AES Corp (AES) — Q3 2016 Earnings Call Transcript

Thanks, Nicole. Good morning and welcome to our third quarter 2016 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning are Andrés Gluski, our President and Chief Executive Officer; Tom O'Flynn, our Chief Financial Officer; and other senior members of our management team. With that, I will now turn the call over to Andrés.

Good morning, everyone, and thank you for joining our third quarter 2016 financial review call. Today, I will provide an update on our year-to-date performance, key market trends and our long-term strategy in the context of those trends. Tom will then review positive regulatory developments at DPL and Ohio, our financial results, as well as provide color on our current guidance. Year-to-date, we generated proportional free cash flow of $1.1 billion, representing 91% of the mid-point of our full-year guidance, and reflecting the collection of outstanding receivables in Bulgaria during the second quarter. Our year-to-date adjusted EPS was $0.64, representing 64% of our full-year guidance, consistent with expectations that we communicated to you previously. These results keep us on track to achieve our full-year guidance, which Tom will address in detail. Now turning to key market trends on slide five. At a high level, we're seeing changes in some of our markets due to the entry of natural gas and low-cost renewables. However, we're generally well positioned to take advantage of these changes because we have already begun to invest in these technologies, and because most of our largely contracted portfolio has locational and cost advantages. Accordingly, despite what we have recently seen in some markets, like Chile, we remain confident in the long-term strength of our portfolio. We see a future where the operator with an efficient thermal and hydro fleet, integrated with new technologies, will be the winner. We're also on track to meet our expectations through 2018, which are driven by our construction and cost reduction programs. Most of our construction programs are going well with the exception of Alto Maipo, which represents 15% of the total megawatts under construction. There's no question that future growth across our markets will be heavily weighted towards less carbon-intensive gas, wind, and solar generation. Accordingly, we've been taking actions in this regard for some time now. For example, as we've discussed on previous calls, we have been expanding our LNG infrastructure into Central America as shown on slide six. Our $1 billion Colon project in Panama will contribute to our growth beyond 2018 and includes a 380 megawatt combined cycle gas plant and 180,000 cubic meter LNG regasification and storage facility. The power plant is contracted under a 10-year U.S. dollar-denominated power purchase agreement. This project will diversify Panama's reliance on hydro-based generation while also meeting a growing need for natural gas across Central America. By introducing natural gas to the region, we're displacing oil-fired generation in favor of a cheaper and cleaner alternative, while also serving the needs of many potential downstream customers, including commercial and industrial users and the transportation industry. On slide seven, we see another example of how we're responding to environmental concerns about coal-fired generation. In Indiana, we just completed a multi-year $550 million rate-based investment in environmental upgrades at our coal plants and the repowering of several units from coal to gas. We will further shift our fuel mix away from coal when we complete the 671 megawatt Eagle Valley Combined Cycle Gas Turbine in Indiana in the first half of 2017. The combined impact of these investments will be to reduce the gigawatt hours IPL produces from coal by about 40%. Turning to slide eight, the growth in renewables not only provides an opportunity for direct investments in wind and solar generations but also creates a market for energy storage. We plan to invest in wind and solar generation in our markets with our primary focus on U.S. dollar-denominated long-term contracts. In fact, since last year, we have added more than 150 megawatts of solar with long-term contracts in the U.S., about half of which is operating, and the rest will come online in 2017. Regarding energy storage, we believe this technology will play a critical role in an increasingly renewables-based generation mix. AES has been designing, deploying, and operating battery-based energy storage systems for almost a decade. Today, with our proprietary Advancion platform, we are the world leader, with more than 400 megawatts in operation, under construction, and in an advanced stage of development across seven countries. In 2016, we have already closed Advancion’s sales to third-parties, totaling more than $70 million in gross revenue. With our proven storage platform, unmatched experience, and global reach through AES and our sales channel partnerships, we are ideally positioned to capitalize on this rapidly growing market. Turning now to slide nine, I’d like to discuss what we consider to be a key underlying strength of our business—a highly contracted portfolio and the competitive nature of our assets, even in those markets where LNG-based and renewable generation are making inroads. As you can see on this slide, as a result of our proactive contracting and portfolio rebalancing initiatives, today about 75% of our business is U.S. dollar based. About 85% of our business is either contracted generation or regulated utilities. The average remaining life on our Power Purchase Agreements at our contracted businesses is seven years, and when we complete our current construction program in 2020, it will be extended to 10 years. Turning to slide ten, although that’s a long average remaining contract life, there are a few markets where our contracts will roll off sooner. Nonetheless, we believe that our position in those particular markets will allow us to continue to earn attractive returns after the current contracts expire. The majority of our businesses are low-cost, flexible, and reliable energy providers with strong locational advantages. Our knowledge of these markets and critical mass also puts us in a position to take advantage of growth opportunities or quickly respond to changing conditions. Let me talk about a few of these markets in more detail. In the Dominican Republic, a portion of our contracts are rolling off in the next three years. However, our plants are mostly gas-fired, and we offer the lowest cost source of generation in the system, which is 54% oil-based. Based on today’s relative fuel prices, our variable cost is half that of oil-fired generation, which puts us in a good position to re-contract our plants on favorable terms. In 2017, we will complete the closing of the cycle at our DBP gas plant, which will add 122 megawatts without increasing our carbon footprint. In the Philippines, we operate a 630 megawatt coal-fired plant and are building a 335 megawatt expansion. The existing Masinloc plant is more than 90% contracted until 2019, and we have already reached an agreement pending regulatory approval with the plant off-taker for an extension to 2022. In terms of the 335 megawatt expansion project, which will come online in 2019, we have already signed 10 to 20-year contracts covering 50% of the capacity. Our plants in the Philippines will be even more competitive once the country’s gas plants, which account for 25% of the system supply, move from base load to mid-merit when their current take-or-pay gas contracts roll off from 2019 to 2023. In California, our Southland contracts are expiring in December of 2019 and 2020, but we have already re-contracted these facilities under a 20-year PPA that will necessitate the repowering of its assets. With the new contract, we expect to see growth in earnings and cash flows from this business. Now moving to Chile, on slide 11, where we are largely contracted. Although there has been a slowdown in economic growth, mainly due to the impact of falling mineral prices on the Chilean economy, we remain optimistic about the future prospects of the country. As you may know, the recent auctions for contracts beginning in 2021 and 2022 cleared significantly below market expectations. We believe these prices reflect aggressive bidding by both new market participants and existing hydro owners. Nonetheless, we do not believe that this will have a meaningful impact on our business in Chile in the near to medium term because AES Gener is largely hedged with an average remaining PPA life of 11 years. Our exposure for the next five years is quite limited, with only 8% of our contracts rolling off in '21 and '22. Although, over the long-term, we do forecast some softening in prices, we do not believe this auction result is necessarily indicative of the long-term price load. While Chile does have excellent solar and good wind resources, some of the assumptions underlying the recent auction outcome may have been aggressive on capital cost declines, load factors, and all-in costs to support renewable assets with a 24/7 load-following obligation. We see renewables, energy storage, and thermal resources as complementary in the future Chilean grid. In fact, we believe our existing portfolio will be even more important in the long-term as we see higher demand growth driven by an eventual acceleration in economic growth. Accordingly, our existing assets are well positioned to provide reliable and competitive energy to the Chilean grid. Now turning to slide 12 regarding our construction program, which is the most significant driver of cash flow and dividend growth in the coming years. Since our last call, we've completed the construction of our 532 megawatt Cochrane power plant in Chile, which is 100% contracted for 18 years. This brings our year-to-date commissioned capacity to 3 gigawatts, all of which were completed on-time and on-budget. We have another 3.4 gigawatts remaining under construction where we are generally making good progress. The main exception to our strong performance on construction is Alto Maipo, a 531 megawatt run-of-the-river hydro plant in Chile, which is by far our most complex construction project underway. Today, the overall project is about 40% completed. As we discussed on our last call, we've encountered geological issues while excavating some underground tunnels. After consultation with the contractor and independent consultant, our expectation is still for Alto Maipo to be completed in 2019, at a cost that is about 10% to 20% over the original budget. We expect the additional capital cost of roughly $200 million to $400 million will be funded by a combination of lenders and project sponsors. Discussions with lenders are underway. I'd note that notwithstanding the challenges we have encountered at Alto Maipo, we have a strong track record of completing projects on-time and on-budget. In the last five years, AES has delivered more than 5 gigawatts of projects, which were completed on-time and on-budget. Accordingly, we are confident that our construction program will continue to drive attractive growth in our free cash flow and earnings. Turning to slide 13, excluding the cost overrun at Alto Maipo, which I mentioned earlier, our 3.4 gigawatts currently under construction represent total capital expenditures of $6.4 billion. However, AES's equity commitment is limited to $1.1 billion. Of this, over $250 million has already been funded. Roughly 70% of our investments are in the Americas, mainly Chile, Panama and the U.S. Before I turn the call over to Tom, I would like to emphasize our de-risking of our company over the last five years on slide 14. Today, we're in a strong position to execute on the strategic growth opportunities I just discussed in large part because of the actions we have taken. We've exited 11 markets, including the riskiest countries in our portfolio. This week we also closed the sale of AES Sul, a utility in Brazil, which decreases our exposure to Brazilian regulatory and hydrology risk to more appropriate levels. In total, our asset sales program since September of 2011 has raised $4 billion in cash to the parent. We are investing our discretionary cash towards projects that are better aligned with our strategy, like LNG in Central America and renewables in the US. In Panama, our hydro assets will be more valuable by 2019 when we begin operating the nation’s first gas-fired plant and LNG facility, which will cap energy prices in times of drought. These investments not only drive solid growth in cash flow and earnings but also offer our investors a more robust and optimal portfolio. Last but not least, de-leveraging has been and will continue to be an important part of the strategy. Over the past five years, we have reduced our parent debt by 28%. Based on the growth of our cash flow, we expect to achieve investment-grade status by 2020. We believe that in conjunction with all these actions, we will deliver attractive risk-adjusted returns to our shareholders. With that, I’ll turn the call over to Tom.

Thanks, Andrés, and good morning. Today, I will review our results, including adjusted EPS, proportional free cash flow, and adjusted pre-tax contribution, or PTC, by Strategic Business Unit or SBU. Then I’ll cover our 2016 capital allocation, as well as our guidance and expectations. Before I get started, I’ll remind you of a couple of items that helped our results in the third quarter of last year—one was the restructuring of Guacolda in Chile that generated $0.06 in equity and earnings, and the other was a large receivables collection in the Dominican Republic, which led to higher than normal proportional free cash flow. Now turning to slide 16, third quarter adjusted EPS of $0.32 was $0.06 lower than 2015. This decline is in line with our expectations that we communicated in our last call. Specifically, our third quarter results reflect positive contribution from our businesses, particularly in the U.S. where we benefited from rate-based growth at our utility IPL in Indiana, and improved availability at DPL in Ohio. The impact of the Guacolda restructuring in 2015 and also the $0.02 impact from the devaluation of foreign currencies as expected, particularly in Andes and Europe. Now to slide 17, proportional free cash flow and adjusted PTC for the quarter. We generated $400 million of proportional free cash flow, a decrease of $221 million from last year. This reflects slightly lower margins and the impact of working capital in the MCAC SBU specifically to the Dominican Republic, where although collections remained strong, we had a large receivable settlement last year. We also earned $272 million in adjusted PTC during the quarter, a decrease of $43 million largely driven by the Guacolda restructuring. Next, I’ll cover our SBUs in more detail over the next six slides, beginning on slide 18. In the U.S., our results reflect relatively higher margins, including the benefit from the environmental upgrades on 1,700 megawatts of capacity that came online through this quarter and from this year’s rate case at IPL, as well as higher contributions in DPL, reflecting our continuing actions to improve the availability of our generation fleet. At Andes, our results reflect higher margins, primarily due to lower spot fuel and energy purchases, as well as the start of commercial operations at Cochrane Unit 1 in Chile. This was partially offset by lower spot prices and generation at Chivor in Columbia, where we replenished reservoir levels after increasing production when energy prices were at record highs in December of last year. Margins also reflect a 38% devaluation of the Argentine peso. Adjusted PTC decreased due to Guacolda restructuring, and proportional free cash flow also reflects the timing of lower VAT collections in Chile after Cochrane came online. In Brazil, our results were largely driven by lower margins, mainly due to exploration Tietê’s PPA at the end of 2015. As part of our rolling hedging strategy that we had in place since 2014, Tietê is about 80% hedged over the next two years. In Mexico, Central America, and the Caribbean, our results reflect lower margins, primarily due to lower rolling 12-month availability in Puerto Rico, which was impacted by fourth quarter outage in 2015. Adjusted PTC was further impacted by lower interest income on overdue receivables in the Dominican Republic where collections have improved. Proportional free cash flow decreased, primarily due to large settlement of receivables in the Dominican Republic. In Europe, our results reflect lower margins due to the contracting capacity price reduction following the successful settlement of outstanding receivables at Maritza in Bulgaria, as well as the 36% devaluation of the Kazakhstan Tenge. Proportional free cash flow benefitted from higher collections at Maritza. It's worth mentioning that we continue to see improved collections in the roughly six months since that settlement, and payments are current. Finally, in Asia, our results reflect steady margins and working capital requirements year-over-year. Now to slide 24, I'll provide an update on our filing at DP&L in Ohio where we've seen some positive momentum on the regulatory front. We remain in active discussions with the commission staff and intervenors. As you may know, last month we amended our ESP filing to propose a distribution modernization rider of $145 million per year over seven years with the aim of achieving and maintaining an investment grade rating at DP&L. Hearings are now set for early December, and we expect the ruling to be effective beginning in the first quarter of 2017 that'll support the financial viability and credit profile of the business. Now to slide 25 and the progress we're making to improve our credit profile. In the third quarter, we prepaid $180 million of parent debt, bringing our total debt pay-down year-to-date to $300 million. Since 2011, we’ve reduced parent debt by $1.8 billion or 28% and reduced interest by 125 basis points, resulting in an annualized interest savings of $180 million. As you'll see on the top of the slide, we have no debt maturing at the parent until 2019, and only $240 million is due. Turning to the bottom of the slide, these proactive steps have helped us reduce our parent leverage ratio from almost 6.5 times to slightly over 5 times debt to parent free cash flow plus interest. These actions reflect our strategy to de-risk our portfolio and improve our credit metrics. We expect our credits to continue to improve, largely driven by a strong growth in parent free cash flow, as well as the modest amount of annual debt reduction. As a result, we expect to attain investment-grade credit metrics by 2020. We believe this will help us reduce our cost of debt, improve financial flexibility, and also, importantly, enhance our equity valuation. Turning now to our 2016 parent capital allocation on slide 26, which is materially in line with our prior discussions. The charts on the left-hand side reflect $1.5 billion of total available discretionary cash, which includes $575 million in parent free cash flow. We remain confident in our 2016 parent free cash flow range of $525 million to $625 million, which is a foundation for our discretionary cash available for dividend growth and value creation. Sources also include proceeds from asset sales, primarily from AES Sul, where we’re estimating net proceeds of $440 million, including a sub-dividend at around $25 million after accounting for working capital adjustments and transaction costs. Although we’ve successfully closed the sale in October, we anticipate receiving the majority of the proceeds at the parent in the first quarter of 2017 after meeting the required notice period for distributions. Now the uses on the right-hand side of the slide, consistent with our capital allocation plan, with 10% growth in our dividend and completed share repurchases, we are returning about a third of our allocated cash to our shareholders this year. Going forward, we continue to see our dividend as the primary means to distribute cash to shareholders. As I just mentioned, we have already prepaid $300 million of our near-term maturities. We’ve also allocated $360 million for investments in our subsidiaries, the majority of which is from new projects driving our growth through 2018 and beyond. After considering these investments in our subsidiaries, debt repayment, and our current dividend, we’re left with roughly $400 million of discretionary cash. This, together with our 2017 free cash flow, will provide a strong foundation to grow our dividend, continue to de-lever, and earn attractive risk-adjusted returns by investing in our development pipeline focused on gas and low-cost renewables. Now turning to slide 27. As reflected in our third quarter and year-to-date, we continue to generate strong proportional free cash flow. Our third quarter adjusted EPS was also in line with our expectations. Accordingly, we are reaffirming our 2016 guidance for all metrics. Since earlier this year, we’ve experienced some headwinds, including outages at two of our businesses in MCAC, as well as a slightly negative impact from reverting back to ESP-1 rates and also some dark spread compression at DPL in Ohio. However, we expect to offset these impacts with a couple of items, one of which would lead to a lower full-year effective tax rate. Finally, before I hand it back to Andrés, I want to briefly discuss our expectations beyond 2016. On our fourth quarter call in February, we plan to provide guidance for 2017, as well as longer-term expectations through at least 2019. At that point, we will have completed our annual budget process and will be in a better position to provide more detailed guidance. Based on our preliminary view, we expect to be within the previously disclosed ranges for average annual growth through 2018. As Andrés discussed, the majority of our new projects are coming online in 2018, so we expect growth to be stronger in 2018 compared to 2017. Accordingly, we are reaffirming our previously disclosed ranges for expected growth from 2017 to 2018 for both proportional free cash flow and adjusted EPS. With that, I’ll now turn it back to Andrés.

Thanks, Tom. To summarize today’s call, we have a portfolio of assets that is generating strong cash flow, and a construction and development pipeline that is driving growth in cash flow and earnings. We are well-positioned to maximize shareholder value through the following. First, we are rebalancing our business mix by exiting certain businesses to reduce risk and redeploying our excess cash in growth projects with long-term U.S. dollar-denominated contracts and focusing on less carbon-intensive sources of generation. Second, we remain committed to continuing to strengthen our credit, which is largely driven by the successful completion of our construction program, cost reductions, and de-leveraging. Accordingly, we remain confident that we can achieve investment-grade status by 2020. Third, we're capitalizing on our advantageous position in key high-growth markets and we continue to expect double-digit growth in all key metrics through 2018. Furthermore, we believe that we are well-placed to deliver attractive growth in cash flow and earnings beyond 2018. With that, I would like to open the call for questions.

On slide 26, compared to the second quarter, it seems the only adjustment is that you mentioned this in your script. I just want to clarify that some of the sales proceeds are moving into 2017 from 2016; otherwise, this slide remains unchanged.

That's right, Greg.

So, on the unallocated discretionary cash, you talked about one of the things you didn't talk about was significant further share repurchases. That was notably absent from the script. Was that on purpose?

Well, as Tom said, we see the dividend as our primary way of getting cash back to our shareholders. On the other hand, we do have an approval, and we have shown in the past that if we think that's the best use of our cash, we will go ahead and buy back our shares. So, we're not taking it off the table, but we're saying our primary focus will be on paying and increasing, and growing the dividend.

It's just, it's a very luxurious position you're in, and you don't have any maturities for a few years. And you're already growing the dividend at a pretty high articulated rate, and yet you still have all this unallocated cash. So if I just, capital allocation is going to be top of mind when we quiz you at EI?

They’ll be good and it's great to be in a luxurious position. I'm very glad that we've been working on this for a long time, and we've successfully improved our debt situation. In terms of terms, the length of the debt is favorable; the majority of the debt is fixed and it's also in the currency of the operating business. So yes, we will be talking about that, and it does give us options.

I have a couple more quick questions. You mentioned that you’re using the commodity and currency curves from the middle of the year in your guidance. When I analyze those changes since then, it seems the dollar has strengthened for you, while commodities have moved against you. Overall, it doesn’t appear to be a significant negative, and it could even be a neutral situation. Could you provide some insight on how those curves have shifted since June 30th?

Greg, you're basically right. They're basically flat. I don't know if Tom, you want to add something to that, but the net is flat.

Yes, that’s fair.

And then in terms of the earnings drag associated with the Chile construction project, should we think about the earnings impact, as you’re seeing the incremental cost of the debt on the cost overrun?

This project will be coming in in 2019, so it currently has no impact prior to that. We have to see again where we’re negotiating now with lenders how much is from the sponsors, how much is from the lenders, and what are the conditions. So it really doesn’t have any impacts through the 2018 window. And I would add to that Hahn Air has its earnings call later today, I think at 11 O’clock, but they come out with their press release. I believe they had the best quarter in the last five years, so Hahn Air is in a strong position. But we must address the issue at Alto Maipo. As I said, we’re working very constructively with our lenders and also with the construction company.

First question I just wanted to clarify this comments you have made. When we look at the next couple of years, you have also reiterated the growth numbers well over 16% EPS growth, but this point about this being greater in ’18 versus ‘17. Just wanted to understand that a little bit better; is the implication that ’17 perhaps is lower than the 12% to 16%, but then you catch up in ’18 or that ’17 is 12%, but ’18 is 16%. I just wanted to understand what you were saying on that ’17 versus ’18 growth number?

Ali, that’s maybe a little more fine-tuning than we want to get to at this point. We’re clearly comfortable with the 12% to 16%. We think that ’18 will be stronger than ’17, and we still think that ’16 to ’17 growth rate is going to be stronger and attractive. But I don’t want to get into too much fine-tuning. We’ll certainly do that in February when we give formal guidance.

But Tom, just to be clear, we should not assume that each year is 12% to 16%, we should assume that that's a cumulative ’16 to ’18 number?

Yes, cumulative or average; however you want to do the math.

Okay.

But there was growth just between ’16 and ’17 we’ll put a fine point on growth each year in February.

And then on Ohio, how concerned are you that there will be inevitable legal challenges to any approval you get, even for this distribution rider? What’s kind of the basis on which you guys are confident that this thing will be sustained?

Ali, you always have a process and you have interveners. Having said that, we have the case of FirstEnergy that we just moved forward with, and we think our case is even more robust. So, we have a high degree of confidence that this will move forward.

I’d just say as it’s a distribution modernization rider, we’re very focused on doing it for the health of DP&L and for the T&E business. We think having a strong credit profile there is important and this will give us a trajectory to do that. Also, we do think that there is investment in the DP&L T&E business that would be good for customers and would also require capital. That’s one of the major components of, frankly, uses of cash as we talk with the commission.

And just to clarify the timing, you alluded to December 5th for the hearings, but you also have discussions. So is this something that potentially we could hear about a settlement before year-end, or should we expect Q1 when decisions and settlements and those kinds of things happen?

Ali, I think it's most likely Q1.

Last question, Andrés. You mentioned contracts that are ending after 2018 and new contracts coming in at that time. I know you'll give more details in February, but at a high level, looking at your business over the next four to five years, or through 2021, how confident are you that you can maintain the growth rate you've promised through 2018? Are you anticipating any challenges that might slow things down?

Ali, we'll provide more color during our fourth quarter call in terms of expanding. But we feel confident in the growth rates that we have given, and we see continued growth past that. We will get more specific into the future. But if you look at our construction programs, you have a lot of things coming online in '19 and '20. And also more discreet items like some of the renewables, such as solar, which we’ll be growing and are quite frankly fully incorporated in some of the construction numbers we give, because there are much shorter periods between development and construction.

Just to clarify one thing I'd said on DP&L, it's a distribution modernization rider. I think I said something other than monetization. It's a big word for me.

So, can I just maybe start in on Ohio, following from the last question. Can you elaborate a little bit? Is the structure analogous to what FirstEnergy recently approved? And then separately, you talked about maintaining investment quality. What metrics do you see going forward with the DMR and ultimately to get to those IG metrics?

Just on DP&L, yes, it's similar. FirstEnergy had some FFO ratios around 14.5%, which is similar to what we're using, so that's what gets us the $145 million of revenue requirements, or DMR. We are focused on seven years. They were shorter with an ability to extend, but we think it's helpful to have a defined longer period, but that's certainly a matter of our discussions right now.

Turning to your longer-term guidance, you talked about '18 being still intact. Can you reiterate your confidence in OPG C2 and maybe a just big uptime, as well as also just curious, Alto Maipo. I suppose it indicates back-half of '18. Is that a material contribution to '18 in terms of your confidence to hit that number?

Taking the first one in terms of Alto Maipo, as I said, it has really no impact on 2018. So we think the key is reaching an agreement with lenders and completing the project. Regarding OPG C2, we will give more information in the future. I think if we look at it as a project in India, it’s overall going quite well. It's a complex project; it does have rail tracks and a coal mine. We’ve got all the coal permits. We’ve got most of the land permits. So in general it’s proceeding well for a project in India.

So, you’re confident in first half of ‘18?

We will update that and OPG C2. We’re making good overall progress.

Can you comment a little more about what you believe is an appropriate level for new entry in Chile, and how you think that will evolve over time? The use of blocks instead of conventional PPAs really changes the market dynamic there.

Well, I think what happened in Chile is that there were about $50 billion in mining projects in Chile. About $40 billion have been suspended. So the growth in demand from the mining sector did not materialize, and those projects are on hold. So that really changed the dynamics to give you a much higher reserve ratio in Chile than certainly any of the projections had. So, when this auction came in, it cleared below what I think were consensus estimates. There were two sides; one was a new entrance on the renewable side, and we believe on the hydro side, people bid lower than expected. I would say of the thermal bids, we were probably the lowest. What do we think is a sustainable level? The sustainable level is north of $60, $60 a megawatt hour. If you look at where this auction cleared, it's more around $47. There are issues with needing to follow the load with intermittent renewables, and you have to put packages together. We think that some of these assumptions, obviously, involve bidding for future capital investment prices and for other costs. So, we think our existing assets put us in a good position for more secure, load-following supply.

And then can you comment briefly on the Philippines and the expansion project, given broader pricing pressures that we’ve seen in Chile, etc.?

Well, it's a different market. In the case of the Philippines, we saw that there was demand for our plant Masinloc, and we could add another unit to Masinloc and 335 megawatts going to be super critical. We could contract that at attractive prices. So we started this. It's under construction today. The Philippine market will change. What you have today is basically a lot of gas plants that are using domestic gas, which are first to be dispatched. So, there are base loads. When these contracts burn off in the next couple of years, they would move to mid-merit status. Quite frankly, they may have to search for new gas sources. Given the location of this plant, we expect it to be well-positioned. I think perhaps you are getting at the new contracts we're signing for 10 and 20-year PPAs at similar prices, and we're basically extending the existing Masinloc at the same price with the off-taker, pending regulatory approval, but we expect that to get approved.

Right now if you look at the valuation on AES, even if you ignored all the utilities, generation is trading at $1,000 of kilowatt, or that's what the market is telling us. Andrés, would you say this is enough, I'm going private, I'm going to take out AES and turn it into a private company?

Well, I think that if you look at AES today, it's certainly been significantly de-risked, and certainly, I think, we have a very attractive future growth profile. I think we are very well positioned. In terms of our valuation, we've faced considerable headwinds over the last five years. Some were external, whether it was droughts, commodity prices, or foreign exchange issues. Now, what we've done is eliminate much of that risk as we move forward. So I think as we deliver on the growth prospects, construction program, and cost cuts, we should see valuations that align more closely with our peers.

I think we'll have a better idea of what the metrics will translate to from the agencies. We want to be careful. I don't want to presume what their judgment would be; that's why we're trying to control what we can control. Our ratios have gone from 6.5% to about 5%, and we aim to go to 4% or low 4s depending on our business mix and stability. I don't think it will materially change our business or financing strategy. I will say that we've done a lot and continue to do a lot to look ahead, refinance, and take advantage of market windows, either at the parent level or throughout our subsidiaries.

Last question, Andrés. AES is going very deep and long into battery storage power. I’m just wondering, because I’m assuming battery power could be useful backup to renewables mostly, and to make sure good stability remains in place. But my understanding is that backup power is typically required for six to eight hour periods, and batteries generally don’t give out too much more output than two to four hours. Is there a disconnect between what the objective of the battery is trying to do, and what the actual reality is?

What we’re seeing first is this market is growing very quickly. We believe that by next year, installations around the world will reach around 1 gigawatt. We are starting from about 200 two years ago. First, it's growing very rapidly. This technology has many applications. It has applications for capacity release, as well as taking plants where you have a lot of renewables. That is our big project in California. It also has applications for the T&E business in alleviating transmission constraints. As for lithium-ion battery energy storage solutions, batteries are just one component. We’ve seen over the last five years battery prices decrease by 65%. There is no technical reason you couldn’t make it an eight-hour solution; it just means adding more batteries, which increases costs. We expect battery prices to continue to drop because these are the same batteries you use in electric vehicles. So, as that market expands, prices should keep falling. We project continued price drops. Our two-pronged approach is to put our Advancion product on our platforms and enhance our renewables or thermal plants and sell it to third parties. We want to be the low-cost provider and also provide the best service.

So, first going back to the Alto Maipo project. Could you tell us how much of the capacity is going to be contracted? And has there been any impact on your ability to contract the remainder of the project, given the outcome of this August solar power auction?

Yes, Angie. I think about 40% of the project is contracted today in long-term contracts. In terms of our ability to re-contract, I would say that obviously it will affect the price of any future contracts. When it was being built, the forecast for Chile was around $100 a megawatt hour, and now we're seeing prices more likely around the mid-60s. So, you're right that the auction affects things, but I believe that more than the auction, the dynamics in the market have changed significantly.

Now, you're assuming that the lenders basically cover the cost overruns. I mean, I am concerned here because it seems like you have fully committed your equity stake here. You've an increase in the cost of construction, and a reduction in revenues due to the drop in power prices. So, is there a scenario where you would actually consider walking away from this project?

You're right, the project looks less attractive today with the cost overruns and the lower prices than it had initially. While it was a very robust project at the beginning, we will consider what is best for AES Gener. We must reach the right agreement with lenders to make this project viable, and that is always an option we are looking into. However, I think the most likely outcome is that we complete the project.

Thank you, everyone, for your questions; we appreciate your participation in today's earnings call. Please feel free to reach out to the IR team if you have any further questions.

Thanks. This is Ahmed. We thank everybody for joining us on today’s call. We look forward to seeing many of you next week at the EEI Conference. As always, the IR team will be available to answer any questions you may have. Thank you, and have a nice day.