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Letter from the Chairman

Dear Stakeholders:

In tough economic times, when every aspect of our business is under scrutiny, some might ask whether we can afford to focus on sustainability. To that I respond: Can we afford not to?

Sustainability – operating our business in a way that is good for people, the planet and profits – is, in my opinion, no longer optional. It is the strategic and decision-making approach we are following at Duke Energy to create long-term value.

Clearly, the current economic crisis colors every aspect of our business. We see several parallels from these economic problems that inform our approach to sustainability, including:

  • The importance of living within our resources – whether financial or environmental;
  • The need to address complex issues and opportunities simultaneously – not sequentially;
  • The value of balanced decisions that consider economic, social and environmental consequences; and
  • The imperative of financial strength to remain a viable, vital corporation.

At Duke Energy, sustainability describes the way we work; it is a competency that leads to improved risk management, efficiency and innovation for today’s complex, resource-constrained and connected world.

Redefining Our Boundaries  

History tells us there are moments in time when conventional wisdom becomes unwise and “the way we’ve always done it” blinds us to new possibilities. With fundamental change happening everywhere – politically, economically, environmentally and socially – I think we are in the midst of one of those historic moments now. 

Our experience with sustainability strengthens my belief that our nation’s energy, economic and environmental challenges can and must be solved together. With energy as a cornerstone of economic recovery, we can provide solutions that do double- or triple-duty – investing in innovations and infrastructure that address not just one issue, but several. In this report, we share some examples of this approach – including the smart grid and other advanced energy technologies.

Our 2008 Summary Annual Report and 2008|2009 Sustainability Report again share a common theme: Redefining our Boundaries. The theme captures our efforts to fundamentally rethink our business, explore new technologies and help solve some of the world’s most pressing problems.

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Duke Energy’s Sustainability Plan

Seeing the world through the lens of sustainability helps redefine our boundaries. Conversations with you – our valued stakeholders – have identified the most material sustainability risks and opportunities we face. Our plan has five focus areas:

  • Provide innovative products and services for a carbon-constrained, competitive world
  • Reduce our environmental footprint
  • Attract and retain a diverse, high-quality workforce
  • Help build strong communities
  • Be profitable and demonstrate strong governance and transparency

On the following pages, we provide an update on our progress and challenges.

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Year in Review

Global climate change continues to be a defining issue for our company and our world. As one of the largest emitters of carbon dioxide (CO2) in the U.S., we take the challenge of reducing greenhouse gases very seriously.

In last year's report, Building Bridges to a Low-Carbon Future, we reviewed our actions to address climate change by:

  • Helping our customers and communities become the most energy efficient in the world;
  • Decarbonizing our fleet; and
  • Advocating fair and effective climate legislation.

We also shared our aspiration to cut our 2006 U.S. CO2 emissions in half by 2030 and the scenarios that emerged from that work. We’ve continued to refine that analysis based on stakeholder input and the signposts we see in this very volatile economy. What’s clear is that reducing CO2 won’t be cheap or easy, and progress may not be linear year-to-year. On page 24, Doug Esamann, senior vice president of strategy and planning, provides an update on the 2030 analysis.

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Improving Energy Efficiency

We view energy efficiency as the “fifth fuel” to power a low-carbon future, but it should be the “first fuel” we invest in. That’s why we consider the save-a-watt energy efficiency plan a foundation of our business and regulatory model for the 21st century.

Most utilities still operate under rules created decades ago, when our primary task was to build generating plants and distribution systems to electrify the U.S. economy. Utilities were rewarded for investing in new power plants and related equipment – a regulatory approach that worked remarkably well. Of course, the world has changed a lot since then and
so, too, must our regulatory model.

Under our proposed save-a-watt model, the bias to invest in power plants over energy efficiency is removed by allowing utilities to earn a return on their investments in energy efficiency based on their “avoided costs.” 

I am pleased to report that in December 2008, the Public Utilities Commission of Ohio was the first of our five state commissions to approve save-a-watt, helping to create a level playing field for energy efficiency and investing in new plants. Regulatory review of save-a-watt in Indiana and Kentucky is pending as I write this letter. We’ve got more work to do in the Carolinas. In early 2009, South Carolina regulators rejected our initial save-a-watt proposal but asked us to return quickly with an alternative program. North Carolina regulators approved our proposed efficiency programs but asked for additional detail on the avoided cost model. We intend to respond quickly to gain approval of save-a-watt in these states as soon as possible.

I feel a sense of urgency in implementing save-a-watt for two reasons:

  • Energy efficiency savings are “perishable.” Buildings under construction today will stand for a half a century or more and should be built to the highest efficiency standards. The same applies to existing structures: Less-efficient design and equipment results in wasted electricity and related CO2 emissions, as well as higher cost. Delays in implementing energy-saving programs like save-a-watt translate to lost opportunities to harvest efficiency improvements.
  • Our industry is facing a period of rising costs as we build more efficient power plants. Programs like save-a-watt put more control in the hands of our customers to better manage and reduce their bills.    

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Smart Grid

To fully realize the potential of energy efficiency, we are planning to invest nearly $1 billion over the next five years in smart grid technology, subject to regulatory approvals. By replacing analog switches, meters and controls with new digital, two-way devices, we bring intelligence and interactivity to electricity. In the near-term, that means our customers will have more information and control over their energy use. And, Duke Energy will have more precise, real-time data to help optimize our system.

Smart grid technology represents the most significant upgrade to our distribution system since electricity was first harnessed, and we think it will lead to capabilities and functions that are unimaginable today. By mid-2009, we will have installed more than 70,000 smart electric meters in three states and about 40,000 digital gas meters in the Midwest. While we’re excited about the pace of our smart grid deployment, the federal stimulus plan may give us opportunities to accelerate that deployment. We’re working hard to make that happen so that our customers can be among the first in the nation to use smart grid technology.

We recently opened Envision Centers in Kentucky and North Carolina to demonstrate the potential and promise of smart grid technology to our regulators, legislators and other stakeholders. We are also field-testing some of these new technologies at a subdivision in Charlotte, N.C.

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Decarbonizing our Fleet

To meet existing and anticipated renewable portfolio standards (RPS), we took aggressive actions in 2008 to build that aspect of our business.

Our utilities issued requests for proposals for renewable energy, announced several contracts, and saw some projects from earlier contracts begin generating power. For example, a 20-year contract with a new wind farm in northern Indiana began supplying up to 100 megawatts (MW) of electricity to our customers in 2008. We signed a long-term agreement to buy all of the output from a photovoltaic solar energy farm in North Carolina that will be among the largest in the country. And, we have agreed to purchase power from two projects in the Carolinas that convert landfill methane gas to electricity. We also developed an innovative plan to install photovoltaic solar panels on the rooftops and land of up to 400 Duke Energy residential and business customers in North Carolina. This proposal, currently being discussed with state utility regulators, would create a solar distributed generation network capable of supplying about 1,300 homes.

Our commercial business acquired wind-developer Catamount Energy in September 2008 and completed wind farms in Wyoming and Texas. We are also a co-owner of the Sweetwater project in Texas – one of the largest wind farms in the world. Wal-Mart agreed to purchase electricity from our Notrees wind farm in Texas to power some of its facilities in the state. At year-end 2008, we had close to 400 MW of wind power in operation and a wind development pipeline of more than 5,000 MW in 14 states. Part of the challenge with renewables is getting the power from the source to the customer. We announced a joint venture with American Electric Power in mid-2008 to build and operate a 240-mile high voltage transmission line in Indiana that will link new and existing generation with customers and help reduce transmission congestion in the Midwest.

In September 2008, we formed ADAGE, a joint venture between Duke Energy and AREVA. ADAGE will build biomass power plants in the U.S. that generate electricity from wood waste. ADAGE plans to start construction on its first biopower plant in 2010.

In last year’s report, we showed the pros and cons of different generating sources to illustrate the importance of fuel diversity. Renewable energy will play a growing part in our supply portfolio. But, because solar power and wind generation operate only when the sun shines and the wind blows – they are considered “intermittent” sources of electricity. Baseload plants fueled by coal and nuclear power are typically the lowest-cost power plants that operate around the clock. 

I have acknowledged in past reports the apparent paradox of advocating climate change legislation while building new coal plants. About 70 percent of our U.S. customers’ electricity was generated with coal in 2008, compared to approximately 50 percent nationally. We simply cannot meet our obligation to serve customers with affordable, reliable and increasingly clean electricity without coal in our fuel mix. As a bridge to new technologies and a lower-carbon future, we are investing approximately $5 billion in two such plants – Edwardsport and Cliffside – that will replace older, less efficient coal units.

In Indiana, the 630-MW Edwardsport integrated gasification combined cycle (IGCC) plant was approximately 20 percent complete at the end of 2008. The plant is designed to convert coal into a synthetic gas that produces power. When Edwardsport begins operating in 2012, it will emit less sulfur dioxide (SO2), nitrogen oxides (NOx) and particulates than the standard coal-fired plant it replaces – while providing more than 10 times the power. And, with the favorable geology in the region, we are working to demonstrate carbon capture and sequestration at Edwardsport – what could be a breakthrough technology for a low-carbon future.

Our Cliffside modernization project in North Carolina – including the construction of a new 825-MW advanced coal unit – was about 30 percent complete at the end of 2008. Construction began following receipt of all applicable state permits. While the plant’s air permit was subsequently challenged, construction remains on schedule as we address the legal issues. In March 2009, the North Carolina Division of Air Quality (DAQ) determined that the new unit is a “minor source” of hazardous air pollutants, confirming that the plant will have among the strictest, most effective air-emission controls available. Once Cliffside Unit 6 is completed in 2012, the plant will eventually replace approximately 1,000 MW of older, higher-emitting coal units. We will take additional actions to make Cliffside Unit 6 “carbon neutral” by 2018.

We are also adding fuel diversity by building two lower-emitting 620-MW combined cycle natural gas plants at existing sites in North Carolina. Once in service, the new plants will displace about 250 MW of older coal-fired units, as part of the 1,000 MW of higher-emitting coal units we agreed to retire with the Cliffside modernization.

I’ve often said if you’re serious about climate change, you need to be serious about nuclear power. Duke Energy has a track record of safe and efficient nuclear operations at our Oconee, McGuire and Catawba stations. We continue to preserve our options to develop a new 2,234-MW nuclear power plant, the William States Lee III Nuclear Station, in Cherokee County, S.C. While a decision to build a new nuclear station is still in the future, we have submitted an application to the U.S. Nuclear Regulatory Commission for a combined construction and operating license.

Beyond the plants and programs that are key to a low-carbon future – energy efficiency, gas, nuclear and cleaner coal – we are also working hard to improve the efficiency of our existing fleet. Today, we are the third largest generator of electricity among the top 20 U.S. investor-owned utilities. Not surprisingly, we are also the third largest emitter of tons of CO2 in this group. Another important measure is carbon intensity – the amount of CO2 by weight emitted per unit of energy. Based on the latest available 2007 data, eight other companies had carbon intensities higher than Duke Energy. As we add cleaner, more efficient power plants in the years ahead, carbon intensity will be a good way to judge our progress in decarbonizing our generation fleet.

We have also focused on reducing air emissions and other waste streams from our plants. We are nearing completion of a 10-year, approximately $5 billion investment in scrubbers and selective catalytic reduction units at our coal plants to lower NOx, SO2 and mercury emissions. Comparing 2008 emissions at the plants we operate to 2006, we reduced the NOx emissions rate by approximately 18 percent and the SO2 emissions rate by approximately 50 percent.

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Legislative Issues

Later in this report, we mention a number of legislative and regulatory issues that could affect our use of coal. Future regulations for coal ash ponds. Tighter sulfur dioxide and nitrogen oxides limits. New requirements to reduce mercury emissions. The long-pending New Source Review case. Concerns about mountaintop removal of coal. All of these issues are important, and represent what I call “stroke of the pen” risks.

Another legislative issue with far-reaching implications for our company and customers is climate change. I believe we need to regulate CO2 and other greenhouse gases, and we need to do it now. We support a cap-and-trade system that applies to all segments of the economy. By putting a price on carbon, companies and consumers alike will be able to make more informed investment decisions. We also believe we need to act with urgency – not panic – and develop a policy approach that first slows the growth of emissions, then stops the growth and transitions to a declining emissions cap. We are advocating legislation that is fair to consumers in all states, that provides funding for investments in technologies that will help solve the problem of climate change, and that includes adequate cost-containment measures to protect our economy.

Duke Energy is one of the founding members of the U.S. Climate Action Partnership (USCAP) – a group of corporations and non-government organizations committed to legislative action on climate change. USCAP worked for two years to create its “Blueprint for Legislative Action,” a plan that I believe is both workable and fair. It protects consumers by smoothing out the energy price increases that will result from capping carbon emissions. In January 2009, I joined some of my USCAP peers in testifying before Congress on these priorities for climate change legislation.

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Water and Energy

The discipline of sustainability trains us to look upstream, downstream and around corners. It also helps us see the connections between issues. As part of my work with the World Economic Forum this year, we published a report on the nexus of energy and water. We’ve included some key points from that report in the Water and Energy section of this online report. 

Unlike climate change – a global issue that demands global solutions – water issues are inherently local. Planning energy and water use in tandem will become the standard as companies and communities manage increasing demands on limited water supplies.

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Employee Safety and Development

We share a number of measures of employee engagement and satisfaction later in this report, but none is more personal or meaningful than safety. 

I am pleased to report that our safety performance in 2008 was our best ever. Despite the record-setting storms that hit our service area last year, despite the special challenges of large construction projects, and despite the distractions of this unsettling economy, we completed 2008 with fewer serious injuries than 2007 and no work-related employee or contractor fatalities. On page 30, you’ll read about some of the ways we made safety personal within our company in 2008.

Talent is often the key differentiator between companies, and this is never more true than in turbulent times. In 2008, we continued to develop our employees with customized training, cross-functional assignments and job rotations. Since January 2008, approximately 40 percent of our top 55 leaders have moved to new or expanded roles.

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Helping our Customers and Communities

The aftershocks from the economic crisis are being felt by our customers, our communities and our states. We continued to support nonprofits in the communities we serve with contributions, volunteerism and creative partnerships. Total contributions from the company, The Duke Energy Foundation, our employees and retirees exceeded $30 million in 2008. Additionally, in January 2009, our Foundation made an emergency grant of $800,000 to energy assistance funds that serve low-income residents in our service areas.

We are also partnering with state and local agencies and economic development officials to support economic recovery. If history is any indication, recessions are typically followed by a rebound in demand for electricity. We are convinced that investing in energy infrastructure can help rebuild our economy – achieving the triple goals of putting people to work, reducing environmental impacts and increasing energy security.

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Financial Performance

In 2008, we reported adjusted diluted earnings of $1.21 per share, below our employee incentive target of $1.27 per share. Our total shareholder return was down 21.7 percent for the year, but we still outperformed the overall markets – the S&P 500 declined 37.0 percent and the Philadelphia Utility Index declined 27.2 percent. 2008 was also the 82nd consecutive year that we’ve paid a quarterly cash dividend on Duke Energy common stock.

We took a number of actions to control costs, including reducing capital spending. And, as we made tough choices, we drew on sustainability principles. For example, for 2009, we reduced labor costs not through layoffs but by freezing base pay for our professional workforce.

Electric utilities are among the most capital-intensive of all industries. At Duke Energy, we have the potential to invest nearly $25 billion over the next five years to modernize and grow our businesses. Even in this “frozen” credit market, the strength of our balance sheet gave us access to capital. From Jan. 1, 2008, to Jan. 31, 2009, we issued approximately $4.5 billion in fixed-rate debt at a weighted-average rate of 6.05 percent.

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The Grandchildren’s Test

Over the past year, we’ve seen increased interest in sustainability as more and more stakeholders view it as a proxy for quality management.  

For the third consecutive year, we were recognized on the Dow Jones Sustainability Index for North America. We were also pleased to be named one of Fortune’s Most Admired Companies, among the 100 Best Corporate Citizens and one of the World’s Most Ethical Companies. While these distinctions are nice, they don’t compare to the tough criteria I call “the grandchildren’s test.” Quite simply, what type of world do I leave for my grandchildren and for yours? How will future generations judge the actions we take today?

Times like these – of unprecedented change and uncharted waters – test our leadership and our creativity. They also test our courage and our conscience.

Sustainability lies at the heart of the grandchildren’s test and underpins our corporate values.

I invite your feedback on our sustainability plans and progress. Your comments help us improve our business and redefine our boundaries.

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Sincerely,

Rogers Signature

Jim Rogers
Chairman, President and
Chief Executive Officer

March 31, 2009