American Electric Power (AEP) Risk Analysis

The rates customers pay to AEP regulated utility businesses are subject to approval by the FERC and the respective state utility commissions of Arkansas, Indiana, Kentucky, Louisiana, Michigan, Ohio, Oklahoma, Tennessee, Texas, Virginia and West Virginia. In certain instances, AEP's applicable regulated utility businesses may agree to negotiated settlements related to various rate matters that are subject to regulatory approval. AEP cannot predict the ultimate outcomes of any settlements or the actions by the FERC or the respective state commissions in establishing rates. If regulated utility earnings exceed the returns established by the relevant commissions, retail electric rates may be subject to review and possible reduction by the commissions, which may decrease future earnings. Additionally, if regulatory bodies do not allow recovery of costs incurred in providing service on a timely basis, it could reduce future net income and cash flows and negatively impact financial condition. Similarly, if recovery or other rate relief authorized in the past is overturned or reversed on appeal, future earnings could be negatively impacted. Any legislation, regulatory action or litigation outcome that triggers a reversal of a regulatory asset or deferred cost generally results in an impairment to the balance sheet and a charge to the income statement of the company involved. New legislation could be adopted in any of the states in which we operate that could alter the regulatory framework and prevent us from getting timely recovery of our costs and investments. In addition, regulators have initiated and may initiate additional proceedings to investigate the prudence of costs in the AEP regulated utility businesses and in base rates and examine, among other things, the reasonableness or prudence of operation and maintenance practices, level of expenditures (including storm costs and costs associated with capital projects), allowed rates of return and rate base, proposed resource acquisitions and previously incurred capital expenditures that the regulated utility businesses seek to place in rates. The regulators may disallow costs subject to their jurisdiction found not to have been prudently incurred or found not to have been incurred in compliance with applicable tariffs, creating some risk to the ultimate recovery of those costs. Regulatory proceedings relating to rates and other matters typically involve multiple parties seeking to limit or reduce rates. Traditional base rate proceedings, as opposed to formula rate plans, generally have long timelines, are primarily based on historical costs and may or may not be limited in scope or duration by statute. The length of these base rate proceedings can cause the regulated utility businesses to experience regulatory lag in recovering costs through rates, such that they may not fully recover all costs during the rate effective period and may, therefore, earn less than their allowed returns. Decisions are typically subject to appeal, further exacerbating the regulatory lag and leading to additional uncertainty associated with rate case proceedings. The AEP regulated utility businesses have large customer and stakeholder bases and, as a result, could be the subject of public criticism or adverse publicity focused on issues including the operation and maintenance of their assets and infrastructure, their preparedness for major storms or other extreme weather events and/or the time it takes to restore service after such events, or the quality of their service or the reasonableness of the cost of their service. Criticism or adverse publicity of this nature could render legislatures and other governing bodies, public service commissions and other regulatory authorities, and government officials less likely to view the applicable operating company in a favorable light and could potentially negatively affect legislative or regulatory processes or outcomes, as well as lead to increased regulatory oversight or more stringent legislative or regulatory requirements or other legislation or regulatory actions that adversely affect the regulated utility businesses. The regulated utility businesses, and the energy industry as a whole, have experienced a period of rising costs and investments and an upward trend in spending, especially with respect to infrastructure investments, which is likely to continue in the foreseeable future and could result in more frequent rate cases and requests for, and the continuation of, cost recovery mechanisms, all of which could face resistance from customers and other stakeholders especially in a rising cost environment, whether due to inflation, tariffs, high fuel prices or otherwise, and/or in periods of economic decline or hardship. Significant increases in costs could increase financing needs and otherwise adversely affect AEP's business, financial position, results of operation or cash flows. See Note 4 – Rate Matters for additional information.

AEP is involved in legal proceedings, claims and litigation arising out of its business operations, the most significant of which are summarized in Note 6 - Commitments, Guarantees and Contingencies.  Adverse outcomes in these proceedings could require significant expenditures that could reduce future net income and cash flows and negatively impact financial condition.

Federal or state laws or regulations may be adopted that would impose new or additional limits on the emissions of greenhouse gases, including, but not limited to, carbon dioxide and methane, from electric generation units using fossil fuels like coal. The potential effects of greenhouse gas emission limits on AEP's electric generation units are subject to significant uncertainties based on, among other things, the timing of the implementation of any new requirements, the required levels of emission reductions, the nature of any market-based or tax-based mechanisms adopted to facilitate reductions, the relative availability of greenhouse gas emission reduction offsets, the development of cost-effective, commercial-scale carbon capture and storage technology and supporting regulations and liability mitigation measures, and the range of available compliance alternatives. AEP is committed to providing reliable affordable power to its customers. To achieve this, AEP and its subsidiaries routinely meet with state regulators and key stakeholders to understand their needs for both dispatchable and renewable generation resources. This process evaluates, amongst other things, future supply and demand fundamentals, the economic aspects of investments, grid reliability and resilience, regulations and evolving RTO requirements, the advancement of generation technologies, and market impacts and constraints. As part of the regulatory process, AEP routinely submits IRPs in various regulatory jurisdictions to address future generation needs. The objective of the IRPs is to recommend future generation and capacity resources that provide the most cost-efficient and reliable power to customers. AEP remains committed to making generation and capacity resource decisions that provide the most cost-efficient and reliable power to customers, irrespective of any specific carbon-reduction goal. Based on the assumptions used in the most recent analysis, AEP expects that its Scope 1 GHG emissions will be reduced by 80% by 2030 (from a 2005 baseline). AEP's GHG reduction efforts are predicated on the combined preferences of the eleven states that we operate in. AEP has made significant progress in reducing GHG emissions from its power generation fleet and while we aspire to be at net-zero Scope 1 and 2 emissions by 2045, our performance will ultimately be driven by the needs and desires of the states we serve. AEP is engaging with regulators and policymakers and our decisions around generation resources are reflected in the preferences of these states. AEP has embraced the advancement of low-carbon generation solutions where supported, which may include early-stage projects to bring small modular nuclear reactors to Virginia and Indiana as an example. Further advancement of affordable new generation technologies and a market for offsets, as well as continued alignment with our states, would be required to achieve net-zero emissions. AEP's results of operations could be materially adversely affected to the extent that new federal or state laws or regulations impose any new greenhouse gas emission limits. Any future limits on greenhouse gas emissions could create substantial additional costs in the form of taxes or emissions allowances, require significant capital investment in carbon capture and storage technology, fuel switching, or the replacement of high-emitting generation facilities with lower-emitting generation facilities and/or could cause AEP to retire generating capacity prior to the end of its estimated useful life. Although AEP typically recovers environmental expenditures, there can be no assurance in the future that AEP can recover such costs which could reduce future net income and cash flows and possibly harm financial condition. Further, real or alleged violations of environmental regulations, including those related to climate change, or an inability to meet AEP's voluntary climate aspirations, could adversely impact AEP's reputation, reduce future net income and cash flows and harm financial condition.

AEP and AEPTCo are holding companies and have no operations of their own.  Their ability to meet their financial obligations associated with their indebtedness and to pay dividends is primarily dependent on the earnings and cash flows of their operating subsidiaries, primarily their regulated utilities, and the ability of their subsidiaries to pay dividends to them or repay loans from them.  Their subsidiaries are separate and distinct legal entities that have no obligation (apart from loans from AEP or AEPTCo) to provide them with funds for their payment obligations, whether by dividends, distributions or other payments.  Payments to AEP or AEPTCo by their subsidiaries are also contingent upon their earnings and business considerations.  AEP and AEPTCo indebtedness and dividends are structurally subordinated to all subsidiary indebtedness.

AEP's business plan calls for extensive investment in capital improvements and additions, including the construction or acquisition of additional transmission and generation facilities, modernizing existing infrastructure, installation of environmental upgrades and retrofits as well as other initiatives.  AEP's public utility subsidiaries currently provide service at rates approved by one or more regulatory commissions.  If these regulatory commissions do not approve adjustments to the rates charged, affected AEP subsidiaries would not be able to recover the costs associated with their investments.  This would cause financial results to be diminished.

Growth in customer accounts and growth of customer usage each directly influence demand for electricity and the need for additional power generation and delivery facilities.  Customer growth and customer usage are affected by a number of factors outside the control of AEP, such as mandated energy efficiency measures, demand-side management goals, distributed generation resources and economic and demographic conditions, such as population changes, job and income growth, housing starts, new business formation and the overall level of economic activity, including changes due to public health considerations. Certain regulatory and legislative bodies have introduced or are considering requirements and/or incentives to further reduce energy consumption.  Additionally, technological advances or other improvements in or applications of technology could lead to declines in per capita energy consumption.  Some or all of these factors, could impact the demand for electricity.

AEP Texas collects receivables from the distribution of electricity from REPs that supply the electricity it distributes to its customers. As of December 31, 2024, AEP Texas did business with approximately 135 REPs. Adverse economic conditions, structural problems in the market served by ERCOT or financial difficulties of one or more REPs could impair the ability of these REPs to pay for these services or could cause them to delay such payments. AEP Texas depends on these REPs to remit payments on a timely basis. Applicable regulatory provisions require that customers be shifted to another REP or a provider of last resort if a REP cannot make timely payments. Applicable PUCT regulations significantly limit the extent to which AEP Texas can apply normal commercial terms or otherwise seek credit protection from firms desiring to provide retail electric service in its service territory, and AEP Texas thus remains at risk for payments related to services provided prior to the shift to another REP or the provider of last resort. In 2024, AEP Texas' two largest REPs accounted for 40% of its operating revenue. Any delay or default in payment by REPs could adversely affect cash flows, financial condition and results of operations. If a REP were unable to meet its obligations, it could consider, among various options, restructuring under the bankruptcy laws, in which event such REP might seek to avoid honoring its obligations, and claims might be made by creditors involving payments AEP Texas had received from such REP.

Climate change creates physical and financial risk.  Physical risks from climate change may include an increase in sea level and changes in weather conditions, such as changes in precipitation and extreme weather events, such as fires.  Customers' energy needs vary with weather conditions, primarily temperature and humidity.  For residential customers, heating and cooling represent their largest energy use.  To the extent weather conditions are affected by climate change, customers' energy use could increase or decrease depending on the duration and magnitude of the changes. Increased energy use due to weather changes may require AEP to invest in additional generating assets, transmission and other infrastructure to serve increased load.  Decreased energy use due to weather changes may affect financial condition through decreased revenues.  Extreme weather conditions in general require more system backup, adding to costs, and can contribute to increased system stress, including service interruptions.  Weather conditions outside of the AEP service territory could also have an impact on revenues.  AEP buys and sells electricity depending upon system needs and market opportunities.  Extreme weather conditions creating high energy demand on AEP's own and/or other systems may raise electricity prices as AEP buys short-term energy to serve AEP's own system, which would increase the cost of energy AEP provides to customers. Severe weather and weather-related events impact AEP's service territories, primarily when thunderstorms, tornadoes, hurricanes, fires, floods and snow or ice storms occur.  To the extent the frequency and intensity of extreme weather events and storms increase, AEP's cost of providing service will increase, including the costs and the availability of procuring insurance related to such impacts, and these costs may not be recoverable.  Changes in wind patterns or in precipitation resulting in droughts, water shortages or floods could adversely affect operations, principally wind generation facilities for changes in wind patterns and the fossil fuel generating units for changes in precipitation. A change in wind patterns or a negative impact to water supplies due to long-term drought conditions or severe flooding could adversely impact AEP's ability to provide electricity to customers, as well as increase the price they pay for energy.  AEP may not recover all costs related to mitigating these physical and financial risks. To the extent climate change impacts a region's economic health, it may also impact revenues.  AEP's financial performance is tied to the health of the regional economies AEP serves.  The price of energy, as a factor in a region's cost of living as well as an important input into the cost of goods and services, has an impact on the economic health of the communities within AEP's service territories. Climate change may impact the economy, which could impact our sales and revenues. The cost of additional regulatory requirements, such as regulation of carbon dioxide emissions, could impact the availability of goods and prices charged by AEP's suppliers which would normally be borne by consumers through higher prices for energy and purchased goods. To the extent financial markets view climate change and carbon dioxide emissions as a financial risk, this could negatively affect AEP's ability to access capital markets or cause AEP to receive less than ideal terms and conditions in capital markets.