January 2005

New Year Bon MOTS

by Roger Feldman  --   Bingham, Dana L.L.P.
(originally published by PMA OnLine Magazine: 2005/01/26)
 

What’s the good word (the “bon mot”, now that France again is no longer our enemy). As the New Year opens, the power industry is confronted with three basic trends which while susceptible of harmonization by a strong and wise regulatory body and an enlightened capital market, are more likely to result in what at least one think tank (mine) refers to as More of the Same (“MOTS”). Each is enlivened by bon mot.

MOT 1 Where better to start than with an organization whose good name alone makes fervid flacks blush, the “Progress and Freedom Foundation (“PFF”). PFF is gunning for Pat Wood a harbinger to what we may expect to be a plethora of attacks on the RTOs and of deregulatory models designed to promote open access and the possibility of competition. PFF goes all the way back and attacks Order 2000 and the subsequent flawed FERC effort to establish coherence among reliability regions through SMD as the cause for the absence of incentives for needed transmission development. In fact, for PFF, this absence of investment capital for transmission is the proof of FERC’s failure to support the demands of a new competitive market.

Well – it is probably true that Pat Wood, who declared last year that the battle over RTO’s is over, (but wasn’t exactly clear which way), will be leaving Washington. And it is also true that the recent comments on FERC’s Notice of Inquiry on RTO Accounting have focused a spotlight on the possibility that RTO’s have become a costly part of the transmission cost problem, in all but the tightest power pools. In those comments, utilities blasting the impact of ISO costs to ratepayers were joined by no less a strange bedfollow than the APPA. The bill for RTO’s has been high; the perceived benefits to consumers has been low; the enthusiasm for the new is old; the power of the entrenched is high. However, there is a hollow sound beneath this pounding on the fragile RTO carapace; no one has suggested how the shortfalls in transmission investment will be met old model alternative. Certainly it is not apparent that renewed interest in wholesale trading among large utilities is likely to have that effect. Which leads to . . .

MOT 2 Nevertheless, with increasing verve, against a thunderous leitmotif of “I told you so”, the battle cry of “Back to Basics” is heard in the electricity Board rooms of the Land. To the probable joy of those consultants who have wrung out the last possible permutations and shaken out the acronym bag of deregulation, the notion has now been reintroduced that utilities should be about, (pause for drum roll), performing service better, cutting costs and servicing shareholders, all under the old style regulatory scheme. Unfortunately, utilities are public-regulated companies and what may be a sure fire slogan for whole grain bread sales is now coming to be questioned out there as the moral fiber equivalent of shrinking to greatness. Wall Street wants action; so do dynamic utility executives. All of which means that the “Back to Basics” slogan will actually mean - now more than ever - an emphasis on consolidation, size, creation of economics of scale, and renewed interest in classical vertical integration. MOT 2 therefore is really a soubriquet for “Support Your Local Mega Merger” (a la Exelon and PSE&G), unless it runs into that hoary of Back to Basics - which is “Back to State Regulation”. Return with us now to the days of rate cases, intervenors, prudency and the possibility that along with the incredible shrinking FERC will come a resurgence of State activism as State Commissioners come to see themselves as Spitzers at the Gate of market dominance. With some glee, consultants now visualize the possibility that in this new climate, previously settled rate case tenets like permissible levels of capital structures, forecasting methodologies and cost allocations may be revisited with fresh (unfamiliar) eyes. Making money with or without making mergers may be harder than some utilities expect. In addition, making holding company leveraged mergers of the type the Unisource acquisition was thought to be, may find more State impedance than was originally looked for. Who remembers the days when concern with something called “regulatory certainty” was the byword of the electric industry. Well, what goes around comes around. The creaking sound beneath the wholesome utility management comeback is the beams of efforts to prevent principles of prevention of market dominance from giving way. The high pitched whine is the entry of new types of traders.

MOT 3  Which brings us to one possible market reaction for which we should be on the alert: “Hedge your bets, sell now”. The chaos of the last few years has wreaked havoc with the ownership of IPPs, brought a new speculative private capital element into both private equity ownership, hedge fund involvement with transient situations, and broader utilization of short term speculative B Loan financing debt. In short, an influx of Movers who are not concerned to be shakers of the status quo, and have even begun to take positions as owners of full scale utilities. Power traders are emerging to create PPAs which make their deals possible. On the one hand, you may say very exciting: certain to add ginger to the “basics” in that rising power dough being baked in the name of “Back to Basics.” However, just as the fuel price at the margin drives power prices; so the market for utilities (and power plants) will be driven by what those who are not in it for the long pull, just betting on the market cycle will do. Will the tectonic plates of utility consolidation and speculative asset divestitures converge into some type of tsunami of deals, without reference directly to actual system operations, a stable regulatory environment and new transmission grid support? Or will the logic of trading desks perversely affect new capital flow into the industry. For example, as one monitor of the trading desk environment has observed: “I would expect that any investment bank or hedge fund currently invested in assets would include a risk premium on expected returns (in new assets) to account for negative impacts in their current investments.” In other words, new capital flows into the market will be sensitive to the impacts of such new capital flows on existing investments. Which could mean a kind of pregnant pause in needed utility market investment while the current investment cobra digests its most recent dinner, and simply is disinterested in fresh asset investment.

So the three bon MOTS of the hour could be:

• Disappearing grid integration impetus;
   
• Consolidating utilities and renewed regulation at the State level;
   
• Dampered new capital flows and synthetic new PPAs.

The three bon mots (progress and freedom; back to basics; hedge your risks”) could turn out to be as wise as three blind mice. It is with interest we await to see how the policies of the new wisdom will impact these intractable realities. Maybe, in the recent great tradition of progress and freedom, the proponents will simply declare (and perhaps from their own personal standpoint believe) that, in another bon MOT of the day: “Mission Accomplished.”

ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon Markets Group has practiced law related to the finance of environmental and energy projects and companies for 40 years.  In particular, he has analyzed and executed a wide variety and substantial value of project financings.  He chairs the American Bar Association’s Committee on Carbon Trading and Finance, serves on the Board of the American Council for Renewable Energy, and has been a senior official in the Federal Energy Administration.  He is a graduate of Brown University, Yale Law School and Harvard Business School.