Feb 18, 2011
Executives
Rebecca Hickman - Director of Investor Relations James R. Hatfield - Senior Vice President and Chief Financial Officer Donald E.
Brandt - Chairman, President and Chief Executive Officer Donald G. Robinson - President and Chief Operating Officer, Arizona Public Service Company
Analysts
Greg Gordon - Morgan Stanley Dan Eggers - Credit Suisse Brian Chin - Citigroup Michael Lapides - Goldman Sachs Ali Agha - SunTrust Robinson Humphrey Paul Patterson - Glenrock Associates Edward Heyn - Catapult Capital Daniele Seitz - Dudack Research Reza Hatefi - Decade Capital
Operator
Greetings and welcome to Pinnacle West’s Earnings Conference. At this time, all participants are in a listen-only mode.
A question-and-answer session will follow the formal presentation. (Operator instructions) As reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Rebecca Hickman, Director of Investor Relations for Pinnacle West. Thank you, you may begin.
Rebecca Hickman
Thank you, Diego. Good morning.
I'd like to thank everyone for participating in this conference call and webcast to review our fourth quarter earnings, recent developments and operating performance. Our speakers today will be our Chairman and CEO, Don Brandt; our CFO, Jim Hatfield; and Don Robinson, President and Chief Operating Officer of APS is also here with us.
Before I turn the call over to our speakers, I need to cover a few details with you. First, the slides we refer to today are available on our Investor Relations website along with our earnings release, supplemental information on our earnings variances and quarterly operating statistics, the webcast and the Form 8-K we filed this morning.
The slides contain reconciliations of certain non-GAAP financial information. Please note that all of our references to per share amounts today will be after income taxes and based on diluted shares outstanding.
Also, it is my responsibility to advise you that this call and our slides contain forward-looking statements based on current expectations and the company assumes no obligation to update these statements, because actual results may differ materially from expectations, we caution you not to place undue reliance on these statements. Please refer to the forward-looking statements language contained in our 2010 Form 10-K, which was filed with the SEC this morning, as well as the MD&A section which identifies risks and uncertainties that could cause actual results to differ materially from those contained in our forward-looking statements.
A replay of this call will be available on our website, www.pinnaclewest.com, for the next 30 days. It will also be available by telephone through February 25.
At this point, I’ll turn the call over to Jim.
James R. Hatfield
Thank you, Becky. The topics I’ll discuss today are outlined on slide 4.
First, I’ll review the consolidated fourth quarter results and discuss the main variances from last year’s corresponding quarter. Second, I will provide a brief update on the status and outlook for the Arizona economy.
Then, I will discuss our full-year results and 2011 earnings guidance. And finally, I’ll close with brief comments on our liquidity and financing.
Slide 5 summarizes our reported and ongoing earnings for the quarter. On a GAAP basis, this year’s fourth quarter, we reported consolidated net income attributable to common share holders of $7 million or $0.07 per share compared with a net loss of $30 million or $0.30 per share for the prior year’s fourth quarter.
Our on going earnings increased $0.22 per share; for the 2010 fourth quarter we have consolidated ongoing earnings of $7 million or $0.06 per share versus an ongoing loss of $16 million or $0.16 per share for the comparable quarter year ago. A reconciliation of our fourth quarter GAAP earnings per share to our ongoing earnings per share is shown on slide 6.
The amounts for both quarters exclude results related to our discontinued real estate operations. My remaining comments on the quarter will focus on our ongoing results.
Turning your attention to slide 7, you will see the variances as that drove the change in quarterly ongoing earnings per share. First, an increase in our regulated electricity segment gross margin added $0.17 per share, compared with those in the prior year’s fourth quarter.
Several pluses and minuses comprises that variance and I’ll cover those in detail on the next slide. Second, continuing favorable resolution of tax matters helped lower our effective tax rate in the fourth quarter, improving earnings by $0.06 per share.
We added $0.04 per share as a result of closure of prior reserves. Additionally the new tax act passed in law in December provided an extended R&D tax credit that benefited the fourth quarter by $0.02 per share.
Third, we recorded cost in the fourth quarter of 2009 to expand APS’ low-income assistance funding as part of regulatory settlement. The absence of comparable costs in this year’s fourth quarter improved earnings by $0.03 per share.
Fourth, improved results for APS Energy Services non-regulated energy consulting services business improved earnings by $0.02 per share. And fifth, net impact of miscellaneous items increased earnings by $0.04 per share.
Partially offsetting those positive results were higher operations and maintenance expenses, which decreased earnings by $0.04 per share. The increase largely reflects higher employee benefit costs.
This change in O&M excludes expenses related the renewable energy standard or RES and our demand side management and energy efficiency efforts because those costs were offset by reflective rate surcharges. We have provided the amounts of pre-tax expenses related to these efforts by quarter over the last couple of years in the appendix to today’s life.
Finally, higher infrastructure-related costs decreased earnings by $0.06 per share reflecting the increases in property taxes, depreciation and amortization and interest expense partially offset by an increase in capitalized financing cost. Turning to slide 8 and the composition of the net increase in our regulated electricity gross margin, total regulated gross margin was up $0.17 per share, compared with 2009's fourth quarter.
The components of that increase were as follows. Retail rate increases favorably impacted our quarterly results by $0.16 per share.
Of this amount, $0.14 per share related to the net base rate increase and $0.02 per share related to the line extension fees recorded as revenue. Both of these items became effective January 1 of 2010 under APS’ retail regulatory settlement.
Lower fuel costs net of deferrals and improved mark-to-market valuation of fuel contracts improved earnings by $0.03 a share. Weather effects improved earnings by $0.03 per share.
To facilitate your analysis, we have added a slide to the appendix to show weather effects compared with normal by quarter over the last couple of years. Lower usage by APS’ retail customers compared with the fourth quarter a year ago decreased our quarterly results by $0.04 per share.
Weather normalized retail kilowatt hour sales were down 1.1% in the quarterly comparison, almost all reflecting the effects of our ACC approved energy efficiency and demand side management programs. Customer growth of one half of 1% over year-ago levels helped offset the decline in kilowatt hour sales.
I'll provide more on the state of our Arizona economy momentarily. And the net effects of miscellaneous gross margin items decreased our results by a penny per share.
Turning to slide 9, and looking at our fundamental growth outlook in the Arizona economy, we currently expect annual customer growth to average about 1.7% for 2011 through 2013. Additionally, we expect our average annual weather normalized retail sales and kilowatt hours to be relatively flat from 2011 through 2013, primarily due to APS's energy efficiency programs offsetting a modest recovery in the economy.
In the fourth quarter of this year, we continue to see signs of stability in the Arizona economy. As shown on slide 9, aside from a brief surge in the middle of 2010, month- over-month non-farm job growth has returned to its highest level since the middle of 2006.
Likewise, we also see a return to more substantial income growth as measured by the personal income tax withholding trend. By this measure, year-over-year income growth is setting its best marks in almost three and a half years.
Mainly unemployment remains high in the metro-Phoenix area and around the state, and we have a longer way to go to recoup the jobs we lost in the recession but we are encouraged by the trajectory of these recent trends. The economic growth story appears to be additionally confirmed by the real estate trends.
Housing prices in the metro-Phoenix at bottom in early 2009 and settled into a narrow range since then, reflecting almost two years of relatively stable and slow absorption of vacant commercial floor space has begun. Excess housing in the Phoenix Metro area has also continued to be absorbed as demand for housing continues at low levels but faster than new supply is being added.
We expect this situation to continue for at least two to three years. On the commercial side, vacancy rates likely peaked at very high levels in 2010, but the trends in demand for both office and retail space are positive again after several quarters of decline.
As I mentioned in our last quarterly call, we continue to be cautiously optimistic that the Arizona economy has found a bottom and that we can begin a long process of recovery. We expect the economy, both nationally and locally, to improve gradually as we move through 2011.
Importantly, we need to see more robust consumer confidence in order to support a stronger recovery in residential usage patterns ignoring weather effect and the impacts of our energy efficiency programs. And we have only just begun to see signs of improvement in this area.
Similarly, commercial and industrial customer usage growth is likely to remain restrained until overall economic growth strengthens a bit more. However, over the long term, we remain confident of Arizona's fundamentals.
We expect customer growth and usage to return to stronger levels as the national and state economic environments improve. Putting this all in context for earnings, let's look at our full year comparison on slide 10.
On a GAAP basis for the year 2010 as a whole, we reported consolidated net income attributable to common shareholders of $350 million, or $3.27 per share, compared with net income of $68 million or $0.67 per share for 2009. Our ongoing earnings increased $0.78 per share year-over-year, some 33% higher.
As a result, from an ongoing earnings perspective, we were pleased to deliver 2010 full year results of $3.08 per share, on higher end of our guidance. From a financial point of view, 2010 was a solid year but not without challenges.
However, weak gross margin was offset by continued cost effectiveness efforts throughout the Company. In my opinion, the Company has done a great job of managing costs with O&M expense essentially flat in 2010 as compared to 2009.
This focus on cost effectiveness will continue as growth returns in the future. Turning to our earnings outlook on slide 11, we expect our consolidated ongoing earnings for 2011 will be between $3.15 per share, which is slightly higher than the range we provided for 2010.
For your reference, a list of key assumptions and factors underlying our 2011 outlook is included in the appendix today's slides. Our 2011, forecast includes unexpected contribution from our Arizona Sun program up about $0.03 to $0.04.
Don will speak about the Arizona Sun program and its progress to date in a few moments. In regards to 2012 guidance, we intend to provide a forecast sometime in the summer after we file our general retail rate case on June 1.
Now a quick update on our liquidity and financing. We'll reference slide 12.
Our capital structure and available liquidity at the end of 2010 is depicted on the slide. APS’ ACC jurisdictional equity ratio at year-end was 53.9%, which is important, given 2010 will be a test year for the upcoming rate case filing.
This equity ratio is comparable to the one allowed in APS’ last retail rate case decision. Pinnacle West common stock issuance in 2010, which resulted in about $250 million of equity proceeds being contributed to APS helped maintain a balanced capital structure at the utility and is consistent with commitments we made in the 2009 regulatory settlement.
For similar reasons, we estimate our next equity issuance will not be until 2012 at the earliest. At year-end, we had about $1.3 billion of available liquidity.
Given our improving cash flow profile, stable credit ratings and solid liquidity position, we feel very comfortable in our ability to fund APS’ capital expenditure program and our ability to access financing markets as necessary. This past Monday APS entered into a $500 million four-year revolving credit facility replacing the revolver that would have otherwise terminated in September of 2011.
Looking ahead, this slide also outlines our major expected financing activities for 2011 and 2012. Switching topics to cash tax benefits, recent federal tax legislation adopted in December extended bonus depreciation through 2012.
Qualified property placed into service after September 8th, of 2010 and through 2011 will be eligible for 100% bonus depreciation for federal income tax purposes. In addition, qualified property placed into service in 2012 will be eligible for 50% bonus depreciation.
Bonus depreciation deductions in 2011 and 2012 are expected to generate $450 million to $500 million of cash tax benefits for APS. As a result of expected utilization of tax net operating loss carry-forwards, we anticipate the bonus depreciation cash benefits will be fully realized by APS by the end of 2013 with a majority of the benefit realized in 2012 and 2013.
The cash generated is an acceleration of tax benefits that APS would have received otherwise over 20 years. For some time, we have been talking about cash tax benefits totaling $110 million at the parent Company expects to realize as a result of the SunCor restructuring.
Approximately half of this benefit was realized by the parent Company in 2010. However, because of the extension of bonus depreciation, we now estimate the parent will realize the remaining SunCor cash tax benefits around the end of 2013.
This concludes my prepared remarks. Now let me turn the call over to Don.
Donald E. Brandt
Thanks, Jim and thank you all for taking the time to join us this morning. Jim has touched on several issues important to our investors including our growth in the Arizona economy.
Although the recession has slowed our historically robust growth patterns, Arizona retains many qualities that make it a desirable place to live and do business. Consequently, we believe that the state's strong growth should return which is an attractive distinguishing feature of our company.
Since our last earnings call, we made distinct progress in some areas and continued our track record of operational excellence. Today I'll update you on the following items, our resource acquisition activities, Arizona regulatory developments, and our recent operating performance.
Beginning with resource acquisition activities, I'll first review several renewable resource additions. As you know, renewable energy is a key part of our resource plan.
It makes sense for our customers and their communities, the environment, and our shareholders. Arizona regulators are supportive of renewable energy in general and particularly solar.
We are on track with plans to significantly increase the amount of renewable energy we provide our customers. We have a strong emphasis on solar power because Arizona has some of the best solar conditions in the world.
Today I'll highlight progress on two major solar initiatives. First, the AZ Sun program.
Through this program APS will develop and own 100 megawatts of photovoltaic utility scale solar plants in Arizona with the facilities being placed in service this year through 2014. The Arizona Corporation Commission has approved constructive rate recovery for the AZ Sun program plants.
Since the program's approval last March, we have announced a portfolio of five generation facilities totaling 83 megawatts, with overall estimated capital expenditures of $377 million. This total includes our announcement earlier this week of the 17-megawatt Paloma Solar Plant to be located about 70 miles Southwest of Phoenix at Gila Bend.
We expect the project's committed to date to be placed in operation primarily in 2011 and 2012. Additional procurement initiatives are under way to fill out the balance of the program.
Slide 15 in the appendix contains a summary of the AZ Sun program and the projects committed to date. In addition to AZ Sun, the Solana Generating Station project has also progressed.
In December, the plant developer, Abengoa Solar, finalized its Department of Energy loan guarantee financing and broke ground on the solar trough facility. As a reminder, APS will purchase all of the Solana plant’s output under a 30 year purchase power agreement with Abengoa.
If Solana were in operation today it would be the largest solar plant in the world. These projects and other renewable initiatives we have underway are important steps toward advancing Arizona's sustainable energy future.
Now I'll update you on our pending Four Corners plan. Last November, we announced a multi-part plan to address several challenges facing our Four Corners coal-fired plant in Northern New Mexico, a plan that presents a balanced solution to address new environmental regulations.
APS has agreed to buy Southern California Edison’s 739 megawatt interest in units four and five, an opportunity that exists because so called Edison has indicated it must exit its interest in the plant by 2016 to comply with California law. The purchase price of $294 million is substantially less than other generation alternatives, and it is the lowest price per kilowatt paid for U.S.
coal capacity since 2005. The acquisition requires approval by Arizona, California and several federal agencies.
Furthermore, the transactions are contingent upon extensions of the land lease with the Navajo Nation and the coal supply contract. The land lease extension was approved by the Navajo Nation this past Tuesday and coal contract negotiations are under way.
We are targeting closing on the purchase in late 2012 and expect to finance the transaction with a mix of debt and equity. Pending regulatory approval, we plan to shut down Four Corners units, one, two and three which totaled 560 megawatts and are wholly owned by APS.
Because these units are older and less efficient than units four and five, we currently estimate compliance with proposed EPA regulations would be very expensive for them compared with the newer units. The net result of the acquisition and closure is a 179 megawatt increase in our share of the plant.
Importantly, completing these transactions will significantly reduce Four Corners' emissions, including greenhouse gas emissions, as well as reduce the capital investment APS will need to make for environmental compliance at the plant. We estimate that APS’ environmental capital expenditures for our revised plant share will be about $300 million, far less than the estimated $620 million capital investment required for our current plant interest under proposed EPA rules.
Obviously, our proposed transactions would provide significant savings while cost effectively adding reliable base load capacity. The proposed Four Corners plan provides a number of other benefits for APS customers, the local economy, the environment, and shareholders.
The transactions and benefits are outlined on slides 16 and 17 in the appendix to today's slides. Turning to Arizona regulatory matters, we continue to work with the Arizona Corporation Commission and various stakeholders to further enhance the state's regulatory framework.
A number of opportunities exist to continue a dialog, cooperatively addressing the interest of customers, shareholders, and other stakeholders alike. The Commission has made progress on a number of generic topics affecting the industry.
Last year they adopted a resource planning and energy efficiency rules as well as renewable transmission action plan for APS. In December, the commissioners unanimously approved a decoupling policy statement.
The effective implementation of which is essential to achieving the state's energy efficiency goals. The policy statement supports a fixed cost revenue per customer methodology, which we and other parties supported.
And allows utilities to propose decoupling mechanisms in upcoming retail rate cases. Other generic dockets are still under way.
The topics of these workshops and public meetings include, among other things, ways to streamline the rate case process and line extension policies. In January, there were changes in the composition of the commission.
Derek Pierce, a Republican, recently reelected and continuing to serve on the Commission was elected Chairman. And Brenda Burns, also a Republican, began her four-year term in office.
The other three commissioners, Democrats Sandra Kennedy and Paul Newman and Republican Bob Stump continue to serve in their capacities. We also have been preparing for APS’ 2011 retail rate case filing.
To that end on February 1, APS filed a notice with the commission that we intend to file a rate case on June 1. The filing provided the 120 days to the notice to the commission and interested parties to facilitate timely processing and collaboration as agreed to in APS’ 2009 regulatory settlement.
The notice outlined a number of key proposals that APS expects to include in the rate case application. Some of these proposals in the notice include a decoupling mechanism, post-test year plant additions to rate base and an infrastructure tracker.
For more detail, a summary of the proposals is provided on slide 18 in the appendix to today's slides. In addition to participating in the ACC's generic workshops, we have been meeting with various stakeholders to enhance common understanding of regulatory and operational issues.
We look forward to continuing this dialog and future progress for our state's regulatory environment. Looking at our operating performance, our base load nuclear and coal fleet continues to perform very well.
During the fourth quarter, we completed a planned refueling and maintenance outage in Palo Verde unit three and during the outage we’ve replaced a reactor vessel head and installed a rapid refueling package, which will help to reduce the time required for future refuelings. This outage lasted 40 days, which was ahead of our schedule.
Unit three vessel head replacement completed the program we began in the fourth quarter of 2009 to install this equipment in all three Palo Verde units. In 2011, we expect each of our two planned refueling outages to last 35 days to 40 days, reflecting the benefits of our recent work, as well as, safe and sound planning and execution.
In 2010 as a whole, Palo Verde produced a site average capacity factor of 91%. Even with the planned extended outages, the nuclear facility had its best production year ever, generating more than 31 million megawatt hours.
Palo Verde is the only U.S. generating facility of any kind to ever exceed 30 million megawatt hours in a single year and it did so last year for the sixth time in its history.
And on an individual unit level, unit two was the world's top nuclear generator in 2010. We continue to progress through the license extension process with the U.S.
Nuclear Regulatory Commission. Currently, we expect the NRC will approve the 20-year license extensions for each of the three units during the first half of this year.
Looking ahead, the Palo Verde team remains focused on achieving safe, sustainable, top tier performance in all aspects of the plant's operations. Our coal-fired plants continued their run of top tier performance also.
In 2010, our coal fleet posted a capacity factor of 81%, which is well above the most recently available industry average of 65%. From our shareholders’ perspective, 2010 was a good year as we outperformed both our industry and the broad market.
We are very pleased that our total return to shareholders comprised of price appreciation, plus dividends, was 20%, which compares very favorably with the U.S. electric utility average of 4% and the S&P 500 index return of 15%.
In summary, our company's goal is to achieve top tier performance and we constantly work toward that objective in every facet of our business. Going forward, we are strongly committed to maintaining operational excellence and achieving superior financial results by concentrating on our core electric utility business.
This concludes our prepared remarks. Operator, at this time, we would be pleased to take any questions.
Operator
(Operator Instructions) Our first question comes from Greg Gordon with Morgan Stanley. Please state your question.
Greg Gordon - Morgan Stanley
Thanks, good morning, gentlemen.
Donald E. Brandt
Good morning, Greg.
Greg Gordon - Morgan Stanley
And Becky.
Rebecca Hickman
Good morning.
Greg Gordon - Morgan Stanley
Very comprehensive answer on the bonus depreciation, much appreciated. All things equal, is it going to have a demonstrable impact on the rate based calculation for your filing or because of the benefits are going to be coming in over a longer period of time due to your pre-existing tax position, do we not need to be concerned about a significant adjustment?
James R. Hatfield
Greg, great question. No impact on the 2011 rate case for this reason.
We are currently sitting with an NOL, so we cannot claim for tax purposes the bonus depreciation. As a result of that, and because we'll claim it in future years, we have an offsetting tax receivable which essentially wipes out the tax for rate based calculation.
Greg Gordon - Morgan Stanley
Great. Second question in terms of equity financing needs, out sort of over the horizon as we look into late 2012 and 2013, I think it's been presumed that there would be financing needs but given this incremental cash in-flow, should we be more hopeful that equity could be minimized or eliminated?
James R. Hatfield
Well, obviously the cash benefit's going to be very helpful from a need to raise capital perspective. I’d just point out that we've assumed 2012 because under the current schedule it's another test year and the equity would need to be injected to keep the capital structure fairly consistent.
I'll point out, however, if for whatever reason that's not a test year, I would not see us issuing equity in 2012.
Greg Gordon - Morgan Stanley
Under what circumstances would that not be a test year?
James R. Hatfield
Well, I'll give you one scenario that's possible. Looking back on the last, let's say we settled the case and we stay out longer, maybe the test year is 2013.
So my only point is, the premises are it’s really based on the regulatory capital structure, more so than a need to raise capital.
Greg Gordon - Morgan Stanley
Great. Don, can I ask you one question, as I look at slide 18 of your release and look at the general framework of the proposed rate case filing.
I think all of us that are recommending or are invested in your stock are there because we believe that over time you can drive the earned return on equity to something that is much more proximate to your authorized returns. Notwithstanding the challenges of having an historic test year and things like that.
So what about the structure of this filing gets us there post 2011?
Donald E. Brandt
Well, Greg, you're exactly right. That's what we're driving towards is earning our allowed rate of return and as you point out, put aside the historic test year.
What we're looking at here proposing are vehicles that help cure the regulatory lag and the impact of a historic test year from the infrastructure tracker to post test year plant additions which we were very successful with in the last settlement, 2009, and we see these as vehicles to help continue that trend.
Greg Gordon - Morgan Stanley
Thank you.
Operator
Our next question comes from Dan Eggers with Credit Suisse. Please state your questions
Dan Eggers - Credit Suisse
Hey, good morning. Don, there's been a little bit of your activity at the commission as far as looking at some of the elements that where in the last rate case that we thought kind of been settled issues.
Is there anything we should be looking into as far as potential trend of more involvement in the ACC looking to maybe re-evaluate either past settlements or precedent those for future settlements?
Donald E. Brandt
No, not necessarily. Dan, I think issues like the line extension policy, there's likely to be changes in that in the future, I think, as part of the rate case and we've clearly telegraphed that.
I mean, after the revenue treatment that's currently in effect for related to line extensions, once that's completed its course with the conclusion in the next rate case, we're somewhat indifferent on line extension policy, but we also are in the position. We think the best position to give the Commission some pretty good advice what makes the most sense for our customers and the different constituencies, including the homebuilders and realtors that are very interested in it.
And we're going to be coming forth with a pretty constructive solution that I think will address those matters.
Dan Eggers - Credit Suisse
Okay. And then on Four Corners, do you guys have book value in the plants you're going to close and what do you envision being the treatment for recovery of that money, if you do have some rate base risk?
Donald E. Brandt
Yeah, Dan, there is some book value. It was being depreciated to 2016 on one, two and three, and/or ask at the Commission is to recover those costs as part of this Four Corners acquisition.
So if granted I wouldn't see an impact financially from closing those early.
Dan Eggers - Credit Suisse
Okay, and then just on O&M, I don't know if you want to give us a little more color kind of on what initiatives are going on to manage costs for 2011 and any insights you could share on where you're seeing better opportunities?
James R. Hatfield
Sure. From a cost perspective, I mean, the initiatives going into ’11 are not different than initiatives coming into ’10.
It continues to be supply chain where we had a very good performance in 2010 that positively impacted both O&M and capital and working capital. We continue with just improving the efficiency of our operating models and fossil IT, shared services and delivery and obviously, Palo Verde continues to perform very well from a cost perspective.
So those are not different than we had in ’10 and those will be the same things we continue to focus on as we go beyond ’11.
Dan Eggers - Credit Suisse
Are you finding any surprise, do you guys go in as far as bigger savings than expected?
James R. Hatfield
No, not really, Dan. I would couch our savings as inline with expectations.
Again, it's not just slashing costs to the bone. It's really focusing on are we cost effective and how we're delivering our services to our customers.
Dan Eggers - Credit Suisse
Got it. Thank you.
Operator
Thank you. Next we have Brian Chin with Citigroup.
Please state your question.
Brian Chin - Citigroup
Asked and answered. Thank you.
Donald E. Brandt
Thanks, Brian.
Operator
Our next question comes from Neil Mehta with Goldman Sachs. Please state your question.
Michael Lapides - Goldman Sachs
Hey, guys. Michael Lapides here.
Can we just kind of do timing real quick on Four Corners, if the acquisition were to close in the fourth quarter of 2012, when would you expect, given the infrastructure rider, to actually begin earning a return on and return of capital on for the Four Corners acquisition? And then if environmental spend starts in really ‘13, what's kind of the lag, if any, on return on and return of capital on the environmental spend?
James R. Hatfield
Michael, if you assume an infrastructure adjustor in this rate case and you assume a fourth quarter closing of the acquisition, under the infrastructure adjustor as sort of envisioned, you would get recovery in 2013. There’d be a little bit of lag because you would have to close your books and true-up your rate base and those sort of things, but that would be sort of the timing of that.
Environmentally, you’d have to put things into service and so we may start spend in ‘12, ‘13 and it would be a matter of getting into service the following year or sometime after that.
Michael Lapides - Goldman Sachs
So in other words, if you start the spend in ‘13 and it takes 18, 24 months to actually put it in service, you have a little bit of lag on the spending on the environment, on putting on the pollution controls, but not dramatic?
James R. Hatfield
That's correct.
Michael Lapides - Goldman Sachs
Okay. Last question.
I just want to make sure I understand. Would you ever consider utilizing a bit more back leverage at the holding company level versus at the operating company level?
Donald E. Brandt
It's not something we talk about, Michael. Obviously, with the Triple B minus credit rating we're really focused on improving FFO to debt and debt-to-capital from the rating agency perspective.
I don't think on a long-term basis that would be something that would benefit shareholders.
Michael Lapides - Goldman Sachs
Got it. Okay.
Thank you very much, guys.
Operator
Thanks. Our next question is Ed Yuen with SunTrust.
Please state your question.
Ali Agha - SunTrust Robinson Humphrey
It's actually Ali Agha here at SunTrust. Good morning.
Donald E. Brandt
Good morning.
Ali Agha - SunTrust Robinson Humphrey
Jim, I apologize if you may have addressed this I’ve got cut off for a little bit. But could you remind us, what was the actual 2010 ROE at the utility and what is sort of embedded in that ‘11 range that you've given us?
James R. Hatfield
The ROE in 2010 was 9.2%, so low 9. The ROE range and the guidance in ’11 is just under 9.
It's really reflective of two things, the continued growth to equity as we continue to retain earnings in the business.
Ali Agha - SunTrust Robinson Humphrey
Okay. And as far as the tax, favorable tax resolution you referred to, are those done, are there more tax issues out there that could further lower the tax rate going forward we should be aware of?
James R. Hatfield
Nothing I envision at this point. Our audits are closed through 2007, only eight is outstanding at the moment.
So, no, there's nothing I see that's going to drive it below the 34. On that subject, I will say on a go-forward basis, I would see our tax in the 34% to 35% effective tax rate being driven largely by the VIE inclusion in the balance sheet FAS 167, which effectively lowers our tax rate.
Ali Agha - SunTrust Robinson Humphrey
Okay. And then, the official ’11 guidance I guess technically you moved it up by $0.05, you've been talking about it very similar to your ’10 range and I’ve officially made it $0.05 greater up.
Is that the AZ Sun or is that on the cost side being better? What drove it to be slightly better now?
James R. Hatfield
Well, I see sort of several things, which are plus and minuses. Obviously, from a gross margin perspective, we were impacted by weather by about $8 million to the negative.
We do see AZ Sun, which we said is about $0.03 or $0.04. We do see another TCA increase in the middle of the year.
And customer growth and slightly more Schedule 3, we ended up with about $19 million Schedule 3 in 2010 and we see that slightly higher ‘11. On an operating expense perspective, I mean, O&M is essentially flat year-over-year, keep in mind, we have a pension deferral in 2011, which helps on that side of the ledger, offset by higher depreciation and property tax and then just a little lower effective tax rate.
Ali Agha - SunTrust Robinson Humphrey
Got it. Last question, with regards to the parameters you've made out in your notice of filing.
Based on the conversations you've been having, et cetera, any sense of where the big pushback or what are the items that will be the focus, for example, I'm thinking the 11% ROE, I mean, any sense of where the focus may be as we move forward on this rate case?
Donald G. Robinson
Ali, this is Don Robinson. Yeah, all of the items that you saw on the slide have pretty much been discussed with the parties and the stakeholders of the case.
I'm guessing ROE's always an issue in a rate case, so there's no surprise there. Probably the other potential one is an infrastructure tracker and how that plays out, although, it’s just an expansion of the environmental tracker we already have in place.
So none of these are new issues or surprises to the parties with case.
James R. Hatfield
Yeah, and Don, I just like to add to that, from a push back perspective the fact, you still have a pretty weak economy. You’re always going to get push back on raising prices, that's just the nature of the business.
Ali Agha - SunTrust Robinson Humphrey
Okay. Thank you.
James R. Hatfield
Thank you very much.
Operator
Our next question comes from Paul Patterson with Glenrock Associates. Please state your question.
Paul Patterson - Glenrock Associates
Good morning.
Donald E. Brandt
Hey Paul, how are you doing?
Paul Patterson - Glenrock Associates
All right. Most of my questions have been answered.
But just one quick one, on the energy efficiency impact here, you mentioned for your 2011 guidance, assuming sort of normal weather and like to see sales growth up about 1% along with customer growth, but that energy efficiencies will off the packages. Give us a little flavor to what it would be without your energy efficiency initiatives, and just any changes you’re seeing there in terms of your expectations on that stuff?
Donald E. Brandt
Energy efficiency?
Paul Patterson - Glenrock Associates
Well, energy efficiency and its impact on sales growth and whatever?
Donald E. Brandt
In the quarter-on-quarter we saw about 1.1%, which pretty much mirrored the reduction in sells generally, and so as we go forward what we expect, usage to be written to more normalized levels from a per customer basis, but increased in energy efficiency is going to totally offset that.
Paul Patterson - Glenrock Associates
Okay. Just to get a flavor, what is the usage expectation that would've been happening absent this energy efficiency initiatives on your part?
Donald E. Brandt
It’s somewhere in the 1.5% range in 2010.
Paul Patterson - Glenrock Associates
1.5%?
Donald E. Brandt
Yes.
Paul Patterson - Glenrock Associates
Okay. So you would have grown 1.5% or wasn’t for the energy efficiency or you would have grown 2.5%?
Donald E. Brandt
1.5%.
Paul Patterson - Glenrock Associates
Okay. So about 0.5% is being taken off because of energy efficiency, is that right?
Donald E. Brandt
1.5% has been take off through energy efficiency. We’re seeing any sort of usage for customer offset totally by the energy efficiency programs.
Paul Patterson - Glenrock Associates
Okay. So, I mean, just to make sure, I'm sorry, this was low, but once again expecting 1% increase in sales growth?
Donald E. Brandt
That’s right.
Paul Patterson - Glenrock Associates
And it would have been 2.5% without the energy efficiency initiatives, is that right?
Donald E. Brandt
That's correct.
Paul Patterson - Glenrock Associates
And then going past that, you're going to have decoupling I guess hopefully, coming up here pretty quickly and what have you, any change in your long-term outlook in terms of what we might see in terms of the long-term growth rate for sales growth?
Donald E. Brandt
First, we get out there on 12, we obviously see growth rates improving, we are more of historical layers on that sort of economy, but we also see energy efficiency increasing as well. So we’ll positive sales growth, but it’s going to be offset to a large degree by these programs.
So we do see positive growth going forward beyond ‘12.
Paul Patterson - Glenrock Associates
Okay. But it sounds like it would be pretty modest and with decoupling I guess it doesn't matter that much either I guess from a financial perspective, is that right?
Donald E. Brandt
Yeah, that's correct.
Paul Patterson - Glenrock Associates
Okay. Thanks a lot.
Operator
Our next question comes from Edward Heyn with Catapult. Please state your question.
Edward Heyn - Catapult Capital
Good morning.
Donald E. Brandt
Good morning.
Edward Heyn - Catapult Capital
I guess my first question was on Four Corners four and five. Just what’s the game plan if you were not to get an infrastructure tracker in the rate case?
I guess what kind of lag issues may crop up? And then I guess in the same vein, does that purchase hurt your chances of reaching a settlement because I would think that not getting an infrastructure tracker would be kind of a needed thing for a settlement.
Donald E. Brandt
I guess I’d couch it this way. Based on our current schedule, ‘12 is a test year so if I close this in late ‘12 when we don't have the infrastructure tracker, it would be lag based on just whatever time frame it takes to adjudicate a case if it goes that route.
I don’t think four and five impacts are ask in anyway because our ask was going to be the same without Four Corners four and five.
Edward Heyn - Catapult Capital
Okay. So basically hopefully you'll that the commission will be constructive or a settlement will be constructive and you'll get some sort of tracking mechanism.
If not, there maybe some lag in ‘13 but that should be picked up in the next rate case.
Donald E. Brandt
That's correct.
Edward Heyn - Catapult Capital
Okay. And then Jim, just separately, can you walk me through with gas prices being around $4, and you still getting 10% sharing on your fuel mechanism.
Can you walk me through kind of where, what's embedded in rates in your current PSA, where have you hedged out gas for this year and kind of what sort of savings or benefit are you getting from that?
James R. Hatfield
Well, the fuel rate embedded in the 2009 settlement is $3.76 and our gas hedges, since they’re longer term hedges, continue to fall from an average price going forward. The benefit we received in the fourth quarter on lower fuel is about $0.02.
So we’re getting some benefit but not a significant benefit from a fuel perspective.
Edward Heyn - Catapult Capital
Okay. The $3.76, that's on a kilowatt hour basis?
James R. Hatfield
Yes, sorry?
Edward Heyn - Catapult Capital
So what's implied from that, from a kind of an MMBtu basis?
James R. Hatfield
I don't have the answer to that off the top of my head.
Edward Heyn - Catapult Capital
Okay.
James R. Hatfield
But, we can get you that information.
Edward Heyn - Catapult Capital
Okay. Fair enough.
So, but I guess just to pull that through, in ’11 you’re assuming maybe a modest benefit from that savings, but not material and then obviously, in your next rate case you're asking just to go back to 100% PSA to kind of get rid of any of that mismatch.
James R. Hatfield
That would be correct.
Edward Heyn - Catapult Capital
Okay. Thanks a lot.
Operator
(Operator Instructions) Our next question comes from Daniele Seitz with Dudack Research. Please state your question.
Daniele Seitz - Dudack Research
Thank you. Most of my questions have been answered.
But one I was wondering about is how much more solar generation do you have to build to come up to the mandate and also do you sense that you have to do it 50/50 bout the rest of it will be built by your company, how does it work?
Donald G. Robinson
Daniele, this is Don Robinson. We have more than enough already in place to meet the settlement requirements that we have and we're well on track to exceed the requirement of the rules themself.
We will continue to try and have primarily ownership interest in new plants as we go forward. The initial plan is to continue to finish out the rest of Arizona Sun and then we'll see what the market is out there and what our needs are.
Daniele Seitz - Dudack Research
Okay, So I just – from here on, it is more on an economic basis that you are going to be choosing solar power and obviously with the Commission's authorization?
Donald G. Robinson
Absolutely. We're going to be working with the Commission and with our customers to see how far they want to go with solar.
Daniele Seitz - Dudack Research
And at this point, you think that it's wide open, there is no mandate on their part or no plans on your part to extend further your plans regarding solar?
Donald G. Robinson
No, we have plans continuing to expand our solar interest. It's as we continue to look – go forward, we'll be looking at them on an individual case-by-case assumption.
We'll be including them as part of our renewable plan that we file with the commission each year.
Daniele Seitz - Dudack Research
And the fact that you are going to add coal capacity, do you have to compensate that with additional renewable capacity, assuming you continue to expand your coal generation?
Donald G. Robinson
Now, we're expanding the coal generation by 179 megawatts of base load. Coal is base load, renewables are not.
They're intermittent, so they are not a trade-off and they’re not going to change our overall sales, it’s just going to change where the generation is coming from.
Daniele Seitz - Dudack Research
Okay. Okay.
Thank you.
Operator
Our next question comes from with Reza Hatefi with Decade Capital. Please state your question.
Reza Hatefi - Decade Capital
Thank you very much. Just going back to the bonus tax question, I guess you guys annually just based on your pretax income couple hundred million of tax, I guess taxes that you have to pay.
Does that mean that you'll essentially pay very little if no taxes for the next couple years?
James R. Hatfield
We will pay, based on the current forecast, zero income tax for the next two years.
Reza Hatefi - Decade Capital
Okay. Great.
And then if I look at slide 19, just adding up these income statement items gets me to earnings of above $320, just if I take the mid-points of the margin, the O&M, interest and I tax it, so forth. Is there anything else that’s kind of missing here that kind of gets you back down to your guidance?
James R. Hatfield
No. I would just point out that the ranges are just ranges around a current point forecast that are there to provide leeway one way or the other.
We may hit the top end of one line item and the lower end of the other line item throughout the year. So that’s how we approach sort of the ranges.
Reza Hatefi - Decade Capital
Okay. And then lastly, one question on load growth again.
I guess also on slide 19, part of your guidance is 1% volume growth but then in your 10-K that just got published I guess you’re guiding to flat kilowatt hour sales growth on average from ‘11 to ‘13. Does that mean ‘12 or ‘13 actually has negative growth that offsets this 1% positive growth?
James R. Hatfield
That's correct. We see a slight rebound in ‘11 just based on the fact that the, we've had a very weak economy and we’ve seen consumer conservation top of mind because of the economy.
So you get somewhat of a rebound effect, so-to-speak, in ‘11. But beyond that, we expect that usage is going to be slightly negative.
Reza Hatefi - Decade Capital
And is that negative mainly because of the energy efficiency programs or is it more the economy?
James R. Hatfield
No, it's really the impact of energy efficiency offsetting any sort of customer growth that you get on the system.
Reza Hatefi - Decade Capital
Okay. Thank you.
Operator
Our next question comes from Neil Mehta with Goldman Sachs. Please state your question.
Michael Lapides - Goldman Sachs
Hi, guys, this is Michael Lapides, asked and answered. Much appreciate it.
Donald G. Robinson
Thank you, Michael.
James R. Hatfield
Thank you.
Operator
Our next question comes from Greg Gordon with Morgan Stanley.
Greg Gordon - Morgan Stanley
Hi, Jim, It’s Greg, a follow-up on Reza’s question. I'm curious as to your confidence in your ability to accurately forecast out that far and sort of relative to just your willingness or necessity to be fundamentally conservative in your outlook, when we look – back at sort of January of last year, the EIA said sales growth in the U.S.
would be 0.8% and every CFO I talked to said model zero and we had a 4% year.
James R. Hatfield
Well, I mean, I'm not trying to be critical. I'm just wondering how you get your mind around a set of variables and sort of scenario analysis and get comfortable with that and is that a conservative baseline, are you really comfortable that's sort of the most likely outcome.
Donald G. Robinson
Well, Greg, I would approach the answer in this way. As a utility we're generally conservative in nature.
We do have history with rebounds. I mean if you look at the Arizona economy historically we go through these cycles.
So we can go back and look at what's happened generally speaking. And on the energy efficiency, we can only assume what's in the energy efficiency standard comes to provision and we put these all together and that becomes our forecast going forward.
I mean, I wish, I could say it's going to be stronger, but the economy's still weak here and that's sort of what we're seeing.
Greg Gordon - Morgan Stanley
Okay. Well, we'll plan for the worst and hope for the best.
Thank you.
Donald E. Brandt
Greg, Don Brandt here. I'll add to Jim's comment there on energy efficiency.
At least in the first few years, it's I think relatively easy to predict it. There's a lot of low-hanging fruit.
As we get further out on that time spectrum, it becomes a little less of the low-hanging fruit and more complicated and revolves around customers changing usage and habits and that as Jim says we essentially are forecasting what the models say will happen, whether in fact it does is something that probably has a significantly greater margin of error in bottom line, we want to do what's most cost effective for our customers as we proceed down the energy efficiency path.
Greg Gordon - Morgan Stanley
Well, Jim, you're on my panel on economic growth prospects at my conference in a few weeks. So we'll discuss it further then.
James R. Hatfield
Look forward to it, Greg.
Greg Gordon - Morgan Stanley
Take care.
Operator
There are no more further questions at this time. I'll now turn the conference back over to management for closing remarks.
Thank you.
Rebecca Hickman
Thank you all for joining us today. Obviously, if you have any questions, please let us know and we’ll be happy to talk with you.
Thank you for your interest in Pinnacle West.
Operator
This concludes today's conference. All parties may now disconnect.
Thank you.