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Letter from the Chairman

Dear Stakeholders:

Whenever I’m asked about the most challenging part of my job, my answer is always the same: striking the right balance to deliver energy that is affordable, reliable and clean. It sounds like a simple goal, but achieving it – year after year and in all economic cycles – is anything but simple.

Meeting our customers’ expectations for clean, reliable and affordable electricity 24 hours a day, seven days a week is both an art and a science. As we develop our long-range plans, we consider economic trends and commodity prices, we model weather patterns, and we estimate supply and demand curves. That’s the “science.” The “art” of planning comes in identifying trends in technology, consumer behavior and public policy that may affect our business. That’s where we are guided by the discipline of sustainability, as well as the talents, culture and values of our people.

The issues we face today – rebuilding the economy, addressing climate change, conserving natural resources – all require integrated solutions. Sustainability helps us recognize linkages, address impacts and seize opportunities that might be missed with more traditional, “linear” approaches to problem-solving. That’s why I think sustainability is an essential part of the art of business planning and leadership in the 21st century.

At Duke Energy, we define sustainability as operating our business in a way that is good for people, the planet and profits. As we look to a cleaner energy future, we see our role as helping to create jobs, reducing environmental impacts and ensuring the economic competitiveness of our company, our investors, our customers and our nation. This Sustainability Report outlines the highlights and challenges of our efforts to become a more sustainable company in 2009, and our mission to deliver reliable, affordable and cleaner electricity.

Energy: The Engine for Economic Recovery

Last year was difficult for both our customers and our industry. In the latter half of 2009, we saw signs the economy might be stabilizing, but we expect the recovery ahead to be slow and uneven.
 
Duke Energy’s regulated electric sales in 2009 – a good barometer of the economy – were down 4 percent from the previous year on a weather-normalized basis, with industrial sales down 14 percent. And, as I write this letter, we’re continuing to see double-digit unemployment in several of our jurisdictions.

No nation can achieve greatness when its people are idled by unemployment. Our company has a special opportunity to lead during this economic recovery. By modernizing our generating fleet and using electricity more efficiently, we can put people to work, reduce carbon dioxide (CO2) and other emissions, improve energy security and maintain competitive prices for our customers.

I believe that repowering our country for the 21st century – delivering reliable, affordable and cleaner electricity – could be the most important opportunity of our time. It could also be the most daunting. The technologies we invest in today can operate for half a century or more and cost billions of dollars. This chart summarizes our current view of supply and energy efficiency options. We use several sustainability criteria to evaluate these options, including cost, reliability, environmental impacts and job creation.

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Update on Climate Policy

Regular readers of this report know that we have taken a leadership role – in the U.S. and globally – in the climate change policy debate. We believe that clear, reasonable regulations and price signals on carbon are required to address climate change and provide businesses with the certainty we need to make long-term investment decisions.

I remain active in the U.S. Climate Action Partnership to advocate for fair legislation in the U.S. and testified twice before Congress in 2009. While Congress has not yet passed legislation to control or reduce greenhouse gases (GHG), the U.S. House of Representatives passed the American Clean Energy and Security Act of 2009 (also known as the Waxman-Markey Bill) in June. And, work on compromise legislation continues in the Senate, led by Senators Graham, Kerry and Lieberman.

In late 2009, the U.S. Environmental Protection Agency took steps to classify GHG as a threat to public health and welfare. This underscores the government’s intent to regulate GHG emissions – either through legislation or rulemaking under the current Clean Air Act (CAA).

I also participated in several meetings on a global framework that can be adopted after the Kyoto Protocol expires in 2012. While the United Nations meeting in Copenhagen failed to meet the high expectations for clarity post-Kyoto, more than 100 countries conditionally endorsed the Copenhagen Accord, signaling their intent to reduce GHG emissions.

The global markets are clearly moving toward a low-carbon economy. This shift represents a unique opportunity for countries that develop and sell cleaner energy technologies. Nations that delay will lose more jobs and the ability to compete globally, and may end up buying clean technology from foreign suppliers.

Beyond climate change, there are a number of other legislative, regulatory and legal issues that could affect our use of coal. (See updates.) These include potential new regulations on air emissions, coal ash storage and use, and mountaintop-removal coal mining, as well as litigation involving New Source Review provisions of the CAA. New regulations could require us to retrofit or retire thousands of megawatts (MW) of coal-fired generation, beyond what we are already planning.

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Reducing our Carbon Footprint

We have shared in the past two editions of this Sustainability Report our aspiration to reduce our 2006 U.S. CO2 emissions by 50 percent by 2030. In 2009, our U.S. generation fleet emitted about 91 million tons of CO2 – down from 105 million tons in 2008. However, some of this reduction is a “false positive,” driven by the weakened economy and resulting lower demand for electricity.

Another important metric is “carbon intensity,” which is the amount of CO2 emitted per unit of electricity produced. As this table shows, our carbon intensity improved in 2009 due to reduced coal-fired generation and more nuclear and hydroelectric generation. Based on 2008 data, the latest available, our carbon intensity ranks us 10th among the 20 largest U.S.-based, investor-owned utilities. Overall fleet efficiency also lowers carbon intensity, and I am particularly proud of our fossil and nuclear power operations, which performed exceptionally well during 2009.

Recent disclosures of inaccuracies or bias in some climate studies have slowed the momentum to address climate change. We maintain that there is no place for bias in scientific research. But, even if the overall body of scientific evidence were reversed to show that climate change isn’t real, Duke Energy would still have to retire and replace most of the generation it operates today within the next 40 years, due to normal aging. As a result, we are modernizing our generating fleet with more efficient and lower-emitting power plants, and helping our customers use energy more efficiently.

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Modernizing and Diversifying our Generation Fleet


Cleaner Coal

Replacing some of our oldest coal-fired plants with new, efficient and lower-emitting coal units makes economic sense because of our nation’s vast supply of affordable coal.

At the end of 2009, our 825-MW Cliffside advanced-coal project in North Carolina was roughly 55 percent complete. When it goes into operation in 2012, this “bridge plant” will help replace about 1,000 MW of older, higher-emitting coal units, which we will retire from service. Construction of the new unit at Cliffside has been opposed by some special interest groups. Because of the very detailed regulatory review that preceded the plant’s licensing and permitting, we have prevailed against every challenge to halt construction.

When completed in 2012, our 630-MW Edwardsport integrated gasification combined-cycle (IGCC) plant under construction in Indiana will be one of the cleanest, largest and most advanced coal gasification plants in the world. The plant, which is about 50 percent complete, will replace 160 MW of higher-emitting generation that is more than half a century old. In addition, we are investing $17 million to study carbon capture at the site. We are also proposing to spend $42 million for the first phase of work to permanently store up to 60 percent of the plant’s CO2 emissions underground.

One of the challenges we have faced during the construction of the Edwardsport IGCC plant is managing the costs associated with design modifications and scope changes.  We will continue to partner with our supplier, General Electric, and the construction management firm, Bechtel, to bring the plant on line in the most timely, cost-effective manner possible.

Our Cliffside and Edwardsport projects represent two of the largest capital projects under way in their states. Together, they will employ approximately 4,000 workers during peak construction.

In addition to our investments in new coal units, we have spent approximately $5 billion over the last decade to significantly reduce sulfur dioxide and nitrogen oxides from our existing coal fleet, improving air quality.

Finally, to gain experience in the carbon offset market, we became the lead investor in GreenTrees, a program that aims to offset carbon emissions through the reforestation of 1 million acres in the Lower Mississippi Alluvial Valley. Our initial investment funded the planting of more than 1 million trees on approximately 1,700 acres in Arkansas.

Natural Gas

The discovery of new shale gas reserves could be significant for our nation’s energy future. We believe a diverse portfolio of fuels protects our customers from price and supply volatility, and natural gas is a part of that equation.

We are building two highly efficient 620-MW combined-cycle natural gas-fired plants at two existing coal-fired generating sites in North Carolina. When completed in 2011 and 2012, these cleaner-burning units will leverage our ability to use growing supplies of domestic natural gas. They will also enable the retirement of about 250 MW of older coal-fired units as part of the 1,000 MW referenced earlier. Building the two North Carolina gas plants creates approximately 1,000 peak construction jobs.

Nuclear Power

Any plan to decarbonize our generation fleet must include nuclear power, which has a proven safety record, emits no greenhouse gases and can produce electricity around the clock. We continue to pursue plans, including potential regional partnerships, to develop a new 2,234-MW nuclear power plant in Cherokee County, S.C. If approved, the William States Lee III Nuclear Station could come on line in the 2021 time frame.

Bringing nuclear energy to the Midwest will help reduce that region’s reliance on coal. In June 2009, we created the Southern Ohio Clean Energy Park Alliance to explore development of a nuclear power plant at a U.S. Department of Energy (DOE) site formerly used for defense manufacturing.

The proposed nuclear power plant in South Carolina and the potential plant in Ohio would create an estimated 7,000 peak construction jobs combined – not to mention hundreds of high-paying permanent jobs and ongoing contributions to the local communities’ tax bases once these facilities are operating.

Renewable Energy

We continued to invest in renewable energy in 2009 to diversify our fuel mix and reduce our carbon footprint. Including our renewable energy assets, our nuclear fleet in the Carolinas and our hydroelectric assets in North America and South America, we are now the third-largest producer of carbon-free electricity in the Americas among U.S.-based, investor-owned utilities. Almost 40 percent of the electricity we generated in 2009 was from carbon-free sources.

In 2009, our commercial wind power business brought more than 360 MW of electric generation on line in three states. We have two wind farms under construction that will raise our total to nearly 1,000 MW in operation by the end of 2010.

Last year, North Carolina’s policymakers passed legislation to enable the exploration of offshore wind power. As a result, we announced plans to install up to three offshore wind turbines in waters between the mainland and the state’s Outer Banks. We are partnering with the University of North Carolina at Chapel Hill on this initiative and gauging local support for the project. The project’s turbines could be among the first placed in waters off the U.S. coast.

Also in 2009, the North Carolina Utilities Commission approved our $50 million program to install solar panels on the properties of a select number of industrial, commercial and residential customers in the state. When the project is complete, Duke Energy will own and operate 8 MW of solar generation – enough to power about 1,300 average-sized homes. We also began buying 4 MW of energy from a North Carolina solar farm in late 2009.

We announced our first commercial solar photovoltaic venture in January 2010 – the 14-MW Blue Wing Solar Project in San Antonio, Texas. Under the terms of a 30-year power purchase agreement, the output from the 139-acre facility will serve customers of CPS Energy, one of the largest municipal utilities in the U.S. In 2009, we also entered into an agreement to jointly develop commercial solar projects in the U.S. with China-based ENN Group.

Additionally, ADAGE, the biopower company we own with AREVA, began the permitting process to build a 55-MW carbon-neutral biomass plant in Florida that will generate electricity by burning wood waste. In early 2010, ADAGE and John Deere announced an alliance for collecting, bundling and transporting wood debris from regional logging operations in western Washington to fuel a proposed 55-MW biopower plant in the area.

We continue to augment the renewable energy component of our regulated portfolio through power purchase agreements. In recent years, we have entered into contracts to buy more than 170 MW of renewable energy, including wind, solar, hydroelectric and landfill gas.

Energy Efficiency

I’ve often said the cleanest, most efficient power plant is the one we never have to build. If we can help our customers save energy – and save money in the process – it can reduce the demand for new power plants.

Most utilities today continue to operate under regulatory frameworks created decades ago that reward them for building new power plants and distribution systems. Utilities therefore lack incentives to invest in energy efficiency. Our regulatory model for energy efficiency is very different from the traditional electric utility model. It gives us an incentive to sell less, not more, electricity, by allowing us an opportunity to earn a return on a portion of what it would cost to build new generation. And, under a “pay for performance” structure, Duke Energy is only compensated for the actual energy savings achieved by customers through our energy efficiency programs.

First approved in Ohio in December 2008, our energy efficiency framework was approved in North Carolina in 2009, and in South Carolina and Indiana in early 2010. We are evaluating our energy efficiency proposal in Kentucky and may file for approval in late 2010.

Smart Grid

Our energy efficiency vision cannot be fully realized without modernizing our power delivery system. That’s why we’re investing up to $1 billion over the next five years in smart grid technologies that will begin to transform today’s century-old power delivery system into an advanced energy network that provides electricity and energy usage information.

Building a smarter grid involves replacing analog switches, meters and controls with new equipment that enables digital, two-way communication between utilities and their customers. A more intelligent power distribution system will improve the reliability of our service, enhance energy efficiency, and give customers more control over their electricity use – and their energy bill.

By the end of 2009, we had invested approximately $90 million to deploy limited-scale smart grid projects. We continue to pursue smart grid deployments in North Carolina, South Carolina, Kentucky and Indiana. In December 2008, we received approval from the Public Utilities Commission of Ohio to move forward with full-scale deployment in our service territory. After conducting successful pilot programs in 2009, we expect to install 140,000 smart electric and gas meters and other associated technologies in 2010. Our Ohio deployment will grow to more than 1 million smart meters and other components installed over the next five years.

In 2009, the DOE awarded us $200 million under the American Recovery and Reinvestment Act to support our smart grid projects in the Midwest, and another $4 million toward our smart grid efforts in the Carolinas. We continue to work with the DOE to finalize the terms of the grant contracts.

Smart grid also paves the way for other innovations in energy technology, such as plug-in electric vehicles (PEVs). To advance this game-changing technology, we are teaming with FPL Group to invest a combined $600 million, with the goal that 100 percent of all new fleet vehicles purchased by 2020 will be PEVs. We foresee great potential for job creation as we transition to lower-carbon transportation. Beyond auto manufacturing, our nation will need to build the new recharging infrastructure for these vehicles.

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Investing in Clean-Energy Research and Development

To accelerate the development of cleaner and more affordable energy technologies, we are sharing research and development experience with partners like the Electric Power Research Institute (EPRI), an independent, nonprofit organization of scientists, engineers and other electricity experts from around the world.

In addition to our commercial solar joint development agreement with ENN Group, we are also working with China’s Huaneng Group to pursue clean-energy technologies, including carbon capture and sequestration. Like the U.S., China has enormous coal reserves and huge potential for the permanent underground storage of CO2. These ventures, along with our EPRI collaboration, will help bring new technologies to scale more quickly and at lower cost.

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Aligning Rates with Our Expenses

We recognize that there’s never a good time to increase rates for customers, and the current economic environment is particularly tough. As we invest in cleaner and more reliable energy infrastructure, customer rates will rise. We are working hard to manage those costs and leverage our low cost of capital to help smooth out the rate impacts on customers. And, our commitment to energy efficiency provides customers with greater ability to manage their costs.

In 2009, we filed for rate increases in several service areas and worked with state regulatory staffs and other stakeholders to negotiate rate increases that were fair for both customers and investors.

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Financial Results

Given the weak economy in 2009, Duke Energy’s employees delivered remarkable results. We reported adjusted diluted earnings of $1.22 per share in 2009, exceeding our employee incentive target of $1.20 per share. We were able to reduce operating expenses by more than $150 million, and we met or exceeded many of our performance goals.

Our total shareholder return (TSR) rose 22 percent in 2009, which helped us again outperform our peers. The TSR for the Philadelphia Utility Index (which consists of 20 utilities including Duke Energy), for example, increased by only 10 percent in 2009.

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Safety

One area where we didn’t meet expectations is employee and contractor safety. After a fatality-free 2008, we suffered three contractor deaths in 2009. This reminds us of the hazards involved in bringing energy to millions of people. Even though our employee injury rate trended to the lowest level ever in 2009, any injuries or fatalities are unacceptable. I have challenged all of our employees and contractors to redouble their efforts in this area.

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Supporting our Communities

In these difficult times, it’s more important than ever to support our communities through contributions, volunteerism and private/public partnerships. In 2009, total contributions from the company, The Duke Energy Foundation, our employees and retirees exceeded $28 million.

We are also working with economic development officials in our five retail states to encourage job growth. As I mentioned earlier, we believe that investing in cleaner, modern power plants and infrastructure is a way to create jobs and improve the environment. (See update.) This includes our efforts to promote the Charlotte, N.C., region as a “the new energy capital” and to support clean-energy investments wherever we operate.

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Sustainability and Employee Engagement

We are seeing real traction from our commitment to sustainability – internally and externally. As you’ll see in our update, we launched an effort in 2009 to engage employees in sustainability, unleash innovation and share best practices. I’ve been impressed by the scope and caliber of ideas that have come from employees, including the members of our new Sustainability Corps – volunteers who provide work group leadership for our sustainability efforts. We view sustainability as a cornerstone of our corporate culture and values. It is part of what differentiates our company and helps us attract and retain talented employees.

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Working with Stakeholders

I have always felt that collaborating with stakeholders leads to better outcomes. The rate settlements we reached with our state regulators and other parties serve as excellent examples of working with diverse stakeholders to find common ground. We also hired Rocky Mountain Institute Chairman and Chief Scientist Amory Lovins and his team to review our fleet modernization plans and help us advance our thinking about energy efficiency. And, we periodically convene energy efficiency collaboratives to gather ideas and feedback from state energy officials, large-business customers, regulators and environmental stakeholders. Finally, we recently launched www.sheddingalight.org, a Web site to promote dialogue between interested citizens and some of today’s foremost authorities on energy, environmental and economic issues.

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In Closing

These are transformative times for our company, our industry and our nation. The challenges our world faces today share energy as an underlying theme and investing in cleaner electricity as a major solution. At Duke Energy, we believe modernizing our fleet and promoting energy efficiency can create jobs, contribute to our nation’s energy security and help improve the global environment. The discipline of sustainability makes us take a multi-disciplinary, multi-stakeholder approach to developing our business. It leads to new ideas and innovation that help solve some of the world’s most challenging problems.

In time, the economy will rebound, and the issues we face today will give way to new challenges. What will not change is our commitment to delivering energy in the most affordable, reliable and cleanest manner possible. It’s what our customers expect, and future generations deserve.

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Sincerely,

Rogers Signature

Jim Rogers
Chairman, President and Chief Executive Officer
April 6, 2010