Excelon Corporation Risk Analysis
Essay by review • February 27, 2011 • Case Study • 2,335 Words (10 Pages) • 2,895 Views
MW 4/8
INTEROFFICE REPORT
Exelon Corporation
March 9, 2005
Prepared for: Katherine Roarke
Prepared by: Debra Warner
Exelon Corporation is the parent company of several subsidiary utility companies, as illustrated on Attachment A, which operate in three distinct business segments: energy delivery, generation, and enterprises. Through their largest subsidiaries, Commonwealth Edison (ComEd) in Illinois and Peco Energy Company (PECO) in Pennsylvania, they currently rank 6th and 12th respectively in terms of electric utility revenue. (15) If their recently announced merger with Public Service Electric & Gas Company (PSEG) is successful, it will result in them becoming "the nation's largest power utility operator." (2)
Major Risks
The three major risk factors that Exelon must currently navigate include market fluctuations, correctly estimating competitive transitions charges, and conforming to environmental regulations imposed by the government. Each risk has the ability to affect their financial stability in detrimental ways. When we compare Exelon to the energy industry as a whole, though, we find that they are in a better position than most to handle the obstacles ahead.
Market Fluctuations
There are two key areas that can affect Exelon in terms of market fluctuations. The first area is interest rates. Exelon attempts to control costs by hedging both energy supplies and funds for future financing ventures. These contracts contain a combination of fixed- and variable-rates, which allows them to achieve a lower cost of capital. The negative aspect of having a variable-rate, though, is that "a hypothetical 10% increase in interest rates would result in a $2 million decrease in pre-tax earnings." (8) This decrease in income will ultimately affect equity and cause uneasiness among investors.
Market fluctuations in commodity prices also create risk for Exelon. "Market price movements because of excess or insufficient generation, changes in fuel costs, market liquidity and other factors" can all have a tremendous impact to net income. (8) While Exelon Generation has an estimated 90% hedge ratio for 2005, this leaves 10% at the mercy of the market. It is estimated that "a 10% reduction in the annual average around-the-clock market price of electricity is approximately a $32 million decrease in net income." (8) Commodity prices can also change in response to fluctuations in the weather, environmental laws, shifts in supply and demand, and state and Federal regulations. (8)
Competitive Transition Charges
Another area of great risk that is linked with market commodity prices is the competitive transition charge (CTC). This charge represents the difference between the wholesale and retail energy prices that Exelon utilitizes. (15) Every spring, the CTC rate is reviewed and accordingly updated to reflect any changes in the current market price. This new rate is then offered to all energy customers within their region, regardless of who they actually purchase their electricity from. (8) If the customer chooses to go with the rate offered, this rate is then locked in for one or more years. While this can definitely benefit revenues for Exelon, there is also a large risk. If the CTC rate is set too low, "a 10% increase in the average market price of electricity in a given six month period would result in a $5 million decrease in CTC revenues." (8) The loss in revenue could increase if more customers choose the lower rate offered. (8)
Environment Regulations
The third risk for Exelon is imposed by the government in the form of environmental regulations. Over 70% of the energy Exelon produces comes from their large fleet of nuclear reactors. (16) The U.S. Government, headed by the Environmental Protection Agency (EPA), has passed numerous laws regarding nuclear plants and the waste they produce, such as the Nuclear Waste Policy Act of 1982 (NWPA). (8) This law requires "the U.S. Department of Energy (DOE) be responsible for the development of a repository for and the disposal of spent nuclear fuel (SNF) and high-level radioactive waste." (8) According to Exelon's company records, the DOE was supposed to have taken possession of SNF no later than January 31, 1998. Currently, the SNF is put into dry cask storage awaiting the opening of a nuclear repository, which the DOE estimates will not open until at least 2012. (8) This leaves Exelon with the responsibility, as well as the large expense, of storing nuclear waste until the site is opened. A recent court victory against the DOE awarded Exelon $80 million to cover costs of SNF storage. (4, 8) With the uncertainty surrounding the opening of an actual disposal site, Exelon's expenses are likely to surpass the amount awarded, leaving the storage burden to the stockholders. (8)
Other areas of environmental regulation that impact Exelon include clean air and water acts. As changes are made to the existing laws, the numerous plants that Exelon owns must be retrofitted to comply with these new rules. Before costs can be determined, an extensive "interpretation of the requirements, resolution of outstanding litigation concerning the requirements, completion of studies to establish biological baselines for each facility, and environmental and economic costs benefit evaluations" must be conducted. (8) As of December 31, 2004, Exelon's subsidiaries had accrued over $124 million "for various environmental investigation and remediation." (1, 8) While they budget for such expenses, there is no sure way to correctly estimate how much will be needed from year to year. (8)
Each of the above mentioned risks is currently being handled well by Exelon's Risk Management Committee (RMC). Whether it be swapping interest rates to obtain the best possible value for their money or performing routine plant check-ups and repairs, Exelon has managed to keep costs low and profits high. Their high profits, though, are not enough to warrant our company acquiring them as an audit client. In order for us to obtain an unbiased analysis, we must compare and contrast their key financial ratios with those of the energy industry as a whole.
Industry Comparison
The areas that are of greatest importance in comparing Exelon to the energy
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