Energy Policy Lacking
We are in desperate need of a comprehensive federal energy policy that addresses environmental concerns and energy security and establishes a long-term energy strategy for the nation. Only a coordinated national plan can ensure our energy security and reliability. Without it, energy-related decisions will, out of necessity, be more tactical than strategic.

If the U.S. Environmental Protection Agency’s proposed rule to control mercury and other emissions is a harbinger of the agency’s plans for several other regulations, our transformation may be accelerated, but with serious financial consequences. It most certainly will increase our costs too comply as well as what our customers pay for electricity.

Let me be clear: We support the Clean Air Act. But the EPA's process and timelines are not realistic, and that is what we take issue with. We support rational environmental regulation that provides significant public health and environmental benefits. But compliance requirements must be affordable and at an achievable pace. Already, we know that compliance with the proposed new hazardous air pollutants rule on the prescribed timeline will be extremely difficult and will prompt premature retirements of some coal units across the country.

The price tag could be staggering; we won’t know the final cost until all of the regulations are finalized, but we estimate the cost of compliance under the EPA’s timeline could be more than double what we have spent so far for environmental controls. Our concern is the failure to consider all of the regulations in total, rather than one-by-one. This impedes our ability to determine which coal units have to be closed and which ones will remain in service. This uncertainty complicates our resource planning. We are deeply concerned that the EPA’s process does not consider the loss of local jobs and community tax revenues and the impact of higher electric rates, especially on low-income customers and electric-intensive industries.

We hope the EPA will listen to our feedback. A few changes to the combined rules would bring tremendous value, allowing us to achieve compliance without harming local and national economies.

Global warming continues to be a concern and one that must be addressed internationally. Our position on this issue has not changed. No single country or company can solve it. It is our fundamental belief that the best way to address this issue is through international collaboration. That’s why in 2011 we signed agreements with two of China’s largest energy companies to support knowledge and technology exchanges related to carbon capture and grid developments enhancement. We also believe that, here in the U.S., the best way to address climate change is through legislation.

The lack of a strategic energy policy also hampers the development and deployment of new and expensive technologies that we need to address climate change. Without a legislative mandate, regulators are telling us loud and clear that they are not willing to pay for them. AEP took the global lead and the financial risk to advance carbon capture and storage (CCS) because this technology is critical if we are serious about reducing carbon dioxide emissions. But regulators in Virginia rejected our request to recover costs associated with the project. We learned a lot from our 20-megawatt (MW) CCS validation project at the Mountaineer Plant in West Virginia, enhancing our knowledge of the process and technology. But substantial financial challenges remain.

Through a joint funding effort with the U.S. Department of Energy’s Clean Coal Power Initiative Round 3, we have begun geologic, engineering and design work for a commercial-scale 235-MW project that could be operational by 2015. We also recently received $4 million from the Global Carbon Capture & Storage Institute in Australia to support engineering work. It is essential that this technology to be brought to maturity and demonstrated on a commercial scale if we want to maintain coal as an option in a carbon-constrained world.  When there is a federal requirement and/or adequate funding to support CCS, AEP is up to the challenge. But without these assurances, the future of our project is very unclear.

We need other options for coal, too. That’s why the John W. Turk, Jr., ultra-supercritical coal plant under construction in southwest Arkansas is important. Once complete, this will be one of the most efficient coal plants in the United States. It is also the first application of this technology in this country.

Balancing All Stakeholder Needs
We are engaged in candid, ongoing discussions about our concerns with regulators, legislators and many other stakeholders. These are difficult and complicated issues, and there are no easy solutions. If we work together, we think the outcome can be positive for stakeholders, customers, the environment and society. We believe sensible regulation and policy can be crafted that balances the costs and benefits. If done right, it would create jobs and economic opportunity, achieve the long-term environmental goals, and spread the costs over time to avoid unnecessary financial hardship for customers. We will continue to connect with our stakeholders and seek their input as we move forward.

We are preparing to undergo a transformation that will significantly change our business. Our responsibility is to manage and reduce our environmental impacts as we deliver reliable electricity to customers. We will increase our earnings potential as we invest in our existing distribution and generation infrastructure and expand the transmission grid inside and outside of our service territory. We will do it by developing our work force to build, operate and maintain new technologies essential to our success. We also are committed to engaging our stakeholders in honest and open dialogue about our plans while doing a better job of informing our customers about the cost and value of electricity.

Our business transformation touches every one of our operating companies, customers, shareholders, employees, communities, legislators and regulators. To be successful, we must continue to deliver strong earnings this decade and beyond; we cannot meet our commitments unless we have the resources to do so.

Operations and maintenance (O&M) expenditures for the entire system, on a GAAP (generally accepted accounting principles) basis, increased $449 million in 2010. The increase primarily related to $293 million (pretax) of severance costs due to our cost reduction initiatives and $114 million (pretax) of expenses associated with dollar-for-dollar rate recovery. Our capital investments of $2.2 billion were down from almost $2.5 billion in 2009 as we responded to regulator and customer concerns about rate increases.

Our 2010 earnings of $3.03 per share on an ongoing basis were at the upper end of our projected range and exceeded 2009 ongoing earnings per share of $2.97. Our total shareholder return was nearly 9 percent for 2010, providing investors in AEP with a steady, solid, competitive return in today’s marketplace.

I am delighted that, twice last year, our board of directors voted to increase the quarterly dividend to shareholders. The total quarterly dividend increase of 12 percent helped to keep our total shareholder return competitive and allowed us to reward our shareholders until our earnings growth can accelerate from increased capital investment and sales growth. It was a thrill to ring the closing bell at the New York Stock Exchange in June 2010 in celebration of AEP’s 400th consecutive quarterly dividend payment, a rare occurrence indeed. On March 10, 2011, we paid our 403rd consecutive quarterly dividend to our shareholders.

Operational Performance
Operating more efficiently and adapting to the changing economic and regulatory environment requires our work force to change, too. We reduced our work force by more than 2,400 employees in 2010 in a realignment of our cost structure with a slow but steady economic recovery. Most of those who left did so voluntarily.

I am pleased to report that, despite this restructuring and associated distractions, our overall safety performance was excellent. AEP employees share a deep commitment to safety and health and strive to live up to that commitment every day. I am profoundly grateful to our employees and our leadership for their dedication to safety and health. No employee lost his or her life while working for AEP in 2010, fewer employees were harmed on the job and the severity of injuries was at a near-record low. Our board of directors passed a resolution commending employees for performing at a level that was among the best in our company’s history.

We have made significant progress, but we can and will do better to improve our safety and health record. Three employees lost their lives on the job during the past five years. We will not tolerate any compromise of safety standards, and we will continue to work hard to achieve and maintain zero harm.

Our environmental performance is excellent: we are a top performer in our industry by almost every measure. We are proud of the fact that this performance is outstanding for a utility of our size and scope. However, we fell short of our goal of zero environmental. In 2010, we had three violations and paid minimal finesof less than $10,000.  As we learn from these events and take steps to prevent recurrences, our goal continues to be zero violations.

Our distribution system reliability improved in 2010. The average length of time that customers were without power and the frequency of interruptions improved significantly, helping us to achieve our best performance in five years. Our gridSMART® initiative, under way in four states, will transform our relationship with our customers from one in which the customer uses power and gets a bill to one in which we work together to save electricity, lower energy demand and consumption, and reduce customer costs. Our transmission strategy to expand inside and outside of our service territory also moved forward. Among our successes were the establishment of transmission companies in Ohio, Michigan and Oklahoma. Applications are pending in West Virginia, Kentucky and Indiana.

Preparing for the future
We all have a role in ensuring the quality of our energy future. We believe that our customers will want to use energy more efficiently, and in most of our service territories, programs and technology are helping them to accomplish this goal. Moving forward, we want to operate our system more efficiently; diversify our fuel generation; develop a more robust grid to enable the utilization of cleaner, more efficient and economic energy; and prepare for the electrification of the transportation sector.

We have many initiatives under way that position us to achieve these goals. We will also work to prepare our regulators, employees, customers and communities for the full impact of coal unit closings, new environmental mandates and the true cost of clean energy. We are ready to listen to ideas they may have for solutions to these complex problems. We will continue to communicate these issues with our stakeholders and collaborate with them to find common ground and pursue common sense solutions.

We are saddened by the terrible loss of life and destruction associated with the earthquake and tsunami that hit Japan in March 2011. We are also concerned with the events at the Fukushima Daiichi Nuclear Station in northeastern Japan. Although all the lessons learned are not yet known, AEP remains committed to learn from these events and to operate our Cook Nuclear Plant to one standard – “Excellence.” We believe that it would be unfortunate and inappropriate to discount nuclear energy as a viable and critical global energy resource for the future.

Finally, a few personal notes. I have tried to prepare for the future since my first day here in 2004. We created an extensive succession planning initiative to broaden the knowledge and skills of our executives and to ensure that the most qualified candidate takes the helm when I step down as CEO. I am very proud that this process resulted in the board having external candidates and four strong internal candidates from which to choose. The board named Nick Akins as president of AEP, and he will work closely with me this year as I continue in the roles of chairman and CEO. If the succession plan continues according to schedule, Nick will also become CEO later this year.  

Two long-time board members will retire this year, bringing yet more change to our leadership team. We are most grateful for the dedicated service of Donald M. Carlton and E.R. “Dick” Brooks, both of whom have served since 2000. Prior to the 2000 merger of AEP and Central and South West Corp. (CSW), Dick was CEO of CSW for nearly 10 years. Both board members have been passionate advocates for employee safety, our nuclear program and our company’s tradition of excellence in governance.

We are in a time of great transformation. Our vision for cleaner, more affordable and more reliable electricity is central to America’s economic recovery and growth. As a nation, we must embrace energy as a powerful engine for our country’s economic growth; as a company, we must strive continually to balance the needs of our customers and shareholders with measurable benefits to the environment and society. The men and women of AEP are making bold changes that will lead us toward a more secure energy future; I invite you to join us in leading this exciting transformation.

Michael G. Morris
Executive Chairman
April 2011