Exhibit 99.1
(Company logo appears here)
Pennsylvania Power & Light Company
Two North Ninth Street
Allentown, PA 18101
610/774-5151
John R. Biggar
Vice President - Finance
610/774-5613
FAX: 610/774-5106
April 1, 1997
Members of the Investment Community:
Re: PP&L's Restructuring Plan
In accordance with the provisions of Pennsylvania's
Electricity Generation Customer Choice and Competition Act
("Customer Choice Act"), Pennsylvania Power & Light Company filed
its Restructuring Plan with the Pennsylvania Public Utility
Commission on April 1, 1997. Under the provisions of the
Customer Choice Act, the PUC is required to take action on the
Restructuring Plan by the end of 1997.
The Restructuring Plan provides a framework for a
smooth transition from today's regulated prices to a marketplace
in which customers will have the ability to have direct access to
the generation supplier of their choice.
Calculation of Stranded Costs
Under the Customer Choice Act, the PUC is authorized to
determine the level of stranded costs for each electric utility
and provide a mechanism for recovery of an appropriate amount of
stranded costs in accordance with the standards established by
the Customer Choice Act. That mechanism is a non-bypassable
competitive transition charge ("CTC") to be paid by all PUC-
jurisdictional customers who receive transmission and
distribution service from the Company.
Stranded costs are defined in the Customer Choice Act
as "an electric utility's known and measurable net electric
generation-related costs, determined on a net present value basis
over the life of the asset or liability as part of its
restructuring plan, which would have been recoverable under a
regulated environment but which may not be recoverable in a
competitive generation market and which the Commission determines
will remain following mitigation by the electric utility."
The Restructuring Plan filed by the Company on April 1
includes a claim of $4.6 billion for stranded costs. As provided
in the Customer Choice Act, the categories of stranded costs are
comprised of:
1. Net plant investments and costs attributable to
existing generation plants and facilities, disposal of spent
nuclear fuel, retirement costs attributable to existing non-
nuclear generating plants and other transition costs,
including employee severance, early retirement, outplacement
and related costs for employees who are affected by changes
that are expected to occur as a result of restructuring of
the electric utility industry;
2. Prudently incurred costs related to the
cancellation, buyout, buydown or renegotiation of NUG
contracts; and
3. Regulatory assets and other deferred charges
typically recoverable under current regulatory practice and
cost obligations under PUC-approved contracts with NUGs.
The Company's calculation of $4.6 billion of stranded
costs is higher than previous public estimates published by other
firms for several reasons. Those estimates were not prepared in
accordance with the methodology required by the Customer Choice
Act. In addition, the public estimates excluded certain elements
of cost, such as fossil decommissioning costs, capital additions
to generating facilities over the remainder of their useful lives
and allocated administrative and general costs. Finally, the
Company is currently projecting a lower market price of
electricity than what was assumed in those estimates of stranded
costs.
The Company's estimate of stranded costs for the
Susquehanna nuclear plant and for its fossil generation plants
was calculated by comparing the annual revenue requirements under
a regulated environment for each generating plant with the annual
revenues that plant would be expected to receive from the sale of
its output using projected market prices of electricity developed
by an independent expert for each year beginning January 1, 1999
to the end of that plant's useful life. A PUC-jurisdictional
percentage was applied to the annual excess or deficiency. The
resulting stream of excesses or deficiencies was discounted to
present value using a discount rate of 7.92% -- the Company's
weighted after-tax cost of capital at December 31, 1996.
NUG stranded costs were determined by comparing the
difference between the contract cost of energy required to be
purchased from non-utility generators under contracts in place
(beginning January 1, 1999 through the end of the contract term)
and the projected market prices of electricity for the energy
required to be purchased under those NUG contracts. This
difference was adjusted for the PUC-jurisdictional portion and
discounted at the Company's weighted after-tax cost of capital to
determine the present value at January 1, 1999. Stranded NUG
costs also include the present value of payments occurring after
December 31, 1998 to buy out two NUG contracts.
The Company's calculation of stranded costs related to
regulatory assets is the present value at January 1, 1999 of the
PUC-jurisdictional portion of regulatory assets that relate to
generation. Among other things, these regulatory assets include
unrecovered energy costs, postretirement benefits other than
pensions, taxes recoverable, deferred Susquehanna operating and
carrying costs, retired miners' health care costs and voluntary
early retirement costs.
In determining the appropriate amount of stranded cost
recovery, the Customer Choice Act requires the PUC to consider
the extent to which an electric utility has taken steps to
mitigate generation-related stranded costs by appropriate means
that are reasonable under the circumstances. Mitigation efforts
undertaken over time prior to the enactment of the Customer
Choice Act are to be considered of equal importance by the PUC in
determining an electric utility's stranded costs as actions taken
after the passage of the Customer Choice Act.
PP&L's Mitigation Efforts
Mitigation describes any efforts by a utility to reduce
costs or increase revenues (other than by rate increases), both
historically and prospectively, and thereby reduce its stranded
costs. Historic mitigation refers to past efforts to reduce
costs and increase revenues. The effect of these historic
efforts is reflected in the level of a utility's current rates
and its corresponding level of stranded costs. Future mitigation
refers to prospective plans and efforts during the transition
period and thereafter to reduce costs or increase revenues, which
will further reduce a utility's stranded cost claim.
Utilities that have been successful in controlling
costs in the past will have lower current rates and
correspondingly lower stranded costs. Utilities, such as the
Company, have already accomplished significant mitigation by
controlling costs and have passed the benefits of lower costs
through to ratepayers over time.
Cost control and efficient management have been an
integral part of the Company's corporate culture for many years,
and it has done an outstanding job of controlling costs and
rates. The Company's efforts in this regard include
refinancings, O&M cost reductions, reductions in planned capital
expenditures, employee reductions, inventory reductions, improved
nuclear and fossil plant operations, buyouts of NUG contracts and
economic development initiatives.
The result of the Company's past mitigation efforts
have resulted in reasonable rates to customers. While it is not
possible to quantify the precise savings achieved through these
mitigation efforts, the success the Company has achieved can be
seen by viewing its rates in perspective over time and comparing
those rates to the rates of other utilities.
The Company's average rate in 1996 was 7.38 cents per
kwh, which is only slightly above the 1986 average rate of 7.34
cents per kwh after the Susquehanna Unit No. 2 rate case in 1985.
Adjusted for inflation, the Company's rates have declined by more
than 25% since 1986. Given the initial 54-month rate cap
contained in the Customer Choice Act, this real price decrease
will likely continue. Assuming that today's rates remain in
place through June 2001 and an annual inflation rate of 2.5%, the
Company's rates will have declined, in real terms, by about one-
third since 1986.
Based on the most recent available data, the Company's
rates are approximately 7% below the Pennsylvania average.
In addition to past mitigation efforts, the Company has
included in its Restructuring Plan additional cost reductions
designed to further reduce its stranded cost claim. These
efforts include the Company's planned reduction of capital
expenditures by $671 million over the five-year period 1996-2000
compared to the Company's 1995 budget for capital expenditures
over that five-year period. The Company has also projected about
$513 million of unspecified reductions of future O&M and
administrative and general costs.
With PUC approval, the Company recently concluded
arrangements for the buyout of a 100 megawatt NUG contract, and
the buyout of a second contract -- 18 megawatts -- is currently
awaiting approval by the PUC. These NUG buyouts are not
reflected in the Company's current rates and reduce stranded
costs by about $100 million.
In its 1995 rate case with the PUC, the Company filed
for, and was granted, the right to extend the lives of its
transmission and distribution plant. If the Company had used
those longer lives when the transmission and distribution
facilities were originally placed in service, the accumulated
depreciation for those facilities would have been less than what
is currently recorded on the Company's books. In its
Restructuring Plan, the Company proposes to take the $205 million
difference between the current actual accumulated depreciation
and the theoretical accumulated depreciation and transfer it to
the accumulated reserve for depreciation associated with the
Susquehanna station.
In total, the Company estimates that its future
mitigation efforts have resulted in a reduction in the Company's
stranded cost claim by over $1 billion.
Summary of Stranded Cost Calculations
As set forth in the Restructuring Plan filed with the
PUC on April 1, the Company's net mitigated stranded cost claim
is $4.6 billion, as summarized below:
Amount
Category of Stranded Cost (Millions of Dollars)
Nuclear Generation $2,852
Fossil Generation 718
NUG Contracts 657
Regulatory Assets 384
$4,611
Financial Implications of the Customer Choice Act
The ultimate impact of the Customer Choice Act on the
Company's financial health will depend on numerous factors.
These factors include:
1. The amount of stranded cost recovery approved
by the PUC, the PUC's overall treatment of the
Company's filing and the effect of the rate cap imposed
under the provisions of the Customer Choice Act;
2. The actual market price of electricity over
the transition period;
3. Future sales levels; and
4. The extent to which the regulatory framework
established by the Customer Choice Act will continue to
be applied.
Under the provisions of the Customer Choice Act, the
Company's rates to PUC-jurisdictional customers are capped at the
level in effect on January 1, 1997 through mid-2001 for
transmission and distribution services and through the year 2005
for generation customers. By applying the CTC proposed by the
Company in its Restructuring Plan (which is restricted by the
rate cap) through the year 2005, the Company anticipates
collecting $4,210 million of its stranded costs. Based on these
projections, the remaining $401 million would be reflected as
lower cash flow to the Company after the transition period than
would have occurred with continued regulated rates.
In this regard, it should be noted that the Company's
stranded cost claim included in the Restructuring Plan is based
on a projection of future market prices and assumes a significant
portion of the Company's stranded costs will be recovered by way
of increased market prices for electricity. This increase may or
may not occur. To the extent that the market price of
electricity does not increase as projected, the Company could be
placed at risk for a greater non-recovery of stranded costs.
In any event, it should be remembered that the estimate
of under-recovery has been calculated on a discounted cash flow
basis over 25 years and does not represent an estimate of an
exposure to an accounting write-off. If the Restructuring Plan
filed by the Company is accepted by the PUC, the Company will
have essentially the same amount of revenues through the end of
the transition period in 2005 that it would have had if today's
regulated rates had been continued over that period of time.
If the PUC permits full recovery of the Company's
stranded costs, including full recovery of all regulatory assets
and above-market NUG costs over the transition period, the
Company estimates that its net income over the transition period
would be reduced by about 5%.
However, the PUC may make adjustments to components or
assumptions included in the Restructuring Plan filed by the
Company that could have an adverse effect on the amount of the
CTC or the categories of stranded costs that are recoverable
through the CTC. As a result of these uncertainties, from an
accounting perspective the Company cannot determine whether and
to what extent it may be subject to a write-off or a reduction in
earnings until the PUC issues an order with respect to the
Restructuring Plan. Based on the substantial amounts involved in
the Restructuring Plan, should the Company be required to incur a
write-off, it could be material in amount.
SFAS No. 71
The Company believes that the Customer Choice Act
establishes a definitive transition to market-based pricing for
electric generation. This transition includes cost-of-service
based ratemaking during the transition period. In addition, the
Company's stranded costs will be collected through a non-
bypassable CTC. Based on this structure, the Company believes it
will continue to meet the requirements of Statement of Financial
Accounting Standard ("SFAS") No. 71 throughout the transition
period.
At the conclusion of the transition period, the Company
believes it will be at risk to recover its generation costs
through market-based revenues. At that time, the Company expects
to discontinue the application of SFAS No. 71 for the electric
generation portion of its business.
The Company understands that the Securities and
Exchange Commission has begun inquiries regarding the
appropriateness of the continued application of SFAS No. 71 by
utilities in states that have enacted deregulation legislation
similar to the Customer Choice Act. As discussed above, the
Company believes it currently meets and will continue to meet the
requirements to apply SFAS No. 71 during the transition period.
In the event that the SEC concludes that the current regulatory
and legal framework in Pennsylvania no longer meets the
requirements to apply SFAS No. 71 to the generation business, the
Company would reevaluate the financial impact of electric
industry restructuring and a material write-off could occur.
Given the current regulatory environment, the Company's
electric transmission and distribution businesses are expected to
remain regulated and, as a result, will continue application of
the provisions of SFAS No. 71.
Securitization
The Company is considering securitizing some portion of
its stranded costs. However, the Company has not included an
application for a qualified rate order as part of its
Restructuring Plan. This should not be viewed as an indication
that the Company is opposed to securitization.
The Company has not included a request for
securitization at this time for several reasons. First, there is
tremendous uncertainty at the present time as to when and if the
Company would be allowed to issue transition bonds. The current
PECO securitization proceeding has been highly contentious and it
appears likely that any PUC decision that permits PECO to issue
transition bonds may be appealed by one or more of the parties.
Any such appeal could significantly delay the actual issuance of
transition bonds.
Second, there are several unresolved issues regarding
tax matters, structure and accounting issues that require further
review. It is apparent that securitization requires much more
analysis than originally contemplated. Rather than rushing to
include securitization in the Restructuring Plan, the Company has
elected to attempt to resolve these issues and present a more
definitive proposal to the PUC.
Third, the Restructuring Plan is itself complex and
raises many important and novel issues. Given the likelihood of
substantial delay in the issuance of transition bonds, the
Company decided not to needlessly complicate its Restructuring
Plan with a securitization proposal at this time.
The Company supports securitization. In reaching a
decision about securitization, the Company will carefully
consider the specific nature of the stranded costs being
securitized and how various categories of stranded costs can
impact the relative benefits of securitization available to
ratepayers and shareowners. For example, a considerable portion
of the Company's stranded costs are related to regulatory assets
and NUG contract payments that have not been financed with
corporate debt or shareowner capital. The securitization of
these costs may not provide rate reductions for our ratepayers in
the same amount as for those stranded costs related to generating
assets that have been previously so financed.
In evaluating securitization, we will also consider the
dilutive effect that securitization could have on earnings per
share if proceeds from the issuance of transition bonds are used
to buy back the common stock of PP&L Resources, Inc. at prices
above book value and the savings from the repurchase of common
stock are passed on to customers. The analysis will include the
potential impact that such dilution could have on the level of
common stock dividends paid by PP&L Resources, Inc.
We will also consider the impact that securitization
could have on the need for the Company to issue securities during
the transition period that would not otherwise have been issued
but for securitization.
* * *
For your reference, I have enclosed a copy of the news
release issued by the Company today with respect to the filing of
its Restructuring Plan with the PUC and a fact sheet that
provides some additional details concerning the Restructuring
Plan.
If you have questions concerning the Restructuring
Plan, the Company's claim for stranded cost recovery or plans for
securitization, please feel free to call Tim Paukovits, our
Investor Relations Manager (610/774-4124) or me (610/774-5613).
Sincerely,
/s/ John R. Biggar
Enclosures
Certain statements contained herein are "forward-
looking statements" within the meaning of the
securities laws. Although the Company believes
that the expectations reflected in such statements
are reasonable, it can give no assurance that such
expectations will prove to have been correct.