December 1997

Sphinx Redux Dangers

by Roger Feldman  --   Bingham, Dana and Gould, P.C.
(originally published by PMA OnLine Magazine: 04/98)

A good vantage point for private power is to understand its opportunity profile is to consider the "negative space" implications of the two fundamental utility strategies which are unfolding in response to deregulation: (1) divestiture of the generation with which they have served their traditional franchise territory; and (2) off set of divestiture revenue losses through new acquisitions of assets in other locations and power marketing sales backstopped by those acquisitions. Clearly the former strategy leaves private power with more running room than the latter.

With respect to the first strategy, there remains healthy skepticism among a large number of utility executives as to the long term competitive viability of utilities as pure T&D companies. The rating agencies have begun to express fear that, in effect, self (or regulatory commission) -inflicted "adverse selection" is at work in current divestitures by utilities, i.e. that utilities will be left holding the least market competitive generating assets in their service territories, i.e. nuclear plants and non-repowerable facilities, and not necessarily recovering their value through stranded cost payments. Even more fundamentally, analysts have begun to question the validity of the characterization of the remaining "rump" T&D utilities as scaled down but still stable revenue versions of their larger vertically integrated, aggregated selves. Key factors of concern are regulatory pressure to provide lower distribution rates (without regard to cost), partly in reflection of traditional ratepayer oriented regulation policies, e.g. lifeline rates, disconnect policies partly as a result of subjection to performance-based ratemaking unrelated to actual operating circumstances. In effect, rump utilities left holding the bag for a customer base of uncertain size (due to retail access); high cost (due to reduced overhead spreading and possible non-compensation for the full cost of purchased power. In addition, T&D companies may be pressed into service to collect the stranded cost charges which they seek to securitize to offset the loss of stranded generation, and thereby pressed into an unwelcome visibility when they deliver their bills, which could impair their efforts to enter "brand name" competition for power marketing.

As a general matter, of course, the private power industry has been pleased to allow the utilities to fantasize themselves into comfort with this impending situation: to proclaim "freedom" from the tie to the old machines; pleasure with the planning out of market forces; preference for increasingly dicey overseas investments; humble though secure comfort with regulated returns. They have gone further fighting to assure disaggregated abstinence by barring utility energy service and power marketers "branding" in their old service territories as an unfair competitive development.

But it should not become too smug too soon and be diverted by (quiet) derision of the penitent from taking cautious note of their shrewd brethren, who are hastening to substitute a better new capacity mix suitable for generation competition (in other service territories if not their own) for that generation which they are being forced to divest. The names of the large competing utilities may change even though the economic clout does not. The canaries in this particular coal mine of potential competition by disaggregated utilities are the major power marketers, who have been taking note of the failure of FERC to adequately assure that transmission system reform under Order 888 is being implemented in a manner supportive of level playing field competition. Among the issues which the power marketers are surfacing are several indicative of residual strength of the strategy of several leading utilities seeking to arise sphinx-like from the ashes of compulsory divestiture by following the alternative strategy mentioned above: attaching new power heads to old T&D rumps. The issues raised by power marketers center on transmission issues which have not been resolved fully. These include the following: - The ability of vertically integrated utilities to arrange for their transmission arms to acquire T&D for captive customers and thereby gain insulate themselves through state (rather than Federal) regulation of transmission service, from potential competition. - The ability of vertically integrated utilities to obtain transmission capacity outside of OASIS operations. - The ability of utilities to use their rights to serve native load under Order 888 as a basis to, in effect, hoard capacity. - The potential adverse impact on non-utility suppliers of NERC tagging.

The upshot should be clear for private power: it should not assume (1) that utilities will go quietly into the generation night, or (2) that apparent utility strategist’s acceptance of the FERC "new look" will, by itself, result in market reshaping on a truly competitive basis. Even with regional ISOs, there still can be market skews favorable to utilities and adverse to themselves. In short, for private power to have long term success, rump redux will not do.

Beware the re-emerging sphinxes.

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.