Everyone, welcome to Portland General Electric Company second quarter 2019 earnings results conference call. Today is Friday, August 2, 2019. This call is being recorded, and as such, all lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key on your telephone keypad. If you do intend to ask a question, please avoid the use of speakerphones. For opening remarks, I will turn the conference over to Portland General Electric's Director of Investor Relations and Treasury, Christopher Liddle. Please go ahead, sir.
Thank you, Michelle. Good morning, everyone. I'm pleased that you're able to join us today. Before we begin this morning, I'd like to remind you that we have prepared a presentation to supplement our discussion, which we'll be referencing throughout the call. The slides are available on our website at investors.portlandgeneral.com. Referring to slide two, I'd like to remind everyone that some of our remarks this morning will constitute forward-looking statements. We caution you that such statements involve inherent risks and uncertainties, and actual results may differ materially from our expectations. For a description of some of the factors that could cause actual results to differ materially, please refer to our earnings press release and our most recent periodic reports on Form 10-K and Form 10-Q, which are also available on our website.
Leading our discussion today are Maria Pope, President and CEO, and James Lobdell, Senior Vice President of Finance, CFO, and Treasurer. Following their prepared remarks, we will open the line for your questions. Now it's my pleasure to turn the call over to Maria.
Thanks, Chris. Good morning, everyone. Welcome to Portland General Electric's second quarter 2019 earnings call. Today, we will share our financial results, updates on our recently filed Integrated Resource Plan, and an overview of our plan to build a new Integrated Operations Center. Turning to slide four. For the second quarter, we reported net income of $25 million or $0.28 per share, a decrease of $0.23 per share compared to 2018. Given our expectations for the balance of the year, we are reaffirming our 2019 earnings guidance of $2.35-$2.50 per diluted share. I'll provide a summary of the factors impacting second quarter results. Jim will go into greater detail. First, net variable power costs were challenging, due in part to significantly lower than average hydro production in the Pacific Northwest. As such, our thermal plants increased generation 22% over the second quarter of 2018.
Concurrently, California experienced very strong hydro conditions, driving down regional power prices and decreasing wholesale revenues. Second, transmission and distribution operating expenses increased due to an enhanced focus on strengthening the resiliency and reliability of our system. Turning to slide five. The economy in our service area is strong. Although immigration has slowed, the labor market remains tight with a 3.5% unemployment rate. Forbes recently reported that Portland jumped in ranking among the top cities for tech talent, reflecting our more cost-competitive market for startups when compared with Silicon Valley or Seattle. This quarter, we continued to see new construction and expansion projects underway across our service area, as well as growth in energy deliveries to industrial customers. I'd like to briefly touch on 2019 Oregon legislative session.
We worked with a broad group of stakeholders in support of regulating greenhouse gas emissions through a state cap-and-trade program that ultimately did not pass. In future sessions, we will keep working with stakeholders towards cost-effective energy and climate policies. In addition to cap-and-trade, we successfully supported a bill to reduce greenhouse gas emissions in the state's transportation sector and boost the adoption of electric vehicles. We also supported several successful bills targeting energy efficiency and low-income customer assistance. Turning to slide six. We filed our 2019 Integrated Resource Plan with the Oregon Public Utility Commission last month. Our filing is the product of a collaborative process that reflects transformation within our industry and our goal of reducing greenhouse gas emissions.
Our plan calls for additional cost-effective energy efficiency, expanding reliance on demand response, 150 average megawatts of renewable resources by 2023, and approximately 595 megawatts of capacity needed by 2025, driven by the expiration of contracts and ceasing of coal fire operations at our Boardman coal plant, offset by the capacity associated with the 150 average megawatts of renewables. We anticipate an order acknowledging our action plan in early 2020. Similar to our last IRP, we expect to conduct RFPs for renewable resources and will seek opportunities for capacity through bilateral negotiations with existing generators in the region. Given the depth of the market, if we're not able to acquire adequate capacity through these negotiations, we will consult with the OPUC and may conduct a second RFP, also focused on non-emitting resources. Finally, turning to slide seven.
I'm excited to announce that this week our board of directors approved the construction of a new Integrated Operations Center. This center advances our integrated grid strategy and is designed for enhanced resilience against seismic, cyber, and physical security threats. The capital cost of the new facility is estimated to be $200 million and will be in service by 2021. Now I'll turn the call over to Jim. Thank you.
Thank you, Maria. Good morning, everyone. To start, I'd like to provide more detail on the specific drivers Maria mentioned and as summarized on slide eight. First, gross margin decreased a total of $0.12 per diluted share. Several factors contributed to this result. While our power supply portfolio performed well, it did not perform as favorably as in 2018. This contributed to an increase in net variable power costs. This was primarily due to the variation in market prices during the first quarter, resulting from the Enbridge pipeline outage, in addition to lower hydro production. In particular, PGE-owned hydro resources in the mid-Columbia projects resulted in a 13% decrease in production when compared to the second quarter of 2018. We experienced lower wholesale revenues due to a 25% decrease in the average wholesale sales price and 26% lower wholesale sales volume.
An increase of $0.03 per share is attributable to an increase in earnings power from our 2019 general rate case. Weather decreased earnings per share by $0.02 due to a decreased demand from fewer heating and cooling degree days. A decrease of $0.07 is attributable to an increased focus on preventative maintenance to enhance grid resiliency, which drove higher distribution expense in the second quarter. There was particular emphasis on vegetation and wildfire management, overhead and underground system inspections, and maintenance, along with cybersecurity. The next item is a decrease of $0.05 from lower production tax credits. A net increase of $0.01 from miscellaneous items. Despite some challenges in higher spending, we are confident that we can achieve our earnings objectives.
We are revising our O&M guidance upwards to a range of $600 million-$620 million, we are reaffirming our EPS guidance of $2.35 to $2.50 per diluted share, as we expect to see continued improvements in revenue through the balance of the year. We also expect improvements in our net variable power costs as we work towards our forecast of being below the PCAM baseline. Despite this quarter's increase in operating expenses, mitigating cost increases will be our focus as we plan for the next several years. As such, we're reaffirming our 4%-6% annual earnings growth guidance that we provided earlier this year. On to slide nine. We have provided a summary of the company's current capital expenditure forecast from 2019 through 2023. This includes the costs associated with our Integrated Operations Center that Maria discussed earlier. On to slide 10.
We continue to maintain a solid balance sheet, including strong liquidity and investment-grade credit ratings. For the remainder of 2019, we expect to fund estimated capital requirements with cash from operations and the issuance of debt securities up to an additional $230 million. Now, operator, we're ready for questions.
Thank you. Ladies and gentlemen, if you have a question at this time, please press star then the number one on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. Our first question comes from the line of Julien Dumoulin-Smith with Bank of America. Your line is open. Please go ahead.
Hey, good morning.
Good morning, Julien.
Good morning, Julien.
Hey. Thank you. Just wanted to follow up on the IRP process here. I know we're very early, but I wanted to kind of get a sense, how are you thinking about the ownership angle here and the opportunity before you, just sort of thinking about structurally, and what might be different from the last go-around in the IRP in which there was at least some amount of award for ownership? I mean that both to the firm capacity and the renewable piece.
Sure. Thank you. On both, we'll be looking at the option for ownership. At this point in time, we expect the IRP process to be concluded in the first quarter of 2020. There are some public hearings that are already scheduled in January. Then we will move very quickly into RFPs. For the renewables in particular, we're hoping to be able to capture some of the production tax credits before they expire, and as such, speed will be important. We don't expect any significant differences from how we approached things in the past. On the capacity side, we're going to start off looking really at what we can find in the existing market with regards to bilateral negotiations, RFPs for existing resources, all of which are not emitting.
Should we not find the depth in the market, then we will go back and work with the commission on putting together further procurement processes.
Got it. Excellent. If I can follow up here just on two more nuanced questions on this process. Historically, there's been pushback on load and demand forecast. Can you speak a little bit to the forecast that you put, that's contemplated and your level of confidence therein, and perhaps what may have changed around that from the last RFP process, again, to firm that up in your view? Separately and related, I suppose historically there's been some degree of pushback on accelerated renewable procurement based on your existing rec balance, if you will. How do you think about that now? I suppose there's the obvious counterpoint of the timeline for tax credit expiration. Anyway, any thoughts on either of those?
Sure. Thanks, Julien. With regards to your first questions with regards to growth, just as a backdrop, and we've talked about this in previous calls and then also in my remarks, our service territory has solid growth, and we see that going out into the future, driven largely by in-migration, but most importantly in terms of load by the tech sector. We have had extensive modeling and discussions with stakeholders, including the Commission, and feel as if we have good consensus around the 1% number that's used in our long-term forecast. With regards to production tax credits and recs and timeliness, to move forward faster with regards to procuring renewable resources is very much consistent with what our customers want us to do. It's also, given the production tax credits, it makes sense for us to move forward to capture those.
We do not see any of our recs expiring, or excuse me, our PTCs expiring. We continue to have cost-effective renewables. The costs in the region are coming down quite significantly. We remain impressed with the competitiveness of the market.
I'll leave it there and get back in the queue. Thank you.
Thanks, Julien.
Thanks, Julien.
Thank you. Our next question comes from the line of Insoo Kim with Goldman Sachs. Your line is open. Please go ahead.
Hi, thank you. My first question is on the, I think your comment on the second quarter O&M focusing on preventative measures on maintenance. Is that stuff items that you would've spent more in the 2020 time period that's a pull forward, or could you just elaborate a little bit more there?
Absolutely. You're correct, and let me let Jim give you some of the details on that.
Yeah. Insoo, as we mentioned, we're focused on vegetation management, wildfires, and then the inspection of the system. We are trying to make sure that we are making investments now that will help us lower our operating costs in the future. That's another reason why we are reaffirming our 4%-6% long-term growth rate.
Understood. Separately, the $200 million of the Operations Center that you have in the capital plan, I assume it'll earn AFUDC during the construction period. Have you had discussions, I know it's recent, but with the regulators at all? What's the process around trying to get recovery of that and timing of that in relation to the timing of the next rate case that you had contemplated previously?
You are correct that AFUDC is being calculated during the construction period associated with it. We have had preliminary conversations with stakeholders associated with that facility and the importance of having that facility if we're going to be able to respond from a resiliency perspective. We will make a determination as we move through time as to the regulatory timing of the recovery of the costs associated with that. It's to be seen.
Understood. Thank you very much.
Thank you.
Thank you. Our next question comes from the line of Gregg Orrill with UBS. Your line is open. Please go ahead.
Morning, Gregg.
Hi.
Good morning.
With regard to the change in the O&M guidance, how much of that have you already spent versus is coming up in the year in your view?
A good part of it has already been spent.
Okay. Thank you.
Thanks, Greg.
Thank you. Our next question comes from the line of Travis Miller with Morningstar. Your line is open. Please go ahead.
Good morning. Thank you.
Morning, Travis.
Morning.
I was wondering, back on the IRP and your initial conversations and planning for the filing, could you give us a sense of that 2022 and 2023 CapEx number, that $500 million? How much of that is dependent on the IRP? Is there a range? Is it all upside if you were to get certain parts of the IRP? Just wondering if you could characterize the early parts of the IRP conversations relative to that $500 million kind of run rate CapEx number.
Yeah, no, thank you for the question. None of the IRP or any subsequent RFP capital is reflected in that $500 million run rate. That $500 million run rate reflects a number of things. It reflects investment in ongoing resiliency and maintenance of our system, upgrades. It also reflects the fact that our service territory is growing quite significantly, and so we have new capital investment to meet customer needs. Anything that might come from an ownership or otherwise options out of the IRP or subsequent RFPs would be an addition.
Okay. Do you have any idea that you could give us in terms of range of that, or would it be kind of the cost of single large projects? Is that the way to think about it?
You could look at single large projects. We've included some 2018 cost numbers in the actual IRP filing for a wide variety of resources, which range from solar, wind, to geothermal, pump storage. It's all included in the document in terms of what were market estimates in 2018.
Sure. Okay. Higher level, what is your view in your service territory with respect to corporate renewable energy purchases? Maybe characterize that, kind of risks, opportunities, challenges that you have as corporate renewable energy buyers come onto your system.
Yeah. That's an excellent question. We certainly are seeing an increase in interest, not only from large corporations, particularly high tech and digital companies, but also from our municipalities for 100% green energy products. We've been working with them for over a year, and have structured some, what we call a Green Future Program that has been hugely well-received, actually, and selling out in a matter of minutes. Let me have James Lobdell go over the phases of that we've done, and it's really been a very successful program for us.
Travis, as Maria had pointed out, we had a very robust response to phase one of what we call our green tariff. We're now working with stakeholders on phase two associated with that. Looking at expanding the program. What about ownership by the company of resources? What about the ability to earn on any PPAs that come in? We're getting testimony from the parties, and then we're looking for a decision associated with that by year-end. As we pointed out, it's been a very robust response. Our corporations, our customers are willing to step up to green up their portfolios.
Is there rate base opportunity there? Any kind of capital or earnings growth type investment that's available there?
It's to be seen. We've got more process that we need to go through.
Okay, great. Thanks so much. Appreciate all the comments.
Thanks, Travis.
Yes.
Thank you. Our next question comes from the line of Andrew Weiss with ExodusPoint. Your line is open. Please go ahead.
Hey, how you doing?
Hey, Andy.
What's going on? All good?
Good. Yeah, it's raining here, though.
Okay. That's all right. Okay. I just want there was a slide that you had, where you show the first two quarters, and then you have the third and fourth quarter combined, I think it was like $1.25 to $1.40. Could you kind of just go over that and in detail explain what the drivers for the third and fourth quarter are? I guess what you're trying to suggest is that you'll kind of be in the, I guess, the midpoint would be like $2.42 in that $1.25-$1.40 range.
You're referring to slide number four in the presentation.
I think the concern, kind of looking at the stock action today, stock's down like 2%. The group's kind of, there's a lot of like weird, not weird, some good stuff happening today. Not of your stock. I think it would be important for you to explain in detail how you kind of make your number. Let's just use the midpoint, the $2.42 of that $1.25 to $1.40 range, for the rest of the year. If you could explain that to us so we can have some comfort in that.
Yeah. Absolutely.
Andy, I'm just going to focus on the going forward. We know what the history is in the first half of the year. The question is, what about achieving the earnings guidance that we put out at the beginning of the year? As I've mentioned previously, and as Maria had mentioned, we've got a lot of strong growth that's occurring in the service territory, especially in the high-tech sector around manufacturing and around data centers, and continue to see growth in a lot of other commercial activities. It's hard to get around Portland because of the amount of construction that's going on in our service territory. We're seeing a lot there. We had decoupling that is going to cover any offsets associated with use per customer. We've got a continued strong growth in customer count, so that's contributing to it.
As we pointed out, we are operating our power costs in line with trying to get below the PCAM baseline. We are working on costs now that will help us reduce costs in the future. Again, we're taking a long-term view as far as our overall cost structure. In addition to that, there's some geography that's going on inside the income statement from top line to O&M expenses, such as we had terminated some long-term service agreements associated with one of our thermal facilities. We ended up putting that in a balancing account. In addition to that, we had a storm in the first quarter that also presents some geography. While overall expenses are up, they're not up as much as you would otherwise read into it by just looking at the raw numbers.
As we pointed out, we are focused on reaching our earnings guidance that we have provided for the year and for the long term.
Let me just reiterate Jim's point in that, in the Pacific Northwest, we can see weather fluctuations, particularly hydro, wind, customer usage can affect quarter-to-quarter results. Long term, we expect that the investments that we're making in our system will lower our overall costs and bear fruit and our confidence in our guidance range.
On the mention of this balancing account relative to, I guess, the power plant. Was that in the first quarter or the second quarter?
That was in the second quarter.
Okay. How much was that?
There's a bunch of items moving back and forth that are sort of puts and takes into the entire quarter. As we look forward, we've given guidance on what our full O&M ranges will be. We're expecting to-
Let me ask it another way, because the way that you guys tend to do things sometimes, you don't really have adjusted earnings. You kind of throw everything in. In the second quarter, whether it's the balancing account, can you tell us how many things were kind of one-time in nature that won't reoccur next year? I'm not talking about hydro conditions or anything like that, but whether it's this balancing account or anything else that you kind of threw in there that affected the quarter in a negative way.
Andy, there's a lot of moving pieces in that, and it'd take a long time to go through to provide an adequate explanation associated with all those items. If you'd like to spend some time with Chris and Peter on that, they'd be more than willing to provide you that clarity. We look at the balance of all of our costs incurred and as we're managing them going forward.
Right. I guess what I'm trying to ask is, were there some one-time costs in nature in the second quarter? We don't know how much they are. We'll have to do that with Chris. Just in general, were there some one-time negative costs beyond having to run your plants because of hydro conditions?
Yes, there were, and we have factored those in into our forecast going forward.
Okay. Just on the second half, can you just categorize, just overall, are you trending towards the low end of the range, the midpoint of the range, high end of the range for the year?
I can't provide you that guidance. We appreciate the question, though. Thank you.
Yep. Okay. Thanks.
Thank you. Thank you, Andy.
Our next question comes from the line of Greg Rice with Cintas. Your line is open. Please go ahead.
Hey, Greg.
Hello?
Greg?
Oh, yes. Can you guys hear me?
Yeah.
Okay, great. Sorry. I'm going to just try on what Andy was just getting at right here. Looking at just kind of where you came in for the first half of the year and then the implied step up to kind of get to the midpoint of the range. It's about $0.19 in the second half of the year. Just looking at how the rate case is coming in, it's about $0.03 a quarter, so that should get you to about $0.06. Just wanted to get a little bit more color on that kind of incremental $0.13 and where that really comes from. Is it net variable power costs? Is it some other items that maybe we're not aware of that are expected to occur in the second half?
Yeah. No, I appreciate that question, Greg. Yes, we're mentioning to Andy, and as we had stated in our prepared remarks, it really gets to we're expecting increased revenues, especially the high-tech sector. We're expecting continued strong customer growth across. We are very diligently working on our power costs and getting them down below the baseline. As I pointed out, we've got efforts around O&M expenses for the balance of the year, and we did have some one-time items in the first quarter of the year. A combination of all those items, plus a bunch of cats and dogs, will get us to where we've got confidence in our full-year guidance.
Gotcha. It also sounded like you guys pulled forward some 2020 expenses into 2019. Is it safe to say that you would have had to have some pretty good, I guess, insights into how the balance of the year would shake out in order to be able to kind of pull forward some expenses and then still reaffirm the guidance range?
Yes, that's correct. I'd say that's a fair assessment.
Okay, great. Thank you very much.
Thanks, Greg.
Thank you. Our next question comes from the line of Anthony Crowdell with Mizuho. Your line is open. Please go ahead.
Good morning.
Morning.
Most of my question's been answered. Just if I could jump on Greg and Andy's question. Is there an estimate you guys have provided for the benefit of growth on a year-over-year basis?
No, we haven't provided that, Anthony. Sorry.
Okay. I'm good. Thanks so much.
Long term, we're still expecting 1% growth, and in our near-term forecast, we have just about half a percent. Right.
You haven't quantified if that's $0.05 a year or anything like that?
No. No, we haven't, Anthony.
Okay. Thanks so much for taking my question.
Yep. Thank you.
Thank you. Our next question comes from the line of Kevin Fallon with Citadel. Your line is open. Please go ahead.
Yeah, hi. I just wanted to ask on the potential savings in the second half on the net variable power costs. You guys are $6 million above the baseline to the first half. Is there any way to quantify where you think that could be in the second half? I think you've said you're targeting below, but it's a benefit, so you're getting at least $6 million back?
Yeah, Kevin, all I'll say is that we're anticipating being below the baseline for the full year.
Just to follow up on that, is it something that you have to see how the market conditions play out, or do you have a fairly high degree of confidence with where your head's right now that it's far less variable than just seeing what occurs over the next six months?
We're just looking at where the power markets are today, what we're anticipating will happen for the rest of the year given the current conditions, and we're forecasting that we think that we'll see improvements in our power costs.
Okay. Just in general, in terms of the guidance overall, is there anything in the first half results or with the O&M increase that moves you in terms of your assumption where you thought you were going to be in the range coming into the year? Are these things that are adjustments of where you thought you were going to be in the year, wherever that was going to be?
Some of these are timing adjustments, as Jim's gone through. Some of these are investments that we pulled forward. Some of them were one-time items. We're looking at the balance of the year, and we may reiterate our guidance, but we're not providing any additional insights as where we are within that guidance.
Okay. Just the last thing for you on the green tariff on the phase 2, what's the timeline for some clarity on whether you guys will be able to invest there or not?
I believe, Kevin, we should have an answer on phase II by the end of the year.
That's terrific. Thank you very much.
Thank you.
Thanks, Kevin.
Thank you. Again, ladies and gentlemen, if you have a question at this time, please press star, then the number 1 on your touch-tone telephone. We do have a follow-up question from the line of Julien Dumoulin-Smith with Bank of America. Your line is open. Please go ahead.
Hey, guys, just not to pile on too much. Curious again about the acceleration of costs and obviously the IOC with respect to confidence on earning ROEs in subsequent years. I know in the past you've talked about perhaps a little bit more of a distance between rate cases at present. Is there something to be read between the lines with respect to the ability to earn your ROEs? I understand that you're accruing AFUDC through the construction period as well as the higher O&M in 2020. I don't want to get too far ahead. I know there's one-time items and different weather variability consistently here. Perhaps just to opine a little bit more on a go-forward basis on confidence level to hold the line on a rate case.
Sure. Julien, our confidence level isn't any different this quarter than it was before. Underlying, our business is very strong. As James has mentioned, and we've discussed quite a bit, we had a number of one-time items and pulled forward some important expenses to address in the second quarter. We feel confident in our guidance and no changes in our ability to earn our ROE or our plans with regards to rate case timing. The IOC, or the operations center, is an important project that we've been working on for over a year and a half and have spent a lot of time talking with stakeholders. It'll be located in Tualatin, just south of here, in an area of seismic stability, and it will include a number of our really important 24/7 operations, our balancing authority, power marketing, trading, distributed resource management, all of our cyber and physical security.
It'll really be a modern center that will allow us also to be able to manage our distribution system in a more integrated fashion, which is heavily supported by stakeholders and the commission as we move forward. We look forward to being able to continue to talk with parties, and to begin to break ground this quarter.
All right, I'll leave it there. Thank you.
Thank you.
Thanks, Julien.
Thank you. I'm showing no further questions at this time, and I would like to turn the conference back over to Ms. Maria Pope for any further remarks.
Great. Thank you all for joining us today. Please join us in October where we'll report our third quarter 2019 results. For those of you attending the Goldman Sachs conference in August or the Barclays conference in September, we look forward to seeing you at both of those conferences. Thank you very much.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect at this time.