ITEM 1.    BUSINESS

We were incorporated under the laws of the State of New Jersey in 1985 and our principal executive offices are located at 80 Park Plaza, Newark, New Jersey 07102. We conduct our business through two direct wholly owned subsidiaries, PSE&G and Power, each of which also has its principal executive offices at 80 Park Plaza, Newark, New Jersey 07102.

We are an energy company with a diversified business mix. Our operations are located primarily in the Northeastern and Mid- Atlantic United States. Our business approach focuses on operational excellence, financial strength and disciplined investment. As a holding company, our profitability depends on our subsidiaries’ operating results. Below are descriptions of our two principal direct operating subsidiaries.

Our other direct wholly owned subsidiaries are: PSEG Long Island LLC (PSEG LI), which operates the Long Island Power Authority’s (LIPA) electric transmission and distribution (T&D) system under a contractual agreement; PSEG Energy Holdings L.L.C. (Energy Holdings), which earns its revenues primarily from its portfolio of lease investments; and PSEG Services Corporation (Services), which provides us and our operating subsidiaries with certain management, administrative and general services at cost.

The following is a more detailed description of our business, including a discussion of our:

BUSINESS OPERATIONS AND STRATEGY

PSE&G

Our regulated transmission and distribution public utility, PSE&G, distributes electric energy and gas to customers within a designated service territory running diagonally across New Jersey where approximately 6.2 million people, or about 70% of

New Jersey’s population resides.

.

Products and Services

Our utility operations primarily earn margins through the transmission and distribution of electricity and the distribution of gas.

The commodity portion of our utility business’ electric and gas sales is managed by basic generation service (BGS) and basic gas supply service (BGSS) suppliers. Pricing for those services are set by the BPU as a pass-through, resulting in no margin for our utility operations.

We also earn margins through competitive services, such as appliance repair.

In addition to our current utility products and services, we have implemented several programs to invest in regulated solar generation within New Jersey, including:

We have also implemented a set of energy efficiency and demand response programs to encourage conservation and energy efficiency by providing energy and cost saving measures directly to businesses and families. For additional information concerning these programs and the components of our tariffs, see Regulatory Issues—State Regulation and Item 8. Financial Statements and Supplementary Data— Note 6. Regulatory Assets and Liabilities .

How PSE&G Operates

We are a transmission owner in PJM Interconnection, L.L.C. (PJM) and we provide distribution service to 2.2 million electric customers and 1.8 million gas customers in a service area that covers approximately 2,600 square miles running diagonally across New Jersey. We serve the most heavily populated, commercialized and industrialized territory in New Jersey, including its six largest cities and approximately 300 suburban and rural communities.

Transmission

We use formula rates for our transmission cost of service and investments. Formula-type rates provide a method of rate recovery where the transmission owner annually determines its revenue requirements through a fixed formula that considers Operation and Maintenance expenditures, rate base and capital investments and applies an approved return on equity (ROE) in developing the weighted average cost of capital. Under this formula, rates are put into effect in January of each year based upon our internal forecast of annual expenses and capital expenditures. Rates are subsequently trued up to reflect actual annual expenses and capital expenditures. Our current approved rates provide for a base ROE of 11.68% on existing and new transmission investment, while certain investments are entitled to earn an additional incentive rate. For more information, see Regulatory Issues—Federal Regulation.

We continue to invest in transmission projects that are included for review in the FERC-approved PJM transmission expansion process. These projects focus on reliability improvements and replacement of aging infrastructure with planned capital spend of $3.8 billion for transmission in 2018-2020 as disclosed in Item 7. MD&A—Capital Requirements .    

Distribution

PSE&G distributes gas and electricity to end users in our respective franchised service territories. Our approved rates, established in our most recent gas and electric base rate proceeding completed in mid-2010, provide for a ROE of 10.3% on distribution rate base. In January 2018, we filed a distribution base rate case requesting an adjustment in electric and gas base delivery rates that, if approved by the BPU, would increase overall revenues by approximately one percent. PSE&G anticipates that new base rates will take effect in the fourth quarter of 2018. The BPU has also approved a series of PSE&G infrastructure, energy efficiency and renewable energy investment programs with cost recovery through various clause mechanisms, with approved ROEs ranging from 9.75% to 10.3%. Our load requirements are split among residential, commercial and industrial customers, as described in the following table for 2017 :

While our customer base has modestly increased since 2013, electric load has declined and gas load has increased as illustrated below:

The decline in electric sales is the result of changes in customer usage patterns, including conservation and more energy efficient appliances. Gas firm sales increased as a result of customer response to continued low gas prices. Only gas firm sales impact margin.

PSE&G, as part of its BPU-approved Energy Strong Program, completed the replacement and modernization of 240 miles of low-pressure cast iron gas mains in or near flood areas. PSE&G continues to execute the Energy Strong Program to upgrade all of its electric substations that were damaged by water in recent storms; make investments that will create redundancy in the electric distribution system, reducing outages when damage occurs; and deploy technologies to better monitor system operations, enabling PSE&G to restore customers more quickly in the event of an electric outage, and with respect to PSE&G’s gas system, upgrade five natural gas metering stations and a liquefied natural gas station recently affected by severe weather or located in flood zones.

PSE&G continues modernizing its gas distribution system as part of our Gas System Modernization Program (GSMP) which was approved by the BPU in late 2015. The GSMP, through which we expect to invest $905 million over three years, will replace approximately 510 miles of cast iron and unprotected steel gas mains and about 38,000 unprotected steel service lines to homes and businesses, including the uprating of the mains to higher pressure. The mains and service lines will be replaced with stronger, more durable plastic piping, reducing the potential for leaks and release of methane gas. The new elevated pressure systems also enable the installation of excess flow valves that automatically shut off gas flow if a service line is damaged, and better support the use of high-efficiency appliances.

In July 2017, we filed a petition with the BPU for a GSMP II program, an extension of our GSMP through which PSE&G has proposed investing $2.7 billion over five years beginning in 2019 to continue to modernize our gas system. For additional information, see Regulatory Issues.

Solar Generation

In order to support New Jersey’s Energy Master Plan and the state’s renewable energy goals, we have undertaken two major solar initiatives at PSE&G, the Solar Loan Program and the Solar 4 All and Solar 4 All Extension Programs. Our Solar Loan Program provides solar system financing to our residential and commercial customers. The loans are repaid with cash or solar renewable energy certificates (SRECs). We sell the SRECs received through periodic auctions and use the proceeds to offset program costs. Our Solar 4 All Programs invest in utility-owned solar photovoltaic (PV) centralized solar systems installed on PSE&G property and third-party sites, including landfill facilities, and solar panels installed on distribution system poles in our electric service territory. We sell the energy and capacity from the systems in the PJM wholesale electricity market. In addition, we sell SRECs generated by the projects through the same periodic auction used in the loan program, the proceeds of which are used to offset program costs.

Supply

Although commodity revenues make up almost 38% of our revenues, we make no margin on the default supply of electricity and gas since the actual costs are passed through to our customers.

All electric and gas customers in New Jersey have the ability to choose their own electric energy and/or gas supplier. Pursuant to BPU requirements, we serve as the supplier of last resort for two types of electric and gas customers within our service territory that are not served by another supplier. The first type, which represents about 80% of PSE&G’s load requirements, provides default supply service for smaller industrial and commercial customers and residential customers at seasonally-adjusted fixed prices for a three-year term (BGS-Residential Small Commercial Pricing (RSCP)). These rates change annually on June 1 and are based on the average price obtained at auctions in the current year and two prior years. The second type provides default supply for larger customers, with energy priced at hourly PJM real-time market prices for a contract term of 12 months (BGS-Commercial Industrial Energy Pricing (CIEP)).

We procure the supply to meet our BGS obligations through auctions authorized by the BPU for New Jersey’s total BGS requirement. These auctions take place annually in February. Results of these auctions determine which energy suppliers are authorized to supply BGS to New Jersey’s electric distribution companies (EDCs). Once validated by the BPU, electricity prices for BGS service are set. Approximately one-third of PSE&G’s total BGS-RSCP eligible load is auctioned each year for a three-year term. For information on current prices, see Item 8. Financial Statements and Supplementary Data— Note 13. Commitments and Contingent Liabilities .

PSE&G procures the supply requirements of its default service BGSS gas customers through a full-requirements contract with Power. The BPU has approved a mechanism designed to recover all gas commodity costs related to BGSS for residential customers. BGSS filings are made annually by June 1 of each year, with an effective date of October 1. PSE&G’s revenues are matched with its costs using deferral accounting, with the goal of achieving a zero cumulative balance by September 30 of each year. In addition, we have the ability to put in place two self-implementing BGSS increases on December 1 and February 1 of up to 5% and also may reduce the BGSS rate at any time and/or provide bill credits. See Item 8. Financial Statements and Supplementary Data— Note 6. Regulatory Assets and Liabilities for information on recent self-implementing credits. Any difference between rates charged under the BGSS contract and rates charged to our residential customers is deferred and collected or refunded through adjustments in future rates. Commercial and industrial customers that do not select third-party suppliers are also supplied under the BGSS arrangement. These customers are charged a market-based price largely determined by prices for commodity futures contracts.

Markets and Market Pricing

Historically, there has been significant volatility in commodity prices. Such volatility can have a considerable impact on us since a rising commodity price environment results in higher delivered electric and gas rates for customers. This could result in decreased demand for electricity and gas, increased regulatory pressures and greater working capital requirements as the collection of higher commodity costs from our customers may be deferred under our regulated rate structure. A declining commodity price on the other hand, would be expected to have the opposite effect. For additional information, including the impact of natural gas commodity prices on electricity prices such as BGS, see Item 7. MD&A—Executive Overview of 2017 and Future Outlook.

Power

Through Power, we seek to produce low-cost electricity by efficiently operating our nuclear, coal, gas, oil-fired and renewable generation assets while balancing generation output, fuel requirements and supply obligations through energy portfolio management. Our commitments for load, such as BGS in New Jersey and other bilateral supply contracts, are backed by the generation we own and may be combined with the use of physical commodity purchases and financial instruments from the market to optimize the economic efficiency of serving the load. Power is a public utility within the meaning of the Federal Power Act and the payments it receives and how it operates are subject to FERC regulation. Power is also subject to certain regulatory requirements imposed by state utility commissions such as those in New York and Connecticut.

Products and Services

As a merchant generator and power marketer, our profit is derived from selling a range of products and services under contract to an array of customers including utilities, other power marketers, such as retail energy providers, or counterparties in the open market. These products and services may be transacted bilaterally or through exchange markets and include but are not limited to:

Power also sells wholesale natural gas, primarily through a full-requirements BGSS contract with PSE&G to meet the gas supply requirements of PSE&G’s customers. In 2014, the BPU approved an extension of the long-term BGSS contract to March 31, 2019 and then year-to-year thereafter unless terminated by either party with a two year notice.

Approximately 45% of PSE&G’s peak daily gas requirements is provided from Power’s firm gas transportation capacity, which is available every day of the year. Power satisfies the remainder of PSE&G’s requirements from storage contracts, liquefied natural gas, seasonal purchases, contract peaking supply and propane. Based upon the availability of natural gas beyond PSE&G’s daily needs, Power sells gas to others and uses it for its generation fleet.

In addition to its nuclear and fossil generation fleet, Power owns and operates 414 MW direct current (dc) of PV solar generation facilities. Power also has a 50% ownership interest in a 208 MW oil-fired generation facility in Hawaii.

The remainder of this section about Power covers our nuclear and fossil fleet in the Mid-Atlantic and Northeast regions which comprises the vast majority of Power’s operations and financial performance.

How Power’s Generation Operates

Nearly all of our generation capacity consists of nuclear and fossil generation ( 10,562 MW) that is located in the Northeast and Mid-Atlantic regions of the United States in some of the country’s largest and most developed electricity markets. For additional information see Item 2. Properties .

The map below shows the locations of our Northeast and Mid-Atlantic nuclear and fossil generation facilities, including projects currently under construction:

Our nuclear and fossil installed capacity utilizes a diverse mix of fuels. As of December 31, 2017 , our fuel mix was comprised of 47% gas, 35% nuclear, 11% coal, 5% oil and 2% pumped storage. This fuel diversity helps to mitigate risks associated with fuel price volatility and market demand cycles. Our total generating output in 2017 was approximately 51,100 GWh. The generation mix by fuel type in recent years has reflected the relatively more favorable price of natural gas compared to coal, making it more economical to run certain of our gas units in place of our coal units. The following table indicates the proportionate share of generating output by fuel type in 2017 .

	Generation by Fuel Type (A)		Actual 2017
	Nuclear:
	New Jersey facilities		41%
	Pennsylvania facilities		21%
	Fossil:
	Coal:
	Pennsylvania facilities		11%
	Connecticut facilities		—%	(B)
	Natural Gas and Oil:
	New Jersey facilities		17%
	New York facilities		10%
	Connecticut facilities		—%	(B)
	Total		100%

(B) Less than one percent.

We are also executing the following growth projects which are included in the 2018-2020 planned capital spend of $520 million for Fossil Growth Opportunities disclosed in Item 7. MD&A—Capital Requirements .

	Major Growth Projects
	As of December 31, 2017
	Project		Location		Expected In-Service Date
	Keys Energy Center gas-fired combined cycle generating station (755 MW)		Maryland		2018
	Sewaren 7 dual-fueled combined cycle generating station (540 MW)		New Jersey		2018
	Bridgeport Harbor 5 gas-fired combined cycle generating station (485 MW)		Connecticut		2019
	Bethlehem Energy Center (BEC) combined cycle uprate (56 MW)		New York		2019	(A)
	Bergen dual-fueled combined cycle uprate (32 MW)		New Jersey		2020

Our generation units have historically been characterized as serving one or more of three general energy market segments: base load; load following; and peaking, based on their operating capability and performance.

In the energy markets in which we operate, owners of power plants specify to the ISO prices at which they are prepared to generate and sell energy based on the marginal cost of generating energy from each individual unit. The ISOs will generally dispatch in merit order, calling on the lowest variable cost units first and dispatching progressively higher-cost units until the point that the entire system demand for power (known as the system “load”) is satisfied reliably. Base load units are dispatched first, with load following units next, followed by peaking units. It should be noted that the sustained lower pricing of natural gas over the past several years has resulted in changes in relative operating costs compared to historical norms, wherein some gas-fired generation is now able to displace some coal-fired generation. This change, combined with the addition of new, more efficient generation capacity, has altered the historical dispatch order of certain plants in the markets where we operate.

During periods when one or more parts of the transmission grid are operating at full capability, thereby resulting in a constraint on the transmission system, it may not be possible to dispatch units in merit order without violating transmission reliability standards. Under such circumstances, the ISO may dispatch higher-cost generation out of merit order within the congested area and power suppliers will be paid an increased Locational Marginal Price (LMP) in congested areas, reflecting the bid prices of those higher-cost generation units.

Typically, the bid price of the last unit dispatched by an ISO establishes the energy market-clearing price. After considering the market-clearing price and the effect of transmission congestion and other factors, the ISO calculates the LMP for every location in the system. The ISO pays all units that are dispatched their respective LMP for each MWh of energy produced, regardless of their specific bid prices. Since bids generally approximate the marginal cost of production, units with lower marginal costs typically generate higher operating profits than units with comparatively higher marginal costs.

This method of determining supply and pricing creates a situation where natural gas prices often have a major influence on the price that generators will receive for their output, especially in periods of relatively strong or weak demand. Therefore, changes in the price of natural gas will often translate into changes in the wholesale price of electricity. This can be seen in the following graphs which present historical annual spot prices and forward calendar prices as averaged over each year at two liquid trading hubs.

Historical data implies that the price of natural gas will continue to have a strong influence on the price of electricity in the primary markets in which we operate.

The prices reflected in the preceding graphs above do not necessarily illustrate our contract prices, but they are representative of market prices at relatively liquid hubs, with nearer-term forward pricing generally resulting from more liquid markets than pricing for later years. As shown above, prices may vary by location resulting from congestion or other factors, such as the availability of natural gas from the Marcellus (Leidy) and other shale-gas regions. These variations can be considerable. Concurrent with the development of regional shale gas, we have been increasing our purchases from the Marcellus/Utica shale gas regions and in 2017 they accounted for approximately 86% of the gas we procured. While these prices provide some perspective on past and future prices, the forward prices are volatile and there can be no assurance that such prices will remain in effect or that we will be able to contract output at these forward prices.

Fuel Supply

Our nuclear fuel contracts cover approximately 100% of our estimated uranium, enrichment and fabrication requirements through 2020 and a significant portion through 2022 .

In order to control emissions levels, our Bridgeport 3 unit uses a specific type of coal obtained from Indonesia. We have coal inventory at the Bridgeport Station as well as off-site storage to meet the plant’s projected requirements.

We have 1.3 billion cubic feet-per-day of firm transportation capacity and 0.9 billion cubic feet-per-day of firm storage delivery under contract to meet our obligations under the BGSS contract. This volume includes capacity from the Pennsylvania and Ohio shale gas regions where we purchase the majority of our natural gas. On an as-available basis, this firm transportation capacity may also be used to serve the gas supply needs of our generation fleet.

Power has contracted for approximately 125 million cubic feet-per-day of delivery capability on the PennEast Pipeline from eastern Pennsylvania to New Jersey with a targeted in-service date in 2019. This additional delivery capability will be used to supplement the BGSS contract.

We expect to be able to meet the fuel supply demands of our customers and our own operations. However, the ability to maintain an adequate fuel supply could be affected by several factors not within our control, including changes in prices and demand, curtailments by suppliers, severe weather, environmental regulations, and other factors. For additional information and a discussion of risks, see Item 1A. Risk Factors, Item 7. MD&A—Executive Overview of 2017 and Future Outlook and Item 8. Financial Statements and Supplementary Data— Note 13. Commitments and Contingent Liabilities .

Markets and Market Pricing

The vast majority of Power’s generation assets are located in three centralized, competitive electricity markets operated by ISO organizations all of which are subject to the regulatory oversight of FERC:

The price of electricity varies by location in each of these markets. Depending upon our production and our obligations, these price differentials may increase or decrease our profitability.

Commodity prices, such as electricity, gas, coal, oil and environmental products, as well as the availability of our diverse fleet of generation units to operate, also have a considerable effect on our profitability. Over the long-term, the higher the forward prices are, the more attractive an environment exists for us to contract for the sale of our anticipated output. However, higher prices also increase the cost of replacement power; thereby placing us at greater risk should our generating units fail to operate effectively or otherwise become unavailable.

Over the past few years, lower wholesale natural gas prices have resulted in lower electric energy prices. One of the reasons for the lower natural gas prices is greater supply from more recently-developed sources, such as shale gas, much of which is produced in adjacent states (e.g. Pennsylvania). This trend has reduced margin on forward sales as we re-contract our expected generation output.

In addition to energy sales, we earn revenue from capacity payments for our generating assets. These payments are compensation for committing our generating units to the ISO for dispatch at its discretion. Capacity payments reflect the value to the ISO of assurance that there will be sufficient generating capacity available at all times to meet system reliability and energy requirements. Currently, there is sufficient capacity in the markets in which we operate. However, in certain areas of these markets there are transmission system transfer limitations which raise concerns about reliability and create a more acute need for capacity.

In PJM and ISO-NE, where we operate most of our generation, the market design for capacity payments provides for a structured, forward-looking, transparent capacity pricing mechanism. This is through the Reliability Pricing Model (RPM) in PJM and the Forward Capacity Market (FCM) in ISO-NE. These mechanisms provide greater transparency regarding the value of capacity and provide a pricing signal to prospective investors in new generating facilities so as to encourage expansion of capacity to meet future market demands.

The prices to be received by generating units in PJM for capacity have been set through RPM base residual and incremental auctions and depend upon the zone in which the generating unit is located. For each delivery year, the prices differ in the various areas of PJM, depending on the transfer limitations of the transmission system in each area. Keystone and Conemaugh receive lower capacity prices than the majority of our PJM generating units since there are fewer constraints in that region and our generating units in New Jersey usually receive higher pricing.

Our PJM generating units are located in several zones and Power expects to realize the following average capacity prices from the base and incremental auctions which have been completed:

The price that must be paid by an entity serving load in the various zones is also set through these auctions. These prices can be higher or lower than the prices noted in the table above due to import and export capability to and from lower-priced areas.

We have obtained price certainty for our PJM capacity through May 2021 and New England capacity through May 2022 through the RPM and FCM pricing mechanisms, respectively.

Like PJM and ISO-NE, the NYISO provides capacity payments to its generating units, but unlike the other two markets, the New York market does not provide a forward price signal beyond a six month auction period.

On a prospective basis, many factors may affect the capacity pricing, including but not limited to:

For additional information on the RPM and FCM markets, as well as on state subsidization through various mechanisms, see Regulatory Issues—Federal Regulation.

Hedging Strategy

To mitigate volatility in our results, we seek to contract in advance for a significant portion of our anticipated electric output, capacity and fuel needs. We seek to sell a portion of our anticipated lower-cost generation over a multi-year forward horizon, normally over a period of two to three years. We believe this hedging strategy increases stability of earnings.

Among the ways in which we hedge our output are: (1) sales at PJM West and (2) BGS and similar full-requirements contracts. Sales at PJM West reflect block energy sales at the liquid PJM Western Hub and other transactions that seek to secure price certainty for our generation related products. The BGS-RSCP contract, a full-requirements contract that includes energy and capacity, ancillary and other services, is awarded for three-year periods through an auction process managed by the BPU. The volume of BGS contracts and the mix of electric utilities that our generation operations serve will vary from year to year. Pricing for the BGS contracts, including a capacity component, for recent and future periods by purchasing utility is as follows:

Although we enter into these hedges in an effort to provide price certainty for a large portion of our anticipated generation, there is variability in both our actual output as well as in the effectiveness of our hedges. Actual output will vary based upon total market demand, the relative cost position of our units compared to other units in the market and the operational flexibility of our units. Hedge volume can also vary, depending on the type of hedge into which we have entered. The BGS auction, for example, results in a contract that provides for the supplier to serve a percentage of the default load of a New Jersey EDC, that is, the load that remains after some customers have chosen to be served directly either by third-party suppliers or through municipal aggregation. The amount of power supplied through the BGS auction varies based on the level of the EDC’s default load, which is affected by the number of customers who are served by third-party suppliers, as well as by other factors such as weather and the economy.

In recent years, as market prices declined from previous levels, there was an incentive for more of the smaller commercial and industrial electric customers to switch to third-party suppliers. In a falling price environment, this has a negative impact on our margins, as the anticipated BGS pricing is replaced by lower spot market pricing. As average BGS rates have declined to a level that more closely resembles current market prices, customers may see less of an incentive to switch to third-party suppliers. We are unable to determine the degree to which this switching, or “migration,” will continue, but the impact on our results could be material should market prices fall or rise significantly.

Power is developing a retail energy business to sell energy directly to commercial and industrial customers. We believe a retail energy platform complements our existing wholesale generation-to-load marketing business that is intended to hedge our generation assets. Power began these marketing activities in 2017 and has been granted retail energy supplier licenses in New Jersey, Pennsylvania and Maryland.

As of February 8, 2018 , we had contracted for the following percentages of our anticipated base load generation output for the next three years with modest amounts beyond 2020 .

 

In a changing market environment, this hedging strategy may cause our realized prices to differ materially from current market prices. In a rising price environment, this strategy normally results in lower margins than would have been the case had no hedging activity been conducted. Alternatively, in a falling price environment, this hedging strategy will tend to create margins higher than those implied by the then-current market.

Our fuel strategy is to maintain certain levels of uranium in inventory and to make periodic purchases to support such levels. Our nuclear fuel commitments cover approximately 100% of our estimated uranium, enrichment and fabrication requirements through 2020 and a significant portion through 2022 . In March 2017, Westinghouse Electric Company (WEC) announced that it had filed for Chapter 11 bankruptcy in New York. WEC provides nuclear fuel fabrication services for Salem Units 1 and 2. In January 2018, Brookfield Business Partners LP announced its intention to acquire WEC. The acquisition is expected to close in 2018 if it receives the required approvals from the regulators and bankruptcy courts. No assurances can be given that the acquisition will be approved. In the event that WEC is unable to continue to provide fabrication services, we can provide no assurance that Power would be able to find alternative providers of such services in a timely manner or on acceptable terms. A failure by WEC to perform its obligations during the pendency of, or following its emergence from, bankruptcy could have a material adverse impact on our business, the financial results of specific plants and on our results of operations.

We also have various long-term fuel purchase commitments for coal to support our Keystone and Conemaugh stations. These purchase obligations are consistent with our strategy in general to enter into contracts for our fuel supply in comparable volumes to our sales contracts.

We take a more opportunistic approach in hedging both the fuel for and the anticipated output of our natural gas-fired generation. The generation from these units is less predictable, as a significant portion of these units will only dispatch when aggregate market demand has exceeded the supply provided by lower-cost units. Additionally, the recent development of low-cost gas supplies in the Marcellus region presents opportunities during certain portions of the year to procure gas for our generating units at attractive prices.

More than half of Power’s expected gross margin in 2018 relates to our hedging strategy, our expected revenues from the capacity market mechanisms described above and certain ancillary service payments such as reactive power.

Other

Energy Holdings primarily owns and manages a portfolio of domestic lease investments. The majority of Energy Holdings’ $565 million of domestic lease investments are primarily energy-related leveraged leases. As of December 31, 2017 , the counterparties for 59% of our total leveraged lease investments were rated below investment grade by Standard & Poor’s (S&P). See Item 8. Financial Statements and Supplementary Data— Note 8. Financing Receivables for additional information.

Energy Holdings’ leveraged leasing portfolio is designed to provide a fixed rate of return. Leveraged lease investments involve three parties: an owner/lessor, a creditor and a lessee. In a typical leveraged lease financing, the lessor purchases an asset to be leased. The purchase price is typically financed 80% with debt provided by the creditor and the balance comes from equity funds provided by the lessor. The creditor provides long-term financing to the transaction secured by the property subject to the lease. Such long-term financing is non-recourse to the lessor and, with respect to our lease investments, is not presented on our Consolidated Balance Sheets.

The lessor acquires economic and tax ownership of the asset and then leases it to the lessee for a period of time no greater than 80% of its remaining useful life. As the owner, the lessor is entitled to depreciate the asset under applicable federal and state tax guidelines. The lessor receives income from lease payments made by the lessee during the term of the lease and from tax benefits associated with interest and depreciation deductions with respect to the leased property. Our ability to realize these tax benefits is dependent on operating gains generated by our other operating subsidiaries and allocated pursuant to the consolidated tax sharing agreement between us and our operating subsidiaries.

Lease rental payments are unconditional obligations of the lessee and are set at levels at least sufficient to service the non-recourse lease debt. The lessor is also entitled to any residual value associated with the leased asset at the end of the lease term. An evaluation of the after-tax cash flows to the lessor determines the return on the investment. Under accounting principles generally accepted in the United States (GAAP), the leveraged lease investment is recorded net of non-recourse debt and income is recognized as a constant return on the net unrecovered investment.

For additional information on leases, including the credit, tax and accounting risks, see Item 1A. Risk Factors, Item 7A. Quantitative and Qualitative Disclosures About Market Risk—Credit Risk, and Item 8. Financial Statements and Supplementary Data— Note 8. Financing Receivables .

In accordance with a twelve year Amended and Restated Operations Services Agreement (OSA) entered into by PSEG LI and LIPA, PSEG LI commenced operating LIPA’s electric T&D system in Long Island, New York on January 1, 2014. As required by the OSA, PSEG LI also provides certain administrative support functions to LIPA. PSEG LI uses its brand in the Long Island T&D service area. Pursuant to the OSA, PSEG LI acts as LIPA’s agent in performing many of its obligations and in return (a) receives reimbursement for pass-through operating expenditures, (b) receives a fixed management fee and (c) is eligible to receive an incentive fee contingent on meeting established performance metrics. In addition, there is the opportunity for the parties to extend the contract for an additional eight years subject to the achievement by PSEG LI of certain performance levels during the initial term of the OSA. Also, since January 2015, Power provides fuel procurement and power management services to LIPA under separate agreements.  

COMPETITIVE ENVIRONMENT

PSE&G

Our T&D business is minimally impacted when customers choose alternate electric or gas suppliers since we earn our return by providing transmission and distribution service, not by supplying the commodity. Increased reliance by customers on net-metered generation, including solar, and changes in customer behaviors can result in decreased reliance on our system and impact our revenues and investment opportunities. The demand for electric energy and gas by customers is affected by customer conservation, economic conditions, weather and other factors not within our control.

Changes in the current policies for building new transmission lines, such as those ordered by FERC and being implemented by PJM and other ISOs to eliminate contractual provisions that previously provided us a “right of first refusal” (ROFR) to construct projects in our service territory, could result in third-party construction of transmission lines in our area in the future and also allow us to seek opportunities to build in other service territories. These implementing rules within the regions are still in flux so both the extent of the risk within our service territory and the opportunities for our transmission business elsewhere remain difficult to assess. For additional information, see the discussion in Regulatory Issues—Federal Regulation—Transmission Regulation, below.

Construction of new local generation and changing customer usage patterns also have the potential to reduce the need for the construction of new transmission to transport remote generation and alleviate system constraints.

Power

Various market participants compete with us and one another in transacting in the wholesale energy markets, entering into bilateral contracts and selling to individual and aggregated retail customers. Our competitors include:

New additions of lower-cost or more efficient generation capacity could make our plants less economic in the future. Although it is not clear if this capacity will be built or, if so, what the economic impact will be, such additions would impact market prices and our competitiveness.

Our business is also under competitive pressure due to demand side management (DSM) and other efficiency efforts aimed at changing the quantity and patterns of usage by consumers which could result in a reduction in load requirements. A reduction in load requirements can also be caused by economic cycles, weather, municipal aggregation and other customer migration and other factors. In addition, how resources such as demand response and capacity imports are permitted to bid into the capacity markets also affects the prices paid to generators such as Power in these markets. It is also possible that advances in technology, such as distributed generation and micro grids, will reduce the cost of alternative methods of producing electricity to a level that is competitive with that of most central station electric production. To the extent that additions to the electric transmission system relieve or reduce limitations and constraints in eastern PJM where most of our plants are located, our revenues could be adversely affected. Changes in the rules governing what types of transmission will be built, who is selected to build transmission and who will pay the costs of future transmission could also impact our generation revenues.

Adverse changes in energy industry law, policies and regulation could have significant economic, environmental and reliability consequences. Changes implemented in the PJM and New England capacity markets and other proposed market changes discussed more fully in Regulatory Issues—Federal Regulation provide the opportunity for additional compensation in both the energy and capacity markets.

Environmental issues, such as restrictions on emissions of carbon dioxide (CO ₂ ) and other pollutants, may also have a competitive impact on us to the extent that it becomes more expensive for some of our plants to remain compliant, thus affecting our ability to be a lower-cost provider compared to competitors without such restrictions. In addition, most of our plants, which are located in the Northeast where rules are more stringent, can be at an economic disadvantage compared to our competitors in certain Midwest states.

While it is our expectation that continued efforts may be undertaken by the federal and state governments to preserve the existing base of fossil and nuclear generating plants, we still believe that pressures from renewable resources will continue to increase. For example, many parts of the country, including the mid-western region served by the Midwest Independent System Operator (MISO), the PJM region and the California ISO, have either implemented or proposed implementing changes to their respective regional transmission planning processes that may enable the construction of large amounts of “public policy” transmission to move renewable generation to load centers. For additional information, see the discussion in Regulatory Issues—Federal Regulation.

REGULATORY ISSUES

In the ordinary course of our business, we are subject to regulation by, and are party to various claims and regulatory proceedings with, FERC, the BPU, the Commodity Futures Trading Commission and various state and federal environmental regulators, among others. For information regarding material matters, other than those discussed below, see Item 3. Legal Proceedings and Item 8. Financial Statements and Supplementary Data—Note 13. Commitments and Contingent Liabilities.

Federal Regulation

FERC

FERC is an independent federal agency that regulates the transmission of electric energy and gas in interstate commerce and the sale of electric energy and gas at wholesale pursuant to the Federal Power Act (FPA) and the Natural Gas Act. PSE&G and the generation and energy trading subsidiaries of Power are public utilities as defined by the FPA. FERC has extensive oversight over such public utilities. FERC approval is usually required when a public utility seeks to: sell or acquire an asset that is regulated by FERC (such as a transmission line or a generating station); collect costs from customers associated with a new transmission facility; charge a rate for wholesale sales under a contract or tariff; or engage in certain mergers and internal corporate reorganizations.

FERC also regulates generating facilities known as qualifying facilities (QFs). QFs are cogeneration facilities that produce electricity and another form of useful thermal energy, or small power production facilities where the primary energy source is renewable, biomass, waste or geothermal resources. QFs must meet certain criteria established by FERC. We own various QFs through Power. QFs are subject to some, but not all, of the same FERC requirements as public utilities.

FERC also regulates Regional Transmission Operators (RTOs)/ISOs, such as PJM, and their energy and capacity markets.

For us, the major effects of FERC regulation fall into five general categories:

Regulation of Wholesale Sales—Generation/Market Issues/Market Power

Under FERC regulations, public utilities that wish to sell power at market rates must receive FERC authorization (MBR Authority) to sell power in interstate commerce before making power sales. They can sell power at cost-based rates or apply to FERC for authority to make market-based rate (MBR) sales. For a requesting company to receive MBR Authority, FERC must first make a determination that the requesting company lacks market power in the relevant markets and/or that market power in the relevant markets is sufficiently mitigated. The following PSEG companies are public utilities and currently have MBR Authority: PSE&G, PSEG Energy Resources & Trade (ER&T), PSEG Fossil, PSEG Nuclear, PSEG Power Connecticut, PSEG New Haven, PSEG Energy Solutions , PSEG Keys Energy Center LLC, Pavant Solar II LLC, San Isabel Solar LLC and Bison Solar LLC. FERC requires that holders of MBR Authority file an update every three years demonstrating that they continue to lack market power and/or that their market power has been sufficiently mitigated and report in the interim to FERC any material change in facts from those FERC relied on in granting MBR Authority. 

In November 2017, FERC issued an order accepting the triennial filing made by the PSEG companies seeking authority to sell energy, capacity and ancillary services at market-based rates.

Energy Clearing Prices

Energy clearing prices in the markets in which we operate are generally based on bids submitted by generating units. Under FERC-approved market rules, bids are subject to price caps and mitigation rules applicable to certain generation units. FERC rules also govern the overall design of these markets. At present, all units within a delivery zone receive a clearing price based on the bid of the marginal unit (i.e. the last unit that must be dispatched to serve the needs of load) which can vary by location. In addition, recent rule changes in the energy markets administered by PJM and ISO-NE (see Capacity Market Issues below) impose rigorous performance obligations and nonperformance penalties on resources during times of system stress. These FERC rules provide an opportunity for bonus payments or require the payment of penalties depending on whether a unit is available during a performance hour.

FERC has also ordered certain favorable changes to energy market price formation rules improving shortage pricing and enhancing bidding flexibility for units. We continue to advocate in this context for additional changes in market rules that would provide more transparency regarding operator actions affecting energy market prices and would promote better alignment between generation dispatch decisions and energy market price outcomes. We cannot predict what actions FERC might ultimately take, but such an examination could lead to future rule changes.

In June 2017, PJM issued an energy price formation proposal to address a flaw in the energy market in which energy prices during off-peak periods often do not reflect the production costs of generators during these periods even though they are serving load. PJM’s proposal would allow large, inflexible units to set price. If placed into effect, this proposal will improve price formation by ensuring that the marginal costs of units serving load will be better reflected in clearing prices. We cannot predict the outcome of this matter.

Capacity Market Issues

PJM, NYISO and ISO-NE each have capacity markets that have been approved by FERC. FERC regulates these markets and continues to examine whether the market design for each of these three capacity markets is working optimally. Various forums are considering how the competitive market framework can incorporate or be reconciled with state public policies that support particular resources, resource attributes or emerging technologies, whether generators are being sufficiently compensated in the capacity market and whether subsidized resources may be adversely affecting capacity market prices. We cannot predict what action, if any, FERC might take with regard to capacity market designs.

PJM —The RPM is the locational installed capacity market design for the PJM region, including a forward auction for installed capacity. Under the RPM, generators located in constrained areas within PJM are paid more for their capacity as an incentive to ensure adequate supply where generation capacity is most needed. The mechanics of the RPM in PJM continue to evolve and be refined in stakeholder proceedings and FERC proceedings in which we are active.

During 2015, PJM implemented a new “Capacity Performance” (CP) mechanism that created a more robust capacity product with enhanced incentives for performance during emergency conditions and significant penalties for non-performance, which was implemented fully in the May 2017 RPM auction for the 2020-2021 Delivery Year. The CP mechanism is intended to enhance the participation of intermittent and demand response resources (seasonal resources). Specifically, FERC approved PJM’s modifications to the aggregation rules to improve the ability of seasonal resources to participate. However, two complaints remain pending that ask FERC to investigate the rules governing the participation of seasonal resources and extend the participation of the base resources for future auctions. We cannot predict the outcome of these matters.

PJM issued a series of white papers in response to public policies that seek to recognize value associated with generation plants beyond their cost effectiveness and reliability attributes. The three proposals are intended to spur stakeholder discussion and include both potential capacity and energy market reforms. The first energy market reform (see Energy Clearing Prices and

Price Formation Initiatives) would allow inflexible generating units to set prices resulting in reduced uplift payments and improved price signals while the second energy market reform contemplates a voluntary carbon pricing program where states that elect to participate in the program would agree to put a price on carbon emissions. The capacity market proposal contemplates a two-stage capacity auction which, in its current form, would improve prices for unsubsidized resources, but would still continue to provide capacity payments for subsidized resources. The two-stage capacity market auction is now pending before the PJM stakeholders for consideration.

ISO-NE —ISO-NE’s market for installed capacity in New England provides fixed capacity payments for generators, imports and demand response. The market design consists of a forward-looking auction for installed capacity that is intended to recognize the locational value of resources on the system and contains incentive mechanisms to encourage availability during stressed system conditions. ISO-NE also employs a mechanism, similar to PJM’s CP mechanism, that provides incentives for performance and that imposes charges for non-performance during times of system stress. We view this mechanism as generally positive for generating resources as providing more robust income streams. However, it also imposes additional financial risk for non-performance. One aspect of the current market design that we do not support due to the capacity market suppression associated with this mechanism is the exemption from the MOPR in the capacity market afforded for up to 200 MW annually (600 MW cumulatively) of renewable resources. Recently, ISO-NE submitted proposed changes to the FCM referred to as the Competitive Auctions and Sponsored Policy Resources (CASPR) proposal to accommodate clean and renewable energy policy resources. The CASPR design creates a second auction that commences immediately following the Forward Capacity Auction and provides the opportunity for certain renewable, clean and alternative energy resources to acquire supply obligations when they cannot clear economically in the Forward Capacity Auction. The CASPR design also proposed to phase out the 200 MW exemption from the minimum offer price rule (MOPR). We cannot predict the outcome of this proceeding.

NYISO —NYISO operates a short-term capacity market that provides a forward price signal only for six months into the future. Various matters pending before FERC could affect the competitiveness of this market and the outcome of these proceedings could result in artificial price suppression unless sufficient market protections are adopted.

One capacity market matter pending before FERC involves rules to govern payments and bidding requirements for generators proposing to exit the market but required to remain in service for reliability reasons. In March 2015, FERC issued an order which held that units receiving special reliability payments could properly take those payments into account in formulating capacity market bids. We believe that this ruling could impact efficient price formation in the capacity market and could artificially suppress capacity market outcomes. In April 2015, a trade association, Independent Power Producers of New York, Inc. (IPPNY) of which Power is a member, filed for rehearing by FERC of this ruling. This rehearing is still pending. Also, in connection with this same proceeding, FERC required NYISO to submit a report addressing whether buyer-side mitigation measures are needed for new entry occurring in the “Rest of State” (ROS) region and for uneconomic retention and repowering anywhere in the state. NYISO filed a report with FERC in December 2015 contending that these measures are not needed. The IPPNY has opposed NYISO’s contentions. The matter remains pending before FERC. In addition, in May 2015, the New York Public Service Commission and other New York agencies filed a complaint at FERC requesting certain exemptions from the NYISO rules that prevent capacity suppliers from submitting bids that are not market competitive. In October 2015, FERC granted in part, certain of the requested exemptions for renewable resources and for resources being used by the owner for self-supply. The IPPNY has challenged NYISO’s proposed implementation of the newly required exemptions. This challenge is still pending.

Price Formation Initiatives

Power has been actively involved both through stakeholder processes and through filings at FERC in seeking improvements to the rules for setting prices for energy in the day-ahead and real-time markets administered by PJM and other system operators. FERC recently issued an order instituting an investigation into the pricing of fast-start resources by three grid operators, PJM, NYISO and Southwest Power Pool. Fast-start resources typically are committed in real-time, very close to the interval when needed and can respond quickly to unforeseen system needs. However, without fast-start pricing, some fast-start resources are ineligible to set prices due to inflexible operating limits. As a result, prices may not reflect the marginal cost of serving load. PJM submitted a response to FERC’s order that supported reforms to fast-start pricing with minor modifications. PJM also contended that all fast-start resource scheduled by PJM should be eligible to set locational marginal prices. We cannot predict the impact that these changes may have on our business.

Notice of Proposed Rulemaking (NOPR) on Baseload Generation

In September 2017, the Secretary of the U.S. Department of Energy (DOE) issued a NOPR to allow a full recovery of costs for certain eligible units physically located within the FERC-approved organized markets. In January 2018, FERC issued an order terminating the proceeding and initiating a new proceeding to explore resilience issues with the RTOs and ISOs. In the new proceeding, FERC is requiring each RTO and ISO to respond to a series of questions that appear to be intended to gain an

understanding of the steps each RTO and ISO is taking to ensure the resilience of their respective grids. We expect to participate in this proceeding, but we are unable to predict the outcome.

Transmission Regulation

FERC has exclusive jurisdiction to establish the rates and terms and conditions of service for interstate transmission. We currently have FERC-approved formula rates in effect to recover the costs of our transmission facilities. Under this formula, rates are put into effect in January of each year based upon our internal forecast of annual expenses and capital expenditures. Rates are subsequently trued up to reflect actual annual expenses and capital expenditures. Our allowed ROE is 11.68% for both existing and new transmission investments and we have received incentive rates, affording a higher ROE, for certain large scale transmission investments.

In October 2017, the 2018 Annual Formula Rate Update was filed with FERC and requested approximately $212 million in increased annual transmission revenues effective January 1, 2018, subject to true-up. In January 2018, PSE&G filed with FERC a revised 2018 Annual Transmission Formula Rate Update reducing the 2018 transmission annual revenue requirement to reflect the federal corporate income tax rate reduction from 35% to 21%, effective January 1, 2018, as provided in new comprehensive tax legislation enacted in December 2017 (Tax Act). This change in the federal corporate income tax rate reduces the annual revenue requirement by $148 million. Each year, transmission revenues are adjusted to reflect items such as updating estimates used in the filing with actual data. For additional information about our transmission formula rate, see Item 8. Financial Statements and Supplementary Data— Note 6. Regulatory Assets and Liabilities .

Transmission Policy Developments —FERC concluded in Order 1000 that the incumbent transmission owner should not always have a ROFR to construct and own transmission projects in its service territory. The current PJM rules retain carve-outs for projects that will continue to default to incumbents for construction responsibility, including immediately needed reliability projects, upgrades to existing transmission facilities, projects cost-allocated to a single transmission zone, and projects being built on existing rights-of-way and whose construction would interfere with incumbents’ use of their rights-of-way.

In a February 2016 order, FERC reversed a previous order and accepted a filing by the PJM transmission owners seeking authority to assign costs for Regional Transmission Expansion Plan projects (subject to PJM Board approval requirements) solely addressing localized needs to customers within the local transmission owner’s zone. FERC’s action in this order provides an exemption from the Order 1000 open window procedures for projects constructed by transmission owners to meet local transmission planning criteria. FERC’s orders have been challenged at the D.C. Circuit and PSE&G has intervened in support of FERC.

There are several matters pending before FERC that concern the allocation of costs associated with transmission projects being constructed by PSE&G contending that insufficient levels of costs are being allocated to customers in the PSE&G transmission zone. Projects involved include the Artificial Island project, the Bergen-Linden project in New Jersey and a smaller project in Sewaren, New Jersey. In April 2016, FERC issued orders denying the complaints and leaving the current cost allocation in effect as to the Artificial Island and Bergen-Linden projects. Due to an intervening FERC order concerning the allocation of costs for projects constructed to meet local reliability requirements, FERC directed that all of the Sewaren costs be allocated to customers in the PSE&G transmission zone. It is anticipated that additional proceedings are likely to occur.

I n February 2016, FERC issued an order granting PSE&G’s request that it be permitted to seek recovery of 100% of its portion of the project’s costs to address identified high voltage issues at Artificial Island in New Jersey if the project is canceled for reasons beyond PSE&G’s control. In April 2016, PSE&G accepted construction responsibility for the three components of the project that PJM assigned to it, based on having reached agreement with PJM regarding an estimate for the project base cost of $273 million, plus risk and contingency for a total project cost of up to $340 million. In March 2017, PJM staff made its final recommendation to the PJM Board with respect to the project. In April 2017, the PJM Board approved a portion of the project to PSE&G of the construction of necessary upgrade work at a cost of approximately $130 million. In October 2017, FERC accepted PJM’s filing on the grounds that PJM correctly applied its Tariff. However, FERC deferred a ruling on whether the cost allocation methodology applied to the Artificial Island project is appropriate. FERC will decide this issue in a separate proceeding that is currently pending. We are unable to predict the outcome.

In June 2015, a transmission developer filed a complaint against PJM claiming that PJM wrongfully refused to provide data and a transparent process for evaluating transmission network upgrade requests that the transmission developer had submitted to PJM. Although not named as a respondent, the complaint identifies PSE&G as one of the companies claimed to have been involved. In January 2018, a FERC administrative law judge issued an order generally finding that PJM and transmission owners, including PSE&G, did not engage in wrongful conduct. In addition, the developer’s assertion of an entitlement to monetary damages was expressly denied. However, in a determination disputed by PSE&G, the order found that the PJM process lacked transparency. The judge’s order will now be briefed by all parties for additional determinations by FERC.We are unable to predict the outcome of these proceedings.

Another proceeding is a matter remanded from a federal appellate court concerning the appropriate cost allocation for certain 500 kV projects in PJM that either have been built or are in the process of being built. A proposed settlement was filed with FERC in June 2016. The settlement, if adopted by FERC, would result in increased annual cost allocations to customers in the PSE&G transmission zone. Under this settlement, Power, as a BGS supplier could become obligated to pay amounts previously paid by other PJM transmission customers. However, we do not believe that the anticipated level of any such potential payments would have a material effect on Power’s financial statements. We believe that there is a mechanism in place under the BGS contract for the pass-through of increases in transmission charges.

In February 2018, FERC issued an order finding that the transmission planning procedures used by the PJM transmission owners, a group that includes PSE&G, for supplemental projects do not adhere to the coordination and transparency principles of FERC’s Order No. 890. FERC determined that certain terms and conditions in the PJM governing documents are unjust and unreasonable. FERC directed PJM and the PJM transmission owners to submit certain revisions to the manner in which the stakeholder process for supplemental projects is conducted. PSE&G will be participating in the PJM transmission owners’ compliance filing.

Transmission Rate Proceedings —Numerous complaints have been filed at FERC in recent years seeking to reduce the base ROE of transmission owners across the country. Many of those complaints were resolved through agreement and settlement resulted in ROE reductions while others remain pending in the FERC adjudication process or are being litigated in the courts. Recent court decisions, as well as anticipated changes in the makeup at FERC, create some uncertainty as to the timing and outcome of these complaints. The results of these settlement and proceedings could set precedents for other transmission owners with formula rates in place, including PSE&G.

Con Edison Wheeling Agreement —Effective May 1, 2017, a wheeling arrangement which enabled Con Edison to move 1,000 MW of power from southeastern New York across the PSE&G system for delivery into New York City expired. Amounts that would have been recovered from Con Edison had this arrangement continued are now being recovered from other customers.  PSE&G believes the current planning assumptions used by PJM are consistent with sound transmission planning principles. However, PSE&G disagrees with the absence of a mechanism to assign PJM transmission upgrade costs to Con Edison that reflect Con Edison’s reliance on the PJM transmission grid. PSE&G and the BPU jointly filed a rehearing application at FERC seeking reversal of a determination not to create such a mechanism in connection with a PJM/NYISO joint operating agreement. In addition, in December 2017, the BPU filed a complaint at FERC against Con Edison and others petitioning FERC to create such a cost allocation mechanism that would assign PJM costs to New York.

Compliance

FERC —For information about the preliminary non-public investigation initiated by the FERC Staff regarding errors in the calculation of certain components of Power’s cost-based bids for its New Jersey fossil generating units in the PJM energy market and the quantity of energy that Power offered into the energy market for its fossil peaking units compared to the amounts for which Power was compensated in the capacity market for those units, see Item 8. Financial Statements and Supplementary Data— Note 13. Commitments and Contingent Liabilities .

Reliability Standards— Congress has required FERC to put in place, through the North American Electric Reliability Council (NERC), national and regional reliability standards to ensure the reliability of the U.S. electric transmission and generation system (grid) and to prevent major system blackouts. As a result, FERC directed the NERC to draft a physical security standard intended to further protect assets deemed “critical” to reliability of the grid. In November 2014, FERC issued an order approving the NERC’s proposed physical security standard. Under the standard, utilities will be required to identify critical substations as well as develop threat assessment plans to be reviewed by independent third parties. In our case, the third-party is PJM. As part of these plans, utilities could decide or be required to build additional redundancy into their systems. This standard will supplement the Critical Infrastructure Protection standards that are already in place and that establish physical and cybersecurity protections for critical systems. We are taking steps to meet these obligations. FERC directed the NERC to develop a new reliability standard to provide security controls for supply chain management associated with the procurement of industrial control system hardware, software, and services related to bulk electric system operations. When adopted, compliance with these new standards would be expected to impose additional obligations and costs.

Commodity Futures Trading Commission (CFTC)

In accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), the SEC and the CFTC are in the process of implementing a new regulatory framework for swaps and security-based swaps. The legislation was enacted to reduce systemic risk, increase transparency and promote market integrity within the financial system by providing for the registration and comprehensive regulation of swap dealers and by imposing recordkeeping, data reporting, margin and clearing requirements with respect to swaps. To implement the Dodd-Frank Act, the CFTC has engaged in a comprehensive rulemaking process and has issued a number of proposed and final rules addressing many of the key issues. We are currently subject to recordkeeping and data reporting requirements applicable to commercial end users. The CFTC has also re-proposed

rules establishing position limits for trading in certain commodities, such as natural gas, and we will begin complying with these rules once they become final.

Nuclear Regulatory Commission (NRC)

Our operation of nuclear generating facilities is subject to comprehensive regulation by the NRC, a federal agency established to regulate nuclear activities to ensure protection of public health and safety, as well as the security and protection of the environment. Such regulation involves testing, evaluation and modification of all aspects of plant operation in light of NRC safety and environmental requirements. Continuous demonstration to the NRC that plant operations meet requirements is also necessary. The NRC has the ultimate authority to determine whether any nuclear generating unit may operate. The current operating licenses of our nuclear facilities expire in the years shown in the following table:

The NRC conducts ongoing reviews of nuclear industry operating experience and may issue or revise regulatory requirements as a result of these ongoing reviews. We are unable to predict the final outcome of these reviews or the cost of any actions we would need to take to comply with any new regulations, including possible modifications to our Salem, Hope Creek and Peach Bottom facilities, but such costs could be material.

State Regulation

Since our operations are primarily located within New Jersey, our principal state regulator is the BPU, which oversees electric and natural gas distribution companies in New Jersey. We are also subject to various other states’ regulations due to our operations in those states.

Our New Jersey utility operations are subject to comprehensive regulation by the BPU including, among other matters, regulation of retail electric and gas distribution rates and service, the issuance and sale of certain types of securities and compliance matters. PSE&G’s participation in solar, demand response and energy efficiency programs is also regulated by the BPU, as the terms and conditions of these programs are approved by the BPU. BPU regulation can also have a direct or indirect impact on our power generation business as it relates to energy supply agreements and energy policy in New Jersey.

We must file electric and gas rate cases with the BPU in order to change our utility base distribution rates. In January 2018, PSE&G filed a distribution base rate case as required by the BPU as a condition of approval of PSE&G’s Energy Strong Program. The filing requests $9.6 billion in rate base as of December 31, 2018, a 10.3% return on equity and a capitalization structure with a 54% equity component. The filing also requests an approximate one percent increase in revenues and seeks to recover investments made to strengthen electric and gas distribution systems. In its filing, PSE&G requested that these rates take into account a reduction in the revenue requirement as a result of the federal corporate income tax rate reduction from 35% to 21% provided in the Tax Act including a one-time credit for estimated excess income taxes collected between January 1, 2018 and the time new rates go into effect, and the flow-back to customers of certain additional tax benefits. PSE&G anticipates the new base rates will go into effect in the fourth quarter of 2018.

Separately, in January 2018, the BPU issued an order commencing a proceeding to ensure that the rate revenue resulting from expenses relating to taxes reflected in rates but no longer owed as the result of the Tax Act shall be passed onto the ratepayers. The BPU directed New Jersey utilities (including PSE&G) to make filings by March 2, 2018 setting forth interim rates to be effective April 1, 2018 reflecting the new federal corporate tax rate, and to subsequently file proposed final rates, effective July 1, 2018, incorporating all other effects of the Tax Act. This proceeding is currently pending.

In addition to base rates, we recover certain costs or earn on certain investments pursuant to mechanisms known as adjustment clauses. These clauses permit the flow-through of costs to, or the recovery of investments from, customers related to specific programs, outside the context of base rate case proceedings. Recovery of these costs or investments is subject to BPU approval for which we make periodic filings. Delays in the pass-through of costs or recovery of investments under these mechanisms could result in significant changes in cash flow. For additional information on our specific filings, see Item 8. Financial Statements and Supplementary Data— Note 6. Regulatory Assets and Liabilities .

Infrastructure Investment Program (IIP) —The BPU has enacted IIP regulations that allow utilities to construct, install or remediate utility plant and facilities related to reliability, resiliency and/or safety to support the provision of safe and adequate

service. Under these regulations, utilities can seek authority to make specified infrastructure investments in programs extending for up to five years with accelerated cost recovery mechanisms. The BPU characterized the IIP regulations as a regulatory initiative intended to create a financial incentive for utilities to accelerate the level of investment needed to promote the timely rehabilitation and replacement of certain non-revenue producing infrastructure that enhances reliability, resiliency, and/or safety. 

Gas System Modernization Program II (GSMP II) —In July 2017, we filed a petition with the BPU for a GSMP II program, an extension of GSMP to continue to modernize our gas system, through which PSE&G has proposed investing $2.7 billion over five years beginning in 2019. Under this proposed program, we plan to replace up to 1,250 miles of gas mains and associated service lines, with cost recovery at a 9.75% rate of return on equity through an accelerated recovery mechanism. This matter is pending. We believe the petition is consistent with the IIP regulations that the BPU approved in December 2017, as described above.

Energy Efficiency 2017 Program (EE 2017) —In August 2017, the BPU approved PSE&G’s petition for EE 2017 to extend three existing energy efficiency subprograms (multi-family, direct install and hospital efficiency) and establish two new residential energy efficiency offerings. The two new offerings include deployment of smart thermostats and a pilot program to provide residential customers with energy usage information enabling them to reduce consumption. EE 2017, as approved, allows PSE&G to extend the subprogram offerings and establish the residential energy efficiency sub-programs under its existing energy efficiency clause recovery process. The EE 2017 allows for $69 million of additional investment and $16 million of additional administrative and information technology costs. The EE 2017 was added as the eleventh component of the Green Program Recovery Charges (GPRC) rate effective September 1, 2017.

BPU Cybersecurity Requirements for Regulated Entities —In March 2016, the BPU issued an order for the regulated electric, natural gas and water/wastewater utilities to further reduce the potential for cyber threats to the reliability and resiliency of utility service and to protect customers’ information. The Order requires these regulated utilities, including PSE&G, to, among other conditions, implement a cybersecurity program that defines and implements organization accountabilities and responsibilities for cyber risk management activities, and establishes policies, plans, processes and procedures for identifying and mitigating cyber risk to critical systems. New Jersey utilities, including PSE&G, were required to be compliant with these requirements by October 1, 2017. We have submitted the required certification of compliance to the BPU.

In an effort to reduce the likelihood and severity of cyber incidents, we have a comprehensive cybersecurity program designed to protect and preserve the confidentiality, integrity and availability of our company and our customers’ information and our systems. In addition, we are subject to maintaining key cybersecurity controls to meet mandatory cybersecurity regulatory requirements. Our cybersecurity program is built on technical, procedural, and people-focused measures to detect, protect against, respond to, and recover from cyber threats to our systems and information including company, employee and customer data. Features of our program include: identifying critical information and systems; conducting cyber risk assessments of our and third party systems; maintaining awareness of cyber threats and vulnerabilities through partnerships with public and private entities, as well as industry groups; maintaining and testing our cybersecurity incident response plans and systems; training personnel on cybersecurity issues; and raising cybersecurity awareness throughout our company with electronic notices and seminars. We cannot assure that our cybersecurity program will be effective in preventing or mitigating cybersecurity incidents. For a discussion of the risks associated with cybersecurity threats, see Item 1A. Risk Factors.

Consolidated Tax Adjustments (CTA) —New Jersey is one of only a few states that make CTA in setting rates for regulated utilities. These adjustments to rate base are made during the rate-setting process and are intended to allocate to utility customers a portion of the tax benefits realized from the filing of a consolidated federal tax return by the utility’s parent corporation. The BPU has been considering the appropriateness of the adjustment and the methodology and mechanics of the calculation for some time. In October 2014, the BPU approved a proposal by its Staff that limits the tax benefit period to be considered in the calculation to five years, sets the distribution rate base adjustment at 25% of any such tax benefit and eliminates from the process any tax benefits tied to transmission earnings. In accordance with this action, this CTA policy will be applied only with respect to future distribution rate base cases, including our distribution base rate case filed in January 2018. In November 2014, the New Jersey Division of Rate Counsel appealed the BPU’s decision and in September 2017, the New Jersey Superior Court, Appellate Division granted that appeal on procedural grounds. Upon remand, in January 2018, and updated in February 2018, the BPU issued a draft proposed rule that is pending review by the Office of Administrative Law. The draft proposal includes a 60-day comment period. We do not expect the application of a CTA to have a material impact on PSE&G’s current earnings or its distribution base rate case filing.

Federal Tax Legislation —As a result of the enactment of the Tax Act, various state regulatory authorities, including the BPU, have taken action to ensure that excess federal income taxes previously collected in rates are returned to ratepayers. We have made filings to adjust the revenue requirement in certain of our rate matters as a result of the change in federal income tax rate. 

We continue to assess whether any further action needs to be taken by the company at this time.

Additional matters are discussed in Item 8. Financial Statements and Supplementary Data— Note 6. Regulatory Assets and Liabilities .

ENVIRONMENTAL MATTERS

We are subject to federal, state and local laws and regulations with regard to environmental matters including, but not limited to:

We expect there will be changes to existing environmental laws and regulations that could significantly impact the manner in which our operations are currently conducted. Such laws and regulations may also affect the timing, cost, location, design, construction and operation of new facilities. Due to evolving environmental regulations, it is difficult to project future costs of compliance and their impact on competition. Capital costs of complying with known pollution control requirements are included in our estimate of construction expenditures in Item 7. MD&A—Capital Requirements. The costs of compliance associated with any new requirements that may be imposed by future regulations are not known, but may be material.

For additional information related to environmental matters, including proceedings not discussed below, as well as anticipated expenditures for installation of pollution control equipment, hazardous substance liabilities and fuel and waste disposal costs, see Item 1A. Risk Factors, Item 3. Legal Proceedings and Item 8. Financial Statements and Supplementary Data— Note 13. Commitments and Contingent Liabilities .

Air Pollution Control

Our facilities are subject to federal regulation under the Clean Air Act (CAA) that requires controls of emissions from sources of air pollution and imposes recordkeeping, reporting and permit requirements. Our facilities are also subject to requirements established under state and local air pollution laws. The CAA requires all major sources, such as our generation facilities, to obtain and keep current an operating permit. The costs of compliance associated with any new requirements that may be imposed and included in these permits in the future could be material and are not included in our estimates of capital expenditures.

Hazardous Air Pollutants Regulation —In February 2012 , the Environmental Protection Agency (EPA) published Mercury Air Toxics Standards (MATS) for both newly-built and existing electric generating sources under the National Emission Standard for Hazardous Air Pollutants (NESHAP) provisions of the CAA. The MATS established allowable levels for mercury as well as other hazardous air pollutants and went into effect in April 2015. In June 2015, the U.S. Supreme Court held that it was unreasonable for the EPA to refuse to consider the materiality of costs in determining whether to regulate hazardous air pollutants from power plants. In April 2016, the EPA released the final Supplemental Finding that considers the materiality of costs in determining whether to regulate hazardous air pollutants from power plants in response to the U.S. Supreme Court’s ruling. Industry participants and various state authorities have filed petitions with the D.C. Circuit challenging the EPA’s Supplemental Finding. The D.C. Circuit is holding the case in abeyance pending further directions from the EPA. We do not expect this Supplemental Finding to impact operation of our facilities.

Climate Change

CO ₂ Regulation under the CAA —In October 2015, the EPA published the New Source Performance Standards (NSPS) for new power plants. The NSPS establishes two emission standards for CO ₂ for the following categories: (i) fossil fuel-fired utility boilers and integrated gasification combined cycle units, and (ii) natural gas combustion turbines. Simple cycle combustion turbines are exempt from the rule.

In October 2015, the EPA also published the Clean Power Plan (CPP), a greenhouse gas (GHG) emissions regulation under the CAA for existing power plants. The regulation establishes state-specific emission rate targets based on implementation of the best system of emission reduction (BSER). The BSER consists of three components: (i) heat rate improvements at existing coal-fired power plants, (ii) increased use of existing natural gas combined cycle capacity, and (iii) operation of incremental zero-emitting generation (renewables and nuclear). States may choose these or other methodologies to achieve the necessary reductions of CO ₂ emissions.

Numerous states and several industry groups filed petitions for review with the D.C. Court to challenge the CPP. In addition, the petitioners sought a stay of the rule. The U.S. Supreme Court stayed the rule pending further review of the case.

In March 2017, the President of the United States issued an Executive Order that instructed the EPA to review the NSPS that establish emissions standards for CO ₂ for certain new fossil power plants and the CPP. The D.C. Circuit granted the EPA’s motion to hold the case in abeyance while the agency reviewed the rule. Upon completion of the review, the EPA Administrator signed a proposed repeal of the CPP. The EPA Administrator concluded that the CPP exceeds the EPA’s statutory authority by considering measures that are beyond the control of the owners of the affected sources (fossil fuel-fired electric generating units). The EPA is considering rulemaking to replace the CPP. PSEG cannot assess the impact of any such rulemaking on our business and future results of operations at this time.

Regional Greenhouse Gas Initiative (RGGI) —In response to concerns over global climate change, some states have developed initiatives to stimulate national climate legislation through CO ₂ emission reductions in the electric power industry. Certain northeastern states (RGGI States), including New York and Connecticut where we have generation facilities, have state-specific rules in place to enable the RGGI regulatory mandate in each state to cap and reduce CO ₂ emissions. These rules make allowances available through a regional auction whereby generators may acquire allowances that are each equal to one ton of CO ₂ emissions. Generators are required to submit an allowance for each ton emitted over a three-year period. Allowances are available through the auction or through secondary markets.

In September 2017, the RGGI States announced their new post-2020 program for a cap on regional CO ₂ emissions, which would require a decline in CO ₂ emissions in 2021 and each year thereafter, resulting in a 30% reduction in the CO ₂ emissions cap by 2030.

New Jersey adopted the Global Warming Response Act in 2007, which calls for stabilizing its GHG emissions to 1990 levels by 2020, followed by a further reduction of greenhouse emissions to 80% below 2006 levels by 2050. To reach this goal, the New Jersey Department of Environmental Protection (NJDEP), the BPU, other state agencies and stakeholders are required to evaluate methods to meet and exceed the emission reduction targets, taking into account their economic benefits and costs. In January 2018, New Jersey Governor Murphy signed an Executive Order requiring the NJDEP to initiate the rulemaking process for New Jersey to reenter RGGI. We cannot estimate the impact of this action on our business or results of operations at this time.

Water Pollution Control

The Federal Water Pollution Control Act (FWPCA) prohibits the discharge of pollutants to U.S. waters from point sources, except pursuant to a National Pollutant Discharge Elimination System (NPDES) permit issued by the EPA or by a state under a federally authorized state program. The FWPCA authorizes the imposition of technology-based and water quality-based effluent limits to regulate the discharge of pollutants into surface waters and ground waters. The EPA has delegated authority to a number of state agencies, including those in New Jersey, New York and Connecticut, to administer the NPDES program through state action. We also have ownership interests in facilities in other jurisdictions that have their own laws and implement regulations to control discharges to their surface waters and ground waters that directly govern our facilities in those jurisdictions.

Steam Electric Effluent Guidelines —In September 2015, the EPA issued a new Effluent Limitation Guidelines Rule (ELG Rule) for steam electric generating units. The rule establishes new best available technology economically achievable (BAT) standards for fly ash transport water, bottom ash transport water, flue gas desulfurization and flue gas mercury control wastewater, and gasification wastewater. Power’s Bridgeport Harbor station and the jointly-owned Keystone and Conemaugh stations have bottom ash transport water discharges that are regulated under the ELG Rule. Keystone and Conemaugh also have flue gas desulfurization wastewaters regulated by the ELG Rule.

Through various orders, the EPA has stayed the compliance dates in the ELG Rule and has announced plans to further revise the requirements and compliance dates of the ELG Rule. Power is unable to determine how this will ultimately impact its compliance requirements or its financial condition and results of operations.

Cooling Water Intake Structure Regulation —In May 2014, the EPA issued a final cooling water intake rule under Section 316(b) of the Clean Water Act (CWA) that establishes requirements for the regulation of cooling water intakes at existing power plants and industrial facilities with a design flow of more than two million gallons of water per day. 

The EPA has structured the rule so that each state Permitting Director will continue to consider renewal permits for existing power facilities on a case by case basis, based on studies related to impingement mortality and entrainment and submit the results with their permit applications to be conducted by the facilities seeking renewal permits.

Several environmental organizations and certain energy industry groups have filed suit under the CWA and the Endangered Species Act. The cases have been consolidated at the Second Circuit and a decision remains pending.

We are assessing the potential impact of the rule on each of our affected facilities and are unable to predict the outcome of permitting decisions and the effect, if any, that they may have on our future capital requirements, financial condition or results of operations, although such impacts could be material. See Item 8. Financial Statements and Supplementary Data— Note 13. Commitments and Contingent Liabilities for additional information.  

In June 2016, the NJDEP issued the final New Jersey Pollutant Discharge Elimination System (NJPDES) permit for Salem. The final permit does not mandate specific service water system modifications but, consistent with Section 316(b) of the CWA, it requires additional studies and the selection of technology to address impingement for the service water system. In July 2016, the Delaware Riverkeeper Network (Riverkeeper) filed a request challenging the NJDEP’s issuance of the final NJPDES renewal permit for Salem. NJDEP has granted the hearing request, but it has not yet been scheduled. The Riverkeeper’s filing does not change the effective date of the permit. For additional information, see Item 8. Financial Statements and Supplementary Data— Note 13. Commitments and Contingent Liabilities .

A permit application for renewal of the current NPDES permit for the Bridgeport Harbor Station Unit 3 (BH3) is under review by the Connecticut Department of Energy and Environmental Protection (CTDEEP). To address compliance with the EPA’s CWA Section 316(b) final rule, we have proposed to continue to operate BH3 without making the capital expenditures for modification to the existing intake structure and retire the BH3 within five years of the effective date of the final permit. Based on discussions with the CTDEEP, if the proposal is accepted, a final NPDES permit could be issued with a retirement date for BH3 by summer 2021, which is four years earlier than the previously estimated useful life ending in 2025. If the permit is not issued and the conditions below are not met, we may seek to operate BH3 through the previously estimated useful life.

We have negotiated a Community Environmental Benefit Agreement (CEBA) with the City of Bridgeport, Connecticut. That CEBA provides that we would retire BH3 early if all of its conditions precedent occur, which include receipt of all final permits to build and operate a proposed new combined cycle generating facility on the same site that BH3 currently operates. Absent those conditions being met, and the permit renewal referred to above not being issued, we may seek to operate BH3 through the previously estimated useful life. See Item 8. Financial Statements and Supplementary Data— Note 3. Early Plant Retirements .

In February 2016, the proposed generating facility, Bridgeport Harbor Station Unit 5 (BH5), was awarded a capacity obligation. Construction has commenced and operations are expected to begin in mid-2019. The Connecticut Siting Council issued an order to approve siting BH5. All major environmental permits have been obtained except for the modified Title V air permit.

Bridgeport Harbor National Pollutant Discharge Elimination System (NPDES) Permit Compliance —In April 2015, we determined that monitoring and reporting practices related to certain permitted wastewater discharges at our Bridgeport Harbor station may have violated conditions of the station’s NPDES permit and applicable regulations and could subject us to fines and penalties. We have notified the CTDEEP of the issues and have taken actions to investigate and resolve the potential non-compliance. We cannot predict the impact of this matter.

Hazardous Substance Liability

The production and delivery of electricity and the distribution and manufacture of gas result in various by-products and substances classified by federal and state regulations as hazardous. These regulations may impose liability for damages to the environment from hazardous substances, including obligations to conduct environmental remediation of discharged hazardous substances as well as monetary payments, regardless of the absence of fault and the absence of any prohibitions against the activity when it occurred, as compensation for injuries to natural resources. See Item 3. Legal Proceedings. Our historic operations and the operations of hundreds of other companies along the Passaic and Hackensack Rivers are alleged by federal and state agencies to have discharged substantial contamination into the Passaic River/Newark Bay Complex. The EPA is also evaluating the Hackensack River, a tributary to Newark Bay, for inclusion in the Superfund program. We no longer manufacture gas. For additional information, see Item 8. Financial Statements and Supplementary Data— Note 13. Commitments and Contingent Liabilities .

Site Remediation —The Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA) and the New Jersey Spill Compensation and Control Act (Spill Act) require the remediation of discharged hazardous substances and authorize the EPA, the NJDEP and private parties to commence lawsuits to compel clean-ups or reimbursement for such remediation. The clean-ups can be more complicated and costly when the hazardous substances are in a body of water.

Natural Resource Damages —CERCLA and the Spill Act authorize the assessment of damages against persons who have discharged a hazardous substance, causing an injury to natural resources. Pursuant to the Spill Act, the NJDEP requires persons conducting remediation to address injuries to natural resources through restoration or damages. The NJDEP adopted regulations concerning site investigation and remediation that require an ecological evaluation of potential damages to natural resources in connection with an environmental investigation of contaminated sites.

Fuel and Waste Disposal

Nuclear Fuel Disposal —The federal government has entered into contracts with the operators of nuclear power plants for transportation and ultimate disposal of spent nuclear fuel. Under the Nuclear Waste Policy Act of 1982 (NWPA), nuclear plant owners are required to contribute to a Nuclear Waste Fund to pay for this service. Since May 2014, the DOE reduced the nuclear waste fee to zero. No assurances can be given that this fee will not be increased in the future. The NWPA allows spent nuclear fuel generated in any reactor to be stored in reactor facility storage pools or in Independent Spent Fuel Storage Installations located at reactors or away from reactor sites.

We have on-site storage facilities that are expected to satisfy the storage needs of Salem 1, Salem 2, Hope Creek, Peach Bottom 2 and Peach Bottom 3 through the end of their operating licenses. 

Low Level Radioactive Waste —As a by-product of their operations, nuclear generation units produce low level radioactive waste. Such waste includes paper, plastics, protective clothing, water purification materials and other materials. These waste materials are accumulated on site and disposed of at licensed permanent disposal facilities. New Jersey, Connecticut and South Carolina have formed the Atlantic Compact, which gives New Jersey nuclear generators continued access to the Barnwell waste disposal facility which is owned by South Carolina. We believe that the Atlantic Compact will provide for adequate low level radioactive waste disposal for Salem and Hope Creek through the end of their current licenses including full decommissioning, although no assurances can be given. Low Level Radioactive Waste is periodically being shipped to the Barnwell site from Salem and Hope Creek. Additionally, there are on-site storage facilities for Salem, Hope Creek and Peach Bottom, which we believe have the capacity for at least five years of temporary storage for each facility.

SEGMENT INFORMATION

Financial information with respect to our business segments is set forth in Item 8. Financial Statements and Supplementary Data— Note 23. Financial Information by Business Segment .