Leadership & Strategy

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.

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.

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.

Employees

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 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.

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 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.

Turk Plant

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 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.

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.

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

AEP Total Shareholder Return
AEP Earnings Per Share History - GAAP
AEP Operating Earnings Per Share History
AEP Dividend History

The New Turk Power Plant

The 600-MW John W. Turk, Jr., Power Plant in southwestern Arkansas is among the nation’s cleanest, most efficient pulverized coal plants.

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