And Jim you remind me, the 2% increases on top on what was the original increase for the... on the prior bid, the prior cost.
James E. Rogers - Chairman, President and Chief Executive Officer
The prior cost, there was about a 16% increase once it was in service.
Daniel Eggers - Credit Suisse
Great. And I guess one last question; industrial demand still seems to be softening, and I guess in all territories.
Is that economic slowdown and when do you guys, do you have any insight into when this might sort of stabilize a bit?
James E. Rogers - Chairman, President and Chief Executive Officer
I think that what we've seen is obviously a lot of manufacturing facilities going from three shifts to two or from two shifts to one. There has been a slowdown in the economy, we don't have any sense of when it turns around, I think our economy has been remarkably strong given the headwinds that we faced.
But more to come on that, David do you want to amplify on that.
David L. Hauser - Group Executive and Chief Financial Officer
Let me add one thing on that, if you look at industrial in the Carolinas excluding textile, its actually up a bit 0.8% as I recall and that one of the things you see happening is some of the centers for people like Google and Fidelity coming into our service area which are very significant energy users. So, certainly we have issues with our economy and things like that but there are some positive things occurring too.
Daniel Eggers - Credit Suisse
Okay. Thank you guys.
James E. Rogers - Chairman, President and Chief Executive Officer
Dan, thank you.
Operator
We'll take our next question from Jonathan Arnold from Merrill Lynch
James E. Rogers - Chairman, President and Chief Executive Officer
Jonathan, welcome.
Jonathan Arnold - Merrill Lynch
Thank you. Quick question on Ohio first, you mentioned in the slides Jim that you didn't see any issues with this excessive earnings test.
But is one of the implications of transferring these assets, if that test would not apply to your generation assets, but if they stay where they are it would apply. I was just wondering how we should think about that?
James E. Rogers - Chairman, President and Chief Executive Officer
Well, its never... the filing of this application wasn't to avoid that test, with respect to the 4,000 megawatts.
It's our judgment with respect to the 3,600 megawatts which have never... were never regulated by Ohio then it is not subject to the test.
Jonathan Arnold - Merrill Lynch
But your understanding is the others would effectively not be subject to the test if they move?
James E. Rogers - Chairman, President and Chief Executive Officer
No, it would be our... what we contemplate that is that those 4,000 megawatts will be subject to the test.
Jonathan Arnold - Merrill Lynch
Even if they move to another…
James E. Rogers - Chairman, President and Chief Executive Officer
Even if they move to an EWB.
Jonathan Arnold - Merrill Lynch
Okay. Why would that be, because I thought the law sort of precludes affiliates from being included in the test calculation?
James E. Rogers - Chairman, President and Chief Executive Officer
I understand, but it is our intent that they be dedicated under the ESP, and because we're going to use the ESP mechanism assuming again that the rules are fair and consistent with the way we believe that they will rollout is that they are going to be subject to the earnings test. This was not a move on our part to get out from under the earnings test with respect to those 4,000 megawatts.
Jonathan Arnold - Merrill Lynch
Okay, thank you for that. Can I ask, I would like to ask one on the Commercial Power results for the quarter as well please, which is showing up 60 million I think in adjusted EBIT, but if you start with the 39 last year and add back the 49 of purchase accounting expense and I think there was another 26 of synfuel O&M that was actually kind of in there last year.
I get to a sort of adjusted base of something like 114 and then... and so you made 99 against that which is down a little and if I pull out the emission allowance sales and the Midwest improvement everything else looks like it might have been down 35 million to 40 million, excluding those kind of one-times from all those non-recurring from last year.
Is that at reasonable analysis and what are those factors in there, is it all the O&M or something else?
David L. Hauser - Group Executive and Chief Financial Officer
I am not sure I totally followed all your math, but let me tell you the way I would look at it if I were you. We are looking at it that last year, was about $39 million adjusted, this year is about $99 million adjusted.
So, that's an apples-to-apples comparison. You are right that a big piece of the increase is the purchase accounting just as you said.
The other two significant ones are improvements in the gas plants. The gas plants were up 10 million and the sale of some emission allowances.
Jonathan Arnold - Merrill Lynch
So there was 26 million of O&M last year, is that correct from synfuels in the Q1'07 number?
David L. Hauser - Group Executive and Chief Financial Officer
We have moved that, so that's not in that number anymore. If you recall, that's in discontinued operations.
Jonathan Arnold - Merrill Lynch
So, that O&M is not in the 39.
David L. Hauser - Group Executive and Chief Financial Officer
That is correct.
Jonathan Arnold - Merrill Lynch
That's helpful, thank you David.
David L. Hauser - Group Executive and Chief Financial Officer
Okay, Jonathan, thank you.
James E. Rogers - Chairman, President and Chief Executive Officer
Jonathan, thank you.
Operator
We will take our next question from Paul Patterson from Glenrock Associates.
Paul Patterson - Glenrock Associates
Good morning guys.
James E. Rogers - Chairman, President and Chief Executive Officer
Paul, good morning.
Paul Patterson - Glenrock Associates
Just a sort of follow-up here, just the $32 million, I think that is a pretax number for weather. Is that versus normal or is that just versus last year?
David L. Hauser - Group Executive and Chief Financial Officer
That is versus last year. It's about $15 million versus normal.
Paul Patterson - Glenrock Associates
Okay, and then with respect to the hybrids in the new issuance that might be happening. Can you just give us a little bit more of feeling for sort of what the share count might now change to as a result of that?
David L. Hauser - Group Executive and Chief Financial Officer
If you look at our plan, we had said we turn it on in 2010, moving to open market purchases. We assumed a little over $200 million a year that to get permit.
So, if its $200 million a year and stock price is 20, then that gives you the share count income.
Paul Patterson - Glenrock Associates
And when that might be turned on?
David L. Hauser - Group Executive and Chief Financial Officer
We have not made that decision. We are looking at the hybrid markets.
We are looking at our capital expenditures, but it's possible we would turn it on this year.
Paul Patterson - Glenrock Associates
Okay. And then the captive insurance cost, what's going on there?
You mentioned that had gone up, just give us a little bit more flavor on that?
David L. Hauser - Group Executive and Chief Financial Officer
Yeah, the simple way to think about that is we set the premiums for all the business units at the beginning of the year, and then as activities occur and losses come in that are different than were reflected in the premiums, those are simply eaten by the captive insurance company, and so the captive insurance company always either makes or loses money based on the premiums that they set in advance.
Paul Patterson - Glenrock Associates
Okay. So, what were the higher losses than expected?
Just what areas did those come from?
David L. Hauser - Group Executive and Chief Financial Officer
Most of those were associated with some generation outages in Franchised Electric and Gas.
Paul Patterson - Glenrock Associates
Okay. And then finally, I noted that you guys have changed and you guys went through this, the mark-to-market accounting and excluding it now from operating earnings.
What was the philosophy…I don't have any problem with that, just wondering what made you guys think about doing that now as opposed to previously?
David L. Hauser - Group Executive and Chief Financial Officer
Yeah, a couple of things. One is, we'll continue to be very transparent on what the numbers are, so people can adjust, however they feel is appropriate, but the reason we did it that way.
We have a mixture of physical and financial contracts. Some of them therefore are not mark-to-market, and some of them are mark-to-market, so you end-up with a distortion of the underlying economics because of the accounting.
We thought the underlying economics would be a lot cleaner if we just backed it up.
Paul Patterson - Glenrock Associates
Okay. So, but the reason for just…okay, so do you guys just covering recently on that side, yes I heard was there anything in particular that let you thinking that way?
David L. Hauser - Group Executive and Chief Financial Officer
Well, I think over time the amount could get bigger and what was really happening is coal prices were running up so much that it was a significant item in the quarter and that kind of growth is specific timing.
Paul Patterson - Glenrock Associates
And the $49 million in purchase accounting expense, just for the rest of the year how should we expect that to unfold, because as I recall I don't remember that being that much built-in year-over-year for a change in purchase accounting.
David L. Hauser - Group Executive and Chief Financial Officer
Around numbers, the number last year was 100 and this year we said it would be about 10 so, you should expect over the course of the year it will be $90 million better off than we were last year.
Paul Patterson - Glenrock Associates
And half of that we already got this year…this quarter excuse me.
David L. Hauser - Group Executive and Chief Financial Officer
That's exactly right.
Paul Patterson - Glenrock Associates
Okay. Thanks a lot guys.
David L. Hauser - Group Executive and Chief Financial Officer
Thank you.
Operator
We'll take our next question from Paul Fremont, from Jefferies.
Paul Fremont - Jefferies & Co.
Thanks. It looks like…
James E. Rogers - Chairman, President and Chief Executive Officer
Welcome, Paul.
Paul Fremont - Jefferies & Co.
Hey, thanks a lot. It looks like in the first quarter you got half year target gains for Franchise Electric and Commercial Power.
Is there something that we should look at in future quarters that represents either the timing of O&M, that will hold back future quarters or should we assume that you're well on track to sort of exceed as a target that you laid out initially?
James E. Rogers - Chairman, President and Chief Executive Officer
I think you should assume we are on track. We got a weather benefit, obviously in the first quarter.
O&M will certainly move around through the year and you probably should keep in mind that the clean air was a big positive year-over-year in the first quarter, by the time you get to the fourth quarter, the one in clean air last year. So, won't be as big positive in the fourth quarter.
But, we are very comfortable with our plan for FE&G
Paul Fremont - Jefferies & Co.
Secondly I guess there is a provision in the Ohio legislation that allows for I guess government aggregated load. I am not sure I understand how that would apply with respect to your unregulated generation business, is that something that could ultimately escape the utility charge or is there some provision there that those customers wouldn't put a burden on the remaining customers, if they left your assistance?
James E. Rogers - Chairman, President and Chief Executive Officer
I think there is some ambiguity in the law with respect to that, but my general understanding is its…the charges non-bypassable even by the government aggregators.
Paul Fremont - Jefferies & Co.
Okay. So it's not bypassable.
James E. Rogers - Chairman, President and Chief Executive Officer
It's not bypassable. This is my understanding.
Paul Fremont - Jefferies & Co.
And last question from me, I am looking last year at a second quarter tax rate of about 28.5%, is that good number to use in assuming the tax rate changes for the second quarter?
David L. Hauser - Group Executive and Chief Financial Officer
No. Why do use the tax rate that looks more like 32.5% or 33%.
Paul Fremont - Jefferies & Co.
Right, in another words, but the comparison should to at 28.5?
David L. Hauser - Group Executive and Chief Financial Officer
28.5 that was last year?
Paul Fremont - Jefferies & Co.
Yeah, second quarter.
David L. Hauser - Group Executive and Chief Financial Officer
Whether it would be perfectly honest Paul, I don't remember last year's second quarter tax rate. So, we'll have to have our folks get with you.
I am pretty sure it will be something like 33 this year.
Paul Fremont - Jefferies & Co.
Okay. Thank you very much.
James E. Rogers - Chairman, President and Chief Executive Officer
Paul, thank you.
Operator
We'll take our next question from Lasan Johong from RBC Capital Markets.
James E. Rogers - Chairman, President and Chief Executive Officer
Welcome.
Lasan Johong - RBC Capital Markets
Thank you. Good morning.
Nice quarter by the way.
James E. Rogers - Chairman, President and Chief Executive Officer
Thank you.
Lasan Johong - RBC Capital Markets
I need to understand the mechanism of how you would charge revenues on the approximate 4000 megawatts of assets in the unregulated saw that you will dedicate to your ESP. If I'm understanding, this correctly you will dedicate those assets based on a cost plus system, where the fuel cost would be more or less straight passthrough.
Am I understanding that correctly?
James E. Rogers - Chairman, President and Chief Executive Officer
No, that's not the way it's worked under the RSP and will not be the way it works under the ESP. We will have negotiated rate with respect of those assets, but we will have and you are right about this, we will have a fuel clause that allows us to track the fuel prices up and down during future periods.
Lasan Johong - RBC Capital Markets
And if I am mistaken, Ohio is more or less a coal dominated market correct?
James E. Rogers - Chairman, President and Chief Executive Officer
That's correct.
Lasan Johong - RBC Capital Markets
I see. And this therefore doesn't require due to engage in long-term hedges for coal supply, correct?
James E. Rogers - Chairman, President and Chief Executive Officer
Yes, that's correct. We can, we have the capability to do that, but historically we have not.
Lasan Johong - RBC Capital Markets
Okay. So…
James E. Rogers - Chairman, President and Chief Executive Officer
Paul, primarily because we operate under long-term contracts for some of the supply some under shorter term. We have a mix of contract links with respect to our coal supply and virtually all of those plants, are plants that are on the Ohio river, so we have access to the barge trade, which gives us more flexibility in terms of sources of coal for those plant.
Unlike many of our plants, which are on a single rail line in the coal fields.
Lasan Johong - RBC Capital Markets
I see. Then if I'm not mistaken, should coal prices continue to stay high or increase from even here.
The 4,000 megawatts of generation would benefit if it were in a market environment versus a ESP environment, where as if coal prices fall, it'd be better if it were in the ESP environment versus being in the market environment, correct?
James E. Rogers - Chairman, President and Chief Executive Officer
Well, it just depends on the contract that you would have to sell the output of the plant. If you were selling the output its fixed price, you would take the risk associated with the movement in the coal price.
But negotiating a price for the use of those plants and then having a tracker with respect to fuel, we don't take on the fuel risk and we lock in the return on the facilities.
Lasan Johong - RBC Capital Markets
But I would assume that, since your plants are pretty early in the dispatch curve from what I remember, you wouldn't necessarily take a five year fixed price contract anyway; you could bid this into market without having or bided into a short term agreement where you can capture the movement of coal prices up and down?
James E. Rogers - Chairman, President and Chief Executive Officer
We could do that, but it's been our judgment that the better risk-reward for us is from the standpoint of committing these under the RSP.
Lasan Johong - RBC Capital Markets
Okay. That's exactly what I needed to know.
On the Edwardsport plant, I'm hearing you say that you'd probably do this plant with a CCS. The question is where do you put the carbon depleted oil and gas wells?
James E. Rogers - Chairman, President and Chief Executive Officer
It's been our intent to develop our carbon capture and sequestration at that site and we will be working with the Department of Energy and others as we put that project together and finance that project going forward. But one of the great advantages of building the IGCC in Indiana at that location is because the geology is perfect for CCS.
Lasan Johong - RBC Capital Markets
That's what I thought.
James E. Rogers - Chairman, President and Chief Executive Officer
And it will also in all likelihood if we are able to develop the project and we have... we're hopeful with respect to the CCS, it will become one of the largest sequestration projects in the US or in the world actually and quit frankly for us to be able to live in a low carbon world is critical that this technology get developed.
Lasan Johong - RBC Capital Markets
Understood. One last question if you don't mind, on Brazil, the S&P upgrade the investment grade.
Does that present any refinancing opportunities that might lower your interest cost and or overall borrowing or cap cost, cost of capital.
David L. Hauser - Group Executive and Chief Financial Officer
I think the answer is yes. Historically the Brazilian markets have been very short term debt markets and have been inflation adjusted type of security.
We are very active in looking at those markets and determining the right time to refinance and I won't be surprised if this gives us that opportunity.
Lasan Johong - RBC Capital Markets
How much debt are we talking about, doing some refinancing on and what's the benefit on the interest expense do you think?
David L. Hauser - Group Executive and Chief Financial Officer
Well, in dollars we have about $540 million of debt that's our share of [inaudible] debt. The interest rate, I think that's a question where it could move around a lot, but it could be 200 or 300 basis points.
Operator
Thank you. And we'll take our next question from…
James E. Rogers - Chairman, President and Chief Executive Officer
Thank you, very much.
Operator
We'll take our next question from Nathan Judge, Atlantic Equities
James E. Rogers - Chairman, President and Chief Executive Officer
Nathan welcome.
Nathan Judge - Atlantic Equities
Thank you and good morning. Wanted to follow up on your comment about 2008 earnings.
I think you said there would be a growth... could be a growth rate of 6% up of your 2007 level.
If you could earn within 50 basis points you are allowed returns and the Ginna [ph] or the Midwest gas plants were to continue to improve. Relative to your expectation that at the beginning of the year what...
could you give us a flavor on how... well reconcile it to your expectations and how and what changed so far that you are seeing that would give you confidence in that number?
David L. Hauser - Group Executive and Chief Financial Officer
Nathan this David. I want to sure we're communicating.
We're talking about the five year of growth rate and so when I look at the 6% that I've stated as I was going through the call there. The 6% is a good way to think about the five year compound annual growth rate, also the '07 earnings and that reflects two things one is an improvement in the gas plants which we're getting more confident of and two is our ability to improve our regulatory compacts in some areas and get closer to the elaborative returns than we had been assuming before.
So we had told you before 5% to 7% and we wanted to put a little more color around that five year compound annual growth rate.
Nathan Judge - Atlantic Equities
Thank you. Would that growth rate...
and that would be through 2012, is that correct just to clarify?
David L. Hauser - Group Executive and Chief Financial Officer
Yes that's correct.
Nathan Judge - Atlantic Equities
Would that include the potential earnings boost from the would be the Cliffside plant in 2013.
David L. Hauser - Group Executive and Chief Financial Officer
Yes that's in total, so Cliffside you learn AFUDC as you build it and then you will have the earnings on it when it goes in service, and keep in mind this is a... this 6% is also actual 2007 earnings that we are talking about now.
Nathan Judge - Atlantic Equities
Okay and then just on the ESP, the EWG, is there a possibility, are you considering moving some of the Midwest gas plants that are not under commitment to the Ohio load putting those into some type of ESP plan?
James E. Rogers - Chairman, President and Chief Executive Officer
Well, I think we will have that option, but quite frankly we are at a place where we are economically indifferent and given the improvement in the economics in PJM and in MISO. It might prove to be a better economic opportunity for us to dedicate those, I mean, to use those plants in the market rather than to dedicate them under an ESP.
Nathan Judge - Atlantic Equities
If Cincinnati, Ohio Gas and Electric were to need, I think you have said something on the magnitude of 1,700 megawatts, would then therefore be the opportunity to build and provide those generation under an ESP.
James E. Rogers - Chairman, President and Chief Executive Officer
That's one of the very positive, aspects of the legislation. Given our short position, with Duke Energy of Ohio of roughly a 1,000 and growing to 1,700 over the next several years.
The ability to either buy generation and dedicate it or to build generation and dedicate it, the current new law provides for that and quite frankly those would be, once we get a better understanding of the regulations with respect to it we'll be decisions as to what, how best to meet that capacity requirement. But again one of the things that we found most favorable in the new law is creating the new opportunity for a regulated entity to build and buy and dedicate to customers new generation.
Nathan Judge - Atlantic Equities
Yeah, and then finally just on the Edwardsport plant, with the updated cost estimate, can you walk us through the process, the timing, the milestones in that and when you expect to sign an EPC contract?
David L. Hauser - Group Executive and Chief Financial Officer
This is on the IGCC with what the process is now?
Nathan Judge - Atlantic Equities
Yes sir.
James E. Rogers - Chairman, President and Chief Executive Officer
Okay. Jim you want to answer that?
James L. Turner - Group Executive; President and Chief Operating Officer, US Franchised Electric and Gas
Yeah, this is Jim turner. What we are going to do is ask the commission to rule expeditiously.
We are hoping for an order by the end of July, on our updated application which would both update the cost estimate that the commission's approved as well as initiate our first CWIP rider and initiate the study of carbon capture and sequestration of the site.
Nathan Judge - Atlantic Equities
Has there been an EPC contract signed yet?
James L. Turner - Group Executive; President and Chief Operating Officer, US Franchised Electric and Gas
What we have is a term sheet with all the material terms and conditions agreed to, but we've not signed a final EPC contract.
Nathan Judge - Atlantic Equities
And you'd wait until the commission ruled before you sign that contract I assume.
James L. Turner - Group Executive; President and Chief Operating Officer, US Franchised Electric and Gas
Well we are going to continue working towards finalization of the contract, but we think we have enough now to initiate with what we know we have enough now to initiate work under the EPC agreement.
Nathan Judge - Atlantic Equities
And the air permit, when would we expect that? Would that be following the commissions ruling?
James L. Turner - Group Executive; President and Chief Operating Officer, US Franchised Electric and Gas
We got that in January.
Nathan Judge - Atlantic Equities
Got that, John [ph]. Thank you.
James E. Rogers - Chairman, President and Chief Executive Officer
Nathan, thank you very much.
Operator
We'll take our next question from Michael Lapides from Goldman Sachs.
Michael Lapides - Goldman Sachs
Hey guys, congratulations on a really good quarter.
James E. Rogers - Chairman, President and Chief Executive Officer
Thank you, Michael, its welcome.
Michael Lapides - Goldman Sachs
Thank you. Question on the excessive earnings test in Ohio, not entirely sure I understand how that's going to work, really two fold, one kind of bigger picture macro like what's the P&L of companies, what's the comp group and then second, how will they likely treat the goodwill that's on the books in your Ohio subsidiary?
David L. Hauser - Group Executive and Chief Financial Officer
I think two things, one is I think there is some ambiguity with respect to the excessive earnings test. I think that...
I would first make the point that this test will be fundamentally different determinations as a traditional... determination of a return on equity, because its test that's normally done in the rate case.
So I think you need to make that differentiation. I think the comp group is really going to be up to us to present to the commission what the group looks like and quite frankly I think you take that from general industry, you could take it from the merchant sector.
There is a variety of comps and will be in the process and I'm sure the commission will be in the process of defining what the comp group looks like. It's our judgment with respect to the goodwill that those were deregulated assets when the acquisition occurred and so that goodwill would be included in the calculation.
James E. Rogers - Chairman, President and Chief Executive Officer
So let me just add one thing, if you started trying to back up the goodwill you would have to go through all the comps and try to back out the goodwill
Nathan Judge - Atlantic Equities
Right.
James E. Rogers - Chairman, President and Chief Executive Officer
Because they all have it.
Michael Lapides - Goldman Sachs
Understood and especially if you include the merchants in the panel there, going back three, four or five years ago there is unbelievable amounts of write downs and changes. Last just kind of thinking about the Edwardsport plant, in the original order giving approval they didn't give approval for CWIP on the plants at that point in time.
Do you have a view or a sense about whether the commission is willing to do it and that was just more of a technical issue?
James E. Rogers - Chairman, President and Chief Executive Officer
It was technical issue, the statute is clear with respect to CWIP and Jim do you want to add that?
James L. Turner - Group Executive; President and Chief Operating Officer, US Franchised Electric and Gas
Yeah Michael the commission did approve CWIP in the underlying order. What they asked us to do come in and do within six months is to give them a progress update on the project, as well as initiate the initial slog of CWIP if you will the initial tranche of CWIP that we will begin to recover.
So it doesn't... CWIP doesn't just happen automatically, the commission wants to review the CWIP filings every six months.
So they did approve CWIP, but now we have to go and actually prove up the amount of CWIP that we need.
Nathan Judge - Atlantic Equities
Got it. Okay, thank you guys.
Much appreciated.
Operator
We'll take our next question from Steve Flashman from Capital Management.
James E. Rogers - Chairman, President and Chief Executive Officer
Steve welcome.
Operator
And looks like his line has disconnected. We'll take our next question from Ashar Khan from S Capital
James E. Rogers - Chairman, President and Chief Executive Officer
Ashar welcome.
Ashar Khan - SAC Capital
Good morning. I just had a question based on this new adjusted methodology that was started.
What were earnings in 2007, if you took to the market-to-market out?
David L. Hauser - Group Executive and Chief Financial Officer
That's would be in a $1.23.
Ashar Khan - SAC Capital
That would be a $1.23. And David could you also give us what it would be in the second quarter last year?
David L. Hauser - Group Executive and Chief Financial Officer
I don't have that off the top of my head, but yeah our people can provide that. Sorry about that.
Ashar Khan - SAC Capital
Okay.
David L. Hauser - Chief Financial Officer, Group Executive
I thought you were going to ask me the second quarter this year.
James E. Rogers - Chairman, President and Chief Executive Officer
That where I thought it was going.
Ashar Khan - SAC Capital
Okay. Thank you very much.
James E. Rogers - Chairman, President and Chief Executive Officer
Thank you.
David L. Hauser - Group Executive and Chief Financial Officer
Thank you, Ashar.
Operator
We will take our next question from Shalini Mahajan of UBS.
Shalini Mahajan - UBS
Thanks and good morning.
James E. Rogers - Chairman, President and Chief Executive Officer
Thank you and welcome.
Shalini Mahajan - UBS
Just a couple of questions for you Jim on Ohio. Do you need FUCO approval to achieve the generation separation because this involves 4,000 megawatts of RSC dedicated assets?
James E. Rogers - Chairman, President and Chief Executive Officer
I think that technically at this time we don't, but under the new law when it becomes effective we will and so as a practical point I believe that its going to be important to have the commission supportive of this.
Shalini Mahajan - UBS
Okay, and then if... any talks on how long or for ESP [ph], are you looking at?
Is it a minimum of three years or something longer than that?
James E. Rogers - Chairman, President and Chief Executive Officer
I think that the way the statute works is that you can do it for longer periods, but they have the ability to review it every four years and I think what that's going to lead to is shorter periods like three year periods rather than longer periods. Again we don't know exactly what that review means and how it will work and that will be spilled out I suspect in the regulations, but just reading the statute and knowing how historically these things work.
I think its going drive us to three year type contracts versus 10 year contracts.
Shalini Mahajan - UBS
And lastly if we... kind of how should we be thinking about ROE at Duke Ohio if you include the ROC dedicated generation there.
What would be the current ROE there?
James E. Rogers - Chairman, President and Chief Executive Officer
I think the way I'd think about it is that we will get a determination of ROE on our transmission and distribution business, and as I mentioned earlier we'll be filing a rate increase in June. But the standard in terms of excess earnings in which the deregulated generation would fall under is a return on common equity of comparable companies and I think that will be the controlling standard.
Shalini Mahajan - UBS
Okay, Okay, alight that's helpful. Thanks Jim so much.
James E. Rogers - Chairman, President and Chief Executive Officer
Thank you very much.
Operator
And this concludes our question and answer session. At this time I'd like to turn the call back over to Mr.
Sean Trauschke for any additional or closing remarks.
R. Sean Trauschke - Senior Vice President, Investor Relations and Financial Planning
Thank you, Steve. We want to thank you for joining us today and as always our team will be available to answer any follow up questions you may have, and we look forward to speaking with you next quarter.
Operator
And this concludes today's teleconference. We thank you for your participation.
Have a wonderful day.