Excelon Corporation Risk Analysis

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,