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Calpine Corp. (NYSE:CPN)

Q1 2017 Earnings Call

April 28, 2017 10:00 am ET

Executives

W. Bryan Kimzey – Calpine Corp.

Thad Hill – Calpine Corp.

Andrew Novotny – Calpine Corp.

Zamir Rauf – Calpine Corp.

W.G. (Trey) Griggs, III – Calpine Corp.

Analysts

Neel Mitra – Tudor, Pickering, Holt & Co. Securities, Inc.

Greg Gordon – Evercore ISI

Keith Stanley – Wolfe Research LLC

Julien Dumoulin-Smith – UBS Securities LLC

Abe C. Azar – Deutsche Bank Securities, Inc.

Ali Agha – SunTrust Robinson Humphrey, Inc.

Praful Mehta – Citigroup Global Markets, Inc.

Operator

Welcome to Calpine’s First Quarter 2017 Earnings Conference Call. My name is Paulette, and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded.

I will now turn the call over to Bryan Kimzey, Vice President of Investor Relations & Financial Planning. You may begin.

W. Bryan Kimzey – Calpine Corp.

Thank you, operator, and good morning, everyone. I’d like to welcome you to Calpine’s investor update conference call, covering our first quarter 2017 results. Today’s call is being broadcast live over the phone and via webcast, which can be found on our website at www.calpine.com. You can access the webcast and a copy of the accompanying presentation materials in the Investor Relations section of our website.

Joining me for this morning’s call are Thad Hill, our President and Chief Executive Officer; and Zamir Rauf, our Chief Financial Officer. Also with us to address any questions you may have on legal, regulatory, or detailed commercial issues are Thad Miller, our Chief Legal Officer; Trey Griggs, EVP and President, Calpine Retail; Andrew Novotny, SVP, Commercial Operations; and Caleb Stephenson, SVP of Wholesale Origination and Commercial Analytics.

Before we begin the presentation, I encourage all listeners to review the Safe Harbor statement included on slide 2 of the presentation which explains the risks of forward-looking statements and the use of non-GAAP financial measures. For additional information, please refer to our most recent SEC filings, which are on file with the SEC and on Calpine’s website.

Additionally, we would like to advise you that statements made during this call are made as of this date and listeners to any replay should understand that the passage of time by itself will diminish the quality of these statements. After our prepared remarks, we’ll open the lines for questions. In the interest of time, each caller will be allowed one question and one follow-up only.

I’ll now turn the call over to Thad to lead our presentation.

Thad Hill – Calpine Corp.

Thank you, Bryan. Good morning to all of you on the call and thank you for your interest in Calpine.

Today, we report first quarter adjusted EBITDA of $326 million and, more importantly, we reconfirm our full year 2017 guidance range of $1.8 billion to $1.95 billion. We’ve had some real successes over the last quarter, but also are challenges, all which I’ll cover. That said, we’re continuing to execute on our plan and believe that our successful execution will continue to create meaningful free cash flow and a stronger balance sheet for Calpine, which should mean real value for you, our investors.

Starting with the numbers, I thought it useful to make sure that both our Q1 results and our balance of year guidance are put into appropriate context in three different ways. First, for Q1, extreme hydro conditions in the West, a higher gas price to eliminate some run hours in Texas, and the warmest winter in the East in history were key headwinds that impacted our results. Our $326 million of reported adjusted EBITDA is $48 million below 2016, but actually quite similar to 2015, our record adjusted EBITDA production year.

Second, from an annual guidance standpoint, to understand how we’re tracking overall, it is helpful to understand the biggest year-over-year variance drivers for quarters two, three and four. Over the balance of the year, we will benefit by approximately $100 million in higher EBITDA from retail and $50 million in higher capacity payments. These items are perfectly offset by the sale of a couple of our power plants and a PG&E gas billing credit we received in the second quarter of last year. But before getting deeper into markets, costs and hedges, you can see the key drivers that are committing us to our guidance range.

Third, on the third quarter call last year, we mentioned that 2018 was tracking $100 million or so above 2017, and that is still the case. 2018 is tracking roughly $100 million above the midpoint of our 2017 guidance. Coming out of the numbers, we’ve continued our focus on operations, the delevering plan, and specifically our unique focus on portfolio management and customers.

Operationally, our retail integration continues on track. And although we had extended outages at two plants, overall, we are showing good availability. We paid off $233 million of debt in the first quarter. We’re well on our way to our targeted $850 million of debt paydown in 2017 and our targeted $2.7 billion of debt paydown target by the end of 2019.

Finally, we continued our relentless portfolio management. We closed on our Osprey sale in Florida, retired our Clear Lake Power Plant in Texas and also added a couple of new accomplishments.

First, as you may recall, in 2015, we entered into a contract to construct a new peaking plant in Texas for a customer by 2019. Earlier this month, we mutually agreed to cancel our agreement with our partner and will no longer build the Guadalupe peaker plant. Instead, we have entered into a new 10-year PPA with Guadalupe Valley Electric Coop.

We decided that investing more capital in this market and taking on the risk to do so did not make sense given the inherently poor regulatory design. That said, we’re bullish on prospects in Texas because we believe the market is on the verge of some asset rationalization. We have a substantial amount of capacity already and view an investment in new capacity as self-defeating unless and until there’s some regulatory reform. So we’ll no longer be spending the capital required to complete this project. Instead, we will meet our customers’ need from our existing capacity.

Second, in Louisiana, we’ve entered into an agreement to monetize a legacy development site in Washington Parish to construct and sell a new peaker project to our customer, Entergy Louisiana. Subject to regulatory approval and other conditions, this agreement will allow us to utilize existing site and infrastructure to build the new plant and sell it to Entergy after commercial operation. This is essentially a monetization of an existing asset, albeit one that requires a construction project first.

We expect that the capital for this project will be overall modest in scope, will be outlaid primarily in 2020, and will be funded through a short-term project finance-like facility that requires little to no equity. Upon completion of the project and receipt of sale proceeds, the project debt will be retired and the residual capital will be available for general corporate purposes. These two efforts taken together show the strength or our customer relationships: in one, we’re stopping our project and securing a PPA; with the other, we’re capturing good value from a non-core asset. I’m proud of our commercial efforts and the team work to accomplish this.

On the next slide, I want to take a brief moment to reflect on the cash flow machine that is Calpine. As you can see, our business has continued its steady financial trajectory for a number of years. If you project this forward, which I’m comfortable doing within a reasonable range, it is impressive to think that we operate a business this stable, while being able to extract capital.

What are the attributes that allow this? This list includes the youngest, cleanest and most flexible fleet, tailor-made for low-gas price environment and the increasing penetration of intermittent renewables.

The future will be built on renewables and gas plants like ours; geographic diversity in the major wholesale power markets that helps manage around weather patterns and regional fundamentals; and agile portfolio management that includes shutting of assets that are more valued by other investors than ours and the last couple of years our entry into retail.

The chart on this slide shows our EBITDA profile. We all know that you can’t spend EBITDA. You spend cash. But we’re also blessed with the fact that we turn every $1 of EBITDA into $0.75 of unlevered free cash flow. This is in part because of the nature of our assets and the lack of environmental retrofits and historical environmental liabilities and in part because of our $6.7 billion of tax net operating losses runoffs. All this supports our ability to continue generating stable financial results, while executing upon our plan to delever by something approaching $3 billion over the next three years.

Even while enjoying this profile, we hear much discussion by the sell-side of catalysts. They say that is what is required to move our stock. My point on the next slide is that while there are some potential near-term catalysts, we don’t necessarily control them. So we are focused on what we do control. First, let me mention some of the potential catalysts for this year. First, fundamental reforms in the PJM and New England tariffs that protect competitive markets from state interference. I’ll return to this on the next slide, but we think there is a real potential for meaningful progress this year.

Second, the potential for EMACC to separate in the upcoming PJM capacity market. I won’t spend a lot of time here given we’ll all know the results in a matter of weeks, but this would be a good thing for us. Third, retirement announcements in Texas by operators of coal plants or 50-year-old to 60-year-old gas steam units that are losing money. Now, let me tell you where we’re focusing our time running the business for value.

We’re engaged in three primary activities this year. First, we’re paying off debt. The $2.7 billion of paydown represents over 70% of our market capitalization. Holding all else equal, this represents some meaningful accretion to equity value. Second, relentless portfolio management. Earlier I discussed our new Guadalupe and Washington Parish announcements which fall into this category. We have also taken steps to divest non-core assets and shut down those that are losing money where there is no obvious buyer. In addition, there are a couple of other asset management storylines worth mention.

In California, we made a filing to notify the California ISO that we would be shutting down four peakers coming off-contract at the end of 2017 since these assets would be cash flow negative without their contracts. I should mention that these four plants run virtually every day in the evening summer hours. The Cal ISO has decided that two of the assets are needed for reliability and is planning on awarding us Reliability Must Run or RMR contracts, for which we’ll earn a return of and return on capital for the two plants.

There are many questions about how the California market will evolve. But we think this demonstrates the point about how important our plants are to ensuring reliability and that, ultimately, either compensation will follow or the assets will come out of service. We will not provide services critical to the grid if we cannot make money. Finally, on portfolio management, we need to finish our York expansion. The commercial operation date has now drifted into the early part of 2018 as our contractor struggle. The good news for us is that our economics are protected by the liquidated damages that will be due from the contractor.

Lastly, in terms of our areas of focus, we’re evolving our business into an integrated portfolio. We are early in the integration effort, but we’ve already captured cost synergies. And much more importantly, we’re able to leverage our naturally long position to offer products to the retail entities that not previously have been able to provide.

Trey is doing a great job quarterbacking the retail efforts, along with Jim Wood, who run Solutions, and Michael Sullivan at Champion. Overall, yes. There is some potential catalyst for our business. But we’re focused on what we can control to create long-term value and believe our focus and diligence will pay off. At the risk of repeating myself, in 2017, we’re all about execution, delevering and integration.

The next slide discusses the rapidly evolving regulatory environment. Over the last several years, some companies have started seeking out of market payments for plants. This has created a situation where energy policy that impinges on federal jurisdiction has been legislated in multiple state houses and then litigated in federal court.

We, along with other competitive power companies and other concerned groups like industrial customers, the AARP, and even the PJM Independent Market Monitor, have begun engaging at the state level. Although New York and Illinois have agreed to provide bailouts to nuclear plants that, by the way, have already had their entire capital base paid for twice, the groundswell against these efforts is gaining momentum, particularly given people’s concern about rates and effect that, in some cases, profitable plants could receive extra compensation for a third time.

In addition, since Ohio and Pennsylvania are in the heart of shale gas territory, we expect there will be significant pushback against bailouts from the oil and gas industry in the Mid-Atlantic region. We do agree with some of the complaints made by our nuclear peers that out of market subsidies for renewables have created part of the problem. But solving one subsidy with another only creates more cascading issues. Two wrongs do not make a right.

Fortunately, we believe that both PJM and the New England ISO fully understand that subsidies distort markets and the lack to mitigate the impact of subsidies on price formation. In fact, earlier this month, the New England ISO published a draft proposal for capacity market tariff reform that takes a step towards making sure out of market subsidies for new resources do not negatively impact other resources.

We’re also hopeful that the new FERC will be pro-market and anti-subsidy regardless of how things evolve in the states and the courts. We believe that there are ways to improve energy market price formation that we hope all generators can support and that there will be FERC support for capacity market reform. The nuclear bailouts have created an enormous of amount of distraction and we think it is overdone.

In summary, first, existing nuclear units are already in the market and many of them have continued to clear the capacity markets, which makes us wonder why anyone would subsidize them in the first place. Second, regardless of how the litigation plays out, we think the story is politically very different in Ohio, Pennsylvania, New Jersey and even Connecticut. And we and others are working to oppose legislator faction there. Third, in any event, we believe fundamental tariff reform from the ISOs is on its way and we think it will be supported at FERC.

On the next slide, I turn to our operations. In the first quarter, we had eight employee reportables versus four last year. This is simply not acceptable, particularly in light of the fact that 2016 was our best safety year ever. I am thankful that none of these accidents was life threatening, mainly slips and strains, but even one injury is too many. We will be redoubling our efforts with employees in this most important of objectives, including an all-employee stand-down and an all plant manager summit that we had yesterday.

In terms of availability, during the first quarter, we did experience two long plant outages. One at a plant in the Northeast which is now back in service and one at a plant in the West, our Delta Energy Center where we had a failure in our steam turbine back in January. I am happy to report that Delta will be operating simple cycle mode by the summer, making sure we fulfill our capacity obligations. And through the use of insurance proceeds, we’ll be back in full service in the fourth quarter.

Aside from these two events, the balance of our fleet achieved a 1.6% forced outage factor, excellent by any objective measure. But, nonetheless, our overall performance was meaningfully impacted by these two events. In the lower right-hand part of the page, let me highlight some relevant retail operational statistics, including our projected load for the year of 65 million megawatt hours, predominantly commercial and industrial. We’re executing here according to our plan, achieving what I believe to be industry-leading retention rates and customer duration.

Our generation profile in the upper right is as many of you may have expected given our projection of 90 million megawatt hours for 2017. The Geysers is back at full output, recovered from the major fire in the fall of 2015. Generation from our gas fleet in the West is down, about half of which was due to the Delta outage. In Texas, our generation was down more materially whereas in the East with the exception of the sales of Mankato and Osprey we were flat year-over-year despite the weather.

I’m going to ask Andrew Novotny to elaborate in more detail about these trends and related current market dynamics on the next page. Andrew?

Andrew Novotny – Calpine Corp.

Thank you, Thad, and good morning, everyone. There were, as Thad said, some headwinds in each of our three markets that are well-known. But there are also some mitigating factors worth calling out. Let’s start with the West.

Many of you have seen headlines reporting extremely low spark spreads in California, primarily due to this year’s pervasive hydro generation. As expected, the hydro levels are indeed driving lower volumes for our gas fleet which you saw on the prior slide. Worth noting, however, is the fact that the vast bulk of this spark decline has been driven by very low mid-day prices during hours when we’re typically not running. As an example, the chart on the left shows the average hourly spark spread in Northern California for the first quarter of 2016 compared to the first quarter of 2017.

As you can see, the 2017 data is a bit peakier featuring higher highs and lower lows. The lower mid-day lows are responsible for the ultra-low market quoted on peak spark spreads that are grabbing all the headlines. What you might find surprising, however, is that the realized spark spreads during the morning and evening peaks weren’t all that different year-on-year. California still relied on our merchant-combined cycles for the majority of the days of the first quarter of 2017.

Moving to Texas, we did see significantly lower volumes year-over-year, primarily due to three factors: mild weather, higher natural gas prices that drove coal to run more, and lower spark spreads in the North that drove our Freestone and Bosque plants to run less. Although the North Hub spark spreads were lower year-on-year, we are fortunate to have most of our fleet located in the Houston zone. This past quarter, the Houston zone cleared at a premium to the North. And, in fact, Houston sparks were actually up year-on-year. This was largely due to transmission outages associated with the work on the Houston Import Project and to some extent deeply discounted Waha gas.

Once the Houston Import Project comes online next summer, it is likely that the premium will erode. However, four factors will mitigate this. First, the continued discount for Waha gas driven by increased Permian production. Second, continued wind development in the West and North, which will continue to pressure Northern prices and increase congestion in the Houston. Third, the significant load growth in the Houston area, including the addition of the Freeport LNG facility, which by itself is almost 1,000 megawatts of additional load. And, fourth, the potential for ERCOT to one day implement a marginal loss construct that would reward generation located in load centers like Houston.

Moving on to the East, on a portfolio normalized basis, our first quarter generation was roughly flat year-over-year despite the mildest Jan-Feb we have ever seen. This may be somewhat surprising for those noticing that the PJM spark spreads at the West Hub were down meaningfully. However, the realized spark spreads at our Eastern PJM plants, which clear closer to PECO load zone prices rather than PJM West Hub prices, were roughly flat year-on-year leading to similar generation levels.

As we look forward, we expect the Eastern load zones to clear even closer to West Hub due to ongoing transmission upgrades in the area, as well as stronger Marcellus gas prices. While it is good that the Eastern spark spreads are unchanged, these represent relatively modest energy margins; and the real upside story centers on the potential for the Eastern MACC region declared a premium in the upcoming capacity auction. All in all, the market fundamentals have been more positive than what has been generally reported.

And now, I’ll turn it back over to Thad.

Thad Hill – Calpine Corp.

Thanks, Andrew. Before I turn it over to Zamir, I’d like to summarize, as I started out by saying, a higher gas price in Texas, the very wet West and a mild winter in the East have not made for a helpful start to 2017, but we remain on track for our guidance range. And we continue to make great progress on paying down debt, managing our portfolio for value and integrating retail. As we continue to utilize our very unique portfolio and retail platform to generate our stable cash flow and meet our delevering commitments, we have every expectation that we will deliver value to our investors.

With that, I’ll turn it over to Zamir.

Zamir Rauf – Calpine Corp.

Thank you, Thad, and good morning, everyone. Thad just covered our operating results for the first quarter. So let’s now review our financial results and put them into context of our full year guidance. At a high level and consistent with our expectations, we benefited in the first quarter from the expansion of our retail portfolio, with offsets resulting from asset sales, regulatory capacity payments in PJM and weaker power markets.

For the full year, these same items have bridged to our guidance range. Over the next three quarters, we will continue to benefit from our retail acquisitions, offset in part by asset sales. However, the year-over-year variance in regulatory capacity payments will improve as a result of higher prices that begin in June of this year, particularly in New England.

Lastly, you’ll note that last year’s second quarter benefited from a natural gas pipeline transportation credit. So that will serve as a year-over-year variance in the upcoming quarter. Markets, hedges and costs comprise the balance of the bridge. As you can see, we are on track with our guidance range of $1.8 billion to $1.95 billion of adjusted EBITDA, and $710 million to $860 million of adjusted free cash flow.

Turning to the next slide, I’ll now cover our first quarter regional results. In the West, adjusted EBITDA increased year-over-year despite a decline in generation volumes, largely driven by our retail acquisitions, an increase in resource adequacy payments and higher revenues at the Geysers, where generation volumes increased now that the Geysers have fully recovered from the wildfire in late 2015.

In Texas, adjusted EBITDA declined slightly from last year’s first quarter as a result of lower contributions from hedges and lower generation volumes driven by the reverse of coal-to-gas switching and a mild winter. In the East, in addition to the sale of our Mankato and Osprey plants, a year-over-year decrease in capacity payments, lower contributions from wholesale hedges and lower realized spark spreads, particularly in New England, resulted in lower adjusted EBITDA. These decreases were partially offset by the benefit of our retail acquisitions.

On the following slide, we provide our updated hedge disclosures. Since Andrew covered our core markets earlier, I will keep my comments on this slide fairly brief. As you may recall, last quarter, we changed our hedge disclosures by removing retail margin and treating it as a separate adder. We continue to utilize this methodology, as summarized in the top right section of the slide.

There haven’t been many significant changes in the wholesale hedge disclosure since our call in February, so I’ll just summarize the slide with a few key messages. Our wholesale volume estimates remain on track with our previous projections. We are well hedged in 2017 and remain positioned for upside in 2018 and 2019. And, finally, we benefit from the stability provided by our retail platform.

Turning now to the final slide, we consistently continue to strengthen and de-risk our balance sheet. Our deleveraging plan, that I will talk about in a moment, is the most obvious one, but we are also de-risking in other ways, including reducing our floating interest rate exposure, reducing interest expense through our recent term loan repricing and extending debt maturities.

As you can see from the chart on the left, we have minimal interest rate exposure through 2020. Taking advantage of the low interest rate environment over the past several months, we have layered on interest rate caps protecting virtually all of our corporate term loan exposure, excluding the two bridges and have hedged $1 billion or two-thirds of CCFC’s term loans through a combination of three-year and five-year swaps.

This leaves us with less than 10% of our debt exposed to interest rate increases through the end of the decade, further stabilizing our free cash flow. As Thad mentioned earlier, we are well underway and on track with our $2.7 billion debt paydown plan as announced last quarter. So far, this year, we have repaid a net total of $233 million of debt, nearly 30% of the way towards fulfilling our 2017 target of $850 million, which includes paying off the Solutions bridge in full as you can see from the chart on the right.

In sum, we are starting this year on track, both in terms of our guidance and debt paydown plan. Upon completion of the $2.7 billion debt paydown, we will not have any corporate debt maturities until 2023. In addition, we will have reduced leverage by approximately 1.5 times at current EBITDA levels. We will have cumulatively saved about $300 million of cash interest through 2020 relative to the current forward LIBOR curve. Our growth CapEx will have decreased significantly over the next three years and we have nearly $2.1 billion of liquidity facilities. Calpine is a cash generation machine that consistently generates stable and strong free cash flow and we will utilize that cash to strengthen our balance sheet and create long-term equity value for our shareholders.

Thank you, again, for your time today. Operator, please open the line for Q&A.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. And our first question comes from Neel Mitra from Tudor, Pickering, Holt. Please go ahead.

Neel Mitra – Tudor, Pickering, Holt & Co. Securities, Inc.

Hi. Good morning.

Thad Hill – Calpine Corp.

Good morning, Neel.

Neel Mitra – Tudor, Pickering, Holt & Co. Securities, Inc.

I had a question on the commodity margins in Texas. You mentioned that you guys were weakened a little bit by the fact that gas went up year-over-year. I thought the switching point was pretty low in Texas, around $2. So why didn’t you benefit from higher gas prices with the CCGT fleet there?

Andrew Novotny – Calpine Corp.

Yeah. Neel, this is Andrew. I think that we were primarily referring to how much our volumes had decreased year-on-year. I mean, if you look, our Texas commodity margin wasn’t really hit tremendously for the quarter relative to our expectations and the volumes in the off-peak were impacted by a significant increase in gas during that first quarter given where those prices were. So, I think that, from a spark spread standpoint, we have, as we pointed out on the slides, seen higher spark spreads specifically in the Eastern zone. Whether that’s due to gas prices or not, it’s tough to say. But I do think the on-peak spot liquidations in Houston have certainly seen a benefit quarter-on-quarter, which is why we laid that on the slide.

Neel Mitra – Tudor, Pickering, Holt & Co. Securities, Inc.

Okay. And the second question, can you quantify how much this project monetization, the plant that you’re going to build for Entergy, what the EBITDA contribution or the range would be for that?

Thad Hill – Calpine Corp.

Yeah, Neel. So, it won’t be EBITDA. It will be cash because we will construct the plant and then we will sell the plant at a premium to our cost of construct. As far as kind of the net cash benefit to Calpine, I really can’t describe it right now. That project is pending regulatory approval before the LPSC and we need to let it work its way through the regulatory process. So, I don’t think we can talk about the economics until we make some progress.

Neel Mitra – Tudor, Pickering, Holt & Co. Securities, Inc.

Okay. Great. Thanks. That’s all I had.

Thad Hill – Calpine Corp.

Okay. Thanks, Neel.

Operator

And our next question comes from Greg Gordon from Evercore ISI. Please go ahead.

Greg Gordon – Evercore ISI

Yeah. Can you talk a little bit about what you think the timeline is for some sort of clarity on what the PJM and/or FERC might do with regard to trying to deal with the potential proliferation of nuclear subsidies? Would you expect some sort of FERC 205 filing after sort of a stakeholder process later this year or some other pattern (29:13)?

Thad Hill – Calpine Corp.

Yeah. Thanks, Greg. There are multiple components to – if some of these nuclear bailouts do go ahead of PJM like they have in Illinois. So, first, of course, we think the litigation is still outstanding there in Illinois. And, secondly, in the other states, Pennsylvania, New Jersey, and Ohio, we think the politics are on our side. But, nonetheless, we do think that PJM is concerned about this and is working on it.

There’s a question about what this does to the energy market and there’s a question about what this does to the capacity market. And obviously PJM is thinking about this and they’ll be able to tell you exactly. But I would expect some stakeholder processes. And I think that we’re going to have to renew FERC commissioners we hope early in the summer. And I would expect there to be a lot of forward momentum this year on this particular topic. I hope there’s something that gets done on this before next year’s auction frankly. And I think that’s within the realm of reason.

Greg Gordon – Evercore ISI

Okay. Thank you.

Thad Hill – Calpine Corp.

Thanks, Greg.

Operator

Our next question comes from Keith Stanley from Wolfe Research. Please go ahead.

Keith Stanley – Wolfe Research LLC

Hi. Good morning.

Thad Hill – Calpine Corp.

Hey, Keith.

Keith Stanley – Wolfe Research LLC

Just on the 2018 outlook, so saying it’s $100 million above 2017, which you guys kind of said I think about six months ago or so. Can you just talk about some of the drivers there over the last six months? Because when we look just at headlines sort of on the spark spreads, you would think the outlook’s come down for 2018, but maybe some of these things you alluded to in the market section with California sparks are down because it’s the middle of the day and you guys aren’t running anyway. Maybe retail is doing better. Just where are some of the offsets that have enabled you to keep that 2018 outlook intact?

Thad Hill – Calpine Corp.

Yes. Keith – and I’m going to let Andrew Novotny in a minute to talk about some of the commodity margin aspects there, but let me just kind of maybe address this holistically. We did say $100 million in the third quarter. We’re saying it again now. Hopefully, that’s conservative. I should also point out that our major maintenance and CapEx expectations are down, and so is the EBITDA number. But our measurements in CapEx expectations are lower in 2018 than they were in 2017. And I should also mention that our growth CapEx will be largely wrapped up early next year. And so, we’re viewing next year as having a lot more deployable cash than this year, not just driven by the EBITDA increase but by those other factors.

We typically don’t guide or give indications of the year out, as you know. And so, we actually talked about whether we should do this, but clearly where the stock is, there seems to be a lot of fear or worry and that may be an understatement. But the fact of the matter is that this business is producing robust cash. It’s going to produce a lot more robust cash next year. And so, we put it out there to make sure that investors understand that is exactly the circumstance. So, with that, I’ll let Andrew talk about the commodity market. Andrew?

Andrew Novotny – Calpine Corp.

Yeah. Thanks. Look, for the wholesale markets over the last three months since the last call we really haven’t seen much of a net change, just kind of going region by region. It’s true that California sparks are down, but to some extent, as we mentioned, the shape value has increased because most of the decrease in the spark is really due to the middle of the day. As we move to Texas, actually Texas summer prices on a spark spread are actually up for 2018, although that’s not an impact that we’ve seen necessarily in 2017 yet in the market. The market is getting kind of more excited about future out-years because that’s actually moved up some modestly.

Then kind of as we mentioned in PJM, we actually really haven’t seen a net change in the Eastern spark spreads. So the West Hub spark spreads are down. The basis discount for the Eastern region has come in actually quite a bit, primarily due to the transmission upgrades that have occurred and somewhat stronger liquidations in the East prices. So, with those three things, when we look at it over the last three months, it really hasn’t changed much.

Keith Stanley – Wolfe Research LLC

And has there been a change in retail at all or no in terms of your outlook there?

Thad Hill – Calpine Corp.

No, I would say our retail outlook remains on track and we’re continuing to manage the business for cost as well.

Keith Stanley – Wolfe Research LLC

Okay. Great. And then just second quick question. Any more color you can give on the contractors, sort of, obligations and how you would be compensated on York 2 because of the delay?

Thad Hill – Calpine Corp.

I’m not going to go into a lot of detail on the contract except to say the contractor is struggling. We are going to provide them all the support we possibly can to get this plant done as soon as we can. It’s primarily in their court, but we’re going to be as supportive as we possibly can. And just that, if I were you, I’d just the treat the plant, the LVs (34:19) will cover us. So I would just treat the plant as if it were there. And I think if you do that, we’ll probably come out in a good place.

Keith Stanley – Wolfe Research LLC

Okay. Great. Thank you.

Thad Hill – Calpine Corp.

Thanks.

Operator

Our next question comes from Julien Dumoulin-Smith from UBS. Please go ahead.

Julien Dumoulin-Smith – UBS Securities LLC

Hey. Good morning.

Thad Hill – Calpine Corp.

Good morning, Julien.

Julien Dumoulin-Smith – UBS Securities LLC

Hey. So a couple quick questions. First, I just want to establish – obviously you guys reaffirmed today and reaffirmed even earlier in the year with the updated volume expectations. To what extent – where are we within the 2017 range? I just want to be very clear about that and give you guys an opportunity here to just opine. To what extent have you guys explicitly and already taken to account sort of the volume pressures that you saw in the first quarter? I just want to make sure we’re crystal clear.

Thad Hill – Calpine Corp.

Yeah. So let me be crystal clear, Julien. The reaffirmation of guidance today takes into account all the volume, all the current price curves and everything else that we know about. And also to be crystal clear is, I think, we never discuss where in our guidance range we are. The guidance range is the guidance range, and it speaks for itself. So there have been puts and there have been takes. But we’re holding the range, and that’s all you’re going to get out of me.

Julien Dumoulin-Smith – UBS Securities LLC

No worries. I’d be curious, as a follow-up, retail has been an emerging strategy for you guys over the last few years. What’s your appetite to continue evaluating expansions of the retail platform perhaps inorganically at this point in time and how you think about that in the context of your cash deployment strategy? I suppose that dovetails in part with the last question just asked.

W.G. (Trey) Griggs, III – Calpine Corp.

Yeah. Hey, Julien. It’s Trey. As we’ve said on the prior calls, we built the platform that we like. So I think large scale M&A is unlikely. And we’ll continue to investigate things that are cheap, smaller acquisitions of books, but organic growth is a heck of a lot cheaper and, frankly, more fun. So we’ll be focused on organic growth and small M&A, but you shouldn’t expect large deals.

Thad Hill – Calpine Corp.

I mean, Julien, we have a billing system. We have a call center. We have our customer information systems. And so, we don’t see a need to replicate that.

Julien Dumoulin-Smith – UBS Securities LLC

Got it. And last quick one, just Waha Hub. Obviously, you’ve seen a lot of the volatility there. Just want to be clear about what you think that means for your portfolio, the puts and takes on a prospective basis quickly?

Andrew Novotny – Calpine Corp.

Yeah. Sure, Julien. This is Andrew. Look, we actually spend a lot of time talking about this, mostly because it’s very complicated. And truth be told, we probably are somewhat agnostic to the price of Waha Hub. And so, it is complicated. On one hand, we’re a consumer for a few of our plants. So cheaper gas, of course, is nice. But on the other hand, the Northern points in Texas have definitely been pressured by Waha Hub.

That being said, take a giant step back, most of our capacity is in Houston. And as we think structurally over the next four years, I think that we do believe that the cheap gas prices in Waha Hub will continue to pressure the Northern prices along with wind, where a lot of the coal outfits are located and we think provide another catalyst for people who are considering when to rationalize coal capacity.

Julien Dumoulin-Smith – UBS Securities LLC

Got it. Excellent. Thank you all.

Thad Hill – Calpine Corp.

Thanks, Julien.

Operator

Our next question comes from Abe Azar from Deutsche Bank. Please go ahead.

Abe C. Azar – Deutsche Bank Securities, Inc.

Good morning, and congratulations on restructuring the Texas contract.

Thad Hill – Calpine Corp.

Thank you, Abe.

Abe C. Azar – Deutsche Bank Securities, Inc.

Thanks. Can you provide a bit more color on how you see New England’s capacity market reform proposal impacting your business?

Thad Hill – Calpine Corp.

Sure. Well, let’s just talk about the proposal first. My super way of describing it, which is why I do believe it is a constructive step, is that subsidized renewables now would – there’s a noper. There’s no ifs, ands or buts about it. And they effectively have their ability to buy their way into the capacity market if some other capacity is willing to take the compensation to step out of the capacity market.

So we actually think it structurally doesn’t necessarily dampen the capacity prices that other units will receive or oversupply the markets. So we think it’s a good step to keep the competitive market going. There are a couple of issues that we don’t think it addresses, one of those being energy prices, which could be negatively impacted. And so, there’s work to be done there. We think there are various ways you can address that.

The second thing about it is that we’re a little – what we don’t like is that once an asset gets in or subsidize resource, it’s probably soon to get (39:11) zero. Now, I’d have to get into the capacity market in the first place through exiting capacity, but that over time can suppress the supply curve. And so, we think there’s some fixes to that as well. So we think it’s a good first step. There’s two caveats which, I think, we need to work through. And so, we’ll see how it plays out.

But we certainly – people are working hard to protect markets even while trying to accommodate some of the stakes. And, ultimately, we hope our court actions prevail. And we’re certainly going to fight some of these existing units on efforts than the other stakes. But we think it’s a positive step.

Abe C. Azar – Deutsche Bank Securities, Inc.

Great. And shifting to PJM. Does the presence of seasonal aggregation change your outlook for EMAAC at all, or was that already embedded in your assumptions last quarter?

Andrew Novotny – Calpine Corp.

Yeah. Sure. This is Andrew. It’s definitely embedded in our assumptions, because we are actually optimistic that the seasonal aggregation is going to end up falling to dip out to lesser zones. So as resources aggregate, rather than consolidate into EMAAC, we believe it will force a consolidation into MAAC or RTO. So while it’s certainly bearish in general for the RTO capacity market, we actually do believe that EMAAC has been protected. And then, just to kind of continue on, we’re also pleased to see that the parameters were updated to see the levels that we were expecting. And so, net-net, we’re still very optimistic on this price.

Thad Hill – Calpine Corp.

And just maybe – and, Andrew, you can correct me if I misstep here. But part of the DR aggregation effort provides our winter capacity, which will be provided by wind. And the reason why it may not make its way all the East is mostly that wind that will provide the winter capacity is not deliverable into East MAAC. And so, structurally, that will move to DR effectively to the West.

Abe C. Azar – Deutsche Bank Securities, Inc.

Very helpful. Thank you.

Thad Hill – Calpine Corp.

Thank you.

Operator

Our next question comes from Ali Agha from SunTrust. Please go ahead.

Ali Agha – SunTrust Robinson Humphrey, Inc.

Thank you. Good morning.

Thad Hill – Calpine Corp.

Good morning, Ali.

Ali Agha – SunTrust Robinson Humphrey, Inc.

Good morning. First question to be clear on your growth CapEx outlook. So, you have $220 million this year and Guadalupe no longer is going to be built. So, should we assume that for 2018 and 2019 there is no growth CapEx or how should we be thinking about that beyond the $220 million this year?

Zamir Rauf – Calpine Corp.

Yeah. Ali, this is Zamir. I mean, we’ve got about $50 million of growth CapEx that we have talked about for next year. I believe that it’s going to come in under that. Beyond that, we really don’t have any growth CapEx in our view. So, that’s pretty much it.

Thad Hill – Calpine Corp.

Yeah. Ali, we will update these as we get more information, but the $270 million that I think is listed during this year and next year definitely taking the under. And there’s nothing major committed out there once we finish York.

Ali Agha – SunTrust Robinson Humphrey, Inc.

Okay. Okay. And then, Thad, as you mentioned, in the near-term, the catalysts that you’re looking at are not directly in your control. Your focus has been on the deleveraging and you still generate a lot of cash. If the public equity markets continue to penalize your shares as they have been continuously, is there a point where you say, look, while the focus has been on deleveraging, my equity is just so cheap that I need to go back and just invest in my equity and maybe the public equity markets are just not getting the underlying value of this portfolio?

Thad Hill – Calpine Corp.

Yeah. Ali, I’m going to interpret that question as asking about share buybacks. Is that fair?

Ali Agha – SunTrust Robinson Humphrey, Inc.

Share buybacks leading all the way to just buying back all the shares.

Thad Hill – Calpine Corp.

Okay. Well, those are two very, very different questions. On the share buyback question, look, it is killing us because we think that the stock is incredibly undervalued, not to be putting money to work in the stock. That being said, when you look at the map, which is just by paying down this debt, at a constant multiple, we get 70% of our market cap paid down. That value directly accretes to equity and that is extremely low risk.

And if I can, over the next 27 months – or sorry, 33 months, between now and the end of 2019, move $2.7 billion out of debt into equity given where we are today, and that’s very well risk – on a risk adjusted basis. So I think that’s probably where we should be spending our money. I think share buyback for this time given the investor perception of the risk they see even though we may not see it, I think, weighted average returns continuing to pay down debt, that’s the right thing.

You asked about – I think what you’ve said is, would you sell the company was the point of your other question or the second part of the question. Look, we’re going to continue to answer this exactly the same way, which is, as I have before and it remains true, if there is somebody out there, whoever it is, a strategic anybody else that values the company a lot more than our shareholders do, we’ll do the right thing. But until and unless that ever occurs, our job is to operate, produce the cash, and do what’s right for the shareholders. We’re going to keep doing it.

Ali Agha – SunTrust Robinson Humphrey, Inc.

Understood. Thank you.

Thad Hill – Calpine Corp.

Thank you.

Operator

And our next question comes from Praful Mehta from Citigroup. Please go ahead.

Praful Mehta – Citigroup Global Markets, Inc.

Thank you. Hi, guys.

Thad Hill – Calpine Corp.

Hey, Praful.

Praful Mehta – Citigroup Global Markets, Inc.

Just to follow-up a little bit on the consolidation – on the industry consolidation point, not necessarily just selling yourself but more industry consolidation. Given that all IPPs are trading and I guess investor perceptions of IPPs, do you think there is a need or a benefit to consolidate and if there is how would you approach it?

Thad Hill – Calpine Corp.

Yeah. So, obviously when you do the math, if the market cap shrink and you do some kind of synergy math, divide the synergies, get to be more and more important on a relative basis. I think that’s what you’re referring to probably. Look, as I mentioned before, the prior question, our number one job is to do whatever is right for shareholders. And so, that is what we will do.

When we think about M&A, generally, particularly the decline you’re talking about, there are really three streams we care a lot about. Certainly synergies is one of those. We also worry – think about the balance sheet and we also think about the quality of the assets. And so, that universe gets pretty small. So, I’m not going to speculate beyond that other than to say I certainly understand the math problem you’re talking about. But we think the balance sheet and the quality of assets matters a lot more over the long run, too.

Praful Mehta – Citigroup Global Markets, Inc.

Got you. Fair enough. And then it’s interesting to see the RMR contract and the deal you have with Entergy. Is there more of that you think to be done, let’s say, in California where more assets could go down that path given they are important to the reliability and any other such opportunities across your portfolio, I guess, where you can have longer term PPA type of contracts as well that you think is another opportunity to probably stabilize your cash flows and give investors a little bit more confidence on longer-term cash flow profile?

Thad Hill – Calpine Corp.

I counted at least two questions in that one question. So, let me try and parse them out.

Praful Mehta – Citigroup Global Markets, Inc.

I squeezed it in.

Thad Hill – Calpine Corp.

And hid a couple of things. You asked about California. I’m going to stay focus in the next year or two here. Just there is a shift in fundamentals that is occurring that we think will be helpful for us even beginning in 2018 and certainly 2019. And there are two things that people I think should be aware of. First off, longer-term, there are a bunch of retirements. But this year we’ve seen a couple of key competitors shut down in Northern California. And those will be the old steam units in Moss Landing and the steam units at Pittsburgh which, I think, between them, it’s 2,500 or 3,000 megawatts. That means that our assets in the Bay Area – the resource adequacy we provide all for them should be more valuable. And so, the question is how can we capture further (47:40) value for that.

More generally, across the State of California, there is something pending at the PUC which, we think, will get a draft ruling out here in the next month or so. That actually has gone back and looked at what they call the effective load carrying capacity of solar. And what that basically says is based on the duck curve that Andrew showed, solar is providing exactly zero benefit to capacity in the middle part of the day or in the peak, because there’s too much of it.

And there is a re-rate going on where we think that on the resource adequacy requirements will be dropped or the benefit – the credit that solar is being given will drop by 3,000 to 4,000 megawatts. And that could be in places early again as the 2018 RA. So, yes, we do think there’s some near-term California opportunity around this supply/demand for resource adequacy getting balanced as early as next year. So, we think there’s some upside there.

More generally in the contract portfolio, contracting effort, you should know that we have a sales force. That is our origination team on the wholesale side and the sales force from our retail businesses. And that they are always looking for opportunities, including asset-backed opportunities. And, I think, we’ve got a pretty good track record there. And so, I’m not going to speak to anything specifically, but we’re continuing to work and, hopefully, we’ll have more announcements coming up on that stuff.

Praful Mehta – Citigroup Global Markets, Inc.

Great. Thanks so much.

Thad Hill – Calpine Corp.

Thank you.

Operator

We have no further questions. I will now turn the call back to Bryan Kimzey for closing comments.

W. Bryan Kimzey – Calpine Corp.

Thanks, everyone, for participating in our call today. For those of you that joined late, an archive recording of the call will be made available for a limited time on our website. If you have any further questions, please don’t hesitate to call Investor Relations. Thanks again for your interest in Calpine Corporation.

Operator

Thank you. Ladies and gentlemen, this concludes today’s conference. Thank you for participating and you may now disconnect.

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