Weather can have a material impact on AEP’s business. Generally, extremes of temperature benefit utility companies because they encourage customers to run either heaters or air conditioners. Unseasonably mild weather on the other hand, results in fewer heating and cooling days, leading to lower electrical demand and lower revenue for AEP.

Electric utilities are heavily regulated by the federal and state governments in the United States. Federal agencies supervise utility companies and ensure that electricity is affordable and that it provides a fair return for the utility company without causing them to earn excess profits. As such, AEP must have all electricity rate hikes approved by various government agencies.

AEP generates nearly 66% of its energy using coal power, making it particularly vulnerable to green legislation like the Renewable Portfolio Standards enacted in 26 states and the Advanced Energy Portfolio Standard being enacted in Ohio. Electric utility companies are under increasing legislative pressure to adopt cleaner electricity generation methods while maintaining competitive prices. AEP produces over two-thirds of its energy from burning coal, but has begun to diversify its electricity generation base by getting into wind. hydroelectric. solar. biomass, and biodiesel energy. AEP owns over 300 megawatts of wind generating capacity within Texas and 800 megawatts of hydroelectric power from its 17 hydroelectric facilities.

Contents

Trends and Forces

Japanese Nuclear Disaster Takes a Toll on AEP’s Share Price

Although nuclear energ8==============D ecipitated by the 9.0 earthquake and tsunami on March 11. The Japanese nuclear crisis has shaken confidence in the future of nuclear energy, which has taken a toll on companies operating in the nuclear energy space.

AEP has stated that its Cook Nuclear Plant on Lake Michigan is designed to withstand extreme environmental hazards, including tornadoes, floods and earthquakes. The U.S. Nuclear Regulatory Commission has also established an agency task force that will conduct both short- and long-term analyses of the lessons that can be learned from Japan. Despite these reassurances, investors still have doubts about the future of nuclear energy.

AEP is expanding its portfolio to include renewable energy

Improvements in technology continue to make renewable energy more competitive with existing fossil-fuel based sources of energy. AEP has recognized this trend by embracing new technologies such as wind energy. hydroelectric energy. solar energy. and biomass.

Wind

AEP has recognized the potential of wind power and now owns 310.5 megawatts of wind generation capacity in Texas. [3] AEP also has agreements to purchase 742 megawatts from several wind power facilities in Illinois, Indiana, Oklahoma and Texas. [3]

Hydroelectric

AEP’s 17 hydroelectric facilities in Virginia, West Virginia, Ohio, Indiana and Michigan generate more than 800 megawatts of electricity. [3] Smith Mountain Hydro Project, on the Roanoke River southeast of Roanoke, Virginia, was the nation’s first major development combining run-of-the-river hydro with pumped storage generation. [3]

Biomass represents a potentially carbon-neutral energy source, in that the carbon released during the conversion of plants and trees into electricity is the same carbon that is taken out of the atmosphere during photosynthesis. AEP has conducted biomass co-firing tests at several of its power plants in the U.S. [3]

Biodiesel AEP is conducting an investigation to determine if it can use biodiesel fuel in one or more of its generating stations in Ohio. AEP issued a request for quotes for biodiesel blended with No. 2 fuel oil for its Picway, Muskingum River and Conesville plants in Ohio. AEP reported that it will be evaluating the use of renewable fuel sources for start-up and flame stabilization in the plants. [5]

Reducing carbon emissions

AEP announced that it was selected by the U.S. Department of Energy to receive funding to cover some costs of installing a commercial-scale carbon dioxide capture and storage system in West Virginia. The system will capture an estimated 1.5 million metric tons of captured carbon dioxide per year, which will be treated and compressed, then injected into geological formations about 1.5 miles underground for permanent storage. [6] AEP expects the system to begin commercial operation in 2015.

AEP has also launched gridSMART, a plan to provide customers with greater control over their energy consumption through the use of a smart electricity meter. The program will also deploy advanced technologies to identify potential problems with AEP’s electricity delivery system, preventing disruptions and increasing the reliability and efficiency of electricity transmission.

Falling coal prices lower AEP’s input costs

Coal prices are fairly stable but are slowly rising. AEP’s profit margin is largely determined by coal prices, which are driven by the economics of supply and demand.

Internationally, coal consumption will depend primarily on the economic conditions in China. India. and Europe. Led by strong economic growth and rising need for cheap energy in China and India, coal consumption is projected to double 2005 consumption levels by 2030. [7] However, the largest increases in consumption are from coal produced and consumed in China, meaning that exports to China have declined dramatically. [8] Although economic growth in China is expected to slow, its infrastructure-focused $586 billion stimulus package should increase the need for coal as a cheap power source. [9]

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US Coal Prices as of December 2010 [10]

Regulations disproportionately affect coal dependent power generators

Utilities face growing pressure from government regulatory bodies to curb their emissions of greenhouse gases. AEP generates nearly 66% of its energy using coal power. making it particularly vulnerable to green legislation like the Renewable Portfolio Standards being enacted in 26 states and the Advanced Energy Portfolio Standard being enacted in Ohio. The company has already experienced troubles related to its emissions.

The company’s CEO believes that fossil fuels will remain the dominant form of energy production in the 21st century, and emissions will be mitigated through the implementation of new technologies [11]. and as a result has taken few steps to increase the company’s nuclear portfolio. It has, however, started to increase its investment in renewable energy sources.

Mild weather dampens AEP’s revenue

Weather can have a material impact on AEP’s business. Generally, extremes of temperature are good for utility companies because they force customers to run either heaters or air conditioners. Unseasonably mild weather on the other hand, can lead to fewer heating and cooling days, in the winter and spring respectively. Additionally, during drought seasons, the amount of hydroelectric electricity generated drops, and coal power electricity is used as an alternative. In general, AEP benefits when the demand for electricity rises and the load on its electrical grid increases, whether caused by drought, unseasonably warm or cold weather, or other factors.

Governments must approve AEP rate hikes

The U.S. and state governments play critical roles in the financial performance of the highly regulated energy sector since the government sets the price of electricity. Electricity is considered a necessary service, and with regulation in place, the government can guarantee that adequate service at an affordable price will be rendered to all who apply for it. Federal agencies that supervise the utilities ensure that it is affordable and that it provides utilities a fair return on their investment without earning excessive profits. Defining fair returns on investment and excessive profits has been the subject of much controversy. Each of AEP’s utility businesses faces a variety of challenges and potential benefits that may arise from changes in legislation and regulatory schemes.

Competition

Utility companies, historically speaking, have faced little competition due to the regulated nature of the industry. Since utility companies are massive operations requiring immense amounts of capital to build power plants, transmission services, and connections into homes, their services only become economical as they add users as they realize economies of scale and diffuse costs over a larger customer base. In this industry, a monopolistic utility guarantees it can provide vital electricity service at an affordable cost, especially to lower socio-economic classes. The government acts as a watch-guard, ensuring that consumers are not overcharged for electricity while granting these utility immunity from anti-trust/monopoly laws.

As a result, AEP faces mild competition from other electric utilities, even in areas that are moving towards de-regulation and an open/free market.

Comparison to Competitors