Power plant acquisitions worry regulators, free-market proponents

Feb 02, 2004 - Greenwire

A growing number of electric power utilities are buying up unaffiliated power plants and so-called merchant generators to provide additional generation to their rate-base customers, a move that industry insiders fear could undermine progress toward further wholesale power market competition.

Over the past year, companies ranging from Cinergy, Entergy and Southern Co., to Southern California Edison, Ameren, Oklahoma Gas & Electric and Florida Power & Light either have added, or proposed to add, generation to their rate bases through new construction, financial deals with unregulated affiliates, or outright purchases of plants from unregulated or financially strapped merchant generators.

Federal regulators and advocates of electric power competition say the deals signal an unwelcome return to cost-of-service regulation, because the costs associated with large plant acquisitions and new construction projects will be covered by ratepayers, thus removing the efficiencies of market competition.

"As the wholesale regulator, I will admit some concern about the acquisition of temporarily distressed generation assets by the local utilities that would otherwise be buying under a long-term contract," said FERC Chairman Pat Wood in a conference call with Wall Street analysts last week.

"They take players out of the competitive market and the wholesale market, and make that market thereby thinner and weaker as a consequence," said Wood, according to a transcript of the conference call.

But from the perspective of electric utilities and state agencies that oversee them, the deals are sound because the facilities are shifting from financially strapped generating companies to well-established power providers at bargain prices. The deals also provide utilities and their retail customers with necessary resources to maintain reliability.

David Owens, executive vice president for business operations at the Edison Electric Institute, said the situation reflects anxiety among regulators and the industry that the wholesale electric power marketplace has not worked.

"One of the fundamental tenets of competition is to have adequate resources," said Owens, whose organization represents investor-owned utilities. "The state commissions have to have some assurance that [utilities] have enough supply to meet demand. They can't play Russian roulette. They need to keep the lights on. They waited for the market to work, but to some degree it hasn't."

Owens further argued that the utilities are helping the market by keeping unprofitable merchant generation plants up and running. Otherwise, he said, cash-strapped merchant owners might have to shutter their operations, essentially removing electricity from the grid when demand continues to increase.

Meanwhile, analysts acknowledge that the trend is likely to continue because in the wake of the industry's financial problems, credit rating agencies are inclined to look more favorably upon a utility's rate-based assets rather than third-party power purchases for what is essentially the same electricity.

Christine Tezak of Schwab SoundView Washington Research said the issue is clouded by a fear that independent power providers will be left with few, if any, real assets. That very problem contributed to the financial undoing of Enron Corp. and other power marketers in 2001.

Now, Tezak said, asset ownership is viewed by creditors as a financial necessity. Tezak said the thinking is, "If you treat a long-term power purchase agreement as a 40-year asset, why not just have the 40-year asset?"

And that is something that FERC cannot change overnight. "It's going to take time," she said.

Symptoms of attitudes in a depressed market Observers say the situation is symptomatic of the industry's increasingly ambiguous attitude toward FERC's march toward competition in the wake of the Enron bankruptcy, a process fueled by the recent economic recession and high natural gas prices. Those three factors combined to depress the competitive power market in recent years, analysts say.

Regardless of the damage done by the Enron scandal to power market trading, one utility industry lawyer said the Houston-based trading giant did provide a counteroffensive to large, investor-owned utilities that initially resisted market competition.

"Enron always did more than its share of trying to push the [competitive] agenda," the lawyer said. "And right now, the people who are left don't have the resources, and they don't necessarily have anybody who's willing, or able, to take a leadership role. They're all trying to bail out their own boat. It's a good time for [the utilities] to go on the offensive."

Plants going into the rate base Among the more recent power plant transactions include a mid-January announcement by Florida Power & Light that after three months of evaluating outside offers to provide power to its service territory, the company will add a 1,100 megawatt natural gas-fired plant to its Turkey Point generating station site 25 miles south of Miami.

In another deal, the corporate parent of Southern California Edison is seeking federal approval of a plan to acquire the 1,054-megawatt Mountainview natural gas power plant. The transaction, which has been approved by state regulators, would allow the Mountainview facility to become an unregulated affiliate providing power to Edison at cost-based rates for 30 years. State regulators have said the company must shift the plant's output to rate base power once the California Legislature finalizes rules for re-regulation of the state's power market.

Edison structured the deal so that FERC would have authority over the rates charged for the electricity instead of the California Public Utilities Commission. State regulators throughout the country, and particularly in California, have in the past struck down utilities' retail power rates even after the rate structure had been in place for some time, creating financial confusion for the utilities.

"We wanted to work under rules that won't let [the state regulators] change their minds," said Les Starck, director of federal regulatory and legislative affairs for Edison.

The deal allows Edison to secure long-term power arrangements without risking its capital in the open market, when the company already is committed to spending $11 billion over the next 10 years of transmission and distribution improvements, Starck said.

Helping or harming competition? Meanwhile, Oklahoma Gas & Electric has received state approval to buy bankrupt NRG Energy's McClain power plant, located within its service territory, to serve its retail customers. FERC, however, has ordered a hearing on the matter out of concern the deal could harm wholesale competition in the region.

Utilities and the Edison Electric Institute are fighting the FERC decision, which was issued in December. In a protest filed with the commission last month, EEI asserted that FERC relied on flawed criteria to determine if the acquisition would give OG&E market dominance because it failed to take into account that the plant's output would be combined with existing resources to satisfy growing native load demand. Oklahoma has not deregulated its retail electric markets.

EEI's argument is that as a regulated utility, OG&E must meet its customers' power needs. Oklahoma regulators had ordered the utility to acquire 400 megawatts to meet retail customers' growing needs, and FERC's use of a test that ignores the utilities' obligations to their regulated retail customers "is improperly biased against vertically integrated electric utilities and also fails to give proper deference to state commission authority."

EEI's Owens added that prohibiting utilities from buying those plants actually will harm, not help, competition. "Certainly the merchant generation model has failed," Owens said. "A lot of merchants are going bankrupt. Unfortunately the vitality of their market isn't there."

Yet officials familiar with the merchant power industry have a different view.

"This is from the industry that brought you how many billions is stranded costs?" noted Julie Simon, vice president of policy for the Electric Power Supply Association, which represents merchant power generators, referring to the valuation of the uneconomic power plants that utilities either wrote off or had ratepayers cover when competition started.

"There is no question whether competition works," Simon said. "The question is whether it will be allowed to work."

A merchant power industry analyst called wholesale power competition "the only attributable element to the fact that there has been consistent, downward pressure on wholesale prices" since Congress passed the Energy Policy Act of 1992. That law opened the wholesale power market to competition.

"The wholesale market for electricity is a vibrant place where trade happens on a daily basis, and it no longer can be otherwise," the analyst said.

Particularly troubling, the analyst added, is that the utilities sometimes will reach the power plant buy-or-build decision without acknowledging that there are many generators out there that could provide the power at market rates that would cost less than what the utility is paying.

"This is another divide between FERC's attempt to create a competitive wholesale generation market and [state regulators'] fears of losing control over any aspects of the structures that are presumably under their jurisdictions," the analyst said.

"Utilities are incapable of building new plants and that stay within budgets and costs," the analyst added. "They always had cost overruns, and it was their ratepayers who had to work out and pay for that inefficiency. There is not a single case of a utility being able to build a plant cheaper and faster than the [independent power] market."

But EEI's Owens said that during meetings with Wall Street analysts last week, he learned that the issue of keeping utilities from buying generators "is foremost on the minds of everyone we met with."

"The financial industry is most concerned about the viability of these assets," Owens said. "They, I believe, look at [the OG&E decision] as limiting potential purchasers of those merchant facilities. My understanding of economics would say that if you limit the potential purchasers, you limit the market. And for them, this portends some outcomes that they find would be very troublesome in developing a vibrant market."

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