Carbon Profile Analysis

In an increasingly carbon-constrained world, investors and owners of carbon-intensive assets (such as coal-fueled power plants) are keenly aware of the potential financial risks associated with those assets. More and more, investors – especially those with a focus on social impact investing – are incorporating this risk into their investment analyses and asking operators about risk mitigation strategies. Some of our own investors and other interested stakeholders have been asking these questions of AEP. In response, we are reporting on our risk exposure and risk mitigation strategies, which align with the transformation of our company that is already underway.

In response to new standards for regional haze and mercury, in 2016, Public Service Company of Oklahoma retired Unit 4 at the Northeastern coal-fired plant and retrofitted Unit 3 with new environmental controls.

Following the retirement of coal-fueled generating units in 2015, 54 percent of AEP’s generating capacity was from coal and 26 percent from natural gas – both fossil fuels. Today, the focus is on coal because it emits approximately double the carbon dioxide (CO2) of natural gas. Some investors are especially concerned about the potential impact to their investment portfolios from stranded coal assets – such as a coal plant that loses economic value well ahead of its anticipated useful life.

AEP’s exposure to carbon regulation is already greatly reduced compared with five years ago. Between 2011 and mid-2016, AEP retired more than 7,200 megawatts (MW) of coal-fueled generating capacity. These retirements were driven by a number of factors, including environmental regulations. Between 2000 and 2015, AEP’s CO2 emissions have declined 39 percent. This is due to a combination of plant retirements, low natural gas prices that caused coal units to operate less frequently, the addition of renewable generation and slowing load growth.

The typical pricing structure that regulators establish for cost recovery of generating stations is based on the useful life of the plant and is depreciated over time. During the life of the units regulators allow us to collect the investment from customers over time. In this case, several coal units were taken out of service before the end of their useful life. Investors have expressed concern about the financial impact of this to AEP. Under today’s regulatory compact, within which we operate, we have been allowed to recover the full value of the units in our regulated utilities when we demonstrate prudency of the investments. In 2015, the remaining net book value of the regulated retired coal units received regulatory approval for cost recovery, except for $148 million, pending final approval. As additional regulated units are retired, we have and will continue to seek recovery of the remaining net book values of those units. Within our competitive generation business, the net book value of those units was zero.

Additional opportunities associated with reducing carbon include investments to refuel or repower coal units with natural gas or the construction of new combined-cycle natural gas units. AEP has no plans to build new coal plants and is carefully scrutinizing all investments in our existing coal fleet.

Where appropriate, we are working with state utility commissions to shorten the time it takes to recover existing and new plant investments; typically we would recover the costs of these investments over the life of the units. This strategy increases the likelihood of full cost recovery if units are retired early, and recognizes the long-term uncertainty of coal generation in our fleet.

Recent debate and calls for divestment in companies that have coal in their fuel portfolio or derive revenues from coal-related activities (i.e. electricity generation) is not constructive and harmful to investors. There is a major transformation under way in the electric utility industry that is expanding resource diversity and should be appropriately considered in the debate.

AEP has reduced carbon dioxide (CO2) emissions 39 percent from 2000 levels and we will continue to reduce our carbon footprint as we transition to more renewables and natural gas. AEP’s coal-fueled generating capacity has been reduced from 68 percent in 1999 to 50 percent in 2016. Between 2000 and 2016, we will have invested $8.5 billion in environmental controls. The funding for these investments comes from equity and debt capital from our shareholders and bondholders which is paid for by customers through increased rates.

AEP’s investments in transmission also interconnect approximately 7,500 MW of renewable resources across our service territory. AEP’s renewable portfolio includes about 3,200 megawatts of wind and solar today (including 59 MW of biomass), and by 2034, with regulatory approval, we will have added approximately another 3,400 MW of solar, 6,300 MW of wind and 3,000 MW of natural gas.

It is our position that those who are interested in emissions reductions, increasing clean energy resources and earning high financial returns can realize these goals by investing in AEP.

Several factors impact carbon asset analysis

  • Risk Factors – policies, regulations, technologies, markets, etc.
    • Clean Power Plan (CPP) - CO2 emissions reductions in energy sector.
    • Lack of commercially-viable technology to directly reduce carbon emissions, such as carbon capture and storage (CCS).
    • Depressed coal market caused by low natural gas prices, and cost-competitiveness of renewables.
    • Regulations driving coal out of the energy supply chain affects resource diversity with possible similar efforts aimed at natural gas production.
    • The current and future state of regulation is uncertain.
  • Exposure – to operators of carbon-intensive assets and financial exposure to lenders and investors.
    • If the CPP is implemented, federal emission guidelines would require states to develop plans to achieve the required emission reductions. These state plans would likely result in a carbon trading system that will place a value (cost) on each ton of carbon emitted from affected generating units.
    • Lack of technology (such as CCS) could limit the viability of traditional coal generation stations in the long-term, should emission limitations require additional significant reductions.
    • Several coal producers have filed for bankruptcy, which may impact future coal supply and lead to industry consolidation.
    • Regulations affecting coal production could affect supply and costs.
  • Analysis – how is carbon risk being evaluated?
    • AEP has been planning for this regulatory possibility for a number of years through the inclusion of a carbon price in its integrated resource planning process. As additional details emerge about how the CPP or other regulations may be implemented, AEP will reassess its carbon price and related planning processes.
    • AEP has assessed the commercial viability of CCS and included carbon regulations within planning processes.
    • AEP continually assesses coal market fundamentals to examine both supply and demand.
  • Management Approach
    • AEP is focusing its investments on shifting to non-emitting generation, such as large-scale renewables, and will have retired approximately 25 percent of its coal generating fleet by the end of 2016.
    • AEP took an active role in advancing CCS technology through research and development several years ago and has reduced potential exposure through coal unit retirements and asset diversification.
    • AEP actively manages its coal procurement process to ensure a diverse, reliable supply of coal is available at a reasonable cost.
    • Capital expenditures have moved substantially from environmental investments to investments in infrastructure, including transmission.
    • Existing coal plants play a vital role in providing reliable, 24/7 capacity and energy to the power grid. We will continue to responsibly operate these plants to deliver value to our customers and communities.
    • AEP does not foresee construction of new coal plants in the U.S.