avatar American Electric Power Transportation, Communications, Electric, Gas, And Sanitary Services
  • Location: Ohio 
  • Founded:
  • Website:

Pages

  • Page 1

    Energy Economy Environment In addition to traditional We are advocating for Compliance is the fuels such as coal and federal resources to assist foundation of our natural gas, we also see in retooling local environmental efforts. transmission, smart grid economies as we also We also set voluntary and energy efficiency as explore ways to reuse targets. Overall, our vital parts of our retired coal plants or performance is very resource mix. plant sites. good. Learn More Learn More Learn More AEP's CEO on The Value of Electricity AEP Overview Sustainability Play Video Play Video Play Video Page 1 of 115


  • Page 2

    2013 Corporate Accountability Report – Index of Content Fast Facts & Reports  Reports  Challenges, Goals & Progress  Service Territory  Plant Emissions Leadership & Strategy  CEO Letter  Board Statement  Strategic Goals  Corporate Leaders & Governance  Materiality Assessment  Resource Diversity  Regulatory & Customer Rate Management  Ethics & Compliance  Lobbying & Political Activity Business Performance  Financial Performance  Energy Reliability & Security  Environmental Performance & Compliance  Safety & Health Opportunities & Risks  Opportunities For Growth  Innovation & Technology  Climate Change  Managing Risk Partnerships & Engagements  How We Engage  Employees  Customers  Diversity  Strong Communities  Sustainable Procurement Participate & Discuss Page 2 of 115


  • Page 3

     Energy E-Cards  Subscribe To AEP E-mail Alerts  Measure Your Carbon Footprint  Contact Us Reports This is AEP’s fourth integrated report combining the Annual Report to Shareholders with the Corporate Sustainability Report. This is our seventh year of reporting our sustainability performance. This website — www.AEPsustainability.com — includes significant data and information about AEP’s performance. This report is based largely on calendar year 2012 with exceptions for early 2013 data as noted. For more information about AEP, visit www.AEP.com. GRI - Global Reporting Initiative This report was developed according to the Global Reporting Initiative (GRI) Sustainability Reporting Guidelines Version 3.1 (G3). The GRI guidelines provide a voluntary reporting framework used by organizations around the world as the basis for sustainability reporting. We are using the G3.1 standards, as well as the Electric Utility Sector Supplement for reporting on industry-specific information. AEP self-declares an Application Level A for its 2013 report, which reflects a high level of transparency in our reporting.  AEP 2013 Corporate Accountability Report - GRI Report (PDF) Audit Review of This Report AEP Audit Services performed a limited review of company performance statements contained within the Business Performance Section of the 2013 AEP Corporate Accountability Report. Financial information was reconciled with AEP's audited financial statements, if applicable, or to such other sources as deemed appropriate. Processes used in accumulating the significant nonfinancial data were reviewed and the data reconciled to the sources(s). The appropriateness of the context in which data are presented was also reviewed. Finally, forward-looking information was verified as consistent with other public information disclosed by AEP. Based upon our review as of April 19, 2013, we believe the information regarding Business Performance is appropriately stated, and that the processes followed in accumulating both the financial and nonfinancial information are reasonable. Richard A. Mueller Vice President, Audit Services Page 3 of 115


  • Page 4

    Who We Are Page 4 of 115


  • Page 5

    Page 5 of 115


  • Page 6

    Page 6 of 115


  • Page 7

    Page 7 of 115


  • Page 8

    Page 8 of 115


  • Page 9

    Page 9 of 115


  • Page 10

    Statement of The AEP Board of Directors The AEP Board of Directors has assigned responsibility for monitoring and overseeing the company’s sustainability initiatives to the Board’s Committee on Directors and Corporate Governance. This is the fourth year AEP has integrated its sustainability reporting with financial reporting. The Committee fully supports this approach. Stakeholders have expressed approval and appreciation for AEP’s leadership with this integrated approach to corporate reporting. Throughout the year, the Committee and company management reviewed the company’s sustainability objectives, challenges, targets and progress. The Committee reviewed and discussed the final text of this report before recommending its approval by the full Board of Directors. The AEP Board of Directors receives frequent reports both from management and from the Committee on Directors and Corporate Governance about the company’s sustainability initiatives and from management and Board committees about the company’s financial reporting and economic performance. Topics in this report have been the subject of active discussion at the Board and Committee meetings. All members of the Board reviewed the report in detail and at the conclusion of this review process the Board of Directors adopted a formal resolution approving the report. The Board believes this document is a reasonable and transparent presentation of the company’s plans and of its environmental, social and financial performance. The Board has emphasized to management that it will continue to be evaluated by its success in executing the company’s strategic plan to meet stakeholders’ and the Board’s expectations, including being agile in responding to changing circumstances while respecting the commitments in this report. Thomas E. Hoaglin Lead Director of the AEP Board of Directors April 9, 2013 Page 10 of 115


  • Page 11

    CEO Letter Dear Friends, It is my privilege to report to you on our business and to share AEP’s road map for future growth. We’ve come through some difficult times, and we are very well positioned for the future and excited about our prospects. AEP has provided its shareholders with dividends for 411 consecutive quarters. And we are on course to continue executing our strategy: creating economic value while protecting the environment and improving the lives of those with whom we interact. Safety is always our top sustainability priority. It was also our proudest accomplishment in 2012, when we achieved the best safety performance in AEP’s history. No AEP employee or contractor lost his or her life in 2012 during the course of their work. We achieved our lowest recordable incident rate ever, and the severity of the injuries that did occur was down significantly. I speak for the Board of Directors and for all of our leaders when I say how profoundly grateful I am to the men and women of AEP who have honored the company with this accomplishment. Our goal remains zero harm – zero fatalities, zero injuries. We have set our sights high, as we always do, and as we get better, the journey to zero gets harder. Yet with continued vigilance and determination, and an abiding commitment to look out for each other, I am confident we will continue to make progress. I invite you to learn more about our safety performance. The energy business is complex, exciting and in the midst of a major transformation. We provide a vital service that for more than a century has supported commerce, contributed to quality of life and strengthened our communities. And as the energy business changes, so do we. Recently, domestic production of oil and natural gas has increased, the price of natural gas has fallen, and the cost of generating electricity from coal has gone up, a result of increasingly expensive environmental compliance requirements. At the same time, energy demand has remained stagnant because of weakness in the economy and gains in energy efficiency. Page 11 of 115


  • Page 12

    These changes have led to some positive outcomes that underpin our sustainable growth strategy, including greater fuel diversity, new jobs, grid modernization and a cleaner environment. AEP has become a more agile, innovative, adaptive and resilient company and has thus continued to create value for customers, shareholders and other stakeholders. We’ve also worked to strengthen our nation’s energy security and its industrial competitiveness in the 11 states where we operate and in which we live. We would all be well served by a national energy strategy and sound public policies to facilitate the generation and delivery of energy. America needs to diversify its fuel sources, invest in transmission systems, replace aging infrastructure, stimulate energy efficiency and finalize a long-term solution to the problem of spent nuclear fuel. Such national energy priorities must be achieved with due consideration of the economic consequences of each option, with all stakeholders having been given a voice in the decision-making process. Energy can accelerate economic growth and create widespread prosperity. But it requires policy makers, regulators and industry leaders to come together to make reasonable plans with consumers, communities, and other stakeholders who are concerned about the environment, job growth, national security and other key issues. Without such plans, the nation’s long-term economic health will continue to be at risk. Sustainability has many definitions, but at its core is a vision we all share: broad prosperity, a clean and healthy environment, and vibrant communities in which our families, neighbors and children can thrive. A Strong Performance In 2012 With a strong balance sheet, a stable base of investors, solid financial performance in 2012 and a sound strategy for the future, AEP is poised to deliver robust financial returns to its investors and to help accelerate economic growth for its customers and communities. 2012 was a year of transition but also one of progress. We have greater clarity about our future in Ohio, a sensible transmission growth strategy, regulated utilities that are delivering strong returns on our investments, and a sturdy platform from which to invest in our core businesses. That is why we are committed to achieving annual earnings growth of 4 percent to 6 percent. In 2012, we also maintained our investment-grade credit ratings, made contributions to our qualified pension plan, and began to recover deferred costs that had been mounting in some jurisdictions for the past few years at the direction of regulators. In a decision that reflects confidence in our business plan, early in 2013 our Board of Directors increased the target payout ratio range of AEP’s dividend to 60 percent to 70 percent of consolidated earnings. This brings us more in line with our regulated peers. Page 12 of 115


  • Page 13

    We took actions last year to identify sustainable cost savings opportunities and improve processes, which led to greater efficiencies. Faced with a rapidly changing operating environment, we conducted an organizational review to identify opportunities to be more agile, focus more on customer service and allow us to prudently reallocate resources to high-growth areas of our business, such as transmission. We will continue to reposition our business to accommodate the need for quality customer service and pursue growth in our regulated businesses. These are all indicators of our financial strength. A strong, healthy organizational culture is imperative to business success. An employee culture survey last year told us that our employees are deeply committed to the company, to its customers and to the safety of one another. But it also showed us that we have areas to work on if we are to successfully implement our strategy. We held nearly 60 focus group meetings across our service territory in early 2013 to seek employees’ ideas and to help us develop a culture that will support stronger leadership throughout the organization, strategic alignment across the company, employee engagement and more meaningful performance recognition. We will work hard this year and in the years to come to ensure that employees have the skills and tools to keep pace with the dynamic changes happening in our business. Investing In The Future Regulated utilities constitute the largest portion of AEP’s business, producing and distributing electricity to more than 5.3 million customers in 11 states. We will use this platform as a growth springboard and will invest approximately $3.6 billion in 2013 and $3.8 billion in 2014 and 2015, respectively, primarily in our regulated businesses. These investments will keep the power on, serve new customers and deliver quality service to all of our customers. Our operating companies work tirelessly to maintain positive, open relationships with regulators, legislators and key stakeholders to ensure that our capital investments are needed and supported. We are successfully pursuing a strategy to create separate transmission companies in our jurisdictions. These investments along with our transmission joint venture projects, all held within AEP Transmission Holding Company, LLC (AEPTHCo), improve service and reliability for our customers and deliver value to our shareholders. From 2010 through the end of 2015, AEPTHCo is forecasted to invest approximately $3 billion in its business. And these investments Page 13 of 115


  • Page 14

    are having an impact. AEPTHCo contributed $0.09 per share to earnings in 2012, 50 percent more than in 2011; this is expected to increase to an estimated $0.36 per share in 2015. With greater certainty about the future in Ohio, we are moving forward with the process of separating our Ohio generating assets from AEP Ohio, known as corporate separation. AEP Ohio is our largest operating company, representing 29 percent of retail revenues system-wide in 2012, and is undergoing the biggest transformation among our operating companies. Once corporate separation is complete, AEP Ohio will be a “wires only” transmission and distribution company. Through 2012, 51 percent of AEP Ohio’s retail customer load had switched generation providers, some of which is now served by our own retail provider. Through our competitive retail and wholesale power marketing business and with the eventual availability of more than 8,000 MW of generation in Ohio on the market, we will be a strong contender. To comply with new and pending environmental regulations, we expect to retire approximately 5,500 MW of generation by the end of 2016 and convert to natural gas or install or upgrade environmental control systems on nearly 11,000 MW of generating capacity. This will cost between $4 billion and $5 billion and is in addition to the $7 billion we have spent since 1990 to significantly reduce air emissions from our coal plants. We understand the intent of the regulations. We also remain concerned about grid reliability due to the timing and scope of plant retirements across the United States, the need for new or replacement transmission or generation to support the grid in the absence of retired coal units, and the need to upgrade and expand the existing transmission system across the country. Overall, the scope and timing of these projects represent large costs for our customers to bear, and they put the reliability of the bulk power system unnecessarily at risk. We continue to be vocal advocates of rational rulemaking that considers the economic impacts of new regulations along with the environmental benefits. An agreement reached in February 2013 to modify our 2007 New Source Review consent decree will accelerate original plans to reduce sulfur dioxide emissions on our Rockport Plant in Indiana while maintaining our flexibility to choose the technology to do it. It also will require the retirement or refueling with natural gas of other coal units and the addition of 200 MW of wind energy to serve our Indiana Michigan Power customers. This agreement, awaiting court approval, is a win for our customers and for the environment because of the flexibility it affords and the reduced environmental impacts that will result. Page 14 of 115


  • Page 15

    As national discussions about climate change continue, we are engaged in the United States and internationally. Climate change is a significant sustainability concern that carries with it operational and financial risk. Our position that this issue must be addressed globally has not changed and we continue to work toward our goal to reduce our carbon emissions by 10 percent from 2010 levels by 2020. The retirement of coal-fired units will support these reductions, as will the increased diversity of our fuel mix. You can learn more about AEP’s climate policy position and strategy here. Resiliency and Reliability We face increasing challenges to the resiliency of the electric grid. The recent severity and frequency of storms has been a blow to our industry and the infrastructure that produces and delivers electricity. During AEP’s 107-year history, 2012 will be remembered as a year when our system sustained unprecedented physical damage from weather events. Tornadoes, an unexpected hurricane-like wind storm (known as a “derecho”) and Super Storm Sandy crumpled thousands of transmission towers and distribution poles, snapped thousands of miles of wire and damaged or destroyed other equipment, leaving millions of customers in the dark and causing hundreds of millions of dollars in damage. I am proud of what our employees accomplished to restore customers safely and as quickly as possible in our service territory and across the country. The magnitude of these events is driving an industry-wide research project to improve the resiliency of the grid. Resource Diversity We believe in a balanced resource portfolio to supply our customers’ needs, to mitigate risk and to provide for a secure energy supply in the future. Coal will continue to be a key part of the fuel mix, as will natural gas, renewable energy, nuclear, hydro and energy efficiency. Rounding out this resource mix are transmission and smart grid. This combination of resources gives us the balance and flexibility we need for the future. We have already taken steps to diversify the fuels we use to generate electricity and will continue to do so. We brought new natural gas and coal plants on line in 2012. In early 2012, the 580-MW, combined-cycle natural gas-fired Dresden Plant in Ohio began commercial operation. And in December 2012, the 600-MW John W. Turk, Jr., ultra-supercritical coal-fired plant began commercial operation in southwest Arkansas. The Turk Plant is one of the cleanest and most efficient pulverized coal plants in the United States, using less fuel and producing fewer emissions compared with traditional pulverized coal plants. This is an example of AEP’s leadership Page 15 of 115


  • Page 16

    to further advance coal generating technologies. In addition to contributing to a more balanced fuel mix for that region, the plant created 109 new local jobs and will generate long-term direct and indirect economic benefits to the region. We have also increased our use of natural gas by 130 percent since 2009 due to low gas prices and the availability of our combined-cycle gas plants. Our use of renewable energy has increased to nearly 2,000 MW, with more to come. Energy efficiency is making strong gains in our states, as are demand response programs. We are investing in our Cook Nuclear Plant in Michigan to ensure that it continues operating smoothly for another 20 years. And our 17 hydroelectric and pumped storage plants continue to be a reliable source of emissions-free electricity. Overall, we expect our coal-fired generating capacity to be around 46 percent in 2020 compared with 65 percent in 2012. These are the hallmarks of a more balanced, diverse resource mix that provides real energy security for the future. AEP Continues Strong Record of Innovation As would any organization striving to become more sustainable, we not only stay focused on the future, we plan for it and sometimes strive to shape it. Innovation has enabled us to meet challenges over and over again that improved our efficiency, our reliability and our customer service. We are an innovative and creative organization, and we have thrived for more than 100 years on the strength of our “intrapreneurs” – the many employees throughout the company who create and help deploy new technologies and services or who simply find better ways to do their jobs and serve our customers. The construction of the Turk Plant in Arkansas is an example of this spirit and commitment. Our Transmission business exemplified our innovative spirit in 2012, developing a new high-capacity, low-profile 345-kV line design that offers a high capacity alternative to conventional 345-kV or higher extra-high voltage lines. Once commercialized, the new line will enable better use of rights of way than traditional 345-kV or 500-kV lines. As a result, the Page 16 of 115


  • Page 17

    new design will help to lessen siting challenges and be less costly per megawatt-hour of energy delivered. Patents for this new design are pending with the U.S. Patent and Trademark Office. In addition, our Transmission team developed ways to accelerate the construction and installation of critical electrical facilities to better serve the growing demand for electric service from oil and gas producers. These new technologies and practices enable AEP to serve these customers in an expedited manner, supporting local economic growth and job creation. I invite you to read more about these and other technology breakthroughs in Innovation and Technology. Sustainability Governance, Reporting and Stakeholder Engagement We have built on our heritage of innovation to become a company that can respond to, and anticipate, the expectations of stakeholders and the public regarding our environmental, social, operational and economic performance. Our capacity for positive and dynamic interaction with our stakeholders will be increasingly vital to our business success in the years to come. Effective engagement occurs when companies and stakeholders disclose important information to one another about their activities and future plans. We started to report on our environmental, social and economic activities and plans in 2007; and, in 2010, we became one of the first companies in the United States to integrate our sustainability report with our annual shareholder report. This approach gives a more holistic and comprehensive view of our company and a better understanding of the interdependencies of our financial and nonfinancial performance. We also began an extensive effort to engage our stakeholders in 2007, meeting with national and regional stakeholders at corporate headquarters in Columbus, Ohio, and with local stakeholders at some of our power plants and operating company headquarters in our service territory. As we moved forward, we realized that it is vitally important for us to be able to prioritize and respond to the issues that our stakeholders consider important and take those issues into account whenever possible. As we have done since 2007, we held a number of meetings and conference calls with key stakeholders in 2012, and we also conducted a survey of more than 250 internal and external stakeholders. This important work helps us to adjust priorities and guides our reporting. I invite you to learn more about this assessment. Page 17 of 115


  • Page 18

    Stakeholder engagement, although sometimes contentious, has always been productive for us. It has helped us to expand our thinking in many ways and has allowed us to be open and candid about our positions and activities in the realm of public policy. Board Changes We will greatly miss the wisdom and guidance of James Cordes, who was elected to our Board of Directors in 2009 and is retiring this year. Jim's decades of experience in the natural gas pipeline business have proved invaluable to us. We wish him all the best in his future endeavors. Three new directors have joined the board in the past year: Sandra Beach Lin, former president and CEO of Calisolar, Inc. (now Silicor Materials); Steve Rasmussen, CEO of Nationwide; and Oliver G. "Rick" Richard III, former chairman, president and CEO of Columbia Energy Group. Already, the board has benefited from the range of backgrounds, skills and perspectives that Sandy, Steve and Rick bring to our deliberations. A Promising Future An energy renaissance is under way in America. The nation is becoming more self-reliant on indigenous resources, including a diversity of fossil fuels, renewable energy and conservation. Safe, reliable and affordable energy has long been the backbone of the U.S. economy, delivering comfort to customers, a competitive edge to businesses and a quality of life to citizens that others seek to emulate. But many of us take energy for granted; we assume that power will always be there wherever we need it and whenever we want it. We learned during several severe weather events in 2012 that no matter how well prepared we are, this may not always be the case. We face harder lessons ahead if we do not gain traction on a national energy policy for the next generation. Just as customers want price signals to help them use energy more efficiently, our industry needs incentives and changes to electricity markets to encourage the significant, long-term investments that are needed for a robust, reliable electric grid in the future. At AEP, we already have the future in focus. Page 18 of 115


  • Page 19

    We are putting steel in the ground as we rebuild and expand our transmission system. We are working with regulators to improve the reliability of our distribution system while moving forward with new smart grid technologies to increase the efficiency of our system and give customers more control of their energy use. We are retiring older coal-fired units, thus reducing our environmental impacts. But coal will be part of our fuel mix as well as the nation’s fuel mix for the foreseeable future. Our commitment is to ensure that we are using it in the safest and most efficient way possible with the least amount of environmental impacts. To that end, we continue to champion research and development of new technologies and to enhance our operating and maintenance practices to continually improve our environmental performance. AEP is a proven industry leader and innovator, and we are putting our knowledge and efforts to work helping our businesses, homes and communities to be safe, secure and prosperous. From developing new power line designs, to streamlining processes that allow us to serve customers faster and more cost efficiently, we are helping America’s industry to be more competitive, creating new jobs and supporting economic expansion where it is needed most. Energy is proving to be the accelerator of economic growth America needs. I am very proud to lead AEP as we move forward together with a clear sense of purpose. We have made much progress, and we have more to accomplish. We invite you to join us and to learn more about who we are, what we have achieved and our plans for the future. Nicholas K. Akins President & Chief Executive Officer April 2013 Page 19 of 115


  • Page 20

    Page 20 of 115


  • Page 21

    Leadership & Strategy Leadership Message “The energy business has changed dramatically during the past few years and so has AEP. These changes have led to some positive outcomes, including greater fuel diversity, environmental gains, new jobs and grid modernization.” - Nick Akins, President and Chief Executive Officer AEP’s Board of Directors From Left to Right: John F. Turner, Lionel L. Nowell III, Steve Rasmussen, Richard C. Notebaert, Linda A. Goodspeed, Oliver G. Richard III, Thomas E. Hoaglin, Nick Akins, Michael G. Morris, James F. Cordes, Sandra Beach Lin, Richard L. Sandor, Ralph D. Crosby, Jr., David J. Anderson, Sara Martinez Tucker Our Philosophy AEP has been in business for more than a century. Our job is to produce and deliver electricity safely and reliably to more than 5.3 million customers in 11 states. Today, there is no statement more relevant in describing our business, our commitment to our customers and our contributions to society as that made by George N. Tidd, president of American Gas & Electric, in 1934. The company was renamed American Electric Power in 1958. This philosophy continues to guide us today. Page 21 of 115


  • Page 22

    “Our job is generating electricity and getting it to where it's used. We're in this business because it is concerned with the supply of a fundamental requirement of modern living, because it's an honorable one, because we like it, and because we want to earn a living at it. We aim to give one kind of service to everyone... the best that's possible. That means supplying our customers with what they want when they want it. It means being courteous at all times and maintaining attractive, easy-to-do-business-with offices. It means doing everything we can to keep complaints from arising, and it means prompt and fair handling of those that do. We are a citizen of each community we serve and take an active part in its affairs. Like any other citizen, we want our neighbors to think well of us. Besides, it makes good business sense. We prosper only as the community prospers; so we help it thrive in every way we can. Such is our job as we see it. We are trying to do it well and to do it better all the time.” Strategic Goals Our focus is on executing our strategy to grow and invest in our regulated businesses; deliver superior service to our customers; provide a collaborative, rewarding work environment for our employees; develop our competitive businesses; and deliver value to our shareholders. To achieve our strategic objective of 4 percent to 6 percent earnings growth, we are executing on the following goals:  Optimize regulated utility returns: AEP’s financial objectives are to earn our allowed returns by prudently investing capital for our customers and maintaining our investment- grade credit ratings.  Grow our transmission business: AEP Transmission’s growth strategy depends on building and cultivating a portfolio of businesses under the AEP Transmission Holding Company. For the year ending Dec. 31, 2013, AEP Transmission Holding Company projects it will contribute $67 million in earnings. Our portfolio consists of: o AEP Transmission Company – A holding company for state-regulated transmission companies, or Transcos. o Joint ventures – Joint ventures with other utilities are longer-term projects offering FERC formula rates and other rate mechanisms that provide a higher return on equity. o Transource Energy – A competitive business started in 2012, Transource focuses on developing projects within and beyond the AEP service territories, with flexibility to add projects and partners as opportunities arise. Page 22 of 115


  • Page 23

     Transform our generation business: External factors continue to call for significant changes in our generating fleet. We will do this by: o Diversifying our fuel mix. o Complying with environmental regulations by retiring approximately 5,500 megawatts (MW) by the end of 2016 and refueling or retrofitting nearly 11,000 MW of coal-fired generation between now and 2020. o Improving the operational performance of our generation fleet.  Build our competitive business platform: AEP formed a new Energy Supply organization in late 2012 to oversee this business unit. Its objectives include: o Achieving corporate separation in Ohio by Jan. 1, 2014. o Integrating competitive generation with our retail and wholesale businesses. o Investing capital conservatively. o Mitigating risk and volatility through hedging activity.  Improve the health of our organizational culture: Culture is a business imperative to successfully execute on our strategy, yet it is abstract and subjective. It’s our job to reach out to all of our employees, communicate the strategy and vision, and focus on how each business unit can contribute to AEP’s overall strategy and vision so all employees know exactly what their roles are. AEP's Executive Team Lana L. Hillebrand, Senior Vice President and Chief Administrative Officer; David M. Feinberg, Executive Vice President, General Counsel and Secretary; Nicholas K. Akins, President and Chief Executive Officer; Brian X. Tierney, Executive Vice President and Chief Financial Officer; Dennis E. Welch, Executive Vice President and Chief External Officer; Robert P. Page 23 of 115


  • Page 24

    Powers, Executive Vice President and Chief Operating Officer; and Lisa M. Barton, Executive Vice President, AEP Transmission. Corporate Leaders and Governance Materiality Assessment Materiality is central to disclosure and investment performance. We consider material issues to be those that have affected, or that are reasonably likely to affect, the company's reputation, liquidity, capital resources or results of operations. Material issues can also include those that stakeholders consider important to their interests and to AEP's sustainability. To prepare this 2013 Corporate Accountability Report, AEP conducted a materiality assessment to ensure that we were reporting on sustainability issues of importance to our stakeholders and our business and to identify potential improvements in our presentation of information. This represents a change in the approach to and engagement of our stakeholders. It provided us an opportunity to ensure that issues deemed to be material by our stakeholders align with our business strategy and risks. Understanding these linkages allows us to be more focused in our engagement and to allocate resources where there is the greatest opportunity for sustainable growth while mitigating potential risks. We sought opinions from more than 250 internal and external stakeholders. This outreach extended to the six-member Committee on Directors and Corporate Governance and the Chairman of the AEP Board of Directors, all of whom completed the survey. This committee has oversight of AEP's sustainability reporting and initiatives and was deemed the most appropriate Board engagement for this first assessment. In the future, we will engage the entire Board. The feedback we received from the survey helped us to prioritize AEP's environmental, social and governance (ESG) performance and to rank those issues based on their importance to stakeholders and to AEP. This report reflects the outcome of this process. Although we reached out to many external stakeholders, we did not receive as robust a response as we had hoped for. We would have especially liked a greater response rate from customers, NGOs and governmental stakeholders and will work harder to engage them in the next survey. AEP worked with MetaVu and CRD Analytics on the assessment, which involved an objective, strategic review of AEP's existing materiality model (issues, stakeholders, methodology, visual charts and stakeholder communications, etc.). It was important to us to include an investment analyst's perspective in this process, which CRD Analytics represented. Page 24 of 115


  • Page 25

    We also sought to understand key changes in reporting expectations as presented by the Global Reporting Initiative (GRI), the International Integrated Reporting Council (IIRC) and the Sustainability Accounting Standards Board (SASB). We aligned those changes in the standards with our material risks as identified by management, the Risk Executive Committee and the Board of Directors, to assure that we were measuring and reporting in a meaningful and useful fashion. Shifting Priorities In 2012, we reported on more than 80 issues; we condensed that list to 36 issues and, of those, 15 continued to be issues of high priority for internal and external stakeholders. Those are the issues we are focusing on most intently. The survey received a 56.3 percent response rate, which exceeded expectations. Participants ranged from AEP Board of Directors members, investors and employees to customers, suppliers (fuel and non-fuel), non-government organizations, contractors, labor unions and trade organizations. Not surprisingly, there are changes in priorities among stakeholder groups. Some issues, such as environmental performance (including climate change) remain a high priority for AEP and its stakeholders. These issues have long dominated many of our conversations with stakeholders and led us to set goals to improve and enhance our environmental performance and reduce CO2 emissions. Environmental performance and regulation uncertainty continue to be significant issues to the company and to society and thus remains a material issue to AEP, as reflected by the amount of time, effort and financial resources we devote to our environmental performance and compliance. We have continued to be transparent about our environmental efforts while narrowing the focus of our reporting. Page 25 of 115


  • Page 26

    At the same time, other issues have risen to the top. This new assessment shows that energy reliability and security, the business value and cost of electricity and innovation and technology are also top areas of interest. We attribute this to the rapidly changing business and operating environment, which is driving a major transformation of our company and our industry. It may also reflect heightened awareness of reliability issues in the wake of several severe weather events in 2012 that caused massive power outages. This assessment was compared with the material risks of the company to validate the relevance and importance of each issue to AEP and its stakeholders. This exercise helped us to level-set our performance with the expectations of our many diverse stakeholders as we move forward and give greater focus to our performance reporting. Resource Diversity A balanced and reliable energy future Our energy security as a nation depends on using multiple sources of energy. A diverse fuel mix is an insurance policy in the event that changing conditions or economic circumstances make any given fuel source impractical or impossible. We project that our fuel generating capacity will shift from 60 percent coal and 23 percent natural gas in 2013, to 46 percent coal and 33 percent natural gas by 2020. The remainder of our resource needs will be filled by renewable energy, nuclear, hydroelectric and pumped storage, and energy efficiency and demand response programs. Although demand response and energy efficiency capacity does not represent a physical asset, it does represent avoided capacity. National electricity consumption is predicted to grow at an annual average rate of 0.7 percent between 2011 and 2040, according to the U.S. Energy Information Administration’s (EIA) Annual Energy Outlook 2013 Early Release Overview. Socioeconomic and market factors as well as additional energy efficiency rules, such as new appliance and building efficiency standards, may slow the growth of energy consumption somewhat. Despite these forces, energy demand is expected to continue its modest growth rate for the foreseeable future. As we seek to balance our fuel mix, we are looking at resources in a different light. In addition to traditional fuels such as coal, natural gas, nuclear and hydroelectric power, we also see transmission, smart grid and energy efficiency as vital parts of our resource mix. This will ultimately drive us to using less coal. Although coal is challenged by regulations, it remains an Page 26 of 115


  • Page 27

    important resource to ensure a reliable, secure energy future. Through the development of shale gas, the growth of renewable energy, the advancement of smart grid technologies and the development of transmission, we now have new and broader resource opportunities. Our decision to build the 600-megawatt (MW) John W. Turk, Jr., Power Plant in southwestern Arkansas exemplifies our continued commitment to the responsible use of coal as a fuel source. The Turk Plant is the first coal-fired plant AEP has built in more than two decades and represents the future of coal-based technology that we continue to advance. The Turk Plant is the only operating U.S. power plant to use ultra-supercritical technology and is among the nation’s cleanest, most efficient pulverized coal plants. Turk began commercial operation in December 2012 after a variety of regulatory and legal challenges were resolved and was officially dedicated in April 2013. The 600-MW John W. Turk, Jr., Power Plant in southwestern Arkansas exemplifies our commitment to the responsible use of coal as a fuel source. SWEPCo owns 73 percent of the plant’s capacity and operates the facility; its share of the construction cost was $1.3 billion of the plant’s $1.8 billion cost. Co-owners are Arkansas Electric Cooperative Corp., 12 percent for its 490,000 members; East Texas Electric Cooperative, 8 percent for its 178,000 customers; and Oklahoma Municipal Power Authority, 7 percent, serving 39 municipal electric systems in the state. In addition to providing energy reliability and fuel diversity to the region, the plant created 109 new, permanent jobs with an estimated annual payroll of $9 million. The plant is estimated to provide an additional $6 million in annual school and property tax revenues in southwest Arkansas. At the peak of construction of the Turk Plant, which began in November 2008, the project provided up to 2,200 construction jobs. Page 27 of 115


  • Page 28

    Page 28 of 115


  • Page 29

    Page 29 of 115


  • Page 30

    Natural Gas: Game Changer Our nation has abundant resources of natural gas, which has certain environmental and price advantages over coal and is capturing an increasing share of the domestic electric generation market. Natural gas creates significantly lower amounts of carbon dioxide and other emissions when burned than does coal. And natural gas prices are expected to remain comparatively low. New gas plants or existing coal units modified to burn natural gas will likely replace a portion of the energy lost as coal units are retired. We have been ramping up our own use of natural gas largely due to the efficiency of our combined cycle gas units and its affordability as part of a balanced portfolio. We have been operating four combined-cycle gas plants: the 840-MW Waterford and 580-MW Dresden plants in Ohio; the 1,200-MW Lawrenceburg Plant in Indiana; and the 543-MW J. Lamar Stall Unit in Louisiana. We have increased our use of natural gas by about 130 percent since 2009. A mild winter (in 2011-2012) and high levels of natural gas production from shale gas formations that led to higher natural gas inventories and downward pressure on gas prices made power generated by these units more economical. Technology advancements in the oil and natural gas industries, through the use of horizontal drilling and hydraulic fracturing, or fracking, are driving significant economic growth and potential for future growth in Arkansas, Oklahoma, Ohio, Louisiana, Texas and West Virginia. And our companies and customers are benefiting from these advancements. Extraction of gas from shale formations is altering the fuel mix throughout the industry by making gas more competitive with other fuel sources. Shale gas is in abundant supply in much of our footprint, and extraction with these technologies is producing economic and customer growth opportunities for much of AEP’s service territory. The 580-MW Dresden Plant in Ohio is one of AEP's four combined-cycle gas plants. Page 30 of 115


  • Page 31

    In Texas, drilling on the Eagle Ford shale formation has created higher demand for, and the need for quick access to, electrical power to operate drilling rigs and processing facilities. Shale gas extraction is supporting local jobs, economic growth and electricity demand growth for our companies. This increase in demand in Texas and elsewhere requires us to engage in a system- wide review of capital investment priorities. Our Economic & Business Development team is on the ground working with the oil and gas industries and in 2012 expanded to the Internet, giving oil and gas companies in Texas and elsewhere, a one-stop shop location for the services they need. At the same time, AEP Texas established a special website specifically for the oil and gas industry to assist with their development needs in that state. We are closely monitoring the risks associated with increased reliance on shale gas, such as concerns related to the possible impacts of fracking on ground water. Production from fracking could be far more limited if it becomes subject to more environmental regulations. As supply decreases or slows, either from regulations or market forces, prices will rise. Reported seismic activity from disposal of fracking fluids poses additional potential for risks. Ohio’s Department of Natural Resources has said it believes that the high-pressure injection of gas drilling wastewater into the ground was responsible for a series of earthquakes in the state and recently imposed new regulations as a result. We support development of shale gas resources as long as it is done in an environmentally responsible manner. Without a doubt, shale gas is changing the industry. It is contributing to low natural gas prices, but because no one can guarantee low natural gas prices for the foreseeable future, and there are many external factors that could cause the same price swings we have seen with natural gas in the past, it is not in the best interest of our nation to become overly dependent on it or any single fuel for our electricity generation. Harmonizing The Gas & Electric Industries The natural gas and electric utility industries have worked together for years to help grow the economy. Utilities are the backbone of our economic growth and prosperity. The electricity sector continues to become more reliant on natural gas. In April 2012, natural gas accounted for the same percentage of total U.S. electricity generation as coal for the first time since the Energy Information Administration began collecting data in 1973. Along with the growing interdependency of the electric and natural gas sectors, concerns have increased about potentially disruptive incompatibilities between the two. These concerns must be addressed to maintain and increase the reliability and cost-effectiveness of natural gas and electricity supplies. Chief among the concerns is the lack of synchronization between the two industries. For example, the natural gas day for securing supplies starts at 9 a.m. Central time, one day and runs Page 31 of 115


  • Page 32

    to 8:59 a.m., Central time, the following day. Conversely, the power market operates on a real- time, calendar-day basis, based on the applicable time zone. The concern is that most gas supplies are not guaranteed before the electricity day markets have cleared, creating uncertainty in supply reliability, cost and availability. In an effort to better understand the interdependency of the electric and natural gas industries, the Federal Energy Regulatory Commission (FERC) asked both industries in 2012 to provide information, particularly regarding the role the agency should play in coordinating the two markets. In response, the North American Energy Standards Board created a committee to identify and assess potential gas-electric harmonization issues and to make recommendations on standards development. FERC held a series of five technical conferences around the country in late summer 2012, and AEP participated in two of them. We also participated in a technical conference in February 2013. Although our risk is minimal now, we will remain engaged in the dialogue. In February 2013, FERC approved an interim information-sharing policy that allows the New England grid operator to share operational data from gas-fired power plants with pipeline operators to avoid gas shortages on cold days, when both electricity and heating demand is high. If effective, this may become a model for the rest of the nation as more power generators increase their use of cleaner-burning natural gas. Nuclear & Hydroelectric Power Nuclear power and hydroelectric power will continue to be important resources in our energy portfolio. AEP’s 2,100-MW Donald C. Cook Nuclear Plant in Bridgman, Mich., provides low- cost, emission-free electricity to Indiana Michigan Power Company’s (I&M) customers and is an important component of I&M’s generation resources. The two units at the Cook Plant produce enough energy to power approximately 1.5 million homes and account for 40 percent of I&M’s power generation portfolio. The Cook Plant received license extensions from the Nuclear Regulatory Commission in 2005 that will allow the units to run until 2034 and 2037, respectively – an additional 20 years beyond their original operating licenses. In February 2013, I&M received approval from the Michigan Public Service Commission (MPSC) for its Life Cycle Management (LCM) Project at the Cook Plant. This project will allow the plant to continue operating effectively during its 20-year operating license extension. Page 32 of 115


  • Page 33

    The MPSC granted I&M’s request for a certificate of necessity at the Cook Plant with respect to the LCM Project and the ability to recover associated costs. A similar request is under consideration in Indiana. AEP operates 17 hydroelectric and pumped storage projects in five states. AEP operates 17 hydroelectric and pumped storage projects in five states. These projects, which help reduce our carbon dioxide emissions, produce approximately 800,000 MWh of generation annually. Renewable energy provides another important form of diversification, and a number of state standards calling for it and providing incentives are driving part of the market. Learn more about AEP’s renewable energy portfolio. Energy efficiency and demand response programs round out what is needed for a balanced resource mix for the future. Efficient Use of Energy AEP is proud of the efficiency gains we’ve been able to accomplish over the last several years across our service territory, and we have always encouraged our customers to use energy wisely and efficiently. Today, we see achievable levels of energy efficiency and demand response as important resources that should be incorporated into our integrated resource planning process. Energy efficiency and demand reduction programs have received regulatory support in most of the states we serve, and appropriate cost recovery will be essential for us to continue to expand these consumer offerings. Appropriate recovery of program costs, lost revenues and an opportunity to earn a reasonable return ensures that energy efficiency programs are considered equally with supply side investments, such as power plants. In the future, AEP needs certainty and consistency around cost recovery for energy efficiency mandates from our state commissions. We need to be treated fairly and uniformly and have the opportunity to earn a return on our investments and recover our costs to comply with those mandates. Page 33 of 115


  • Page 34

    “The successful utilities of the future will figure out how to truly make energy efficiency a key element of their business model.” - AEP Stakeholder In 2008, AEP established a goal to reduce demand by 1,000 megawatts (MW) and energy consumption by 2,250,000 megawatt-hours (MWh) by the end of 2012 through energy efficiency and demand response programs. Since that time, AEP’s operating companies have implemented a wide variety of new consumer programs across most of the states we serve. In fact, more than 100 energy efficiency and demand response programs are now in place. This allowed us to achieve our objective of ramping up energy efficiency programs where they are supported. Preliminary estimates indicate that we exceeded our goal. From 2008 through 2012, AEP achieved 3,016,400 MWh of energy reduction and 1,011 MW of demand reduction, or 134% and 101% of goal, respectively. For the same period, AEP’s operating companies have invested more than $368 million in energy efficiency and demand response initiatives. Final results are subject to independent third-party evaluation and verification of savings, as required. However, with increasing efficiency standards, such as enhanced building codes and appliance standards, we are concerned that energy efficiency mandates will become more difficult to achieve in the future. Regulators in some of our states are rethinking their mandates in part due to cost and achievability. Our concern is that financial penalties could be imposed if we do not achieve escalating benchmark requirements, even if a good-faith effort was made. Further, certain mandated requirements may be virtually unachievable from an economic perspective. In other words, the cost to attain the participation requirements could be much higher than the overall benefits associated with the corresponding impacts. In such instances, AEP would be opposed to implementing any programs that are not cost-effective, and AEP should not be penalized for not achieving energy efficiency targets. Page 34 of 115


  • Page 35

    We have also made significant investments to enhance the efficiency of many of our coal-fired plants, thereby offsetting the energy needed to run emission control technologies. And we have taken measures to reduce energy consumption in our office buildings and service centers. We reduced our kilowatt-hour (kWh) usage by 23.8 percent by the end of 2012, compared with the 2007 baseline. The equivalent accumulated savings from reduced energy consumption at more than 400 facilities exceeds $12 million. We achieved these energy consumption reductions through equipment investments, such as new heating and cooling equipment, and an employee education campaign. By reducing usage, we are able to sell the unused energy in the wholesale energy market, or not produce it at all, as well as reduce our impacts to the environment. In addition to energy savings in our buildings and power plants, AEP Transmission installed new low-loss transformers at two of its stations in 2012. These new transformers provide more than a 30 percent reduction in total energy losses compared with the transformers installed in previous years. The higher efficiency transformers have lower energy losses from the equipment and will provide significant cost savings over time. Regulatory & Customer Rate Management There are many factors that can affect the price and reliability of energy throughout the country. AEP has advocated for years that we need a national energy policy to serve as a road map for how our country will generate and deliver electricity in a reliable, cost-effective manner over the long term. The key is whether our elected leaders can overcome the political gridlock in Washington, D.C., and develop a federal energy policy that supports business and job growth. There are some important aspects of an energy strategy that need to be addressed:  Preventing overdependence on one fuel/maintaining fuel diversity  Aligning the natural gas and electricity markets to address issues such as pipeline capacity and location, pricing and scheduling protocols, which need to be coordinated to address reliability concerns  Infrastructure investment and transmission development  Rational energy and environmental regulations Because Congress has not been able to achieve a broad solution to environmental and energy policy, the U.S. Environmental Protection Agency (EPA) may be more aggressive over the next four years in initiating new rules that will impact this industry over the long term, enacting Page 35 of 115


  • Page 36

    energy policy through regulations. Our industry will make a huge investment through the end of the decade just to comply with new EPA regulations affecting power plants. For AEP alone, we estimate the cost to be $4 billion to $5 billion between now and 2020 to make the remaining coal units comply with current and anticipated EPA regulations. The regulations coming from the EPA need to be as reasonable as possible in the implementation timelines to minimize detrimental economic impacts to the states in which we operate and to minimize negative reliability impacts on the grid across the nation. In addition to environmental compliance costs, the electric utility industry will need to invest approximately $2 trillion over the next two decades to refurbish and replace existing infrastructure and to build new facilities to meet the nation’s future energy needs. With investments this large, it is easy to see why we need a national energy policy to allow our industry to plan with more certainty over the long term. Regulatory Environment The electric utility industry regulatory environment is vastly different from five years ago. A combination of slow economic growth, the low cost of natural gas, more stringent and expensive environmental regulations and other factors have forced us to be more agile and adaptable to ensure our long-term health. We have made significant strides to reduce the time between investment and cost recovery from customers (known in the industry as regulatory lag). We have done this by collaborating with regulators and other stakeholders to develop rate frameworks that balance AEP’s need to recover its costs to maintain and operate its system with our customers’ ability to pay for it. Current Regulatory Activity Operating Company Model We have a responsibility to deliver safe, reliable, quality electricity to our customers. In doing so, we strive for operational excellence and seek to deliver the best customer service we can. To support this compact, we are dependent upon a regulatory framework that determines the rates we can charge our customers to operate and maintain our system and the returns we can earn on our investments – unlike most private sector companies. Our shareholders lose value and the company’s earnings suffer if we make investments and are not allowed to recover our costs or are unable to earn a reasonable rate of return. At the same Page 36 of 115


  • Page 37

    time, customers are sensitive to rate increases. To address this issue, we decentralized our business operations model, putting more responsibility and accountability in the hands of our operating company presidents. As a result, operating company presidents have more autonomy along with greater responsibility for their companies’ balance sheets, credit ratings, liquidity, earnings, capital allocation, rate base growth, regulatory relationships and overall performance. They work collaboratively with all other business units and with each other to meet the needs of their customers. This local approach also strengthens their relationships with their communities and provides a better understanding of what local regulators will support. This improved line of sight has helped us to develop several rate frameworks that have enhanced our ability to recover costs. We also have improved many of our regulatory relationships, which are important as we embark on significant capital investment programs to comply with environmental regulations, invest in our transmission infrastructure and maintain the operational integrity and reliability of the entire system. In spite of this localized control, our operating companies are challenged by the availability and competition for finite capital resources, the demands of operating and maintaining an aging grid, more environmental and reliability regulations, growing retail competition in some states, a sluggish economy, and little growth in electricity demand. They must address these competing needs while balancing customers’ ability to pay for the increasing costs of maintaining a reliable electric system. Page 37 of 115


  • Page 38

    The Cost of Electricity Many factors can affect the price and reliability of electricity. The cost of energy is important to customers and to the economic conditions of our service territory. High electricity rates have particularly affected economic growth in the eastern part of our service territory due to the large concentrations of energy-dependent heavy industry. In energy-intensive industries, such as primary metals, paper and chemical manufacturing, where electricity is a major cost of production, companies need to be able to plan and budget with some certainty if they are to continue operations. Rapidly increasing rates can result in a downward spiral for our regions if manufacturers are no longer able to compete and are forced to move elsewhere. Our service territory consists of many states in which mean household incomes are already below the national average. There are very real social and economic concerns to consider as the cost of electricity goes up. To foster more timely recovery of expenses and greater regulatory certainty, AEP supports the use of alternative ratemaking models. The traditional rate case process cannot accommodate the scale and speed required for timely recovery of necessary utility investments, which puts upward price pressures on our customers. More timely recovery reduces regulatory lag, which allows for more uniform rate increases. Certain state regulators have ordered some costs, such as fuel, to be deferred and collected in the future. But the bill eventually comes due and customers must pay for the costs of regulation, fuel used to generate their electricity in previous years, or investments that are needed to maintain reliability. Securitization is a process in which certain regulatory assets, such as deferred fuel costs, are converted into cash through a sale of securities. Although we believe fuel should be recovered as those costs are incurred, securitization can mitigate the adverse impact of a large recoverable cost by spreading the cost to customers over several years at a lower interest rate. For example, in Texas, AEP has used securitization to recover state-mandated restructuring and stranded costs - costs associated with assets that are no longer in rates. Securitization legislation has been passed in other AEP jurisdictions where customers may experience similar upward price pressures. Page 38 of 115


  • Page 39

    Market Shifts In Ohio More than a decade after Ohio’s governor signed a bill into law deregulating the state’s electricity market, the legal and regulatory web of actions implementing deregulation is still being woven. The long and complicated shift toward a competitive market for power generation in AEP Ohio’s service territory moved forward in 2012 but still has several milestones to clear before it is completed. What happens in Ohio is extremely important to all of AEP. AEP Ohio accounts for almost 30 percent of the corporation’s customers and owned generation and 29 percent of AEP’s retail revenues. In 1999, Ohio’s state legislature passed Senate Bill 3, deregulating the state’s electricity market. For the first eight years the bill was in effect, few customers in AEP Ohio’s service territory shopped because AEP’s regulated rates were lower than market prices. In 2008, Senate Bill 221 was passed, continuing the long and complicated journey to competition for AEP Ohio. The company filed its first Electric Security Plan (ESP) in 2008 and it was working well until the recession, when customer demand for electricity dropped sharply. At the same time, natural gas prices started to fall, due in large part to shale gas development. AEP filed a second ESP in 2011 and received approval in August 2012. While some issues have not been finally resolved, AEP Ohio’s service territory is well along the path to a competitive generation market. This means AEP Ohio must separate its generation business from its transmission and distribution businesses, and it expects to complete this process by Jan. 1, 2014. AEP Ohio-owned power plants will be moved to the new AEP Generation Resources Inc., pending FERC approval. Some of the generation will be transferred to other operating companies that need the capacity and the energy to serve their customers, pending FERC and state regulatory approvals. The process also includes the termination of a regional generation pool agreement among AEP’s eastern operating companies. The companies historically “pooled” their resources and dispatched the most efficient units to meet the combined demand of the companies. This decades-old pool agreement has become less effective due to changes in the electricity markets. After corporate separation, AEP Ohio will be a fully regulated transmission and distribution company and will no longer own generation assets. As AEP Ohio moves its generation assets to a competitive electricity environment, the company will transition toward establishing its generation rates through competitive auctions for customers who have not switched providers. Once the transition is complete, competitive electricity suppliers will bid to provide the electricity supply needed by AEP Ohio’s remaining customers. Customers will continue to have a choice of competitive generation providers. Page 39 of 115


  • Page 40

    Retail Competition Competition for retail electricity customers among various service providers continued to accelerate in Ohio in 2012. The ability to switch suppliers of electricity has been in place in Ohio since Jan. 1, 2001, following approval of restructuring legislation approved by the Ohio General Assembly in 1999. While competition began appearing in some of the higher-priced markets in Ohio shortly thereafter, AEP’s low rates made it difficult for competitors to gain a foothold through much of the first decade of the 21st century. “Market competitiveness is a measure of understanding the market, selling cost-effective solutions that yield the best possible product for the consumer and achieving profitability levels that ensure continued development and growth.” - AEP Stakeholder A stagnant economy and low power prices, coupled with the PUCO proactively choosing the competitive market model over a cost-based model, opened the door for competition within the state of Ohio. At the end of 2012, customer switching in Ohio had resulted in the generation-related gross margin loss of approximately $235 million. That equated to an annual average of approximately 51 percent of AEP Ohio’s retail customer load being served by an alternative supplier over the course of 2012. Our competitive energy business, AEP Energy, is a retail electricity supplier to residential, commercial and industrial customers. AEP Energy, which acquired BlueStar Energy, provides a wide array of energy solutions, including retail electric supply and energy management solutions. The company provides electricity supply in Delaware, Illinois, Maryland, New Jersey, Pennsylvania, Ohio and Washington, D.C., and energy management solutions nationwide. AEP Energy is one of the fastest-growing business units within AEP. At the end of 2012, AEP Energy had more than 160,000 customers compared with 40,000 at the end of 2011. A challenge for AEP Energy, in a very competitive marketplace with low energy prices, is to profitably grow at a pace that delivers superior financial returns for the associated risk. To achieve this, the company is focused on providing customized products, excellent customer service and timely and accurate billing, and developing robust systems to manage significant growth. Page 40 of 115


  • Page 41

    Ethics and Compliance As an organization, we are guided by our Principles of Business Conduct, which require us to operate with integrity, fairness, respect, and care. Any employee who raises concerns about ethics, safety or compliance issues needs to be able to do so without fear of retribution. This freedom is part and parcel of fostering a risk-aware culture. We have made significant progress toward this goal during the past few years, providing employees with a variety of safe ways to communicate information and concerns. However, we recognize that we have more work to do. This is especially true following our recent organizational review. As our company changes, if employees are unwilling to report an ethics or compliance violation for fear of retaliation, our corporate culture, the financial health of the company and our reputation are put at risk. Consequently, we are redoubling our efforts to communicate with and engage employees so that they feel free to communicate concerns. Part of this effort will be incorporated into our strategy to develop a stronger, healthier culture. Lobbying and Political Activity We actively participate in the political process to advance our long-term business interests and the interests of our customers, employees, shareholders and other stakeholders. We also lobby and work for what we believe is in the best interests of our communities and the nation. We maintain five political action committees (PACs) – one for federal candidates and separate state PACs in Michigan, Ohio, Texas and Virginia. Approximately 30 percent of the employees eligible to participate in one of our PACs do so. AEP’s federal PAC, the AEP Committee for Responsible Government, contributed more than $740,000 to candidates for public office in 2012 and received about $652,000 from employees. The difference was made up by surplus funds from previous years. Pursuant to federal and state laws, AEP is permitted to pay expenses of operating its PACs. We also have a process whereby political contributions are reviewed annually by AEP’s board of directors. In 2012, we spent about $7.5 million on internal and external lobbying activities at the state and federal level. This includes dues to trade or national associations for which a portion is used for lobbying. We maintain an office in Washington, D.C., to address issues involving federal legislation and regulation. Each of our operating companies has lobbyists who work in their respective state capitals. Page 41 of 115


  • Page 42

    We belong to or participate in several state, local and national organizations, including the Edison Electric Institute, the Business Roundtable and the National Association of Manufacturers (NAM). We do so for a variety of reasons, including staying current on issues, learning best business practices from our peers, and strengthening our relationships with our customers, many of whom are also members. We disclose our political contributions as well as the portion of membership dues to various organizations that is used for lobbying purposes on an annual basis. For more information see our lobbying policy and our disclosure for 2012. We believe that, as a general rule, it is more beneficial to AEP to remain involved, even if we occasionally disagree, than to withdraw. We believe that we can be far more effective in shaping the policies of the organizations from within, rather than sitting on the sideline. From time to time, many, if not most, of the organizations to which we belong reach conclusions or take positions with which we disagree. If we feel strongly enough, we voice our disagreement and work to change the organization’s position. Sometimes our views prevail, sometimes they do not. Many times we are able to reach some sort of compromise. We are firm believers in transparency and participating actively in public debate. That belief is based on our deeply held cultural value of collaboration, which we practice both internally and externally. We believe that open, candid discussion and a good-faith attempt to reach common ground is the best way to do business. Page 42 of 115


  • Page 43

    Business Performance Our Performance Our success is the sum of our financial and non-financial performance. Both are integral to our ability to achieve sustainable growth, keep our environmental and social commitments, and deliver safe, reliable and cost-effective electricity to our customers while delivering fair returns to our shareholders. Zero Harm is Achievable Safety is a top sustainability priority at AEP. Our goal is to achieve zero harm -- zero injuries and zero fatalities. We are making progress toward this goal every year and while 2012 was our best performance in AEP's history, we can do better. During the past 17 years, we have worked 5 years without work-related employee fatalities. In 2012, there were no employee or contractor fatalities. We measure our success based on financial performance, the reliability of our system, our environmental performance and compliance, our ability to manage spending and receive regulatory support for the investments we make in the grid and the safety of our employees, contractors and the public. Financial Performance At AEP, we believe sustainability underlies our business strategy and is a key business opportunity. Incorporating sustainability throughout our business enhances our ability to deliver profits to shareholders, meet our obligations to lenders and fulfill our environmental and social commitments. Improving our environmental and social performance, in turn, contributes to our financial well-being. Our successful execution of financial and operational goals during 2012 was rewarded in the marketplace. AEP shareholders received an 8.22 percent total return, including dividends, which was well above the total shareholder return of negative 0.55 percent for the S&P 500 Electric Page 43 of 115


  • Page 44

    Utilities Index. AEP’s historical stock-price discount to our peer companies has effectively been eliminated, primarily due to the clarity and risk reduction we have provided our shareholders. In 2012, we seized the opportunity afforded by low-priced debt capital to redeem all of our long-term, parent- company debt, replacing it with new long-term debt at more attractive rates that will save a projected $30 million a year in both 2013 and 2014. In February 2013, AEP further strengthened its liquidity capacity by closing on a new $1 billion, 27-month term loan agreement that matures May 13, 2015. We are using this to fund maturities of senior notes at Ohio Power through the corporate separation transition period. We reduced our post-employment benefit liability by $570 million, or 25 percent, through adjustments to our retiree medical benefits. This retirement medical plan was 91 percent funded at year-end. We made a $200 million discretionary contribution to our qualified pension plan during 2012, which was 92 percent funded at the end of the year. Over the past three years, we have contributed $1.15 billion to our qualified pension fund. AEP ended 2012 with a strong financial profile and is well positioned to achieve its goal of attaining 4 percent to 6 percent operating earnings growth (from a 2013 earnings base), supported by our regulated operations. These operations also will continue to support the dividend. Including dividends, we forecast a total return opportunity for shareholders of 8 percent to 10 percent. Execution Remains The Theme In 2013 Investors have more clarity about what to expect from AEP than they did a year ago, but there is still a lot of work to do. While issues around Ohio’s move toward a competitive generation business and the corporate separation of generation assets in Ohio are closer to resolution, we need to finalize the regulatory approvals for these transactions and complete the separation. We also have significant rate activity in our SWEPCo subsidiary in order to get the Turk Plant into rates. We have been successful in doing so in Louisiana and we need to continue to seek similar regulatory support in Texas and perhaps Arkansas as well. The financial promise of our Page 44 of 115


  • Page 45

    Transmission business and evolving competitive business are reasons for optimism in 2013 and beyond. The repositioning study that AEP completed last year and began implementing early this year will affect how we are structured and how we operate going forward, and it will help us financially well into the future. The study allows us to streamline processes and increase efficiencies while also capturing sustainable cost savings that will help us achieve earnings growth and reallocate resources to growth areas such as transmission. A Program Management Office was formed to ensure the long-term savings and process improvements identified by the study are attained and to facilitate future savings opportunities that emerge apart from the study. Identified cost savings are allowing AEP to keep its operations and maintenance budget flat from 2012 to 2013, in spite of other increases such as new operations and employee-related costs. 2012 Results AEP’s earnings for 2012, based on Generally Accepted Accounting Principles (GAAP), totaled $1.26 billion or $2.60 per share, compared with $1.94 billion or $4.02 per share for 2011. AEP’s operating earnings for 2012, GAAP earnings excluding special items, totaled $1.497 billion or $3.09 per share, down slightly from the corresponding 2011 results of $1.504 billion or $3.12 per share. Operating earnings were higher than GAAP earnings due to the exclusion of impairment charges related to Ohio generating plants, an adjustment charge associated with the Texas cap on construction costs of the Turk Plant, a charge relating to our cost restructuring efforts and a tax provision associated with U.K. windfall taxes. We were able to mitigate unfavorable earnings impacts for 2012, such as customer switching in Ohio, through disciplined operations and maintenance spending. Other unfavorable earnings impacts in 2012 included higher depreciation and amortization expense due to projections for shorter lives of some generating units and higher amortization costs associated with regulatory assets, drought conditions that had a negative impact on AEP River Operations, higher storm restoration costs, and lower off-system sales margins stemming mainly from lower power prices. Weather-adjusted sales of electricity fell 0.8 percent in 2012 from 2011. The only customer segment to show improvement in 2012 was the commercial segment, in which sales increased 0.3 percent due to strong sales in Texas. The increase in commercial load was the first for that segment since the start of the recession in 2008. Our liquidity, or access to cash, has increased and our balance sheet remains strong. At year-end 2012, we had $3.25 billion in credit facility commitments to support our operations. In February 2013, we refinanced at a lower cost, and increased to $1.75 billion and extended by one year the previous $1.5 billion core credit facility due to expire in June 2015. We also refinanced and Page 45 of 115


  • Page 46

    extended by one year the previous $1.75 billion core credit facility due to expire in July 2016. We ended 2012 with a debt-to-total-capitalization ratio of 55.2 percent, which is within our target range of the mid-50s. Because AEP’s corporate credit ratings are investment grade, BBB from Standard & Poor’s (S&P) and Fitch Ratings, and Baa2 from Moody’s Investors Service, we expect to continue to access the debt capital markets at a reasonable cost. Maintaining these ratings requires close attention to spending decisions and a constructive regulatory outlook in the states we serve. In September 2012, S&P completed a review of AEP’s credit and declared our business risk profile to be excellent. However, in February 2013, Fitch Ratings put AEP on negative outlook, down from stable outlook. The agency indicated in its opinion that the negative outlook reflects uncertainty around increased financial and business risks with the restructuring of AEP Ohio. Page 46 of 115


  • Page 47

    Looking To 2013 and Beyond Our projected operating earnings range is $3.05 to $3.25 per share for 2013 and $3.15 to $3.45 per share for 2014. We expect that success in the regulatory arena, continued cost control and increased earnings contributions from Transmission operations will help offset the continued effects of customer switching in Ohio and other increased expenses. Electricity sales are expected to grow 0.5 percent in 2013, driven by projected industrial growth of 1.8 percent. In Ohio, West Virginia, Oklahoma and Texas, we anticipate increases related to shale gas development and oil and gas production. Residential load is forecasted to fall 0.4 percent from 2012 levels with commercial load expected to decline 0.1 percent. Growing the dividend for our shareholders remains a priority. In fact, our Board of Directors is targeting a dividend payout ratio (annual dividend divided by operating earnings per share) of 60 percent to 70 percent of earnings, an increase from the previous 50 percent to 60 percent target. The dividend is supported by our regulated operations. AEP has paid a dividend for 411 consecutive quarters, a feat only a handful of companies can claim. Coupled with the increase in the payout ratio, this further indicates the Board of Directors’ commitment to our regulated business model and to rewarding AEP’s shareholders. Our capital plan calls for investments of $3.6 billion in 2013 and an estimated $3.8 billion in both 2014 and 2015, supported by cash flows from operations and financing activities. Equity financing beyond the existing Dividend Reinvestment Plan and employee purchases of company stock through 401(k) plans is not anticipated. Capital allocation is a subject AEP’s management takes very seriously. The executive management team works year-round with our operating company presidents and business unit leaders to focus on getting capital to work where customers want it, where regulators support it and where we have attractive returns and reduced lag in cost recovery. Based on the above criteria, we are moving capital dollars into transmission, nuclear and the regulated environmental component of generation, and this capital investment underpins our earnings growth forecast. Page 47 of 115


  • Page 48

    Page 48 of 115


  • Page 49

    AEP was named to the Target Rock Advisors 2013 Sustainable Utility Leaders Index (SULI), which is a stock index for guiding sustainable and socially responsible investment decisions. The Index also recognizes the work of utilities that have excelled at socially responsible corporate citizenship. AEP was one of 24 utilities named to the SULI. Page 49 of 115


  • Page 50

    Energy Reliability and Security The U.S. electric grid is a sophisticated, interconnected network of components that work in unison to provide a reliable power supply. When one part of the system isn’t functioning optimally, a loss of power can occur. When that happens, no matter the reason, customers expect their service to be restored quickly. If it isn’t, the result may have political, regulatory, economic and social ramifications for our customers and communities that can hurt AEP far more than the damage to the electrical system itself. Reliability refers to our ability to provide energy upon demand. We must prevent outages to the extent we can and restore power as safely and efficiently as we can when it does go out. Security refers to our capacity to protect the supply of energy, under any circumstance, from external and internal interruptions. Our ability to secure energy and deliver power reliably hinges on a variety of regulatory, economic, environmental and social factors. Operating and maintaining the grid is more complex than ever. We face many challenges affecting our ability to maintain the existing system while also upgrading that system to meet future demands. Among these challenges are the aging of the current system, the threat of external interruption, the need for greater capacity, the difficulty of siting new facilities, new and pending environmental regulations, and covering the cost of needed investments. System Reliability Parts of AEP’s service territory sustained historic damage in 2012 due to severe weather. The two most significant weather events were the June 29 derecho and “Super Storm Sandy” in late Page 50 of 115

  • View More

Get the full picture and Receive alerts on lawsuits, news articles, publications and more!