Exelon 2003 Annual Report Download - page 29

27Management’s Discussion and Analysis of Financial Condition and Results of Operations
EXELON CORPORATION AND SUBSIDIARY COMPANIES
ices to customers. Energy Delivery continues to make im-
provements to its delivery systems to minimize the fre-
quency and duration of service interruptions, while working
more efficiently to lower their costs. We believe that Energy
Delivery will continue to provide a significant and steady
source of earnings and cash flows over the next several
years.
Both Illinois and Pennsylvania have adopted restructur-
ing legislation designed to foster competition in the retail
sale of electricity. As a result of these restructuring ini-
tiatives, both ComEd and PECO are subject to rate freezes or
caps through mandated restructuring transition periods.
During these periods, the results of operations of ComEd and
PECO will depend on our ability to deliver energy in a cost-
efficient manner and to offset infrastructure investments
and inflation with cost savings initiatives. ComEd and PECO
each expect to continue to have long-term, full-
requirements supply contracts with Generation, helping to
mitigate the risk of changing energy supply costs during
their respective transition periods. We are also managing
operations and maintenance costs by implementing The
Exelon Way business model, while maintaining our focus on
both reliability and safety in operating our business.
We cannot currently predict the frameworks that will be
used by the Illinois and Pennsylvania state regulators to es-
tablish rates after the transition periods. We also cannot
predict the outcome of any new laws that may impact our
business. Nevertheless, we expect ComEd and PECO will re-
tain significant POLR obligations, whereby each utility is re-
quired to provide service to customers in its service area.
ComEd and PECO therefore must continue to ensure ad-
equate supplies of electricity and gas are available at
reasonable costs. While ComEd and PECO do not have their
own generation capabilities, their ongoing relationship with
Generation will serve to lessen the supply and price risks
associated with their expected ongoing power procurement
responsibilities.
More detailed explanations for each of these and other
challenges in managing our energy delivery business are as
follows:
We must comply with numerous regulatory requirements in
managing our energy delivery business, which affect our costs
and responsiveness to changing events and opportunities.
Our energy delivery business is subject to regulation at the
state and Federal levels. ComEd is regulated by the ICC, and
PECO is regulated by the PUC. These state commissions regu-
late the rates, terms and conditions of service; various busi-
ness practices and transactions; financing; and transactions
between the utilities and our affiliates. Both ComEd and
PECO are also subject to regulation by the FERC, which regu-
lates their transmission rates, certain other aspects of their
businesses and, for PECO, gas pipelines. The regulations
adopted by these state and Federal agencies affect the man-
ner in which we do business, our ability to undertake speci-
fied actions, the costs of our operations, and the level of rates
we may charge to recover such costs.
We must manage Energy Delivery’s costs due to the rate and
equity return limitations imposed on its revenues.
Rate freezes or caps in effect at ComEd and PECO currently
limit our ability to recover increased expenses and the costs
of investments in new transmission and distribution facili-
ties. As a result, our future results of operations will depend
on the ability of ComEd and PECO to deliver electricity and, in
the case of PECO, natural gas, in a cost-efficient manner and
to realize cost savings under The Exelon Way to offset in-
creased infrastructure investments and inflation.
Rate limitations.ComEd is subject to a legislatively man-
dated rate freeze on bundled retail rates that will remain in
effect until January 1, 2007. Pursuant to a Merger-related
settlement agreement with the PUC, PECO is subject to
agreed-upon rate reductions of $200 million, in aggregate,
for the period 2002 through 2005, including $80 million, in
aggregate, for the years 2004 and 2005, and caps (subject to
limited exceptions for significant increases in Federal or
state income taxes or other significant changes in law or
regulation that do not allow PECO to earn a fair rate of re-
turn) on its transmission and distribution rates through
December 31, 2006, and on its generation rates through De-
cember 31, 2010.
Equity return limitation. ComEd is subject to a legislatively
mandated cap on its return on common equity through the
end of 2006. The cap is based on a two-year average of the
U.S. Treasury long-term rates (25 years and above) plus 8.5%
and is compared to a two-year average return on ComEd’s
common equity. The legislation requires customer refunds
equal to one-half of any excess earnings above the cap.
ComEd is allowed to include regulatory asset amortization in
the calculation of earnings. ComEd has not triggered the
earnings provision and currently does not expect to trigger
the earnings sharing provision in the years 2004 through
2006.
Energy Delivery’s long-term purchased power agreements
provide a hedge to its customers’ demand.
To effectively manage its obligation to provide power to
meet its customers’ demand, Energy Delivery has established
full-requirements, power supply agreements with Gen-
eration which reduce exposure to the volatility of customer
demand and market prices through 2006 for ComEd and
through 2010 for PECO. Market prices relative to Energy
Delivery’s regulated rates still influence switching behavior
among retail customers.