Praying for Profits

"Living on a prayer" is how AEP CEO Nick Akins describes his company's Wind Catcher project.  I will allow you a moment to wallow in 1986 now, when your pimply garage band may have created meaning for the rest of your teenage life.

So, this has been a normal quarter financially, but an outstanding quarter overall from an execution standpoint that sets the tone for 2018 and beyond with several rate case outcomes and settlements regarding Wind Catcher behind us, as Rush's classic rock song, Red Barchetta, which – Red Barchetta is a car, it's a two-seater Italian car – would say it's time to strip away the old debris, fire up the shiny Red Barchetta and respond with a roar. That's what I see in the excitement, the energy of our teams of employees at this company working on projects such as Wind Catcher and other technology advancements that will change the face of AEP's interaction with our customers.
To paraphrase one of the latest Rock and Roll Hall of Fame inductees, Bon Jovi, and I know this phrase will stick with you the rest of the day, we're halfway there, living on a prayer, take our hand and we'll make it, we swear. So, enjoy the ride with American Electric Power. Brian?

Oh, yes, please, Brian, save us from this glory days gibberish, won't you?

Corporate earnings calls are always amusing, but more so for regulated investor owned utilities, where the big executives sing and dance for analysts that they probably wouldn't waste their spit on if they saw them on fire and lying alongside a deserted road in a different scenario.  The executives pretend they're profitable, and the analysts pretend they believe them.  And the ordinary utility ratepayer sees a whole different side of their utility, who ordinarily likes to pretend it's working hard to provide value for customers in a tough regulated context; meanwhile behind customer and regulator backs the utility is bragging to analysts about how profitable it is and how regulators sit up and beg on utility leashes.  The result is pure hilarity.

How about a little reality here, AEP?  The vast majority of questions lobbed by analysts on last week's call were related to Wind Catcher.  I'm sort of left with the thought that the analysts don't expect the project to actually happen.  But no matter the question, Akins had a glorious and positive spin for it.  But what was he really saying?

Greg Gordon - Evercore ISI
Good morning, guys. Several questions for you. I'll try to make them brief. First is congrats on the Wind Catcher settlement in Oklahoma. You have a couple parties on board, but you have many more that have not officially signed on. But can you give us some color around the negotiations there? And what, on the margin, you have conceded to give up in this settlement to give customer protections versus the prior deal? And what it might take to get more parties on board?
Nicholas K. Akins - American Electric Power Co., Inc.
Yeah, Greg. Obviously, a great question. We continue to try to get other parties on board. But as we said from the beginning, it was extremely important to get the industrials on board in Oklahoma. And I think by getting them on board, it certainly sets the predicate for the opportunity for the commissioners themselves to look at this and say, okay, we've got both the industrial customers and Walmart, and the customers have spoken.
Now, there are other parties, as you mentioned. And certainly, we're trying to get the Oklahoma staff engaged in this process and, certainly, the Attorney General – probably not likely to get the Attorney General on board. But others will continue to be open to that, including the Attorney General.
But at this point, though, I think it's framed up pretty well, because a lot of work's been done in the background. Our people have been working tirelessly with all these parties around the various jurisdictions to try to drive some consistency around what the risks were being taken. And a lot of it centered on the 10-year look-backs, the performance guarantees, certainly the force majeure-related provisions as well.
And it really – as we looked at it, and as I mentioned early on in our discussion, you have to – if you're going to do regulated renewables, then certainly we'll have to meet the market on what risks are being taken relative to regulated renewable investments. And we looked at it, looked at it in a lot of detail. We have a lot of, like – as I mentioned earlier, engineering and construction. We looked that in detail, the operational characteristics of particularly the generation tie (22:16), and we've come a long way in terms of the evaluation of those risks.
We were willing to take it, and the industrials were ultimately supportive. So, I think it just sets the tone for continued discussions. But as far as I'm concerned, we've put it in a very good place, and you'll note that those provisions are pretty consistent with the settlements that have been done previously by SPS over in New Mexico and Texas. And we're having discussions with the Texas parties now. So, you're starting to see, in my opinion, a coalition around what risk parameters, what the framework of a deal looks like, and I see that momentum gaining.

The analyst wants to know how AEP plans to get other parties in Oklahoma on board with its quasi-settlement with only two of the numerous parties to the case.  What is AEP giving up to get the other parties to settle, and what are the chances of it actually happening?

Akins thinks having industrial customers on board "sets the predicate for the opportunity..."  In other words, only big corporate customers matter to the commission?  This is hogwash.  Industrial customer coalitions negotiate for their own self-interest, not yours.  Sometimes, industrials negotiate for rate perks that end up being paid by the other customers.  Because they buy so much electricity, they're always looking for sweetheart deals that cut a price break for their companies.  The utility oftentimes makes up the difference with rate increases for the other customers.  Big corporate customers also have big corporate lobbyists who may apply political pressure to get big questionable deals approved by state authorities.  Who's lobbying for all the residential and small business electric customers?  Maybe the Attorney General, who is "probably not likely" to agree.  Or perhaps the staff of the OCC, who maybe could be propped up to look like they represent the other customers.  And what about all this "work" that's been done "in the background?"  Does he mean "work" being done behind closed doors between lobbyists and government officials?  Sure sounds a bit suspicious doesn't it?  Don't bother looking for an answer about risk... it really is the mumbo jumbo nonsense it appears to be.

Bottom line:  We're still working on a settlement in Oklahoma, but we haven't been too successful so far.
Analysts's response:  "Well. Good luck with that."
Then he asks another question about AEP's flagging profits in Oklahoma.  Akins answer is quite revealing about the purpose of Wind Catcher.  If Wind Catcher gets approved, it will correct the Oklahoma rate problem and the profits will be secure for many years.  And who is going to pay for those increased profits?  Electric customers... and taxpayers nationwide who pay for those wind production tax credits AEP is using to supposedly lower electric rates.

Let's try another:

Steve Fleishman - Wolfe Research LLC
So, speaking of living on a prayer, I have a few Wind Catcher question. Sorry. I couldn't help. You asked for that one.
Yeah. Thank you for the Rush references, those are great. So just if I recall back last fall, you had talked about wanting decisions by April to make sure that you would have it online to get the full PTCs.
Is May-June going to be okay to be able to capture full PTCs? Like, what is the real deadline?
Nicholas K. Akins - American Electric Power Co., Inc.
Yeah, we'll be fine. Really, we have to get to a point of getting these orders in place, and then we'll cover it with our board, obviously, in our July meeting. And then once they approve it, we're off and running. So if we get it in that June timeframe, we get the orders in the May to June timeframe, we'll be in good shape.

Last time, Akins claimed he needed approvals in all states by April.  Now, because that hasn't happened, he says May or June would be fine.  If May or June is fine, why wasn't that the original deadline?  If May or June doesn't happen, will a new deadline appear?  Is there even a deadline at all?

And then the analyst again attempts to get a straight answer about risk.  The risk is that AEP will dump too much money into trying to get this project done and be left with nothing but bills if it doesn't get approval, or perhaps AEP will give too much away in settlement and then the project won't be profitable.  Where's the tipping point when AEP will put this project on a shelf?  According to Akin's mumbo jumbo, there is no tipping point.  The rewards will outweigh the risk, because AEP can "adjust."  Oh, I see.  "Adjustment" causes money to fall from the sky... or at least from ratepayer pockets.

Next....

Julien Dumoulin-Smith - Bank of America Merrill Lynch
Got it. Excellent. And then turning back to Wind Catcher real quickly, obviously, you're working every state front. To the extent to which, let's say, Texas and those negotiations aren't necessarily as fruitful here on the prescribed timeline that you just talked about, how confident are you about signing up alternatives like munis and co-ops just to be able to continue working on the project, notwithstanding clarity in Texas, shall we say?
Nicholas K. Akins - American Electric Power Co., Inc.
Julien, I really think we are going to get a result in Texas. And I think it'd be problematic during the pendency of something that's working to go sell somewhere else. So, we're feeling pretty good about the direction this all is taking and the timing of it.

The analyst poses the question of what could happen if AEP can't come up with a settlement in Texas.  Instead of going for approval from the Public Utility Commission to involuntarily charge the cost of Wind Catcher to ratepayers, might AEP instead try to sell Wind Catcher's generation and transmission voluntarily to Texas cities and electric co-ops?  This would use a merchant model in one of the states, something AEP has not considered.  In fact, if AEP were doing this project on a merchant basis, state approvals would be a whole lot easier.  What wouldn't be easier would be coercing electric distributors to shoulder the risk that this project would be cost effective.  That's been a non-starter with other transmission/generation projects and it is unlikely that AEP could sell its project to voluntary customers.  So, of course Akins doesn't want to even talk about that.  He's so sure he'll get approval in Texas he doesn't want to muck up his chances by taking the merchant route.  The reality is that a merchant route in Texas would probably knock the bottom out of rate settlements in the other jurisdictions as well.  Why should ratepayers take a risk when it can be left on AEP's doorstep?  If it can't pawn the risk off onto ratepayers, AEP doesn't want to play this game anymore.

Paul T. Ridzon - KeyBanc Capital Markets, Inc.
Two questions. Is there a statutory deadline in any of the Wind Catcher states, when this has to be done by?
Nicholas K. Akins - American Electric Power Co., Inc.
I don't think there's a statutory deadline, but certainly there's a business deadline. I mean, we've been very transparent about the timing necessary and the procedural schedules have been set up consistent with getting a decision on time. So, I think it's really more driven by, I guess, one of the previous questions sort of brought out, when is our drop-dead date and that kind of thing. But I can just tell you that May and June fits.

The analyst is probing to see if there is a drop dead date on this project, and when AEP is going to cut its losses and give up.  Now it's May and June.  Still no answer to the real question.

Paul T. Ridzon - KeyBanc Capital Markets, Inc.
And then some of the concessions you've made are around cost caps. Who's wearing that risk? Is it you or the contractors?
Nicholas K. Akins - American Electric Power Co., Inc.
Yeah. It's both. We have fixed-price contracts with the appropriate contingencies. And I think that that risk is being shared. And actually, this tells you a little bit about the commitment of the suppliers that we're working with. I mean, these are established suppliers that do a lot of business that we do a lot of business with. And I can guarantee a lot of homework's been done on what these operational provisions will look like, what the construction side will look like, what the supply will look like, what risks are being borne. And also even if route changes were to occur on the generation tie (38:02) that those have been discussed and (38:05) as well. So, we feel very good about where our suppliers sit at this point.

This analyst wants to know who is covering the cost caps on the project if it goes over budget.  Is it the contractors?  Or is it AEP, in which case cost overruns will cut into profits?  The perfect mumbo jumbo answer is that it's both... and neither... and let's not even talk about cost overruns because those will never happen.  Right.

And then other questions started to get a little hard for ol' Nick.  But instead of answering them, he throws a delicious plum into the center of the room and reminds analysts that AEP will be looking for investors for its Wind Catcher project to the tune of $4.5B, and there's a lot of profit potential for good investors who stop asking so many hard questions. 

Nicholas K. Akins - American Electric Power Co., Inc.
Yeah. So, we are in the middle of what I would call an M&A transaction without a premium. It's called the Wind Catcher. And so when we look at the strength of the balance sheet, certainly we'll be looking at the financing needs for Wind Catcher and that's a $4.5 billion transaction. So, that's where our thoughts are at this point.

Nice touch.  But the questions come back...

Ali Agha - SunTrust Robinson Humphrey, Inc.
Thank you. Good morning. Nick, to clarify, as you're looking at the four states for approval in Wind Catcher, is it fair to say just given where we are that Oklahoma probably is the most challenged of the four? And related to that, could you theoretically complete the project if the other three states say yes and Oklahoma was to say no?
Nicholas K. Akins - American Electric Power Co., Inc.
Yes. So, on the first point, I would agree with you. Oklahoma has been the most challenging. And really, with the ALJ order there, it made even more of a challenge for the commissioners to really take a look at it from a positive standpoint. But I really believe they will at the end of the day and – because they obviously look at much broader issues. And so, with that said, I think as far as Wind Catcher is concerned, we intend on this project being for those four states and certainly the FERC customers. There's some FERC customers too that are involved. And if one were to fall out, we're really – as I said, I mean, I think we're at a good place in terms of the transition of getting this thing across the finish line. And at this point, we really aren't entertaining the notion of going forward with the project without one of the jurisdictions. I really don't see that happening.

The analyst wants to know if Oklahoma is really going to be the problem it appears, and how is AEP going to fix that?  What's the plan if Oklahoma says no?  Is there a Plan B?

There is no Plan B.  If one of the states rejects AEP's plan, they're done.  Of course, AEP once said it needed to get this project approved by April.  Deadlines and decisions have a way of shifting because at some point they'll be too far down the pipe and must come up with a plan to recover their losses.

He sure seems confident that he can finagle this thing to get his way at four different regulatory commissions though, doesn't he?  It's almost like he has some other way to get approval that we're all not seeing.  Is it over confidence?  Or does Nick know something we don't?

Paul Patterson - Glenrock Associates LLC
Just sort of quickly follow up here on Wind Catcher. Why is it that the – what are the key issues, I guess, sort of maybe stopping the OCC staff and others from coming on board?
Nicholas K. Akins - American Electric Power Co., Inc.
Your guess is as good as mine. I think, obviously, the ALJ looked at it from a procedural basis it seemed like to me. But we're pretty convinced we did file under the right provisions under Oklahoma law. But obviously, we'll continue with discussions with certainly the Oklahoma staff. And I think – I really do believe we put provisions in place with the industrials that should benefit that discussion with them. Obviously, to have that kind of company of the customers certainly would help from a policy side and from a staff side to really take a hard look at this. So, the verdict's still out on that and we'll continue those discussions.

Oh yes, those folks in Oklahoma are just silly for not agreeing.  He seems to think that he can use the Oklahoma industrial customers as a stand-in for retail customers who disagree in order to get the OCC staff to acquiesce.  Because, remember, only big corporate customers matter in Oklahoma.  Nobody is fighting for the little guy... supposedly.

And what about the Oklahoma legislature's march toward ending state renewable energy credits?

Paul Patterson - Glenrock Associates LLC
Okay. And then, in Oklahoma, there's this tax issue on Wind. I guess we expect it's intertwined with school funding and there was something that passed the House yesterday. And I was just wondering how would that work with respect to the settlement or with respect to the project, or does it have any impact. Can you give us sort of a sense about that?
Nicholas K. Akins - American Electric Power Co., Inc.
Well, it won't have any impact on the project. And it got poured out of the legislature yesterday. So, we don't see that happening.
Paul Patterson - Glenrock Associates LLC
I mean, I thought it passed the House is what I just saw.
Nicholas K. Akins - American Electric Power Co., Inc.
No.
Paul Patterson - Glenrock Associates LLC
The provision for the tax credit, I thought it was removed. But we can talk about it later. But what you're saying is you don't see any activity on that whatsoever, is what you're...?
Nicholas K. Akins - American Electric Power Co., Inc.
No.
Paul Patterson - Glenrock Associates LLC
Okay. So if something like that did happen, though, since it's been sort of debated and what have you, and the school funding issue, in terms of the settlement, how would that – would that be something that you guys would absorb or would that be something that – how would that be treated if there was subsequently some sort of impact on wind generation in Oklahoma as a result of something that the state legislature may or may not do in the future?
Nicholas K. Akins - American Electric Power Co., Inc.
Yes. So, there is that risk, but not likely. And the state tax credit wasn't assumed in the Wind Catcher economics, to begin with. So if something were to occur, it wouldn't have any effect.

Can Akins be any more clueless?  Deny.  Deny.  Deny.  Oh, wait... that?  Tut, tut, tut, it doesn't affect us.  Is that just like AEP's fungible drop dead date?  AEP seriously would not take a state tax credit it was eligible for, and didn't use that in its desperate cost figures?  Sure, I believe you.

Let's sum this up:  Despite its earlier admission that it must have Wind Catcher approved in four states by April, AEP has now moved its deadline ahead by two months because it's having trouble getting it approved.  If approval isn't achieved by June, there is no Plan B, just perhaps new deadlines.  And maybe some swearing.  And praying.  Lots and lots of praying.