January 1998
THE SECURITIZATION DANCE HALL TANGO

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

As we roll into the 1998 Congressional election year, eyes will be turned, of course, to whether Federal legislation of retail electric access will be enacted. While the need and the likelihood of mandatory legislation are a function of many factors, it is increasingly clear that politically its future - and also the potential value of the legislation - will arise from the permitted monetization of utility stranded costs whether through "securitization" (which may involve issuance of "rate reduction" bonds).

Several interesting factors lead to this conclusion. First, the DOE Energy Information Agency (EIA) has raised the reality of deregulatory economics into bold relief raising it above the level of populist rhetoric. In its catchily named study, "Electricity Prices in a Competitive Environment: Marginal Cost Pricing of Generation Services of Financial Status of Electric Utilities: A Preliminary Analysis through 2015, EIA notes that while competition will likely lower electricity prices in most areas of the United States for end use consumers, many of the short term savings will be offset if State authorities mandate recovery of stranded costs. Indeed, with 100% recovery, competitive prices would differ little from where regulated prices would be! (Of course, commercial and industrial classes of consumers would do much better.) Other securitization critics have articulated this conclusion more violently: "Like trying to craft fine furniture with a chain saw" asserted an NRRI economist; a "utility bailout" declaimed an Illinois commissioner.

Second, the issue is not one of merely academic debate: a mere trailing rain cloud after the thunderhead of deregulation/retail access has passed by. In each of the bi-coastal State leaders in deregulation, Massachusetts and California, consumer groups have filed ballot initiatives to roll back what has already been passed. A coalition of California consumer groups have filed a ballot initiative to roll back electric rates by 20% and prohibit utilities from passing on the "bailout" costs of nuclear power plants to consumers. If this latest assertion of California citizen democracy makes it to the ballot, issuance of future "securitization" bonds authorized by the California legislation would be jeopardized. In Massachusetts, repeal of deregulation legislation is being sought, and Ralph Nader has signed on to the effort to stop the "hidden tax" of securitization and thereby to cover estimated unrecovered $10 billion in stranded costs - after powerplant divestiture.

Third and fourth, competitive notes sharpen the equities of the issue. In both California and Massachusetts the utility assets sales to date have been at hefty premiums; the nuclear plants, of course, have not been sold. The issue nevertheless remains one with vitality. Perhaps this is partly because, as NRRI’s research highlights, while the extent of actual utility stranded costs are extremely downwardly sensitive to market power price increases, the amount of bonds issued to securitize stranded costs - and benefiting utilities - is not. "A mismatch between the benefits of securitization and its uses" intones NRRI. What they are saying is that in the utility/consumer coin flip: it is heads utilities win, tails consumers lose.

In addition, Securitization which obviously props up home state utilities in the midst of deregulation, is a spoke in the wheel of competition to out-of-staters. Or, as they have framed the issue: it will allow California utilities an unfair advantage since they will be able to go virtually debt free into the deregulated era. "This is an out-of-state energy company vs. California energy companies" issue opines a pro-utility California state legislation opposing the ballot initiative. In sum, securitization has given deregulated retail access on interclass and inter-state energy supplier disputational character.

Where does that tactically leave private power? Its conceptual model for Federal legislative change has been a sophisticated one: interstate competitive pressures forcing states to act themselves, and Federal legislation to provide national cohesion on issues demanding federal action, such as reciprocity, grandfathering, and state authority to order retail wheeling and transmission issues. This so-called "tango strategy" contemplates of the Federal and State dancers "answering" each other more successive (and presumably more deregulatory progressive) moves.

But there is a wet spot on the dance floor: a problem with the private power approach. It overlooks the spin which stranded cost recovery may give both to the nature of State deregulation and the role which Federal consistency legislation must play. The four anti-securitization factors summarized above may prevent the dancers from reaching desired synchronization.

There may be an element of wishful thinking in this myopia: private power is seeking the same securitization benefits as are IOUs. If IOUs lose, so does private power, on its QF contracts which are priced above, what it is expected the market will bear. Strand IOUs; strand IPPs as well.

Definitely a conundrum for a business class which started life with the sympathies of the Naderites and now must look for succor to the rating agencies. More significantly, it could be that IOU securitization initiatives will prove a roadblock on the much sought after superhighway to deregulation if opposition to stranded cost recovery grows too strong. Ability to compete early and often by private power in deregulating states could be impaired. The elegant private power tango could turn into a chicken dance . . .

As private power enters the new year then, reconsideration of the industry’s posture on the need for Federal legislation and the form it should appropriately take - particularly, as it relates to securitization - has some merit.

This is one tango with so many players it’s really a line dance (and possibly a dirty one as well). It takes more than two to securitize.

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.