Ameren Corporation (NYSE: AEE) is an electric and natural gas utility in Illinois and Missouri. Like most utilities, Ameren is heavily regulated and may only raise its rates for certain groups of customers with the permission of state regulatory agencies. Although Ameren ultimately benefits from supplying energy to both regulated and unregulated customers, its ability and incentives to adapt rapidly to the regulated market are often restricted within that market. Although AEE is permitted to adjust prices according to the price of fuel, raising prices often encourages customers to contact their regulating agency to have them reduced. Ameren's experience with rate regulation has more often than not been negative. Following the deregulation of the Illinois electricity market, regulators responding to public outcry over the prospect of sharply higher rates imposed a decade long rate freeze from 1997-2007. Following the expiration of the rate freeze, consumers in Illinois pushed for a 3 year extension. Although the extension was not passed, Ameren was required to reduce its new rates by $150MM. 
The company's dependence on coal power makes complying with continually evolving environmental standards - the most significant of which are mercury and greenhouse gas emissions standards - very costly. AEE estimates that these costs will range between $4B and $5B by 2017. Although AEE generates power using a combination of nuclear, coal, oil, natural gas, and hydroelectric power generation systems, coal represents the largest source of power by percentage of total energy generated at 84%.
Ameren Corporation's subsidiaries include Union Electric Company (UE), Illinois Power Company (IP), Central Illinois Public Service Company (CIPS), Ameren Energy Generating Company (Genco), Ameren Illinois Transmission Company (AITC) and CILCORP Inc. (CILCORP). These subsidiaries operate rate-regulated electric generation, transmission, and distribution businesses, rate-regulated natural gas transmission and distribution businesses, and merchant generation businesses in Missouri and Illinois. Ameren has three reportable segments: Missouri Regulated, Illinois Regulated, and Merchant Generation. CILCO has two reportable segments: Illinois Regulated and Merchant Generation. In August 2010, the Company announced the formation of a new subsidiary, Ameren Transmission Company, focused on electric transmission infrastructure investment.
As a holding company, Ameren's financial performance largely depends on the individual performances of its subsidiaries, namely UE, CIPS, Genco, CILCORP, and IP. Revenue comes from the sale of electrical power and natural gas to customers. Many of Ameren's customers fall under state rate regulation laws which dictate both the amount and price at which Ameren is required to supply electric power. Under Illinois rate regulation laws, Ameren subsidiaries (CIPS, CILCO, and IP) supply power according to requirements of customers and at prices determined at a low cost auction among suppliers held in 2006. Under a new Illinois law, as of 2009, price will be determined through a request-for-proposal-process to be reviewed by the Illinois Commerce Commission. All contracts already in place will hold until they expire. In the event that an AEE subsidiary cannot produce the volume of power demanded, or if cheaper electricity is available on the market, AEE will purchase it from a third party supplier.
Second Quarter 2010 Results
Ameren reported GAAP net income for the second quarter of $152 million, or 64 cents per share, compared to second quarter 2009 GAAP net income of $165 million, or 77 cents per share. Sales of electricity to native load utility customers increased 9% in the second quarter of 2010, compared to sales in the second quarter of 2009. The higher sales reflected a recovering economy, the return to full capacity in March 2010 of a large customer's aluminum smelter plant, and warmer summer weather. Kilowatthour sales to industrial customers rose 26% and 17% excluding sales to the smelter plant. Sales to residential customers rose 4%, and sales to commercial customers rose 1%. Merchant generation revenues and margins in the second quarter of 2010 were lower than those in the second quarter of 2009 as a result of lower realized power prices and higher fuel and related transportation costs.
Operations and maintenance expenses decreased, compared to those incurred in the second quarter of 2009, despite a scheduled refueling and maintenance outage at the Callaway Nuclear Plant. The Callaway Plant did not have a refueling outage in 2009. The reduced expenses are attributable to disciplined cost management across all business segments. In addition, financing costs declined, reflecting increased regulatory recovery of such costs. The impact on earnings per share of these positive factors was offset by higher depreciation and amortization expenses as a result of infrastructure investment and an increase in the average number of common shares outstanding, largely due to the September 2009 stock issuance.
Coal is typically purchased in five year contracts, with one fifth of the total coal supply contracts expiring each year. Approximately 94% of Ameren's coal is purchased from the Powder River Basin located in Wyoming, and 6% is purchased from the Illinois Basin.
Natural Gas is purchased from a wider range of vendors which include the Panhandle Eastern Pipeline Company, the Trunkline Gas Company, and the Natural Gas Pipeline Company of America. Due to greater variability in natural gas prices over time, Ameren is permitted by law to pass natural gas expenses on to rate regulated customers, subject to ICC review.
The UE Callaway nuclear plant is refueled at eighteen month intervals. During a refueling, power must be purchased from a third party or generated by another power facility. UE is price-hedging 87% of the plant's 2010 and 2011 fuel.
Due to rate regulation laws and government price controls, Ameren is less able to adapt to changing markets or fuel prices than it would be otherwise. Although it is likely that competitive pricing will be approved after an increase in fuel pricing, it is not likely to be approved as quickly as in a case where Ameren alone controlled prices. For example, AEE applied to the ICC in November 2007 to increase rates for regulated natural gas sales. The ICC is not required to reach a decision until September 2008, and that decision could actually mean a reduction in rates.
As environmental regulations and concerns develop or become more stringent, Ameren is required to adapt by altering generation processes, incurring additional costs. Some of the most prominent costs include the introduction of new air quality regulations, mercury regulations, and potential greenhouse gas emissions standards. Starting in 2009, AEE was required to invest in capital expenditures to comply with laws calling for significant additional reductions in emissions. Although only 61% of Ameren's capacity to produce electricity is fueled by coal, because coal is an inexpensive fuel source, it accounts for 84% of annual production. If the changes are of large enough scope, AEE will shut down one or more coal fired plants. Implementation costs are estimated to be between $4B and $5B by 2017.
Due to the Missouri “Construction in Progress” laws, power companies are not permitted to finance the construction of new nuclear facilities with increases in pricing while the facilities are under construction. For Ameren to construct another Callaway plant at $7 billion, Ameren is required to borrow a larger portion of the construction costs than it would without the price controls. Customers would still finance the cost of building a new nuclear facility, but would incur additional interest costs in addition to the actual costs of construction. Ameren is campaigning to change the law.